ARMSTRONG FLOORING, INC. The following discussion supplements and should be read in conjunction with the accompanying unaudited condensed consolidated financial statements as well as the audited consolidated financial statements of the Company, including the notes thereto, included in the Company's Annual Report on Form 10-K for the fiscal year endedDecember 31, 2020 , which includes additional information about the Company's critical accounting policies, contractual obligations, and transactions that support the financial results and provides a more comprehensive summary of the Company's outlooks, trends and strategies for 2021 and beyond. Executive Overview We are a leading global producer of flooring products for use primarily in the construction and renovation of commercial, residential and institutional buildings. We design, manufacture, source and sell resilient flooring products primarily inNorth America and thePacific Rim . As ofSeptember 30, 2021 , we operated seven manufacturing plants in three countries, including five manufacturing plants located throughout theU.S. (Illinois ,Mississippi ,Oklahoma and two inPennsylvania ) and one plant each inChina andAustralia . During early 2020, we established a multi-year strategic roadmap to transform and modernize our operations to become a leaner, faster-growing and more profitable business. The transformation encompasses three critical objectives: (i) expanding customer reach; (ii) simplifying product offerings and operations; and (iii) strengthening core capabilities. In addition, we have implemented a new operating model to more effectively accomplish these objectives by: (i) placing customers first by aligning services and products through a more seamless value chain; (ii) leading the industry in product innovation; (iii) simplifying processes and operating complexity to become more competitive and efficient; (iv) realigning the go-to-market model to reach all relevant channels and customers; (v) implementing system changes to improve operations, reduce costs and reignite organic growth; and (vi) investing thoughtfully with a return-focused mindset. The goal of this focused strategy is to transform and modernize AFI, resulting in a company that is more agile, faster-growing and more profitable. Building on the positive momentum and achievements from the prior year, during 2021 we have (i) completed the phased relocation of our new corporate headquarters and Technical Center including a first-of-its-kind design center to showcase our full capabilities, with expected cost savings of approximately 60% when fully annualized; (ii) launched several new key products including additions to the American Charm collection and the introduction of NexProTM, NexproTM XMB, and Rest & RefugeTM; (iii) commenced shipments from the Company's new fully operational west coast distribution center; (iv) continued to execute on our multichannel go-to-market strategy including expanded rebranding initiatives and the launch of the new distributor-driven Armstrong® Flooring SignatureTM brand and the Armstrong® Flooring ProTM brand that is focused on the builder and multi-family channels; (v) continued initiatives aimed at improving manufacturing efficiency and customer experiences; (vi) continued to make investments in both talent and process improvements; (vii) we made our initial sales to the hospitality channel; and (viii) received numerous product and project awards which recognize our commitment to quality and innovation. Despite this positive momentum, the Company's transformation has been delayed and impacted by supply chain issues and inflationary pressures related to transportation, labor and raw materials. We have instituted multiple prices increases during 2021, the realization of which have lagged the increased input costs and have not been adequate to cover inflationary pressures. Accordingly, effectiveNovember 1, 2021 , the Company instituted an additional price increase, resulting in a complete price re-positioning on installation materials, commercial tile and select residential sheet and commercial/residential manufactured and sourced products, representing some of the most comprehensive pricing actions that the Company has taken to date. In addition, the Company is implementing an ocean freight surcharge. The Company expects these and other actions to begin to mitigate the impact of the inflationary pressures that have impacted current year operating results and to generate more positive momentum in margins heading into 2022. The Company will continue to monitor the larger macro-economic environment and will further adjust its pricing strategy as necessary. OnMarch 10, 2021 we completed the sale of our South Gate Facility for a total purchase price of$76.7 million . The Company received proceeds of$65.3 million , net of fees, expenses and certain amounts held in an environmental-related escrow account. The Company recognized a gain of$46.0 million on the sale. Concurrent with the sale, the Company paid$20.4 million toPathlight Capital L.P. , including a$20.0 million mandatory repayment of our Term Loan Facility and$0.4 million of prepayment premium fees. Additionally, upon completion of the sale, the temporary$30.0 million restriction on available liquidity under the Amended ABL Credit Facility was removed. 21
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COVID-19
As the COVID-19 pandemic continues, we have seen the overall impact on our business decline. However, we remain committed to safeguarding our employees and the communities in which we operate, while continuing to deliver our products to customers. We have experienced the impact of the imbalance of global shipping capacity and demand which has led to delays in the receipt of goods fromChina andVietnam atU.S. ports. Additionally, while overall economic activity has improved, some of our customers' commercial projects in the retail, office, medical and educational sectors continue to be postponed. These factors have led to a softer demand environment in certain states and channels. The ultimate duration and impact of the pandemic on our future results is unknown.
Outlook
Looking forward, we remain committed to profitable growth over the medium and long-term; however, results will continue to be negatively impacted by inflation, supply chain disruptions and the timing of pricing increases as well as COVID-19 in 2021, primarily in the commercial markets served by the Company as well as costs associated with Company's on-going business transformation initiatives. The Company's view for the remainder of 2021 is supported by the below factors, which should be considered in the context of other risks, trends and strategies described in the Company's Annual Report on Form 10-K for the year endedDecember 31, 2020 : •The Company expects sales to improve during the full year 2021 compared to 2020 as a result of decreased COVID-19 pressures, the impact of recently announced price increases, continued expansion into additional market segments, and positive trends in residential end markets and new product introductions. •Operating results in the short-term continue to be negatively impacted by incremental expenses necessary to execute the Company's business transformation initiatives. This includes anticipated higher Selling, general and administrative expenses, primarily during the remainder of 2021, to support the Company's go-to-market changes. Funding for these initiatives will be aided by the deployment of capital associated with the sale of the Company's South Gate Facility. •As the Company navigates 2021, it is focused on several uncertainties, which may impact operating results, including navigating the continued impact of COVID-19, inflationary and labor pressures continued global logistics and shipping challenges as well as recently announced energy policy restrictions inChina . The global logistics and shipping challenges delayed a substantial number of anticipated order deliveries from the second and third quarter of 2021 until the fourth quarter of 2021 and the first quarter of 2022 and the Company continues to maintain a strong backlog. •During the third quarter of 2021, the Company continued to experience higher product and transportation costs, which offset a favorable product mix for the quarter. The higher product and transportation costs were driven by the unusual inflationary impacts of the transitory macro-economic recovery which have been higher than historic norms. As a result, the Company currently estimates that total product and transportation costs for the full-year 2021 will be approximately$85 million to$90 million higher than prior year on a comparable basis. The Company is committed to cost containment efforts to offset the impact of inflation (including price increases) and the Company's ability to manage these costs will continue to impact the Company's gross margins, results of operations and cash flows for the remainder of 2021. •The Company has instituted multiple price increases during the nine months endedSeptember 30, 2021 with additional pricing actions to take affect later this year. The Company expects these increases and actions to begin to mitigate the impact of the recent inflationary pressures that have impacted current year operating results and to generate more positive momentum in margins heading into 2022 and beyond. It is possible that increased selling prices could result in decreased demand for certain product or channels. •As the Company continues to execute against its multi-year strategic roadmap, the primary areas of focus for the remainder of 2021 continue to include: (i) continued focus on improving the customer experience while also improving overall profitability; (ii) continued introduction of compelling products into the markets the Company serves; and (iii) expansion of existing and entry into new market segments. •Based on current projections, as a result of worsening supply chain disruptions during the third quarter of 2021 and continued inflationary pressures related to transportation, labor and raw materials, which are expected to continue through 2022, the Company does not currently expect to remain in compliance with certain financial covenants under the asset-backed revolving Credit Agreement or the Term Loan Agreement, each, as amended, for the entirety of the twelve-month period from filing of this Form 10-Q. While the Company has implemented substantial pricing actions, continues to work with its lenders to secure longer-term relief and evaluates other initiatives that could enhance its liquidity, there can be no assurances that these actions will be successful. 22
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Geographic Areas
See Note 11, Revenue, in Part I "Financial Statements" to the condensed consolidated financial statements for additional financial information by geographic areas.
Results of Operations Condensed Consolidated Results from Continuing Operations Below is a summary of comparative results of operations for the three and nine months endedSeptember 30, 2021 and 2020: Three months ended September
30, Nine Months Ended
(Dollars in millions) 2021 2020 2021 2020 Net sales$ 168.5 $ 156.6 $ 485.5 $ 440.9 Cost of goods sold 155.6 129.0 431.5 365.3 Gross profit 12.9 27.6 54.0 75.6 Selling, general and administrative expenses 41.7 37.7 119.3 104.6 Gain on sale of property - - (46.0) - Operating income (loss) (28.8) (10.1) (19.3) (29.0) Interest expense 2.6 2.8 8.9 4.6 Other expense (income), net (2.3) (1.5) (6.7) (2.4) Income (loss) before income taxes (29.1) (11.4) (21.5) (31.2) Income tax expense (benefit) 0.6 0.3 0.5 - Net income (loss)$ (29.7) $ (11.7) $ (22.0) $ (31.2) Net sales Net sales by percentage point change are shown in the table below: Three Months Ended September 30, Change Percentage Point Change Due to (Dollars in millions) 2021 2020 $ % Price Volume / Mix Currency$ 168.5 $ 156.6 $ 11.9 7.6 % 5.6 % 0.3 % 1.7 % Nine Months Ended September 30, Change Percentage Point Change Due to (Dollars in millions) 2021 2020 $ % Price Volume / Mix Currency$ 485.5 $ 440.9 $ 44.6 10.1 % 4.5 % 3.6 % 2.0 % Net sales for the three months endedSeptember 30, 2021 increased$11.9 million and 7.6% compared to the three months endedSeptember 30, 2020 . For the nine months endedSeptember 30, 2021 , Net sales increased$44.6 million and 10.1% compared to the nine months endedSeptember 30, 2020 . These increases reflect growth in each region in which the Company operates. Demand improvements, favorable product mix and impacts from previously announced pricing initiatives drove sales increases in both Commercial and Residential channels, offset by supply chain disruptions, including the impact of winter storms during the first quarter of 2021 and ocean shipping delays related to sourced products which have delayed receipt of certain products from the second and third quarter of 2021 until the fourth quarter of 2021 and first quarter of 2022, despite strong demand. 23
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Cost of goods sold Cost of goods sold for the three months endedSeptember 30, 2021 was 92.3% of net sales compared to 82.4% of net sales in the three months endedSeptember 30, 2020 . For the three months endedSeptember 30, 2021 , costs of goods sold increased$26.6 million and 20.6% compared to the three months endedSeptember 30, 2020 . For the nine months endedSeptember 30, 2021 , cost of goods sold was 88.9% of net sales compared to 82.9% of net sales in the nine months endedSeptember 30, 2020 . For the nine months endedSeptember 30, 2021 , costs of goods sold increased$66.2 million and 18.1% compared to the nine months endedSeptember 30, 2020 . These increases were primarily attributable to increased volume, inflation related to the critical input costs and supply interruptions which have caused manufacturing inefficiencies. In addition, the first quarter of 2021 was impacted by manufacturing inefficiencies caused by winter storms which affected multiple manufacturing plants and the second quarter of 2021 was impacted by a$4.5 million charge, which included$3.3 million of accelerated depreciation expense for property, plant and equipment for which no alternative use was identified and a$1.2 million inventory rationalization charge related to the Company's business transformation initiatives. Selling, general & administrative expenses Selling, general and administrative expenses for the three months endedSeptember 30, 2021 increased$4.0 million and 10.6% compared to the three months endedSeptember 30, 2020 and increased$14.7 million and 14.1% for the nine months endedSeptember 30, 2021 . The increases in both periods were due primarily to increased headcount in our sales organization to support changes in our go-to-market strategy, higher incentive compensation accruals compared to the same periods in prior year, increased advertising and promotion costs compared to the same periods in prior year and cost reduction measures implemented during 2020, in response to the impact of COVID-19, which did not repeat during the current year. In addition, there were incremental expenses of$0.2 million and$1.0 million related to the relocation of the Company's headquarters during the three months and nine months endedSeptember 30, 2021 , respectively. We expect current year costs to be more indicative of our future cost structure. Business transformation costs Beginning in 2018, the Company commenced a multi-year business transformation which resulted in a strategic roadmap formally announced during 2020. The multi-year roadmap encompasses three critical objectives: (i) expanding customer reach; (ii) simplifying product offerings and operations; and (iii) strengthening core capabilities. Such costs (or gains) are included in the captions Costs of goods sold; Selling, general and administrative expenses; or Gain (loss) on sale of property on the Company's Consolidated Statements of Operations as required byU.S. GAAP. A summary of business transformation costs (or gains) included in these captions for the periods presented include: For
the Three Months Ended
2021 2020
Selling, General & (Gain) Loss on Selling, General &
Cost of Goods Administrative Sale of Administrative
(Dollars in millions) Sold Expenses Property Expenses
Site exit and relocation costs $ - $ 0.2 $ - $ 0.3
Strategic initiative costs - - - 0.7
Employee termination costs - - - -
Product and asset rationalization - - - -
Net gains - - - -
Total $ - $ 0.2 $ - $ 1.0
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For
the Nine Months Ended
2021 2020
Selling, General & Selling, General &
Cost of Goods Administrative (Gain) Loss on Administrative
(Dollars in millions) Sold Expenses Sale of Property Expenses
Site exit and relocation costs $ - $ 1.0 $ - $ 0.3
Strategic initiative costs - - - 0.7
Employee termination costs - - - 0.7
Product and asset rationalization 4.5 - - -
Net gains - - (46.0) -
Total $ 4.5 $ 1.0 $ (46.0) $ 1.7
Site exit and relocation costs - Site exit and relocation costs include costs
associated with exit or disposal activities, including asset write-downs, and
non-recurring costs associated with relocation of Company operations. Costs
incurred during the both the three and nine months ended September 30, 2021 and
2020 related to the Company's corporate headquarters relocation.
Strategic initiative costs - Costs of non-recurring strategic projects,
including executive leadership transitions, that are not considered part of
normal operations. Costs incurred during the three and nine months ended
September 30, 2020 related to non-severance costs related to the Company's CFO
transition.
Employee termination costs - Costs of involuntary termination benefits
associated with one-time benefit arrangements provided as part of an exit or
disposal activity are recognized by the Company when a formal plan for
reorganization is approved at the appropriate level of management and
communicated to the affected employees. The employee termination benefit costs
during the nine months ended September 30, 2020 relate to our former CFO.
Product and asset rationalization - As part the Company's on-going business
transformation efforts, it may from time-to-time determine to stop producing
certain products. As a result, the Company may incur accelerated depreciation
charges for certain assets and inventory reserve charges to reflect inventory at
estimated market value. Costs incurred during the nine months ended September
30, 2021 related to such determinations included accelerated depreciation
expense for idled assets with no future alternative use and certain inventory
related charges related to product rationalization decisions.
Net gains - Net gains result from the sale of redundant properties (primarily
land and buildings) and non-core assets. During the nine months ended September
30, 2021 net gains related to the sale of our South Gate Facility which was
classified as Assets held-for-sale during 2020. See Note 4, Property, Plant and
Equipment, in Part I "Financial Statements" for additional discussion related to
this transaction.
Interest expense
Interest expense decreased $0.2 million for the three months ended September 30,
2021 compared to the three months ended September 30, 2020 , primarily due to a
first quarter 2021 $20 million repayment on our Term Loan Facility.
Interest increased $4.3 million for the nine months ended September 30, 2021
compared to the and nine months ended September 30, 2020 due to higher interest
rates on debt outstanding resulting from our June 2020 refinancing.
Other (income) expense, net
Other income increased $0.8 million and $4.3 million , respectively, for the
three and nine months ended September 30, 2021 , respectively, compared to the
three and nine months ended September 30, 2020 primarily reflecting the positive
impact from changes in actuarial assumptions related to defined-benefit pension
and postretirement plans.
Income tax expense (benefit)
We recorded income tax expense of $0.6 million for the three months ended
September 30, 2021 compared to $0.3 income tax expense for the three months
ended September 30, 2020 . The 2021 expense relates to foreign income tax expense
from various jurisdictions.
We recorded an income tax expense of $0.5 million for the nine months ended
September 30, 2021 compared to no income tax expense for the nine months ended
September 30, 2020 related to various foreign jurisdictions partially offset by
a U.S. income tax benefit related to a reduction in the Company's deferred tax
liabilities due to the sale of the South Gate Facility.
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Liquidity and Capital Resources
InNovember 2021 , the Company entered into the Fourth Amendment to its Amended ABL Credit Facility and the First Amendment to its Term Loan Agreement, both of which modify covenant requirements as ofSeptember 30, 2021 . The Fourth Amendment to the Amended ABL Credit Facility includes a new financial covenant which requires minimum availability of$32.5 million throughNovember 30, 2021 ; and$25.0 million thereafter.
The
Upon the sale of our South Gate Facility we made a mandatory payment of$20.0 million toPathlight Capital L.P. towards the principal balance on our Term Loan Facility as required by the Term Loan Agreement. As part of this mandatory payment, we paid an additional$0.4 million in prepayment premium fees. Additional proceeds from the South Gate Facility sale were applied to outstanding borrowings under our Amended ABL Credit Facility. Additionally, upon completion of the sale, the temporary$30.0 million restriction on available liquidity under the Amended ABL Credit Facility was removed. DuringMarch 2021 , we entered into a new line of credit inChina . The new credit limit is$9.3 million with a one-year maturity date and a variable interest rate of 3.85% to 4.35%. The loan is secured by the land and building of our Chinese facility. There was$4.5 million outstanding under the new line of credit atSeptember 30, 2021 . Subsequent to entering into the new line of credit inChina , inApril 2021 , we repaid$3.5 million of borrowings outstanding under an existing local borrowing arrangement inChina which matured inFebruary 2021 . Cash Flow Summary The table below shows our cash (used for) provided by operating, investing and financing activities: Nine Months Ended September 30, (Dollars in millions) 2021 2020
Net cash provided by (used for) operating activities
49.3 (15.1)
Net cash provided by (used for) financing activities (7.4)
26.3
Operating Activities - Net cash used for operating activities for the nine months endedSeptember 30, 2021 was$40.6 million , an increase in use of$24.3 million from the nine months endedSeptember 30, 2020 . The increase was due to lower net cash income partially offset by working capital improvements driven by imporved accounts payable and accrued expense management. Investing Activities - Net cash provided by investing activities for the nine months endedSeptember 30, 2021 was$49.3 million , an increase of$64.4 million from the cash used for investing activities during the nine months endedSeptember 30, 2020 . The increase is due to proceeds from the sale of our South Gate Facility, partially offset by slightly higher capital spending. Financing Activities - Net cash used for financing activities for the nine months endedSeptember 30, 2021 was$7.4 million , a decrease of$33.7 million from net cash provided by financing activities for the nine months endedSeptember 30, 2020 . The decrease was due to new Term Loan Facility of$70.0 million in prior year which did not repeat and mandatory prepayments on the Term Loan Facility during 2021 after the sale of our South Gate Facility, partially offset by higher net borrowings on Amended ABL Credit Facility in the current year and payment of deferred financing costs in prior year which did not repeat during the current year. Sources and Uses of Cash As discussed in Note 1, Basis of Presentation, in Part 1, Item 1, "Financial Statements," inNovember 2021 , the Company entered into the Fourth Amendment to its Amended ABL Credit Facility and the First Amendment to its Term Loan Agreement, both of which modify covenant requirements as ofSeptember 30, 2021 . The Company was in compliance with these covenants atSeptember 30, 2021 . 26
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Based on current projections, as a result of worsening supply chain disruptions during the third quarter of 2021 and continued inflationary pressures related to transportation, labor and raw materials, which are expected to continue through 2022, the Company does not currently expect to remain in compliance with certain financial covenants under the asset-backed revolving Credit Agreement or the Term Loan Agreement, each, as amended, for the entirety of the twelve-month period from filing of this Form 10-Q. While the Company has implemented substantial pricing actions, continues to work with its lenders to secure longer-term relief and evaluates other initiatives that could enhance its liquidity, there can be no assurances that these actions will be successful. These factors raise substantial doubt about the Company's ability to continue as a going concern. As ofSeptember 30, 2021 there were borrowings of$24.1 million outstanding under our Amended ABL Credit Facility, while outstanding letters of credit were$6.6 million . Total net availability under the Amended ABL Credit Facility and Term Loan Facility as ofSeptember 30, 2021 was$57.2 million . We are required to pay a commitment fee, payable quarterly in arrears, on the average daily unused amount of the revolving Amended ABL Credit Facility, which varies according to the net leverage ratio and was 0.50% as ofSeptember 30, 2021 . Outstanding letters of credit issued under the Amended ABL Credit Facility are subject to fees which will be due quarterly in arrears based on the applicable margin described above plus a fronting fee. The total rate for letters of credit was 4.125% as ofSeptember 30, 2021 . Our foreign subsidiaries had available lines of credit totaling$9.3 million and there were$4.6 million borrowings under these lines of credit as ofSeptember 30, 2021 . Total availability under these foreign lines of credit as ofSeptember 30, 2021 was$4.7 million .
In addition, the Company had
Based on the foregoing, the Company had total liquidity (including Cash and cash
equivalents) of
Debt Covenants The Amended ABL Credit Facility requires, among other things, that we maintain a minimum Consolidated Cash Flow (as defined in the Amendment) for the three-fiscal quarter period endingSeptember 30, 2020 and for any four-fiscal quarter period ending thereafter and during a Financial Covenant Trigger Period (as defined in the Amendment) and maintain a minimum Consolidated Fixed Charge Coverage Ratio (as defined in the Amendment) of at least 1.00 to 1.00. The Amended Term Loan Agreement contains a number of covenants that, among other things and subject to certain exceptions, restrict our ability to create liens, to undertake fundamental changes, to incur debt, to sell or dispose of assets, to make investments, to make restricted payments such as dividends, distributions or equity repurchases, to change the nature of our businesses, to enter into transactions with affiliates and to enter into certain burdensome agreements. The Company was in compliance with these covenants atSeptember 30, 2021 . However, based on current projections, as a result of worsening supply chain disruptions during the third quarter of 2021 and continued inflationary pressures related to transportation, labor and raw materials, which are expected to continue through 2022, the Company does not currently expect to remain in compliance with certain financial covenants under the asset-backed revolving Credit Agreement or the Term Loan Agreement, each, as amended, for the entirety of the twelve-month period from filing of this Form 10-Q. While the Company has implemented substantial pricing actions, continues to work with its lenders to secure longer-term relief and evaluates other initiatives that could enhance its liquidity, there can be no assurances that these actions will be successful. These factors raise substantial doubt about the Company's ability to continue as a going concern. Cash Management The Company has various cash management systems throughout the world that centralize cash in various bank accounts where it is economically justifiable and legally permissible to do so. These centralized cash balances are then redeployed to other operations to reduce short-term borrowings and to finance working capital needs or capital expenditures. Due to the transitory nature of cash balances, they are normally invested in bank deposits that can be withdrawn at will or in very liquid short-term bank time deposits. The Company's policy is to primarily use the banks that participate in our Amended ABL credit facility located in the various countries in which the Company operates. The Company monitors the creditworthiness of banks and when appropriate will adjust banking operations to reduce or eliminate exposure to less creditworthy banks. 27
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AtSeptember 30, 2021 , our Cash and cash equivalents totaled$14.9 million , of which$3.8 million was held in theU.S. and$11.1 million held by non-U.S. subsidiaries. AtSeptember 30, 2021 none of our consolidated cash and cash equivalents had regulatory restrictions that would preclude the transfer of funds with and among subsidiaries. While our remaining non-U.S. cash and cash equivalents can be transferred with and among subsidiaries, the majority of these non-U.S. cash balances will be used to support the ongoing working capital needs and continued growth of our non-U.S. operations. Recent Accounting Pronouncements See Note 1, Business and Basis of Presentation, in Part I "Financial Statements" for a discussion of recent accounting pronouncements, including accounting pronouncements that are effective in future periods.
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