Armstrong Flooring's (AFI) CEO Donald Maier on Q4 2016 Results - Earnings Call Transcript

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Armstrong Flooring, Inc. (NYSE:AFI) Q4 2016 Earnings Conference Call March 6, 2017 10:00 AM ET

Executives

Douglas Bingham - Vice President, Treasury and Investor Relations

Donald Maier - President and Chief Executive Officer

John Jay Thompson - Vice President, Chief Financial Officer

Analysts

Keith Hughes - SunTrust Robinson Humphrey

Alvaro Lacayo - Gabelli & Company

John Baugh - Stifel Financial Corp.

Scott Rednor - Zelman & Associates

Jim Barrett - C.L. King & Associates

James Morrish - Evercore ISI

Stephen Kim - Evercore ISI

Operator

Greetings, and welcome to the Armstrong Flooring, Inc. Fourth Quarter and Full Year 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Doug Bingham, Vice President, Treasury and Investor Relations. Thank you, sir. You may begin.

Douglas Bingham

Thank you for joining us today for Armstrong Flooring’s fourth quarter and full-year 2016 earnings conference call. Today’s call is hosted by Chief Executive Officer, Don Maier; and Chief Financial Officer, Jay Thompson.

We trust you have seen our fourth quarter and full-year 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.armstrongflooring.com.

I refer you to Slide 2 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 SEC 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. Please note that beginning with fourth quarter and full-year 2016 results we have amended our accounting for inventories in the Wood segment from the use of Last In First Out, or LIFO, to the First In First Out or FIFO method.

Adjusted financial results now also include the impacts of foreign currency translation. For added clarity, we have provided select financial results using both current and prior accounting methods throughout the presentation as appropriate. Jay will provide more detail on those accounting changes.

With that, I will now turn the call over to Don.

Donald Maier

Thank you, Doug. Good morning, everyone, and thank you for joining us for our fourth quarter 2016 earnings call. Today, I will discuss our operating highlights and business activity. Jay will then cover additional details on our financial results and outlook. After our prepared remarks, we will open up the call to answer your questions.

Page 3 provides some key highlights of our financial results. For full-year 2016, we grew sales modestly for the first time in three years. This was accomplished amid a challenging market environment, which mainly reflects a stronger than anticipated downward trend in our legacy portfolio. These legacy categories consist of our traditional resilient products, primarily vinyl sheet and tile, laminate and linoleum, which collectively still comprise a significant portion of our total sales.

We expect the challenges faced by our legacy portfolio to continue into 2017. Offsetting this, we continue to make significant progress in our strategic growth initiatives. As a result, we are more committed than ever to our growth strategy, while also taking the necessary actions to revitalize our legacy business. Our work in innovation not only benefits our higher growth categories, but also allows us to apply new technologies to our legacy products.

We are continually refreshing designs and visuals to keep our products on trend across our portfolio. Additionally, we are continuing our investments in merchandising and displays to further increase our presence in retail, and support our distributors in the marketplace.

On the operational side, we are reaping the benefits of targeted productivity initiatives to improve our cost structure. And regards to SG&A, today we announced a streamlining of our go-to-market structure to better serve our customers, which we expect will result in annualized cost savings of roughly $6 million to $7 million by year-end.

We are excited about the positive impact this will make for our customers, which will both drive top line growth and improved profitability. Our cash flow profile was much improved in 2016 with free cash flow of $17 million, representing an improvement of $23 million compared to prior year. As we generate cash, we plan to invest in attractive opportunities to improve returns and to fund our growth initiatives. We are not limiting ourselves to organic investments and we continue to evaluate M&A opportunities to support our growth objectives.

And as we drive towards our 10% EBITDA margin goal, we expect to reserve ample liquidity, while still returning a portion of excess capital to shareholders. In line with these capital deployment objectives, today we announced a $50 million share repurchase program, which we believe will be an effective way to deliver additional value to our shareholders.

Looking at 2016, full-year net sales increased approximately 1% excluding currency translation. Market acceptance of our advanced flooring products such as our Diamond 10 Technology and Rigid Core continue to push growth rates in the luxury vinyl or LVT category well in excess of the market.

Our shipments in the residential end-markets, particularly in solid wood, grew during the year. However, as I mentioned during the past year, that progress was offset by structural industry challenges in our legacy portfolio. We were further impacted by broad-based industry price pressure. And in our traditional resilient business, we encountered softer than expected commercial demand.

For the full-year 2016, we’ve reported adjusted EBITDA of $83 million, excluding the changes in accounting method from LIFO to FIFO, adjusted EBITDA was $73 million as compared to $61 million in the prior year. This improvement was made possible by significant productivity improvements and tighter SG&A management. Jay will provide additional context in his section.

I will now turn to our strategic priorities update on Page 4. As I mentioned, in light of tougher market environments, we remain committed to executing our growth strategy, while taking actions to enhance our competitive position in the legacy categories. We are accomplishing this through our strategic priorities, which I will now review.

Continuous innovation in durability and design remains a central part of our strategy across all major Wood and Resilient categories, and will allow us to not only maintain strong competitive position in legacy categories, but will also give us the ability to launch new products and drive share in growing categories.

Examples of these innovations include Diamond 10 Technology, Rigid Core Technology and alternative materials, such as our newly introduced Pryzm LVT. These investments are helping to improve our mix of sales from higher growth products, and in our legacy portfolio, we are not sitting still. During the fourth quarter, we launched our commercial sheet with Diamond 10 Technology, which was met with strong interest.

In January, we introduced our residential sheet products also with Diamond 10 Technology. In addition to these enhancements and legacy product features, we are also introducing award-winning designs and refreshing our product offering. We believe these efforts will help us win new specifications and new consumers in our targeted end-markets.

We are working on additional innovation advancements to extend our leadership position across the entire product portfolio. Our focus on innovation goes hand-in-hand with efforts to grow our share of wallet with distributors. Our goal is to win in all categories we service.

We continue to support new product rollouts with the marketing investments to deepen customer engagement and become the preferred choice for distributors, retailers and other channel partners. We are focused on expanding our retailer program Elevate, which is driving better alignment with retailers and providing the merchandize and support they need to be successful.

More recently, we have introduced the Unite [ph] program to strengthen our relationship with distributors to drive sales growth. Additionally, as I mentioned earlier, our go-to-market streamlining effort is already underway to combine our commercial and residential structures.

The new structure is designed to provide enhanced support and responsiveness to retailers, contractors and users, as well as greater alignment with distributors, which cover both commercial and residential businesses. We anticipate this streamlining effort will improve our competitive positioning and profitability while enhancing our global brand.

During the fourth quarter, our LVT shipments grew significantly faster than the market. Through a combination of sourced and internally produced LVT, we grew commercial and residential LVT as a percent of Resilient sales from 15% in 2015 to 20% in 2016. This outperformance is a direct result of better designs in structures that validate our innovation efforts.

Through our sourced to manufactured products, we have one of the broadest LVT portfolios in the industry, including industry-leading technology like Diamond 10 and Rigid Core. We are also excited about our new LVT product called Pryzm, which we introduced at the Surfaces industry trade show in January.

We are the industry innovator with Pryzm, which features superior dent resistance, better scratch resistance and sharper visuals, all while being completely waterproof. LVT has been trending towards Rigid Core products and with Pryzm we have innovated a superior product that represents the next generation of LVT.

In our Wood business, solid wood performs stronger on to top-line year on year. On the engineered side, a combination of market challenges such as imports and price competition, have impacted our ability to grow sales. We have a three-pronged approach to improve segment performance, which includes productivity, a focus on higher margin products and a differentiated approach with entry-level products.

On productivity, we have established a culture of continuous improvement to drive better results. During 2016, these efforts paid off. Lean initiatives to improve production yields, scrap rates and product quality resulted in approximately $9 million of Wood segment productivity to counteract industry price pressure.

In 2017, we plan to intensify our efforts to improve margins in price competitive segments. To drive growth in higher-end products, we are adding offerings to improve our mix and margin, and to reinforce our leadership position in design. A good example of this is our Artistic Timbers family of products featuring the TimberBrushed collection, which launched in 2016, and the latest collection TimberCuts, which was launched at Surfaces in January, both are trend-leading visuals that carry higher selling price and margins than our engineered portfolio at large.

At the entry level, where the growth rates are highest, most of the competitive landscape is dominated by imports, which keep margins thin. We continue to develop innovations to improve our cost profile for these products, including a differentiated supply-chain approach to service this demand.

Overall, we believe our strategic priorities will help drive top and bottom line growth to achieve our medium-term 10% EBITDA margin goal.

I will now turn the call over to Jay to walk through the details of our financial performance.

John Jay Thompson

Thank you, Don. Good morning to those on the call today. Turning to Page 5 of the presentation, as I walk through the results, I will provide some context on the inventory accounting change we announced today, which impacts fourth quarter and full-year 2016 results.

As we detailed in our earnings release, we have amended our inventory accounting for the Wood segment from the use of the LIFO method to the FIFO method. This accounting change has no impact on the Resilient segment.

The reconciliation table on Page 5 shows the adjusted EBITDA comparisons under our new basis of presentation using Wood FIFO in actual currency versus our prior basis of presentation, which use Wood LIFO in constant currency. Our 2016 outlook was based on LIFO accounting and our results for the year on that basis were $73 million as compared to $61 million in 2015.

I’ll also highlight that our 2016 budget was based on Wood LIFO, and as such, we ran our business in 2016 on that same basis, measuring year-over-year performance versus 2015 on Wood LIFO.

Moving forward, our results will be presented using Wood FIFO and actual currency translation. On this basis, our full-year 2016 adjusted EBITDA was $83 million. We believe the change to FIFO will provide more accurate comparisons of our business performance, given the long production cycles and volatile input prices inherent to the Wood business.

FIFO will also provide a better matching of the material costs and wood product revenues. As an example, the lag between purchases of green lumber and the sale of our finished products typically averages five to six months. The lumber cost inflation that we saw in the second half of 2016 will hit the P&L beginning in the first half of 2017 under the FIFO method.

I’ll expand upon the impact of 2017 inflation a bit later. Finally, we believe our results will be more comparable to those of our peers under the Wood FIFO method. Fourth quarter adjusted EBITDA of $5.5 million under the Wood FIFO method would have been $2.1 million under the Wood LIFO method. On the following pages, I’ll discuss results based upon the Wood LIFO method in constant foreign exchange rates for consistency with our 2016 guidance and prior period year-over-year bridges.

Page 6 provides our key highlights for the year on a LIFO basis. Excluding the impact of foreign currency, 2016 full-year net sales were up approximately 1%, in line with our expectations. Adjusted EBITDA increased $12 million to $73 million from 2015 to 2016, representing an adjusted EBITDA margin of 6.1%, a 90 basis point improvement from the prior year. This marks tangible progress towards our goal of achieving a 10% adjusted EBITDA margin by the year 2020.

During the year, we benefitted from productivity gains, net of ramp-up costs incurred at our LVT facility. Positive volume gains in Wood were offset by unfavorable mix and substantial price pressure in both segments. Resilient volumes were essentially flat. Top line performance was stronger in the first half of 2016, as market pressures intensified, as we move through the year and prior year comps became increasingly challenging.

SG&A was lower by $9 million with lower than expected corporate spending and more efficient promotional spending.

Turning to the fourth quarter results on Slide 7, in the fourth quarter, sales were down in both segments resulting in a 3% overall sales decline. LVT and solid wood shipments continue to grow. However, negative market trends on our legacy portfolio impacted overall volume. As a result, adjusted EBITDA was lower in the fourth quarter. Flow through from lower net sales more than offset the benefits of productivity gains and lower SG&A spending.

Turning to our fourth quarter Resilient segment results on page 8, net sales were down 4%, primarily due to lower pricing in response to market pressure. Additionally, market softness in our commercial markets continued during the fourth quarter, mostly impacting our traditional vinyl tile and sheet product shipments. Vinyl sheet was further impacted by lower sales in the strategic retail customer channel, trends which we expect to continue through 2017.

We experience double-digit growth in LVT from both sourced and manufactured products, which as Don previously mentioned, now represents 20% of overall Resilient sales as compared to 15% in the prior year. Adjusted EBITDA of $5 million improved by $7 million versus the prior year quarter. We benefited from lower input costs and healthy productivity gains, as for the first time, the ramp-up cost associated with our LVT operations were minimal compared to the initial start-up cost in Q4 2015.

The majority of our total SG&A improvement for the quarter was driven by lower promotional spending. Segment adjusted EBITDA as a percentage of net sales was 3.3%, a 400 basis point improvement from the prior year quarter. With our Lancaster LVT operation substantially ramped up, we’re focused on driving improved unit costs and margins. LVT sales growth will continue to come from both sourced and manufactured products.

Across our legacy commercial portfolio, we announced a 3% to 6% price increase across most products to help compensate for a rise in raw material inputs, as well as to partially offset second-half price compression. The price increases went into effect in February.

Now, moving to our fourth quarter Wood segment results on Page 9, Q4 net sales of $113 million were down 2% compared to the prior year quarter, primarily attributable to broad-based industry price pressure. Stronger wood shipments resulted in 2% segment volume growth. Engineered wood shipments were lower as we held firmer on price, in an effort to improve margins.

In the engineered wood business, as Don mentioned, we’re focused on improving profitability across the product line, particularly for entry-level products. Wood adjusted EBITDA was negative $3 million as compared to a $7 million gain in the prior-year quarter. This was a result of year-over-year price compression combined with a significant increase in year-over-year lumber costs under LIFO.

We saw modest but steady lumber input cost inflation throughout 2016 relative to the beginning of the year. In 2017, we expect lumber costs to be up on a year-over-year basis, but relatively stable on a sequential basis during the year.

Turning to our cash flow on Page 10, we delivered positive free cash flow of $17 million for the year as compared to a $6 million outflow in 2015. For the full year, we spent $37 million on CapEx, as compared to $59 million in the prior year. Spending in 2016 was below guidance, driven by greater efficiency and the later timing of projects within the year.

We were pleased with our ability to generate positive free cash flow for the year. In the fourth quarter, we experienced a $10 million outflow of free cash flow as compared to a $15 million outflow in the prior year quarter. We typically generate our highest periods of cash flow in the middle of the year, hence the outflows during the first and fourth quarters as we build up inventory, consistent with our seasonal cadence.

The first quarter draw in a given year is typically more significant than the fourth quarter draw. We ended the year with a strong balance sheet with approximately $21 million of debt and $31 million of cash.

Now turning to our outlook on Page 11, during 2016, we grew adjusted EBITDA by controlling costs and realizing the benefits of targeted productivity initiatives. Given our change in inventory accounting method, we have presented our adjusted EBITDA outlook under both accounting methods to help with the transition from Wood LIFO in 2016 to Wood FIFO in 2017.

As you can see under the prior Wood LIFO accounting method, our 2017 adjusted EBITDA outlook would have shown improvement to a range of $74 million to $84 million, as compared to $73 million in 2016.

However, moving forward we’ll use the Wood FIFO method for our internal budgeting and external reporting purposes, along with the relevant year-over-year comparisons. As a result, we expect adjusted EBITDA in 2017 to be in the range of $75 million to $85 million under the Wood FIFO accounting method and using actual exchange rates.

Although the year-over-year optics of the accounting change are challenging, we believe Wood segment financial results and overall financial results under this new accounting method will provide a better matching of revenues and costs of the product sold in a given year.

As a reminder, our reported $83 million adjusted EBITDA in 2016 was augmented by $10.3 million benefit from the realization of lower wood raw material costs under FIFO. Conversely, in 2017, we expect an $8 million to $10 million raw material headwind, mainly tied to lumber input costs.

During the second half of 2016, hard lumber spot prices continue to trend higher year-over-year on a sequential basis. Under the FIFO accounting method, the actual recognition of these higher cost purchases made during the second half of 2016 will be reflected in the P&L in 2017. We expect lumber spot prices to level off in early 2017.

We expect the realignment of our go-to-market structure to generate an annualized SG&A savings of roughly $6 million to $7 million. In connection with these cost savings, we expect to incur a pre-tax charge of $4 million to $5 million in the first half of 2017. This realignment in cost reduction plan is an integral part of our transformational effort to improve margins over time. Excluding the unfavorable comparison driven by the inventory accounting change, we believe our adjusted EBITDA range of $75 million to $85 million represents progress towards our commitment to grow adjusted EBITDA and margin over the medium term.

In the first quarter, we expect the adjusted EBITDA comparison to be the most challenging as compared to the prior-year quarter. In Q1 2016, approximately a third of our sales growth was attributable to a one-time load in activity and our G&A spending was lower as our standalone corporate costs were still ramping in advance of our separation.

We are confident we will continue to generate positive free cash flow in the coming year, we expect capital expenditures in the range of $45 million to $50 million, with maintenance CapEx approximating 2% to 2.5% of sales. And the balance of the spending on high return investments consisting of productivity projects with short paybacks and innovation projects where we can expect a strong return.

Over the medium-term, we expect free cash flow generation to increase as EBITDA increases. We expect our continued progress on free cash flow generation will allow us to maintain a strong capital position. This position provides us the opportunity to build value through our $50 million share repurchase program, while making progress towards a target leverage ratio of 1.5 to 2 times EBITDA and preserving ample liquidity to invest in internal and other projects to drive growth.

I’ll now turn the call back over to Don.

Donald Maier

Thanks, Jay. I will conclude with our medium-term outlook on Slide 12. As evidenced by 2016 financial results, we are making progress to establish a more profitable foundation for our company through innovation, a widening share of wallet, LVT penetration and improved Wood profitability.

In the past, we have discussed an annual growth - sales growth rate of 5% to 6% over the medium-term. However, on the heels of a tougher-than-expected growth environment in 2016, it is now more clear that our medium-term sales trajectory will likely continue to be weighed down by our legacy portfolio and competitive pressures. Consequently, as we work to reposition our portfolio, we anticipate the trends we saw in 2016 will continue to impact our 2017 sales.

Due to this choppiness, we are no longer providing a medium-term sales outlook at this time, but remain committed to growing faster than the industry average of our product categories. We are working hard to grow revenue responsibly through our strategic priorities. We believe we are taking the right actions to improve our mix of products from higher growth categories and apply new technologies to our legacy products to help offset the structural industry headwinds.

We believe these growth initiatives will help accelerate positive momentum in our business longer-term, combined with our ongoing success with productivity gains, SG&A controls and operational enhancements, we remain very confident in our ability to achieving a 10% adjusted EBITDA margin target by 2020.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Keith Hughes with SunTrust Robinson Humphrey. Please proceed with your question.

Keith Hughes

Thank you. Getting to the price increase you discussed, 3% to 6%, that was just in the Resilient segment. Is that correct?

Donald Maier

That’s correct, Keith.

Keith Hughes

And amongst the products, can you give us any sort of feel for which ones and how much amongst those, there is a lot in that segment.

Donald Maier

Yes. So the price increase was announced is on our commercial Resilient products. We have not announced anything on our residential Resilient products.

Keith Hughes

Okay. And what LVT prices, can you give us a feel for where they’re at in that mix?

Donald Maier

So I would say that it’s - this is kind of a normal price increase for us, Keith. I wouldn’t want to go into all of the specifics given our channel that we’re looking at. I might ask Jay, if you want to comment on a specific price impacts that we would want to include here.

John Jay Thompson

Keith, we’re attempting to take 3% to 6% across the commercial line. It’s designed to cover the - both the input cost increases we’ve seen in recent months, as well as to stem some of the price pressure that we saw in the second half of 2016.

And then, specifically we’re not taking a price increase on LVT. So it’s the other commercial products. We’re going to continue to work to hold the line on LVT, but we’re not taking a specific price increase on LVT.

Keith Hughes

And LVT prices are - how are they trending first half of the year versus what you saw in 2016?

Donald Maier

Yes. On the LVT pricing environment, Keith, it is pretty consistent with what we have seen. Obviously, a more price pressure on kind of one of the lower end opening price points. And obviously, we’re driving our innovation in technologies with Diamond 10 and Rigid Core, to really grow into some of the higher price segments with premium pricing there.

Keith Hughes

Final question, on the restructuring plan you highlighted, there was a mention of putting commercial, residential together. Are you going to be having salesmen doing both or what kind of - structurally what does this look like after the restructuring is done?

Donald Maier

Yes, great question. Thank you for that, Keith. So we are combining our residential and commercial businesses. This includes our more traditional back office functions such as marketing and product management alike into one team, and that’s providing some economies of scale and efficiency for us.

The largest portion of the change is in the combination of our sales leadership teams in the field, where it comes down to actual selling resources. They will still be dedicated to the specific product lines or areas that they’re focused on. So it’s really a consolidation of the field-based sales leadership teams.

Keith Hughes

Thank you.

Donald Maier

Thanks, Keith.

Operator

Thank you. Our next question comes from the line of Alvaro Lacayo with Gabelli & Company. Please proceed with your question.

Alvaro Lacayo

Good morning, guys.

Donald Maier

Good morning, Alvaro.

Alvaro Lacayo

Just - so, I guess, starting on the top line for 2017, and maybe just an order of magnitude, if you could provide a little bit more color in terms of the cadence of when we’ll really see the impact from the mix drivers that you’re pushing forward to sort of get that better mix, whether it’d be the rollout of the Diamond 10 across portfolio, and just move towards more premium product?

And then secondly, if you can just maybe provide a little bit more color on the retail channel that you called out for weakness and maybe make some commentary around the home center channel as well, in terms of what you’re seeing from a competitive standpoint?

Donald Maier

Great. So first of all, as it relates to the kind of the mix of the legacy portfolio and our growth initiatives, there is really - I think four vectors that are really a factor in answering your question. Number one is obviously, we are very focused on driving our growth initiatives. And I would say to a tee they are all meeting or exceeding our expectations and so we are continuing to invest into those.

Number two is the rate at which we can revitalize our legacy offering. And as I mentioned earlier in the call, the nice part with the innovations that we’re bringing to the market, we’re able to bring those down into the legacy portfolio. So we are very excited to support our - both our resilient and commercial sheet businesses by now being out in the market with Diamond 10 Technology on those products. And as we brought those out as well, we’ve refreshed the designs and styling of those products as well to increase the consumer appeal for those products.

Number three is always the overall market dynamics. And while we hear a lot of encouraging words out there, I would say our view in the market is consistent with what we’ve seen over the past several years.

And then lastly is the competitive dynamics that exist. In particular, we’ve shared over the past several calls some structural concerns we have with the resilient sheet market in the residential, in particular with the capacity that’s been brought on amidst a transition in that business or a cannibalization by other product forms like LVT, so very, very difficult with those four vectors to give you any specific guidance. And that’s we are eliminating the guidance. What we do believe, and what we built into the outlook that we provided is a consistent trend in 2017 in sales, to what we saw in 2016.

Alvaro Lacayo

Got it. Okay. And then on the restructuring that you announced that $6 million to $7 million run rate, is that achieved by the end of the year or when is the timing of all that expected?

Donald Maier

Yes. We are obviously in the midst of launching that today and making those changes start today, we’ll have all of the changes completed by year-end.

Alvaro Lacayo

Okay. And then on the share repurchase, if you could just comment on sort of how you guys think about the cadence of the repurchase or your approach, is it going to be systematic versus opportunistic or how do you see that sort of evolution of that as you go through that program?

John Jay Thompson

Hi, Alvaro, it’s Jay. So it’s a combination of both. We believe the right thing to do is to repurchase shares over time to move towards our target capital structure. But at the same time, the repurchase authorization gives us an opportunity to be opportunistic. So I’d say it’s a combination of both.

Alvaro Lacayo

Okay. Thank you, guys.

Donald Maier

Thank you.

John Jay Thompson

Thank you.

Operator

Thank you. Our next question comes from the line of John Baugh with Stifel. Please proceed with your question.

John Baugh

Thank you, Don and Jay, and good morning. Just a few things quickly. One, could you refresh my memory, are you making Rigid LVT in Lancaster plants. And if not, correctly do you have the capability of doing so?

Donald Maier

So we source our Rigid Core products as well as the Pryzm product that we launched at Surfaces. We source those products. The facility here in Lancaster, our LVT plant does not manufacture those products and would take, I would say, some significant investments to do that. We do have other manufacturing capabilities and assets that would probably be more a shorter part to realign to produce those products. But at this point in time, those are all sourced.

John Baugh

Okay. Thanks for that, Don. And then, I think with a comment on the Resilient segment that mix was negatively impacted by a more sourced versus produced. So even though, I guess, I’m trying to get a feel for the plants coming up you’re making more in-house. But, obviously, you’re sourcing rigid. Do those lines change so that you make more in-house than sourced at some point even maybe this year or no because Rigid is growing so fast you’re going to have to source that?

Donald Maier

Yes. So the dynamic that you’re describing is correct. We’re seeing large growth in the Rigid Core category, which brings with it a higher price, but lower margins than our domestically produced products. With that said, this is part of our overall strategy to really drive entrants into markets quickly. And where we see the sales generating sufficient returns to warrant capital investments, we’ll be making those investments.

So this is just part of our ongoing manufacturing strategy of sourcing to get into markets, and then where appropriate making capital investments behind that.

John Baugh

Okay. Super. And then a question on Wood, so correct me if I’m wrong, there is no price action in the marketplace. It sounds like the pressure on the entry-level remains acute even though lumber is inflated, so there is just no opportunity to raise prices. Do I have all that right? And it sounds like you’re trying to move mix up within Wood. I’m just curious. And you did a great job, thank you of breaking out the Wood headwind and cost versus tailwind on FIFO basis.

I’m just kind of curious how the price mix, cost dynamics in wood play out this year and into the future. Thank you.

Donald Maier

Great, yes. So we have not made a broad brushed price increase announcement on Wood. However, we continually, I would say, on a surgical basis work to deal with channels or markets that are not generating the returns that we expect.

So it’s more of a surgical approach on price. And that process has been and continues to be ongoing for us. Your comments around mix are well aligned, which is the other real vector for us of driving value. And so we’ve been very focused as you saw at Surfaces with coming out with really leading-edge both visuals and designs that are coming in at a premium price well above our average for either those solid wood or engineered categories.

John Baugh

Great. Thanks and good luck.

Donald Maier

Thanks, John.

Operator

Thank you. Our next question comes from the line of Scott Rednor with Zelman & Associates. Please proceed with your question.

Scott Rednor

Hey, good morning.

Donald Maier

Good morning, Scott.

Scott Rednor

Jay, a question for you on the CapEx, I think at the - about a year ago, you guys got it to $50 million to $60 million as the near-term or midterm guidance. You came in well below that in 2016 and in 2017 it’s below that. Is that efficiency? Is that timing? Could you maybe give us additional color there?

John Jay Thompson

Yes, sure. As we saw in 2016, we’re able to invest in the capital projects that we saw that would drive the business growth, enabled to do that with less capital than we had initially planned to. And so the $45 million to $50 million really recognizes the fact that we can drive efficiencies below that $50 million to $60 million level, but still invest in the projects to grow the business.

So, yes, I think no change in the overall strategy, but a sense that we can do - we can invest more efficiently behind the business. And as we think about the medium term, we think of that $45 million to $50 million is the right level to support our financial goals.

Donald Maier

And I just would add Scott that we certainly have a detailed operating plan and budget. But we don’t consider any capital investments that are budgeted to be approved. And we put a lot of continuous improvement efforts and kaizen were behind any capital that is spent. In some cases, we’ve reduced the amount of capital that is necessary for a project.

In some cases, we’ve been able to generate the benefit without spending the capital at all. And so that is just a part of our culture moving forward. And we will continue to work to that end. However, we think it’s prudent to build in the appropriate capital to drive the financial outlook that we are providing.

Scott Rednor

And then, Don, I think to maybe just ask on one of your earlier comments to a question, as you guys think about balancing, I think M&A was mentioned, the share repo, but you’re also seeing outsized growth in some of the source products. At what point those, adding another line or facility in some of the higher growth areas come into consideration or maybe it’s already under consideration?

Donald Maier

Yes, I would say that we have an active the M&A pipeline and probably what I would share at this point is there are no breakout investments here. These are all investments we would make to align and support our growth strategy in the businesses that we’re in today.

Scott Rednor

Okay. And maybe just lastly, given how far you guys are into the quarter, just a flavor for how you’re trending and maybe what’s a reasonable set of expectations for 1Q here?

Donald Maier

Yes, so first quarter is in line with our expectations. But as Jay covered, this is going to be a very challenging comp in Q1 coming on the heels of a 11% growth last year. And also having some significant drivers behind that, about a third of that growth as we had indicated back last year was related to pull ahead in load in. So it’s going to be a tough comp quarter, but I would say that right now it is firming up as we’ve anticipated.

And then, any comments you’d like to add?

John Jay Thompson

Yes, I’d just touch on the G&A side of things. And I mentioned that we were still ramping our standalone corporate G&A costs in the first quarter last year, so the overlap is tough from that standpoint. And then, the realignment benefits are going to benefit us later in the year, so we are not going to get that in Q1. So from a G&A standpoint as well as from a sales standpoint it’s a tough overlap.

Scott Rednor

Thank you.

Donald Maier

Thank you, Scott.

John Jay Thompson

Thanks, Scott.

Operator

Thank you. Our next question comes from the line of Jim Barrett with C.L. King & Associates. Please proceed with your question.

Jim Barrett

Good morning, everyone.

Donald Maier

Good morning, Jim.

John Jay Thompson

Good morning.

Jim Barrett

Good morning, Don. Can you talk a bit about your marketing and promotional programs and budgets for 2017? How will they compare to what the company invested in 2016?

Donald Maier

Yes. Well, we are continuing to be very encouraged by the results we are seeing from those investments. And so, we are doing everything we can to not only maintain that level of spend, but to increase where we can. And so our commitment to our retailers has really been solidified with our Elevate program. And additionally, with the Unite program that we mentioned, we are giving our distributors the tools and the economics they need to go drive the appropriate investments in the marketplace.

Jim Barrett

Okay. And in broad strokes the - could you give us some sense as to the level of price premium for Diamond 10 and your Pryzm introductions relative to the prior generation products in those categories?

Donald Maier

I don’t know that we’ve disclosed that. I can say it is a premium and it’s a significant premium for us. So obviously, that is something we’re not only enjoying on our LVT, both commercially and residentially, but look forward as well to have that be a key part of revitalizing our commercial sheet and residential sheet.

Jim Barrett

Thank you. And, Jay, any opportunities to on an absolute basis reduced working capital, or should we just assume that over the next few years, working capital moves in line with sales?

John Jay Thompson

I’d say it will increase with sales, Jim, but we’ll drive efficiencies. So it won’t increase as fast as sales. And one thing I would point out is, part of the inventories at yearend reflect the inflation throughout the year in 2016. But I would say, yes, working capital will grow but more slowly than sales.

Jim Barrett

Thank you, both.

John Jay Thompson

Thank you.

Donald Maier

Thank you.

Operator

Thank you. Our next question comes from the line of Stephen Kim with Evercore ISI. Please proceed with your question.

James Morrish

Hi guys, this is actually Trey on for Steve. We noticed that you saw quite a bit of manufacturing input cost benefits throughout the year and in your fourth quarter. Could you talk about how your outlook for both those input costs and manufacturing into shaping your guidance for 2017?

John Jay Thompson

Sure, Trey. So I mentioned that we are seeing year-over-year inflation in 2017, and we saw a benefit throughout 2016. We expect - across both of our segments, we expect the inflation to be about $8 million to $10 million year-over-year in 2017. And we’re working to combat that, but that’s what’s reflected in our 2017 guidance.

Stephen Kim

Hey, guys. It’s Steve Kim. I just jumped on. So if you could drill into that just a little bit more. We know that you talked about some price increases that you put through particularly on the Resilient side. I was curious as to whether or not you are optimistic that you would be able to see those price increases have an effect early enough to be able to offset inflation in 2017, particularly in the first half of the year or if you anticipate perhaps a first half that might be impacted by some input but then the back half would have any price recovery.

So if you could just give us a sense for the quarterly cadence that would be great.

John Jay Thompson

Hey, Steve, thanks for the question. So we’re optimistic at the commercial price increases that went into effect in February that will get realization consistent with what we historically have. And we’ve got a pretty good track record on the commercial side of the business of being able to get price. Input costs were lowest at the beginning of the year.

So as we move through the year, I expect that we will see some year-over-year margin pressure, which will ease as we get closer to the end of the year. So the pricing will go into effect as expected, but the benefit year-over-year will increase as we move through the year.

Stephen Kim

Okay. That’s great.

Donald Maier

Yes, Steve, this is Don. On the Wood side of the business, we’ve historically seen a lag in price moves with the input materials. And we, of course, enjoyed that in 2016 as lumber prices came down in the first half and we’re able to hold on to that.

We modeled into our outlook at a historic kind of delay and being able to get price amidst input cost changes for our Wood business, as built into our outlook.

Stephen Kim

Okay, great. Thanks very much guys.

John Jay Thompson

Thank you.

Operator

Thank you. There are no further questions at this time. I would like to turn the call back over to Mr. Don Maier for closing remarks.

Donald Maier

Well, great. Thank you, everyone, for joining us today. We truly do appreciate your continued interest in Armstrong Flooring. And we look forward to updating you on future calls. Have a great day.

Operator

Ladies and gentlemen, this concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation. And have a wonderful day.

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