Armstrong Flooring's (AFI) CEO Don Maier on Q2 2018 Results - Earnings Call Transcript

Armstrong Flooring Inc. (AFI) Q2 2018 Earnings Conference Call August 7, 2018 11:00 AM ET

Executives

Doug Bingham – Vice President-Treasury and Investor Relations

Don Maier – Chief Executive Officer

Ron Ford – Chief Financial Officer

Analysts

Keith Hughes – SunTrust

Michael Wood – Nomura

Alvaro Lacayo – Gabelli

John Baugh – Stifel

Justin Speer – Zelman & Associates

Operator

Greetings and welcome to the Armstrong Flooring’s Second Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. And as a reminder, this conference is being recorded.

I would now like to turn the conference over to, Doug Bingham, Vice President, Treasury and Investor Relations. Thank you. Please go ahead.

Doug Bingham

Thank you for joining us today for Armstrong Flooring’s second quarter 2018 earnings conference call. Today’s call is hosted by Chief Executive Officer, Don Maier; and Chief Financial Officer, Ron Ford. We trust you have seen our press release this morning. Additionally, a copy of the slide presentation to accompany this call is available on the Investors section of our website at www.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.

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

Don Maier

Thank you, Doug. Good morning, everyone, and thank you for participating on our second quarter 2018 earnings call. Today, I will discuss our operating highlights and business activity. Ron will then cover additional details on our financial results and outlook before I offer closing comments. After our prepared remarks, we will open the call to answer your questions.

I ask that you turn to Page 3, which provides some key highlights and updates. We are excited by our performance during the second quarter in which we grew sales, delivered incremental margins of nearly 50% and generated solid cash flow.

Net sales increased 3% in part driven by significant volume growth in Luxury Vinyl Tile, or LVT, which offsets sustained challenges in legacy categories. We also attained higher selling price in most product categories largely attributable to our pricing actions in April and May. These pricing actions were an important part of our efforts to mitigate the intensifying inflationary pressure evident across the entire flooring industry. These efforts, along with stronger productivity, our cost saving actions, such as our previously announced wood plant closures and SG&A savings, allowed us to grow adjusted EBITDA by 16% to $30 million while expanding adjusted EBITDA margins by 110 basis points to 9.7%.

Our free cash flow performance in the second quarter is aligned with our expectations to generate cash flow in 2018 consistent with recent years. With our strong liquidity and conservatively leveraged balance sheet, we are actively working to build value in our company through all avenues, and we are committed to investing in our business to generate solid returns.

I’ll now move to our strategic priorities on Page 4. We have a wide range of targeted initiatives in motion to further advance our strategic priorities. These priorities include LVT leadership, innovation, share of wallet with distributors, wood profit enhancements and revitalization of our legacy categories. These combined efforts are helping to improve our competitive position and drive transformative growth as we have demonstrated in the first half of 2018.

I will now share with you updates on our progress. In LVT, our new product introductions and expanded supply capabilities are driving consistent volume gains. As an example, we recently debuted our unleashed LVT product line, primarily for commercial customers. Unleashed is a thicker, flexible product, which covers minor subfloor imperfections and is quicker and more efficient to install, all of which we anticipate will gain the product rapid market acceptance.

Additionally, our other new LVT products, such as Prism, Alterna Planks, Rigid Core Elements, and Vantage SPC Rigid Core, collectively continue to drive higher sales in the marketplace. Beyond these products, we have an exciting pipeline in the next generation of LVT, and we plan to continue to invest in our broad and compelling portfolio of high demand products.

We are also investing in new products across each of our other categories. Innovations and durability and design is central to our strategy in all major Wood and Resilient categories. This is most evident in the rapid expansion of our proprietary Diamond 10 Technology, which is now available in five key product categories, which collectively represent over 80% of our sales.

In May, we announced our most recent launch of the Diamond 10 Technology on Vinyl Composition Tile, or VCT, which has gained strong market response helped by lower installation costs and enhanced scratch and stain resistance, leading to a lower total cost of ownership. These are all important features for VCT in any [ph] category within the overall hard surface flooring industry.

In distribution, we are focused on gaining additional share of wallet and aligning ourselves with partners, who are best positioned to support our growth strategy. Earlier in the year, we announced a change in our distributor partnerships, including a shift in direct marketing and merchandising efforts for our residential products, which is still on track to better serve customers at a lower cost. We are making good progress for distributors to begin providing their own merchandising in Q3, with the full transition to be completed by year-end in 2018.

This shift in responsibility will come with higher margins for our distributors, which will give them further incentive to expand their share of wallet with us while our distributors will have more flexibility to serve the unique needs of our important residential customers in their markets. We are excited to focus more of our marketing spend on commercial and national accounts, where we believe we can better leverage our scale.

In our Wood segment, we continue to work towards improving the segment’s margin profile, especially in engineered wood, where we have experienced sustained pressure from import competition, particularly at the low end. To counter these unfavorable economics, we recently introduced a new licensing model in which we believe we can unlock some of our strong brand value. Specifically, we are establishing a licensing program with a well known and trusted supplier, who will produce market entry-level engineered wood products through our distributors.

We do not currently have a product offering in this value segment, which is rapidly growing and as the program rolls out, we expect accretive benefits in 2019 in addition to our current source and manufactured models. While we will continue to manufacture sourced engineered wood, especially at the higher end, this additional license product will allow us to generate superior returns through more attractive EBITDA margins. We look forward to providing further updates on the growth and potential for this initiative on future calls.

In our legacy categories, we are actively revitalizing our product portfolio, improving capacity utilization and driving productivity at our plants to more effectively compete in our markets. In addition to the expansion of Diamond 10 Technology on the VCT that I mentioned earlier, we are excited about our recent launch of the completely refreshed heterogeneous commercial sheet offering called rejuvenations, which also features our Diamond 10 Technology. This should position us well in this important category. These efforts are driving stronger profitability and more productive selling efforts while moving us closer to our medium-term margin goals.

Overall, we are driving improvement across our products, channels and operations. This is made possible by our focus on innovation, which encompasses all facets of our business. We are determined to drive sales by providing an even more competitive lineup of winning products and to build partnerships throughout all channels by delivering exceptional service. Combined with our numerous initiatives to improve efficiency, Armstrong Flooring is poised to strengthen its position as the leader in hard surface flooring.

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

Ron Ford

Thank you, Don, and good morning to those on the call today. I’ll begin with a review of our financial results on Page 5. In Resilient, net sales were up 6.4% to $200 million, primarily due to strong growth in LVT and better price across many categories. And LVT we generated double-digit volume growth, resulting in a positive impact to sales mix. In our other resilient categories, we were pleased to see stronger pricing. This partially offset software volume due to continued competitive pressures. Additionally, similar to Q1, as planned, the migration of a portion of our laminate sales to a licensing model generated lower reported sales albeit at more attractive EBITDA margins for that category. This accretive laminate licensing transition will occur throughout 2018.

In Wood, net sales were down 3.1% to $106 million compared to the prior year quarter. The decline was a result of lower volumes in engineered wood. This was attributable to continued industry pressure at the low end from import competition, as Don mentioned. Solid wood volume was modestly higher helped by improved sales to major retail customers. We were especially pleased to see total adjusted EBITDA increased by 16% to $29.6 million compared to the prior year quarter. The increase was largely due to productivity gains, better pricing and lower manufacturing costs, including the benefits of previously announced wood plant closures. These positive factors more than offset intense inflationary pressures resulting in higher overall adjusted EBITDA.

To that point, our team collectively did a great job in overcoming the challenges presented by raw material inflation in our overall business. During the quarter, in Wood, we were able to more than offset inflation to a combination of better manufacturing costs, productivity, SG&A and pricing. This drove Wood segment adjusted EBITDA to $8.1 million compared to $1.5 million in the prior year quarter.

In Resilient, inflation more than offset the benefits of higher sales and stronger productivity, causing a modest decline in that segment’s adjusted EBITDA to $21.5 million. As we discussed on prior calls, we are experiencing cost increases in energy, transportation, raw materials and operating costs, which we expect to continue rising throughout the remainder of the year.

In response, during the second quarter, we announced several price increases and introduced freight and energy surcharges. This collectively resulted in better pricing for most categories. That said lumber costs had moved even higher as availability has further tightened. We have responded with additional price actions, including an announced 9% increase in solid wood products and a 3% increase in engineered wood, both effective in August 2018.

In response to continued inflation for Resilient raw materials and freight, we have also announced price increases of 3% to 5% on many Resilient products effective in October. We anticipate the impact of these pricing actions in Q4, combined with additional productivity gains and other cost savings, will help offset intensifying inflationary pressures.

Turning to our free cash flow and liquidity on Slide 6. During the first half of 2018, we generated $7 million of free cash flow. This compared to negative $13 million in the prior year period. The improvement is a reflection of more efficient management of networking capital along with our stronger earnings and lower CapEx spend in 2018. CapEx was below depreciation, which has an annual run rate of approximately $50 million. We ended the quarter with a strong balance sheet, consisting of $41 million of net debt. This places us conservatively below our longer-term target net leverage ratio of 1.5 to 2 times, which gives us the flexibility to invest in ongoing transformational initiatives and pursue additional growth opportunities.

Turning to our outlook on Slide 7. We were encouraged by our results year-to-date and the tangible results coming from numerous transformative initiatives, we remain confident in our outlook and reiterate our expectation to deliver adjusted EBITDA in the range of $70 million to $80 million for the full-year 2018. While we expect lumber and other input costs to remain considerable headwinds through year-end, as I mentioned, we believe we can offset the impact of these higher costs through price actions, cost savings and additional productivity gains.

Our sales outlook is also unchanged. For the full-year 2018, we continue to expect sales growth in the low single digits. We expect to continue to face growth challenges due to lumber availability and potential competitive responses to our pricing actions in this inflationary environment, especially in Q3.

In addition, our price increases to combat inflationary pressure take effect in Q4. Therefore, we anticipate that our growth and margin improvement in the second half will be weighted towards the fourth quarter as we focus on higher growth categories, product innovation and strengthened distribution partnerships.

Let me take a moment to discuss preliminary thoughts on the potential impact on our business from the recently proposed tariffs on flooring. We are primarily a domestic manufacturer, with three quarters of our sales in 2017 coming from product we produce. This model provides us a natural insulation from trade disputes. The two categories where we source a meaningful amount of product are engineered wood and LVT. In both of these categories, we believe, most peers source heavily from China. We have both oversee sourcing as well as domestic production in both.

So overall, we expect that any tariffs would impact us less than most of our competitors. We will continue to monitor trade developments and provide updates as appropriate. We continue to expect capital expenditures for 2018 to be in the range of $40 million to $45 million. Maintenance CapEx should be approximately 2% to 2.5% of sales, with the balance of the spending budgeted for high-return investments consisting of productivity projects with short paybacks or innovation projects where we expect a strong return.

On the P&L, our effective tax rate could change significantly quarter-to-quarter, but it’s worth remembering that we expect our full-year cash taxes to be zero as a result of federal NOLs. We anticipate that 2018 will be another year of positive free cash flow, in line with recent years.

With that, I will now hand the call back to Don for closing comments.

Don Maier

Thanks, Ron. I’ll ask that you to turn to Slide 8 please. I am very proud of the Armstrong Flooring team as we delivered better results in the second quarter and the first half of 2018. This was made possible by mixed benefits from our investments in LVT, Diamond 10 Technology and other product innovations, along with increased efficiency from capacity enhancements, strengthened distributor partnerships and cost reduction actions.

Additionally, stronger pricing in the second quarter in the face of continued inflation highlighted the strengths of our products and strategy. I am encouraged by our progress in 2018 and believe we are taking the appropriate steps to improve our overall business performance through our strategic priorities.

Innovation, expanded distribution and operating efficiencies are the cornerstone of our profitable growth trajectory moving forward. These collective actions reinforce our commitment to achieving a 10% EBITDA margin by 2020. We look forward on – to executing on all of our objectives as we build on our strong brand and market leadership to drive shareholder returns.

Operator, we are now ready to take questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. Our first question comes from the line of Keith Hughes with SunTrust.

Keith Hughes

Thank you. First question on – within wood. You have in the slide $6 million of manufacturing and input costs to the positive. Can you just split up what was the magnitude of the positive from manufacturing input cost [indiscernible] clearly up here in the quarter?

Ron Ford

Sure, Keith. As previously announced, we had plant closures late last year with an annual impact of $8 million to $10 million and previously announced SG&A actions with an annual impact – sorry, plant closures of $8 million to $10 million and SG&A actions with an annual impact of $10 million to $12 million. Those were executed in such a way that we saw those fall through pro rata in the quarter.

Keith Hughes

Okay. And so would that continue on a pro rata amount into the third, or was there some upfront quick savings again?

Ron Ford

No. We should continue pro rata throughout the year.

Keith Hughes

Okay. And so I can interpolate with the manufacturing input, but from your prepared statements, it’s clear those costs have gone up sequentially from the second to the third. Is that correct?

Ron Ford

What I would say is that we – one of the benefits we had in Q3 is a terrific performance by our operations organization and strong productivity in the quarter, which also added to the improvement in our Wood results in the quarter.

Keith Hughes

Yes. And so that the costs, I think you telegraphed in your statement had accelerated and it will take till the fourth quarter to be able to cover those, is that correct?

Ron Ford

Correct.

Keith Hughes

Okay. And then switching back to Resilient real quick, you had some nice revenue growth in the quarter. Looks like it’s primarily units. Have we now gotten to the point given the size of LVT within your business and its growth in the market, are we going to switch and see just from a relative size standpoint and be able to drive more consistent top-line growth in this segment to one degree or the other in subsequent quarters?

Don Maier

Yes. Keith, this is Don. We did see in the first half nice improvement in volume, as you noted, but also in price realization and mix growth. And those were all pretty evenly distributed. As we look forward, as you know, we've been working on the legacy parts of our portfolio that have been a kind of a counter force to the significant growth that we've been able to drive in LVT and, most recently, in VCT. And as those categories, res sheet and engineered wood in particular, the actions that we're taking are beginning to soften the headwinds that we get from them. And that's allowing the growth to come through the P&L. So we are encouraged to see that trend continue in Q2 here, and that was a key driver to our 3% growth for the quarter.

Keith Hughes

Okay. Thank you.

Operator

Our next question comes from the line of Michael Wood with Nomura. Please go ahead.

Michael Wood

Hi, good morning.

Don Maier

Hi, Mike.

Michael Wood

I’m not sure if I heard. Can you give the LVT growth rate that you saw in the quarter?

Don Maier

So, Mike, we didn’t give the detail to that level. I would say that we continue to be pleased with our growth relative to where we believe the market is at. We have in particular seen strong growth in the Rigid Core and SPC categories, where we have put up tremendous amount of our effort in new product development into.

Michael Wood

And did you have any sourcing issues to note like one of your large competitors in LVT? And I'm curious if you are aware or know of any supply changes ahead of potential tariffs later this month in any of your products?

Don Maier

So, I think just what we saw was actually our growth exceeding kind of our inventory positions collectively between our distributors and our warehousing. And so our supply base in China did a phenomenal job in responding to that, and we feel good about having the inventory built to support the business, not only in the quarter, but moving forward here.

Michael Wood

Got it. And can you also break out the $4 million year-over-year manufacturing input cost decline in Resilient? Was that primarily the input costs? Or was there any manufacturing efficiency changes in that number?

Ron Ford

Yes. There were both, principally manufacturing efficiencies. As you'll recall, our Lancaster LVT plant was less than optimal this time last year, and our folks have done a great job improving the performance there. And that's contributed a significant amount to our overall productivity.

Michael Wood

Great. One last question. With the licensing changes you're making in engineered, is there any plant closures or changes happening related to that?

Don Maier

Mike, the target for the initial tranche of products that we'll be licensing is a price point that we're not currently serving, so this should be incremental to the overall business. Obviously, we will monitor and give more updates on that program as it develops. And we have intentions for it to work its way up in through the line.

Michael Wood

Great. Thank you.

Operator

Our next question comes from the line of Alvaro Lacayo with Gabelli.

Alvaro Lacayo

Good morning, guys.

Don Maier

Hi, Alvaro.

Ron Ford

Hi, Alvaro.

Alvaro Lacayo

So, I guess, I had a quick question if maybe you could provide some commentary around just what you've been seeing from a domestic industry capacity standpoint in terms of what's been coming online and then what categories, what potential impact that could have on pricing. And in terms of additional tariffs in the flooring space, I think you have some competitors that are for it and some that are against it, maybe if you could sort of highlight what your stance is in terms of where you stand there and then maybe talk about pricing dynamics in those categories that are more sourced than manufactured LVT and engineered wood.

Don Maier

Sure. I’ll take the last part of your question first. We pretty much manufacture in the regions where we sell our products. And as you know, over the past several years, we've on-shored production of both engineered and – engineered wood and LVT into domestic capacity. And as we've announced, we continued to invest behind that and are focused on establishing Rigid Core and SPC capabilities domestically as well. In its total sense, about 25% of our 2017 sales were sourced outside the U.S. that's largely related to engineered wood and LVT, as we had discussed. However, as we noted, we also do have domestic capacity for those here as well for both product categories. The – where the tariff actually lands, what products are included, what the rate is, when is it implemented are all undetermined at this point in time. We have taken a view as to what we think that outcome will be, and we believe that our guidance range will cover any variability that would be in there, but I think our exposure is maybe less than many of our competitors in the industry. Look, our position has and will continue to be to support fair trade around the globe. However, as it relates to this particular tariff, we're going to leave that to the policymakers and not take an official position one way or the other. And we do support the intent behind it, which is to create that level playing field around the globe. Concerning capacity, I will – I'll defer on any competitive announcements on capacity to them. We continue to be very focused on our next tranche of capacity domestically here, focused on Rigid Core. As we've indicated, we think we have an ability to repurpose some of our existing assets combined with some breakthroughs on the chemistry and material side to give us that capability with a very capital-light approach and to yield a product that has got a very favorable cost profile.

Alvaro Lacayo

Great, thank you. And then can you walk me through the numbers? So going into the year, you had about $25 million in different programs and savings. How much of that was realized in the first half versus expectations for the second half? And then just on working capital, looks like it's been coming down year-on-year. Maybe if you can update us with the plant closures and the licensing and all that, what that means for working capital as a percent of sales and then how you guys think about that flowing into free cash flow?

Ron Ford

Sure. So, let me take your latter part of the question first, which is our indications are as they have been that our – for the year, our free cash flow should come in line with recent years. And we still believe that while we did generate a substantial more working capital, free cash flow in the first half this year versus last year, there are a couple of reasons for that. One is because of a particular transaction that was happening about midyear last year, we were building inventory and consuming working capital. We're not lapping. So we're lapping that this year. Secondly, the demand for our LVT products is so strong and building that we anticipate building more inventory to meet customer demand in the second half of this year. So we're – therefore, we're – so reaffirming our guidance relative to free cash flow for the entire year.

Back to your first question, which is relative to, as we said, the building blocks that we laid out for our plan for this year, we get you somewhere in the neighborhood of $26 million worth of improvements, that being plant closures, SG&A reductions, et cetera. We've experienced – we're very pleased with the experience that we've gotten from those perspectives for each of those initiatives. Those – against those were some headwinds, including some inflation that we anticipated as well as the reinstatement of incentive compensation this year, which we hope to achieve – plan to achieve. And so all of those actions as evidenced by our numbers are on plan, and we're pleased with them.

Alvaro Lacayo

That $26 million, do you have a number on how much has been realized in the first half?

Ron Ford

I would – it’s reasonable to assume it's pro rata.

Alvaro Lacayo

Perfect. Thank you very much.

Operator

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

John Baugh

Thank you. And congrats on your progress to-date, it’s nice to see. I was wondering on VCT quickly. Are we fully lapped in the June quarter? Any acquisition changes there? And give me a flavor if we haven't, what the pro forma? I assume VCT pro forma is still down in volume, but there were a lot of cost saves, and maybe that's captured in the $26 million number, I don't know, but I'm trying to get a flavor for how that transaction is working for you.

Don Maier

Thanks, John. So yes, you are correct, the Mannington acquisition and the resulting impacts were – are included in the building blocks that you referenced on the $26 million. What we had indicated and I would say we can reaffirm is that the pro forma revenue from that was right around $20 million and that the flow-through on that was at the high end of our margin flow-through of about 30%. And so we're still pleased with that acquisition, and we're pleased with the growth that we're seeing that comes with that. We have seen some in some regions some competitive response on VCT, and we've taken appropriate actions to make sure that we defend our share in those markets.

John Baugh

Okay. And if I heard it, it sounded like there were some revenue pressures more so in Q2 than what you expect in Q4. And then also, I don't know how to think about revenue growth in Q3 versus Q2. Very pleased to see the growth in Q2. Did I hear that wrong? And what – I think you referenced your concern about price increases perhaps impacting. Just kind of curious whether you can give a little more detail around precisely what you’re seeing and why you made those comments.

Ron Ford

Sure. It’s Ron. I’ll just – I’ll give you some building blocks and – which may be helpful. We have affirmed that we expect to have revenue growth in the low single digits for the year. You can calculate what our revenue growth is in the first half of the year. Going into the second half of the year, there are, as Don mentioned, some market competitive dynamics, which we’re considering. There are other factors, including the timing of inflation and the timing of price increases. There are other factors, which include on the Wood side, as we discussed some availability of wood, which we have to consider in our timing. So as we think about all of those things and more and we look at our second half outlook, we would tend to – it appears to us as though more of our growth than we might have originally expected will come from Q4.

John Baugh

Okay. That’s helpful. And then I don’t know, if I remember this correctly, but in the past, I recall some vague reference to sort of what percentage of all your sales were legacy and what were growing. And if I don’t remember that correctly, I apologize. But I’m curious, Don, whether there’s any kind of back to Keith’s question, where are we in the balance of stuff that’s shrinking versus stuff that’s growing in terms of impacting revenue? Any help there?

Don Maier

I’m trying to think how I can provide something that’s useful for you, John. The bottom line is we have continued to see very strong growth in LVT. We have experienced nice growth through our commercial product offering. And with the Mannington acquisition, nice growth in VCT. The counter balance to that has really been residential sheet, which we indicated is now less than 10% of our sales. And so the, I guess, the curve is starting to get a bit acidotic, if you will, in that category, although I would say there’s still pressure and there’s still industry dynamics that need to be address. There’s structurally, just way too much capacity against a backdrop of demand shifting over to other categories like LVT. And then the other pressure point is on the engineered wood and as you saw a continued progress in the quarter on engineered wood and we’re excited about the licensing model that’s going to further bolster our profitability in that category, and we enjoyed some modest growth on the solid side, which has got a very favorable profitability view to us.

John Baugh

Okay. And then my last question is just on the distribution changes and the support changes that you outlined earlier in the year. It sounded like they’re going through as planned, and we’ll see a sort of transitioning here in Q3 and then done by the end of Q4. I’m assuming you’re on path with sort of the cost elements as it relates to Armstrong Flooring on that project. My question is what, if any, reaction have you seen from your distributors to date? I’m thinking more about revenue there. Obviously, you’ve talked about how you can offer them a higher product margin, but now they have to bear certain costs. I’m just curious as to what they’re seeing or indicating to you.

Don Maier

Yes. So, first of all, we are absolutely on track, and there are – it’s a tremendous amount of work, but no issues with the time line and where we’re at in that process. It’s important to note, this is something we’ve been working on collaboratively with our distributors, frankly, for close to 2.5, maybe even three years. So they’re an integral part of the overall strategy, and they are equally excited about the flexibility that it’s going to provide them to actually even provide better service to our retail customers.

So the – there have been recently a number of planning sessions with representatives from our distributor partners. And I would classify those meetings as comments like best meeting we ever had. Very excited about where this is going to take us and what it’s going to provide us. Still work to do, but I think there’s tremendous alignment between our team and our distributors teams in working through this realignment.

John Baugh

So Don, there might be some, I don’t know, shelf space wins and some shelf space losses. But in terms of revenue, with your distributors as it relates to this change, you haven’t really seen much of an impact? Or are you trying to tell us that you think you’re going to have a favorable impact of revenue?

Don Maier

So, first of all, we’ve supported all of the launches and merchandising efforts, really, really heavily focused on the spring season, but that’s continued through Q2, and we continue to support that. At the same time, our distributors have been ramping up on their side of the equation. And so I think the flexibility and the positive impacts that we’ll see with the retailers in the top line that, that we’re comping to that is really a back end, if not 2019 story. Certainly, the efficiencies and elimination of redundancies and cost benefits, those are ramping through the course of 2018.

John Baugh

Thanks for taking my questions. Appreciate it. Good luck.

Don Maier

Thanks John.

Operator

And our next questions come from the line of Justin Speer with Zelman & Associates. Please go ahead.

Justin Speer

Thank you, gentlemen. Appreciate it. Can you help us distill those cost bucket that maybe on a segment basis, how to think about maybe the EBIT contribution for these segments from the plant closures and the SG&A initiatives that you expressed and how to think about that going forward?

Ron Ford

Sure, Justin, thanks for the question. Keeping in mind that the two plant closures were wood plant closures. You can pretty well park that in that garage [indiscernible] and then the SG&A savings I consider on a roughly right of revenue – proportional to revenue basis.

Justin Speer

Okay, perfect. And thinking about that wood piece of the business and thinking about this licensing arrangement that you expect to generate more attractive, I think you said attractive EBITDA margins associated with this. Maybe help us think about how to model for that from both a revenue standpoint and from a cost standpoint, or maybe help us understand the economics behind that arrangement.

Don Maier

Yes. I’ll take a little bit of approach to see if you have a better understanding of the model, and then Ron, you can sprinkle anything else that you would like on the economics. But this is the same model that we deployed last year on our laminate business. What we are doing is we have partnered with one of our existing suppliers, and we will be licensing them access to our Bruce brand and selling directly to our distributor partners and to our distributor partners only. We get a royalty and are not involved in the transaction, so there’s no revenue that is recognized by us. So it’s a pure licensing royalty model, and this then gives access to the brand to our distributors at an acquisition price that allows them to be much more competitive in the market.

Much of this product is sold through the builder channel, but not exclusively, and as important to be able to get your base grade positioned in the model homes such that you then have the upsale opportunity to our higher margin products. So we’re in the process of rolling this out with distribution. There will be minimal impact in 2018, but we expect that to be a significant driver as we exit Q4 2019 and plugging this hole and a gap in the product offering that we’ve given our distributors, getting the upsale and the incremental EBITDA that comes from the royalty.

Justin Speer

Do you have an estimate in terms of the royalty streams? And is that – is there an offset from the underlying EBIT run rate that will be, I guess, transitioned to a royalty stream that makes it a net number? Or maybe give us the kind of a gross feel versus a net feel from the profit contribution from the transaction.

Ron Ford

I think, I can help you there it’s just a little bit Justin, the – so in terms of our sourced wood we’re taking licensing some subset of that. Arguably, the lowest margin sourced wood products that we have as we’re dealing with our anchors. We wouldn’t be doing that unless it was incremental to EBITDA, so that should be helpful. And in total, our total sourced wood is less than 5% of our revenue.

Justin Speer

Perfect. And then I just following up and thinking about this drive towards 10% midterm EBITDA margins. In view of all these moves that you’ve made, is there a required revenue run rate that you have to be at to achieve that? Or do you think you can get there through efficiency moves? And I understand there’s a lot of moving pieces here from a macro – company standpoint, but just thinking about that ambition to drive to 10%, maybe help investors and the market understand what you’re thinking about as you march towards that ambition.

Don Maier

Yes. So I’ll take that one Justin. We’ve established, if you will, playbooks for all sorts of different potential market and revenue scenarios. Clearly, we feel very good about a lot of the self-help work that we’ve done with our cost structures, plant footprints et cetera as we discussed. The piece that we’ve really been chasing is to get the top line growth to be part of that story as well. And I would say as we’re looking at 2018, we’re encouraged by the progress that we’re seeing there, largely driven by our investments in new products and innovation. So that’s providing the growth backdrop.

And I’m particularly pleased in the quarter that you saw the team be able to deliver those growth results and margin expansion against a backdrop of rather significant inflation. And I feel good about our performance versus our peers in that area, so that gives me confidence as we look to our guidance for the back half of the year.

Justin Speer

I’m thinking more of that 10% number that you – I realize it – we’re talking in intermediate term, but to give maybe some context on – as you think about all those different scenarios, is there a range of revenue outcome that you require in order to hit that on a consolidated basis, that 10% number versus where you sit today.

Don Maier

So what we’ve disclosed is that we see top line growth as being an important element to getting there. However, we do have other levers throughout the P&L as we’ve described that are pressure relief valves should we not see the growth that we aspire to. We haven’t provided specific guidance around that.

Justin Speer

Thank you very much. Appreciate your time.

Don Maier

Absolutely. Thanks Justin.

Operator

Thank you. This concludes our question-and-answer session. I would like to turn the call floor back to Don Maier for closing remarks.

Don Maier

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

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.