Armstrong Flooring Inc (AFI) Q1 2019 Earnings Call Transcript

While we are not pleased with our first quarter results, we made encouraging progress on several fronts. During the quarter, we continued to drive innovation and bring new products to the market. We also realized higher selling prices and productivity gains which helped partly offset input cost increases. While input cost increases are likely to remain higher on a year-on-year basis, we are seeing cost pressures moderate on a sequential basis and we took additional price actions in April.

Following the sale of our Woods business in the fourth quarter, we have achieved the number of planned reductions in overhead to right-size our operation as a purely resilient company. We have worked closely with our customers to maintain strong relationships and exceptional levels of service with the transition to a purely resilient company. All of these factors support our confidence in a more favorable operating environment as we move into the back half of 2019. We have a strong portfolio of award winning products and our team is committed to expanding it's leadership positions in the resilient flooring industry. We are working to improve our growth trajectory and augment our margin profile.

Our actions are primarily focused on LVT leadership, differentiated innovation, strengthened distribution partnerships, and leveraging our strong position in commercial channels. In LVT, we continue to energize our market presence through a steady stream of new products, including a comprehensive set of cutting edge LVT products. We have also refreshed our Alterna, Elements, Rigid Core, Vantage and other product lines. Overall, we remain excited by our growth prospects in this attractive category.

Looking at innovation across our broader set of categories; advances in design, durability, installation, maintenance and material composition remain key to our success. Our proprietary award-winning Diamond 10 Technology, continues to have good traction with customers in all of our key categories. Our innovation pipeline remains strong and we plan to continue to invest in our broad portfolio of compelling high demand products.

In distribution, as I mentioned earlier, we have experienced a seamless transition to a purely resilient relationship. Additionally, our 2018 go-to-market pivot to focus on commercial and national accounts is progressing well and aligned with the weighting of our portfolio toward the commercial end-market. Through all of these efforts, our team is dedicated to improving our operational performance in all categories through innovation and cost efficiencies to more effectively grow our market presence. We have a strong balance sheet to invest in growing our resilient categories to take advantage of significant opportunities ahead.

Combined with our focus on rationalizing costs and streamlining processes, we believe that we are making progress to strengthen our position as a leader in resilient flooring.

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

Doug Bingham -- Senior Vice President & Chief Financial Officer

Thank you, Larry. I'll begin with the review of our first quarter results on Slide 5. The first quarter 2019 net sales were down 13.8 % to $142 million as compared to $164 million in the prior year quarter. The decrease in net sales was largely due to unfavorable mix and lower volumes in almost all product categories, including residential LVT. Our first quarter volumes were affected by distributor destocking and soft end-market conditions, along with wet weather in many regions of the U.S. These dynamics were particularly acute in our residential categories; this was partially offset by overall higher selling prices in response to inflationary pressure. Changes in currency exchange rates had an unfavorable impact of 120 basis points year-over-year.

In the distributor channel, which represents three quarters of our sales, customers continued to work down inventory levels from unusually high levels at year-end. As we explained last quarter, many distributors stocked up inventory in the third quarter 2018 ahead of U.S. tariffs on Chinese imports, implemented on October 1. The subsequent delay and general uncertainty around further tariffs have created a temporary departure from normal seasonal buying patterns since that time. While inflation in reported results is likely to continue to be higher year-over-year, we have experienced a moderation in input cost increases on a sequential basis compared to the fourth quarter, which is encouraging. Our price increases that went into effect on October, 1 have allowed us to partly blunt the impact of inflation due to tariffs and other input costs. We have implemented additional price increases of 4% to 6%, based on inflation and freight in select commercial and residential products, effective on April 1.

Our first quarter 2019, adjusted EBITDA was breakeven as compared to $10.6 million in the first quarter of 2018. The decline in adjusted EBITDA was primarily due to input cost inflation pressure, lower net sales, and higher SG&A spend; partly offset by improved productivity. Higher report of SG&A spending was primarily driven by the timing of a benefit of $4.3 million related to customer reimbursements in the prior year quarter which did not reoccur in the first quarter 2019. During the first quarter, we experienced an operating cash outflow of approximately $63 million compared to an outflow of approximately $5 million in the same period last year. As we mentioned on our last call, in the first quarter 2019 we rebuilt working capital off year-end lows and also experienced normal seasonality of first quarter gas usage.

For the quarter we invested $9 million in CapEx which remained below our run rate depreciation. In our financing activities, we've paid down the $25 million of outstanding borrowings on our revolving credit facility. We ended the quarter with a strong balance sheet and net cash position. We have announced that our current unused share repurchase authorization has been set at $50 million; this is in addition to the $41 million that we have already deployed. This will allow us to return excess capital to shareholders, while still preserving flexibility to invest in initiatives and growth avenues that make sense for our business. Our capital allocation objectives remain unchanged with our focus on maintaining the business, funding internal growth initiatives and pursuing M&A opportunities that support our growth strategy.

Moving to our full year outlook, based on our first quarter performance and the likely challenging remainder of the first half, we are moderating our full year expectations. For the full year 2019, we now anticipate adjusted EBITDA to be in the range of $50 million to $58 million. We expect energy, transportation, raw materials, operating costs and tariffs to be a headwind on our P&L in 2019, despite some moderation and costs on a sequential basis. We expect that the impact of pricing actions, productivity gains, and other cost savings will help to offset these continuing inflationary pressures. Additionally, activity in our end-markets, particularly in residential, have improved in recent months, which is encouraging. With this in mind, we continue to expect full year EBITDA to be heavily weighted toward the second half of 2019 as the market strengthens in elevated inventory levels in the channel where we're down (ph).

On the P&L, our effective tax rate could change significantly quarter-to-quarter. We continue to expect our tax rate to be approximately 25% in 2019. In regards to cash flow, we expect capital expenditures of approximately $30 million for the year. Maintenance CapEx should continue to approximate 2% to 3% of sales with the balance of the spending budgeted for high return investments. While we are not providing a full year 2019 free cash flow outlook, the majority of our 2019 working capital investments were planned for the first quarter and we expect to build cash as we progressed through the year.

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

Larry McWilliams -- Chairman

Thanks, Doug. As we have discussed today, while the year is off to a challenging start, we believe we will experience a better operating environment in the second half. I along with the entire Armstrong Flooring team are committed to improving our business through our efforts to grow share in LVT, enhance innovation across our award-winning portfolio, strengthen our distribution partnerships, and leverage our leadership position in traditional, commercial categories.