Armstrong World Industries, Inc. — 2017 Q3 Form 10-Q Summary
Business context and reporting period
Armstrong World Industries is a global producer of ceiling systems for commercial, institutional and residential buildings. The filing covers the unaudited three and nine months ended September 30, 2017, compared with the corresponding 2016 periods. Results reflect the April 2016 separation of Armstrong Flooring, Inc. as a discontinued operation. On January 13, 2017, AWI acquired Tectum, Inc. for $31.4 million, adding acoustical ceiling, wall and structural solutions to the Americas segment.
Reportable segments are Americas, Europe, Middle East and Africa, and Pacific Rim. AWI also owns a 50% interest in Worthington Armstrong Venture, or WAVE, a suspension-system joint venture.
Financial performance and position
| Metric | Q3 2017 | Q3 2016 | 9M 2017 | 9M 2016 |
|---|---|---|---|---|
| Net sales | $351.9 million | $334.9 million | $998.1 million | $936.6 million |
| Gross profit | $110.9 million | $109.7 million | $321.3 million | $285.5 million |
| Operating income | $69.0 million | $71.0 million | $210.4 million | $144.3 million |
| Earnings from continuing operations | $43.5 million | $55.9 million | $115.8 million | $65.4 million |
| Net earnings | $49.4 million | $70.6 million | $121.1 million | $77.6 million |
| Diluted EPS from continuing operations | $0.81 | $0.99 | $2.14 | $1.16 |
| Diluted net EPS | $0.92 | $1.26 | $2.24 | $1.38 |
- Q3 revenue increased 5.1%; excluding a $5 million foreign-exchange benefit, growth was 3.7%, driven by $8 million of higher volume and $5 million of favorable average unit value.
- 9M revenue increased 6.6%, driven by $40 million of higher volume and $22 million of favorable average unit value.
- Calculated gross margin was approximately 31.5% in Q3 2017 versus 32.8% in Q3 2016, and 32.2% for 9M 2017 versus 30.5% in 9M 2016.
- Calculated operating margin was approximately 19.6% in Q3 2017 versus 21.2% in Q3 2016, and 21.1% for 9M 2017 versus 15.4% in 9M 2016.
- Q3 continuing-operations earnings declined primarily because of higher income taxes, pension settlement costs, lower WAVE earnings and China plant closure charges. The 9M comparison benefited from the absence of 2016 separation costs and lower interest expense.
- WAVE equity earnings were $13.9 million in Q3 and $51.9 million for 9M, down from $19.0 million and $57.0 million, respectively, primarily because of higher selling and administrative charges and, in Q3, higher steel costs.
- Q3 and 9M net earnings included gains from discontinued operations of $5.9 million and $5.3 million, respectively, largely reflecting tax benefits from the reversal of uncertain tax-position reserves.
Cash flow, debt and liquidity
- Cash provided by operating activities was $104.9 million for 9M 2017, compared with $2.6 million used in 9M 2016.
- Cash used in investing activities was $41.3 million, including $63.2 million of capital expenditures and the $31.4 million Tectum acquisition, partially offset by a $52.8 million return of investment from WAVE.
- Cash used in financing activities was $92.2 million, including $75.4 million for share repurchases and $16.8 million of long-term debt repayments.
- Cash and cash equivalents were $116.5 million at September 30, 2017, compared with $141.9 million at December 31, 2016.
- Total debt, including current installments, was $857.8 million at September 30, 2017, compared with $873.6 million at year-end 2016. No borrowings were outstanding under the revolving credit facility or accounts receivable securitization facility.
- The company reported $155.6 million of available letter-of-credit capacity, although the accounts receivable securitization facility showed $2.5 million of letters of credit above its stated limit, classified as restricted cash.
- AWI stated that cash on hand, operating cash flow and available credit facilities should be adequate for foreseeable liquidity needs. The company was in compliance with its debt covenants at September 30, 2017.
Material changes, outlook and unusual items
- Americas Q3 sales increased 3.5% to $233.8 million, while operating income decreased 1.5% to $67.6 million. The segment benefited from pricing and an environmental insurance settlement but was hurt by pension settlement costs, lower WAVE earnings, input costs and Tectum-related expenses.
- EMEA Q3 sales increased 3.1% to $76.5 million, while operating income declined 7.3% to $3.8 million. Nine-month operating loss improved to $1.1 million from $5.2 million.
- Pacific Rim Q3 sales increased 19.9% to $41.6 million, but the segment reported a $2.4 million operating loss versus $1.0 million of income. The loss included a $4.0 million accelerated depreciation charge related to the permanent closure of a previously idled China plant.
- Q3 included $20.8 million of U.S. pension plan settlement losses, recorded in cost of goods sold and SG&A. A $6.5 million environmental insurance settlement reduced cost of goods sold and SG&A by $5.0 million and $1.5 million, respectively.
- AWI repriced its Term Loan B in February 2017, reducing the LIBOR spread from 3.25% to 2.75%; maturity and other terms were unchanged.
- Management emphasized profitable global volume growth and improved international returns. The filing does not provide specific numerical revenue, earnings or EBITDA guidance.
- Risks include construction and economic conditions, raw-material and energy costs, competition, customer concentration, foreign-exchange exposure, WAVE performance, debt covenants and leverage, pension obligations, environmental liabilities, litigation and execution of productivity initiatives.
- Environmental liabilities recorded as probable and reasonably estimable totaled $5.2 million at September 30, 2017. Potential additional costs at several sites, including St. Helens, Macon and Elizabeth City, cannot presently be estimated and could be material.
- Roxul USA filed an antitrust lawsuit in September 2017 seeking unspecified damages and remedial measures. AWI considers the allegations without merit and intends to defend the matter.
- AWI repurchased 1.8 million shares for $75.4 million during the first nine months of 2017. After quarter-end, the company announced an additional $250 million repurchase authorization and extended the program through October 31, 2020.
Important facts for investors to verify
- Whether Q3 margin pressure from pension settlement costs, China closure charges and input costs persists after the one-time items.
- The sustainability of WAVE earnings and distributions, particularly given higher steel costs and increased administrative charges.
- Progress and returns from the Tectum acquisition and the company’s international growth initiatives.
- Year-end leverage, covenant headroom, scheduled debt amortization and the effect of variable interest rates.
- Final costs and potential insurance recoveries related to environmental sites, especially following Kaiser’s bankruptcy and ongoing remediation proceedings.
- The outcome and potential exposure from the Roxul antitrust litigation and other claims.
- Future effects of share repurchases on cash balances, leverage and diluted share count.
- Implementation of the new revenue-recognition standard, which management expected to have no material effect on the timing or amount of revenue but may expand disclosures.