Armstrong World Industries, Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; filed May 1, 2017. Results are unaudited and reflect continuing operations following the April 1, 2016 separation of Armstrong Flooring, Inc. AWI produces ceiling systems for residential, commercial, and institutional buildings through its Americas, EMEA, and Pacific Rim segments.
Key financial metrics
| Metric | Q1 2017 | Q1 2016 | Change |
|---|---|---|---|
| Net sales | $315.4 million | $287.4 million | 9.7% increase |
| Gross profit | $99.3 million | $84.3 million | 17.8% increase |
| Gross margin | 31.5% | 29.3% | Up 220 basis points |
| Operating income | $63.0 million | $21.6 million | Increase of $41.4 million |
| Operating margin | 20.0% | 7.5% | Up 1,250 basis points |
| Earnings from continuing operations | $30.8 million | $(7.1) million | Improved by $37.9 million |
| Net earnings | $30.4 million | $(9.9) million | Improved by $40.3 million |
| Diluted EPS | $0.56 | $(0.18) | Improved by $0.74 |
| Operating cash flow | $10.6 million | $(65.0) million | Improved by $75.6 million |
Revenue, operations, cash flow, debt, and liquidity
- Revenue growth was driven by higher volumes of approximately $22 million and favorable average unit value of approximately $8 million, partly offset by a $2 million unfavorable foreign-exchange impact.
- Americas sales increased 9.8% to $219.8 million, with operating income rising 19.8% to $67.2 million. EMEA sales increased 11.7% to $66.6 million, while its operating loss improved to $3.1 million. Pacific Rim sales increased 4.7% to $29.0 million, with a $1.1 million operating loss.
- Cost of goods sold declined to 68.5% of sales from 70.7%, primarily due to a $6 million reduction in U.S. pension expense. SG&A was $54.6 million, or 17.3% of sales, compared with $53.7 million, or 18.7%, in the prior-year quarter.
- WAVE joint-venture equity earnings were $18.3 million, compared with $18.1 million. WAVE reported first-quarter net earnings of $39.6 million on sales of $101.8 million.
- Interest expense declined to $9.2 million from $21.9 million, primarily due to the 2016 refinancing, lower debt and lower interest-rate spreads. The 2016 amount included a $10.7 million loss reclassified from accumulated other comprehensive income following settlement of interest-rate swaps.
- Cash flow from operations was $10.6 million. Capital expenditures were $25.3 million, cash paid for the Tectum acquisition was $31.4 million, and the company received $19.2 million from its joint venture.
- Cash and cash equivalents were $81.0 million at March 31, 2017, down from $141.9 million at December 31, 2016. Cash included $12.2 million in the U.S. and $68.8 million in foreign jurisdictions.
- Total debt was approximately $888.0 million, including $15.0 million of short-term debt and $32.5 million of current long-term debt. Total long-term debt, including current installments, had a carrying amount of $873.0 million and estimated fair value of $869.7 million.
- The company had a $1.05 billion senior credit facility, including a $200 million revolving facility, $600 million Term Loan A, and $250 million Term Loan B. It had $15.0 million drawn on the revolver and no borrowings under its accounts receivable securitization facility. Management stated that all debt covenants were satisfied at March 31, 2017.
- Available letter-of-credit capacity was reported at $153.0 million, although the accounts receivable securitization facility showed $3.0 million of letters of credit above its stated limit, classified as restricted cash.
Material changes versus the prior comparable period
- The year-over-year improvement reflects the absence of $27.1 million of AFI separation costs recorded in Q1 2016 and the absence of the $10.7 million interest-rate swap loss recognized in Q1 2016.
- AFI’s prior-year results are presented as discontinued operations. Q1 2016 included a $2.8 million net loss from discontinued operations; Q1 2017 included a $0.4 million net loss related primarily to disposal matters.
- AWI acquired Tectum on January 13, 2017 for $31.4 million. The acquisition added approximately $16.5 million of identified intangible assets and $9.0 million of goodwill and was included in the Americas segment.
- The company repurchased 1.2 million shares for $50.0 million during the quarter, reducing outstanding shares and contributing to the decline in cash.
- 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.
- Adoption of ASU 2016-09 increased retained earnings and deferred tax assets by $8.7 million on January 1, 2017. The adoption did not materially affect current-quarter operations or cash flow.
Guidance, outlook, risks, contingencies, and unusual items
- No specific quantitative earnings or revenue guidance is provided in the filing. Management expects continued focus on profitable global volume growth and improving returns in international operations.
- Management reported improving construction and renovation activity in the Americas, broad improvement in EMEA from a weak Q1 2016, continued challenges in Chinese commercial office markets, and improvement in India and Australia.
- AWI implemented ceiling tile and grid price increases across its regions and announced additional Americas grid price increases effective in Q2 2017. Raw materials, sourced products, and energy negatively affected Q1 operating income by approximately $1 million year over year.
- Material risks include construction and macroeconomic conditions, competition, customer concentration, raw-material and energy costs, foreign exchange, international operations, WAVE performance, debt covenants and liquidity, tax matters, pension obligations, labor, environmental liabilities, litigation, and execution of productivity initiatives.
- Environmental liabilities recorded were $5.1 million at March 31, 2017. Potential additional costs at the St. Helens, Macon, and Elizabeth City sites may be material, and insurance or third-party recoveries are uncertain.
- In April 2017, AWI entered into an $11.8 million settlement with the administrator of the DLW insolvency proceeding; the filing identifies an $11.9 million related contingent liability at March 31, 2017.
- The company believes available cash, operating cash flow, credit facilities, and remaining revolver capacity will meet foreseeable liquidity needs, but cash flow is seasonally lower in the first and fourth quarters.
Important facts for investors to verify
- Assess the sustainability of margin expansion after favorable pension-cost comparisons, the absence of 2016 separation costs, and other nonrecurring items.
- Monitor leverage, covenant compliance, interest-rate exposure, scheduled debt maturities, and the effect of variable-rate debt despite the Term Loan B repricing.
- Evaluate whether Tectum contributes expected revenue and profitability and whether acquisition-related goodwill and intangible assets create impairment risk.
- Track working-capital requirements and cash balances after the $50.0 million share repurchase and $31.4 million acquisition payment.
- Review environmental, DLW, tax, pension, and other legal contingencies, including potential costs exceeding recorded reserves or expected insurance recoveries.
- Confirm the impact of construction activity, pricing actions, foreign exchange, steel and other input costs, and continuing weakness in certain international markets.