ARMSTRONG WORLD INDUSTRIES INC quarterly report, Q3 FY2013

Armstrong World Industries, Inc. — Form 10-Q Summary

Business context and reporting period

Armstrong World Industries, Inc. is a global manufacturer of ceiling systems and flooring products, operating through Building Products, Resilient Flooring, and Wood Flooring segments. The filing covers the three and nine months ended September 30, 2013, with comparative periods ended September 30, 2012. Results are unaudited and presented under U.S. GAAP. The cabinets business is classified as discontinued operations.

Financial performance and position

Metric	Q3 2013	Q3 2012	9M 2013	9M 2012
Net sales	$729.7 million	$694.7 million	$2,058.6 million	$2,006.1 million
Gross profit	$179.9 million	$186.9 million	$488.7 million	$497.5 million
Operating income	$93.6 million	$108.6 million	$208.2 million	$228.9 million
Earnings from continuing operations	$55.9 million	$74.0 million	$89.7 million	$135.2 million
Net earnings	$50.4 million	$62.9 million	$83.3 million	$122.9 million
Diluted EPS	$0.85	$1.05	$1.39	$2.05

Q3 sales increased 5.0%; nine-month sales increased 2.6%. Operating income declined 13.8% in Q3 and 9.0% for the nine months.
Approximate gross margin was 24.7% in Q3 and 23.7% for the nine months, versus 26.9% and 24.8%, respectively, in the prior-year periods. Approximate operating margin was 12.8% in Q3 and 10.1% for the nine months.
Higher raw-material, sourced-product, energy, labor, and production costs reduced operating income by $12 million in Q3 and $28 million for the nine months versus 2012.
SG&A was $103.0 million in Q3 and $326.9 million for the nine months, up from $94.0 million and $312.6 million, respectively.
The effective tax rate rose to 31.8% in Q3 and 41.6% for the nine months, from 22.0% and 29.1%, primarily because of valuation allowances related to foreign affiliates and the absence of a favorable 2012 foreign tax credit valuation allowance release.
Operating cash flow was $161.7 million for the first nine months, compared with $141.1 million in 2012. Capital expenditures were $139.9 million, producing approximate operating cash flow less capital expenditures of $21.8 million.
Cash and cash equivalents declined to $137.7 million at September 30, 2013, from $336.4 million at December 31, 2012.
Total debt, including current installments, was $1,067.6 million; shareholders’ equity was $579.6 million.
The company held $137.7 million of cash, including $26.4 million in the U.S. and $111.3 million internationally. It also reported a $250 million revolving facility, a $75 million receivables securitization facility, and $72.0 million of outstanding letters of credit.

Material changes versus the prior comparable period

Segment performance: Building Products sales rose 2.9% in Q3 and 2.0% for the nine months, while operating income increased 6.9% and 18.4%. Resilient Flooring sales were essentially flat in Q3 and down 1.9% for the nine months, with operating income down 11.1% and 19.5%. Wood Flooring sales increased 20.9% in Q3 and 13.6% for the nine months, but operating income fell 80.7% and 81.2% because of higher lumber, labor, manufacturing, and input costs.
Sales benefited from higher volume and favorable price and mix, but were negatively affected by the divestiture of the Patriot wood flooring distribution business.
The company refinanced its $1.3 billion senior credit facility in March 2013. Interest-rate spreads declined from 3.0% to 2.5%, and maturities were extended to 2018 for Term Loan A and 2020 for Term Loan B. The refinancing generated an $18.9 million write-off of prior debt financing costs, contributing to higher nine-month interest expense.
During Q3, the company repurchased 5,057,382 shares for approximately $260 million, funded with cash and borrowings. The shares were placed in treasury; the company did not have a share-buyback program.
Discontinued operations included a $7.5 million liability for a potential multi-employer pension withdrawal obligation related to the cabinets divestiture. Net loss from discontinued operations was $5.5 million in Q3 and $6.4 million for the nine months.
The company sold its previously idled Mobile, Alabama facility and recorded a $3.8 million pretax gain.

Guidance, outlook, commentary, risks, and unusual items

Management reported improving residential markets, especially builder activity, but continued softness in commercial markets, particularly education and healthcare. Australia remained weak, while selected markets in China, India, and Southeast Asia improved.
Management stated that additional pricing actions may be implemented if raw-material prices remain elevated or increase. No specific earnings or revenue guidance was provided in the filing text.
Management expects cash on hand, operating cash flow, credit facilities, and receivables securitization capacity to meet foreseeable liquidity needs. However, debt agreements impose interest-coverage and leverage covenants, as well as potential mandatory prepayments beginning in 2014 if the applicable net leverage test is met.
Capital projects were projected at approximately $310 million in total, with approximately $225 million incurred through September 30, 2013. A Lancaster, Pennsylvania luxury vinyl tile expansion was approved with projected spending of approximately $40 million through 2015.
Key risks include construction-market weakness, raw-material and energy inflation, pricing pressure, customer concentration, labor disputes and expiring collective bargaining agreements, foreign exchange and commodity volatility, leverage and covenant restrictions, environmental liabilities, litigation, and execution risks associated with manufacturing investments and cost initiatives.
Environmental liabilities considered probable and estimable totaled $7.7 million at September 30, 2013. Potential additional remediation costs at the St. Helens, Oregon and Macon, Georgia sites could be material, although the company could not reasonably estimate them.
The filing states that all asbestos-related personal injury claims against AWI are channeled to the Asbestos Personal Injury Settlement Trust, and the Chapter 11 case was resolved and closed in 2006.
Management concluded that disclosure controls were effective and that no material change occurred in internal control over financial reporting during the quarter.

Most important facts for investors to verify

Whether higher raw-material, lumber, labor, and manufacturing costs continue to compress margins, particularly in Wood Flooring.
Compliance with the senior credit facility’s interest-coverage and net-leverage covenants and the potential for mandatory excess-cash-flow prepayments.
Liquidity after the $260 million treasury-share purchase, planned capital expenditures, seasonal working-capital needs, and scheduled debt payments.
The ultimate amount and timing of the $15.2 million claimed multi-employer pension withdrawal liability, including the outcome of arbitration.
Potentially material environmental remediation costs not yet estimable at St. Helens, Macon, and other sites.
Progress, remaining costs, and returns from the manufacturing expansions and Lancaster luxury vinyl tile project.
Whether commercial construction conditions, foreign exchange movements, and residential market improvement develop as management expects.