Armstrong World Industries, Inc. — Q1 2013 Form 10-Q Summary
Business context and reporting period
Armstrong World Industries is a global producer of flooring products and ceiling systems for residential, commercial, and institutional construction and renovation markets. The filing covers the unaudited three months ended March 31, 2013, with results recast to exclude the cabinets business, which was sold in October 2012 and presented as discontinued operations. The company operated 34 manufacturing plants in eight countries and had approximately 8,700 employees at quarter-end.
Financial performance and position
| Metric | Q1 2013 | Q1 2012 | Change |
|---|---|---|---|
| Net sales | $622.3 million | $636.0 million | (2.2%) |
| Gross profit | $144.5 million | $140.0 million | +3.2% |
| Gross margin | 23.2% | 22.0% | +120 bps |
| Operating income | $47.0 million | $42.7 million | +10.1% |
| Operating margin | 7.6% | 6.7% | +90 bps |
| Earnings from continuing operations | $3.2 million | $19.0 million | $(15.8) million |
| Net earnings | $3.0 million | $18.2 million | $(15.2) million |
| Diluted EPS | $0.05 | $0.31 | Down |
| Cash flow from operations | $(14.0) million | $(32.9) million | Improved |
| Capital expenditures | $52.3 million | $34.4 million | +$17.9 million |
Sales declined primarily because of $16 million of lower volume, partially offset by approximately $11 million from favorable pricing and mix. Pricing actions contributed approximately $3 million and mix improvements approximately $8 million to the year-over-year sales comparison. The sale of the Patriot wood flooring distribution business reduced first-quarter 2013 sales by approximately $9 million compared with the prior year.
- Building Products: Sales were $292.8 million, down 3.4%; operating income was $59.3 million, up 37.0%.
- Resilient Flooring: Sales were $214.8 million, down 5.5%; operating income was $6.4 million, down 40.2%.
- Wood Flooring: Sales were $114.7 million, up 8.6%; operating income was $0.5 million, down 80.0%.
- WAVE joint venture: Equity earnings increased to $15.2 million from $13.6 million.
Cost of goods sold was 76.8% of sales versus 78.0% in the prior-year quarter. SG&A increased to $112.7 million, or 18.1% of sales, from $110.7 million, or 17.4%. The effective tax rate rose to 78.8% from 41.2%, primarily because valuation allowances reduced deferred tax assets associated with losses of certain foreign affiliates.
At March 31, 2013, cash and cash equivalents were $278.0 million, down from $336.4 million at December 31, 2012. Net debt, based on reported debt of $1,070.1 million less cash, was approximately $792.1 million. Total assets were $2.87 billion and shareholders’ equity was $734.8 million. The company had $250 million of revolving credit capacity, subject to applicable availability and covenants, and a $75 million accounts receivable securitization facility.
Material changes versus the prior comparable period
- Operating income improved despite lower sales, largely because Q1 2012 included approximately $15 million of accelerated depreciation and impairment charges related to the Mobile, Alabama plant closure and approximately $4 million of Marietta labor-contract settlement costs.
- Interest expense increased to $33.2 million from $11.2 million, principally due to a $18.9 million write-off of unamortized debt financing costs associated with the March 2013 refinancing.
- Resilient Flooring results were pressured by lower volumes and $5.2 million of severance and related costs for approximately 80 position eliminations in Europe and Australia.
- Wood Flooring sales benefited from higher volumes, promotional activity, share gains, and stronger new residential construction demand, but profitability declined because of unfavorable price and mix and higher labor and input costs.
- Cash use from investing activities increased to $37.3 million, primarily because of higher capital spending.
- The company refinanced its $1.3 billion senior credit facility, reducing the interest-rate spread from 3.0% to 2.5% and extending Term Loan A maturity to March 2018 and Term Loan B maturity to March 2020.
Guidance, outlook, commentary, risks, and unusual items
The filing does not provide a clear formal full-year revenue or earnings guidance figure. Management reported mixed market conditions: softness in North American commercial markets, continued weakness in European commercial markets, improving builder activity and modestly better renovation activity, positive commercial trends in China, and continued weakness in Australian commercial construction.
Management announced or implemented pricing actions in ceilings, grid, and wood flooring. A further wood flooring price increase was scheduled for the second quarter in response to higher lumber costs. Management stated that additional pricing actions may be implemented if raw material prices remain elevated or increase.
Management believes cash on hand, operating cash flow, credit lines, securitization availability, and the revolving facility will be adequate for foreseeable liquidity needs, including capital projects and scheduled debt payments. Five manufacturing projects have projected total spending of approximately $310 million; approximately $200 million had been incurred through March 31, 2013, with most remaining spending expected in 2013 and the balance through 2015.
- Debt agreements include interest coverage and leverage covenants. A year-end 2013 net leverage ratio of at least 3.5 to 1.0 could require prepayment of 50% of defined excess cash flow.
- The company was in compliance with all debt covenants during the first quarter.
- The company received a $15.2 million demand notice for alleged multi-employer pension withdrawal liability related to the cabinets sale. Management stated that the liability was not probable and estimable at quarter-end.
- Recorded environmental liabilities were $9.6 million. Additional remediation costs at the St. Helens, Oregon and Macon, Georgia sites cannot presently be reasonably estimated and could be material.
- First-quarter results included $5.2 million of severance and related costs and the unusual $18.9 million debt-financing-cost write-off.
- Asbestos-related personal injury claims are generally channeled to the Asbestos Personal Injury Settlement Trust under the company’s post-bankruptcy plan.
- Key continuing risks include construction-market downturns, raw-material and energy cost inflation, leverage and covenant constraints, foreign exchange and interest-rate changes, competition, labor issues, environmental matters, litigation, and execution of restructuring and capital projects.
Important facts for investors to verify
- Whether lower commercial-market volumes persist, particularly in Resilient Flooring and European and Australian operations.
- The effect of the refinancing on recurring interest expense after excluding the one-time $18.9 million financing-cost write-off.
- Compliance with the 3.0x interest coverage and applicable net leverage covenants, including the potential 2014 mandatory prepayment.
- Actual capital spending and cash generation relative to the approximately $310 million manufacturing-project plan.
- The outcome and potential cost of the $15.2 million multi-employer pension withdrawal claim and related indemnification obligations to the cabinets buyer.
- Developments at the St. Helens, Macon, Mobile, and Elizabeth City environmental sites, where additional costs may be material.
- Progress in improving Resilient Flooring and Wood Flooring profitability and whether announced price increases offset raw-material, labor, and energy inflation.
- The utilization and potential expiration of foreign tax credit carryforwards, including the $2.7 million expected to expire by the end of 2013 if unused.