Armstrong World Industries, Inc. — Q2 2017 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2017. Results are unaudited and reflect continuing operations of the ceiling-systems business following the April 1, 2016 separation of Armstrong Flooring, Inc. The company operates through Americas, EMEA, and Pacific Rim segments.
Financial performance and position
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|
| Net sales | $330.8 million | $314.3 million | $646.2 million | $601.7 million |
| Gross profit | $111.1 million | $91.5 million | $210.4 million | $175.8 million |
| Operating income | $78.4 million | $51.7 million | $141.4 million | $73.3 million |
| Earnings from continuing operations | $41.5 million | $16.6 million | $72.3 million | $9.5 million |
| Net earnings | $41.3 million | $16.9 million | $71.7 million | $7.0 million |
| Diluted EPS | $0.77 | $0.30 | $1.32 | $0.13 |
- Sales increased 5.2% in the quarter and 7.4% year to date. Excluding foreign exchange, sales growth was 6.1% and 8.2%, driven by higher volumes and favorable average unit value.
- Gross margin was approximately 33.6% in Q2 and 32.6% year to date, versus approximately 29.1% and 29.2% in the comparable periods. Cost of goods sold benefited primarily from lower U.S. pension expense.
- Operating margin was approximately 23.7% in Q2 and 21.9% year to date, compared with approximately 16.4% and 12.2% in 2016.
- SG&A expense declined to $52.4 million from $55.8 million in Q2 and to $107.0 million from $109.5 million year to date.
- Interest expense declined to $9.2 million from $12.5 million in Q2 and to $18.4 million from $34.4 million year to date. The 2016 comparison included refinancing costs and a $10.7 million interest-rate-swap loss.
- Effective tax rates were 40.8% in Q2 and 42.4% year to date, versus 59.8% and 79.4% in 2016, when separation-related effects adversely affected tax expense.
Segments and material changes
| Segment | Q2 sales | Q2 operating income/(loss) | Six-month sales | Six-month operating income/(loss) |
|---|
| Americas | $225.6 million | $79.9 million | $445.4 million | $147.1 million |
| EMEA | $68.7 million | $(1.8) million | $135.3 million | $(4.9) million |
| Pacific Rim | $36.5 million | $0.3 million | $65.5 million | $(0.8) million |
- Americas growth reflected new construction, renovation, pricing, mix, and volume. Activity remained positive but moderated slightly from Q1.
- EMEA improved year over year but remained loss-making; low oil prices continued to hinder markets linked to oil, including Russia and the Middle East.
- Pacific Rim improved, including better China and India activity; Australia remained weaker.
- On January 13, 2017, AWI acquired Tectum for $31.4 million. The acquisition added $16.5 million of intangible assets and $9.0 million of goodwill and was included in the Americas segment.
- Separation costs were zero in 2017 versus $3.9 million in Q2 2016 and $31.0 million in the first six months of 2016.
- AWI repurchased 1.7 million shares for $70.9 million during the first six months, reducing outstanding shares and shareholders’ equity.
- In February 2017, AWI repriced its Term Loan B, reducing the LIBOR spread from 3.25% to 2.75%; maturity and other terms were unchanged.
Cash flow, debt, liquidity, and outlook
- Operating cash flow was $42.4 million for the first six months, compared with $(55.4) million in 2016.
- Investing cash flow was $(40.7) million, including $44.8 million of capital expenditures, a $31.4 million Tectum acquisition payment, and a $35.0 million return of investment from WAVE.
- Financing cash flow was $(64.6) million, primarily reflecting the $70.9 million share repurchase.
- Cash and cash equivalents were $79.7 million at June 30, 2017, down from $141.9 million at December 31, 2016. Approximately $67.4 million was held in foreign jurisdictions and $12.3 million in the United States.
- Total long-term debt, including current installments, was approximately $865.4 million carrying value. Revolver borrowings were $15.0 million; there were no borrowings under the accounts receivable securitization facility.
- Letters of credit totaled $55.4 million used and $159.8 million available across disclosed facilities. AWI reported compliance with all senior-credit-facility covenants as of June 30, 2017.
- Management stated that cash on hand, operating cash flow, credit lines, securitization availability, and remaining revolver capacity should satisfy foreseeable liquidity needs under current expectations.
- Management continued to focus on profitable global volume growth, improved international returns, pricing actions, and expansion of product and solution offerings. The filing does not provide a quantitative earnings or revenue guidance range.
Risks, contingencies, and unusual items
- Environmental liabilities recorded were $5.5 million at June 30, 2017. Potential costs at the St. Helens, Macon, and Elizabeth City sites could exceed recorded amounts, and insurance or third-party recoveries are uncertain.
- The bankruptcy of Kaiser Gypsum could affect cost sharing and remediation obligations at St. Helens and could increase AWI’s potential costs.
- AWI settled certain legacy environmental insurance litigation during Q2; the settlements were not material to the financial statements. Additional settlements may occur.
- Other key risks include construction and economic conditions, competition, raw-material and energy costs, foreign exchange, international operations, WAVE performance, debt covenants, leverage, liquidity, taxes, benefit obligations, labor, intellectual property, and litigation.
- AWI adopted ASU 2016-09 effective January 1, 2017, recording an $8.7 million cumulative increase to retained earnings and deferred tax assets. The company expects the new revenue-recognition standard, planned for January 1, 2018 adoption, to have no material impact, but its evaluation was not yet complete.
- AWI reported effective disclosure controls and procedures and no material changes in internal control over financial reporting during the quarter. Management reported no other material changes to the risk factors in the 2016 Form 10-K.
Investor verification points
- Verify that earnings growth is sustainable after adjusting for lower pension expense, the absence of 2016 separation costs, and nonrecurring refinancing effects.
- Assess cash conversion and working-capital trends, particularly the decline in cash despite positive operating cash flow and substantial share repurchases.
- Review leverage, debt maturities, variable-rate exposure, covenant calculations, and the availability of revolving and securitization facilities.
- Evaluate the performance and integration of Tectum and the effect of continued pricing actions relative to raw-material, energy, and steel-cost inflation.
- Monitor EMEA losses, Pacific Rim profitability, foreign-exchange effects, and construction-market conditions.
- Review environmental reserves, Kaiser’s bankruptcy, potential remediation costs, and the uncertain timing and amount of insurance recoveries.
