Armstrong World Industries, Inc. — Q2 2013 Form 10-Q Summary
Business context and reporting period
Armstrong World Industries, Inc. (AWI) is a global manufacturer of ceiling systems and resilient and wood flooring products. Its reportable segments are Building Products, Resilient Flooring, and Wood Flooring. The filing covers the unaudited three and six months ended June 30, 2013, compared with the corresponding 2012 periods.
AWI operated 34 manufacturing plants in eight countries and employed approximately 8,800 people at June 30, 2013. The cabinets business sold in October 2012 is presented as discontinued operations for all periods.
Financial performance and liquidity
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $706.6 million | $675.4 million | $1,328.9 million | $1,311.4 million |
| Gross profit | $164.3 million | $170.6 million | $308.8 million | $310.6 million |
| Operating income | $67.6 million | $77.6 million | $114.6 million | $120.3 million |
| Net earnings | $29.9 million | $41.8 million | $32.9 million | $60.0 million |
| Diluted EPS | $0.50 | $0.70 | $0.54 | $1.01 |
| Operating cash flow | Not provided | Not provided | $43.2 million | $30.0 million |
Gross margin declined to approximately 23.3% in Q2 2013 from 25.3% in Q2 2012 and to approximately 23.2% for the first six months from 23.7%. Operating margin was approximately 9.6% in Q2 2013 versus 11.5% in the prior-year quarter, and approximately 8.6% for the first six months versus 9.2%. Higher raw material, sourced product, energy, lumber, and labor costs were principal pressures.
At June 30, 2013, cash and cash equivalents were $304.7 million, compared with $336.4 million at December 31, 2012. Total debt, including current maturities, was $1,068.8 million, versus $1,071.0 million at year-end. Current assets were $1,084.3 million and current liabilities were $399.8 million. The company generated $43.2 million of operating cash flow, spent $92.4 million on capital expenditures, and ended the period with $304.7 million of cash.
AWI refinanced its senior credit facility in March 2013 with a $250 million revolving facility, a $550 million Term Loan A, and a $475 million Term Loan B. Term Loan A matures in March 2018 and Term Loan B in March 2020. The company reported compliance with all debt covenants through June 30, 2013. The accounts receivable securitization facility was reduced from $100 million to $75 million and extended to March 2016.
Material changes versus the prior comparable period
- Q2 net sales increased 4.6%, while first-half sales increased 1.3%. Volume contributed $37 million in Q2 and $23 million in the first half; favorable price and mix contributed $7 million and $16 million, respectively.
- Building Products performed strongly: Q2 sales increased 6.5% and operating income increased 20.9%; first-half operating income increased 28.1%.
- Resilient Flooring sales declined 0.6% in Q2 and 2.9% for the first half; operating income declined 19.2% and 26.1%, respectively, due to lower volumes, unfavorable price and mix, input costs, and $7 million of severance charges in 2013.
- Wood Flooring sales rose 10.7% in Q2 and 9.8% for the first half, but operating income fell 81.9% and 81.6%, respectively, primarily because of higher lumber and labor costs.
- Interest expense declined in Q2 to $11.8 million from $14.4 million, but increased to $45.0 million for the first half from $25.6 million because AWI wrote off $18.9 million of prior debt-financing costs during the refinancing.
- The effective tax rate increased to 45.8% in Q2 and 52.8% for the first half, from 33.6% and 36.2%, respectively, primarily because valuation allowances reduced deferred tax assets related to losses at certain foreign affiliates.
- Net earnings included losses from discontinued operations of $0.7 million in Q2 and $0.9 million for the first half. The cabinets sale generated a $0.7 million Q2 loss and a $0.9 million first-half loss from sale-related adjustments.
Guidance, outlook, risks, contingencies, and unusual items
Management did not provide specific quantitative earnings or sales guidance in the filing. Management expected residential markets to continue improving, supported by builder activity, while commercial markets remained mixed. Public-sector-related education and healthcare construction was soft, office activity varied regionally, and retail was stronger. China improved, while Australia and portions of Europe remained weak.
AWI announced or implemented price increases in Wood Flooring, Building Products, and other businesses to address rising lumber and raw-material costs. Management stated that additional pricing actions could be taken if input costs remained elevated.
- Debt leverage and covenant compliance remain significant risks. Beginning with the year ending December 31, 2013, a consolidated net leverage ratio of at least 3.5 to 1.0 could require a mandatory prepayment equal to 50% of defined excess cash flow. Other covenants require minimum interest coverage and maximum leverage ratios.
- AWI had approximately $310 million of projected spending for five manufacturing plants; approximately $215 million had been incurred by June 30, 2013, with most remaining spending expected in 2014.
- Environmental liabilities considered probable and estimable totaled $8.2 million at June 30, 2013. Potential additional costs at the St. Helens, Oregon, Macon, Georgia, Mobile, Alabama, and Elizabeth City, North Carolina, sites could be material, but certain amounts could not reasonably be estimated.
- The Carpenters Labor-Management Pension Fund asserted a $15.2 million withdrawal liability related to the cabinets divestiture. AWI did not believe the liability was probable and estimable at the reporting date and stated that any resulting accrual would be recorded in discontinued operations.
- Key operating risks include construction-market weakness, raw-material and energy inflation, competitive pricing, customer concentration, foreign exchange, interest rates, labor issues, environmental and product claims, strategic transaction costs, and reliance on third-party service providers.
- AWI uses interest-rate, foreign-currency, and natural-gas derivatives for hedging rather than speculative trading. The filing reported no material changes in market-risk exposures from December 31, 2012.
Investor verification checklist
- Verify whether the company can recover higher lumber and other input costs through announced pricing actions without sacrificing volume or market share.
- Monitor Wood Flooring profitability, Resilient Flooring volume trends, and the sustainability of Building Products’ improvement.
- Reconcile reported cash flow with capital spending, plant-construction commitments, and future debt amortization or mandatory prepayments.
- Review leverage and interest-coverage ratios under the amended credit agreement, including the December 31, 2013 testing requirements.
- Assess the effect of elevated foreign valuation allowances and the resulting effective tax rate.
- Track the $15.2 million pension withdrawal claim and unresolved environmental investigations for potential additional liabilities.
- Confirm the final working-capital adjustment and other continuing obligations related to the cabinets divestiture.