Armstrong World Industries, Inc. — Form 10-Q Summary
Reporting period: Three and nine months ended September 30, 2011; filed October 31, 2011. The interim financial statements are unaudited and were reviewed by KPMG LLP.
Business Context
AWI is a global manufacturer of flooring products and ceiling systems, with additional U.S. kitchen and bathroom cabinet operations. Reportable segments are Building Products, Resilient Flooring, Wood Flooring and Cabinets. As of September 30, 2011, the company operated 31 manufacturing plants in seven countries and employed approximately 9,300 people.
AWI emerged from Chapter 11 in 2006 following a reorganization addressing asbestos-related liabilities. Personal-injury asbestos claims are channeled to the Asbestos Personal Injury Settlement Trust.
Key Financial Metrics
| Metric | Q3 2011 | Q3 2010 | 9M 2011 | 9M 2010 |
|---|---|---|---|---|
| Net sales | $773.6 million | $739.8 million | $2,207.4 million | $2,123.5 million |
| Gross profit | $196.9 million | $172.0 million | $542.3 million | $488.2 million |
| Gross margin | 25.4% | 23.3% | 24.6% | 23.0% |
| Operating income | $92.8 million | $45.0 million | $217.6 million | $111.3 million |
| Operating margin | 12.0% | 6.1% | 9.9% | 5.2% |
| Net earnings | $52.5 million | $24.6 million | $103.9 million | $32.0 million |
| Net margin | 6.8% | 3.3% | 4.7% | 1.5% |
| Diluted EPS | $0.89 | $0.42 | $1.75 | $0.55 |
- Operating cash flow: $129.9 million for the first nine months, compared with $141.3 million in the prior-year period.
- Capital expenditures: $91.8 million, versus $52.2 million in the first nine months of 2010.
- Cash and cash equivalents: $376.9 million at September 30, 2011, including $281.2 million in the U.S. and $95.7 million internationally.
- Total debt: $843.5 million, including current maturities; debt fair value was estimated at $823.8 million.
- Liquidity: The company had a $250 million revolving credit facility, a $100 million receivables securitization program and $22.6 million of unused foreign borrowing capacity. Letters of credit outstanding totaled $70.4 million.
- Leverage and covenants: AWI reported compliance with all debt covenants during the first nine months. Management stated that default was currently unlikely.
Material Changes Versus the Prior Comparable Period
- Sales increased 4.6% in the third quarter and 4.0% for the first nine months. Growth reflected pricing, mix and favorable foreign exchange, partly offset by volume declines.
- Operating income increased 106% in the third quarter and 95.5% for the first nine months, driven by lower manufacturing and SG&A costs, improved pricing and mix, and stronger segment performance.
- Building Products sales increased 8.4% in the quarter and 9.9% year to date; operating income increased 22.3% and 23.3%, respectively.
- Resilient Flooring sales declined 1.6% in the quarter and 0.4% year to date, primarily because of European restructuring and lower volumes. Operating income nevertheless increased 5.0% and 38.3%.
- Wood Flooring returned to operating income of $17.4 million in the quarter and $34.3 million year to date, compared with losses of $13.3 million and $13.8 million in the prior-year periods.
- Cabinets returned to operating income of $1.7 million in both periods, compared with losses of $1.2 million in the quarter and $5.5 million year to date.
- SG&A declined to 15.4% of sales in the quarter and 16.4% year to date, from 16.9% and 18.9%, respectively.
- Interest expense rose to $37.6 million year to date from $11.8 million, primarily because of higher debt balances and rates following the 2010 refinancing.
- The effective tax rate declined to 36.8% from 45.5% in the quarter and to 42.9% from 69.4% year to date, reflecting lower unbenefited foreign losses and prior-year tax effects.
- Cash flow from operations declined despite higher earnings because of increased receivables and inventories and higher restructuring payments.
Guidance, Outlook, Risks and Unusual Items
- Management targeted at least $165 million of cumulative manufacturing and SG&A cost reductions by 2013. It reported $35 million of savings in 2010, expected $100 million in 2011 and an additional $30 million to $40 million in 2012.
- Capital spending for a U.S. mineral wool plant, expanded Building Products capacity in China and two Chinese flooring plants was projected at approximately $200 million over several years, with most spending in 2011 and 2012.
- Management stated that cash, operating cash flow, credit facilities and receivables financing should be adequate for foreseeable liquidity needs, but actual results may be affected by economic conditions, raw-material prices, foreign exchange and construction activity.
- Restructuring charges were $8.0 million for the first nine months, with approximately $31 million of costs associated with broader cost-reduction initiatives. European flooring restructuring costs were expected to reach up to $30 million through 2011; North American SG&A restructuring costs were expected to reach up to $8 million through 2012.
- A $2.2 million third-quarter impairment charge was recorded for a European Resilient Flooring office building. The Beaver Falls plant was sold during the quarter, producing a $0.7 million net gain.
- The Marietta, Pennsylvania, Building Products plant was subject to a labor lockout involving approximately 260 workers beginning July 17, 2011, pending ratification of a new collective bargaining agreement.
- Environmental proceedings at the St. Helens, Oregon, and Macon, Georgia, sites could require additional corrective or remediation costs that may be material; the ultimate amounts were not reasonably estimable. Recorded environmental liabilities were $7.8 million.
- AWI faced antidumping and countervailing-duty proceedings involving Chinese engineered wood flooring. Final announced rates were 1.5% CVD and 3.31% AD; management did not expect a material adverse effect, but the final outcome remained uncertain at the filing date.
- The company used interest-rate swaps with aggregate notional amounts of $300 million. The swaps had a $14.2 million mark-to-market loss at September 30, 2011.
- Management reported no material changes to previously disclosed risk factors and stated that disclosure controls and internal control over financial reporting were effective.
Investor Verification Priorities
- Verify whether the reported margin expansion and cost savings were sustainable after adjusting for restructuring benefits, prior-year CEO transition costs, impairments and other unusual items.
- Monitor debt reduction, interest expense, covenant headroom and the impact of variable-rate borrowings and interest-rate swaps.
- Assess cash conversion, particularly the increases in receivables and inventories relative to sales growth.
- Track execution and funding of the approximately $200 million multi-year capital program.
- Follow the Marietta labor dispute and any operational impact from the lockout.
- Review developments in the St. Helens and Macon environmental matters, including potential liabilities beyond the $7.8 million recorded reserve.
- Evaluate the effect of European flooring restructuring, including remaining severance and closure costs and the segment’s continuing losses.
- Confirm the final outcome and cash impact of the Chinese flooring trade-duty proceedings.