Armstrong World Industries, Inc. — 2012 Q3 Form 10-Q Summary
Business context and reporting period
Armstrong World Industries is a global producer of flooring products and ceiling systems. Continuing operations comprise Building Products, Resilient Flooring, and Wood Flooring. The filing covers the three and nine months ended September 30, 2012, with comparative periods ended September 30, 2011. The financial statements are unaudited and were reviewed by KPMG.
In September 2012, AWI agreed to sell its Cabinets business to American Industrial Partners for $27 million in cash, subject to customary closing conditions and working-capital adjustments. Cabinets was reclassified to discontinued operations for all periods presented, with closing expected in the fourth quarter of 2012.
Financial performance and key metrics
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Net sales | $694.7 million | $734.2 million | $2,006.1 million | $2,100.1 million |
| Gross profit | $186.9 million | $189.1 million | $497.5 million | $522.2 million |
| Operating income | $108.6 million | $91.1 million | $228.9 million | $215.9 million |
| Earnings from continuing operations | $74.0 million | $51.6 million | $135.2 million | $103.0 million |
| Net earnings | $62.9 million | $52.5 million | $122.9 million | $103.9 million |
| Diluted EPS from continuing operations | $1.24 | $0.88 | $2.26 | $1.74 |
| Diluted net EPS | $1.05 | $0.89 | $2.05 | $1.75 |
Q3 gross margin was approximately 26.9%, compared with 25.8% in the prior-year quarter. Operating margin was approximately 15.6%, compared with 12.4%. For the first nine months, gross margin was approximately 24.8%, compared with 24.9%, while operating margin improved to approximately 11.4% from 10.3%.
- Q3 sales declined 5.4%; nine-month sales declined 4.5%. Unfavorable foreign exchange reduced sales by approximately $24 million in Q3 and $44 million for the nine months.
- Q3 operating income increased 19.2%; nine-month operating income increased 6.0%.
- SG&A declined to $94.0 million in Q3 from $112.7 million and to $312.6 million for the nine months from $342.7 million.
- Interest expense increased to $14.1 million in Q3 from $11.3 million and to $39.7 million for the nine months from $37.6 million, primarily because of additional debt issued in March 2012.
- The effective tax rate decreased to 22.0% from 36.6% in Q3 and to 29.1% from 42.8% for the nine months, primarily due to improved utilization of foreign tax credits and a favorable international income mix.
Segment results
| Segment | Q3 sales | Q3 operating income | 9M sales | 9M operating income |
|---|---|---|---|---|
| Building Products | $325.9 million, down 3.0% | $81.1 million, up 12.0% | $926.1 million, down 2.3% | $177.9 million, down 6.9% |
| Resilient Flooring | $246.4 million, down 9.1% | $25.3 million, versus $10.6 million | $727.2 million, down 6.8% | $57.9 million, versus $20.6 million |
| Wood Flooring | $122.4 million, down 3.8% | $13.5 million, down 22.4% | $352.8 million, down 5.1% | $29.8 million, down 13.1% |
Cash flow, debt, liquidity, and balance sheet
- Operating cash flow was $140.8 million for the first nine months, compared with $129.9 million in 2011.
- Capital expenditures were $125.7 million, compared with $91.8 million. Investing activities used $61.4 million.
- Financing activities used $262.7 million, including $503.5 million of special dividend payments, partly offset by $251.9 million of long-term debt proceeds.
- Cash and cash equivalents declined to $298.6 million at September 30, 2012, from $480.6 million at December 31, 2011. Approximately $209.7 million was in the U.S. and $88.9 million was held in foreign jurisdictions.
- Total debt, including current maturities, was approximately $1.0825 billion, compared with $843.0 million at year-end 2011. Long-term debt was $1.0463 billion and current installments were $34.9 million.
- The amended senior credit facility totals $1.3 billion, comprising a $250 million revolving facility, a $250 million Term Loan A, and an $800 million Term Loan B. AWI was in compliance with all covenants through the first nine months.
- Letters of credit totaled $71.7 million. The company also had a $100 million receivables securitization program and $17.5 million of foreign financing arrangements, of which $16.7 million was available.
- Management stated that cash on hand, operating cash flow, credit lines, the receivables securitization program, and the revolving facility should be adequate for foreseeable liquidity needs.
Material changes versus the prior comparable period
- Sales weakened because volume declines and foreign exchange losses more than offset favorable pricing and mix. Management estimated pricing actions increased Q3 sales by approximately $6 million and nine-month sales by $23 million; mix increased sales by approximately $8 million and $17 million, respectively.
- Profitability improved in Q3 primarily through manufacturing and SG&A cost reductions, pricing, and mix. Resilient Flooring benefited from substantially lower restructuring and impairment costs than in 2011.
- Building Products Q3 profitability improved, but nine-month results declined because of volume pressure, emerging-market investment costs, European severances, and approximately $20 million of 2012 costs related to the Mobile plant closure.
- Wood Flooring results declined due to soft renovation activity, unfavorable pricing and mix, lower home-center sales, and the sale of the Patriot distribution business.
- Cabinets generated a Q3 net loss from discontinued operations of $11.1 million, including a $17.5 million impairment charge, compared with $0.9 million of income in Q3 2011.
- Shareholders received a special cash dividend of $8.55 per share, or $508.2 million in aggregate. The dividend was funded partly with existing cash and partly with additional Term Loan B borrowings.
Guidance, outlook, commentary, and risks
- Management targeted at least $200 million of cumulative manufacturing and SG&A cost removal by the end of 2012, including an expected $50 million of savings during 2012. Approximately $26 million of related expenses were recorded in the first nine months.
- Price increases were announced for ceilings and grid products in the Americas beginning in Q4 2012 and for wood flooring late in Q4. Additional pricing actions may be taken if raw-material prices remain elevated or increase.
- North American commercial markets remained soft, particularly education, healthcare, and portions of the office market. Residential builder activity improved, but renovation activity remained weak.
- European demand was lower than expected, particularly in Central and Western Europe, and currency weakness materially reduced reported sales. Australia and portions of the Pacific Rim also remained soft.
- AWI projected approximately $310 million of capital spending for five manufacturing projects through 2015; approximately $143 million had been incurred through September 30, 2012, with most remaining spending expected in 2013.
- Environmental liabilities considered probable and reasonably estimable totaled $10.8 million. Potential additional remediation costs at St. Helens, Oregon; Macon, Georgia; Mobile, Alabama; and Elizabeth City, North Carolina could be material, although the filing states that some amounts cannot currently be reasonably estimated.
- The filing identifies exposure to raw-material and energy costs, foreign exchange, interest rates, customer credit, economic conditions, debt covenants, discontinued-operation sale execution, environmental matters, product claims, and other litigation.
- Management stated that there were no material changes to the risk factors disclosed in the 2011 Form 10-K. Disclosure controls were considered effective, and no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Completion and final proceeds from the planned $27 million Cabinets sale, including working-capital adjustments and any additional operating losses before closing.
- Remaining cash requirements and leverage following the $508.2 million special dividend and $250 million Term Loan B borrowing.
- Progress toward the 2012 cost-savings target and whether savings offset continuing volume, currency, and market pressures.
- Execution and funding of the approximately $310 million manufacturing investment program, particularly the expected concentration of spending in 2013.
- Potential environmental remediation obligations beyond the $10.8 million recorded liability.
- Segment demand trends, especially European flooring, North American commercial construction, residential renovation, and Wood Flooring pricing and mix.
- Future effective tax rates and the sustainability of foreign tax-credit utilization benefits.