Armstrong World Industries, Inc. — Form 10-Q Summary
Business Context and Reporting Period
Armstrong World Industries, Inc. is a global manufacturer of flooring products and ceiling systems, with a U.S. cabinets business. Reportable segments are Building Products, Resilient Flooring, Wood Flooring and Cabinets. The filing covers the unaudited three and six months ended June 30, 2012, compared with the corresponding 2011 periods.
At June 30, 2012, the company operated 33 manufacturing plants in eight countries and had approximately 9,300 employees. The company had emerged from Chapter 11 in 2006; asbestos personal-injury claims are generally channeled to the Asbestos Personal Injury Settlement Trust.
Key Financial Metrics
| Metric | Q2 2012 | Q2 2011 | Six Months 2012 | Six Months 2011 |
|---|---|---|---|---|
| Net sales | $709.9 million | $748.6 million | $1,377.9 million | $1,433.8 million |
| Gross profit | $176.2 million | $184.7 million | $321.0 million | $345.4 million |
| Gross margin | 24.8% | 24.7% | 23.3% | 24.1% |
| Operating income | $76.9 million | $72.7 million | $118.5 million | $124.8 million |
| Operating margin | 10.8% | 9.7% | 8.6% | 8.7% |
| Earnings | $41.8 million | $37.9 million | $60.0 million | $51.4 million |
| Diluted EPS | $0.70 | $0.64 | $1.01 | $0.87 |
| Operating cash flow | Not separately provided | Not separately provided | $29.6 million | $32.1 million |
Q2 net sales declined 5.2%, while operating income increased 5.8% and earnings increased 10.3%. For the first six months, sales declined 3.9%, operating income declined 5.0%, and earnings increased 16.7%, primarily reflecting a lower effective tax rate.
Q2 cost of goods sold was 75.2% of sales versus 75.3% in the prior-year quarter. Six-month cost of goods sold increased to 76.7% of sales from 75.9%, including approximately $19 million of costs associated with the Mobile, Alabama plant closure. Q2 SG&A declined to $114.2 million from $122.2 million, and the six-month amount declined to $230.8 million from $242.3 million.
Segment Performance and Material Changes
- Building Products: Q2 sales declined 2.6% to $297.0 million and operating income declined 6.3% to $53.5 million. Six-month sales declined 1.9% to $600.1 million and operating income declined 18.4% to $96.8 million. Results reflected volume declines, higher manufacturing costs at the Millwood, West Virginia plant, environmental charges, European severances and Mobile plant closure costs.
- Resilient Flooring: Q2 sales declined 7.7% to $253.5 million, but operating income increased 93.8% to $21.9 million. Six-month sales declined 5.6% to $480.8 million, while operating income increased to $32.6 million from $10.0 million. Cost reductions, favorable price and mix, and lower SG&A more than offset volume declines.
- Wood Flooring: Q2 sales declined 6.6% to $124.8 million, while operating income increased 3.0% to $13.8 million. Six-month sales declined 5.8% to $230.4 million and operating income declined 3.6% to $16.3 million. Results were affected primarily by inventory reductions at a national home-center customer.
- Cabinets: Q2 sales declined 2.0% to $34.6 million and the segment recorded a $0.7 million operating loss. Six-month sales declined 1.9% to $66.6 million and the segment recorded a $1.8 million operating loss. Management performed an impairment test because of losses; tangible assets were considered recoverable based on projected undiscounted cash flows.
Macroeconomic benchmarks declined during the quarter. Commercial markets, especially education and healthcare, remained soft in North America; European demand declined sharply, particularly in Central and Western Europe; and Australia and portions of China also experienced weakness. Pricing and mix contributed approximately $9 million and $7 million, respectively, to Q2 sales versus the prior year, but could not offset volume and foreign-exchange effects.
Cash Flow, Debt and Liquidity
- Six-month operating cash flow was $29.6 million, compared with $32.1 million in 2011.
- Capital expenditures were $77.4 million, compared with $49.7 million in 2011. Investing cash outflow was $42.2 million, partly offset by a $33.7 million return of investment from the WAVE joint venture.
- Cash used in financing was $249.1 million, including $503.2 million of special dividend payments, partly offset by $251.9 million of new long-term debt.
- Cash and cash equivalents declined to $217.3 million at June 30, 2012, from $480.6 million at December 31, 2011. Approximately $122.3 million was held in the U.S. and $95.0 million internationally.
- Total debt, including current maturities, was $1,095.6 million at June 30, 2012, versus $843.0 million at year-end 2011. Long-term debt increased primarily because of the additional $250 million Term Loan B borrowing.
- The amended senior credit facility totals $1.3 billion: a $250 million revolving facility, a $250 million Term Loan A and an $800 million Term Loan B. The company was in compliance with all covenants through June 30, 2012.
- Letters of credit totaled $72.1 million. The company also had a $100 million receivables securitization program and $19.3 million of foreign financing arrangements, of which $18.6 million was available.
Management stated that cash on hand, operating cash flow, credit lines, receivables securitization availability and the revolving facility should be adequate for foreseeable liquidity needs. Planned capital spending for previously approved projects is approximately $310 million through 2015; approximately $116 million had been incurred through June 30, 2012.
Guidance, Outlook, Risks and Unusual Items
- Management continued to target at least $200 million of manufacturing and SG&A cost removal by the end of 2012, including an expected $50 million of savings during 2012. Approximately $24 million of related expenses were recorded in the first six months.
- The company expects up to $8 million of additional North American SG&A restructuring expense through 2012. It does not expect further material restructuring costs for the European flooring initiative.
- The Mobile, Alabama facility was permanently closed. First-half results included approximately $19 million of accelerated depreciation, impairment and other related charges, including a $4.6 million building impairment charge and $9.3 million of accelerated depreciation.
- A special cash dividend of $8.55 per share, or $508.2 million in total, was declared in March 2012 and funded partly with additional debt. Approximately $502.9 million was paid in April, with the remaining $5.3 million payable as employee shares vest.
- Environmental liabilities increased to $11.1 million from $7.3 million at year-end. Potential additional costs at the St. Helens, Oregon; Macon, Georgia; and Mobile, Alabama sites may be material, and certain future costs cannot currently be reasonably estimated.
- Market risks include foreign-exchange movements, variable interest rates and natural-gas prices. The company uses derivatives primarily as cash-flow hedges; the filing states that there were no material changes in market-risk exposures from year-end 2011.
- The effective tax rate declined to 33.5% in Q2 and 36.2% for the first six months, compared with 38.1% and 48.0%, respectively, mainly due to international income mix and foreign tax-credit valuation allowance changes.
- The filing states that there were no material changes to previously disclosed risk factors and that ordinary-course legal matters were not expected to have a material adverse effect. Interim financial statements received a review report, not a full audit opinion.
Investor Verification Checklist
- Verify whether weak commercial and European markets continue to pressure volumes and foreign-exchange-adjusted sales.
- Assess the sustainability and execution risk of the targeted 2012 cost savings, including associated restructuring and plant-closure costs.
- Monitor debt reduction, covenant headroom, variable-rate exposure and liquidity after the special dividend and additional Term Loan B borrowing.
- Reconcile planned capital spending of approximately $310 million with operating cash generation and available financing.
- Review developments and reserve adequacy for environmental matters, especially St. Helens, Macon and Mobile.
- Evaluate whether Cabinets can return to profitability after recording losses in both the quarter and year-to-date period.