Armstrong World Industries, Inc. — 2014 Q2 Form 10-Q Summary
Business context and reporting period
Armstrong World Industries is a global manufacturer of ceiling systems and resilient and wood flooring products. At June 30, 2014, it operated 35 manufacturing plants in eight countries and had approximately 8,600 employees. Reportable segments were Building Products, Resilient Flooring, and Wood Flooring. The cabinets business is reported as discontinued operations.
This unaudited Form 10-Q covers the three and six months ended June 30, 2014, compared with the corresponding 2013 periods. The financial statements were prepared under U.S. GAAP and reviewed, but not audited, by KPMG LLP.
Financial performance and key metrics
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net sales | $710.0 million | $706.6 million | $1,344.4 million | $1,328.9 million |
| Gross profit | $155.7 million | $164.3 million | $310.7 million | $308.8 million |
| Gross margin | 21.9% | 23.3% | 23.1% | 23.2% |
| Operating income | $57.8 million | $67.6 million | $110.3 million | $114.6 million |
| Operating margin | 8.1% | 9.6% | 8.2% | 8.6% |
| Earnings from continuing operations | $21.0 million | $30.6 million | $37.9 million | $33.8 million |
| Net earnings | $18.9 million | $29.9 million | $35.8 million | $32.9 million |
| Diluted EPS | $0.34 | $0.50 | $0.64 | $0.54 |
| Operating cash flow | Not separately provided | Not separately provided | $22.4 million | $43.2 million |
Q2 sales increased 0.5%, while operating income declined 14.5%. Six-month sales increased 1.2%, while operating income declined 3.8%. Price and mix contributed approximately $27 million to Q2 sales and $50 million to six-month sales, offsetting volume declines of approximately $24 million and $30 million, respectively.
- Building Products sales increased 2.3% in Q2 and 3.7% for the six months; operating income was essentially flat in Q2 and declined 1.0% for the six months.
- Resilient Flooring sales declined 2.0% in Q2 and 2.5% for the six months; Q2 operating income declined 14.7%, primarily due to lower volumes and plant-closure charges.
- Wood Flooring sales increased 0.9% in Q2 and 1.8% for the six months, but Q2 operating income fell to a $2.6 million loss from $2.5 million of income.
- WAVE joint-venture equity earnings increased to $17.6 million in Q2 and $32.4 million for the six months, compared with $14.4 million and $29.6 million, respectively.
Cash flow, balance sheet, debt and liquidity
- Cash and cash equivalents were $152.6 million at June 30, 2014, compared with $135.2 million at December 31, 2013.
- Operating activities generated $22.4 million during the first six months, while capital expenditures were $102.9 million. Investing cash outflow was $67.8 million.
- Financing activities provided $61.3 million, primarily from net borrowings under revolving and short-term facilities and proceeds from exercised stock options. Cash increased $17.4 million during the period.
- Total debt was approximately $1.12 billion, including $57.8 million of short-term debt, $33.4 million of current long-term debt installments, and $1.024 billion of long-term debt.
- Outstanding borrowings at June 30, 2014 included $40.0 million under the revolving credit facility and $17.8 million under the accounts receivable securitization facility. Available capacity was reduced by outstanding letters of credit totaling $64.9 million.
- The senior credit facility includes a $250 million revolver, 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 was in compliance with all debt covenants at June 30, 2014.
- Management stated that cash on hand, operating cash flow, credit lines, securitization capacity, and revolver availability should be adequate for foreseeable liquidity needs under current assumptions.
Material changes versus the prior comparable period
- Sales were modestly higher, but Q2 profitability weakened materially. Higher raw-material, sourced-product, and energy costs reduced operating income by approximately $10 million in Q2 and $22 million for the six months versus 2013.
- Q2 cost of goods sold rose to 78.1% of sales from 76.7%, while SG&A increased to 16.2% of sales from 15.7%. Six-month SG&A increased to 17.3% of sales from 16.8%.
- The company recorded $5.4 million of Q2 charges related to closing the Thomastown, Australia resilient flooring plant and the Kunshan, China engineered wood flooring plant, including severance, accelerated depreciation, and goodwill impairment.
- The company recorded a $4.4 million impairment charge for idle equipment at five wood flooring facilities.
- Six-month interest expense declined to $23.4 million from $45.0 million, primarily because the prior-year period included an $18.9 million write-off of debt-financing costs.
- The effective tax rate increased to 53.9% from 45.8% in Q2, primarily because of increased foreign losses that did not receive tax benefits and lower consolidated pretax income.
- Average diluted shares declined to 55.3 million in Q2 and 55.2 million for the six months, versus 59.9 million and 59.8 million, respectively, reflecting prior share repurchases and secondary offerings.
Outlook, management commentary, risks and unusual items
Management described softness in commercial markets, particularly healthcare and education, regional variability in office construction, weaker builder activity, and constrained renovation activity. Severe first-quarter weather negatively affected first-half results. Management implemented price increases in grid, resilient flooring, and wood flooring and announced an additional Building Products price increase effective in the third quarter.
Additional third-quarter charges were estimated at approximately $6.0 million, consisting of $5.0 million of accelerated depreciation and $1.0 million of severance related to plant closures and cost-reduction actions. The European Resilient Flooring business continued to produce disappointing results, and management was evaluating strategic alternatives, potentially before year-end 2014. The filing did not provide a clear formal revenue, earnings, or EBITDA guidance range.
- European Resilient Flooring assets had a carrying value of $187.5 million and liabilities of $187.4 million at June 30, 2014, including a $137.1 million unfunded pension liability. Strategic decisions could affect asset carrying values.
- The company recorded a $3.3 million additional expense related to a disputed multi-employer pension withdrawal liability associated with the divested cabinets business. The recorded liability was $10.0 million; the Fund’s claimed amount was $15.2 million.
- Environmental liabilities considered probable and reasonably estimable totaled $7.8 million. Potential additional costs at the St. Helens, Oregon; Macon, Georgia; and Elizabeth City, North Carolina sites could be material, although the filing states they cannot presently be reasonably estimated.
- An additional sale of shares by the Asbestos Personal Injury Settlement Trust before December 2015 could potentially trigger a Section 382 ownership change and limit use of tax attributes. Management estimated a possible one-time non-cash earnings reduction of $4.0 million to $8.0 million if such a change had occurred in Q2 2014.
- Key risks include construction and global economic conditions, raw-material and energy costs, indebtedness and covenants, liquidity, competition, customer and labor matters, plant projects, the WAVE joint venture, environmental matters, tax assets, international operations, litigation, and strategic transactions.
Most important facts for investors to verify
- Whether price increases will offset continued raw-material, energy, freight, and sourced-product inflation.
- Execution and total costs of the Thomastown and Kunshan closures, including the estimated third-quarter charges.
- Strategic actions and potential impairment exposure in European Resilient Flooring.
- Operating cash conversion, inventory growth, capital spending requirements, and revolver and securitization-facility availability.
- Debt covenant headroom and refinancing or mandatory-prepayment requirements.
- Resolution of the multi-employer pension withdrawal dispute and potential environmental remediation costs.
- Future Asbestos PI Trust share sales and the resulting risk of a Section 382 ownership change and tax-attribute limitation.