Armstrong World Industries, Inc. — 2018 Form 10-K Summary
Business Context and Reporting Period
Annual report for the fiscal year ended December 31, 2018, filed February 25, 2019. AWI produces ceiling systems, primarily mineral fiber, fiberglass wool and metal, for commercial and residential construction and renovation markets in the Americas. Reported continuing operations comprise Mineral Fiber, Architectural Specialties and Unallocated Corporate; EMEA and Pacific Rim operations were classified as discontinued operations pending sale to Knauf.
- Acquired Plasterform in May 2018 and Steel Ceilings in August 2018, both added to Architectural Specialties.
- Acquired Tectum in January 2017.
- WAVE, a 50%-owned joint venture with Worthington Industries, remains a significant contributor to earnings.
Key Financial Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $975.3 million | $893.6 million | +9.1% |
| Gross profit | $333.5 million | $315.4 million | +5.7% |
| Operating income | $249.4 million | $243.8 million | +2.3% |
| Operating margin | 25.6% | 27.3% | Down 170 bps |
| Earnings from continuing operations | $189.6 million | $220.6 million | -14.1% |
| Diluted EPS from continuing operations | $3.63 | $4.08 | -11.0% |
| Net earnings | $185.9 million | $154.8 million | +20.1% |
| Cash flow from operations | $203.2 million | $170.4 million | +19.3% |
| Capital expenditures | $71.9 million | $89.7 million | Lower |
| Cash and cash equivalents | $325.7 million | $159.6 million | Higher |
| Principal debt outstanding | $825.6 million | $858.1 million | Lower |
2018 continuing-operations gross margin was approximately 34.2%, compared with 35.3% in 2017. Cost of goods sold increased to 65.8% of sales from 64.7%, reflecting higher input costs and $14.0 million of accelerated depreciation and closure costs related to the St. Helens, Oregon plant.
- Mineral Fiber sales were $801.6 million, up 6.0%; operating income was $223.8 million, down 4.2%.
- Architectural Specialties sales were $173.7 million, up 26.6%; operating income was $34.3 million, up 23.8%.
- WAVE equity earnings were $74.9 million, versus $67.0 million in 2017.
- 2018 income tax expense was $53.1 million, compared with $1.5 million in 2017; the prior-year rate benefited from an $82.5 million Tax Cuts and Jobs Act benefit.
- 2018 diluted net EPS was $3.56, including a $0.07 loss from discontinued operations.
Fourth-Quarter Results
| Metric | Q4 2018 | Q4 2017 |
|---|---|---|
| Net sales | $238.9 million | $214.3 million |
| Gross profit | $82.1 million | $61.1 million |
| Operating income | $52.5 million | $43.4 million |
| Earnings from continuing operations | $36.6 million | $104.1 million |
| Diluted EPS from continuing operations | $0.73 | $1.92 |
Fourth-quarter sales increased 11.4%, driven by higher volume and favorable average unit value. Gross margin improved because 2017 included higher plant closure and accelerated depreciation charges. Earnings from continuing operations declined primarily because Q4 2017 included the $82.5 million tax reform benefit.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected approximately $43 million of favorable average unit value and $39 million of higher volume.
- Raw materials, sourced products and energy reduced 2018 operating income by approximately $7.0 million versus 2017.
- SG&A increased to $159.0 million from $138.6 million, driven by higher selling expense, legal fees and stock-based compensation.
- Environmental insurance settlements benefited 2017 results more than 2018 results.
- Operating cash flow improved by $32.8 million, while investing cash flow shifted to a $309.6 million inflow, mainly because of $330.0 million received from Knauf, partly offset by $70.0 million remitted to WAVE.
- Financing cash usage increased to $329.3 million, primarily due to $306.6 million of share repurchases and $8.6 million of dividends.
- AWI repurchased approximately 4.7 million shares in 2018 for $306.5 million and increased total authorized repurchases to $700 million.
- Total shareholders’ equity declined to $261.2 million from $419.3 million, principally reflecting share repurchases and other comprehensive losses.
Guidance, Outlook, Risks and Unusual Items
- Management expected the Knauf transaction to close by the end of the first half of 2019. The transaction had conditional European Commission clearance and remained subject to regulatory remedies and other closing conditions.
- Knauf paid $330.0 million in 2018 before closing; AWI recorded a $22.4 million payable to WAVE, and final consideration remained subject to purchase-price adjustments.
- Management highlighted construction activity, economic conditions, competition, customer concentration, raw-material and energy costs, WAVE performance, debt covenants, liquidity, litigation, environmental obligations, cybersecurity and labor conditions as key risks.
- AWI recorded a $19.3 million estimated loss in 2018 on the anticipated disposal of EMEA and Pacific Rim businesses, compared with $74.0 million in 2017.
- Environmental liabilities were $12.4 million at year-end 2018; additional costs at the St. Helens, Macon and Elizabeth City sites could exceed recorded amounts, although recoveries may be available.
- Rockfon antitrust litigation remained unresolved; damages were unspecified, and a trial was reserved for early Q2 2019 if necessary.
- AWI was compliant with all senior credit facility covenants. The facility included $547.5 million of Term Loan A borrowings and $243.1 million of Term Loan B borrowings, with no revolving borrowings outstanding.
- Cash flow benefited from the Knauf proceeds and WAVE distributions and may not represent recurring operating liquidity.
- AWI adopted the new lease standard on January 1, 2019 and expected to recognize approximately $25.0 million to $30.0 million of right-of-use assets and lease liabilities, with no material income-statement or cash-flow impact expected.
- Management stated that internal control over financial reporting was effective, and KPMG issued unqualified audit opinions.
Investor Verification Checklist
- Verify completion, final proceeds and purchase-price adjustments for the Knauf divestiture, including required European divestments.
- Assess recurring operating margins excluding plant closure costs, environmental settlements, acquisition effects and other unusual items.
- Reconcile continuing-operations earnings with reported net earnings, particularly the discontinued-operations loss and prior-year tax benefit.
- Monitor debt maturities, floating-rate exposure, interest-rate swaps and compliance with leverage and interest-coverage covenants.
- Evaluate the sustainability of cash flow after excluding Knauf proceeds, WAVE distributions and other non-recurring items.
- Review customer concentration: three commercial distributors accounted for $459.3 million of 2018 sales.
- Assess exposure to construction cycles, raw-material inflation, customer consolidation and competitive pricing.
- Track environmental remediation liabilities, insurance recoveries and the Rockfon litigation.
- Evaluate realizability of deferred tax assets, including $79.6 million of valuation allowances and $42.6 million of unrecognized tax benefits.