Armstrong World Industries, Inc. — Q2 2019 Form 10-Q Summary
Business context and reporting period
AWI is a global producer of ceiling systems, including mineral fiber, fiberglass wool, metal and wood products, primarily serving commercial, institutional and residential construction and renovation markets in the Americas. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019, compared with the corresponding 2018 periods.
Continuing operations comprise the Mineral Fiber and Architectural Specialties segments. EMEA and Pacific Rim operations, including the related WAVE businesses, remain classified as discontinued operations pending the expected sale to Knauf. AWI acquired Architectural Components Group, Inc. on March 4, 2019 for $43.1 million.
Key financial metrics
| ($ millions, except per-share data) | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net sales | $272.0 | $248.6 | $514.1 | $475.9 |
| Gross profit | $103.4 | $82.7 | $194.8 | $153.5 |
| Gross margin | 38.0% | 33.3% | 37.9% | 32.3% |
| Operating income | $87.2 | $66.0 | $141.9 | $115.6 |
| Operating margin | 32.1% | 26.5% | 27.6% | 24.3% |
| Earnings from continuing operations | $63.7 | $47.6 | $100.1 | $88.8 |
| Diluted EPS from continuing operations | $1.28 | $0.90 | $2.01 | $1.66 |
| Net earnings | $54.5 | $47.3 | $93.6 | $75.1 |
| Diluted EPS | $1.09 | $0.89 | $1.88 | $1.40 |
Q2 continuing-operations sales increased 9.4%, while operating income increased 32.1%. Six-month sales increased 8.0%, and operating income increased 22.8%. The effective tax rate was 23.3% in Q2 and 24.6% for the first six months, compared with 27.1% and 22.6%, respectively, in the prior-year periods.
- Segment performance: Mineral Fiber sales increased 3.6% in Q2 and 3.4% year to date; operating income increased 33.4% and 23.1%, respectively. Architectural Specialties sales increased 38.2% in Q2 and 31.6% year to date; operating income increased 10.5% and 10.7%.
- Cash flow: Operating activities generated $47.0 million in the first six months, down from $89.0 million. Investing cash use was $31.6 million, including $43.1 million for the ACGI acquisition and $27.1 million of capital expenditures. Financing cash use was $102.6 million, including $48.1 million of share repurchases, $17.3 million of dividends and $23.8 million of debt repayments.
- Liquidity: Continuing-operations cash was $240.3 million at June 30, 2019. Total long-term debt, including current maturities, was $797.1 million. The company had no revolving-credit borrowings, $163.6 million of available letter-of-credit capacity, and stated that cash flow, cash on hand and committed facilities should cover foreseeable liquidity needs.
- Leverage and hedging: Debt outstanding included $525.0 million under Term Loan A, $241.9 million under Term Loan B and a $35.0 million variable-rate industrial development bond. AWI was in compliance with its debt covenants at June 30, 2019. On July 3, 2019, it prepaid $100.0 million of Term Loan B. Interest-rate swaps covered $600.0 million of variable-rate exposure.
Material changes versus the prior comparable period
- Pricing and product mix were significant drivers: favorable average unit value contributed approximately $13 million to Q2 sales and $31 million to six-month sales. Volume was lower in Mineral Fiber, particularly for lower-end products.
- Margins benefited from the 2018 closure of the St. Helens, Oregon plant and the absence of accelerated depreciation recorded in 2018, which improved operating income by approximately $7 million in Q2 and $18 million year to date.
- Architectural Specialties benefited from acquisitions, increased market penetration and new construction activity. The acquisitions contributed approximately $11 million of Q2 sales and $18 million of six-month sales.
- Six-month SG&A increased to $93.0 million from $78.4 million, primarily because of $19.7 million of expenses related to the Rockfon antitrust litigation, including settlement-related legal expenses. The matter was settled and dismissed with prejudice in April 2019, and AWI does not expect additional costs.
- Operating cash flow declined because of working-capital changes, lower environmental insurance receipts and higher income-tax payments, despite higher earnings.
- AWI repurchased 0.6 million shares for $48.1 million during the first six months and paid quarterly dividends of $0.175 per share. The remaining share-repurchase authorization was approximately $251.9 million at June 30, 2019.
Guidance, outlook, risks and unusual items
The filing does not provide quantitative full-year revenue, earnings or EBITDA guidance. Management expects the Knauf transaction to close during the third quarter of 2019. Closing remains subject to required regulatory and transaction conditions, including divestitures required by the European Commission. AWI had received $330.0 million of advance consideration, recorded related payables of $203.3 million to Knauf and $22.4 million to WAVE, and estimated an additional $34.3 million liability to Knauf for consideration adjustments as of June 30, 2019.
- Management announced Mineral Fiber ceiling tile and grid price increases for the third quarter of 2019 and may take additional pricing actions depending on raw-material, energy and sourced-product costs.
- Key market risks include economic conditions, construction activity, competition, customer concentration and consolidation, raw-material and energy costs, labor, international operations, cybersecurity, litigation, environmental obligations, defined-benefit plans, debt covenants and liquidity.
- Environmental liabilities considered probable and reasonably estimable totaled $11.3 million at June 30, 2019. The Macon, Georgia investigation could lead to material future remediation costs that cannot currently be reasonably estimated. The St. Helens, Oregon matter was resolved through a consent judgment requiring an $8.6 million payment and remedial work.
- Discontinued operations generated a net loss of $9.2 million in Q2 and $6.5 million year to date, including estimated disposal losses of $6.9 million and $4.7 million, respectively. The filing also corrected an immaterial prior-period error that reduced December 31, 2018 assets and shareholders’ equity by $35.2 million.
- AWI adopted the new lease standard on January 1, 2019, recognizing $30.3 million of lease right-of-use assets and $30.3 million of lease liabilities at June 30, 2019. The company also adopted updated hedge-accounting guidance without a material reported impact.
Investor verification checklist
- Verify the timing and final economics of the Knauf sale, including regulatory remedies, working-capital and debt-related adjustments, WAVE consideration and any additional disposal losses.
- Reconcile continuing-operations performance with reported consolidated earnings, particularly discontinued-operations losses and the prior-period error correction.
- Monitor cash conversion, working-capital requirements, acquisition spending, share repurchases and the impact of the July 2019 $100.0 million Term Loan B prepayment.
- Assess whether Mineral Fiber volume weakness persists and whether announced pricing actions offset raw-material, energy and manufacturing-cost inflation.
- Review environmental reserves and potential remediation exposure at the Macon, Georgia and Elizabeth City, North Carolina sites.
- Confirm debt-covenant compliance, variable-rate exposure, interest-rate swap valuations and refinancing or maturity requirements.