Armstrong World Industries, Inc. — 2018 Second-Quarter Form 10-Q Summary
Business Context and Reporting Period
Armstrong World Industries, Inc. is a global producer of ceiling systems serving commercial, institutional and residential construction and renovation markets. Continuing operations comprise Mineral Fiber, Architectural Specialties and Unallocated Corporate. Results for the quarter and six months ended June 30, 2018 are unaudited and are compared with the corresponding 2017 periods.
EMEA and Pacific Rim operations are presented as discontinued operations in connection with the planned sale to Knauf. AWI acquired Plasterform on May 31, 2018 for $11.6 million, adding architectural cast ceiling and related products to Architectural Specialties.
Key Financial Metrics
| Metric | Three Months Ended June 30 | Six Months Ended June 30 |
|---|---|---|
| Net sales | $248.6 million vs. $225.6 million | $475.9 million vs. $445.4 million |
| Gross profit | $82.7 million vs. $85.2 million | $153.5 million vs. $163.5 million |
| Operating income | $66.0 million vs. $69.2 million | $115.6 million vs. $126.5 million |
| Earnings from continuing operations | $47.6 million vs. $43.7 million | $88.8 million vs. $79.2 million |
| Net earnings | $47.3 million vs. $41.3 million | $75.1 million vs. $71.7 million |
| Diluted EPS | $0.89 vs. $0.77 | $1.40 vs. $1.32 |
| Operating cash flow | Not separately provided | $89.0 million vs. $42.4 million |
Calculated margins declined year over year: second-quarter gross margin was approximately 33.3% versus 37.8%, and operating margin was approximately 26.5% versus 30.7%. Six-month gross margin was approximately 32.3% versus 36.7%, and operating margin was approximately 24.3% versus 28.4%.
- Mineral Fiber sales increased 8.7% in the quarter and 4.6% year to date, while operating income decreased 7.2% and 13.7%, respectively.
- Architectural Specialties sales increased 18.0% in the quarter and 19.8% year to date; operating income increased 6.2% and 31.0%, respectively.
- WAVE equity earnings increased to $24.2 million in the quarter and $40.5 million year to date, compared with $19.7 million and $38.0 million in 2017.
- Cash and cash equivalents from continuing operations were $129.0 million at June 30, 2018, compared with $159.6 million at December 31, 2017. Total cash, including discontinued operations, was $139.0 million.
- Total debt, including current maturities, was $835.0 million at June 30, 2018, compared with $850.2 million at year-end 2017. Debt consisted primarily of $562.5 million under Term Loan A, $244.4 million under Term Loan B and a $35.0 million variable-rate industrial development bond.
- No borrowings were outstanding under the $200.0 million revolving credit facility. Available letter-of-credit capacity was $165.4 million, and management stated that liquidity was adequate for foreseeable needs.
Material Changes Versus the Prior Comparable Period
- Sales growth reflected higher volumes and favorable average unit value, including approximately $6 million of favorable AUV impact in the quarter and $17 million in the first six months.
- Profitability was pressured by approximately $7 million in second-quarter and $15 million in year-to-date accelerated depreciation and maintenance costs associated with the closure of the St. Helens, Oregon plant.
- Raw material, sourced-product, energy and freight costs reduced operating income by approximately $2 million in the quarter and $3 million year to date. Higher legal, environmental and severance costs also increased SG&A expense.
- The effective tax rate declined to 27.1% from 36.3% in the quarter and to 22.6% from 37.1% year to date, primarily due to the 2017 Tax Act and, year to date, excess tax benefits from stock compensation.
- AWI repurchased 1.8 million shares for $105.0 million during the first six months, reducing shares outstanding and contributing to EPS growth.
- Net cash used in financing activities increased to $105.8 million from $64.6 million, principally because of higher share repurchases.
Guidance, Outlook, Risks and Unusual Items
- No formal full-year numerical revenue or earnings guidance is provided in the filing. Management expects the Knauf transaction to close before December 31, 2018, subject to remaining regulatory approvals and other closing conditions.
- Under a July 18, 2018 amendment, Knauf agreed to pay $250 million on August 1, 2018 and $80 million on September 15, 2018 if specified conditions were not satisfied or closing had not occurred by the relevant dates. Potential purchase-price adjustments for competition remedies were reduced from a maximum of $35 million to $20 million.
- AWI implemented price increases during the second quarter and announced additional ceiling tile and grid price increases effective in the third quarter. Future pricing actions may depend on raw-material and sourced-product costs, market conditions and competition.
- Discontinued operations recorded a $23.4 million impairment charge in the first six months, resulting in a $13.7 million net loss from discontinued operations for the period. EMEA and Pacific Rim assets and liabilities classified as discontinued operations totaled $297.9 million and $114.9 million, respectively, at June 30, 2018.
- Environmental liabilities were $13.1 million. Potential additional costs at the Macon, Georgia and Elizabeth City, North Carolina sites may be material, although the ultimate amounts cannot currently be reasonably estimated. The St. Helens, Oregon remediation settlement remains subject to court approval and bankruptcy-related proceedings involving Kaiser.
- Roxul litigation alleging anticompetitive conduct remains ongoing. AWI believes the allegations are without merit; the filing states that current claims are not expected to have a material adverse effect, but outcomes cannot be assured.
- Principal risks include construction and economic conditions, competition, raw-material and energy costs, customer concentration, WAVE performance, leverage and debt covenants, liquidity, the Knauf transaction, environmental matters, pension obligations, cybersecurity, labor, litigation and international operations.
Important Facts for Investors to Verify
- Completion timing, regulatory approvals, final consideration and any purchase-price adjustments for the Knauf transaction.
- Whether the planned $330 million sale proceeds and amended payment schedule are received as expected and how proceeds affect debt, liquidity and capital allocation.
- The sustainability of Mineral Fiber margins after St. Helens closure costs, input-cost inflation and announced pricing actions.
- Compliance with the senior credit facility covenants and the effect of variable interest rates after expiration of the $250 million interest-rate swap.
- Final accounting for the 2017 Tax Act provisional amounts, which management expected to complete in the second half of 2018.
- Potential environmental remediation costs, insurance recoveries and outcomes of the Roxul and other legal proceedings.
- The impact of Plasterform integration and the performance of Architectural Specialties, whose project-driven revenue can be comparatively volatile.