Armstrong World Industries, Inc. — 2016 Q2 Form 10-Q Summary
Business context and reporting period
Quarterly report for the three and six months ended June 30, 2016. AWI is a global producer of ceiling systems for commercial, institutional and residential buildings. On April 1, 2016, AWI completed the separation and distribution of Armstrong Flooring, Inc. (AFI). AFI’s flooring businesses are presented as discontinued operations, while AWI’s continuing operations primarily comprise ceiling products and its 50% WAVE joint venture.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net sales | $314.3 million | $306.1 million | $601.7 million | $598.1 million |
| Gross profit | $91.5 million | $91.5 million | $175.8 million | $180.6 million |
| Gross margin | 29.1% | 29.9% | 29.2% | 30.2% |
| Operating income | $51.7 million | $41.2 million | $73.3 million | $75.3 million |
| Operating margin | 16.4% | 13.5% | 12.2% | 12.6% |
| Earnings from continuing operations | $16.6 million | $15.1 million | $9.5 million | $20.8 million |
| Net earnings | $16.9 million | $29.6 million | $7.0 million | $76.2 million |
| Diluted EPS from continuing operations | $0.29 | $0.27 | $0.17 | $0.37 |
- SG&A was $55.8 million in Q2 and $109.5 million for the first six months, compared with $61.6 million and $125.9 million, respectively, in the prior-year periods.
- Cost of goods sold represented 70.9% of sales in Q2 and 70.8% for the first six months, versus 70.1% and 69.8% in 2015.
- WAVE equity earnings increased to $19.9 million in Q2 and $38.0 million year to date, from $16.4 million and $30.0 million, respectively.
- Operating cash flow was negative $55.4 million for the first six months, compared with positive $58.9 million in 2015. Capital expenditures were $53.4 million.
- Cash and cash equivalents were $99.4 million at June 30, 2016, compared with $209.3 million at December 31, 2015.
- Total debt was $873.8 million, including current maturities, compared with $988.3 million at year-end 2015. Debt fair value was $870.6 million.
- Total assets were $1.697 billion and shareholders’ equity was $202.4 million at June 30, 2016. The reduction in equity primarily reflects the AFI separation.
Material changes versus the prior comparable period
- Q2 continuing-operations sales increased 2.7%; excluding $4 million of unfavorable foreign exchange, sales increased 3.9%, driven by $8 million of volume growth and $4 million of favorable average unit value.
- First-half sales increased 0.6%; excluding $11 million of unfavorable foreign exchange, sales increased 2.6%.
- Q2 operating income rose 25.5%, despite lower gross margin, primarily because of lower SG&A, lower corporate costs and higher WAVE earnings. First-half operating income declined 2.7%, principally because of $31.0 million of separation costs versus $9.4 million in 2015.
- Americas sales increased 6.0% in Q2 and 5.3% year to date, but operating income declined 10.6% and 11.7%, respectively, due largely to separation-related costs and higher SG&A and manufacturing costs.
- EMEA sales declined 4.4% in Q2 and 10.0% year to date amid weak commercial markets, low oil prices and reduced Middle East project funding. Pacific Rim sales declined 2.6% and 5.2%, respectively; Q2 results included $3 million of severance costs related to idling a China plant.
- Interest expense increased to $12.5 million in Q2 and $34.4 million year to date, from $11.4 million and $22.6 million, respectively. The increase included a $10.7 million loss reclassified from accumulated other comprehensive income following debt-related interest-rate swap settlements.
- The effective tax rate increased to 59.8% in Q2 and 79.4% year to date, from 54.2% and 62.5%, primarily because of negative tax effects associated with the AFI separation.
Guidance, outlook, risks and unusual items
- Management expects cash on hand, operating cash flow, credit lines, receivables securitization availability and the revolving facility to meet foreseeable liquidity needs based on current expectations. No specific earnings or revenue guidance was provided.
- Management reported improving North American commercial activity and broad volume growth, but continued softness in EMEA and challenging commercial conditions in China and India.
- AWI refinanced its $1.275 billion senior facility on April 1, 2016 with a $1.050 billion facility consisting of a $200 million revolver, $600 million Term Loan A and $250 million Term Loan B. Maturities were extended to 2021 for the revolver and Term Loan A and 2023 for Term Loan B. AWI was in compliance with all debt covenants at June 30, 2016.
- The company had no revolver or accounts receivable securitization borrowings outstanding, but had $56.8 million of letters of credit outstanding.
- Separation costs totaled $3.9 million in Q2 and $31.0 million year to date. The company also recorded $3.0 million of additional China plant-idling severance costs in Q2.
- Environmental liabilities recorded were $3.5 million. Potential additional costs at the St. Helens, Oregon, Macon, Georgia, and Elizabeth City, North Carolina sites cannot be reasonably estimated and could be material. Insurance recovery proceedings are ongoing.
- The AFI separation was supported by a tax opinion, but the IRS or courts could determine that the transaction was taxable. AWI also cautioned that the post-separation company is less diversified and may not realize anticipated benefits.
- Management stated that disclosure controls were effective as of June 30, 2016. Staffing and responsibilities changed in connection with the AFI separation, and AFI will provide certain transition services through no later than December 31, 2017.
Most important facts for investors to verify
- Reconcile continuing-operations results after the AFI separation and confirm the treatment of all discontinued operations and separation-related costs.
- Assess whether negative first-half operating cash flow reflects temporary separation-related working-capital outflows or a sustained cash conversion issue.
- Review debt maturities, interest-rate swaps, covenant calculations and the effect of higher interest expense on future earnings.
- Monitor EMEA and Pacific Rim demand, the China plant idling and the ability of pricing actions to offset input costs and foreign exchange.
- Evaluate the sustainability of WAVE’s contribution to earnings and cash distributions.
- Track tax exposure related to the separation and the unusually high 2016 effective tax rate.
- Review environmental remediation estimates, potential uninsured liabilities and the status of insurance recovery claims.