Armstrong World Industries, Inc. — Q1 2014 Form 10-Q Summary
Business context and reporting period
Armstrong World Industries is a global manufacturer of flooring products and ceiling systems serving residential, commercial, and institutional construction and renovation markets. The company operated 35 manufacturing plants in eight countries and reported three segments: Building Products, Resilient Flooring, and Wood Flooring. The filing covers the unaudited three months ended March 31, 2014, compared with the three months ended March 31, 2013.
The former cabinets business is presented as discontinued operations. The company emerged from Chapter 11 in 2006; asbestos-related personal injury claims are generally channeled to the Asbestos Personal Injury Settlement Trust.
Financial performance and key metrics
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Net sales | $634.4 million | $622.3 million | 1.9% increase |
| Gross profit | $155.0 million | $144.5 million | 7.3% increase |
| Gross margin | 24.4% | 23.2% | Up approximately 120 basis points |
| Operating income | $52.5 million | $47.0 million | 11.7% increase |
| Operating margin | 8.3% | 7.6% | Up approximately 70 basis points |
| Earnings from continuing operations | $16.9 million | $3.2 million | Material increase |
| Net earnings | $16.9 million | $3.0 million | Material increase |
| Diluted earnings per share | $0.30 | $0.05 | Material increase |
| Cash flow from operating activities | $(32.9) million | $(14.0) million | Greater use of cash |
| Capital expenditures | $40.9 million | $52.3 million | Lower spending |
Sales growth reflected approximately $21 million of favorable pricing and product mix, partly offset by approximately $8 million of lower volume. Cost of goods sold declined to 75.6% of sales from 76.8%, supported by productivity improvements and the absence of approximately $5 million of 2013 Resilient Flooring severance charges. SG&A increased to $117.3 million, or 18.5% of sales, from $112.7 million, or 18.1%, primarily due to promotional spending and market-development investments.
Interest expense fell to $11.6 million from $33.2 million, primarily because Q1 2013 included an $18.9 million write-off of unamortized debt-financing costs. The effective tax rate was 53.3%, compared with 78.8% in the prior-year quarter.
Segment performance
| Segment | Q1 2014 sales | Q1 2013 sales | Q1 2014 operating income | Q1 2013 operating income |
|---|---|---|---|---|
| Building Products | $308.2 million | $292.8 million | $57.8 million | $59.3 million |
| Resilient Flooring | $208.1 million | $214.8 million | $9.4 million | $6.4 million |
| Wood Flooring | $118.1 million | $114.7 million | $5.1 million | $0.5 million |
- Building Products sales increased 5.3%, but operating income declined 2.5% because of unfavorable price and mix, higher SG&A, and higher manufacturing and input costs.
- Resilient Flooring sales declined 3.1% on lower volume, while operating income increased 46.9% due to lower manufacturing and input costs and the absence of 2013 severance charges.
- Wood Flooring sales increased 3.0%; operating income improved substantially as favorable pricing and mix more than offset higher lumber costs and lower volume.
Financial position, debt, liquidity, and cash flow
At March 31, 2014, cash and cash equivalents were $131.0 million, compared with $135.2 million at December 31, 2013. Total current assets were $953.5 million and total current liabilities were $456.0 million. Receivables increased to $244.3 million and inventories increased to $428.5 million, contributing to the operating cash outflow.
Total debt, including current installments and short-term debt, was approximately $1.1 billion: $42.7 million of short-term debt, $30.3 million of current long-term debt, and $1,035.0 million of long-term debt excluding current installments. The company reported $20.0 million outstanding under its revolving credit facility and $17.8 million under its $75 million accounts receivable securitization facility. Outstanding letters of credit totaled $64.9 million.
The senior credit facility includes a $250 million revolving facility, a $550 million Term Loan A maturing in March 2018, and a $475 million Term Loan B maturing in March 2020. The company was in compliance with all debt covenants at March 31, 2014. Management stated that cash on hand, operating cash flow, credit lines, and available facility capacity are expected to meet foreseeable liquidity needs.
Operating activities used $32.9 million of cash, investing activities used $22.0 million, and financing activities provided $51.9 million. Financing inflows primarily reflected borrowings and proceeds from exercised stock options. The company expects total spending on previously approved plant projects to be approximately $375 million; approximately $292 million had been incurred through March 31, 2014.
Material changes, outlook, and unusual items
- Severe weather negatively affected revenues in the first quarter, while commercial markets remained soft, particularly education and healthcare. Residential markets continued to improve, led by builder activity.
- Raw materials, sourced products, and energy costs reduced year-over-year operating income by approximately $12 million. The company announced additional price increases in resilient and wood flooring effective in Q2 2014 and may take further pricing actions if input costs rise.
- Management estimated that pricing actions added approximately $12 million to Q1 2014 sales and mix improvements added approximately $9 million.
- In March 2014, the Asbestos PI Trust and TPG completed a secondary offering of 3.9 million shares. TPG no longer owned company shares, and the Trust owned approximately 17% of outstanding shares. The offering did not provide proceeds to Armstrong.
- Adoption of new income-tax presentation guidance reduced noncurrent income taxes payable and increased noncurrent deferred tax liabilities by approximately $40 million, with no effect on earnings or cash flow.
- A future sale of shares by the Asbestos PI Trust before December 2015 could reasonably be expected to trigger an Internal Revenue Code Section 382 ownership change. Management estimated that such an event could result in a one-time noncash earnings charge of approximately $4 million to $8 million, although the actual amount could differ.
- The company recorded a $7.0 million liability related to a disputed multi-employer pension withdrawal claim associated with the sale of the cabinets business. The claimed amount is $15.2 million, and arbitration was expected in 2014.
- Probable environmental liabilities totaled $7.9 million. Potential additional remediation costs at the St. Helens, Oregon, and Macon, Georgia, sites could be material but could not be reasonably estimated.
- Preliminary antidumping and countervailing-duty rates for the company’s Chinese wood flooring operations were not expected by management to have a material impact, but final rates were pending.
Key investor verification points
- Verify whether pricing actions offset continuing raw-material, energy, freight, and labor inflation and whether volume weakness persists in commercial markets.
- Monitor working-capital requirements, particularly the significant increase in inventories and the recurring seasonal first-quarter operating cash outflow.
- Review leverage, variable-rate debt exposure, interest-rate swaps, covenant compliance, and available revolving and securitization capacity.
- Track completion and spending for the Russia and Lancaster plant projects and any effect on capital expenditures and liquidity.
- Assess the potential tax impact of additional Asbestos PI Trust share sales and any Section 382 ownership change.
- Follow the multi-employer pension arbitration, environmental investigations, and antidumping and countervailing-duty proceedings.
- Consider that the interim financial statements were reviewed, not audited, and that quarterly results may not be indicative of full-year performance.