Armstrong World Industries Inc (AWI) 2006 Q4 法說會逐字稿

[Replay audio begins with call in progress] --- percent versus 2005. That's really driven by the volume decline in the North American Resilient business. We actually saw volume growth in the European and Asian Resilient businesses. A mix was favorable across each of the Resilient geographies and price was up overall, in particular in the commercial business, which offset some of the declines in the residential Resilient business.

Turning to Wood Flooring, Wood Flooring sales were down 8% in the quarter, really all driven by volume and mix, mostly volume. There wasn't much change in pricing in wood flooring in the fourth quarter, and the decline really extends both to engineered wood and solid Wood Flooring in the fourth quarter.

In terms of Building Products, the 7.5% growth in sales in the fourth quarter was largely price and mix. Volume declined slightly in the North American Ceilings business in the fourth quarter, mostly due to the weak retail business.

The core Commercial business in North America showed volume growth, and then we also had volume growth in both Europe and Asian Ceilings in the fourth quarter. Cabinets, Cabinets grew 11.7% in the fourth quarter, really due to volume and price.

Turning to operating income in Resilient Flooring, Resilient Flooring increased their operating income by $11 million in the quarter, really driven by two things, by the sales growth that I mentioned in Europe and Asia as well as the cost reduction in North America Resilient both in manufacturing as well as in SG&A.

Profitability in Wood Flooring declined by 12 million, really driven by the lower volume and the weaker mix in the business. We also spent a little more on promotional activities in the fourth quarter and that is evidenced in the SG&A increase in the Wood business.

In terms of Building Products, the $8 million or 24% increase in earnings year over year is driven by sales. Sales growth in really all geographies, as I mentioned a minute ago. And Cabinets had a slight increase in earnings year over year in corporate, mostly due to reductions in staff expenses as well as lower costs and benefit plans reduced the cost year over year by about 5 million.

Okay, so that's the discussion on the fourth quarter. Before I turn to the full year, let me just walk through, because there was a lot of interest in this on the November call, the impact of emergence and fresh start accounting on the Balance Sheet.

So what I have here are three columns, what we call the Predecessor Company Balance Sheet as of September 30 of 2006, the adjustments that we made due to both emergence and the adoption of fresh start accounting, and then the Successor Company or the opening Balance Sheet for AWI as of October 2nd. And I won't go through every line here, but just want to highlight some of the key changes in the opening Balance Sheet from the Predecessor Company.

Beginning with cash, we had noted that as part of emergence, we would be paying out a healthy portion of the cash that we had generated on a Balance Sheet so you can see that $300 million of decline in cash was paid to the trust and the creditors.

If you move down to fixed assets, you can see we had Balance Sheet values of 1.2 billion for the fixed assets. The Successor Company, the opening Balance Sheet is 950 million, really two changes there as we fair valued the fixed assets, the value came down somewhat and also as we moved the Textile business to a discontinued operation, we moved their fixed assets out of this line on the Balance Sheet to a separate account.

The Investment and Affiliates line, this is principally Wave. Wave was carried at about $100 million value on the Balance Sheet. Previously, we did a valuation of Wave, we stepped up the value to about 300 million, so there's the 200 million increase in Investments and Affiliates.

A goodwill, we had a balance of goodwill of $150 million, that was basically wiped out as we allocated the reorganization value of Armstrong to the assets, we had a high portion of the valuation go to other intangibles and so really, nothing left over, if you will, to goodwill.

The next line there, you can see other intangibles increasing by $600 million and this is the value that we placed in fresh-start accounting on the brand, on the customer lists in the businesses and some other intangibles. So that's the most significant change really on the asset side of the Balance Sheet is the increase in other intangibles, and again some of these are amortizable through the P&L, some of them are not.

The Deferred Tax line here is somewhat involved. We had a $1 billion deferred tax asset in the Predecessor Company. It's now about $300 million. That $300 million includes the domestic NOL that was created upon funding the trust. The big change in deferred taxes, $700 million, is really due to the recognition of debt forgiveness income. So as we settled liabilities, mostly the debt for less than the face value, we realized a gain from that, and the effect of that on deferred taxes is to reduce the deferred tax assets.

Okay, moving down to Liabilities Subject to Compromise, we had estimated the liabilities at $4.9 billion. Of course, all of those went away as we settled those for about $3.4 billion of value upon emergence. Our long-term debt basically had very little prior to emergence. We issued $800 million of long-term debt in October, and then you can see, finally, the shareholders equity, we had a deficit in the Predecessor Company of 1.2 billion.

The equity, the book equity in the opening Balance Sheet is 2.1 billion. So a change of 3.3 billion. So really, a relatively healthy Balance Sheet if you look at the traditional credit metrics, debt-to-capital is about 25%, debt to EBITDA is about -- is about two times. Okay, so that's the opening Balance Sheet.

The next chart is -- is just a brief summary of the full-year performance of 2006 and, again, this is on the same basis as before for the fourth quarter. This is before the impact of fresh-start accounting and adjusting for some of the non-recurring items.

So you can see that sales for the full year were up about 3%. Volume was flat to very slightly down. Price and mix were both positive.

The gross profit was up about 8.5% or 110 basis points in margin. Similar to the fourth quarter, we had a favorable effect here of price and mix on margin as well as a significant amount of productivity in the plant and that more than offset the negative influence of inflation in raw materials and energy.

SG&A for the full year was actually down, down about $15 million or 2.5%. Most of that decline was in the Floor businesses and in Corporate. The Cabinets, I guess, was down a little bit as well. Building Products increased SG&A somewhat in line with inflation.

So for the full year, the operating income on this basis, 255 million, compared to 168 last year or a 52% increase on a 240 basis point increase in the margin.

Cash flow, free operating cash flow for the full year was 100 million, compared to 39 million in 2005. Again, the favorable variance here is due to the rather sizeable increase in cash earnings. We also spent less on a restructuring than we did in 2005, and the Wave dividend was also somewhat higher in 2006 versus last year.

So if we look at the components of -- that drove that 50% or so increase in operating income in '06 versus '05, again, a similar chart to what I showed for the quarter, you can see that we had relatively significant gains in pricing and we had a healthy improvement in profit due to mix.

Again, the volume number was relatively unchanged versus a year ago, and so the sum of those two more than offset the impact of raw material inflation and energy inflation, which was somewhat sizeable at about $60 million, and this was split, roughly equally, between inflation in PVC and plastersizer and other materials for the Ceilings business and natural gas which is the largest component of energy inflation for us.

The rather significant improvement in earnings due to manufacturing costs, again, were largely due to activities in the Flooring businesses. We're seeing the -- really the winding down of the year-over-year benefits of closing of the Lancaster Plant in the Flooring business as well as some really pretty impressive productivity in the Wood plant in 2006.

SG&A, I mentioned declined 15 million year over year and then Wave, this is the 50% of their earnings that we account for through equity and earnings, that 50% was worth about $13 million of incremental operating income year over year.

Okay, the next chart on Page 12, again, in a similar manner to the charts for the fourth quarter, this shows the performance in sales and earnings of each of our segments versus 2005 for the full year. So in Resilient Flooring, sales were down about 2%, most of this driven by a volume decline in the North American Resilient business. The residential business was down. Commercial was up, but overall, volume was down about 3% in the North American Resilient business.

Mix was favorable across really all of the geographies in Resilient, and pricing was pretty level with a year ago, actually higher in the commercial products and lower in the residential products.

In terms of Wood Flooring, Wood Flooring sales were up about 1%. I think Mike mentioned that through the first seven or eight months of the year we saw pretty healthy growth -- volume growth in the Flooring business, kind of 5%, 6% and then the volume really fell off a cliff in the last four months of the year, and we saw significant decline. So for the full year, we were up 1%, but really a very different story through the first two-thirds of the year versus the last third of the year.

Building Product sales were up 9.5%, mostly driven by gains in pricing and mix. Volume was kind of flat to slightly up in North America and Europe and certainly up in Asia.

In Cabinets, the 8 -- 8.7% growth in sales was really due to price and mix, unit volumes, although they grew in the fourth quarter, were basically flat for the full year.

Okay. In terms of profitability, again, on a full-year basis, Resilient Flooring increased operating income by 24 million. This segment actually had a slight loss in 2005. So the gain here of 24 million was really driven by the sales growth in North America and Asia as well as the significant cost reduction in both manufacturing and SG&A that were realized in the North American Resilient business.

In terms of Wood Flooring, operating income was down 15 million or about 20%, due to some softer prices that we saw in wood throughout the year as well as higher lumber prices. We also increased our investment in SG&A in the Wood business,s and all of this was not sufficient to offset the gains that we saw in productivity in the Wood plants.

Okay. Building Products increased earnings by 25% or 40 million year over year, driven by sales, the improvement in Wave that I mentioned, and really the improvements were across all geographies, North America, Europe as well as Asia.

In Cabinets, they improved their profitability 15 million. They had lost 8 million of operating income in 2005. They earned a profit of 7 million in 2006. That turnaround was really due to many, many factors. The higher sales growth, the productivity in the plants and also the reduction in SG&A costs.

In Corporate, Corporate contributed $22 million of the improvement in operating income year over year, due to reductions in staff costs as well as reductions in some of the benefit plans that were the result of some structural changes that we made earlier in the year.

Okay. The next chart, Number 13, Mike touched on this. It was in the press release today. I just wanted to make a few comments on the sale of Desseaux or the European Textile and Sports Flooring business. The price that we received of EUR40 million was about six times trailing EBITDA.

The sale is, as you might imagine given the low profitability in the business, accretive to the profit margins as well as to the return on capital of Armstrong, and you don't see an impact of the sale on the P&L because as part of fresh-start accounting, we effectively wrote down the business to fair market value and approximately what we received for the business. So there was really no gain or loss on the sale of Desseaux in the fourth quarter -- or I'm sorry -- yes, in the quarter.

Okay. Just a few comments on the outlook for 2007, and, again, we're not going to give specific guidance. The next chart, Page 14, is a summary of how we expect each of the segments to perform in 2007, beginning with Resilient Flooring. The sales growth there we have is the yellow, we expect kind of low single-digit volume declines in Resilient businesses.

We expect the mix to be a little better year over year, but overall, for the category, kind of low single-digit volume declines.

I have the margin growth here as a green, really only because despite the softness in volume, we expect to hold margins in the Resilient category, due to continued cost reduction in SG&A and, kind of, 3% or 4% annual productivity gains in each of the plants.

In terms of Wood Flooring, we also have the sales growth here as yellow. We expect low to mid-single digit volume declines in the Wood Flooring business on a full year basis and really the price and the mix effect on sales to be quite modest.

In terms of margin growth, we do expect the margins to soften somewhat in the Wood Flooring category. They are expecting a somewhat larger decline in volume than Resilient. That is problematic in terms of absorbing fixed costs in the plants. So that's contributing to the margin weakness as well as in SG&A, we're planning on continuing to invest in the Wood Flooring category in particular in 2007 in media spend. So those are the two contributors to the margin softness in Wood Flooring year over year.

Building Products, we expect sales and margins to expand in 2007 in terms of sales, most of that, the gain in revenue we expect to come from price and mix, although we do expect low single-digit volume growth in Building Products.

In terms of the margins, we -- if you look at the impact of pricing, we expect that to continue to be favorable inflation. We expect to be somewhat less than what -- than what we've been seeing, certainly from what we saw in 2005, and we expect continued productivity and manufacturing as well. So we do expect margins to expand in Building Products next year -- or this year.

In Cabinets perhaps somewhat counterintuitive given that much of their business goes to residential, we are expecting revenue growth in 2007, due to all three, price, volume, and mix. We each -- we expect each of those to be slightly -- slightly better than last year.

In terms of margins, we expect continued margin growth in Cabinets as we saw in 2005, due to gains in price and mix as well as ongoing improvements in manufacturing productivity.

And I showed Corporate here in terms of margin. Really, that's cost, right. We expect the cost at Corporate, the unallocated Corporate cost to be somewhat higher than they were in 2006, largely due to the expenses associated with the equity that was granted to Management as part of emerging from Chapter 11.

Okay. Then the last chart here, just a few more comments on the outlook for 2007. In terms of raw material and energy inflation, as you saw from the bridges, this has been a significant contributor to the change in earnings over the past couple years. It was about $60 million of headwind in 2006.

We expect that to lessen somewhat to $40 to $50 million, still higher than 2006, but not quite at the same rate. In terms of productivity and manufacturing, we expect on a dollar basis that that pick up year over year to be about half of what it was in 2006, due to the run-off of restructuring benefits that are really fully baked in on a run rate basis at this point.

SG&A, we expect the growth in SG&A to be somewhat below the rate of inflation, so call it 2% or 3%. Interest expense on our long-term debt that we issued in October, and this is net of some interest income, we expect to be between $45 to $55 million for the full year.

Cash taxes and the effective tax rate, we have assumed at this point that we are going to file for a two-year carry back of the NOL that was created upon funding the asbestos trust, and if in fact we do that on a net basis, we will have a refund of about $50 million in taxes in 2007.

And then in terms of the effective tax rate, we expect that to be between 42% and 43%. That's slightly higher than one -- what one might expect, and that's really due to the losses that we generate in our European Flooring business and the fact that we don't get a tax benefit for those losses, so that takes the rate from kind of a more normal 38%, 39% rate up to 42% or 43%.

In terms of the impact of fresh-start accounting, I believe I mentioned this earlier, we expect that to be about $20 million favorable, and this isn't so much year over year as it is against 2007 if we had not adopted fresh-start accounting. So $20 million of additional operating income, due to fresh-start accounting and just the components of that, we expect depreciation amortization to be about 5 or 10 million higher.

We expect the impact of having written up the Wave investment to be a negative $5 to $10 million, and all of that offset by about a $30 or $40 million increase in earnings due to the fresh-start accounting impact on our benefit plans.

That's mostly the domestic defined benefit pension plan and what happens in fresh-start accounting is that you basically recognize all at once the previously unrecognized losses on the plan, and so we no longer have to amortize those losses going forward. So we have a pick up each year going forward. So the pension credit, which has been kind of in the $40 to $45 million range will be about $60 million in 2007.

In terms of how we see the year unfolding relative to 2006, certainly the first half of the year will be weaker since the comparisons are more difficult. The -- we really saw the turn in the residential business in the second half of last year. So the comps will be easier in the second half than the first half, although with that said, we're not expecting a recovery in the second half of the year. It's just simply that the comparison will be easier.

And then finally in terms of cash flow, we -- I mentioned that we generated about $100 million of free operating cash flow in 2006. We expect that number to step up to $250 to $300 million in 2007, really due to two things. I mentioned that the tax refund of $50 million against cash taxes paid last year of about $50 million, so we have a net change in taxes, cash taxes of about $100 million and then the dividend from Wave.

We have taken an extraordinary dividend from Wave. We've paid out their cash. We've added some leverage to the business, and so the Wave dividend year over year will be $60 or $70 million higher than it was last year. So, those are really the two components that lead to the almost tripling of cash flow year over year.

Okay. Why don't we open the line up for questions?

Thank you, sir.

[OPERATOR INSTRUCTIONS]

One moment, please, for the first question.

Our first question comes from the line of Ian Zaffino of Oppenheimer. Please go ahead.

Great, thank you.

This is a very informative presentation. Just a couple questions here.

The first one would be, what's the cash balance pro forma for the sale, pro forma for the rebates you're expecting.

And then as far as the free cash flow guidance, I imagine that is after CapEx, so that's just like a free cash flow number, that's it. Thank you.

Yes, I'm sorry, the first question was in reference to the tax refund?

What's the pro forma cash balance? I mean, you finished the year with about 252 million and then you got about 53 million from the Textile Sports and then you are getting a tax refund, so what's the total pro forma cash tax -- cash balance?

Okay. At the end of 2007?

2006. Well, yes, yes, sure.

Okay, well we certainly expect to not carry as much cash as we have.

The debt that we've issued is pre-payable, and so we'll do that. So we ended the year with kind of net debt of 600 million or so, and I mentioned that free operating cash flow should be 250 to 300 million.

Right, but I'm sorry, ending '06 what was the cash balance? You had 252 and then you're getting about 53 million from the Textile Sports so you're up to, call it 310 or 305, are there any other pieces I'm missing here?

No.

The sale of the Textile business just closed today, so obviously that cash would not be reflected on the year-end Balance Sheet.

No, I know that. So for you to make the adjustments for the things that are not in the Balance Sheet, what would it be?

Okay. It would be that.

It would be for the Desseaux proceeds, and we also received, I guess, about half of the expected dividend for the year from Wave in the first quarter.

Okay.

So that was 50 -- $50 million or so, but generally --

So the rest of that would be 25 million or --

No.

The dividend was 100. Our portion of it was 50.

Okay.

But you need to keep in mind that the first quarter is generally a drain of cash. We have negative cash flows from both inventories going into the second and third quarter. So the free cash flow in the first quarter will be negative.

Was there a rebate from the AHI settlement?

No.

There's not a rebate. We're actually paying them $20 million to control the tax return.

Right, but on the tax line, there's no rebate.

No.

Okay. All right. Thank you very much.

Next we go to the line of Jim Barrett of CL King & Associates.

Please go ahead.

Good afternoon.

Mike, can you talk about, implicitly what your assumption is about new housing starts in your guidance?

Well, we're down about 15% in new housing starts for the year.

For the entire -- and with some front-end loading first half?

Well, it's more in the first half, but we don't expect to see it recovered. Obviously, by the time we get to the fourth quarter, we'll have a lot easier comparison, but it's front-end loaded.

Okay.

We don't expect to see benefits to our business from any kind of change in new housing until 2008.

Right.

And Nick, can you talk about your CapEx plans by your major segments?

Well, the CapEx figure last year was about 130 million across the Company, we expect to spend somewhat less than that this year, probably 115 to 120 million.

I really don't have it broken down by segment in front of me.

And then finally, could you discuss the magnitude of pricing that you're seeing in Building Products?

Such as the price increases you already announced on that front?

Yes.

At this point I'd say on a run rate basis, the year-over-year increases in pricing are kind of mid to high-single digits.

Okay. Okay.

Well, thank you very much.

And next we go to the line of John Baugh of Stifel Nicolaus. Please go ahead.

I first want to try to nail down 2006 EBITDA on the Adjusted EBIT of 255. D&A was about 133 and were there any deferred taxes or other numbers that would adjust the EBITDA figure for '06?

No.

No.

So we're right about 255 and 133?

That's right.

Okay.

The Building Products North American volumes, I think you've mentioned the core Commercial U.S. was still up in the fourth quarter.

Did that decelerate though from the first nine months, first half of the year, and I think you mentioned you see that going up slightly in '07, just kind of give me a better feel for what's going on in that business?

Well, I think what we're seeing is kind of more of the same, kind of very low single-digit growth in volume in the Commercial business and some choppiness in the Retail business. So I wouldn't say we've seen any discernible change in the year-over-year volume growth in the core Ceilings business.

So the core Ceilings business was up very low-single digits throughout calendar '06?

Right.

And so most of the sales gain was pricing and mix?

That's right.

Okay.

On the, I was going to ask about the NOL figure and the overfunded pension amount figure as of calendar year-end.

Okay.

What do you want to know?

What were the numbers? What were the raw numbers?

I'm sorry?

What was the NOL -- gross NOL at the end of '06 and what was the gross amount of the overfunded pension at the end of '06.

Okay.

Well, the gross amount of the NOL was 1.6 billion. The tax effected NOL non-discounted is embedded on the Balance Sheet and deferred tax asset is about 500 million.

Okay.

And -- Okay.

Obviously, the discounted value of that would be somewhat less. And then on the pension, I think we ended the year with 530 million overfunded position on the U.S. domestic plan.

Okay.

And, again, keep in mind that that's the U.S. plan. We have some foreign plans that are underfunded or not funded at all.

What's going on in Cabinets that will enable you to grow in units in '07 when 70% of your end market is basically domestic and residential construction?

That's something that's a weekly question we ask ourselves.

Year to date our orders are up over last year and ahead of what we expected them to be. I think it's a combination of last year at the beginning of the year, we had problems that were associated with manufacturing performance that meant that we couldn't deliver particularly well, and so we're just in a better service position.

We've improved our product line offerings in maple and cherry which are important species to be competitive, and so we have just been enjoying more success in a marketplace. Now, when you look at us, remember that in Cabinets, we're not nationwide. We're really only in 38 Markets. So it isn't like we're bucking a trend nationwide on this, but we have been very fortunate in our ability to do that.

Now, the one other thing that's worth mentioning about Cabinets is we do tend to have a pretty good share of multi-family which has tended to be a little better than -- particularly apartments has been a little better market for people. So we don't honestly -- other than the fact that we're providing good customer service, good quality, it's not clear to us why we're doing better than competition.

I do say that one thing -- because of our narrow geographic focus, we don't do much with large builders. We don't do anything with big box and -- because we really don't have the infrastructure to service them. And so clearly, the large builders have taken a disproportionate amount of the hit in new housing, and so we do have some benefit that's accruing to us as a result of that, but -- okay?

Great.

And last question, on Wood Flooring, you made a couple of small acquisitions. What was the revenue help from those acquisitions either from fourth quarter end or '06?

About 5 million for the fourth quarter and probably 13 and 14 for the year.

Great. Thank you very much.

Sure.

[OPERATOR INSTRUCTIONS]

And we go to the line of Matt Sherwood from C.S Fund. Please go ahead.

Hi. Good quarter. Just had a couple quick questions.

First, can you give a little more color on the options with respect to the NOL? I know you guys were assuming the two-year carry back, but could you walk through the logic between that relative to the ten year?

Yes. I really, I'll make a few comments but I don't want to get into too much detail.

It's a very complex area and there are many different potential outcomes here. But basically, how the NOL is applied is a function of the future earnings in the business, right? And the relative tax rate of the historical earnings versus the future earnings. So we have assumed in a -- in let's say a change of control case where the leverage put on the business is relatively modest, that the best outcome would be a two-year carry back. So that's what we've assumed at this point, okay?

But there are scenarios where the future earnings of the Company were dampened sufficiently by leverage or whatever that one might elect to do a ten-year carry back and get a substantial refund, but then, of course, have less carry forward and to shelter against higher tax earnings in the future.

Great. That's helpful.

And just a quick question, on the Wave dividend, it seems like since both -- has there been any change in philosophy there just given that Wave had been carrying a large cash balance and generates a lot of free cash flow and both partners had had net debt on their Balance Sheet?

I think if you simply look at the incremental borrowing rate of Wave given their profile, it's a good thing to do economically.

Yes.

We're paying LIBOR plus 50, 150 to 175 and Wave can borrow less than that, and our partner felt the same way.

Great. And then just one final question.

Could you give a little bit of flavor behind this 115 to 120 of CapEx? Is it more maintenance type CapEx or it's growth projects or just a little more color on that?

Roughly, it's kind of 50% to 60% maintenance, and the balance would be cost reduction initiatives and some support for new products, that type of thing.

Okay. All right. Great.

Thanks a lot. Great quarter.

And there are no other questions or comments in queue. Please continue.

All right. Well, thank you again, everybody, for joining us this evening and, again, I will be available for follow-up calls at 717-396-3278.

Thank you.

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