Armstrong World Industries Inc (AWI) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to Armstrong World Industries, Inc. second quarter 2007 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to turn the conference over to our host, Ms. Beth Riley, Director of Investor Relations. Please go ahead, ma'em.

Thank you, Matt. Good evening and welcome. Please note that the members of the media have been invited to listen to this call and the call is being broadcast live on our website at www.armstrong.com. With me this evening are Michael Lockhart, our Chairman and CEO, and Nicholas Grasberger, our Senior VP and CFO. You have probably seen our results in this afternoon's press release and both the release and the presentation Nick will reference on the call are posted on the website on the investor relations section.

In keeping with the SEC requirements, I advise that during this call, we will be making forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those expected or implied. For a more detailed discussion of the risks and uncertainties that may effect Armstrong World Industries, please review the reports we have filed with the SEC, including the 10-Q to be filed later this week. In addition, our discussion of operating performance will include non-GAAP financial measures within the meaning of SEC Regulation G, including references to operating income on an adjusted basis, as defined in today's press release. A reconciliation of the differences between these measures with the most directly comparable financial measures calculated in accordance with GAAP is included in the press release and in the appendix of the presentation we'll reference during the call. Both are available on our website. With that, I would like to turn the call over to Mike.

Thanks, Beth. Good evening, everybody, and thanks for participating on our second quarter earnings call. I say that, recognizing that there mean more interest in the status of our review of strategic alternatives than in our second quarter financial results. The review of strategic alternatives is taking longer than many people thought it would, and this has led to a great deal of speculation, informed and otherwise. To everyone's disappointment, no doubt, we have nothing to say about the review beyond saying that it continues. I would also like to say we do understand our disclosure obligations, and when a conclusion is reached, we will make a timely appropriate disclosure about the process.

We're pleased to say our second quarter financial results were gratifying. Sales increased and operating income rose over 20%. Our performance varied by segment and we believe we beat the market in all of our North American businesses. North American resilient sales declined due to weak residential markets, but volume was down only 6% in what was a brutal market. Residential sales declines were dampened by strong performance from commercial products and by improved product mix in both residential and commercial products. One residential bright spot was laminate. Sales to the independent channel increased, indicating good acceptance of our new laminate product line.

Reduced manufacturing costs, prudent reductions in sales, general and administrative spending and raw material deflation combined to more than offset the effect of lower sales, allowing us to deliver higher operating income in this segment. In constant dollars, European resilient sales improved. There has been volume growth in this business in each of the last two quarters. The benefits of higher sales were offset at the operating income line by expected negative synergies related to our divestiture of the textile and sports flooring business. We expect these negative synotures to dissipate over time.

Building products continues its excellent performance. Continued success in selling high-value products, as improved product mix offsetting inflationary pressures. The Wave joint venture, which produces the grid used to install ceiling tiles, also performed well, showing only a small impact from higher steel prices. Wood flooring was hit hard by declines in the U.S. housing market. We estimate that 55% of wood sales go to new houses, the remainder to residential renovation. Volume declined 5% for the quarter in the Wood business. Lower sales combined with increased lumber prices to reduce operating income for the quarter, despite substantial benefits from manufacturing and productivity.

Our cabinet business has about 70% of its business going to new housing. Yet it delivered volume growth. Consistent manufacturing performance improved our customer service levels to industry standards or better and improved service and quality combined with product line improvements to drive sales growth and also to earn Armstrong first place in the J.D. Power & Associates first-ever Cabinet Satisfaction Study. The business also benefited from not having exposure to the largest home builders who have been the hardest hit by the housing downturn. We do expect lower volumes in the second half of 2007.

Asia is split evenly between floors and the ceilings and it continues to perform well in growing markets, particularly Australia and India. Market growth in China is slower than we had thought it would be, but long-term prospects are still good. Overall, we delivered solid performance in the second quarter and significant cash generation in the first half has allowed us to repay $200 million in debt.

Let me turn to the second half. The outlook for U.S. housing is poor. Last week the commerce department reported new home sales dropped for the fifth time in six months. Sales of single-family homes fell 6.6%, while the inventory rose and median prices fell. Demand for existing homes has fallen to the lowest point since November 2002. Higher mortgage rates, tightening lending standards, growing inventories of unsold homes and resulting price declines imply little chance of near-term improvement for housing.

Factors which influence renovation spending remain mixed. Existing home sales and equity from refinancing are both down, while household income levels are increasing. If our customers or channels are representative, the renovation market is soft. Fortunately, we expect most commercial markets to be flat to slightly up and the developing markets to be strong. Commercial growth and market share gains will lessen the impact of the weak U.S. housing market. The benefits are higher prices and manufacturing productivity should offset raw material inflation.

Our objective is to gain market share and improved product mix through innovative products and services that deliver value to our customers. We will continue to control costs and to improve productivity. Nick will now provide a discussion of the numbers.

Thank you, Mike. I will review the first four charts posted on the website on the June quarter results, and then make a few additional comments on the outlook for the second half of the year. The charts that are provided are related to the year-to-date performance are for your reference only.

The first chart on page 4 simply shows that our operating income in the June quarter on a reported basis is consistent with what we view as adjusted operating income. The $94 million of operating income equates to about $0.93 of EPS from continuing operations on a diluted basis. As can you see on the charts that the costs from chapter 11 and our strategic review process are offset by the benefits that we received in the quarter versus a year-ago from the adoption of fresh start accounting. You may recall that the $6 million per quarter is comprised of about an $8 million favorable impact from our benefit plans and a $2 million adverse impact from higher depreciation and amortization.

Chart 5 are the key metrics, financial metrics for the quarter, and, again, these are all on the adjusted basis as just discussed. Beginning with sales, sales were up about 2% in the quarter versus a year ago. Price and mix were each up about 200 basis points and volume was down about 200 basis points. Looking at the gross profit line, gross profit was up 6%, the margin improved 80 basis points. The pricing we realized in the business for the quarter did not quite offset inflation, although a better product mix and lower manufacturing cost more than offset that gap to lead to a growth in the gross margin.

SG&A expense was actually down $3 million versus a year ago, or 2.4%. The intensity of SG&A to sales declined about 70 basis points from 16.6% to 15.9%. And most of the reduction year-over-year was from the North America floor business. Operating income, $94 million, was up 18%. The margin at 10.2% is the highest margin for a quarter that we have realized in over seven years. In fact, it's the first double-digit operating margin that we have generated at Armstrong in over seven years. The operating margin improved about 140 basis points and the fall through of profit of operating income was quite high in the quarter.

Cash flow of $156 million was quite strong, $45 million higher than a year ago. Really driven by higher cash earnings, dividends from Wave and also the utilization of our net operating loss which has shielded the tax on earnings this year. The way to think about cash flow in the quarter is we had roughly $120 million of cash from earnings. We spent about $20 million on Cap Ex so there is $100 million and then we received about $50 million of dividends from Wave. And beyond that, we did receive the proceeds from the sale of [Desto] early in the quarter, so we have, as Mike mention, reduced debt by $200 million since the beginning of the year. The next chart is an operating income bridge. That bridges the operating income of $79 million in the June quarter of 2006 to $94 million of operating income in the June quarter of 2007. The price, price increases generated about $15 million of incremental profits, most of that was in building products, although each of the other businesses was either flat in pricing or up year-on-year.

In terms of volume and mix, $6 million of operating income generated here, this is mostly mix as volume was down as I noted earlier in the quarter, and most of the mixed benefits were from the ceilings business, from building products. The raw material and energy insulation of $18 million was derived mostly from the building products business as well. The natural gas prices being higher year-over-year, and mineral wool also having significant inflation year-over-year. We have also seen some higher costs of raw lumber. The other businesses for the most part had their raw material and energy inflation down or perhaps flat versus a year ago.

Manufacturing costs reduction contributed $9 million to the earnings growth in the quarter. Most of that manufacturing improvement was in the floor North America business, but all businesses did better, with the exception of the cabinets business on a year-over-year basis. SG&A, SG&A reduced by $4 million year-over-year, I believe I mentioned that that was mostly derived from the floor business in North America. And finally, Wave, the earnings from wave declined by $2 million in the quarter due mostly to volume shortfalls, margins were largely the same, and versus a year ago, there is also interest expense now on Wave where there was interest income a year ago, and given the way we account for that and operating income, that also reduced the earnings from Wave to Armstrong.

Okay, the next chart on page 7 shows the segment performance in the quarter versus a year ago, both on a sales basis and operating income basis. In the June quarter, from a sales standpoint, the Resilient Flooring business was flat, roughly flat in sales, the Wood flooring business was down about 5%, most of that due to the engineered Wood products. The solid wood flooring products, the growth was largely unchanged year-over-year. And building products at 9% growth in sales was driven by price and mix and the cabinets, 9% growth was mostly volume.

Turning to operating income, resilient flooring improved operating income by $8 million. That was derived mostly from manufacturing and SG&A savings. In the wood flooring business, the decline of $4 million was driven by lower volumes, a slightly weaker mix and higher lumber prices. In building products, the $10 million growth in operating income year-over-year was mostly a price in productivity exceeding in flags and a higher -- in inflation and a higher product mix. In cabinets, the $2 million growth and earnings was driven by volume and lower SG&A and in corporate, we had $2 million of higher costs year-over-year due largely to incentive compensation.

With respect to the second half of the year, just a few comments to support what Mike mentioned earlier in terms of sales, we expect sales for the third quarter to be largely flat versus year ago. Declines in the North American flooring business and increases in the ceilings and cabinets businesses. In the fourth quarter, the comps get a little bit easier. The third quarter, we did not begin to see the weakness in the residential markets until late in the third quarter last year, but we do have easier comps in the fourth quarter so we expect kind of a low-single digit growth in sales in the fourth quarter.

For the second half of the year, we expect sales to be up 1 to 2%. For the full-year, we expect sales to be up 2 to 3% and volume down about 1% for the full year. In terms of operating income, we expect operating income growth in the second half of the year up in the single-digit range, the fourth quarter should be stronger than the third. The third quarter in fact could be down in profitability versus a year ago. It's -- if so, very modestly, and for the full-year then, we expect operating income growth to be in the range of 10 to 15%.

In terms of cash flow, year-to-date cash flow has been about $150 million, after, that the proceeds from the sale of Desto and we generated cash and a total of $200 million. We would expect in the second half of the year to generate another $150 million or so. If you look at net debt today, we're at $500 million and we should be between 3 and $400 million at the end of the year. Again, I will not step through the charts on the year-to-date performance, but you can see sales and earnings were both up nicely year-over-year and margins are also higher. Okay, I will now open the line for any questions that you may have.

(OPERATOR INSTRUCTIONS) Our first question will come from John Baugh with Stifel Nicolaus.

Hello, this is actually Stanley in for John. First of all, I would like to say nice quarter. Second -- a quick question for you. Could you tell us how much cash the asbestos trust currently has or could you give us an update on the filing claims, and estimates of when they might be making payments?

Say that again? I got -- I missed the middle part. About how much cash we have to date. We don't have any visibility into what cash they have today.

Okay.

They are making payments. They have been paying claims since May. And we're not firm with the rate at which they're paying claims or the amount of cash that they have today.

Okay. Could you help me then better understand kind of what happens if they were hypothetically to run out of cash, what were their options, could they do a leverage recap or sell on the open market, secondary, I'm trying to get a better understanding of that process.

You mean what can they do with their stock?

Correct.

Okay, was going to say, you know, they can not run it in a way that runs out of cash. In terms of selling their stock, their rights are only limited by the ability to make the same offer -- hat can't sell anymore than 5% on a basis that isn't available to all other shareholders. I think that is called tag along rights. The minority shareholders have tag along rights and they have, this trust has the right to request registration for us to register stuff, register stock or for sale. Otherwise, there is no restriction on what they can do.

Very good. Thank you very much.

(OPERATOR INSTRUCTIONS). We'll go next to Andrew Dakos with Full Value Partners.

Thank you. Question. What was the depreciation expense for the quarter?

Depreciation expense for the quarter, one second. Depreciation and amortization for the quarter was about $33 million.

$33 million and you're saying your Cap Ex was about $20 million for the quarter?

Was about 20. Now, the capital spending at armstrong is phased more towards the second half of the year. We'll spend maybe $120 million this year, 40 or so in the first half and 80 in the second half.

Forty in the first -- okay. Thank you, that was all.

(OPERATOR INSTRUCTIONS). We'll take a question from [Daniel Lonch from Citadel.]

Good afternoon, how are you?

Can you give us a better sense to why the strategic review is taking longer than expected as you refer to in your opening remarks?

We said we were not going to comment on the strategic review and we're really not going to do that. I can't answer your question.

Okay. How about with regards to your uses of cash on the balance sheet and given your free cash flow generation, especially this quarter, how should we think about when you plan to use that cash for and what is an appropriate level of leverage that you see for operating the business?

Well certainly the plan will be to continue to pay down debts. We're very comfortable with the leverage we have in the business but at this point, we really don't have any plans to do anything with that cash beyond reducing debt.

Okay, great. Can you tell us what the cash and debt balances were at Wave at the end of the quarter?

Yes, the cash balance would have been relatively small. Say less than $10 million, and the debt balance would have been around $100 million.

Thank you.

We'll go next to Ian Zaffino with Oppenheimer.

This is [Brian] sitting in for Ian. I just had a question with the third and fourth quarter gross margins. Are we going see those year-over-year lower than last year?

No, I don't believe so. Again, the comps in the fourth quarter are relatively easy.

Okay. Bear with me one second here. We expect the gross margins to be higher in the second half of the year. Higher. Okay, thank you.

(OPERATOR INSTRUCTIONS). We'll take a question from Oliver Butt with JPMorgan.

Hey, it's Gerry Madigan with JPMorgan. A quick question. Do you guys break out how much you make in the Wave JV, or how can we get -- I think we saw numbers out of Worthington. Are those apples-to-apples comparisons?

Apples-to-apples comparisons, we --

Yes, do you guys break out Wave?

Yes, we do. You'll see that in the Q.

It's in the press release in the equity earnings line, if you look at the P&L. That's almost entirely Wave.

Yes, so that's our 50% portion.

Terrific, terrific, thank you.

And there are no further questions in the queue at this time.

All right. Thank you, everybody, for joining us, and I'll certainly be available for follow-up calls. Have a good evening.

And that does conclude today's teleconference. We'd like to thank everyone for their participation, and wish everyone a great day.