Armstrong World Industries Inc (AWI) 2008 Q1 法說會逐字稿

Good day everyone and welcome to Armstrong World Industries first quarter 2008 earnings conference call. (OPERATOR INSTRUCTIONS) As a reminder today's conference is being recorded. I would now like to turn the conference over to your host, Ms. Beth Riley, Director of Investor Relations. Please go ahead.

Thank you, Kim. Good morning and welcome. Please know, that members of the media have been invite to do listen to this call and the call is being broadcast live on our Web site at armstrong.com. With me this morning are Mike Lockhart, our Chairman and CEO, and Nick Grasberger, our Senior VP and CFO. Hopefully you've seen our press release this morning and both the release and the presentation Nick will reference during this call are posted on our web site in the Investor Relations section. In keeping with SEC requirements, I advise that during this call we will be making forward-looking statements that involve risks and uncertainties. Actual outcomes may differ materially from those expected or implied. For a more detailed discussion of the risks and uncertainties that may affect Armstrong please review our SEC filings including the 10-Q filed last night. In addition, our discussion of operating performance will include non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of these measures with the most directly comparable GAAP measures is included in the press release and in the appendix of the presentation. Again, both are available on our web site. And with that I would like to turn the call over to Mike.

Thanks, Beth. And good morning everybody. Thanks for participating in today's earnings call. As we expected, the first quarter was a challenge but we are pleased that our results are at the high-end of guidance. If we exclude the benefit of foreign exchange, sales declined 7%.

Adjusted operating income declined 30% to $46 million. We had modest improvements in price and mix, but those were not enough to offset lower volume. The majority of the volume declines were in the businesses most dependent on housing, wood flooring and cabinets. Another problem in the comparison is that we had great results in the first quarter of 2007. In 2007, wood flooring had significant growth from a big box promotional event. And cabinets grew because of our lack of exposure to large builders and big box customers. Last year's results also benefited from (inaudible) sharing cost with the textile business that we sold in the second quarter of 2007. But the earnings decline was not all a matter of a tough comparison. It was also due to SG&A spending, weighted toward the first quarter.

We increased promotional spending in wood flooring to support special order sales growth later in 2008 and SG&A spending in European floor increased due to the normal triennial new product introduction cycle. During the first quarter we returned nearly $260 million to shareholders through a special dividend. Building products, our ceilings business continues to perform well despite decline in the U.S. commercial markets. European markets showed growth and that helped sales and operating income to grow modestly. Product mix improved and price realization increased. We continue to see gains in the ceilings business from increasing manufacturing efficiency.

North American resilient sales declined about 2% in the first quarter. Volumes were down high single digits. Improved product mix and commercial price realization only partially offset lower volume. Operating income declined nearly 50% due to the lower volume. Price realization offset raw material cost increases, SG&A was flat and manufacturing cost declined. Ignoring currency effects European resilient sales decreased about 4%. The operating loss increased significantly due to lower volume, raw material inflation and increased SG&A expense. Wood flooring is a U.S. residential business.

In normal times we expect that approximately 55% of sales went to new home construction. The remainder was used in residential renovations. This exposure was particularly challenging in the first quarter. The renovation market declined at a double-digit rate and, of course, the travails of the new housing market are well publicized. The result, wood flooring declined about 20%. About a third of the decline related to the big box promotion that we talked about earlier which was not repeated in 2008. Lower volume and increased promotional spending more than offset substantial manufacturing productivity to reduce our (inaudible) income. Cabinets, also a U.S. residential business, experienced similar volume declines. The operating loss for the quarter stands in contrast to a modest income in 2007. This was largely due to reduced volume.

We performed as expected in the first quarter and anticipate our year-over-year comparisons will improve throughout the year. We are confirming our guidance for 2008. Obviously we are retaining a broad range to reflect the challenges of this year of declining U.S. and residential and commercial markets. Our guidance assumes a 25 to 30% decline in housing starts and high single-digit decline in residential renovation. But clearly conditions could be worse than we expect. We expect our domestic ceilings markets to decline at a mid single-digit rate. Our commercial flooring business which has a different mix of markets is expected to be approximately flat. There is risk here but less so than in the residential markets.

Our European ceilings business is performing at all time highs and has a strong outlook. Our European floor business had a difficult first quarter and will likely continue to be challenged through the year. We are not happy with the performance in Europe. There are some market issues but our poor performance is largely the result of structural problems. Scale and process disadvantages which affect production cost and SG&A. We are commit to do developing an accredible plan to address these issues and begin implementation of this plan by year end. This plan is likely to involve a mix of plant closures, sourcing products, outsourcing administrative work and plant investment. We are actively evaluating many different options. For the full year we expect to continue to outperform our markets but at the midpoint of our range adjusted operating income is still expected to decline about 5%. These expectations are the result of several largely offsetting factors. Improved product mix partially offsetting mid single-digit volume declines, price realization and manufacturing productivity offsetting inflation, and flat G&A spending. In this tough environment our objective remains to use product and service innovation and quality to deliver increased value to our customers permitting to us improve mix and increase share. We will continue to control cost and to improve productivity. Now Nick will take you through the numbers.

Okay, thank you, Mike. The first chart that I'll refer to is number Page Three, the presentation that's posted on the web site. This is the operating income bridge for the first quarter from the reported figure of $39 million to the adjusted figure of $46 million. The reported figure of $39 million compares to the guidance we had provided of a range of 27 to $32 million, and the adjusted figure of $46 million compares to our guidance for the quarter of 40 to $45 million. You can see on the chart the components of the change between reported and adjusted. We had $5 million of expenses related to corporate severance. We had about $1 million of fees related to our advisors in the strategic review process. We had an incremental $2 million of depreciation and amortization related to a fresh start adjustment. And then we had about $1 million of benefits related mostly to Chapter 11. The next chart looks at the key metrics-- key financial metrics for the quarter. And these are adjusted for non-recurring items and for foreign exchange. Starting with sales, sales on an adjusted basis were down about 7%. The reported figure was down 4%. The difference was foreign exchange. Unit volume was down about 10%. Price was up about 2% and mix was up about 1%. Looking at gross profit, down 9%. The margin was relatively unchanged, down 40 basis points. From a manufacturing or gross profit margin standpoint the ABP businesses and wood businesses were up and the margins in resilient and cabinets were down. SG&A expense for the quarter was up about 4%, really driven by the investments that Mike mentioned in the European floor business as well as the wood business. Collectively the other businesses were flat to down in SG&A spending year-over-year. Operating income down about 30%. This is the first decline we've seen in a quarter since the second quarter of 2005. We were up 30% in the first quarter of 2007. So we do have a difficult comparison. And the margin declined about two points. Looking at cash flow, cash flow was a use of $93 million. This is compared to a $5 million use in 2007. The differences, and I'll step through in a minute, were largely cash earnings, working capital and an extraordinary dividend that we received from Wave in the first quarter of last year. Looking at the debt balance and this is not on the chart, you may recall that we ended 2007 with about $.5 billion of debt and $.5 billion of cash. At the end of the first quarter, that cash balance had declined by $350 million to about $150 million we still have the debt of $.5 billion. So the net debt now is $350 million. So we had cash flow for the business of about $100 million negative and then the dividend of about $250 million. So that accounts for the $350 million change in cash for the quarter. Page Five is the adjusted operating income bridge for the first quarter from 2007 to 2008. Looking at the components, price was up about $16 million and really every business increased price, some modestly, some a bit more. But this is mostly the commercial businesses that were successful increasing price in the quarter. And you'll see compared to the raw material and energy inflation of $15 million, we just offset that inflation with price. Operating income was negatively affected by $33 million due to volume and mix. Mix was a slight positive.

Volume was down significantly, again 10% in units and about 90% of that was due to declines in the U.S. residential businesses. The other business that had a notable decline in volume was the ceilings business in North America which was down about 7%. The inflation we saw in raw materials and energy was split about 90% raw materials, 20% energy. And of the raw material inflation, about three quarters of that was related to our vinyl businesses and to linoleum. The balance, the 25% was in the ABP businesses and cabinets.

We had a notice for all quarter in manufacturing especially in the wood business and in ceilings North America. So we generated $14 million of incremental earnings year over year due to reduced manufacturing costs. SG&A, I mentioned before, was up about $6 million. Again this is accounted for by the wood business and floor Europe. The other businesses were flat to down including corporate. And then Wave, Wave contributed about $3 million of incremental earnings. For the quarter Wave sales were up 5% and their profit was up about 20%. Driven by the margins per square foot in Wave were up about 20% versus the end of the first quarter last year.

Turning to Page Six, looking at the sales and operating income by segments for the first quarter versus last year, this chart really reflects the comments we've already made. Resilient Flooring, as a category, sales were down about 3%, unit volume was down 7% and price and mix were both positive and about equal to each other. Wood flooring down 20% in sales. That's really all volume. Floating products was up 1%.

On a global basis volume was down about 3% and mix collectively up about 4% And then cabinets the 26% decline in that category was really all due to unit volume. Turning to operating income, the Resilient Flooring segment saw a $17 million decline in operating income year over year. About 65% of this was due to the European resilient business, the balance in North America. And really the dynamics here were we had price realization less than inflation of about $5 million. Unit volume declines affected earnings buy about $10 million. SG&A, another negative $5 million, then manufacturing was actually positive in both the U.S. and European resilient businesses. Wood flooring, earnings were down $6 million year-over-year. This is really due to volume and SG&A.

Even though manufacturing was a significant positive it's not sufficient to offset the impact of volume and SG&A. In building products earnings were up on a global basis about $4 million year over year. Price and manufacturing efficiency were higher than inflation and then the Wave business had a nice contribution to growth as well as. Cabinets was down $5 million. This is really all due to unit volume declines, both manufacturing costs and SG&A spending were down or improved year over year. And finally corporate, corporate expenses were $3 million lower year over year due mostly to salaries and benefit programs.

Wanted to show a chart on cash flow for the first quarter of '08 versus '07, because there was a significant decline. On the (inaudible) inside of this chart seven, you can see the variance by category that comprise the $88 million short fall relative to last year, and free cash flow. The components really are-- our cash earnings were down $27 million. Working capital was up about $60 million relative to the change in working capital in Q1 of last year. That's due mostly to inventory and accounts payable. Inventory was up about $30 million in the quarter relative to last year. And, it's really a timing issue. This is not a permanent investment-- incremental investment in inventory. We had a very strong quarter last year in the wood business. Inventories were driven down at the end of the first quarter last year further than we anticipated. And, on the flip side, this year, the wood business was a bit weaker. So we ended the quarter with higher inventory. So, again, this is really related to a timing issue.

Accounts payable , net of receivables was a use of about $30 million for the quarter relative to last year's first quarter. And this is really all around the decrease in activity in the business. We had a extraordinary dividend of $50 million from Wave in the first quarter of last year. This first quarter, in '08, was a more normal dividend, so we had a negative variance year-over-year, due to the Wave dividends. So you can see the free cash flow was an $88 million unfavorable variance to the same quarter of last year. You then step down and see the impact of the dividend that we paid, you see the net change in cash.was $350 million. Chart Eight is just simply restating the guidance for the full year. Mike mentioned that we're not changing the guidance. This is the same chart that we showed in late February. Sales down 1 to up 3 for the year. and so forth, so we're not changing our sales or earnings guidance and cash flow should continue to be in the range of 175 to $200 million for the year. Chart Nine, just shows in a picture, kind of our view of the markets and margins for each of the businesses for the last nine months of the year.

Starting with resilience, sales we expect for the full year to be flat to maybe slightly up. Of course down in residential and North America. Sales in the commercial business flat to maybe slightly up. And then in Europe and Asia, we expect growth in resilient flooring. The margin for the full year for this segment we expect to be down versus 2007, a point or two. Wood flooring, in terms of sales of course mostly exposed to residential, the comps will get easier as the year progresses and we also have some promotional activities going on in the Big Box channel that should help somewhat offset the weakness in residential. So, we do expect kind of a high single digit decline for the full year in volume in the wood floor business. In terms of margins, we would expect wood flooring margins to be off about two points versus the margin of last year.

Building products, globally we expect a low single digit growth in volume and sales. Obviously the residential market in North America is weak, but that's a small portion of the business. We do expect North American commercial to grow in sales with price and mix more than offsetting a 4 to 5% decline in unit volume. Then we expect growth in price volume and mix in Europe and Asia in ceilings. So for the full year, we would anticipate the margins for the building products segment to flat to maybe up a point. In cabinets, the story is clear. We expect significant decline in unit volume and sales in 2008 and the margin to contract three to four points. Corporate expenses, we now estimate will be down 10 to $15 million for the full year. This is the corporate unallocated segment that we report in our filings. This 10 to $15 million decline is really drawn from a lower staff costs, improved benefit costs and a higher pension credit year-over-year of about $5 million. So the last slide here is just a bit more commentary on the outlook for the full year starting with raw material and energy inflation. When we had provided guidance back in late February, we were looking at inflation in these categories to be about 55 to $65 million year-over-year. We've now increased that by about $20 million, 75 to $85 million. And, the assumption is that we'll offset about 75% of this inflation with price. But when you factor in the manufacturing efficiencies, we will be 110 to 120% above inflation.

SG&A, as Mike mentioned, we expect to be roughly unchanged for the year. Interest expense in a range of 20 to $25 million, this is net interest expense, because we do have sizeable cash balance and that will build throughout the balance of the year. So 20 to $25 million versus about $40 million last year, most of that variance is due to volume. Of course, we're also getting some benefit in rate. Cash taxes should be about $20 million for the year. This is down about $5 million from the previous estimate. But the effective tax rate we're staying with the original guidance of 44 to 45%. And, just to remind you, the components of that rate, because it is somewhat high, optically, the Federal rate of course is 35%, and we're looking at about a 3 to 4% state tax rate. The non benefited foreign losses in European floor negatively impact the effective tax rate by about five points. We're also accruing interest on the portion of our ten year carry back from the (inaudible) that we are reserving on the balance sheet. And that interest that we accrue negatively affects the tax rate by about three points. Then we have some other sundry favorable impacts that collectively are-- help us by about two points in the tax rate. So, 44 to 45% on the effective tax rate for the year. You saw it was 52% for the first quarter. We're not going to give a specific guidance on earnings for the second quarter, but let me just help you understand the phasing for the balance of the year. As you saw the first quarter earnings were down about 30%. We expect the second quarter earnings to also be down year-over-year, but less than what we saw in the first quarter. And then for the balance of the year, we-- the last six months, we would expect to actually increase earnings in the latter part of the year, not for the full second half, but we'll see some growth later in the year.

Capital spending. We're staying with the original estimate of about $100 million. The share count is unchanged at about 57 million. We had discussed in late February about $20 million of exclusions from reported earnings. That figure for the full year now is down to $15 million. So, we have assumed some higher costs related to ending our strategic review that we now believe we will not incur. Okay, that ends my comments on the figures, so we'll open the lines for questions.

(OPERATOR INSTRUCTIONS) Our first question is from Keith Hughes, from SunTrust

Thank you. Had a couple questions. On the payables, is that something that's going to correct itself as the year goes along? Is that another timing issue, like inventory?

It should. Certainly we'll have a-- probably not to the same degree, but a further negative on payables in the second quarter. But then, as we begin to lapse there is a weakness in our businesses in the second half of the year. It should lessen.

Okay, Within the revenues in the hardwood. You talked about the macro stuff going on. This was going on most of last year, though, and your results have been pretty impressive. Was there anything specific in the quarter, a program you were getting out of, that you had to sell at a discount or anything along those lines that made it specifically worse in the first quarter in hardwoods?

First quarter of last year, or just the first quarter this year?

First quarter this year.

The one thing we have this year, is we've been investing and putting out displays with one of the Big Box customers-- special order displays. And, we're continuing-- continuing that process. Otherwise, the business performs as you would expect. I think the-- North American floor business suffered both Resilient and wood from volume-- or from inventory adjustments by our customers. So both our distributors and our retailers have adjusted inventory and that had a significant impact in the first quarter, which we would expect to lessen. If you listen to the-- to the calls by the Big Box guys, they are all pushing on inventory, and so we would expect to see them continue to push on ours. But there are a couple-- it's sort of mid single digit affect on sales from inventory declines in both Resilient-- domestic Resilient and the wood business.

Okay. And final question. Are you taking some pricing actions and vinyl laminate in the second quarter in response to the raw material we discussed earlier?

Yeah, we're seeing some higher prices in the vinyl businesses and in the laminate business, our average (inaudible) values up substantially due to mix. And so we're-- if you look at the breakdown of our business, we would expect to-- we actually see substantially higher sales of laminate in the first quarter this year than we did last year. We will see some pricing actions. On the other hand in wood we have the opposite of that.

One of the advantages we have in the flooring business and in the ceilings business I guess, too, is we have several different facilities and as a result as we lose volume we can take out plants and maintain a relatively high level of capacity utilization. Some of our competitors have one or maybe two facilities and as this comes down they wind up trying to keep the plant full through price reduction. So we would, we expect to see some price pressure particularly in the wood business and throughout the rest of the year.

Hopefully offset by somewhat better raw material prices as we are finally beginning to see some better lumber prices in those businesses, So, Keith for the full year we expect to offset in the North American Resilient business about 80% of the inflation, a little more in commercial, a little less in residential and actually less than that though in the European business. If you look at one of the issues we have in the European Resilient business we are having a difficult time offsetting inflation with price.

All right. Thank you.

Our next question will come from [Jim Barrett from CL King Associates].

Good morning everyone.

Good morning.

Mike, could you talk about the preliminary announcement related to the second special dividend? And is the assumption that that will be paid if the earnings and cash flows fall within the stated guidance range or how should investors broadly look at that?

Well, I think what we said the last time would be the same thing we'd say today is that we broke it into two pieces because we felt it was imprudent to put that much pressure on our cash situation in the first half of the year given the uncertainties, that if our performance is within the range what have we think it's going to be, we-- the board is going to consider the dividend and we wouldn't have said it if we didn't think they wouldn't do it. So if we are within our guidance range I would expect the board to favorably do that.

Saying that, it's up to the board, so we have to condition it with that. We are sticking with our view that our performance in the first quarter was a little better than we thought it was going to be. Performance for the rest, the second and third quarter where we think they are going to be would be our expectation we would pay that dividend.

Okay. And a question an analogous to the question just asked for flooring, where do you see pricing in the cabinet business for the remainder of the year?

We expect really to see no change. Maybe, in the first quarter I think we picked up about $1 million in price. So I would see prices declining but nor do we expect to see much by the way of increases.

Well, thank you both.

(OPERATOR INSTRUCTIONS) Our next question comes from [Ben Wanger from Talc investments].

Hi, good morning. Could you just remind us on your cash flow guidance for the year, the 175 to $200 million, is that predividend?

Yes, that is predividend.

Okay. Great. And with regard to the dividend guidance itself, should cash flow come in meaningfully lower than that would we see a ratcheting down of the dividends or a reduction of it all together or how should we think about that?

I think if it was meaningfully lower we would have to look at that. Obviously we don't think that's the case or we wouldn't have been so positive in our statements with respect to the dividend. We believe that if we achieve what we are looking at, in terms of range, that we should be able to pay that dividend, have sufficient debt capacity and cash to do everything we want to do in 2009. In part because we think we are going to generate a bunch of cash again in 2009. We think it's okay. To say that, if we had a $100 million swing in cash for some reason we would obvious have to look at it. It's pretty, that would be a pretty unusual thing in our world to get that kind of swing in cash.

And the dividend is not predicated on the Capital Markets being one way or the other. Is that right.

We will largely pay the dividend out of cash.

And if you see any sort of improvement in the Capital Markets, would that change your views on leverage?

Not short term.

Okay. Thank you.

We will take our next question from John Baugh from Stifel Nicolaus.

Good morning. On the cash flow again, was this first quarter performance in line with your thinking in terms of a use of about $90 million if not you haven't changed your guidance for the year, what areas do you expect to see a jump to come back?

Well, we did a little better in the first quarter than we thought largely around slower spending on capital in the plants. Got a little bit better in cash earnings and working capital was a little bit better but not in a significant way that would cause us to change the full year guidance.

So this was actually better than --

It was a little bit better than our plan, yes.

Okay.

And for the balance of the year, it's really more seasonality that's going to lead to a pick up in working capital. We typically have a significant use of cash in the first quarter, Q.s two and three and actually four as well are then quite strong. So we would be looking for cash flow roughly in each of the remaining three quarters to be about $100 million.

I don't want to leave you with the impression though that we are going to underspend our targeted CapEx as we were a little slower in the first quarter. We will-- our forecasts do anticipate spending the targeted amount of CapEx .

Right. And then, Mike, maybe help us with the mix, in ceilings we've seen that get better and better and now we are facing declining unit demand. Typically in an environment like we are in you see a big stray down. So speak to what you are doing, what's going on and then how sustainable that is for the balance of the year.

We haven't seen anything that would -- we haven't seen the value engineer that you're talking about. If you go back to 2001, 02 and 03, we saw some negative mix as a result of value engineering. People were doing rehabs. They took a look at it. The rents were down and other stuff so they traded down from our high-end products to our immediate and low ends products. We haven't seen that yet.

Our strategy has all been around introducing higher products and so some of our mix is coming from products that don't-- you can't-- it isn't an easy trade down from. So we have architectural specialties where we are selling metal ceilings and wooden ceilings and other types of nonfiber materials that people aren't going to trade from that to a mineral fiber thing. So that's going to help us. And, that business continues to be pretty strong. The other part of it is in our product innovation has always been targeted towards that end of it and to some extent our pricing strategy has been towards that end of it.

And that's one of the reasons is we had said-- that we were going to see-- we expected to see slightly, maybe some small share losses towards the bottom end of the segment of our-- of the ceilings market because of that strategy. So we think it's going-- we think it's going to hold up. We haven't seen anything that suggests it won't. Now when you see a real downturn in the office market, particularly in high mix areas like New York City and places like that. You might see-- you might see that. We just haven't seen that happen quite yet.

Okay. Great. And then on the European flooring, and I know you're working on that, I believe you talked about a $20 million give or take swing in EBIT once that's adjusted from whatever it is you decide to do. Is that, is that still kind of on plan and the timing of that, has that changed?

Well, I think the, that when we look at-- we hesitate to predict how much of the swing there's going to be when we get it done. But obviously it hurts us by a lot today. I don't think there's any change in the timing. Remember as we talk about structural change in Europe it's going to take some time and so we wouldn't expect to see real significant benefits from that until 2010 because of the time it takes to close plants. And so-- some of the plants-- the good thing about Europe is its very integrated into our worldwide commercial flooring, as well, worldwide flooring strategy.

We take a fair amount of residential product and an awful lot of commercial product out of there and sell it in the United States so we've got to figure out what we are going to do to replace that source if we were to eliminate the source in Europe. So I don't think so-- but nobody should look for substantially better results out of that until 2010 because of the lengthy transition. And we really-- and as I said, we know some of the things we need to do but we are actively engaged in outsourcing SG&A and so we know, we've got some things underway but the structural stuff we haven't decided yet.

Great. Thanks for answering my questions.

(OPERATOR INSTRUCTIONS) It appears there are no further questions today. Speakers, I'll tough the conference back to you.

Thanks, Kim. Thanks again everybody for joining us this morning. As always I'll be available all day for your follow up questions. Thank you.

That does conclude our conference call today. Thank you all for your participation.