Armstrong World Industries Inc (AWI) 2008 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the third quarter 2008 Armstrong World Industries Incorporated Earnings Conference Call. My name is [Shaquana] and I will be your coordinator for today. At this time, all participants are in a listen-only-mode. We will facilitate a question-and-answer session towards the end of this conference. (Operator Instructions).

I would now like to turn the call over to your host for today Ms. Beth Riley, Director of Investor Relations. Please proceed ma'am.

Thank you, Shaquana. Good morning and welcome. Please note that members of the media have been invited to listen to this call, and the call is being broadcast live on our website at armstrong.com. With me this morning are Mike Lockhart, our Chairman and CEO; and Nick Grasberger, our Senior VP and CFO. Hopefully you have seen our press release and 10-Q this morning and both the release and the presentation Nick will reference during this call are posted on our website 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 this morning. 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. Both are available on our website. With that, I would like to turn the call over to Mike.

Thanks, Beth. Good morning everybody, and thanks for participating in today's earnings call. I am sure everyone is weary of hearing about the global economic and credit market challenges.

The US residential markets continue their descent, the consumer has stopped spending, US commercial markets are declining, Western European market growth has slowed and some European markets are declining. Asia has been growing, but at this point all of our markets are in turmoil.

In this increasingly chaotic environment, we are pleased that excluding the benefit of foreign exchange, sales declined only 1%, and adjusted third quarter operating income actually grew 5% to $93 million.

The consistent themes across our business are improved manufacturing productivity and reduced SG&A spending and we need these improvements to offset inflation and weak volume.

The largest volume declines were in businesses serving the US housing market, Resilient and Wood Flooring, and Cabinets. In the aggregate, higher price in the quarter offset two-thirds of raw material and energy inflation.

Building products, our ceilings business continues to perform well despite weak US commercial markets, a slowdown in most Western European markets and increased cost inflation. Prices rose and product mix improved. SG&A costs were slightly lower and WAVEs earnings increased.

North American Resilient sales were down about 3% in the quarter. Mid single-digit volume declines offset modestly better price realization and improved mix. While the volume declines were more severe for residential products, commercial volume fell too. Operating income declined more than 40%.

The adverse effects of lower volume and raw material cost inflation exceeded the benefits of better price realization, lower manufacturing, and SG&A costs.

Ignoring currency effects, European Resilient sales were up less than 1%, with improved product mix and modest price increases offsetting slight volume declines. Reduced manufacturing and SG&A costs combined with the benefit of modestly higher sales to reduce the operating loss in the European floor business by 40% compared to last year and this was achieved despite substantial material cost inflation.

In the European floor business, we recorded a liability for severance cost to eliminate SG&A jobs as well as to transfer SG&A jobs from Germany to our Prague customer order service center and to outsourcing providers in Eastern Europe and India.

We are in the process of selling excess properties in Europe, which will help pay for the restructuring. We now expect these sales to slip into 2009.

We are well advanced in finalizing plans to restore this business to profitability. We are still evaluating options to achieve this sooner and with less risk. And when we talk about our fourth quarter performance, we will present our plans for Europe.

Wood Flooring, which is almost entirely a US residential business, saw 11% lower sales in the quarter. The margin effect of lower volume more than offset lower SG&A cost reducing income by nearly 50%.

Cabinets is also almost entirely a US residential business. It experienced a 19% sales decline, which produced a $1 million operating loss for the quarter.

For the full year, we expect to continue to outperform our markets. Operating income this year is likely to be towards the lower end of our original range. This is the result of high single-digit volume declines and significant inflation in raw material and in energy, offsetting improved price realization, reduced manufacturing and SG&A costs and higher earnings from WAVE.

In the fourth quarter, the AWI board will evaluate paying a second dividend. This will be done in light of 2008 operating results and the medium-term outlook for the global economy and credit markets.

Like other companies and most prudent individuals, we are reviewing all of our spending plans to ensure that our analyses reflect the most current market outlook and that we have appropriately weighed the benefits versus the risks of delaying investments. It is now very unlikely we will spend capital in 2009 on a Russian ceilings plant or expanding our Shanghai ceilings plant.

As we seek to deal with the market turbulence, here is what we are saying to ourselves and I am quoting from a letter that we sent to all AWI employees. In the last few years, every one of our businesses has benefitted from new products. Every business has benefitted from improved quality. Where we have had customer service problems, we have addressed them. We have increased our advertising substantially. These efforts have led to improving market share in virtually every business. We have to continue this.

Our objective must be to come out of this global economic downturn better positioned than when we went into it and to remain profitable throughout the period. This can be done. It requires us to be intensely focused on product innovation, investing in the brand, providing great customer service and industry leading quality, properly investing in our manufacturing facilities, and becoming more productive in all we do.

It is a nervous time. As we enter this downturn, we are all lucky to be working for an industry leading profitable company with a conservative balance sheet. We will face significant challenges, but if we stay focused, we can emerge from this a better company.

Now, Nick would you take us through the numbers?

Okay. Thank you, Mike. And as Beth noted in her opening comments, my remarks will refer to a series of charts that are posted on the website. The first chart is numbered 3 and that is the key financial metrics for the September quarter adjusted for non-recurring items and foreign exchange.

Now beginning with sales, sales for the quarter were $914 million, down about seven-tenths of 1%. This compares to the reported figure of up 2%, which includes the benefit of currency. So breaking down the net sales variance, price increased 2.5 points, volume was down about 4 points, and mix improved by about 100 points, sorry, 1 point.

Operating income for the quarter $93 million was up about 4% versus last year's third quarter. The operating margin of 10.1% is actually the highest operating margin that we've seen in the third quarter since the year 2000. The operating income performance was a little better than we thought. It would be mostly because of in Building products, slightly higher volumes, and better performance from WAVE.

Earnings per share of $0.85 was down about $0.03, interest expense was down, the effective tax rate was up about 7.5 points due mostly to the recognition of interest expense on the carry back NOL election we made last year, and also some state tax rate changes in the past quarter.

A cash flow of $92 million was down about $24 million versus the same period last year mostly due to higher cash taxes and lower cash earnings on a reported basis.

Our net debt, this is gross debt net of US cash was about $350 million at the end of the quarter. Debt was $500. Cash in the US was about $150.

And just a few comments on our liquidity situation. The debt that we have is largely in two tranches; one matures in 2011, the other in 2013.

We have three financial covenants. The first covenant is the debt-to-EBITDA covenant that we cannot exceed 3.75. At the end of the quarter, debt-to-EBITDA was about 1.2. So, we have plenty of room under that covenant.

Interest coverage, that covenant is about three times, we are at 13 times on a trailing 12 months basis, so clearly well in excess of that covenant as well.

The third covenant is that we need to maintain a minimum liquidity of a $100 million and at the end of the third quarter we have liquidity of about $400 million, and that would be cash in the US of $150 and capacity under our revolver of about$ 250. And this does not include by the way cash we have abroad. We have about $150 million in cash outside the US.

So turning to chart 4, this is the operating income bridge for the third quarter in 2008 versus the third quarter in 2007 and you can see adjusted operating income improved about $4 million between the two periods. Beginning with price which contributed $24 million of higher earnings, really all businesses were successful in increasing price with the exception of the Wood Flooring business, but most of the price realization was in the US commercial businesses.

The volume and mix down $10 million collectively. This is attributed to vinyl, globally wood and cabinets. Building products globally actually increased volume and mix across most geographies.

Raw material and energy inflation was $36 million year-over-year, about 75% of that figure was raw materials and the remaining 25% is energy. And of course as we look forward, we are seeing some favorable trends in both of those categories.

The manufacturing cost year-over-year were down about $4 million. This is true across all segments, they were down. We actually had some inventory reductions, which reduced this figure from $10 to $4, so the true productivity in the business absent those inventory reductions was about $10 million.

SG&A contributed $18 million of higher earnings year-over-year. This is a reduction of about 11% and every segment of Armstrong showed a reduction in SG&A this quarter.

The earnings at WAVE, again this was a bit of a positive surprise for us. Earnings at WAVE were up about $4 million year-over-year, sales were up about 13% in WAVE and profits were up about 25%.

Okay, turning to the next chart, chart 5, this is just a look by segments at sales growth and earnings growth quarter-over-quarter. Starting with Resilient Flooring, sales down 1% year-over-year. As Mike mentioned, North America Resilient was down 3%, but we did see gains in Europe of about 2% and gains of about 20% in Asia.

Wood Flooring, down 11%, volume was down 9%, pricing mix were also slightly weaker than they were a year ago. In Building products, sales were up 9% mostly due to mix and price volume globally was up about 1%, it was up about 1% in Europe, a little bit less, and up in Asia as well. Cabinet sales were down 19% driven mostly by volume. Unit volume was down 16% in cabinets for the quarter.

Turning to earnings, Resilient Flooring operating income was down $5 million versus the quarter a year ago. All of this was due to a decline in North America due to lower volume and the inability of covering inflation with price. Resilient earnings in Europe were up and were also up in Asia.

Wood Flooring earnings were down about $8 million. This is really due to lower price, lower volume, and lower mix. Building products earnings were up 15%. Really across all geographies, price volume and mix were better, manufacturing and SG&A costs were lower and as I mentioned the earnings from WAVE were better as well.

Cabinets business saw a decline of $3 million in operating income due principally to volume and mix. And at Corporate, corporate costs were down $5 million year-over-year due to lower staff costs and lower compensation costs.

Returning to the next chart, this is just simply a look year-to-date at the reported operating income number versus the adjusted operating income number. Really the only change here versus what we showed you in the first couple of quarters was the restructuring in the European floor business that Mike mentioned.

I will skip over the next few charts. The chart 7 is simply a look at the key financial metrics for the first nine months of 2008 versus 2007 and chart 8 is just a look at year-to-date cash flow.

So moving to chart 9, this is the updated guidance for the full year that we are providing. We are now saying net sales will be in the range for the full year between $3.45 billion and $3.5 billion or down 1% to 3% for the full year. And at the midpoint, this is about a $75 million reduction in sales versus the previous guidance and most of the reduction we expect to occur in Q4 and is primarily North American residential softness.

Operating income, the new guidance range for the full year is $260 million to $275 million. This compared to guidance previously of $260 to $290, so the mid points of the range has gone down from $275 to $268. And again, this is really due to lower earnings in Q4 for flooring and cabinets.

EPS, in a similar fashion we expect to -- with the mid point to be lower than it was previously. The mid point previously was $2.45. We are now expecting EPS at the mid point of the range to be $2.33 and that's due to both lower earnings and also a higher effective tax rate now for the full year.

Our cash flow, the previous range of guidance was $175 million to $200 million. Now we believe cash flow for the year will be about $150 million and it's really due to two items. First of all, Mike mentioned the delay of selling some property in Europe, that's about a $25 million negative variance to the previous estimate and also the lower earnings versus the previous guidance.

So turning to chart 10, this is the guidance for the fourth quarter and admittedly this is a rather broad range reflecting the very high degree of uncertainty that we have on Q4. But it does make the point of course that we will continue to be profitable. We do expect sales though to be down in the range of 4% to 10%, earnings to be down between about 30% and 60% and so on. We do expect cash flow to continue to be positive, about $70 million for the fourth quarter and that means our liquidity situation will improve by about that amount by the end of the year. So, we should improve our liquidity before the allocation of $100 million surplus from about $300 million to $400 million.

Okay, the last chart here I would like to review is just a little more commentary on the full year outlook. The raw material and energy inflation of $95 to $100 million is about the same as what we were expecting it to be a few months ago. It came in a little bit higher in the third quarter than we thought. It should be a little bit lower in the fourth quarter.

SG&A, we had expected a reduction on a full year basis of between 3% and 5%. We now think it will be about 5%. Interest expense net of interest income, we had been expecting it to be about $20 million. With the increase in LIBOR rates that adds a few million to it, and so we are now saying the range will be $20 to $25.

Cash taxes, $20 million is about the same as we have been seeing. Most of that $20 million is paying taxes outside the US.

Capital spending, we've stuck with our previous guidance of about a $100 million for the year. The share count has not changed and on a full year basis we now expect the exclusions from reported earnings to be $25 million. We had previously indicated it would be in the range of $15 to $20, but as we said we've announced some additional charges on reducing headcount in our European floor business.

So those are the charts that I'd like to review and Mike and I will now take questions.

(Operator Instructions). Your first question comes from the line of Keith Hughes with SunTrust. Please proceed.

Thank you. I just had some questions -- one question to the fourth quarter. The operating income decline that you are discussing in the chart on that, it's a lot more severe than the revenue decline, are we going to be pulling back in production preparing for WAVE business next year or is there something unusual seasonal going on in the fourth quarter?

No, there are certainly no plans to pull back on production necessarily. Of course we are looking at that on a continuous basis. But, no, I think part of this reflects as we mentioned the WAVE business coming off a little bit in the fourth quarter from a margin standpoint relative to where they had been. So, we will see lower earnings from WAVE and of course there is no -- we don't consolidate their sales. So, there is a bit of higher leverage than you might expect on the downside because of WAVE.

And the weakness in residential in the North American Flooring business is going to be in commercial and that has a much higher margin than the residential products do.

Okay, thank you.

Your next question comes from the line of John Baugh with Stifel. Please proceed.

Okay, John Baugh. Good morning. I'm curious whether you can give us some kind of feel. We're all trying to feel or think about how bad "bad" is going to be next year, and maybe two areas. Do you think you can remain profitable or break even, let's say, in Flooring, globally, next year under "any scenario" within reason? And what is the sensitivity to WAVE if we were to assume that revenues fell 10% to 30% or something? What kind of variable fixed expense and what is the net margin there that's been running around 30% year-to-date? What happens under such a scenario? Thank you.

Well, first, I'd say that it is hard to imagine a scenario in 2009 where the Flooring business on a global basis would lose money. We would expect the European business pre-restructuring to continue to make losses, but certainly the North American Flooring business and the Asian Flooring business are solvently profitable and we would expect that to continue, although at lower levels, certainly North America.

In the WAVE business, John, honestly I've not looked forward to 2009 and kind of modeled out what the downside scenario could be for WAVE. Certainly the margins have remained at all time highs and we would expect those to come off as steel prices come off. There's probably not a lot of fixed expense that will come out of the business, but as you know, it's not a very capital intensive business. There's not a lot of fixed cost in that business to begin with. So, the fall through from sales to earnings is pretty high.

Okay. And then, CapEx. Was it $55 million year-to-date and your budgeting a $100 for '08, is that correct?

Yes. We still expect that we'll spend $100 for the full year.

Okay. And any thoughts out into '09?

The basic spending would be about $100 plus anything we did on -- in a major -- the only thing we have which is major is, we announced this morning -- I assume we announced this morning -- that we were going to convert our Lancaster Floor plant to produce [fiber glass] products. So, on top of that, we'll have a $20 million -- $25 million spend on that. So, it would be -- maybe it would be a $100 plus or minus some plus the $25 for Lancaster.

Okay. And Nick, is there any thought about repatriating a $150 million odd foreign cash at this point?

Yeah, we are looking at that John. We certainly have had some plans to use that cash to fund some offshore investment opportunities that we may well be delaying in this environment. So we need to think about repatriating that cash in the context of still making those investments at some point.

Thanks. I'll defer the others.

(Operator Instructions). Your next question comes from the line of Jim Barrett with C.L. King and Associates. Please proceed.

Good morning, everyone.

Good morning.

Mike, is share repurchase out of the-- not on the table at this point, I understand it's a board decision, but what are your thoughts on share repurchase at these levels?

We still have-- there's still a tax benefit to doing -- it's really dividend, and so I think a return of capital to shareholders would be highly likely to be a dividend, even at these share levels. We honestly think the shares are terribly undervalued, but even given that, I think that tax advantages would suggest that we'd rather do-- that we'd rather return capitals as a dividend.

I see. And at your analyst day, you laid out financial targets for fiscal 2011. Is it reasonable to assume those targets are in suspension for the time being? How should we look at those?

Well, I think, that's-- obviously that's where we'd like to be, but we sure as heck don't know what the world's going to look like between now and then, and I'm told that lots of CEOs are ducking this question about what 209 is -- what 2009 is going to look like. Now, you guys, I don't think any of us have a clue what 2009 is going to look like and nor do we understand -- know what 2011 is. If we get -- if we have the market that we were looking for, which was not particularly strong, we should be able to make those improvements. We do -- the beauty of where we are today is that we're profitable, we have good cash flow, and we can make the investments we need to make to improve the business. We're going to continue to do that.

Okay. And then finally, Nick, can you at least give us some thoughts directionally on how we should view the pension credit income for next year.

That's actually a very involved calculation. The impact on pension income will be much less that what you might think given the way that calculation is made. So, if we assume that we ended the year on September 30 and reset that, the figure for 2008 would be $60 million to $63 million. The figure for 2009 would be kind of in the $45 million to $55 million range. It wouldn't be as significant as what might be implied by the decline in our surplus.

I see. You said $45 to $50?

$45 to $55.

Thank you both.

You have a follow-up question from the line of John Baugh with Stifel. Please proceed.

What it was the European Flooring EBIT loss? You mentioned it improved 40%. Where did that come in?

It was $2 million.

And do we still hope with whatever you're going to tell us 90 days from now that we can get close to break even under some normal reasonable volume assumption. Is that still kind of the game plan?

Yes.

Okay. And then on the raw materials, are you seeing anything turn right now or are you just looking at what net gas and oil are doing? How do you think about raw materials versus pricing going in to '09?

Clearly, with the decline in natural gas, it will benefit us, we won't see the full benefit until late 2009 and of course in 2010 because of our hedging policy which hedges 80% of forecast needs 15 months in advance. So, we won't see a lot of benefit from that in 2009. And the biggest thing we buy is lumber, and we are seeing some slightly lower lumber prices that we think will continue to benefit us in 2009. And then the next biggest thing is PVC and we will see some modest benefit from PVC in the fourth quarter and we should see a significant benefit from PVC in plasticizers in 2009. Now, on the residential side, we never got price increases to cover it, so we would hope we wouldn't have to lower prices as we see some declining raw material cost. We might see some small price offset in the commercial business.

Great. And then lastly, are you projecting to lose EBIT in Flooring in Q4? And if so, or close to break even, is that just due to the sudden decline we've seen here in the last 60 days, the inability to adjust SG&A spend and other things accordingly or some kind of feel for that for Q4?

Yeah, we certainly expect, when you say to lose the EBIT, yes, I mean we expect it to decline year-over-year in a fairly significant way.

Not decline, be negative?

In the US, no, on a global basis, yes. The global Resilient business will likely lose money in the fourth quarter.

Okay. Great. Thanks for that color Mike, Nick.

At this time, there are no further questions. I would now like to turn the call over to Ms. Beth Riley for closing remarks.

Thanks. I just want to thank you all again for joining us this morning. As always, I will be available the rest of the day and in the following days for any follow-up questions. Have a good day.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect and have a good day.