ARMSTRONG WORLD INDUSTRIES INC annual report, FY2014

Armstrong World Industries, Inc. — 2014 Form 10-K Summary

Business context and reporting period

Armstrong World Industries, Inc. designs, manufactures and sells ceiling systems and flooring products for residential, commercial and institutional construction and renovation markets. Reportable segments were Building Products, Resilient Flooring, Wood Flooring and Unallocated Corporate. This annual report covers the fiscal year ended December 31, 2014, with fourth-quarter information included.

The company operated 31 manufacturing plants in eight countries and had approximately 7,400 employees at year-end. About 25% of revenue came from operations outside the United States and Canada. No customer represented at least 10% of consolidated sales.

Key financial metrics

Metric	2014	2013	Change
Net sales	$2,515.3 million	$2,527.4 million	(0.5%)
Gross profit	$583.3 million	$593.0 million	(1.6%)
Gross margin	23.2%	23.5%	Down 30 bps
Operating income	$239.1 million	$265.6 million	(10.0%)
Operating margin	9.5%	10.5%	Down 100 bps
Earnings from continuing operations	$102.0 million	$127.3 million	(19.9%)
Net earnings	$63.8 million	$94.1 million	(32.2%)
Diluted EPS from continuing operations	$1.83	$2.17	(15.7%)
Diluted net EPS	$1.14	$1.60	(28.8%)
Cash flow from operations	$208.8 million	$213.7 million	Down $4.9 million
Capital expenditures	$222.9 million	$213.7 million	Up $9.2 million

Net sales were affected by approximately $19 million of unfavorable foreign exchange, $100 million of lower volume and $106 million of favorable price and mix. Pricing actions increased sales by approximately $57 million and mix improvements by approximately $49 million.

Building Products: Sales of $1,294.3 million, up 2.3%; operating income of $264.7 million, up 0.6%.
Resilient Flooring: Sales of $712.9 million, down 2.2%; operating income of $61.6 million, down 11.7%.
Wood Flooring: Sales of $508.1 million, down 4.9%; operating loss of $14.9 million versus income of $6.0 million.
WAVE joint venture: Equity earnings increased to $65.1 million from $59.4 million; distributions received were $67.9 million.

Liquidity, debt and balance sheet

Cash and cash equivalents were $185.3 million at December 31, 2014, compared with $112.3 million of continuing operations cash at the prior year-end.
Total debt was $1,042.6 million, including $39.6 million classified as current; long-term debt was $1,003.0 million.
The company had no borrowings under its $250 million revolving credit facility and reported $242.2 million of availability. The receivables securitization facility had no borrowings and $16.2 million of remaining availability after letters of credit.
Letters of credit totaled $67.3 million. The company was in compliance with all debt covenants and stated that no mandatory excess-cash-flow payment would be required in 2015.
Total assets were $2,606.2 million and shareholders’ equity was $649.1 million at year-end.
There were no dividends declared in 2014 or 2013. The company had no current share repurchase program.

Material changes versus the prior comparable period

Operating performance weakened as lower volumes, foreign exchange, competitive pressure and higher input costs more than offset pricing, mix and productivity improvements.
Input costs for raw materials, sourced products and energy reduced operating income by approximately $34 million.
2014 included approximately $15 million of charges related to closing the Thomastown, Australia resilient flooring plant and the Kunshan, China engineered wood flooring plant.
A $10.0 million non-cash impairment charge was recorded against a Wood Flooring trademark. Additional asset impairment and accelerated depreciation charges were recorded for plant closures and idle equipment.
The company ceased funding its former European resilient flooring subsidiary, DLW, which filed for insolvency in Germany on December 11, 2014. DLW was deconsolidated and presented as discontinued operations.
Discontinued operations produced a $38.2 million net loss in 2014, including a $12.3 million net loss on disposal. The company recorded a $12.9 million contingent liability related to DLW’s insolvency proceedings.
Other comprehensive income shifted to a $123.9 million loss from $99.8 million of income, primarily because of pension and postretirement actuarial losses, foreign currency translation and derivative losses.
The U.S. pension plans moved from a $110.3 million funded position at year-end 2013 to an $83.6 million underfunded position at year-end 2014, primarily due to lower discount rates and updated mortality assumptions.

Fourth-quarter results and outlook

Fourth-quarter 2014 sales were $587.3 million, down from $614.8 million in the fourth quarter of 2013. Earnings from continuing operations were $10.6 million, or $0.19 diluted EPS, compared with $23.4 million, or $0.42 diluted EPS, in the prior-year quarter. Fourth-quarter operating income was $35.9 million versus $43.0 million.

Fourth-quarter results reflected a 15% decline in Wood Flooring sales caused by lost sales to competitors, a $10.0 million trademark impairment, unfavorable foreign exchange and a higher effective tax rate of 55.1% versus 24.0% in the prior-year quarter.

The filing does not provide formal earnings or revenue guidance. Management expected continued foreign losses in 2015 but did not view them as a long-term trend. The company announced price increases effective in the first quarter of 2015 and expected to continue productivity, cost-reduction and manufacturing-investment initiatives.

On February 19, 2015, the board approved a plan to separate the flooring business from the ceilings business through a spinoff into two independent public companies. Completion was subject to customary conditions, including tax and regulatory matters, and was targeted for the first quarter of 2016 but was not assured.

Principal risks, contingencies and unusual items

Construction-market cyclicality, weak commercial and residential demand, customer inventory changes and intense competition may pressure volumes, pricing and margins.
Raw-material, energy, labor and sourced-product costs may increase faster than the company can recover through pricing.
Debt agreements impose leverage, interest-coverage and restricted-payment covenants. A covenant breach could accelerate debt and terminate borrowing commitments.
The proposed spinoff could create execution, tax, customer, employee, financing and separation-cost risks. Failure to qualify as tax-free could result in substantial tax liabilities.
Future sales by the Asbestos PI Trust could trigger an ownership change under Section 382, limiting use of tax attributes. Management estimated a potential one-time non-cash earnings reduction of $4 million to $8 million if such a change had occurred in the fourth quarter of 2014.
Deferred tax assets included $54.3 million of federal foreign tax credits and $41.3 million of state NOL assets; valuation allowances totaled $87.9 million. The company estimated it needed approximately $1,012.8 million of future taxable income to fully realize net deferred tax assets for state tax purposes.
DLW insolvency proceedings could result in additional claims, claw-backs, support obligations or increased product-purchasing costs.
Environmental matters at sites including St. Helens, Oregon; Macon, Georgia; and Elizabeth City, North Carolina could require costs exceeding recorded liabilities. Recorded environmental liabilities were $4.4 million.
Unrecognized tax benefits totaled $142.6 million, including $101.9 million that would affect the effective tax rate if recognized.
Capital spending for major manufacturing projects was projected at approximately $380 million, with approximately $348 million incurred through year-end 2014; most remaining spending was expected in 2015.

Important facts for investors to verify

Reconcile continuing-operations results with discontinued DLW and cabinets operations, including the $38.2 million 2014 discontinued-operations loss.
Assess whether Wood Flooring can recover from volume losses, competitive pressure and the $10.0 million trademark impairment.
Monitor 2015 pricing actions, input costs, foreign exchange and demand in commercial and residential construction markets.
Review debt maturities, covenant calculations, variable-rate exposure and the availability of revolving and securitization facilities.
Track the DLW insolvency process and any resulting claims or additional liabilities.
Evaluate the proposed flooring and ceilings spinoff, including timing, tax opinions, registration requirements, transaction costs and standalone leverage and liquidity.
Assess realizability of deferred tax assets, the potential Section 382 ownership-change impact and the outcome of open tax examinations.
Review pension funding requirements, actuarial assumptions and the effect of discount-rate changes on future earnings and cash contributions.