AWI

Business Context and Reporting Period

Company: Armstrong World Industries, Inc. (AWI)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2008
Business Overview: AWI is a leading global producer of flooring products (resilient and wood) and ceiling systems for commercial, institutional, and residential buildings. It also manufactures kitchen and bathroom cabinets in the U.S. The company operates 40 manufacturing plants in 10 countries. AWI emerged from Chapter 11 bankruptcy in October 2006 and adopted fresh-start reporting, rendering post-emergence financials non-comparable to pre-emergence periods.

Key Financial Metrics (Year Ended Dec 31, 2008)

Segment Performance:

• Building Products: Record sales ($1,369.1M) and operating income ($239.7M) driven by price increases and Pacific Rim growth.
• Resilient Flooring: Sales declined slightly ($1,220.1M); operating loss of $16.8M due to volume declines and inflation.
• Wood Flooring: Sales dropped 21.1% ($624.6M); operating loss of $2.4M due to housing market weakness and a $25.4M intangible asset impairment.
• Cabinets: Sales dropped 23.8% ($179.2M); operating loss of $6.7M due to U.S. housing market deterioration.

Material Changes vs. Prior Period

• Revenue Decline: Consolidated net sales decreased 4.4% year-over-year. Excluding foreign exchange effects, sales declined 6.0% due to volume declines in the Americas and Europe, offset partially by price increases and product mix improvements.
• Profitability Compression: Operating income fell 29% to $210.9 million. This was driven by lower sales volumes, input cost inflation (approx. $87 million higher than 2007), and a $25.4 million non-cash impairment charge on Wood Flooring trademarks.
• Cost Reductions: SG&A expenses decreased to $579.9 million (17.1% of sales) from $611.3 million (17.2% of sales), aided by lower incentive compensation and reduced strategic review costs.
• Dividend Payment: A special cash dividend of $4.50 per share ($256.4 million total) was paid in March 2008, significantly reducing cash balances.

Guidance, Outlook, and Risks

Management Commentary:

• Management expects continued weakness in domestic residential markets and accelerating weakness in commercial markets.
• Cost reduction initiatives are ongoing, including plant idlings announced in February 2009 (Canada and Mississippi) and layoffs impacting ~600 employees.
• Strategic review of alternatives was completed in February 2008; the Board decided to continue as a publicly traded company.

Risks and Contingencies:

• Construction Dependency: Business is highly sensitive to construction activity and global economic conditions.
• Raw Materials: Volatility in costs for PVC, lumber, and natural gas impacts margins; ability to pass costs to customers is limited by competition.
• Asbestos Litigation: While AWI has no recorded liability for asbestos personal injury claims (channeled to the Asbestos PI Trust), uncertainty remains regarding the effectiveness of injunctions in foreign jurisdictions.
• Environmental Liabilities: Probable environmental liabilities are estimated at $6.5 million.
• Tax Refunds: A substantial federal income tax refund received in 2007 is under IRS audit; repayment could adversely affect liquidity.

Investor Verification Checklist

• Intangible Asset Impairment: Verify the assumptions used for the $25.4 million Wood Flooring trademark impairment and its impact on future cash flow projections.
• Debt Covenants: Confirm compliance with the senior credit facility covenants (Interest Coverage > 3.00x; Indebtedness/EBITDA < 3.75x), especially given the recent dividend payment and market downturn.
• IRS Audit Status: Monitor the status of the IRS audit regarding the 2007 federal income tax refund of $178.7 million.
• Plant Closures: Assess the financial impact and timeline of the announced plant idlings in Canada and Mississippi scheduled for Q2 2009.
• Foreign Exchange Exposure: Review the effectiveness of hedging strategies given that ~30% of sales are outside North America.