Armstrong World Industries Inc
ARMSTRONG WORLD INDUSTRIES INC (Form: 10-K, Received: 02/27/2017 09:06:35)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2016

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                   to                  

Commission File Number 1-2116

ARMSTRONG WORLD INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)

 

Pennsylvania

 

23-0366390

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

 

2500 Columbia Avenue, Lancaster, Pennsylvania

 

17603

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code (717) 397-0611

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Common Stock ($0.01 par value)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes       No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes       No  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.    Yes       No  

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter time period that the registrant was required to submit and post such files).    Yes       No  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 

Smaller reporting company

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes       No  

The aggregate market value of the Common Stock of Armstrong World Industries, Inc. held by non-affiliates based on the closing price ($39.15 per share) on the New York Stock Exchange (trading symbol AWI) of June 30, 2016 was approximately $1,800 million.  As of February 21, 2017, the number of shares outstanding of registrant's Common Stock was 53,839,882.

Documents Incorporated by Reference

Certain sections of Armstrong World Industries, Inc.’s definitive Proxy Statement for use in connection with its 2017 annual meeting of shareholders, to be filed no later than May 1, 2017 (120 days after the last day of our 2016 fiscal year), are incorporated by reference into Part III of this Form 10-K Report where indicated.

 

 

 

 

 


TABLE OF CONTENTS

 

 

 

PAGE

 

 

 

 

Cautionary Note Regarding Forward-Looking Statements

3

 

 

 

 

PART I

 

Item 1.

Business

4

Item 1A.

Risk Factors

8

Item 1B.

Unresolved Staff Comments

13

Item 2.

Properties

13

Item 3.

Legal Proceedings

14

Item 4.

Mine Safety Disclosures

14

 

 

 

 

PART II

 

Item 5.

Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

15

Item 6.

Selected Financial Data

16

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17

Item 7A.

Quantitative and Qualitative Disclosures about Market Risk

32

Item 8.

Financial Statements and Supplementary Data

34

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

85

Item 9A.

Controls and Procedures

85

Item 9B.

Other Information

85

 

 

 

 

PART III

 

Item 10.

Directors, Executive Officers and Corporate Governance

86

Item 11.

Executive Compensation

87

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

87

Item 13.

Certain Relationships and Related Transactions, and Director Independence

87

Item 14.

Principal Accountant Fees and Services

87

 

 

 

 

PART IV

 

Item 15.

Exhibits and Financial Statement Schedules

88

 

 

 

Signatures

95

 

 

2


 

When we refer to “AWI,” the “Company,” “we,” “our” and “us”, we are referring to Armstrong World Industries, Inc. and its subsidiaries.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements in this Annual Report on Form 10-K and the documents incorporated by reference may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Those forward-looking statements are subject to various risks and uncertainties and include all statements that are not historical statements of fact and those regarding our intent, belief or expectations, including, but not limited to, our expectations concerning our residential and commercial markets and their effect on our operating results; our expectations regarding the payment of dividends, and our ability to increase revenues, earnings and EBITDA (as such terms are defined by documents incorporated by reference herein). Words such as “anticipate,” “expect,” “intend,” “plan,” “target,” “project,” “predict,” “believe,” “may,” “will,” “would,” “could,” “should,” “seek,” “estimate” and similar expressions are intended to identify such forward-looking statements. These statements are based on management’s current expectations and beliefs and are subject to a number of factors that could lead to actual results materially different from those described in the forward-looking statements. Although we believe that the assumptions underlying the forward-looking statements are reasonable, we can give no assurance that our expectations will be attained. Factors that could have a material adverse effect on our financial condition, liquidity, results of operations or future prospects or which could cause actual results to differ materially from our expectations include, but are not limited to:

 

global economic conditions;

 

construction activity;

 

the tax consequences of the separation of our flooring business from our ceilings (buildings products) business;

 

competition;

 

key customers;

 

availability and costs of raw materials and energy;

 

international operations;

 

Worthington Armstrong Venture (“WAVE”), our joint venture with Worthington Industries, Inc;

 

environmental matters;

 

covenants in our debt agreements;

 

our indebtedness;

 

our liquidity;

 

strategic transactions;

 

negative tax consequences;

 

defined benefit plan obligations;

 

claims and litigation;

 

labor;

 

intellectual property rights;

 

costs savings and productivity initiatives; and

 

other risks detailed from time to time in our filings with the Securities and Exchange Commission (the “SEC”), press releases and other communications, including those set forth under “Risk Factors” included elsewhere in this Annual Report on Form 10-K and in the documents incorporated by reference.

Such forward-looking statements speak only as of the date they are made.  We expressly disclaim any obligation to release publicly any updates or revisions to any forward-looking statements to reflect any change in our expectations with regard thereto or change in events, conditions or circumstances on which any statement is based.

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PART I

ITEM 1.

BUSINESS

Armstrong World Industries, Inc. (“AWI” or the “Company”) is a Pennsylvania corporation incorporated in 1891.  When we refer to “we,” “our” and “us” in this report, we are referring to AWI and its subsidiaries.

We are a leading global producer of ceiling systems and, prior to April 1, 2016, flooring products for use primarily in the construction and renovation of residential, commercial and institutional buildings. We design, manufacture and sell ceiling systems (primarily mineral fiber, fiberglass wool and metal) and, prior to April 1, 2016, flooring products (primarily resilient and wood) around the world.

On April 1, 2016, we completed our previously announced separation of Armstrong Flooring, Inc. (“AFI”) by allocating the assets and liabilities related primarily to the Resilient Flooring and Wood Flooring segments to AFI and then distributing the common stock of AFI to our shareholders at a ratio of one share of AFI common stock for every two shares of AWI common stock.  Subsequent to the separation and distribution, AWI and AFI operate as two independent, publicly-traded companies, with AFI owning and operating the Resilient Flooring and Wood Flooring segments and AWI continuing to own and operate the Building Products (Ceilings) segment.  AFI’s historical financial results have been reflected in AWI’s Consolidated Financial Statements as a discontinued operation for all periods presented.  See Note 4 to the Consolidated Financial Statements for additional information.

We are focused on driving sustainable shareholder value creation. Our strategic priorities are to accelerate profitable volume growth globally and to improve the returns in our international business.  Our primary goal is to expand into new and grow in existing markets by selling a broader array of products and solutions into those markets.  

Reportable Segments

Effective April 1, 2016 and in connection with our separation of AFI, our former Resilient Flooring and Wood Flooring segments have been excluded from our results of continuing operations.  In addition, effective April 1, 2016, we disaggregated our former Building Products operating segment into the following three distinct geographical segments:  Americas (including Canada); Europe, Middle East and Africa (including Russia) (“EMEA”); and Pacific Rim.  See Note 3 to the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Form 10-K for additional financial information on our reportable segments.

Markets

We are well positioned in the industry segments and markets in which we operate, often holding a leadership or significant market share position. The major markets in which we compete are:

North American Commercial.   Many of our products are used in commercial and institutional buildings.  Our revenue opportunities come from new construction as well as renovation of existing buildings.  Renovation work is estimated to represent the majority of the total North American commercial market opportunity.  Most of our revenue comes from four major segments of commercial building – office, education, retail and healthcare.  We monitor U.S. construction starts and follow project activity.  Our revenue from new construction can lag behind construction starts by as much as 18 to 24 months.  We also monitor office vacancy rates, gross domestic product (“GDP”) and general employment levels, which can indicate movement in renovation and new construction opportunities.  We believe that these statistics, taking into account the time-lag effect, provide a reasonable indication of our future revenue opportunity from commercial renovation and new construction.  However, we believe that consumers’ preferences for product type, style, color, availability, affordability and ease of installation also affect our revenue.

North American Residential.   Our Americas segment sells products for use in single and multi-family housing.  Our products compete against mineral fiber and fiberglass products from other manufacturers, as well as drywall.  We compete directly with other domestic and international suppliers of these products.  We estimate that existing home renovation (also known as replacement / remodel) work represents the majority of the total North American residential market opportunity.  Key U.S. statistics that indicate market opportunity include existing home sales (a key indicator for renovation opportunity), housing starts, housing completions, home prices, interest rates and consumer confidence.  

Outside of North America.   About 30% of our 2016 consolidated sales were in EMEA and the Pacific Rim and almost all were commercial in nature.  For the countries in which we have significant revenue, we monitor various national statistics (such as GDP) as well as construction data (starts and project-related information).  Revenues come primarily from new construction and renovation work.

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The following table provides an estimate of our major markets that affected 2016 net sales.

 

(Estimated percentages of individual segment’s sales)

 

North American

Residential

 

 

North American

Commercial

 

 

Outside of North America

 

 

 

 

 

 

 

New

 

 

Renovation

 

 

New

 

 

Renovation

 

 

New

 

 

Renovation

 

 

Total

 

Americas

 

 

0

%

 

 

5

%

 

 

20

%

 

 

75

%

 

 

0

%

 

 

0

%

 

 

100

%

EMEA

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

55

%

 

 

45

%

 

 

100

%

Pacific Rim

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

80

%

 

 

20

%

 

 

100

%

Total

 

 

0

%

 

 

5

%

 

 

15

%

 

 

50

%

 

 

20

%

 

 

10

%

 

 

100

%

 

Management has used estimates in creating the table above because the end-use of our products is not easily determinable.

Geographic Areas

See Note 3 to the Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Form 10-K for additional financial information by geographic areas.

Customers

We use our reputation, capabilities, service and brand recognition to develop long-standing relationships with our customers.  We principally sell commercial products to building materials distributors, who re-sell our products to contractors, subcontractors’ alliances, large architect and design firms, and major facility owners. In our North American retail channel, which sells to end-users in the residential and light commercial segments, we have important relationships with national home centers such as Lowe’s Companies, Inc. and The Home Depot, Inc., as well as wholesalers who re-sell our products to dealers who service builders, contractors and consumers.

Approximately 80% of our consolidated net sales are to distributors.  Sales to large home centers account for less than 10% of our consolidated sales.  Our remaining sales are to contractors and retailers.

Revenues from two commercial distributors, included within our Americas segment, individually exceeded 10% of our consolidated revenues in 2016.  Net sales in 2016 to these two customers totaled $284.0 million.  Net sales of $131.7 million from one of these customers also exceeded 10% of our consolidated revenues in 2015.  No one customer accounted for 10% or more of our total consolidated net sales in 2014.  

Working Capital

We produce goods for inventory and sell on credit to our customers.  Generally, our distributors carry inventory as needed to meet local or rapid delivery requirements.  We sell the vast majority of our products to select, pre-approved customers using customary trade terms that allow for payment in the future.  These practices are typical within the industry.  

Competition

We face strong competition in all of our businesses.  Principal attributes of competition include product performance, product styling, service and price.  Competition in North America comes from both domestic and international manufacturers.  Additionally, some of our products compete with alternative products or finishing solutions.  Our products compete with drywall and exposed structure (also known as open plenum).  Excess industry capacity exists for certain products in some geographies, which tends to increase price competition.  The following companies are our primary competitors:

CertainTeed Corporation (a subsidiary of Saint-Gobain), Chicago Metallic Corporation (owned by Rockwool International), Georgia-Pacific Corporation, Knauf AMF GmbH & Co. KG, Lafarge SA, Odenwald Faserplattenwerk GmbH, Rockfon A/S (owned by Rockwool International), Saint-Gobain and USG Corporation.

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Raw Materials

We purchase raw materials from numerous suppliers worldwide in the ordinary course of business.  The principal raw materials include: mineral fiber, fiberglass, perlite, waste paper, pigments, clays and starches.  In addition, we use aluminum and steel in the production of metal ceilings and by WAVE, our joint venture that manufactures ceiling grid.

We also purchase significant amounts of packaging materials and consume substantial amounts of energy, such as electricity and natural gas, and water.

In general, adequate supplies of raw materials are available to all of our operations.  However, availability can change for a number of reasons, including environmental conditions, laws and regulations, shifts in demand by other industries competing for the same materials, transportation disruptions and/or business decisions made by, or events that affect, our suppliers.  There is no assurance that these raw materials will remain in adequate supply to us.

Prices for certain high usage raw materials can fluctuate dramatically.  Cost increases for these materials can have a significant adverse impact on our manufacturing costs.  Given the competitiveness of our markets, we may not be able to recover the increased manufacturing costs through increasing selling prices to our customers.

Sourced Products

Some of the products that we sell are sourced from third parties.  Our primary sourced products include specialty ceiling products.  We purchase some of our sourced products from suppliers that are located outside of the U.S., primarily from the Pacific Rim and Europe.  Sales of sourced products represented approximately 10% of our total consolidated revenue in 2016.

In general, we believe we have adequate supplies of sourced products.  However, we cannot guarantee that the supply will remain adequate.

Seasonality

Generally, our sales in North America and Europe tend to be stronger in the second and third quarters of our fiscal year due to more favorable weather conditions, customer business cycles, the timing of renovation and new construction.  We see similar patterns with respect to our sales in the Pacific Rim, though the timing of the Chinese New Year can affect buying behaviors.

Patent and Intellectual Property Rights

Patent protection is important to our business.  Our competitive position has been enhanced by U.S. and foreign patents on products and processes developed or perfected within AWI or obtained through acquisitions and licenses.  In addition, we benefit from our trade secrets for certain products and processes.

Patent protection extends for varying periods according to the date of patent filing or grant and the legal term of a patent in the various countries where patent protection is obtained.  The actual protection afforded by a patent, which can vary from country to country, depends upon the type of patent, the scope of its coverage and the availability of legal remedies.  Although we consider that, in the aggregate, our patents, licenses and trade secrets constitute a valuable asset of material importance to our business, we do not believe we are materially dependent upon any single patent or trade secret, or any group of related patents or trade secrets.

Certain of our trademarks, including without limitation,   , Armstrong®, BioGuard™, Calla®, Cirrus®, Cortega®, Dune™, Huiyi™, Humiguard®, Infusions®, Lyra®, MetalWorks™,  Optima®, Perla™, Soundscapes®, Total Acoustics™,  Ultima®, and WoodWorks®, are important to our business because of their significant brand name recognition.  Trademark protection continues in some countries as long as the mark is used, and continues in other countries as long as the mark is registered.  Registrations are generally for fixed, but renewable, terms.

In connection with the separation and distribution of AFI, we entered into several agreements with AFI that, together with a plan of division, provided for the separation and allocation of assets between AWI and AFI.  These agreements include a Trademark License Agreement and a Transition Trademark License Agreement.  Pursuant to the Trademark License Agreement, AWI provided AFI with a perpetual, royalty-free license to utilize the “Armstrong” trade name and logo.  Pursuant to the Transition Trademark License Agreement, AFI provided us with a five-year royalty-free license to utilize the “Inspiring Great Spaces” tagline, logo and related color scheme.

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We review the carrying value of trademarks annually for potential impairment.   See the “Critical Accounting Estimates” section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 of this Form 10-K for further information.

Employees

As of December 31, 2016, we had approximately 3,700 full-time and part-time employees worldwide compared to approximately 3,800 (excluding AFI) as of December 31, 2015.  Effective April 1, 2016, approximately 3,900 of our former employees were employed by AFI as a result of the separation.   

As of December 31, 2016, approximately 73% of our 940 production employees in the U.S. were represented by labor unions.  Collective bargaining agreements covering approximately 300 employees at two U.S. plants will expire during 2017.  Outside the U.S., most of our production employees are covered by either industry-sponsored and/or state-sponsored collective bargaining mechanisms.  During the fourth quarter of 2016, we idled one of our plants in China.  As a result, we expect a reduction of approximately 190 employees in China in the first quarter of 2017.  We believe that our relations with our employees are satisfactory.

Research & Development

Research and development (“R&D”) activities are important and necessary in helping us improve our products’ competitiveness.  Principal R&D functions include the development and improvement of products and manufacturing processes.  We incurred $18.8 million in 2016, $19.7 million in 2015 and $19.8 million in 2014 of R&D expenses worldwide.

Sustainability and Environmental Matters

The adoption of environmentally responsible building codes and standards such as the Leadership in Energy and Environmental Design, or LEED, rating system established by the U.S. Green Building Council, has the potential to increase demand for products, systems and services that contribute to building sustainable spaces. Many of our products meet the requirements for the award of LEED credits, and we are continuing to develop new products, systems and services to address market demand for products that enable construction of buildings that require fewer natural resources to build, operate and maintain. Our competitors also have developed and introduced to the market products with an increased focus on sustainability.

We expect that there will be increased demand over time for products, systems and services that meet evolving regulatory and customer sustainability standards and preferences and decreased demand for products that produce significant greenhouse gas emissions. We also believe that our ability to continue to provide these products, systems and services to our customers will be necessary to maintain our competitive position in the marketplace.  We are committed to complying with all environmental laws and regulations that are applicable to our operations.

Legal and Regulatory Proceedings

Regulatory activities of particular importance to our operations include proceedings under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), and state Superfund and similar type environmental laws governing existing or potential environmental contamination at several domestically owned, formerly owned and non-owned locations allegedly resulting from past industrial activity.  In a few cases, we are one of several Potentially Responsible Parties (“PRPs”) and have agreed to jointly fund required investigation, while preserving our defenses to the liability.  We may also have rights of contribution or reimbursement from other parties or coverage under applicable insurance policies.  

Most of our manufacturing and certain of our research facilities are affected by various federal, state and local environmental requirements relating to the discharge of materials or the protection of the environment.  We make expenditures necessary for compliance with applicable environmental requirements at each of our operating facilities. We have not experienced a material adverse effect upon our capital expenditures or competitive position as a result of environmental control legislation and regulations.

We are involved in various lawsuits, claims, investigations and other legal matters from time to time that arise in the ordinary course of business, including matters involving our products, intellectual property, relationships with suppliers, relationships with distributors, relationships with competitors, employees and other matters. From time to time, for example, we may be a party to various litigation matters that involve product liability, tort liability and other claims under a wide range of allegations, including illness due to exposure to certain chemicals used in the workplace; or medical conditions arising from exposure to product ingredients or the presence of trace contaminants.  Such allegations may involve multiple defendants and relate to legacy products that we and other defendants purportedly manufactured or sold. We believe that any current claims are without merit and intend to defend them vigorously. For these matters, we also may have rights of contribution or reimbursement from other parties or coverage under

7


 

applicable insurance policies.  When applicable and appropriate, we will pursue coverage and recoveries under those policies, but are unable to predict the outcome of those demands.  While complete assurance cannot be given to the ou tcome of these proceedings, we do not believe that any current claims, individually or in the aggregate, will have a material adverse effect on our financial condition, liquidity or results of operations.

Liabilities of $4.7 million and $6.0 million as of December 31, 2016 and December 31, 2015, respectively, were recorded for potential environmental liabilities and relating to locations for which we are a PRP that we consider probable and for which a reasonable estimate of the probable liability could be made.  See Note 27 to the Consolidated Financial Statements and Risk Factors in Item 1A of this Form 10-K, for information regarding the possible effects that compliance with environmental laws and regulations may have on our businesses and operating results.

Website

We maintain a website at http://www.armstrongceilings.com.  Information contained on our website is not incorporated into this document.  Reference in this Form 10-K to our website is an inactive text reference only.  Annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, all amendments to those reports and other information about us are available free of charge through this website as soon as reasonably practicable after the reports are electronically filed with the SEC.  These materials are also available from the SEC’s website at www.sec.gov.

ITEM 1A.

RISK FACTORS

Worldwide economic conditions could have a material adverse impact on our financial condition, liquidity or results of operations.

Our business is influenced by conditions in domestic and foreign economies, including inflation, deflation, interest rates, availability and cost of capital, consumer spending rates, energy availability and the effects of governmental initiatives to manage economic conditions.  Volatility in financial markets and the continued softness or further deterioration of national and global economic conditions could have a material adverse effect on our financial condition, liquidity or results of operations, including as follows:

 

the financial stability of our customers or suppliers may be compromised, which could result in additional bad debts for us or non-performance by suppliers;

 

commercial and residential consumers of our products may postpone spending in response to tighter credit, negative financial news and/or stagnation or further declines in income or asset values, which could have a material adverse impact on the demand for our product;

 

the value of investments underlying our defined benefit pension plans may decline, which could result in negative plan investment performance and additional charges which may involve significant cash contributions to such plans, to meet obligations or regulatory requirements; and

 

our asset impairment assessments and underlying valuation assumptions may change, which could result from changes to estimates of future sales and cash flows that may lead to substantial impairment charges.

Continued or sustained deterioration of economic conditions would likely exacerbate and prolong these adverse effects.

Our business is dependent on construction activity. Downturns in construction activity could adversely affect our financial condition, liquidity or results of operations.

Our businesses have greater sales opportunities when construction activity is strong and, conversely, have fewer opportunities when such activity declines.  The cyclical nature of commercial and residential construction activity, including construction activity funded by the public sector, tends to be influenced by prevailing economic conditions, including the rate of growth in gross domestic product, prevailing interest rates, government spending patterns, business, investor and consumer confidence and other factors beyond our control.  Prolonged downturns in construction activity could have a material adverse effect on our financial condition, liquidity or results of operations.

If the separation and distribution of Armstrong Flooring, Inc. (“AFI”) fails to qualify as a tax-free transaction for U.S. federal income tax purposes, then AFI, AWI and AWI’s shareholders could be subject to significant tax liability or tax indemnity obligations.

On April 1, 2016, we completed our previously announced separation of AFI by allocating the assets and liabilities related primarily to the Resilient Flooring and Wood Flooring segments to AFI and then distributing the common stock of AFI to our shareholders at a ratio of one share of AFI common stock for every two shares of AWI common stock.  In connection with the distribution, we received

8


 

an opinion from our special tax counsel, on the basis of certain facts, representations, covenants and assumptions set forth in such opinion, substantially to the effect that, for U.S. federal income tax purposes, the separation and di stribution should qualify as a transaction that generally is tax-free to us and our shareholders under Sections 355 and 368(a)(1)(D) of the Internal Revenue Code.

Notwithstanding the tax opinion, the Internal Revenue Service (“IRS”) could determine on audit that the distribution should be treated as a taxable transaction if it determines that any of the facts, assumptions, representations or covenants set forth in the tax opinion is not correct or has been violated, or that the distribution should be taxable for other reasons, including as a result of a significant change in stock or asset ownership after the distribution, or if the IRS were to disagree with the conclusions of the tax opinion. If the distribution is ultimately determined to be taxable, the distribution could be treated as a taxable dividend to each U.S. holder of our common shares who receives shares of AFI in connection with the spinoff for U.S. federal income tax purposes, and such shareholders could incur significant U.S. federal income tax liabilities. In addition, we and/or AFI could incur significant U.S. federal income tax liabilities or tax indemnification obligations, whether under applicable law or the Tax Matters Agreement that we entered into with AFI, if it is ultimately determined that certain related transactions undertaken in anticipation of the distribution are taxable.

Our markets are highly competitive. Competition can reduce demand for our products or cause us to lower prices. Failure to compete effectively by meeting consumer preferences, developing and marketing innovative solutions, maintaining strong customer service and distribution relationships, growing market share, and expanding our solutions capabilities and reach could adversely affect our results.

Our markets are highly competitive.  Competition can reduce demand for our products, negatively affect our product sales mix or cause us to lower prices. Failure to compete effectively by meeting consumer preferences, developing and marketing innovative solutions, maintaining strong customer service and distribution relationships, growing market share and expanding our solutions capabilities and reach could have a material adverse effect on our financial condition, liquidity or results of operations.  Our customers consider our products’ performance, product styling, customer service and price when deciding whether to purchase our products.  Shifting consumer preference in our highly competitive markets, from acoustical solutions to other ceiling products, for example, whether for performance or styling preferences or our inability to develop and offer new competitive performance features could have an adverse effect on our sales.  Similarly, our ability to identify, protect and market new and innovative solutions is critical to our long-term growth strategy, namely to sell into more spaces and sell more solutions in every space.  In addition, excess industry capacity for certain products in several geographic markets could lead to industry consolidation and/or increased price competition.  In certain local markets, we are also subject to potential increased price competition from foreign competitors, which may have lower cost structures.

Sales fluctuations to and changes in our relationships with key customers could have a material adverse effect on our financial condition, liquidity or results of operations.

Some of our markets are dependent on certain key customers, including independent distributors.   The loss, reduction, or fluctuation of sales to key customers, or any adverse change in our business relationship with them, whether as a result of competition, industry consolidation or otherwise, could have a material adverse effect on our financial condition, liquidity or results of operations.

If the availability of raw materials or energy decreases, or the costs increase, and we are unable to pass along increased costs, our financial condition, liquidity or results of operations could be adversely affected.

The availability and cost of raw materials, packaging materials, energy and sourced products are critical to our operations.  For example, we use substantial quantities of natural gas and petroleum-based raw materials in our manufacturing operations.  The cost of some of these items has been volatile in recent years and availability has been limited at times.  We source some materials from a limited number of suppliers, which, among other things, increases the risk of unavailability.  Limited availability could cause us to reformulate products or limit our production.  Decreased access to raw materials and energy or significant increased cost to purchase these items and any corresponding inability to pass along such costs through price increases could have a material adverse effect on our financial condition, liquidity or results of operations.

We are subject to risks associated with our international operations in both established and emerging markets. Legislative, political, regulatory and economic volatility, as well as vulnerability to infrastructure and labor disruptions, could have an adverse effect on our financial condition, liquidity or results of operations.

A significant portion of our products move in international trade, with approximately 30% of our revenues from operations outside the United States and Canada in 2016.  See Note 3 to the Consolidated Financial Statements for further information.  Our international trade is subject to currency exchange fluctuations, trade regulations, import duties, logistics costs, delays and other related risks.  Our international operations are also subject to various tax rates, credit risks in emerging markets, political risks, uncertain legal systems, high costs in repatriating profits to the United States from some countries, and loss of sales to local competitors following currency

9


 

devaluations in countries where we import products for sale.  In addition, our international growth strategy depends, in part, on our ability to expand our operations in certain emerging markets.  However, some emerging markets have greate r political and economic volatility and greater vulnerability to infrastructure and labor disruptions than established markets.  Similarly, our efforts to enhance the profitability or accelerate the growth of our operations in certain markets depends large ly on the economic and geopolitical conditions in those local or regional markets.

In addition, in many countries outside of the United States, particularly in those with developing economies, it may be common for others to engage in business practices prohibited by laws and regulations applicable to us, such as the Foreign Corrupt Practices Act or similar local anti-corruption or anti-bribery laws.  These laws generally prohibit companies and their employees, contractors or agents from making improper payments to government officials for the purpose of obtaining or retaining business.  Failure to comply with these laws, as well as U.S. and foreign export and trading laws, could subject us to civil and criminal penalties.  As we continue to expand our business globally, including in emerging markets, we may have difficulty anticipating and effectively managing these and other risks that our international operations may face, which may adversely affect our business outside the United States and our financial condition, liquidity or results of operations.

The performance of our WAVE joint venture is important to our financial results.  Changes in the demand for, or quality of, WAVE products, or in the operational or financial performance of the WAVE joint venture, could have a material adverse effect on our financial condition, liquidity or results of operations.  Similarly, if there is a change with respect to our joint venture partner that adversely impacts its relationship with us, WAVE’s performance could be adversely impacted.

Our equity investment in our WAVE joint venture remains important to our financial results.  We believe an important element in the success of this joint venture is the relationship with our partner, Worthington Industries, Inc.  If there is a change in ownership, a change of control, a change in management or management philosophy, a change in business strategy or another event with respect to our partner that adversely impacts our relationship, WAVE’s performance could be adversely impacted.  In addition, our partner may have economic or business interests or goals that are different from or inconsistent with our interests or goals, which may impact our ability to influence or align WAVE’s strategy and operations.

We may be subject to liability under, and may make substantial future expenditures to comply with environmental laws and regulations, which could materially adversely affect our financial condition, liquidity or results of operations.

We are actively involved in environmental investigation and remediation activities relating to several domestically owned, formerly owned and non-owned locations allegedly resulting from past industrial activity, for which our ultimate liability may exceed the currently estimated and accrued amounts.  See Note 27 to the Consolidated Financial Statements for further information related to our current environmental matters and the potential liabilities associated therewith. It is also possible that we could become subject to additional environmental matters and corresponding liabilities in the future.

The building materials industry has been subject to claims relating to raw materials such as silicates, polychlorinated biphenyl (“PCB”), PVC, formaldehyde, fire-retardants and claims relating to other issues such as mold and toxic fumes, as well as claims for incidents of catastrophic loss, such as building fires.  We have not received any significant claims involving our raw materials or our product performance; however, product liability insurance coverage may not be available or adequate in all circumstances to cover claims that may arise in the future.

In addition, our operations are subject to various domestic and foreign environmental, health, and safety laws and regulations.  These laws and regulations not only govern our current operations and products, but also impose potential liability on us for our past operations.  Our costs to comply with these laws and regulations may increase as these requirements become more stringent in the future, and these increased costs may materially adversely affect our financial condition, liquidity or results of operations.

The agreements that govern our indebtedness contain a number of covenants that impose significant operating and financial restrictions, including restrictions on our ability to engage in activities that may be in our best long-term interests.

The agreements that govern our indebtedness include covenants that, among other things, may impose significant operating and financial restrictions, including restrictions on our ability to engage in activities that may be in our best long-term interests.  These covenants may restrict our ability to:

 

incur additional debt;

 

pay dividends on or make other distributions in respect of our capital stock or redeem, repurchase or retire our capital stock or subordinated debt or make certain other restricted payments;

 

make certain acquisitions;

10


 

 

sell certain assets;

 

consolidate, merge, sell or otherwise dispose of all or substantially all of our assets; and

 

create liens on certain assets to secure debt.

Under the terms of our senior secured credit facility, we are required to maintain specified leverage and interest coverage ratios.  Our ability to meet these ratios could be affected by events beyond our control, and we cannot assure that we will meet them.  A breach of any of the restrictive covenants or ratios would result in a default under the senior secured credit facility.  If any such default occurs, the lenders under the senior secured credit facility may be able to elect to declare all outstanding borrowings under our facilities, together with accrued interest and other fees, to be immediately due and payable, or enforce their security interest.  The lenders may also have the right in these circumstances to terminate commitments to provide further borrowings.

Our indebtedness may adversely affect our cash flow and our ability to operate our business, make payments on our indebtedness and declare dividends on our capital stock.

Our level of indebtedness and degree of leverage could:

 

make it more difficult for us to satisfy our obligations with respect to our indebtedness;

 

make us more vulnerable to adverse changes in general economic, industry and competitive conditions and adverse changes in government regulation;

 

limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

place us at a competitive disadvantage compared to our competitors that are less leveraged and, therefore, more able to take advantage of opportunities that our leverage prevents us from exploiting;

 

limit our ability to refinance existing indebtedness or borrow additional amounts for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy or other purposes;

 

restrict our ability to pay dividends on our capital stock; and

 

adversely affect our credit ratings.

We may also incur additional indebtedness, which could exacerbate the risks described above.  In addition, to the extent that our indebtedness bears interest at floating rates, our sensitivity to interest rate fluctuations will increase.

Any of the above listed factors could materially adversely affect our financial condition, liquidity or results of operations.

We require a significant amount of liquidity to fund our operations, and borrowing has increased our vulnerability to negative unforeseen events.

Our liquidity needs vary throughout the year.  If our business experiences materially negative unforeseen events, we may be unable to generate sufficient cash flow from operations to fund our needs or maintain sufficient liquidity to operate and remain in compliance with our debt covenants, which could result in reduced or delayed planned capital expenditures and other investments and adversely affect our financial condition or results of operations.

We may pursue strategic transactions that could create risks and present unforeseen integration obstacles or costs, any of which could materially adversely affect our financial condition, liquidity or results of operations.

We have evaluated, and expect to continue to evaluate, potential strategic transactions as opportunities arise.  We routinely engage in discussions with third parties regarding potential transactions, including joint ventures, which could be significant.  Any such strategic transaction involves a number of risks, including potential disruption of our ongoing business and distraction of management, difficulty with integrating or separating personnel and business operations and infrastructure, and increasing or decreasing the scope, geographic diversity and complexity of our operations.  Strategic transactions could involve payment by us of a substantial amount of cash, assumption of liabilities and indemnification obligations, regulatory requirements, incurrence of a substantial amount of debt or issuance of a substantial amount of equity.  Certain strategic opportunities may not result in the consummation of a transaction or may fail to realize the intended benefits and synergies.  If we fail to consummate and integrate our strategic transactions in a timely and cost-effective manner, our financial condition, liquidity or results of operation could be materially and adversely affected.

11


 

Negative tax consequences can have an unanticipated effect on our financial results.

We are subject to the tax laws of the many jurisdictions in which we operate.  The tax laws are complex, and the manner in which they apply to our operations and results is sometimes open to interpretation.  Because our income tax expense for any period depends heavily on the mix of income derived from the various taxing jurisdictions, our income tax expense and reported net income may fluctuate significantly, and may be materially different than forecasted or experienced in the past.  Our financial condition, liquidity, results of operations or tax liability could be adversely affected by changes in the effective tax rate as a result of a change in the mix of earnings in countries with differing statutory tax rates, changes in our overall profitability, changes in tax legislation and rates, changes in the amount of earnings permanently reinvested offshore, the results of examinations of previously filed tax returns, and ongoing assessments of our tax exposures.

Our financial condition, liquidity, results of operations or tax liability could also be adversely affected by changes in the valuation of deferred tax assets and liabilities. We have substantial deferred tax assets related to U.S. domestic foreign tax credits, or FTCs, and state net operating losses, or NOLs, which are available to reduce our U.S. income tax liability and to offset future state taxable income.  However, our ability to utilize the current carrying value of these deferred tax assets may be impacted as a result of certain future events, such as changes in tax legislation and insufficient future taxable income prior to expiration of the FTCs and NOLs.

Significant changes in factors and assumptions used to measure our defined benefit plan obligations, actual investment returns on pension assets and other factors could negatively impact our operating results and cash flows.

We maintain pension and postretirement plans throughout the world, with the most significant plans located in the U.S.  The recognition of costs and liabilities associated with these plans for financial reporting purposes is affected by assumptions made by management and used by actuaries engaged by us to calculate the benefit obligations and the expenses recognized for these plans.

The inputs used in developing the required estimates are calculated using a number of assumptions, which represent management’s best estimate of the future.  The assumptions that have the most significant impact on reported results are the discount rate, the estimated long-term return on plan assets for the funded plans, retirement rates, and mortality rates and, for postretirement plans, the estimated inflation in health care costs.  These assumptions are generally updated annually.

Our U.S. pension plans were underfunded by $9.5 million as of December 31, 2016.  Our unfunded U.S. postretirement plan liabilities were $93.1 million as of December 31, 2016.  If our cash flows and capital resources are insufficient to fund our pension and postretirement plans obligations, we could be forced to reduce or delay investments and capital expenditures, seek additional capital, or restructure or refinance our indebtedness.

Adverse judgments in regulatory actions, product claims, environmental claims and other litigation could be costly.  Insurance coverage may not be available or adequate in all circumstances.

In the ordinary course of business, we are subject to various claims and litigation.  Any such claims, whether with or without merit, could be time consuming and expensive to defend and could divert management’s attention and resources.  While we strive to ensure that our products comply with applicable government regulatory standards and internal requirements, and that our products perform effectively and safely, customers from time to time could claim that our products do not meet warranty or contractual requirements, and users could claim to be harmed by use or misuse of our products.  These claims could give rise to breach of contract, warranty or recall claims, or claims for negligence, product liability, strict liability, personal injury or property damage.  They could also result in negative publicity.

In addition, claims and investigations may arise related to patent infringement, distributor relationships, commercial contracts, antitrust or competition law requirements, employment matters, employee benefits issues, and other compliance and regulatory matters, including anti-corruption and anti-bribery matters.  While we have processes and policies designed to mitigate these risks and to investigate and address such claims as they arise, we cannot predict or, in some cases, control the costs to defend or resolve such claims.

We currently maintain insurance against some, but not all, of these potential claims. In the future, we may not be able to maintain insurance at commercially acceptable premium levels.  In addition, the levels of insurance we maintain may not be adequate to fully cover any and all losses or liabilities.  If any significant judgment or claim is not fully insured or indemnified against, it could have a material adverse impact. We cannot assure that the outcome of all current or future litigation will not have a material adverse effect on our financial condition, liquidity or results of operations.

12


 

Increased costs of labor, labor disputes, work stoppages or union organizing activity c ould delay or impede production and could have a material adverse effect on our financial condition, liquidity or results of operations.

Increased costs of U.S. and international labor, including the costs of employee benefits plans, labor disputes, work stoppages or union organizing activity could delay or impede production and have a material adverse effect on our financial condition, liquidity or results of operations.  As the majority of our manufacturing employees are represented by unions and covered by collective bargaining or similar agreements, we often incur costs attributable to periodic renegotiation of those agreements, which may be difficult to project.  We are also subject to the risk that strikes or other conflicts with organized personnel may arise or that we may become the subject of union organizing activity at our facilities that do not currently have union representation.  Prolonged negotiations, conflicts or related activities could also lead to costly work stoppages and loss of productivity.

Our intellectual property rights may not provide meaningful commercial protection for our products or brands, which could adversely impact our financial condition, liquidity or results of operations.

We rely on our proprietary intellectual property, including numerous patents and registered trademarks, as well as our licensed intellectual property to market, promote and sell our products.  We monitor and protect against activities that might infringe, dilute, or otherwise harm our patents, trademarks and other intellectual property and rely on the patent, trademark and other laws of the U.S. and other countries.  However, we may be unable to prevent third parties from using our intellectual property without our authorization.  In addition, the laws of some non-U.S. jurisdictions, particularly those of certain emerging markets, provide less protection for our proprietary rights than the laws of the U.S. and present greater risks of counterfeiting and other infringement.  To the extent we cannot protect our intellectual property, unauthorized use and misuse of our intellectual property could harm our competitive position and have a material adverse effect on our financial condition, liquidity or results of operations.

Our cost-saving and productivity initiatives may not achieve expected savings in our operating costs or improved operating results.

We aggressively look for ways to make our operations more efficient and effective.  We reduce, move, modify and expand our plants and operations, as well as our sourcing and supply chain arrangements, as needed, to control costs and improve productivity.  Such actions involve substantial planning, often require capital investments and may result in charges for fixed asset impairments or obsolescence and substantial severance costs.  Our ability to achieve cost savings and other benefits within expected time frames is subject to many estimates and assumptions.  These estimates and assumptions are subject to significant economic, competitive and other uncertainties, some of which are beyond our control.  If these estimates and assumptions are incorrect, if we experience delays, or if other unforeseen events occur, our financial condition, liquidity or results of operations could be materially and adversely affected.

ITEM 1B.

UNRESOLVED STAFF COMMENTS

None.

ITEM 2.

PROPERTIES

Our world headquarters is in Lancaster, Pennsylvania.  We own a 100-acre, multi-building campus comprising the site of our corporate headquarters, most of our operational headquarters, our U.S. R&D operations and marketing, and customer service headquarters.

We produce and market Armstrong products and services throughout the world.  As of December 31, 2016, we had 15 manufacturing plants in eight countries.  Three of our plants are leased and the remaining 12 are owned.  We operate six plants located throughout the United States.  In addition, our WAVE joint venture operates 9 additional plants in five countries.

 

Number of

Plants

 

Location of Principal Facilities

 

 

 

15

 

U.S. (Florida, Georgia, Ohio, Oregon, Pennsylvania and West Virginia), Austria, Canada, China, France, Germany, Russia and the U.K.

 

During the fourth quarter of 2016, we idled one of our plants in China.

Sales and administrative offices are leased and/or owned worldwide, and leased facilities are utilized to supplement our owned warehousing facilities.

13


 

Production capacity and the extent of utilization of our facilities are difficult to quantify with certainty.  In any one facility, utilization of our capacity va ries periodically depending upon demand for the product that is being manufactured.  We believe our facilities are adequate and suitable to support the business.  Additional incremental investments in plant facilities are made as appropriate to balance cap acity with anticipated demand, improve quality and service, and reduce costs.

ITEM 3.

LEGAL PROCEEDINGS

See the “Specific Material Events” section of the “Environmental Matters” section of Note 27 to the Consolidated Financial Statements, which is incorporated herein by reference, for a description of our significant legal proceedings.

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

 

 

14


 

PART II

ITEM 5.

MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

AWI’s common shares trade on the New York Stock Exchange under the ticker symbol “AWI.”  As of February 21, 2017, there were approximately 280 holders of record of AWI’s common stock.

 

 

 

First

 

 

Second

 

 

Third

 

 

Fourth

 

 

Total Year

 

2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Price range of common stock - high

 

$

48.66

 

 

$

48.39

 

 

$

45.75

 

 

$

45.00

 

 

$

48.66

 

Price range of common stock - low

 

$

35.92

 

 

$

36.33

 

 

$

37.49

 

 

$

36.38

 

 

$

35.92

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2015

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Price range of common stock - high

 

$

58.42

 

 

$

58.96

 

 

$

60.70

 

 

$

52.33

 

 

$

60.70

 

Price range of common stock - low

 

$

48.60

 

 

$

52.94

 

 

$

46.47

 

 

$

44.43

 

 

$

44.43

 

 

The above figures represent the high and low intra-day sale prices for our common stock as reported by the New York Stock Exchange.  Historical prices have not been restated as a result of our separation of AFI.

There were no dividends declared during 2016 or 2015.

Dividends are paid when declared by our Board of Directors and in accordance with restrictions set forth in our debt agreements. In general, our debt agreements allow us to make “restricted payments,” which include dividends and stock repurchases, subject to certain limitations and other restrictions and provided that we are in compliance with the financial and other covenants of our debt agreements and meet certain liquidity requirements after giving effect to the restricted payment.   For further discussion of the debt agreements, see the financial condition and liquidity section of Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and Risk Factors in Item 1A in this Form 10-K.

Issuer Purchases of Equity Securities

 

Period

 

Total Number of

Shares

Purchased 1

 

 

Average Price

Paid per Share

 

 

Total Number of

Shares

Purchased as

Part of Publicly

Announced Plans

or Programs

 

 

Maximum

Approximate Value of

Shares that may

yet be Purchased

under the Plans

or Programs

 

October 1 – 31, 2016

 

 

262,356

 

 

$

40.12

 

 

 

262,112

 

 

$

131,653,141

 

November 1 – 30, 2016

 

 

589,404

 

 

$

38.07

 

 

 

586,858

 

 

 

109,310,207

 

December 1 – 31, 2016

 

 

77,517

 

 

$

42.51

 

 

 

75,224

 

 

 

106,118,019

 

Total

 

 

929,277

 

 

 

 

 

 

 

924,194

 

 

 

 

 

 

1

Includes shares reacquired through the withholding of shares to pay employee tax obligations upon the exercise of options or vesting of restricted shares previously granted under long-term incentive plans.  For more information regarding securities authorized for issuance under our equity compensation plans, see Note 21 to the Consolidated Financial Statements included in this Form 10-K.

On July 29, 2016, the Company announced that its Board of Directors had approved a share repurchase program pursuant to which the Company is authorized to repurchase up to $150.0 million of its outstanding shares of common stock through July 31, 2018 (the “Program”).  Repurchases under the Program may be made through open market, block and privately-negotiated transactions, including Rule 10b5-1 plans, at times and in such amounts as management deems appropriate, subject to market and business conditions, regulatory requirements and other factors. The Program does not obligate the Company to repurchase any particular amount of common stock and may be suspended or discontinued at any time without notice.   During 2016, 1.1 million shares were repurchased under the Program for a total cost of $43.8 million, or an average price of $39.45 per share.

 

 

15


 

ITEM 6.

SELECTE D FINANCIAL DATA

The following selected historical consolidated financial data should be read in conjunction with our audited consolidated financial statements, the accompanying notes and Management’s Discussion and Analysis of Financial Condition and Results of Operations included in this Form 10-K.  The selected historical consolidated financial data for the periods presented have been derived from our audited consolidated financial statements.

 

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

(amounts in millions, except for per-share data)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income statement data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net sales

 

$

1,234.5

 

 

$

1,231.3

 

 

$

1,294.3

 

 

$

1,264.6

 

 

$

1,218.9

 

Operating income

 

 

184.6

 

 

 

140.5

 

 

 

198.1

 

 

 

196.8

 

 

 

180.7

 

Earnings from continuing operations

 

 

93.9

 

 

 

26.6

 

 

 

79.1

 

 

 

88.4

 

 

 

89.3

 

Per common share - basic (a)

 

$

1.69

 

 

$

0.48

 

 

$

1.43

 

 

$

1.52

 

 

$

1.51

 

Per common share - diluted (a)

 

$

1.68

 

 

$

0.47

 

 

$

1.42

 

 

$

1.51

 

 

$

1.49

 

Dividends declared per share of common stock

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

$

8.55

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance sheet data (end of period)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

1,758.0

 

 

$

2,687.2

 

 

$

2,599.6

 

 

$

2,907.7

 

 

$

2,830.4

 

Long-term debt

 

 

848.6

 

 

 

936.2

 

 

 

986.3

 

 

 

1,023.7

 

 

 

1,004.1

 

Total shareholders' equity

 

 

266.4

 

 

 

768.8

 

 

 

649.1

 

 

 

673.2

 

 

 

719.1

 

 

Notes:

(a)

See definition of basic and diluted earnings per share in Note 2 to the Consolidated Financial Statements.

 

 

16


ITEM 7 .

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Armstrong World Industries, Inc. (“AWI”) is a Pennsylvania corporation incorporated in 1891.

This discussion should be read in conjunction with the financial statements, the accompanying notes, the cautionary note regarding forward-looking statements and risk factors included in this Form 10-K.

Overview

We are a leading global producer of ceiling systems and, prior to April 1, 2016, flooring products for use primarily in the construction and renovation of residential, commercial and institutional buildings. We design, manufacture and sell ceiling systems (primarily mineral fiber, fiberglass wool and metal) and, prior to April 1, 2016, flooring products (primarily resilient and wood) around the world.

On April 1, 2016, we completed our previously announced separation of Armstrong Flooring, Inc. (“AFI”) by allocating the assets and liabilities related primarily to the Resilient Flooring and Wood Flooring segments to AFI and then distributing the common stock of AFI to our shareholders at a ratio of one share of AFI common stock for every two shares of AWI common stock.  Subsequent to the separation and distribution, AWI and AFI operate as two independent, publicly-traded companies, with AFI owning and operating the Resilient Flooring and Wood Flooring segments and AWI continuing to own and operate the Building Products (Ceilings) segment.  AFI’s historical financial results have been reflected in AWI’s Consolidated Financial Statements as a discontinued operation for all periods presented.  

We are focused on driving sustainable shareholder value creation. Our strategic priorities are to accelerate profitable volume growth globally and to improve the returns in our international business.  Our primary goal is to expand into new and grow in existing markets by selling a broader array of products and solutions into those markets.  

As of December 31, 2016, we had 15 manufacturing plants in eight countries, including six plants located throughout the U.S. During the fourth quarter of 2016 we idled one of our mineral fiber plants in China.

Worthington Armstrong Venture (“WAVE”), our joint venture with Worthington Industries, Inc. in which we hold a 50% equity interest, operates 9 additional plants in five countries to produce suspension system (grid) products, which we use and sell in our ceiling systems.

Reportable Segments 

Effective April 1, 2016 and in connection with our separation of AFI, our former Resilient Flooring and Wood Flooring segments have been excluded from our results of continuing operations.  In addition, effective April 1, 2016, we disaggregated our former Building Products operating segment into the following three distinct geographical segments:  Americas (including Canada); Europe, Middle East and Africa (including Russia) (“EMEA”); and Pacific Rim.  

Each of our geographical segments produce suspended fiber and metal ceilings for use in commercial and institutional settings in addition to sourcing complimentary ceiling products.  Commercial ceiling materials and accessories are sold to resale distributors and to ceiling systems contractors.  Residential ceiling products are sold in the Americas primarily to wholesalers and retailers (including large home centers).  Each segment also includes our WAVE joint venture, which manufactures suspension system (grid) products that are invoiced by both us and WAVE.  In each of our segments, WAVE primarily sells its suspension system products directly to customers, for which we provide sales and administrative support.  To a lesser extent, however, in some markets, WAVE sells its suspension systems products to us for resale to customers.  Our segment results reflect those sales transactions.

In addition, effective April 1, 2016, we reclassified the majority of the assets and liabilities formally allocated to our Unallocated Corporate segment to our Americas segment for all periods presented.  The assets and liabilities reclassified to our Americas segment most notably included the Armstrong trade name intangible asset, property, plant and equipment comprised primarily of Corporate campus facilities, the cash surrender value of life insurance supporting deferred compensation liabilities and income tax assets and liabilities and pension and postretirement assets and liabilities.  

Balance sheet items classified as Unallocated Corporate primarily include cash and cash equivalents and outstanding borrowings under our senior credit facilities.  

17


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Effective January 1, 2016, in anticipation of the April 1, 2016 AFI separation, the majority of our historical corporate support functions, representing costs of approximately $85 million for 2016 were incorporated into our Americas segment.  As a result, Unallocat ed Corporate support expenses have decreased significantly during 2016 in comparison to 2015.  

For 2016, 2015 and 2014, Unallocated Corporate segment operating (loss) was comprised of the following (dollar amounts in millions):

 

 

 

2016

 

 

2015

 

 

2014

 

Corporate expenses

 

$

(4.3

)

 

$

(90.0

)

 

$

(66.6

)

Separation costs

 

 

(34.5

)

 

 

(34.3

)

 

 

-

 

Total Unallocated Corporate segment operating (loss)

 

$

(38.8

)

 

$

(124.3

)

 

$

(66.6

)

 

Factors Affecting Revenues

For information on our segments’ 2016 net sales by geography, see Note 3 to the Consolidated Financial Statements included in this Form 10-K.

Markets. We compete in building material markets around the world, with the majority of our sales in the Americas.  We closely monitor publicly available macroeconomic trends that provide insight into commercial and residential market activity, including Gross Domestic Product, office vacancy rates, the Architecture Billings Index, new commercial construction starts, state and local government spending, corporate profits and retail sales.  

In addition, we noted several factors and trends within our markets that directly affected our business performance during 2016, including: 

Americas

We believe we experienced growth from new construction and, to a lesser extent, renovation and remodel activity, based on the mix of products sold.  Both new construction and renovation activity were strong in the first half of 2016, with new construction activity continuing its momentum, albeit at a more moderate pace, throughout the second half of the year.  

EMEA

We experienced continued softness in commercial sectors, such as office, education and healthcare.  Market opportunities continue to be hindered by low global oil prices, particularly in economies closely linked to oil, such as Russia and the Middle East.  While recent improvements in oil prices have begun to positively impact market opportunities in Russia, building activity in the Middle East continues to be negatively impacted by lower project funding. 

Pacific Rim

Commercial office markets in China continued to experience challenging conditions, while India markets were impacted by tight project financing.    

Average Unit Value .  We periodically modify prices in each of our business segments due to changes in costs for raw materials and energy, market conditions and the competitive environment.  In certain cases, realized price increases are less than the announced price increases because of competitive reactions and changing market conditions.  Additionally, we offer a wide assortment of products that are differentiated by style, design and performance attributes.  Pricing and margins for products within the assortment vary.   In addition, changes in the relative quantity of products purchased at different price points can impact year-to-year comparisons of net sales and operating income. We focus on improving sales dollars per unit sold, or average unit value (“AUV”), as a measure that accounts for the varying assortment of products and geographic mix impacting our revenues.  We estimate that favorable AUV increased our total consolidated net sales for the full year of 2016 by approximately $24 million compared to 2015.  

In the first quarter of 2016, we implemented ceiling tile pricing increases in the Americas, EMEA and Pacific Rim.  In the second quarter of 2016, we implemented price increases on grid products in the Americas.  In the third quarter of 2016 we implemented price increases on ceilings tiles in the Americas and grid products in EMEA.  We also announced price increases on ceiling tile and grid products in the Americas effective in the first quarter of 2017.  We may implement additional pricing actions based on upon future movements in raw material prices or foreign currency valuations.

18


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Factors Affecting Operating Costs

Operating Expenses.   Our operating expenses are comprised of direct production costs (principally raw materials, labor and energy), manufacturing overhead costs, freight, costs to purchase sourced products and selling, general, and administrative (“SG&A”) expenses. 

Our largest individual raw material expenditures are for fiberglass, mineral wool, perlite, starch and waste paper.  Natural gas and packaging materials are also significant input costs.  Fluctuations in the prices of these inputs are generally beyond our control and have a direct impact on our financial results.  In 2016, the costs for raw materials, sourced products and energy positively impacted operating income by approximately $9 million, compared to 2015.

We continue to evaluate the efficiency of our manufacturing footprint and may take additional actions in support of our cost and standardization initiatives.  The charges associated with any additional cost reduction initiatives could include severance and related termination benefits, fixed asset write-downs, asset impairments and accelerated depreciation and may be material to our financial statements.

See also “Results of Operations” for further discussion of other significant items affecting operating costs.

Employees

As of December 31, 2016, we had approximately 3,700 full-time and part-time employees worldwide compared to approximately 3,800 (excluding AFI) as of December 31, 2015.  Effective April 1, 2016, approximately 3,900 of our former employees were employed by AFI as a result of the separation.    Collective bargaining agreements covering approximately 300 employees at two U.S. plants will expire during 2017.  

During the fourth quarter of 2016, we idled one of our plants in China.  As a result, we expect a reduction of approximately 190 employees in China in the first quarter of 2017.  We believe that our relations with our employees are satisfactory.

CRITICAL ACCOUNTING ESTIMATES

In preparing our consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”), we are required to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period.  We evaluate our estimates and assumptions on an on-going basis, using relevant internal and external information.  We believe that our estimates and assumptions are reasonable.  However, actual results may differ from what was estimated and could have a significant impact on the financial statements.

We have identified the following as our critical accounting estimates.  We have discussed these critical accounting estimates with our Audit Committee.

U.S. Pension Credit and Postretirement Benefit Costs – We maintain pension and postretirement plans throughout the world, with the most significant plans located in the U.S.  Our defined benefit pension and postretirement benefit costs are developed from actuarial valuations.  These valuations are calculated using a number of assumptions, which represent management’s best estimate of the future.  The assumptions that have the most significant impact on reported results are the discount rate, the estimated long-term return on plan assets and the estimated inflation in health care costs.  These assumptions are generally updated annually.

Effective December 31, 2016, we elected to measure the U.S. pension plans’ and U.S. postretirement plan’s benefit obligations by applying spot rates along the yield curve to the relevant projected cash flows, as we believe this provides a better measurement of these costs.  This change in methodology requires management to utilize different discount rates to measure service cost and interest cost.  We have accounted for this change in discount rate methodology as a change in accounting estimate and, accordingly have applied it on a prospective basis.  This change did not affect the measurement of the total benefit obligation.

19


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Management utilizes the Aon Hewitt AA only above median yield curve, which is a hypothetical AA yield curve comprised of a series of annualized individual discount r ates, as the primary basis for determining discount rates.  As of December 31, 2016 and 2015, we assumed discount rates of 4.12% and 4.40%, respectively, for the U.S. defined benefit pension plans.  As of December 31, 2016 and 2015, we assumed a discount r ates of 4.10% and 4.25%, respectively, for the U.S. postretirement plan.  The effects of the change in discount rate will be amortized into earnings as described below.  Absent any other changes, a one-quarter percentage point increase or decrease in the d iscount rates for the U.S. pension and postretirement plans would not have a material impact on 2017 operating income.

We manage two U.S. defined benefit pension plans, a qualified funded plan and a nonqualified unfunded plan.  For the qualified funded plan, the expected long-term return on plan assets represents a long-term view of the future estimated investment return on plan assets.  This estimate is determined based on the target allocation of plan assets among asset classes and input from investment professionals on the expected performance of the asset classes over 10 to 30 years.  Historical asset returns are monitored and considered when we develop our expected long-term return on plan assets.  An incremental component is added for the expected return from active management based on historical information obtained from the plan’s investment consultants.  These forecasted gross returns are reduced by estimated management fees and expenses.  Over the 10 year period ended December 31, 2016, the historical annualized return was approximately 5.4% compared to an average expected return of 7.3%.  The actual gain on plan assets achieved for 2016 was 9.2%.  The difference between the actual and expected rate of return on plan assets will be amortized into earnings as described below.

The expected long-term return on plan assets used in determining our 2016 U.S. pension cost was 6.75%.  We have assumed a return on plan assets for 2017 of 6.50%.  The 2017 expected return on assets was calculated in a manner consistent with 2016.  A one-quarter percentage point increase or decrease in this assumption would increase or decrease 2017 operating income by approximately $3.8 million.

Contributions to the unfunded plan were $4.2 million in 2016 and were made on a monthly basis to fund benefit payments.  We estimate the 2017 contributions will be approximately $3.9 million.  See Note 16 to the Consolidated Financial Statements for more information.

The estimated inflation in health care costs represents a 5-10 year view of the expected inflation in our postretirement health care costs.  We separately estimate expected health care cost increases for pre-65 retirees and post-65 retirees due to the influence of Medicare coverage at age 65, as illustrated below:

 

 

 

Assumptions

 

 

 

Actual

 

 

 

 

Post 65

 

 

 

Pre 65

 

 

 

Post 65

 

 

 

Pre 65

 

 

2015

 

 

6.8

 

%

 

 

7.5

 

%

 

 

0.2

 

%

 

 

(10.3

)

%

2016

 

 

9.0

 

%

 

 

7.5

 

%

 

 

8.6

 

%

 

 

3.3

 

%

2017

 

 

8.5

 

%

 

 

7.3

 

%

 

 

 

 

 

 

 

 

 

 

 

The difference between the actual and expected health care costs is amortized into earnings as described below.  As of December 31, 2016, health care cost increases are estimated to decrease ratably until 2025, after which they are estimated to be constant at 4.5%.  A one percentage point increase or decrease in the assumed health care cost trend rate would not have a material impact on 2017 operating income.  See Note 16 to the Consolidated Financial Statements for more information.

Actual results that differ from our various pension and postretirement plan estimates are captured as actuarial gains/losses.  During 2016, as a result of certain thresholds being met, actuarial gains and losses were amortized into future earnings over the expected remaining service period of plan participants, which was approximately eight years for our U.S. pension plans and our U.S. postretirement plan.  Beginning in 2017, actuarial gains and losses will be amortized over the remaining life expectancy of participants, which is estimated to be approximately 20 years for our U.S. pension plans and approximately 10 years for our U.S. postretirement plans.  The 2017 change in amortization period for our U.S. pension plans results from active AFI participants leaving our plan, which correspondingly results in retirees representing a larger portion of our plan participants.  Changes in assumptions could have significant effects on earnings in future years.

Excluding the impact of the separation of AFI, we recognized a decrease in net actuarial losses related to our U.S. pension benefit plans of $81.8 million in 2016 primarily due to changes in actuarial assumptions (most significantly a 28 basis point decrease in the discount rate) and the amortization of net actuarial losses recorded as a component of 2016 net periodic pension cost.  The $81.8 million actuarial gain impacting our U.S. pension plans is reflected as a component of other comprehensive income in our Consolidated Statement of Earnings and Comprehensive Income (Loss) along with actuarial gains and losses from our foreign pension plans and our U.S. postretirement benefit plan.

20


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Income Taxes – Our effective tax rate is primarily determined based on our pre-tax income and the statutory income tax rates in the jurisdictions in which we operate.  The effective tax rate also reflects the tax impacts of items treated differently for tax purposes than for financial reporting purposes.  Some of these dif ferences are permanent, such as expenses that are not deductible in our tax returns, and some differences are temporary, reversing over time, such as depreciation expense.  These temporary differences create deferred income tax assets and liabilities.  Def erred income tax assets are also recorded for net operating loss (“NOL”) and foreign tax credit (“FTC”) carryforwards.

Deferred income tax assets and liabilities are recognized by applying enacted tax rates to temporary differences that exist as of the balance sheet date.  We reduce the carrying amounts of deferred tax assets by a valuation allowance if, based on the available evidence, it is more likely than not that such assets will not be realized.  The need to establish valuation allowances for deferred tax assets is assessed quarterly. In assessing the requirement for, and amount of, a valuation allowance in accordance with the more likely than not standard, we give appropriate consideration to all positive and negative evidence related to the realization of the deferred tax assets.  This assessment considers, among other matters, the nature, frequency and severity of current and cumulative losses, forecasts of future profitability and foreign source income (“FSI”), the duration of statutory carryforward periods, and our experience with operating loss and tax credit carryforward expirations.  A history of cumulative losses is a significant piece of negative evidence used in our assessment.  If a history of cumulative losses is incurred for a tax jurisdiction, forecasts of future profitability are not used as positive evidence related to the realization of the deferred tax assets in the assessment.

Our domestic FTC carryforward deferred tax asset as of December 31, 2016 was $22.1 million on a gross basis ($19.3 million when netted with unrecognized tax benefits).  As of December 31, 2016, our valuation allowance for our domestic FTC carryforward deferred tax asset was $0.8 million.   We considered the following positive and negative evidence in assessing the need for a valuation allowance for our domestic FTC carryforward deferred tax asset:

Positive Evidence

 

Under U.S. tax law, approximately $10.2 million of our domestic source income in future years can be characterized as FSI to enable the utilization of our FTCs.  This amount primarily represents prior year intercompany dividends associated with the FTC carryforwards.  These dividends created domestic taxable income that was reduced by the utilization of domestic NOLs; and

 

Forecasts of future profitability and FSI.

Negative Evidence

 

Our stated position to permanently reinvest unremitted earnings of our foreign subsidiaries.

The ability to fully utilize the FTC carryforwards may be affected by the following factors:

 

FSI of $63.1 million is needed to fully utilize the FTC carryforward of $22.1 million before they expire in 2022.  In addition to the $10.2 million of domestic source income that can be characterized as FSI in future years, $52.9 million of additional foreign source income is needed.

 

The main factor that could result in our inability to re-characterize domestic source income to foreign source income is a U.S. tax law change.

 

The main factors that could contribute to lower FSI are decreased export sales and increased allocable expenses.

As of December 31, 2016, we have recorded valuation allowances totaling $60.5 million for various federal, state, and foreign deferred tax assets.  While we have considered future taxable income in assessing the need for the valuation allowances based on our best available projections, if these estimates and assumptions change in the future or if actual results differ from our projections, we may be required to adjust our valuation allowances accordingly.  Such adjustments could be material to our Consolidated Financial Statements.

As further described in Note 14 to the Consolidated Financial Statements, our Consolidated Balance Sheet as of December 31, 2016 includes net deferred income tax assets of $159.1 million.  Included in this amount are deferred federal income tax assets for FTC carryforwards of $22.1 million, state NOL deferred income tax assets of $32.0 million, and foreign NOL deferred tax assets of $39.9 million.  We have established valuation allowances in the amount of $60.5 million consisting of $0.8 million for federal deferred tax assets related to FTC carryovers, $16.5 million for state deferred tax assets, primarily operating loss carryovers, and $43.2 million for foreign deferred tax assets, primarily foreign operating loss carryovers.

21


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Inherent in dete rmining our effective tax rate are judgments regarding business plans and expectations about future operations.  These judgments include the amount and geographic mix of future taxable income, the amount of FSI, limitations on usage of NOL carryforwards, t he impact of ongoing or potential tax audits, earnings repatriation plans, and other future tax consequences.

We estimate we will need to generate future U.S. taxable income of approximately $772.7 million for state income tax purposes during the respective realization periods (ranging from 2017 to 2036) in order to fully realize the net deferred income tax assets.

As previously disclosed in prior SEC filings, our ability to utilize deferred tax assets may be impacted by certain future events, such as changes in tax legislation and insufficient future taxable income prior to expiration of certain deferred tax assets.

We recognize the tax benefits of an uncertain tax position if those benefits are more likely than not to be sustained based on existing tax law.  Additionally, we establish a reserve for tax positions that are more likely than not to be sustained based on existing tax law, but uncertain in the ultimate benefit to be sustained upon examination by the relevant taxing authorities.  Unrecognized tax benefits are subsequently recognized at the time the more likely than not recognition threshold is met, the tax matter is effectively settled or the statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired, whichever is earlier.

Impairments of Long-Lived Tangible and Intangible Assets – Our indefinite-lived intangibles are primarily trademarks and brand names, which are integral to our corporate identity and expected to contribute indefinitely to our corporate cash flows.  Accordingly, they have been assigned an indefinite life.  We conduct our annual impairment test for non-amortizable intangible assets during the fourth quarter, although we conduct interim impairment tests if events or circumstances indicate the asset might be impaired.   We conduct impairment tests for tangible assets and amortizable intangible assets when indicators of impairment exist, such as operating losses and/or negative cash flows.  If an indication of impairment exists, we compare the carrying amount of the asset group to the estimated undiscounted future cash flows expected to be generated by the assets.  The estimate of an asset group’s fair value is based on discounted future cash flows expected to be generated by the asset group, or based on management’s estimated exit price assuming the assets could be sold in an orderly transaction between market participants or estimated salvage value if no sale is assumed.  If the fair value is less than the carrying value of the asset group, we record an impairment charge equal to the difference between the fair value and carrying value of the asset group.

The principal assumption utilized in our impairment tests for definite-lived intangible assets is operating profit adjusted for depreciation and amortization.  The principal assumptions utilized in our impairment tests for indefinite-lived intangible assets include revenue growth rate, discount rate and royalty rate.  Revenue growth rate and operating profit assumptions are derived from those utilized in our operating plan and strategic planning processes.  The discount rate assumption is calculated based upon an estimated weighted average cost of equity which reflects the overall level of inherent risk and the rate of return a market participant would expect to achieve.  The royalty rate assumption represents the estimated contribution of the intangible assets to the overall profits of the reporting unit.

In 2016, indefinite-lived intangibles were tested for impairment based on our existing reporting units, which changed as a result of the separation of AFI and the subsequent change in our operating segments.  No other methodologies used for valuing our intangible assets changed from prior periods.

The cash flow estimates used in applying our impairment tests are based on management’s analysis of information available at the time of the impairment test.  Actual cash flows lower than the estimate could lead to significant future impairments.  If subsequent testing indicates that fair values have declined, the carrying values would be reduced and our future statements of income would be affected.

There were no material impairment charges recorded in 2016, 2015 or 2014 related to intangible assets.

We did not test tangible assets for impairment in 2016, 2015 or 2014 as no indicators of impairment existed.

We cannot predict the occurrence of certain events that might lead to material impairment charges in the future.  Such events may include, but are not limited to, the impact of economic environments, particularly related to the commercial and residential construction industries, material adverse changes in relationships with significant customers, or strategic decisions made in response to economic and competitive conditions.

See Notes 3 and 10 to the Consolidated Financial Statements for further information.

Environmental Liabilities – We are actively involved in the investigation, closure and/or remediation of existing or potential environmental contamination under the Comprehensive Environmental Response, Compensation and Liability Act (“CERCLA”), and

22


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

state Superfund and similar type environmental laws at several domestically owned, formerly owned and non-owned locations allegedly resulting from past industrial activity.  In a few cases, we are one of several potentially responsible parties and have agreed to jointly fund the required investigation, while preserving our defenses to the liability.  We may also have rights of contribution or reimbursement from other parties or coverage unde r applicable insurance policies.  

We provide for environmental remediation costs and penalties when the responsibility to remediate is probable and the amount of associated costs is reasonably determinable.  Accruals are estimates based on the judgment of management related to ongoing proceedings.  Estimates of our future liability at the environmental sites are based on evaluations of currently available facts regarding each individual site.  In determining the probability of contribution, we consider the solvency of other parties, the site activities of other parties, whether liability is being disputed, the terms of any existing agreements and experience with similar matters, and the effect of our October 2006 Chapter 11 reorganization upon the validity of the claim.  

We evaluate the measurement of recorded liabilities each reporting period based on current facts and circumstances specific to each matter.  The ultimate losses incurred upon final resolution may materially differ from the estimated liability recorded.  Changes in estimates are recorded in earnings in the period in which such changes occur.

We are unable to predict the extent to which any recoveries from other parties or coverage under insurance policies might cover our final share of costs for these sites.  Our final share of investigation and remediation costs may exceed any such recoveries, and such amounts net of insurance recoveries may be material.

ACCOUNTING PRONOUNCEMENTS EFFECTIVE IN FUTURE PERIODS

See Note 2 to the Consolidated Financial Statements for further information.

RESULTS OF OPERATIONS

Unless otherwise indicated, net sales in these results of operations are reported based upon the AWI location where the sale was made.  Please refer to Notes 3 and 4 to the Consolidated Financial Statements for a reconciliation of segment operating income to consolidated earnings from continuing operations before income taxes and additional financial information related to discontinued operations.

2016 COMPARED TO 2015

CONSOLIDATED RESULTS FROM CONTINUING OPERATIONS

(dollar amounts in millions)

 

 

 

2016

 

 

2015

 

 

Change is Favorable

 

 

Total consolidated net sales

 

$

1,234.5

 

 

$

1,231.3

 

 

 

0.3

 

%

Operating income

 

$

184.6

 

 

$

140.5

 

 

 

31.4

 

%

 

Excluding the unfavorable impact of foreign exchange of $22 million, consolidated net sales increased 2.0% due to favorable AUV of $24 million and higher volumes of $1 million.

Cost of goods sold was 69.9% of net sales in 2016, compared to 69.4% in 2015.  The comparison was impacted by $5 million of severance and other charges associated with the idling of a plant in China in 2016.

SG&A expenses in 2016 were $225.2 million, or 18.2% of net sales, compared to $267.7 million, or 21.7% of net sales, in 2015.  The decrease was primarily the result the impact of the separation and cost control measures, particularly in international markets to offset soft market demand.

Separation costs of $34.5 million in 2016, compared to $34.3 million in 2015, were primarily related to outside professional services and employee compensation and severance accruals incurred in conjunction with our initiative to separate our flooring business from our ceilings business.

Equity earnings from our WAVE joint venture were $73.1 million in 2016, compared to $66.1 million in 2015.  The increase was due to higher sales volumes, favorable AUV and lower manufacturing input costs, partially offset by higher SG&A expenses for go-to-market investments.  See Note 9 to the Consolidated Financial Statements for further information.  

23


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Interest expense was $49.8 million in 2016, compared to $45.3 million in 2015. The increase in interest expense was due to $10.7 million of losses that were reclassified from accumulated other comprehensive income to i nterest expense during the first quarter of 2016 as a result of the settlement of $450.0 million of notional amount interest rate swaps which occurred in connection with the refinancing of our credit facilities, partially offset by lower costs due to a red uction in total debt outstanding and a lower interest rate spread and $2.4 million of gains that were reclassified from accumulated other comprehensive income to interest expense during the fourth quarter of 2016 in connection with our entering into $450.0 million of notional amount of basis rate swaps.  See Note 15 to the Consolidated Financial Statements for details related to our debt refinancing and Note 18 to the Consolidated Financial Statements for details related to our interest rate swap transactio ns.    

Other non-operating income was $9.6 million in 2016 and $5.0 million in 2015.  The changes in other non-operating income were primarily due to foreign exchange rate gains on the translation of unhedged cross-currency intercompany loans.

Other non-operating expenses were $0.1 million in 2016, compared to $20.1 million in 2015.  Expenses in 2015 were primarily due to foreign exchange rate losses on the translation of unhedged cross-currency intercompany loans denominated in Russian rubles, related to the construction of our Russian mineral fiber ceiling plant that was completed in the first quarter of 2015.  During the fourth quarter of 2016, all Russian ruble denominated intercompany loans were settled with intercompany capital contributions.  Where efficient, reliable and liquid markets exist we may utilize foreign currency forward exchange contracts to hedge exposures created by cross-currency intercompany loans and dividends. Our largest unhedged foreign currency exposures are in Chinese renminbi and Russian rubles.  

Income tax expense was $50.4 million and $53.5 million in 2016 and 2015, respectively.  The effective tax rate for 2016 was 34.9% as compared to a rate of 66.8% for 2015.  The effective tax rate for 2016 was lower than 2015 primarily due to income tax benefits recorded during the second half of 2016 resulting from the reversal of reserves for uncertain tax positions as a result of an expiration of the federal statute of limitations to review previously filed income tax returns and a benefit resulting from the write-off of the historical tax basis of one of our foreign subsidiaries.

Total other comprehensive income (“OCI”) was $23.6 million for 2016 compared to $8.1 million for 2015.  Foreign currency translation adjustments represent the change in the U.S. dollar value of assets and liabilities denominated in foreign currencies. Foreign currency losses in 2016 were driven primarily by changes in the exchange rate of the British pound, the Chinese renminbi, partially offset by gains in the Russian ruble.  Derivative gain/loss represents the mark to market value adjustments of our derivative assets and liabilities and the recognition of gains and losses previously deferred in OCI.  Derivative gains in 2016 were primarily due to the mark to market changes related to interest rate swaps and our natural gas hedges, partially offset by losses on our foreign currency hedges.  Gains on interest rate hedges were partially offset by $8.3 million of net losses related to settlements of interest rates swaps in 2016.  Pension and postretirement adjustments represent actuarial gains and losses related to our defined-benefit pension and postretirement plans with gains in 2016 primarily related to our U.S. pension plans.

REPORTABLE SEGMENT RESULTS

Americas

(dollar amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

Change is Favorable/

 

 

 

 

2016

 

 

2015

 

 

(Unfavorable)

 

 

Total segment net sales

 

$

837.3

 

 

$

805.1

 

 

 

4.0

 

%

Operating income

 

$

232.1

 

 

$

283.5

 

 

 

(18.1

)

%

 

Excluding the unfavorable impact of foreign exchange of $2 million, net sales in the Americas increased 4.3% due to higher volumes of $20 million and favorable AUV of $15 million.

Operating income decreased as higher earnings from WAVE of $7 million, the favorable margin impact of higher volumes of $5 million, and the favorable margin impact of higher AUV of $5 million were more than offset by higher SG&A expenses of $54 million and higher manufacturing and input costs of $14 million. The increase in SG&A expenses in 2016 was primarily a result of the inclusion of costs formally assigned to our Corporate Unallocated segment, partially offset by a reduction in costs primarily due to the separation.  The increase in manufacturing costs was impacted by investments in our manufacturing footprint to expand and enhance our capabilities to produce high end products.  

24


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

EMEA

(dollar amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

Change is Favorable/

 

 

 

 

2016

 

 

2015

 

 

(Unfavorable)

 

 

Total segment net sales

 

$

263.1

 

 

$

289.9

 

 

 

(9.2

)

%

Operating (loss)

 

$

(8.2

)

 

$

(11.9

)

 

 

31.1

 

%

 

Excluding the unfavorable impact of foreign exchange of $15 million, net sales in the EMEA markets decreased 4.0% due to lower volumes of $17 million which were only partially offset by favorable AUV of $6 million.  The decline in volumes was driven by the Middle East and to a lesser extent the United Kingdom.

Operating loss decreased driven by lower SG&A expenses of $9 million and lower manufacturing and input costs of $3 million, which was mostly offset by the margin impact of lower volumes of $6 million and the margin impact of unfavorable AUV of $4 million.  The comparison was also impacted by $2 million of severance costs associated with cost reduction actions in 2015.  

Pacific Rim

(dollar amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

Change is Favorable/

 

 

 

 

2016

 

 

2015

 

 

(Unfavorable)

 

 

Total segment net sales

 

$

134.1

 

 

$

136.3

 

 

 

(1.6

)

%

Operating (loss)

 

$

(0.5

)

 

$

(6.8

)

 

 

92.6

 

%

 

Excluding the unfavorable impact of foreign exchange of $4 million, net sales in the Pacific Rim increased 1.5% due to higher AUV of $4 million partially offset by lower volumes of $2 million. Sales volumes in Australia and China grew in comparison to the prior year while India sales softened.  

Operating loss decreased driven by the margin impact of favorable AUV of $3 million, lower manufacturing and input costs of $2 million and lower SG&A expense of $1 million. The comparison was also impacted by $5 million and $3 million of severance and other charges associated with the idling of a plant in China during 2016 and 2015, respectively.  

Unallocated Corporate

Unallocated corporate expense of $38.8 million decreased from $124.3 million in the prior year.  The decrease was due to the inclusion of most of the Corporate functions within the Americas segment as a result of the separation.

FINANCIAL CONDITION AND LIQUIDITY

Cash Flow

The discussion that follows includes cash flows related to discontinued operations.

Operating activities for 2016 provided $49.3 million of cash, compared to $203.7 million of cash provided in 2015.  The decrease was primarily due to change in working capital, most notably a decrease accounts payable and accrued expenses related to the separation of AFI.  The decrease due to the change in working capital was partially offset by higher cash earnings partially offset by a reduction in depreciation and amortization.

Net cash used for investing activities was $17.0 million in 2016, compared to $101.5 million in 2015. The change in investing activities cash flows was primarily due to decreased purchases of property, plant and equipment, partially offset by higher dividends from our WAVE joint venture.

Net cash used by financing activities was $128.9 million in 2016, compared to $32.3 million in 2015.  The unfavorable use of cash was primarily the result of higher payments of debt and repurchase of outstanding common stock.

25


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Liquidity

Our liquidity needs for operations vary throughout the year.  We retain lines of credit to facilitate our seasonal cash flow needs, since cash flow is generally lower during the first and fourth quarters of our fiscal year.  

On April 1, 2016, we refinanced our $1,275.0 million senior credit facility, utilizing a $50.0 million cash dividend from AFI and cash on hand to pay down a portion of the debt outstanding.  The $1,050.0 million new credit facility is composed of a $200.0 million revolving credit facility (with a $150.0 million sublimit for letters of credit), a $600.0 million Term Loan A and a $250.0 million Term Loan B.  The terms of the credit facility resulted in a lower interest rate spread for both the revolving credit facility and Term Loan A (2.00% vs. 2.50%) and a higher spread for Term Loan B (3.25% vs. 2.50%).  In addition, we lowered the interest rate floor on the Term Loan B from 1.00% to 0.75%. We also extended the maturity of both the revolving credit facility and Term Loan A from March 2018 to April 2021 and of Term Loan B from November 2020 to April 2023.  This $1,050.0 million senior credit facility is secured by U.S. personal property, the capital stock of material U.S. subsidiaries and a pledge of 65% of the stock of our material first tier foreign subsidiaries.  Finally, in April 2016, we established a $25.0 million letter of credit facility with the Bank of Nova Scotia, also known as our bi-lateral facility.  

As of December 31, 2016, total borrowing outstanding under our senior credit facility were $600.0 million under Term Loan A and $248.1 million under Term Loan B.  There were no borrowings outstanding under the revolving credit facility or the bi-lateral facility.  

Under our refinanced senior credit facility we are subject to year-end leverage tests that may trigger mandatory prepayments.  If our ratio of consolidated funded indebtedness minus AWI and domestic subsidiary unrestricted cash and cash equivalents up to $100 million to consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) (“Consolidated Net Leverage Ratio”) is greater than 3.5 to 1.0, the prepayment amount would be based on a computation of 50% of Consolidated Excess Cash Flow, as defined by the credit agreement.  These annual payments would be made in the first quarter of the following year.  No payment will be required in 2017.

The refinanced senior credit facility includes two financial covenants that require the ratio of consolidated EBITDA to consolidated cash interest expense minus cash consolidated interest income to be greater than or equal to 3.0 to 1.0 and requires the Consolidated Net Leverage Ratio to be less than or equal to 3.75 to 1.0.  As of December 31, 2016, we were in compliance with all covenants of the senior credit facility.

The Term Loan A and Term Loan B were both fully drawn and are currently priced on a variable interest rate basis.  The following table summarizes our interest rate swaps (dollar amounts in millions):

 

Trade Date

 

Notional

Amount

 

 

Coverage Period

 

Risk Coverage

November 13, 2016

 

$

250.0

 

 

November 2016 to March 2018

 

Term Loan A

November 13, 2016

 

$

200.0

 

 

November 2016 to March 2021

 

Term Loan A

April 1, 2016

 

$

100.0

 

 

April 2016 to March 2023

 

Term Loan B

 

These swaps are designated as cash flow hedges against changes in LIBOR for a portion of our variable rate debt.  The unpaid balances of Term Loan A, the Revolving Credit Facility and Term Loan B may be prepaid without penalty at the maturity of their respective interest reset periods.  Any amounts prepaid on the Term Loan A or Term Loan B may not be re-borrowed.  

In connection with the refinancing of our credit facilities in April 2016, $450.0 million of notional amount Term Loan B swaps with a trade date of March 27, 2012 were settled and $10.7 million of losses previously recorded as a component of accumulated other comprehensive income were reclassified to interest expense in 2016.  

As of December 31, 2015, we had a $250.0 million notional Term A swap with a trade date of April 16, 2013 and a maturity date of March 2018, in which we received 3-month LIBOR and paid a fixed rate over the hedged period.  On April 1, 2016, we entered into an additional $200.0 million notional amount Term Loan A swap with a maturity date of March 2021, in which we also received 3-month LIBOR and paid a fixed rate over the hedged period, collectively resulting in $450.0 million notional Term Loan A interest rate swaps (the “Term Loan A Swaps”).

During the fourth quarter of 2016, we elected to change the basis for interest payments due under our Term Loan A from 3-month LIBOR to 1-month LIBOR.  In connection with the change in our underlying interest payments, in November 2016 we entered into $450.0 million forward-starting notional amount basis rate swaps to convert the floating rate risk under our Term Loan A Swaps from 3-month LIBOR to 1-month LIBOR and jointly designated the basis swaps with our Term Loan A Swaps in cash flow hedging

26


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

relationships.  As a result of this transaction, $2.4 million of gains previously recorded as a component o f accumulated other comprehensive income were reclassified as a reduction to interest expense during the fourth quarter of 2016.  Since the basis rate swaps had a non-zero fair value upon designation as cash flow hedges, mark-to-market gains or losses on i neffective portions of these hedges will be recorded as a component of interest expense.  

Also on April 1, 2016, we entered into a $100.0 million notional Term Loan B swap in which we receive the greater of 3-month LIBOR or a 0.75% LIBOR Floor and pay a fixed rate over the hedged period.  

As of December 31, 2016 our outstanding long-term debt included a $35.0 million variable rate, tax-exempt industrial development bond that financed the construction of a plant in prior years. This bond has a scheduled final maturity of 2041 and is remarketed by an agent on a regular basis at a market-clearing interest rate. Any portion of the bond that is not successfully remarketed by the agent are required to be repurchased. This bond is backed by letters of credit which will be drawn if a portion of the bond is not successfully remarketed.  We have not had to repurchase the bond.

Our foreign subsidiaries had available lines of credit totaling $4.1 million as of December 31, 2016. These lines of credit are uncommitted, and poor operating results or credit concerns at the related foreign subsidiaries could result in the lines being withdrawn by the lenders.  We have historically been able to maintain and, as needed, replace credit facilities to support our non-U.S. operations. As of December 31, 2016 we had no borrowings under these lines of credit.

As of December 31, 2016, we had $141.9 million of cash and cash equivalents, $86.8 million in various foreign jurisdictions and $55.1 million in the U.S. 

In February 2017, we repriced the interest rate of our $248.1 million Term Loan B borrowing, resulting in a lower LIBOR spread (2.75% vs. 3.25%).  The maturity date remained unchanged along with all other terms and conditions.  In connection with the repricing we paid $0.6 million of bank, legal and other fees, the majority of which were capitalized.  

In March 2016, we amended and decreased our $100.0 million Accounts Receivable Securitization Facility with the Bank of Nova Scotia (the “funding entity”) to $40.0 million to reflect a lower anticipated receivables balance in connection with the separation of AFI, and we extended the maturity date from December 2017 to March 2019.  Under our Accounts Receivable Securitization Facility we sell accounts receivables to Armstrong Receivables Company, LLC (“ARC”), a Delaware entity that is consolidated in these financial statements.  ARC is a 100% wholly owned single member LLC special purpose entity created specifically for this transaction; therefore, any receivables sold to ARC are not available to the general creditors of AWI.  ARC then sells an undivided interest in the purchased accounts receivables to the funding entity.  This undivided interest acts as collateral for drawings on the facility.  Any borrowings under this facility are obligations of ARC and not AWI.  ARC contracts with and pays a servicing fee to AWI to manage, collect and service the purchased accounts receivables.  All new receivables under the program are continuously purchased by ARC with the proceeds from collections of receivables previously purchased.  As of December 31, 2016 we had no borrowings under this facility.

We utilize lines of credit and other commercial commitments in order to ensure that adequate funds are available to meet operating requirements.  Letters of credit are currently arranged through our revolving credit facility, our bi-lateral facility and our securitization facility.  In addition, our foreign subsidiaries’ available lines of credit are available for letters of credit and guarantees.  Letters of credit are issued to third party suppliers, insurance and financial institutions and typically can only be drawn upon in the event of AWI’s failure to pay its obligations to the beneficiary. The following table presents details related to our letters of credit (dollar amounts in millions):

 

 

 

As of December 31, 2016

 

Financing Arrangement

 

Limit

 

 

Used

 

 

Available

 

Revolving credit facility

 

$

150.0

 

 

$

-

 

 

$

150.0

 

Bi-lateral facility

 

 

25.0

 

 

 

19.2

 

 

 

5.8

 

Accounts receivable securitization facility

 

 

32.2

 

 

 

36.2

 

 

 

(4.0

)

Foreign lines of credit

 

 

0.2

 

 

 

0.1

 

 

 

0.1

 

Total

 

$

207.4

 

 

$

55.5

 

 

$

151.9

 

 

As of December 31, 2016, $4.0 million of letters of credits issued under our accounts receivable securitization facility in excess of our maximum limit were classified as restricted cash and reported as a component of Cash and cash equivalents on our Consolidated Balance Sheets.  This restriction will lapse upon replacement of collateral with accounts receivables and/or upon a change in the letter of credit limit as a result of higher securitized accounts receivable balances.  

27


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

We believe that cash on hand and cash generated from operations, together with lines of credit, availability under our securitization facility and the availability under our revolving credit facility, will be adequate to address our foreseeable liquidity n eeds based on current expectations of our business operations, capital expenditures and scheduled payments of debt obligations.

2015 COMPARED TO 2014

CONSOLIDATED RESULTS FROM CONTINUING OPERATIONS

(dollar amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

Change is

 

 

 

 

2015

 

 

2014

 

 

(Unfavorable)

 

 

Total consolidated net sales

 

$

1,231.3

 

 

$

1,294.3

 

 

 

(4.9

)

%

Operating income

 

$

140.5

 

 

$

198.1

 

 

 

(29.1

)

%

 

Excluding the unfavorable impact of foreign exchange of $76 million, consolidated net sales for 2015 increased 1.0% due to favorable AUV of $48 million, partially offset by lower volumes of $35 million.  

Cost of goods sold was 69.4% of net sales in 2015, compared to 70.4% in 2014.  Compared to the prior year, the reduction was caused by lower input costs, partially offset by higher manufacturing and U.S. pension costs.  

SG&A expenses in 2015 were $267.7 million, or 21.7% of net sales, compared to $250.1 million, or 19.3% of net sales in 2014.  The increase was primarily due to an increase in go-to-market investments in the Americas and an increase in U.S. pension costs.  See Reportable Segment Results for additional information.

Separation costs of $34.3 million in 2015 were primarily related to outside professional services and employee retention and severance accruals incurred in conjunction with our initiative to separate our flooring business from our ceilings business.

Equity earnings from our WAVE joint venture were $66.1 million in 2015, compared to $65.1 million in 2014.

Interest expense was $45.3 million in 2015, compared to $46.0 million in 2014.  

Income tax expense was $53.5 million and $69.3 million in 2015 and 2014, respectively.  The effective tax rate for 2015 was 66.8% as compared to a rate of 46.7% for 2014.  The effective tax rate for 2015 was higher than 2014 primarily due to lower pre-tax income causing a higher rate of unbenefited foreign operating losses, non-deductible separation costs, a decrease in research and development tax credits as 2014 included the benefit of multiple years of such credits and state net operating loss write-offs resulting from a change in ownership under Section 382 of the Internal Revenue Code.

REPORTABLE SEGMENT RESULTS

Americas

(dollar amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

Change is

 

 

 

 

2015

 

 

2014

 

 

Favorable

 

 

Total segment net sales

 

$

805.1

 

 

$

798.3

 

 

 

0.9

 

%

Operating income

 

$

283.5

 

 

$

272.1

 

 

 

4.2

 

%

 

Excluding the unfavorable impact of foreign exchange of $9 million, net sales in the Americas increased 2.0% due to favorable AUV of $26 million, partially offset by lower volumes of $10 million.

Operating income increased primarily due to the margin impact of favorable AUV of $19 million, lower manufacturing and input costs of $10 million and higher earnings from WAVE of $2 million, partially offset by the margin impact of lower volumes of $11 million and higher SG&A expenses of $7 million.

28


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

EMEA

(dollar amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

Change is

 

 

 

 

2015

 

 

2014

 

 

(Unfavorable)

 

 

Total segment net sales

 

$

289.9

 

 

$

353.4

 

 

 

(18.0

)

%

Operating (loss)

 

$

(11.9

)

 

$

(5.4

)

 

Unfavorable

 

 

 

Excluding the unfavorable impact of foreign exchange of $58 million, net sales in EMEA decreased 1.7% due to lower volumes of $21 million, partially offset by favorable AUV of $16 million.

Operating loss increased primarily due to the margin impact of lower volumes of $10 million, an increase in manufacturing and input costs of $8 million, due primarily to start-up costs associated with our Russian mineral fiber plant and $2 million higher severance charges in 2015 for cost reduction actions.  Partially offsetting these increases in operating loss was the margin impact of favorable AUV of $8 million and lower SG&A expense of $7 million.

Pacific Rim

(dollar amounts in millions)

 

 

 

 

 

 

 

 

 

 

 

Change is

 

 

 

 

2015

 

 

2014

 

 

(Unfavorable)

 

 

Total segment net sales

 

$

136.3

 

 

$

142.6

 

 

 

(4.4

)

%

Operating (loss)

 

$

(6.8

)

 

$

(2.0

)

 

Unfavorable

 

 

 

Excluding the unfavorable impact of foreign exchange of $10 million, net sales in the Pacific Rim increased 2.2% due to favorable AUV of $7 million, partially offset by lower volumes of $4 million.

Operating loss increased primarily due to $5 million of severance and other charges in 2015 related to our decision to idle one of our plants in China.

Unallocated Corporate

Unallocated corporate expense of $124.3 million increased from $66.6 million in the prior year, due to separation costs of $34 million recorded in 2015 and higher U.S. pension costs of $17 million and a $4 million increase in environmental reserves related to our Macon, Georgia facility.

Cash Flow

The discussion that follows includes cash flows related to discontinued operations.

Operating activities for 2015 provided $203.7 million of cash, compared to $208.8 million of cash provided in 2014.  Lower cash earnings in 2015 were partially offset by favorable changes in working capital, primarily due to favorable timing of accounts payable and accrued expenses.

Net cash used for investing activities was $101.5 million for 2015, compared to $149.3 million in 2014. This change was primarily due to decreased purchases of property, plant and equipment.

Net cash used by financing activities was $32.3 million for 2015, compared to $3.3 million provided during 2014.  Net cash used in 2015 was primarily driven by payments on long-term debt. Net cash provided in 2014 was driven by proceeds from exercised stock options and excess tax benefits from share-based awards, partially offset by payments of long-term debt.

OFF-BALANCE SHEET ARRANGEMENTS

No disclosures are required pursuant to Item 303(a)(4) of Regulation S-K.

29


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

CONTRACTUAL OBLIGATIONS

As part of our normal operations, we enter into numerous contractual obligations that require specific payments during the term of the various agreements.  The following table includes amounts ongoing under contractual obligations existing as of December 31, 2016.  Only known payments that are dependent solely on the passage of time are included.  Obligations under contracts that contain minimum payment amounts are shown at the minimum payment amount.  Contracts that contain variable payment structures without minimum payments are excluded.  Purchase orders that are entered into in the normal course of business are also excluded because they are generally cancelable and not legally binding.  Amounts are presented below based upon the currently scheduled payment terms.  Actual future payments may differ from the amounts presented below due to changes in payment terms or events affecting the payments.

 

(dollar amounts in millions)

 

2017

 

 

2018

 

 

2019

 

 

2020

 

 

2021

 

 

Thereafter

 

 

Total

 

Long-term debt (1)

 

$

25.0

 

 

$

32.5

 

 

$

55.0

 

 

$

62.5

 

 

$

437.5

 

 

$

270.6

 

 

$

883.1

 

Scheduled interest payments (2)

 

 

32.3

 

 

 

33.0

 

 

 

34.1

 

 

 

33.0

 

 

 

18.5

 

 

 

34.1

 

 

 

185.0

 

Operating lease obligations, net of sublease

   income (3)

 

 

7.3

 

 

 

5.9

 

 

 

4.5

 

 

 

3.1

 

 

 

2.4

 

 

 

2.4

 

 

 

25.6

 

Unconditional purchase obligations (4)

 

 

78.1

 

 

 

49.3

 

 

 

1.8

 

 

 

0.5

 

 

 

0.3

 

 

 

0.7

 

 

 

130.7

 

Pension contributions (5)

 

 

6.6

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

6.6

 

Other obligations (6), (7)

 

 

6.0

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

-

 

 

 

6.0

 

Total contractual obligations

 

$

155.3

 

 

$

120.7

 

 

$

95.4

 

 

$

99.1

 

 

$

458.7

 

 

$

307.8

 

 

$

1,237.0

 

 

(1)

Excludes $9.5 million of unamortized debt financing costs as of December 31, 2016.  

(2)

For debt with variable interest rates and interest rate swaps, we projected future interest payments based on market-based interest rate swap curves.

(3)

Lease obligations include the minimum payments due under existing agreements with non-cancelable lease terms in excess of one year.

(4)

Unconditional purchase obligations include (a) purchase contracts whereby we must make guaranteed minimum payments of a specified amount regardless of how little material is actually purchased (“take or pay” contracts) and (b) service agreements.  Unconditional purchase obligations exclude contracts entered into during the normal course of business that are non-cancelable and have fixed per unit fees, but where the monthly commitment varies based upon usage.  Cellular phone contracts are an example.

(5)

Pension contributions include estimated contributions for our defined benefit pension plans.  We are not presenting estimated payments in the table above beyond 2017 as funding can vary significantly from year to year based upon changes in the fair value of plan assets, funding regulations and actuarial assumptions.

(6)

Other obligations include payments under severance agreements.

(7)

Other obligations, does not include $86.9 million of liabilities under ASC 740 “Income Taxes.”   Due to the uncertainty relating to these positions, we are unable to reasonably estimate the ultimate amount or timing of the settlement of these issues.  See Note 14 to the Consolidated Financial Statements for more information.

This table excludes obligations related to postretirement benefits (retiree health care and life insurance) since we voluntarily provide these benefits.  The amount of benefit payments we made in 2016 was $8.3 million.  See Note 16 to the Consolidated Financial Statements for additional information regarding future expected cash payments for postretirement benefits.

We are party to supply agreements, some of which require the purchase of inventory remaining at the supplier upon termination of the agreement.  Had these agreements terminated at December 31, 2016, we would have been obligated to purchase approximately $0.9 million of inventory.  Historically, due to production planning, we have not had to purchase material amounts of product at the end of similar contracts.  Accordingly, no liability has been recorded for these guarantees.

30


Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Letters of credit are currently arranged through our revolving credi t facility, our bi-lateral facility and our securitization facility. In addition, our foreign subsidiaries’ available lines of credit are available for letters of credit and guarantees.  Letters of credit are issued to third party suppliers, insurance and financial institutions and typically can only be drawn upon in the event of AWI’s failure to pay its obligations to the beneficiary. The following table summarizes the commitments we have available for use as of December 31, 2016.  

 

Other Commercial Commitments

(dollar amounts in millions)

 

Total Amounts Committed

 

 

Less

Than 1

Year

 

 

1 – 3

Years

 

 

4 – 5

Years

 

 

Over 5

Years

 

Letters of credit

 

$

55.5

 

 

$

55.5

 

 

$

-

 

 

$

-

 

 

$

-

 

 

In connection with our disposition of certain assets through a variety of unrelated transactions, we have entered into contracts that included various indemnity provisions, some of which are customary for such transactions, while others hold the acquirer of the assets harmless with respect to liabilities relating to such matters as taxes, environmental and other litigation.  Some of these provisions include exposure limits, but many do not.  Due to the nature of the indemnities, it is not possible to estimate the potential maximum exposure under these contractual provisions.  As of December 31, 2016, we had no liabilities recorded for which an indemnity claim had been received.

 

 

31


 

ITEM 7A.

QUANTITATIVE AND QUALITA TIVE DISCLOSURES ABOUT MARKET RISK

Market Risk

We are exposed to market risk from changes in foreign currency exchange rates, interest rates and commodity prices that could impact our results of operations, cash flows and financial condition.  We use forward swaps and option contracts to hedge these exposures, which are entered into for periods consistent with underlying exposure and do not constitute positions independent of those exposures.  We use derivative financial instruments as risk management tools and not for speculative trading purposes.  In addition, derivative financial instruments are entered into with a diversified group of major financial institutions in order to manage our exposure to potential nonperformance on such instruments.  We regularly monitor developments in the capital markets.

Counterparty Risk

We only enter into derivative transactions with established counterparties having an investment grade or better.  We monitor counterparty credit default swap levels and credit ratings on a regular basis.  All of our derivative transactions with counterparties are governed by master International Swap and Derivatives Association agreements (“ISDAs”) with netting arrangements.  These agreements can limit our exposure in situations where we have gain and loss positions outstanding with a single counterparty.  We do not post nor receive cash collateral with any counterparty for our derivative transactions.  As of December 31, 2016 we had no cash collateral posted or received for any of our derivative transactions.  These ISDAs do not contain any credit contingent features other than those contained in our bank credit facility.  Exposure to individual counterparties is controlled, and thus we consider the risk of counterparty default to be negligible.

Interest Rate Sensitivity

We are subject to interest rate variability on our Term Loan A, Term Loan B, revolving credit facility and other borrowings.  A hypothetical increase of one-quarter percentage point in LIBOR interest rates from December 31, 2016 levels would increase 2017 interest expense by approximately $0.8 million.  As of December 31, 2016, $248.1 million of our debt has a 0.75% LIBOR floor which would not be affected by a one-quarter percentage point move in LIBOR given the current interest rate environment. We also have $550.0 million of interest rate swaps outstanding, which fix the interest rates for a portion of our debt. The current portion of the interest rate swaps is included in this calculation.  

As of December 31, 2016, we had interest rate swaps outstanding on Term Loan A and on Term Loan B, with notional amounts of $450.0 million and $100.0 million, respectively.  We utilize interest rate swaps to minimize the fluctuations in earnings caused by interest rate volatility.  Under the terms of the Term Loan A swaps we receive 1-month LIBOR and pay a fixed rate over the hedged period.  Under the terms of our Term Loan B, we receive the greater of 3-month LIBOR or a 0.75% LIBOR Floor and pay a fixed rate over the hedged period.  The following table summarizes our interest rate swaps as of December 31, 2016 (dollar amounts in millions):

 

Trade Date

 

Notional

Amount

 

 

Coverage Period

 

Risk Coverage

November 13, 2016

 

$

250.0

 

 

November 2016 to March 2018

 

Term Loan A

November 13, 2016

 

$

200.0

 

 

November 2016 to March 2021

 

Term Loan A

April 1, 2016

 

$

100.0

 

 

April 2016 to March 2023

 

Term Loan B

 

These swaps are designated as cash flow hedges against changes in LIBOR for a portion of our variable rate debt. The net asset measured at fair value was $6.9 million at December 31, 2016.

The table below provides information about our long-term debt obligations as of December 31, 2016, including payment requirements and related weighted-average interest rates by scheduled maturity dates.  Weighted average variable rates are based on implied forward rates in the yield curve and are exclusive of our interest rate swaps.

 

Scheduled maturity date

(dollar amounts in millions)

 

2017

 

 

2018

 

 

2019

 

 

2020

 

 

2021

 

 

After

2021

 

 

Total

 

Variable rate principal

   payments

 

$

25.0

 

 

$

32.5

 

 

$

55.0

 

 

$

62.5

 

 

$

437.5

 

 

$

270.6

 

 

$

883.1

 

Average interest rate

 

 

3.31

%

 

 

3.78

%

 

 

4.05

%

 

 

4.20

%

 

 

4.31

%

 

 

3.66

%

 

 

4.04

%

 

Variable rate principle payments reflected in the preceding table exclude $9.5 million of unamortized debt financing costs as of December 31, 2016.  

32


 

Exchange Rate Sensitivity

We manufacture and sell our products in a number of countries throughout the world and, as a result, are exposed to movements in foreign currency exchange rates.  To a large extent, our global manufacturing and sales provide a natural hedge of foreign currency exchange rate movement.  We use foreign currency forward exchange contracts to reduce our remaining exposure.  As of December 31, 2016, our major foreign currency exposures are to the Chinese renminbi, Russian ruble, Euro and Canadian dollar. A 10% strengthening of all currencies against the U.S. dollar compared to December 31, 2016 levels would increase our 2017 earnings before income taxes by approximately $8.5 million, including the impact of current foreign currency forward exchange contracts.

We also may use foreign currency forward exchange contracts to hedge exposures created by cross-currency intercompany loans.

The table below details our outstanding currency instruments as of December 31, 2016.

 

On balance sheet foreign exchange related derivatives

(dollar amounts in millions)