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Shares of Armstrong World Industries, Inc. (AWI - Analyst Report) have dropped 3% since it reported an 11% year-over-year decline in its third-quarter 2013 adjusted earnings to 87 cents per share on Oct 28. Higher labor costs associated with added crews at several solid wood plants to meet increased demand, and increased manufacturing and input costs dragged down the profits despite a rise in revenues. However, earnings were ahead of the Zacks Consensus Estimate by a penny.

Including one time items, earnings decreased 24% to 84 cents per share from the prior-year quarter’s earnings of $1.24 a share.

Operational Update

Net sales increased 5% year over year to $730 million in the reported quarter, but failed to match the Zacks Consensus Estimate of $744 million. Higher volumes in residential businesses, particularly Wood Flooring, and positive price and mix led to year-over-year improvement.  However, the sale of the Patriot wood flooring distribution business in the third quarter of 2012 had a negative impact of $7 million on sales in the quarter.

Cost of sales increased 8% to $550 million in the reported quarter. Gross profit declined 4% to $180 million from the year-ago quarter. Gross margin contracted 220 basis points (bps) year over year to 24.7% in the quarter.

Selling, general and administrative expenses increased 10% to $103 million in the quarter in order to support emerging market and architectural specialties growth initiatives. Adjusted operating income decreased 14% to $96 million in the quarter from $111 million in the prior-year quarter due to higher manufacturing and input costs as well as higher SG&A expenses. Operating margin contracted 280 bps year over year to 13.2%.

Segment Performance

Building Products: Net sales at the Building Products segment increased 3% to $335 million, aided by higher volumes and positive price and mix performance. Adjusted operating profit for the segment increased 4% to $85 million from $82 million in the year-ago quarter. Improved price and mix performance and higher earnings from WAVE were somewhat offset by increased SG&A expenses to support growth initiatives in emerging markets and architectural specialties.

Resilient Flooring: The Resilient Flooring segment reported sales of $246 million, flat year over year. Benefits from favorable foreign exchange, improved mix and higher volumes were negated by unfavorable price. Volume growth was witnessed in the Americas, but lower volumes in Australia and Europe were a deterrent. 

The segment’s adjusted operating profit was $24 million, down 8% from $26 million in the year-ago quarter. Positive impact from lower manufacturing and input costs were not enough to outweigh the negative impact of unfavorable pricing, foreign exchange manufacturing and plant start-up costs in China.

Wood Flooring: Net sales in the reported quarter went up 21% year over year to $148 million. The improvement was driven by strong volume growth owing to favorable pricing, strong demand from independent distributors as well as share gains and new product introductions with independent distributors as well as the home center channel. However, adjusted operating income plunged 79% to $3 million in the reported quarter from $14 million in the prior-year quarter.

Financials

Cash and cash equivalents were $138 million as of Sep 30, 2013 compared with $299 million as of Sep 30, 2012. Cash flow used from operating activities was $162 million in the reported quarter compared with $141 million in the prior-year quarter. Armstrong World repurchased shares for $260 million in the quarter.

Free cash flow was $95 million in the quarter, up from $78 million in the prior-year quarter. The improvement was attributed to increase in working capital, proceeds from the sale of assets, lower interest expense, and higher dividends from the WAVE joint venture, which were offset by lower cash earnings and higher capital expenditures.

Outlook

Armstrong World trimmed its full-year 2013 sales guidance to the range of $2.70 - $2.74 billion from the previous $2.7 - $2.8 billion. Thus, Armstrong World has lowered its forecast for adjusted EBITDA to the band of $370 - $390 million from the previous $370 - $400 million. The company has also reduced its full-year adjusted EPS from the previous range of $2.00 - $2.20 to the new range of $2.15 - $2.45.

For the fourth quarter of 2013, Armstrong World expects sales to be between $645 and $685 million and adjusted EBITDA in the range of $70 - $90 million.    

Pennsylvania-based Armstrong World is a leading global producer of flooring products and ceiling systems for use in the construction and renovation of residential, commercial and institutional buildings. Armstrong also designs, manufactures and sells kitchen and bathroom cabinets in the U.S.

Armstrong currently retains a short-term Zacks Rank #2 (Buy). Other companies in the building and construction industry with favorable Zacks Ranks are Masco Corp. (MAS - Analyst Report) and Trex Co. Inc. (TREX - Snapshot Report); each carrying a Zacks Rank #2 (Buy).

One peer, PGT, Inc. (PGTI - Snapshot Report), delivered 160% improvement in its third quarter earnings to 13 cents per share, a penny ahead of the Zacks Consensus Estimate of 12 cents.

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