FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2000 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------ ----- ARMSTRONG HOLDINGS, INC. ------------------------ (Exact name of registrant as specified in its charter) Pennsylvania 333-32530 23-3033414 - -------------------------------------------------------------------------------- (State or other jurisdiction of Commission file (I.R.S. Employer incorporation or organization) number Identification No.) P. O. Box 3001, Lancaster, Pennsylvania 17604 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (717) 397-0611 ----------------------------- ARMSTRONG WORLD INDUSTRIES, INC. -------------------------------- (Exact name of registrant as specified in its charter) Pennsylvania 1-2116 23-0366390 - -------------------------------------------------------------------------------- (State or other jurisdiction of Commission file (I.R.S. Employer incorporation or organization) number Identification No.) P. O. Box 3001, Lancaster, Pennsylvania 17604 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (717) 397-0611 ----------------------------- Armstrong World Industries, Inc. meets the conditions set forth in General Instructions H(1)(a) and (b) of Form 10-Q and is therefore participating in the filing of this form in the reduced disclosure format permitted by such Instructions. 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 X No ------ ------ Number of shares of Armstrong Holdings, Inc.'s common stock outstanding as of October 31, 2000 - 40,863,840 1 Part I - Financial Information ------------------------------ Item 1 - Financial Statements - ----------------------------- Armstrong Holdings, Inc., and Subsidiaries Condensed Consolidated Statements of Earnings (amounts in millions except for per-share data) Unaudited Three Months Ended Nine Months Ended September 30 September 30 ------------ ------------ 2000 1999 2000 1999 ------- ------- ------- ------- Net sales $835.6 $844.3 $2,443.8 $2,444.4 Cost of goods sold 595.9 554.0 1,709.4 1,614.7 ------- ------- -------- -------- Gross profit 239.7 290.3 734.4 829.7 Selling, general and administrative expense 154.8 159.7 469.8 480.4 Charge for asbestos liability - - 236.0 - Reorganization charges, net 15.7 - 15.7 - Goodwill amortization 5.9 6.5 18.2 18.6 Equity (earnings) from affiliates (4.9) (5.2) (14.1) (13.1) ------- ------- -------- -------- Operating income 68.2 129.3 8.8 343.8 Interest expense 26.0 25.8 79.8 78.9 Other (income) expense, net (61.6) 3.4 (67.0) (4.5) ------- ------- -------- -------- Earnings (loss) from continuing operations before income taxes 103.8 100.1 (4.0) 269.4 Income taxes (benefit) 31.8 38.2 (0.8) 101.3 ------- ------- -------- -------- Earnings (loss) from continuing operations $72.0 $61.9 ($3.2) $168.1 ------- ------- -------- -------- Earnings from discontinued operations, net of tax of $0, $4.3, $3.2, and $11.0, respectively - $9.8 $7.0 $24.7 Gain on sale of discontinued operations, net of tax of $0.9, $0, $42.8 and $0 respectively $2.3 - 108.7 - ------- ------- -------- -------- Earnings from discontinued operations 2.3 9.8 115.7 24.7 Net earnings $74.3 $71.7 $112.5 $192.8 ======= ======= ======== ======== Earnings (loss) per share of common stock, continuing operations: Basic $1.79 $1.55 ($0.08) $4.22 Diluted $1.77 $1.54 ($0.08) $4.18 Earnings per share of common stock, discontinued operations: Basic - $0.25 $0.17 $0.62 Diluted - $0.24 $0.17 $0.61 Earnings per share of common stock, gain on sale of discontinued operations: Basic $0.06 - $2.70 - Diluted $0.06 - $2.70 - Net earnings per share of common stock: Basic $1.84 $1.80 $2.80 $4.84 Diluted $1.83 $1.78 $2.80 $4.80 Average number of common shares outstanding: Basic 40.3 39.9 40.2 39.8 Diluted 40.7 40.2 40.4 40.2 See accompanying footnotes to the unaudited condensed consolidated financial statements beginning on page 6. 2 Armstrong Holdings, Inc., and Subsidiaries Condensed Consolidated Balance Sheets (amounts in millions) Unaudited Assets September 30, 2000 December 31, 1999 ------ ------------------ ----------------- Current assets: Cash and cash equivalents $33.6 $26.6 Accounts receivable less allowance for discounts and losses 479.6 403.4 Inventories: Finished goods 263.4 257.9 Work in process 54.4 42.4 Raw materials and supplies 162.5 154.6 -------- -------- Total gross inventories 480.3 454.9 Less LIFO and other reserves 50.8 48.0 -------- -------- Total inventories 429.5 406.9 Deferred income taxes 55.7 40.6 Net assets of discontinued operations - 93.5 Other current assets 84.1 86.7 -------- -------- Total current assets 1,082.5 1,057.7 Property, plant, and equipment 2,365.6 2,481.1 Less accumulated depreciation and amortization 1,061.1 1,123.6 -------- -------- Net property, plant and equipment 1,304.5 1,357.5 Insurance for asbestos-related liabilities, noncurrent 236.1 270.0 Investment in affiliates 35.6 34.2 Goodwill, net 890.5 935.1 Other intangibles, net 55.8 54.9 Other noncurrent assets 427.2 374.4 -------- -------- Total assets $4,032.2 $4,083.8 ======== ======== Liabilities and Shareholders' Equity ------------------------------------ Current liabilities: Short-term debt $24.0 $64.7 Current installments of long-term debt 14.8 36.1 Accounts payable and accrued expenses 724.5 636.2 Income taxes 35.8 2.1 -------- -------- Total current liabilities 799.1 739.1 Long-term debt, less current installments 1,314.3 1,412.9 Employee Stock Ownership Plan (ESOP) loan guarantee 142.2 155.3 Postretirement and postemployment benefit liabilities 244.6 244.5 Pension benefit liabilities 147.1 166.2 Asbestos-related long-term liabilities 483.8 506.5 Other long-term liabilities 94.8 105.4 Deferred income taxes 62.7 62.9 Minority interest in subsidiaries 8.3 11.8 -------- -------- Total noncurrent liabilities 2,497.8 2,665.5 Shareholders' equity: Common stock 51.9 51.9 Capital in excess of par value 166.9 176.4 Reduction for ESOP loan guarantee (180.5) (190.3) Retained earnings 1,251.3 1,196.2 Accumulated other comprehensive loss (35.7) (16.5) Treasury stock (518.6) (538.5) -------- -------- Total shareholders' equity 735.3 679.2 -------- -------- Total liabilities and shareholders' equity $4,032.2 $4,083.8 ======== ======== See accompanying footnotes to the unaudited condensed consolidated financial statements beginning on page 6. 3 Armstrong Holdings, Inc., and Subsidiaries Condensed Consolidated Statements of Shareholders' Equity (amounts in millions) Unaudited 2000 1999 -------- -------- Common stock, $1 par value: - --------------------------- Balance at beginning of year & September 30 $ 51.9 $ 51.9 -------- -------- Capital in excess of par value: - ------------------------------- Balance at beginning of year $ 176.4 $173.0 Stock issuances and other (4.2) 5.9 Contribution of treasury stock to ESOP (5.3) - -------- -------- Balance at September 30 $ 166.9 $178.9 -------- -------- Reduction for ESOP loan guarantee: - ---------------------------------- Balance at beginning of year $(190.3) $ (199.1) Principal paid 13.2 11.2 Loans to ESOP (7.3) (0.8) Contribution of treasury stock to ESOP (4.1) - Accrued compensation 8.0 4.8 -------- -------- Balance at September 30 $(180.5) $ (183.9) -------- -------- Retained earnings: - ------------------ Balance at beginning of year $1,196.2 $1,257.0 Net earnings 112.5 $112.5 192.8 $192.8 Tax benefit on dividends paid on unallocated common shares 0.7 1.4 -------- -------- Total $1,309.4 $1,451.2 Less common stock dividends 58.1 57.7 -------- -------- Balance at September 30 $1,251.3 $1,393.5 -------- -------- Accumulated other comprehensive income (loss): - ---------------------------------------------- Balance at beginning of year $ (16.5) $ (25.4) Foreign currency translation adjustments and hedging activities (13.5) 1.1 Unrealized loss on available for sale securities (2.5) - Minimum pension liability adjustments (3.2) 3.0 -------- -------- Total other comprehensive income (loss) (19.2) (19.2) 4.1 4.1 -------- -------- -------- ------- Balance at September 30 $ (35.7) $ (21.3) -------- -------- Comprehensive income $93.3 $196.9 - -------------------- ======= ======= Less treasury stock at cost: - ---------------------------- Balance at beginning of year $ 538.5 $547.7 Stock purchases 1.4 0.8 Stock issuance activity, net (11.9) (2.4) Contribution of treasury stock to ESOP (9.4) - -------- -------- Balance at September 30 $ 518.6 $546.1 -------- -------- Total shareholders' equity $ 735.3 $873.0 ======== ======= See accompanying footnotes to the unaudited condensed consolidated financial statements beginning on page 6. 4 Armstrong Holdings, Inc., and Subsidiaries Condensed Consolidated Statements of Cash Flows (amounts in millions) Unaudited Nine Months Ended September 30, 2000 1999 ---- ---- Cash flows from operating activities: Net earnings $112.5 $192.8 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization, continuing operations 125.7 117.2 Depreciation and amortization, discontinued operations 3.9 7.7 Gain on sale of businesses (211.3) (1.8) Deferred income taxes 1.6 3.3 Equity earnings from affiliates (14.1) (13.1) Reorganization and restructuring payments (2.9) (14.8) Payments for asbestos-related claims, net of recoveries (131.0) (52.4) Charge for asbestos liability 236.0 - Decrease in net assets of businesses held for sale (0.3) (3.7) Increase in net assets of discontinued operations - (7.8) Changes in operating assets and liabilities net of effects of reorganization, restructuring and dispositions: Increase in receivables (67.5) (86.9) (Increase)/decrease in inventories (30.2) 1.6 (Increase)/decrease in other current assets (11.1) 44.8 Increase in other noncurrent assets (44.0) (55.7) Increase in accounts payable and accrued expenses 4.9 73.1 Increase in income taxes payable 29.1 85.5 Increase/(decrease) in other long-term liabilities (8.7) 9.0 Other, net 24.4 (5.0) ------ ------ Net cash provided by operating activities 17.0 293.8 ------ ------ Cash flows from investing activities: Purchases of property, plant and equipment, continuing operations (107.8) (115.3) Purchases of property, plant and equipment, discontinued operations (2.8) (5.6) Investment in computer software (8.5) (6.4) Acquisitions, net of cash acquired (6.5) (3.8) Distributions from equity affiliates 11.1 10.7 Proceeds from the sale of assets 3.3 3.5 Proceeds from the sale of businesses 329.3 87.6 Other, net - (0.2) ------ ------ Net cash provided by (used for) investing activities 218.1 (29.5) ------ ------ Cash flows from financing activities: Decrease in short-term debt, net (42.8) (34.1) Issuance of long-term debt - 200.0 Payments of long-term debt (127.2) (347.6) Cash dividends paid (58.1) (57.7) Purchase of common stock for the treasury, net (1.4) (0.8) Proceeds from exercised stock options 0.1 1.2 Other, net 5.9 (0.3) ------ ------ Net cash used for financing activities (223.5) (239.3) ------ ------ Effect of exchange rate changes on cash and cash equivalents (4.6) (0.1) ------- ------ Net increase in cash and cash equivalents $7.0 $24.9 Cash and cash equivalents at beginning of period $26.6 $38.2 ------- ------ Cash and cash equivalents at end of period $33.6 $63.1 ======= ======= See accompanying notes to the unaudited condensed consolidated financial statements beginning on page 6. 5 Note 1. BASIS OF PRESENTATION - ----------------------------- The accompanying consolidated financial statements contain the financial results of Armstrong Holdings, Inc. ("Armstrong"). Armstrong acquired the stock of Armstrong World Industries, Inc. on May 1, 2000. An indirect holding in Armstrong World Industries, Inc. makes up substantially all of the assets of Armstrong. Financial statements of Armstrong World Industries, Inc., a wholly owned subsidiary of Armstrong, are shown due to the existence of publicly-traded debt. Since Armstrong was not a publicly traded company and had no substantial operations prior to May 1, 2000, the 1999 results of operations and financial condition of Armstrong World Industries, Inc. are used for comparative purposes. See Note 12 for discussion of the financial statement differences between Armstrong Holdings, Inc. and Armstrong World Industries, Inc. Operating results of 2000, compared with the corresponding period of 1999 included in this report, are unaudited. However, these results have been reviewed by Armstrong's independent public accountants in accordance with established professional standards and procedures for a limited review of interim financial information. Armstrong completed the previously announced sale of its Insulation Products segment on May 31, 2000 (see Note 2). Accordingly, the accompanying condensed consolidated financial statements reflect this business as a discontinued operation and prior periods have been restated. The accounting policies used in preparing these statements are the same as those used in preparing Armstrong's consolidated financial statements for the year ended December 31, 1999. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Armstrong's annual report and Form 10-K for the fiscal year ended December 31, 1999. In the opinion of management, all adjustments of a normal recurring nature have been included to provide a fair statement of the results for the reporting periods presented. Quarterly results are not necessarily indicative of annual earnings. The third quarters of the wood products segment ended on September 30, 2000 and October 2, 1999. No events occurred between September 30, 1999 and October 2, 1999 materially affecting Armstrong's financial position or results of operations. Note 2. DISCONTINUED OPERATIONS - ------------------------------- On May 31, 2000, Armstrong completed its sale of all of the entities, assets and certain liabilities comprising its Insulation Products segment to Orion Einundvierzigste Beteiligungsgesellschaft Mbh, a subsidiary of the Dutch investment firm Gilde Investment Management N.V. for $264 million. The transaction resulted in an after tax gain of $106.4 million, or $2.64 per share in Armstrong's second quarter. The after tax gain on sale of $2.3 million recorded in the third quarter relates to certain accrual and post-closing adjustments. Armstrong expects all post-closing adjustments to be finalized in the fourth quarter of 2000. Note 3. DIVESTITURES - -------------------- On July 31, 2000, Armstrong completed the sale of its Installation Products Group ("IPG") to subsidiaries of the German company Ardex GmbH, for $86 million in cash. Ardex purchased substantially all of the assets and liabilities of IPG including its shares of the W.W. Henry Company. The transaction resulted in a gain of $59.9 million ($44.4 million after tax or $1.09 per share) and was recorded in other income during the third quarter. The financial results of IPG were reported as part of the floor coverings segment. The proceeds and gain are subject to certain post-closing adjustments. Under the terms of the agreement and a related supply agreement, Armstrong will purchase some of its installation products needs from Ardex for an initial term of eight years, subject to certain minimums for the first five years after the sale. The agreement also calls for price adjustments based upon changing market prices for raw materials, labor and energy costs. Note 4. ACQUISITIONS - -------------------- On May 18, 2000 Armstrong acquired privately-held Switzerland-based Gema Holdings AG ("Gema"), a leading manufacturer and installer of metal ceilings, for $6 million plus certain contingent consideration based on future results over the next three years. Gema, with annual sales of nearly $50 million, has two manufacturing sites located in Austria and Switzerland and employs nearly 300 people. The acquisition has 6 been recorded under the purchase method of accounting. The purchase price has been allocated to the assets acquired and the liabilities assumed based on the estimated fair market value at the date of acquisition. The purchase price allocation is preliminary. Pro-forma results of Gema have been omitted, as they are not material. Note 5. INDUSTRY SEGMENTS - ------------------------- During the third quarter, it was determined that the textiles and sports flooring operating segment should be separately presented. Previously, this segment was included as part of the floor coverings segment. Prior year amounts have been restated for comparability. (amounts in millions) Three months Nine months ended September 30 ended September 30 Net sales to external customers 2000 1999 2000 1999 - ------------------------------- ---- ---- ---- ---- Floor coverings $ 339.5 $ 351.3 $ 974.5 $ 986.2 Building products 214.1 200.0 594.8 571.8 Wood products 215.7 210.0 676.8 615.9 Textiles and sports flooring 66.3 76.5 197.7 220.1 All other - 6.5 - 50.4 ------- ------- ---------- ---------- Total sales to external customers $ 835.6 $ 844.3 $ 2,443.8 $ 2,444.4 ======= ======= ========== ========== Three months Nine months ended September 30 ended September 30 Segment operating income (loss) 2000 1999 2000 1999 - ------------------------------- ---- ---- ---- ---- Floor coverings $ 35.2 $ 70.1 $ 108.2 $ 169.8 Building products 35.4 34.4 92.3 95.1 Wood products 18.5 22.1 65.6 70.6 Textiles and sports flooring (2.6) 4.4 1.1 10.4 All other 0.4 0.8 0.5 5.9 ------- ------- ---------- ---------- Total segment operating income 86.9 131.8 267.7 351.8 Charge for asbestos liability - - (236.0) - Unallocated corporate (expense) (18.7) (2.5) (22.9) (8.0) ------- ------- ---------- ---------- Total consolidated operating income $ 68.2 $ 129.3 $ 8.8 $ 343.8 ======= ======= ========== ========== September 30 December 31 Segment assets 2000 1999 - -------------- ---- ---- Floor coverings $ 996.0 $1,071.4 Building products 544.6 535.1 Wood products 1,366.4 1,308.0 Textiles and sports flooring 212.4 211.0 All other 16.1 16.0 --------- --------- Total segment assets 3,135.5 3,141.5 Assets not assigned to business units 896.7 942.3 --------- --------- Total consolidated assets $ 4,032.2 $ 4,083.8 ========= ========= Note 6. REORGANIZATION AND RESTRUCTURING ACTIVITIES - --------------------------------------------------- The following table summarizes activity in the reorganization and restructuring accruals for the first nine months of 2000 and 1999: Beginning Cash Net Charges/ Ending (amounts in millions) balance payments (Reversals) Other balance ------- -------- ----------- ----- ------- 2000 $12.1 ($2.9) $15.7 ($1.0) $ 23.9 1999 30.6 (14.8) - (0.1) 15.7 A $17.0 million pre-tax reorganization charge was recorded in the third quarter of 2000, of which $8.6 million related to severance and enhanced retirement benefits for more than 180 positions (approximately 66% related to salaried positions) within the European Flooring business. Reorganization actions include staff reductions due to the elimination of administrative positions, the consolidation and closing of sales offices in Europe and the closure of the Team Valley, England commercial tile plant. The remaining portion of the reorganization charge primarily related to the remaining payments on a noncancelable operating lease for 7 an office facility in the U.S. The employees who occupied this office facility are being relocated to the corporate headquarters. Armstrong also recorded a $12.2 million charge to cost of goods sold in the third quarter of 2000 for write-downs of inventory and production-line assets that were not categorized as reorganization costs related to the European reorganization efforts. The inventory write-downs were related to changes in product offerings while the write-downs of production-line assets primarily related to changes in production facilities and product offerings. In addition, $1.3 million of the remaining accrual for the 1998 reorganization was reversed, comprising certain severance accruals that were no longer necessary as certain individuals remained employed by Armstrong. The amount in "other" is primarily related to foreign currency translation. Excluding the $17.0 million accrual related to the third quarter 2000 reorganization charge, most of the remaining balance at September 30, 2000 relates to a noncancelable operating lease. Note 7. OTHER COMPREHENSIVE INCOME (LOSS) - ----------------------------------------- The related tax effects allocated to each component of other comprehensive income (loss) for the nine months ended September 30, 2000 are as follows. Before Net of Tax Tax Tax (amounts in millions) Amount Benefit Amount ------ ------- ------ Foreign currency translation adjustments and hedging activities $(13.5) - $(13.5) Unrealized loss on available for sale securities (2.5) - (2.5) Minimum pension liability adjustment (5.0) $1.8 (3.2) ------- ---- ------- Other comprehensive income (loss) $(21.0) $1.8 $(19.2) ======= ==== ======= Note 8. SUPPLEMENTAL CASH FLOW INFORMATION - ------------------------------------------ (amounts in millions) Nine Months Ended September 30 2000 1999 ---- ---- Interest paid $ 76.3 $ 74.9 Income taxes paid, net $ 11.1 $ 21.1 Note 9. EARNINGS (LOSS) PER SHARE - --------------------------------- The difference between the average number of basic and diluted common shares outstanding is due to contingently issuable shares and the effect of dilutive stock options. Earnings per share components may not add due to rounding. The diluted earnings per share components for the first nine months of 2000 use the basic number of shares due to the loss on continuing operations. Note 10. OVERVIEW OF ASBESTOS-RELATED LEGAL PROCEEDINGS - ------------------------------------------------------- Personal Injury Litigation Armstrong is involved in significant asbestos-related litigation which is described more fully under the heading "Legal Proceedings" in Item 1 of Part II of this report which should be read in conjunction with this discussion and analysis. During the first nine months of 2000, the Center for Claims Resolution ("Center") received and verified approximately 45,300 claims naming Armstrong as a defendant compared to approximately 40,500 during the first nine months of 1999. Armstrong is a defendant in approximately 173,000 pending personal injury claims as of September 30, 2000. Approximately 85,000 (or 49%) of these claims are covered under the Center's Strategic Settlement Program ("SSP") compared to 36% SSP coverage of the December 31, 1999 pending claims. Asbestos-Related Liability 8 In continually evaluating its estimated asbestos-related liability, Armstrong reviews, among other things, its recent and historical settlement amounts, the incidence of past and recent claims, the mix of the injuries and occupations of the plaintiffs, the number of cases pending against it and the status and results of broad-based settlement discussions. Based on this review, Armstrong has estimated its share of liability to defend and resolve probable asbestos-related personal injury claims. This estimate is highly uncertain due to the limitations of the available data and the difficulty of forecasting with any certainty the numerous variables that can affect the range of the liability. Armstrong will continue to study the variables in light of additional information in order to identify trends that may become evident and to assess their impact on the range of liability that is probable and estimable. In the second quarter of 2000, Armstrong recorded a charge to increase its estimate of probable asbestos-related liability by $236.0 million. The increase in the estimated liability reflected higher than anticipated claims and higher average settlement costs for claims during the first half of 2000, primarily for settlements outside of the Center's SSP. In the third quarter of 2000, the number of filed claims was within the current expectations but Armstrong's average cost to settle claims was higher than anticipated. Armstrong will continue to study its experience to identify trends and to assess their impact on the range of liability that is probable and estimable. If additional study determines that current cost levels will continue, an increase in the probable asbestos-related liability will be necessary. Armstrong's estimate of its asbestos-related liability that is probable and estimable through 2006 ranges from $758.8 million to $1,363.3 million as of September 30, 2000. The range of probable and estimable liability reflects uncertainty in the number of future claims that will be filed and the cost to settle those claims, which may be influenced by a number of factors, including the outcome of the ongoing broad-based settlement negotiations, the cost to settle claims outside the broad-based settlement program and Armstrong's overall effective share of the Center's liabilities. Armstrong has concluded that no amount within that range is more likely than any other, and therefore has reflected $758.8 million as a liability in the condensed consolidated financial statements in accordance with generally accepted accounting principles. Of this amount, management expects to incur asbestos liability payments of approximately $275.0 million over the next 12 months and has reflected such amount as a current liability as of September 30, 2000. This compares to total liability payments over the prior 12 months of $220.8 million. The Center is involved in numerous legal proceedings with a former member of the Center related to the former member's refusal to pay its share of certain settlements concluded by the Center while that company was a member. In addition, another Center member has terminated its membership due to exhaustion of the assets of its claims trust. This member has also asserted that it is entitled to reductions of certain payments. While the Center believes the member is not entitled to any adjustment, the impact, if any, on the timing of cash flows or amount of recorded liability is uncertain. In estimating its recorded liability, Armstrong has not anticipated unfavorable outcomes resulting from the legal proceedings or any increases in Armstrong's share of liability stemming from the termination of these former Center members. Armstrong's share of liability could increase should there be any negative developments related to these matters. Armstrong's estimated range of liability is primarily based on known claims and an estimate of future claims that are likely to occur and can be reasonably estimated through 2006. Accordingly, substantially all of the range discussed above, and as recorded by Armstrong, comprises management's best estimate of claims expected to be filed within the forthcoming 6 years. For claims that may be filed beyond 2006, management believes that the level of uncertainty is too great to provide for reasonable estimation of the number of future claims, the nature of such claims, or the cost to resolve them. Accordingly, it is reasonably possible that the total exposure to personal injury claims may be greater than the estimated range of liability. Because of the uncertainties related to the number of claims, the ultimate settlement amounts, and similar matters, it is extremely difficult to obtain reasonable estimates of the amount of the ultimate liability. As additional experience is gained regarding claims and such settlement discussions or other new information becomes available regarding the potential liability, Armstrong will reassess its potential liability and revise the estimates as appropriate. Although some settlements have already been reached, Armstrong is currently uncertain as to the ultimate success and timing of the remaining broad-based settlement discussions. However, if those discussions are unsuccessful or if unfavorable claims experiences occur, significant changes in the assumptions used in the estimate of Armstrong's liability may result. Those changes, if any, could lead to increases in the recorded liability. 9 CODEFENDANT BANKRUPTCIES Certain codefendant companies have filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code, including recent filings by Babcock & Wilcox, Pittsburgh Corning and Owens Corning. As a consequence, litigation against them (with some exceptions) has been stayed or restricted. However, Armstrong does not expect to see a significant increase in the number of claims filed since it has been named as a defendant in the majority of claims against these co-defendants. Armstrong could see higher settlement demands from claimants as the number of defendants in the litigation has decreased, but the Center plans to negotiate to minimize any impact on settlement costs. Due to the uncertainties involved, the long-term effect of these proceedings on the litigation cannot be predicted and Armstrong believes it could be several months before Armstrong receives the sufficient data to allow it to ascertain the impact. Insurance Asset As with its estimated asbestos related liability, Armstrong continually evaluates the probable insurance asset to be recorded. An insurance asset in the amount of $268.3 million is recorded as of September 30, 2000. Approximately $27.7 million was received in the second quarter of 2000 pursuant to existing settlements. Of the total recorded asset, approximately $75.8 million represents partial settlement for previous claims which will be paid in a fixed and determinable flow and is reported at its net present value discounted at 6.50%. The total amount recorded reflects Armstrong's belief in the availability of insurance in this amount, based upon Armstrong's success in insurance recoveries, recent settlement agreements that provide such coverage, the nonproducts recoveries by other companies and the opinion of outside counsel. Such insurance is either available through settlement or probable of recovery through negotiation, litigation or resolution of the ADR process that is in the trial phase of binding arbitration. Depending on further progress of the ADR, activities such as settlement discussions with insurance carriers party to the ADR and those not party to the ADR, the final determination of coverage shared with ACandS and the financial condition of the insurers, Armstrong may revise its estimate of probable insurance recoveries. Of the $268.3 million asset, $32.2 million has been recorded as a current asset reflecting management's estimate of the minimum insurance payments to be received in the next 12 months. However, the actual amount of payments to be received in the next 12 months could increase dependent upon the nature and result of settlement discussions. Management estimates that the timing of future cash payments for the remainder of the recorded asset may extend beyond 10 years. Conclusion Since many uncertainties exist surrounding asbestos litigation, Armstrong will continue to evaluate its asbestos related estimated liability and corresponding estimated insurance recoveries asset as well as the underlying assumptions used to record these amounts. These uncertainties include the number of future claims to be filed, the cost to settle claims in the future, which may be influenced by factors including, but not limited to, the financial viability of other defendants, the impact of any potential legislation and the ability of the Center to achieve future SSP agreements, and the impact of the ADR proceedings on the insurance asset. The recorded liability and asset reflect management's best estimate of probable amounts based on current information. However, it is reasonably possible that Armstrong's total exposure to personal injury claims may be greater than the recorded liability and accordingly future charges to income may be necessary. Armstrong believes that potential future charges may be material to the periods in which they are taken. See further discussion of Liquidity and Capital Resources in Note 13. Note 11. - ENVIRONMENTAL LIABILITIES - ------------------------------------ Liabilities of $14.8 million and $14.7 million were recorded at September 30, 2000 and December 31, 1999, respectively, for potential environmental liabilities that Armstrong considers probable and for which a reasonable estimate of the probable liability could be made. Where existing data is sufficient to estimate the amount of the liability, that estimate has been used; where only a range of probable liability is available and no amount within that range is more likely than any other, the lower end of the range has been used. As assessments and remediation activities progress at each individual site, these liabilities are reviewed to reflect additional information as it becomes available. The estimated liabilities do not take into account any claims for recoveries from insurance or third parties. Such recoveries, where probable, have been recorded as an asset in the consolidated financial statements and are either available through settlement or probable of recovery through negotiation or litigation. Actual costs to be incurred at identified sites in the future may vary from estimates, given the inherent uncertainties in evaluating environmental liabilities. Subject to the imprecision in estimating environmental remediation costs, Armstrong believes that any sum it may have to pay in connection with environmental matters in excess of the amounts noted above may be material to earnings in such future period. Note 12 - DIFFERENCES BETWEEN ARMSTRONG HOLDINGS INC. AND ARMSTRONG WORLD - -------------------------------------------------------------------------- INDUSTRIES, INC. ---------------- The difference between the financial statements is primarily due to transactions related to the formation of Armstrong Holdings, Inc. and stock activity. Note 13 - LIQUIDITY AND CAPITAL RESOURCES - ----------------------------------------- 10 As of September 30, 2000, Armstrong had no outstanding borrowings under Armstrong World Industries, Inc.'s $450 million credit facility that expires in October 2003 or under Armstrong World Industries, Inc.'s $450 million, 364 day credit facility that expired on October 19, 2000. These lines have been in support of commercial paper issuances. The outstanding amount of commercial paper at September 30, 2000 was $352.6 million. On October 5, 2000, Owens Corning voluntarily filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. This filing has had a significant effect on Armstrong's liquidity. In early October, Armstrong was in discussions to obtain a 364 day credit facility of up to $400 million, with the intention of completing the new facility prior to the October 19, 2000 expiration of the existing $450 million, 364 day credit facility. Whereas indications from participant banks led Armstrong to believe the facility would be fully subscribed, following the Owens Corning filing the potential participants in the new credit facility decided to reevaluate their credit exposures to Armstrong, primarily due to Armstrong's asbestos liability. Agreement was not reached on terms for a new facility. Subsequently the $450 million, 364 day credit facility expired on October 19, 2000. On October 25, 2000, both Standard & Poor's and Moody's Investors Services downgraded Armstrong's long term debt ratings to BBB- and Baa3 and short term debt ratings to A-3 and P-3, respectively, citing the reduction in committed credit facilities, prospects for weaker operating performance and continued uncertainty surrounding the asbestos liability, owing to among other things, the Owens Corning bankruptcy filing. Both agencies indicated the potential for additional downgrades which could result from, among other things, the inability to increase untapped committed borrowing capacity, significant increases in the cash flow required to service the asbestos liability, or deteriorating operating performance. Since October 25, 2000, Armstrong stopped issuing commercial paper and began to draw on its $450 million credit facility that expires in October 2003. As of November 14, 2000, the $450 million credit facility was fully drawn, approximately $83 million of commercial paper was outstanding and Armstrong had approximately $127 million of cash on deposit. The remaining outstanding commercial paper will mature by November 22, 2000. Armstrong will face liquidity pressures in the near future. Such pressures will be exacerbated should certain events occur. Specifically, should Armstrong's long term debt ratings be further downgraded by both Standard & Poor's and Moody's, holders of Employee Stock Ownership Plan bonds totaling $142.2 million as of September 30, 2000 would have the right to require Armstrong to redeem them under the terms of the Note Purchase Agreement dated June 19, 1989 for 8.43% Series A Guaranteed Serial ESOP Notes due 1989-2001 and 9.00% Series B Guaranteed Serial ESOP Notes due 2000-2004. As of November 14, 2000, Armstrong was not in violation of any debt covenants. The $450 million credit facility that expires in 2003 contains customary events of default, including failure to make payments, failure to meet other material obligations within specific time periods and the acceleration of other material indebtedness. In addition, should Armstrong World Indutstires, Inc.'s consolidated net worth decline by more than $180.6 million from its September 30, 2000 balance, Armstrong would violate the minimum consolidated net worth covenant of the $450 million credit facility. Any event of default could result in the acceleration of the maturity of the facility. Other factors could also influence Armstrong's liquidity. The outlook for Armstrong World Industries, Inc.'s asbestos liability cash payments is highly uncertain. See Part II, Item I "Legal Proceedings" for additional information concerning asbestos litigation. Unforeseen deterioration in expected earnings or working capital requirements would also negatively impact liquidity. On October 30, 2000, Armstrong's Board of Directors elected to suspend the quarterly cash dividend payment with the intent to increase financial flexibility. Armstrong has acted to reduce working capital and capital expenditures and is currently evaluating other alternatives to increase liquidity, which include, among other things, selling non-core assets and businesses, obtaining secured financing, and selling receivables. Armstrong believes that sufficient incremental credit will be available to prevent a liquidity crisis in the next few months but it is unclear whether obtaining such incremental credit would be in the best interests of Armstrong. If Armstrong does not obtain sufficient additional liquidity in the next few months, Armstrong will have to consider seeking protection under the U.S. Bankruptcy Code. 11 Independent Auditors' Review Report ----------------------------------- The Board of Directors and Shareholders of Armstrong Holdings, Inc.: We have reviewed the condensed consolidated balance sheet of Armstrong Holdings, Inc., and subsidiaries as of September 30, 2000, and the related condensed consolidated statements of earnings for the three and nine-month periods ended September 30, 2000 and 1999, and the condensed consolidated statements of cash flows and shareholders' equity for the nine-month periods ended September 30, 2000 and 1999. These condensed consolidated financial statements are the responsibility of the Company's management. We conducted our review in accordance with standards established by the American Institute of Certified Public Accountants. A review of interim financial information consists principally of applying analytical procedures to financial data and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with generally accepted auditing standards, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion. Based on our review, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with generally accepted accounting principles. We have previously audited, in accordance with generally accepted auditing standards, the consolidated balance sheet of Armstrong World Industries, Inc., and subsidiaries as of December 31, 1999, and the related consolidated statements of earnings, cash flows and shareholders' equity for the year then ended (not presented herein); and in our report dated February 2, 2000, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 1999, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived. KPMG LLP Philadelphia, Pennsylvania November 14, 2000 12 Armstrong World Industries, Inc., and Subsidiaries Condensed Consolidated Statements of Earnings (amounts in millions) Unaudited Three Months Ended Nine Months Ended September 30 September 30 ------------ ------------ 2000 1999 2000 1999 ---- ---- ---- ---- Net sales $835.6 $844.3 $2,443.8 $2,444.4 Cost of goods sold 595.9 554.0 1,709.4 1,614.7 ------ ------ -------- -------- Gross profit 239.7 290.3 734.4 829.7 Selling, general and administrative expense 154.8 159.7 469.3 480.4 Charge for asbestos liability - - 236.0 - Reorganization charges, net 15.7 - 15.7 - Goodwill amortization 5.9 6.5 18.2 18.6 Equity (earnings) from affiliates (4.9) (5.2) (14.1) (13.1) ------ ------ -------- -------- Operating income 68.2 129.3 9.3 343.8 Interest expense 26.0 25.8 79.8 78.9 Other (income) expense, net (61.6) 3.4 (67.0) (4.5) ------ ------ -------- -------- Earnings (loss) from continuing operations before income taxes 103.8 100.1 (3.5) 269.4 Income taxes (benefit) 31.8 38.2 (0.6) 101.3 ------ ------ -------- -------- Earnings (loss) from continuing operations $72.0 $61.9 ($2.9) $168.1 ------ ------ -------- -------- Earnings from discontinued operations, net of tax of $0, $4.3, $3.2, and $11.0, respectively - $9.8 $7.0 $24.7 Gain on sale of discontinued operations, net of tax of $0.9, $0, $42.8 and $0 respectively $2.3 - 108.7 - ------ ------ -------- -------- Earnings from discontinued operations 2.3 9.8 115.7 24.7 Net earnings $74.3 $71.7 $112.8 $192.8 ====== ====== ======== ======== See accompanying footnotes to the unaudited condensed consolidated financial statements beginning on page 17. 13 Armstrong World Industries, Inc., and Subsidiaries Condensed Consolidated Balance Sheets (amounts in millions) Unaudited Assets September 30, 2000 December 31, 1999 ------ ------------------ ----------------- Current assets: Cash and cash equivalents $33.6 $26.6 Accounts receivable less allowance for discounts and losses 479.6 403.4 Inventories: Finished goods 263.4 257.9 Work in process 54.4 42.4 Raw materials and supplies 162.5 154.6 -------- -------- Total gross inventories 480.3 454.9 Less LIFO and other reserves 50.8 48.0 -------- -------- Total inventories 429.5 406.9 Deferred income taxes 55.7 40.6 Net assets of discontinued operations - 93.5 Other current assets 84.1 86.7 -------- -------- Total current assets 1,082.5 1,057.7 Property, plant, and equipment 2,365.6 2,481.1 Less accumulated depreciation and amortization 1,061.1 1,123.6 -------- -------- Net property, plant and equipment 1,304.5 1,357.5 Insurance for asbestos-related liabilities, noncurrent 236.1 270.0 Investment in affiliates 35.6 34.2 Goodwill, net 890.5 935.1 Other intangibles, net 55.8 54.9 Other noncurrent assets 427.2 374.4 -------- -------- Total assets $4,032.2 $4,083.8 ======== ======== Liabilities and Shareholders' Equity ------------------------------------ Current liabilities: Short-term debt $24.0 $64.7 Current installments of long-term debt 14.8 36.1 Accounts payable and accrued expenses 724.5 636.2 Income taxes 35.8 2.1 -------- -------- Total current liabilities 799.1 739.1 Long-term debt, less current installments 1,314.3 1,412.9 Long-term amounts payable to parent company 4.7 - Employee Stock Ownership Plan (ESOP) loan guarantee 142.2 155.3 Postretirement and postemployment benefit liabilities 244.6 244.5 Pension benefit liabilities 147.1 166.2 Asbestos-related long-term liabilities 483.8 506.5 Other long-term liabilities 94.8 105.4 Deferred income taxes 62.7 62.9 Minority interest in subsidiaries 8.3 11.8 -------- -------- Total noncurrent liabilities 2,502.5 2,665.5 Shareholders' equity: Common stock 51.9 51.9 Capital in excess of par value 175.8 176.4 Reduction for ESOP loan guarantee (180.5) (190.3) Retained earnings 1,247.6 1,196.2 Accumulated other comprehensive loss (35.7) (16.5) Treasury stock (528.5) (538.5) -------- -------- Total shareholders' equity 730.6 679.2 -------- -------- Total liabilities and shareholders' equity $4,032.2 $4,083.8 ======== ======== See accompanying footnotes to the unaudited condensed consolidated financial statements beginning on page 17. 14 Armstrong World Industries, Inc., and Subsidiaries Condensed Consolidated Statements of Shareholders' Equity (amounts in millions) Unaudited 2000 1999 ---- ---- Common stock, $1 par value: - -------------------------- Balance at beginning of year & September 30 $ 51.9 $ 51.9 --------- --------- Capital in excess of par value: - ------------------------------ Balance at beginning of year $ 176.4 $ 173.0 Stock issuances and other 4.7 5.9 Contribution of treasury stock to ESOP (5.3) - --------- --------- Balance at September 30 $ 175.8 $ 178.9 --------- --------- Reduction for ESOP loan guarantee: - --------------------------------- Balance at beginning of year $ (190.3) $ (199.1) Principal paid 13.2 11.2 Loans to ESOP (7.3) (0.8) Contribution of treasury stock to ESOP (4.1) - Accrued compensation 8.0 4.8 --------- --------- Balance at September 30 $ (180.5) $ (183.9) --------- --------- Retained earnings: - ----------------- Balance at beginning of year $1,196.2 $1,257.0 Net earnings 112.8 $112.8 192.8 $ 192.8 Tax benefit on dividends paid on unallocated common shares 0.7 1.4 --------- --------- Total $1,309.7 $1,451.2 Less rights redemptions 2.0 - Less common stock dividends 60.1 57.7 --------- --------- Balance at September 30 $1,247.6 $1,393.5 --------- --------- Accumulated other comprehensive income (loss): - --------------------------------------------- Balance at beginning of year $ (16.5) $ (25.4) Foreign currency translation adjustments and hedging activities (13.5) 1.1 Unrealized loss on available for sale securities (2.5) - Minimum pension liability adjustments (3.2) 3.0 --------- --------- Total other comprehensive income (loss) (19.2) (19.2) 4.1 4.1 --------- ------- --------- ------- Balance at September 30 $ (35.7) $ (21.3) --------- --------- Comprehensive income $ 93.6 $ 196.9 - -------------------- ======= ======= Less treasury stock at cost: - --------------------------- Balance at beginning of year $ 538.5 $ 547.7 Stock purchases - 0.8 Stock issuance activity, net (0.6) (2.4) Contribution of treasury stock to ESOP (9.4) - --------- --------- Balance at September 30 $ 528.5 $ 546.1 --------- --------- Total shareholders' equity $ 730.6 $ 873.0 ======== ======== See accompanying footnotes to the unaudited condensed consolidated financial statements beginning on page 17. 15 Armstrong World Industries, Inc., and Subsidiaries Condensed Consolidated Statements of Cash Flows (amounts in millions) Unaudited Nine Months Ended September 30, 2000 1999 ---- ---- Cash flows from operating activities: Net earnings $112.8 $192.8 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization, continuing operations 125.7 117.2 Depreciation and amortization, discontinued operations 3.9 7.7 Gain on sale of businesses (211.3) (1.8) Deferred income taxes 1.6 3.3 Equity earnings from affiliates (14.1) (13.1) Reorganization and restructuring payments (2.9) (14.8) Payments for asbestos-related claims, net of recoveries (131.0) (52.4) Charge for asbestos liability 236.0 - Decrease in net assets of businesses held for sale (0.3) (3.7) Increase in net assets of discontinued operations - (7.8) Changes in operating assets and liabilities net of effects of reorganization, restructuring and dispositions: Increase in receivables (67.5) (86.9) (Increase)/decrease in inventories (30.2) 1.6 (Increase)/decrease in other current assets (11.1) 44.8 Increase in other noncurrent assets (44.0) (55.7) Increase in accounts payable and accrued expenses 4.9 73.1 Increase in income taxes payable 29.1 85.5 Increase/(decrease) in other long-term liabilities (8.7) 9.0 Other, net 24.1 (5.0) ------ ------ Net cash provided by operating activities 17.0 293.8 ------ ------ Cash flows from investing activities: Purchases of property, plant and equipment, continuing operations (107.8) (115.3) Purchases of property, plant and equipment, discontinued operations (2.8) (5.6) Investment in computer software (8.5) (6.4) Acquisitions, net of cash acquired (6.5) (3.8) Distributions from equity affiliates 11.1 10.7 Proceeds from the sale of assets 3.3 3.5 Proceeds from the sale of businesses 329.3 87.6 Other, net - (0.2) ------ ------ Net cash provided by (used for) investing activities 218.1 (29.5) ------ ------ Cash flows from financing activities: Decrease in short-term debt, net (42.8) (34.1) Issuance of long-term debt - 200.0 Payments of long-term debt (127.2) (347.6) Cash dividends paid (58.1) (57.7) Purchase of common stock for the treasury, net (1.4) (0.8) Proceeds from exercised stock options 0.1 1.2 Other, net 5.9 (0.3) ------ ------ Net cash used for financing activities (223.5) (239.3) ------ ------ Effect of exchange rate changes on cash and cash equivalents (4.6) (0.1) ------ ------ Net increase in cash and cash equivalents $7.0 $24.9 Cash and cash equivalents at beginning of period $26.6 $38.2 ------ ------ Cash and cash equivalents at end of period $33.6 $63.1 ====== ====== See accompanying notes to the unaudited condensed consolidated financial statements beginning on page 17. 16 Note 1. BASIS OF PRESENTATION - ----------------------------- The accompanying consolidated financial statements contain the financial results of Armstrong World Industries, Inc. ("Armstrong"). Armstrong Holdings, Inc. acquired the stock of Armstrong on May 1, 2000. An indirect holding in Armstrong makes up substantially all of the assets of Armstrong Holdings, Inc. Financial statements of Armstrong, a wholly owned subsidiary of Armstrong Holdings, Inc., are shown due to the existence of publicly-traded debt. See Note 11 for discussion of the financial statement differences between Armstrong Holdings, Inc. and Armstrong World Industries, Inc. Operating results of 2000, compared with the corresponding period of 1999 included in this report, are unaudited. Armstrong completed the previously announced sale of its Insulation Products segment on May 31, 2000 (see Note 2). Accordingly, the accompanying condensed consolidated financial statements reflect this business as a discontinued operation and prior periods have been restated. The accounting policies used in preparing these statements are the same as those used in preparing Armstrong's consolidated financial statements for the year ended December 31, 1999. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Armstrong's annual report and Form 10-K for the fiscal year ended December 31, 1999. In the opinion of management, all adjustments of a normal recurring nature have been included to provide a fair statement of the results for the reporting periods presented. Quarterly results are not necessarily indicative of annual earnings. The third quarters of the wood products segment ended on September 30, 2000 and October 2, 1999. No events occurred between September 30, 1999 and October 2, 1999 materially affecting Armstrong's financial position or results of operations. Note 2. DISCONTINUED OPERATIONS - ------------------------------- On May 31, 2000, Armstrong completed its sale of all of the entities, assets and certain liabilities comprising its Insulation Products segment to Orion Einundvierzigste Beteiligungsgesellschaft Mbh, a subsidiary of the Dutch investment firm Gilde Investment Management N.V. for $264 million. The transaction resulted in an after tax gain of $106.4 million, or $2.64 per share in Armstrong's second quarter. The after tax gain on sale of $2.3 million recorded in the third quarter relates to certain accrual and post-closing adjustments. Armstrong expects all post-closing adjustments to be finalized in the fourth quarter of 2000. Note 3. DIVESTITURES - -------------------- On July 31, 2000, Armstrong completed the sale of its Installation Products Group ("IPG") to subsidiaries of the German company Ardex GmbH, for $86 million in cash. Ardex purchased substantially all of the assets and liabilities of IPG including its shares of the W.W. Henry Company. The transaction resulted in a gain of $59.9 million ($44.4 million after tax or $1.09 per share) and was recorded in other income during the third quarter. The financial results of IPG were reported as part of the floor coverings segment. The proceeds and gain are subject to certain post-closing adjustments. Under the terms of the agreement and a related supply agreement, Armstrong will purchase some of its installation products needs from Ardex for an initial term of eight years, subject to certain minimums for the first five years after the sale. The agreement also calls for price adjustments based upon changing market prices for raw materials, labor and energy costs. Note 4. ACQUISITIONS - -------------------- On May 18, 2000 Armstrong acquired privately-held Switzerland-based Gema Holdings AG ("Gema"), a leading manufacturer and installer of metal ceilings, for $6 million plus certain contingent consideration based on future results over the next three years. Gema, with annual sales of nearly $50 million, has two manufacturing sites located in Austria and Switzerland and employs nearly 300 people. The acquisition has been recorded under the purchase method of accounting. The purchase price has been allocated to the assets acquired and the liabilities assumed based on the estimated fair market value at the date of acquisition. The purchase price allocation is preliminary. Pro-forma results of Gema have been omitted, as they are not material. 17 Note 5. INDUSTRY SEGMENTS - ------------------------- During the third quarter, it was determined that the textiles and sports flooring operating segment should be separately presented. Previously, this segment was included as part of the floor coverings segment. Prior year amounts have been restated for comparability. (amounts in millions) Three months Nine months ended September 30 ended September 30 Net sales to external customers 2000 1999 2000 1999 - ------------------------------- ---- ---- ---- ---- Floor coverings $ 339.5 $ 351.3 $ 974.5 $ 986.2 Building products 214.1 200.0 594.8 571.8 Wood products 215.7 210.0 676.8 615.9 Textiles and sports flooring 66.3 76.5 197.7 220.1 All other - 6.5 - 50.4 ------- ------- --------- --------- Total sales to external customers $ 835.6 $ 844.3 $ 2,443.8 $ 2,444.4 ======= ======= ========= ========= Three months Nine months ended September 30 ended September 30 Segment operating income (loss) 2000 1999 2000 1999 - ------------------------------- ---- ---- ---- ---- Floor coverings $ 35.2 $ 70.1 $ 108.2 $ 169.8 Building products 35.4 34.4 92.3 95.1 Wood products 18.5 22.1 65.6 70.6 Textiles and sports flooring (2.6) 4.4 1.1 10.4 All other 0.4 0.8 0.5 5.9 ------- ------- --------- --------- Total segment operating income 86.9 131.8 267.7 351.8 Charge for asbestos liability - - (236.0) - Unallocated corporate (expense) (18.7) (2.5) (22.4) (8.0) ------- ------- --------- --------- Total consolidated operating income $ 68.2 $ 129.3 $ 9.3 $ 343.8 ======= ======= ========= ========= September 30 December 31 Segment assets 2000 1999 - -------------- ---- ---- Floor coverings $ 996.0 $ 1,071.4 Building products 544.6 535.1 Wood products 1,366.4 1,308.0 Textiles and sports flooring 212.4 211.0 All other 16.1 16.0 --------- --------- Total segment assets 3,135.5 3,141.5 Assets not assigned to business units 896.7 942.3 --------- --------- Total consolidated assets $ 4,032.2 $ 4,083.8 ========= ========= Note 6. REORGANIZATION AND RESTRUCTURING ACTIVITIES - --------------------------------------------------- The following table summarizes activity in the reorganization and restructuring accruals for the first nine months of 2000 and 1999: Beginning Cash Net Charges/ Ending (amounts in millions) balance payments (Reversals) Other balance ------- -------- ----------- ----- ------- 2000 $12.1 ($2.9) $15.7 ($1.0) $ 23.9 1999 30.6 (14.8) - (0.1) 15.7 A $17.0 million pre-tax reorganization charge was recorded in the third quarter of 2000, of which $8.6 million related to severance and enhanced retirement benefits for more than 180 positions (approximately 66% related to salaried positions) within the European Flooring business. Reorganization actions include staff reductions due to the elimination of administrative positions, the consolidation and closing of sales offices in Europe and the closure of the Team Valley, England commercial tile plant. The remaining portion of the reorganization charge primarily related to remaining payments on a noncancelable operating lease for an office facility in the U.S. The employees who occupied this office facility are being relocated to the corporate headquarters. Armstrong also recorded a $12.2 million charge to cost of goods sold in the third quarter of 2000 for write-downs of inventory and production-line assets that were not categorized as reorganization costs related to 18 the European reorganization efforts. The inventory write-downs were related to changes in product offerings while the write-downs of production-line assets primarily related to changes in production facilities and product offerings. In addition, $1.3 million of the remaining accrual for the 1998 reorganization charge was reversed, comprising certain severance accruals that were no longer necessary as certain individuals remained employed by Armstrong. The amount in "other" is primarily related to foreign currency translation. Excluding the $17.0 million accrual related to the third quarter 2000 reorganization charge, most of the remaining balance at September 30, 2000 relates to a noncancelable operating lease. Note 7. OTHER COMPREHENSIVE INCOME (LOSS) - ----------------------------------------- The related tax effects allocated to each component of other comprehensive income (loss) for the nine months ended September 30, 2000 are as follows. Before Net of Tax Tax Tax (amounts in millions) Amount Benefit Amount ------ ------- ------ Foreign currency translation adjustments and hedging activities $(13.5) - $(13.5) Unrealized loss on available for sale securities (2.5) - (2.5) Minimum pension liability adjustment (5.0) $1.8 (3.2) ------- ---- ------- Other comprehensive income (loss) $(21.0) $1.8 $(19.2) ======= ==== ======= Note 8. SUPPLEMENTAL CASH FLOW INFORMATION - ------------------------------------------ (amounts in millions) Nine Months Ended September 30 2000 1999 ---- ---- Interest paid $ 76.3 $ 74.9 Income taxes paid, net $ 11.1 $ 21.1 Note 9. OVERVIEW OF ASBESTOS-RELATED LEGAL PROCEEDINGS - ------------------------------------------------------ Personal Injury Litigation Armstrong is involved in significant asbestos-related litigation which is described more fully under the heading "Legal Proceedings" in Item 1 of Part II of this report which should be read in conjunction with this discussion and analysis. During the first nine months of 2000, the Center for Claims Resolution ("Center") received and verified approximately 45,300 claims naming Armstrong as a defendant compared to approximately 40,500 during the first nine months of 1999. Armstrong is a defendant in approximately 173,000 pending personal injury claims as of September 30, 2000. Approximately 85,000 (or 49%) of these claims are covered under the Center's Strategic Settlement Program ("SSP") compared to 36% SSP coverage of the December 31, 1999 pending claims. Asbestos-Related Liability In continually evaluating its estimated asbestos-related liability, Armstrong reviews, among other things, its recent and historical settlement amounts, the incidence of past and recent claims, the mix of the injuries and occupations of the plaintiffs, the number of cases pending against it and the status and results of broad-based settlement discussions. Based on this review, Armstrong has estimated its share of liability to defend and resolve probable asbestos-related personal injury claims. This estimate is highly uncertain due to the limitations of the available data and the difficulty of forecasting with any certainty the numerous variables that can affect the range of the liability. Armstrong will continue to study the variables in light of additional information in order to identify trends that may become evident and to assess their impact on the range of liability that is probable and estimable. 19 In the second quarter of 2000, Armstrong recorded a charge to increase its estimate of probable asbestos-related liability by $236.0 million. The increase in the estimated liability reflected higher than anticipated claims and higher average settlement costs for claims during the first half of 2000, primarily for settlements outside of the Center's SSP. In the third quarter of 2000, the number of filed claims was within the current expectations but Armstrong's average cost to settle claims was higher than anticipated. Armstrong will continue to study its experience to identify trends and to assess their impact on the range of liability that is probable and estimable. If additional study determines that current cost levels will continue, an increase in the probable asbestos-related liability will be necessary. Armstrong's estimate of its asbestos-related liability that is probable and estimable through 2006 ranges from $758.8 million to $1,363.3 million as of September 30, 2000. The range of probable and estimable liability reflects uncertainty in the number of future claims that will be filed and the cost to settle those claims, which may be influenced by a number of factors, including the outcome of the ongoing broad-based settlement negotiations, the cost to settle claims outside the broad-based settlement program and Armstrong's overall effective share of the Center's liabilities. Armstrong has concluded that no amount within that range is more likely than any other, and therefore has reflected $758.8 million as a liability in the condensed consolidated financial statements in accordance with generally accepted accounting principles. Of this amount, management expects to incur asbestos liability payments of approximately $275.0 million over the next 12 months and has reflected such amount as a current liability as of September 30, 2000. This compares to total liability payments over the prior 12 months of $220.8 million. The Center is involved in numerous legal proceedings with a former member of the Center related to the former member's refusal to pay its share of certain settlements concluded by the Center while that company was a member. In addition, another Center member has terminated its membership due to exhaustion of the assets of its claims trust. This member has also asserted that it is entitled to reductions of certain payments. While the Center believes the member is not entitled to any adjustment, the impact, if any, on the timing of cash flows or amount of recorded liability is uncertain. In estimating its recorded liability, Armstrong has not anticipated unfavorable outcomes resulting from the legal proceedings or any increases in Armstrong's share of liability stemming from the termination of these former Center members. Armstrong's share of liability could increase should there be any negative developments related to these matters. Armstrong's estimated range of liability is primarily based on known claims and an estimate of future claims that are likely to occur and can be reasonably estimated through 2006. Accordingly, substantially all of the range discussed above, and as recorded by Armstrong, comprises management's best estimate of claims expected to be filed within the forthcoming 6 years. For claims that may be filed beyond 2006, management believes that the level of uncertainty is too great to provide for reasonable estimation of the number of future claims, the nature of such claims, or the cost to resolve them. Accordingly, it is reasonably possible that the total exposure to personal injury claims may be greater than the estimated range of liability. Because of the uncertainties related to the number of claims, the ultimate settlement amounts, and similar matters, it is extremely difficult to obtain reasonable estimates of the amount of the ultimate liability. As additional experience is gained regarding claims and such settlement discussions or other new information becomes available regarding the potential liability, Armstrong will reassess its potential liability and revise the estimates as appropriate. Although some settlements have already been reached, Armstrong is currently uncertain as to the ultimate success and timing of the remaining broad-based settlement discussions. However, if those discussions are unsuccessful or if unfavorable claims experiences occur, significant changes in the assumptions used in the estimate of Armstrong's liability may result. Those changes, if any, could lead to increases in the recorded liability. CODEFENDANT BANKRUPTCIES Certain codefendant companies have filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code, including recent filings by Babcock & Wilcox, Pittsburgh Corning and Owens Corning. As a consequence, litigation against them (with some exceptions) has been stayed or restricted. However, Armstrong does not expect to see a significant increase in the number of claims filed since it has been named as a defendant in the majority of claims against these co-defendants. Armstrong could see higher settlement demands from claimants as the number of defendants in the litigation has decreased, but the Center plans to negotiate to minimize any impact on settlement costs. Due to the uncertainties involved, the 20 long-term effect of these proceedings on the litigation cannot be predicted and Armstrong believes it could be several months before Armstrong receives the sufficient data to allow it to ascertain the impact. Insurance Asset As with its estimated asbestos related liability, Armstrong continually evaluates the probable insurance asset to be recorded. An insurance asset in the amount of $268.3 million is recorded as of September 30, 2000. Approximately $27.7 million was received in the second quarter of 2000 pursuant to existing settlements. Of the total recorded asset, approximately $75.8 million represents partial settlement for previous claims which will be paid in a fixed and determinable flow and is reported at its net present value discounted at 6.50%. The total amount recorded reflects Armstrong's belief in the availability of insurance in this amount, based upon Armstrong's success in insurance recoveries, recent settlement agreements that provide such coverage, the nonproducts recoveries by other companies and the opinion of outside counsel. Such insurance is either available through settlement or probable of recovery through negotiation, litigation or resolution of the ADR process that is in the trial phase of binding arbitration. Depending on further progress of the ADR, activities such as settlement discussions with insurance carriers party to the ADR and those not party to the ADR, the final determination of coverage shared with ACandS and the financial condition of the insurers, Armstrong may revise its estimate of probable insurance recoveries. Of the $268.3 million asset, $32.2 million has been recorded as a current asset reflecting management's estimate of the minimum insurance payments to be received in the next 12 months. However, the actual amount of payments to be received in the next 12 months could increase dependent upon the nature and result of settlement discussions. Management estimates that the timing of future cash payments for the remainder of the recorded asset may extend beyond 10 years. Conclusion Since many uncertainties exist surrounding asbestos litigation, Armstrong will continue to evaluate its asbestos related estimated liability and corresponding estimated insurance recoveries asset as well as the underlying assumptions used to record these amounts. These uncertainties include the number of future claims to be filed, the cost to settle claims in the future, which may be influenced by factors including, but not limited to, the financial viability of other defendants, the impact of any potential legislation and the ability of the Center to achieve future SSP agreements, and the impact of the ADR proceedings on the insurance asset. The recorded liability and asset reflect management's best estimate of probable amounts based on current information. However, it is reasonably possible that Armstrong's total exposure to personal injury claims may be greater than the recorded liability and accordingly future charges to income may be necessary. Armstrong believes that potential future charges may be material to the periods in which they are taken. See further discussion of Liquidity and Capital Resources in Note 12. Note 10. - ENVIRONMENTAL LIABILITIES - ------------------------------------ Liabilities of $14.8 million and $14.7 million were recorded at September 30, 2000 and December 31, 1999, respectively, for potential environmental liabilities that Armstrong considers probable and for which a reasonable estimate of the probable liability could be made. Where existing data is sufficient to estimate the amount of the liability, that estimate has been used; where only a range of probable liability is available and no amount within that range is more likely than any other, the lower end of the range has been used. As assessments and remediation activities progress at each individual site, these liabilities are reviewed to reflect additional information as it becomes available. The estimated liabilities do not take into account any claims for recoveries from insurance or third parties. Such recoveries, where probable, have been recorded as an asset in the consolidated financial statements and are either available through settlement or probable of recovery through negotiation or litigation. Actual costs to be incurred at identified sites in the future may vary from estimates, given the inherent uncertainties in evaluating environmental liabilities. Subject to the imprecision in estimating environmental remediation costs, Armstrong believes that any sum it may have to pay in connection with environmental matters in excess of the amounts noted above may be material to earnings in such future period. Note 11 - DIFFERENCES BETWEEN ARMSTRONG HOLDINGS INC. AND ARMSTRONG WORLD - -------------------------------------------------------------------------- INDUSTRIES, INC. ---------------- The difference between the financial statements is primarily due to transactions related to the formation of Armstrong Holdings, Inc. and stock activity. Note 12 - LIQUIDITY AND CAPITAL RESOURCES - ----------------------------------------- As of September 30, 2000, Armstrong had no outstanding borrowings under Armstrong World Industries Inc.'s $450 million credit facility that expires in October 2003 or under Armstrong World Industries Inc.'s $450 million, 364 day credit facility that expired on October 19, 2000. These lines have been in support of commercial paper issuances. The outstanding amount of commercial paper at September 30, 2000 was $352.6 million. On October 5, 2000, Owens Corning voluntarily filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. This filing has had a significant effect on Armstrong's liquidity. In early October, Armstrong was in discussions to obtain a 364 day credit facility of up to $400 million, with the intention of 21 completing the new facility prior to the October 19, 2000 expiration of the existing $450 million, 364 day credit facility. Whereas indications from participant banks led Armstrong to believe the facility would be fully subscribed, following the Owens Corning filing the potential participants in the new credit facility decided to reevaluate their credit exposures to Armstrong, primarily due to Armstrong's asbestos liability. Agreement was not reached on terms for a new facility. Subsequently the $450 million, 364 day credit facility expired on October 19, 2000. On October 25, 2000, both Standard & Poor's and Moody's Investors Services downgraded Armstrong's long term debt ratings to BBB- and Baa3 and short term debt ratings to A-3 and P-3, respectively, citing the reduction in committed credit facilities, prospects for weaker operating performance and continued uncertainty surrounding the asbestos liability, owing to among other things, the Owens Corning bankruptcy filing. Both agencies indicated the potential for additional downgrades which could result from, among other things, the inability to increase untapped committed borrowing capacity, significant increases in the cash flow required to service the asbestos liability, or deteriorating operating performance. Since October 25, 2000, Armstrong stopped issuing commercial paper and began to draw on its $450 million credit facility that expires in October 2003. As of November 14, 2000, the $450 million credit facility was fully drawn, approximately $83 million of commercial paper was outstanding and Armstrong had approximately $127 million of cash on deposit. The remaining outstanding commercial paper will mature by November 22, 2000. Armstrong will face liquidity pressures in the near future. Such pressures will be exacerbated should certain events occur. Specifically, should Armstrong's long term debt ratings be further downgraded by both Standard & Poor's and Moody's, holders of Employee Stock Ownership Plan bonds totaling $142.2 million as of September 30, 2000 would have the right to require Armstrong to redeem them under the terms of the Note Purchase Agreement dated June 19, 1989 for 8.43% Series A Guaranteed Serial ESOP Notes due 1989-2001 and 9.00% Series B Guaranteed Serial ESOP Notes due 2000-2004. As of November 14, 2000, Armstrong was not in violation of any debt covenants. The $450 million credit facility that expires in 2003 contains customary events of default, including failure to make payments, failure to meet other material obligations within specific time periods and the acceleration of other material indebtedness. In addition, should Armstrong World Industries, Inc.'s consolidated net worth decline by more than $180.6 million from its September 30, 2000 balance, Armstrong would violate the minimum consolidated net worth covenant of the $450 million credit facility. Any event of default could result in the acceleration of the maturity of the facility. Other factors could also influence Armstrong's liquidity. The outlook for Armstrong's asbestos liability cash payments is highly uncertain. See Part II, Item I "Legal Proceedings" for additional information concerning asbestos litigation. Unforeseen deterioration in expected earnings or working capital requirements would also negatively impact liquidity. On October 30, 2000, Armstrong's Board of Directors elected to suspend the quarterly cash dividend payment with the intent to increase financial flexibility. Armstrong has acted to reduce working capital and capital expenditures and is currently evaluating other alternatives to increase liquidity, which include, among other things, selling non-core assets and businesses, obtaining secured financing, and selling receivables. Armstrong believes that sufficient incremental credit will be available to prevent a liquidity crisis in the next few months but it is unclear whether obtaining such incremental credit would be in the best interests of Armstrong. If Armstrong does not obtain sufficient additional liquidity in the next few months, Armstrong will have to consider seeking protection under the U.S. Bankruptcy Code. 22 Item 2. Management's Discussion and Analysis of Financial Condition and Results - ------ ----------------------------------------------------------------------- of Operations ------------- The following discussion and analysis correspond to Armstrong Holdings, Inc. See Notes 1, 2 and 12 to the unaudited condensed consolidated financial statements for further discussion. Financial Condition - ------------------- As shown on the condensed Consolidated Balance Sheets (see page 3), Armstrong had cash and cash equivalents of $33.6 million at September 30, 2000. Working capital was $283.4 million as of September 30, 2000, $35.2 million lower than the $318.6 million recorded at the end of 1999. The ratio of current assets to current liabilities was 1.35 to 1 as of September 30, 2000, compared with 1.43 to 1 as of December 31, 1999. Long-term debt, excluding Armstrong's guarantee of an ESOP loan, decreased in the third quarter of 2000. At September 30, 2000, long-term debt of $1,314.3 million, or 58.9 percent of total capital, compared with $1,412.9 million, or 60.2 percent of total capital, at the end of 1999. At September 30, 2000, and December 31, 1999, the ratios of total debt (including Armstrong's guarantee of the ESOP loan) as a percent of total capital were 67.0 percent and 71.1 percent, respectively. The decrease in long-term debt was primarily due to the receipt of proceeds from the divestitures of the Insulation Products segment and the Installation Products Group, (which was part of the floor coverings segment) which was used to pay outstanding debt. As shown on the condensed Consolidated Statements of Cash Flows (see page 5), net cash provided by operating activities for the nine months ended September 30, 2000, was $17.0 million compared with $293.8 million for the comparable period in 1999. The decrease was primarily due to several items including lower net income, higher net payments for asbestos claims and changes in working capital. Net cash provided by investing activities was $218.1 million for the nine months ended September 30, 2000, compared with net cash used for investing activities of $29.5 million for the nine months ended September 30, 1999. The increase was primarily due to proceeds from the sale of the Insulation Products segment and the Installation Products Group. Net cash used for financing activities was $223.5 million for the nine months ended September 30, 2000 compared with $239.3 million for the nine months ended September 30, 1999. The decrease was primarily due to the $170.0 million net decrease in debt during 2000 compared to the $181.7 million net decrease in debt during 1999. Armstrong is regularly evaluating its various business units and may from time to time dispose of, or restructure, those units. During 2000, Armstrong sold its Insulation Products segment and its Installation Products while reorganizing its European flooring business. Armstrong is also currently in divestiture discussions and evaluations related to its textiles and sports flooring products segment. Asbestos-Related Litigation - --------------------------- Personal Injury Litigation Armstrong is involved in significant asbestos-related litigation which is described more fully under the heading "Legal Proceedings" in Item 1 of Part II of this report which should be read in conjunction with this discussion and analysis. During the first nine months of 2000, the Center for Claims Resolution ("Center") received and verified approximately 45,300 claims naming Armstrong as a defendant compared to approximately 40,500 during the first nine months of 1999. Armstrong is a defendant in approximately 173,000 pending personal injury claims as of September 30, 2000. Approximately 85,000 (or 49%) of these claims are covered under the Center's Strategic Settlement Program ("SSP") compared to 36% SSP coverage of the December 31, 1999 pending claims. Armstrong continues to seek broad-based settlements of claims through the Center. To date, the Center has reached SSP agreements with law firms that cover approximately 130,000 claims that name Armstrong as a defendant, including agreements with 16 law firms covering approximately 36,000 claims during the first nine months of 2000. Some of these claims have already been paid, some are currently pending and some have yet to be filed. These agreements typically provide for multiyear payments for settlement of current claims and establish specific medical and other criteria for the settlement of future claims as well as annual limits on the number of claims that can be filed by these firms. These agreements also establish fixed settlement values for different asbestos-related medical conditions which are subject to periodic re-negotiation over a period of 2 to 5 years. The plaintiff law firms are required to recommend settlements to 23 their clients although future claimants are not legally obligated to accept the settlements. These agreements also provide for nominal payments to future claimants who are unimpaired but who are eligible for additional compensation if they develop a more serious asbestos-related illness. The Center can terminate an agreement with an individual law firm if a significant number of that firm's clients elect not to participate under the agreement. For some agreements, the component of the agreement that covers future claims is subject to re-negotiation if members leave the Center. As discussed later, several Center members departed in 2000 and the Center is currently in discussions with plaintiff law firms to address the treatment of future claims. Although it is early in the negotiation process, it is possible that the re-negotiation of these agreements could lead to an increase in the asbestos liability. Negotiations with additional law firms engaged in asbestos-related litigation that could resolve additional pending claims are ongoing. The ultimate success and timing of those negotiations is uncertain. Asbestos - Related Liability In continually evaluating its estimated asbestos-related liability, Armstrong reviews, among other things, its recent and historical settlement amounts, the incidence of past and recent claims, the mix of the injuries and occupations of the plaintiffs, the number of cases pending against it and the status and results of broad-based settlement discussions. Based on this review, Armstrong has estimated its share of liability to defend and resolve probable asbestos-related personal injury claims. This estimate is highly uncertain due to the limitations of the available data and the difficulty of forecasting with any certainty the numerous variables that can affect the range of the liability. Armstrong will continue to study the variables in light of additional information in order to identify trends that may become evident and to assess their impact on the range of liability that is probable and estimable. In the second quarter of 2000, Armstrong recorded a charge to increase its estimate of probable asbestos-related liability by $236.0 million. The increase in the estimated liability reflected higher than anticipated claims and higher average settlement costs for claims during the first half of 2000, primarily for settlements outside of the Center's SSP. In the third quarter of 2000, the number of filed claims was within the current expectations but Armstrong's average cost to settle claims was higher than anticipated. Armstrong will continue to study its experience to identify trends and to assess their impact on the range of liability that is probable and estimable. If additional study determines that current cost levels will continue, an increase in the probable asbestos-related liability will be necessary. Armstrong's estimate of its asbestos-related liability that is probable and estimable through 2006 ranges from $758.8 million to $1,363.3 million as of September 30, 2000. The range of probable and estimable liability reflects uncertainty in the number of future claims that will be filed and the cost to settle those claims, which may be influenced by a number of factors, including the outcome of the ongoing broad-based settlement negotiations, the cost to settle claims outside the broad-based settlement program and Armstrong's overall effective share of the Center's liabilities. Armstrong has concluded that no amount within that range is more likely than any other, and therefore has reflected $758.8 million as a liability in the condensed consolidated financial statements in accordance with generally accepted accounting principles. Of this amount, management expects to incur asbestos liability payments of approximately $275.0 million over the next 12 months and has reflected such amount as a current liability as of September 30, 2000. This compares to total liability payments over the prior 12 months of $220.8 million. The Center is involved in numerous legal proceedings with a former member of the Center related to the former member's refusal to pay its share of certain settlements concluded by the Center while that company was a member. In addition, another Center member has terminated its membership due to exhaustion of the assets of its claims trust. This member has also asserted that it is entitled to reductions of certain payments. While the Center believes the member is not entitled to any adjustment, the impact, if any, on the timing of cash flows or amount of recorded liability is uncertain. In estimating its recorded liability, Armstrong has not anticipated unfavorable outcomes resulting from the legal proceedings or any increases in Armstrong's share of liability stemming from the termination of these former Center members. Armstrong's share of liability could increase should there be any negative developments related to these matters. Armstrong's estimated range of liability is primarily based on known claims and an estimate of future claims that are likely to occur and can be reasonably estimated through 2006. Accordingly, substantially all of the range discussed above, and as recorded by Armstrong, comprises management's best estimate of claims expected to be filed within the forthcoming 6 years. For claims that may be filed beyond 2006, management believes that the level of uncertainty is too great to provide for reasonable estimation of the number of future claims, the nature of such claims, or the cost to resolve them. Accordingly, it is reasonably possible that the total exposure to personal injury claims may be greater than the estimated range of liability. Because of the 24 uncertainties related to the number of claims, the ultimate settlement amounts, and similar matters, it is extremely difficult to obtain reasonable estimates of the amount of the ultimate liability. As additional experience is gained regarding claims and such settlement discussions or other new information becomes available regarding the potential liability, Armstrong will reassess its potential liability and revise the estimates as appropriate. Although some settlements have already been reached, Armstrong is currently uncertain as to the ultimate success and timing of the remaining broad-based settlement discussions. However, if those discussions are unsuccessful or if unfavorable claims experiences occur, significant changes in the assumptions used in the estimate of Armstrong's liability may result. Those changes, if any, could lead to increases in the recorded liability. Collateral Requirements As of September 30, 2000, Armstrong had secured $56.2 million of future claim payments with a surety bond to meet minimum collateral requirements established by the Center. On October 27, 2000, the insurance company that underwrote the surety bond informed Armstrong and the Center of its intention not to renew the surety bond effective February 28, 2001. Armstrong is assessing its alternatives relative to the terminated bond. Alternatives include replacing the bond with another insurance company, purchasing a letter of credit from a financial institution, posting cash as collateral or negotiating with the Center to waive the collateral requirement. Insurance Recovery Proceedings A substantial portion of Armstrong's primary and excess remaining insurance asset is nonproducts (general liability) insurance for personal injury claims, including among others, those that involve alleged exposure during Armstrong's installation of asbestos materials. Armstrong has entered into settlements with a number of the carriers resolving its coverage issues. However, an alternative dispute resolution ("ADR") procedure under the Wellington Agreement is under way against certain carriers to determine the percentage of resolved and unresolved claims that are nonproducts claims, to establish the entitlement to such coverage and to determine whether and how much reinstatement of prematurely exhausted products hazard insurance is warranted. The nonproducts coverage potentially available is substantial and includes defense costs in addition to limits. The carriers have raised various defenses, including waiver, laches, statutes of limitations and contractual defenses. One primary carrier alleges that it is no longer bound by the Wellington Agreement, and another alleges that Armstrong agreed to limit its claims for nonproducts coverage against that carrier when the Wellington Agreement was signed. The ADR process is in the trial phase of binding arbitration. One insurer has taken the position that it is entitled to litigate in court certain issues in the ADR proceeding. During 1999, Armstrong received preliminary decisions in the initial phases of the trial proceeding of the ADR which were generally favorable to Armstrong on a number of issues related to insurance coverage. However, during the third quarter of 2000, it was determined that a new trial judge should be selected for the ADR. That process is underway but a new trial judge has not yet been selected. Armstrong is uncertain at this time as to the impact, if any, this change will have on the preliminary decisions of the initial phases of the ADR. Because of the continuing ADR process and the possibilities for appeal on certain matters, Armstrong has not yet completely determined the financial implications of the decisions. Other proceedings against non-Wellington carriers may become necessary. Insurance Asset As with its estimated asbestos related liability, Armstrong continually evaluates the probable insurance asset to be recorded. An insurance asset in the amount of $268.3 million is recorded as of September 30, 2000. Approximately $27.7 million was received in the second quarter of 2000 pursuant to existing settlements. Of the total recorded asset, approximately $75.8 million represents partial settlement for previous claims which will be paid in a fixed and determinable flow and is reported at its net present value discounted at 6.50%. The total amount recorded reflects Armstrong's belief in the availability of insurance in this amount, based upon Armstrong's success in insurance recoveries, recent settlement agreements that provide such coverage, the nonproducts recoveries by other companies and the opinion of outside counsel. Such insurance is either available through settlement or probable of recovery through negotiation, litigation or resolution of the ADR process that is in the trial phase of binding arbitration. Depending on further progress of the ADR, activities such as settlement discussions with insurance carriers party to the ADR and those not party to the ADR, the final determination of coverage shared with ACandS and the financial condition of the insurers, Armstrong may revise its estimate of probable insurance recoveries. Of the $268.3 million asset, $32.2 million has been recorded as a current asset reflecting management's estimate of the minimum insurance payments to be received in the next 12 months. However, the actual amount of payments to be received in the next 12 months could increase dependent upon the nature and result of settlement discussions. Management estimates that the timing of future cash payments for the remainder of the recorded asset may extend beyond 10 years. Armstrong paid $158.7 million for asbestos related claims in the first nine months of 2000 compared to $111.1 million in the first nine months of 1999. Armstrong currently expects to pay between $243.0 million and $251.0 million for asbestos related claims in 2000 compared to $173.0 million in 1999. Armstrong received $27.7 million in asbestos-related insurance recoveries during the first nine months of 2000 compared to $58.7 million during the first nine months of 1999. Armstrong does not anticipate any additional insurance proceeds during the fourth quarter of 2000 and did not receive any insurance proceeds during the fourth quarter of 1999. Therefore, Armstrong currently expects to pay approximately $140.0 million to $145.0 million for asbestos related claims and expenses in 2000, net of expected insurance recoveries and taxes, compared to $74.3 million in 1999. Conclusion Since many uncertainties exist surrounding asbestos litigation, Armstrong will continue to evaluate its asbestos related estimated liability and corresponding estimated insurance recoveries asset as well as the underlying assumptions used to record these amounts. These uncertainties include the number of future claims to be filed, the cost to settle claims in the future, which may be influenced by factors including, but not limited to, the financial viability of other defendants, the impact of any potential legislation and the ability of the Center to achieve future SSP agreements, and the impact of the ADR proceedings on the insurance asset. The recorded liability and asset reflect management's best estimate of probable amounts based on current information. However, it is reasonably possible that Armstrong's total exposure to personal injury claims may be greater than the recorded liability and accordingly future charges to income may be necessary. Armstrong believes that potential future charges may be material to the periods in which they are taken. See further discussion of Liquidity and Capital Resources below. 25 Liquidity and Capital Resources - ------------------------------- As of September 30, 2000, Armstrong had no outstanding borrowings under Armstrong World Industries, Inc.'s $450 million credit facility that expires in October 2003 or under Armstrong World Industries, Inc.'s $450 million, 364 day credit facility that expired on October 19, 2000. These lines have been in support of commercial paper issuances. The outstanding amount of commercial paper at September 30, 2000 was $352.6 million. On October 5, 2000, Owens Corning voluntarily filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code. This filing has had a significant effect on Armstrong's liquidity. In early October, Armstrong was in discussions to obtain a 364 day credit facility of up to $400 million, with the intention of completing the new facility prior to the October 19, 2000 expiration of the existing $450 million, 364 day credit facility. Whereas indications from participant banks led Armstrong to believe the facility would be fully subscribed, following the Owens Corning filing the potential participants in the new credit facility decided to reevaluate their credit exposures to Armstrong, primarily due to Armstrong's asbestos liability. Agreement was not reached on terms for a new facility. Subsequently the $450 million, 364 day credit facility expired on October 19, 2000. On October 25, 2000, both Standard & Poor's and Moody's Investors Services downgraded Armstrong's long term debt ratings to BBB- and Baa3 and short term debt ratings to A-3 and P-3, respectively, citing the reduction in committed credit facilities, prospects for weaker operating performance and continued uncertainty surrounding the asbestos liability, owing to among other things, the Owens Corning bankruptcy filing. Both agencies indicated the potential for additional downgrades which could result from, among other things, the inability to increase untapped committed borrowing capacity, significant increases in the cash flow required to service the asbestos liability, or deteriorating operating performance. Since October 25, 2000, Armstrong stopped issuing commercial paper and began to draw on its $450 million credit facility that expires in October 2003. As of November 14, 2000, the $450 million credit facility was fully drawn, approximately $83 million of commercial paper was outstanding and Armstrong had approximately $127 million of cash on deposit. The remaining outstanding commercial paper will mature by November 22, 2000. Armstrong will face liquidity pressures in the near future. Such pressures will be exacerbated should certain events occur. Specifically, should Armstrong's long term debt ratings be further downgraded by both Standard & Poor's and Moody's, holders of Employee Stock Ownership Plan bonds totaling $142.2 million as of September 30, 2000 would have the right to require Armstrong to redeem them under the terms of the Note Purchase Agreement dated June 19, 1989 for 8.43% Series A Guaranteed Serial ESOP Notes due 1989-2001 and 9.00% Series B Guaranteed Serial ESOP Notes due 2000-2004. As of November 14, 2000, Armstrong was not in violation of any debt covenants. The $450 million credit facility that expires in 2003 contains customary events of default, including failure to make payments, failure to meet other material obligations within specific time periods and the acceleration of other material indebtedness. In addition, should Armstrong's World Industries, Inc.'s consolidated net worth decline by more than $180.6 million from its September 30, 2000 balance, Armstrong would violate the minimum consolidated net worth covenant of the $450 million credit facility. Any envent of default could result in the acceleration of the maturity of the facility. Other factors could also influence Armstrong's liquidity. The outlook for Armstrong's asbestos liability cash payments is highly uncertain. See Part II, Item I "Legal Proceedings" for additional information concerning asbestos litigation. Unforeseen deterioration in expected earnings or working capital requirements would also negatively impact liquidity. On October 30, 2000, Armstrong's Board of Directors elected to suspend the quarterly cash dividend payment with the intent to increase financial flexibility. Armstrong has acted to reduce working capital and capital expenditures and is currently evaluating other alternatives to increase liquidity, which include, among other things, selling non-core assets and businesses, obtaining secured financing, and selling receivables. Armstrong believes that sufficient incremental credit will be available to prevent a liquidity crisis in the next few months but it is unclear whether obtaining such incremental credit would be in the best interests of Armstrong. If Armstrong does not obtain sufficient additional liquidity in the next few months, Armstrong will have to consider seeking protection under the U.S. Bankruptcy Code. Consolidated Results - -------------------- The following discussions of consolidated results are on a continuing operations basis. Third-quarter net sales of $835.6 million from continuing operations were 1.0% lower than in the third quarter of 1999. Included in the third quarter of 1999 were sales from the textile products business which was sold on September 30, 1999. Excluding the impact of the 1999 divestiture and the impact of unfavorable foreign currency translation, sales increased 3.2%. Building products sales increased 7.1% driven primarily by the second quarter 2000 acquisition of our European metal ceilings subsidiary, Gema. Wood products sales 26 increased 2.7%. Sales in the floor coverings and textile and sports flooring products segments decreased 3.4% and 13.3%, respectively, due mainly to lower unfavorable foreign currency translation in Europe. Third-quarter 2000 earnings from continuing operations were $72.0 million or $1.77 per diluted share. This included a pre-tax gain of $59.9 million from the sale of the Installation Products Group ("IPG"), which was part of the floor coverings segment. The third quarter of 2000 included a pre-tax reorganization charge of $17.0 million, of which $8.6 million related to severance and enhanced retirement benefits for more than 180 positions within the European Flooring business. Reorganization actions included staff reductions due to the elimination of administrative positions, the consolidation and closing of sales offices in Europe and the closure of the Team Valley, England commercial tile plant. The remaining portion of the reorganization charge primarily related to remaining payments on a noncancelable operating lease for an office facility in the U.S. The employees who occupied this office facility are being relocated to the corporate headquarters. In addition, $1.3 million of the remaining accrual for the 1998 reorganization charge was reversed, comprising certain severance accruals that were no longer necessary as certain individuals remained employed by Armstrong. Armstrong also recorded a $12.2 million charge to cost of goods sold in the third quarter of 2000 for write-downs of inventory and production-line assets that were not categorized as reorganization costs related to the European reorganization efforts. The inventory write-downs were related to changes in product offerings while the write-downs of production-line assets primarily related to changes in production facilities and product offerings. In addition, Armstrong recorded $11.2 million within SG&A expense for CEO and management transition costs during the third quarter of 2000. The components of this amount included hiring a new CEO, expenses related to the departure of the prior CEO, covenant agreements related to non-compete arrangements and other management transition costs. There will also be approximately $7.6 million of costs in the fourth quarter of 2000 related to settlements of certain benefit plan obligations for former executive employees. Armstrong also recorded $2.3 million within SG&A expense for fixed asset impairments related to the decision to vacate office space in the U.S. Excluding these items discussed above, earnings from continuing operations for the third quarter of 2000 would have been $54.8 million, or $1.35 per diluted share. Third quarter 1999 earnings from continuing operations were $61.9 million, or $1.54 per diluted share. This included a $5.7 million pre-tax loss from the sale of the textile products business and a $2.6 million pre-tax gain from proceeds from the demutualization of an insurance company with whom the Company has company-owned life insurance policies. Excluding these items, earnings from continuing operations for the third quarter of 1999 would have been $62.9 million, or $1.56 per diluted share. The cost of goods sold in the third quarter was 71.3 percent of net sales compared to 65.6 percent of net sales in the third quarter of 1999. Excluding $12.2 million of expenses associated with the third quarter 2000 reorganization of the European flooring business and a $3.6 million insurance settlement received in 1999 for past product claims, cost of goods sold increased from 66.0% of sales in 1999 to 69.9% of sales in 2000. Higher raw material costs primarily in floor coverings and wood products and higher energy costs in building products were the primary drivers of the increase. Third-quarter 2000 SG&A expenses were 18.5 percent of net sales compared to 18.9 percent of net sales in last year's third quarter. The percentage decrease is primarily due to lower incentive bonus accruals and lower selling expense partially offset by CEO and management transition costs, expenses related to the reorganization of European flooring business and asset write-downs related to the decision to vacate office space in Lancaster, PA. Interest expense of $26.0 million was $0.2 million higher than the amount recorded in the third quarter of 1999 principally due to higher interest rates partially offset by lower outstanding debt. Net sales for the first nine months of 2000 were $2,443.8 million, essentially similar to last year's net sales of $2,444.4 million. Excluding the impact of the 1999 divestitures and the impact of foreign exchange rate translation, sales increased 5.2%. A loss from continuing operations of $3.2 million was recorded for the first nine months of 2000. Excluding the third quarter 2000 items described above (gain on the sale of IPG, costs associated with the reorganization of the European flooring business and CEO and management transition costs), the second 27 quarter 2000 asbestos charge and a second quarter demutualization gain, earnings from continuing operations for the first nine months of 2000 would have been $129.6 million, or $3.21 per diluted share. Earnings from continuing operations for the first nine months of 1999 were $168.1 million, or $4.18 per diluted share. Excluding the loss from the sale of the textile products business, a third quarter 1999 demutualization gain and the gain on the sale of a 65% interest in Armstrong Industrial Specialities, Inc., earnings from continuing operations for the first nine months of 1999 would have been $161.6 million, or $4.02 per diluted share. The effective tax rate from continuing operations for the third quarter was 30.6% versus 38.2% for the third quarter of 1999. Excluding the impact of the gain on sale of Installation Products, the reorganization charge and other related expenses in 2000 and the loss from the sale of textile products business in 1999, the third quarter effective tax rate decreased from 38.1% to 36.1% primarily due to increased foreign tax credit utilization. Industry Segment Results - ------------------------ Floor coverings net sales were $339.5 million and $351.3 million in the third quarter of 2000 and 1999, respectively. Sales in the Americas decreased 0.4% versus prior year. European sales of $64.9 million were 19.6% below 1999 levels as a result of unfavorable foreign exchange rate translation, lower prices and a less favorable mix driven by continued market weakness. Excluding the effects of foreign exchange rate translation, sales in Europe were 8.2% below last year. Pacific area sales increased 5.2% versus 1999. Operating income of $35.2 million was 10.4% of sales compared to $70.1 million in the third quarter of 1999, or 20.0% of sales. Excluding expenses associated with reorganizing the European business, other management changes, and $3.6 million received in 1999 for an insurance settlement for past product claims, operating income was $56.7 million or 14.7% below 1999. Operating margin excluding these expenses decreased from 18.9% to 16.7%. The operating margin reduction was driven primarily by higher manufacturing costs, principally higher raw material and production costs for the new ToughGuard product, lower volume in the Americas, and weaker volume and prices in Europe. Building products net sales of $214.1 million increased from $200.0 million in the third quarter of 1999. Excluding the impact of foreign currency translation, sales increased 10.8%. Americas sales increased 2.1% driven primarily by higher sales in the U.S. commercial channel. In Europe, sales increased 18.3% primarily due to incremental sales from Gema, our metal ceilings subsidiary acquired during the second quarter of 2000, and increased sales to emerging markets. Pacific area sales increased 3.5% versus 1999. Operating income increased $1.0 million to $35.4 million as improved volume and increased price in the Americas was largely offset by higher manufacturing expense including raw materials and energy. Overall operating margins decreased from 17.2% to 16.5%. Wood products net sales of $215.7 million in the third quarter of 2000 compared to net sales of $210.0 million in 1999. Cabinet sales decreased 5.7% due to lower volume. Wood flooring sales increased 5.7% versus 1999 driven primarily by volume growth and improved pricing. Operating margins declined from 10.5% to 8.6% primarily driven by higher lumber costs which are relatively unchanged since the first quarter of 2000 but 10.6% above last year. Textiles and sports flooring products net sales of $66.3 million in the third quarter of 2000 were 13.3% lower than last year. Excluding the impact of unfavorable foreign currency translation, sales increased 2.3% driven by volume growth primarily in the sports flooring business. An operating loss of $2.6 million was incurred compared to operating income of $4.4 million in 1999. Excluding the impact of expenses associated with European reorganization and management changes, the operating loss was $0.6 million or $5.0 million lower than 1999. The operating income reduction was driven mainly by less favorable mix of products sold, increased manufacturing and SG&A expense and unfavorable foreign currency translation which more than offset the impact of volume growth. In the all other segment, sales and operating margin were down $6.5 million and $0.4 million, respectively due to the absence of the textile products business which was sold in the third quarter of 1999. Unallocated corporate expense for the third quarter of 2000 of $18.7 million increased $16.2 million versus 1999. Excluding $19.7 million in expenses related to the CEO transition and other management changes and the decision to vacate an office facility in the U.S., unallocated corporate expense decreased $3.5 million primarily due to lower incentive compensation expense. 28 Recent Accounting Pronouncements - -------------------------------- The Securities and Exchange Commission ("SEC") has issued Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition in Financial Statements, as amended on June 26, 2000. SAB No. 101 provides the SEC staff's views in applying generally accepted accounting principles to selected revenue recognition issues, and is effective beginning in the fourth quarter of 2000. Armstrong is evaluating the effects of implementation, if any, on its financial statements. In June 2000, the Financial Accounting Standards Board ("FASB") issued Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities ("FAS 138"), an amendment of FASB Statement No. 133 ("FAS 133"). FAS 138 amends some accounting and reporting standards contained in FAS 133 and also addresses a limited number of issues causing implementation difficulties in applying FAS 133. Armstrong has formed a team to identify and implement the appropriate systems and processes to adopt these statements effective January 1, 2001. The statements provide for the recognition of a cumulative adjustment for an accounting change, as of the date of adoption. The effects of these statements on Armstrong's financial position or results of operations have not yet been determined. In October 2000, the FASB issued Statement No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ("FAS 140"), a replacement of FASB SFAS No. 125." This statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishment of liabilities. This statement is effective March 2001. Armstrong is evaluating the effects of implementation, if any, on its financial statements. Cautionary Statements About Future Results - ------------------------------------------ This discussion is provided under the Private Securities Litigation Reform Act of 1995. Our disclosures in reports here and in other public comments contain forward-looking statements. These statements provide our expectations or forecasts of future events and can be identified by the use of words such as "anticipate," "estimate," "expect," "project," "intend," "plan," "believe," "outlook," and others of similar meaning in discussions of future operating or financial performance. In particular, these include statements relating to future liquidity, future earnings per share, dividends, financial results, operating results, prospective products, future performance of current products, future sales or expenses, and the outcome of contingencies such as legal proceedings. Any of these forward-looking statements may turn out to be wrong. Actual future results may vary materially. Consequently, no forward-looking statement can be guaranteed. Many factors could cause our actual results to differ materially from those expected. These factors include: . our ability to secure sufficient additional financial flexibility and liquidity . our asbestos-related and any other litigation . downgrade in our credit rating . greater than expected working capital requirements . variations in raw material and energy costs, and our success in achieving manufacturing efficiencies and price increases, . our success in introducing new products, . product and price competition caused by factors such as worldwide excess industry capacity, . interest, foreign exchange and effective tax rates . integration of our acquisitions, . business combinations among competitors and suppliers, . the strength of domestic and foreign end-use markets and improved efficiencies in the European flooring market, and . impacts to international operations caused by changes in intellectual property protections and trade regulations, and the political climate in emerging markets. This should not be considered to be a complete list of all risks and uncertainties that might affect our future results. We undertake no obligation to update any forward-looking statement. Related disclosures in our most recent report on Form 10-K, in our reports on Form 10-Q and any further disclosures in subsequent 10-Q, 8-K and 10-K reports should also be consulted. 29 Part II - Other Information --------------------------- Item 1. Legal Proceedings - ------ ----------------- ASBESTOS-RELATED LITIGATION - --------------------------- The following is a summary update of asbestos-related litigation; see Note 26 to the financial statements of Armstrong's 1999 Form 10-K filing for additional information. Armstrong World Industries, Inc. is a defendant in personal injury claims and property damage claims related to asbestos containing products. In the discussion in this Item, "Armstrong" means Armstrong World Industries, Inc. PERSONAL INJURY CLAIMS Nearly all claims seek general and punitive damages arising from alleged exposures, at various times, from World War II onward, to asbestos-containing products. Claims against Armstrong, which can involve allegations of negligence, strict liability, breach of warranty and conspiracy, primarily relate to Armstrong's involvement with asbestos-containing insulation products. Armstrong discontinued the sale of all such insulation products in 1969. In addition, other Armstrong products, such as gasket materials, have been named in some litigation. Claims may arise many years after first exposure to asbestos in light of the long latency period (up to 40 years) for asbestos-related injury. Product identification and determining exposure periods are difficult and uncertain. Armstrong believes that many current plaintiffs are unimpaired. Armstrong is involved in all stages of claims resolution and litigation, including individual trials, consolidated trials and appeals. During the first nine months of 2000, the Center for Claims Resolution ("Center") received and verified approximately 45,300 claims naming Armstrong as a defendant compared to approximately 40,500 during the first nine months of 1999. Armstrong is a defendant in approximately 173,000 pending personal injury claims as of September 30, 2000. Approximately 85,000 (or 49%) of these claims are covered under the Center's Strategic Settlement Program ("SSP") compared to 36% SSP coverage of the December 31, 1999 pending claims. Armstrong continues to seek broad-based settlements of claims through the Center. To date, the Center has reached SSP agreements with law firms that cover approximately 130,000 claims that name Armstrong as a defendant, including agreements with 16 law firms covering approximately 36,000 claims during the first nine months of 2000. Some of these claims have already been paid, some are currently pending and some have yet to be filed. These agreements typically provide for multiyear payments for settlement of current claims and establish specific medical and other criteria for the settlement of future claims as well as annual limits on the number of claims that can be filed by these firms. These agreements also establish fixed settlement values for different asbestos-related medical conditions which are subject to periodic re-negotiation over a period of 2 to 5 years. The plaintiff law firms are required to recommend settlements to their clients although future claimants are not legally obligated to accept the settlements. These agreements also provide for nominal payments to future claimants who are unimpaired but who are eligible for additional compensation if they develop a more serious asbestos-related illness. The Center can terminate an agreement with an individual law firm if a significant number of that firm's clients elect not to participate under the agreement. For some agreements, the component of the agreement that covers future claims is subject to re-negotiation if members leave the Center. As discussed later, several Center members departed in 2000 and the Center is currently in discussions with plaintiff law firms to address the treatment of future claims. Although it is early in the negotiation process, it is possible that the re-negotiation of these agreements could lead to an increase in the asbestos liability. Negotiations with additional law firms engaged in asbestos-related litigation that could resolve additional pending claims are ongoing. The ultimate success and timing of those negotiations is uncertain. Asbestos-Related Liability In continually evaluating its estimated asbestos-related liability, Armstrong reviews, among other things, its recent and historical settlement amounts, the incidence of past and recent claims, the mix of the injuries and occupations of the plaintiffs, the number of cases pending against it and the status and results of broad-based settlement discussions. Based on this review, Armstrong has estimated its share of liability to defend and resolve probable asbestos-related personal injury claims. This estimate is highly uncertain due to the limitations of the available data and the difficulty of forecasting with any certainty the numerous variables that can affect the range of the liability. Armstrong will continue to study the variables in light of additional 30 information in order to identify trends that may become evident and to assess their impact on the range of liability that is probable and estimable. In the second quarter of 2000, Armstrong recorded a charge to increase its estimate of probable asbestos-related liability by $236.0 million. The increase in the estimated liability reflected higher than anticipated claims and higher average settlement costs for claims during the first half of 2000, primarily for settlements outside of the Center's SSP. In the third quarter of 2000, the number of filed claims was within the current expectations but Armstrong's average cost to settle claims was higher than anticipated. Armstrong will continue to study its experience to identify trends and to assess their impact on the range of liability that is probable and estimable. If additional study determines that current cost levels will continue, an increase in the probable asbestos-related liability will be necessary. Armstrong's estimate of its asbestos-related liability that is probable and estimable through 2006 ranges from $758.8 million to $1,363.3 million as of September 30, 2000. The range of probable and estimable liability reflects uncertainty in the number of future claims that will be filed and the cost to settle those claims, which may be influenced by a number of factors, including the outcome of the ongoing broad-based settlement negotiations, the cost to settle claims outside the broad-based settlement program and Armstrong's overall effective share of the Center's liabilities. Armstrong has concluded that no amount within that range is more likely than any other, and therefore has reflected $758.8 million as a liability in the condensed consolidated financial statements in accordance with generally accepted accounting principles. Of this amount, management expects to incur asbestos liability payments of approximately $275.0 million over the next 12 months and has reflected such amount as a current liability as of September 30, 2000. This compares to total liability payments over the prior 12 months of $220.8 million. The Center is involved in numerous legal proceedings with a former member of the Center related to the former member's refusal to pay its share of certain settlements concluded by the Center while that company was a member. In addition, another Center member has terminated its membership due to exhaustion of the assets of its claims trust. This member has also asserted that it is entitled to reductions of certain payments. While the Center believes the member is not entitled to any adjustment, the impact, if any, on the timing of cash flows or amount of recorded liability is uncertain. In estimating its recorded liability, Armstrong has not anticipated unfavorable outcomes resulting from the legal proceedings or any increases in Armstrong's share of liability stemming from the termination of these former Center members. Armstrong's share of liability could increase should there be any negative developments related to these matters. Armstrong's estimated range of liability is primarily based on known claims and an estimate of future claims that are likely to occur and can be reasonably estimated through 2006. Accordingly, substantially all of the range discussed above, and as recorded by Armstrong, comprises management's best estimate of claims expected to be filed within the forthcoming 6 years. For claims that may be filed beyond 2006, management believes that the level of uncertainty is too great to provide for reasonable estimation of the number of future claims, the nature of such claims, or the cost to resolve them. Accordingly, it is reasonably possible that the total exposure to personal injury claims may be greater than the estimated range of liability. Because of the uncertainties related to the number of claims, the ultimate settlement amounts, and similar matters, it is extremely difficult to obtain reasonable estimates of the amount of the ultimate liability. As additional experience is gained regarding claims and such settlement discussions or other new information becomes available regarding the potential liability, Armstrong will reassess its potential liability and revise the estimates as appropriate. Although some settlements have already been reached, Armstrong is currently uncertain as to the ultimate success and timing of the remaining broad-based settlement discussions. However, if those discussions are unsuccessful or if unfavorable claims experiences occur, significant changes in the assumptions used in the estimate of Armstrong's liability may result. Those changes, if any, could lead to increases in the recorded liability. CODEFENDANT BANKRUPTCIES Certain codefendant companies have filed for reorganization under Chapter 11 of the U.S. Bankruptcy Code, including recent filings by Babcock & Wilcox, Pittsburgh Corning and Owens Corning. As a consequence, litigation against them (with some exceptions) has been stayed or restricted. However, Armstrong does not expect to see a significant increase in the number of claims filed since it has been named as a defendant in the majority of claims against these co-defendants. Armstrong could see higher 31 settlement demands from claimants as the number of defendants in the litigation has decreased, but the Center plans to negotiate to minimize any impact on settlement costs. Due to the uncertainties involved, the long-term effect of these proceedings on the litigation cannot be predicted and Armstrong believes it could be several months before Armstrong receives the sufficient data to allow it to ascertain the impact. COLLATERAL REQUIREMENTS As of September 30, 2000, Armstrong had secured $56.2 million of future claim payments with a surety bond to meet minimum collateral requirements established by the Center. On October 27, 2000, the insurance company that underwrote the surety bond informed Armstrong and the Center of its intention not to renew the surety bond effective February 28, 2001. Armstrong is assessing its alternatives relative to the terminated bond. Alternatives include replacing the bond with another insurance company, purchasing a letter of credit from a financial institution, posting cash as collateral or negotiating with the Center to waive the collateral requirement. Property Damage Litigation Armstrong is also one of many defendants in seven pending property damage claims as of September 30, 2000, that were filed by public and private building owners. These cases present allegations of damage to the plaintiffs' buildings caused by asbestos-containing products and generally seek compensatory and punitive damages and equitable relief, including reimbursement of expenditures for removal and replacement of such products. In the second quarter of 2000, Armstrong was served with a lawsuit seeking class certification of Texas residents who own asbestos-containing products. This case includes allegations that Armstrong asbestos-containing products caused damage to buildings and generally seeks compensatory damages and equitable relief, including testing, reimbursement for removal and diminution of property value. Armstrong vigorously denies the validity of the allegations against it in these claims and believes that any costs will be covered by insurance. These claims are handled directly by Armstrong and not by the Center. Insurance Coverage During relevant time periods, Armstrong purchased primary and excess insurance policies providing coverage for personal injury claims and property damage claims. Certain policies also provide coverage to ACandS, Inc., a former subsidiary of Armstrong. Armstrong and ACandS agreed to share certain coverage on a first-come first-served basis and to reserve for ACandS a certain amount of excess coverage. Wellington Agreement In 1985, Armstrong and 52 other companies (asbestos defendants and insurers) signed the Wellington Agreement. This Agreement settled disputes concerning personal injury insurance coverage with signatory carriers. It provides broad coverage for both defense and indemnity and applies to both products hazard and nonproducts (general liability) coverages. Armstrong has resolved most asbestos-related personal injury products hazard coverage matters with its solvent carriers through the Wellington Agreement or other settlements. Insurance Recovery Proceedings A substantial portion of Armstrong's primary and excess remaining insurance asset is nonproducts (general liability) insurance for personal injury claims, including among others, those that involve alleged exposure during Armstrong's installation of asbestos materials. Armstrong has entered into settlements with a number of the carriers resolving its coverage issues. However, an alternative dispute resolution ("ADR") procedure under the Wellington Agreement is under way against certain carriers to determine the percentage of resolved and unresolved claims that are nonproducts claims, to establish the entitlement to such coverage and to determine whether and how much reinstatement of prematurely exhausted products hazard insurance is warranted. The nonproducts coverage potentially available is substantial and includes defense costs in addition to limits. The carriers have raised various defenses, including waiver, laches, statutes of limitations and contractual defenses. One primary carrier alleges that it is no longer bound by the Wellington Agreement, and another alleges that Armstrong agreed to limit its claims for nonproducts coverage against that carrier when the Wellington Agreement was signed. The ADR process is in the trial phase of binding arbitration. One insurer has taken the position that it is entitled to litigate in court certain issues in the ADR proceeding. During 1999, Armstrong received preliminary decisions in the initial phases of the trial proceeding of the ADR which were generally favorable to Armstrong on a number of issues related to insurance coverage. However, during the third quarter of 2000, it was determined that a new trial judge should be selected for the ADR. That process is underway but a new trial judge has not yet been selected. 32 Armstrong is uncertain at this time as to the impact, if any, this change will have on the preliminary decisions of the initial phases of the ADR. Because of the continuing ADR process and the possibilities for appeal on certain matters, Armstrong has not yet completely determined the financial implications of the decisions. Other proceedings against non-Wellington carriers may become necessary. Insurance Asset As with its estimated asbestos related liability, Armstrong continually evaluates the probable insurance asset to be recorded. An insurance asset in the amount of $268.3 million is recorded as of September 30, 2000. Approximately $27.7 million was received in the second quarter of 2000 pursuant to existing settlements. Of the total recorded asset, approximately $75.8 million represents partial settlement for previous claims which will be paid in a fixed and determinable flow and is reported at its net present value discounted at 6.50%. The total amount recorded reflects Armstrong's belief in the availability of insurance in this amount, based upon Armstrong's success in insurance recoveries, recent settlement agreements that provide such coverage, the nonproducts recoveries by other companies and the opinion of outside counsel. Such insurance is either available through settlement or probable of recovery through negotiation, litigation or resolution of the ADR process that is in the trial phase of binding arbitration. Depending on further progress of the ADR, activities such as settlement discussions with insurance carriers party to the ADR and those not party to the ADR, the final determination of coverage shared with ACandS and the financial condition of the insurers, Armstrong may revise its estimate of probable insurance recoveries. Of the $268.3 million asset, $32.2 million has been recorded as a current asset reflecting management's estimate of the minimum insurance payments to be received in the next 12 months. However, the actual amount of payments to be received in the next 12 months could increase dependent upon the nature and result of settlement discussions. Management estimates that the timing of future cash payments for the remainder of the recorded asset may extend beyond 10 years. CASH FLOW IMPACT Armstrong paid $158.7 million for asbestos related claims in the first nine months of 2000 compared to $111.1 million in the first nine months of 1999. Armstrong currently expects to pay between $243.0 million and $251.0 million for asbestos related claims in 2000 compared to $173.0 million in 1999. Armstrong received $27.7 million in asbestos-related insurance recoveries during the first nine months of 2000 compared to $58.7 million during the first nine months of 1999. Armstrong does not anticipate any additional insurance proceeds during the fourth quarter of 2000 and did not receive any insurance proceeds during the fourth quarter of 1999. Therefore, Armstrong currently expects to pay approximately $140.0 million to $145.0 million for asbestos related claims and expenses in 2000, net of expected insurance recoveries and taxes, compared to $74.3 million in 1999. Conclusion - Since many uncertainties exist surrounding asbestos litigation, Armstrong will continue to evaluate its asbestos related estimated liability and corresponding estimated insurance recoveries asset as well as the underlying assumptions used to record these amounts. These uncertainties include the number of future claims to be filed, the cost to settle claims in the future, which may be influenced by factors including, but not limited to, the financial viability of other defendants, the impact of any potential legislation and the ability of the Center to achieve future SSP agreements, and the impact of the ADR proceedings on the insurance asset. The recorded liability and asset reflect management's best estimate of probable amounts based on current information. However, it is reasonably possible that Armstrong's total exposure to personal injury claims may be greater than the recorded liability and accordingly future charges to income may be necessary. Armstrong believes that potential future charges may be material to the periods in which they are taken. See further discussion in the Liquidity and Capital Resources section of Management's Discussion and Analysis. ENVIRONMENTAL MATTERS Armstrong's operations are subject to federal, state, local and foreign environmental laws and regulations. As with many industrial companies, Armstrong is currently involved in proceedings under the Comprehensive Environmental Response, Compensation and Liability Act ("Superfund"), and similar state laws at approximately 22 sites. In most cases, Armstrong is one of many potentially responsible parties ("PRPs") who have voluntarily agreed to jointly fund the required investigation and remediation of each site. 33 With regard to some sites, however, Armstrong disputes the liability, the proposed remedy or the proposed cost allocation among the PRPs. Armstrong may also have rights of contribution or reimbursement from other parties or coverage under applicable insurance policies. Armstrong is also remediating environmental contamination resulting from past industrial activity at certain of its current and former plant sites. Estimates of future liability are based on an evaluation of currently available facts regarding each individual site and consider factors including existing technology, presently enacted laws and regulations and prior Armstrong experience in remediation of contaminated sites. Although current law may impose joint and several liability on all parties at any Superfund site, Armstrong's contribution to the remediation of these sites is expected to be limited by the number of other companies also identified as potentially liable for site costs. As a result, Armstrong's estimated liability reflects only Armstrong's expected share. In determining the probability of contribution, Armstrong considers the solvency of the parties, whether responsibility is being disputed, the terms of any existing agreements and experience regarding similar matters. Liabilities of $14.8 million were recorded at September 30, 2000 for potential environmental liabilities that Armstrong considers probable and for which a reasonable estimate of the probable liability could be made. Where existing data is sufficient to estimate the amount of the liability, that estimate has been used; where only a range of probable liability is available and no amount within that range is more likely than any other, the lower end of the range has been used. As assessments and remediation activities progress at each individual site, these liabilities are reviewed to reflect additional information as it becomes available. The estimated liabilities do not take into account any claims for recoveries from insurance or third parties. Such recoveries, where probable, have been recorded as an asset in the consolidated financial statements and are either available through settlement or probable of recovery through negotiation or litigation. Actual costs to be incurred at identified sites in the future may vary from estimates, given the inherent uncertainties in evaluating environmental liabilities. Subject to the imprecision in estimating environmental remediation costs, Armstrong believes that any sum it may have to pay in connection with environmental matters in excess of the amounts noted above may be material to earnings in such future period. 34 Item 6. - Exhibits and Reports on Form 8-K - ------ -------------------------------- (a) The following exhibits are filed as a part of the Quarterly Report on Form 10-Q: Exhibits -------- No. 4(a) Note Purchase Agreement dated June 19, 1989 for 8.43% Series A Guaranteed Serial ESOP Notes due 1989-2001 and 9.00% Series B Guaranteed Serial ESOP Notes due 2000-2004 for the Armstrong World Industries, Inc. Employee Stock Ownership Plan ("Share in Success Plan") Trust, with Armstrong World Industries, Inc., as guarantor. No. 10(a) Employment Agreement between Armstrong Holdings, Inc. and Michael D. Lockhart, dated August 7, 2000 No. 10(b) Employment Agreement between Armstrong Holdings, Inc. and Frank A. Riddick, dated August 7, 2000 No. 10(c) Amended and Restated Employment and Consulting Agreement between Armstrong Holdings, Inc., Armstrong World Industries, Inc. and George A. Lorch, dated August 7, 2000 and as amended October 30, 2000 No. 10(d) Stock Option Surrender Agreement between Armstrong Holdings, Inc. and George A. Lorch, dated September 25, 2000 No. 10(e) Change in Control Agreement between Armstrong Holdings, Inc. and Michael D. Lockhart, dated August 7, 2000 No. 10(f) Indemnification Agreement between Armstrong Holdings, Inc. and Michael D. Lockhart, dated August 7, 2000 No. 10(g) Management Services Agreement between Armstrong Holdings, Inc. and Armstrong World Industries, Inc., dated August 7, 2000 No. 10(h) Armstrong Holdings, Inc. Stock Award Plan is incorporate by reference herein from Armstrong Holdings, Inc.'s registration statement on Form S-8 filed August 16, 2000, wherein in appeared as Exhibit 4.1. No. 10(i) Terms of Restricted Stock for Stock Option Exchange Program Offered to Employees and Schedule of Participating Executive Officers. No. 15 Letter re Unaudited Interim Financial Information No. 27 Financial Data Schedules (b) The following reports on Form 8-K were filed during the third quarter of 2000. On July 31, 2000, the registrants filed reports on form 8-K reporting Armstrong Holdings, Inc.'s sales and profits for the second quarter of 2000. On July 21, 2000, the registrants filed reports on form 8-K discussing the sale of Armstrong World Industries, Inc.'s Installation Products Group to subsidiaries of the German company Ardex GmbH. 35 Signatures ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Armstrong Holdings, Inc. Armstrong World Industries, Inc. By: /s/ John N. Rigas ----------------------------------------------- John N. Rigas, Senior Vice President, Secretary and General Counsel By: /s/ William C. Rodruan ----------------------------------------------- William C. Rodruan, Vice President and Controller (Principal Accounting Officer) Date: November 14, 2000 Exhibit Index ------------- Exhibit No. - ---------- No. 4(a) Note Purchase Agreement dated June 19, 1989 for 8.43% Series A Guaranteed Serial ESOP Notes due 1989-2001 and 9.00% Series B Guaranteed Serial ESOP Notes due 2000-2004 for the Armstrong World Industries, Inc. Employee Stock Ownership Plan ("Share in Success Plan") Trust, with Armstrong World Industries, Inc., as guarantor No. 10(a) Employment Agreement between Armstrong Holdings, Inc. and Michael D. Lockhart, dated August 7, 2000 No. 10(b) Employment Agreement between Armstrong Holdings, Inc. and Frank A. Riddick, dated August 7, 2000 No. 10(c) Amended and Restated Employment and Consulting Agreement between Armstrong Holdings, Inc., Armstrong World Industries, Inc. and George A. Lorch, dated August 7, 2000 and as amended October 30, 2000 No. 10(d) Stock Option Surrender Agreement between Armstrong Holdings, Inc. and George A. Lorch, dated September 25, 2000 No. 10(e) Change in Control Agreement between Armstrong Holdings, Inc. and Michael D. Lockhart, dated August 7, 2000 No. 10(f) Indemnification Agreement between Armstrong Holdings, Inc. and Michael D. Lockhart, dated August 7, 2000 No. 10(g) Management Services Agreement between Armstrong Holdings, Inc. and Armstrong World Industries, Inc., dated August 7, 2000 No. 10(h) Armstrong Holdings, Inc. Stock Award Plan is incorporate by reference herein from Armstrong Holdings, Inc.'s registration statement on Form S-8 filed August 16, 2000, wherein in appeared as Exhibit 4.1. No. 10(i) Terms of Restricted Stock for Stock Option Exchange Program Offered to Employees and Schedule of Participating Executive Officers No. 15 Letter re: Unaudited Interim Financial Information No. 27 Financial Data Schedules