ARMSTRONG WORLD INDUSTRIES INC - 10-K Annual Report

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FORM 10-K

SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
(Mark One)

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

For the fiscal year ended December 31, 1998
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OR

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

For the transition period from to
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Commission file number 1-2116
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Armstrong World Industries, Inc.
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(Exact name of registrant as specified in its charter)

Pennsylvania 23-0366390
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

2500 Columbia Avenue, Lancaster, Pennsylvania 17603
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(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code (717) 397-0611
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Securities registered pursuant to Section 12(b) of the Act:

Name of each exchange on
Title of each class which registered
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Common Stock ($1 par value) New York Stock Exchange, Inc.

Preferred Stock Purchase Rights Pacific Stock Exchange, Inc. (a)

9-3/4% Debentures Due 2008 Philadelphia Stock Exchange, Inc. (a)
7.45% Senior Quarterly Interest Bonds
Due 2038
(a) Common Stock and Preferred
Stock Purchase Rights only

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

None

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
----- -----

1

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

[ ]

The aggregate market value of the Common Stock of registrant held by
non-affiliates of the registrant based on the closing price ($50.625 per share)
on the New York Stock Exchange on February 19, 1999, was approximately $1.7
billion. For purposes of determining this amount only, registrant has defined
affiliates as including (a) the executive officers named in Item 10 of this 10-K
Report, (b) all directors of registrant, and (c) each shareholder that has
informed registrant by February 15, 1999, as having sole or shared voting power
over 5% or more of the outstanding Common Stock of registrant as of December 31,
1998. As of February 19, 1999, the number of shares outstanding of registrant's
Common Stock was 40,023,675. This amount includes the 2,898,100 shares of Common
Stock as of December 31, 1998, held by Mellon Bank, N.A., as Trustee for the
employee stock ownership accounts of the Company's Retirement Savings and Stock
Ownership Plan.

Documents Incorporated by Reference

Portions of the Proxy Statement dated March 16, 1999, relative to the
April 26, 1999, annual meeting of the shareholders of registrant (the "Company's
1999 Proxy Statement") have been incorporated by reference into Part III of this
Form 10-K Report.

2

PART I
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Item 1. Business
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Armstrong World Industries, Inc. is a Pennsylvania corporation incorporated in
1891. The Company designs, manufactures and sells interior furnishings, most
notably floor coverings and ceiling systems. These products are sold primarily
for use in the furnishing, refurbishing, repair, modernization and construction
of residential, commercial and institutional buildings. The Company also
manufactures various industrial and other products, including pipe insulation,
gasket material and textile machine parts. On July 22, 1998, the Company
acquired Triangle Pacific Corp. ("Triangle Pacific"). Triangle Pacific
manufactures hardwood and other flooring and relevant products, as well as
kitchen and bathroom cabinets. Effective August 31, 1998, the Company acquired
93 percent of DLW Aktiengesellschaft ("DLW"), a German company, which
manufactures flooring and some office furniture in Europe. In 1998, the Company
also sold its equity investment in Dal-Tile International Inc. ("Dal-Tile"),
through which investment the Company participated in the ceramic tile market.
Unless the context indicates otherwise, the term "Company" means Armstrong World
Industries, Inc. and its consolidated subsidiaries.

Industry Segments

The Company's businesses include five reportable segments: floor coverings,
building products, wood products, insulation products, and all other.

NATURE OF OPERATIONS

INDUSTRY SEGMENTS

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For year ended 1998
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Floor Building Wood Insulation All
(millions) coverings products products products other Totals
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Net sales to external customers $ 1,317.6 $ 756.8 $ 346.0 $ 230.0 $ 95.8 $ 2,746.2
Intersegment sales -- -- -- -- 39.5 39.5
Equity (earnings) loss from affiliates 0.2 (14.2) -- -- 0.2 (13.8)
Segment operating income 176.5 116.6 38.6 46.3 9.1 387.1
Reorganization charges 53.5 10.1 -- 0.2 1.9 65.7
Segment assets 1,476.7 550.1 1,355.5 174.6 80.7 3,637.6
Depreciation and amortization 63.6 39.2 15.3 12.1 7.2 137.4
Equity investment 2.2 39.6 -- -- -- 41.8
Capital additions 93.6 42.5 12.4 11.3 5.9 165.7
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For year ended 1997
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Floor Building Wood Insulation All
(millions) coverings products products products other Totals
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Net sales to external customers $ 1,116.0 $ 754.5 $ -- $ 228.4 $ 99.8 $ 2,198.7
Intersegment sales -- -- -- -- 35.8 35.8
Equity (earnings) loss from affiliates 0.2 (12.9) -- -- 42.4 29.7
Segment operating income (loss) 186.5 122.3 -- 45.4 (2.6) 351.6
Segment assets 713.8 554.9 -- 165.1 219.2 1,653.0
Depreciation and amortization 65.5 37.5 -- 12.0 9.6 124.6
Equity investment 2.5 36.7 -- -- 135.7 174.9
Capital additions 76.6 54.4 -- 13.4 3.1 147.5
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For year ended 1996
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Floor Building Wood Insulation All
(millions) coverings products products products other Totals
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Net sales to external customers $ 1,091.8 $ 718.4 $ -- $ 246.8 $ 99.4 $ 2,156.4
Intersegment sales -- -- -- -- 40.9 40.9
Equity (earnings) loss from affiliates -- (9.1) -- -- (10.0) (19.1)
Segment operating income 195.4 103.4 -- 42.4 11.6 352.8
Reorganization and restructuring charges 14.5 8.3 -- 2.8 1.2 26.8
Segment assets 687.9 541.1 -- 184.0 257.5 1,670.5
Depreciation and amortization 53.9 37.0 -- 10.0 13.4 114.3
Equity investment -- 35.6 -- -- 168.7 204.3
Capital additions 117.7 67.7 -- 20.4 2.1 207.9
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Segment information has been prepared in accordance with Financial Accounting
Standards Board (FASB) Statement of Financial Accounting Standards (SFAS) No.
131, "Disclosures about Segments of an Enterprise and Related Information."
Segments were determined based on products and services provided by each
segment. Accounting policies of the segments are the same as those described in
the summary of significant accounting policies. Performance of the segments is
evaluated on operating income before income taxes excluding reorganization and
restructuring charges, unusual gains and losses, and interest expense. The
Company accounts for intersegment sales and transfers as if the sales or
transfers were to third parties at current market prices.

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The table below provides a reconciliation of segment information to total
consolidated information.

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(millions) 1998 1997 1996
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Net sales:
Total segment sales $ 2,746.2 $ 2,198.7 $ 2,156.4
Intersegment sales 39.5 35.8 40.9
Elimination of intersegment sales (39.5) (35.8) (40.9)
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Total consolidated sales $ 2,746.2 $ 2,198.7 $ 2,156.4
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Operating income:
Total segment operating income $ 387.1 $ 351.6 $ 352.8
Segment reorganization and
restructuring charges (65.7) -- (26.8)
Corporate reorganization and
restructuring charges (8.9) -- (19.7)
Flooring discoloration charge -- -- (34.0)
Dal-Tile charge -- (29.7) --
Asbestos liability charge (274.2) -- --
Unallocated corporate (expense)
income 1.6 0.1 (16.4)
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Total consolidated operating income $ 39.9 $ 322.0 $ 255.9
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Assets:
Total assets for reportable
segments $ 3,637.6 $ 1,653.0 $ 1,670.5
Assets not assigned to business
segments 635.6 722.5 465.1
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Total consolidated assets $ 4,273.2 $ 2,375.5 $ 2,135.6
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Other significant items:
Depreciation and amortization
expense:
Segment totals $ 137.4 $ 124.6 $ 114.3
Unallocated corporate
depreciation and
amortization expense 5.3 8.1 9.4
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Total consolidated depreciation and
amortization expense $ 142.7 $ 132.7 $ 123.7
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Capital additions:
Segment totals $ 165.7 $ 147.5 $ 207.9
Unallocated corporate
capital additions 18.6 13.0 20.1
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Total consolidated capital additions $ 184.3 $ 160.5 $ 228.0
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Narrative Description of Business

The Company designs, manufactures and sells interior furnishings, including
floor coverings, building products (primarily ceiling systems), wood flooring
products, and a variety of specialty products for the building, automotive,
textile and other industries. The Company's activities extend worldwide.

Floor Coverings

The Company is a prominent worldwide manufacturer of floor coverings for the
interiors of homes and commercial and institutional buildings, with a broad
range of resilient flooring together with adhesives, installation and
maintenance materials and accessories. Resilient flooring, in both sheet and
tile form, together with laminate flooring, linoleum, carpet and sports
flooring, is made in a wide variety of types, designs, and colors. Included are
types of flooring that offer such features as ease of installation, reduced
maintenance (no-wax), and cushioning for greater underfoot comfort. Floor
covering products are sold to the commercial and residential market segments
through wholesalers, retailers (including large home centers), and contractors,
and to the hotel/motel and manufactured homes industries.

Building Products

A major producer of ceiling materials in the United States and abroad, the
Company markets both residential and commercial ceiling systems. Ceiling
materials for the home are offered in a variety of types and designs; most
provide noise reduction and incorporate Company-designed features intended to
permit ease of installation. These residential ceiling products are sold through
wholesalers and retailers (including large home centers). Commercial

4

ceiling systems, designed for use in shopping centers, offices, schools,
hospitals, and other commercial and institutional structures, are available in
numerous colors, performance characteristics and designs and offer
characteristics such as acoustical control, rated fire protection, and aesthetic
appeal. Commercial ceiling materials and accessories, along with acoustical wall
panels, are sold by the Company to ceiling systems contractors and to resale
distributors. Suspension ceiling systems products are manufactured and sold
through a joint venture with Worthington Industries.

Wood Products

The Company, through Triangle Pacific, manufactures and sells hardwood flooring
and other flooring and related products. The wood products segment also
manufactures and distributes kitchen and bathroom cabinets. These products are
used primarily in residential new construction and remodeling, with some
commercial applications such as retail stores and restaurants. Flooring sales
are generally made through independent wholesale flooring distributors and the
cabinets are distributed through Company-operated distributors and directly to
the end-user. The business of this segment is seasonal, with demand for its
products generally the highest between the months of April and November.

Insulation Products

The Company manufactures insulation products for the technical insulation
market. Insulation products are made in a wide variety of types and designs to
satisfy various industrial and commercial applications with the majority of the
products comprising closed cell flexible foams. A broad range of cladding and
other related materials for the insulation contracting market are also produced.
Insulation products are sold primarily throughout Europe and North America, with
increasing markets in Asia and South America.

All Other

Other business units include the making of a variety of specialty products for
the automotive, textile and other industries worldwide. Gasket materials are
sold for new and replacement use in the automotive, farm equipment, appliance,
small engine, compressor and other industries. Textile products include cots and
aprons sold to equipment manufacturers and textile mills. Gasket and textile
products are sold, depending on type and ultimate use, to original equipment
manufacturers, contractors, wholesalers, fabricators and end users.
Approximately one third of the total sales of this segment relate to three
customers. Also, prior to the disposition of the Company's equity investment in
Dal-Tile in 1998, ceramic tile for floors, walls and countertops, together with
adhesives, installation and maintenance materials and accessories were sold
through home centers, independent ceramic and floor covering wholesalers and
sales service centers operated by Dal-Tile.

-----------------------------------

The principal raw materials used in the manufacture of the Company's products
are synthetic resins, plasticizers, latex, linseed oil, limestone, cork, mineral
fibers and fillers, clays, starches, perlite, rubber, films, pigments, inks, oak
lumber and logs, veneer, acrylics, plywood, particleboard and fiberboard. In
addition, the Company uses a wide variety of other raw materials. Most raw
materials are purchased from sources outside of the Company. The Company also
purchases significant amounts of packaging materials for the containment and
shipment of its various products. During 1998, adequate supplies of raw
materials were available to all of the Company's industry segments.

Customers' orders for the Company's products are typically for immediate
shipment. Thus, in each industry segment, the Company has implemented inventory
systems, including its "just in time" inventory system, pursuant to which orders
are promptly filled out of inventory on hand or the product is

5

manufactured to meet the delivery date specified in the order. As a result,
there historically has been no material backlog in any industry segment.

The competitive position of the Company has been enhanced by patents on products
and processes developed or perfected within the Company or obtained through
acquisition. Although the Company considers that, in the aggregate, its patents
constitute a valuable asset, it does not regard any industry segment as being
materially dependent upon any single patent or any group of related patents.

In addition, certain of the Company's trademarks, including Armstrong, Bruce,
Hartco, Robbins, and DLW, are important to the Company's business because of
their significant brand name recognition.

There is significant competition in all of the industry segments in which the
Company does business. Competition in each industry segment includes numerous
active companies (domestic and foreign), with emphasis on price, product
performance and service. In addition, with the exception of industrial and other
products and services, product styling is a significant method of competition in
the Company's industry segments. Increasing domestic competition from foreign
producers is apparent in certain industry segments and actions continue to be
taken to meet this competition.

Research and development activities are important and necessary in assisting the
Company to carry on and improve its businesses. Principal research and
development functions include the development of new products and processes and
the improvement of existing products and processes.

The Company spent $42.2 million in 1998, $47.8 million in 1997, and $55.2
million in 1996 on research and development activities worldwide for the
continuing businesses.

GEOGRAPHIC AREAS

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Net trade sales at December 31 (millions) 1998 1997 1996
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Americas:
United States $ 1,803.2 $ 1,412.2 $ 1,385.2
Canada 98.6 89.3 87.2
Other Americas 20.2 16.6 11.2
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Total Americas $ 1,922.0 $ 1,518.1 $ 1,483.6
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Europe:
Germany $ 182.5 $ 110.2 $ 142.4
England 142.5 130.3 129.5
France 65.9 53.1 63.2
Netherlands 57.0 33.1 37.2
Other Europe 183.4 161.7 123.0
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Total Europe $ 631.3 $ 488.4 $ 495.3
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Pacific area and other foreign $ 192.9 $ 192.2 $ 177.5
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Total net trade sales $ 2,746.2 $ 2,198.7 $ 2,156.4
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Sales are attributed to countries based on location of customer.

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Long-lived assets at December 31 (millions) 1998 1997 1996
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Americas:
United States $ 991.9 $ 746.3 $ 728.9
Canada 17.1 20.5 20.7
Other Americas 0.1 0.1 0.1
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Total Americas $ 1,009.1 $ 766.9 $ 749.7
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Europe:
Germany $ 270.3 $ 47.7 $ 58.0
England 52.7 54.7 51.4
Netherlands 42.3 13.0 16.8
Belgium 34.5 -- --
France 15.9 15.1 17.6
Other Europe 36.0 32.6 25.5
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Total Europe $ 451.7 $ 163.1 $ 169.3
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Pacific area:
China $ 34.0 $ 34.0 $ 34.9
Other Pacific area 7.2 8.2 10.1
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Total Pacific area $ 41.2 $ 42.2 $ 45.0
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Total long-lived assets $ 1,502.0 $ 972.2 $ 964.0
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6

The Company's foreign operations are subject to foreign government legislation
involving restrictions on investments (including transfers thereof), tariff
restrictions, personnel administration, and other actions by foreign
governments. In addition, consolidated earnings are subject to both U.S. and
foreign tax laws with respect to earnings of foreign subsidiaries, and to the
effects of currency fluctuations.

ACQUISITIONS

On July 22, 1998, the Company completed its acquisition of Triangle Pacific
Corp. ("Triangle Pacific"), a Delaware corporation. Triangle Pacific is a
leading U.S. manufacturer of hardwood flooring and other flooring and related
products and a substantial manufacturer of kitchen and bathroom cabinets. The
acquisition, recorded under the purchase method of accounting, included the
purchase of outstanding shares of common stock of Triangle Pacific at $55.50 per
share which, plus acquisition costs, resulted in a total purchase price of
$911.5 million. A portion of the purchase price has been allocated to assets
acquired and liabilities assumed based on estimated fair market value at the
date of acquisition while the balance of $831.1 million was recorded as goodwill
and is being amortized over forty years on a straight-line basis.

Effective August 31, 1998, the Company acquired approximately 93% of the
total share capital of DLW Aktiengesellschaft ("DLW"), a corporation organized
under the laws of the Federal Republic of Germany. DLW is a leading flooring
manufacturer in Germany. The acquisition, recorded under the purchase method of
accounting, included the purchase of 93% of the total share capital of DLW
which, plus acquisition costs resulted in a total purchase price of $289.9
million. A portion of the purchase price has been allocated to assets acquired
and liabilities assumed based on fair market value at the date of acquisition
while the balance of $117.2 million was recorded as goodwill and is being
amortized over forty years on a straight-line basis. In this purchase price
allocation, $49.6 million was allocated to the estimable net realizable value of
DLW's furniture business and a carpet manufacturing business in the Netherlands,
which the Company has identified as businesses held for sale.

The allocation of the purchase price to the businesses held for sale was
determined as follows:

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(millions) 1998
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Estimated sales price $54.3
Less: Estimated cash outflows through disposal date (2.2)
Allocated interest through disposal date (2.5)
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Total $49.6
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The final sales price and cash flows pertaining to these businesses may
differ from these amounts. Disposals of these businesses should occur in the
first half of 1999.

The table below reflects the adjustment to the carrying value of the
businesses held for sale relating to interest allocation, profits and cash flows
in 1998.

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(millions) 1998
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Carrying value at August 31, 1998 $49.6
Interest allocated September 1 - December 31, 1998 1.1
Effect of exchange rate change 2.8
Profits excluded from consolidated earnings (0.4)
Cash flows funded by parent 2.8
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Carrying value at December 31, 1998 $55.9
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The purchase price allocation for these acquisitions is preliminary and
further refinements are likely to be made based on the completion of final
valuation studies. The operating results of these acquired businesses have been
included in the Consolidated Statements of Earnings from the dates of
acquisition. Triangle Pacific's fiscal year ends on the Saturday closest to
December 31, which was January 2, 1999. The difference in Triangle Pacific's
fiscal year from that of the parent company was due to the difficulty in
changing its financial reporting systems to accommodate a calendar year end. No
events occurred between December 31 and January 2 at Triangle Pacific materially
affecting the Company's financial position or results of operations.

The table below reflects unaudited pro forma combined results of the
Company, Triangle Pacific and DLW as if the acquisitions had taken place at the
beginning of fiscal 1998 and 1997:

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(millions) 1998 1997
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Net sales $3,479.8 $3,350.0
Net earnings (14.2) 173.2
Net earnings per diluted share (0.36) 4.22
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In management's opinion, these unaudited pro forma amounts are not
necessarily indicative of what the actual combined results of operations might
have been if the acquisitions had been effective at the beginning of fiscal 1997
and 1998.

REORGANIZATION AND OTHER ACTIONS

In 1998 the Company recognized charges of $65.6 million, or $42.6 million after
tax, related to severance and enhanced retirement benefits for more than 650
positions, approximately 75% of which were salaried positions. In addition, the
Company recorded an estimated loss of $9.0 million, or $5.9 million after tax,
related to redundant flooring products machinery and equipment held for
disposal. Reorganization actions include corporate and business unit staff
reductions reflecting reorganization of engineering, research and development
and product styling and design; realignment of support activities in connection
with implementation of a new corporate logistics and financial software system;
changes to production processes in the Company's Lancaster flooring plant; and
elimination of redundant positions in formation of a new combined business
organization for Floor Products, Corporate Retail Accounts and Installation
Products. Approximately $28.6 million is cash expenditures for severance which
will occur over the next 12 months. The remainder is a noncash charge for
enhanced retirement benefits.

A second-quarter 1996 restructuring charge related primarily to the
reorganization of corporate and business unit staff positions; realignment and
consolidation of the Armstrong and W.W. Henry installation products businesses;
restructuring of production processes in the Munster, Germany, ceilings
facility; early retirement opportunities for employees in the Fulton, New York,
gasket and specialty paper products facility; and write-downs of assets. These
actions affected approximately 500 employees, about two-thirds of whom were in
staff positions. The majority of the cash outflow occurred within the following
12 months. As of December 31, 1998, an immaterial amount remained in the 1996
reserve related to a non-cancelable operating lease.

Severance payments of $10.4 million were made in 1998 for the elimination
of 209 positions related to the 1996 and 1998 reorganization and restructuring
actions.

EQUITY INVESTMENTS

Investments in affiliates were $41.8 million at December 31, 1998, a decrease of
$133.1 million, reflecting the sale of the Company's ownership of Dal-Tile,
somewhat offset by an increase in the Company's 50% interest in its WAVE joint
venture with Worthington Industries.

Equity earnings from affiliates for 1998 primarily comprised income from a
50% interest in the WAVE joint venture and the Company's share of a net loss at
Dal-Tile and amortization of the excess of the Company's investment in Dal-Tile
over the underlying equity in net assets. Equity losses from affiliates in 1997
included $8.4 million for the Company's share of operating losses incurred by
Dal-Tile; a $29.7 million loss for the Company's share of a charge incurred by
Dal-Tile, primarily for uncollectible receivables and overstocked inventories;
and $4.3 million for the amortization of Armstrong's initial investment in
Dal-Tile over the underlying equity in net assets. Equity earnings from
affiliates for 1996 primarily comprised the Company's after-tax share of the net
income of the Dal-Tile International Inc. business combination, amortization of
the excess of the Company's investment in Dal-Tile over the underlying equity in
net assets, and earnings from its 50% interest in the WAVE joint venture.

In 1995 the Company entered into a business combination with Dal-Tile
whereby the Company exchanged cash and the stock of its ceramic tile operations,
consisting primarily of American Olean Tile company, a wholly-owned subsidiary,
for ownership of 37% of the shares of Dal-Tile. In August 1996, Dal-Tile issued
new shares in a public offering decreasing the Company's ownership share from
37% to 33%. During 1997, the Company purchased additional shares of Dal-Tile
stock, increasing the Company's ownership to 34%.

In 1996 Dal-Tile refinanced all of its existing debt and recorded an
extraordinary loss. The Company's share of the extraordinary loss was $8.9
million after tax or $0.21 per diluted share.

In 1998 the Company announced its intention to dispose of its investment in
Dal-Tile. In July the Company sold 10.35 million shares of Dal-Tile at $8.50 per
share before commission and fees. Since this sale reduced the Company's
ownership of Dal-Tile below 20%, remaining shares were classified as
available-for-sale under the terms of Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." An unrealized holding gain arising from valuing the securities at
market price was excluded from income and recognized as a separate component of
shareholders' equity.

In October and November, the Company sold its remaining 8.02 million shares
of Dal-Tile at $8.50 per share before commission and fees. The Company recorded
a total gain of $12.8 million after tax, classified as "Other income," in the
last half of 1998 on these sales.

8

ENVIRONMENTAL MATTERS

The Company incurred capital expenditures of approximately $6.7 million in 1998,
$1.2 million in 1997 and $3.0 million in 1996 for environmental compliance and
control facilities and anticipates comparable annual expenditures for those
purposes for the years 1999 and 2000. The Company does not anticipate that it
will incur significant capital expenditures in order to meet the requirements of
the Clean Air Act of 1990 ("CAA") and the final implementing regulations
promulgated by various state agencies. Until all new CAA regulatory requirements
are known, uncertainty will remain regarding future estimates of capital
expenditures.

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. 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. The Company 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 Company
experience in remediation of contaminated sites. Although current law imposes
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, the Company's estimated liability reflects only the Company's
expected share. In determining the probability of contribution, the Company
considers the solvency of the parties, whether responsibility is being disputed,
the terms of any existing agreements and experience regarding similar matters.
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.

Reserves of $18.3 million at December 31, 1998, and $9.3 million at
December 31, 1997, were for potential environmental liabilities that the Company
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 a result, the Company has accrued,
before agreed-to insurance coverage, $18.3 million to reflect its estimated
undiscounted liability for environmental remediation. As assessments and
remediation activities progress at each individual site, these liabilities are
reviewed to reflect additional information as it becomes available.

Actual costs to be incurred at identified sites in the future may vary from
the estimates, given the inherent uncertainties in evaluating environmental
liabilities. Subject to the imprecision in estimating environmental remediation
costs, the Company believes that any sum it may have to pay in connection with
environmental matters in excess of the amounts noted above would not have a
material adverse effect on its financial condition, liquidity or results of
operations, although the recording of future costs may be material to earnings
in such future period.

As of December 31, 1998, the Company had approximately 18,900 active employees,
of whom approximately 6,800 are located outside the United States. About 50% of
the Company's approximately 8,800 hourly or salaried production and maintenance
employees in the United States are represented by labor unions. In February,
1999, the Company began to negotiate a new collective bargaining agreement with
the United Steel Workers of America at its Lancaster, Pennsylvania, plant.

9

Item 2. Properties
- -------------------

The Company produces and markets its products and services throughout the world,
owning and operating 69 manufacturing plants in 15 countries (including 5 plants
acquired as part of the DLW acquisition which are currently held for sale).
Forty of these facilities are located throughout the United States. The Company
also has an interest through joint ventures in an additional 17 plants in 7
countries.

Floor covering products and adhesives are produced at 27 plants with principal
manufacturing facilities located in Lancaster, Pennsylvania; Kankakee, Illinois;
Stillwater, Oklahoma; and Bietigheim-Bissingen, and Delmenhorst, Germany.
Building products are produced at 20 plants with principal facilities in Macon,
Georgia; the Florida-Alabama Gulf Coast area; and Marietta, Pennsylvania. Wood
products are produced at 17 plants, comprised of 13 wood flooring and 4 cabinet
facilities. Principal wood products facilities include Beverly, West Virginia;
Nashville and Oneida, Tennessee; and Thompsontown, Pennsylvania. Insulation
products are produced at 13 plants with the principal facility located at
Munster, Germany. Textile mill supplies, fiber gasket materials and specialty
papers and other products for industry are manufactured at 8 plants with
principal manufacturing facilities at Munster, Germany, and Fulton, New York.

Sales offices are leased worldwide, and leased facilities are utilized to
supplement the Company's owned warehousing facilities.

Productive capacity and extent of utilization of the Company's facilities are
difficult to quantify with certainty because in any one facility, maximum
capacity and utilization vary periodically depending upon the product that is
being manufactured, and individual facilities manufacture more than one type of
product. Certain manufacturing locations also provide for the manufacture of
products for more than one industry segment. In this context, the Company
estimates that the production facilities in each of its industry segments were
effectively utilized during 1998 at 80% to 90% of overall productive capacity in
meeting market conditions. Remaining productive capacity is sufficient to meet
expected customer demands.

The Company believes its various facilities are adequate and suitable.
Additional incremental investments in plant facilities are being made as
appropriate to balance capacity with anticipated demand, improve quality and
service, and reduce costs.

Item 3. Legal Proceedings
- --------------------------

ASBESTOS-RELATED LITIGATION

PERSONAL INJURY LITIGATION

The Company is one of many defendants in approximately 154,000 pending claims as
of December 31, 1998, alleging personal injury from exposure to asbestos.

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 the Company generally involve allegations of
negligence, strict liability, breach of warranty and conspiracy with respect to
its involvement with asbestos-containing insulation products. The Company
discontinued the sale of all such products in 1969. The claims also allege that
injury may be determined many years (up to 40 years) after first exposure to
asbestos. Nearly all suits name many defendants, and over 100 different
companies are reportedly involved. The Company believes that many current
plaintiffs are unimpaired. A large number of claims have been settled,
dismissed, put on inactive lists or otherwise resolved, and the Company
generally is involved in all stages of claims resolution and litigation,
including individual trials, consolidated trials and appeals. Neither the rate
of future filings and resolutions nor the total number of future claims can be
predicted at this time with a high degree of certainty.

Attention has been given by various parties to securing a comprehensive
resolution of the litigation. In 1991, the Judicial Panel for Multidistrict
Litigation ordered the transfer of federal cases to the Eastern District of
Pennsylvania in Philadelphia for pretrial purposes. The Company supported this
transfer. Some cases are periodically released for trial, although the issue of
punitive damages is retained by the transferee court. That court has been
instrumental in having the parties resolve large numbers of cases in various
jurisdictions and has been receptive to different approaches to the resolution
of claims. Claims in state courts have not been directly affected by the
transfer, although most recent cases have been filed in state courts.

Amchem Settlement Class Action

Georgine v. Amchem ("Amchem") was a settlement class action filed in the Eastern
- ------------------
District of Pennsylvania on January 15, 1993, that included essentially all
future personal injury claims against members of the Center for Claims
Resolution ("Center"), including the Company. It was designed to establish a
nonlitigation system for the resolution of such claims, and offered a method for
prompt compensation to claimants who were occupationally exposed to asbestos if
they met certain exposure and medical criteria. Compensation amounts were
derived from historical settlement data and no punitive damages were to be paid.
The settlement was designed to, among other things, minimize transactional
costs, including attorneys' fees, expedite compensation to claimants with
qualifying claims, and relieve the courts of the burden of handling future
claims.

10

The District Court, after exhaustive discovery and testimony, approved the
settlement class action and issued a preliminary injunction that barred class
members from pursuing claims against Center members in the tort system. The U.S.
Court of Appeals for the Third Circuit reversed that decision, and the reversal
was sustained by the U.S. Supreme Court on June 25, 1997, holding that the
settlement class did not meet the requirements for class certification under
Federal Rule of Civil Procedure 23. The preliminary injunction was vacated on
July 21, 1997, resulting in the immediate reinstatement of enjoined cases and a
loss of the bar against the filing of claims in the tort system. The Company
believes that an alternative claims resolution mechanism similar to Amchem is
likely to emerge.

Recent Events

During 1998, pending claims increased by 71,000 claims. This increase was higher
than previously anticipated. The Company and its outside counsel believe the
increase in claims filed during 1998 was partially due to acceleration of
pending claims as a result of the Supreme Court's decision on Amchem and
additional claims that had been filed in the tort system against other
defendants (and not against Center members) while Amchem was pending.

Asbestos-Related Liability

The Company continually evaluates the nature and amount of recent claim
settlements and their impact on the Company's projected asbestos resolution and
defense costs. In doing so, the Company reviews, among other things, its recent
and historical settlement amounts, the incidence of past claims, the mix of the
injuries and occupations of the plaintiffs, the number of cases pending against
it, the previous estimates based on the Amchem projection and its recent
experience. Subject to the uncertainties, limitations and other factors referred
to above and based upon its experience, the Company has estimated its share of
liability to defend and resolve probable asbestos-related personal injury
claims. The Company's estimation of such liability that is probable and
estimable through 2004 ranges from $424.7 million to $813 million. The Company
has concluded that no amount within that range is more likely than any other,
and therefore has reflected $424.7 million as a liability in the accompanying
consolidated financial statements. This estimate includes an assumption that the
number of new claims filed annually will be less than the number filed in 1998
as discussed above under "Recent Events." Of this amount, management expects to
incur approximately $80.0 million in 1999 and has reflected this amount as a
current liability. The Company believes it can reasonably estimate the number
and nature of future claims that may be filed during the next six years. However
for claims that may be filed beyond that period, 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 recorded liability. The increase in
recorded liability of $274.2 million in 1998 is primarily reflective of the
increases in claims filed in 1998, recent settlement experience and current
expectations about future claims.

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. The Company's
evaluation of the range of probable liability is primarily based on known
pending claims and an estimate of potential claims that are likely to occur and
can be reasonably estimated. The estimate of likely claims to be filed in the
future is subject to a greater degree of uncertainty each year into the future.
As additional experience is gained regarding claims and settlements or other new
information becomes available regarding the potential liability, the Company
will reassess its potential liability and revise the estimates as appropriate.

Because, among other things, payment of the liability will extend over many
years, management believes that the potential additional costs for claims net of
any potential insurance recoveries, will not have a material after-tax effect on
the financial condition of the Company or its liquidity, although the net
after-tax effect of any future liabilities recorded in excess of insurance
assets could be material to earnings in a future period.

CODEFENDANT BANKRUPTCIES

Certain codefendant companies have filed for reorganization under Chapter 11 of
the Federal Bankruptcy Code. As a consequence, litigation against them (with
some exceptions) has been stayed or restricted. Due to the uncertainties
involved, the long-term effect of these proceedings on the litigation cannot be
predicted.

PROPERTY DAMAGE LITIGATION

The Company is also one of many defendants in eight pending claims as of
December 31, 1998, brought by public and private building owners. These claims
include allegations of damage to 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. Among the lawsuits that have been resolved are four class
actions, which involve public and private schools, Michigan state public and
private schools, colleges and universities, and private property owners who
leased facilities to the federal government. The Company vigorously denies the
validity of the allegations against it in these claims. These suits and claims
are not handled by the Center. Insurance coverage has been resolved and is
expected to cover almost all costs of these claims.

11

INSURANCE COVERAGE

The Company's primary and excess insurance policies provide product hazard and
nonproducts (general liability) coverages for personal injury claims, and
product hazard coverage for property damage claims. Certain policies also
provide coverage to ACandS, Inc., a former subsidiary of the Company. The
Company and ACandS, Inc., share certain limits that both have accessed and have
entered into an agreement that reserved for ACandS, Inc., a certain amount of
excess insurance.

The insurance carriers that provide personal injury products hazard,
nonproducts or property damage coverages include the following: Reliance
Insurance Company; Aetna (now Travelers) Casualty and Surety Company; Liberty
Mutual Insurance Company; Travelers Insurance Company; Fireman's Fund Insurance
Company; Insurance Company of North America; Lloyds of London; various London
market companies; Fidelity and Casualty Insurance Company; First State Insurance
Company; U.S. Fire Insurance Company; Home Insurance Company; Great American
Insurance Company; American Home Assurance Company and National Union Fire
Insurance Company (now part of AIG); Central National Insurance Company;
Interstate Insurance Company; Puritan Insurance Company; and Commercial Union
Insurance Company. Midland Insurance Company, an excess carrier that provided
$25 million of personal injury coverage, certain London companies, and certain
excess carriers providing only property damage coverage are insolvent. The
Company is pursuing claims against insolvents in a number of forums.

Wellington Agreement

In 1985, the Company and 52 other companies (asbestos defendants and insurers)
signed the Wellington Agreement. This Agreement settled nearly all disputes
concerning personal injury insurance coverage with most of the Company's
carriers, provided broad coverage for both defense and indemnity and addressed
both products hazard and nonproducts (general liability) coverages.

California Insurance Coverage Lawsuit

Trial court decisions in the insurance lawsuit filed by the Company in
California held that the trigger of coverage for personal injury claims was
continuous from exposure through death or filing of a claim, that a triggered
insurance policy should respond with full indemnification up to policy limits,
and that any defense obligation ceases upon exhaustion of policy limits.
Although not as comprehensive, another decision established favorable defense
and indemnity coverage for property damage claims, providing coverage during the
period of installation and any subsequent period in which a release of fibers
occurred. The California appellate courts substantially upheld the trial court,
and that insurance coverage litigation is now concluded. The Company has
resolved most personal injury products hazard coverage matters with its solvent
carriers through the Wellington Agreement, referred to above, or other
settlements. In 1989, a settlement with a carrier having both primary and excess
coverages provided for certain minimum and maximum percentages of costs for
personal injury claims to be allocated to nonproducts (general liability)
coverage, the percentage to be determined by negotiation or in alternative
dispute resolution ("ADR").

Asbestos Claims Facility ("Facility") and Center for Claims Resolution

The Wellington Agreement established the Facility to evaluate, settle, pay and
defend all personal injury claims against member companies. Resolution and
defense costs were allocated by formula. The Facility subsequently dissolved,
and the Center was created in October 1988 by 21 former Facility members,
including the Company. Insurance carriers, while not members, are represented ex
officio on the Center's governing board and have agreed annually to provide a
portion of the Center's operational costs. The Center adopted many of the
conceptual features of the Facility and has addressed the claims in a manner
consistent with the prompt, fair resolution of meritorious claims. Resolution
and defense costs are allocated by formula; adjustments over time have resulted
in some increased share for the Company.

Insurance Recovery Proceedings

A substantial portion of the Company's primary and excess insurance asset is
nonproducts (general liability) insurance for personal injury claims, including
among others, those that involve exposure during installation of asbestos
materials. The Wellington Agreement and the 1989 settlement agreement referred
to above have provisions for such coverage. An ADR process under the Wellington
Agreement is underway 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, for some policies, 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 the Company 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. The Company has entered
into a settlement with a number of the carriers resolving its access to
coverage.

12

Other proceedings against non-Wellington carriers may become necessary.

An insurance asset in the amount of $264.8 million is recorded on the
Consolidated Balance Sheet. Of this amount, approximately $26 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 6.35%.
The total amount recorded reflects the Company's belief in the availability of
insurance in this amount, based upon the Company'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 which is in the
trial phase of binding arbitration. Of the $264.8 million asset, $16.0 million
has been recorded as a current asset reflecting management's estimate of the
minimum insurance payments to be received in 1999.

CONCLUSIONS

The Company does not know how many claims will be filed against it in the
future, or the details thereof or of pending suits not fully reviewed, or the
defense and resolution costs that may ultimately result therefrom, or whether an
alternative to the Amchem settlement vehicle may emerge, or the scope of its
insurance coverage ultimately deemed available.

The Company continually evaluates the nature and amount of recent claim
settlements and their impact on the Company's projected asbestos resolution and
defense costs. In doing so, the Company reviews, among other things, its recent
and historical settlement amounts, the incidence of past claims, the mix of the
injuries and occupations of the plaintiffs, the number of cases pending against
it, the previous estimates based on the Amchem projection and its recent
experience. Subject to the uncertainties, limitations and other factors referred
to above and based upon its experience, the Company has estimated its share of
liability to defend and resolve probable asbestos-related personal injury
claims. The Company's estimation of such liability that is probable and
estimable through 2004 ranges from $424.7 million to $813 million. The Company
has concluded that no amount within that range is more likely than any other,
and therefore has reflected $424.7 million as a liability in the accompanying
consolidated financial statements. Of this amount, management expects to incur
approximately $80.0 million in 1999 and has reflected this amount as a current
liability. The Company believes it can reasonably estimate the number and nature
of future claims that may be filed during the next six years. However for claims
that may be filed beyond that period, 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 recorded liability. The increase in
recorded liability of $274.2 million in 1998 is primarily reflective of the
increases in claims filed in 1998, recent settlement experience and current
expectations about future claims.

Because of the uncertainties related to asbestos litigation, it is not
possible to precisely estimate the number of personal injury claims that may
ultimately be filed or their cost. It is reasonably possible there will be
additional claims beyond management's estimates. Management believes that the
potential additional costs for such additional claims, net of any potential
insurance recoveries, will not have a material after-tax effect on the financial
condition of the Company or its liquidity, although the net after-tax effect of
any future liabilities recorded in excess of insurance assets could be material
to earnings in a future period.

An insurance asset in the amount of $264.8 million is recorded on the
Consolidated Balance Sheet and reflects the Company's belief in the availability
of insurance in this amount, based upon the Company's success in insurance
recoveries, 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
the ADR process, negotiation or litigation.

The Company believes that a claims resolution mechanism alternative to the
Amchem settlement will eventually emerge, but the liability is likely to be
higher than the projection in Amchem.

Subject to the uncertainties, limitations and other factors referred to
elsewhere in this note and based upon its experience, the Company believes it is
probable that substantially all of the defense and resolution costs of property
damage claims will be covered by insurance.

Even though uncertainties remain as to the potential number of unasserted
claims and the liability resulting therefrom, and after consideration of the
factors involved, including the ultimate scope of its insurance coverage, the
Wellington Agreement and other settlements with insurance carriers, the results
of the California insurance coverage litigation, the establishment of the
Center, the likelihood that an alternative to the Amchem settlement will
eventually emerge, and its experience, the Company believes the asbestos-related
claims against the Company would not be material either to the financial
condition of the Company or to its liquidity, although the net after-tax effect
of any future liabilities recorded in excess of insurance assets could be
material to earnings in such future period.

13

Recent Developments
- -------------------

On February 26, 1999, the Company received a preliminary decision in the initial
phase of the trial proceeding of the ADR which was favorable to the Company on a
number of issues related to insurance coverage. The decision, while favorable,
relates to the initial phase of the ADR proceeding. The Company has not yet
determined the financial implications of the decision.

Item 4. Submission of Matters to a Vote of Security Holders
- ------------------------------------------------------------

Not applicable.

Executive Officers of the Registrant
- ------------------------------------

The information appearing in Item 10 hereof under the caption "Executive
Officers of the Registrant" is incorporated by reference herein.

PART II
-------

Item 5. Market for the Registrant's Common Equity and Related Stockholder
-----------------------------------------------------------------
Matters
-------

The Company's Common Stock is traded on the New York Stock Exchange, Inc., the
Philadelphia Stock Exchange, Inc., and the Pacific Stock Exchange, Inc. As of
March 1, 1999, there were approximately 6,829 holders of record of the Company's
Common Stock.

During 1998, the Company issued a total of 2,400 shares of restricted Common
Stock to nonemployee directors of the Company pursuant to the Company's
Restricted Stock Plan for Nonemployee Directors. Given the small number of
persons to whom these shares were issued, applicable restrictions on transfer
and the information regarding the Company possessed by the directors, these
shares were issued without registration in reliance on Section 4(2) of the
Securities Act of 1933, as amended.

Quarterly Financial Information

(millions except for per-share data) First Second Third Fourth Total year
- -----------------------------------------------------------------------------------------------------------------------------

1998 Dividends per share of common stock 0.44 0.48 0.48 0.48 1.88
Price range of common stock --high 87 7/8 90 68 3/8 70 1/4 90
Price range of common stock -- low 69 7/8 67 3/8 46 15/16 50 1/2 46 15/16
- -----------------------------------------------------------------------------------------------------------------------------
1997 Dividends per share of common stock 0.40 0.44 0.44 0.44 1.72
Price range of common stock --high 72 1/4 75 1/4 74 9/16 75 3/8 75 3/8
Price range of common stock -- low 64 3/4 61 1/2 64 3/8 64 1/8 61 1/2
- -----------------------------------------------------------------------------------------------------------------------------

Item 6. Selected Financial Data

ELEVEN-YEAR SUMMARY

(Dollars in millions except for
per-share data) For year 1998 1997 1996 1995
- ------------------------------------------------------------------------------------------------

Net sales 2,746.2 2,198.7 2,156.4 2,325.0
Cost of goods sold 1,838.6 1,461.7 1,459.9 1,581.1
Total selling, general and
administrative expenses and
goodwill amortization 532.7 385.3 413.2 457.0
Equity (earnings) loss from
affiliates (13.8) 29.7 (19.1) (6.2)
Reorganization and restructuring
charges 74.6 -- 46.5 71.8
Charge for asbestos liability 274.2 -- -- --
Loss from ceramic tile business
formation/(gain) from sales
of woodlands -- -- -- 177.2
Operating income (loss) 39.9 322.0 255.9 44.1
Interest expense 62.2 28.0 22.6 34.0
Other expense (income), net (1.7) (2.2) (6.9) 1.9
Earnings (loss) from continuing
businesses before income taxes (20.6) 296.2 240.2 8.2
Income taxes (11.3) 111.2 75.4 (5.4)
Earnings (loss) from continuing
businesses (9.3) 185.0 164.8 13.6
As a percentage of sales -0.3% 8.4% 7.6% 0.6%
As a percentage of average
monthly assets (a) -0.3% 9.0% 8.5% 0.7%
Earnings (loss) from continuing
businesses applicable to
common stock (b) (9.3) 185.0 158.0 (0.7)
Per common share-- basic (c) (0.23) 4.55 4.04 (0.02)
Per common share-- diluted (c) (0.23) 4.50 3.82 (0.02)
Net earnings (loss) (9.3) 185.0 155.9 123.3
As a percentage of sales -0.3% 8.4% 7.2% 5.3%
Net earnings (loss) applicable
to common stock (b) (9.3) 185.0 149.1 109.0
As a percentage of average
shareholders' equity -1.2% 22.3% 19.6% 15.0%
Per common share-- basic (c) (0.23) 4.55 3.81 2.94
Per common share-- diluted (c) (0.23) 4.50 3.61 2.68
Dividends declared per share of
common stock 1.88 1.72 1.56 1.40
Capital expenditures 184.3 160.5 228.0 182.7
Aggregate cost of acquisitions 1,175.7 4.2 -- 20.7
Total depreciation and amortization 142.7 132.7 123.7 123.1
Average number of employees--
continuing businesses 13,881 10,643 10,572 13,433
Average number of common shares
outstanding (millions) 39.8 40.6 39.1 37.1
- ------------------------------------------------------------------------------------------------
Year-end position
Working capital--continuing businesses 367.8 128.5 243.5 346.8
Net property, plant and equipment--
continuing businesses 1,502.0 972.2 964.0 878.2
Total assets 4,273.2 2,375.5 2,135.6 2,149.8
Net long-term debt 1,562.8 223.1 219.4 188.3
Total debt as a percentage of
total capital (d) 73.1% 39.2% 37.2% 38.5%
Shareholders' equity 709.7 810.6 790.0 775.0
Book value per share of common stock 17.57 20.20 19.19 20.10
Number of shareholders (e) 6,868 7,137 7,424 7,084
Common shares outstanding (millions) 39.8 40.1 41.2 36.9
Market value per common share 60 5/16 74 3/4 69 1/2 62
- ------------------------------------------------------------------------------------------------

Notes:

(a) Assets exclude insurance recoveries for asbestos-related liabilities
(b) After deducting preferred dividend requirements and adding the tax benefits
for unallocated preferred shares.
(c) See definition of basic and diluted earnings per share on page 31.
(d) Total debt includes short-term debt, current installments of long-term
debt, long-term debt and ESOP loan guarantee. Total capital includes total
debt and total shareholders' equity.
(e) Includes one trustee who is the shareholder of record on behalf of
approximately 6,000 to 6,500 employees for years 1988 through 1996.

14

From 1996 to July 1998, ceramic tile results were reported under the equity
method, whereas prior to 1996, ceramic tile operations were reported on a
consolidated or line item basis.

From July 1998 to November 1998, ceramic tile operations were reported under the
cost method.

Beginning in 1998, consolidated results include the Company's acquisitions of
Triangle Pacific and DLW.

(Dollars in millions except for
per-share data) For year 1994 1993 1992 1991 1990 1989 1988
- ------------------------------------------------------------------------------------------------------------------------------------

Net sales 2,226.0 2,075.7 2,111.4 2,021.4 2,082.4 2,050.4 1,843.4
Cost of goods sold 1,483.9 1,453.7 1,536.1 1,473.7 1,469.8 1,423.2 1,287.6
Total selling, general and
administrative expenses and
goodwill amortization 449.2 435.6 446.6 415.1 404.0 380.7 331.3
Equity (earnings) loss from
affiliates (1.7) (1.4) (0.2) -- -- -- --
Reorganization and restructuring
charges -- 89.3 160.8 12.5 6.8 5.9 --
Charge for asbestos liability -- -- -- -- -- -- --
Loss from ceramic tile business
formation/(gain) from sales
of woodlands -- -- -- -- (60.4) (9.5) (1.9)
Operating income (loss) 294.6 98.5 (31.9) 120.1 262.2 250.1 226.4
Interest expense 28.3 38.0 41.6 45.8 37.5 40.5 25.8
Other expense (income), net 0.5 (6.1) (7.2) (8.5) 19.7 (5.7) (13.1)
Earnings (loss) from continuing
businesses before income taxes 265.8 66.6 (66.3) 82.8 205.0 215.3 213.7
Income taxes 78.6 17.6 (2.9) 32.7 69.5 74.6 79.4
Earnings (loss) from continuing
businesses 187.2 49.0 (63.4) 50.1 135.5 140.7 134.3
As a percentage of sales 8.4% 2.4% -3.0% 2.5% 6.5% 6.9% 7.3%
As a percentage of average
monthly assets (a) 10.7% 2.8% -3.3% 2.7% 7.5% 8.6% 10.4%
Earnings (loss) from continuing
businesses applicable to
common stock (b) 173.1 35.1 (77.2) 30.7 116.0 131.0 133.9
Per common share-- basic (c) 4.62 0.95 (2.08) 0.83 2.98 2.88 2.90
Per common share-- diluted (c) 4.09 0.93 (2.08) 0.83 2.73 2.75 2.88
Net earnings (loss) 210.4 63.5 (227.7) 48.2 141.0 187.6 162.7
As a percentage of sales 9.5% 3.1% -10.8% 2.4% 6.8% 9.1% 8.8%
Net earnings (loss) applicable
to common stock (b) 196.3 49.6 (241.5) 28.8 121.5 177.9 162.3
As a percentage of average
shareholders' equity 31.3% 9.0% -33.9% 3.3% 13.0% 17.9% 17.0%
Per common share-- basic (c) 5.24 1.34 (6.51) 0.78 3.12 3.92 3.51
Per common share-- diluted (c) 4.62 1.27 (6.51) 0.78 2.86 3.72 3.50
Dividends declared per share of
common stock 1.26 1.20 1.20 1.19 1.135 1.045 0.975

Capital expenditures 138.4 110.3 109.8 129.7 186.5 216.9 167.8
Aggregate cost of acquisitions -- -- 4.2 -- 16.1 -- 355.8
Total depreciation and amortization 120.7 117.0 123.4 122.1 116.5 121.6 99.4
Average number of employees--
continuing businesses 13,784 14,796 16,045 16,438 16,926 17,167 15,016
Average number of common shares
outstanding (millions) 37.5 37.2 37.1 37.1 38.9 45.4 46.2
- ------------------------------------------------------------------------------------------------------------------------------------

Year-end position
Working capital--continuing businesses 384.4 279.3 239.8 353.8 305.2 449.4 260.6
Net property, plant and equipment--
continuing businesses 966.4 937.6 967.2 1,042.8 1,032.7 944.0 930.4
Total assets 2,159.0 1,869.2 1,944.3 2,125.7 2,124.4 2,008.9 2,073.1
Net long-term debt 237.2 256.8 266.6 301.4 233.2 181.3 185.9
Total debt as a percentage of
total capital (d) 41.4% 52.2% 57.2% 46.9% 45.7% 36.1% 35.9%
Shareholders' equity 735.1 569.5 569.2 885.5 899.2 976.5 1,021.8
Book value per share of common stock 18.97 14.71 14.87 23.55 24.07 23.04 21.86
Number of shareholders (e) 7,473 7,963 8,611 8,896 9,110 9,322 10,355
Common shares outstanding (millions) 37.2 37.2 37.1 37.1 37.1 42.3 46.3
Market value per common share 38 1/2 53 1/4 31 7/8 29 1/4 25 37 1/4 35
- ------------------------------------------------------------------------------------------------------------------------------------

Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

1998 COMPARED WITH 1997

ACQUISITIONS

On July 22, 1998, Armstrong completed its acquisition of Triangle Pacific Corp.
("Triangle Pacific"). Triangle Pacific is a leading U.S. manufacturer of
hardwood flooring and other flooring and related products and a substantial
manufacturer of kitchen and bathroom cabinets. The acquisition, recorded under
the purchase method of accounting, included the purchase of outstanding shares
of common stock of Triangle Pacific at $55.50 per share which, plus acquisition
costs, resulted in a total purchase price of $911.5 million. A portion of the
purchase price has been allocated to assets acquired and liabilities assumed
based on fair market value at the date of acquisition, while the balance of
$831.1 million was recorded as goodwill and is being amortized over forty years
on a straight-line basis.

Effective August 31, 1998, Armstrong acquired approximately 93% of the
total share capital of DLW Aktiengesellschaft ("DLW"), a leading flooring
manufacturer in Germany. The acquisition, recorded under the purchase method of
accounting, included the purchase of 93% of the total share capital of DLW
which, plus acquisition costs, resulted in a total purchase price of $289.9
million. A portion of the purchase price has been allocated to assets acquired
and liabilities assumed based on fair market value at the date of acquisition,
while the balance of $117.2 million was recorded as goodwill and is being
amortized over forty years on a straight-line basis. In this purchase price
allocation, $49.6 million was allocated to the estimable net realizable value of
DLW's furniture business and of a carpet manufacturing business in the
Netherlands, which the Company has identified as businesses held for sale.
Disposals of these businesses should occur in the first half of 1999. Earnings
in these businesses, which have been excluded from the Company's operating
results, were $0.4 million in 1998. Interest costs of $1.1 million were
allocated to these businesses in 1998.

The allocation of purchase price to the assets and liabilities of Triangle
Pacific and DLW was still preliminary at December 31, 1998, and further
refinements are possible. The operating results of these acquired businesses
have been included in the Consolidated Statements of Earnings from the dates of
acquisition. Triangle Pacific results are included in Armstrong's wood products
segment and DLW results are included in Armstrong's floor coverings segment.

15

SALE OF DAL-TILE STOCK

In 1995 the Company entered into a business combination with Dal-Tile
International Inc. ("Dal-Tile") whereby the Company exchanged cash and the stock
of its ceramic tile operations, consisting primarily of American Olean Tile
Company, a wholly-owned subsidiary, for ownership of 37% of the shares of
Dal-Tile. In August 1996, Dal-Tile issued new shares in a public offering
there by decreasing the Company's ownership share from 37% to 33%. During 1997
the Company purchased additional shares of Dal-Tile stock, increasing the
Company's ownership to 34%.

In 1998 the Company announced its intention to dispose of its investment in
Dal-Tile. In July the Company settled its sale of 10.35 million shares of
Dal-Tile at $8.50 per share before commission and fees. In October and November,
the Company sold its remaining 8.02 million shares of Dal-Tile at $8.50 per
share before commission and fees. The Company reported a gain of $12.8 million
after tax in 1998 on these sales.

FINANCING

On July 13, 1998, the Company entered into a new commercial paper program and
subsequently issued $1.0 billion of commercial paper. This commercial paper,
secured by lines of credit under a bank credit facility entered into on July 17,
1998, has maturities of up to 364 days and bears interest at rates between
approximately 5.0% and 5.25% at the beginning of 1999.

On July 15, 1998, Standard & Poor's ("S&P") lowered the ratings of the
Company's corporate credit, senior unsecured debt and revolving credit facility
to A minus from A and lowered its commercial paper rating on the Company to A-2
from A-1. On July 16, 1998, Moody's Investors Service ("Moody's") lowered the
Company's corporate credit, senior unsecured debt and revolving credit facility
ratings to Baa1 from A2 and lowered its commercial paper rating on the Company
to P-2 from P-1. Both Moody's and S&P cited factors relating to the acquisitions
of Triangle Pacific and DLW as the major reasons for their actions. It is
management's opinion that the Company has sufficient financial strength to
warrant any required support from lending institutions and financial markets.

On August 11, 1998, the Company completed an offering of $200 million of
6.35% Senior Notes due 2003 and a concurrent offering of $150 million of 6.5%
Senior Notes due 2005. On October 28, 1998, the Company completed an offering of
$180 million of 7.45% Senior Quarterly Interest Bonds due 2038. The Company used
the proceeds to repay outstanding commercial paper.

On October 29, 1998, the Company completed a new bank credit facility for
$900 million which comprise a $450 million line of credit expiring in 364 days
and a $450 million line of credit expiring in five years. This facility replaced
a $1.0 billion, 364-day bank credit facility entered into on July 17, 1998.

FINANCIAL CONDITION

As shown on the Consolidated Balance Sheets on page 28, the Company had cash and
cash equivalents of $38.2 million at December 31, 1998. As a result of
additional current assets added with the acquisitions of Triangle Pacific and
DLW, working capital at December 31, 1998, was $367.8 million compared with
$128.5 million recorded at the end of 1997. The ratio of current assets to
current liabilities was 1.49 to 1 as of December 31, 1998, compared with 1.27 to
1 as of December 31, 1997. The increase in this ratio from December 31, 1997,
primarily reflected asset and liability changes resulting from the acquisitions
of Triangle Pacific and DLW.

Long-term debt, excluding the Company's guarantee of an ESOP loan,
increased $1,339.7 million in 1998 due to the public debt offerings mentioned
above and classification of $750.0 million of commercial paper supported by
long-term bank credit facilities as long-term debt. At December 31, 1998,
long-term debt of $1,562.8 million, or 59.3 percent of total capital, compared
with $223.1 million, or 16.7 percent of total capital, at the end of 1997. For
the periods ended December 31, 1998, and December 31, 1997, ratios of total debt
(including the Company's guarantee of an ESOP loan) as a percent of total
capital were 73.1 percent and 39.2 percent, respectively.

As shown on the Consolidated Statements of Cash Flows on page 29, net cash
provided by operating activities for the year ended December 31, 1998, was
$252.2 million compared with $246.6 million in 1997. The increase is explained
by substantial reductions in Armstrong's pre-acquisition business units' current
assets partially offset by higher payments for asbestos claim payments prior to
insurance recoveries.

Net cash used for investing activities was $1,209.7 million for the year
ended December 31, 1998, compared with $152.8 million in 1997. The increase was
primarily due to expenditures for acquisitions and was partially offset by the
sale of the Company's investment in Dal-Tile.

Net cash provided by financing activities was $937.3 million for the year
ended December 31, 1998, primarily due to the commercial paper issuance and the
three public debt offerings mentioned above. In the prior year, net cash used
for financing activities, including a net reduction in debt and the repurchase
of common shares, was $98.6 million.

Under plans approved by the Company's Board of Directors for the repurchase
of 5.5 million shares of common stock, the Company had repurchased approximately
4,017,000 shares through June 30, 1998. In June 1998, the Company halted open
market purchases of its common shares upon the announcement of its intent to
purchase Triangle Pacific and DLW.

The Company is constantly evaluating its various business units and may
from time to time dispose of, or restructure, those units. On February 2, 1999,
the Company announced its intent to form a joint venture in the worldwide
technical insulation business with NMC (USA)/Nomaco (Belgium) and Thermaflex
(Netherlands).

[BAR CHART APPEARS HERE]

16

ASBESTOS-RELATED LITIGATION

The Company is involved in significant asbestos-related litigation which is
described more fully on pages 47-50 and which should be read in connection with
this discussion and analysis. The Company does not know how many claims will be
filed against it in the future, nor the details thereof, nor of pending suits
not fully reviewed, nor the defense and resolution costs that may ultimately
result therefrom, nor whether an alternative to the Amchem settlement vehicle
may emerge, nor the scope of its insurance coverage ultimately deemed available.

The Company continually evaluates the nature and amount of recent claim
settlements and their impact on the Company's projected asbestos resolution and
defense costs. Subject to the uncertainties, limitations and other factors
referred to above and based upon its experience, the Company has estimated its
share of liability to defend and resolve probable asbestos-related personal
injury claims. The Company's estimation of such liability that is probable and
estimable through 2004 ranges from $424.7 million to $813 million. The Company
has concluded that no amount within that range is more likely than any other,
and therefore has recorded $424.7 million as a liability in the accompanying
consolidated financial statements. The increase of $274.2 million in recorded
liability in 1998 is primarily reflective of the increases in claims filed in
1998, recent settlement experience and current expectations about future claims.

Management estimates that the timing of the cash flows required to resolve the
recorded liability will extend beyond 2004.

Because of the uncertainties related to asbestos litigation, it is not
possible to estimate precisely the number or cost of personal injury claims that
may ultimately be filed. The Company believes it can reasonably estimate the
number and nature of future claims that may be filed during the next six years.
However for claims that may be filed beyond that period, 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 recorded liability. Management
believes that the potential additional costs for such additional claims, net of
any potential insurance recoveries, will not have a material after-tax effect on
the financial condition or liquidity of the Company, although the net after-tax
effect of any future liabilities recorded in excess of insurance assets could be
material to earnings in a future period.

An insurance asset in the amount of $264.8 million, recorded on the
Consolidated Balance Sheet, reflects the Company's belief in the availability of
insurance in this amount based upon the Company's success in insurance
recoveries, settlement agreements that provide such coverage, nonproducts
recoveries by other companies, the opinion of outside counsel, and a recent
agreement with a number of carriers. Such insurance is either available due to
settlement or probable of recovery through negotiation, litigation or resolution
of an alternative dispute resolution (ADR) process which is in the trial phase
of binding arbitration. Further, depending on the Company's future assessment of
the conclusion of the trial phase of the ADR expected in early 1999, additional
insurance assets may be available. Of the $264.8 million asset, $16.0 million
has been recorded as a current asset reflecting management's estimate of the
minimum insurance payments to be received in 1999. However, the actual amount of
payments to be received in 1999 is dependent upon the actual liability incurred
and 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.

The Company believes that a claims resolution mechanism alternative to the
Amchem settlement will eventually emerge, but any liability is likely to be
higher than the projection in Amchem.

Subject to the uncertainties, limitations and other factors previously
stated and based upon its experience, the Company believes it is probable that
substantially all of the defense and resolution costs of property damage claims
will be covered by insurance.

Even though uncertainties remain as to the potential number of unasserted
claims and the liability resulting therefrom, and after consideration of the
factors involved, including the ultimate scope of its insurance coverage, the
Wellington Agreement and other settlements with insurance carriers, the results
of the California insurance coverage litigation, the establishment of the Center
for Claims Resolution, the likelihood that an alternative to the Amchem
settlement will eventually emerge, and its experience, the Company believes
asbestos-related claims against the Company will not be material either to the
financial condition or liquidity of the Company, although the net after-tax
effect of any future liabilities recorded in excess of insurance assets could be
material to earnings in such future period.

17

ACTIVITIES RELATED TO DOMCO INC.

In the fourth quarter of 1998, the Company declined to extend its cash tender
offer for all of the outstanding voting stock of Domco Inc. ("Domco"), a
Canadian flooring manufacturer. In June 1997, the Company commenced litigation
against Sommer Allibert, S.A. ("Sommer"), the majority shareholder of Domco,
alleging, among other things, that Sommer misused confidential information
provided to it by the Company and that Sommer breached a confidentiality
agreement with the Company in connection with earlier negotiations between the
Company and Sommer. That litigation remains pending in the U.S. District Court
for the Eastern District of Pennsylvania, although Sommer's counterclaim against
the Company and certain of its officers and certain of the Company's claims have
been dismissed. The Company intends to pursue its claim for damages, including
punitive damages, from Sommer. A trial date has not been set.

The Company recognized expenses arising from activities involving Domco and
Sommer totaling $12.3 million pretax, or $8.0 million after tax, in 1998.

CONSOLIDATED RESULTS

Net sales in 1998 of $2.75 billion were 24.9% higher when compared with net
sales of $2.20 billion in 1997. Triangle Pacific contributed $346.0 million of
sales and DLW $193.0 million of sales to the Company's business sales figure
before acquisitions of $2.21 billion.

Sales were affected unfavorably by economic developments in emerging
markets. For the Company's business before acquisitions, sales increased less
than 1% in each of floor coverings, building products and insulation products.
Pacific area sales were 13.5% below 1997, although insulation products increased
both domestic sales and exports from its Panyu, China, plant. In Europe, despite
a cessation of sales to Russia in August by all business units, floor coverings
increased sales to other customers including those in Eastern Europe. In total,
emerging market turmoil reduced 1998 sales by an estimated $14.7 million versus
last year, with over three-quarters of this total from lower Russian sales.

The Company reported a net loss of $9.3 million, or $0.23 per share,
including losses of $1.2 million related to Triangle Pacific and $2.8 million
related to DLW as well as after-tax charges of $178.2 million for an increase in
the estimated liability for asbestos-related claims and $48.5 million for cost
savings and reorganization. These results compare to net earnings of $185.0
million, or $4.50 per diluted share, in 1997.

The Company's Economic Value Added (EVA) performance as measured by return
on EVA capital of 13.6% in 1998 exceeded the Company's cost of capital of 11%
and the return on EVA capital of 13.3% in 1997. EVA calculations exclude
financial activity related to asbestos liability claims, while reorganization
charges are treated as investments upon which a return must be earned.

Cost of goods sold in 1998 was 67.0% of sales, higher than cost of goods
sold of 66.5% in 1997. The change reflected required purchase price accounting
adjustments related to Triangle Pacific and DLW. The Company's pre-acquisition
business had a cost of goods sold of 65.9% in 1998 due to manufacturing
efficiencies and lower raw material costs. The cost of goods sold also benefited
from several efficiency and policy savings related to the implementation of the
SAP Corporate Enterprise System, including a change in vacation policy resulting
in a $5.2 million benefit in the fourth quarter.

Selling, general and administrative (SG&A) expenses in 1998 were $522.0
million, or 19% of sales, primarily reflecting higher advertising costs. In
1997, SG&A expenses were $383.5 million, or 17.4% of sales.

In the fourth-quarter 1998, a noncash pretax charge of $274.2 million, or
$178.2 million after tax, was recorded for an increase in the estimated
liability for asbestos-related claims. This change primarily arose from a
greater-than-anticipated increase in personal injury filings since the Amchem
class settlement was invalidated in 1997, the Company's assessment of future
claims and recent settlements with plaintiffs' counsels. The Company also
recognized cost reduction and reorganization charges of $65.6 million, or $42.6
million after tax. This charge encompassed severance and enhanced retirement
benefits related to the termination of more than 650 positions, approximately
75% of which were salaried positions. In addition the Company recorded an
estimated loss of $9.0 million related to redundant flooring products machinery
and equipment held for disposal. Reorganization actions include corporate and
business unit staff reductions reflecting reorganization of engineering,
research and development and product styling and design; realignment of support
activities in connection with implementation of a new corporate logistics and
financial software system; changes to production processes in the Company's
Lancaster flooring plant; and elimination of redundant positions in formation of
a new combined business organization for Floor Products, Corporate Retail
Accounts and Installation Products. Approximately $28.6 million of the pretax
amount is for cash expenditures for severance which will occur over the next 12
months. The remainder is a noncash charge for enhanced retirement benefits.
Management believes that anticipated savings from the reorganization should
permit recovery of these charges in approximately two years. Severance payments
of $10.4 million in 1998 were made for the elimination of 209 positions related
to 1996 and 1998 restructuring and reorganization actions.

Interest expense of $62.2 million in 1998 was higher than interest expense
of $28.0 million in 1997 due to higher levels of short- and long-term debt used
to finance acquisitions.

The Company's 1998 tax benefit was generated by the charge for the increase
in asbestos liability, cost reduction and reorganization charges, and a tax
benefit associated with the gain on the sale of the Dal-Tile shares, partially
offset by the nondeductibility of goodwill in the Company's reported earnings.

18

INDUSTRY SEGMENT RESULTS (see pages 32 and 33)

FLOOR COVERINGS

Worldwide floor coverings sales in 1998 of $1,317.6 million included sales of
$193.0 million from DLW. Excluding DLW, flooring sales grew over 2% in the
Americas due to strong laminate sales that more than offset a decline to
residential vinyl markets. Sales through the home center channel continued to
capture significant volume with sales increases of 16.6% over 1997. In Europe
and the Pacific area, sales were down 8%. Sales for installation products rose
3.8% over 1997.

[BAR CHART APPEARS HERE]

Operating income of $176.5 million in 1998, which excluded cost reduction and
reorganization charges of $53.5 million and included a loss related to DLW of
$0.7 million, compared to $186.5 million in 1997. Lower operating margins were
due to pricing pressure in North America, an unfavorable product mix, and higher
advertising expenses only partially offset by lower raw material and other
costs. The cost reduction and reorganization charges of $53.5 million relate to
reductions of hourly and salaried staff in the U.S. and foreign operations and
changes to production processes in the Company's Lancaster flooring plant.

OUTLOOK

Sales in 1999 are expected to increase modestly due to a better mix in
the Americas in residential sheet flooring and laminates. European sales results
are anticipated to be slightly lower with weaker sales in Western Europe
reflecting price competition partially offset by more robust sales in Eastern
Europe. A more aggressive marketing program in Asia should increase sales in
that region. Operating income should improve, driven by announced cost
reductions and a favorable product mix.

BUILDING PRODUCTS

Building products sales of $756.8 million were slightly higher than the $754.5
million in 1997, as strong sales in the U.S. commercial segments and a favorable
mix were offset by weakness in emerging markets, principally Russia and the
Pacific area, down 29.4% compared to 1997.

Operating income of $116.6 million, which excluded cost reduction and
reorganization charges of $10.1 million, compared to $122.3 million in 1997. The
operating income decline reflected weaker performance by the business's metal
and soft fiber joint ventures in Europe and lower volumes to emerging markets,
partially offset by lower raw material and other costs. Results from the
Company's WAVE grid joint venture with Worthington Industries continue to be
strong, showing an 11% improvement over 1997. The cost reduction and
reorganization charges of $10.1 million relate to reductions of hourly and
salaried staff in the U.S. and foreign operations.

OUTLOOK

Sales in 1999 are expected to exceed those of 1998 with the largest growth
in U.S. commercial sales. Sales are anticipated to increase in Europe with the
exception of Russia, and sales in Asia should continue to reflect depressed
market conditions. Operating income should increase in 1999 reflecting lower
manufacturing and administrative costs and improved operating income from WAVE.

[BAR CHART APPEARS HERE]

WOOD PRODUCTS

This segment contributed $346.0 million to sales for the period from July 22,
1998, from which time Triangle Pacific's results were consolidated in the
Company's financial statements. Sales for Triangle Pacific in 1998, although
approximately 11% ahead of sales reported by Triangle Pacific in the comparable
period in 1997, reflected competitive pricing pressures created by falling
lumber prices and imported products.

Operating income from the date of consolidation of $38.6 million included
the amortization of acquisition goodwill and the costs of nonrecurring purchase
price adjustments related to inventory. On a comparable basis, operating income
for Triangle Pacific in 1998 was approximately 35% above operating income
reported by Triangle Pacific in 1997.

OUTLOOK

Triangle Pacific anticipates sales growth through its expansion of
dealer programs, continued growth of new products and improved product finishes.
Lower lumber prices, increases in sales volumes and continuing production
efficiencies should positively affect operating income. The integration of
Triangle Pacific should result in synergies as early as 1999.

19

INSULATION PRODUCTS

Sales of $230.0 million increased from $228.4 million in 1997. Sales in Europe
and the U.S. were level. Despite difficulties in the Pacific area, sales
increased from last year due to strong performance from the business's Panyu,
China, plant. Operating income of $46.3 million increased from $45.4 million in
1997, excluding cost reduction and reorganization charges of $0.2 million,
primarily due to cost cutting and SG&A expense reductions.

OUTLOOK

Price pressures in the markets for insulation products are expected to continue
into 1999. However, volume growth in sales of these products should offset this
negative pressure and result in a small operating income increase for this
business unit.

ALL OTHER

Sales reported in this segment comprise gasket materials and textile mill
supplies. Sales of $95.8 million decreased 4% compared to 1997. The major
influence on gasket products sales was the General Motors strike. Textile sales
declined due to slow sales to European textile machinery manufacturers.
Operating income reported in this segment comprises operating income from gasket
and textile products and ceramic tile. Operating income of $9.1 million
excluding cost reduction and reorganization charges of $1.9 million compared
with a loss of $2.6 million in 1997 reflecting the absence of losses from
Dal-Tile.

OUTLOOK

Sales of gasket products are anticipated to continue to reflect weakness in the
automotive sector and a downturn in the diesel market. Cost containment efforts
in gasket manufacturing should offset the effect of the sales volume decline.
Textile products are expected to be affected by price pressures in 1999.

GEOGRAPHIC AREAS (SEE PAGE 33)

Net sales in the Americas in 1998 were $1.92 billion, compared to $1.52 billion
recorded in 1997. The increase in sales to customers in the United States and
Canada was primarily due to the addition of Triangle Pacific sales. For the
Company's pre-acquisition business, sales growth continued to be strong in the
U.S. home center channel. Net sales in Europe in 1998 were $631.3 million,
compared to $488.4 million in 1997. Additional sales from DLW were somewhat
offset by lower sales to Eastern Europe, most notably Russia. Sales to
Scandinavian countries have continued to grow, reflecting increased sales from
the Swedish flooring and ceiling joint ventures. Sales to the Pacific area and
other foreign countries of $192.9 million were level with sales of $192.2
million in 1997.

Long-lived assets in the Americas in 1998 were $1.01 billion compared to
$0.77 billion in 1997. This increase reflects additional assets from the
acquisition of Triangle Pacific. Long-lived assets in Europe in 1998 were $451.7
million compared to $163.1 million in 1997. This increase reflects additional
assets from the acquisition of DLW. Long-lived assets in the Pacific area in
1998 were $41.2 million compared to $42.2 million in 1997.

MARKET RISK

The Company uses financial instruments, including fixed and variable rate debt,
as well as swap, forward and option contracts to finance its operations and to
hedge interest rate, currency and commodity exposures. Swap, forward and option
contracts are entered into for periods consistent with underlying exposure and
do not constitute positions independent of those exposures. The Company does not
enter into contracts for speculative purposes and is not a party to any
leveraged instruments.

20

INTEREST RATE SENSITIVITY

The table below provides information about the Company's long-term debt
obligations as of December 31, 1998, and December 31, 1997. The table presents
principal cash flows and related weighted average interest rates by expected
maturity dates. Weighted average variable rates are based on implied forward
rates in the yield curve at the reporting date. The information is presented in
US dollar equivalents, which is the Company's reporting currency.

- ------------------------------------------------------------------------------------------------------------------------------------

Expected
maturity date After
($ millions) 1998 1999 2000 2001 2002 2003 2003 Total
- ------------------------------------------------------------------------------------------------------------------------------------

As of December 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------------

Liabilities
Long-term debt:
Fixed rate -- $ 28.9 $ 46.2 $ 29.7 $ 5.5 $ 206.5 $ 507.9 $ 824.7
Avg. interest
rate -- 5.19% 6.38% 5.46% 6.42% 6.36% 7.50% 6.99%

- ------------------------------------------------------------------------------------------------------------------------------------

Variable rate -- $ 4.0 $ 5.0 $ 302.0 $ 0.0 $ 450.0 $ 10.0 $ 771.0
Avg. interest
rate -- 7.0% 7.0% 5.71% 0.00% 5.90% 4.00% 5.81%

- ------------------------------------------------------------------------------------------------------------------------------------

Expected
maturity date After
($ millions) 1998 1999 2000 2001 2002 2002 Total
- ------------------------------------------------------------------------------------------------------------------------------------

As of December 31, 1997
- ------------------------------------------------------------------------------------------------------------------------------------

Liabilities
Long-term debt:
Fixed rate $ 13.5 $ 21.0 $ 22.1 $ 7.5 $ 0.0 $ 153.0 $ 217.1
Avg. interest
rate 8.88% 4.79% 8.14% 9.00% 0.00% 9.13% 8.59%

- ------------------------------------------------------------------------------------------------------------------------------------

Variable rate $ 1.0 $ 4.0 $ 5.0 $ 2.0 $ 0.0 $ 8.5 $ 20.5
Avg. interest
rate 9.38% 8.28% 8.28% 8.28% 0.00% 3.90% 6.52%

- ------------------------------------------------------------------------------------------------------------------------------------

Debt cash flows increased as of December 31, 1998, in comparison to December 31,
1997, as a result of financing entered into in 1998 (see page 16). In 1997 and
1998 the Company entered into forward-starting interest rate swaps designated as
hedges of long-term bonds. In 1998 the Company terminated these interest rate
swaps concurrent with the issuance of its 7.45% quarterly interest bond due
2038. The loss of $16.3 million upon termination of the swaps will be recognized
as an adjustment to interest expense over the life of the bond.

The Company had no interest rate hedging agreements in place on December
31, 1998.

EXCHANGE RATE SENSITIVITY

The Company uses foreign currency forward contracts to reduce the risk that
future cash flows from transactions in foreign currencies will be affected
unfavorably by changes in exchange rates.

The table below provides anticipated net foreign cash flows for goods,
services and financing transactions for the following 12 months as of December
31, 1998, and December 31, 1997.

- --------------------------------------------------------------------------------
Foreign currency Commercial Financing Net Net
exposure ($ millions) exposure exposure hedge position
- --------------------------------------------------------------------------------
As of December 31, 1998
- --------------------------------------------------------------------------------
British pound $ 10.3 $(67.0) $ 53.2 $ (3.5)
Canadian dollar 51.6 -- -- 51.6
French franc 31.3 7.5 (7.5) 31.3
German mark (64.6) 277.5 (267.6) (54.7)
Italian lira 31.8 2.4 (2.4) 31.8
Spanish peseta 18.6 -- -- 18.6
Australian dollar 8.5 4.3 (4.3) 8.5
Belgian franc (22.6) (38.1) -- (60.7)
Dutch guilder (9.8) -- 12.0 2.2
Swedish krona (2.8) 2.2 (1.2) (1.8)
Swiss franc 1.6 (5.9) 3.7 (0.6)
United States dollar* 9.7 (9.5) -- 0.2
- --------------------------------------------------------------------------------
As of December 31, 1997
- --------------------------------------------------------------------------------
British pound $(24.0) $(17.1) $ 12.1 $(29.0)
Canadian dollar 37.0 -- -- 37.0
French franc (17.0) 3.3 (3.3) (17.0)
German mark (48.0) 12.4 (12.4) (48.0)
Italian lira 25.0 2.3 (2.3) 25.0
Spanish peseta 7.0 2.3 (2.3) 7.0
- --------------------------------------------------------------------------------

Note: A positive amount indicates the Company is a net receiver of this
currency, while a negative amount indicates the Company is a net payer.

*Related to U.S. dollar exposures by foreign subsidiaries with a foreign
functional currency.

21

Company policy allows hedges of cash flow exposures of up to one year. The
table below summarizes the Company's foreign currency forward contracts and
average contract rates at December 31, 1998, and December 31, 1997. Foreign
currency amounts are translated at exchange rates as of December 31, 1998, and
December 31, 1997.

- --------------------------------------------------------------------------------
Foreign currency Forward Contracts
contracts ($ millions) Sold Avg. rate Bought Avg. rate
- --------------------------------------------------------------------------------
As of December 31, 1998
- --------------------------------------------------------------------------------
British pound $ 13.8 1.68 $67.0 1.67
French franc 7.5 5.57 -- --
German mark 329.4 1.64 61.8 1.65
Italian lira 2.4 1653 -- --
Australian dollar 4.3 0.6207 -- --
Dutch guilder -- -- 12.0 1.88
Swedish krona 1.2 8.0 -- --
Swiss franc 2.2 1.34 5.9 1.31
- --------------------------------------------------------------------------------
As of December 31, 1997
- --------------------------------------------------------------------------------
British pound $ 5.0 1.68 $17.1 1.61
Dutch guilder 2.0 2.00 -- --
French franc 3.3 5.9 -- --
German mark 12.4 1.79 -- --
Italian lira 2.3 1726 -- --
Spanish peseta 2.3 151.5 -- --
- --------------------------------------------------------------------------------

Foreign currency hedges are contracts that have no embedded options or other
terms that involve a higher level of complexity or risk.

COMMODITY PRICE SENSITIVITY

The table below provides information about the Company's natural gas swap
contracts that are sensitive to changes in commodity prices. Notional amounts
are in millions of Btu's (MMBtu) and weighted average contract prices. All
contracts mature in or before December 2000.

- --------------------------------------------------------------------------------
On Balance Sheet Commodity
Related Derivatives 1998 1999 2000 Total
- --------------------------------------------------------------------------------
As of December 31, 1998
- --------------------------------------