Armstrong World Industries Inc (AWI) 2007 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to Armstrong World Industries' third quarter 2007 earnings conference call.

(OPERATOR INSTRUCTIONS)

I would now like to turn the conference over to our host, Ms. Beth Riley, Director of Investor Relations. Please go ahead.

Thank you. Good morning and welcome. Please note that members of the media have been invited to listen to this call and the call is being broadcast live on our website at armstrong.com.

With me this morning at Mike Lockhart, our Chairman and CEO, and Nick Grasberger, our Senior VP and CFO.

You hopefully have seen our results in this morning's press release and both the release and the presentation Nick will reference during the call are posted on our website in the investor relations section.

In keeping with SEC requirements, I advise that during this call we will be making forward-looking statements that involve risks and uncertainties. Actual results may differ materially from those expected or implied. For a more detailed discussion of the risks and uncertainties that may affect Armstrong, please review our SEC filings, including the 10-Q filed this morning.

In addition, our discussion of operating performance will include non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of these measures, with the most directly comparable GAAP measures, is included in the press release and in the appendix of the presentation. Both are available on our website.

With that I'd like to turn the call over to Mike.

Thanks Beth. Let me begin by saying that we still have nothing to offer you about our review of strategic alternatives, beyond the statement that we remain actively involved in the process. We still don't know where the process will lead and when a conclusion is reached we will make a timely disclosure.

We can talk about what were encouraging results in the third quarter. Our third quarter results modestly exceeded our expectations. Both sales and operating income grew despite the challenge of the weak U.S. housing market. We generated in excess of $100 million of cash in the quarter. In addition, a $180 million tax refund was received in the beginning of October. This refund will be reflected in our fourth quarter financial statements.

We continue to improve the factors that are within our control and thus mitigate the residential market related volume declines.

Quarter-to-quarter and year-to-date, we have improved product mix and price realization while reducing manufacturing expenses.

Building products, our ceilings business, continues to perform well. We saw improved product mix and increased price realization. Encouragingly, we also saw process improvement increasing manufacturing efficiency, which contributed to profit growth in this segment.

Resilient flooring more than doubled operating income despite flat sales.

North American resilient sales declined 2% in the third quarter.

Our volumes of residential products were down mid-single digits in markets that were much weaker.

Continuing the trend of the first half, higher sales from commercial products and improved product mix in both residential and commercial products largely offset the residential volume pressures. For both the quarter and year-to-date, significantly reduced manufacturing costs, lower SG&A spending, and raw material deflation contributed significantly to profit growth.

In constant dollars, European resilient sales increased about 3% for both the quarter and year-to-date. The operating income benefits of higher sales were offset by higher raw material costs and the negative synergies related to our divestiture of the textile and sports flooring businesses. These negative synergies, which were anticipated, should dissipate over the next couple of quarters.

Wood flooring has the greatest exposure to the new housing market in the U.S. Approximately 55% of wood sales goes to new houses and the remainder to residential renovation. As a result of weak new home construction, our wood volume declined about 12% to 13% for the quarter and about 8% year-to-date.

Lower sales combined with increased lumber prices to reduce operating income for the quarter despite substantial benefits from manufacturing productivity.

Cabinet sales grew in the first half of the year. But as we previously mentioned, we never believed we could indefinitely sustain sales growth given the significant weakness in the U.S. housing markets. This proved to be true in the third quarter.

In the first half we benefited from our lack of exposure to large builders in the big box customers. Initially, these customers took a disproportionate hit from declines in new housing. As the downturn has deepened, our customer base of small to mid-sized builders has been increasingly hard hit and in the third quarter cabinet sales declined due to those worsening markets and to service problems related to an ERP implementation. The fourth quarter will benefit more than normal from sales carried over from the third quarter.

The ERP implementation problems also caused manufacturing inefficiencies, which hurt third quarter profitability.

While the system will provide significant benefits over the long term, we took a one quarter hit to both sales and earnings during the implementation.

Overall we've delivered solid performance in the third quarter and I believe we've continued to outperform our markets in the North America.

For the full year, we expect results to be in the previously announced range, albeit at the low end of the range. The outlook for U.S. housing remains bleak for reasons you're all familiar with -- lower housing starts, weak existing home sales, all time high inventories of unsold homes, falling home prices.

Concerns about sub prime mortgages, increasing interest rates, and the recent tightening of credit standards have created serious issues with mortgage availability.

Renovation spending varies significantly by region, but if our customers are representative the overall renovation market is soft.

In this tough environment, our objective remains to gain market share and improve product mix through innovative products and services that deliver value to our customers. We'll continue to control cost and to improve productivity.

And now, Nick will provide a discussion of the numbers.

All right, thank you Mike. As Beth noted, my comments will refer to the slides posted to our website. I'll start with the first chart, which is numbered page 3.

This chart reconciles the operating income for the quarter from what we reported in the 10-Q and in the press release, to the adjusted number that we'll use for analysis.

The components of the bridge here are consistent with those in previous quarters. And you may recall back in the spring we had a very detailed reconciliation of the adjustments for fresh start accounting. In this quarter, they provided a benefit of about $6 million, which was a net of the write-off of certain unrecognized losses and then the -- some incremental depreciation related to the write-off of assets. So the adjusted number for the quarter is $83 million.

The next chart shows the key metrics for the quarter compared to the same metrics for last year. Sales were down 70-basis points. Unit volume was down about 5%. Price and mix each contributed about 2 percentage points of growth.

If you consider the volume decline at 5%, that was almost all due to the North American residential businesses both in flooring and cabinets.

The gross profit margin improved 110-basis points to 24.4%. That's driven largely by higher pricing in manufacturing efficiencies more than offsetting the impact of inflation.

SG&A expenses were up 3.6% at $251 million. There are two items really that led to that increase. Excluding those items, SG&A would have been down. The first item is we took a rather large, at least for us, $3 million reserve on accounts receivables for a wood distributor on the east coast that's experiencing some credit problems. We also have this year the amortization in recognition of the expense related to our emergence equity program for management that we did not have last year. So if you take those two items out, SG&A expense actually would be down versus year go.

Operating income was up about 3%. The margin improved to 9.2%.

And cash flow was about $100 million higher than last year due to a number of factors. First of all, profit, cash earnings, are up year-over-year. We're not currently paying domestic tax. Working capital is down for the quarter and capital spending was also below last year.

So at the end of the third quarter our net debt position was about $250 million.

Chart 5 shows the reconciliation of the $80 million of operating income earned in the third quarter of last year to the $83 million earned in the September quarter of this year.

You can see in terms of price we generated $16 million of incremental operating income due to higher pricing. About three quarters of that was due to building products, the balance was North American commercial flooring.

Volume and mix contributed -- I guess reduced earnings by $10 million year-over-year. The impact of lower volume was $15 million, again mostly due to North American residential. The mix was actually --contributed plus $5 million of earnings.

Inflation in raw materials and energy was mostly in building products. Products from their waste ring, the input cost and waste paper, mineral wall, starch and so forth.

Manufacturing costs were $6 million lower year-over-year principally due to North American flooring and also North American building products.

Corporate expenses are up about $5 million year-over-year due largely, again, to the accounting for the emergence equity program for management.

And the WAVE business experienced no change in operating income versus year ago. The operations of the business actually improved by about $2 million in earnings, but relative to last year we had higher interest expense that offset the impact of higher earnings.

So, again, operating income on an adjusted basis is up about 3% versus last year.

Chart 6 shows the change in sales and operating income for the quarter versus last year by business unit, both sales and operating income. The resilient flooring segment experienced no change in sales. Volume was down, price and mix were up. Within volume, North American volume was down, European volume in resilient was largely flat and Asia was up.

The wood-flooring decline of 12% in sales was due mostly to volume. The increase of 7% in building products, about 150-basis points of that was volume, the balance of it price and mix -- more mix than price.

And in cabinets, the 4% decline was mostly volume.

Looking at operating income, year-over-year resilient was up over $7 million. The impact of improved pricing and mix offset the impact of lower volumes, but manufacturing and SG&A costs were both down year-over-year contributing to the increase.

The operating income in wood flooring was down $3 million despite manufacturing and SG&A costs being lower. The impact of lower volume more than offset that.

In building products, profit was also up about $7 million, mostly due to a North America pricing and mix.

In cabinets business, earnings declined $3 million due to volume and higher manufacturing costs.

And then at corporate, again, a $5 million increase due to the accounting incentive compensation programs.

I have a few charts here showing really the same data on a year-to-date basis. I won't go through it in the same detail. On chart 7, you can see the adjustments reported to adjusted operating income. The components being the same as they were for the quarter.

On chart 8, we show the key metrics on a year-to-date basis. Sales up 1.5%, volume is down through nine months about 2%, and price and mix are each up about 175-basis points.

The gross margin and the operating margin are each up about 1 point versus year ago. Again, largely due to the fact that pricing and mix and manufacturing efficiencies are more than offsetting the impact of inflation.

In terms of cash flow, cash flow of $264 million versus a year ago, much higher. Pre-tax income was $60 million higher than year ago. Cash taxes are $70 million lower. Working capital is about $35 million lower. And then we have an extraordinary dividend that we took out of our WAVE joint venture of about $85 million.

Looking at the bridge through nine months on page 9, again similar components to those of the quarter. Earnings increased 15% on a like basis. Pricing and manufacturing costs being the large drivers of earnings growth.

Volume down somewhat, largely offset by mix. And the inflation of $25 million that we've seen year-to-date is due to building products.

Page 10 shows the business unit performance, sales and operating income on a year-to-date basis. The trends are largely the same as they were in the quarter with the exception of cabinets. In the first six months of the year, cabinets had shown reasonable growth in sales and earnings. That trend reversed in the third quarter.

Chart 11 shows the guidance for the year. And, again, this is unchanged from what we shared with you in late July. We expect sales to be up 2% to 3%. Embedded in that is a volume decline of about 2% and price and mix up about 4%.

Operating income up 10% to 15% for the year. You may recall on the call in late July, we expected the third quarter to be slightly down. In fact, the third quarter, as you've seen, has come in slightly above a year ago. We do expect now the fourth quarter though to be slightly weaker than last year compared to our previous outlook that the fourth quarter would be a little better.

And then cash flow for the full year we expect to be between $470 and $490 million. A significant variance versus year ago. And what that translates into is a net debt number at year-end of about $50 million. And you may recall when we emerged from bankruptcy back in the fall of 2006 that we started with net debt in excess of $700 million.

The final chart here, just some directional comments on each of the businesses for the full year and these were -- are largely consistent with the indicators, the outlook that we had provided back in March. In terms of resilient flooring sales, we expect to be slightly down, but the margin in resilient for the full year should be up about 200-basis points versus year ago.

Similar volume trends in wood flooring. The margin growth though will be down about 100-basis points year-over-year.

Building products, sales will be up kind of mid to high-single digits for the full year with the margin up about 200-basis points.

And cabinets, their margin should be relatively flat on a full year basis, but relative to our peers certainly we expect the margins to look attractive.

Okay. So that concludes the review of the quarter and year-to-date. We'll open the line for questions.

(OPERATOR INSTRUCTIONS) John Baugh of Stifel Nicolaus.

Couple of things. First of all, the net debt guidance for the end of the year, in light of the tax refund does that imply really no free cash generation of the fourth quarter? Help me there.

Yes, no, I still think if you do the math we'd expect $50 to $75 million of free cash flow in the fourth quarter from operations.

Does that not get you then below a $50 million number? You have $180, you said, from the tax refund and what was your net debt position?

250 or so, plus or minus.

So that would get you closer to zero debt but hopefully that's a conservative assumption or estimate.

Yes.

Okay. Just curious whether you can make any additional comment. You're spending on the strategic review went up fairly significantly in the third quarter. What do I read into that and the fact that we still don't hear anything?

I don't think you read into it anything more than we said at the start, which is that we're still very actively involved in the process and that we have nothing that we can comment on publicly.

Are you in a position where -- your balance sheet is essentially going debt free here within a month or two, that's probably not the capital structure you want long term. Do you just wait and see what the strategic review comes out or do you make a step in the interim?

I think we will wait and see.

Thank you.

[Matt Sherwood of (Inaudible).]

Hi, great quarter guys. Just to build on John's question before, I was wondering in your post emergence presentation you had said that an appropriate level of debt is two to three times EBITDA. I recognize that it's not anywhere close to that based on the strategic review, but have you adjusted your view as to appropriate levels of leverage or not?

No, I would say that over the long term that that would be a targeted leverage structure for the company.

All right, thank you.

Andrew Simon, Kingdon Capital.

Thanks. I just want to talk for a minute about emergence pay and how you guys are getting paid. And my question is the senior management of the company, do they have a choice of taking their pay right now in stock or in cash and if so, what choice are they making?

Andy, they don't -- let me tell you how we're paid and then we can -- the answer to your question is we don't have the choice. But when we emerged we had what is generally seen as a typical emergence equity grant which kind of was at the mid point of the range of what people see coming out of bankruptcy, 1.5% or something like that, which got spread across 450-some-odd people.

And so that's -- it represented for most people two or three years worth of what would think of as a long term incentive. And so those people didn't receive -- most of those people didn't receive a grant in -- long term incentive grant in 2007. Most of them won't receive a grant again in 2008.

The stock vests over four years beginning at year two, beginning at the end of year two, and that represents their long-term incentive.

We have the normal base and bonus structure that you would expect us to have which is -- we're kind of right at the -- in the fiftieth, the sixtieth percentile of the thing. And the bonus typically to date has been done based on performance against budgeted income.

And over the last several years our average -- the average performance against that has been about 95%. We've achieved about -- we've been 4% or 5% below budget. This year we're substantially over budget.

That is a very thorough answer and I thank you for that. What I'm just trying to get at is I mean I think your stock is remarkably inexpensive and so I'm trying to see whether the management and board shares my opinion. And the way that I would see that is if they are, to the extent they are able, trying to get paid in shares as opposed to cash right now. So that's what I was looking for. But I guess you said nobody has a choice.

Nobody has a choice. I mean the board does get -- the board just received its annual grant of shares so that it is paid in shares. So we all have a substantial portion of our income that's related to the stock price.

Thanks for that. I have one other question and that's in regard to deferred taxes. For some reason during this quarter the deferred tax asset dropped from $200 million to about $112 million, and the deferred tax liability went from 56 to 116. So those are big changes that haven't occurred in previous quarters and I was just wondering if you could explain to me what happened.

Well, the principal driver of that change is a change in our election of a carry back with the NOL. We had been assuming that we would make a two-year carry back election, and as we've disclosed we've elected a 10-year carry back election. And that utilized effectively more of the losses in that carry back than we had assumed in the previous deferred tax account.

Excellent. Thank you.

(OPERATOR INSTRUCTIONS) Matt Sherwood, (inaudible) Fund.

Just had a quick question on the wood flooring side. I know there have been several significant transactions with the Shaw, Anderson, and Mohawk, Columbia. Does that, in your view, change the competitive landscape at all for you or not at all?

No, we don't think so. I mean obviously both of those companies were heavy suppliers to the companies that bought them and so we don't think it changes the competitive landscape.

And this is -- obviously wood's an area where we've seen good growth, we've got a strong market position, we've seen what we think is market share increases this year. And it's an area where we have interest in acquisition if the right opportunity comes along.

So we don't see that as a big deal in terms of our competitive position in the wood. And we don't think that's the last wood acquisition that's going to be done this year.

Thank you.

John Baugh, Stifel Nicolaus

Yes, what was your fourth quarter a year ago adjusted EBIT number?

One second. The adjusted operating income figure last year was about $50 million.

So you would anticipate being slightly below that in this fourth quarter? I'm curious would it be all wood flooring? Is resilient weakening in the U.S. as well, cabinets as well? We've obviously got a housing depression going on here.

Yes, well one item that's -- well, there are two things really. The first one is within the wood flooring business. We're making some marketing investments related to a program with Home Depot, the benefits of which we will see in 2008 and beyond. So we are making some investments in marketing.

We also have -- if you look at some of the other businesses how they've been spending throughout the year, there has been some lagged SG&A expenses that they will anticipate to make in the fourth quarter.

Could you make a comment on sort of the commercial side of the world, both flooring and particularly ceiling tiles. A lot in the press about credit tightening affecting commercial building spend next year. Have you seen anything in your order book on the commercial side of the world both domestically and in Europe that concerns you?

Well, we said we haven't seen anything in Europe that would be concerning us. Obviously when we -- we have two things really. One is everybody who talks about commercial you've got to talk about which elements of commercial are important to you. When you look at ceilings, the biggest driver of demand for ceilings is in the office market and that's generally heavily influenced by a growth in office employment. It still is pretty good.

On the other hand, you've seen a flattening vacancy rate. We never thought that we'd see lots of growth in that market next year. We had it initially as flat. If we look at it today, we'd probably think it's down 1% from next year.

On the resilient side, our customers are more institutional. There's a lot in education, a lot in medical stuff, which we think will continue to be pretty good. We also sell some into retail, which is going to be slower for a couple reasons. One, because of the slowdown in residential and, two, because of the change in the way they have their design concept in floors is increasingly the large guys are going to polished concrete instead of having a floor covering.

So, what we'd say is we'd probably see a 1-point softening of our outlook in '08 for the commercial business as it relates to ceilings. And we should -- we think we'll be okay, we'll see a modest growth in commercial in the resilient business.

And the business in Europe has been pretty good. It moves around. But the U.K.'s terribly important to us in the ceiling business and orders in the U.K. are up over last year in ceilings and so we feel pretty good about that.

Okay. And then the last question was, CapEx and DNA for both '07 and then '08, if you have it. And then is there another dividend coming out of WAVE this year or any guess on next year?

Well, regarding WAVE, the extraordinary dividends are behind us. We have a plan to take out probably three-quarters of the cash earnings for the quarter in the fourth quarter. So, yes, we will likely receive another dividend in the fourth quarter.

With respect to DNA and CapEx, CapEx for the year, I think, is now expected to be in the $100 to $110 million range and depreciation is $130 to $140, something like that.

Any thoughts on next year Nick?

Not yet John.

Okay. Thanks, congratulations. Appreciate it.

We have a question now from Constantine Mamakos, Quaker Capital Management.

Thanks for taking my question. One quick one, what's the net debt at WAVE?

WAVE has outstanding debt of about $100 million now. And they have a modest amount of cash.

And then as I look at your cash flow from operations guidance of $4.33 to $4.44 for the year.

Sorry, that's not from operations, that's after capital spending.

What are the one-time items within that? Is there the $230 million tax refund? Is that all that's anticipated from refunds in that number?

Right. We just received $180 million refund from a 10-year carry back, and then earlier in the year we had received a refund of about $50 million for taxes paid in 2006.

There are a couple of offsets to that -- partial offsets, about $30 million in post chapter 11 costs and we made a $20 million payment to AHI in the settlement which also ran through cash from operations.

Is that within the $25 to $29 million estimate there? The payment to AHI?

Yes, that was the settlement we paid.

And then going forward, the WAVE business, do you expect to take dividends out roughly equal to their equity earnings in that business?

Yes, probably a little bit less, 75% to 80% I would say.

And last question, if you hit $3.5 million in sales for the year and the low end of your EBIT guidance, it looks like something like an 11.8% EBITDA margin. And I think your long-term goals are 12% to 14%. And I was wondering what specific initiatives will be required to get toward the high end of that range?

Well, certainly a recovery in the North American residential business would be a big boost to that. Beyond that, as we look at our global manufacturing structure we continue to believe that we have opportunities, as we have realized over the past three or four years, to improve manufacturing costs.

And if you look at the commercial business, we've continued to see an improvement in the selling mix. We would expect that to continue.

Okay, that's all. Thanks.

David MacGregor, Longbow Research.

Yes, good morning. I wonder if you could talk a little bit about your lumber cost outlook. I realize obviously it's determined in large part by what's happening in residential construction but more specifically with respect to risk management programs you may have or hedging programs, can you give us some outlook of how your lumber prices are going to play out over the next two, three, four quarters.

Our lumber situation's very different than what you normally hear of when people talk about lumber because we're buying hardwood, not softwood. And we buy from 1800 supplies, 1850 different suppliers, and really we buy virtually all of it on the spot market. We've never found a cost effective mechanism to hedge it beyond buying trees. Years ago we did own trees but we don't think trees are a good investment.

And so we haven't really found a good way to insulate ourselves from swings in the market.

The market itself is also odd because when you cut a tree you get a mix of quality of lumber out of the tree. The highest grades of the lumber go to the furniture industry. And so the decline of the furniture industry in the United States has caused decline for the highest grades of lumber to decline. That reduces the revenue that people can expect when they cut a tree, which leads to fewer trees cut, which means we have to pay more in order to get the amount of lumber we need for our product. It's very counterintuitive. We have studied the heck out of it and we think it's right. And so we -- that's why we have the unusual anomaly of falling demand for our product and yet higher raw material costs.

Thanks. That's a pretty full answer, I appreciate that. What percentage of your lumber source, of those 1850 suppliers, are domestic versus foreign?

95% of the wood we make is -- we sell is from the United States.

Is domestic, okay. Thank you. The next couple of questions just on the commercial business, can you give us an update on what commercial represents as a percentage of your total sales?

As I said, it was sort of 45% to 48% of the sales. That's roughly where it is.

And how much forward visibility do you have in your North American ceilings and resilient flooring businesses?

Excuse me?

How much forward visibility do you have in your North American ceilings and resilient flooring business?

We don't have -- in terms of orders, not much. What we use for visibility is Dodge and sort of the same thing everybody uses, Dodge information. And our ceilings business sells pretty aggressively to architects and we do try to maintain a sense of how busy the architects are as an indicator of what's going to happen.

And that's why I mention all the architects we see coming through here are very busy right now, and so that's why we're not quite as pessimistic about our markets as Dodge is in the overall situation.

Would it be fair to say there might be three months of forward visibility in terms of orders?

No, it's not that long.

It's not that long. Okay. Very good, thank you for your help.

Jerry Rivera, SAC Capital.

Just a question. I guess as you enter the ninth month of the review management really has been pretty handicapped by not being able to talk to more sell side analysts, buy side analysts, go on non-deal road shows to New York and Boston. Is there a specific law that prevents you from talking to investors as you go through this strategic review? Is there something that your lawyers are looking at not letting you do that?

I John' know the answer to that.

No, there's not.

It's a matter of prudence as opposed to something else.

So you think it's prudent to not go and talk to investors.

Wait a second, that question -- that's one of the questions that we're not going to answer. What we think is it is prudent given that being in the midst of a strategic review, a strategic option, to not be aggressively marketing the stock. That's what we think is a prudent thing.

But the answer is it prudent not to talk to investors, honestly that's a question that's phrased better as an answer as opposed to a question.

And then you made a comment earlier, you said you were looking at making acquisitions in the wood industry. Did I hear that correctly?

What we said was that we -- that the wood was an area where we think there may be acquisition opportunities that we would (inaudible).

And that would be, I guess, considered separately from the strategic review.

Yes, no, that's -- I mean that's routine. I rather think of that as a routine thing. There's nothing -- we're big enough that we couldn't do anything that would be -- we're big enough in the wood business we would be prohibited from doing anything that's really large and that would change the nature of the company very much.

But there's a lot of different wood manufacturers, a lot of them are suffering mightily from this downturn, and there's some good guys out there that are going to find themselves in trouble and we'd like to help them if we can.

And then lastly on the capital structure. I guess also you commented that you would wait until the conclusion of the process to be able to right size your capital structure. Why is that? I mean I would consider that something as routine as making a small wood acquisition.

I think it -- I'm not sure that everybody would agree with you on that. It wouldn't make a sense to borrow a lot of money today, which is what we'd really have to do, and then get involved in some sort of strategic disposition of all or part of the company. I mean it doesn't make -- and then have to repay the debt. So, we're going to continue to have relatively low levels of net debt until we figure out what the structure of the company is going to look like.

Okay, thank you.

Alex Mitchell, Scopus Asset Management.

Hi good morning. I just have a couple of questions just about the drag from the ERP and how long does that continue as well as the negative synergies that you talked about.

I didn't hear the second part of it.

As well as the negative synergies that you talked about, how much of a drag is that--

When we bought PLW in 1998, it comprised a resilient business and a textile business. We disposed of the textile businesses -- if you look at the (inaudible) structure of the industry in Europe for that, we think at this point all -- if not all, virtually all resilient manufacturers have divested textile assets. When we looked at the structure of the textile business we were a relatively large player in one of 400 people and we felt that a substantial investment was going to be needed.

While the business we had gotten -- we'd improved the business, (inaudible) was making money but substantial further investment was going to be needed to make it competitive, moving stuff to Eastern Europe blah-blah-blah-blah. And we had an opportunity to sell it to private equity which we did beginning of the year.

We had a combined sales force and a combined SG&A -- really a combined SG&A structure. When we took out what essentially were half of the sales, we didn't -- we couldn't take out a proportion -- immediately couldn't take out a proportional amount of the cost and so that's what led us to problems. We had -- there was two problems -- we have excess cost, and, two, we lost -- in markets where the textile business was the larger market, we lost a great percentage of the sales force that we had selling our product.

So we're restoring the sales force in the markets where we need to and we're trying to go through the process, improvements needed to take the people out in the restructure. So that's why it's taken us a little time to work through it.

Now, in terms of Europe, the problem Europe has is that while we have -- based on some good work that they did in terms of product, we've had reasonably good market acceptance of our products, we are a relatively high cost manufacturer. And when you look at each of the products is in a slightly different position. In our linoleum business we're in the midst of doing the final evaluation of the project, which will bring us into cost parity with the leader in the market, we're the number two guy there. We're at a substantial cost disadvantage in sort of double-digit percentage in our vinyl products. We're in the middle of a process -- really at the beginning of the process in Germany that will enhance that.

And we're evaluating our alternatives with respect to the other two vinyl plants as to whether or not -- as to exactly how we can make them cost effective.

And then, of course, in Europe there will be opportunities, or should be opportunities, for a strategic combination which we generally said that that was something that could be an attractive alternative for us.

So we expect to see some improvement in manufacturing productivity over the next year and we have another series of product introductions that'll come in late '08, early '09, and which we hope will leave us with a product line that continues to be well accepted in the marketplace.

Alex, were you also asking about the ERP system at the cabinets business?

Mr. Mitchell, your line is still open.

Let's take the next question.

[John Kim of Alpine.]

Had a quick question about your pricing initiative. Obviously that offset a lot of the overall margin decline for the quarter and for the year. And I suspect a lot of that came from the building products segment. Could you talk a little bit about whether that -- first of all, whether the rate of increases year-to-date has been in line with competitors. I assume it has.

And then, given the lag in pricing increases in Europe, ability to manage the margin decline in offsetting that. What are your anticipations for pricing increases within those various segments of your business in the next quarter let's say?

In other words, you would obviously have to plan right now to anticipate any -- to offset any anticipated weaknesses in various businesses. So I'm just wondering as a forecasting tool what divisions you're looking at and how you're approaching that strategy.

Well, we tend to adjust prices in ceilings a couple of times a year assuming that we have cost pressures that we need to deal with. When you look at the price realization, half of our improved price realization is mix -- selling higher value products. And that's been a beneficial thing in virtually every element of our business in the third quarter.

The only places where we didn't see mix improvement was in European ceilings and Asian floors. So mix has been a big deal for us.

In the building products business, we have been able to get higher prices but we also had a lot of raw material cost pressure that caused us to need higher prices. The cost pressures come from the fact that we use a lot of waste streams and there's increasing demand from China for those waste streams and that's driving the raw material costs.

But I don't think we have any price increases actually in the fourth quarter or we announced to make in the fourth quarter. So we do it a couple of times a year. And it varies depending on where -- on what we think we need to do competitively but sort of in -- so it varies during the year. We did have a couple of price increases within ceilings and in the floor business in the third quarter.

Okay, thank you.

David MacGregor of Longbow Research.

Yes. You talked about the Home Depot initiative in your wood flooring business. Can you just give us a general sense of how your advertising promotion expense might be up or down year-over-year, year-to-date.

It's up year -- in the floor business it's up about $3 million. But immediate costs we're spending about $14 million, last year we were about $10 or $11. That really comes from the addition of television to the mix in response to competition. We tend to -- we have always tended to spend more money in advertising than other flooring manufacturers and we continue to do that.

When we're dealing with the Home Depot, what Nick referred to is a program that we -- where a special order program for wood at Home Depot which we're in the middle of implementing displays to make that work.

Now, wood you've got a good, better, best brand positioning strategy and you talked in response to the question from the last caller about the fact that mix drove half the price increases in the third quarter. Presumably that was the case in wood flooring. Can you just talk a little bit further about what you did see within mix and wood flooring?

Well, mix and wood flooring, I don't -- let me take one second just because I don't think it is true that the mix in wood flooring was up -- was 50% of the total. Because in wood flooring clearly as we got into -- we had a disproportionate demand in wood flooring through the big box customers for an entry level product and so in wood flooring we didn't get the same lift from mix that we did in other products.

We did have a beneficial mix but it wasn't of the same magnitude. So it's the sales of low end product and entry-level product.

Was that channel sale associated with this Home Depot initiative or was that just--? Was that channel sale associated with the Home Depot initiative or was that a reflection of POS?

That was just basic demand. Remember one of the things in wood that we can't lose sight of is that the low end of wood is considered an upgrade in a house. And so as we see people trying to move houses, one of the things they're doing is upgrading from vinyl to wood flooring. And so we've seen demand at that low end of the wood as people have been adding that as an incentive to sell houses.

Thank you. And then last question, can you remind us what percentage of your sales are through big box retailers right now?

About 20% David.

20% to big box. Okay, thank you very much.

Alex Mitchell of Scopus Asset Management

I'm sorry about -- I don't know what happened, I couldn't follow up before. Just on the initiatives that you're making, do you have a target on how much costs you're able to take out? I mean you talked about by the end of '08 you'd be through many of those initiatives.

We wouldn't have targets per se. We are in the midst of our budget process for 2008, and I suspect we can talk in more detail about that in the new year when we update you on our outlook for 2008.

And then, yes, I did want to ask about the European, how much of a drag that was and how much -- how long will that continue?

Yes, we believe that the drag, if you will, around the European implementation of cabinets was isolated in the third quarter. We believe that there should be some incremental sales in Q4 spilling over from Q3 due to that. But we believe, again, those issues to be behind us.

Okay. Do you have a dollar amount that that took out?

A few million dollars of earnings I'd say.

Okay, thank you.

At this time we have no further questions on the phone lines. I'd like to turn the conference back over to Ms. Riley for any closing or final remarks.

All right. Than you, again, everyone for joining us. I will be available for calls at 717-396-6354. Have a good day.

That does conclude today's conference. We thank you for your participation. Please have a good day.