Armstrong World Industries Inc (AWI) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2012 Armstrong World Industries, Inc. earnings conference call. My name is Deanna and I'll be the operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session. (Operator Instructions) As a reminder, today's conference is being recorded. I would now like to turn the call over to your host, Mr. Tom Waters, Vice President, Treasury and Investor Relations. Please go ahead.

Thank you, Deanna.

Good afternoon 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 afternoon are Matt Espe, our President and CEO; Tom Mangas, our CFO; Frank Ready, CEO of our worldwide floor businesses; and Vic Grizzle, CEO of our worldwide ceilings businesses. Hopefully you have seen our press release this morning and both the release and the presentation Tom Mangas will reference during this 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 outcomes 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. Forward-looking statements speak only as of the date they are made.

We undertake no obligation to update any forward-looking statement beyond what is required by applicable securities law. 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 will turn the call over to Matt.

Thanks, Tom. Good afternoon, everyone, and thanks for participating in our call this afternoon.

The second quarter of 2012 exhibited many of the same themes as the first quarter. European economies continue to struggle and market demand was below our already pessimistic assumption. North American commercial markets performed below our expectations, while new residential construction was up, albeit off a very low base, and Asia was a mixed bag. Given this macroeconomic backdrop, Armstrong's performance in the quarter was largely as you would expect.

Sales of $710 million were down $39 million or 5% from 2011, with the overwhelming majority of the drop coming in Europe. European sales performance was exacerbated by the Euro currency weakness. Excluding the impact of foreign exchange, sales were down $22 million or 3%, with more than all of the difference in foreign exchange coming from the Euro. Sales were below the low end of the guidance range of $740 million, driven primarily by the issues in Europe, softness in US commercial markets, and severe inventory reductions at one of our big-box customers, all versus our expectation.

Year-to-date sales are $1.378 billion, down $56 million or 4% from 2011. And as with the quarter, the sales decline is primarily driven by the Euro zone and exacerbated by currency. On comparable foreign exchange basis, sales were down 2.5%.

Despite the top line challenges, we were able to deliver adjusted EBITDA of $110 million, up $2 million from the second quarter of 2011 and within our guidance range of $105 million to $120 million. EBITDA performance was helped by continued productivity improvements and ongoing SG&A expense management. I am pleased to announce that we now expect to achieve $200 million from our cost savings program by the end of 2012. This is up from our most recent estimate of $185 million and the original target of $150 million. The additional savings will come from both SG&A and manufacturing productivity.

Now given the prominence Europe has been receiving in the headlines, I wanted to help you contextualize the region for Armstrong. Europe for Armstrong reporting purposes includes the Middle East, as well as Africa. And 2011, this region represented about 20% of our sales and 7% of adjusted EBITDA, with more than all the EBITDA coming from the Ceilings business. Italy and Spain represent about 7% of our European sale. Obviously, these are large economies that are going through difficult times and our sales to those countries are down more than 20% year on year. But, Italy and Spain are only a fraction of the European story for Armstrong.

The Middle East, Africa, and emerging Eastern European countries, including Russia, produce almost 25% of the regional revenue and provide some offset to struggling Western European market. For instance, our sales to Russia are up 30% year-to-date. As we've mentioned in the past, our Ceilings business in Europe is broadly spread across the region at significant sales to Russia and the Middle East. Thus, ceilings sales for the quarter were only down 2% versus 2011 on a comparable foreign exchange basis. Our Flooring business is largely concentrated in the Euro zone and experienced a sales drop of 17% on a comparable foreign exchange basis. Despite sales being down $25 million for the quarter, adjusted EBITDA is actually up versus 2011, as Europe benefits from cost reduction action.

In the Americas, we continue to see softness in commercial markets, particularly K to 12 education, and healthcare, as government budgets remain constrained. Also, the weakness we saw in the first quarter in the Northeast office market continued into the second quarter, although June activity actually ticked up. For Armstrong, these trends impact both our Ceilings and Resilient Flooring businesses, but more so the flooring side, which depends on education and healthcare for over 50% of its sales. We're adjusting our outlook for US commercial activity down, impacting both of our Businesses, and of course this is reflected in our updated guidance.

The residential sector continues to show signs of improvement, but even here, activity is mixed. We see strong performance in our Builder business, as new home construction picks up and builder sentiment improves. However, repair/remodel activity is fairly flat and recent consumer confidence reports and lower existing home sales figures leave us cautious on the subsegment.

In the quarter, our residential resillient products saw sales increases versus 2011, with continued strong performance from our high end Alterna and Luxe Plank product. And while our North American wood sales were down just under 5% year on year due to a big-box customer, sales to independent retailers and builders were up. Despite lower sales in the wood business, an adjusted EBITDA was up year on year. Inventory and customer service issues we discussed in our first quarter results have been fixed, as we've added staffing and capacity at three plants.

In Asia, the office sector in China slowed and our Ceilings business experienced year on year sales decline. Our flooring business in China, which is more exposed to education and healthcare, saw sales increases. The opposite was true in India, where ceiling sales were up, but flooring was down. Australia continued to experience a soft commercial construction market and both businesses were down year on year.

As I mentioned before, on a consolidated basis, Armstrong's adjusted EBITDA for the quarter was up $2 million over 2011. Cost savings in both manufacturing and SG&A and price and mix improvements offset volume declines and modest input cost inflation.

Profitability in the second quarter was also negatively impacted by slower than expected ramp-up of our Millwood, West Virginia mineral wool plant and by environmental charges at our ceilings plants in St. Helens, Oregon and Macon, Georgia. Looking forward, we're lowering our sales and EBITDA guidance based on the market conditions just discussed. We're essentially calling for flat sales year on year with gains in North American residential product and Asia being offset by significant weakness in our European Flooring market. Adjusted EBITDA for the year should be in the range of $400 million to $430 million. This is up from 2011 adjusted EBITDA of $377 million, but down from our previous guidance range of $420 million to $460 million.

Tom Mangas will provide more details on these figures, as well as our guidance for the third quarter. With that, I'll turn the call over to Tom to review the financials.

Thanks, Matt. Good afternoon to everyone on the call.

In reviewing our second quarter and year-to-date results, I'll be referring to the slides available on our website starting with slide 4, Key Metrics, as Tom Waters already covered slide 2 and slide 3 is simply an explanation regarding our standard basis presentation.

As Matt mentioned, EBITDA for the second quarter rose 1%, despite a sales decrease of $22 million on excluding foreign exchange impacts. Adjusted operating income and earnings per share results both increased by 3%. Second quarter free cash flow was $36 million, down from the same period in 2011. I will address the drivers of EBITDA and free cash flow in more detail on upcoming slide. We closed the first quarter with net debt of $878 million, up from $409 million at the end of the first quarter and $542 million at the end of the second quarter of 2011, as we paid our $500 million special cash dividend in April.

Slide 5 details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $42 million on the quarter. The cost reduction initiative and accelerated depreciation adjustments for the second quarter of 2012 are related to the permanent closure of our Mobile, Alabama ceiling facility, announced on our first quarter earnings call, and SG&A cost reductions in our European Ceilings business.

You'll recall the second quarter of 2011 was impacted by restructuring and cost out efforts in European Flooring and the closure of our Beaver Falls, Pennsylvania ceiling facility. Interest expense was higher in 2012 than 2011, as debt increased by about $250 million, as we financed a portion of the dividend we paid in April 2012. Tax expense was lower versus the prior year, driven by an increase in international income from lower tax jurisdictions.

Moving to slide 6, this provides our sales and adjusted EBITDA by segment for the quarter. Excluding the impact of foreign exchange, Resilient Flooring had a sales decline of 5%, driven by weakness in Europe, which saw sales decline by 17%.

The sales drop was more than entirely volume-driven, as price and mix were favorable. Again, excluding the impact of foreign exchange, sales in Asia were essentially flat with declines in Australia and India offsetting continued growth in China. North American resilient was down slightly, even though we saw mid-single improvement in our independent residential Resilient business. Commercial flooring volumes declined mid-single digits, particularly in sectors driven by public spending, offsetting gains in price and mix. Resilient Flooring EBITDA improved due to our cost-out efforts and price and mix gains.

As Matt mentioned, Wood Flooring sales were down due to inventory reductions at a big-box customer. However, we saw mid-to-high single digit gains in the independent retail channel and builder segments, as new housing construction growth begins to flow through to our sales. Despite overall lower volumes, the Wood business was able to grow EBITDA versus 2011, driven by manufacturing productivity improvements.

Building product sales were flat, as price and mix gains offset volume declines in all regions. In the US, we saw a continuation of the weakness in our Commercial business, that Matt has already discussed. For the quarter, commercial ceilings volumes were down in the low single digits.

The sales decline in Europe was primarily the result of lower volumes in the Euro zone, although as Matt highlighted, sales in eastern European markets grew. Excluding the impact of foreign exchange, sales in Asia were down 4%, as activity in new office construction in China slowed in the second quarter.

Adjusted EBITDA at Building Products was also flat, as the price gains and higher profit from our WAVE joint venture offset the volume drop and input inflation. As Matt mentioned, ABP's profitability was also suppressed by over $5 million of costs in the quarter associated with the delayed startup of Millwood and the environmental charges at our domestic plants that we are carrying in our adjusted EBITDA results. Cabinet sales and adjusted EBITDA declined on lower volumes. The corporate segment was down due to the expected continued decrease of our non cash pension credit, or corporate expenses were lower year on year.

Slide 7 shows the building blocks of adjusted EBITDA from the second quarter of 2011 to our current results. The story on the quarter was of volume decline across our commercial-oriented markets. This was $19 million -- a $19 million drag on quarterly earnings. For a perspective, Europe volume weakness alone contributed to just over half the total EBITDA impact from volume versus the prior year. Price and mix gains exceeded input cost inflation at the company level.

Resilient Flooring was particularly noteworthy in its ability to drive mix, as luxury vinyl tile continues to grow faster than the market and our products, like Alterna and Migrations, our corn-based tile, are gaining share. Continued SG&A and manufacturing cost reductions totalling $14 million, and higher year on year earnings from WAVE offset volume headwinds and the lower non cash pension credit. The net manufacturing cost improvement of $6 million versus the prior year is inclusive of the $5 million of costs associated with the Millwood startup and the environmental charges.

Turning now to slide 8, you can see our free cash flow for the quarter. Cash earnings are higher than the prior year, driven by lower cash taxes, but more than offset by higher working capital and increased capital expenditures. The increase in working capital is a year-over-year comparison story, as we are now lapping our successful account payables actions that drove outsized payables gains in 2011. Accounts payable was still a contributor to free cash flow in 2012, as is typical in the second quarter. The large capital expenditures are associated with our emerging market plant construction projects. WAVE was also positive year on year. Finally, we made significant cash payments for restructuring in the prior year that did not repeat in this quarter and which makes the bulk -- makes up the bulk of the restructuring and Other line.

Slides 9 through 12 illustrate our year-to-date financial results. Sales were down 2.5% on a comparable foreign exchange basis, driven by European macroeconomic issues and continued softness in commercial markets in the US. Operating income, adjusted EBITDA, earnings per share, and free cash flow were also lower, driven by, largely, our first quarter results.

Slide 10 illustrates our sales and adjusted EBITDA by segment for the first half of 2012. The story is essentially the same as for the quarter, so I won't spend much time on this page. But I do want to remind you that in addition to the Millwood and environmental headwinds that building product space in the second quarter, the Ceilings business absorbed $4 million of expenses in the first quarter for our transition of the Marietta plant back to our permanent staff and the temporary workers who ran the plant during the lockout.

Slide 11 is our year-to-date EBITDA bridge, and again, the story is very similar to the quarter. Lower commercial market opportunity across our core geographies has been a significant drag on EBITDA in the first half. Like in the second quarter numbers, our European segments drove half of the impact to EBITDA from volume.

It is this experience in Europe and the continued softness in the US and Asia that is leading us to lower our full-year sales and earnings guidance. I'll share more on that later. Of note on this slide, you can see the combined $24 million of savings we have achieved in manufacturing and SG&A expenses to date, which is on track with our updated savings target for the year of $50 million.

Slide 12 is the year-to-date free cash flow bridge and just like the quarter, cash, earnings and WAVE are offset by working capital and capital expenditures. On Slide 13, as Matt mentioned, we have increased the amount of our cost savings program to $200 million, a 33% increase from our original target of $150 million, and now we expect to achieve $50 million of cost savings in 2012. While before we were not expecting to have additional SG&A savings in 2012 over 2011, the market conditions in Europe and in the US commercial segments have forced us to look deeper to find additional SG&A cost savings and we are seeing a higher yield from our efforts initiated in 2011. The charges we took on the quarter for European restructuring and ceilings were to support some of these permanent savings. In addition, we are targeting further manufacturing productivity across our plant network. Our goal is to have the full $50 million in savings fall through to the bottom line in 2012.

Slide 14 updates the guidance for 2012. We are lowering our sales guidance from a range of $2.9 billion to $3 billion, now to a range of $2.75 billion to $2.85 billion, due to the macroeconomic issues and resulting lower market opportunity we have discussed. Given an essentially flat sales expectation, we are lowering our EBITDA guidance range from $420 million to $460 million to a range of $400 million to $430 million. At the midpoint of this guidance, we would realize a 10% improvement versus 2011 despite low single-digit volume declines company-wide. This, again, illustrates the power of our cost reduction initiatives.

As a result of lower earnings, we now expect free cash flow to be in the $30 million to $70 million range, down from $170 million in 2011, as we do not anticipate a special dividend from WAVE in 2012, and as capital expenditures rise related to our three China plants and the recently announced Russia plant. The midpoint of our earnings per share range is down $0.30 from the previous guidance, driven by our lower expected earnings for the year.

Slide 15 provides more detailed assumptions going into our earnings guidance and includes the specifics on the third quarter. Raw material costs have moderated somewhat, but we still expect to see inflation of $20 million to $30 million from an array of items, including PVC and plasticizers, TI02, waste paper, corn starch and other input materials. We continue to expect to fully offset material inflation with price in 2012.

Despite flat sales, our manufacturing cost out efforts, continued focus on improving mix and measured pricing to recover commodity inflation should drive improved gross margins of 50 to 100 basis points. This is down versus our prior guidance, as we are not able to benefit from as much fixed manufacturing cost absorption due to the lower volumes. Our non cash US pension credit will decline to $12 million, as we reflect the final stages of our pension de-risking strategy, update demographic and discount rate assumptions and continue to amortize market losses in 2008. This is unchanged from April.

We expect WAVE's earnings to be flat with 2011, as global revenues decline similar to our core business. This is down from our previous expectation of a slight increase. We forecast cash taxes of roughly $10 million to $20 million on the year, also unchanged from April. Our estimate for the third quarter projects sales to be in the range of $740 million to $780 million, basically flat with 2011 on a constant exchange basis. We expect the third quarter of 2012 to produce EBITDA of $120 million to $140 million compared to $124 million on a comparable basis in 2011.

We expect worldwide volumes to continue the trajectories we saw in the second quarter, with commercial ceiling volumes down in the US in the low single digits, commercial flooring to be down mid-single digits, and the Euro zone to be down double digits. We expect US new residential and Asia to be the few bright spots, with volumes to be up year on year. Global price and mix gains will help sales get back to flat on a year-over-year basis in the quarter. Manufacturing productivity and mix improvements will be our core earnings drivers in the third quarter. Our capital spending range of $225 million to $250 million is lower than previous guidance, as we uncover savings opportunities and the timing of some spending shifts into 2013.

Our emerging market plants remain on schedule. Lastly, for the full year 2012, we now anticipate $10 million to $15 million in EBITDA adjustments associated with already announced actions. This also is unchanged from previous guidance.

Clearly, the macro climate is a challenge, which we remain confident we are doing all we can to manage in the areas we can control to deliver strong shareholder value creation over the long run. With that, I'll now turn it back to Matt.

Thanks, Tom.

As Tom just said it, is a tough macroeconomic environment and just when one sector of the region starts to show signs of recovery, another takes a step back. But while the markets sort themselves out, everyone at Armstrong remains focused on our strategic priorities, and of course they include building and maintaining a competitive cost structure driven by our now $200 million cost reduction program, investing in organic growth and priority of emerging markets, as evidenced by building three plants in China and the SUMIX plant in Russia. Finally, building a winning team, a globally aligned organization, as illustrated by our recently formed global architectural specialties team.

So thank you very much for your attention today. And with that, we would be happy to take any questions.

(Operator Instructions)

Your first question is from Keith Hughes with SunTrust.

Questions both in Resilient and on Hardwood about this inventory takedown -- that your independent channel numbers were very encouraging, and obviously kind of screwed the quarter up. Can you give us any sort of metrics around how big this was in terms of dollars or units or anything of that nature?

Go ahead, Frank.

Yes, Keith, the inventory takedown was more than 100% of the decline in the Americas for the total business. So it was in the range of $10 million to $15 million of sales out as a result of the inventory reductions.

I'm sorry. You said $10 million to $15 million in sales?

Yes.

And is that wood and --

The predominance is wood, but there is also some Resilient in there as well.

Okay, and what are the big-boxes telling you the reason for this -- to basically slower sales coming and they did this for a reason, I guess. What's their view?

Well, their view -- one, you have to ask them obviously, why they did it. What we've been told is they want to run the business on lower inventory. And so they are relying more on special order express versus in-stock as a way to drive inventory out of the store.

Okay, and question in Ceilings, at least domestically -- any sort of changes in terms of trends in July? I guess I would say the same thing for Resilient in Wood.

Well, I would say that July order rate supports the estimate for July, for the third quarter, Keith. What we saw was a fairly precipitous drop in the second quarter in almost every commercial subsegment -- education, healthcare, retail. Not only in new construction, which was, if you go back to the September 2011, we laid in the 2012 operating plan, but also in the remodel. We saw a little bit of softening there as well.

All right. Thank you.

Your next question comes from the line of Stephen Kim, Barclays.

It's John, actually, filling in for Steve. We're just trying to get a better idea of how to reconcile the sales decline in Wood Flooring to recent results from Lumber Liquidators, where they showed high single-digit -- sales up high single digits. Do you think it could possibly be share shift? Or just trying to get a better idea around that.

Yes, John, it's Matt.

I think, as Frank said, we had a single big-box retailer make a significant reduction in their in-store inventories. We didn't lose share at that retailer, but that retailer's actions probably affected their sell-through. We saw an offset, not entirely, but through other independent channels. So I think that's the best way we could describe it. As Frank said, it was more than 100% of the drop, so one customer, one decision affected us.

Got it, and for the Wood Flooring business, what is the percentage of big-box sales done?

It's between 25% and 30% of our total volume.

Got it. All right. Thank you.

You bet.

Your next question comes from the line of Mike Wood, Macquarie Capital.

Do you have visibility in your channel in terms of weeks supply of inventory and could you give us that number?

You mean the inventory on the part of the channel themselves?

Yes, do they give you that data to know what the current level of inventory is running? And are we bottomed-out now? Have they done the full destocking?

They don't -- we don't really have visibility to that. We try to manage or measure sales out. That's as good a proxy. We're obviously very close to the distributors.

Okay, and then sequentially, in the Wood Flooring business, it looks like your incremental margins were something like 59% 1Q to 2Q. Is that largely a favorable margin shift from a higher independent retail mix?

I'm sorry, Michael. I'm not sure I understand the question. Could you repeat that?

1Q to 2Q, on slightly higher sales, you had a pretty big operating margin improvement. I'm wondering if that was a favorable margin shift that you had from having less big-box sale versus the independent retail sales in that Wood Flooring segment.

Yes, Mike, this is Tom.

I would say, one, Wood business is significantly benefiting from prior year cost takeout. And sequentially, sales were up almost $20 million on a normalized basis. So I think you're getting simply a little bit of that SG&A and productivity benefit that we're taking the whole year up on, as well as the fall through on the sales. So I think there's a big cost story there. Productivity at the wood plant has been good.

Okay, thank you.

Your next question comes from the line of Kathryn Thompson, Thompson Research Group.

Not to beat a dead horse and talk about Wood Flooring again, but are big-box inventory reductions just specific to flooring? Or are there other categories that are being impacted by pushing this big-box retailer to reduce inventory?

Well, in our case, Kathryn, obviously it's more significant in flooring than it is in Building Products, just because it's a bigger part of Frank's business than Vic's. That one customer's actions affected both categories, both Businesses, but was a bigger, much bigger part of what happened to Frank.

So you're seeing it in other categories -- so a push to reduce inventories meaningfully?

Well, we're seeing it not only in the categories that we sell, but across a lot of the categories they merchandise.

What other categories?

You mean beyond ceilings and floors?

Yes, yes.

You know what -- I would hesitate to comment on that. That's probably better left for them to comment on. I would confirm that, to the extent that they destocked, it's a lesser impact on Building Products, our Building Products Business felt it as well.

And did they give a rationale for a broad-based inventory reduction?

You know what, I just feel a little uncomfortable continuing to comment on what their strategy might be. Just -- our intent here is to point out the fact that, that decision had an inordinate, probably disproportionate, impact on our business. We are just trying to be transparent about it.

Okay. How much did a softer Europe impact Ceiling demand in the quarter?

Well, I think Ceilings, because of the balance, the breadth of the coverage -- I mean, our Building Products Business gets significant benefit from a strong Russia. As we said, sales were up 30%. Middle East continued to be very strong, just in general terms, for us. So it had a significantly less negative impact us on than it would have in Floors.

Our Flooring Business is almost entirely Eurozone; while centered in the Germanic countries, which was less affected than the Mediterranean countries, obviously we had a more significant impact there. 90% of our business, our flooring business in Europe is tied to public spending, so with austerity and the austerity measures being taken and some of just the political stuff that went on in the quarter, it certainly affected our Flooring business more than our Ceilings business.

Basically, if I could add, Kathryn, I would say, clearly, we expected Europe to be down on the second quarter. It just was worse than we expected. It wasn't the whole miss on sales. We had dramatic variation on our sales versus our guidance range; that wasn't all explained by Europe, because we had built some of that in. But it did get worse, what I'll call in the 5% to 10% range.

Okay. So Flooring had a bigger impact than Ceilings?

Absolutely.

All right. I'll get back in the queue. Thanks.

Thank you.

Your next question comes from the line of Bob Wetenhall, RBC.

I wanted to understand -- last year you guys did around $375 million of EBITDA, and Tom had said in his prepared remarks that you're looking for $50 million of cost savings to drop to the bottom line. So I'm just trying to understand -- that gets you to $425 million?

And given what's going on in Europe and the difficult macro condition, are you very confident that the bottom floor for EBITDA this year is going to be $400 million? Or do you think that's -- what's the assumption going into that, around Europe in the back half of the year?

Sure. This is Tom.

Well, I would say that our guidance range of $400 million to $430 million is, given the volatility of our business and the excellent on the way up and tough on the way down incremental margins, it's a pretty tight range. So it does have an assumption of some level of macroeconomic activity built in. And I would say that we're still assuming Europe's down double digits in the back half. And that the domestic market continues to be down as well in the commercial segments -- low-single digits in North American Ceiling, as I highlighted, and on the commercial side of Flooring, also down low- to mid-single digits.

So we have an assumption of continued pressure on volume, heavy from Europe, but how much worse can Europe get? To lose $10 million of EBITDA at kind of our average incremental margin we've talked about, only have to lose $30 million in sales to move $10 million of EBITDA, right? So, comes down to what your expectation of how bad Europe can get. Right now we feel like we've got it called accurately, but that's a tough crystal ball to read.

Understood. Obviously, the volume environment is kind of soft right now. Do you think the difficulty from demand side will impact the price and mix area where you're doing so well? Or do you think that's also susceptible?

Well, yes, Bob -- this is Matt.

Price and mix continues to be a bright spot for us. I think the team's done a great job driving price in both Businesses. We're seeing mix benefits from new product, some of the segment shift. So, we're hopeful that, that holds on, even in light of some demand pressure.

I do think the way to look at our pricing, Bob, would be kind of net of material costs. I think the indicator to watch is what's happening in commodity costs and inputs. I think to the extent that we have volatility, we'll continue to be able to price and hold price in that environment. I think if it's a straight nosedive down on commodities, we'll get a benefit there, but we also may not be able to get the price that we hope for. I think in net, we'll still be, clearly be, positive on the year and still be able to likely do better than competition in that measure.

And if I could just sneak one last one in quickly -- could you just give a little color on what you're seeing in terms of the inflationary headwinds and where those are coming across?

Well, we're looking at $20 million to $30 million of additional inflation this year. So it's increasing at a lower rate than we saw last year. And it still is based primarily on PVC, plasticizers, and to a lesser degree, CIO2.

Got it.

And one thing that's rearing its ugly head right now is corn starch, which is a big ingredient in ceiling tiles with corn running hot, so I think it will continue to be in those key materials.

Thank you very much.

Your next question comes from the line of Dennis McGill, Zelman and Associates.

Matt, I think you touched on this a little bit, but correct me if I'm wrong -- I think you said Flooring in Europe was down 17% for the quarter, Ceilings was down 2%. Can you just talk about the pace of what you saw, and maybe split it between both Europes? And then kind of a similar question on just domestic non-res -- as far as the pace through the quarter and then into July, are you seeing any bottoming or improvement in those rates of decline?

Yes, as Tom mentioned a while ago, we certainly expected Europe in total to be soft. It was just softer than we anticipated. And again, the European Business is very different or the European environment affects Flooring and Ceilings very differently. As you rightfully said, our Business, Flooring Business was down 17%. It's been a tough year on the demand side for Flooring all year, as we're tied 90% to public spending.

It dropped a little bit through the quarter, a little bit more than we had anticipated. And again, geographically, we're seeing the relatively broad-based drop geographically. The Ceilings business was helped by the Middle East and pretty significantly by Russia. As we pointed out, we're up about 30% there. So we have a broader economic base in Ceilings. We also have a bigger position in the UK in Ceilings than we do in floor.

So it's -- while we are a little disappointed in the Ceilings volume based on what's going on in the market, we're satisfied with that plus the earnings improvement we saw based on the cost reduction activities in both mineral, fiber and metal ceilings, architectural specialty, nice improvement there.

In terms of North America non-res, that's flattish. Certainly the new construction is up and kind of about where we expected it to be. So no good, no better news than expected, but no worse news. But we did see softening in the remodel business, as consumer confidence is bagged and existing home sales is bagged. So we see them down 6.

And that's a source of remodel. You buy an existing home, you remodel it. And so that goes, as zero that is going to put pressure on remodel. So we see that, of course, in residential Resilient and Wood Floor demand.

Okay. So that second comment on North America -- that was across all the products, not Ceilings-related?

Exactly. That was --

Okay.

North America would be almost entirely Floors.

Right. So there are a lot of issues going on within the Wood Flooring, between inventory correction this quarter and then the service issue last quarter, and then you've got a little bit of a disconnect between the construction cycle and when the floors go in. How do you think about the underlying growth between, on the Flooring side, between residential new and home improvement, if you think about pure customer demand?

Well, it's a good question. So the Flooring service issues are behind us. So we executed the plan that Frank laid out for you a quarter ago. Service levels there are back to historic highs and really no perceptible impact on demand as a result of that.

The downdraft that we got in the big-box -- certainly didn't anticipate it coming into the quarter. We would like to hope that, that gets corrected. I think that we -- the fundamental demand in residential new construction will continue to be the same. It will be a positive, albeit where we expect through the year.

I am concerned about resi remodel, because it is very dependent on consumer confidence and probably less directly on meaningful improvement in unemployment. So that isn't where we want it to be and we have a very modest view of that. That is factored into our outlook and estimate for the balance of the year, though.

Okay, and then just to wrap that up -- the residential side, realizing those consumer issues and you mentioned existing home sales -- good debate whether that's a driver or not -- you've seen strength at the independent retailer side, though. So do you feel like they are taking share? Or is there something else going on within that segment of your customer base?

Go ahead, Frank, please.

I think, as Tom and Matt had said earlier, Dennis, we experienced mid- to high-single digits growth in our independent business, largely driven off of the strength of new construction. And the strength of that market. We think we did as well as, if not slightly better than, the market in terms of performance; but clearly, on the independent side with the mid- to high-single digits, we're benefiting from the strength in new construction.

Okay. Thank you very much, guys.

Okay.

Your next question comes from the line of Jim Barrett, CL King & Associates.

Tom, I think this is a question for you.

Can you give us your current outlook for steel costs for the grid Business? And how would you expect WAVE's margins to behave if steel prices were to subside near to intermediate term from here?

Well, I would say, number one, grid had a very good second quarter, largely -- a little bit of a history lesson on WAVE on the margins -- you recall last year they had a price increase in the first quarter, a couple price increases that pulled a lot of volume in to the first quarter of last year. So, number one, they had a tougher second quarter of 2011 and a pretty easy comp this time around, although we did build some share, we believe, this quarter. And I think, fundamentally, given the uncertainty around steel prices, I don't think that they are going to be able to drive significantly more margin growth in the current year beyond what we've seen to add earnings.

I think really, they are going to be a let's drive volume, let's drive share, and that's going to be their orientation, particularly in Europe. And that will be the story that hopefully holds them flat despite a tough market environment.

And to your first point, on the actual price of steel -- that's a factor in this forecast; I am going to have to get back to you on that one. I don't have that off the top of my head, Jim.

And generally is the view that you're taking share from your leading competitor or from some of the weaker player or players in the market?

Yes, we don't think we're winning share versus USG.

Yes.

Which is the big player here in the US.

Right.

Clearly, we think we're winning in Europe. They are a player in Europe, although I wouldn't necessarily say they are the share donor. There are lots of more fragmented players. A lot of our key competitors don't have their own grid. They are sourcing a grid from a third party. That's where our system sale, I think, is really adding value to us.

Vic, do you want to add anything to that point?

No, I think that's right.

Okay. Well, thank you both very much.

I'll get you back to that data point you asked about.

Appreciate it.

Your next question comes from the line of Rodney Nacier, KeyBanc Capital Markets.

I dropped off for a little bit, so sorry if my question's already been asked.

I'm just going back to the Wood business for my first question. You had commented on big-box, and they are looking to run on a more just-in-time model, I think you said. And so I was wondering -- how does that impact your supply chain capabilities and your ability to meet demand on a more real-time basis? And specifically, the impact on your margins and leverage going forward in the Wood business?

And then secondly, along the same lines, what would your expectations be if similar inventory actions, potentially out of some of your other big-box customers, as a broader and market trend?

Our ability -- we haven't adjusted significantly the supply chain to address this. We're hopeful that they will reverse the strategy, quite candidly. There's no sign that any of the other big-box would follow this strategy. And again, I don't want to comment on a customer's strategy at all. But, I think if that does become a trend, and it's unlikely, Rodney, we would be able to adjust accordingly. As Frank pointed out, we certainly picked up a lot of that lost share to the segment, if you will, through the independent channel. We saw pretty significant growth.

Okay. That's helpful.

And my next question is more on your capacity buildout in China. In the past, I think you framed out in aggregate the amount of sales you expect out of those three China plants at roughly $200 million. And with the current environment in China, and you commented on maybe some slowdown in Asia, could you provide some sensitivity around what sales outlook might be if trends don't improve? Or perhaps the timeline to ramp up to that $200 million?

Yes, it's all good questions. At this point, we don't really -- we're not adjusting our outlook. We've seen a little softening in Commercial Office. Our Building Products team is working hard to drive specifications in Healthcare and Education. That's benefiting our Flooring Business. So the relative strength you see in Flooring there is the value proposition for Resilient Flooring is accepted in Education and Healthcare.

We're working on conversion of cinder block and drywall in both those segments for Ceiling. So we remain bullish on China. And despite the government managing the economy to deflect inflation, they are still focused on segments in the economy that are traditionally very strong for us.

So we're sitting here today optimistic that the plants open on time, the teams are working to build demand, and we're not changing our outlook or timeline or guidance relative to that at all, just based on kind of what we've seen recently.

And just -- the plants in China are to serve broad Pan Asian demand. So that's to serve demand in India, serve demand in Southeast Asia, and these are all places that, that demand's being served today from capacity outside of Asia. So we still view a lot of this, Rodney, as catch-up.

Okay, all right. Well, thank you very much.

You bet. Thank you.

(Operator Instructions)

Your next question is a follow-up from the line of Keith Hughes, SunTrust.

Frank, just on the inventory takedown at the big-box -- was that the results of a line review, or have you lost some slots or SKUs? Or is it just simply emptying a warehouse out?

Absolutely not. We had no line review impact. Our relative share there hasn't moved. It's their broad-based retail strategy, Keith. I don't know anything else.

No, that's correct. It's not a result of any line review. Our facings have not changed. In fact, the number of facings we have has gone up slightly in the last five months. It's clearly right now an inventory play.

And one follow-up on your comments on residential renovation -- we've seen that your earnings, very similar comments to what you guys are making. Frank, as you talk to retailers in the Flooring space, what are they telling you, what are they hearing from consumers? Why is it not following along with this continuing boom here in new construction?

Well, I think there's a couple things. One is, what retailers tell us is there's not a lot of people in their stores. So there's just -- it's very sporadic, Keith. They will have a Saturday where they will have four or five, six, appointments for installs and then they will go three or four days with nothing.

And what it comes back to is, one is -- we talk about a boom in new construction. On a percentage basis, that's true. But when you look at absolute number of housing starts, incremental, it's not that significant. And there still is a lot of uncertainty around where's the economy going, making big investments in the home. Existing home sales are down, people don't have the equity to move. I think it's all that familiar tape that we've heard before, that continues, I think, to suppress some of the remodel/replace activity.

Thanks, guys.

A little bit of color on that, Keith. We track very closely existing home sales, and first quarter, according to the US Census Bureau and National Association of Realtors, existing home sales declined 6%. The trailing 12-month inclusive of the first quarter was off only 1%. So you saw a deceleration of the existing home sales, and that churn of the housing stock is a much bigger driver -- clearly, obviously, to remodel -- but as a total portion of our residential business. That's one we're watching closely. I think the step back of consumer confidence is a reflection on that.

All right. Thanks, guys.

Your next question is a follow-up from the line of Bob Wetenhall from RBC.

Thanks again for the color today. I was hoping, as opposed to just talking about this quarter, you could give an update on what you're thinking about in terms of longer-term growth prospects for 2013. I know you're building some stuff out in Russia and China. And I was trying to get an idea of, if those will be coming on and become the growth engine for the Armstrong story next year. Or if you feel that, that's going to be delayed a bit, due to macro developments.

Well, we're not prepared to really talk about 2013 and beyond, beyond the information we shared at our Investor Day. But the Russia plant comes on the end of 2014, 2015, so that's a driver of relative growth then. The other plants in China are coming on as we forecasted in the past.

So, obviously as we think about 2013, we need to consider exiting this year in a softer environment here in North America and Europe that we anticipated entering it. But we still think that even in a challenging operating environment, making big bets in emerging markets like China, like Russia, expanding our presence in places like the Middle East, India make sense.

Our ability to adjust our value proposition and fit those -- whether it's Resilient Flooring in a hospital in Riyadh, whether it's architectural specialties in an airport in Dubai, whether it's just driving continued penetration in Russia by improved service and targeted products with a plant there, driving conversion in China from drywall and cinder block to mineral fiber ceilings, or participating in the government's emphasis in healthcare and education in China -- our value proposition works, the investments are meaningful, but I think well-placed and very responsible.

So, even in a tougher operating environment that may come our way in the next two to three years, we think these investments make, frankly, arguably, more sense than ever.

One other point, if I could chime in there -- we are on track for the plant startups, so you'll start seeing revenue show up in the first quarter from our Homogeneous plant in China, on schedule. You'll start seeing revenue from our Ceilings plant in China in the end of the second quarter, middle to end of second quarter.

So they start coming on and are revenue contributors next year; and as Matt framed, Russia is out a bit and Hetero is in the second half of 2013. It starts to build in 2013. We haven't given specific revenue numbers, but we do see those plants as important contributors because we think it's probably still going to be tough next year in the domestic market.

And one of the things -- while we don't like the fact that our sales are down, we're very proud of the fact we are delivering year-over-year EBITDA and earnings per share performance, despite tough volume and despite significant investments to build these plants, to build out the organizations in those markets. Those organizations don't turn on when the plants come on. We're investing now with feet on the ground. We're investing teams to build these plants, all running through the earnings that are dropping to the bottom line.

And so, we've talked about the savings program. I think the thing that's keeping our earnings afloat is the savings program, and we're really proud that we were able to frame now the goal up to $200 million and net all falling to the bottom line is our goal in the current year. We've never said that, despite us building all four of these plants and building out the organizations and more to come.

So a little bit of the context there, and hopefully these investments pay off soon and on schedule. But we're all a little bit of the wait and see mode at this point; till those plants come online.

That's helpful. And good luck with the growth story and thanks for all the color.

Thank you.

Thanks, Bob.

Thank you, ladies and gentlemen, for your questions. This concludes today's conference. Thank you, again, for your participation. You may now disconnect and have a great day.