Armstrong World Industries Inc (AWI) 2013 Q1 法說會逐字稿

Good day ladies and gentlemen, and welcome to the first-quarter 2013 Armstrong World Industries, Inc. earnings conference call. At this time, all participants are in a listen-only mode.

(Operator Instructions)

As a reminder, this conference is being recorded for replay purposes. I would now like to turn the call over to Mr. Tom Waters, Vice President of Treasury and Investor Relations. You may begin.

Thank you, Frances. 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, the CEO of our Worldwide Flooring Businesses; and Vic Grizzle, CEO of our Worldwide Ceiling Business. 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.

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 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 Laws.

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. Thank you for participating in our call today. The first quarter of 2013 unfolded largely as expected, with the exception of demand for wood flooring, which was greater than we anticipated. We experienced continued commercial softness in North America, Western Europe, and Australia. Emerging markets for the most part remained strong, but with choppy shipment activity impacted by large projects and distributor inventory adjustments. The US residential market continues to recover, with particular strength in new home construction. We are starting to see some signs of life in the remodel area, but existing homeowners are still cautious on big-ticket purchases.

I'm pleased to announce the first quarter also marked the opening of two of our new emerging markets plants, with the Chinese Homogeneous flooring plant and Mineral Fiber ceilings plant beginning shipments in March. These plants were built safely, on time, and on budget. The teams did a great job with these projects, and I want to commend their efforts.

Sales for the quarter of $622 million were in the middle of our guidance range of $600 million to $650 million. Sales were down just over 2% from 2012, with minimal year-on-year foreign exchange impact. Most of the sales decline was driven by the disposition of our Patriot hardwood flooring distribution business in 2012. Excluding the impact of Patriot, sales were down less than 1%, with volume declines offsetting mix and price gains.

Adjusted EBITDA of $79 million was on the high side of our guidance range of $68 million to $83 million. EBITDA was down $5 million from 2012, driven by the volume declines. Wood flooring, our most residentially exposed segment, saw strong demand in the first quarter. Excluding $9 million in sales from the Patriot business in 2012, volumes were up in the mid 20% range. Demand was strong in all channels, and aided by big box promotional activity and opening price point share gain. In fact, demand was so strong that we were challenged to keep up with orders for solid hardwood flooring.

To that end, we added a crew at our Beverly, West Virginia, facility in January, and we're now in the process of adding and training crews at our Witt, Arkansas, and Jackson, Tennessee, plants. We also have plans in place to add an additional crew to Beverly in June. In total, we'll add over 400 employees to meet this demand and absorb the hiring, training, and inefficiencies associated with these new crews. In addition, we're currently running maximum overtime at all of our solid hardwood plants. It should be noted that solid hardwood represents about two-thirds of our wood flooring segment -- the other third being engineered hardwood, where capacity isn't an issue.

The other impact the surge in demand is having is on cost. Inflation in lumber is significant, with composite lumber prices up approximately 40% year-on-year, and up 20% from December. As a reminder, we purchased hard woods, primarily red oak, as opposed to the more frequently quoted softwood lumber, which is used in framing and other construction applications. Softwood lumber prices are up 60% year-on-year. The flooring grade of lumber we buy is the same grade used for truck bed liners, railroad ties, and energy drilling platforms, so we're competing for materials with other sectors which are also seeing strong growth.

We believe hardwood lumber prices will continue to increase in the coming months, and not begin to stabilize until the third quarter. Thus, despite the price increases we took in December and March, we've announced another increase on wood products effective in May. This price versus inflation pattern is typical for the wood business, where price increases run behind lumber inflation on the way up. In periods of strong demand, we recapture inflation with price. This solid-wood flooring situation is a nice problem to have after years of declining volumes, but it will take a couple of quarters to work through. Wood profitability was down in the first quarter, despite the higher volumes, and that will be the case in the second quarter as well.

As expected, resilient flooring, which has minimal exposure to new residential activity, saw sales declines in all regions, with continued weakness in the education and health care sectors, which are tied to public spending here in North America and Western Europe. The Pacific Rim was also down, driven by significant volume declines in Australia; but sales in China were up over 20% from last year. Mix and price in North America and Europe both improved year-on-year, and manufacturing and SG&A performance were largely in line with our guidance.

The ceilings business saw lower sales with the same commercial sector weakness I mentioned in the flooring business, impacting the Americas. Sales in the Americas has also been variable month to month and by region. This reinforces our feeling that a broad commercial rebound is not yet occurring, and we think is unlikely for the next several quarters. Canada and Latin America were down versus last year due to strong project sales in the base period.

Sales in Europe were down high single-digits, with continued weakness in Western Europe, and no offset from Russia, as we lap a strong first quarter of 2012, and the Russian economy has weakened somewhat. As a reminder, in the last two quarters, we've transitioned almost all of our Russian business from an ex works basis at our UK and German plants to Armstrong in-country distribution. Some of the first-quarter European volume declines, especially in the UK and Russia, is just timing. We continue to anticipate growth in Russia for the full year. However, the Euro zone weakness, especially in France, is likely to persist for the entire year, and maybe beyond.

Volume declines in Australia drove ceiling sales in the Pacific Rim lower. China and India continue to grow, but were unable to offset Australia. Our global architectural ceilings business experienced strong growth everywhere but Europe, where the comparison is difficult due to 2012 airport projects in Berlin and Dubai. Despite first-quarter weakness in Europe, we're optimistic that our architectural specialties business can grow in Europe for the full year, as we've won significant project business that we anticipate shipping in 2013. We remain very bullish on this business outside of Europe.

Ceilings profitability was up in the quarter, but it should be noted that some of this was driven by one-time expenses related to getting our locked-out Marietta plant back up and running in 2012. Of note, in the first quarter we took advantage of favorable capital markets and refinanced our credit agreement, resulting in lower future interest expense, and an extension of maturities to 2018 and 2020. The level of debt was essentially unchanged. This refinancing further strengthens our balance sheet, and leaves us in a position of focus on operational and strategic issues.

Construction on our Chinese Heterogeneous flooring plant and Russian ceiling plant continues on schedule. I was just over in Russia for the ground-breaking ceremony on the ceilings plant, and I can tell you that the team is excited to begin the next phase of construction. I look forward to opening the Heterogeneous flooring plant in China later this summer, and the Russian ceilings plant late next year. With that, I'll turn it over to Tom Mangas for a more detailed discussion of our financial performance, and an update on guidance and the outlook for the second quarter. Tom?

Thanks, Matt. Good afternoon to everyone on the call. In reviewing our first-quarter 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 of presentation.

Matt mentioned quarterly sales and EBITDA results, so I will only point out that adjusted operating income and adjusted EPS were also down versus last year, by 9% and 55%, respectively. EPS was impacted by the non-cash write-off of fees related to our previous credit agreement of $19 million, or $0.19 per share, as a result of our recent refinancing. First-quarter free cash flow was a use of $51 million, similar to the use of $50 million in the first quarter of 2012. This use of cash in the first quarter is typical due to the seasonality of our business. I will address the drivers of EBITDA and free cash flow in more detail on upcoming slides.

We closed the first quarter with net debt of $792 million, up from $409 million at the end of the first quarter of 2012. This increase is largely driven by the $500 million special cash dividend that we paid in the second quarter of 2012, partially offset by cash generation over the past year. Finally, our unadjusted return on invested capital on a continuing operations basis, was 10.3%, an increase of 210 basis points over the prior year. This continued improvement represents another record since our emergence from Chapter 11.

Slide 5 details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $3 million in the quarter. As you can see, this past quarter we incurred $6 million of expenses related to head-count reductions in our flooring businesses in Europe and Australia. In 2012, we had $14 million of accelerated depreciation and impairments associated with the closure of our Mobile, Alabama, ceilings plant and $2 million of severance in the European flooring business. Interest expense was higher in 2013 due to the expensing of the previously capitalized fees I just mentioned.

Tax expense was essentially flat, despite earnings being down year-on-year, primarily due to greater unbenefited foreign losses in 2013. This year-on-year increase in foreign losses is largely a result of the expenses in China and Russia associated with plant construction and startup costs.

Moving to Slide 6, this illustrates our sales and adjusted EBITDA by segment for the quarter. Excluding the impact of foreign exchange, resilient flooring sales were down 5%, driven by volume declines in North America, Europe, and Australia. Despite the sales decline and startup costs in our China flooring plants, our ongoing productivity efforts enabled us to keep adjusted EBITDA flat with 2012. Wood flooring sales were up 9%, and would have been up 18%, if not for the Patriot divestiture. Volume growth exceeded sales growth, as mix was negative, driven by strong builder product sales and the opening price point share gains we made in the home-center channel. We were obviously pleased to have wood demand coming back, but the velocity of the increase is causing manufacturing inefficiencies as we staff up to meet demand.

Matt mentioned our ongoing pricing actions on wood. Just to be sure you're aware of the details of recent actions, I want to remind you that we took a 6% price increase on both solid and engineered wood products effective in December; increases of up to 10% on solid wood products effective in March; and just recently, we announced another increase of 10% on all wood flooring products, effective in May.

Building product sales were down 4% as volume declines in the Americas and Europe more than offset global mix and price gains, and modest volume increases in the Pacific Rim. Adjusted EBITDA in building products increased $3 million versus the first quarter of 2012, despite the lower sales, driven by costs we incurred at our Marietta, Pennsylvania, facility in 2012. The corporate segment was down, largely driven by the expected continued decrease of our non-cash pension credit, foreign pension expense, and by insurance program reserves.

Slide 7 shows the building blocks of adjusted EBITDA from the first quarter of 2012 to our current results. As you can see, mix and price were modestly beneficial, but volume was a significant head wind for the quarter. You may be surprised to see input costs show up as a positive, given all our discussion on lumber inflation. However, keep in mind that while our cash purchase costs are indeed rising sharply, inventory accounting rules hang this immediate increase on the balance sheet to be released when products are sold. So the inflation we are experiencing now will impact our income statement in coming quarters.

Manufacturing costs show up as a slight negative on the earnings bridge, but really illustrate two stories. One, we are absorbing several million dollars of overhead and inefficient production expenses as our Chinese plants start up; and two, we are partially offsetting these costs with ongoing productivity gains in our developed world ceilings and resilient facilities. SG&A was flat year-on-year, despite our continued investment in the emerging markets. However, we still anticipate SG&A increases in coming quarters consistent with prior guidance. WAVE had an excellent quarter, and added $2 million to our year-on-year results. Finally, our non-cash pension credit is lower in 2013, as we mentioned in our guidance in February.

Now turning to Slide 8, you can see our free cash flow for the quarter was very similar to 2012. Cash earnings were lower than prior year, driven by reduced earnings and a higher tax rate. Working capital was a use of $48 million of free cash flow in the quarter, but that was improved from last year by $20 million. Keep in mind that working capital can be volatile from quarter to quarter, and that for the full year, we don't anticipate significant changes. Capital expenditures were higher than in 2012 due to the timing of equipment purchases for emerging-market plant builds.

Cash interest expense increased by $3 million, primarily due to the additional debt from our March 2012 refinancing in support of the April 2012 special cash dividend. WAVE's contribution to cash was slightly negative, as they were able to squeeze more from their operational cash accounts of 2012 due to their then-newly available revolving credit facility. The remaining positive contribution to free cash flow of $11 million, illustrated in the Other bar, relates to the timing of certain payments in 2012.

Slide 9 updates our guidance for 2013. As Matt said, we are largely maintaining our prior guidance. We have not significantly changed our view of the market opportunity since our last call. We expect new residential construction to continue to be a bright spot, and forecast 990,000 new home starts in 2013, up slightly from our prior estimate of 950,000. But as you know, this growth has skewed a bit to multi-family, which is not a large segment for us. However, we see some improvement in residential remodel, and are now projecting low single-digit growth in the segment for the year, up from our flat outlook in February. This has positively impacted our wood sales, and gives us confidence on our price actions to mitigate lumber inflation.

On the commercial front, in the US we anticipate a continuation of flat to slightly down commercial volumes, with ongoing weakness in education, and to a lesser extent, health care. Retail has been a bright spot domestically. However, Europe has been weaker than we anticipated, and will experience mid single-digit volume declines on the year. In the Pacific Rim, we continue to anticipate China's sales to be up double-digits. We also expect to grow sales in India and Southeast Asia. However, we expect that Australia will continue to be a drag, and will partially offset our emerging market gains in the Pacific Rim for the year.

Net, these changes will result in us holding our sales guidance for the year. Specifically, we continue to expect sales of $2.7 billion to $2.8 billion, adjusted EBITDA in the $390 million to $420 million range, and free cash flow of $75 million to $125 million. EPS guidance is down $0.15 on both the high and the low end of our previous range, driven by the expensing of $0.19 per share of fees associated with previous credit facilities, with a slight offset from lower interest expense in the coming quarters.

Our interest expense pattern has been complicated by the refinancing, so let me spend a moment to lay it out. We incurred $33 million of interest expense and financing fees in the first quarter, and expect to incur an additional $36 million over the remainder of the year, for a total interest expense of just under $70 million for 2013. The real income statement benefit of our recent refinancing will show up in 2014, where we anticipate interest expense to drop to less than $50 million.

Slide 10 provides the more detailed assumptions going into our earnings guidance and includes the specifics on the second quarter. We now anticipate inflation in the range of $50 million to $60 million, up $10 million from our previous guidance, with more than all of the increase coming in the wood segment. Inflation on the other input costs is slightly lower than our previous guidance. Guidance on the pension credit, earnings from WAVE, and capital expenditures are unchanged from February.

Cash taxes of $10 million to $30 million are down from our previous guidance of $25 million to $50 million, due to the increased tax expense -- due to the increased interest expense in 2013 triggered by the refinancing, as well as additional tax planning actions and analysis. Our estimate for the second quarter projects sales, including anticipated FX impacts, to be in the range of $680 million to $730 million. At the mid-point, sales would be up over 5% from the second quarter of 2012, when adjusted for the Patriot disposition. We expect to earn $85 million to $105 million of adjusted EBITDA, compared to $110 million on a comparable basis in 2012. The adjusted EBITDA estimate is impacted by significant lumber inflation, startup manufacturing expenses in China and Russia, and higher SG&A spend in our growth platforms.

Lastly, for the full year 2013, we currently anticipate $5 million to $10 million associated with cost reduction initiatives in our Western European and Australian flooring businesses. This is up slightly from our initial guidance, as we are taking more actions to adjust our cost platform to the lower market opportunities in both regions. We look forward to catching up with wood demand and inflation, and to driving meaningful growth from our emerging market expansion now that our plant footprint is coming online. With that, I will now turn it back to Matt.

Thanks, Tom. By and large, 2013 is unfolding as expected, as you can see from our reiterated guidance. Aside from market softness, especially in Europe, our biggest challenge and opportunity is in our wood business. We are implementing the necessary pricing actions and deploying the required resources to service our customers and take advantage of the strong wood flooring demand. We remain hopeful that the strength we're seeing in new residential drives confidence in homeowners to spur remodel activity, and eventually, commercial activity. But we remain cautious on those in 2013. So with that, thank you for your time today, and we would be happy to take any questions.

Thank you.

(Operator Instructions)

Our first question is from the line of Stephen Kim from Barclays. You may proceed.

Thanks, guys. I guess a lot of questions I could ask, but let me ask you about the wood flooring. You made a couple of statements -- I just wanted to follow up a little bit. One, you mentioned that engineered was -- you were not seeing as much of a bottlenecking there in your solid. I was a little surprised. I guess I was just trying to understand what that tells us about the underlying demand. Most of the new builds that I go into, actually, I see a lot of engineered. I just wanted to -- maybe you could provide a little bit of color around that?

While you're on the wood, if you could, give us an understanding of when you're talking about this lagging effect of your price versus your costs, it sounds like you're looking for an inflection at the end of the year, maybe third quarter or fourth quarter, it sounds like? Can you give us a sense for where you see margins likely to sort of settle out after you reach this inflection in the lag effect of the price versus cost? Thanks.

Let me -- Steve, this is Matt. Thanks for the question. Let me give you some context, and then we'll hand it over to Frank for additional comments. The drivers for the wood demand are residential, which is largely new residential. That would be -- that drives the mix somewhat down a little bit. It's builder-based or builder-grade hardwood flooring. Engineering demand at this point, while robust, is more than served by our existing footprint. I wouldn't say that engineering demand -- engineering wood demand isn't relatively strong, but I think we have the manufacturing capacity to serve that demand.

With respect to the crossover in inflation and productivity, we expect that by the end of the second half, we will be sort of on the other side of that hump, if you will, where our pricing actions will be in excess of the material we are experiencing -- the material inflation we're experiencing in the second half. We will not be ahead of the game for the pricing pressure that we've experienced early in the cycle. Then manufacturing productivity in the wood plants becomes positive at the end of the second half, as well as these 400 new employees become productive. We kind of move through the training phase, they're in place and yielding the results.

I don't know, Frank, if there's anything --

No, I think that's well said. On the engineered, demand, as Matt says, is robust. We had flex capacity both in China and Somerset that we could bring on very, very quickly. The other difference is, in solid, you have the lag time to get the green lumber, where you don't have that same effect in engineered. So, you can respond more quickly to upticks in demand.

Good.

And ladies and gentlemen, please limit your questions to one.

(Operator Instructions)

Your next question is from the line of Michael Rehaut from JPMorgan.

Hi, this is actually Jason Marcus in for Mike. I think in the past you've mentioned that regarding potential M&A opportunities, you might consider an acquisition in architectural specialties. I guess on the acquisition front, I was wondering what you're seeing, and if you've been examining any different opportunities, and how you're thinking about that now?

Well, we're always looking and evaluating potential acquisitions, Jason, and what we've said in the past is an opportunity we think that exists is a smaller, what we would refer to as tuck-in acquisitions, in architectural specialties business. So, Vic and the team are continuing to review and monitor those. Obviously, nothing to announce today, but I think we have the balance-sheet strength to continue to evaluate good deals, and if one exists, take advantage of it. So, we don't see that changing -- that part of our story changing at all, based on anything we're experiencing, either internally with the wood challenges or externally in the greater market.

Your next question comes from the line of Kathryn Thompson from Thompson Research Group. You may proceed.

Thanks for taking my questions today. Looking at [each of] your segments -- resilient, wood and ceilings -- could you give clarity on Q1 volume trends, and the look into early Q2 for volume trends in those three sectors? Thank you.

Well, in terms of volume trends in the first quarter on resilient flooring, the commercial market segments, we saw relative volume weakness in the first quarter, mostly in education and health care. As we said in the prepared remarks, that's still somewhat publicly funded-driven. We did see and continue to see some attractive relative strength in retail. This is mostly retail remodel, not new retail, so that's encouraging. The ceilings volume is following a very similar pattern in North America. Western Europe continues to be weak somewhat across the board for resilient flooring and mineral fiber ceilings. We got off to a slow start in Russia -- that seems to be correcting itself somewhat, even though the market is a little softer than we anticipated.

In Asia, just to remind everybody, our business in Asia and Australia more than offsets relatively strong volume growth we're seeing in both China and India. It's a little disproportionate at this point. So, Australia as a mature market continues to be very, very soft for us. The teams are taking actions in place to reduce operating expenses and SG&A to continue to improve our operating position there. Resilient flooring in China is off to a very strong start. Volumes over 20%, and ceilings are kind of low-double digits there as well.

Yes, Kathryn, this is Tom Mangas. On the commercial front of the Americas, both sides of our commercial business -- ceilings and floorings -- saw volume declines in the mid-single digits. Europe was really the -- as Matt said, the tough spot, where we saw just over double-digit declines in volumes there. So, that remains to be the tough part of our business, and the emerging markets remain strong.

I think the last part of your question was the outlook for the second quarter. What we can comment on is the order trends we're seeing, at least thus far in April, give us confidence around our revenue guidance for the second quarter.

And your next question is from the line of Ken Zener from KeyBanc. You may proceed.

I want to compliment first your new disclosure in the Q. I think more companies should do what you guys did. It's very helpful, and I want to explore that, given that you're talking about your volume and price mix leverage. Can you kind of frame the building product leverage that you might have related to price mix, as the cycle recovers? So, when you look at how much EBIT dollars you might have lost from mix of product, given that it looks like you're about 45% leveraged, give or take, in each of those, in price mix as well as volume.

And then if you could also just expand on how different was price mix by region? Did you hold share or did you really see more pressure in one region or another? Thank you very much.

Ken, your question was specific to building products, right?

Correct.

This is Tom. First, we continue to stand behind our incremental margin thesis on ceilings, which we believe is 30% to 40% with volume growth. That has been our historical achievement, and is aided by the fact we're able to pick up significant fixed costs from our plant network. Yes, if we are able to continue this string of pricing ahead of inflation, that continues to be -- what puts us to the high end of that range, of that 30% to 40% incremental margin range, and that's something we believe is an important part of our investment thesis.

Your next question is from the line of Dennis McGill from Zelman and Associates. You may proceed.

Thank you. Matt, I was just hoping you could maybe put a little bit more detail behind what you're seeing on the public spending front. It sounds like domestically, ceiling -- and specific to ceiling, I think to start with -- domestically, volumes were down mid-single, I think you said, and that's being led by the public side. So, how much is that business down? I realize this is, I think, the third year now where that's been the case, and we're up against two pretty tough years for school spending. Any sense on how close this is to a trough, or how you guys think the summer period might unfold for that side of the business?

As you said, Dennis, we continue to see state budget pressure translating to slower volumes in public education K-12, and that affects not only resilient flooring, but also mineral fiber ceilings. We're seeing volume softness there in the mid- to high-single digits, in really both of our businesses. Health care is similar, as they also get affected by a reduction in health care -- a reduction in public spending. Then in the health care industry, you have other capital allocation priorities in the short term. These guys continue to consolidate health care systems. They're rationalizing the assets post the consolidation moves. We're seeing an increased investment in health-care-oriented technology and software. That stuff, at least in the near term, along with a broader reduction in investment, sort of keeps them out of the facilities upgrade activities for the short term.

Your next question is from the line of David MacGregor from Longbow Research. You may proceed.

Yes, good afternoon, everyone. I just wanted to explore, in the building products, the whole mix issue here. I wonder if you could just talk about movement you're seeing within mix? If you think about the business in kind of three buckets -- the commodity board versus the high-end board versus your architectural specialties products.

Then I think there were a couple questions earlier on architectural specialties. Maybe just if you could elaborate on what we should be thinking about in terms of growth over that business over the course of the year ahead? What percentage would that represent of the building products revenues now?

Yes, David, this is Vic Grizzle. On the trends in the marketplace, and this is something that's been continuing from the last 18 months, architects are preferring a higher-quality, higher-end product in the specification cycle. So, we've been developing and introducing new products at the high end for a number of years now. A lot of this is gaining critical mass, and this is continuing. So, we're seeing the growth at the high end, and that's what's driving the mix both here in the US and in Europe. So, we see it in both places.

Architectural specialties is an extension of that. As architects want to create more, what we call wow spaces or statement spaces in the buildings, we have expanded our portfolio to be more relevant and to have more offerings for them in that space. We can see double-digit growth in that product line, which, again, adds to the mix. So, we've got really kind of two things going -- driving a richer mix, both in the US and in Europe.

Then your final part of the question, architectural specialty is about 10% to 15% of the ceilings segment sales.

Your next question is from the line of George Staphos from Bank of America Merrill Lynch. You may proceed.

I was curious if you could put a bit finer point on the amount of start-up expenses from the new facilities -- what the effect was in the quarter, and how we might see that progress over the next several quarters? Related to that, might we not see also depreciation expense maybe pick up a bit as you start to release what's been capitalized? Thanks.

All right, George. This is (inaudible - background noise). Yes, to your last point there, yes, you should expect to see depreciation pick up as these plants get capitalized and roll through our depreciation schedules.

I think we guided in the February call that we expected $10 million to $15 million of start-up expenses associated with the three plants, and as we said, the first two began shipments in March. We are at the early phase of absorption. We had certainly some for these plants getting up the start-up curve. But as you saw, we were able to offset those with productivity efforts elsewhere. You should expect that the production drag continues into the second and third quarters, as we get these plants really shipping at going levels of capability, and also bring up the heterogeneous plant. I will also remind you, we also guided SG&A in the $5 million to $10 million range, associated with incremental SG&A investment of these plants as well, which would be a drag that comes with commercialization.

Your next question is from the line of Bob Wetenhall from RBC. You may proceed.

The midpoint of your second-quarter guidance would suggest that sales were up 1.2% for the first part of the year. Then if I look at your full-year guidance, it suggests that the back half would have to be up 8.8% for you to get to the midpoint of your full-year guidance. I'm just trying to get a little directional insight, among your three product groups, what's the lever in the second half of the year which is going to get you that sales out-performance? Is it price in ceilings, or is it just better volumes across the portfolio? Where do you see that lift coming from?

Well, good question, Bob. Clearly, we expect to see continued growth in residential flooring, so we continue to see very strong demand, and an improved ability to meet demand of our wood flooring business. We see volumes in the commercial segments stabilizing flattish in the second half. We see continued strength in retail. We have some big shipments -- big orders dropping in architectural specialties. We see orders rebounding in -- slowly but surely rebounding in Russia. And we count on India; and China continues to drive double-digit revenue growth in both of those -- in both of our businesses there. And we see productive yield out of the new plants -- the two new ceiling -- I'm sorry, the two new flooring plants -- and the ceiling plants in China.

First, Bob, you've got to remember, we've got the Patriot divestiture that happened in August in the third quarter -- so that's worth a couple points in the back half alone, differential. Just to Matt's point, we are seeing strength in the residential segment, so we expect that to carry forward. As we outlook into 2014 and the continued evolution of domestic GDP, we do have a thesis here that the back half is a better back half on the commercial side. Certainly as we've done our market checks, and visited with customers and contractors, they are more optimistic in the back half, and that's reflected in our guidance, which really is not that changed from a phasing view versus our view that we presented in February.

Even -- just to continue the point -- even going from first quarter to second quarter, the first quarter on a constant FX basis we were down 2% inclusive of the Patriot divestiture. At the midpoint, we're at 5% in the second quarter, so we're starting to call that ball already in the second quarter. As Matt suggested, what we've seen in April confirms our guidance on that.

Your next question comes from the line of Keith Hughes from SunTrust. You may proceed.

You made some comments in the last question and earlier about your improved uptick on residential replacement demand. Is that a function of what you have seen in the March-April shipments? Or is that more just reading the same economic tea leaves we're looking at?

We're actually seeing -- we're experiencing very modest recovery in our results, in sort of February, March, and April. We expected, or are anticipating that to be flat to slightly down. That was certainly the experience we had last year. We see even a slight -- frankly, flat or moderately up results as a net positive to our expectations coming in. Again, it's tenuous. We're anticipating that continuing as we think about the second half of the year.

I think that's right, Keith. We just couldn't look past what was happening in the wood business, and attribute all of that, given how we see it flowing through our channels, as only new construction-related. So, we did see a strong growth in our home center channel, and certainly see that tied to more repair, remodeling.

Your next question comes from the line of John Baugh from Stifel Nicolaus. You may proceed.

Thank you, and good afternoon. I guess this question is directed to Frank. There was a reference to some price aggressiveness in wood flooring with the home centers. Was that on solids or engineered, or both? Could you discuss the rationale in light of somewhat tight capacity situation?

Well, this is Matt. We wouldn't comment on any of our customers' retail or consumer pricing strategies. So, we're -- I would just say that we are enjoying pretty good flow of business at the big-box channel. As we pointed out, we've seen an increase in promotions there. Beyond that, it's really not -- I don't think it's really for us to comment on any pricing that they may -- that they might execute or not execute in the resale pricing.

I don't know, Frank, if have you any additional --?

No, I think that's right. I think as they see the market come back, and they are trying to compete in the marketplace, John, they have just become more promotionally active in their tabs around the category; and I think that's driven people into their stores, and we've been a benefactor of that.

Your next question comes from the line of Will Randow from Citi. You may proceed.

Hi. Thanks for taking my question. This is actually Scott Schreier in for Will. I just wanted to see if you can help us think about how forward sales trends outside of North America, specifically as growth in the new Chinese plants are going to help offset potential negative trends in Europe?

Well, we -- the plants are just coming online. We expect the plants to be sort of full from a capacity perspective in 2015, '16. So, call it sort of three years or so. So, that would be 2016 and '17. We're looking for an incremental -- I'm sorry, we're looking for a total revenue out of those three plants at that running rate of about $200 million. We're saying about 75% or 80% of that represents incremental revenue.

The plants weren't built, obviously, as a strategy to offset European weakness, but the plants were built to take advantage of the expansion of the market opportunities in China, India, and Southeast Asia. In addition to the plants, though, we've added hundreds of people there over the last couple of years in demand-creation roles in India and in China to help not only build broad demand for those plants, but specifically targeting what we think are the most attractive segments -- again, health care, education, to name two.

Yes, the only thing I would say on that, Scott, is absolutely we're counting on China and the growth from those plants, like we've enjoyed in the first quarter and last quarter of 2012, to continue and to be an important offset to weakness in the developed world. The scale of Europe, though, is much greater than the scale of China. So, total European segment sales for us are about $550 million. And total Asia, including Australia right now, is in that $200 million and $250 million range. So, China really needs to ramp up. If we got all that $200 million over time, sure, it's going to offset European softness, but it's not coming all in 2013.

Right, and the European softness we're experiencing tends to be Western Europe, the Euro zone. We're seeing, again, relative strength in Russia, and we've very optimistic long term about the opportunities for both of our businesses in the Middle East, which we include in European operating results.

Your next question is from the line of Mike Wood from MacQuarie. You may proceed.

Hi, guys. This is Adam in for Mike. Just to touch on the wood share gains one more time, has there been any change in inventory strategy at any of your key retailers, maybe keeping more product in stock versus special order?

This is Frank. Nothing of significance, really, at all. What we're seeing is really just increased demand and acceptance of our products in the marketplace. So, there's no significant inventory shift that is driving the numbers we presented this morning.

Your next question is from the line of David MacGregor from Longbow Research. You may proceed.

Thanks for taking the follow-up. I guess following new home construction, historically we've typically seen a recovery in existing home sales and remodeling spending. I guess I'm just trying to get a sense of, were that to occur again -- let's hope it does -- that you're going to see a better mix in terms of your wood product business. I'm just wondering if you can help us quantify that?

Well, this is Matt. Let me kind of frame that a little bit. We were surprised at this time last year when kind of at the first quarter, second quarter, we began to see some sustained growth in new residential construction, and we saw that sort of coming through our demand for wood flooring. And we saw a softening, almost at the same time, with the remodel business. That hasn't happened before, and so we're watching that very carefully. We think more -- we think the driver of the relative softness in remodel is sort of the macroeconomic overhang. The relatively high unemployment rate, the relatively -- or relative choppiness of the economic recovery -- we think that's keeping a lot of people on the sidelines.

The other thing we're finding is that there is less a tendency now to sort of down-select once homeowners have made choices around remodel. So, if you have gone into a kitchen and you've decided on cabinets, floors and appliances, and become comfortable with that, rather than go forward but down-select in some other categories of products, you go on the sidelines, you wait for the recovery, wait for a little bit more stability in the economy, a little bit more confidence, and then you move in. So, that would suggest to some extent a pent-up demand for resi remodel, and we're obviously waiting to see that.

What we're seeing right now is kind of a year-over-year stability. I would coin residential remodel as much as not getting worse as actually getting better. Again, our view is you would have to see some continued improvement in unemployment, and some continued improvement in actual GDP growth, not just forecasted GDP growth, to kind of get those guys off the sidelines.

The other thing I'll throw in there, David, is we do offer a broad range of products in each of our categories in floor, as Vic also outlined in ceilings. The price range is immense for consumers to choose from, and we're seeing in the builder business that they are typically putting in our lowest-priced, opening price point type product form, which also drives for us a poorer mix. But as consumers are individually buying through our retail network, they can be doubling the price point that they are paying on a per-square-foot basis, and even tripling it if they went all the way to our [homeware] wood product lines, and that brings commensurate levels of margin improvement. That's why we talk about mix improvement that comes with remodel, given the range of product we have available and the margin structure that follows the tiering up on the product mix.

Your next question is from the line of Jack Kasprzak from BB&T. You may proceed.

You guys talked about the issues in wood flooring that you're facing meeting demand. Do you think that those issues will persist through the year, such that even on a recovery in housing and higher sales, wood flooring operating profit will be down for the year?

Well, we certainly see and anticipate a second-half correction over the first-half run rate. As the 400 people we're adding become more productive, and as our three price increases, and potentially more, offset continued inflationary pressures. So, the second half of the year, we would anticipate stronger margins and stronger revenue. That's reflected in the guidance that we reiterated this morning in terms of revenue and earnings.

Yes, I think, Jack, we're not going to get it all back this calendar year in 2013. We do think that we've kind of dug ourselves a hole on the margin basis, given the front-half, back-half dynamic Matt has mentioned. But clearly we have all the confidence in the world that we're going to -- through this pricing series that Frank has announced -- recover our margin trajectory, and deliver on the incremental economics we have talked about for the wood business.

At this time, there are no other questions in the queue. I would like to turn the call over to Mr. Matt Espe for your closing remarks.

Thank you very much. We appreciate everybody's interest and everybody's questions. We will continue to operate and execute on the things within our control in a very challenging environment, and we hope to see you all very soon. Thank you very much.

Ladies and gentlemen, this concludes your presentation. You may now disconnect. Have a great day.