Armstrong World Industries Inc (AWI) 2013 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. And welcome to the Armstrong World Industries, Inc. third-quarter 2013 earnings conference call.

(Operator Instructions)

As a reminder, today's conference call is being recorded. It's now my pleasure to turn the floor over to Tom Waters, Vice President Treasury and Investor Relations. Sir, the floor is yours.

Thanks, Huey. Good afternoon, everyone, 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 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.

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 statements 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 today. In the third quarter we saw a pause in commercial volume growth leading to disappointing top-line sales. We were able to deliver adjusted EBITDA results near the top end of our guidance range. In the quarter, we experienced significant positive achievements and, unfortunately, some continuing challenges. Noteworthy for us in the quarter was the start of production at our China heterogeneous flooring plant in August. With that, we have completed our three-plant construction effort and have dramatically changed our footprint in Asia. This positions us to benefit from the significant growth we expect in the region in the coming years, particularly in our targeted verticals of healthcare and education.

Now, closer to home, we announced a $41 million investment in LVT manufacturing here in Lancaster, Pennsylvania. By utilizing an existing facility, we'll be able to accelerate the project time line and leverage existing infrastructure and plant management capability. Construction will begin in early 2014 and shipments from the plant will start in the first half of 2015. In terms of quarterly financial highlights, we achieved record adjusted EBITDA in our global ceilings business. This was accomplished with volumes down more than 20% from peak levels and is a testament to our ability to cut and control costs, drive product mix and manufacturing productivity, and achieve price over inflation.

This result is also partly attributable to our WAVE joint venture which has also grown profits despite lower volumes. Additionally in the quarter, two of our largest shareholders, the Asbestos Trust and TPG, executed a sale of 12 million shares of our stock. Armstrong repurchased 5 million shares as part of the transaction. This investment of $260 million on our part, which was accomplished using surplus cash, will drive earnings per share accretion and create value for our shareholders.

The wood flooring business continued to be a challenge for us in the third quarter. On our last call we laid out the four key issues this segment was facing. Number one, the need to add capacity by onboarding production workers at our solid wood plants. Number two, the availability of green lumber. Number three, cost and manufacturing productivity issues driven by purchases of kiln-dried lumber. And, number four, pricing actions lagging lumber inflation.

As you may recall, we spent some time last quarter discussing the progress we had been making against those four headwinds. But unfortunately, we did not see improved profitability in the third quarter. Green lumber availability and the issues around kiln-dried lumber are largely where we thought they would be. And were not really factors in our performance versus expectations. [Crewing] has been completed. But yield and productivity at our solid wood plants is still not where we need it to be.

We achieved price increases of over $10 million in the quarter, but lumber costs, which we noted had stabilized at the end of the second quarter, resumed their upward trajectory in August and September. Thus, we continue to play catch-up with inflation in the third quarter. Given the disappointing lack of progress in our financial performance in the segment, I want to be cautious on predicting an immediate turnaround. The team continues to work extremely hard to fix our manufacturing issues, and execute the price and mix objectives that will put us on the right path. With these additional actions, we hope to begin demonstrating improved performance in the fourth quarter, though clearly not at the pace we had previously anticipated.

Turning now to our financial results, third-quarter sales of $730 million were $10 million below the low end of our guidance range as we experienced weaker than expected demand in all of our businesses and geographies. Sales for the quarter were up 5% from 2012 with minimal year-on-year foreign exchange impact, and minimal impact from the Patriot wood distribution business that we divested in the third quarter of 2012. On a comparable foreign exchange basis, the Americas and Asia saw sales growth in the quarter, while sales in Europe were down less than 1%. The Americas saw strong volume growth in residential products, particularly in the wood segment. Commercial volumes, which had picked up in the second quarter, softened in the third quarter and were essentially flat year on year.

Volumes were down in Europe but up in the Pacific Rim, despite continued weakness in Australia. India, and Southeast Asia were particular bright spots. Despite the lower than anticipated sales adjusted EBITDA of $124 million was on the high side of our guidance range of $110 million to $130 million. EBITDA was down, as expected, by $11 million from 2012, driven by the continued challenges in our wood business, expenses associated with the three start-up plants in China, and softness in Europe. Manufacturing productivity in our global ceilings plants and SG&A management in the flooring business drove profitability to the high side of the guidance range.

I'll turn now to our reported segment results. In the third quarter, the wood business continued to see strong demand from home builders, and experienced positive year-on-year growth in the home center and independent retailer channels. Our wood business is also benefiting from new product introductions and share gains. Sales of $148 million were up $26 million, or 21%, from 2012. And when adjusted for the Patriot divestiture, were up $32 million, or almost 30%. Wood shipments were up in the mid-20% range. Price was higher than last year but, as I mentioned, we are still chasing lumber inflation. Adjusted EBITDA was down from 2012, driven by the headwinds I just discussed.

Resilient flooring sales were down less than 1% in the quarter. Sales in the Americas were up, driven by residential products, while Europe was down with weakness in most markets. The Pacific Rim was down with strength in India being offset by weakness in Australia. And lower volumes in China as our customers destocked to adapt to our local production model. As expected, profitability in the resilient segment was down versus last year.

The ceilings business experienced higher sales and profitability in the third quarter. Sales were up in all geographies. On a global basis, price, volume and mix were all up despite slightly lower volumes in the Americas. Ceilings profitability was up in the quarter, driven by the sales gains, as well as manufacturing productivity, which overcame the cost headwinds associated with our new ceilings plant in China and the plant construction project in Russia. As I mentioned, ABP produced record adjusted EBITDA this quarter.

Within the ceilings segment, our global architectural specialities business experienced another quarter of strong growth, with sales up in the mid teens versus 2012. And, for the year, this business had grown sales and EBITDA by double digits. We just approved a project that will add metal ceilings manufacturing capability in Asia. This investment will be housed within our new China mineral fiber ceilings plant.

I'll come back in a few minutes and give you a preview of how we're looking at our 2014 opportunity. But, first, Tom Mangas will provide a more detailed discussion of our financial performance including year-to-date financial information, and an update on guidance and the outlook for the fourth quarter. Tom?

Thanks, Matt. Good afternoon to everyone on the call. In reviewing our third-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 as simply an explanation regarding our standard basis of presentation.

Matt mentioned that quarterly sales grew 4.8% and adjusted EBITDA declined 8.6%. Adjusted operating income and adjusted EPS were also down versus last year by 13% and 11%, respectively. Third-quarter free cash flow of $95 million was up from the $78 million generated in the third quarter of 2012. I will address the drivers of EBITDA and free cash flow in more detail on upcoming slides. We closed the third quarter with net debt of $930 million, up from $784 million at the end of the third quarter of 2012. Net debt was impacted by our recent $260 million share repurchase, partially offset by 12 months of positive cash generation. Finally, our unadjusted return on invested capital on a continuing operations basis was 8.3%, down from prior years as profitability was lower due to our plant start-up costs, issues in the wood business, softness in Europe, the lower year-on-year pension credit, and a higher effective tax rate.

Slide 5 details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $56 million in the quarter. As you can see, there was minimal impact from cost reduction items and foreign exchange in both the current quarter and prior year. Interest expense was lower than in 2012 as a result of our March 2013 refinancing. Tax expense was slightly higher despite earnings being down year on year, primarily due to greater unbenefited foreign losses in 2013 and to the significant foreign tax credit valuation allowance released in 2012. The year-on-year increase in foreign losses is largely a result of the expenses in China and Russia associated with plant construction and start-up costs.

Moving to slide 6, this illustrates our sales and adjusted EBITDA by segment for the quarter. Resilient flooring sales were down 1% as volume growth in the Americas, primarily from residential vinyl products, was offset by declines in Europe and Australia. North American commercial volumes were essentially flat after being up the prior quarter, despite continued high single-digit volume growth in commercial LVT. Volume in the Pacific Rim were strongly positive in India, Southeast Asia and in customer acceptance of our new homogeneous products in China, which saw shipments increase 20% year on year. On the negative side, we saw significant weakness in Australia and destocking in China of heterogeneous products, as we roll out our locally produced product, replacing products previously sourced from Europe and Australia with longer lead times. Overall for the segment price was down, partially offset by positive mix from LVT growth. Adjusted EBITDA was flat for the segment with manufacturing productivity in the Americas and Europe offsetting plant start-up costs in China and weaker sales.

Wood flooring sales were up 21%, and would have been up 28% if not for the Patriot divestiture in 2012. Volume was up 20% excluding the Patriot divestiture. Price was up in the high single digits, while mix continues to be negative with much of the growth coming in the builder segments. Matt detailed many of the factors driving lower adjusted EBITDA in the wood segment, so I just want to point out that the 2012 sale of Patriot resulted in a $3 million benefit to the base period, thus creating a headwind this year.

Building products sales were up 3%. Global sales were driven by gains in price, mix and volume. North America ceilings unit volumes had a slight decrease, but sales grew with improved pricing year on year. Europe, Middle East and Africa saw sales increase on the back of strong mix, driven by an almost 50% increase in the Middle East, a high average unit value market and relative strength in the UK, our best European market. The European ceilings business demonstrated the impact of our full portfolio in the region. Emerging market weakness in Russia was offset by strength in the Middle East, Africa and Turkey. And weakness in mineral fiber products was offset by strength in architectural specialty ceilings.

Pacific Rim sales were up in the high single digits when excluding the impact of foreign exchange. Again, the portfolio effect is on display as weakness in Australia and, to a lesser degree, in China [mineral] was more than offset by strong performance in India, Southeast Asia and China mineral fiber. Adjusted EBITDA in the building products segment increased $5 million versus the third quarter of 2012, as sales, manufacturing productivity and earnings growth from our WAVE joint venture offset emerging market investments in China and Russia. The corporate segment was down, driven by the decline of our domestic pension credit, higher foreign pension expenses, outside consulting services and higher benefit costs.

Slide 7 shows the building blocks of adjusted EBITDA from the third quarter of 2012 to our current results. As you can see, price/mix was a positive, as was volume, where the benefit came from residential products and Asia. The large inflation headwind was almost entirely due to lumber, but the ceilings business also experienced some year-on-year inflation in pearlite and starch. Manufacturing costs were flat as the headwinds from the wood segment and our plant start-up costs were offset by productivity improvements in the ceilings and resilient businesses.

SG&A costs were up as the emerging markets spend and some of the corporate expense items I mentioned earlier drove the increase. WAVE added $1 million to year-on-year results. Our non-cash pension credit is lower in 2013 as we had mentioned throughout the year. Finally, depreciation is increasing as we bring our new manufacturing facilities online.

Turning to slide 8, you can see our free cash flow for the quarter versus 2012. Cash earnings were lower than the prior year, but working capital improved significantly. Working capital provided $41 million of free cash flow in the quarter, up $26 million from last year with favorable payables and inventories. Capital expenditures were similar to 2012, with this year's spend in Russia roughly matching last year's spend in China. Cash interest expense decreased by $2 million as a result of our March refinancing. And WAVE's contribution to cash was positive versus last year.

Starting with slide 9 I'll begin discussing year-to-date results. As you can see, sales were up 2.6% and would have been up almost 4% if we adjusted for the Patriot divestiture in 2012. Year-to-date sales growth came primarily from our residential flooring businesses, our North American ceilings business and Asia. Europe and Australia were down over the past nine months.

Operating income, adjusted EBITDA and EPS are all down year to date. As with the quarter, the outsized drop in EPS relative to EBITDA and operating income is driven by the release of foreign tax credit valuation allowances in 2012. And we're facing the headwind of higher unbenefited foreign losses in 2013 due to our Russia and China investments. In addition, you will recall we took a $19 million charge in the first quarter to write down unamortized fees from prior credit agreements with our March 2013 refinancing and new credit agreement.

Slide 10 illustrates our sales and adjusted EBITDA by segment for the year-to-date period. Resilient flooring sales were down 2%. Volumes were down in all regions but global price and mix combined were higher. EBITDA was down in the Pacific Rim and Europe due to plant start-up costs and volume declines, respectively. As with the quarter, profitability in the Americas was up year to date. The year-to-date improvement in the Americas was driven by strong manufacturing productivity gains, better mix, much of it coming from the LVT category, as I mentioned before, and lower SG&A overcoming the lower year-to-date volumes.

Wood flooring sales were up 14%, and would have been up 23% if not for the Patriot divestiture. Year to date, the wood EBITDA story here is the same as the quarter, so I won't repeat myself further. Building product sales were up 2% through September. Sales were up in North America and the Pacific Rim but down slightly in Europe.

Global price and mix gains and volume growth in China and India more than offset volume declines in Europe, Australia and North America. Adjusted EBITDA in the building products segment increased $14 million year to date. The increase in profitability was driven by the Americas as price, mix, manufacturing productivity and earnings from the WAVE joint venture all improved, which more than offset volume declines and the emerging market expansion expenses. The corporate segment was down $16 million driven by the same factors affecting the quarter.

Slide 11 shows the building blocks of adjusted EBITDA. Similar to the quarter, price and mix are lagging inflation, driven by the wood business. Modest volume gains and improvements from WAVE were not enough to offset headwinds from SG&A investments, the pension credit and the net drag from manufacturing costs, as plant start-up expenses and challenges in the wood business more than offset over $20 million in productivity gains in our developed world ceilings and resilient plants.

Slide 12 shows the Company generated $75 million of free cash flow for the year, higher than the $63 million generated in the first nine months of 2012. Cash earnings were lower but working capital experienced significant year-over-year improvement driven by accounts payable. Interest expense and WAVE offset each other.

Slide 13 updates our guidance for the year. We are lowering the top end of our sales guidance from $2.8 billion to $2.74 billion. We're also reducing the top end of our profit guidance as follows. Adjusted operating income from $290 million to $280 million. Adjusted EBITDA from $400 million to $390 million. And earnings per share from $2.30 to $2.20 per share. The September repurchase of 5 million shares did positively impact EPS in the third quarter. But as EPS is calculated based on a daily average, the benefit of the reduced share count is muted in 2013. The full 8.5% EPS accretion benefit will fully reveal itself through the coming quarters.

We are increasing our cash flow expectations for the year to a range of $80 million to $110 million as a result of better working capital expectations and the sale of our idle Mobile, Alabama property. A somewhat dampened market outlook as a result of our softer than expected sales experience in the third quarter and the ongoing challenges in the wood business are the drivers of our sales and profitability guidance changes. Specifically, after enjoying our first quarter of volume growth in our developed regions since 2006, volumes took a step back in Q3 in commercial markets in the US and Europe. In addition, we saw marked slowdown in September across both commercial and residential markets versus what we saw in July and August.

Slide 14 provides more detailed assumptions going into our earnings guidance and provides the specifics on this fourth quarter. With the recent uptick in lumber prices we now expect annual inflation in the range of $55 million to $65 million, with the lion's share of the increases impacting the wood segment. Our outlook for consolidated adjusted gross margin remains a decline of 100 to 150 basis points on the full year versus last year. We expect SG&A as a percent of sales to come in at 16% to 16.25%, up slightly versus 2012, due to our investments in the emerging markets. Guidance on the pension credit, earnings from WAVE and taxes are unchanged from July.

Our estimate for the fourth-quarter sales, including anticipated FX impacts, is a range of $645 million to $685 million. At the midpoint, sales would be up over 8% from the fourth quarter in 2012, driven by residential volumes, pricing, and a soft Europe base period. Sequentially, we will no longer suffer from any drag from the Patriot divestiture. We expect to earn $70 million to $90 million of adjusted EBITDA compared to $73 million on a comparable basis in 2012. At the midpoint we would deliver earnings growth for the first time in 2013. Our expectations for capital spending are unchanged. And we now expect exclusions from EBITDA to be $10 million for the year, down slightly from our previous range of $10 million to $15 million.

We've been talking a lot about our three main growth engines, architectural specialities, China and Russia and have been getting questions as to what they can mean for Armstrong. Page 15 illustrates the recent history and potential we see in these opportunities. As you can see, 2013 sales are up more than 50% from 2009 in these areas of emphasis. And we expect even faster growth rate in the coming years as we benefit from increased feet on the street and local manufacturing capabilities in China and Russia, and from increased investment and management attention in architectural specialties. It was apparent to us early in the year that some investors did not fully understand the pattern of profitability to expect from these investments.

As you can see, profitability has decreased from 2009 to 2013 despite the higher sales. We've absorbed significant plant start-up costs in 2012 and even more so in 2013. And we have added sales and marketing resources in all three of these areas to drive future profitability. You can see that by 2016, when the China plants are fully effective and the Russia plant is in its second year of operations, the margins in these areas start to approach Company-wide levels. 2014 will demonstrate progress versus 2013 but the significant improvement won't be apparent until 2015 and 2016.

Finally, of note, our WAVE joint venture just last week completed refinancing their revolving credit facility. The new five-year, $200 million deal is $25 million greater than before, although the draw amount is unchanged. Pricing has been adjusted down such that WAVE will pay 25 basis points less on this debt than previously. This will result in almost a $400,000 annual savings to the JV. And the extra available capacity provides WAVE with the financial flexibility to pursue strategic initiatives, should they arise. Overall, we're a little more cautious about the fourth quarter given the slowdown we've just experienced compared to our stronger second quarter. And, as Matt mentioned, we're disappointed in the lack of progress on improving wood profitability. That said, our $260 million share repurchase in September shows we continue to focus on driving shareholder value, both through our business growth and productivity strategies, as well as how we deploy our balance sheet.

And with that I'll turn it back to Matt.

Thanks, Tom. As you'd expect we're now in the midst of our annual operational planning cycle. And, as in past years, we'll provide specific 2014 guidance on our next earnings call. But I did want to take a moment and share a few of our initial insights to help frame what 2014 might look like for us.

As we look at the revenue outlook, we're cautiously optimistic about most end markets. North American commercial markets should continue the modest growth we saw in the second quarter, with office and retail leading the way. In the North American residential sector we believe new home construction will continue to grow. But housing starts will likely be at less than the 20% year-on-year improvement we're seeing this year. Repair and remodel activity will likely continue to see modest growth. But to be fair, this is an area where our visibility and confidence are a little more limited.

We don't expect much, really if any, sales growth from the developed markets in Europe. But do expect to see growth in Eastern Europe, Russia, and the Middle East. Growth in Asia markets should continue in the double digits but weakness in Australia will suppress our overall rate of growth in the Pacific Rim. Regarding productivity, as you know, our gross margins improved every year from 2008 through 2012, as we shut plants, reduced costs, and rolled lean through our operations. However, this trend reversed in 2013 as we absorbed the start-up costs and manufacturing inefficiencies of our three new plants in China, which Tom has just discussed, and as we struggled to meet demand in solid wood.

In 2014, we'll be back on the path of improving gross margins despite the continuing ramp of our China facilities and expenses associated with the Russia and LVT projects. 2014 gross margins should be about 75 to 150 basis points better than 2013. As I said at the outset, we're still in the process of building our plans for 2014, but wanted to share an early glimpse of our thinking. And then, finally, we continue to believe that our mid-cycle guidance of $4 billion in sales, a 20% EBITDA margin, and ROIC exceeding 15% are achievable from the manufacturing and sales platforms we have in place and under construction.

So that said, I want to thank you for your time today and we'd be happy to take any questions.

(Operator Instructions)

Dennis McGill with Zelman & Associates.

Hi, good evening, guys. Thank you. For the first question, could you just expand a little bit on the comment that you made about the marked slowdown, I think you mentioned in September? And it sounded like it was across both residential and nonresidential. Could you just maybe be a little more specific on what you saw, and whether that's your orders, that you're hearing that from customers, as well, or anything further?

Sure. It was broad-based in both commercial and market segments. We believe that this is not a share issue with us. We think it was market-based.

We saw within those numbers -- and again, commercial slowdown, remember, affects both of our businesses slightly differently. When you consider commercial office, that will affect ceilings more than floors. Healthcare, education, probably somewhat equally. So the dynamics around the segments we pursue affect our businesses somewhat differently. But I'd say within that, the relative performance we saw, healthcare and education, everything government funded, continued to get soft and got a little softer.

Retail is holding up relatively well. And commercial office space softened a little bit as we went through the quarter. Residential demand slowed down. Still strong year over year, but I think sequentially slowed down as we entered the end of August and September. We would assess that being a function of a little rise in the mortgage rates, some overbuild in the builders, and maybe some tightening of the credit restrictions.

Yes, I think in October we've seen the commercial come back a bit, Dennis, though we've seen residential still be pressured a lot.

Michael Rehaut with JPMorgan.

Thanks. Good afternoon, everyone. Just had a couple quick questions on the ceilings business. The profitability there continues to be very, very impressive. And I just wanted your thoughts in terms of, as you look at that business over the next couple of years, some of the puts and takes, and if you could just review with us your thoughts on incremental margins there. With the margins this quarter, understandably that's a --- seasonally a better quarter within the year, but still at around 21%.

How much better can that go? And particularly over the next year or two? Sorry for the long-winded, but particularly over the next year or two if you have continued above average growth in architectural specialty, which is a below average margin business. Just some of the puts and takes. Thanks.

Yes, those are all very good questions. We're not providing specific guidance for 2014 and beyond on this call. But to try to answer your question more broadly, we're confident in the ability of our ABP business, our ceilings business, to continue to drive profitability and expand margins even in a flat volume environment. We would expect, as we think about 2014 and beyond, as we said, we're looking for slight incremental volumes, slight incremental volume increases in the commercial market segment. So that should bode reasonably well for the business.

Incremental margins for ceilings we said are in the 30% to 40% range. Drivers for our business continue to be commercial -- really, all four commercial segments. The remodel and repair business provides very strong margins, very strong mix for us. The business continues to invest in new product introductions in mineral fiber with improved acoustic and light attenuation properties. We have very solid relationships with our channels around the world.

We're seeing very strong markets in Asia, particularly in China and India, as we pointed out. In the Middle East, very strong businesses. And in Eastern Europe. The architectural specialties, as you said, is now a global business platform for us. Vic and his team globalized the business structure about a year ago. We've seen strong double-digit earnings and revenue growth as we continue to gain share in a somewhat more fragmented part of the business than we see in mineral fiber. The combined value proposition is very strong in the global architectural community.

The ability to combine architectural specialities platforms with very strong mineral fiber businesses is a somewhat unique value proposition. And we think that differentiates us. And, again, our position in market, very strong markets like Asia and the Middle East where we see relative strength there, gives a lot of confidence that the business will continue to grow and expand margins as we go forward. Any revenue here or any volume here would help a lot.

One other point. You were right, Mike. This is Tom, by the way. Third quarter is seasonally the high point for us in our annual quarterly progression of margins. We're pleased that every quarter this year we've been ahead of the prior-year quarter, despite the investments in the emerging markets. And that's what gives us confidence in the mid-cycle guidance that Matt talked about in the script. We believe that that's still an achievable goal for us.

And, as we've talked before, running through the model and the incremental volumes we would expect that those incremental rates, we think the ceilings business on a full-year basis can get up to the high 20s as an EBITDA margin. And as you can tell, on an adjusted basis we were at that point in the third quarter already this year. But again, that's the seasonal high point. Thank you.

Keith Hughes with SunTrust.

Yes, a follow-up question to the first one on the October results so far. Within residential, are you seeing a distinction between renovation or transactional type business versus what you're getting out of the home builder channel in October?

Keith, this is Frank. On a relative basis they both decelerated in the second, third week of September. Those retail customers where we get POS data for our category, we saw a deceleration. And we have seen somewhat of a pause in new construction, as well. So it's really across both.

Kathryn Thompson with Thompson Research Group.

Great. Thanks. My question is, first, focused on wood flooring. Given some of the hiccups that we've had in terms of pushing through the price increase, but also managing operational inefficiencies, with the perverse problem of trying to keep up with demand, how should we think about margins going forward? And then also is there any type of --- is there any mix that we should take into account when taking into account margins as we model going forward? Thank you.

Kathryn, it's a good question. As I said in the prepared remarks, we're not going to provide additional transparency on the segment going forward. I think our biggest single challenge as we think about the third-quarter actual performance versus expectations was the coming up-to-speed in terms of capacity in the plants and the timing of increases over inflation. And lumber inflation increasing a bit again, at least on a very targeted species.

We're continuing to work on all four items. I think our immediate focus, our primary focus at this point is capacity in the plants. We do have, as Frank pointed out, a softening in demand as we exited the third quarter and entered the fourth quarter. That allows us to work down some backlog, obviously, but that's a little bit of concern, as well.

We're going to work the items hard. We expect continued progress. We know where we need to be by the end of the fourth quarter. But at this point we're a little reluctant to add additional quantitative color on the business segment.

Kathryn, this is Tom. We're not moving off our mid-cycle guidance expectation for wood, which is in the mid to higher teens for an EBITDA margin. We're just not guiding which quarter that's going to start showing itself, because we are facing those headwinds and continue to see volatility in the commodity market.

And just the last comment. We're seeing progress across all fronts. The issue is not that we're not making progress. The issue is the pace of the progress on some of the items. That's how I would characterize it, as well. Thank you.

George Staphos with Bank of America-Merrill Lynch.

Thanks, hi, everyone, good afternoon. I had a two-part question on pricing. I thought I saw or heard you say that in residential flooring pricing was down in aggregate. Was that mostly a mix issue? And could you talk to what was driving that?

And then, looking at ceilings going forward, how much more opportunity do you think you have to sell higher value and sell a higher mix and, for that matter, pricing? Or do you think the earnings leverage from here will really have to come, really, from volume? Thank you, guys.

Let me take the ceilings question first. The business has historically been able to get price over inflation, even in -- as we pointed out, we had record earnings with volumes down 20% from the peak. The market rewards mix so there is a general innovation in mineral fiber ceilings. We continue to see opportunities to drive price into the marketplace. There's nothing that would indicate that we're near the end of that.

So as we get price over inflation, the businesses has worked very hard to continue to refresh its product mix, which drives mix. So, I think we're very optimistic that we'll continue to do that. And there's nothing in the external environment that would indicate that the architectural community and the end users are not in a position to appreciate new product innovation using it in other applications.

We are continuing to drive productivity as we fill the plants. Lean has made a significant contribution in the productivity of the plants. We've continued to invest across the spectrum of the plants. So it really is a balanced approach. This business, even with significantly weaker volumes, continues to execute price over inflation, continues to drive new products in the marketplace, hence mix.

We have very solid, very stable and very strong channels to market with our independent channel partners, and continues to drive real productivity. That combination delivers earnings growth and performance that we've seen, really, for the last year or two.

Frank, do you want to take the wood question?

Sure. Just on the price question, just to clarify, in the wood business we got price realization just short of $11 million, which covered just over 80% of the in-quarter inflation. To your point, on resilient worldwide, we saw some price degradation, about $3 million. Really, the primary driver of that is we're actually seeing deflation in some of the core input costs in the resilient business, which is resulting in some price give, as a result. And that's really across North America, as well as Europe.

Ken Zener with KeyBanc Capital.

Afternoon. Luxury vinyl tile, you guys are doing an expansion that will become effective in 2015. A competitor is also doing some domestic expansion. Can you give us your thoughts on what that means with production coming back into the US, taking away what's being imported from China? And what that might mean in terms of the competitive landscape as we move into 2014, 2015?

Yes, Ken. I'm a little reluctant to comment on what a competitor's investment thesis is. But I think the economic value proposition is the same for both of us. There's a significant productivity benefit as it relates to supply chain costs and distribution costs and re-insourcing that product in the US.

We are, as we said in the comments, we believe we're uniquely positioned to achieve this in the most productive way because of the fact that we're using an existing plant, but also the specific layout of our plant and manufacturing engineering, innovations we'll be able to deploy in making the LVT. So it's a category that, as we've said, is driving the growth inside resilient. It's growing at a multiple of the marketplace. The margins are very strong. It's a relatively small part of the segment, but as I said rapidly growing.

It is a product line that has a fashion dimension to it. So the ability to keep the product line fresh is very critical to driving value in the market. And, of course, the savings from re-insourcing this with relatively low labor content in the US really makes it a very compelling value proposition for us. And so that's why we did it. Thank you.

David McGregor with Longbow Research.

Good afternoon, guys. Just looking at the growth initiatives you've got going on, you have a number of different initiatives underway right now. And I'm just wondering if there's any way to quantify the impact that might have had on the earnings for the quarter. I know you talked about SG&A being an $8 million delta, and $12 million year to date. Is that the right way to think about this? Or are the sum total of all these growth initiatives actually a greater number than that?

The way to think about growth initiatives is two dimensionally. We've got geographic initiatives around emerging markets, hence the three new plants in China, an upcoming plant in Russia, and our strength in the Middle East. So when we think about opportunities, we think that we have underserved opportunities in those three markets in the world and we're investing in them in different ways.

We are in the transition year now where we brought up three plants in one year. The Company hasn't built a plant in 15 years and we brought three online in one year. So, the headwind you see in the expense and related cost is just as we expected, experienced, as we brought the plants online. Commercially we're very happy with the execution across the board in both businesses, ceilings and floors in China and very robust presence in India.

So I think, financially, as we work through the -- clearly, the expenses had a little headwind in EBITDA but certainly nothing more than what we anticipated. And then you have a business adjacency opportunity in architectural specialities, as we've said. We globalized the platform. We've seen significant growth, again in the Middle East and China, here in the US. So you've got revenue growth and you have earnings growth at a multiple of the revenue growth as we continue to penetrate what is a slightly more fragmented opportunity.

So those, I think, really are the cornerstone of our growth platform. So it's geographic focus in two to three emerging markets, it's a product line adjacency that we've organized and energized around. And I would say they are meeting or exceeding the revenue opportunities, the margin opportunities as we work through one-year transition costs, bringing the plants up-to-speed.

And David, this is Tom. We have guided on the year. It's going to be about $25 million of start-up costs, $10 million to $15 million of manufacturing start-up costs, another $5 million to $10 million in SG&A costs. As you can imagine, we've opened these three plants through the first three quarters of the year so we've been absorbing those costs through the quarters. And we've been adding the feet on the street and the SG&A through the year.

So if you just did it simplistically, it's about $6 million a quarter. But that's not really how it's flowing. We haven't guided specifically how it's flowing, but you can imagine the first three quarters of the year were the heaviest burden on manufacturing startup, and probably the SG&A is more back-half loaded given the commercialization of those plants.

Thank you.

Michael Wood with Macquarie.

Hi, thanks. Can you give some more color on the Russia ceilings weakness that you called out? And what gives you the confidence in the growth going forward? Whether the weakness was specific to the timing of plant investments or whether it was macro.

Sure, Mike. Thank you. The Russian market, first of all, it's not plant investments, it's macro and market. We estimate the market's down about 5% or so. It was soft to begin with. This has more to do with government investment and the timing of the release of funds for government infrastructure projects as anything else.

We keep a pretty close tab on import documentation. So we have a pretty good sense of what's going on with share. And the information we have would indicate we've held, and you could, arguably, gain share slightly in a soft market. Remember, the investment thesis for the plant, there was less to generate revenue, although we're always all about revenue, but more to improve our operating margins.

We're avoiding import duties by building a plant in Russia. We are currently serving that market today from mineral fiber plants in Western Europe. So the investment theory and the business case for margin improvement from the investment in Russia is still very strong, irrespective of a near-term softness in the market.

So, the market's a little softer than we outlooked coming in. It seems to be broad-based and macro. We are holding or gaining share. We have a very strong share position in suspended ceilings in Russia. The plant's on schedule for commercial production early 2015. And the margin benefit from the plant is still intact.

The other thing I'd add, Matt, is that relative to when we announced the plant, the macro was better last year. We did better than we thought last year and we are doing slightly softer this year because of the macro environment. But in total our volumes versus where we expected to be at this point are about where we had in the investment thesis. So we're very comfortable with Russia and feel like that global project is going very well.

Exactly. And the plant's on track so far. We expect it to be on track as we roll through it. Thank you.

Stephen Kim with Barclays.

Thanks very much. It's Steve Kim from Barclays. Just wanted to follow up on the resilient pricing issue. I know you alluded to the fact that pricing was negatively affected, you mentioned by core input drivers, some deflation there of about $3 million.

But I was wondering if you could help us understand the competitive dynamics in the resilient flooring business. In particular, I would think that, given the strong history of the Company driving margin, that just because your inputs might be down a bit doesn't necessarily mean that that would necessarily show up on the top line. So, I was curious if you could talk about the competitive dynamics. And is there any geographic element here which is worth calling out? You talked about some destocking in China. Just wanted to get a picture of how you see the competitive dynamics affecting pricing. Thanks.

Yes, I'll frame it and then maybe ask Frank to jump in. It's slightly more fragmented. It's a slightly more fragmented market than we experienced in ABP, in our ceilings business, for instance. There are two large global players along with ourselves that are in resilient flooring. And then you have significant niche players. There are guys that are only in linoleum, there are guys that are only in predominantly North America. So it's a bit more fragmented.

We have very good line of sight in resilient flooring to the input materials -- so inflation and deflation. The pricing tends to adjust fairly quickly to that, given the market structure. In inflationary times, as we have with our ceiling business, where we have price over inflation.

We do have a very dynamic set of markets right now. Most of the developed markets -- for us that would be Western Europe, North America and Australia -- in relative terms volumes are soft. We had significant softness in Australia. The Western European markets continue to be somewhat soft. And, of course, in the Americas it's flattish.

You had that offset by very strong volumes, on a relatively small base, though, in India, China and Russia. You have the dynamic in Russia or in China, as Frank mentioned, of the destocking effect, as our distributors in China work down the inventory of the material we used to import from Western Europe or Australia and stock up on the stuff coming off the new homogeneous line and then, most recently, the heterogeneous line. So, you have that clean-up effect, if you will, that pressures volumes in the short term.

Frank, did you want to --?

I think you hit the highlights. It really is market by market and product line by product line. And where we're seeing the deflation is both in linoleum, where you have really three global players, as well as in vinyl, where in North America you have as many as four or five competing for the space. So, it really does vary by market. And I think Matt said it well. When raw materials, there's changes, there tends to be a fairly quick adjustment to price on the market side to those changes.

Thanks, Steve.

Nishu Sood with Deutsche Bank.

Thanks. I wanted to drill down into the fourth quarter sales number. So the $665 million, if I take the middle of the range, is an 8% increase, if I did my math right, year over year. So I just wanted to understand, given the deceleration in September in resi as carried over into October, commercial there's been some rebound. I just wanted to understand, as you're looking at the fourth quarter, what gives you confidence that you can get back up to that level of year-over-year growth?

Okay, Nishu, this is Tom. So, to start with, we have the benefit of not having the Patriot divestiture in our base. So if you look on a constant FX, we did 5% in the second quarter sales growth. We did 5% in the third quarter. Both of those were burdened by the Patriot divestiture in the base, so that rolls off. That's a meaningful contributor on the reason it might be higher.

Plus, we've been taking significant pricing on both the ceilings business. So we had a 5% price increase in ceilings in August. We had several rounds of pricing through this year on the flooring business. And while we're saying flooring, the residential side has been softer, the pace in the second quarter was torrid. We couldn't keep up with demand. So that was 20% unit volume growth there. So, really, between continued growth, but maybe not at the same torrid rate as we saw in residential, the pricing and the lack of the Patriot in the base, that's what's leading us to be able to guide at that mid point of 8% growth.

Bob Wetenhall with RBC Capital Markets.

Good afternoon. I just wanted to see if either Matt or Tom could give a little clarity around what you're thinking in terms of CapEx spend for 2014. And whether the big improvement in working capital this year goes away. Or are you going to be able to maintain the lower investment level. I'm just trying to think about this in the context of free cash flow for 2014.

Thanks so much.

Thanks, Bob. It's Matt. We aren't guiding yet for 2014 CapEx. We'll provide some more clarity around that early next year. Having said that, the large project left would be the buildout of the Russian plant. And, of course, the start-up of the new LVT plant here in Lancaster, which begins next year and goes through the first half of 2015. So, those would be the drivers of CapEx above the normal running rate, which we've said before is about $100 million. So, more to come on that, but those would be the two incremental drivers over the normal $100 million running rate.

I think that's right. So it's still going to be a heavier CapEx year because of those projects, but will it exceed this year? We don't think that's likely.

On the working capital, we've made tremendous progress. We focus on cash conversion cycle which is a days based measure. We're very pleased that in 2010, while we were here and getting going, we delivered 81 days of cash conversion cycle. We've driven that down to, I think, on a year-to-date basis 56, 58 days through, really, focused on payables and inventories. We've always feel we've been best in class in receivables. So we've really been able to extend out payables, which was a big benefit in the quarter, drive inventories lower. So, our objective is to sustain the days.

But on a cash flow basis sustaining days with an expansionary market presumably will lead to some cash drain. So, we're always going to keep tight on cash, we may try to drive it further. But, given the big releases that have come out of working capital this year, those flow benefits become next year's base, so it's harder to anniversary those. We do feel like we're getting our cash conversion cycle down to the right targeted level for our kind of Company. Thanks for that question, Bob.

Jim Barrett with CL King & Associates.

Good afternoon. This may be a question for Frank or Matt. You're reporting remodeling activity is up slightly currently. Other peers are reporting mid to high single digit growth in that segment, in the high ticket remodeling projects. So I'm trying to understand, is there something unusual about flooring that would explain why it may be lagging other categories? Is it the fact that wood pricing is rising?

Maybe a couple things, Jim. I can't speak to competition, but when you look at the mix of products we're in, we don't participate in ceramic, which as a category is fairly high growth and taking category share from other components. And we don't participate in carpet which is, I think, benefiting from some fairly significant activity from retailers to try to drive volume. So, part of it could be explained by the mix of categories that we're in, and part of it may be we just have maybe a different outlook. We see it in the low, at best mid, single digits in terms of overall.

Keith Hughes with SunTrust.

You referred in the prepared comments to the new LVT facility. Give us an update of your US residential business, what percentage LVT currently stands at?

This Frank, Keith. To make sure I understand the question, specific to residential, what percent is LVT? Is that the question?

Yes. Currently, the residential commercial. Just some sense of how much of the business this represents.

Order of magnitude, it's around 10% of the total commercial residential in North America.

Keith, we already do today about $100 million of worldwide LVT sales. We have production, small production, in Germany. And we have a small production in one of our North America facilities in the Midwest. But really, the Lancaster production would become the primary insourcing for all our Asian production that is sourced from third-party sources.

So, we already have a meaningful business. And, again, the LVT play, while it drives a lot of the improved design and customer service elements that Matt talked about, we do expect it to be a lot like the Russian plant as a margin-enhancing savings project for us.

David McGregor with Longbow Research.

Just a follow-up question on the architectural specialities business. You laid out a picture for 2016. As we think about the growth in that business going forward, is it largely organic growth or do acquisitions become a factor in your plans? Could you talk a little further about that?

Sure, David. We think, first of all, there's a great organic growth opportunity. So, when you look at the market, the geographic markets we're talking about, when you think about the coverage extension in the global architects, we think that the market lends itself to real opportunities. This would be a place where we would look for smaller, what we would call tuck-in acquisitions. It's a very fragmented, competitive landscape. There are a couple relatively large guys.

But it's an opportunity for us to move in and look at smaller regional players that may have product lines or product technologies that we find attractive. We did one a couple years ago with Simplex up in Canada. But as we pointed out, we're also making organic investments. We're going to be expanding our metal capability in China inside the complex that houses the new mineral fiber plant.

So this is a place where we would look for small, modest tuck-in acquisitions as they may make sense, and we can do them rapidly. Certainly not a place we're afraid to go and increase our organic investment, as well. It's just a broad opportunity that we think we've been organized much better to address, really, across the board, not only in the US but in the world.

The other thing I'd add, just for clarity, on slide 15, that we did review the business, the 2016 numbers do not presume acquisitions. So this is what we've got in-house in our own organic expansion activities. So, the lift you see in the architectural specialities is not predicated on doing a deal in capital deployment. Obviously if we could find incremental opportunities to deploy capital and drive this number better, we will. But that's not presumed in the data we've provided.

That's a good point, thank you.

Thank you presenters. At this time I'm showing no additional phone questions in the queue. I'd like to turn the program back over to Mr. Espe for any additional or closing remarks.

Thank you, everybody. We appreciate your interest. We appreciate the questions. We look forward to a very solid fourth quarter and a very robust end of the year. And we appreciate everybody's attention. Thank you very much.

Thank you presenters and, again, thank you ladies and gentlemen. This does conclude today's call. Thank you for your participation and have a wonderful day. Attendees, you may now all disconnect.