Armstrong World Industries Inc (AWI) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Armstrong World Industries, Inc. fourth quarter 2013 earnings conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time.

(Operator Instructions)

As a reminder, this call may be recorded. I'd now like to introduce your host for today's conference, Tom Waters, Vice President and Treasury of Investor Relations, you may begin.

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

With me today are Matt Espe; our President and CEO; Dave Schulz, our CFO; Tom Mangas, CEO of our Worldwide Floor Businesses; and Vic Grizzle, CEO of our Worldwide Ceilings Business. Hopefully you've seen our press release this morning and both the release and the presentation Dave Schulz 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 more detailed discussion of the risks and uncertainties that may affect Armstrong, please review our SEC filings including the 10-K filed this morning.

Forward-looking statements speak only as to 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 and good morning, everyone. I'll lead off this morning with a recap of quite frankly a year of mixed results. Then I'll spend a minute on fourth quarter results versus our guidance, review 2013 market and operating performance versus our expectations when we entered the year, and then update you on the challenges in the wood segment.

I'll recap 2013 strategic events and finally give you a preview of our thinking on 2014. Then Dave Schulz will take a deeper dive into our 2013 results and 2014 guidance.

On a top line basis, the fourth quarter of 2013 was about as expected, with sales of $661 million in the middle of our guidance range of $645 million to $685 million. EBITDA for the quarter of $71 million was within our guidance range, but disappointingly close to the $70 million bottom of the range.

Wood flooring profitability continued to be a challenge as lumber inflation, weak mix, and a continued reliance on pre-dried lumber hurt our profitability. I'll discuss in a few minutes a change in our strategic approach to the wood business.

On the bright side, the ceilings business delivered another record EBITDA quarter in the Americas and globally. Ceilings also capped off a record year of EBITDA despite volumes more than 20% below peak levels.

We entered 2013 expecting an uptick in new home construction and modest improvement in residential repair and remodel activity and our forecast turned out to be pretty accurate. Strong demand in the building channel and share gains at the home centers and independent retailers contributed to top line sales growth in our wood business. Wood volumes were up in the high teens when excluding the impact of the 2012 divestiture of the Patriot distribution business from the base period.

On the North American commercial side, we anticipated a continuation of flat to slightly down commercial volumes. Again, we were largely on the mark here. Pockets of the ceilings business in the US exhibited growth for the first time since 2006, but commercial growth in ceilings didn't translate into the flooring business as education and healthcare remained depressed.

The commercial flooring business in the Americas did experience significant mix gains as high end LVT grew while base grade VCT contracted. In Europe, we expected lower sales in the UK and Continental Europe but anticipated growth in Russia and the Middle East. Markets for both our businesses in Continental Europe came in below expectations, but the ceilings business saw growth in the UK.

Volumes were up in Russia, the Middle East and other emerging European markets, but below our expectations. In the Pacific Rim we expected double-digit sales growth in China, India, and Southeast Asia, and continued declines in Australia. India exceeded expectations, Southeast Asia was essentially on target, but China lagged.

Mineral fiber ceilings and resilient flooring sales were up in China, but only in the high single digits as softness in privately funded sectors hindered sales. Australia was down as expected.

Sales for the year of $2.72 billion were within our initial guidance range of $2.7 billion to $2.8 billion. Operationally we largely performed as expected with solid productivity in North American resilient flooring and ceilings. However, the exception to this as we have talked throughout 2013 was our wood segment.

Bottom line results in this segment have been and remain challenged. During 2013 wood flooring was faced with an unprecedented series of headwinds, an unexpected surge in demand, scarcity of green lumber, and extraordinarily rapid and persistent inflation.

In response to these challenges we added staff and ran our crews on overtime. We purchased pre-dried lumber at an increasing premium to green lumber and we implemented numerous and significant price increases.

Despite these actions, margins have yet to improve. These challenges have been exacerbated by the fact that the majority of the demand surge has been for new home construction which is our lowest mix and margin channel.

As a consequence of these challenges and soft European market conditions, our full year adjusted EBITDA was $371 million. This was within the guidance range of $370 million to $390 million that we provided at the end of the third quarter, but below our initial 2013 guidance that we outlined at this time last year of $390 million to $420 million. Essentially, the entire miss versus our initial EBITDA guidance can be attributed to the wood segment.

With Tom Mangas taking over the floor leadership position and with other recent management changes in the business, we've taken a fresh look at our strategic options for wood. As a result of continuing lumber inflation, increasing premiums for pre-dried lumber and weak mix, we've taken a decision to change our approach in this segment.

Now instead of trying to maximize share growth, we're shifting to manufacturing the volume and mix of products that restore structural attractiveness to the segment. We'll constrain purchases of pre-dried lumber to select high valued species and we'll significantly limit overtime. At current market prices it doesn't pay to endure overtime costs in the pre-dried premium for lumber.

Finally, we'll prioritize the manufacturing of higher end products. On top of these actions, we'll need to continue to drive further price increases to cover lumber inflation. To that end, we executed 6% to 12% increases that took effect earlier this month on selected products.

This increase covers lumber inflation through February. If lumber rises beyond current levels, additional actions are going to be necessary.

Hidden within the bad news in the wood segment is the increased manufacturing capacity we've created at our solid wood plants through our lean efforts. These plants can now finish more wood than they can dry.

So within our 2014 capital expenditure plan is about $10 million to increase green lumber drying capacity. This increased capacity won't come online until late this year so we'll constrain 2014 output to our current drying capacity which is lower than 2013 volumes.

If pre-dried lumber prices drop to more normalized premiums versus green lumber we may resume utilizing this material to drive volume growth. Barring that, 2014 will be a year of giving back some of the share we gained in 2013. Price increases and mix improvements should result in roughly flat year-on-year wood sales, however with improving margins.

Dave will walk you through more of the details of our quarterly and full-year financial performance in a few minutes. Stepping back for a moment to look at the big picture, 2013 was an important year in the evolution of Armstrong. We took significant steps to position us to benefit from future global growth.

We completed and operationalized a new mineral fiber ceiling plant, and heterogeneous and homogeneous flooring plants in China. Our Russian ceiling plant is now under roof and beginning to receive equipment with construction completion targeted for year-end.

We announced a $40 million investment in LVT capability to be housed within our Lancaster, Pennsylvania flooring plant. We're making investments in metal ceiling manufacturing in China, have added capacity and capability at our Hilliard, Ohio ceiling facility. At $214 million of capital expenditures, 2013 was the largest organic investment year in Armstrong's 150 plus year history.

With elevated levels of investments continuing through 2014, Armstrong will spend about $750 million on capital expenditures from 2011 through 2014. Almost double our normal run rate. Importantly, these projects have been completed largely on time in aggregate under budget and with an exceptional level of safety.

Also significant in the fourth quarter, the Asbestos Trust and TPG executed an additional secondary offering of 6 million shares of Armstrong stock in November. When coupled with their September sale of 12 million shares, of which we repurchased 5 million shares, the Trust and TPG have reduced their combined ownership of Armstrong from over 50% at the beginning of 2013 to roughly 25% at year-end.

Looking forward to 2014, we expect sales growth to be aided by commercial volume gains for the first time since 2006. However, as in recent years, we anticipate price and mix to provide the majority of year-on-year sales gains. In the ceilings business, we anticipate volumes to be slightly -- to be up slightly in the Americas.

In Europe, despite the recent uptick in residential activity, we expect commercial sectors on the continent and in the UK to continue to contract but the overall European region should expand with growth in Russia and the Middle East. Pacific Rim sales will be up despite a continued weak Australia.

Architectural specialties will contribute to ceilings growth in all geographies. The flooring business will see strong volume gains in the Pacific Rim, led by China. We expect modest growth in Europe, driven by new products as well as growth in Russia and the Middle East.

Commercial flooring in the Americas will be roughly flat with growth in retail, but continued challenges in education and healthcare. Now, as you think about North American commercial construction, let me remind you that given our products, a new commercial project started today typically doesn't have its floors or ceilings installed for 12 to 24 months. Now as we contemplate a commercial recovery, there are several differentiating factors from the wood business that I would like you to be aware of.

First, we typically have much more visibility in terms of commercial construction than residential as illustrated by the lead time of new projects I just mentioned. Second, the resilient flooring and ceilings businesses have much less volatility in their raw materials and have better pricing power than the wood business. Finally, capacity is available and easier to scale up as ceiling and resilient flooring manufacturing is less labor intensive than wood flooring and our plants are located in more populous regions than the wood plants.

So with global sales growth in the mid single digits, we're poised to grow adjusted EBITDA. Year-on-year manufacturing productivity should return at historical levels as we anticipate gross margins will improve by 100 to 150 basis points in 2014.

The China plants will contribute to positive results versus 2013, but Russia and the LVT plant in Lancaster will largely offset these gains. It won't be until 2015 when all plants are operational that we'd expect tailwinds from these investments.

Inflation is expected to remain a headwind in the wood business, but Tom and the team are focused on price realization, limiting pre-dried lumber, and driving operational execution. SG&A spend will be up as we continue to invest in our growth opportunities in the emerging markets and architectural specialties, and as we cope with wage and benefit inflation on a global level.

So with that, let me turn it over to Dave to discuss our results and outlook in more detail including our guidance on the first quarter of 2014.

Thanks, Matt, good morning to everyone on the call.

In reviewing our fourth quarter and full year results, I will 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 of our standard basis of presentation.

As you can see, while quarterly sales grew 8.1% versus 2012, on a comparable FX basis the various profitability measures and free cash flow were down year-on-year. I will address the drivers of EBITDA and free cash flow on upcoming slides. We closed the fourth quarter with net debt of $931 million, up from $735 million at the end of 2012.

Net debt was impacted by our $260 million share repurchase in September, partially offset by 12 months of positive cash generation. Finally, our unadjusted return on invested capital on a continuing operations basis was 8.2%, down from prior years as profitability was lower in 2013 than in 2012. I'll discuss the drivers of profitability when I review the full year numbers.

Slide 5 details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $11 million in the quarter. As you can see, we have $9 million of cost reduction charges related to severance in our European and Australian flooring manufacturing sites, as we right-size capacity for market opportunity. In 2012, we had various small cost reduction initiatives totaling $4 million.

Our typical fourth quarter tax rate is usually quite high due to the large impact of unbenefited foreign tax losses in a seasonally low profit quarter. This was true in the fourth quarter of 2012, when our book tax rate was almost 70%. In 2013, we have fully utilized our federal bankruptcy related NOLs and have engaged in tax planning around R&D credits and domestic production activity deductions.

In the fourth quarter of 2013, we booked a multi-year R&D tax credit and benefited from the favorable year-over-year impact of D-Pad. These planning activities lowered our tax rate to 41% and will provide continued benefits although not of this magnitude going forward.

Moving to slide 6, this illustrates our sales and adjusted EBITDA by segment for the quarter. Resilient flooring sales were down 2%. Sales in North America were down driven by modest volume declines.

Sales in Europe increased and the Pacific Rim was down as volume growth in China and India were more than offset by declines in Australia and foreign exchange. Overall for the segment, price was down slightly while mix was up driven by premium BCT and LVT.

Despite lower sales, adjusted EBITDA was up $9 million with improvements in all geographies. Global mix gains and manufacturing productivity as well as SG&A savings in developed markets drove the year-on-year profitability gains.

Wood flooring sales were up 24%. Volume was up double digits and price gains were greater than 10%. In the third quarter, price increases were just under 9% year-on-year, so you can see that we continue to get traction on pricing.

Despite the volume and price gains, wood profitability lagged the prior year. Adjusted EBITDA was down $7 million, as lumber inflation, manufacturing costs, and weak mix continued.

Turning to building products. Sales were up 10% driven by gains in volume, price, and mix. All geographies experienced volume gains.

Sales in the Americas were up driven by both the US commercial and retail channels. The Europe, Middle East and Africa region saw sales growth in Russia, the UK and the Middle East. Additionally, European sales benefited from strong results in the architectural specialties business.

Pacific Rim sales were up double-digits when excluding the impact of foreign exchange. India, Australia and Southeast Asia were all up. China mineral fiber sales were up double-digit offset by architectural specialty sales which were down against a prior year quarter.

Adjusted EBITDA in building products increased $1 million versus the fourth quarter of 2012. As Matt mentioned, the Americas saw record fourth quarter profitability with adjusted EBITDA up over last year as strong sales and production performance offset timing driven increases in SG&A and an environmental reserve increase.

European profitability was down despite higher sales driven by cost from our Russian plant construction and SG&A expenses. Asia profitability was up slightly as increased revenues offset higher fixed manufacturing costs from our new plants. The corporate segment was down driven by pension expenses and higher benefit costs.

Slide 7 shows the building blocks of adjusted EBITDA from the fourth quarter of 2012 to our current results. As you can see, price mix and volume were all positive, but price did not cover inflation due to continued increases in lumber costs in the wood segment. The inflation headwind was almost entirely due to lumber.

Manufacturing costs were slightly negative as the headwinds from the wood segment and our plant start-up costs more than offset productivity improvements in the ceilings and North American resilient businesses. SG&A costs were up driven by spending in the emerging markets, architectural specialties, some of the corporate expense items I mentioned earlier, and timing relative to other quarters particularly in the ceilings business.

WAVE added $2 million to our year-on-year results primarily driven by the benefit of volume and manufacturing productivity. Our non-cash pension credit is lower in 2013 as we have mentioned throughout the year. Finally, depreciation is increasing as we bring our new manufacturing facilities online.

Turning now to slide 8. You can see our free cash flow for the quarter versus 2012. Cash earnings were lower than prior year and while working capital was flat in the quarter when compared to 2012, receivables and inventories did not drop as significantly as in the prior year.

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 $3 million, as a result of our March refinancing.

Beginning with slide 9, I will discuss year-to-date results. As you can see, sales were up 3.9% and would have been up almost 5% if we adjusted for the Patriot divestiture in 2012.

Year-to-date sales growth came primarily from our wood flooring and US commercial ceilings business. European flooring and our Australian businesses were down. Operating income, adjusted EBITDA and EPS are all down year-to-date.

The outsize drop in EPS per share relative to EBITDA and operating income is driven by a $19 million non-cash charge we took in the first quarter to write down unamortized fees from prior credit agreements. Recall this was part of our March 2013 refinancing and new credit agreement. This negatively impacted EPS for the full year by $0.19.

Slide 10 illustrates our sales and adjusted EBITDA by segment for the full year period. Resilient flooring sales were down 2%. Volumes were down in all regions, partially offset by higher price and mix.

Adjusted EBITDA was up $6 million for the year driven by strong performance in the Americas. EBITDA was down in the Pacific Rim and Europe due to plant startup costs and volume declines respectively.

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, and lower SG&A expenses overcoming the lower year-to-date volumes. Our worldwide resilient business achieved its highest EBITDA since emergence from bankruptcy despite historically depressed volumes and investments in emerging markets.

Wood flooring sales were up 16% and would have been up more than 20% if not for the Patriot divestiture. For the year, wood EBITDA is down $31 million from 2012. Matt detailed the issues in wood so I will not repeat them here.

Building product sales were up 4%. Sales were up in all regions driven by volume gains in Asia and emerging European markets as well as improved price. Adjusted EBITDA in the building products segment increased $16 million.

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 the emerging market expansion expenses in Europe and Asia. The corporate segment was down $22 million, driven by global pension expenses, higher benefit costs, and outside consulting services.

Slide 11 shows the building blocks of adjusted EBITDA for the year. The bars are all directionally the same as the quarter, so I won't dwell on this slide, but I do want to reiterate the magnitude of the lumber inflation which accounts for the majority of the $49 million input cost bar.

Slide 12 shows the Company generated $68 million of free cash flow for the year, down from $88 million in 2012. Cash earnings were lower, but working capital experienced significant year-over-year improvement driven by accounts payable. Capital expenditures were higher and interest expense lower as a result of our March refinancing.

Slide 13 provides guidance for 2014. We expect sales in the range of $2.8 billion to $2.9 billion, up 5% at the midpoint from 2013, and adjusted EBITDA in the range of $400 million to $430 million, up 12% at the midpoint over 2013. Free cash flow expectations for the year range from $60 million to $100 million.

Slide 14 provides more details of the assumptions in our 2014 guidance. I want to provide some additional comments on some of these factors.

Gross margins are expected to increase 100 to 150 basis points as we continue to focus on manufacturing productivity and the actions that Matt discussed in the wood business to improve margins. Let me provide some additional perspective on the new plants.

Recall we provided guidance in 2013 that we would have about $15 million of incremental manufacturing costs above 2012 related to the new plants, plus about $10 million of additional SG&A as we build out the organization in the emerging markets. We also indicated that the $10 million of incremental SG&A for the emerging markets will continue into 2014.

For 2014, we expect an additional $10 million of expenses associated with the Russia ceilings plant and LVT investments. These costs are essentially offset by the incremental benefit of the EBITDA generated from the three new plants in China. We anticipate SG&A will increase 50 basis points in 2014 as we continue to invest in the emerging markets and the architectural specialties business.

Lastly, I want to comment on the tax rate. We expect our 2014 tax rate to be 44%, up versus the 2013 rate and reflecting the impact of losses in our foreign subsidiaries. This is driven by two issues -- continued market softness in Europe, and the cost of adding new manufacturing plants in China and Russia. We continue to expect the long-term adjusted ETR to be about 39%.

For Q1, we expect sales will be in the $625 million to $665 million range. At the midpoint, this represents a 4% increase over the prior year quarter. We anticipate EBITDA will range from $75 million to $90 million, a 6% increase at the midpoint driven by modest volume, price and manufacturing savings, partially offset by inflation and the emerging market investments discussed earlier.

With that I'll turn the call back to Matt.

Thanks, Dave.

The other important change you witnessed with Armstrong in 2013 was an example of the organization vitality initiatives that I discussed at various points in time. With the retirement of Frank Ready as head of our Global Flooring business in the fourth quarter, we were able to execute on a series of succession moves that had been planned in advance with our Board of Directors. And transitioned Tom Mangas from CFO into the flooring leadership role.

We were also able to promote Dave Schulz from his position as Vice President of Finance in our global ceilings business into the CFO role. These changes as well as promotion of Ellen Romano to the Senior Vice President of HR role that happened earlier in the year, are great examples of the organizational development actions that have been implemented since 2010 and provide a glimpse at the management depth we've been able to build and retain within the company.

So with that, we'd be happy to take any questions.

Thank you.

(Operator Instructions)

Our first question comes from Keith Hughes of SunTrust. Your line is open.

Thanks. Wanted to dig into two areas. One, just any more detail you can give us on Building Products in the quarter, on the -- how recurring some of the SG&A costs and things like that, the breakout between that and plant startups. We just would have expected a lot more flow through and good sales numbers.

Well, just a couple comments and let Vic add. The SG&A expenses invested in the fourth quarter are really in emerging markets and Architectural Specialties.

So those will largely be in place as we go forward as we continue to invest for growth in Russia, India, and China. The recurring -- the revenue stream tends to be largely at this point largely remodel, so I think that will continue to be pretty solid and predictable. Vic?

Yes, I would just add, I think overall the questions around margin structure, there's no change to the margin structure in the Ceilings business going forward. I think the additional SG&A expense is in support of the revenue growth plans that we have in place in emerging markets and Architectural Specialties. In both of those cases we're starting to see the revenue traction there.

The big impact to the margin structure that you saw is around the period expense that Dave outlined in his talking points around the expenses and the additional period expense around our new plants and that will continue. The expenses around those plants expire as the plants come online, but the fixed period expense stay with those plants until we can more fully utilize those plants from a volume standpoint. So in addition to what you said, (technical difficulty) would address that.

Good, thank you.

Thank you. Our next question comes from George Staphos of Bank of America-Merrill Lynch. Your line is open.

Thanks. Good morning everybody. I just wanted to follow up on that question on SG&A and then a second part just talk about return on invested capital. So the incremental $10 million of SG&A spending this year, does that spending drop off in 2015 or 2016? And then the related question, you know, return on invested capital I think was roughly around 8% for the year.

Obviously it's the reported, not an unadjusted -- or an adjusted number, but it's still a ways off from the 15% goal. What progress do you think you'll make, what makes you confident you'll see higher ROIC in 2014? Thank you, guys.

Sure. It's Dave Schulz. So first, let me address the SG&A. As we mentioned, we increased our SG&A in the emerging markets by about $10 million in 2013. That spending will continue going forward as we've increased our go-to-market capability. That is a going cost, structural going forward.

Your question about ROIC, obviously we did have some of our business units that had results below our expectations during the current year. Moving forward, our focus on margin improvement and sales growth will continue to improve our ROIC.

Thank you.

Thank you. Our next question comes from Ken Zener of KeyBanc. Your line is open.

Good morning, gentlemen. The Wood strategy or shift if you will, it sounds like that's obviously a different approach. Could you highlight how much business, you know, when that began in the fourth quarter, or how much business you walked away from because it looks like your growth rate is in the high teens and fallen to about 11%?

And then how does that change from where you're standing today impact the margin ramp if you will in 2014? Because it sounds like you've taken away a lot of variance since you're selecting what business you want. If you could highlight some of those trends. Thank you.

Before I hand it over to Tom, just to create a little context here. The operating assumptions we had at the first half of 2013 was that -- were that wood inflation would abate, we started to see it flatten out if you remember at midpoint through the year and at the relative premium for prekiln-dried lumber versus green lumber would normalize.

When we entered the third or fourth quarter we just didn't see that so we decided it was time for a different approach to the business. So as I said in the prepared remarks, we appointed Tom to lead the Floor business. Tom went in, looked at our strategic options and developed -- helped develop the strategy of really constraining manufacturing capacity to our drying capacity which really virtually eliminates the use of PKD outside, as we said, some very specific species that are very high end.

So that allows us to begin to manage things within our control. We avoid the accelerated premium for PKD and it allows us to take out some of the overtime. So we begin to manage within our manufacturing or drying constraints, if you will. That allows us then to begin driving a richer mix into the market as our supplies constrain.

What we are giving up to your point is a little bit of revenue, a little bit of volume, certainly some of the share we gained last year. What we get in response, in return is a strategy where we're managing a lot more of the variables, much more of this is under control and gives us an opportunity to drive mix improvement.

Thank you for that context, Matt. This is Tom Mangas. Thank you, Ken for your question. I would say none of the Q4 results that you see were impacted by this change of strategy. It's something we debated and discussed and decided on at the beginning of December for implementation in the first quarter.

We definitely saw a weaker demand environment for the Wood business in November; it really crossed the builder channel significantly as they took a step back on some of their weakening numbers. As well as in the repair, remodel. The lower volumes off the second and third quarter run rates were a factor of consumer and home builder demand.

To Matt's point, these changes I think are important to restore the structural attractiveness of wood. That is the focus that I'm taking here, and we are preparing to trade off some of the share gains we enjoyed last year. On a like for like basis, taking out the Patriot divestiture, the Wood business grew 22% last year. I think if you looked at any of our peers out there in wood, I don't think any of them grew that fast.

So I think we overshot our capability to grow that business as Matt said by driving lots of overtime and buying PKD. So we are starting in this quarter dialing that back. That said, we continue to chase raw materials higher. So we exited the 2013 year with a raw material cost of green lumber only at around $765 per thousand board feet and already through February it's accelerated to $789.

So we are going to -- these strategies are essential to restore structural attractiveness. That said, if we continue to face an accelerating commodity environment like we continue to face in green lumber today, we'll be chasing it.

Given the way we have LIFO accounting, we'll always be penalized on the way up with commodity cost increases and facing the typical lags we endure with selling price increases through. My focus is when this business becomes -- when the external environment normalizes to what we call it a steady state, at whatever level of commodity lumber inputs we have, that this business is structurally attractive and is on track to deliver our mid-cycle guidance for ROIC in the segment.

Thank you. Our next question comes from Michael Rehaut of JPMorgan. Your line is open.

Thanks. Good morning everyone.

Good morning.

Just another question if I might on Wood. You've talked about it and we appreciate all of the detail and the color. When you talk about strategic options also what comes to mind is keep it or don't keep it. And it seems like you're looking at 2014 with the different levers you're going to be pulling.

If I'm interpreting this right, a critical year in terms of what you think you may or may not be able to do in terms of restoring some of the profitability. Is it fair to think that towards the end of the year, based on the results, you'd be making decisions whether or not this is a core business for you? Or would you be willing to give it a longer time period than that?

Fair question. This is Matt. Again, some context. What we're dealing with here is unprecedented rates of raw material inflation and unprecedented premiums in PKD over the inflation. So you could take a look at our relative performance in the last six months and extrapolate it. But what we're dealing with here is something that cuts against the normal cyclical patterns that we've seen in this business over the last several years.

Our priority right now is to implement the strategies that we've laid out, that Tom just detailed a little bit. Capping output within our drying range and within our control. Selectively making CapEx investments to expand that drying range responsibly. Minimizing the usage of PKD, significantly reducing overtime, improving our yields, and continuing to drive price over inflation.

So that's really the priority we have today. I would say that I think this leadership team has done, has demonstrated an intellectual and strategic flexibility that allows us to think about any element of our business portfolio as it relates to the core, and as it relates to broader shareholder benefit. So while our priority right now is to fix the business, get it back on track, we'll certainly, there will be a time to think about the broader question you mentioned, but right now what we're focused on is getting this business back on track.

Mike, this is Tom Mangas, just to add a couple points to that. Only in 2011, in that stable commodity environment, we were running an ROIC of about 9% in Wood in 2011 and 2012. So it wasn't too far ago that it was pretty close to our Company WACC. And that was at a sales level that was at trough levels. And so in our EBITDA margin in 2011 and 2012 at trough sales levels was higher than it was at peak in 2006, at peak sales levels, almost 40% lower sales.

So I believe as a market share leader in North America, with about a [28%] share in the Wood business we deserve to have a strong ROIC potential and I think when commodities are rising, that's what makes it tough. I think we may have overstretched for share compounding on our execution last year.

Going forward I think as a share leader with appropriate pricing and channel management, we deserve to have a extremely strong return on invested capital in a normal economy. I think we're going to look really smart when commodities come down, maybe smarter than we really are and we maybe look a little more foolish when commodities are up, maybe a little more foolish than we really are. Thank you.

Next question comes from Bob Wetenhall of RBC Capital Markets.

Good morning, guys. I want to move past the Wood question cause that horse got beaten to death. Can we talk about the Resilient business? I'm just trying to understand, you had good margin performance in the quarter, but I'm more concerned about the trend because you've had 11 consecutive quarters of year-over-year sales decline.

I'm trying to understand what's causing the decline and given some of the resurgence in that market do you expect that to turn the corner this year? And what's the upside from a margin standpoint if you start getting top line growth?

I think a lot of the decline we've seen, Bob, has been most of it's market related obviously in North America and Western Europe, accelerated by our exit of the residential flooring business in Western Europe a couple years ago. We expect to see broad demand for Resilient Flooring in the commercial segments strengthen next year or this year.

We continue to see or expect a little bit of challenge in the healthcare and education markets as those heal a little bit more slowly than the others. We anticipate some relative strength in the retail segment and by retail, of course, this is flooring going into stores, not sold through stores of the consumer market. And we have very modest expectations for Western Europe next year and we expect to see continued traction in emerging markets, primarily China.

Bob, let me give a -- first, you're right, the Resilient segment worldwide is down. The data I have got in front of me is last 8 quarters, so you're probably right, the last 12. I'll tell you, in 2013 the difficulties in the education and healthcare segments were a major driver worldwide, particularly in Europe and North America.

Number two, we have taken a significant step on, stepping back on laminate. I mean our laminate business is driving the bulk of that decline in North America on the residential side as we're not prime there; we're competing at the high end. So a little bit of a taste of what we're doing in Wood is we're focusing on the high end where we can make margin. We've given up some volume and sales growth on the laminate, residential side of the business.

On the positive side, and we were very excited about our ability to innovate in Resilient. Our Alterna product is up 15% this year as a new product introduction that is winning the hearts and minds of residential consumers. Our LVT business worldwide is up dramatically. In the North America commercial and residential segments, we're probably up almost 10% in LVT.

So I think there are a lot of great bright spots where we're investing and focusing to drive growth and fundamentally this is a manufacturing system that knows how to get productivity. So despite volumes being down and sales overall worldwide, 2% in Resilient segment, we grew to a record EBITDA level. So I think the incremental margins are real with volume growth.

I think that the plants are going to continue to deliver productivity and with incremental volume as education, healthcare recover, as we extend into LVT, as we grow our homo and hetero sheet business in China, I think you're going to love the margins and this business on a worldwide basis will have a strong return on invested capital.

Thank you. Our next question comes from Kathryn Thompson of Thompson Research Group. Your line is open.

Hi, a two part question, first on Ceilings and second Wood Flooring, but I'll try not to beat the horse too much on that segment. On Ceilings, how much did higher SG&A versus a lower gross margin impact overall operating margins and related to that, how are you managing rising energy costs particularly natural gas going to 2014?

I didn't catch the first part of the question, Kathryn, I'm sorry.

For Ceilings, if you look at your overall operating margins for that segment, a little bit below our expectations. How much did the higher SG&A versus slightly lower gross margin impact the overall net operating margin?

Kathryn, it's Dave Schulz. So overall the SG&A increases to support the emerging markets and Architectural Specialties was the key driver for the margin erosion that you see within Q4.

Okay. That's helpful. And then on Wood Flooring, and this may be just some clarification on feedback that we've gotten from the channel.

But it had been our understanding that you'd had a fair amount of -- or a certain amount of volumes tied to big home builders perhaps at lower prices. Could you clarify would the back orders or backlog of orders you have, is there a different pricing scheme for those products, big home builders versus other volumes which would be tied more to the price increases that we saw last year and that are in the market right now?

Thank you, Kathryn, this is Tom again. So first, just to recap. We have about a third of our business sells into big box, a third into independent distributors for retail and then finally, a third into builder. The answer is yes, in 2011 and 2012 in the depth of the crisis and very anemic volumes the business did commit to a couple key builders -- some key builders, pricing that had a fixed component to it for the year or a couple of years.

And that both the fact that the builder mix is a weaker mix and those contracts did constrain our ability to take pricing in 2013, and contributed to the weaker mix because that's where the volume growth was, you can be assured that as those contracts roll off we are indexing those guys straight to where the market is. We are very diligently managing to ensure like for like pricing across for all our channels in order to not have channel conflicts create reasons for customers to switch away from us.

I'm very confident that's on track. We're not totally out of it in 2014, but we've significantly worked it down and something that I think will continue to work its way out of the system and become less noticeable over time.

Thank you.

Thank you. Our next question comes from Nishu Sood of Deutsche Bank. Your line is open.

Thanks. I wanted to revisit the Ceilings margin. If you look at it on a sequential basis, or a year-over-year basis, or against what the expectations were. Your Ceilings EBITDA was about $5 million to $10 million light and so there's three things you folks have mentioned. The environmental reserve, the SG&A -- Dave was just mentioning about SG&A as the main component but there's the Architectural Specialties aspect of that, as well as the Russian plant startup.

So I was just wondering if you could provide, in the environmental reserve you haven't commented on that, what amount that was. It was a -- the $5 million to $10 million, it was a pretty big miss against the trend line. You've had a terrific trend line in that business.

Vic did mention that, look, the underlying economics of this business haven't changed yet. So just wanted to understand given the magnitude of the deterioration in the EBITDA there, how those three things break down in terms of what they affected and the recurring nature of them.

Again, I think in terms of broad statement, we've talked about the $10 million of SG&A being somewhat structural as these are investments in emerging markets that will accelerate revenue growth in those markets as we go forward. We have about $15 million associated with the new plant in Russia which is, you know should be a one year -- those are expenses associated with plant start-up.

Do you want to comment on the reserve?

Sure. So within the fourth quarter, as Matt mentioned, we had the SG&A investments for the emerging markets in Architectural Specialties which was sequentially higher and obviously well ahead of prior year. We also had the investments for our plant startups which for 2013 combined for all of our plants as Matt mentioned, we had roughly $15 million of incremental expenses. In Q4, we also saw some of that being part of our Russia plant startup.

So as we put the building under roof, we had some incremental expenses that you did not see in the sequential quarter profile. The third piece that you mentioned was the environmental reserve which we talked about in our prepared remarks. So we did have a sequential increase in environmental reserve related to a couple of our facilities here in the United States. Those were still relatively modest but did have a slight impact on gross margin.

Thank you. Our next question comes from Will Randow of Citigroup. Your line is open.

Good morning. Thanks for taking my question.

Good morning.

In regards to CapEx levels, you guys are still guiding considerably above where you've ran. Where do you think mid-cycle is today? Have you taken a fresh look at that? When do you think you'll reach kind of more mid-cycle levels of I'm guessing $120 million or so per year?

We've said about that level is normal run rate, Will. We have the Russia Ceiling plant, the vast majority of that would be taken care of this year. We have the LVT plant coming online. That's $40 million that begins this year into next year.

In terms of the $100 -- we don't want -- we're not guiding outside of 2014, but if you think about the timing of those facilities again, Russia done this year, LVT a more modest investment done certainly 2015. So post that, we're not anticipating any additional major CapEx moves, so 2014, 2015, 2016 you'd see us kind of return to that normal run rate of about $100 million to $120 million.

Thank you. Our next question comes from David MacGregor of Longbow Research. Your line is open.

Good morning everyone. Just a question on the Ceilings business. One of your competitors had talked about pull-forward into the fourth quarter from 1Q and I was just wondering if you saw any influence that way in your business? Did you take anything from 1Q?

The short answer is no.

Okay. (laughter) Sorry? You also referenced some inflation in your Ceilings business. I wonder if you could just talk about that?

Yes, natural gas has continued to rise all throughout the year; it's up 72% year-over-year. It's probably the biggest driver that we saw in terms of inflation. But overall as you know in the Americas business here we do a pretty good job of getting price over inflation and that was no different for us in the fourth quarter.

Our next question comes from Dennis McGill of Zelman & Associates.

Hi thank you. Just following on that last question for the Ceilings business, fourth quarter, the growth there 9%. How do you get at whether there was or was not pull-forward? And then I guess just related to that, if there was no pull-forward, seeing that accelerate from 2% in the third quarter -- or 3% in the third quarter, what are the big drivers there?

The biggest driver on volume for us was really broad-based volume growth. We had Middle East and Russia, good volume growth as Matt had talked about. And then also in Asia, both our India and China business contributed to the overall volume growth there. So it was broad-based. I think which was different than the third quarter.

Again we know pretty carefully in our discussions with our distributors as you know 85% of our business goes through distributors on what's pulled forward and what's not. As we had a pretty strong volume quarter going, we wanted to make sure that we were servicing the existing demand in the right way. So we have a pretty good confidence level on the pull-forward level and again the broad-based contribution to volume delivered the 9% growth.

Dennis, it's Dave Schulz. I also want to comment that, recall in the base period, we had our Russia go local that was effective at the beginning of Q4. So we did capture some of the customs and duties in our pricing which also led to the year-over-year increase primarily of our European business, but that flows through to obviously the entire ABP segment.

Thank you. Our next question comes from Eli Hackel of Goldman Sachs. Your line is open.

Thank you. Just a question about your investments into China and Russia. Clearly a lot of headlines these days about slowing economies in both those markets. I wonder if you just could give us a recap or remind us of the importance of investing in these markets in the face of economic slowdown in the local economies.

Yes, that's a good question. Just for context, 70% of our revenue comes from North America, 20% from Europe and 10% from the Pac Rim. In total scale, it's relatively small.

We've been in China for decades. We have a very strong team there. We are making significant in-roads and contributions in the industry to driving conversion from in Mineral Fiber Ceiling, from drywall to Mineral Fiber Ceilings and then from Resilient Flooring, from ceramic to Resilient Flooring.

So we think that as the market evolves and emerges, these investments are there to support demand that has sort of largely in process if you will. We've had a Ceiling plant there for 10 to 15 years, it has been sold out for the last 5 or 6. We've been shipping Resilient Flooring in from Western Europe and Australia so you can imagine the margin deterioration on that kind of supply chain.

So we think our investments are responsible. We think it addresses the current size of the market, the trends of the market. Clearly, China's not as robust a growth engine as it was a few years ago but it's still significantly -- it's a significant market with a very attractive overall growth rate.

Within the macro look at China, our targeted market segments: education, healthcare, transportation, continue to be a priority for the government where they're investing. So we think we're well positioned. We think our product lines in both businesses had very valuable or very strong value proposals into the targeted market segments.

Thank you. Our next question comes from Stephen Kim of Barclays. Your line is open.

Thanks very much, guys. I guess my question could be broadly categorized under mix shift questions. In Ceilings, I was curious as to whether you could comment whether there's been any discernible mix shifts that you've seen there. In the context of that I think that you said your Architectural Specialty sales were down in the quarter. I just wanted to follow -- you know, understand how that rolls into it.

And then in the Wood side when you've talked about your strategy of being willing to accept some lower share and then your different pricing scheme in builder, I'm wondering if we should be expecting that your mix will benefit from perhaps some less builder sales and/or if you anticipate an improving mix in some other way in Wood this year?

We'll let Vic tackle the Ceiling mix discussion, then we'll pivot over to Tom for the Wood discussion.

Overall broadly speaking, worldwide level mix was lesser of a contributor, but a positive contributor, but lesser of a contributor than prior years. And a little bit of color around that.

In the US, we continue to have very strong mix as we continue to drive specifications around the higher value products in our portfolio, customers are moving that direction and really like the new products that we're introducing at that level and Architectural Specialties overall contributes to a higher level of mix.

In Europe, we saw a mix shift downward based on the market mix in terms of the overall country mix in Europe. And then Asia mix was overall flat. So overall, a little bit of the US gains in mix was offset by a weaker mix in Europe which we believe is a temporary phenomenon based on the current country mix there.

Stephen, Tom Mangas here. 2013 mix was a significant drag. If you look at the K, talks about us having $12 million of improved price and mix on the whole year. Price is a significant gain, mix was a significant dilution. So to your point, yes, I'm counting on mix to be a significant driver of profit improvement and I am treating price and mix as equivalent.

So I do think that customers who have been benefiting from -- builders who have been benefiting from unusually low prices because of contractual agreements, if they get a little sticker shock and don't want to come along with us, they will drop off. That will show up in our P&L as a mix gain. And clearly part of our strategy is to recover price, commodity increases with price and mix and so I do think you'll see that trend reverse in 2014.

In summary, Steve, the Ceilings mix is driven by geography, predominantly. In Wood, mix is driven by customer segment predominantly.

Stephen, this is Tom Waters just one more point. You asked specifically about Architectural Specialties and you commented that you thought we said it was down in the quarter, it was not in the quarter. It was up and pretty much the same run rate that it's been up quarter-over-quarter throughout the year.

It's Dave Schulz. We had mentioned in our prepared remarks that one of the reconciling items within Asia sales was that Architectural Specialties in China was down year-over-year.

That's probably where he got it.

But we had significant growth in Architectural Specialties worldwide versus the prior year quarter.

Thank you. Looks like we have time for one more question from Justin Bergner of Gabelli & Company. Your line is open.

Good morning everyone and thank you for taking my question. Most have been answered already. First quick question was in the Wood segment, the headwinds associated with pre-dried lumber, and overtime, and builder contracts; when over the course of 2014 should we see those headwinds as having mainly ceased in terms of the quarterly build over 2014?

This is Tom Mangas again. Thank you for your question, Justin. We have implemented that strategy as I described, we talked about it in December, we put it in effect in January, so it is in effect now. Obviously we're living with contracts. We have contracts that will roll off naturally, but the change in the PKD strategy and the overtime strategy was felt across our plants in the month of January, not necessarily at the beginning and that continues to wave through.

And that's critical because as I said, commodity inflation continues to accelerate. So we continue to chase higher commodity lumber inflation. We've taken our price increases. Our price increases were effective in February. So we have implemented those strategies in the first quarter.

I think you'll start to see yield in the fourth quarter -- pardon me, in the first quarter. But again, continue to face that same level of headwind. As I said we exited the year around $760 per thousand board feet and now we're $789, so about a $30 increase in the cost of lumber which will continue to put pressure particularly given our variance accounting.

Thank you.

I'm not showing any other questions in the queue. I'd like to turn the call back over to Management for any further remarks.

Thank you very much. We appreciate everybody's interest today. We are optimistic about our prospects for 2014 as we continue to invest significantly but responsibly in emerging markets.

As we continue to manage things under our control -- price, mix, manufacturing capacity, we have very strong businesses in our global Resilient Flooring business, in our Building Products business and Architectural Specialties. We have an evolution of our strategy in the Wood business that we think will drive margin enhancement as we go through 2014.

So thank you very much for your interest and we'll see you soon.

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone have a great day.