Armstrong World Industries Inc (AWI) 2014 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q2 2014 Armstrong World Industries Incorporation earnings conference call.

(Operator Instructions)

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

Thanks, Sylvia. Good morning, and welcome to everyone on the call. 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.

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

Forward-looking statements speak only as of the date they are made. We undertake no obligation to update any forward-looking statement beyond what is required by applicable securities law.

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

Thanks, Tom and good morning everyone. Our second-quarter financial performance was largely a continuation of the first quarter. Our global sales and manufacturing operations executed crisply, but similar to the first quarter, markets were softer than expected. Sales versus guidance came in at the low end of our range, but as with Q1, we were able to deliver EBITDA in the middle of our guidance.

When we discussed market conditions in April and May, we were cautiously optimistic that the first quarter's subdued activity was a result of the severe winter weather in parts of North America, and that the second quarter, and especially the second half of the year, would see improved conditions. We anticipated that 2014 would mark an inflection point in commercial markets in North America.

Now, as a result of market activity in May and June, and the recent significant downward revisions to GDP, we no longer believe this to be the case. While we continue to see growth in new commercial construction, that's a small part of our overall business. We now believe that both residential and commercial discretionary repair and remodel spend, the large majority of our US business, will be flat to down for the full year, and that overall commercial volumes will also be down.

Now, I say this while being fully aware that GDP and construction forecasts for the second half of the year remain favorable, and that there remains significant optimism in our customer base. Well, that said, we do not believe it's prudent to maintain optimism in our guidance, absent actual realized activity to support the view.

So as a result, we're lowering our full-year guidance for sales by $100 million, and our adjusted EBITDA range by $30 million. Other than lower than expected volumes and some related mix degradation, primarily in the Americas, very little has changed from our previous view. Dave will provide more specifics on guidance, but you I wanted to be up front about this change in our outlook for the year.

So, turning back to the quarter. As I mentioned, sales of $710 million were at the bottom of our guidance range of $710 million to $750 million. Sales were up $3 million or 0.5% from 2013.

Foreign exchange had minimal influence on the year-on-year sales growth. Adjusted EBITDA for the quarter of $99 million was right in the middle of our $90 million to $110 million range, as softer sales were offset by lower than estimated SG&A spending, most of which is timing related, as spend was deferred in the second half of the year.

As we mentioned at our Investor Day in May, we constantly review our portfolio of businesses and our manufacturing footprint. In the quarter, we took additional steps to right-size our global plant portfolio.

We announced the closure of our Thomastown, Australia vinyl flooring plant, effective July 31st. This small facility was no longer economically viable, given the shrinking size of the Australian vinyl tile market. We'll be able to service Australian customers cost effectively from our South Gate, California plant

And also just today, we announced that we would be closing our Kunshan, China engineered wood flooring plant with production scheduled to cease at the end of September. Now, as many of you know, this facility manufactured wood flooring utilizing veneers shipped from the US, scraped by hand in China, and then exported back to North America for sale. Rising labor and freight costs in these products have been among the factors negatively impacting our recent segment profitability.

Proprietary manufacturing advances now enable us to on-shore this production to our Somerset, Kentucky facility, and produce a desired scraped visuals more cost effectively here in the US. In addition, this shift will allow for lower transportation costs, reduced inventory levels, and better customer service. This is yet another action we're taking to restore the wood segment to an acceptable return on capital.

Dave will walk you through our performance by segment and geography, but I want to talk about a few of the areas of recent interest. Wood performance, Russia, and our European flooring business.

As many of you know, we had a good first quarter in the wood segment, when compared with last year. We highlighted that the second quarter was likely to be a pause in the upward trajectory of the segment, as lumber inflation was again likely to be out in front of price increases. We're pleased that in the second quarter the segment delivered EBITDA up almost 50% versus 2013, and modestly above our expectations.

Sales were up slightly versus last year, as 10% volume declines were offset by strong price and mix gains. As expected, price lagged year-over-year inflation, but we should now be priced appropriately versus our outlook for lumber costs for the second half of the year.

Mix was positive year-on-year as our emphasis on higher end products continues to bear fruit. However, as I mentioned in my opening comments, wood volume, especially in repair and remodel channels, was below the expectations that informed our guidance. This also drove negative mix results guidance, mix versus guidance.

SG&A spend was also lower than we forecast, as spending was moved into the back half of the year. Despite improvements in unemployment and housing prices, we continue to see restrained demand for big-ticket discretionary projects. As we look forward, we continue to expect the Wood segment to make progress, but the challenge in the second half now looks to be an uncertain consumer demand environment.

I want to comment on Russia. Last quarter, I mentioned that our construction and business process were proceeding without complications, despite the issues in Ukraine, and that our biggest challenge was the decline in the ruble. We instituted a 10% price increase in April to offset the ruble devaluation, and so far, this has held with seemingly minimal impact on demand.

Plant construction and product shipments continue unimpeded. The situation remains fluid, so we'll continue to keep you posted.

Finally, at our Investor Day in May, we discussed the challenges that we've been experiencing in our flooring business in Western Europe. As you may have noticed in our 10-Q, we mentioned that we are evaluating strategic alternatives for this business.

At this time, I don't really have anything more to add to this statement, other than to say all options are on the table, and that we'll keep you appraised as decisions are made. I also want to be clear that any decision we make on the European flooring business will have minimal to no impact on our core markets here in North America, the Pacific Rim, and the Middle East.

So with that, let me turn the call over to Dave for more details on our financial performance and guidance. Dave?

Thanks, Matt. Good morning to everyone on the call. In reviewing our second-quarter results, I'll be referring to the slides available on our website, starting with slide 4, key metrics, as Tom already covered slide 2, and slide 3 is simply an explanation regarding our standard basis of presentation.

For the second quarter, sales of $705 million were up slightly versus 2013, on a comparable foreign exchange basis. Operating income was down 5%, but EBITDA was up 2.5%, largely due to higher depreciation in 2014. Earnings per share was roughly flat, as this year's lower share count offset lower after-tax income on a per-share basis.

Free cash flow for the quarter was $10 million, down from $32 million last year. I'll talk more about cash flow and EBITDA on coming slides.

Net debt was up $199 million, driven by our $260 million share repurchase in September of 2013, partially offset by operational cash generation. Return on invested capital was lower, driven by a reduction in unadjusted earnings, and a slightly higher capital base.

Slide 5 details the adjustments we made to EBITDA and provides a reconciliation to our reported quarterly net income of $21 million. Matt mentioned the plant closures we are executing at Thomastown and Kunshan, and as a result, we are recognizing $8 million of cost and impairment charges primarily associated with these actions. In contrast, last year we had $3 million of cost reduction expenses related to actions in Europe.

Our 2014 tax rate of 54% is higher than prior year, as the impact of unbenefited foreign losses was greater this year than in the second quarter of 2013. The increase in unbenefited foreign losses in the current year was also impacted in part by the Kunshan plant closure, I just mentioned.

Moving to slide 6, this illustrates our sales and adjusted EBITDA by segment for the quarter. Excluding the impact of foreign exchange, resilient flooring sales were down 2%, as volume declined in North America and Europe. North America was driven by the repair, remodel factors Matt discussed, as well as continued weakness in the healthcare sector. EMEA sales were impacted by continuing weakness in central Europe. Of note in this region, sales in the Middle East more than doubled in the period.

Pacific Rim sales benefited from a more than 50% increase in China, and very strong growth in India, partially offset by continued weakness in Australia, and a down quarter in the volatile Southeast Asia markets. Mix in North America continued to be positive. Despite lower sales, the resilient segment delivered flat EBITDA as manufacturing productivity, reductions in SG&A in the Americas, and profitability improvements in Asia, offset the volume weakness.

The wood segment saw sales increase 1%, driven by price and mix, and profitability increased $3 million, despite significant volume declines. Matt commented on these results so I won't dwell on them, but I will note that lumber costs appear to be stabilizing, albeit at near record levels.

Ceiling sales were up 2% on an equivalent foreign exchange basis, despite volume declines in the Americas and Europe. Volume in the Americas was impacted by the same factors as the resilient business, but somewhat softened by the relative strength in new office activity.

Europe experienced continued soft demand in the Eurozone and the UK. We called out the UK in the first quarter, and mentioned that the issue was largely related to distributor inventory levels. We continue to believe this to be the case, and expect a stronger performance from the UK in the back half of the year.

Europe did benefit from strong sales to the Middle East, up over 25% from last year, as the architectural specialities business had a great quarter related to the Jeddah, Saudi Arabia project. Russia sales were up, driven by our April price increase, but volumes were relatively flat. Pacific Rim sales were up mid single digits, aided by strength in the architectural specialities business.

China volumes were up, but mix was down, as the project business remains soft. India had a strong quarter, and Australia was up on the quarter behind growth in the architectural specialties business. Price and mix was up modestly in all regions.

Building products' EBITDA was up $2 million on a global basis, as margin gains in the Americas were offset by declines in Europe and the Pacific Rim. The Americas benefited from price and mix gains, as well as SG&A deferral.

European profitability was down, due to the Russian plant construction costs and Pacific Rim profitability was impacted by higher SG&A spending. Corporate expenses were higher than last year, largely due to the timing of project work, including expenses associated with the analysis of strategic alternatives for the flooring business in Europe.

Slide 7 shows the building blocks of adjusted EBITDA from the second quarter of 2013 to our current results. Of note, price and mix offset inflationary headwinds from lumber costs, but volume was negative, primarily in flooring.

Manufacturing was a positive, primarily in flooring in the Americas and Europe. Despite the business segments deferring some spending in the quarter, SG&A was up year-on-year, due to the corporate expenses I just mentioned.

Turning now to slide 8. You can see our free cash flow for the quarter was impacted by a lower after-tax cash earnings and greater year-on-year capital spending. On capital, the Russia and LVT plant expenditures are at a high level now versus the China plant spending winding down at this time last year. The other category largely reflect VAT recapture in Asia, as our plants begin to sell finished goods and collect VAT.

Slide 9 begins our discussion of year-to-date results. Sales, operating income and EBITDA are following a similar pattern to the quarter. EPS is up for the first half of the year, driven by our $260 million share repurchase last September. Free cash flow is down, and I will discuss that and EBITDA details in the next few slides.

Slide 10 shows segment-level EBITDA year-to-date, and the only significant variance with the second-quarter results is the inclusion of the relatively strong first-quarter EBITDA performance in the wood segment, demonstrating the effectiveness of our new strategy. Slide 11 shows the building blocks of adjusted EBITDA from the first half of 2013 to our current results. All of the bars mirror the quarter directionally, as first-quarter trends continue into the second quarter.

Turning to slide 12. You see that our free cash flow for the year is down versus 2013, primarily due to unusually favorable working capital in the first quarter of 2013, and higher CapEx spend in the second quarter of 2014.

Slide 13 updates our guidance for 2014. As Matt mentioned, as a result of market conditions, we are reducing the top and bottom of our sales range for the year by $100 million, to $2.7 billion to $2.8 billion. At the midpoint, this would be a 2% increase in sales.

I want to provide some additional comments on the market. Recall previously, we assumed a modest recovery for the year. While we still believe key market indicators point to a longer term recovery, particularly in new construction, continued softness in GDP, and the impact on the repair/remodel segment inform our view that 2014 will be flat to slightly down, compared to last year.

For markets outside the US, our view is generally unchanged for the year. We believe key markets in Western Europe and Australia will be flat to down, consistent with our previous guidance. The Middle East continues to be an area of growth, while we now expect the Russia market will be down high single to low-double digits, given the current political environment.

We are also reducing our operating income and EBITDA ranges by $30 million, due to lower volume and the fall-through to profits. At the midpoint of the range EBITDA would be up 5%. Earnings per share is also reduced, and at the midpoint of our range, EPS would be up 15%. Free cash flow is lower than the previous guidance, primarily due to lower after-tax cash earnings.

Slide 14 provides more details on guidance. Our inflation expectation for the year is unchanged at $30 million to $40 million. This assumes lumber prices remain stable through the balance of the year.

Productivity and SG&A as a percent of sales worsen as a result of the lower volumes and mix decline. Expectations for capital spending and earnings from WAVE are unchanged. On taxes, we continue to anticipate an effective tax rate of 48% to 50%, but have taken our cash taxes down $5 million.

For the third quarter, we expect sales of $740 million to $780 million, and adjusted EBITDA of $110 million to $130 million. Finally, with the closures of Thomastown and Kunshan, we have increased our expected exclusions to $15 million to $20 million. With that, I'll turn it back over to Matt.

Thanks, Dave. Well, overall, this is a mixed quarter for Armstrong. On the plus side, adjusted EBITDA improved in wood for the second quarter in a row, after our strategic pivot at year-end. Architectural specialities, especially in the EMEA and Pacific Rim regions, had a very solid quarter. The Americas ceilings business achieved a record EBITDA margin, and the total business was able to deliver the midpoint in our EBITDA guidance, despite softer sales.

On the negative side, our view of improving end markets, especially here in North America, is not being realized. If markets are stronger than we now anticipate, we're well positioned to take advantage of the opportunity, but we now believe 2014 will be another down year for volumes. We continue to focus on the items in our control, and drive commercial excellence around the globe. With that, we'd be happy to take questions.

(Operator Instructions)

Our first question comes from Keith Hughes from SunTrust.

My question on the guidance cuts, has there something occurred in your commercial orders in June or July, making you take some upside out of these numbers? Just what are you seeing recently, I guess, is the question?

Well, Keith, it's Matt. First of all, in the commercial -- new construction in commercial segments, we're actually seeing fairly robust activity in office, and to a slightly lesser degree, in retail. That's showing up in backlog, particularly in the ABP business, and in mix in the backlog in ABP business. The issue is that's only about 20%, 25% of our -- of the revenue stream for ABP.

What we're seeing is the effect of a relatively softer GDP in the overall market demand for remodel in all commercial segments, applying downward pressure, not only in our ceilings business, but also to a lesser degree in resilient flooring. So there's a fairly high correlation between performance in GDP and the remodel business, so we're seeing a little bit softer remodel and repair than we anticipated.

Thank you. Our next question comes from Bob Wetenhall from RBC Capital Markets.

I love the granularity on that, Matt. If you could expand just office, retail, industrial, as well as healthcare and education, how those trends are playing out? Obviously your commentary around volume was -- your commentary suggests that there's not a lot of acceleration. Is this because trends are going in one direction for all these categories, or do you see pretty substantial differences by end market? Thank you.

It's a good question, Bob. If you look at commercial in North America, office is up. New construction, and to a lesser degree, remodel. Healthcare is weaker in both. In some cases, actually significantly weaker than the outlook coming into the year. Education is flat to down, in both new construction and remodel, and retail is slightly up.

I would say a little better than anticipated, particularly in new construction, but not quite as strong as we're seeing in office. We're seeing pretty significant new construction closes in retail and office, in both of our businesses in North America. Again, the issue we're experiencing is in the remodel business.

If you look at Western Europe, coming in just going outside the US, coming in about as anticipated, flat to slightly down. As we said in the remarks, Russia is down high single digits to low double digits, based on the political environment that we're experiencing there. Our revenue in Russia's actually up, due more to our price performance and volume, and we think we actually continuing to gain share in Russia. And then emerging markets in China and India are performing largely as we expected. So that's kind of a quick run around the world.

Bob, this is Tom. Just a couple extra thoughts on education. It was a slow start, also back to Keith's point, it was a slow start to the summer repair/remodel season. I think the delay, particularly in the north and Mid-Atlantic, the weather extending school openings through middle of June in many places, put a significant delay on school remodel, and we're still trying to read the tea leaves on that one. I think that's somewhat of the weather hangover effect.

People are trying to jam jobs in. There's a significant amount of pent-up demand out there. I'm not clear what the demand trajectory is for the balance of the summer, given the late start. To amplify Matt's point on healthcare which is a big, important segment to the flooring business, it's been tough on healthcare, and I think people are still on the wait and see mode on how economics work out for healthcare reform, before they dive in and put significant new capital into repair/remodel.

Thank you. And our next question comes from George Staphos from BOA - Merrill Lynch. Your line is open.

Good morning, thanks for all the details. Continuing on the guidance adjustment question, so in the end markets, where you've seen less than expected improvement, if that's the theme here, in which markets did you see the most variance, relative to what your initial forecasts were?

The related question would be, free cash flow guidance dropped more than the guidance for your other metrics, recognizing it's off a small base. What was driving that? Thank you.

Let me comment on the market and segment performance. I'll let Dave comment on free cash flow. I guess, in general, George, we're seeing greater than expected softness in all of our served commercial markets in repair and remodel, again, due primarily to the GDP and weakness in demand there. We anticipated the first-quarter softness to be somewhat related to the weather related issues we experienced, but as we exited the first quarter and entered the second quarter, we saw very choppy demand month-by-month in Q2, which pointed to something other than weather.

Going to new construction in commercial, I would say that -- I'd characterize office, new construction, about as expected. Retail, about as expected. I think as Tom mentioned, healthcare, weaker than we expected. And education, about as we expected in new construction.

Residential, we had a very good start in new construction. It's weakening a little bit. The challenge we have with the housing starts performance is the mix of multi-family versus single family. Multi-family units do not use as much wood, and the resilient product that goes into those applications is a little bit lower mix.

So while we're encouraged that in general, there's some level of strength in new residential construction, we'd like to see more single family starts. Of course, residential remodel is tracking similar to what we experienced in commercial. And then, Dave, free cash flow?

George, it's Dave Schulz. Just on the free cash flow, as we mentioned during our prepared remarks, the primary driver is just the lower fall-through from the volume that we guided to. Also the mix of where that volume is anticipated impacting our cash flow.

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

Thanks. Digging into the third-quarter guidance, you have revenues midpoint at $760 million, which is a 4% increase from last year. But EBITDA, you have at $120 million midpoint, which is a decline year-over-year. It certainly runs counter to what we've seen in the first half of the year where you've been able to deliver some solid operating leverage, despite some softness in revenues.

You mentioned some SG&A being pushed from the second quarter into the third quarter. I was wondering if you could quantify and describe that a little bit more. Also, you have this phenomenon I'm describing, reversing in your implied fourth-quarter guidance, with better operating leverage, so I guess I'm just trying to dig into why the EBITDA outlook for the third quarter is worse than the revenue outlook, and why that reverses in the fourth quarter?

Nishu, it's Dave Schulz. Thank you for your question.

A couple of factors. The first is that we do have a couple of the expenses associated with the Russia plant build that are going to impact. Those expenses are higher than what we had realized in Q3 prior year, related to our China plant build.

The second part of your question about the SG&A is absolutely right. We do have more SG&A that was deferred out of Q2. Obviously, as we saw some of the volume patterns developing in late May and in early June, the business units deferred some of the spending on SG&A related to the volume build plans. We haven't provided you any specific guidance on Q3 to that relative impact, but I can tell you that some of that is related to some of the additional promotional and selling activities that we have planned in the back half, primarily here in the United States.

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

Thanks very much. I wanted to follow up on the raw material and energy inflation guidance you've given for the year, $30 million to $40 million. I think we heard in your prepared remarks that lumber was about $17 million year-to-date and so what I was hoping we could get from you is a little bit more of a granular breakdown, separating maybe raw material versus energy, first of all, in that $30 million to $40 million, and secondly, the remainder, how you expect that to play out over the different divisions, that would be great. Thanks very much.

Sure, Stephen. It's Dave Schulz. In terms of what you're seeing year-to-date, and what we already commented on related to wood, as I mentioned, we anticipate that wood pricing has stabilized for the balance of the year. That's incorporated into the guidance that we've provided you. I would anticipate we would see about 2X what we experienced in the first half of the year impacting the wood business.

Obviously, as you take that into account, we have some puts and calls related to materials, plus freight and transportation and energy costs, within the business units. We generally don't break those out for you, but obviously just based on the trends that you're seeing on lumber relative to the total inflation impact for the year, I would anticipate that the balance of that would be split between the two business units, about equally.

Thank you. Our next question comes from Dennis McGill from Zelman & Associates. Your line is open.

Matt, just going back to your comments on the non-res, I think the numbers that you've been citing are the McGraw-Hill starts numbers, but correct me if I'm wrong. When we look at those, those were up double digits the last couple of years, and there's a lag with that flowing through both ceilings and flooring. And volatility around GDP, but GDP has been positive, employment's been accelerating.

So even if you were to look over the last four quarters or so, it seems like volume's been a struggle on the non-res side, even though that backdrop would seemingly imply some volume improvement, whether you wanted to look new construction or remodel. Just wondering why some of those macro data might not align with what you're seeing on the ceilings and flooring side.

It actually is aligning in terms of new construction. Our new construction orders are up, and backlog is up. The issue is really one of mix and percentage represented in the revenue streams. GDP has to be better than positive in order for volume growth in remodel, it has to be close to 3%. So GDP growth at 1.5% or 2%, 2.5%, doesn't really help us much.

Market volume's been down really year-over-year in remodels since 2008, so we are seeing traction in new construction, as we said, particularly in office, and to a lesser degree, but positive in retail. It's showing up in our backlog, it's showing up in richer mix in our backlog. But with GDP tracking anywhere between 1.5 points and 2.5 points, that's not enough to drive meaningful remodel business in the commercial segments. Tom?

Dennis, this is Tom Mangas. I've got the McGraw-Hill data. Education and healthcare in 2012 and 2013 on starts were both down. So we agreed that we live off those on a lag basis. And so on the new component of education and healthcare, we are living through those negative years in 2014.

I think the important point is on where it is favorable on retail and office. It's just on the proportion of the total business, it's only probably 20% of the total volume there, so we really are much more dependent on the repair/remodel side to pull that through.

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

Regarding the European resilient business, I apologize if you touched of on this. Can you talk about what a drag it's been in regards to EBITDA, as well as when you think you'll come to the decision on what to do with that business?

Sure. We've been fairly transparent on this, and I think we went into some detail at the investor meeting. It's been a negative EBITDA performer for the last decade, just to give you some context. Four years ago, we decided and executed a plan to exit the significantly underperforming portion of our business, resilient business, resilient flooring business in Europe. That being the residential business. And we also exited our business in France, the home of our two largest European competitors.

So what we had was a focused number-four position commercial business. That business has further been pressured, primarily due to a lack of recovery in the European markets. We are focused on the Germanic markets, Scandinavia primarily. The volume has not come back, particularly in government-related investment, as we anticipated three or four years ago.

So we shared this, and I'll let Tom comment on it here in a second. We shared this with increased transparency during the investor meeting in May, and we've reached a decision to start reviewing strategic alternatives. We're not in a position to comment. We would say that everything's on the table, as we said in our remarks. We're really not positioned to comment on timing yet, but we wanted you to know that we've begun the work. So Tom?

The business, the European business has been running in the low single digit EBITDA margins, negative EBITDA margins, really since we merged. That was through significant restructuring, and of course European crisis. We've not been able to get above breakeven, which has been a long-term goal of ours, as of Jacks are better to open point of view.

We certainly want to make it -- our aspiration has been to make it an ROIC accretive business and it's just increasingly difficult to do that, since we started the strategic option review. Timing-wise, we're going to move with haste. It is an important structural building block on our assessment, how we improve the overall attractiveness of the resilient segment. I think we put in the Q, that we hope to have a decision, it's likely we could have a decision by the end of the calendar year.

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

Just sorry again, just wanted to touch on the commercial R&R side. Are you seeing R&R growth decelerate or turn negative, is it getting worse as the year goes on? I'm just trying to understand the different drivers from May 21 to today, that obviously impacted the guidance. Are things getting better slowly, or are they actually starting to go the other direction? Thank you.

It's Dave Schulz. Let me just provide a little bit of context on that, and you referenced back to our Investor Day. What we saw was a relatively good April, consistent with what we had guided towards, back during our call on the Q1 results. We saw towards the tail end of May, things really started to look much different than what we had discussed during our Investor Day. May came in much softer than we had anticipated.

June did recover very nicely, but not enough to offset what we saw during the month of May from an overall sales perspective, primarily here in the Americas. So what we would anticipate is continued acceleration, but still when we take a look at the full year, on both the US commercial R&R in both businesses, we don't see that being better than flat to slightly down versus the prior year.

So what I would say is that we really saw a deceleration during the month of May. June recovered. We anticipate based on our input from all of our contacts through the industry, what we're seeing through our discussions with our management teams, with our sales force, is we do see some of that recovering in the back half, but not enough to make the full year better than flat year-over-year.

If I could just add some additional color. Just to provide some context for how we outlook our remodel. Our visibility to the remodel business is 60 to 90 days, at best. So these are largely jobs -- there's some exceptions to this, but these are largely projects and jobs served by our independent distribution in the local marketplace. We wouldn't track these as projects, as we would a new office building, or a new Target store, for instance.

But we see these as restocking and replenishment orders from our distribution channel. So this is not a segment that we have a lot of visibility to. It's a segment that we can model fairly confidently, as it relates to GDP. So when we take a look at the outlook, it's a combination of what we're experiencing currently, but also forecasting based on our model, knowing that we don't have a lot of visibility beyond 30 to 60 to 90 days.

Eli, you asked about commercial. I think it's worthwhile for residential to take its pound of flesh donated here, because it's not all a commercial story on the guidance change. We are seeing weaker consumer repair/remodel trends. I think you've seen it in other consumer flooring companies that have announced.

You see it showing up both in the starts that were anticipated in June, from May decelerating, June year-over-year decelerating on single family starts. The deceleration in total starts from May to June. So that's a piece that's impacting our residential business, which again is [$850] million to the Company.

Similar, you see it just track through in some of the key regions. We continue to see a couple key regions like the Northeast and the Mid-Atlantic struggle on a year versus prior year basis, across the product categories. We're not sure why that is, but it is -- seems to be pretty specific, and we're pretty convinced that it's not a share-related issue. It is simply a consumer dynamic in these markets in the Northeast and Mid-Atlantic. So that's what's also influencing the sales decline in our guidance.

And our next question comes from Michael Rehaut from JPMorgan. Your line is open.

Just wanted to hit on wood flooring for a moment. Appreciate all the detail, as always. I guess looking at the top line and then the margins, from the top line perspective, with the volumes down, continuing from 1Q into 2Q, just wanted to get a sense of how much of that is the continued new direction of the Company, in terms of not chasing volume, or going after more profitable segments, rather than the industry itself? And if that's going to play out for the rest of the year?

Then on the margin side, margins were down sequentially, I think, as you had pointed to last quarter. You have said that the input costs have stabilized, albeit at very high levels. Given the timing of price increases, a quarter ago, we were thinking about a rebound perhaps back to 1Q margin levels, if not higher in had the back half of the year. Just wanted to know if that's the right way to think about things at this point, given your updated comments on inflation?

I'll just quick comment and then hand it over to Tom. What we clearly have as one of the cornerstones of our new approach to the wood business capping volume at our drying capacity, and the team is executing extremely well on that. They've executed extremely well on productivity and on price and mix over inflation. So I think on the things under our control in the wood flooring business, we've done a great job.

The primary driver for the relative volume weakness in the wood business is not necessarily our containment strategy on production volume, and we're executing that. But again, it is, as Tom pointed out, a weaker than outlook market opportunity, particularly, again, and I repeat, in remodel/repair. We've seen that evidenced through other retail channels. And also in the mix of new construction, again, multifamily over single family starts. Tom?

Thank you, Mike, for that. Appreciate those questions. They're very good questions. Let me try to dive into that a bit.

First, as Matt said, the market is a driver of our volumes. It's not 100%. Clearly, the weather impacted us in the first quarter, affected consumer demand and that is part of what I just described, affecting -- I don't know if it's weather or the GDP or the spill-on effects, but the high wood markets like the Northeast and Mid-Atlantic continue to struggle across all product lines, not just wood. So we do think there's a market element there.

Clearly, we're being scraped by competition, and that's costing us some share, and we think it's the appropriate share to give back, as we try to give a much more aggressive pricing and mix-up approach and that's providing some opportunities at the opening price point level, for some of our competitors to scrape along. They're certainly feeling the same level of commodity increases that we've had to endure, but see it as an opportunity to scrape in, and take some near-term volume. Volume that we don't think is particularly sticky, as we experienced as a loss. Probably can get it back at the point we think it's an attractive volume to get back.

There is a mix of market and our approach there to manage the business from the margins. We're very pleased we were able to grow EBITDA. I think EBITDA is the most important measure to look at here. We've had a lot of -- with the Kunshan closure, and as you'll see in the Q, some other asset impairments, fixed asset impairments that we have tried to clean up a bit with the Kunshan closure, gets a little bit lost in the operating income, but on EBITDA we're up almost 50% in the second quarter. On earnings, almost 90% year-to-date.

So we're making progress. That's just prior to relative to last year, not nearly where we'd like to be. And so we are continuing to push on our price and mix program. We've taken pricing in June, July. It has been sold through and continue to work on our mix approach.

The one thing on the commodities, as I anticipated, and we called out in either the quarterly call or the investor call, our inflation costs relative to the first quarter, so second quarter versus first quarter, were up 50%. And that is what's putting pressure there. Our price achievement is still equal to or better, price-mix achievement equal to or better to what we achieved in the first quarter. So really that is the story there.

When we guided to $30 million to $40 million of commodity costs at the Company level, we had forecasted a trajectory of wood, and that trajectory is about what's playing out. That is the leveling out at this point, which is still embedded in our guidance for commodity costs. But yet, that still is the bulk of the Company's $30 million to $40 million commodity increase, as evidenced by the $17 million absorbed year-to-date.

So we think we've got the -- hopefully commodities have stabilized. I think we've got that called right. We've priced to recover at the current level of commodity inflation, and then the challenges, as your last part of the question was, how do I exit the year, we're still not in a position to guide on that because it's volatile, given what you've seen in commodity and commodities skew up or down.

Also, the volume is a big wild card, as Matt mentioned. And we are simply less optimistic on the back half, plus we're anniversarying, go back to Q3, Q4 last year, relative to the first half, you'll recall, we had all sorts of service issues in the first half of the year. We weren't able to get the volume out.

We accrued up massively, started buying PKD to chase it, and that volume flushed out in the third and fourth quarter, and you'll see it back then, we were growing sales at a clip of 20%-plus, mostly volume driven, and so clearly that surge of backlog to orders isn't going to flow through this year, because we're not sitting on a backlog. We've been able to ship what we've been promising. So that's a little bit of the year-over-year comparison, that you'll want to factor through.

We feel very confident we're on the right track with wood. We wish we weren't being scraped, but we're going to continue to be aggressive on addressing the cost profile of this business, as such with our Kunshan closure and on-shoring a significant product line, that I think will be very exciting for consumers, to be able to have a made in America engineered scraped product. I think it will be a margin and a share builder for us. Thank you, Michael.

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

Focusing on ceilings. So the 2.3% growth in the quarter, how much was volume versus price? And follow along with that, how much of the spring price do you think was accepted? We have another price increase that is going to be flowing through the market.

So how much the spring price increase do you think is accepted, the thought process for this second price increase, and more broadly speaking, in terms of price, are you seeing any type of change in conviction level with the end market in terms of accepting price? Thank you.

I'll be happy to take that. Kathryn, this is Vic Grizzle. In the second quarter, your first question around price, mix and volume, really, it was mostly price and mix, for the most part, driving the top line growth. Again, the Americas volume was soft and slightly down, so that's the dynamics really of the second quarter. On the pricing, our pricing actions continue to be driven by raw material increases, both energy and transportation contributing as well.

These are industry-wide and very public, so they're not specific to Armstrong. And those discussions with customers are going very well, so we remain confident that the price increase that we have in the fall will be realized, as we realize the expected price that we had in February. So we don't see any change in that. I think those discussions continue to go well with our customers, and again, they understand this is an industry-wide raw material and price cost increase that we're seeing.

Thank you. Our next question comes from Mike Wood from Macquarie. Your line is now open.

You mentioned several times the better new construction versus the weaker repair/remodel across your various end markets. How significant was that on the margin mix, particularly in hardwood, where you reported an 18% sequential sales improvement, but you barely moved the EBITDA performance. So was that meeting your expectations? Thanks.

Well, in terms of new construction, we saw the benefit of new construction more in commercial, and again in office and retail, than residential. The residential new construction is hampered somewhat by the mix, again, multi-family over single family. Tom, did you want to add additional comments?

I would say on the sequential progress on EBITDA with the sales, it's mostly a raw materials commodity story, the increase of 50% higher commodities in the second quarter versus the first quarter driving that fundamentally. But yes, the builder business tends to be a lower-price, lower-mix product form for us. So that does create a drag in a high builder closing season, where they're finishing a floor up and closing the building. That has some drag.

But again, we have been working through those builder fixed pricing contracts. We continue to make progress on that. Builders, about one third of our overall wood business, so it is a meaningful piece. There is a seasonality to it.

But we have been able to take price and through the bulk of our builder contracts, I think it's going to very important business for us, one we're committed to winning. Our goal there is to make sure we're bringing the product and product innovation through the builder channel that allows them to have an attractive opening price point, but then incentivize their customers, their consumers to mix up with us.

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

You talked about Russia being down. So I guess the question pertains to investments in emerging market SG&A, and I guess any changes to the rate at which you're making these investments? And then presumably, with the guidance revision today, you're going to begin 2015 at a slightly lower pace or slightly slower pace. Do you have an opportunity to flex up there, if the fundamentals should improve, and maybe just update us on that whole emerging market growth story heading into 2015? Thanks.

Sure. In summary, we're finished investing in the emerging markets. So we are -- the three plants in China are up and operational. The plant in Russia is on schedule, and on budget. We should complete construction at the end of the year and, we should have product sellable out of the plant early next year.

No changes whatsoever. We're not anticipating any additional investments in the emerging markets at this point. So in terms of rate of investment, consider the rate of investment slowing down significantly after these plants are built.

The challenge we've had in both markets, in both India -- I'm sorry, both China and Russia, are the market conditions, as outlook when we start building the plants, are different, now that the plants are constructed. More dramatic difference in Russia, hopefully a short-term, dramatic difference. A little bit just more broadly experienced market growth erosion in China. But we're still seeing a GDP in the 7% to 7.5% range, and we still see significant opportunities.

Remember that China's the second largest suspended ceiling market in the world, with penetration in the commercial office space of ceilings of 10% to 15%, as compared to a fully developed market, where that penetration is close to 85%. So the macro opportunities in China for both ceilings and flooring continue to be extremely attractive, and we're seeing pretty solid revenue and volume growth in both of our businesses in China and India, as a result of the investments the new plants, and investments in the new plant in China give us a stronger platform from which to enter Southeast Asia, again in both of our businesses.

We're still very bullish on those investments even though the market outlook extends the payback a little bit. We think it makes fundamentally good sense to be there, and we're glad we made the investment.

Russia's the third largest suspended ceiling market in the world, one where we have significant share position. Arguably, demonstrably the share leader. Again, the investment in Russia is a significant improvement, when completed to our margins there, as we're able to move production inside of Russia. That's allowed us to -- going local there has provided the opportunity to expand our geographic coverage.

We've expanded our distribution footprint. And again, experiencing very significant performance there, in light of a hopefully near-term pressured environment. We expect that to move through.

So we think that both of these investments make long-term midterm sense. We certainly wish the markets were a little bit more stable, but I think long term, we'll be glad we made both investments. No further investments anticipated at this point. And when it comes to 2015, and how we'd inflect up or bounce up, it's a little premature for that. We'll save comments on 2015, until we get a little closer to that.

We still believe that in a mid-cycle recovery, the fundamental position we're in provides real opportunities to gain leverage. This business and our Company, both of our businesses have tremendous earnings leverage over volume, and broad-based volume, that would be new construction and remodel, that comes with the mid cycle recovery.

Thank you. And our next question comes from Jim Barrett from CL King and Associates. Your line is now open.

Matt, a question for you. Are the outside consultants, are they focused just on the European flooring business, or are they also -- can you share with us what else they're studying in the other parts of the business, if they are?

Most of the work that's being done, virtually all of the work that's being done is to help us develop options for the European flooring business.

Okay. Well, thank you very much.

You're welcome. Thanks for asking.

Thank you. And our next question comes from Keith Hughes from SunTrust. Your line is now open.

Yes, to build on that last question, you report in resilient segments, or revenues that are Europe or the Middle East. Are all of those part of this review or is it just a subsection of them? And if so, how much?

Keith, at this point let's just say that all options for the European business are on the table. Tom?

You're correct, Middle East is included in the sub-segment for revenue that's broken out there. As Matt had in his opening script, the Middle East is a very important business for us, and really the strategic review really is focusing primarily on Western Europe.

Thank you. And our next question comes from Ken Zener from KeyBanc. Your line is now open.

You continue to have I think the best -- some of the best disclosure in the industry in your filings, so I appreciate that, but no good deed goes unpunished. So I have a compound question as it relates to ceiling. Given the changing outlook, driven largely, it sounds by the US market, you've talked about 2% to 3% positive volume before. If I do a 3% volume change on roughly $750 million of sales, that's roughly $25 million, or at 40% leverage, we think about $0.10 which would be a quarter of your guidance for the year. Could you talk about how much in the US is changing?

And the second part of that is, in the filing you highlighted $5 million of increased costs versus last year, which is an increase from the first-quarter $1 million headwind. What costs are going up, and how is that not impacting the annual guidance? Thank you very much.

So Ken, let me -- it's Dave Schulz. Let me address that. Obviously, we never came out specifically with what we were assuming the US market would recover. I think that you were implying there was a 2% to 3% volume opportunity in the US ceilings business. So we never provided that specific of a guidance, particularly by segment.

What I would say is that relative to the outlook we're seeing overall in the US residential and commercial markets, primarily on repair and recovery, that has been the majority of the reduction in our guidance range. One of the things that we've also mentioned that you can see in our results year to date, that is we would anticipate that we would have a little bit of a mix drag as the market opportunity has lessened. So the combination of that volume plus mix is what makes up the majority of our guidance range coming down. As you also mentioned, the increasing cost, about $5 million.

Obviously, we have not only some increase in cost but we also have productivity programs, and based on the timing of when those productivity programs offset some of those cost increases, it's informed our guidance for the balance of the year.

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

Thanks for taking my follow-on question. Question for Vic Grizzle. Vic, on pricing within ceilings, you mentioned there's some very well-understood raw material cost increases that are driving it. Could you comment as to what actually is driving it? Because it sounds like most of the commodity pressure's really in, as you mentioned, in wood.

And then the related question, obviously you've got a great track record when we look back at history, in passing along costs ultimately to your customer and getting paid for the value you provide. If we look back in the past, have there been ever times when you haven't been able to get that accomplished, and what kind of economic environment was associated with that misstep on pricing? Thank you. And again, good luck on the quarter.

Thanks, George. With regards to the cost input drivers, I would reframe that and say energy and transportation are the largest impact. There are some raw material increases along there, but the major drivers are higher gas and transportation expenses. And again, this is why we believe this is an industry-wide, and not very specific to Armstrong.

To go back to your second part of the question on when we've not been able to recover our inflationary costs with price, you'd have to go back many years. And so again, we remain confident that the discussions we're having with customers around these increases are going very well. We remain confident in this current environment, that we'll be a able to realize and recover the inflationary impact on our business.

Thank you. And our next question comes from Michael Rehaut from JPMorgan. Your line is now open.

Yes, thanks. Thanks for taking my follow-up. Just wanted to go back to, and certainly don't mean to beat a dead horse too much on this topic, but back six weeks, eight weeks ago, when we came out to visit, there was really two Company-specific comments that anchored your optimism for the back half, and certainly appreciate the month-by-month commentary and how things have come along. But just want to understand, when we met, you talked about optimism across the distributor network, as well as positive backlog trends.

So I was just curious, when you think about those two drivers to your back-half outlook then, how those two areas, how you're seeing both of those two areas in terms of the distributor network, and the positive backlog trend? Have either of those changed, and this is just -- or is -- have they remained the same? And the revised downward guidance is actually just what you're seeing in the marketplace notwithstanding?

Michael, great question. The channel remains optimistic, particularly as it relates to new construction. They are active in bidding and closing new construction work. That's coming through in our expanded backlogs. Again, particularly in commercial office and retail.

That would boost our ceilings business a little bit more than resilient flooring business, just because of the relative position of those applications. What we'd really like to see for resilient flooring to come through as stronger healthcare, stronger education. I would say, if you talked to our distributors today, they would still be guardedly optimistic particularly when looking at new construction.

The largest change informing our outlook, and again, it sounds like I'm beating the dead horse now, is a significant reduction in the outlook for GDP for the year, coming at the end of the second quarter. As Dave said, we had a relatively weak first quarter. We had an acceptably strong April, a very weak May, and a respectable June, although as Dave said, not strong enough to offset the weakness in May.

So we came out of the second quarter with this lumpy, choppy demand, along with a revision downward in GDP. Again, that drives the remodel business. So I think, as I said in my remarks, we would love to share everybody's optimism, and we do, as it relates to a couple segments in new construction, but we also feel responsible to report an outlook what we're experiencing, and there's been a full percentage point reduction, or a 1.5 point in some cases reduction in the outlook for the GDP this year, and that applies a tremendous amount of headwind to the remodel business.

Thank you. And I don't see any questions in the queue at this time.

Okay. Well, thank you very much for your interest and great questions, everybody. We certainly understand the nature of the questions, and thank you very much, and have a good day.

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