Armstrong World Industries Inc (AWI) 2014 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Armstrong World Industries Incorporated Q3 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

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

Thanks Brandy, and 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; Vic Grizzle, CEO of our Worldwide Ceilings Business; and Don Maier, CEO of our Worldwide Floor Businesses.

Hopefully you have 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 laws.

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

With that, I will turn the call over to Matt.

Thanks Tom, and good morning everyone. Before we dive in, let me frame what we want to talk about today.

First, I want to spend some time on our new outlook for the year and give you the color you need to understand what's changed and how we are responding. Then I want to give you a bigger picture view of our residential flooring business and how we're thinking about it going forward. Dave will then take you through our financial performance versus 2013, and then of course we'll take questions.

As we previewed with our announcement on October 13th, sales in the third quarter of $728 million were below our guidance range of $740 million to $780 million. Adjusted EBITDA of $117 million was within our guidance range of $110 million to $130 million. And our outlook for full year sales and EBITDA is now of course lower than before.

Dave will cover this in detail in a few minutes. As you know, we took the decision to preannounce our revised outlook recognizing that we updated our annual guidance when we released second quarter earnings, and mindful that we're now into the final quarter of the year, we therefore felt it was prudent to share this news in a timely fashion.

Our North American commercial businesses continued to perform well and drive our overall profitability. The announcement called out three specific areas that drove the third quarter sales miss, causing us to reduce our annual guidance for sales and EBITDA. Residential resilient category issues in North America, industry-wide overcapacity issues driving increased competition in European flooring, and competitive price and share issues in wood flooring.

The residential resilient change was the largest contributor to our EBITDA guidance revision, was driven by several factors including, number one, a softer than expected repair and remodel environment. And number two, faster than anticipated shifts in consumer trends within the residential sheet category, where growth in share of glass-back relative to felt-back products exceeded our expectations. This is important to us as we have a relatively higher share of felt versus glass.

Number three, within glass, we lost share as our pricing has become uncompetitive in an industry suffering from significant overcapacity. And also, glass sales mix down in our higher-end new product launches were disappointing in the quarter.

Number four, finally, moves between product categories, particularly from residential sheet and standard tile products to LVT accelerated in the quarter. Now, since we have leading positions in traditional residential resilient products but a relatively smaller share in LVT, this shift impacts both our sales and margins. This trend reinforces the importance of the LVT investment in Lancaster, which as you know, is scheduled to come online in mid-2015.

Now, we're taking targeted steps with select customers, re-evaluating the positioning of our recently launched product lines, and doing a better job of differentiating products and prices. But we now have lower expectations for revenues and margin in this space for 2014.

European flooring had the second largest impact on the EBITDA outlook. This business is challenged by a difficult operating environment softened further in the third quarter. Industry-wide over-capacity and the challenges of rationalizing costs in Europe led to an acceleration of competitive activity in the quarter, primarily in linoleum, and drove lower than expected volumes and increased manufacturing absorption and efficiencies.

As you know, we announced on our last quarterly call that we're evaluating strategic alternatives for this business. Progress has been made.

But we're not in a position to announces anything conclusive at this time. A decision prior to year-end is possible.

The smallest of the three EBITDA reductions was in the wood flooring segment. As we entered 2014, you'll recall we delineated a strategy with three key components.

The first, raising solid wood prices to anticipated levels of lumber costs. The second, driving a richer sales mix through our pricing actions and product enhancements. Third, rationalizing manufacturing output to eliminate PKD lumber purchases and overtime at the solid wood plants.

We anticipated that these actions would reduce volumes as we walked away from unattractive parts of the business. We believed that sales would be flat year on year as volume declines were offset by price and mix gains, but the profitability would start to improve towards acceptable levels.

For the first half of the year, this is what transpired as sales were up slightly and adjusted EBITDA rose over 80%. However, as the third quarter progressed, housing starts and homeowner remodel activity continued to lag expectations. Our June price increase was not followed in the market; in fact, competitive pricing and share pressure intensified, particularly at opening price points where, of course, switching costs were low.

While we delivered continued earnings progress versus prior year, margins declined throughout the quarter as we responded to the competitive actions. A secondary trend within the wood segment that accelerated during the quarter was home builders shifting from solid wood to engineered wood products as prices of solid products have risen significantly in relation to engineered products over the last two years. This impacts us materially, as solid wood products have a higher sales price and margin per square foot and we have a relatively higher share of the solid market versus the engineered market.

In the short term, we will respond with targeted programs to drive volume and mix with channels and customers who can deliver value. Additionally, we've executed cost reduction measures across the plant network. These actions will only partially contribute in the fourth quarter; the full benefit won't be apparent until 2015.

To address the solid to engineered shift, we're in the process of on-shoring engineered wood production capabilities. Now, as you know, this is one of the key pillars in our strategy to restore structural attractiveness to the wood business. There are two phases to the project, and Phase I is essentially complete.

We have ramped up production of our front tier product line in our Somerset, Kentucky facility and begun shipping the new American-made Frontier with the added advantage of shorter lead times and lower inventory levels for our customers. This translates into immediate savings as we avoid duty and freight and reduce working capital.

Phase II is well underway and we're installing machinery and equipment and adding jobs. We expect the new products at the Somerset plant to be completely online in early 2015.

We continue working to optimize our product and channel mix to deliver better margins and better cost absorption at our plants. However, as a result of the competitive actions and our response in the third quarter, sales and margins will be lower than previously anticipated in the fourth quarter. Our adjusted EBITDA expectations for global ceilings and North American commercial flooring are unchanged from our previous guidance so I'll leave it to Dave to review year on year results.

I do, however, want to congratulate the North American ceilings team for delivering a record in quarterly sales and yet another record in quarterly EBITDA margin. All aspect of the business executed crisply. Mix, price, and even volume was positive for the quarter.

The plants ran very well and WAVE earnings were up. Record sales, despite volumes down more than 20% from the previous peak, was in fact a remarkable achievement.

Now, I realize I've just covered a lot of granular detail, and now for a bit broader perspective I want to step back for a minute and share my thoughts on Armstrong's overall flooring business. This business has faced significant headwinds these past few years, from a collapse in new residential construction in North America, the significant declines in commercial spending, especially in healthcare facilities and schools globally. Unprecedented inflation and volatile demand patterns further affected the wood segment.

In the face of all these challenges, the global flooring business is on pace to deliver adjusted EBITDA over 50% higher than the trough in 2010 despite continued volume declines. Armstrong's North American flooring businesses are valuable franchises with leading share positions in solid and engineered wood, residential sheet and VCT, and meaningful share of the laminate and LVT categories. In Asia, we have two commercial flooring plants coming up to speed in a market where construction spending in healthcare, education, and retail space is likely to grow dramatically for many years.

Yes, the markets and our ability to forecast them have disappointed. And we have opportunities to improve our execution. But I believe it's important to keep a bigger picture in mind when framing thoughts about the flooring business.

Now, in light of the evolving market dynamics, I'm currently leading a deep-dive review of all aspects of our residential flooring business, and believe me, this won't be business as usual. Broadly speaking, we feel our strategy's correct. Acceleration of the growth of LVT and engineered wood reaffirms our recent investments in Lancaster and Somerset.

However, we need to reconsider how we engage with and lever our extensive distribution partners. We need to be more in tune with the market and competitive dynamics. We need to listen better to the voice of the customer.

In some cases, I suspect we're guilty of trying to sell what we make, as opposed to making what customers want to buy. We need to think about the opportunity more broadly across product categories, not just within narrowly-defined niches that happen to align with our manufacturing capabilities, but have little bearing on how our consumer thinks about their home. We're looking to modify our organization to better align with customers for more efficient and effective relationships.

Don Maier, with his previous experience as head of global operations, will bring an increased sense of urgency around customer focus and execution. We're committed to building and managing a more predictable and profitable residential flooring business.

So with that said, I'll turn it over to Dave to discuss year on year results and provide details on our guidance. Dave?

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

In reviewing our third quarter results, I'll be referring to the slides available on our website, starting with slide 4, key metrics. As Tom already covered, slide 2 and slide 3 is simply an explanation regarding our standard basis of presentation.

For the third quarter, sales of $725 million were down slightly versus 2013 on a comparable foreign exchange basis. Operating income was down 8%, while EBITDA was down 4%, as a result of higher depreciation in 2014.

Earnings per share of $0.83 were down $0.02 from 2013. Free cash flow for the quarter was $60 million, down from $95 million last year. I'll talk more about cash flow and EBITDA in upcoming slides.

Net debt was down $28 million, driven by operational cash generation in the past year. Return on invested capital was lower, driven by lower unadjusted earnings.

Slide 5 details the adjustments we made to EBITDA and provides a reconciliation to our reported quarterly net income of $32 million. The accelerated depreciation and impairments in the third quarter of $17 million are primarily related to our European flooring business.

As Matt discussed, our outlook for the year was reduced to reflect a tougher operating environment in Europe. We took an impairment charge of $12 million in the quarter to reflect this change.

There were also a few million dollars associated with our previously announced closures of the Kunshan, China engineered wood flooring plant and the Thomastown, Australia vinyl flooring plant that spilled into the third quarter. Our third quarter 2014 tax rate of 45% is higher than prior year, primarily due to the European flooring impairment I just mentioned, that resulted in higher unbenefited foreign losses that in third quarter 2013.

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 3% driven by the volume declines in North America and Europe that Matt mentioned. Pacific Rim sales were up but strong gains in China were somewhat offset by continued weakness in Australia where restrained public spending is negatively impacting our business.

Southeast Asia and Japan were also notably down in the quarter. North America continued to benefit from a richer mix of sales year on year, driven by continued LVT gains. Resilient profitability was down $11 million in the quarter, driven primarily by the volume declines in the Americas and Europe.

Weaker mix in Europe and higher SG&A in fixed manufacturing spend in Europe also contributed to the decline. The Pacific Rim profitability was up. The wood segment saw sales decline 7% as mid-teens volume losses were only partially offset by higher price and a richer mix.

Matt already provided some details of what we're seeing from a market and competitive perspective, but let me provide a little more detail about the financial results. For the quarter, wood profitability was up $4 million year on year, as price, mix, and manufacturing improvements more than offset continued lumber inflation and volume declines. Lumber prices have moderated versus the prior quarter, but are still up almost 15% on a like for like basis versus 2013.

Ceiling sales were up 4% on an equivalent foreign exchange basis with mix, price, and volume gains in the Americas, and double-digit volume gains in the Pacific Rim, offsetting a slight sales decline in Europe. In the Americas, we continue to see strength in our higher-end Ultima and Optima products which have a strong presence in new office projects.

Pacific Rim sales were up in Southeast Asia, Australia, and India. Australian sales were driven by architectural specialties projects. China was relatively flat as the privately funded office sector contracted.

In Europe, we saw the rebound in the UK that we had anticipated as distributor inventory issues have been resolved. New case sales are now basically flat for the year. The eurozone was down again this quarter.

We had another good quarter in Russia, despite a difficult economic backdrop. Our localization efforts are clearly paying off and resulting in share gains. This is encouraging in advance of our plant opening at year-end and the beginning of shipments in the first quarter of 2015. Ruble weakness resulted in our taking a 5% price increase effective October 15th.

Building products adjusted EBITDA rose $3 million with the record performance in North America that Matt mentioned, offsetting declines in Europe, primarily related to start-up costs at the Russia plant and slight profit declines in the Pacific Rim, driven by soft mix in China. Corporate expenses were slightly higher than last year which includes expenses associated with our strategic evaluation of the European flooring business.

Slide 7 shows the building blocks of adjusted EBITDA from the third quarter of 2013 to our current results. Of note, price and mix more than offset inflationary headwinds from lumber costs, while volume continued to be a drag on earnings, primarily in flooring.

Manufacturing was a slight positive, primarily in the Americas. SG&A was up, related to the release of deferred spending from earlier in the current year.

Turning now to slide 8, you can see our free cash flow for the quarter was impacted by lower aftertax cash earnings. Let me provide some additional perspective on working capital.

Overall, working capital was a positive contributor to cash flow in the quarter, but at a lower rate than in 2013. The change in other free cash flow compared to the prior year was primarily driven by the impact of the multi-employer pension payment associated with our divestiture of the cabinets business.

Slide 9 begins our discussion of year-to-date results. As you can see, sales are up almost 1% as price and mix gains in the wood and ceiling segments offset volume losses in the flooring businesses. Operating income is down $10 million, driven by the volume declines, but EBITDA is up $3 million as we have higher depreciation expense due to our plant construction projects.

Adjusted EPS is higher than 2013, driven by our $260 million share repurchase last September, and lower interest expense, partially due to the expensing of capitalized interest when we refinanced in the prior year. Free cash flow is down and I will discuss that and EBITDA details in the next few slides.

Slide 10 shows year-to-date segment level EBITDA performance. Sales of resilient flooring are down 3%, driven by volume declines in the Americas and Europe, which more than offset continued mix gains in the Americas driven by LVT and volume gains in the Pacific Rim, particularly in China. Resilient profitability is down $10 million year-to-date, with the Americas' volume decline being the most significant contributor.

Additionally, Europe's loss versus the prior year increased, and SG&A spend is higher, partially offset by improving results in the Pacific Rim. Wood sales are down 1% year-to-date, with sales gains in the first half of the year offset by volume declines in the most recent quarter. Volumes are down more than 10%, but price and mix gains masked the decline.

Wood profitability is up $11 million, or more than 80%, as price offsets lumber inflation and mix gains and manufacturing improvements drive better results. Building products sales are up 4% for the year as mix, price, and volume gains all contribute.

Top-line growth, higher earnings from WAVE, and excellent manufacturing performance in the Americas drove the $5 million profit improvement. Corporate expense is up $3 million, primarily related to inflation and strategic project expenses.

Slide 11 shows the building blocks of adjusted EBITDA from the first nine months of 2013 to our current results. The story is essentially the same as the quarter, with price and mix gains, manufacturing improvements and WAVE contributing positive gains, but higher inflation, lower volumes in flooring, and higher SG&A spend ultimately driving a basically flat year-on-year profit performance.

Turning to slide 12, you can 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. As with the quarter, the change in Other was driven by the impact of the multi-employer pension payment I discussed.

Slide 13 reiterates the guidance we provided on October 13th, and provides more detail for 2014. As previously announced, we are reducing the top and bottom of our sales range for the year, to $2.68 billion to $2.72 billion. At the midpoint, this would be flat with 2013.

We are also reducing our operating income and adjusted EBITDA ranges as lower sales fall through to profitability. At the midpoint of the range, EBITDA would be basically flat with 2013. We anticipate adjusted EPS will be up versus prior year due to lower interest expense and our 2013 share repurchase, and net cash flow will be positive for the year, but down from 2013.

Slide 14 provides more details on guidance. Our inflation expectation for the year is unchanged at $30 million to $40 million. Productivity worsens as a result of the lower volumes and weaker than previously anticipated mix.

Earnings from WAVE is unchanged from previous guidance at $0 million to $5 million versus the previous year. On taxes, we continue to anticipate an effective tax rate of 48% to 50%, but have taken our cash tax range down by $10 million.

For the fourth quarter, we expect sales of $610 million to $650 million, and adjusted EBITDA of $55 million to $75 million. Finally, with the impairment charge in our European flooring business, we have increased our expected exclusions for the year to $25 million to $30 million.

Before wrapping up, I want to provide some additional perspective related to pension. As you will likely be hearing from many companies with pension liabilities in the coming months, the Society of Actuaries is expected to finalize a new set of mortality tables by the end of October. These tables are expected to provide longer life expectancies to be used in calculating our defined benefit pension liability.

I bring this up because as you know, Armstrong's pension liability is large in relation to the size of the Company and any change in pension accounting assumptions tends to have an outsized impact on our reported financial statements. Based on the exposure drafts, we anticipate an increase in non-cash pension expense of $22 million to $28 million in 2015. Our pension plan is currently fully funded and we continue to anticipate no required cash contributions to the plan.

Given the significant nature of this non-cash expense, we wanted to provide you with this information as it will clearly impact our reported earnings but not our business unit results or cash flow in 2015. With that, I'll turn it back over to Matt.

Thank you, Dave. We are, of course, disappointed that we had to lower guidance. I want to reiterate that much of our business is executing well, despite challenging conditions, and we won't take our eye off the ball in our North American commercial portion of the portfolio.

We're also committed to making the tactical and strategic changes necessary to drive predictable and acceptable financial results in our residential flooring business. And I look forward to working with Don and Joe Bondi, our new VP of residential products, and the rest of the team to make that happen. With that, we'd be happy to take your questions.

(Operator Instructions)

Nishu Sood, Deutsche Bank.

I wanted to ask the first question about the European operations. Wanted to get an update on the status of the review of that operation. And also, related to that, it's still being classified as a continued operation. I was wondering whether that gives us some reflection on the status of how you're considering that business.

Yes, thank you, Nishu. As we said in the remarks, the review is still under way. No final decisions or conclusions have been reached yet. Obviously, we're disappointed that we're unable to update you on the call. And, as we said, it's possible that we'll have some news by the end of the year. Really, that's about all I can say at this point.

Michael Rehaut, JPMorgan.

Wanted to ask about resilient flooring, which you had cited was the biggest driver in the reduced guidance. And you listed several impacts there, and in particular some of the shift within products, glass-back versus felt-back and towards LVT. I guess with some of the actions that you're trying to take there, how should we think about the trajectory of margins over the next two, three, four quarters?

Certainly this most recent quarter is a big step backwards, unfortunately. In the interim, could margins perhaps get hurt further? Certainly you've issued your guidance for 4Q and we can triangulate there. But would things get worse before they get better, given some of the actions that are going to take time to implement over the next several quarters?

Yes, let me try to answer that. Let's characterize what happened. We had continued pressure in Europe, market related, mostly linoleum. We have a -- we're not the share leader there. As was mentioned earlier, we have plans in place and actions underway to resolve the issue in Europe.

If you go to North America, the vast majority, virtually all of the pressure we saw -- experienced in our residential -- in the resilient flooring business was in residential, fundamentally related again to competitive pressures in North America.

We maintained, I'd say, price leadership, and provided a price umbrella in glass-back that was above the market. And we were, I think, a little slow in responding to the pricing environment that we encountered. We also saw a more-than-anticipated shift from resilient sheet to LVT, which in some cases is actually a good thing and validates the need for the LVT investment that we're making here in Lancaster.

So, we can't really comment on 2015 margins. We're not going to do that until 2015. We are not -- our strategy was not to lose share in resilient flooring. We need to do a better job understanding the market pricing dynamics.

As I said, we already have actions underway with selected customers repositioning our new products, we think, more appropriately in the marketplace, and we need to get some of that share back. We were not -- we're not in the business of losing share in resilient flooring.

David MacGregor, Longbow Research.

Matt, I guess historically your business has relied heavily on distributors to go to market, and the two-step distribution's been an important part of the business model. You said in your prepared remarks that you're rethinking how you engage with distributors. And I'm just wondering if it's possible to have you elaborate further, at least on a preliminary basis, what some of your thoughts might be there.

I think we've done -- and I want to compliment Don, and Joe Bondi, for spending a tremendous amount of time in the field with our distribution partners. I think that, honestly, we're guilty of telling the distributors what we need them to do rather than engaging them constructively and proactively in the process. As we go on offense a bit and start preparing for a fairly -- hopefully a stronger environment moving forward, we need to rethink how we leverage these partnerships.

We've got very strong distribution in each of our served markets in North America. Our distributors have very strong engaged sales forces. We have not been responsive enough to them in the last year or two.

And as we've gotten more focused on the marketplace, they've been very candid with us about things we need to do differently and I think we need to engage them in a different way than we have historically. And I think Don and Joe have done a good job on this. Don, if you want to make any comments on your visits with the distributors.

Just to reinforce everything that Matt said, and I think we have drifted a bit but not so far that we can't gain this back. And we have not lost any time in getting forward movement on a number of specific programs and engaging our distributors intimately in the development of those programs. So, I'm encouraged by the potential that we have in that part of the recovery here.

These are really great partners for us in the marketplace. And we've been sort of fighting this battle, I think, with one arm tied behind our back. So engaging these guys more constructively and more proactively we think is vital. And we're doing that.

Dennis McGill, Zelman & Associates.

My question was just more on the LVT side. It sounds like the market, as you said, has been shifting on the traditional side more than expected. It's been a little while since you announced the investment in the LVT plant. Can you just talk specifically about the investments that you're seeing across the industry in LVT and what you're seeing within that part of the business as it relates to competitive pressures, price, capacity, and how that might compare to your initial expectations when you announced the plan?

Thanks, Dennis. Listen, the LVT category continues to be a very exciting part of the hard-surface flooring business, very attractive growth rates. It's an opportunity for us to differentiate ourselves.

We're excited about transitioning from an outsourcing mode to an in-house mode. That gives us accelerated product development, certainly cost and margin improvement. And a part of the Company that -- or a part of the business that really benefits from both of those things.

I think our competition, rightfully so, sees the same opportunity, and that doesn't intimidate us. We think that the industry will benefit from strong players -- strong domestic players in the industry. We're not in the process of rethinking the economics around our investment. We're excited about the opportunity that the LVT segment provides us.

I think what we need to do a little better, Dennis, as we think about the product portfolio is understand, across the portfolio, how our products sort of interact with each other. I think we've taken too much of a product-siloed approach. We look at resi sheet, then we look at LVT, then we look at laminate, we look at engineered wood and wood, for instance.

And what we really need to do a better job of understanding what's sort of happening in the market is, you know, there's an overlap now between segments of our residential sheet and LVT as LVT moves in to kind of take some of that space up. That's ultimately good for us if we understand it better and position our products a little more thoughtfully, rather than just kind of go to market through these products niches.

So we see the LVT -- we see LVT as a huge opportunity for the entire hard-surface flooring industry. It remains very exciting. We're thrilled about our investment, and we think it's one of the bright spots as we go forward.

Ken Zener, KeyBanc.

Could you -- on the wood side, relative to your comments about engineered, and I think you highlighted the homebuilders comments to move towards engineered, could you please put in the current price spread between those two categories today and give us a context for what it was historically, so we can perhaps have a better understanding if that's going to move back in your favor?

And then, just please clarify that non-pension incremental cost in 2015 -- it sounded like it was in the high to mid-$20 million -- and if any particular segment's impacted more or less. Thank you.

Let me -- I'll comment on the wood pricing and then let Dave handle the pension question. But, fundamentally, the wood -- the difference between solid-wood and engineered-wood pricing is reasonably significant. We haven't really commented on average price positioning.

But what's driven the separation is the incredible inflation we've seen in solid wood, in terms of hard surface or hardwood price increases going forward. And, as you might imagine, that's going to affect solid a lot more than it would engineered wood. So that separation's occurring and that differential pricing is occurring, which makes it a lot tougher to position them side by side.

And, at the same time, the surface performance and the surface visuals on engineered wood have actually improved. So, if you put these side by side, frequently that difference in surface visuals isn't enough to justify, in a lot of people's minds, the premium for a hardwood -- or for solid wood. This is also somewhat exacerbated -- that dynamic's exacerbated because of the parts of the United States that really require engineered wood versus solid wood.

So you have inflation driving pricing separation between these two, you have sort of a convergence in the quality of the visuals, and then you have an expansion of the geographies in the US which favor one over the other.

Ken, it's Dave Schulz. First, let me comment on the gap between solid and engineered wood to the shopper -- that gap has stayed relatively consistent within a couple of basis points.

The issue is that, as we've continued to take price increases on solid, the price has accelerated faster on the solid wood versus the pre-finished engineered. And what we believe we're seeing is that if a shopper has a budget to spend, they have to make a choice within that budget. And obviously we've taken substantial increases on our solid-wood flooring -- about, as we mentioned, about 15% lumber cost, which we've captured in price year over year.

So, let me turn to the pension. So, just to provide a little bit more clarity on our discussion, basically what we're seeing right now, based on draft exposure to the mortality tables, is a range of $22 million to $28 million of impact year over year due to pension. That would be a non-cash pension expense and obviously that impacts not only our -- it's primarily a US defined pension benefit. It would be held in corporate. And so it would not be flowing down to the business units in our reported results.

Stephen Kim, Barclays.

Wanted to ask you, Matt, I guess regarding your comment about not wanting to be too influenced by the manufacturing base you have, and maybe focusing a little bit more on changes you can make in order to be closer to how the customer sees decorating the home. I wanted to try to understand what that -- what implications that might have for specifically, I guess, the solid-wood flooring business, which you've just talked about.

I imagine that, as you went back to the builders and renegotiated some of those longer-term contracts, that they basically said that they're going to move to engineered and I assume they probably also were willing to move away from Armstrong, is the sense I'm getting from your commentary. Just let me know if that's incorrect. But, in light of this broader move away from solid towards engineered, does this fit into your comment about maybe looking at your manufacturing base versus the customer preferences differently?

Well, let me try to answer that. I think that the thing that's driving the pricing separation that Dave just described is an accelerated inflation in raw materials. If we do see that abate, and we see some movement down in that rate of inflation, then that gap narrows and things might return to a quasi-normal state.

We've begun adjusting our manufacturing footprint to address what customers are looking for. So I don't mean to imply that this is something we've just discovered. When we talked earlier about driving better mix out of our manufacturing footprint in wood, reducing the need for PKD, that's a step towards refining and tuning our product categories and our -- and the manufacturing footprint to what the customer needs. The LVT plant is another example. That allows us to do a much better job adapting and responding to evolutions and changes in design and surface treatments in LVT.

So when I'm talking about that, Stephen, I'm talking less about huge transformation in the manufacturing footprint and really just more about process improvement in getting the voice of the customers more into the mix. And it's how we think about developing new products, how we think about tweaking the products we have, and it's getting a firmer voice to the customer into that mix as we go forward. And again, as Don mentioned earlier, the way we're engaging our distribution base as a very viable voice in that process will help a lot.

So, this is a lot less around spending tons of money and revamping our manufacturing footprint to adjust to this. It's really more about how we think about it internally and how we prioritize it internally.

Mike Wood, Macquarie.

Your guidance puts you on track for flat-to-down sales this year and negative sales volumes. It appears most analysts pushed out their sales ramp into next year with 5% growth forecasted. So, I'm not asking you to comment on 2015, but can you discuss items, like your GDP model in ceilings, in the context of current third-party forecasts to help frame what you're seeing in relation to this potential growth acceleration? Thanks.

Is that in relation to 2015 or just the -- or the evolution for 2014?

Mike, it's Dave Schulz. So just to clarify, so you're asking specifically about some of the indicators that we're seeing for 2015, is that correct? I'm assuming that, that's what you're looking for.

We've not provided any specific outlook for 2015 beyond what we just discussed on pension. Obviously, you guys all have access to the same data that we do. I'm sure you're all taking a look at what you're seeing in ABI, the Architectural Billing Index.

Obviously, we're taking a look at GDP; if you take a look at some of the blue-chip GDP numbers for next year there is an improvement year over year on an annualized basis. But, obviously, that's about the extent that we can talk about at this time as we've not provided any additional specifics for 2015 yet.

Eli Hackel, Goldman Sachs.

Just switching gears, talking about the ceilings for a second. Seems like maybe you actually had an okay-to-good quarter. What are you seeing on the commercial side in North America? I know it's going according to your plan. But is that a recent pickup or is that things have been getting better as you moved into the back half of the year? What are you hearing from your distributors in terms of their quotes and bids as we go into the end of the year and into 2015? Thanks.

We'll let Vic answer that.

Okay, thank you. Yes, the commercial market globally, and the US as well, continues to be very uneven -- and I would call it mixed -- it's definitely recovering at a slower rate than we all expected. The US office new construction starts, are definitely positive, and have been positive, and we're feeling that, as Dave mentioned in his opening remarks, with our higher end of our products reflecting the specifications that come out of those new construction starts.

But, region to region, we're seeing a lot of mix. A lot of the regions that were up last year are down this year and vice versa. So, it's very uneven and very mixed, and again, continues to be driven by office for the most part.

And then, as you go around the world, we have a very similar mixed commercial market recovery in Europe and Asia, where some markets are down still and contracting, and then some markets are starting to see some of that new construction activity come into new project business. So, overall, again, very uneven, very mixed across the globe.

Keith Hughes, SunTrust.

We talked a lot on this call and residential US flooring about listening to customers and things of that nature. And I think I understand where you're heading there. Are there other elements to this deep dive within that business that will also be considered in terms of more back office operations or anything along those lines?

Yes, Keith, not that I'm willing to share at this point. I think what we need to do is make sure we understand the operating environment and how it's changed in the second half of the year. Clearly, we're seeing an increase in price pressure in the residential market. We have to do a better job of responding to that. So I think part of it's how we think about our organizational structure. A lot of it is how we engage our distributors, at the risk of being a little repetitive.

How we think about product management, and then just setting up processes to be more responsive. We want to get pricing power a little bit closer to the customers, a little bit closer to the transaction. There's a regional dimension of the flooring business that we've probably been -- we've been addressing nationally.

And so there's some very simple things we can do within our control to start reversing the trend. But I think what we're guilty of is holding price up in an environment where we've got competitors that are -- took advantage of it, quite honestly, and our response was too slow.

And so we understand that and we've got plans and actions underway, on a targeted basis, to address that. And I think in a little bit longer range, how we engage our distribution better and more thoughtfully will help as well.

George Staphos, Bank of America-Merrill Lynch.

Thanks for taking my question. I apologize if you've covered this already, I've been juggling conflicting calls. To the last question, would you see the potential for realigning any of your manufacturing in residential -- or resilient, I should say, given that you've had differing trends between commercial and residential, or would that even be possible? And the related question, you talked about being more thoughtful as regards LVT versus traditional resilient. How would being more thoughtful -- what would the specifics be that would help you perform better, given what are the secular trends, favoring LVT versus traditional resilient? Thanks. Good luck in the quarter.

Thank you very much. Two very good questions. Yes, a review of our strategy would include a review and discussion of our manufacturing footprint as we think about how we serve demand. So we've got to understand what demand is, what demand trends are. And clearly, it wouldn't be a thorough review of our strategy if we didn't think about manufacturing footprint. But it's certainly not limited to that. We've got a lot of opportunity to think across the business in light of what we find to kind of be a tougher-than-expected environment.

By thoughtful, what I was talking about was thinking more around how we position products at points of overlap in the portfolio. So, high-end expensive resi sheet might not be as good an alternative for our residential customer. There may be a more competitively positioned LVT.

And so, right now, what we have is product managers -- because we've asked them to do this, product managers that are oriented around optimizing their product portfolio, when we really should be obviously focused on that, but still looking at these points of intersection and being more strategic and informed as to how we position that. So, a very practical example -- and I only put this up there as an example -- would be maybe favoring more competitively priced LVT products instead of a higher-end resilient resi sheet product. And so, thinking about how those points overlap up the food chain.

Another one would be at the other end of the spectrum -- how we would think about wood flooring, solid wood and engineered wood, and understanding those gaps and how they affect our product portfolio and thinking about additions or deletions from the portfolio with that in mind. And I think what we've been able -- we've been successful at, and it's worked reasonably well in the last several years, is kind of optimizing within these product silos, and we need to take a look, holistically, across. So think in terms of good, better, best, not only within the product silos but across the product silos.

John Baugh, Stifel.

Quickly, I had two questions, unrelated. The first one was, I think you mentioned a mid-teens or high teens wood volume decline in the quarter. Is there any way you could give color between the builder market and the retail on that?

And secondly, is there a kind of cash flow year-to-date drag on European flooring? Thank you.

So, in terms of the wood erosion in the quarter from a revenue perspective, it's almost a third, a third, a third from a segment perspective. We've had probably the traditional segments, so into the small local retailers is probably almost half, I guess. And then you think about big box, that might be half. So, as I think about it, it's largely big box related and traditional, not so much for us in the quarter in the contracting market.

So, John, it's Dave Schulz. So let me provide you some perspective on the impact of the European flooring on our cash flows. The impairment charge that we took in Q3 of about $12 million was a non-cash expense. However, we do have some of the carryover expenses associated with some of the choices that we made earlier in the year that do have cash impacts. So we mentioned that there's about $7 million between Kunshan and then Thomastown. There was also a very small amount of carryover in the quarter related to the flooring business in Europe that has a cash impact. That's primarily related to separations that were done earlier in the year.

Robert Wetenhall, RBC Capital Markets.

Hi, guys. Thanks for all the candor today. Two questions. I was hoping Dave could elaborate what your -- how you're thinking about 4Q in terms of FX impact and energy costs.

And just a final question for Matt. I was hoping you could just kind of break down some of the things you're seeing in flooring and ceilings between transitory competitive pressures and what you see as structural changes as you head into 2015. Thanks.

Let me address the FX and energy. So obviously we did have a slight FX issue in Q3. It was relatively small compared to our comparable FX year over year. We do have some of the exposure, obviously related to Russia, where we continue to see some devaluation. We do anticipate that there will be a slight impact on a transactional foreign exchange basis related to the ruble. But most of our other exposures -- from an EBITDA perspective, we do have the natural hedge. We are generally producing in local currency and selling in local currency, with the exception of Russia. Related to energy, obviously across the industry you've been seeing some continued tightness on freight expense, obviously with gas prices going down we haven't seen that flow through directly into our freight costs but I would anticipate that, that would be a minor impact sequentially in Q4.

Bob, you talked about structural versus transitory pressures in residential resilient. Clearly, one of the things that continues to pressure the entire segment from an industry perspective is the relative softness we are seeing in the repair and the remodel environment. So, that's a significant majority of this revenue stream. Structurally, we are seeing the transition from felt-back to glass-back. Rated pace of that, yet to be determined. We have a much bigger share in felt than glass so it affects us more.

We think we have product opportunities in felt to offset that a little bit, and obviously we've made an investment in Lancaster to get into the glass business three or four years ago, and we're in it in a big way. So I think that might be structural but I think we've got plans in place to address our position within that.

Glass, we've got capacity utilization challenges in the entire industry. Our opportunity to participate more directly at the current price levels is there. We just need to take advantage of it.

So positioning our products more competitively in the environment is well within our reach and repositioning new products launched at the high end of glass in a more competitive way is well within our reach. And then, the move from LVT to residential sheet, I believe that's structural. As LVT becomes a little bit more attractive an option for the multifamily particularly, remodel customer, or the multifamily builder, we have a -- we know what it means to play there as well.

So with the breadth of our portfolio across resilient platforms and into wood and laminate, we're able to play up and down the spectrum. Again, I think a lot of it gets back to how we think about product positioning and just being faster in response to the marketplace.

Jim Barrett, CL King and Associates.

Matt, if you could drill down into solid wood flooring. At this point, given your high market share, is Armstrong the low-cost manufacturer and, if so, does this suggest your competitors are operating at breakeven or a loss?

We think we have a very competitive cost structure. I can't comment on my competitors' strategies or what's driving their decisions. I think everybody's playing a slightly different game. You have to think about this in terms of served segments -- big box contractor, traditional distributor.

I know that we have opportunities to do our job better. I think we have opportunities, again, to be more responsive to the marketplace. I think we have opportunities to engage our distribution better and move pricing authority a little bit closer to deals. I think we have opportunities for improved positioning of new products in the marketplace.

I don't think we're at a manufacturing or cost disadvantage. I think we held a price umbrella up there too far. So we've got to be more responsive. We intended and expected to lose a little bit of share in 2014 as we drove mix and price. We've achieved mix and price, we still see very steady improvement and EBITDA in the wood flooring business year to date. But we lost a little bit more share than we wanted to, and that was not our strategy.

Justin Bergner, Gabelli & Company.

My first question relates to building products, and I guess I want to better understand why Armstrong wasn't able to better leverage the growth in sales and volumes in the third quarter at the adjusted EBITDA, or adjusted operating income line.

Hi, this is Vic Grizzle. I'll take that. There was good price and mix across the network, actually, that really drove and overcame pretty much flat volumes for the quarter. So we're very happy with that. We had good leverage in our manufacturing operations, our productivity initiatives were actually ahead of plan.

The big headwind here, and there were two of them, were the expenses that we have in our investments in Russia and China. Those continued to overshadow, I guess, some of the gains and the leverage that we're getting in the operations. The other is we had a little bit of FX headwind in a couple of our areas, in particular the Russian ruble, which is temporary as we're -- I think, Dave mentioned this, we're after a price increase and have launched a price increase in the middle of October that we're getting good realization on. So some of that FX is a little bit of timing. But the big headwind here, again, is our investments that we're making in Russia and China.

Michael Rehaut from JPMorgan.

One quick technical one, as well as on the flooring side. On the technical question, just to clarify for the pension expense next year, in the corporate line, given that it's -- when you talk about non-cash but at the same time it's not obviously falling under the D&A line, I presume that, that would still be included in -- the net impact would be included or reflected in the EBITDA guidance, that's number one. Maybe be broken out but still included in the stated or reported EBITDA guidance.

Secondly, on the resilient flooring, when you think about -- and wood flooring, for that matter, when you think about shift from felt-back to glass-back, solid wood to engineering wood, resilient sheet to LVT, it appears that, in all three categories, you have a higher share in where the market's moving away from, and at the same time it's probably also a higher-margin product. So, in thinking about that over the next several quarters into next year in terms of what you have to do as a company, and if I'm right in terms of the lower margins that are in the categories that the market is moving towards, are there things that you can do, and I guess is that part of your evaluation from a manufacturing side or other parts of the business, things that you can do that you're looking at right now to improve those margin profiles? Thanks.

Mike, it's Dave Schulz. So the pension expense is going to be non-cash. It will be included in our EBITDA results for the Company. And so we will be able to clarify and point out how much of the year-over-year impact is pension related, but it will be included in our EBITDA presentation on a go-forward basis.

And just a very thoughtful question on the categories for residential flooring. The answer is, yes, there are things we can do. We have -- many of the things that are already in place are aimed at that.

The LVT investment here will significantly improve our cost position and our ability and rate of pace at which we can launch new products. So that gets us in the LVT game in a much more competitive-responsive way than we are today. The investments we're making in Somerset for Frontier will allow us to be more responsive and more competitive in engineered wood versus solid wood, so those are very tangible and investments to drive productivity and new product launches that are being received extremely well by the market.

We expanded our glass-back capability in Lancaster about three years ago. So we have a bigger and better position in that segment than we have today. So I think a lot of the larger investments have been made. We just need to accelerate them, and I think, honestly, we just need to be a little bit more realistic and close to the market on pricing.

Thank you. This does conclude the question-and-answer session of the call. I would like to turn the call back over to Matt Espe, CEO.

Thanks very much. We appreciate everybody's attention and have a great day. Thank you.

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