Armstrong World Industries Inc (AWI) 2017 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Q4 and Full Year 2017 Armstrong World Industries, Inc. Earnings Conference Call. (Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to introduce your host for today's conference, Mr. Tom Waters, with Investor Relations for Armstrong World Industries, Inc. Mr. Waters, you may begin.

Thank you, Daniel. 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 armstrongceilings.com.

With me today are Vic Grizzle, our CEO; and Brian MacNeal, our CFO. Hopefully, you have seen our press release this morning, and both the release and the presentation Brian MacNeal 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 World Industries, please review our SEC filings, including the 10-K filed earlier 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.

Finally, in discussing our financial results today, I want to remind you that with our announced agreement to sell our EMEA and Pacific Rim businesses to Knauf, we will be referring to our North American continuing operations only, with the exception of discussions regarding cash flow.

With that, I'll turn the call over to Vic.

Thanks, Tom, and good morning, everyone. It's good to be with you today to discuss an important and productive year in Armstrong's continued transformation, a year where we made significant progress on our 2 strategic imperatives: accelerating top line growth and addressing the poor returns in our international segments.

In my prepared remarks this morning, I'll provide an overview of our fourth quarter and full year financial results for 2017 while introducing our 2 new external operating segments: Mineral Fiber and Architectural Specialties, and Brian will provide more details on each of these in a few moments. I will also want to take a few moments to recap for you the progress on our key 2017 initiatives, including a brief update on the sale of our EMEA and Pacific Rim businesses. Finally, I'll provide some additional information on our recent management changes and wrap up with some insights on what excites us about 2018.

So beginning with the fourth quarter results. We had strong sales in the quarter, with revenue up 9%. Both volume and positive average unit value, or AUV, which, as a reminder, is the combination of both like-for-like pricing and mix, contributed to this solid top line growth in the quarter. Architectural Specialties led the way, with sales up nearly 50%. The Tectum acquisition was a significant contributing factor, but organic Architectural Specialties sales were up almost 25%. Another strong quarter in Architectural Specialties is a reflection of the continued momentum in our penetration into this important segment.

Sales in our Mineral Fiber segment were also positive, with revenues up 3%. Most of the growth here was driven by continued improvement in average unit value. Mineral Fiber volumes were modestly positive in the quarter. Our like-for-like pricing gains, which we continue to earn with our industry-leading customer service and quality, once again outpaced raw material and energy costs in the current inflationary environment. And positive mix continued, as growth in our high-end Mineral Fiber products remained well above market growth rates. These 2 factors led to continued expansion of margins.

Adjusted EBITDA in the quarter of $65 million was up 9% from Q4 2016. Sales gains, along with solid SG&A management, more than offset higher temporary costs associated with the ramp-up of the Flex line investment at our Marietta facility that we spoke about on our last call as a key part of our $100 million advanced manufacturing capital investment. Softer results at WAVE, driven by steel inflation and increased support costs, also muted margin expansion on stronger sales.

Now for the full year. Sales were up 7%, which is the best top line growth here since 2011 and represents the change in trajectory of our top line we are striving for. Higher volumes from Architectural Specialties and continuation of solid AUV improvement in our Mineral Fiber segment drove this result. After averaging less than 3% sales growth over the previous 5 years, I'm very encouraged by this result and pleased with the work we have done on establishing a sustainable growth pipeline. With this more robust pipeline, I believe we can continue to deliver growth in this range in 2018 and beyond.

Architectural Specialties sales grew 36% for the full year, aided by the Tectum acquisition. However, excluding Tectum, core Architectural Specialties sales were again up double digits as the strength of the Armstrong platform, with its commercial reach and new design capabilities, allow us to continue to win key projects and gain share in specialty ceilings.

Mineral Fiber sales for the full year were up 3%, with solid gains in AUV overcoming a slight volume decline. Sales of our higher-end Mineral Fiber products experienced strong growth again and once again outpaced the overall market as customers continue to demand more features and benefits in their ceiling solutions, a trend we expect to continue for many years. Volumes declined in the low end of our product portfolio, primarily driven by weaker education repair and remodel activity as we highlighted in the third quarter as well as continued softness in the retail and health care sectors.

Adjusted EBITDA for 2017 was $317 million, an 8% increase from prior year. And free cash flow was $147 million, up a solid 26% over 2016. Operational headwinds in our manufacturing facilities at year-end, including temporary issues around the start-up of advanced manufacturing equipment, namely the Flex line, along with steel costs from inflation at WAVE, constrained annual EBITDA growth below our double-digit expectations. Now with these start-up challenges behind us, we are back on track for double-digit EBITDA growth in 2018.

Now before I turn it over to Brian to provide more detail on the financials, I would like to take a few minutes and summarize what, as I said, was a productive year in 2017. The separation of the flooring business in 2016 required that we change how we think about our opportunities for growth and to accelerate actions to transform the ceilings business. In 2016, we took steps to set the table to allow us to change the trajectory of our top line in 2017, which we did. Investments in industry-shaping new products, namely Total Acoustics, products that provide both sound absorption and sound blocking benefits in the same tile; and investments in the expansion of our sales and support capabilities, including the creation of You Inspire Solutions Center, which helped drive more than 20% increase in custom project work; and the establishment of an M&A pipeline, all of these bore fruit in 2017.

In January 2017, we closed on the purchase of Tectum, which accelerated our penetration into specialty ceilings and walls. Throughout 2017, our team integrated Tectum into the Armstrong platform, and I'm pleased to report that the results have exceeded our expectations. Now having fully integrated the business in 2017, we can now begin making modest capital investments to further enhance capabilities and profitability in this new product line.

In the spring of 2017, we took another major step in further revitalizing the Mineral Fiber category with the launch of Sustain. The Sustain family of products are free of all Red List chemicals. And as I have mentioned in the past, along with Total Acoustics, these launches have experienced unprecedented rates of adoption by architects, and we expect the penetration of these products to continue in 2018 and beyond. Coupled with our 2016 introduction of Total Acoustics, we have clearly strengthened our leadership position in the high end of the Mineral Fiber segment.

Also in 2017, we concluded a $100 million investment to create industry-leading Mineral Fiber manufacturing capabilities to further support volume and AUV growth. Total Acoustics and Sustain products can now be manufactured in a highly automated and cost-effective manner. And now with the Flex line at Marietta up and running, we are able to efficiently produce our high-end products in custom shapes, sizes and colors. And I'm not just talking about different sizes of squares and rectangles or different shades of white. We have automated the production of circles and triangles and trapezoids and others and in any color an architect or designer could imagine. These are the type of products that architects have told us they want to specify as these new products provide architects with the ability to create more dynamic and multidimensional ceilings. This is the latest step in our ongoing efforts to revitalize the Mineral Fiber category.

In 2017, we also took steps to optimize our manufacturing footprint and our overall cost structure. In November, we announced our intention to close our plant in St. Helens, Oregon, and to open a distribution center this summer to provide better service to West Coast customers, which we have now determined will be located near Phoenix. We also announced a plan to restructure our G&A profile to serve an Americas-focused business. Combined, these actions will yield cost savings of $15 million to $20 million by the end of 2019.

On our third quarter earnings call, we discussed several insurance settlements related to legacy environmental sites. Progress continues on this front. I'm pleased to announce that in December, after nearly 20 years of reporting externally on this matter, we reached a settlement in principle with the Oregon Department of Environmental Quality regarding our St. Helens facility. When finalized, this $8.6 million settlement will resolve our liability with the state and facilitate our planned sale of the property.

Finally, in November, we announced our agreement to sell our EMEA and Pacific Rim businesses to Knauf with an expectation to close in mid-2018. I'm pleased to report this transaction remains on schedule. Progress on regulatory approval is well under way, and the Armstrong and WAVE international businesses are performing well. We continue to expect to achieve close to $250 million in net after-tax cash in connection with the transaction and to returning a majority of the cash to shareholders.

So as you can see, both an exciting and productive year in 2017 for the Armstrong team. All of these actions are part of an ongoing transformation of our business that will benefit Armstrong for years to come as we strive to further accelerate top and bottom line performance and improve on our already best-in-class EBITDA margins and free cash flow.

So let me pause here and turn the call over to Brian to discuss more of the details around our financial performance. Brian?

Thanks, Vic. Good morning to everyone on the call. Today, I will be reviewing our fourth quarter and full year 2017 results. But before we go into the financials, as a friendly reminder, I'll be referring to the slides available on our website.

Slide 3 details our basis of presentation used throughout this discussion. The primary differences to our reported results are expenses related to the separation of the flooring business in 2016, the impact of the sale of our international businesses, the exclusion of net environmental insurance settlements in 2017, adjustments made for our U.S. pension plan and costs associated with the restructuring activities we announced in November. With the agreement to sell our EMEA and Pacific Rim businesses, we are unveiling new segment reporting today. We are now reporting 3 segments: Mineral Fiber, Architectural Specialties, and Corporate Unallocated. The corporate segment contains cash, debt, our fully funded U.S. pension plan and certain other miscellaneous balance sheet items. I will not be speaking about this segment as it has no sales or adjusted EBITDA going forward. You'll also note on Slide 3 that we are no longer -- we will no longer be presenting currency-adjusted sales as movements in the Canadian dollar should not be material to our results.

Slide 4 is a review of 2017 highlights, which Vic has already addressed. I do, however, want to emphasize our strong cash flow performance and note a 200 basis point improvement in free cash flow yield as a percentage of sales.

Turning to Slide 5, for our fourth quarter results. Sales of $214 million were up 9% from fourth quarter of 2016, adjusted EBITDA increased 9% and margins expanded. Adjusted diluted earnings per share were up 22% due to a lower tax rate and our share repurchase activity. Adjusted free cash flow improved by 16% over the prior year quarter due primarily to higher cash earnings and a larger cash dividend from WAVE. Net debt declined by $41 million.

Turning now to Slide 6. Adjusted EBITDA increased 9% driven by higher volumes, primarily in our Architectural Specialties business. Manufacturing costs were a headwind in the quarter driven by the Flex line start-up issue that Vic mentioned. In addition, we accelerated planned 2018 manufacturing spending into December to meet high demand for our high-end products. SG&A costs benefited from tighter controls and a revised support cost agreement with WAVE. WAVE equity earnings were lower this quarter due to higher steel costs and the revised support cost arrangement. Depreciation was higher in the quarter, largely as a result of our decision to close the St. Helens plant, which drove a $4 million accelerated depreciation charge.

Slide 7 shows our change in adjusted free cash flow, which grew 16% compared to the prior year quarter. Earnings growth and a variety of small factors contribute to this improvement.

Slide 8 begins our new segment reporting. With the establishment of the Mineral Fiber and Architectural Specialties operating segments, we revisited SG&A allocations to assign overhead costs to each new segment. The resulting allocations reflect the relative profitability of the 2 segments: a strong annual 22% EBITDA margin for AS; and a world-class, almost 40% annual margin for the Mineral Fiber segment. In the quarter, Mineral Fiber sales grew 3% driven by AUV gains and modest volume improvement. EBITDA was up with the sales gains and SG&A savings, which more than offset the manufacturing performance we have discussed. These production headwinds are now behind us, and the plants are all running well.

Moving to our Architectural Specialties segment, on Slide 9. Quarterly sales increased by almost 50%, organic sales grew more than 20% and the Tectum acquisition contributed. Armstrong's broadest specialty ceilings and walls portfolio, coupled with our superior service and support capabilities, is allowing us to increase penetration in this area and grow dramatically in a relatively flat market.

Adjusted EBITDA in AS was up over 80% as sales dropped through to the bottom line, with only modestly higher SG&A. EBITDA margins expanded 400 basis points. This quarter demonstrates not only the top line potential of the Architectural Specialties business but its ability to meaningfully help us grow the bottom line and expand margins as well.

Turning now to our full year results, on Slide 10. Sales improved 7% driven by volume growth as well as AUV improvements. AUV benefited from both mix gains as our new product initiatives accelerated and like-for-like pricing in excess of inflation continued in 2017.

Adjusted diluted earnings per share improved by 23%. Higher tax profits, a lower tax rate and our repurchase program all contributed. In 2017, we bought back over 1.8 million shares for just under $80 million. Since inception of the program, we bought back roughly 3 million shares for $125 million. These actions demonstrate our confidence in our strategies and growth initiatives and our commitment to balanced capital allocation and enhancing shareholder value. Adjusted free cash flow grew 26%, and free cash flow yield grew 200 basis points.

On Slide 11, you'll see the drivers of our consolidated adjusted EBITDA performance for the year. The margin impact of higher volumes and AUV achievement offset higher input costs and manufacturing headwinds. The SG&A gains in the WAVE results were impacted by the support cost change but also reflect SG&A productivity and WAVE's steel cost inflation. The D&A increase was largely St. Helens and also includes depreciation related to our manufacturing investments.

Slide 12 details our year-to-date change in adjusted free cash flow, which improved by 26% against the prior year, primarily driven by higher cash earnings. Working capital expanded to support higher sales, and WAVE's cash distribution was below 2017 as WAVE provided each parent with a $13 million special dividend last year tied to its international operation. For the year, our EMEA and Pacific Rim businesses contributed $12 million to our free cash flow.

Slide 13 bridges full year Mineral Fiber results versus 2016. Sales were up 3% for the year as continued strong AUV growth offset modest volume declines at the low end of the product range. EBITDA grew 4% as the AUV fall-through and SG&A cost actions offset the manufacturing headwinds we experienced as our plants completed the $100 million advanced manufacturing program during 2017. WAVE's results were impacted by the full year support cost adjustment and higher steel costs.

Slide 14 illustrates the Architectural Specialties segment full year results. Sales growth of 36% was a combination of the Tectum acquisition and double-digit organic growth. Sales gains were offset partially by SG&A increases, primarily the absorption of Tectum's SG&A structure, and led to adjusted EBITDA growth of almost 50% and an expansion of EBITDA margins by 175 basis points. Continued sales leverage and capital investments at Tectum will allow this business to continue to expand margins in 2018 and beyond.

Slide 15 outlines our 2018 guidance. Consistent with our previously commuted medium- to long-term outlook, we expect sales growth of 5% to 7%, aided by a modest uptick in volume, AUV improvement in Mineral Fiber and continued double-digit sales gains in Architectural Specialties. We expect that this level of sales growth will allow us to drive double-digit adjusted EBITDA improvements as the sales gains, productivity improvements in our plants and the impact of our announced restructuring activities fall to the bottom line.

Tax reform will reduce our tax rate from 35% to 25% and provides a significant boost to our EPS and cash flow. At a constant 25% rate, we expect EPS to grow 17% to 24%. We anticipate that free cash flow will grow 20% to 30%, aided by lower capital expenditures and a cash tax rate in the low 20s. At the midpoint, this would represent a 300 basis point improvement and free cash flow yield to 19%.

Drilling into taxes a bit more. In addition to reducing our effective and cash tax rates on a go-forward basis, the changes in the law also require us to revalue certain deferred tax items as of the date that the tax reform took effect. As a result, our fourth quarter as-reported P&L includes approximately $85 million of noncash income resulting primarily from changes to our deferred tax liability balance. There are, of course, other moving parts related to the tax reform, but this is the most impactful item and drove our reported -- as-reported effective tax rate for the year to almost 0. On the deemed foreign income repatriation element, we will offset $10 million of tax expense with $5 million of foreign tax credits for a net liability of $5 million, which will -- we will elect to pay over 8 years.

Lastly, regarding our liquidity. As of the year-end on a continuing operations basis, we remain near the low end of our targeted net leverage range of 2 to 3x adjusted EBITDA and have plenty of liquidity to support our capital allocation priorities, including M&A.

To close, I'm pleased with the progress we've made in 2017. As you saw on Slide 4, we have accomplished a great deal. In 2018, we will continue to drive sales growth, and manufacturing productivity will improve. We are confident that the investments and actions we have put in place will drive the sales, earnings and cash flow we have outlined in our guidance.

With that, I'll turn it back to Vic.

Thanks, Brian. Before we get into 2018, I want to offer a few comments on the leadership transition we recently announced. On Friday, we announced that Americas Senior Vice President, Dave Cookson, has decided to retire, effective July 1, after 39 years of service. It's difficult to list the contributions Dave has made to Armstrong during his long and distinguished career. He's been instrumental in the development and success of the ceilings business and to Armstrong's market leadership position. Dave has driven a customer-focused approach that has helped build Armstrong's reputation to what it is today, and his leadership and dedication has created significant shareholder value over the years. He will be missed by me personally and by many others in the organization. I want to take this opportunity to publicly wish Dave and his family great health and happiness in retirement.

Now in light of Dave's retirement and as part of our ongoing succession planning, Senior Vice President, Charlie Chiappone, has accepted the newly created position of Senior Vice President, Ceiling and Wall Solutions, effective April 1. In this new role, Charlie will lead the Mineral Fiber and Architectural Specialties segments. With Dave's retirement, it's the right time to consolidate these businesses under one leader and create a leaner, more nimble, integrated organization. And with Dave's advanced notice, we are afforded time to execute a seamless transition.

Having successfully led the WAVE and Architectural Specialties businesses over the last 6 years, Charlie has the knowledge, the key relationships and leadership skills to drive the combined businesses forward. I'm excited for him and for the opportunities that lie ahead for all of us as we continue to grow our business by selling into more spaces and selling more into every space.

Now looking ahead. We anticipate 2018 to be another exciting and productive year for Armstrong. We are expecting to operate in a more favorable economic environment, which will support more repair and remodel activity. And we expect a continuation of positive new building construction activity as the starts of 2015 through 2017 turn into completions.

And 2018 is off to a good start. Year-to-date volumes are up, well within our guidance range and versus a strong volume quarter in Q1 of 2017.

Now, however, regardless of market conditions, there are several factors entirely within our control that will allow us to drive sales growth and improved profitability in 2018. As I mentioned, since separating from the flooring business, we have been strategically investing in new products, sales and support services and advanced manufacturing capabilities. In 2017, we gained traction in the new product area. We began to see a return from our sales and support initiatives, and we've completed our advanced manufacturing investments. In 2018, we will see even greater returns from these strategic actions, driving sales gains through both volume and AUV. EBITDA will improve as a result of this sales growth and will be accelerated further by improved efficiencies in our manufacturing operations. After years of elevated capital investments, our manufacturing team will now intensify their focus on productivity and running our plants more efficiently as they have in past years. In fact, I expect to be talking a lot more about the positive performance of our plants in 2018.

Our product innovation efforts remain robust, and you will see us continue to introduce new products and services, further extending our leadership in next-generation interior space solutions. We will continue to deliver double-digit organic growth in the architectural specialties sector, and we will supplement this growth through a more focused M&A activity.

Our restructuring activities, the $15 million to $20 million of savings around the closing of St. Helens and reducing our G&A costs, are being accelerated and expanded. These actions will provide tailwinds to EBITDA growth in the second half of the year and keep us on track to deliver $400 million of adjusted EBITDA in 2019.

And finally, we look forward to closing the sale of our EMEA and Pacific Rim businesses and returning a majority of the cash to shareholders on top of our ongoing share repurchase program.

So thank you for your attention this morning. And with that, I'll open it up to questions.

(Operator Instructions)

And our first question comes from Keith Hughes with SunTrust.

Just 2 questions. First, on the quarter. The flow-through within Mineral Fiber on pricing, it seems a little weak versus what we had thought going in, what we kind of heard in the market. Can you just talk about pricing on Mineral Fiber for the quarter? How much of the price increase you saw on the top line and if there was anything inhibiting the flow to the bottom line?

Yes. Keith, this is Vic. For the fall-through rate, it's primarily been affected by the temporary start-up issues I talked about in manufacturing. We had good price realization in the quarter. We had actually excellent AUV improvement overall in the quarter. Again, that flow-through rate was interrupted by the temporary start-up costs that I mentioned, especially in our Marietta facility. So I'll say, the fourth quarter saw the acceleration that we talked about in the third quarter in terms of pricing. It was the highest realization quarter that we had all year and continued to build the momentum off of the price increase we announced in the summer. We have announced another price increase in February, and we plan to continue to stay ahead of inflation with our price realization. And I expect the fall-through rate to improve significantly -- or I'd say, it'll be significant from our fourth quarter fall-through rate but certainly back to our historical norms as we get our manufacturing productivity back to the levels that it has been in the past.

And the plant issues, did they prevent delivery of some higher-priced goods? Or how does that impact the AUV?

Yes. No, it was primarily around the start-up of new equipment. So there was no delay in terms of servicing that -- those products. Those products are being supplied by other plants at the moment. And once we have this automation equipment online -- or I'm sorry, it's online now, and it's up the learning curve. As we get it higher up on the learning curve, we'll be moving all the products to this automated facility, which will greatly enhance the profitability of those products as well.

Okay. Second question, your EBITDA guidance for the year, you had referred to $15 million to $20 million of productivity SG&A savings. How much of that is contemplated in the EBITDA guidance for '18?

Yes. $15 million to $20 million is the total G&A and manufacturing footprint optimization range. And we said that -- back in November, we said that, that was going to be over a 2-year period. So we would be implementing that in '18 and also partially in '19. So by the end of '19, we should be at that run rate. I also mentioned in my prepared remarks, Keith, that we were expanding this and accelerating it, so pulling some of those cost reductions forward so that we should see a bigger impact in the second half. So we're not breaking out exactly the contribution as some of these may float, but there is definitely a second half impact in acceleration in our EBITDA numbers that we guided to.

Is it fair to say you're going to see a higher dollar impact in '19 than '18 on this one?

Yes, I think so. I think that's fair to say.

And our next question comes from Kathryn Thompson with Thompson Research Group.

Just some follow-up on the Oregon plant closure. I know you gave some color on the impact to the quarter, but if you could just maybe quantify a little bit more specifically the impact in the quarter and also clarify how we should think about the cost flow-through as you wrap up those operations for the remainder of fiscal '18?

Kathryn, this is Brian. So a couple points there on the St. Helens. One, we've mentioned that -- in our prepared remarks that we had -- took a $4 million accelerated depreciation hit in the quarter, so for those that look at EBIT versus EBITDA, and we'll continue to see that in 2018. And as Vic mentioned, we're now at the completion of the $100 million advanced manufacturing investment that we made. So some of the operational headwinds we saw weren't just at St. Helens. It was across the whole system. And we accelerated the start-up of the ramp-up curve in our biggest plant, Marietta, for the Flex line. We pulled that forward into December so we could get out of the gate in 2017 stronger from a performance -- for 2018 from a performance standpoint.

Should we see -- as that St. Helens plant wraps up in Q1, will there be any other lingering costs specifically related to the plant for the remainder of the year? Just wanted to make sure that we're on the same page just in terms of wrapping up that plant impact.

Yes. We will -- as we said previously, we'll wrap up production in that plant. We'll continue to service the customers out of that plant through until the DC is set up in Phoenix.

Okay. Shifting focus to future and what to do with your cash flows. We spent some time in the past, the last conference call and since then, talking about areas to invest, including walls. Could you give an update of where you're thinking strategically in terms of walls, but also clarify a little bit more of what you can do to expand the Tectum family of products as they are being integrated into Armstrong?

Yes. Kathryn, this is Vic. I'm going to be very careful not to signal where we're focusing in terms of new product development, but I do want to say that the Tectum platform, coupled with our existing specialty wall platform, really does give us a lot of latitude for us to innovate in, and we are innovating in that. We are investing in several new lines of products connected to those 2 technologies that we're very excited about and will continue to get the focus of our team. So I'd say, in '18, you're going to see some new products around those 2 new platforms that are going to further our penetration to specialty walls. So I'd like to leave it there for now and not to signal too much, but it is an exciting area for us. It's an exciting adjacency. The architectural specialty capabilities that we've been working on for the last 5 or 6 years, specifically around design capabilities, really does give us the platform of capability to move into this adjacency. And again, as you mentioned, with the Tectum acquisition, it gives us a whole another platform to -- as a material platform for us to innovate to. So very exciting, and more to come on that.

Okay. And finally, just quickly a question on rising steel costs and how that impacts WAVE. Do you feel like you've been able to keep up with rising costs in that particular -- for steel? And how should we think about -- I assume that you're going to attack that with multiple price increases. Just any color on rising steel and WAVE.

Yes. Yes, so the steel inflation really started in the second half of 2016 and began accelerating, put us in a bit of the -- behind the curve in 2017 and although we were successful in raising price successfully and gaining in each of the quarters of 2017, we never caught up to the gap that was created in the second half of 2016. We -- as you know, we've announced a number of price increases. In November was our last one. We've got another one in February. And I'm confident that we're going to catch up to the steel inflation with our price increases, and we're on the right trajectory to do that. So, yes, we will be raising price accordingly to make sure that we're covering steel inflation in 2018.

And our next question comes from Stephen Kim with Evercore ISI.

Wanted to talk a little bit about Architectural Specialties, if I could. Was curious if, going forward, you can give us a sense for what you think the normalized incremental margin we should be using in Arc Spec is. And also are you going to, at any point in the foreseeable future, start breaking out AUV in Arc Spec?

Stephen, this is Brian. So on the AUV point, more than likely not. It's very difficult, given the customization that occurs in Architectural Specialties, to really pinpoint the exact price and mix benefit. So we'll continue to show on our bridges there that mostly is volume, and we'll continue to invest in some SG&A to help the front end of the design phase of AS. On the margins going forward, 22% EBITDA margins are a pretty good proxy at this stage. I mean, obviously, that's not the gross margin. But like I mentioned, we'll continue to invest in SG&A. And so using that 20% to 25% range is a good incremental margin number.

Okay, got it. And then -- that's helpful. And then as you think about opportunities outside of just the Mineral Fiber ceiling tiles, I mean, obviously, Arc Spec encompasses a lot of different kinds of things. In general, as you look at adjacencies, are they -- are you typically finding opportunities with EBITDA margin in that kind of range of the existing 22% to 25%? Or is it your expectation that you'll boost the top line but obviously -- but the EBITDA will come down a bit?

Yes. I would say, compared to the Mineral Fiber EBITDA margins, it's tough to find that standard, right? I mean, that's a pretty high benchmark out there. But here's how we think about it: We think about these opportunities that are outside the Armstrong system, when they're brought into the Armstrong system, what is the margin expansion and profitability opportunity that exists? By leveraging something that we're already doing very, very well, whether it's gaining specifications or partnering with our -- through our distribution channels. So there's -- that's how we think about those opportunities and the synergies and the leverage we can get with the existing Armstrong model. And that's how we're thinking about what else we want to bring into the Armstrong system is that opportunity. And we'll continue to size up those based on those leverage points.

Yes, that makes sense. Lastly, on productivity, you had mentioned that productivity would be probably in line with inflation in the guidance for 2018. But I just wanted to delve into that a little bit more. Can you give us a sense for what kind of level each might be? I know that you said that it might be about the same, but like how much inflation are we thinking about here in terms of dollars for 2018? And am I correct in assuming that you might see the inflation costs hit you more in the front half or the productivity gains might be more weighted to the back half? Or do you think they actually might be synchronized quarterly?

So, Stephen, this is Brian. The productivity will improve right away. We had some headwinds there in 2017 as we tried to prepare for the St. Helens closing and complete that $100 million advanced manufacturing investment. So we expect that productivity to start right out of the gates. From an inflationary standpoint from our guidance, this year, we saw just right around 2%. We had guided 2% to 3%, so it came in a little bit towards the lower end. And we expect it to pick up some here in 2018 from an inflationary standpoint. But net-net, this business historically has delivered over $10 million of productivity, and we didn't see it in '17. We expect and we are confident we'll see it in 2018.

And our next question comes from Nishu Sood with Deutsche Bank.

I wanted to ask first about the plans for the cash generation from the sale of the international operations. Your diluted share count guidance for this year kind of indicates no share repurchases. So just wondering, because you mentioned the majority of those cash proceeds are going to be returned to shareholders, is -- does that tell us that it will be returned in another way? Or is that just a placeholder since the transaction obviously hasn't been completed yet?

Nishu, it's Brian. We just assumed -- and we want to be clear with everybody that we assumed in our EPS guidance 53 million. I mean, obviously, we're going to continue to complete and be active against our existing share repurchase. On the use of proceeds from the sale of international, we continue to have a great dialogue with our board. Obviously, the transaction has not closed, and we intend to return the majority of it to shareholders, with the vehicle to be determined.

Got it, got it. Great. Okay. And on the acquisition pipeline, Tectum, obviously, a very successful deal in terms of integration and driving cost savings from there. How does the pipeline look at this stage? And what generally should we be expecting in terms of pacing? Obviously, recognizing that deal flow comes up -- comes up when it comes up and when things work out. But how active do you intend to be in terms of that? And then what generally should folks be expecting in that regard?

Nishu, this is Vic. The pipeline continues to be very encouraging, and it's building. It's -- from a year ago, it's so much better than what -- from 6 months ago, it's improved. So I like what I'm seeing in the pipeline. As you talked about, some of these things are very hit or miss, and the timing is dependent on both parties. So there's a lot of timing elements to this. But the pipeline itself, the opportunities and the way that we're thinking about the growth opportunities, the bolt-on to this very capable go-to-market machine that we have here, we're very excited about this. And as I mentioned in my prepared remarks, this is a focused effort for us now. We have a team of people, this is what they do every day, is mine for opportunities to take advantage of the successful Armstrong business model that we have. So I continue to be encouraged and excited about the pipeline. And you should expect as we've outlooked 1 to 3 bolt-on acquisitions a year, and I think we're building a pipeline to accomplish that.

Got it. And obviously, the enhancement of cash flow from the lower tax rate, does that change the capital allocation hierarchy in any way? Or does it just give you more to play with in terms of either, obviously, investments or acquisitions or cash return?

It doesn't change our capital allocation strategy at this time. Not at all. I think it further enhances what we're focusing on, but it doesn't change the prioritization.

And our next question comes from John Lovallo with Bank of America.

The first one is, it seems that Mineral Fiber volume was kind of flattish in 2016. It was down, call it, 1%, 1.5% in 2017. What do you think needs to happen to hit the high end of your 0% to 2%? And how much confidence would you have in the high end of that range?

Yes. I think the new construction activity continues to be very healthy, especially in the office sector. But when you look at health care and education, the new construction side of the business is encouraging for 2018 and potentially beyond. That R&R component is where we've seen a little bit of softness. And a quarter here, a quarter there, you'll get some spikes in activity. But we haven't had this consistent R&R activity. I think what has to happen there is a broader based economic environment, much like what we're coming into in 2018, where you have more sectors of the economy participating. And that's why we're outlooking a better R&R environment in 2018. As we come into -- from the tax reform and the impact on a broader basis, we're expecting some better activity there. So I think that's what has to happen, and I think that's what we're outlooking to happen in 2018.

Okay, that's helpful. And then maybe along those same lines, did you see any pickup in the education sector with school being back in session? Or is that still a relative soft spot?

Well, we didn't expect to see any uptick in education because when they're back in school, the renovation activity really comes to a halt. It's really those summer months that are really important when the kids are out of school for them to be doing the renovation work. So it kind of returned to normal, as we reported, in October and November. So that's -- I think that's kind of where we are. We'll have to wait and see, as May, June rolls around here, how the summer is looking for education. But again, with a lot of the bond approvals to allocate more funds toward education that we saw in California and Texas and across several states, actually, we're optimistic that we'll have a better R&R season in education.

Great. One quick one here. China, it appears that you have 1 Mineral Fiber plant in China that you're keeping post-Knauf. What's the rationale for that? Or was it just a timing issue?

Yes. It's a timing issue because we've closed that plant, and it's just a matter of what's the right disposition of that plant at this point.

And our next question comes from Michael Wood with Nomura Instinet.

First, just wanted to walk through fourth quarter Mineral Fiber volumes. With just about 2 months ago, I guess, in the year, you'd given the full year guidance for 7% to 11% Americas sales growth. It looks like you came in just under the bottom end of that range. Just wondering, was there any particular area that was softer versus your expectations?

Yes. The one area that we highlighted in the third quarter was the education repair and remodel. That -- again, it was as late in the season as June where discretionary budgets were cut. And so we saw really soft education R&R season, which is a very important volume season for us. So that was really the major, I think, change and relative to the overall guidance that we had put at the beginning of the year.

Okay. One of your other competitors came out and saw stronger growth in the fourth quarter. There was some attribution to inventory stocking, also some sales to weather-related, storm-impacted areas. Just curious why you felt like you didn't get the participation in that activity.

Well, it's really hard to compare quarter-to-quarter, right? I mean, there's large projects that can influence. There's channel purchases that can influence quarter-to-quarter. So I would be very careful with the assumption that we didn't participate. We had a very good fourth quarter, 9% top line growth, lots of activity and overall pretty good growth.

Okay. And then on Sustain, you'd mentioned more than 30% of your sales in Sustain product. Does that rollout continue in 2018? And do you think we continue to see penetration in that product?

Yes. We expect to see that continue. Architects want to spec more of these types of products. And as we get more specs rolling through the system, we expect penetration rate to continue to go up. Absolutely.

And our next question comes from Garik Shmois with Longbow Research.

First question, just on the AUV guidance. Is this assuming just carryover from 2017 price actions plus the February price increase? Or are you going to need additional pricing to hit the at least 3% AUV increase for 2018?

Garik, this is Brian. So we price every year twice a year on the tile side of the business. WAVE is a little bit more dynamic. But generally, it's twice a year also. We just announced a 5% increase in February. And we typically do another one late summer, early fall, kind of in that August 1 time frame. So the guidance we've provided assumes that we will do, just like history, 2 pricing actions.

Okay, that's helpful. And then I just want to ask on Architectural Specialties. It seems like other competitors are just investing more in this business as well. I'm just curious, it seems like you've had a moat around it for quite some time. Are you seeing any change in the competitive landscape? And just speak to your level of confidence in driving double-digit growth in 2018.

Yes. My confidence level is high. And in Architectural Specialties, one of the unique parts of this is it's a very project-oriented business, so the visibility of the pipeline is sometimes better than in the Mineral Fiber part of the business because of the project nature of it, a lot of custom-type projects. So I like what I see in our pipeline, and we have the pipeline that supports another year of double-digit growth there. And so my confidence level is high here. We've got a great team. We've been working on capabilities that are very different than the Mineral Fiber business. They are much more design oriented. And that team just continues to strengthen its capabilities, and the type of projects that we're participating in just continues to increase. So that's what gives us confidence that we'll have another year of double-digit growth there.

And our next question comes from Michael Rehaut with JPMorgan.

First question I had was on average unit value and your outlook in -- for '18 for a roughly 3% contribution. Just wanted to understand if you felt that would be coming more from price versus mix given the discussions around price increases and if that would be more weighted in the Mineral Fiber segment.

Mike, this is Brian. So historically, our AUV contribution has roughly been 50-50 between price and mix. It obviously moves depending on the inflationary backdrop. In 2017, we saw a little bit more on the mix side than history. As we go into an inflationary market, we believe that will be more balanced like it has been historically. And so that's reflected in our guidance.

That's helpful. Also, I think there was an earlier question about cadence around productivity over inflation, and so the thoughts there were helpful. I think just taking a step back as well, thinking about first half and even first quarter versus back half, you had mentioned that you expect some contribution from the SG&A saves to start hitting in the back half of the year. When you think about the growth and the margin expansion -- EBITDA margin expansion and growth that you expect for 2018, should there -- should that growth be even throughout the year and that margin expansion even throughout the year? Or there are many companies that have kind of guided to a little more 2H weighted and maybe the expansion being a little bit less or even flattish in the first half or the first quarter and a little bit above the full year average in the back half. So any thoughts around that would be very helpful.

Sure, Mike. This is Brian. We have a history of driving EBITDA margin expansion. So we continue to expect in the first half kind of a historic performance there. As Vic mentioned and as I've talked about, too, the restructuring will benefit the second half, so we'll see that pick up. And clearly, from the guide that we've provided, we're expecting nice, pretty significant margin expansion. Our plants, as we've mentioned, did not run as well as we had hoped and didn't drive the productivity in '17. And so as we get focused on delivering $10 million of productivity in 2018, that will be spread across the whole year.

Okay. No, that's great. And just lastly, on the pension, which is included -- the pension expense, which is included in the table to get to the adjusted EBITDA, is that pension expense something that -- in terms of adding it back, something that you saw in 2017? Is this something that we should be expecting as a kind of continued expense over the next 2, 3, 4 years? I think people sometimes focus on whether or not to add something back and count it within an adjusted, if it's more of a shorter-term expense that's not going to recur or if it's something that you expect in this type of magnitude for the next several years.

No, Mike. So, a, it was an expense in 2016. It's a credit in 2017. And that's really -- the reason it was a credit was really the reflection of the spin of floors and settling in the compensation of our pensioners. We don't expect to see any huge changes in the creditor expense position going forward. They're really a function of the separation of our floor business.

Okay. So then that $20 million should be something that we should expect over the next few years, and just to clarify if that's noncash versus cash.

Correct. It's over 100% fully funded pension. And so this is accounting for the changes in the spend.

Okay. So noncash then?

Yes, noncash.

And our next question comes from Ken Zener with KeyBanc.

So, I do appreciate the color, the new segment reporting here. I believe, Brian, you talked about AS, you said it was 20% organic. That was for the full year, I believe?

Yes.

Now is that -- just so -- and I realize you might not talk about FY '18. Did that have a pretty steady cadence? Or is there seasonality in the business that we should be aware of outside of any M&A?

Yes. Ken, on -- this is Vic. On the -- because it's a very project-oriented business, it has less of a seasonality influence to it like our Mineral Fiber business. So it can be influenced by the shipment of large projects in a quarter. So it can have some lumpiness to it. It doesn't really follow a seasonal pattern as much as the Mineral Fiber business. I hope that was your question, and I hope that helps.

Yes. Yes. And I would just say to that effect, like there was load-in in the retail and ceilings in the past. If you see any of that volatility coming that would be useful, I would say, in advance.

That's not typical in the AS just because of the custom nature of the products. Yes.

Good. And then, I guess, Brian, just going -- you talked about EBITDA. In general, we talked about a little stronger back half. Historically, in Mineral -- well, at least for the last 2 years that we now have data on, 51% of EBIT came in the first half. Is it -- are you implying that it could be like 55% in the back half as opposed to just under 50%? Or when you say that back half, is it something that you feel comfortable putting a number around so we can have a little more clarity?

Ken, I mean, if you look back at history, this business runs either 49% first, 51% back; or 51% front and 49% back. It doesn't swing that drastically, and we don't anticipate that big of a swing, while it will -- the second half will benefit from the restructuring activities.

And our next question comes from Phil Ng with Jefferies.

This is actually Collin Verron on for Phil. My first question, just you and your largest competitor out with price increases for February. Can you talk about the impact that you're seeing from increased competition with the new supply entering the market?

This is Vic. I think that the competitive environment continues to be the same as we've seen. It's competitive, and you have to earn what you get out there every day. And we continue to focus on serving our customers in a way which we can earn these price increases with better service, better quality. And certainly, our new product introductions at the high end of the market continue to help us drive and earn those prices. So there's no material difference out there. You just have to work hard every day to get it.

Okay. And I believe you said the Architectural Specialties sales are growing at 20%-plus organically. And looking out into 2018, you say greater than 10% in your guidance. Is this 20% organic growth rate something that can continue in that business?

Well, hypothetically, it can continue, but what we've been delivering is a double-digit growth rate in that 10% to 20% range over the last several years. So we continue to be excited about the pipeline and the opportunities based on our capabilities that we've developed over the last several years. So we're very optimistic about the possibilities to continue a double-digit growth scenario in that business.

And our next question comes from Dennis McGill with Zelman & Associates.

First question, just going back to the guidance for Mineral Fiber for the year, the 0% to 2%. And just to clarify, is that your assumption for the market for the year, and the variance there is just whether the end channels become stronger now and some of the other end channels kick in relative to '17? Or are there any execution benefits that you're seeing from the strategic investments that would impact the number versus the market?

Dennis, this is Brian. So the 0% to 2% is consistent with what our expectation of the market. There's no share gain in there.

Okay, perfect. And then just Architectural Specialties. On the organic side, I know in the quarter you said it's just about 25%. On our numbers, that's a lot higher than earlier in the year. Can you just clarify what the full year organic was and then in the fourth quarter specifically?

So we've said in our prepared remarks, Q4 was up 50% in totality. We previously called out that AS -- or Tectum acquisition benefited for the full year at roughly $26 million in sales. You can pretty much back into the AS growth.

Okay, that's what I was getting to. So in the fourth quarter, it's a big step-up in organic growth relative to the first 3 quarters. So was that just project related? Was there a big project that hit in the fourth quarter?

Yes.

Yes, that's exactly right. That's exactly right.

Okay. And any carryover from the large project like that again into the first quarter?

Well, we continue to like our pipeline. We should have a good first quarter and, I think, a good year in Architectural Specialties in 2018.

But nothing as you sit here today that would tell you, you'd have an outsize growth in the first quarter for something that you know is going to deliver that's rather large?

Well, we're not going to guide on quarter. But I think that, again, the pipeline supports another double-digit growth year for us, and we're going to get off to a good start in the first half this year.

(Operator Instructions)

And we do have a follow-up from Keith Hughes with SunTrust.

You had talked at the beginning of this call about volume being related to economic growth. Obviously, with tax -- tax reform, there's some questions on whether that's going to accelerate. My question to you is have you seen anything in the last couple of months from not even just orders, but from quotation activity, giving you an indication that the -- at least the Mineral Fiber volume could start picking up?

Well, our project-based backlog, Keith, this is Vic, has picked up. And we like what we see on the new-project side. And you know as well as anybody, that's a smaller portion of the overall business. The R&R portion is less visible. But there are some good signs in terms of activity out there that are encouraging. And as I talk to the customers and both the distribution and the contractors, they're all very optimistic about the bid activity that they have going on out in the marketplace. So there are several signals that give us some hope for a better economic environment.

And I'm not showing any further questions at this time.

Okay. Thank you very much for everybody's attention this morning and participation. Again, just a couple of closing comments. A productive year, very busy, very productive year. We're excited about the growth opportunities that are resulting from our thinking as a focus on the Americas. And the start-up issues that we talked about and we saw in the fourth quarter are behind us. Big focus on productivity as we get into 2018. The line of sight on rightsizing cost actions, and I talked about expanding those and even accelerating those together with the industry-leading innovations that we've launched in the marketplace, we're well positioned for a terrific 2018 and beyond. And we're excited about it. And we look forward to updating you after our first quarter results. So thank you, everybody, and have a nice day.

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