Good day, ladies and gentlemen, welcome to the Q2 2017 Armstrong World Industries Inc. earnings conference call. At this time, all participants are in listen-only mode. Following management's introductions, we will host a question and answer session. Our instructions will follow at that time. If during the conference you do require operator assistance, please press star and zero on your telephone keypad. As a reminder, this conference may be recorded. It is now my pleasure to hand the conference over to Kristy Olson, Director of Investor Relations. Ma'am, please proceed.
Thank you, Brian. Good morning and welcome. Please note that members of the media have been invited to listen to this call. 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. 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-Q 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. With that, I'll turn the call over to Vic.
Thanks, Kristy. Good morning, everyone. It's good to be with you today to discuss our second quarter and to summarize our first half results. Let me begin in the second quarter. Globally, we delivered over 6% top-line growth on a constant currency basis, with all regions contributing to this result. Execution of our growth initiatives are resulting in solid top-line acceleration. As expected, led to margin expansion in the quarter. We continue to invest in innovation. Our industry-leading efforts are delivering solid growth and are supporting higher average unit values. Improving market conditions in our international markets also aided our results. Architectural Specialties continues to deliver strong growth with sales up over 20% globally in the quarter. Our Tectum acquisition, which is now part of our Architectural Specialties portfolio, continues to perform well and integration remains on schedule.
Together, solid execution of our growth initiatives and solid execution in our manufacturing plants resulted in good margin growth in the second quarter as we expanded adjusted gross margins globally by 210 basis points and adjusted EBITDA margins by 190 basis points. As we reported in the first quarter, the core value drivers in this business remain strong and continue to drive margin expansion. Higher volumes, realization of positive like-for-like pricing, covering inflation, industry-leading innovation, driving favorable mix, and lean-driven productivity gains drove solid margin expansion over what you all will remember was a very strong prior year quarter. Focusing on our Americas segment. Sales in the Americas were up solidly, up over 5% in the second quarter, on top of 6% growth in the second quarter of last year. Solid mid-single-digit growth in average unit value or AUV drove the sales growth along with higher volumes.
Our average unit value achievement improved sequentially from the first quarter as we continue to benefit from selling a richer mix of products and additional realization of positive like-for-like pricing from our February price increase. Sales growth at the high end of the Mineral Fiber product portfolio was again positive and continues to outpace growth across the rest of our portfolio, demonstrating that our investments to drive profitable organic growth through innovation are working. Similarly, volumes improved in the second quarter over mid-single-digit volume growth in the prior year quarter. Our U.S. commercial channel drove the volume improvement, which more than offset softness in Canada, Latin America, and the big box channel. Architectural Specialties products in the Americas continued to deliver strong growth with sales up double digits versus a strong prior year quarter.
I'm pleased that we returned to our traditional cadence of margin expansion in the Americas, delivering solid margin growth. Adjusted EBITDA margins expanded by 140 basis points with similar adjusted gross margin expansion in the quarter. The margin drivers for the Americas were similar to those of the global business as our core value drivers of positive like-for-like pricing over inflation, favorable mix, higher volumes, and productivity gains all enabled margin expansion over, again, a very strong prior year quarter. Our international business also contributed solidly to our top-line growth, delivering nearly 8% constant currency sales growth over the prior year quarter. Consistent with last quarter, improvement in our end markets and continued traction from our growth initiatives drove this result. In particular, we saw a nice pickup in the activity in emerging markets, which were up 20% over the prior year.
In addition, our growth initiatives are contributing with our Architectural Specialties products up double digits in our international markets. I'm also pleased to see the work we've been doing around cost reductions contributed to margin expansion again this quarter. There's more to do here, but a continuation of steady progress. Adjusted EBITDA margins improved in our international business by 230 basis points, and gross margins improved by 380 basis points over the prior year quarter. Summing up the first half, globally, we delivered just over 8% top-line growth on a constant currency basis, with all regions contributing nicely to this result. First-half sales drivers were similar to drivers in the quarter, as our growth initiatives around innovation led to higher AUVs, along with strong double-digit growth in Architectural Specialties against a backdrop of improved market conditions.
In the first half, globally adjusted gross margins expanded by 110 basis points, and adjusted EBITDA margins improved by 50 basis points. Similar to the quarter, higher volumes, favorable AUV, and productivity gains more than offset inflation. Our year-to-date adjusted EBITDA margin expansion was negatively impacted by higher SG&A expenses, which, as we communicated in the first quarter, was the result of higher expenses from the Tectum acquisition and the timing of increased investments in our selling organization in the Americas, which we began in the back half of 2016. Normalizing for these items, SG&A expenses would have been almost flat year-on-year in the first half of 2017. Let me pause 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. Before we jump into the financials, as a friendly reminder, I'll be referring to the slides available on our website. Slide three details our basis of presentation used throughout this discussion. The primary differences to our reported results are expenses related to the separation in the prior year and the adjustments made for our U.S. pension plan. As a reminder, we do not expect to make any cash contribution to our U.S. pension plan in 2017. Turning now to Slide four, consolidated constant currency sales of $330 million grew 6% versus the prior year quarter. Adjusted operating income increased double digits, up 19%, while adjusted EBITDA increased 14% versus the prior year quarter.
We return to our typical pattern of margin expansion as adjusted EBITDA margins expanded 190 basis points in the quarter. Adjusted diluted earnings per share were up over 31% due to the higher earnings and a lower share count as a result of our share repurchase activity. Adjusted free cash flow improved by 19% over the prior year quarter, due primarily to higher cash earnings. Borrowing on our revolver to finance our acquisition of Tectum and a slightly lower cash position increased net debt by $27 million. Turning now to Slide five, adjusted EBITDA increased 14%, driven by strong AUV fall through to profit, higher volumes, and favorable manufacturing costs. AUV improvements in the Americas drove this result, growing high mid-single-digits over the prior year quarter.
Both positive mix and positive like-for-like pricing led to the strong AUV fall through as we continue to sell a richer mix of products and benefit from prior pricing actions. Globally, volume improved, driven by the U.S. commercial channel and a pickup in the emerging markets, which were up 20% over the prior year quarter. Manufacturing productivity gains in the Americas and EMEA also contributed to this result as our supply to Asia accelerated. Higher input costs and SG&A expenses were up modestly this quarter. Slide six shows our change in adjusted free cash flow compared to the prior year quarter, which grew 19%, driven mainly by higher cash earnings. Sales growth in all of our reportable segments led to favorability in cash earnings. Working capital negatively impacted adjusted free cash flow due to the impact of separation payments in the prior year quarter.
After excluding these payments, working capital would have slightly benefited adjusted free cash flow. WAVE dividends were also down versus the prior year quarter, as the special dividend we received in the second quarter of last year was not repeated. Turning now to our segments on Slide seven. The Americas delivered a solid quarter, with constant currency sales up 5.4%, while wrapping a strong prior year quarter, which was up 6%. AUV accelerated sequentially from the first quarter, up 90 basis points, and growing mid-single digits versus the prior year. This quarter's strong AUV fall-through rate demonstrates our ability to consistently sell high-value, higher-margin Mineral Fiber products and our continued ability to realize the benefits of like-for-like pricing from our prior pricing actions. As a reminder, our AS sales are captured in volume. Volume grew modestly against a strong prior year quarter where volumes were up mid-single digits.
Our largest channel, U.S. commercial, drove the volume gains this quarter, which were partially offset by declines in Canada, Latin America, and the big box channel. As expected and outlined on our last call, inventory builds in the big box channel did take some volume out of this quarter. Within our U.S. commercial channel, Architectural Specialties delivered strong double-digit growth aided by Tectum, our newly acquired AS product line. The high end of the Mineral Fiber market continues to grow as our products with better visuals, enhanced transparency, sustainable attributes, and superior acoustics are becoming more appreciated and specified and continue to support a mix-up tailwind that will benefit us for many years to come. Adjusted EBITDA increased over 9%, and we expanded margins by 140 basis points mainly due to our strong AUV fall-through rate to profit and aided by higher volumes and productivity.
WAVE equity earnings were down slightly off their all-time record earnings quarter last year. Moving to our EMEA segment on Slide eight. Quarterly constant currency sales increased almost 8%, driven by AUV improvement and strength in the Middle East and Russia. Adjusted EBITDA margins expanded 450 basis points, driven by the margin impact of higher volumes, positive like-for-like pricing, and productivity gains as EMEA ramped up their supply to Asia. This more than offset some selling and marketing investments to drive the top-line results and promote new product offerings in Europe. Moving to our Pacific Rim segment on Slide nine. Quarterly constant currency sales increased by 8%, driven by strength in China and India, which partially offset softness in Australia. I'm encouraged by the strength we're seeing in China as the office market bounces off the bottom, and we continue to gain penetration into the education sector.
Adjusted EBITDA declined as outlined in our guidance, predominantly from the sourcing strategy changes as a result of the idling of our Qingpu plant. Turning now to our first half 2017 results on Slide 10. Constant currency sales improved by 8%, driven by broad-based strength across our reportable segments. Adjusted operating income increased 14%, and margins expanded by 110 basis points. Adjusted EBITDA grew double digits up 10%, while margins expanded by 50 basis points, driven by strength in the second quarter, which was more than offset the timing-related items that impacted margins in the first quarter. Adjusted diluted earnings per share improved by 22% due to higher earnings and a lower share count as a result of our share repurchase activity. Free cash flow almost doubled versus the prior year, driven by the higher cash earnings.
On Slide 11, you'll see the drivers of our consolidated adjusted EBITDA performance for the first half. The drivers were similar to the quarter, with favorable volume and AUV, along with lower manufacturing expenses, offsetting higher input costs and modest SG&A investments to drive top-line results, along with the integration of Tectum. Slide 12 details our first-half change in adjusted free cash flow, which improved by over 90% against the prior year. Drivers were similar to the quarter, with higher cash earnings as a result of the higher sales growth being the primary driver. Slide 13 outlines our updated 2017 guidance. We are increasing our expectations for constant currency sales, adjusted diluted earnings per share, and adjusted free cash flow.
Given our healthy sales growth in the first half of the year and our expectations for improving performance in our international markets for the balance of the year, we now expect constant currency sales to grow 6%-9% over the prior year. We're reiterating our adjusted EBITDA guidance as higher sales internationally fall through to profit at a lower rate than our best-in-class adjusted EBITDA margins here in the Americas. Our adjusted EPS guidance is increasing to reflect our share repurchase activity through the first half of the year and has an assumed share count of approximately 54 million diluted shares for the full year. Given our stock price this quarter, we've been opportunistically buying in the market and repurchased about a half a million shares, representing a $21 million spend in the second quarter.
This brings our total spend to $115 million since inception of the program last August, repurchasing approximately 2.8 million shares or 5% of our float. As of quarter end, we had $35 million remaining under our current share repurchase authorization, and we will continue to be opportunistic in the market. We also increased our adjusted free cash flow guidance and now expect 28% growth year-over-year at the midpoint of the range, driven by better sales and capital spending coming in at the lower ends of the range. I want to emphasize the broader organization remains keenly focused on prudent cash management. Lastly, regarding our liquidity, we're within our targeted leverage range of two to three times. In closing, I'm pleased with the solid quarter. Our core value drivers enabled good margin expansion as we grew adjusted EBITDA margins globally by 190 basis points.
As outlined in our last call, we did experience sequential margin improvement in the quarter and expect to continue to drive grow margins year-over-year in the back half of 2017. With that, I'll turn it back to Vic.
In closing, as Brian mentioned, our team delivered a solid quarter, generating good momentum going into the second half. I continue to be impressed with the adoption rate of some of our new product platforms like Total Acoustics and SUSTAIN. Our market-leading innovation efforts and our expanding Architectural Specialties capabilities are clearly differentiating us in the marketplace and enabling us to deliver higher growth rates than the overall market. We saw higher AUVs again, supported by our industry-leading innovation, continued share gains in the Architectural Specialties product category, and continued improvement in our international business, all complemented by prudently managed costs, which enabled good margin expansion in the quarter. I trust that you can see that Armstrong is no longer just a Mineral Fiber suspended ceiling company. Armstrong has moved into the expanded market of total ceilings and is becoming a complete ceiling solutions company.
We are selling into more spaces than ever before with our broad portfolio, including Architectural Specialties and Tectum-like products, and we are selling more into every space with our component products from our WAVE joint venture. This strategy is about growth. Growth beyond the traditional core Mineral Fiber ceiling products. We plan to be more aggressive with our M&A efforts to accelerate our penetration into these new spaces while leveraging our best-in-class distribution and our industry-leading specification capability. We couldn't be more excited about our future, as we are well-positioned to further separate ourselves from our Mineral Fiber competitors. With that, we are happy to take your questions.
Thank you, sir. Ladies and gentlemen, at this time, if you would like to ask a question over the phone, please press star and then one on your telephone keypad. To everyone participating in today's question and answer session, we ask kindly that you please limit yourself to one question, and if you have additional or follow-up questions, please rejoin the queue. If your questions have been answered or you do wish to remove yourself from the queue, please press the pound key. Our first question will come from the line of Stephen Kim with Evercore ISI. Please proceed.
Thanks very much, guys. Good quarter. Congratulations on that.
Hey, Steve. Thank you.
Thanks, Steve.
First question I had is the acquisitions. Could you give us a sense for how much the acquisitions contributed in the quarter in terms of sales in dollars?
Steve, we're not breaking out specifically by quarter. As you know, that acquisition, the Tectum acquisition, which we closed in January of this year, is estimated to add somewhere between $25 and $30 million of sales this year. On the annual basis, I think that's what we have publicly disclosed. I continue to be very impressed with the Tectum team and the traction that we're getting in our distribution channel also with the Tectum products. The architectural community continues to be very excited about this product platform as well. I think, again, it's going very well, and the integration efforts that are ongoing are, as I stated, are right on track.
Got it
more positive about that.
Okay, got it. That gives us a ballpark for the business. Secondly, I guess, can you talk a little bit about the dynamics you're seeing in the U.S. business? You talked a little bit about the big box channel. Can you give us a little bit of background on maybe what's happened there? Was there just some quarterly push from one quarter to the other or some timing issue there? Obviously you have this little bit larger than, well, substantially larger than normal price increase out in the marketplace. If you could just sort of comment on maybe what the genesis of that was, I think that increased year-over-year percentage improvement in the price ask, and also how it's going.
Yeah, Steve, let me comment on the big box, because we pointed very specifically to this in the first quarter, right? We had a pretty nice demand profile in the first quarter that we pointed to, and we anticipated that that might pull forward some volume-
Right
I really would point to that. I really like what we're seeing in terms of our flow through our big box channels. The point-of-sale data is very encouraging. I think this is a little bit of the timing between quarters, as we talked about in the first quarter.
Got it.
Relative to the price increase, Stephen, it's early to talk about how that's going so far. We're only a couple of weeks into that. The justification for that price increase is in proportion to the level of inflation that we're seeing. We're committed to staying ahead of inflation. As we have in the first half of this year, we've done very well with our price realization and staying ahead of inflation. As we're outlooking an acceleration of inflation, we're making sure that we stay ahead of that. That is the primary justification for the size of this price increase.
Okay, excellent. Good luck, guys.
Thank you, Stephen.
Thanks, Stephen.
Thank you. Our next question will come from the line of Kathryn with Thompson Research. Please proceed.
Thanks very much. I appreciate that you are limited in what you can comment on Tectum. That said, in the past, when you were talking a little bit about guidance, you had previously said that Americas to contribute $32 million-$33 million, and Tectum around $4 million. That's what they contributed last year. International at $1 million. Has this contribution changed, particularly since you pointed it out with your adjusted guidance? Along with that, could you give us a better understanding how rising inflation may play into your EBITDA guidance range? Thank you.
Yeah. First of all, on the Tectum, no change. What we outlooked, we're continuing to see, and we're very confident in how that's performing, as I said earlier. No change there.
What was the second question?
International. Yeah.
International.
Kathryn, we did back in the original guide show roughly $1 million for international, that's clearly been outperforming. I'd say that's now looking like $5 million.
With the delta, essentially with the EBITDA range being unchanged, I would assume is the delta of the headwind more from inflation and higher SG&A? Just wanted to make sure I have the puts and takes of that EBITDA guidance, make sure I'm understanding it correctly.
Yeah, I think you're dead on. It's the inflation piece that's going to come in closer to the higher end as all building products company are seeing some more headwinds on the inflation side, which is again, back to Stephen's question, one of the justifications for the higher price increase.
Great. Thank you so much.
Yeah. Thanks, Kathryn.
Thank you. Our next question will come from the line of Jason Marcus with JPMorgan. Please proceed.
Good morning. First question, just wanted to hit on the competitive environment that you're seeing right now in the U.S. in the ceiling tile business. I think we heard last week from your major competitor that price competition has ramped up a little bit, it looks like you guys are still continuing to get positive like-for-like pricing, which is great. Just wanted to see if you could run through your different product lines and working from kind of the basic commodity product to the more premium product, and just kind of give us the dynamics you're seeing from a competitive pricing perspective.
Yeah. Hi, Jason. Yeah. The competitive environment, is very similar to how I described it in the first quarter. It continues to be competitive. It was very competitive last year. It's been competitive, actually, for as long as I've been running the business, it's been very competitive. It just continues to be competitive. Really going through the segments, it's competitive across all of the product platforms. That's not anything different than what we've seen in the past. I expect it to be as competitive as it is today going forward. As you alluded to, we're being very successful in selling value to our customers. We're getting paid for that value, and we continue to be committed to driving positive like-for-like pricing across the entire portfolio, as we did it again in the second quarter. I'd say the competitive environment is tough.
It's always been tough and will continue to be tough, and we're ready to win in that environment.
Okay, great. Then in the Americas, I think the margins showed some nice upside relative to what we were looking for. I think it maybe came in a bit better than what you had pointed to, when you spoke about what the quarter might look like in early June. Just wanted to see what the primary sources of upside relative to your expectations a couple of months ago were.
Well, I think the drivers, as we stated, were clearly a positive AUV, so better mix and better like-for-like pricing. We had good productivity and execution in our plants, and our teams did a really good job in controlling SG&A. I think those are the three primary drivers that delivered the nice expansion. Again, I wouldn't say it was a surprise for us, as you alluded to, but it came in very nicely. Thank you.
Okay.
Thank you. Our next question will come from the line of Mike Wood with Nomura Instinet. Please proceed.
Hi, thanks for taking my question. Maybe the first question just on products. I'm curious when you launched the SUSTAIN product and what your early trends are there, and if you can provide any color in terms of the growth rate you're seeing in the Total Acoustics line.
Yeah, Mike, good morning to you. Both of those platforms are, again, as I said in my statements, the adoption rate in the architectural community to these two platforms has been faster than any other product platforms that we've launched. Total Acoustics is, again, I'm not going to break out the exact growth rate, but we're finding architects changing specifications that they've already completed to a Total Acoustics product specification. It speaks a lot to, I think, how we're making it very simple for architects to specify acoustical performance with both dimensions in the same product. That continues to gain traction, and we're very pleased with that. Again, that's driving at the high end of the portfolio, a richer mix for us. Now, the SUSTAIN product-
Great.
The SUSTAIN, Mike, just to complete your question there, is fairly new in the marketplace, but I can tell you we have well into double-digit specification work that they're requiring a SUSTAIN solution in. Again, we're within just a few weeks of launching this. It's off the charts positive from the response from the architects. We're going to continue to drive this forward. I think the architects are going to continue to pull it, and we're very excited about both of those platforms driving growth at the high end of the portfolio, again, supporting our AUV and mix-up value driver.
That's good to hear. Also on the WAVE JV, with the pricing actions that you have in there to date, have you recouped the steel inflation? Will we see that flatten out by third quarter in terms of price cost within WAVE?
I'll remind everybody, in our second quarter last year, we had an all-time record quarter in our Wave joint venture in terms of profitability. We had the lowest steel prices, and we were holding on to market pricing. That created just really a perfect storm of margin spread there. When I look at our performance in the second quarter, I'm very pleased that we were able to get back to pretty close to flat margins against, again, a record quarter while we're digesting higher cost steel. Our May price increase, as you know, we went out with a price increase in May in reflection to the higher steel costs, and the realization that we're getting there is very encouraging.
Although we didn't get back to full margin expansion in the quarter, I believe in the second half, with this price increase in place, we'll get back to expanding margins in that business again.
Thank you.
You're welcome, Mike. Thanks.
Thank you. Our next question will come from Scott Rednor with Zelman & Associates. Please proceed.
Hi, good morning.
Morning.
Question on the manufacturing input cost side, obviously very nice improvement from last quarter, when it was a headwind in 1Q and a benefit in this quarter.
Is any of that related to the sourcing change and just you guys getting that ramped up here in Q2 where it was only partially in effect in Q1, or is there something else we should consider as to that benefit in the quarter?
Well, it's true. We did point to, in our first quarter comments, where we had some one-time startup expenses for our sourcing changes, both here in the Americas as well as in Europe. Those are behind us now, and we're up and running. That was part of the story. Our plants ran better in the second quarter. They initiated productivity programs and executed very well on those in the second quarter. I think it was a combination of those two things that I think creates some nice momentum going into the second half.
Great. On the Grand Central Station project that you guys alluded to with a press release last quarter, I know that some of that's been delayed, just the overall project. When's a realistic time that you guys think that will start impacting the P&L? Can you maybe give us some more color as to how impactful that could be for your business?
Yeah, it's a great project. It's a very sizable project. It's obviously iconic. I highlighted this project in the first quarter, not because we highlight project that we win frequently, but certainly, I wanted to highlight this one for one point, and that is the capabilities that Armstrong has developed over the last two or three years, has allowed us to not only participate in the Grand Central Station project, but win it. That speaks to the capabilities that we're developing to participate in this expanded market of total ceilings and being a total ceiling solution provider. It's that type of project that's, I think, demonstrating the capabilities that Armstrong is developing. As I talked about in the first quarter, the real impact of that won't be until the first quarter of 2018.
From our vantage point, it seems to be right on track for us to start to deliver those products in the first quarter of 2018. Everything's on track, and we're executing against that schedule.
Thank you. Our next question will come from the line of Nishu Sood with Deutsche Bank. Please proceed.
Thank you. In the first quarter, you had a really strong Americas, U.S. volume number. It looks to have backed off a little bit in the second quarter, clearly had strong comps in both quarters. How are you thinking about that heading into the back half of the year? Obviously, growth can be quite choppy from quarter to quarter, but the comps do get quite a bit easier, and you haven't taken your Americas volumes assumptions up. I was just wondering, are you thinking about the somewhat slowed down pace in Q2 is extending into second half, or how should we think about that?
How we think about it is what we saw in the second quarter with the growth at the high end of the portfolio with Architectural Specialties, the double-digit growth, it's pretty much in line with what we expected and what we expect to happen in the second half. The comps, as you say, Nishu, do get a little bit easier in the second half. Overall, I think what we see in the marketplace in the second quarter lines up with what we expect to see in the second half.
Got it. Okay, great. Architectural Specialties, just a kind of bigger picture question. Obviously, you've grown that business nicely. It's, I think, about 15%-16% of sales last year. How should we think about that mix progressing over time? Since that seems to be where the growth is, would you ever consider splitting it out as a division, or how should we think about it growing in the next few years?
Well, I think as we've stated before, Nishu, this is a double-digit growth segment and product category for us overall. I think, again, it's a lot less about what the market is doing. It's about us penetrating and participating more broadly in some of these spaces where we haven't played before with the broad portfolio that we've built in Architectural Specialties. The way to think about this is that we expect this to grow double digits for several years to come.
Okay, thank you.
You're welcome.
Thank you. Our next question will come from the line of John Lovallo with Bank of America. Please proceed.
Hi, guys. Thanks for taking my questions as well. The first question is, I know that you don't want to get too specific about Tectum, but is it reasonable to assume that in the Americas, excluding Tectum, that volume was actually down in the quarter year-over-year?
Again, Canada, Latin America, and the big box, as we talked about earlier, were all headwinds in the quarter in terms of volume growth. The U.S. business overall volumes were fairly flattish overall, again, as expected with the new construction part of the market growing and, again, against tough comps in the second quarter last year, which had very broad-based volume growth. Again, we're pleased with the volumes that we saw in the second quarter given the tough comps that we had with high volumes at the high end of the market and Architectural Specialties growing double digits. I would say that's, again, in line with what we expected in the second quarter.
Okay. Thank you. What is your exposure to OCC or wastepaper, and is there any way you could quantify the impact in the quarter there?
Yeah. You want to take that, Brian?
Yeah, sure. We don't use OCC in our process. We do use wastepaper. We are seeing inflation like many others, but not quite to the same extent. We don't break down exactly how much that was a headwind for us. Clearly we're seeing some visible inflation, and as I mentioned to Kathryn, that's one of the offsets, I'd say, in our guidance of why we held EBITDA where it was, and obviously we just announced and supported a 10% price increase on our Americas tile business.
Okay. Thanks, guys.
Thanks.
Yep.
Thank you. Our next question will come from Robert Wetenhall with RBC. Please proceed.
Gentlemen, good morning. Very nice quarter.
Hey, Bob. Thank you.
Just want to understand, I want to get kind of specific, is Architectural Specialties, which is growing double digit pace, cannibalizing the core ceiling tile business in North America? Because I understand you guys give some great detail on what's going on between big box and geographically in North America, but you're getting tons of growth out of this smaller size business, and it seems like the core business is down low single digits. Obviously, that's still an extremely profitable business. Is part of what's going on with Armstrong, and I'm not trying to be just about this quarter, but big picture, that the high-end business of Architectural Specialty is growing so fast, it's just eating into the core business, or is that not the right way to think about it?
Yeah, that's a good question. It's not the right way to think about it because Architectural Specialty products are going into different spaces in commercial buildings. It's not going into the spaces of traditional Mineral Fiber, which is why this is an exciting growth platform for us, where, as I said, we are playing in more spaces in a commercial building that require these Architectural Specialty products because we've expanded our product portfolio and capability there, as well as our design capability. It's not cannibalizing Mineral Fiber. It's an addition to Mineral Fiber and allow us to participate in a broader base of spaces within a commercial building. Thanks for the question. I think it's great clarification.
Yeah. Thank you. That's helpful to understand. Also too, just kind of on that same train of thought, can you talk to us what is real like for like pricing, which seems like it's doing well? You guys have some price momentum. The way you're reporting it's tough to understand. Is that because there's such a big mix shift up towards Architectural Specialties versus what like for like pricing is? How can we kind of get an understanding, or is that not the right question overall, just because the way you go to market, whether it's patch and match on the R&R side or new build commercial, is that no longer an applicable question because each job has its own unique characteristics, so we're kind of not looking at it or thinking about it the right way?
Let me start, and I'll ask Brian to fill in here, but Brian mentioned this earlier. Architectural Specialties is in volume. It's not in mix, and it's not contributing to like-for-like pricing. Our like-for-like pricing is measured on our Mineral Fiber, core Mineral Fiber products only because we understand that's the important value driver here. That's one point of clarification. We don't break out like-for-like pricing versus mix, as those can shift quarter-to-quarter. We had positive, again, greater positive like-for-like pricing in the quarter, and we also had very high positive mix in the quarter as well, contributing to the strong top-line that you saw. Brian, you want to add any color commentary to that?
Bob, I'd just add that the high end of total ceiling spaces is that Architectural Specialties, metals and wood. As we look at, as we've mentioned, it's in volume. As we look at Mineral Fiber, there's clearly a segmentation even below that product ranges, and there's a high end within Mineral Fiber where Total Acoustics Sustain play a part. There's a good distinction around how folks define that high end.
Got it. Brian, if I could just sneak one in to you. You're raising revenues guidance for the year. You're keeping your EBITDA outlook consistent with what it was, and you're raising free cash flow as well. Can you talk about how much of the rev raise is due to FX, and just explain why you're raising free cash flow, EBITDA stays constant. Thanks and good luck.
Thanks, Bob. As you look at the details of what we change in our guidance, it's really the international growth, which has a lower fall-through rate, which is why we kept the EBITDA unchanged. On the cash guidance, we are coming in at the lower end of our CapEx spending, and also on the lower end of our cash tax rate. They're the two key drivers for the increase in free cash flow outlook.
Sounds good. Good luck.
Yeah. Thanks, Bob.
Yeah. Thanks.
Thank you. Our next question will come from the line of Keith Hughes with SunTrust. Please proceed.
Thank you. Question on WAVE. When Worthington put out their numbers, they showed a pretty significant decline in WAVE. Of course, their calendar is different than yours, which would imply June was a big month. You talked about some pricing in June. Could you just talk about the differences there and how the volume, I know there's price increases, but how the volume from the grid product is doing versus tile?
Yeah, the volume is actually doing very well. It's very consistent with tile. I think there's a little bit of period noise in there because we had the price increase last year, that pulled some volume forward and did some different comparisons in the quarter. Overall, again, I'm very pleased, Keith, with the volume and the pricing that we're starting to read through from our May price increase in the WAVE business and the overall profitability of that business. As I said, we'll catch up in the second half, as volumes hang in there and our price realization continues to build.
Okay, thank you.
Thank you. Our next question will come from the line of Will Randow with Citigroup. Please proceed.
Hey, good morning, and congrats on the progress.
Thank you, Will.
Thanks, Will.
In terms of leverage, you guys historically have been comfortable with a $couple of hundred million more on a net debt to EBITDA basis. How are you thinking about leverage in the capital structure as well as, returning cash to shareholders?
Will, this is Brian. We're pretty comfortable with the 2x-3x leverage. We continue to focus on our capital allocation priorities of investing back in the business, accelerating our M&A to support our strategic initiatives, and completing our share repurchase. We'll continue to be focused on those priorities.
I guess, a follow-up from the past. In terms of the Russia plant and capacity utilization as well as profitability, can you give us an update there?
I'll let you add some color, Brian, but just overall, the Russia plant continues to build out its capability, and the volume there has been very strong throughout the year so far. We've added a second crew in Russia and continue to execute very well. I'm very proud of that team, how that's ramped up in a very tough economic environment. As we add more volume and capacity to that plant and the ramp, it gains in its profitability as well. Brian, I don't know if you want to add any more color to that.
No, I'd say we generally don't break out country-specific stuff, but I know we've talked this topic before. Russia will be both positive on the EBITDA and cash flow basis this full year.
Great. Thank you.
Great. Thank you.
Thank you. Our next question will come from the line of Garik Shmois with Longbow Research. Please proceed.
Hi, thank you. Just wanted to ask about mix in retail. I think if we look back to the third quarter of last year, you called out an air pocket. Presumably you have some fairly easy comparisons. You talked about point of sales being very good, the second quarter was impacted obviously by inventory timing. If sales accelerate in retail in the third quarter, presumably in the back half of the year, would that have any impact at all to overall mix?
Yeah. It's a question of degrees, right? How big would the spike have to be to influence mix? It would have to be a pretty big spike given the size of the U.S. commercial business relative to the retail business. We're not anticipating that. The mix progress that we have in our U.S. commercial business continues to be very strong because we're growing at the high end faster than the rest of the market. As long as that continues as it has for several years, it should be offsetting anything that's not an extraordinary spike in volume in the big box.
Okay, thanks. Just a follow-up question is, last week, a competitor talked about staffing up in Architectural Specialties. You were kind enough to answer a question regarding the competitive landscape by segment. I wonder if you could talk about maybe the medium-term outlook in Architectural, if the competitive environment does change, how well do you feel that you're protected against that?
In Architectural Specialties, there's a unique capability required, not only the product and the manufacturing capability of those types of products, but in the design capability. Anybody that wants to participate, needs to make those investments and develop those capabilities over time. Armstrong didn't develop those yesterday or last year. It's been a four or five-year concerted effort to build these capabilities as we were not playing in this segment holistically four or five years ago. I think you have to give appreciation to the capability required to win jobs and to participate in this category. Our competitors continue to be non-traditional Mineral Fiber competitors for the most part, who are in that particular space and have been for a while and are very good competitors. We're continuing to improve our capabilities there to be more competitive.
Again, I love the traction that we're getting and the affirmation that we're getting from the specification community on Armstrong's capabilities to really handle any space within their commercial buildings that brings a lot of productivity to them. I'm very pleased with our progress, we're going to continue to push forward with this.
Thank you.
You're welcome. Thank you.
Thank you. Our next question will come from the line of Kenneth Zener with KeyBank. Please proceed.
Good morning, all.
Hey, Ken.
Hey, Ken.
I'm going to ask two questions, if you don't mind. One of them is just going to kind of state what I think has already been summarized, which is with Tectum, that's going through your volume. Architectural Specialties is going through volume. Tectum was kind of two and a half, three points last quarter. Assume a similar rate this quarter. Architectural Specialties, 15+% of sales, growing double digit. If you add those two up, that's like 5% running through volume. It would imply that your core volume was down directionally, like some others might have talked about. However, this is, I think, the key point that I don't understand. Because Architectural Specialties is growing so nicely, and it appears that you have a very early and perhaps defensible lead there.
The pricing that we're seeing on the core side, is that because you're geared so much to the higher end, given your market share on those traditional tiles? I'm just trying to understand if 80% of your profits are flowing through that higher end, as you would call it, tile, as opposed to the commodity where it's really vicious and not a lot of EBIT?
Okay, Ken, let me take that question because it's very important to understand. We have positive like-for-like pricing across the Mineral Fiber category of products.
Price points.
Price points. It's positive like-for-like pricing, positive pricing, pure pricing, in the Mineral Fiber category. It's not influenced by Architectural Specialties mix-
Correct
or pricing. Okay? I want to make sure that's clear. At the high end, we're getting additional, not only price there, but volume growth, which is contributing, obviously, to the profitability. We are getting like-for-like pricing across the portfolio, which is contributing, again, that's the bigger base, right? That's the bigger base of business. That is contributing very nicely to profitability and will continue to be.
Can I
Is that clear?
It is, yeah. I understand how Architectural Specialties is all that stuff's going up in the volume side. It's interesting because, and it was kind of not before your time, but within your timeframe. The idea was that volume perhaps would recover in the U.S. tied to education, state spending, where it's kind of more commoditized product. You could actually see some net dilution from that volume growth from those categories because they're not the high-end office or retail space. Is that still a fair roadmap to think about as how pricing might happen, or is it just that, look, wherever the volume comes from, we're taking price like for like everywhere, so you won't have that pricing dilution?
That's correct. We raise price or announce price increases in the marketplace. They are broad-based and across all product platforms and categories.
Thank you.
You're welcome.
Thank you. Our next question will come from the line of James Barrett with C.L. King & Associates. Please proceed.
Good morning, Vic, Brian, Kristy.
Good morning.
Good morning, Jim.
Vic, in EMEA, you highlighted in the Middle East. How is Continental Europe performing, and specifically, how is the U.K. performing considering the Brexit issue?
Yeah, we had positive growth in the U.K. We had positive growth across really most of our markets. The big drivers for EMEA were the Middle East. We had a very strong shipments quarter in the Middle East, and Russia, again, was up double digits. We had nice of our emerging markets in the EMEA, the big drivers there. We had nice low single digit, mid-single digit growth across the rest of the regions.
Thank you. Brian, a question for you. You mentioned there was not a special dividend from WAVE this quarter. Is there any reason why that joint venture is not even reasonably leveraged up to return cash to its owners other than its inherent cyclicality?
I think, Jim, both parents look at that leverage on a consistent basis. The special dividend we highlighted that didn't repeat was really an overseas dividend from France that didn't repeat this quarter. I think the WAVE JV continued to deliver. As you know, it's a 45% EBITDA margin business and generates a ton of cash for us. We don't expect any change in the flow of cash from that JV.
Thank you both.
Great. Thanks, Jim.
Thank you. Ladies and gentlemen, this concludes our question and answer session for today. It's my pleasure to hand the conference back over to Mr. Vic Grizzle, Chief Executive Officer, for some closing comments and remarks. Sir?
Great. Yeah, thank you very much. Thank you everybody for joining the call today. Again, very pleased with the quarter. Our employees around the world are executing very well and are excited about the future of this business. We do carry some nice momentum into the second half of the year, and we'll look forward to updating you after our third quarter. Thank you.
Ladies and gentlemen, thank you for your participation on today's conference. This does conclude the program, and you may all disconnect. Everybody, have a wonderful day.