Good day, ladies and gentlemen, and welcome to the Q2 2014 Armstrong World Industries Incorporation Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this call is being recorded. I will now like to introduce your host for today's conference, Mr. Tom Waters, Vice President of Treasury and Investor Relations. Sir, you may begin.
Thanks, Sylvia, good morning and welcome to everyone on the call. Please note that members of the media have been invited to listen to this call, and the call is being broadcast live on our website at armstrong.com. With me today are Matthew Espe, our President and CEO, Dave Schulz, our CFO, Tom Mangas, CEO of our worldwide floor businesses, Vic Grizzle, CEO of our worldwide ceilings business. Hopefully, you have seen our press release this morning, both the release and the presentation Dave Schulz will reference during this call are posted on our website in the investor relations section. I advise you that during this call, we will be making forward-looking statements that involve risks and uncertainties. Actual outcomes may differ materially from those expected or implied.
For more detailed discussion of the risks and uncertainties that may affect Armstrong, please review our SEC filing, including the 10-Q filed this morning. Forward-looking statements speak only as of the date they are made. We undertake no obligation to update any forward-looking statement beyond what is required by applicable securities law. In addition, our discussion of operating performance will include non-GAAP financial measures within the meaning of SEC Regulation G. A reconciliation of these measures with the most directly comparable GAAP measures is included in the press release and in the appendix of the presentation. Both are available on our website. With that, I'll turn the call over to Matt.
Thanks, Tom, good morning, everyone. Our second quarter financial performance was largely a continuation of the first quarter. Our global sales and manufacturing operations executed crisply, but similar to the first quarter, markets were softer than expected. Sales versus guidance came in at the low end of our range, but as with Q1, we were able to deliver EBITDA in the middle of our guidance. Now, when we discussed market conditions in April and May, we were cautiously optimistic that the first quarter subdued activity was a result of the severe winter weather in parts of North America, and that the second quarter, and especially the second half of the year, would see improved conditions. We anticipated that 2014 would mark an inflection point in commercial markets in North America.
As a result of market activity in May and June and the recent significant downward revisions to GDP, we no longer believe this to be the case. While we continue to see growth in new commercial construction, that's a small part of our overall business. We now believe that both residential and commercial discretionary repair and remodel spend, the large majority of our U.S. business, will be flat to down for the full year, and that overall commercial volumes will also be down. I say this while being fully aware that GDP and construction forecasts for the second half of the year remain favorable and that there remains significant optimism in our customer base. We do not believe it's prudent to maintain optimism in our guidance absent actual realized activity to support the view.
As a result, we're lowering our full-year guidance for sales by $100 million and our adjusted EBITDA range by $30 million. Other than lower than expected volumes and some related mix degradation, primarily in the Americas, very little has changed from our previous view. Dave will provide more specifics on guidance, but I wanted to be upfront about this change in our outlook for the year. Turning back to the quarter. As I mentioned, sales of $710 million were at the bottom of our guidance range of $710 million-$750 million. Sales were up $3 million or half a percent from 2013. Foreign exchange had minimal influence on the year-on-year sales growth.
Adjusted EBITDA for the quarter of $99 million was right in the middle of our $90 million-$110 million range as softer sales were offset by lower than estimated SG&A spending, most of which is timing related, as spend was deferred in the second half of the year. As we mentioned at our investor day in May, we constantly review our portfolio of businesses and our manufacturing footprint. In the quarter, we took additional steps to rightsize our global plant portfolio. We announced the closure of our Thomastown, Australia, vinyl tile flooring plant effective July 31st. This small facility was no longer economically viable given the shrinking size of the Australian vinyl tile market. We'll be able to service Australian customers cost effectively from our South Gate, California, plant.
Also just today, we announced that we would be closing our Kunshan, China, engineered wood flooring plant, with production scheduled to cease at the end of September. As many of you know, this facility manufactured wood flooring utilizing veneers shipped from the U.S., scraped by hand in China, and then exported back to North America for sale. Rising labor and freight costs in these products have been among the factors negatively impacting our recent segment profitability. Proprietary manufacturing advances now enable us to onshore this production to our Somerset, Kentucky, facility and produce the desired scraped visuals more cost effectively here in the U.S. In addition, this shift will allow for lower transportation costs, reduced inventory levels, and better customer service. This is yet another action we're taking to restore the wood segment to an acceptable return on capital.
Dave will walk you through our performance by segment and geography. I want to talk about a few of the areas of recent interest, wood performance, Russia, and our European flooring business. As many of you know, we had a good first quarter in the wood segment when compared with last year. We highlighted that the second quarter was likely to be a pause in the upward trajectory of the segment, as lumber inflation was, again, likely to be out in front of price increases. We're pleased that in the second quarter, the segment delivered EBITDA up almost 50% versus 2013, and modestly above our expectations. Sales were up slightly versus last year, as 10% volume declines were offset by strong price and mix gains.
As expected, price lagged year-over-year inflation. We should now be priced appropriately versus our outlook for lumber cost for the second half of the year. Mix was positive year-on-year as our emphasis on higher end products continues to bear fruit. As I mentioned in my opening comments, wood volume, especially in repair and remodel channels, was below the expectations that informed our guidance. This also drove negative mix versus guidance. SG&A spend was also lower than we forecast as spending was moved in the back half of the year. Despite improvements in unemployment and housing prices, we continue to see restrained demand for big-ticket discretionary projects. As we look forward, we continue to expect the wood segment to make progress, the challenge in the second half now looks to be an uncertain consumer demand environment. I want to comment on Russia.
Last quarter, I mentioned that our construction and business process were proceeding without complications despite the issues in Ukraine, and that our biggest challenge was the decline in the ruble. We instituted a 10% price increase in April to offset the ruble devaluation, and so far, this has held with seemingly minimal impact on demand. Plant construction and product shipments continue unimpeded. The situation remains fluid, so we'll continue to keep you posted. Finally, at our investor day in May, we discussed the challenges that we've been experiencing in our flooring business in Western Europe. As you may have noticed in our 10-Q, we mentioned that we are evaluating strategic alternatives for this business. At this time, I really don't have anything more to add to this statement other than say all options are on the table, and that we'll keep you appraised as decisions are made.
I also want to be clear that any decision we make on the European flooring business will have minimal to no impact on our core markets here in North America, the Pacific Rim, and the Middle East. For that, let me turn the call over to Dave for more details on our financial performance and guidance. Dave?
Thanks, Matt. Good morning to everyone on the call. In reviewing our second quarter results, I'll be referring to the slides available on our website, starting with slide four, key metrics. As Tom already covered slide two and slide three, it's simply an explanation regarding our standard basis of presentation. For the second quarter, sales of $705 million were up slightly versus 2013 on a comparable foreign exchange basis. Operating income was down 5%, but EBITDA was up 2.5%, largely due to higher depreciation in 2014. Earnings per share was roughly flat as this year's lower share count offset lower after-tax income on a per share basis. Free cash flow for the quarter was $10 million, down from $32 million last year. I'll talk more about cash flow and EBITDA on coming slides.
Net debt was up $199 million, driven by our $260 million share repurchase in September of 2013, partially offset by operational cash generation. Return on invested capital was lower, driven by a reduction in unadjusted earnings and a slightly higher capital base. Slide five details the adjustments we made to EBITDA and provides a reconciliation to our reported quarterly net income of $21 million. Matt mentioned the plant closures we are executing at Thomastown and Kunshan, and as a result, we are recognizing $8 million of cost and impairment charges primarily associated with these actions. In contrast, last year, we had $3 million of cost reduction expenses related to actions in Europe. Our 2014 tax rate of 54% is higher than prior year as the impact of unbenefited foreign losses was greater this year than in the second quarter of 2013.
The increase in unbenefited foreign losses in the current year was also impacted in part by the Kunshan plant closure I just mentioned. Moving to slide six, this illustrates our sales and adjusted EBITDA by segment for the quarter. Excluding the impact of foreign exchange, resilient flooring sales were down 2% as volume declined in North America and Europe. North America was driven by the repair remodel factors Matt discussed, as well as continued weakness in the healthcare sector. EMEA sales were impacted by continuing weakness in Central Europe. Of note in this region, sales in the Middle East more than doubled in the period. Pacific Rim sales benefited from a more than 50% increase in China and very strong growth in India, partially offset by continued weakness in Australia and a down quarter in the volatile Southeast Asia markets. Mix in North America continued to be positive.
Despite lower sales, the resilient segment delivered flat EBITDA as manufacturing productivity, reductions in SG&A in the Americas, and profitability improvements in Asia offset the volume weakness. The wood segment saw sales increase 1% driven by price and mix, and profitability increased $3 million despite significant volume declines. Matt commented on these results, so I won't dwell on them, but I will note that lumber costs appear to be stabilizing, albeit at near record level. Ceiling sales were up 2% on an equivalent foreign exchange basis, despite volume declines in the Americas and Europe. Volume in the Americas was impacted by the same factors as the resilient business, but somewhat softened by the relative strength in new office activity. Europe experienced continued soft demand in the Eurozone and the U.K.
We called out the U.K. in the first quarter and mentioned that the issue was largely related to distributor inventory levels. We continue to believe this to be the case and expect a stronger performance from the U.K. in the back half of the year. Europe did benefit from strong sales to the Middle East, up over 25% from last year, as the Architectural Specialties business had a great quarter related to the Jeddah, Saudi Arabia airport project. Russia sales were up, driven by our April price increase, but volumes were relatively flat. Pacific Rim sales were up mid-single digits, aided by strength in the Architectural Specialties business. China volumes were up, but mix was down as the project business remained soft. India had a strong quarter, and Australia was up on the quarter behind growth in the Architectural Specialties business.
Price and mix was up modestly in all regions. Building products EBITDA was up $2 million on a global basis as margin gains in the Americas were offset by declines in Europe and the Pacific Rim. The Americas benefited from price and mix gains as well as SG&A deferral. European profitability was down due to the Russian plant construction costs, and Pacific Rim profitability was impacted by higher SG&A spending. Corporate expenses were higher than last year, largely due to the timing of project work, including expenses associated with the analysis of strategic alternatives for the flooring business in Europe. Slide seven shows the building blocks of adjusted EBITDA from the second quarter of 2013 to our current results. Of note, price and mix offset inflationary headwinds from lumber costs, but volume was negative, primarily in flooring. Manufacturing was a positive, primarily in flooring in the Americas and Europe.
Despite the business segments deferring some spending in the quarter, SG&A was up year-over-year due to the corporate expenses I just mentioned. Turning now to slide eight, you can see our free cash flow for the quarter was impacted by lower after-tax cash earnings and greater year-over-year capital spending. On capital, the Russia and LBP plant expenditures are at a high level now versus the China plant spending winding down at this time last year. The other category largely reflects VAT recapture in Asia as our plants begin to sell finished goods and collect VAT. Slide nine begins our discussion of year-to-date results. Sales, operating income, and EBITDA are following a similar pattern to the quarter. EPS is up for the first half of the year, driven by our $260 million share repurchase last September.
Free cash flow is down. I will discuss that and the EBITDA details in the next few slides. Slide 10 shows segment-level EBITDA year to date, and the only significant variance with the second quarter results is the inclusion of the relatively strong first quarter EBITDA performance in the wood segment, demonstrating the effectiveness of our new strategy. Slide 11 shows the building blocks of adjusted EBITDA from the first half of 2013 to our current results. All of the bars mirror the quarter directionally as first quarter trends continued into the second quarter. Turning to slide 12, you see that our free cash flow for the year is down versus 2013, primarily due to unusually favorable working capital in the first quarter of 2013 and higher CapEx spend in the second quarter of 2014. Slide 13 updates our guidance for 2014.
As Matt mentioned, as a result of market conditions, we are reducing the top and bottom of our sales range for the year by $100 million to $2.7 billion-$2.8 billion. At the midpoint, this will be a 2% increase in sales. I want to provide some additional comments on the markets. Recall previously, we assumed a modest recovery for the year. While we still believe key market indicators point to a longer-term recovery, particularly in new construction, continued softness in GDP, and the impact on the repair remodel segment inform our view that 2014 will be flat to slightly down compared to last year. For markets outside the U.S., our view is generally unchanged for the year. We believe key markets in Western Europe and Australia will be flat to down, consistent with our previous guidance.
The Middle East continues to be an area of growth, while we now expect the Russia market will be down high single to low double digits given the current political environment. We are also reducing our operating income and EBITDA ranges by $30 million due to lower volume and the fall through to profit. At the midpoint of the range, EBITDA would be up 5%. Earnings per share is also reduced, and at the midpoint of our range, EPS would be up 15%. Free cash flow is lower than the previous guidance, primarily due to lower after-tax cash earnings. Slide 14 provides more details on guidance. Our inflation expectation for the year is unchanged at $30 million-$40 million. This assumes lumber prices remain stable through the balance of the year. Productivity and SG&A as a % of sales worsen as a result of the lower volumes and mix decline.
Expectations for capital spending and earnings from WAVE are unchanged. On taxes, we continue to anticipate an effective tax rate of 48%-50% but have taken our cash taxes down $5 million. For the third quarter, we expect sales of $740 million-$780 million and adjusted EBITDA of $110 million-$130 million. Finally, with the closures of Thomastown and Kunshan, we have increased our expected exclusions to $15 million-$20 million. With that, I'll turn it back over to Matt.
Thanks, Dave
Overall, this is a mixed quarter for Armstrong. On the plus side, adjusted EBITDA improved in Wood for the second quarter in a row after our strategic pivot at year-end. Architectural Specialties, especially in the EMEA and Pacific Rim regions, had a very solid quarter. The Americas Ceilings business achieved a record EBITDA margin, and the Toll business was able to deliver the midpoint on our EBITDA guidance despite softer sales. On the negative side, our view of improving end markets, especially here in North America, is not being realized. If markets are stronger than we now anticipate, we're well positioned to take advantage of the opportunity. We now believe 2014 will be another down year for volumes. We continue to focus on the items in our control and drive commercial excellence around the globe. With that, we'd be happy to take questions.
Thank you. Ladies and gentlemen, if you do have a question at this time, please press star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Due to time restraints, we ask you to limit yourself to one question. If you have a follow-up question, feel free to jump back into the queue. One moment for questions. Our first question comes from Keith Hughes from SunTrust. Your line is open.
My question on the guidance cut, has there something occurred in your commercial orders in June or July making you take some upside out of these numbers? Just what are you seeing recently, I guess is the question.
Keith, it's Matt. First of all, on new construction in commercial segments, we're actually seeing fairly robust activity in office and to a slightly lesser degree in retail. That's showing up in backlog, particularly in the ABP business and in mix in the backlog in the ABP business. The issue is that's only about 20%-25% of the revenue stream for ABP. What we're seeing is the effect of a relatively softer GDP in the overall market demand for remodel in all commercial segments applying a little downward pressure, not only in our ceilings business, but also to a lesser degree in resilient flooring. There's a fairly tight correlation between performance and GDP and in the remodel business. We're seeing a little bit softer remodel and repair than we anticipated.
Thank you. Our next question comes from Robert Wetenhall from RBC Capital Markets. Your line is open.
Good morning. I love the granularity on that. Matt, if you could extend just office, retail, industrial, as well as healthcare and education, how those trends are playing out. Obviously, your commentary suggests that there's not a lot of acceleration. Is this because trends are going in one direction for all these categories, or do you see pretty substantial differences by end market? Thank you.
Yep. It's a good question, Bob. If you look at commercial in North America, office is up, new construction and to a lesser degree, remodel. Healthcare is weaker in both. In some cases, actually significantly weaker than we outlook coming into the year. Education is flat to down in both new construction and remodel, retail is slightly up. I would say a little better than anticipated, particularly in new construction, but not quite as strong as we're seeing in office. We're seeing pretty significant new construction closes in retail and office in both of our businesses in North America. Again, the issue we're experiencing is in the remodel business. If you look at Western Europe coming in, just going outside the U.S., coming in about as anticipated, flat to slightly down.
As we said in the remarks, Russia is down high single digits to low double digits based on sort of the political environment that we're experiencing there. Our revenue in Russia is actually up due more to our price performance and volume, we think we actually continue to gain share in Russia. Emerging markets in China and India are performing largely as we expected. That's kind of a quick run around the world.
Bob, it's Tom.
Tom.
Just a couple extra thoughts on education. It was a slow start. Also back to Keith Hughes' point, it was a slow start to the summer repair, remodel season. I think the delay, particularly in the North and the Middle Atlantic with the weather extending school openings through middle of June in many places, put a significant delay on school remodel, and we're still trying to read the tea leaves on that one. I think that's somewhat of the weather hangover effect and people are trying to jam jobs in, and there's a significant amount of pent-up demand out there, but I'm not clear what the demand trajectory is for the balance of the summer, given the late start. Just to amplify Matthew Espe's point on healthcare, which is a big important segment to the flooring business.
It's been tough on healthcare, I think people are still in the wait and see mode on how the economics work out from healthcare reform and before they dive in and put significant new capital into repair, remodel.
Thank you. Our next question comes from George Staphos from Bank of America Merrill Lynch . Your line is open.
Good morning. Thanks for all the details. Continuing on the guidance adjustment question,
In the end markets where you've seen less than expected improvement, if that's the theme here, in which markets did you see the most variance relative to what your initial forecasts were? The related question would be, free cash flow guidance dropped more than the guidance for your other metrics. Recognizing it's off a small base, what was driving that? Thank you.
Let me comment on the market and segment performance. I'll let Dave comment on free cash flow. I guess in general, George, we're seeing greater than expected softness in all of our served commercial markets in repair and remodel. Due primarily to the GDP weakness in demand there. We anticipated the first quarter softness to be somewhat related to the weather-related issues we experienced, but as we exited the first quarter and entered the second quarter, we saw very choppy demand month by month in Q2, which pointed to something other than weather. Going to new construction in commercial, I would say that I'd characterize office new construction about as expected. Retail, about as expected. I think as Tom mentioned, healthcare, weaker than we expected, and education, about as we expected in new construction. Residential, we had a very good start in new construction. It's weakening a little bit.
The challenge we have with the housing starts performance is the mix of multi-family versus single family. Multi-family units do not use as much wood, and the resilient product that goes into those applications is a little bit lower mix. While we're encouraged that in general, there's some level of strength in new residential construction, we'd like to see more single-family starts. Of course, residential remodel is kind of tracking similar to what we're experiencing in commercial. Then Dave, free cash flow?
Sure. Hey, George, it's David Schulz. Just on the free cash flow, as we mentioned during our prepared remarks, the primary driver is just the lower fall through from the volume that we guided to. Also, the mix of where that volume is anticipated impacting our cash flow.
Thank you. Our next question comes from Nishu Sood from Deutsche Bank. Your line is open.
Thanks. Digging into the third quarter guidance. You have revenues midpoint at $760, which is a 4% increase from last year. EBITDA you have at $120 midpoint, which is a decline year-over-year. It certainly runs counter to what we've seen in the first half of the year, where you've been able to deliver some solid operating leverage despite some softness in revenues. You mentioned some SG&A being pushed from the second quarter into the third quarter. I was wondering if you could quantify and describe that a little bit more. Also, you have this phenomenon I'm describing reversing in your kind of implied fourth quarter guidance with better operating leverage. I guess I'm just trying to dig into why the EBITDA outlook for the third quarter is worse than the revenue outlook and why that reverses in the fourth quarter.
Sure, Nishu, it's David Schulz. Thank you for your question. A couple of factors. The first is that we do have a couple of the expenses associated with the Russia plant build that are going to impact. Those expenses are higher than what we had realized in Q3 prior year related to our China plant build. The second part of your question about the SG&A is absolutely right. We do have more SG&A that was deferred out of Q2. Obviously, as we saw some of the volume patterns developing in late May and in early June, the business units deferred some of the spending on SG&A related to the volume build plans. We haven't provided you any specific guidance on Q3 to that relative impact.
I can tell you that some of that is related to some of the additional promotional and selling activities that we have planned in the back half, primarily here in the United States.
Thank you. Our next question comes from Stephen Kim from Barclays. Your line is open.
Thanks very much. I wanted to follow up on the raw material energy inflation guidance you've given for the year, $30 million to $40 million. I think we heard in your prepared remarks that lumber was about $17 million year to date. What I was hoping we could get from you is a little bit more of a granular breakdown, separating maybe raw material versus energy, first of all, in that 30 to 40. Secondly, the remainder, how you expect that to play out over the different divisions. That'd be great. Thanks very much.
Sure, Stephen, it's David Schulz. In terms of what you're seeing year to date and what we already commented on related to wood, as I mentioned, we anticipate that wood pricing has stabilized for the balance of the year. That's incorporated into the guidance that we've provided you. I would anticipate that we would see about 2X what we experienced in the first half of the year impacting the wood business. Obviously, as you take that into account, we have some puts and calls related to materials plus freight and transportation and energy costs within the business units. We generally don't break those out for you, but obviously, just based on the trends that you're seeing
On lumber relative to the total inflation impact for the year, I would anticipate that the balance of that would be split between the two business units about equally.
Thank you. Our next question comes from Dennis McGill from Zelman & Associates, your line is open.
Thank you. Matt, just going back to your comments on the non-res. I think the numbers that you've been citing are the McGraw Hill starts numbers, but correct me if I'm wrong. When we look at those were up double digits the last couple of years, there's a lag with that flowing through both ceilings and flooring. The volatility around GDP, but GDP has been positive, employment's been accelerating. Even if you were to look over the last four quarters or so, it seems like volume's been a struggle on the non-res side, even though that backdrop would seemingly imply some volume improvement, whether you wanted to look new construction or remodel. Just wondering why some of those macro datas might not align with what you're seeing on the ceilings and flooring side.
Sure, Dennis. It actually is aligning in terms of new construction. Our new construction orders are up and backlog is up. The issue is really one of mix and percentage represented in the revenue streams. GDP has to be better than positive in order for volume growth in remodel. It has to be close to 3%. GDP growth at 1.5 or 2.5 doesn't really help as much. Market volume's been down really year-over-year in remodels since 2008. We are seeing traction in new construction, as we said, particularly in office and to a lesser degree, but positive in retail. It's showing up in our backlog, showing up in richer mix in our backlog. With GDP tracking anywhere between a point and a half and two and a half points, that's not enough to drive meaningful remodel business in the commercial segments. Tom?
Dennis, this is Thomas Mangas. I've got the McGraw Hill data. Education and healthcare in 2012 and 2013 on starts were both down. We agreed that we live off those on a lag basis. On the new component of education and healthcare, we are living through those negative years in 2014. I think the important point is on where it is favorable on retail and office. It's just on the proportion of the total business. It's only probably 20% of the total volume there. We really are much more dependent on the repair, remodel side to pull that through.
Thank you. Our next question comes from Willy Randow from Citigroup. Your line is open.
Thank you. My question. Regarding the European resilient business, I apologize if you touched on this. Can you talk about what a drag it's been in regards to EBITDA, as well as when you think you'll come to decision on what to do with that business?
Sure. We've been fairly transparent on this, I think we went into some detail at the investor meeting. It's been a negative EBITDA performer for the last decade. Just give some context. Four years ago, we decided and executed a plan to exit the significantly underperforming portion of our resilient flooring business in Europe, that being the residential business. We also exited our business in France, the home of our two largest European competitors. What we had was a focused kind of number 4 position commercial business. That business has further been pressured primarily due to a lack of recovery in the European markets. We are focused on the Germanic markets, Scandinavia, and the Benelux primarily. The volume has not come back, particularly in government-related investment as we anticipated three or four years ago.
We shared this, and I'll let Tom comment on it here in a second. We shared this with increased transparency during the investor meeting in May. We've reached a decision to start reviewing strategic alternatives. We are not in a position to comment. We would say that everything is on the table, as we said in our remarks. We are really not in a position to comment on timing yet, but we wanted you to know that we have begun the work. Tom?
Willy. The European business has been running in the low single-digit negative EBITDA margins, really since we emerged. That was through significant restructuring and of course, European crisis. We have not been able to get above breakeven, which has been a long-term goal of ours. I think as jacks or better to open point of view, we certainly want to make it our aspiration has been to make it a ROIC accretive business, and it is just increasingly difficult to do that since we started the strategic options review. Timing-wise, we are going to move with haste. It is an important structural building block on our assessment, how do we improve the overall attractiveness of the resilient segment. I think we put in the 10-Q that we hope to have a decision. It is likely that we could have a decision by the end of this calendar year.
Thank you. Our next question comes from Eli Hackel from Goldman Sachs. Your line is open.
Thanks. Sorry again, just wanted to touch on the commercial R&R side. Are you seeing R&R growth decelerate or turn negative? Is it getting worse as the year goes on? I am just trying to understand the different drivers from May 21st to today that obviously impacted the guidance. Are things getting better slowly, or are they actually starting to go the other direction? Thank you.
Hi. It's David Schulz. Let me just provide a little bit of context on that, and you referenced back to our investor day. What we saw was a relatively good April, consistent with what we had guided towards back during our call on the Q1 results. We saw towards the tail end of May, things really started to look much different than what we had discussed during our investor day. May came in much softer than we had anticipated. June did recover very nicely, but not enough to offset what we saw during the month of May from an overall sales perspective, primarily here in the Americas.
What we would anticipate is continued acceleration, but still, when we take a look at the full year on both the U.S. commercial R&R and both businesses, we don't see that being better than flat to slightly down versus the prior year. What I would say is that we really saw a deceleration during the month of May. June recovered, we anticipate, based on our input from all of our contacts through the industry. What we're seeing through our discussions with our management teams, with our sales force, is we do see some of that recovering in the back half, but not enough to make the full year better than flat year-over-year.
If I could just add some additional color. Just to provide some context for how we outlook our remodel. Our visibility to the remodel business is sort of 60 to 90 days at best. There's some exceptions to this, but these are largely projects and jobs served by our independent distribution in the local marketplace. We wouldn't track these as projects as we would a new office building or a new Target store, for instance. We see these as restocking and replenishment orders from our distribution channel. This is not a segment that we have a lot of visibility to. It's a segment that we can model fairly confidently as it relates to GDP.
When we take a look at the outlook, it's a combination of what we're experiencing currently, but also forecasting based on our model, knowing that we don't have a lot of visibility beyond sort of 60 to 90 days.
Hey, Eli, you asked about commercial. I think it's worthwhile for residential to take its pound of flesh donated here, because it's not all a commercial story on the guidance change. We are seeing weaker consumer repair, remodel trends. I think you've seen it in other consumer flooring companies that have announced. You see it showing up both in the starts that were anticipated in June from May decelerating, June year-over-year decelerating on single-family starts, the deceleration in total starts from May to June. That's a piece that's impacting our residential business, which again, is $850 million to the company. Similar, you see it just track through in some of the key regions. We continue to see a couple key regions like the Northeast and the Mid-Atlantic struggle on a versus prior year basis across the product categories.
We're not sure why that is, but it seems to be pretty specific, and we're pretty convinced that it's not a share-related issue. It is simply a consumer dynamic in these markets in the Northeast and the Mid-Atlantic. That's what's also influencing some of the sales decline in our guidance.
Thank you. Our next question comes from Michael Rehaut from J.P. Morgan. Your line is open.
Thanks. Good morning, everyone. Just wanted to hit on wood flooring for a moment. Appreciate all the detail, as always. I guess looking at the top-line and then the margins, from the top-line perspective, with the volumes down continuing from 1Q into 2Q, just wanted to get a sense of how much of that is the continued new direction of the company in terms of not chasing volume or going after more profitable segments rather than the industry itself, and if that's going to play out for the rest of the year. Then on the margin side, margins were down sequentially, I think, as you had pointed to last quarter. You said that the input costs have stabilized, albeit at very high levels.
Given the timing of price increases, a quarter ago, we were thinking about a rebound perhaps back to 1Q margin levels, if not higher, in the back half of the year. Just wanted to know if that's the right way to think about things at this point, given your updated comments on inflation.
I'll just quick comment and then hand over to Tom. Clearly have as one of the cornerstones of our new approach of the wood business, capping volume at our drying capacity, and the team has executed extremely well on that. They've executed extremely well on productivity and on price and mix over inflation. I think on the things under our control in the wood flooring business, we've done a great job. The primary driver for the relative volume weakness in the wood business is not necessarily our containment strategy on production volume. We're executing that. Again, it is, as Tom pointed out, a weaker than outlooked market opportunity, particularly, again, to repeat in remodel and repair, and we've seen that evidenced through other retail channels. Also in the mix of new construction, again, multifamily over single-family starts. Tom?
Thank you, Mike. Let me try to tackle those questions. They're very good questions. Thank you, Mike, for that. Appreciate those questions. They're very good questions. Let me try to dive into that a bit. First, as Matt said, the market is a driver of our volumes. It's not 100%. Clearly, the weather impacted us in the first quarter, affected consumer demand, and that is part of what I just described, affecting, I don't know if it's weather or the GDP or the spill-on effects, but the high wood markets like the Northeast and Mid-Atlantic continue to struggle across all product lines, not just wood. We do think there is a market element there. Clearly, we're being scraped by competition, and that's costing us some share, and we think it's the appropriate share to give back as we try to give a much more aggressive pricing and mix-up approach.
That's providing some opportunities at the opening price point level for some of our competitors to scrape along. They're certainly feeling the same level of commodity increases that we've had to endure, but see it as an opportunity to scrape in and take some near-term volume. Volume that we don't think is particularly sticky as we experienced as a loss. We probably can get it back at the point where we think it is an attractive volume to get back. There is a mix of market and our approach there to manage the business for better margins.
We're very pleased that we were able to grow EBITDA. I think EBITDA is the most important measure to look at here because we've had a lot of, with the Kunshan closure and some, as you'll see in the 10-Q, some other asset impairments, fixed asset impairments that we've tried to clean up a bit with the Kunshan closure. It gets a little bit lost in the operating income. On EBITDA, we're up almost 50% in the second quarter on earnings, almost 90% year-to-date. We're making progress. Now, that's just prior to relative to last year. It's not nearly where we'd like to be. We are continuing to push on our price and mix program. We've taken pricing in June, July. It has been sold through. Continue to work our mix approach.
The one thing on the commodities, as I anticipated and we called out in either the quarterly call or the investor call, our inflation cost relative to the first quarter, so second quarter versus first quarter, we're up 50%. That is what's putting pressure there. Our price achievement is still equal to or better. Price mix achievement equal to or better than what we achieved in the first quarter. Really, that is the story there. When we guided the $30 million-$40 million of commodity cost at the company level, we had forecasted a trajectory of wood, and that trajectory is about what's playing out. That is the leveling out at this point, which is still embedded in our guidance for commodity costs.
Yet, that still is the bulk of the company's $30 million-$40 million of commodity increase, as evidenced by the $17 million absorbed year-to-date. We think hopefully the commodities stabilize. I think we've got that called right. We've priced to recover at the current level of commodity inflation. The challenge then as your last part of the question was, how do I exit the year? We're still not in a position to guide on that because it's volatile, given what you've seen in commodity, and commodities can go up or down. Also, the volume is a big wild card, as Matt mentioned. We are simply less optimistic on the back half. Plus, we're anniversarying. Go back to Q3, Q4 last year relative to the first half. You'll recall we had all sorts of service issues in the first half of the year.
We weren't able to get the volume out. We crewed up massively, started buying PKD to chase it, and that volume flushed out in the third and fourth quarter. You'll see back then we were growing sales at a clip of 20-plus%, mostly volume driven. Clearly that surge of backlog, the orders isn't going to flow through this year because we're not sitting on a backlog. We've been able to ship what we've been promising. That's a little bit of the year-over-year comparison that you'll want to factor through. We feel very confident that we're on the right track with wood.
We wish we weren't being scraped, we're going to continue to be aggressive on addressing the cost profile of this business, as such with our Kunshan closure and onshoring a significant product line that I think will be very exciting for consumers to be able to have a Made in America engineered, great product. I think it'll be a margin and a share builder for us. Thank you, Mike.
Thank you. Our next question comes from Kathryn Thompson from Thompson Research Group. Your line is now open.
Hi, thanks for taking my questions today. Focusing on ceilings, the 2.3% growth in the quarter, how much was volume versus price? Follow along with that, how much of the spring price do you think is accepted? We have another price increase that is going to be flowing through the market. How much of the spring price increase do you think is accepted? The thought process for the second price increase. More broadly speaking, in terms of price, are you seeing any type of change in conviction level with the end market in terms of accepting price? Thank you.
I'll be happy to say that. Hi, Kathryn, this is Victor Grizzle. In the second quarter, your first question around price mix and volume, really, it was mostly price and mix for the most part, driving the top-line growth. Again, the Americas volume was soft and slightly down. That's the dynamics really of the second quarter. On the pricing, our pricing actions are continuing to be driven by raw material increases, both energy and transportation contributing as well. These are industry-wide and very public, they're not specific to Armstrong. Those discussions with customers are going very well. We remain confident that the price increase that we have in the fall will be realized as we realize the expected price that we had in February. We don't see any change in that. I think those discussions continue to go well with our customers.
Again, they understand this is an industry-wide raw material and price cost increase that we're seeing.
Thank you. Our next question comes from Michael Wood from Macquarie. Your line is now open.
Thank you. You mentioned several times the better new construction versus the weaker repair model across your various end markets. How significant was that on the margin mix, particularly in hardwood, where you reported an 18% sequential sales improvement, but you barely moved the EBITDA performance. Was that meeting your expectations? Thanks.
Well, in terms of new construction, we saw the benefit of new construction more in commercial, again, in office and retail than residential. The residential new construction is hampered somewhat by the mix. Again, multifamily over single family. Tom, did you want to add anything?
Yes, I would say on the sequential progress on EBITDA with the sales, it's mostly a raw material commodity story. It's the increase of 50% higher commodities in the second quarter versus the first quarter, driving that fundamentally. Yes, the builder business tends to be a lower price, lower mix product form for us, so that does create a drag in a high builder closing season where they're finishing their floor up and closing the building, and that has some drag. Again, we have been working through those builder fixed pricing contracts. We continue to make progress on that. Builders are about a third of our overall wood business, so it is a meaningful piece.
There is a seasonality to it, but we have been able to take price and through the bulk of our builder contracts, and think it's going to be a continued very important business for us, one we're committed to winning. Our goal there is really to make sure we're bringing the kind of product and product innovation through the builder channel that allows them to have an attractive opening price point, but then incentivize their customers, their consumers, to mix up with us.
Thank you. Our next question comes from David MacGregor from Longbow Research. Your line is now open.
Yes. Good morning, everyone. You talked about Russia being down, I guess the question pertains to investments in emerging market SG&A, I guess, any changes to the rate at which you're making these investments. Presumably, with the guidance revision today, you're going to begin 2015 at a slightly lower pace or a slightly slower pace. Do you have the opportunity to flex up there if the fundamental story should improve? Maybe just update us on that whole emerging market growth story heading into 2015. Thanks.
Sure. In summary, we're finished investing in the emerging markets. The three plants in China are up and operational. The plant in Russia is on schedule and on budget. We should complete construction at the end of the year, and we should have product sellable out of the plant early next year. No changes whatsoever. We're not anticipating any additional investment in the emerging markets at this point. In terms of rate of investment, consider the rate of investment slowing down significantly after these plants are built. The challenge we've had in both China and Russia are the market conditions as outlook when we started building the plants are different now that the plants are constructed. More dramatic difference in Russia, hopefully a short-term dramatic difference.
A little bit just more broadly experienced market growth erosion in China, we're still seeing a GDP in the 7%-7.5% range, and we still see significant opportunities. Remember that China is the second largest suspended ceiling market in the world, with penetration in the commercial office space of ceilings of 10%-15%, as compared to a fully developed market where that penetration is closer to 85%. The macro opportunities in China for both ceilings and flooring continue to be extremely attractive, and we're seeing pretty solid revenue and volume growth in both of our businesses in China and India as a result of the investments in the new plants. Investments in the new plant in China give us a stronger platform from which to enter Southeast Asia, again, in both of our businesses.
We're still very bullish on those investments, even though the market outlook extends the payback a little bit. We think it still makes fundamental good sense to be there, and we're glad we made the investment. Russia is the third largest suspended ceiling market in the world, one where we have significant share position, arguably, demonstrably the share leader. Again, the investment in Russia is a significant improvement when completed to our margins there, as we're able to move production inside of Russia. Going local there has provided the opportunity to expand our geographic coverage. We've expanded our distribution footprint. Again, experiencing very significant performance there in light of a hopefully near-term pressured environment. We expect that to kind of move through. We think that both of these investments make long-term, midterm sense.
We certainly wish the markets were a little bit more stable, I think long-term, we'll be glad we made both investments. No further investments anticipated at this point. When it comes to 2015 and how we flex up or bounce up, it's a little premature for that. We'll save comments on 2015 until we get a little closer to that. We still believe that in a mid-cycle recovery, the fundamental position we're in provides real opportunities to gain leverage. This business and our company, both of our businesses
Have tremendous earnings leverage over volume and broad-based volume that would be new construction and remodel that comes with a mid-cycle recovery.
Thank you. Our next question comes from James Barrett from C.L. King & Associates. Your line is now open.
Barrett. Matt, a question for you. Are they focused just on the European flooring business or can you share with us what else they're studying in other parts of the business if they are?
Most of the work that's being done, virtually all the work that's being done, is to help us develop options for the European flooring business.
Okay.
Yeah.
Okay. Well, thank you very much.
You're welcome. Thanks for asking.
Thank you. Our next question comes from Keith Hughes from SunTrust. Your line is now open.
Yes. To build on that last question, you report in Resilient a segment or revenues that are Europe and the Middle East. Are all of those part of this review or is it just a subsection of them? If so, how much?
Keith, at this point, let's just say that all options for the European business are on the table. Tom?
Yeah. You're correct. Middle East is included in the sub-segment for revenue that's broken out there. As Matt had in his opening script, the Middle East is a very important business for us and really, the strategic review really is focusing primarily on Western Europe.
Thank you. Our next question comes from Kenneth Zener from KeyBank. Your line is now open.
Good morning, gentlemen.
Good morning.
Ken.
You guys continue to have, I think, some of the best disclosure in the industry in your filings. I appreciate that. No good deed goes unpunished. I have a compound question as it relates to ceiling. Given the changing outlook, driven largely, it sounds, by the U.S. market, you've kind of talked about 2%-3% positive volume before. If I do a 3% volume change on roughly $750 million of sales, that's about $25 million, or at 40% leverage, we think about $0.10, which would be a quarter of your guidance revision. Could you kind of talk about how much in the U.S. is changing? And the second part of that is, in the filing, you highlighted $5 million of increased cost versus last year, which is an increase from the first quarter, $1 million headwind. What costs are going up?
How is that not impacting, I guess, the annual guidance? Thank you very much.
Ken, it's Dave Schulz. Let me address that. Obviously, we never came out specifically with what we were assuming the U.S. market would recover. I think that you were implying that there was a 2%-3% volume opportunity in the U.S. ceilings business. We never provided that specific of a guidance, particularly by segment. What I would say is that relative to the outlook we're seeing overall in the U.S. residential and commercial markets, primarily on repair and recovery, that has been the majority of the reduction in our guidance range. One of the things that we've also mentioned that you can see in our results here to date is that we would anticipate that we would have a little bit of a mix drag as the market opportunity is lessened.
The combination of that volume plus mix is what makes up the majority of our guidance range coming down. As you also mentioned, the increase in cost, about $5 million. Obviously, we have not only some increase in cost, but we also have productivity programs. Based on the timing of when those productivity programs offset some of those cost increases, it's informed our guidance for the balance of the year.
Thank you. Our next question comes from George Staphos from Bank of America Merrill Lynch. Your line is now open.
Thank you. Thanks for taking my follow-on question. Question for Vic Grizzle. Vic, on pricing within ceilings, you mentioned that there are some very well-understood raw material cost increases that are driving it. Could you comment as to what actually is driving it? Because it sounds like most of the commodity pressure's really in, as you mentioned, in wood. The related question, obviously, you've got a great track record when we look back at history in passing along costs ultimately to your customer and getting paid for the value you provide. If we look back in the past, have there been ever times where you haven't been able to get that accomplished, and what kind of economic environment was associated with that kind of misstep on pricing? Thank you. Again, good luck in the quarter.
Yeah. Thanks, George. With regards to the cost input drivers, I would reframe that and say energy and transportation are the largest impact. There are some raw material increases along there, but the major drivers are higher gas and transportation expenses. Again, this is why we believe this is an industry-wide and not very specific to Armstrong. To go back to your second part of the question on when we've not been able to recover our inflationary cost with price, we'd have to go back many years. Again, we remain confident that the discussions we're having with customers around these increases are going very well. We remain confident in this current environment that we'll be able to realize and recover the inflationary impact on our business.
Thank you. Our next question comes from Michael Rehaut from J.P. Morgan. Your line is now open.
Yes, thanks. Thanks for taking my follow-up. Just wanted to go back to, and certainly don't mean to beat a dead horse too much on this topic. Back six weeks, eight weeks ago, when we came out to visit, there's really two company-specific comments that kind of anchored your optimism for the back half, and certainly appreciate the month-by-month commentary and how things have come along. Just want to understand, when we met, you talked about optimism across the distributor network as well as positive backlog trends. I was just curious, when you think about those two drivers to your back half outlook, how you're seeing both of those two areas in terms of the distributor network and the positive backlog trends.
Have either of those changed, or have they remained the same and the revised downward guidance is actually just what you're seeing in the marketplace notwithstanding?
Yeah. Michael, great question. The channel remains optimistic, particularly as it relates to new construction. They are active in bidding and closing new construction work that's coming through in our expanded backlogs, again, particularly in commercial office and retail. That would boost our ceilings business a little bit more than resilient flooring business, just because of the relative position in those applications. What we'd really like to see for resilient flooring to come through is stronger healthcare, stronger education. I would say, if you talk to our distributors today, they would still be guardedly optimistic, particularly when looking at new construction. The largest change in forming our outlook, and again, I sound like I'm beating the dead horse now, is a significant reduction in the outlook for GDP for the year coming at the end of the second quarter. As Dave said, we had a relatively weak first quarter.
We had an acceptably strong April, a very weak May, and a respectable June, although, as Dave said, not strong enough to offset the weakness in May. We came out of the second quarter with this kind of lumpy, choppy demand, along with a revision downward in GDP. Again, that drives the remodel business. I think, as I said in my remarks, we would love to share everybody's optimism, and we do as it relates to a couple of segments in new construction. We also feel responsible to sort of report and outlook what we're experiencing. There's been a full percentage point reduction, or a point and a half, in some cases, reduction in the outlook for the GDP this year, and that applies a tremendous amount of headwind to the remodel business.
Thank you. I don't see any questions in the queue at this time.
Well, thank you very much for your interest and great questions, everybody. We certainly understand the nature of the questions, and thank you very much, and have a good day.
Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a wonderful day.