Good day, ladies and gentlemen, and thank you for standing by. And welcome to the Armstrong World Industries Incorporated Third Quarter twenty thirteen Earnings Conference Call. At this time, all participants are in a listen only mode. Later, we'll conduct a question and answer session and As a reminder, today's conference call is being recorded. It's now my pleasure to turn the floor over to Tom Waters, Vice President of Treasury and Investor Relations.
Sir, the floor is yours.
Thanks, Huey. Good afternoon, everyone, and welcome. Please note that members of the media have been invited to listen to this call and the call is being broadcast live on our website at armstrong.com. With me this afternoon are Matt Espie, our President and CEO Tom Mangus, our CFO Frank Reddy, CEO of our Worldwide Floor businesses and Vic Grizzle, CEO of our Worldwide Ceiling business. Hopefully, you have seen our press release this morning and both the release and the presentation Tom Mangus will reference during this call are posted on our website in the Investor Relations section.
In keeping with SEC requirements, I advise that during this call, we will be making forward looking statements that involve risks and uncertainties. Actual outcomes may differ materially from those expected or implied. For a more detailed discussion of the risks and uncertainties that may affect Armstrong, please review our SEC filings, including the 10 Q filed this morning. Forward looking statements speak only as of the date they are made. We undertake no obligation to update any forward looking statements 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 afternoon, everyone, and thanks for participating in our call today. In the third quarter, we saw a pause in commercial volume growth leading to disappointing top line sales. We were able to deliver adjusted EBITDA results near the top end of our guidance range.
In the quarter, we experienced significant positive achievements and unfortunately some continuing challenges. Noteworthy for us in the quarter was the start of production at our China heterogeneous flooring plant in August. With that, we have completed our three plant construction effort and have dramatically changed our footprint in Asia. This positions us to benefit from the significant growth we expect in the region in the coming years, particularly in our targeted verticals of healthcare and education. Now closer to home, we announced a $41,000,000 investment in LVT manufacturing here in Lancaster, Pennsylvania.
By utilizing an existing facility, we'll be able to accelerate the project timeline and leverage existing infrastructure and plant management capability. Construction will begin in early twenty fourteen fourteen and shipments from the plant will start in the first half of twenty fifteen. In terms of quarterly financial highlights, we achieved record adjusted EBITDA in our Global Ceilings business. This was accomplished with volumes down more than 20% from peak levels and is a testament to our ability to cut and control costs, drive product mix and manufacturing productivity and achieve price over inflation. This result is also partly attributable to our Wave joint venture which has also grown profits despite lower volumes.
Additionally in the quarter, two of our largest shareholders, the Asbestos Trust and TPG executed a sale of 12,000,000 shares of our stock. Armstrong repurchased 5,000,000 shares as part of the transaction. This investment of $260,000,000 on our part which was accomplished using surplus cash will drive earnings per share accretion and create value for our shareholders. The Wood Flooring business continued to be a challenge for us in the third quarter. On our last call, we laid out the four key issues this segment was facing.
Number one, the need to add capacity by on boarding production workers at our solid wood plants. Number two, the availability of green lumber. Number three, cost and manufacturing productivity issues driven by purchases of kiln dried lumber and number four, pricing actions lagging lumber inflation. As you may recall, we spent some time last quarter discussing the progress we have been making against those four headwinds. But unfortunately we did not see improved profitability in the third quarter.
Green lumber availability and the issues around kiln dried lumber are largely where we thought they would be and were not really factors in our performance versus expectations. Crewing has been completed, but yield and productivity at our solid wood plants is still not where we need it to be. We achieved price increases of over $10,000,000 in the quarter, but lumber costs which we noted had stabilized at the end of the second quarter resumed their upward trajectory in August and September. Thus, we continue to play catch up with inflation in the third quarter. Given the disappointing lack of progress in our financial performance in this segment, I want to be cautious on predicting an immediate turnaround.
The team continues to work extremely hard to fix our manufacturing issues and execute the price and mix objectives that will put us on the right path. With these additional actions, we hope to begin demonstrating improved performance in the fourth quarter, though clearly not at the pace we had previously anticipated. Turning now to our financial results. Third quarter sales of $730,000,000 were $10,000,000 below the low end of our guidance range as we experienced weaker than expected demand in all of our businesses and geographies. Sales for the quarter were up 5% from 2012 with minimal year on year foreign exchange impact and minimal impact from the Patriot Wood distribution business that we divested in the the third quarter of twenty twelve.
On a comparable foreign exchange basis, The Americas and Asia saw sales growth in the quarter, while sales in Europe were down less than 1%. The Americas saw strong volume growth in residential products, particularly in the Wood segment. Commercial volumes, which had picked up in the second quarter, softened in the third quarter and were essentially flat year on year. Volumes were down in Europe, but up in the Pacific Rim despite continued weakness in Australia. India and Southeast Asia were particular bright spots.
Despite the lower than anticipated sales, adjusted EBITDA of $124,000,000 was on the high side of our guidance range of $110,000,000 to $130,000,000 EBITDA was down as expected by $11,000,000 from 2012 driven by the continued challenges in our wood business, expenses associated with the three start up plants in China and softness in Europe. Manufacturing productivity in our global ceilings plants and SG and A management in the Flooring business drove profitability to the high side of the guidance range. I'll turn now to our reported segment results. In the third quarter, the Wood business continued to see strong demand from homebuilders and experienced positive year on year growth in the home center and independent retailer channels. Our Wood business is also benefiting from new product introductions and share gains.
Sales of 148,000,000 were up $26,000,000 or 21% from 2012 and when adjusted for the Patriot divestiture were up $32,000,000 or almost 30%. Wood shipments were up in the mid-twenty percent range. Price was higher than last year, but as I mentioned, we are still chasing lumber inflation. Adjusted EBITDA was down from 2012 driven by the headwinds I just discussed. Brazilian flooring sales were down less than 1% in the quarter.
Sales in The Americas were up driven by residential products while Europe was down with weakness in most markets. The Pacific Rim was down with strength in India being offset by weakness in Australia and lower volumes in China as our customers destock to adapt to our local production model. And as expected profitability in the Resilience segment was down versus last year. The ceilings business experienced higher sales and profitability in the third quarter. Sales were up in all geographies.
On a global basis, price volume and mix were all up despite slightly lower volumes in The Americas. Ceilings profitability was up in the quarter driven by the sales gains as well as manufacturing productivity, which overcame the cost headwinds associated with our new ceilings plant in China and the plant construction project in Russia. As I mentioned, ABP produced record adjusted EBITDA this quarter. Within the ceilings segment, our global Architectural Specialties business experienced another quarter of strong growth with sales up in the mid teens versus 2012. And for the year, this business had grown sales and EBITDA by double digits.
We just approved a project that will add metal ceilings manufacturing capability in Asia. This investment will be housed within our new China metal fiber ceilings plant. I'll come back in a few minutes and give you a preview of how we're looking at our 2014 opportunity. But first, Tom Mangos will provide a more detailed discussion of our financial performance, including year to date financial information and an update on guidance and the outlook for
the fourth quarter. Tom? Thanks, Matt. Good afternoon to everyone on the call. In reviewing our third quarter results, I'll be referring to the slides available on our website starting with slide four, key metrics as Tom Waters already covered slide two and slide three is simply an explanation regarding our standard basis of presentation.
Matt mentioned that quarterly sales grew 4.8% and adjusted EBITDA declined 8.6%. Adjusted operating income and adjusted EPS were also down versus last year by 1311% respectively. Third quarter free cash flow of $95,000,000 was up from the $78,000,000 generated in the third quarter of twenty twelve. I will address the drivers of EBITDA and free cash flow in more detail on upcoming slides. We closed the third quarter with net debt of $930,000,000 up from $784,000,000 at the end of the third quarter of twenty twelve.
Net debt was impacted by a recent $260,000,000 share repurchase, partially offset by twelve months of positive cash generation. Finally, our unadjusted return on invested capital on a continuing operations basis was 8.3%, down from prior years as profitability was lower due to our plant startup costs, issues in the wood business, softness in Europe, the lower year on year pension credit and a higher effective tax rate. Slide five details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $56,000,000 in the quarter. As you can see, there was minimal impact from cost reduction items and foreign exchange in both the current quarter and prior year. Interest expense was lower than in 2012 as a result of our March 2013 refinancing.
Tax expense was slightly higher despite earnings being down year on year primarily due to greater unbenefited foreign losses in 2013 and the significant foreign tax credit valuation allowance released in 2012. The year on year increase in foreign losses is largely a result of the expenses in China and Russia associated with plant construction and startup costs. Moving to slide six, this illustrates our sales and adjusted EBITDA by segment for the quarter. Resilient flooring sales were down 1% as volume growth in The Americas primarily from residential vinyl products was offset by declines in Europe and Australia. North American commercial volumes were essentially flat after being up the prior quarter despite continued high single digit volume growth in commercial LVT.
Volume in The Pacific REM were strongly positive in India, Southeast Asia and in customer acceptance of our new homogeneous products in China, which saw shipments increase 20% year on year. On the negative side, we saw significant weakness in Australia and destocking in China of heterogeneous products as we roll out our locally produced product, replacing products previously sourced from Europe and Australia with longer lead times. Overall for this segment, price was down, partially offset by positive mix from LVT growth. Adjusted EBITDA was flat for the segment with manufacturing productivity in The Americas and Europe offsetting plant startup costs in China and weaker sales. Wood flooring sales were up 21% and would have been up 28% if not for the Patriot divestiture in 2012.
Volume was up 20% excluding the Patriot divestiture. Price was up in the high single digits while mix continues to be negative with much of the growth coming in the builder segments. Matt detailed many of the factors driving lower adjusted EBITDA in the Wood segment. So I just want to point out that the 2012 sale of Patriot resulted in a $3,000,000 benefit to the base period, thus creating a headwind this year. Building products sales were up 3%.
Global sales were driven by gains in price, mix and volume. North America ceilings unit volumes had a slight decrease, but sales grew with improved pricing year on year. Europe, Middle East and Africa saw sales increase on the back of strong mix driven by an almost 50% increase in The Middle East, a high average unit value market and relative strength in The UK, our best European market. The European ceilings business demonstrated the impact of our full portfolio in the region. Emerging market weakness in Russia was offset by strength in The Middle East, Africa and Turkey and weakness in Mineral Fiber Products was offset by strength in Architectural Specialty ceilings.
Pacific Rim sales were up in the high single digits when excluding the impact of foreign exchange. Again, the portfolio effect is on display as weakness in Australia and to a lesser degree in China Metal was more than offset by strong performance in India, Southeast Asia and China Mineral Fiber. Adjusted EBITDA in the Building Products segment increased $5,000,000 versus the third quarter of twenty twelve as sales, manufacturing productivity and earnings growth from our Wave joint venture offset emerging market investments in China and Russia. The corporate segment was down driven by the decline of our domestic pension credit, higher foreign pension expenses, outside consulting services and higher benefit costs. Slide seven shows the building blocks of adjusted EBITDA from the third quarter of twenty twelve to our current results.
As you can see, price mix was a positive as was volume where the benefit came from residential products and Asia. The large inflation headwind was almost entirely due to lumber, but the ceilings business also experienced some year on year inflation in perlite and starch. Manufacturing costs were flat as the headwinds from the wood segment and our plant startup costs were offset by productivity improvements in the ceilings and resilient businesses. SG and A costs were up as emerging markets spend and some of the corporate expense items I mentioned earlier drove the increase. WAVE added $1,000,000 to year on year results.
Our non cash pension credit is lower in 2013 as we have mentioned throughout the year. Finally, depreciation is increasing as we bring our new manufacturing facilities online. Turning to slide eight, you can see our free cash flow for the quarter versus 2012. Cash earnings were lower than the prior year, but working capital improved significantly. Working capital provided $41,000,000 of free cash flow in the quarter, up $26,000,000 from last year with favorable payables and inventories.
Capital expenditures were similar to 2012 with this year's spend in Russia roughly matching last year's spend in China. Cash interest expense decreased by $2,000,000 as a result of our March refinancing and Wei's contribution to cash was positive versus last year. Starting with slide nine, I'll begin discussing year to date results. As you can see, sales were up 2.6 and would have been up almost 4% if we adjusted for the Patriot divestiture in 2012. Year to date sales growth came primarily from our residential flooring businesses, our North American ceilings business and Asia.
Europe and Australia were down over the past nine months. Operating income, adjusted EBITDA and EPS are all down year to date. As with the quarter, the outsized drop in EPS relative to EBITDA and operating income is driven by the release of foreign tax credit valuation allowances in 2012 and we're facing the headwind of higher unbenefited foreign losses in 2013 due to our Russia and China investments. In addition, you will recall we took a $19,000,000 charge in the first quarter to write down unamortized fees from prior credit agreements with our March 2013 refinancing and new credit agreement. Slide 10 illustrates our sales and adjusted EBITDA by segment for the year to date period.
Resilient Flooring sales were down 2%. Volumes were down in all regions, but global price and mix combined were higher. EBITDA was down in The Pacific Rim and Europe due to plant startup costs and volume declines respectively. Year to date improvement in The Americas was driven by strong manufacturing productivity gains, better mix, much of it coming from the LVT category as I mentioned before and lower SG and A overcoming the lower year to date volumes. Wood flooring sales were up 14% and would have been up 23% if not for the Patriot divestiture.
Year to date, the wood EBITDA story here is the same as the quarter, so I won't repeat myself further. Building product sales were up 2% through September. Sales were up in North America and The Pacific Rim, but down slightly in Europe. Global price and mix gains and volume growth in China and India more than offset volume declines in Europe, Australia and North America. Adjusted EBITDA in the Building Products segments increased $14,000,000 year to date.
The increase in profitability was driven by The Americas as price mix manufacturing productivity and earnings from the Wave joint venture all improved, which more than offset volume declines and the emerging market expansion expenses. The corporate segment was down $16,000,000 driven by the same factors affecting the quarter. Slide 11 shows the building blocks of adjusted EBITDA. Similar to the quarter, price and mix are lagging inflation driven by the wood business. Modest volume gains and improvements from WAVE were not enough to offset headwinds from SG and A investments, the pension credit and the net drag from manufacturing costs as plant startup expenses and challenges in the wood business more than offset over $20,000,000 in productivity gains in our developed world ceilings and resilient plants.
Slide 12 shows the company generated $75,000,000 of free cash flow for the year higher than the $63,000,000 generated in first nine months of 2012. Cash earnings were lower, but working capital experienced significant year over year improvement driven by accounts payable. Interest expense and waive offset each other. Slide 13 updates our guidance for the year. We're lowering the top end of our sales guidance from $2,800,000,000 to $2,740,000,000 We're also reducing the top end of our profit guidance as follows: adjusted operating income from $290,000,000 to $280,000,000 adjusted EBITDA from $400,000,000 to $390,000,000 and earnings per share from $2.3 to $2.2 per share The September repurchase of 5,000,000 shares did positively impact EPS in the third quarter, but as EPS is calculated based on a daily average, the benefit of the reduced share count is muted in 2013.
The full 8.5% EPS accretion benefit will fully reveal itself through the coming quarters. We are increasing our cash flow expectations for the year to a range of $80,000,000 to $110,000,000 as a result of better working capital expectations and the sale of our Idle Mobile Alabama property. A somewhat dampened market outlook as result of our softer than expected sales experience in the third quarter and the ongoing challenges in the wood business are the drivers of our sales and profitability guidance changes. Specifically, after enjoying our first quarter of volume growth in our developed region since 02/2006, volumes took a step back in Q3 in commercial markets in The U. S.
And Europe. In addition, we saw a marked slowdown in September across both commercial and residential markets versus what we saw in July and August. Slide 14 provides more detailed assumptions going into our earnings guidance and provides the specifics on this fourth quarter. With the recent uptick in lumber prices, we now expect annual inflation in the range of $55,000,000 to $65,000,000 with the lion share of the increases impacting the Wood segment. Our outlook for consolidated adjusted gross margin remains a decline of 100 to 150 basis points on the full year versus last year.
We expect SG and A as a percent of sales to come in at 16% to 16.25%, up slightly versus 2012 due to our investments in emerging markets. Guidance on the pension credit, earnings from WAVE and taxes are unchanged from July. Our estimate for the fourth quarter sales including anticipated FX impacts is a range of $645,000,000 to $685,000,000 At the midpoint, sales would be up over 8% from the fourth quarter in 2012 driven by residential volumes, pricing and a soft Europe base period. Sequentially, we'll no longer suffer from any drag from the Patriot divestiture. We expect to earn $70,000,000 to $90,000,000 of adjusted EBITDA compared to $73,000,000 on a comparable basis in 2012.
At the midpoint, we would deliver earnings growth for the first time in 2013. Our expectations for capital spending are unchanged and we now expect exclusions from EBITDA spending are unchanged and we now expect exclusions from EBITDA to be $10,000,000 for the year down slightly from our previous range of $10,000,000 to $15,000,000 We've been talking a lot about our three main growth engines Architectural Specialties, China and Russia and have been getting questions as to what they can mean for Armstrong. Page 15 illustrates the recent history and potential we see in these opportunities. As you can see, 2013 sales are up more than 50% from 02/2009 in these areas of emphasis. And we expect an even faster growth rate in the coming years as we benefit from increased feet on the street and local manufacturing capabilities in China and Russia and from increased investment and management attention in architectural specialties.
It was apparent to us early in the year that some investors do not fully understand the pattern of profitability to expect from these investments. As you can see, profitability has decreased from 02/2009 to 2013 despite the higher sales. We've absorbed significant plant startup costs in 2012 and even more so in 2013 and we have added sales and marketing resources in all three of these areas to drive future profitability. You can see that by 2016 when the China plants are fully effective and the Russia plant is in its second year of operations, the margins in these areas start to approach company wide levels. 2014 will demonstrate progress versus 2013, but the significant improvement won't be apparent until 2015 and 2016.
Finally, of note, our WAVE joint venture just last week completed refinancing their revolving credit facility. The new five year two hundred million dollars deal is $25,000,000 greater than before, although the draw amount is unchanged. Pricing has been adjusted down such that Wave will pay 25 basis points less on this debt than previously. This will result in almost a $400,000 annual savings to the JV and the extra available capacity provides Wave with the financial flexibility to pursue strategic initiatives should they arise. Overall, we're a little more cautious about the fourth quarter given the slowdown we've just experienced compared to our stronger second quarter.
And as Matt mentioned, we're disappointed in the lack of progress on improving wood profitability. That said, our $260,000,000 share repurchase in September shows we continue to focus on driving shareholder value both through our business growth and productivity strategies as well as how we deploy our balance sheet. And with that, I'll turn it back to Matt.
Thanks, Tom. As you'd expect, we're now in the midst of our annual operational planning cycle. As you'd expect, we're now in the midst of our annual operational planning cycle. And as in past years, we'll provide specific 2014 guidance on our next earnings call. But I did want to take a moment and share a few of our initial insights to help frame what 2014 might look like for us.
Now as we look at the revenue outlook, we're cautiously optimistic about most end markets. North American commercial market should continue the modest growth we saw in the second quarter with office and retail leading the way. In the North American residential sector, we believe new home construction will continue to grow, but housing starts will likely be up less than the 20% year on year improvement we're seeing this year. Repair and remodel activity will likely continue to see modest growth, but to be fair this is an area where our visibility and confidence are a little more limited. We don't expect much really if any sales growth from the developed markets in Europe, but do expect to see growth in Eastern Europe, Russia and The Middle East.
Growth in Asia markets should continue in the double digits, but weakness in Australia will suppress our overall rate of growth in the Pacific Rim. Regarding productivity, as you know, our gross margins improved every year from 2,008 to twenty twelve as we shut plants, reduced costs and rolled lean through our operations. However, this trend reversed in 2013 as we absorbed the start up costs and manufacturing inefficiencies of our three new plants in China, which Tom has just discussed and as we struggled to meet demand in solid wood. In 2014, we'll be back on the path of improving gross margins despite the continuing ramp of our China facilities and expenses associated with the Russia and LVT projects. 2014 gross margin should be about 75 to 150 basis points better than 2013.
As I said at the outset, we're still in the process of building our plans for 2014, but wanted to share an early glimpse of our thinking. And then from the manufacturing and sales platforms we have in place, from the manufacturing and sales platforms we have in place and under construction. So with that said, I want to thank you for your time today and we'd be happy to take any questions.
Sure. Thanks, sir. And it looks like our first question on the phone lines will come from the line of Dennis McGill with Zelman and Associates. Please go ahead. Your line is open.
Hi. Good evening, guys. Thank you. Hey, guys. For the
first question, I guess, could
you just expand a little bit on the comment that you made about the marked slowdown I think you mentioned in September and it sounded like it was across both residential and non residential. Can you just may be a little bit more specific on what you saw and whether that's your orders that you're hearing that from customers as well or anything further?
Sure. It was broad based in both commercial and market segments. We believe that this is not a share issue with us. We think it was market based. We saw within those numbers and again commercial slowdown remember affects both of our businesses slightly differently.
When you consider commercial office that will affect ceilings more than floors, healthcare education probably somewhat equally. So the dynamics around the segments we pursue affect our businesses somewhat differently. But I'd say within that the relative performance we saw healthcare and education, everything government funded continued to get soft and got a little softer. Retail was holding up relatively well and commercial office space softened a little bit as we went through the quarter. Residential demand slowed down, still strong year over year, but I think sequentially slowed down as we entered the August and September.
That's probably we would assess that being a function of a little rise in the mortgage rates, some overbuild in the builders and maybe some tightening of the credit restrictions.
Yes. I think in October, we've seen the commercial come back a bit, Dennis, but we've seen residential still be pressured a lot.
Thank you. Our next questioner in the phone queue will come from the line of Michael Brillhaut with JPMorgan. Please go ahead. Your line is open.
Thanks. Good afternoon, everyone.
Hi, Michael.
Just on had a couple of quick questions on the ceilings business. The profitability there continues to be very, very impressive. And I just wanted your thoughts in terms of as you look at that business over the next couple of years, some of the puts and takes, and if you could just review us kind of review with us your thoughts on incremental margins there. With the margins this quarter, understandably, that's seasonally a better quarter within the year, but still at around 21%. How much better can that go?
And particularly over the next year or two sorry for the long winded, but particularly over the next year or two if you have continued above average growth in Architectural Specialty, which is a below average margin business,
Just some of
the puts and takes. Thanks.
Yeah. That's those are all very good questions. I we're not providing specific guidance for 2014 and beyond on this call. But to try to answer your question more broadly, we're confident in the ability of our ABP business, our ceilings business to continue to drive profitability and expand margins even in a flat volume environment. We would expect as we think about 2014 beyond as we said.
We're looking for slight incremental volumes slight incremental volume increases in the commercial market segment. So that should bode reasonably well for the business. Incremental margins for ceilings we've said are in the 30% to 40% range. Drivers for our business continue to be commercial really all four commercial segments. The remodel and repair business provides very strong margins, very strong mix for us.
The business continues to invest in new product introductions in Mineral Fiber with improved acoustic and light attenuation properties. We have very solid relationships with our channels around the world. We're seeing very strong markets in Asia, particularly in China and India as we pointed out in The Middle East very strong businesses and in Eastern Europe. The Architectural Specialties as you said is now a global business platform for us. Vik and the team globalized business structure about a year ago.
We've seen strong double digit earnings and revenue growth as we continue to gain share in a somewhat more fragmented part of the business than we see in Mineral Fiber. The combined value proposition is very strong in the global architectural community. The ability to combine architectural specialties platforms with very strong Mineral Fiber business is a somewhat unique value proposition and we think that differentiates us. And again, our position in markets very strong markets like Asia and The Middle East where we see relative strength there gives a lot of confidence that the business will continue to grow and expand margins as we go forward. Any revenue here or any volume here would help a lot.
Just one of the points. You are right, Mike, that this is Tom, by the way. Third quarter is seasonally the high point for us in our annual quarterly progression of margins. We're pleased that every quarter this year we've been ahead of the prior year quarter despite the investments in the emerging markets. And that's what gives us confidence in the mid cycle guidance that Matt talked about in the script that we believe that that's still an achievable goal for us.
And as we've talked before, we running through the model and the incremental volumes, we would expect that those incremental rates, we think that the ceilings business on a full year basis can get up to the high 20s as an EBITDA margin. And as you can tell on an adjusted basis, we were at that point in the third quarter already this year. But again, that's the seasonal high point. Thank you.
Thank you, sir. Our next questioner in queue comes from Keith Hughes with SunTrust. Please go ahead. Your line is open.
Yes. Kind of follow-up question to the first one on the October results so far. Within residential, are you seeing a distinction between the renovation or transactional type business versus what the you're getting out of the homebuilder channel in October?
Greg, do you want to Keith, this is Frank. On a relative basis, they both decelerated in the September. Those retail customers where we get POS data, for our category, we saw a deceleration and we have seen somewhat of a pause in new construction as well. So it's really across both.
Thank you. Next questioner in the phone queue comes from the line of Catherine Thompson with Thompson Research Group. Please go ahead. Your line is open.
Great. Thanks. My question is first focused on wood flooring. Given some of the hiccups that we've had in terms of pushing through the price increase, but also managing operational inefficiencies with the perverse problem of trying to keep up with demand? How should we think about margins going forward?
And then also is there any type of is there any mix that we should take into account when taking into account margins as we model going forward? Thank you.
Well, Catherine, it's a good question. I mean, as I said in the prepared remarks, I mean, we're not going to provide additional transparency on the segment going forward. The I think our biggest single challenge as we think about the third quarter actual performance versus expectations was the coming up to speed in terms of capacity in the plants and timing of increases over inflation. And lumber inflation sort of increasing a bit again at least on very targeted species. So we're continuing to work on all four items.
I think our immediate focus or our primary focus at this point is capacity in the plants. We do have as Frank pointed out kind of a softening in demand as we entered exited the third quarter and entered the fourth quarter. We're that allows us to work down some concern as well. So we're going to work the items hard. We expect continued progress.
We know where we need to be by the end of the fourth quarter. But at this point, we're reluctant to add additional quantitative color on the business segment.
Yes. We're not Catharine, we're not moving off our mid cycle guidance expectation for Wood, which is in the mid to higher teens for an EBITDA margin. We're just not guiding which quarter that's going to start showing itself because we are facing those headwinds and continue to see volatility in the commodity market.
And I would just well, I'll ask, Tommy. I mean, we're seeing progress across all fronts. It's just the issue is not that we're not making progress. The issue is rate and pace of the progress in some of the items.
So that's how I
would characterize it as well. So thank you.
Thank you. Our next question will come from Troy Stapis with Bank of America Merrill Lynch. Please go ahead. Your line is open.
Thanks, everyone. Good afternoon. I had a two part question on pricing. I thought I saw or heard you say that in residential flooring pricing was down in aggregate. Was that mostly a mix issue?
And could you sort of talk to what was driving that? And then looking at ceilings going forward, how much more opportunity do you think you have to sell higher value and sell higher mix and for that matter pricing? Or do you think the earnings leverage from here will really have to come from really from volume? Thank you guys.
Yes. I'll let me take the Celine's question first. The business has historically been able to get price over inflation. Even in as we pointed out, we had record earnings with volumes down 20% from the peak. The market rewards mix.
So there is a general innovation in Mineral Fiber Ceilings. We continue to see opportunities to drive price into the marketplace. There's nothing that would indicate that we're near the end of that. So as we get price over inflation, the business has worked very hard to continue to refresh its product mix, which drives mix. So I think we're very optimistic that we'll continue to do that.
And there's nothing in the external environment that would indicate that the architectural community and the end users are not in a position to appreciate new product innovation using it
in other
applications. So and we are continuing to drive productivity as the plants as we fill the plants. Lean has made a significant contribution in the productivity of the plants. We've continued to invest across the spectrum of the plants. So it really is a balanced approach.
I mean, this business even with significantly weaker volumes continues to execute price over inflation continues to drive new products in the marketplace, hence mix. We have very solid, very stable and very strong channels to market with our independent channel partners and continues to drive real productivity. So that combination delivers kind of earnings growth and performance that we've seen really for the last year or two. And then Frank, do you want to take the wood question?
Just on the price question, just to clarify. In the wood business, we got price realization just short of $11,000,000 which covered just over 80% quarter inflation. To your point on resilient worldwide, we saw some price degradation about $3,000,000 Really the primary driver of that is we're actually seeing deflation in some of the core input costs in the resilient business which is resulting in some price give as a result. And that's really across North America as well as Europe.
Thank you.
Thank you, sir. Our next question in queue will come from Ken Zener with KeyBanc Capital. Please go ahead. Your line is open.
Afternoon. Gentlemen?
Hello? Yes, go ahead. Proceed then.
Sorry, couldn't hear you. Luxury Vinyl tile, you guys are doing an expansion that will become effective in 2015. A competitor is bringing also also doing some domestic expansion. Can you give us your thoughts on kind of what that means with production coming back into The U. S, I guess, taking away what's being imported from China?
And what that might mean in terms of the competitive landscape as we move into 2014, '20 '15?
Yes, Ken. I mean I'm a little reluctant to comment on what our competitors investment thesis is, but I think the economic value proposition is the same for both of us. I mean there's a significant productivity benefit as it relates to supply chain costs and distribution costs and reinsourcing that product in The U. S. We are as we said in the comments, we believe we're uniquely positioned to achieve this in the most productive way because of the fact that we're using an existing plant, but also the specific layout of our plant and manufacturing engineering innovations that we'll be able to deploy in making the OBT.
So it's a category that as we've said is driving the growth inside resilient. It's growing at a multiple of the marketplace. The margins are very strong. It's a relatively small part of the segment, but as I said rapidly growing. It is a product line that has a fashion dimension to it.
So the ability to keep the product line fresh is very critical to driving value in the market. And of course, the savings from reinsourcing this with relatively low labor content in The U. S. Really makes it very compelling value proposition for us. And so that's why we did it.
Thank you.
Thank you, sir. Our next question will come from David Greger with Longbow Research. Please go ahead. Your line is open.
Yes. Good afternoon, guys. Just looking at the growth initiatives you've got going on, you have a number of different initiatives underway right now. And I'm just wondering if there's any way to quantify the impact that might have had on the earnings for the quarter. I know when you talk about SG and A being an $8,000,000 delta on the quarter and twelve year to date.
Is that the right way to think about this? Or are the total sum total of all these growth initiatives actually a greater number than that? Well, I mean, we've got the way to think about growth initiatives are sort of two dimensionally. I mean, we've got geographic initiatives around emerging markets, hence the three new plants in China and the upcoming plant in Russia and our strength in The Middle East. So when we think about opportunities, we think we have underserved opportunities in those three markets in the world and we're investing in them in different ways.
We're in the transition year now where we brought up three plants in one year. The company hasn't built a plant in fifteen years. We brought three online in one year. So the headwind you see in the expense and related costs is just as we expected the experience as we've run the plants online. Commercially, we're very happy with the execution across the board in both businesses ceilings and floors in China and very robust presence in India.
So I think financially as we work through the clearly the expenses have had a little headwind in EBITDA, but certainly nothing more than what we anticipated. And then you have a business adjacency opportunity in Architectural Specialties as we've said. I mean, we globalized the platform. We've seen significant growth again in The Middle East and China here in The U. S.
So you've got earnings, you've got revenue growth and you have earnings growth at a multiple of the revenue growth as we continue to penetrate which what is a slightly more fragmented opportunity. So those I think really are the cornerstone of our growth platform. So it's geographic focus in two to three emerging markets. It's a product line adjacency that we've organized and energized around. And I would say they are meeting or exceeding the revenue opportunities, the margin opportunities as we work through kind of one year transition costs bringing the plants up to speed.
And David, this is Tom. We have guided on the year it's going to be about $25,000,000 of startup costs, $10,000,000 to $15,000,000 of manufacturing startup costs, another $5,000,000 to $10,000,000 in SG and A costs. And as you can imagine, we've opened these three plants through the first three quarters of the year. So we've been absorbing those costs through the quarters and we've been adding the feet on the street and the SG and A through the year. So if you just did it simplistically, it's about $6,000,000 a quarter, but that's not really how it's flowing.
We haven't guided specifically how it's flowing. But you can imagine the first three quarters of the year were the heaviest burden on manufacturing startup and probably SG and A is more back half loaded given the commercialization of those plants.
Thank you.
Thank you, sir. Our next polling question will come from Michael Wood with Macquarie. Please go ahead. Your line is now open.
Hi, thanks. Can you give some more color on the Russia ceilings weakness that you called out? And what gives you the confidence in the growth going forward? Whether the weakness was specific to the timing of plant investments or whether it was macro?
Sure, Mike. Thank you. The Russian market first of all, it's not plant investments. It's macro and market. We estimate the market's down about 5% or so.
It was soft to begin with. This has more to do with government investment and the timing of the release of funds for government infrastructure projects as anything else. We keep a pretty close tab on import documentation. So we have a pretty good sense of what's going on with share. And the information we have would indicate we've held and you could arguably gain share slightly in a soft market.
Remember the investment thesis for the plant there was less to generate revenue, although we're always all about we're about revenue, but more to improve our operating margins. We're avoiding import duties by building a plant in Russia. We were serving are currently serving that market today from mineral fiber plants in Western Europe. So the investment theory and the business case for margin improvement from the investment in Russia is still very strong irrespective of a near term softness in the market. So the market is a little softer than we outlook coming in.
It seems to be broad based and macro. We are holding or gaining share. We have a very strong share position in suspended ceilings in Russia. The plants on position in suspended ceilings in Russia. The plant's on schedule to be for commercial production early twenty fifteen and the margin benefit from the plant is still intact.
Another thing I'd add Matt is that relative to when we announced the plan, the macro was better last year. Right.
We did better than we thought last year and we are doing slightly softer this year because of the macro environment. But in total, our volumes versus where we expected to be at this point about where we had in the investment thesis. So we're very comfortable with Russia and feel like that go local project is going very well. Exactly.
And the plant is on track so far. So we're expected to be on track as we roll through
it. Thank you. Thank you. Our next
one question will come from the line of Stephen King with Barclays. Please go ahead. Your line is now open. Your question
please. Thanks very
much. Yes, Steve Kim from Barclays. I just wanted to follow-up Hi. Just wanted to follow-up on the resilient pricing issue. I know you alluded to the fact that pricing was negatively
affected.
I guess you mentioned by core input drivers, some deflation there of about $3,000,000 But I was wondering if you could help us understand the competitive dynamics in the Resilient Flooring business. In particular, I would think that given the strong history of the company driving margin that just because your inputs might be down a bit doesn't necessarily mean that that would necessarily show up on the top line. So I was curious if you could talk about the competitive dynamics and maybe is there any geographic element here which is worth calling out? You talked about some destocking in China. I just wanted to get a picture of how you see the competitive dynamics affecting pricing?
Thanks.
Yes. I'll frame it and then maybe ask Frank to jump in. But from a it's slightly more fragmented it's a slightly more fragmented market than we experienced in ABP in our ceilings business for instance. There are two large global players along with ourselves that are in resilient flooring and then you have some significant niche players. They're guys that are only in linoleum.
They're guys that are only in predominantly in North America. So it's a bit more fragmented. We have very good line of sight in resilient flooring to the input material, so inflation and deflation. The pricing tends to adjust fairly quickly to that given the market structure. In inflationary times as we have with our ceiling business, we're able to get price over inflation.
We do have a very dynamic set of markets right now. Most of the developed markets, so for us that would be Western Europe, North America and Australia. In relative terms, volumes are soft. We have significant softness in Australia. The Western European markets continue to be somewhat soft.
And of course, in The Americas, it's kind of flattish. You have that offset by very strong volumes in on a relatively small base though in India, China and Russia. You have the dynamic in Russia or in China as Frank mentioned of the destocking effect as our distributors in China sort of work down the inventory of the material we used to import from Western Europe or Australia and sort of stock up in the stuff coming off the new homogeneous line and then most recently the heterogeneous line. So you have that kind of sort of cleanup effect if you will that sort of pressures volumes in the short term. Frank did you want to
I think Matt you hit the highlights. It really is by market and product line by product line. And where we're seeing the deflation is both in linoleum where you have really three global players as well as in vinyl where in North America you have as many as four or five competing for the space. So it really does vary by market. And I think Matt said it well when raw materials there's changes there tends to be a fairly quick adjustment to price on the market side to those changes.
Thanks, Steve.
Thank you, sir. Our next question in queue will come from the Joseph with Deutsche Bank. Please go ahead. Your line is open.
Thanks. I wanted to drill down into the fourth quarter sales number. So the $6.65 the middle of the range is an 8% increase if I did my math right year over year. So I just wanted to understand given the deceleration in September and resi has carried over into October. Commercial, there's been some rebound.
I just wanted to understand as you're looking at the fourth quarter, what gives you confidence that you can get back up to that level of year over year growth?
Sure. Okay, Nishu, thanks. This is Tom. So let me start with
we have
the benefit of not having the Patriot divestiture in our base. So if you look at our Con and Constant FX, we did 5% in the second quarter sales growth. We did 5% in the third quarter. Both of those were burdened by the Patriot divestiture in the base. So that rolls off.
That's a meaningful contributor on the reason it might be higher. Plus, we've been taking significant pricing on both the ceilings business. So we had a 5% price increase in ceilings in August. We had several rounds of pricing through this year on the flooring business. And while we're saying flooring the residential side has been softer, the pace in the second quarter was toward, right?
We couldn't keep up with demand. So that was 20% unit volume growth there. So really between continued growth, but maybe not at the same toward rate as we saw in residential, the pricing and the lack of the Patriot in the base, that's what's leading us to be able to guide at that midpoint of 8% growth. Thank you for the question.
Thank you, sir. Our next one question will come from the line of Bob Wittenhofe with RBC Capital Markets. Please go ahead. Your question
please. Hey, good afternoon. I just wanted to see if either Matt or Tom could give a little clarity around what you're thinking in terms of CapEx spend for 2014 and whether the big improvement in working capital this year goes away or are you going to be able to maintain the lower investment level? And just trying to think about this in the context of free cash flow for 2014. Thanks so much.
Thanks, Bob. It's Matt. We aren't guiding yet for 2014 CapEx and we'll provide some more clarity around that early next year. Having said that, the large project left would be the build out of the Russian plant. And of course, the start up of the new LVT plant here in Lancaster, which begins next year and goes through the first half of twenty before is about $100,000,000 So more to come on that, but those would be the two incremental drivers over the normal $100,000,000 kind of running rate.
Yes. I think that's right. So it's still going to be a heavier CapEx year because of those projects, but it will it exceed this year? We don't think that's likely. On the working capital, we've made tremendous progress.
We focus on cash conversion cycle, which is a days based measure. We're very pleased that in 2010 while we were here and getting going, we delivered eighty one days of cash conversion cycle. We've driven that down to I think on a year to date basis around fifty six, fifty eight days through really focus on payables and inventories. We've always felt we've invested in class in receivables. So we've really been able to extend out payables which was a big benefit in the quarter, drive inventories lower.
So our objective is to sustain the days, but on a cash flow basis sustaining days with an expansionary market presumably will lead to some cash drain. So we're always going to keep tight on cash. We may try to drive it further. But given the big releases that have come out of working capital this year that those flow benefits become next year's base, right? So it's harder to anniversary those.
We do feel like we're getting our those. We do feel like we're getting our cash conversion cycle down to the right targeted level for our kind of company. Thanks for that question, Bob.
Thank you, sir. Our next question will come from Jim Barrett with C. L. King and Associates. Please go ahead.
Your line is now open.
Good afternoon. This may be a question for Frank or Matt. You were reporting that remodeling activity is up slightly currently. Other peers are reporting mid to high single digit growth in that segment in the high ticket remodeling projects. So I'm trying to understand is there something unusual about
competition. But when you look at
the mix of products we're in, to competition, but when you look at the mix of products we're in, we don't participate in ceramic, which as a category is fairly high growth and taking category share from other components. And we don't participate in carpet, which is I think benefiting from some fairly significant activity from retailers to try to drive volume. So part of it could be explained by the mix of categories that we're in. And part of it maybe we just have a maybe a different outlook, but we see it kind of in the low at best mid single digits in terms of overall.
Thank you, sir. Our next phone question will come from Keith Hughes with SunTrust. Please go ahead. Your line is open.
You referred and prepared comments to the new LVT facility. Give us kind of an update of your U. S. Residential business. What percentage LVT currently stands at?
Percentage just to make sure this is Frank Keith. To make sure I understand the question, specific to residential, what percent is LVT? Is that the question?
Yes. Currently, Larry, you want to put residential, commercial. Just kind of some kind of sense of how much of the business this represents?
It's order of magnitude, it's around 10%
of the total
commercial residential in North America.
We already do say Keith, we already do today about $100,000,000 in worldwide LVT sales. We have production small production in Germany and we have a small production in one of our North America facilities in the Midwest. But really the Lancaster production would become the primary insourcing for all our Asian production that is sourced from third party sources. So we already have a meaningful business. And again the LVT play while it drives a lot of the improved design and customer service elements that Matt talked about, we do expect it to be a lot like the Russia plant as a margin enhancing savings project for us.
Thank you. Our next question in queue comes from the line of David MacGregor with Longbow Research. Please go ahead. Your line is now open. Yes.
Just a follow-up question on the Architectural Specialties business. You kind of laid out a picture for 2016. As we think about the growth in that business going forward, is it largely organic growth? Or do acquisitions become a factor in your plans? Could you talk a little further about that?
Sure, David. We think first of all there's a great organic growth opportunity. So when you look at the market, the geographic markets we're talking about, when you think about the coverage extension in the global architects, we think that the market lends itself to real opportunities. This would be a place where we would look for smaller, what we would call tuck in acquisitions. It's a very fragmented competitive landscape.
There are a couple relatively large guys. But it's an opportunity for us to move in and look at smaller regional players that may have product lines or product technologies that we find attractive. We did one a couple of years ago with Simplex up in Canada. But as we pointed out, we're also making organic investments. We're going to be expanding our metal capability in China inside the complex that houses the new Mineral Fiber plant.
So this is a place where we would look for small modest tuck in acquisitions if they make sense and we can do them rapidly. Certainly not a place we're afraid to go and increase our organic investment as well. So it's just a broad opportunity that we think we've been organized much better to address really across the board not only in The U. S. But around the world.
The other thing I'd add just for clarity on slide 15 that we did review the business. This doesn't the twenty sixteen numbers do not presume acquisition. So this is what we've got in house in our own organic expansion activities. So the lift you see in the architectural specialties is not predicated on doing a deal in capital deployment. Obviously, if we can find incremental opportunities to deploy capital and drive this number better, we will, but that's not presumed in the data we provided.
That's a
good point.
Thank you.
Thank you, presenters. And at this time, I'm showing no additional phone questions in the queue. I'd like to turn the program back over to Ms. Asby for any additional or closing remarks.
Thank you, everybody. We appreciate your interest. We appreciate the questions. We look forward to a very solid fourth quarter and a very robust end of the year. And we appreciate everybody's attention.
Thank you very much.
Thank you, presenters. And again, thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation and have a wonderful day. Attendees, you may now all disconnect.