Good day, ladies and gentlemen, and welcome to the Armstrong World Industry, Inc. Q2 twenty thirteen 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 be given at that time. As a reminder, today's conference call is being recorded.
I'd now like to turn the conference over to your host, Mr. Tom Waters, Vice President, Treasury and Investor Relations. Please go ahead.
Thanks, Ali. 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 businesses. 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 will turn the call over to Matt. Thanks, Tom.
Good afternoon, everyone, and thank you for participating in today's call. This past quarter marked the first year on year positive volume story for Armstrong since the second quarter of twenty ten. While 2010 growth was driven by emerging markets, in this past quarter, we experienced volume growth across all geographies. We also experienced volume growth in all three of our North American businesses for the first time since the February. Signs of a modest recovery in The U.
S. Commercial markets are starting to appear. On our last call, I mentioned that we had just begun shipments from our new ceiling plant and homogeneous flooring plant in China. Ninety Days into active production, I'm happy to report that orders, product acceptance and manufacturing costs are all as anticipated. I look forward to the heterogeneous flooring plant starting service in August.
Second quarter results on both the top line and bottom line were in the middle of our guidance ranges. Sales for the quarter of $7.00 $7,000,000 were up 5% from 2012 with minimal year on year foreign exchange impact. Patriot wood distribution business that we divested in 2012, sales in the second quarter of twenty thirteen were up 6%. All of our regions experienced sales growth. Sales were up in North America, primarily driven by homebuilder demand for wood flooring, but we also saw improvements in commercial ceilings and flooring.
European sales were up in the quarter, though the ceilings business did benefit from a relatively easy year on year comparison. Pacific Rim sales were up despite continued weakness in Australia. And we were pleased with our sales performance in ABP Americas, but we missed our expectations in our businesses in Europe. Adjusted EBITDA was $98,000,000 EBITDA was down as expected by $12,000,000 from 2012 driven by lumber inflation and wood manufacturing costs, the production and SG and A expenses associated with our three plant starts in China and a lower non cash pension credit. Both ceilings and resilient flooring saw profitability improve in The Americas, but Europe and Pacific Rim are down.
Year to date sales of $1,329,000,000 dollars were up 1% from 2012 with minimal foreign exchange impact. Again, if we exclude the 2012 impact of the Patriot business, our sales were up about 3%. Adjusted EBITDA for the first half of twenty thirteen was $177,000,000 down $17,000,000 from 2012. And as with the quarter, wood costs, plant start up expenses and the pension credit were the drivers of the decline. The wood business remained a challenge for us in the second quarter.
And before reviewing segment results, let me update you on that situation. Now when we talked to you about our first quarter results, we noted that the wood business was facing several headwinds. Number one, the need to add capacity by onboarding 400 new production employees at our solid wood plants number two, the availability of green lumber number three, cost and manufacturing productivity issues driven by the purchases of kiln dried lumber and number four, pricing actions lagging lumber inflation. At that time, we anticipated that manufacturing productivity improvements and changes in the price versus inflation dynamic would allow us to get our service rates and profitability back to expected levels by the third quarter. However, as the quarter unfolded, it became apparent that while we were making progress on all four issues, the pace of change in some areas was slower than we anticipated.
I want to spend a minute on each of the four areas to give you comfort that the improvements we're now seeing are real and sustainable. Number one, crew additions have moved forward, but ramping up capacity and achieving desired productivity are behind plan. Now that said, the final crew has just started at our Beverly, West Virginia facility and will be running at full capacity and effectiveness in all plants later in the second half and return service levels to our targeted fill rates in the fourth quarter. Number two, purchases of green oak are up 10% in the second quarter compared to the first quarter. And as you know, kiln dried lumber can cost between 30% to 50% more than green lumber.
So having an appropriate amount of green lumber for us to dry in our yards is critical. Number three, purchases of kiln dried lumber have been steadily declining. By June, we were purchasing 50% less kiln dried oak in the first quarter. Improvements in this area are actually slightly ahead of plan. Reducing the use of kiln dried versus green lumber not only lowers input costs, but has a positive impact on manufacturing yields and product quality.
Number four, green lumber costs continue to rise in the second quarter and increase beyond our expectations, but they appear to have plateaued in June. As you may have noticed, we recently announced an additional 5% to 7% price increase that took effect in mid July. Now at this point in time, we have price increases scheduled and accepted by all members of our three key channels: builders, big box and independent retailers. Sequential monthly price improvements in the second quarter give us confidence that we're now on track to close the price versus inflation gap by the fourth quarter. The delay in the wood recovery is disappointing.
But as I visited the plants in July and as I've reviewed recent price and lumber cost trends, I'm confident we've taken the necessary actions and are on top of the issues. Wood profitability will build momentum in the third quarter and we anticipate being ahead of last year by the fourth quarter. Now in the second quarter, the Wood business continued to see strong demand from homebuilders and a modest uptick in consumer buying. Sales of $138,000,000 were up $13,000,000 from 2012 and when adjusted for the Patriot divestiture were up over $24,000,000 Despite our lumber procurement and productivity challenges, wood shipments were up in the high teens. Price was higher, but we're still chasing lumber inflation and Tom Angus will provide more details on lumber in a few moments.
Adjusted EBITDA was down from 2012, driven by the headwinds just discussed. Year to date Wood sales were up 20% when excluding the Patriot sales from the base period, but profitability is down, again driven by the same factors that impacted the second quarter. Resilient Flooring sales were down slightly in the quarter. In The Americas, the small decline was driven by price and mix as volume was up modestly. We experienced strength in commercial and residential vinyl products in The Americas, particularly luxury vinyl tile, but the laminate category faced tough year on year comparisons in the home center Channel.
European sales were up slightly driven by price gains, while volume and mix were flat. Within Europe, the markets were a mixed bag with strength in Central And Eastern Europe, but continued weakness in Southern Europe, the Benelux in Scandinavia. Pacific Rim sales were down as Australia commercial declines persisted in the second quarter, but the trend was better than the first quarter. And as expected, profitability in the Resilience segment was down versus last year. Year to date Resilience sales were down 3% driven by lower volumes in all geographies.
Profitability was lower due to sales declines in Europe and plant startup costs in China. And profitability was up in The Americas despite lower volumes. The ceilings business experienced higher sales and profitability in the second quarter with all geographies growing sales. The sales gains were primarily volume driven, but mix in price also contributed. Much of the quarterly improvement was driven by The U.
S. Commercial sector, which saw solid improvements in volume, price and mix. Europe was up with strength in The UK and the Pacific Rim was up despite continued weakness in Australia. Ceilings profitability was up in the quarter, driven by 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. Year to date building product sales were up just over 1% despite lower sales in the first quarter.
Profitability was also up on a year to date basis as second quarter gains more than offset year on year declines in the first quarter. Within the ceilings segment, our global architectural specialties business experienced strong growth with sales up in the mid teens versus 2012. All regions experienced sales growth with Europe leading the way as several projects shipped in the quarter. For the year, this business has grown sales by more than 10% and continues to provide positive synergies for our core ceilings business. And finally, I'm pleased to announce that we've just received board approval to build a North American luxury vinyl tile plant.
This $40,000,000 investment will begin construction later this year after we complete a site selection process. I've spoken about LVT in the past, citing the fast growth of this high value category, which is driven by the appealing visuals and superior performance and installation characteristics of the products. Now for the most part, we source and import these products today. But given current and projected volumes, manufacturing in The U. S.
Is now a financially attractive option. Local production and the elimination of freight and duty expense will drive lower cost, reduce inventories and provide better customer service and lead times. This is an exciting product category for us and an appealing investment in financial terms as well. This investment along with our Millwood, West Virginia mineral wool plant, the three plants in in China and the ceiling plant in Russia brings to six the number of significant new manufacturing investments we've initiated in the last three years and will further expand and improve our product category range. So with that, I'll turn it over to Tom Mangus for a more detailed discussion of our financial performance and an update on guidance and the outlook for the quarter.
Thanks, Matt. Good afternoon 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 Waters already covered Slide two and Slide three is simply an explanation regarding our standard basis of presentation. Matt mentioned quarterly sales and EBITDA results, so I will only point out that adjusted operating income and adjusted EPS were also down versus last year by 1715% respectively. Second quarter free cash flow of $32,000,000 was similar to the $36,000,000 generated in the second quarter of twenty twelve.
I will address the drivers of EBITDA and free cash flow in more detail on upcoming slides. We closed the second quarter with net debt of $764,000,000 down from $878,000,000 at the end of the second quarter of twenty twelve. Almost all the change reflects our cash generation in the last twelve months as debt is practically the same as 2012. Finally, our unadjusted return on invested capital on a continuing operations basis was 9.3, an increase of 100 basis points over the prior year. Slide five details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $31,000,000 in the quarter.
The $3,000,000 cost reduction adjustments in this past quarter include $2,000,000 associated with the closure of a wave plant in Spain and additional expenses associated with headcount reductions in our European and Australian businesses, which we announced last quarter. In 2012, we had $8,000,000 associated with the closure of our Mobile Alabama ceilings plant, including some environmental charges and cost reduction actions in our European ceilings business. Interest expense was lower than in 2012 as we begin to benefit from 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. This 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 flat. Volumes were up in North America low single digits driven by both residential and commercial LVT and other commercial products. Volumes were down in Pacific Rim due to weakness in Australia. Sales in China were also down, but this was expected.
Our customers in China adjusted to our change in service from local pardon me, in service from import to local production and reduced their inventory levels to benefit from our shorter lead times. Overall for the segment, price and mix were essentially flat. Adjusted EBITDA was down $2,000,000 due to plants the plant startup costs impacting Pacific Rim results and mix and production costs dragging in Europe. Profitability
in The
Americas was up double digits in the resilient business, driven primarily by manufacturing productivity improvements, mix gains in commercial products and lower SG and A. Wood flooring sales were up 11% and would have been up roughly 20% if not for the Patriot divestiture. Volume was in the high teens excluding the Patriot divestiture. Price was up. However, negative mix offset price as sales growth in the builder channel exceeded growth to independent and big box customers.
Matt detailed many of the factors driving lower adjusted EBITDA in the Wood segment, so I just want to point out that negative mix as anticipated was also a factor in the year on year profit decline. One of the areas we've begun we've been getting a lot of questions on is lumber prices and there appears to be some confusion on the subject. Please turn ahead to slide seven for a moment as I want to discuss this issue. The species of lumber we buy are hardwoods, primarily oak, but also maple, hickory, ash and others. The more common lumber discussed in the financial marketplace is framing lumber, the material in 2x4s.
This comes from softwood species such as spruce, pine and fir and is more widely used than hardwoods. Framing lumber futures trade on the Chicago Mercantile Exchange. As you can see from the graph on slide seven, while these two types of lumber prices move with some positive correlation, there are different supply and demand characteristics for each and sometimes like now price trends diverge. The Appalachian green oak that is our predominant input has been rising in price since early twenty twelve and accelerated meaningfully in the second half of last year. We now see green lumber prices stabilizing, but at levels we've not experienced in more than a decade.
This explains our many price increases in the past year and why our price realization is chasing inflation in our financial results for this quarter. As Matt mentioned, we do expect to recover our wood margins to the mid-twenty 12 levels by the fourth quarter. Turning back to slide six, you can see that building product sales were up 7%. Global sales were driven by gains in volume, price and mix. North America ceilings unit volumes increased low single digits.
Regionally, we saw particular strength in the Northeast and we believe a good portion of that strength to be driven by Hurricane Sandy related repair activity. Europe, Middle East and Africa saw sales increase despite little to no benefit from emerging markets. Matt mentioned strong sales in The U. K. This quarter.
You might recall in the first quarter we highlighted the weaker start to the year in The U. K. We attributed to an unusually strong Q1 of twenty twelve. Similarly, we think this quarter's relative strength is again a base period issue just now in our favor. Pacific Rim sales were up in the high single digits despite declines in Australia.
Adjusted EBITDA in Building Products increased $7,000,000 versus the second quarter of twenty twelve, driven by sales, manufacturing productivity and earnings growth from our WAVE joint venture. The corporate segment was down, driven by the decline in our domestic pension credit, higher foreign pension expenses, outside consulting services and higher benefit costs. Slide eight shows the building blocks of adjusted EBITDA from the second quarter of twenty twelve to our current results. As you can see, mix and price were slightly down as positive price was more than offset by mix in the Wood segment and in both European businesses. As Matt mentioned in his introductory comments, we are delighted to see growth from volume for the first time since the second quarter of twenty ten, now driven by modest growth in the developed world.
Inflation was almost entirely due to lumber. The $3,000,000 manufacturing decline is the net of all this wood segment issues we have detailed, which were partially offset by excellent progress on our North American ceilings and resilient flooring facilities. The SG and A increase was driven by headwinds in corporate and emerging markets, partially offset by savings in the developed world business units. Wave added $1,000,000 to our year on year results. Finally, our non cash pension credit is lower in 2013 as we mentioned in our guidance in February.
Turning now to slide nine, you can see our free cash flow for the quarter was very similar to 2012 in total. Cash earnings were lower than the prior year driven by reduced earnings and a higher tax rate. Working capital was a use of just $1,000,000 of free cash flow in the quarter, but that was improved from last year by $12,000,000 with favorable inventories and payables offsetting higher receivables, which are linked to our higher sales. Capital expenditures were lower than in 2012 due to the timing of equipment purchases for our emerging market plant builds. Cash interest expense decreased by $3,000,000 as we realized the cash benefit of our March refinancing.
Ray's contribution to cash was slightly negative. The remaining use of $12,000,000 illustrated in the other bar relates to VAT payments on equipment purchases in China and the timing of environmental costs associated with the closure of our Mobile, Alabama facility. Beginning with Slide 10, I'll begin discussing year to date results. As you can see, sales were up just over 1% and would have been up 3% if adjusted for the Patriot divestiture in 2012. Year to date sales growth came from North America.
Europe was down as was Pacific Rim due to Australia. Operating income, adjusted EBITDA, EPS and free cash flow were all down year to date. Slide 11 illustrates our sales and adjusted EBITDA by segment for the year to date period. Resilient flooring sales were down 3% with the entire decline occurring in the first quarter. Drawings were down in all regions, but global price and mix were up.
EBITDA was down in the Pacific Rim and Europe Nutan plant startup costs and volume declines respectively. As with the quarter, profitability in The Americas was up double digits year to date. The year to date improvement was driven by manufacturing productivity gains, better mix, much of it coming from the LVT category as I mentioned before and lower SG and A overcoming lower year to date volumes. Wood flooring sales were up 10% and would have been up 20% if not for the Patriot divestiture. Year to date, the wood EBITDA story is the same as the second quarter, so I will not repeat myself here.
Building product sales were up 2% through June. Sales were up in North America and Pacific Rim, but down in Europe. Global mix and price 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 segment increased $9,000,000 year to date. Price, manufacturing improvements in The U.
S. And increased contributions from the Wave joint venture more than offset volume declines and the emerging market expansion expenses. The corporate segment was down $11,000,000 driven by the same factor affecting the second quarter. Slide 12 shows the building blocks of adjusted EBITDA. The only difference from the quarterly story is volume.
Year to date, we are still behind 2012 creating a drag on earnings. All of the other factors are essentially the same as the second quarter. Slide 13 shows free cash flow for the year is a use of $19,000,000 similar to the fourteen million dollars used in 2012. However, the elements of the story are different. Cash earnings are lower and capital expense higher driven by plant expansion capital spending.
But these headwinds are overcome by working capital, which improved due to increased accounts payable. Wade's contribution to cash was slightly negative as they were able to squeeze more from their operational cash accounts in 2012 due to their then newly available revolving credit facility. Slide 14 updates our guidance for 2013. We are maintaining our top line guidance of $2,700,000,000 to $2,800,000,000 but as a result of the delay in wood the wood segment recovery and Europe, we are lowering our adjusted EBITDA and cash flow expectations for the year. Specifically, we now project full year EBITDA to be $370,000,000 to $400,000,000 Our free to $100,000,000 due to the lower earnings range.
In North America, we have not changed our view of the commercial or residential market opportunity since our last call. That outlook suggests essentially flat to low single digit growth in the commercial opportunity in the back half of the year. However, we are revising our outlook for Europe down despite the low single digit volume growth we enjoyed in the second quarter. June data from EuroConstruct, which publishes macroeconomic projections we used in our forecasting processes, points to more negative trends in non residential construction for both new and renovation activity than their December 2012 projections, which had informed our previous guidance. Expectations for year on year change in critical markets like The U.
K, France, Germany, Italy and The Netherlands are all down. This more than offsets positive revisions to countries like Spain, Belgium and Ireland. We expect China, India and Southeast Asia to grow faster than what was included in our previous guidance, but this is somewhat offset by an even more negative view on Australia. Slide 15 provides the more detailed assumptions going into our earnings guidance and includes the specifics on the third quarter. We continue to expect annual inflation in the range of $50,000,000 to $60,000,000 the lion's share of the increase impacting the Wood segment.
We continue to target a 2.5% annual improvement in gross manufacturing productivity year over year. However, it's clear we will not hit that in 2013 due to the Wood manufacturing productivity challenges Matt described. Our outlook for consolidated adjusted gross margin is now a decline of 100 to 150 basis points on the full year versus last year, down 50 basis points from our last guidance due to the weaker Wood segment margins. We expect total SG and A as a percent of sales to come in at 15.75% to 16.75%, just up slightly at the midpoint versus 2012 due to our investments in emerging markets. Guidance on the pension credit and earnings from WAVE are unchanged from April and we have tightened our range on cash taxes modestly.
Our estimate for the third quarter sales including anticipated FX and tax is a range of $740,000,000 to $780,000,000 At the midpoint, sales would be up over 9% from the third quarter of twenty twelve when adjusted for the Patriot disposition. We expect to earn $110,000,000 to $130,000,000 of adjusted EBITDA compared to $135,000,000 on a comparable basis in 2012. The adjusted EBITDA estimate is impacted by significant lumber inflation, startup manufacturing expenses in China and higher SG and A spend on our growth platforms including Russia and Architectural Specialties. We are increasing our capital expenditure estimate for the year to 180,000,000 to $200,000,000 due to the LVT investment that Matt just announced. Lastly, with the WAVE European plant closure costs, we now anticipate $10,000,000 to $15,000,000 associated with cost reduction initiatives.
We look forward to catching up with wood demand and inflation and to driving meaningful growth from our emerging market expansion now that our plant footprint is coming online. And with that, I now turn it back to Matt. Thanks, Tom. While we're disappointed in the timing of the wood recovery and the outlook for further weakness in Europe, we're pleased with the top line strength we saw in North America, optimistic that a commercial recovery may finally be starting, and as we outlined in detail, are confident we've taken the necessary steps to address our wood segment challenges. So we'd like to thank you for your time today.
And with that, we'd be happy to take any questions.
Our first question comes from Dennis McGill of Zelman and Associates. Please go ahead. Hello. Thank you very much. I guess the first question is just as it relates to capacity in the wood business.
Can you maybe just update us on where capacity will stand now after this last crew you said was up and running and how to think about that over the course of the recovery? And then just as it relates to those hires, can you just discuss a little bit about what you're finding with respect to availability of labor out there, the quality of that labor, the ability to retain the labor after you have it? Any kind of color you could put around that?
Thank you. Let me frame it and then we'll toss over to Frank for some more detail. So as the 400 plus new labor employees or new production employees come online, we expect to have the capacity necessary to drive service levels back to kind of our historical highs, if you will, by the end of the certainly in the fourth quarter. So we think that we'll be able to manage capacity and be at an acceptable capacity at least capacity standpoint then and with an acceptable capacity utilization. In terms of labor, it has been a bit of a challenge.
Certainly early in the recruiting process, we had some challenges in a couple of our plants in terms of stability. That seems to be largely behind us. Availability of labor is tough in some of the places just given the nature where our plants are. And we tend to be in most of the locations of our wood plants the largest single employer in the area anyway. So we kind of soaked up a lot of the labor pool just to begin with.
Again, we've seen very strong improvement in the trends in the labor productivity and the labor stability and we're confident that we'll be back at the appropriate and competitive service levels in the fourth quarter. Frank anything to add to that?
No. I think Matt summarized it well, both on the capacity we'll be in full recovery position in fourth quarter and we anticipate we'd be able to support demand going into 2014 at current market projections.
So other than that I think Matt covered it.
Our next question comes from Michael Rehaut of JPMorgan. Please go ahead.
Thanks. Good afternoon, everyone. My question is with regards to Europe. I believe you mentioned at the end of your prepared remarks that the change in outlook is really driven by a change in forecasts that across all the different countries in Europe and you kind of went through obviously the different ones. Just wanted to touch get a little more granular there, but really in terms of if those forecasts are consistent with what you're actually seeing in the field in terms of order trends and from your own sales force, if it's really more the latter that's driving your change in view rather than the service and the forecast that you're subscribing to?
Well, when we think about an outlook for a market, it's a compilation of factors. I mean, we certainly consider external sources. Euro construct being, I think, a source that we consult regularly. But we also look hard at the third and fourth quarter outlooks from our sales force. We have a relatively strong enough share position in each of our businesses that we think that reflects real life market dynamics.
And we look at the loading in our backlog and order trends. So it's really it's a compilation of those things. And then secondly, we are somewhat affected by our relative position geographically in Europe. As you know, we are in our building products business, we're strong in The UK. In our Flooring business, we have relatively strong positions in Central Europe and in the Scandinavian countries.
In addition to that, we have a very strong presence in Russia in our ceilings business, not so much in our flooring business. And both of our businesses have, I would say, competitive and strong positions and expanding positions in The Middle East, which we include in our European results. As a company, we have very limited exposure to what we would consider traditional Southern Europe. So Italy, France and Spain, those numbers change a little bit business by business. So it's our outlook is a function of certainly external resources, our sales force and a grounded forecasting method that we have in both of our business and our geographic presence, our weighting, if you will, by geography and over time.
Mike, Tom here. A couple of thoughts. First, we did see Europe coming weaker in the second quarter. I know that was in Matt's opening comments. So it did come in weaker.
Even though we had a pretty good quarter all in, our flooring business had actual sales growth in the quarter as and our ceilings business actually had 7% growth on a constant FX basis. So the optics of the second quarter looked pretty good, but it was weaker than we expected largely because we had some big jobs shipped there. And so we're not just looking at macro forecast. Certainly, we had an experience in the second quarter that influenced us here and it triangulated well with the Euro construct. I mean, The UK projections are down a good 150 basis point.
France is down about 300 basis points on growth rates for commercial forecasts. So that both those factors are driving our forecast.
Our next question comes from Nishu Sood of Deutsche Bank. Please go ahead.
Thanks. Wanted to also focus in on the Wood Flooring division. Appreciate all the color and the breakdown of the drivers. Obviously, most of the factors that you were mentioning related to materials and what sorts of materials you're purchasing and the labor as well. On the cost side, you mentioned that EBITDA margins should be up, I believe, on a year over year basis by the fourth quarter.
So my question related to that is what are the risks you see? Obviously, there's been a volatile time for that business. What are the risks you see to the forecast? And also, most of the discussion was around the impact on margins. Has there been any negative impact on sales as well from the issues that that business has been facing?
All very good questions. To answer the last question first, there's no evidence that our revenue or at least incoming sales have been affected by the service delays. This is a these issues are facing the entire wood flooring industry, not just us. I mean, clearly, as a shared leader, we'll fill these proportional to our share position. But this is these are challenges that everybody in the wood flooring business is facing.
The order book remains strong. And so again, we're confident that we're maintaining our share and the revenue outlook should be in pretty good shape. In terms of risk, we believe we have very robust processes in place. We are micromanaging the actions to address the four issues that we laid out. To the extent there's any risk, I would characterize the risk as more timing than execution.
So in our view, said another way, we don't think it's a matter of if, it might be a matter of when. But having said that, we believe we factored responsibly any sort of timing risks in the outlook that we shared with you guys today. And then Frank, any additional color? No.
I mean, we look at green lumber versus PKD, we have seen green lumber receipts come up. This is the time of year that you can get green lumber. So feel very good about where we stand there, PKD versus green. Inflation, as I think Tom and Matt indicated earlier while at a high level the rate of increase has slowed down and in some cases stopped. So seemingly we found where the ceiling is so to speak on inflation.
And those two factors are the biggest drivers going forward that we need to see come through. So all in all, I think we've categorized the risk appropriately. And I think Matt said it well when he said it's a function of timing versus whether we'll get it or not.
Our next question comes from Ken Zener of KeyBanc Capital Markets. Please go ahead.
Afternoon, gentlemen.
Hey, Ken.
With so much of your EBIT corporate EBIT tied to Sealing Systems in The U. S. Can you talk about the increase in volume that we saw in the quarter as it relates to I think you guys had talked about retail R and R kind of leading the way initially. But can you expand on that as it relates to perhaps seasonal education, healthcare given that we're seeing positive volume in The U. S?
Thank you.
Yes. Just a couple of opening comments. We'll throw it over to Vic. We saw in North America, we actually saw very solid signs of a modest recovery. So we're beginning to see some traction in a lot of segments.
I would point to the office segment and remodel as holding up relatively well. We're still seeing relative weakness in healthcare and education as it relate of course those are both tied to public spending. We haven't seen state budgets healing measurably yet. I think we're going to have to see employment strengthen somewhat more significantly than we have to see the tax revenue drive into the state budgets and that then finding its way into construction of schools and remodeled schools. So we're still a little cautious there, but we did see relatively strong results in almost every region in The U.
S. Across a series of market segments. And we think that's mostly market related. And Vic? Yes.
I think in the opening remarks, we talked about the impact of the Sandy renovation activity up in the Northeast Region. So we had one region particularly strong and that volume was driven again due to the Sandy renovation work. As Matt said, we're not seeing any education or health care bump. In fact, those starts continue to be negative year over year. And the volume driven is broad based, as Matt said, and it's driven by the office renovation activity for the most part.
I would reiterate just before we close out this one that our billing products business saw strength really in all regions. So we saw it in North America, Europe and in the Pacific Rim.
Our next question comes from Katherine Thompson of Thompson Research. Please go ahead.
Thanks for taking my questions today. Wanted to take more of a forward look on demand. And in your prepared comments, you noted that global architectural sales were up in the mid teens, which would theoretically imply an acceleration of trends for your non res focused sales. Could you talk about early Q3 trends in your Ceiling segment related to that? And then also if you could touch on trends and Wood given that there has been a lot of focus on the impact of rising interest rates on potential residential demand?
And finally touch on resilient flooring too and any other relevant trends you'd care to share?
Sure. I mean, Architectural Specialties, we're seeing broad based strength geographically, Catherine, Architectural Specialties. Part of the world that's exceptionally exciting for us right now is The Middle East. So the good news is it's a great market for that. There are there's very significant projects there and our position is we feel we have a very competitive position.
As we've discussed in the past, there's a drafting effect of a good strong architectural specialty specification and the fact that it drafts the mineral fiber with it. The tough part about that part of the world is the fact that it's project. So it's binary. You have to bid the project, write the project and then of course these projects all have to ship as forecasted. So it challenges us a little bit from a calendar perspective on outlooking the revenue.
But I would say that we're seeing broad based strength in Architectural Specialties as that segment within ceilings continues to grow, we're well positioned there. In terms of and I'll take well, why don't you Vic, do you want to comment on that and then we can get over that? No, I think you said it very well. And again, I think we also have a pretty good pipeline of projects in The Americas and in Europe to continue in addition to The Middle East. So I think there is a little bit of momentum to that business and we should see some continued growth there.
Yes. Tom, if I could add just one thing, Kath, and just to put an exclamation point on it. The growth the very exciting growth in Architectural Specialties we're seeing, we believe is share gain, okay? This is not a signal of incremental demand. This is a result of our intentional investment in the Architectural Specialties space in all regions of the world that's showing through on the top line and the bottom line for us.
Relative to kind of what are we seeing in July, let me just speak a bit about the second quarter than July. Really, the quarter came in largely as we expected in the second quarter, which meant a pretty strong April and May and a pretty soft June. That's kind of how we expected it. That's how it came in. That was that's true across both flooring and ceilings in the month of June.
But in the month of July, we see it coming back. So I think it's going to continue to be choppy. We're going to have signals of strength of demand. We're going to have signals of weakness in demand. And so we're just trying to do our best to discern it.
But I'd say June is off to a reasonably good start, but in line with the kind of outlook we provided on the quarter. And then the other comment with respect to Wood, despite some tightening in the financial belt, there doesn't seem to be any softening in the outlook for demand on housing starts. And as we said, we're beginning to see a little strength in resi remodels that will drive some of the wood business too. And we'll see that through the big box channel. So listen, we're keeping an eye on this obviously constantly, but currently there just doesn't seem to be any change in that trajectory.
And in addition, like we said, we're starting to see some strength in remodeling. Frank, I don't know if you want to add anything to that or I think that's well said.
Our next question comes from Stephen Kim of Barclays. Please go ahead.
Great, guys. Wanted to ask you a couple of questions. Well, I guess a question about your plant openings. If you could, you mentioned about the LVT plan and I guess you took up your CapEx spending about $10,000,000 for this year. Is that going to be the extent of the investment in this LVT plant?
If you could talk a little bit more about also what you're expecting from this plant, the kind of ramp up it will provide and ultimately what you think its run rate might be? And then in China, you mentioned something about the plant there about how the because you're starting to produce more locally there that you've the customers are holding less inventory. Could you quantify that for us?
Well, let's talk about the OET plant first. So the $10,000,000 Steven represents the amount of investment in that plant that we anticipate this year. We've got a lot of work to do to finalize things like site selection, engineering, etcetera. So we'll be sharing more information on the economics behind the plan and the timing behind the plan as we go into the year. So everything you asked about is somewhat dependent on the first decision we have to make, which is site selection.
And so we're hopeful to have that done shortly and we're hopeful to be able to share more information about that in the third quarter call. But LBT represents a significant growth opportunity for us. We do believe the economics despite sites in The U. S. Are compelling just in terms of the import duty and distribution cost avoidance.
It gives us tremendous flexibility from a manufacturing perspective, allows us to maintain a less inventory and frankly gives Frank's team a lot more flexibility around design and so we're able to fine tune the products a lot faster. So it's margin should improve, responsiveness should improve and our ability to innovate improves as well. So we're excited about it and again there's tons to share as we go forward and just wanted to share the fact that the Board supported us for yet another significant investment in manufacturing as we look to revenue and position the business or the company for further sales growth in the future. And the second question was? On China, the impact of the you want to take that, Frank?
Yes.
I think the question was in China, what was the impact on going local production versus sourcing? And the best way I can answer that is to tell you when we source products into China, typically the lead time was twelve to fifteen weeks. Going local that's now down to two to three weeks. So we cut the supply chain by 70% which then had the significant impact on inventory reduction in the system. That's largely behind us.
We knew it would be a two to three month adjustment of inventory. And so what we should see going forward is largely the result of demand supported by local production.
Our next question comes from David MacGregor of Longbow Research. Please go ahead. David, your line is open. Please check your mute button.
Hi. Good afternoon. Sorry about that. Just to follow-up on the LVT question a moment ago, I guess the reason you can't really talk about the total available market is these plants have a limited shipping radius and it will depend on where you're situated. Is that how we should interpret your answer?
It's a good question, David. No, not at all. I mean, I think we've got we've modified our LVT capability in Europe and we're seeing some strength there. But no, this is this isn't necessarily a factor of a geographic limitation. I think what we want to do is make sure we get the nail down the economics of the plant before we sort of become a little bit more transparent on what we want to how we want to describe the economics.
And we'll always try to place a plant investment and returns on that investment in the context of the market. So rather than talk about the market without the plant, we want to put the story together and kind of share it with you in the third quarter. And Frank? Yes, I would this is Tom. Just I mean, we are expecting this plant to be extremely attractive IRR project.
It will be in excess of the plants we built in the emerging markets given the North America margin structure. And Stephen to your earlier point, we are expecting about $10,000,000 in the current year just to get going. We're expecting the bulk of the spend to happen in 2014. Again, that's going to depend on the site selection though. That's why we're being a little ambiguous here because we need to pick the site, decide do we need a building, do we not need a building and how fast can we get going on it to articulate ramp up speed.
But we have framed I think for the board another very attractive investment, mostly a savings project not dependent on share growth to achieve returns, which I think we've got a great track record of delivering. And just to reconfirm what
we said earlier on, the site selection, this is a North American plant to support the North American market. So as we go through site selection, we'll pick the right location in North America, but this plant is not a global plant. This is to support the local North American market and demand.
Our next question comes from George Staphos of Bank of America Merrill Lynch. Please go ahead.
Thanks, everyone. I want to ask kind of a two part on manufacturing and the outlook. On LVT, from your vantage point, is there anyone else considering adding capacity in luxury vinyl tile in North America? Or do you think you'll be the only new capacity being added and therefore meeting a market that's more attractive than it would be otherwise? And then the second question I had just in terms of wood products, do you think there's been any kind of pre buying or double booking in current fundamentals that's leading to perhaps a pullback in demand just when you're ready to produce in the fourth quarter and beyond?
Thanks, guys. Good luck in the quarter.
Thanks. Two good questions. The first is, to our knowledge, nobody is considering an LVT investment. Of course, it's impossible to be 100% certain, but there's no evidence that anybody else is considering that. Of course, that could change at any time.
We don't think an additional investment by our competition, if at all, would change the economics of our product, but that'd be something to consider. In terms of doubling up on wood demand, again, there's no evidence of that going on. Frank's team looks at post sell to retail sell through. We look at our residential construct contractors building schedules. So we try to keep an eye on the demand of our customers as well as the demand from our customers.
And again, we try to pressure check this regularly to make sure that we haven't got excessive demand signals in the backlog, but there's really no evidence to suggest that's the case, but that's something we look at and monitor all the time.
Our next question comes from Bob Wentenhall of RBC Capital Markets. Please go ahead.
Hey, good afternoon. Hey, Bob. It sounds like your guidance suggests that EBIT margin might comp negative in the third quarter in resilient flooring and ceilings. And I was wondering if the implied negative comp is just due to the startup ramp costs you have with the new plants that you've been talking about? And just if I could sneak one other in, is there any risk to the wood price increase in flooring?
Is that something which is from your perspective in the bag? Thanks a lot. Good luck. Let Let me take the wood pricing increase question first and we'll kick it over to Tom to talk about the EBITDA outlook. At this point, Bob, the most recent price increase obviously hasn't gone into effect yet, but we are getting we've been successful in negotiating the historic we've been successful in negotiating the historic levels of realization of those price increases.
We think demand will continue to be strong in the third and fourth quarter. We think supply will tight or loosen somewhat, but certainly still be relatively tight when you consider it somewhat historically. So again, Frank's team is working very hard with our channel partners in Big Box and our and the residential contractors to make sure that we are in a position to continue to serve their demand. And again, they've been successful. It's tough negotiations and being somewhat successful in getting the price.
So nothing yet to suggest that the next price increase won't hold, but we're not there yet. And so in terms of the EBITDA and the pressures on EBITDA in the third quarter, Tom? Yes. Bob, good afternoon. This is Tom.
Yes, I think you've summarized it correctly. The we are ramping up the heterogeneous plant here in the third quarter, so that is one of the three plants starting up concurrent in the third quarter along with both the ceilings and the homogeneous plant beginning to achieve the commercialization. And so we are spending heavily on SG and A on both those segments to deliver against the growth plans of those plants and get the plants start up and through really the start up curves. These plants don't start at full capacity and they'll start in a straight line, vertical. And so that is correct.
And this is probably not that different of the third quarter outlook than what we would provide before except for the Wood segment. So I think relative to the expectation we would have had or you might have had before, what's changed in the third quarter is much more on the wood side and a little bit of Europe.
Our next question comes from Mike Wood of Macquarie. Please go ahead.
Hi. Thank you. You mentioned the green lumber seats are up. Is this seasonal or is supply finally starting to catch up? And if you could just talk also about what your expectations embedded for the price inflation would for the fourth quarter.
Is it to subside like framing lumber has or is it flat from current levels? Thank
you. Mike, the answer to your question the answer to the first part of your question is both. I mean, there's certainly a seasonal component to getting the wood. There's a weather dimension, etcetera. So we do see steady improvement in green lumber availability and you've got capacity coming online and seasonality.
So that says that the improvements we're seeing should be sustainable and certainly we're the drying sheds at our hardwood flooring plants are certainly a lot more full than they were in the first quarter. In terms of inflation, the outlook as we think about the balance of the year, as Frank as we pointed out in the comments, I think Frank will back this up. We see it settling in at higher than historical levels, but it appears to be leveling off. There's nothing to suggest that's going to peak up again, but again, like so many other things on this one, we watch it all the time. There's no evidence to suggest at this point.
There's no stimulus to suggest it should increase, but we watch it all the time. And Tom, anything to I think you've covered. Our outlook on the year assumes that it's plateauing here and we priced for the plateau. And so that's built into our outlook.
Our next question comes from Will Randell of Citigroup. Please go ahead.
Hey, good afternoon and thanks for taking my question.
You
bet. A question on the balance sheet. It looks like you brought leverage down about half a turn on a net debt to EBITDA basis year on year as well as you expect to build about $1 per share in cash from free cash flow. So I guess, how are you thinking about capital deployment outside of the plant you mentioned? Any room here for special dividends or anything of that nature?
Well, thank you for the question, Will. This is Tom. Obviously, we are always keeping an eye on the balance sheet. We have framed a range, as you know, of two to three times net debt to EBITDA as our target range. And yes, at the end of the second quarter, we are at 2.2 basically on a net debt to EBITDA range, so we're coming at the low end of the range.
We've never said that as soon as we hit the bottom of the do something automatically. We obviously evaluate capital deployment against other alternatives out there like acquisitions or organic capital expansion. And so we will continue to dialogue it over here. No announcement today, obviously, on dividend or other deployment. But certainly we are cognizant that we are through our cash generation and earnings growth that we're projecting this year and through our mid cycle guides that we'll be delevering quickly and want to look for smart ways to deploy that.
Thanks for that.
Our next question comes from John Boss, Stifel Nicholas. Please go ahead.
Thank you. Good afternoon. Just a quick question on the Wood segment, if I could. The mix erosion you alluded to with Builder being stronger. I assume that's something that's going to continue going forward.
So could you sort of discuss how mix plays into your guidance? And then I think you made a reference to being back to mid-twenty twelve EBIT ranges by the fourth quarter. I just wanted to make sure what kind of that number was? Thank you.
Sure. Well, I'll comment on the mix dynamics and then Tom or Frank can comment on the margins. The mix is purely the mix dynamics is really a function of the customer segment strength. So as you might imagine, you've got the strength coming out of the blocks was residential contractors. So you're dealing with kind of base layer product at that point.
We'll continue to see that demand remain, but the mix increase or improvement we see comes from big box. So we would see our two large big box channel delivering improved mix over that as remodel improves and just the sell through from them improves. So as they come on stronger, we expect the mix to move in the right direction, but it's purely a function of customer segment dynamics. And John on the margin, you heard correctly, our plans for that improved mix for the pricing catching up with the inflation and the improvement in wood productivity should yield a Q4 EBIT margin that gets to go down call mid-twenty twelve EBIT margins and you can go back and look you'll see it was about a hair over 11 on an EBIT margin basis. We're obviously well below that in the current quarter.
Our next question comes from Jim Barrett of C. L. King and Associates. Please go ahead.
Good afternoon. This is a question for either Matt or Vic. To what degree is the second half guidance incorporate your August price increase in ceilings in The U. S. Being successful?
Could you comment on that? Yes. I mean, I think we've had this is Matt. I think we've had a track record the last couple of years of getting strong yield from those price increases. There's nothing to suggest that we will fail to get our historical yield from the announced price increase.
So when Vic's team puts together the outlook, the forecast, they factored in historical price increase yield on that. And Vic any? No, that's well said. Yes. Okay.
Okay. Well, thank you very much.
You betcha.
Our next question is a follow-up from Nishu Sood of Deutsche Bank. Please go ahead.
Thanks. I wanted to ask about the more specifically about the sales guidance for the third quarter. The $740,000,000 I believe it was to $780,000,000 So with sales in the first and second quarter kind of having come in where you've expected, you continue to expect this acceleration into the back half of the year. I was wondering if you could break that down for us geographically since you're saying Europe is maybe a little bit weaker. Does that imply a greater than expected trajectory in North America?
And also divisionally, I was wondering if you could break it down for us whether the kind of relative sales strength that we've seen in the first half of the year will persist into the second half?
Okay. So in terms of geographic cut, we are expecting continued strength in the North American business. If you look at our ceilings business, we're modestly optimistic at a modest commercial recovery. We would continue to describe the environment as choppy, but I think we're somewhat we like what we see in the second half. Clearly on the flooring side of the business, we'll see resilient flooring kind of maintain a flattish kind of an outlook, but the wood business will continue to be extremely strong.
And so as we go on the other side of the supply versus demand issues, I mean, we're going to see our ability to supply that demand go up significantly as these 400 labor production employees come online and become more productive. Europe is a it's kind of a mixed bag. We've got some benefit of some timing in the first half. We expect to see Russia strengthen continued strengthening the Russian market and it will help in architectural specialties in The Middle East. In the Pacific Rim, we'll see relative strength in China and India.
And both businesses will continue to expect an outlook of relatively weak Australia. Tom? Yes. So maybe a little bit more building up from ground zero here on the blocks. We've been taking huge pricing in both businesses.
So on a year on year basis, we have all the wood pricing kicking in. Our last announced increase is effective July. That's cumulative on top of the other increases we've taken. We've got the ceilings price increase August effective. And also similarly they took a price increase in February.
So we've had significant pricing in The Americas kicking in. That's a big contributor. Secondly, we continue to expect the strength of volume demand driven by new construction and wood. So you take those two things and then you also back out the fact that we will be anniversarying in August our Patriot divestiture, which has been a drag for prior three quarters. We will not have that as significant of a drag there.
I think that's how we get confident around the level of sales growth that we've seen and that also helped drive the sales growth we enjoyed in the second quarter.
Our next question comes from David MacGregor of Longbow Research. Please go ahead.
Yes. Just as a follow-up, I wonder
if you could talk about your third quarter guidance and specifically the total plant startup expenses that you have in that number?
Yes, David. We haven't guided on a quarterly level how the plant expenses are. On a full year basis, we've told folks we expect it to be $10,000,000 to $15,000,000 of plant startup expense and another $5,000,000 to $10,000,000 of SG and A expense associated with the emerging market plant startups. And we haven't really put that in a quarter by quarter basis. So that's about as specific as we've gotten on that.
And with no further questions at this time, I'd like to turn the conference back over to Mr. Matt Espie for any closing remarks.
Okay. Well, on behalf of everybody here, we appreciate your interest this afternoon and your questions. We've got our work cut out for us certainly in the wood business. We're confident that we've got the right actions in place and we're tracking appropriately. And we feel that everywhere around the world, Armstrong is positioned to take advantage of a strong market if it occurs or continue to win in challenging markets if that be the case.
So thank you very much. Have a great day.
Ladies and gentlemen, this does conclude today's conference. You may all disconnect and have a wonderful day.