Armstrong World Industries, Inc. (AWI) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. Welcome to the second quarter 2011 Armstrong World Industries, Inc earnings conference call. My name is Deana, and I will be the operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, today's conference is being recorded. I would now turn the call over to your host, Mr. Tom Waters, Vice President, Treasury and Investor Relations. Please go ahead.

Thank you, Deana. Good afternoon 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 Espe, our President and Chief Executive Officer; Tom Mangas, our CFO; Frank Ready, 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 Mangas 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 thanks for participating in our call this afternoon. The second quarter of 2012 exhibited many of the same themes as the first quarter. The European economies continue to struggle and market demand was below our already pessimistic assumption. North American commercial markets performed below our expectations while new residential construction was up, albeit off a very low base and Asia was a mix bag. Given this macroeconomic backdrop, Armstrong's performance in the quarter was largely as you would expect. Sales of $710 million were down $39 million, or 5% from 2011 with the overwhelming majority of the drop coming in Europe. European sales performance was exacerbated by the euro currency weakness. Excluding the impact of foreign exchange, sales were down $22 million or 3% with more than all the difference in foreign exchange coming from the Euro. Sales were below the low end of the guidance range of $740 million, driven primarily by the issues in Europe, softness in U.S. commercial markets and severe inventory reductions at one of our big box customers, all versus our expectation. Year-to-date sales are $1,378 billion, down $56 million or 4% from 2011. As with the quarter, the sales decline is primarily driven by the euro zone and exacerbated by currency. On a comparable foreign exchange basis, sales were down 2%. Despite the top line challenges, we were able to deliver adjusted EBITDA of $110 million, up $2 million from the second quarter of 2011, and within our guidance range of $105 to $120 million. EBITDA performance was helped by continued productivity improvements and ongoing SG&A expense management. I am pleased to announce that we now expect to achieve $200 million from our cost savings program by the end of 2012. This is up from our most recent estimate from $185 million and the original target of $150 million. The additional savings will come from both, SG&A and manufacturing productivity. Given the prominence, Europe has been receiving in the headlines, I wanted to help you contextualize the region for Armstrong. Europe for Armstrong for reporting purposes includes a Middle East as well as Africa, and 2011 this region represented about 20% of our sales and 7% of adjusted EBITDA with more than all of the EBITDA coming from ceilings business. Italy and Spain represented about 7% of our European sale. Obviously, these are large economies that are going through difficult times and our sales to those countries are down more 20% year-on-year, but Italy and Spain are only a fraction of the European story for Armstrong. The Middle East, Africa and emerging Eastern European countries, including Russia produced almost 25% of the regional revenue and provide some offset to struggling Western European market. For instance, our sales to Russia were up 30% year-to-date. As we have mentioned in the past, our ceilings business in Europe is broadly spread across the region and significant sales to Russia and Middle East, thus ceiling sales for the quarter were only down 2% versus 2011 on a comparable foreign exchange basis. Our flooring business is largely concentrated in the euro zone and experienced a sales drop of 17% on a comparable foreign exchange basis. Despite sales being down $25 million for the quarter, adjusted EBITDA was actually up versus 2011 as Europe benefits from cost reduction action. In the America, we continue to see softness in commercial markets, particular K-12 education and healthcare as government budgets remain constrained. Also, the weakness we saw in the first quarter in the Northeast office market continued into the second quarter although June activity actually ticked up. For Armstrong, these trends impact both, our Ceiling's and Resilient Flooring businesses, but more so the flooring side, which depends on education and healthcare, were over 50% of its sales. We are adjusting our outlook for the U.S. commercial activity down, impacting both of our business, and of course this is reflected in our updated guidance. The Residential sector continues to show signs of improvement, but even here activity is mixed. We see strong performance in our builder business as new home construction picks up and builder sentiment improves. However, repair remodel activity is fairly flat and recent consumer confidence reports and lower existing home sales figures leave us cautious on this sub-segment. In the quarter, our Residential Resilient product saw sales increases versus 2011 with continued strong performance from our high-end Alterna and Luxe Plank product. While our North American wood sales were down just under 5% year-on-year due to a big box customer, sales to independent retailers and builders were up despite lower sales in the wood business and adjusted EBITDA was up year-on-year. Inventory and customer service issues we discussed in our first quarter results have been fixed as we have added staffing and capacity at three plants. In Asia, the office sector in China slowed and our ceilings business experienced year-on-year sales decline. Our Flooring business in China, which is more exposed to education and healthcare, saw sales increases. The opposite was true in India, where ceilings sales were up, but flooring was down. Australia continued to experience a soft commercial construction market and both businesses were down year-on-year. As I mentioned before, on a consolidated basis, Armstrong's adjusted EBITDA for the quarter was up $2 million over 2011. Cost savings in both, manufacturing and SG&A and price and mix improvements offset volume declines and modest input cost inflation. Profitability in the second quarter was also negatively impacted by slower than expected ramp up of our Millwood, West Virginia mineral wool plant and by environmental charges at our ceilings plants in St. Helens, Oregon and Macon, Georgia. Looking forward, we are lowering our sales and EBITDA guidance based on the market conditions just discussed. We are essentially calling for flat sales year-on-year with gains in North American residential product and Asia being offset by significant weakness in our European flooring market. Adjusted EBITDA for the year should be in the range of $400 million to $430 million. This is up from 2011 adjusted EBITDA of $377 million, but down from our previous guidance range $430 million to $460 million. Tom Mangas will provide more details on these figures as well as our guidance for the third quarter. With that, I'll turn the call over to Tom to review the financials.

Thanks, Matt. Good afternoon to everyone on the call. In reviewing our second quarter and year to-date results, I will be referring to the slides available on our website. Starting with slide four, key metrics. As Tom Waters already slide two and slide three is simply an explanation regarding our standard base of the presentation. As Matt mentioned, EBITDA for the second quarter rose 1%, despite a sales decrease of $22 million when excluding foreign exchange impact. Adjusted operating income and earnings per share results both increased by 3%. Second quarter free cash flow was $36 million, down from the same period in 2011. I will address the drivers of EBITDA and free cash flow in more detail on upcoming slide. We closed the first quarter with net debt of $878 million, up from $409 million at the end of the first quarter, and $542 million at the end of the second quarter of 2011, as we paid our $500 million special cash dividend in April. Slide five details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $42 million in the quarter. The cost reduction initiative and accelerated depreciation adjustments for the second quarter of 2012 are related to the permanent closure of our Mobile, Alabama ceiling facility announced in our first quarter earnings call and SG&A cost reductions in our European ceilings business. If you recall, the second quarter 2011 was impacted by restructuring and cost out efforts in European flooring and the closure of the Beaver Falls, Pennsylvania ceiling facility. Interest expense was higher in 2012 than 2011 as debt increased by about $250 million as we financed the portion of the dividend we paid in April 2012. Tax expense was lower versus the prior year driven by an increase in international income from lower tax jurisdictions. Moving to slide six. This provides our sales and adjusted EBITDA by segment for the quarter. Excluding the impact of foreign exchange Resilient Flooring had a sales decline of 5%, driven by weakness in Europe, which saw sales decline by 17%. The sales drop was more than entirely volume-driven as price and mix were favorable. Again, excluding the impact of foreign exchange, sales in Asia were essentially flat with declines in Australia and India offsetting continued growth in China. North American Resilient was down slightly even though we saw mid single-digit improvement in our independent Residential Resilient business. Commercial Flooring volumes declined mid single-digit, particularly in sectors driven by public spending offsetting gains and pricing mix. Resilient Flooring EBITDA improved due to our cost-out efforts and price and mix gains. As Matt mentioned, Wood Flooring sales were down due to inventory reductions at a big box customer. However, we saw mid to high single digit gains in the independent retailer channel and builder segments as new housing construction growth begins to flow through to our sales. Despite overall lower volumes, the Wood business was able to grow EBITDA versus 2011 driven by manufacturing productivity improvements. Building products sales were flat as price and mix gains offset volume declines in all regions. In the U.S., we saw continuation of the weakness in our commercial business that Matt has already discussed. For the quarter commercial ceiling's volumes were down in the low single digits. The sales decline in Europe was primarily the result of lower volumes in the euro zone. Although as Matt highlighted, sales in Eastern European markets grew. Excluding the impact of foreign exchange, sales in Asia were down 4%, as activity in new office construction in China slowed in the second quarter. Adjusted EBITDA in building products was also flat as the price gains and higher profit from our WAVE joint venture offset the volume drop and input inflation. As Matt mentioned, AVP's profitability was also suppressed by over $5 million of cost in the quarter associated with the delayed start-up of Millwood and the environmental charges at our domestic plants that we are carrying in our adjusted EBITDA results. Cabinet sales and adjusted EBITDA declined on lower volumes. The Corporate segment was down due to the expected continued decrease of our non-cash pension credit. Core corporate expenses were lower year-on-year. Slide seven shows the building blocks of adjusted EBITDA in the second quarter of 2011 to our current results. Story on the quarter was a volume decline across our commercial-oriented market. This was a $19 million drag on quarterly earnings. For perspective, Europe volume weakness alone contributed to just over half the total EBITDA impact in volume versus the prior year. Price and mix gains exceeded input cost inflation at the company level. Resilient Flooring was particularly noteworthy in its ability to drive mix as Luxury Vinyl continues to grow faster than the market and our products like Alterna and Migrations, our corn-based tile are gaining share. Continued SG&A and manufacturing cost reductions totaling $14 million and higher year-on-year earnings WAVE offset volume headwinds and the lower non-cash pension credit. The net manufacturing cost improvement of $6 million versus the prior year is inclusive of the $5 million of cost associated with the Millwood startup and the environmental charges. Turning now to side eight. You can see our free cash flow for the quarter. Cash earnings are higher than the prior year driven by lower cash taxes but more than offset by higher working capital and increased capital expenditures. The increase in working capital is a year-over-year comparison story as we are now lapping our successful account payables actions that drove outsized payables gains in 2011. Accounts payable was still a contributor to free cash flow in 2012 as is typical from the second quarter. The large capital expenditures are associated with our emerging market plant construction projects. WAVE was also positive year-on-year. Finally, we made significant cash payments for restructuring in the prior year that did not repeat in this quarter and which makes up the bulk of the restructuring and other line. Slides nine through 12 illustrate our year-to-date financial results. Sales were down 2.5% on a comparable foreign exchange basis driven by European macroeconomic issues and continued softness in commercial markets in the U.S. Operating income, adjusted EBITDA, earnings per share and free cash flow were also lower driven by largely our first quarter results. Slide 10 illustrates our sales and adjusted EBITDA by segment for the first half of 2012. The story is essentially the same as for the quarter, so I won't spend much time on this page, but I do want to remind you that in addition to the Millwood and environmental headwinds that building products faced in the second quarter, the ceilings business absorbed $4 million of expenses in the first quarter via transition of the Marietta plant back to our permanent staff and the temporary workers who ran the plant during the lock-out. Slide 11 is our Year-to-date EBITDA bridge and again the story is very similar to the quarter. Lower commercial market opportunity across our core geographies has been a significant drag on EBITDA in the first half. Like in the second quarter numbers, our European segment drove half of the impact to EBITDA from volume. This experience in Europe and the continued softness in U.S. and Asia that is leading us to lower our full year sales and earnings guidance, I'll share more on that later. Of note on the slide, you can see the combined $24 million of savings we have achieved in manufacturing and SG&A expenses to-date, which is on track of our updated savings target for the year of $50 million. Slide 12 is the year-to-date free cash flow bridge, and just like the quarter cash earnings and WAVE were offset by working capital and capital expenditures. On slide 13. As Matt mentioned, we have increased the amount of our cost savings programs to $200 million, a 33% increase from our original target of $150 million and now we expect to achieve $50 million in cost savings in 2012. While before we were not expecting to have additional SG&A savings in 2012 over 2011, the market conditions in Europe and in the U.S. commercial segments have forced us to look deeper to find additional SG&A cost savings and we are seeing a higher yield from our efforts initiated in 2011. The charges we took on the quarter for European restructuring and ceilings would support some of these permanent savings. In addition, we are targeting further manufacturing productivity across our plant network. Our goal is to have the full $50 million in savings fall through to the bottom line in 2012. Slide 14 updates the guidance of 2012. We are lowering our sales guidance from a range of $2.9 billion to $3 billion, now to a range of $2.75 billion to $2.85 billion due to the macroeconomic issues and resulting lower market opportunity we have discussed. Given an essentially flat sales expectation, we are lowering our EBITDA guidance range from $420 million to $460 million to a range of $400 million to $430 million. At the midpoint of this guidance, we would realize a 10% improvement versus 2011, despite low single digit volume declines company-wide. This again illustrates the power of our cost reduction initiatives. As a result of lower earnings, we now expect free cash flow to be in the $30 million to $70 million range, down from $170 million in 2011, as we now anticipate a special dividend from WAVE in 2012 and as capital expenditures rise related to our three China plants and recently announced Russia plant. The midpoint of our earnings per share range is $0.30 from the previous guidance driven by a lower expected earnings for the year. Slide 15 provides more detailed assumptions going into our earnings guidance and includes the specifics on the third quarter. Raw material costs have moderated somewhat, but we still expect to see inflation of $20 million to $30 million from array of items including PVC and plasticizers, TiO2, waste paper, corn starch and other input materials. We continue to expect the fully offset material inflation with price in 2012. Despite flat sales, our manufacturing cost-out efforts, continued focus on improving mix and measured pricing to recover commodity inflation should drive improved gross margins of 50 to 100 basis points. This is down versus our prior guidance as we are not able to benefit from as much fixed manufacturing cost absorption due to the lower volumes. Our non-cash U.S. pension credit will decline to $12 million as we reflect the final stages of our pension de-risking strategy, update demographic and discount rate assumptions and continued amortized market losses in 2008. This is unchanged from April. We expect WAVE's earnings to be flat with 2011, as global revenues decline similar to our core business. This is down from our pervious expectation of a slight increase. We forecast cash taxes of roughly $10 million to $20 million on year, also unchanged from April. Our estimate for the third quarter, project sales to be in the range of $740 million to $780 million basically flat with 2011 on a constant exchange basis. We expect the third quarter of 2012 to produce EBITDA of $120 million to $140 million, compared to $124 million on a comparable basis in 2011. We expect worldwide volumes to continue the trajectories we saw in the second quarter with commercial ceiling volumes down in the U.S. in the low single-digits, commercial flooring to be down mid single digits and the euro zone to be down double digits. We expect U.S. new residential and Asia to be the few bright spots with volumes to be up year-on-year. Global price and mix gains will help sales get back to flat on a year-over-year basis in the quarter. Manufacturing, productivity and mix improvements will be our core earnings drivers in the third quarter. Our capital spending range of $225 million to $250 million is lower than pervious guidance as we uncover savings opportunities and the timing of some spending shifts into 2013. Our emerging market plans remain on schedule. Lastly, for the full year 2012, we now anticipate $10 million to $15 million in EBITDA adjustments associated with already announced actions. This also is unchanged from previous guidance. Clearly the macro climate is a challenge, which we remain confident we are doing all we can to manage in the areas we could control to deliver strong shareholder value creation over the long run. With that, I will now turn it back to Matt.

Thanks, Tom. Well, Tom just said, it is a tough macroeconomic environment and just when one sector or region starts to show signs of recovering another takes a step back. While the market sought themselves out, everyone at Armstrong remains focused on our strategic priorities and of course it includes building and maintaining a competitive cost structure, driven by our now $200 million cost reduction program, investing in organic growth and priority emerging markets as evidenced by building three plants in China and the ceilings plant in Russian, and finally building a winning a team, a globally aligned organization as illustrated by our recently formed global architectural specialties team. So, thank you very much for your attention today, and with that we would be happy to take any questions.

[Operator Instructions] Your first question will come from the line of Keith Hughes, SunTrust.

The question is on both, in Resilient and on Hardwood about the inventory takedown. Your independent channel numbers were very encouraging, and obviously kind of screwed the quarter up. Can you give us any sort of metrics around how big this was in terms of dollars and units or anything of that nature?

Keith, the inventory takedown was more than 100% of the decline in the Americas for the total business. So it was in the range of $10 million to $15 million of sales out as a result of the inventory reductions.

So you said $10 million to $15 million sales?

Yes.

And is that wood?

The predominance is wood, but there is also some Resilient in there as well.

Okay. What are the big boxes telling you the reason for this to basically slower sales coming maybe there is the reason I guess, what's their view?

Their view, one, you have to ask them obviously why they did it, but what we have been told is they want to run the business on lower inventory and so they are relying more on special order express versus in-stock as a way to drive inventory out of the store.

Okay. A question on ceilings, at least domestically, any sort of changes in terms of trends in July, and I guess I would say the same things for Resilient and Wood.

Well, I would say the July order rates reports the estimate for July, they are for the third quarter, Keith. What we saw as a fairly precipitous drop in second quarter and almost every commercial sub-segment, education, healthcare, retail. Not only in new construction, which was, if you go back to the sort of September 2011, or late in the 2012 operating plan, but also in their remodel we saw some of a little bit of softening there as well.

Next question comes from the line of Stephen Kim, Barclays Capital.

Hi, guys. It's John actually filling in for Steve. We are just trying to get a better idea of how to reconcile the sales decline in wood, floor into recent results from like Lumber Liquidators, where they showed sales up high single digits. Do you think it could possibly be share shift, or just trying to get a better idea around that.

Yes. John, it's Matt. I think as Frank said, we had a single big box retailer make a significant reduction in their in-store inventories. We didn't lose share at that retailer, but that retailer's actions probably affected their sell-through. We saw an offset, not entirely, but through other independent channels. So I think that's the best way we could describe. As Frank said, it was more than 100% of the drop. So one customer, one decision affected us.

Got it. For the Wood Flooring business, what is the percentage of big box sales done?

It's between 25% and 30% of our total volume.

The next question comes from the line of Mike Wood, Macquarie Capital.

Do you have visibility in your channel in terms of weak supply of inventory and could you give us that number?

You mean the inventory part of that channel themselves?

Yes. Did they give you that data to know what the current level of inventory is running, I guess are we bottomed out now. They have done the full de-stocking?

We don't really have visibility to that. We try to manage or measure sales out. That's as good a proxy. We are obviously very close to the distributors.

Okay. Then sequentially in the Wood Flooring business, looks like your incremental margin were something like 59% 1Q to 2Q. Is that largely a favorable margin shift from a higher independent retail mix?

I am sorry, Mike. I'm not sure I understand the question. Could you repeat that?

1Q to 2Q, on slightly higher sales, you had a pretty big operating margin improvement and I am wondering if that was a favorable margin shift that you had from having less big box sales versus the independent retail sales in that Wood Flooring segment?

Yes, Mike. This is Tom. I would say. Wood business is significantly benefitting from prior year cost takeout, and sequentially sales were up almost $20 million on a normalized basis. So I think you are getting simply a little bit of that SG&A and productivity benefit that we are taking the whole year up on as well as the fall through on the sale. So I think there is a cost or productivity at the plant have been good.

Your next question comes from the line of Kathryn Thompson, Thompson Research Group,

Hi, thanks for taking my questions today. Not to beat the dead horse and talk about with wood flooring again, but our big box inventory reduction is just specific to flooring or are there other categories that are being impacted the push in this big box retailer to reduce inventory.

In our case, Kathryn, obviously it's more significant in flooring than it is in building products, just because it's a bigger part of Frank's business than Vic. So that one customer's actions affected both, categories, both businesses, but it was a much bigger part what happened to Frank.

So you are seeing in other categories a push to reduce inventories meaningfully?

Well, we are seeing it not only in the categories that we sell, but across a lot of the categories they merchandise.

What are the categories?

Beyond ceilings and floors?

Yes.

I would hesitate to comment on that. That's probably better left for them to comment on. I mean I would confirm that to the extent that they have de-stocked, it's a lesser impact on our building products felt good as well.

Did they give a rationale for a broad-based inventory reduction?

You know what? I just feel uncomfortable continuing to comment on what their strategy might be. Our intent here is to point out the fact that that decision had an inordinate and probably disproportionate impact on our business. We are just trying to be transparent about it.

Okay. How much did a softer Europe impact ceiling demand in the quarter?

I think ceilings because of the balance, the breadth of the coverage. Our building products business gets significant benefit from a strong Russia as we said sales were up 30%, Middle East continued to be very strong just in general terms for us. So it had significantly less negative impact on us than it would have had in floors. Our Flooring business is almost entirely euro zone, while centered in the Germanic countries, which was less effective than the Mediterranean countries. Obviously, we had a more significant impact there. 90% of our flooring business in Europe is tied to public spending. So with that austerity measures been taken and some are just the political stuff that went on in the quarter, it's only affected our flooring business more than our ceilings business.

If I could add, Kathryn. I would say, clearly we expected Europe to be down on the second quarter. It just was worse than we expected. It wasn't the whole miss on sales, and we have dramatic variation on our sales versus our guidance range. That wasn't all to claim by Europe as we had to build some of that up, but it did get worse, what I will the 5% to 10%.

Okay. So, flooring had a bigger impact than ceiling?

Yes.

Absolutely.

All right. I will get back in the queue. Thanks.

The next question comes from the line of Bob Wetenhall, RBC.

Hey, good afternoon. Thanks for taking the question. I wanted to understand, last year, you guys did around $375 million of EBITDA and Tom had said in his prepared remarks that you are looking for $50 million of cost savings to drop to the bottom line. So I am just trying to understand, that gets you the $425 million? And given what's going on in Europe in the difficult macro condition, care you very confident that the bottom for EBITDA this year is going to be $400 million. What's the assumption going into that around Europe in the back half of the year?

Sure. This is Tom. What I would say that our guidance range of $400 million to $430 million, given the volatility of our business and the excellent on the way up and tough on the way down incremental margins. It's a pretty tight range. So it does have an assumption of kind of some level of macroeconomic activity built in, and I would say that we are still assuming Europe down double-digit in the back half, and that the domestic market continues to be down as well into commercial segments, low single digits in North American ceiling as I highlighted. On the commercial side, flooring also down low to mid single digit. So we have an assumption of continued pressure on volume, heavy from Europe, but how much worst can Europe get? To lose $10 million of EBITDA at kind of our average incremental margin we have talked about, one would have to lose $30 million in sales to move $10 million of EBITDA, all right? So, comes out to what your expectation how bad Europe can get. Right now we felt like we have got it called accurately, but it's tough first of all to read?

Understood. Obviously, the volume environment is kind of soft right now, do you think the difficulty from demand side will impact the price and mix area we are doing so well, or do you think that's also susceptible?

Bob, this is Matt. Price and mix continues to be a bright spot for us. I think team is doing a great job of driving price in both businesses. We are seeing mixed benefits from new product, some of the segment shift, and we are hopeful that holds on even in light of some demand pressure.

I do think the way to look at our pricing, Bob, will be kind of net of material cost. So I think the indicator to watch is what's happening to commodity costs and inputs I think to the extent to that we have kind of volatility. We will continue to be able to price and hold price in that environment. I think that it's a straight nose drag down on commodities. We will get a benefit there, but we're also going to be able to get the price that we hope for, but I think in net, we'll still be positive on the year and still be able to likely do better than competition in that measure.

If could just sneak last one in quickly, could you just give a little color on what you are seeing in terms of the inflationary headwinds and where those are coming across?

Yes. We are looking at $20 million to $30 million of additional inflation this year. So it's increasing at a lower rate than we saw last year, and it still is based primarily on PVC plasticizers than to a lesser TiO2.

One thing, that's kind of rearing its ugly head for us right now is corn starch, which is a big ingredient in ceiling piles with corn running hot. So I think it will continue to be in those key materials.

The next question comes from the line of Dennis McGill, Zelman & Associates.

Hi. Thank you very much. Matt, I think you touched on this a little bit, but correct me if I am wrong, I think you said flooring in Europe was down 17 for the quarter, ceilings was down 2. Can you just talk about the pace of what you saw, maybe sort of between both, Europe and then some more question on just domestic non-res. As far as the [Phase 3] in the quarter ended July are you seeing any bottoming or improvement in those rates of decline?

Yes. As Tom mentioned a while ago, we certainly expect that Europe in total to be soft. It was just softer than we anticipated. Again, the European business is very different, or the European environment affects flooring and ceilings very different. As you rightfully say our flooring business was 17% it's been a tough year on the demand side for flooring all year. We are tied 90% to the public spending. It dropped a little bit through the quarter, little bit more than we had anticipated and again geographically we are staying relatively broad-based drop geographically. The Ceilings business was helped by the Middle East and pretty significantly by Russia as we pointed out we are about 30% there. So we have a broader economic base. In ceilings, we also have a bigger position in the U.K. in ceilings than we do in floor. So while we were little disappointed in the ceilings volume based on what's going in the market, we are satisfied with our +B earnings improvement we saw based on the cost reduction activity, both in our fiber and metal ceiling architecture, so nice improvement there. In terms of North America non-res, that's flattish. Certainly, the new construction is up and kind of about where we expected it to be. So no good, no better news than expected but now worst news, but we did see softening in the remodel business as consumer confidence is back and existing home sale is back. So we will see them down and that's a source of remodel. You buy an existing home, you remodel it. So that goes as past zero, that is going to put pressure on that remodel. So we will see that of curse and Residential Resilient and wood for demand.

Okay. That second comment on North America that was across all the products, not ceilings related?

Exactly.

Okay.

North America would be almost entirely floors.

Right. There are a lot of issues going on within the Wood Floor and between inventory corrections in the quarter and then the service issue last quarter and then you have got a little bit of a disconnect between the construction cycle and when the floors go in. How do you think about sort of the underlying growth between on the flooring side between residential, new and home improvement, if you think about pure customer demand.

Well, that's a good question. The flooring services issues are behind us, so we executed the plan that Frank laid out for you a quarter ago. Service levels there are back to the historic highs, and there are really no perceptible impact on demand as a result of that, but down draught that we got in the big box, certainly didn't anticipate it coming into the quarter. We would like to hope the decade is corrected. I think that the fundamental demand in residential new construction will continue to sustain. It will be a positive, albeit kind of where we expect through the year. I am concerned about resi remodel, because it is very dependent on our consumer confidence than probably less directly on meaningful improvement in unemployment. So that isn't where we wanted to be and we have a very modest view of that that is factored into our outlook in the estimate for the balance of the year's outlook.

Then just to wrap it up, the residential side realizing those consumer issues and you mentioned existing home sales it could be but whether that's a driver or not. You are seeing strength of the independent retail side though. So do you feel like they are taking share? Or is there something else going on within that segment of your customer base?

I think as Tom and Matt had said earlier, Dennis, we experienced mid-to-high single digits growth in our independent business. I think largely driven off of the strength of new construction and the strength of that market. We think we did as well as if not slightly better than the market in terms of performance, but clearly on the independent side with the mid to high single digits, we are benefitting from the strength in the new construction.

Next question comes from the line of Jim Barrett, C.L. King & Associates.

Tom, I think this is a question for you. Can you give us your current outlook for steel cost for the grid business, and how would you expect WAVE's margins to behave if steel prices were to subside near to intermediate term from here.

Well, I would say number one, the grid had a very good second quarter largely. Little bit of history lesson our WAVE on the margin. If you recall they had price increase in the first quarter, a couple of price increase that pulled a lot of volume, in the first quarter of last year. So number one, they had a tougher second quarter of 2011, and a pretty easy comp this time around. Although we did built some share, we believe, this quarter and I think fundamentally given the uncertainty around steel prices, I don't think that they are going to be able to drive significantly more margin growth in the current year beyond what we have seen to add to earnings. I think really there's going to be a let's drive volume, let's drive share and that's going to be the orientation particularly in Europe and that will be the story that hopefully holds some flex by the tough market environment. To your first point on the actual price of steel that's in fact in this forecast. I will have to get back to you on that one. I don't have that at the top of my head, Jim.

Generally, is the view that you are taking share from your leading competitor or from some of the weaker player or players in the market?

We don't think we are winning share versus USG, which is the big player here in the U.S., I think we are winning in Europe. They are a player in Europe, although I wouldn't necessarily they are the share donor or there are a lots of more fragmented players a lot of our key competitors don't have their own grid, they are sourcing a grid from the third-party and that's where our system sale is really adding value to us. Vic, you want to add anything to that point.

No, nothing to add.

Thank you, both very much though.

I will get you back that data point you asked for.

Appreciate it.

Next question comes from the line of Rodny Nacier, KeyBanc Capital Markets.

Hi. Good afternoon, everyone.

Hi, Rodny.

All right, I dropped off for a little bit, so sorry if my question has already been asked, but just going back to the wood business for my question. You had commented on big box, and they are looking to run on a more adjustment time model I think you said, so I was wondering how does that impact your supply chain capabilities and your ability to meet demand on a more real time basis and specifically the impact on your margins and leverage going forward in the wood business. Then secondly, along the same lines, what would your expectations be of similar inventory actions potentially out of some of your other Big Box customers as a broader end market trend?

We haven't adjusted significantly to supply chain to address this. We are hopeful that they will reverse the strategy quite candidly. There is no sign that any of the other big box would follow the strategy. Again I don’t want to comment on a customer's strategy at all, but I think if that does become a trend, and if then likely Rodny, we would be able to adjust accordingly. As Frank pointed out, we certainly picked up a lot of that lost share to the segment, if you will, through the independent channel, we saw pretty significant growth.

Okay. That's helpful. My next question is more on your capacity build out. In China, in the past, I think you framed out in aggregate amount of sales you expect out of those three China plants at rough $200 million. With the current environment in China, and you commented on maybe some slowdown in Asia, could you provide some sensitivity around what sales outlook might be if trends don't improve, or perhaps maybe the time line to ramp up to the $200 million?

Yes. All good questions. At this point, we are not adjusting our outlook. We have seen a little softening in commercial office. Our building products team is working hard to drive specifications in healthcare and education. That's benefitting our flooring business. So the relative strength you see in flooring there is value proposition for Resilient Flooring is accepted. In education and healthcare, we are working on conversion of cinder block and drywall in both of those segments for ceiling. So we remain bullish on China, and despite the government managing the economy to sort of reflect the inflation, they're still focused on segments of the economy that are traditionally very strong for us. So we are sitting here today optimistic that the plants open on time, our teams are working to build demand and we are not changing our outlook or timeline or guidance relative to that at all just based on what we've seen recently. The plants in China are to serve broad pan-Asian demand. So that's the sort of demand in India, good sort of demand in Southeast Asia, and these are all places that demand is being served today from capacity outside of Asia. So we still view a lot of this, Rodny, as a catch-up.

[Operator Instructions]. Your next question is a follow-up from the line of Keith Hughes, SunTrust.

Frank, just on the inventory takedown of the big box, was that the result of kind line review or have you lost some slots or skews or is it just simply emptying a warehouse though?

Absolutely not. We had no line review impact. Our relative share there hasn't moved it. They are broad-based retail strategy. Anything else?

No. That's correct. It's not a result of any line review. Our facings have not changed in fact the base number of facings we have has gone up slightly in the last five months. It's, clearly, right now an inventory play.

One follow-up on your comments on residential renovation. You also always see into earnings very similar comments to what you guys are making. Frank, as you talk to retailers, in the flooring space, what are they telling you, what are they hearing from consumers. Why is they have not followed along with this continuing boom here in new construction?

Well, I think there's a couple of things. One is when retailers tell us is, there's not a lot of people in their stores. So it's very sporadic, Keith. They will have a Saturday, where they'll have four, five, six appointments for installs and then they will go through four days with nothing. What it comes back to is one is we talk about boom in new construction, on a percentage basis that's true and you look at absolute number of housing starts incremental, it's not that significant. There still is lot of uncertainty around. Where is the economy going making big investments in the home, existing sales were down, people don't have the equity to move. I think it's all that familiar tape that we have heard before that continues I think to suppress some of the remodel or replace activity.

A little bit of color on that, Keith. We track very closely existing home sales and first quarter according to U.S. Census Bureau and National Association of Realtors, existing home sales declined 6%. The trailing 12-month inclusive of the first quarter was off only 1%, so you saw a deceleration of the existing home sales, and that churn of the housing stock is a much bigger driver obviously through the remodel, but as a total portion of our residential business. So that's what we're watching closely I think the step back of consumer confidence as a reflection of that.

Your next question is a follow-up from the line of Bob Wetenhall, RBC.

Hi. Thanks again for the color today. I was hoping, as opposed just to talking about this quarter, you could give update on what you are thinking about in terms longer term growth prospects for 2013. I know you are building some stuff out in Russia and China, and I was trying to get an idea if those will be coming on and kind of become their growth engine for the Armstrong story next year or if you feel that that's going to be delayed a bit due to macro development.

Well, we are not prepared really to talk about 2013 and beyond the information we share at our Investor Day, but the Russia plants comes out in the end of 2014, 2015. So that's a driver of relative growth then the other plans in China coming on as we forecast in the past. Obviously as we think about 2013, we need to consider exiting this year in a softer environment here in North America that we anticipated entering it. We still that even in a challenging operating environment, making big bets in emerging markets like China, like Russia, expanding our presence in places like the Middle East, India, make sense. Our ability to adjust our value proposition and fit those whether it's Resilient Flooring in a hospital and re-ad, whether it's architectural specialties in an airport in Dubai, whether it's just driving continued penetration in Russia by improved services and targeted products with a plant there, driving conversion in China from drywall and cinder block. Fiber ceilings are participating in the government emphasis on healthcare and education in China. Our value proposition works, the investments are meaningful, but I think well priced very responsible. So even in a tougher operating environment that may come our way in the next two to three years we think these investments make frankly, arguably more sense than ever.

One other point if I could chime in there. We are on track for the plant start up. So you will start seeing show up in the first quarter from a homogenous plant in China on schedule. You will start revenue from our ceilings from China and into the second quarter. So they start coming on and are revenue contributors next year and as Matt framed Russia is out of that and head roll is in the second half 2013. So that starts to build in 2013. I think we haven't given specific revenue numbers, but we do see those plant as important contributors, because we think that' probably still going to be tough next year in the domestic market. One of the things why we don't like the fact that our sales were down, we're very proud of the fact, we are delivering year-over-year EBITDA and earnings per share performance. Despite tough volume and despite significant investments to build these plants, they built out the organizations in those markets, right? Those organizations don't turn on when the plants come on. We are investing now with feet on the ground. We are investing teams to build these plants all running through, the earnings that are dropping to the bottom line and so we talked about the savings program. I think that's keeping our earnings afloat is the savings program and we are really proud that we are able to frame now the goal up to $200 million and net all falling to the bottom line as our goal in the current year. We have never said that despite us building out more of these plants and building up the organizations and more to come. So a little bit of the context and hopefully these investments pay off soon and on schedule, but we are all in a little bit of the wait and see mode at this point until those plants come online.

That's helpful and good luck with the growth story, and thanks for all the color.

Thank you, ladies and gentlemen, for your questions. This concludes today's conference. Thank you for your participation in today's presentation. You may now disconnect and have a great day.