Armstrong World Industries' CEO Discusses Q4 2013 Results - Earnings Call Transcript

Feb.24.14 | About: Armstrong World (AWI)

Armstrong World Industries, Inc. (NYSE:AWI)

Q4 2013 Results Earnings Conference Call

February 24, 2014, 11:00 AM ET

Executives

Thomas Waters - Investor Relations

Matthew J. Espe - Chief Executive Officer

David S. Schulz - Senior Vice President and Chief Financial Officer

Thomas B. Mangas - Executive Vice President and Chief Executive Officer, Armstrong Floor Products Worldwide

Vic Grizzle - CEO of our Worldwide Ceilings Business

Analysts

Keith B. Hughes - SunTrust Robinson Humphrey, Inc.

George L. Staphos - BofA Merrill Lynch

Kenneth R. Zener - KeyBanc Capital Markets Inc.

Michael Rehaut - JPMorgan

Robert C. Wetenhall - RBC Capital Markets, LLC

Kathryn I. Thompson - Thompson Research Group, LLC

Nishu Sood - Deutsche Bank AG

Will Randow – Citi Group

David MacGregor – Longbow Research

Dennis McGill - Zelman Associates

Eli Hackel – Goldman Sachs

Stephen S. Kim - Barclays Capital

Justin Bergner - Gabelli and Company

Operator

Good day, ladies and gentlemen, and welcome to the Armstrong World Industries, Inc. Fourth Quarter 2013 Earnings Conference Call. At this time all participants are on a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). As a reminder this call may be recorded.

I will now introduce your host for today's conference, Tom Waters, Vice President of Treasury and Investor Relations. You may begin.

Thomas Waters

Thanks, Ashley. 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 today are Matt Espe, our President and CEO; Dave Schulz, our CFO, Tom Mangas, CEO of our Worldwide Floor businesses; and Vic Grizzle, CEO of our Worldwide Ceiling's business.

Hopefully you have seen our press release this morning, and both the release and the presentation Dave Schulz 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 more detailed discussion of the risks and uncertainties that may affect Armstrong please review our SEC filings, including the 10-K filed this morning. Forward-looking statements speak only as to 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.

Matthew J. Espe

Thanks, Tom and good morning everyone. I will lead off this morning with a recap of quite frankly a year of mixed results and I will spend a minute on fourth quarter results versus our guidance for the 2013 market and operating performance versus our expectations when we entered the year and then update you on the challenges in the Wood segment. I will recap 2013 strategic events and finally give you a preview of our thinking on 2014. Dave Schulz will take a deeper dive in our 2013 results and 2014 guidance.

On a top line basis the fourth quarter 2013 was about as expected with sales of $661 million in the middle of our guidance range of $645 million to $685 million. EBITDA for the quarter at $71 million was within our guidance range but disappointingly close to the $70 million bottom of the range. Wood Flooring profitability continued to be a challenge as lumber inflation, weak mix and a continued reliance on pre-dried lumber hurt our profitability.

I will discuss in a few minutes a change in our strategic approach to the Wood business. On the bright side, the Ceilings business delivered another record EBITDA quarter in the Americas and globally. Ceilings also capped off a record year of EBITDA despite volumes more than 20% below peak levels. We entered 2013 expecting an uptick in new home construction and modest improvement in residential repair and remodel activity, and our forecast turned out to be pretty accurate.

Strong demand in the building channel ensured gains at the home centers and independent retailers contributed to top line sales growth in our Wood business. Wood volumes were up in the high teens, and excluding the impact of the 2012 divestiture of the Patriot distribution business from the base period.

On the North American commercial side, we anticipated a continuation of flat to slightly down commercial volumes, again we were largely on the mark here. Pockets of the Ceilings business in the U.S. exhibited growth for the first time since 2006. The commercial growth in Ceilings didn’t translate into the flooring business as education in healthcare remained depressed.

The Commercial Flooring business in the Americas did experience significant mix gains as high-end LVT grew while base grade VCT contracted. In Europe, we expected lower sales in UK and in continental Europe, but anticipated growth in Russia and Middle East.

Markets for both our businesses in continental Europe came in below expectations. But the Ceilings business saw growth in the UK. Volumes were up in Russia, in Middle East, and other emerging European markets but below our expectations.

In the Pacific Rim, we expected double-digit sales growth in China, India, and Southeast Asia, and continued declines in Australia. India exceeded expectations. Southeast Asia was essentially on target, but China lagged. Mineral fiber ceilings and resilient flooring sales were up in China but only in the high-single digits as softness in privately funded sectors hindered sales. Australia was down as expected. Sales for the year of $2.72 billion were within our initial guidance range of $2.7 billion to $2.8 billion.

Operationally, we largely performed as expected with solid productivity in North American resilient flooring and ceilings. However, the exception to this as we have talked throughout 2013 was our Wood segment. Bottom line results in this segment have been and remained challenged. During 2013, Wood Flooring was faced with an unprecedented series of headwinds, an unexpected surge in demand, scarcity of green lumber, and an extraordinarily rapid and persistent inflation.

In response to these challenges, we added staff and ran our crews on overtime. We purchased pre-dried lumber at an increasing premium to green lumber, and we implemented numerous and significant price increases. Despite these actions, margins have yet to improve. These challenges have been exacerbated by the fact that the majority of the demand surge has been for new home construction, which is our lowest mix and margin channel.

As a consequence of these challenges and soft European market conditions, our full year adjusted EBITDA was $371 million. This was within the guidance range of $370 million to $390 million that we provided at the end of the third quarter but below our initial 2013 guidance that we outlined at the start of last year at $390 million to $420 million. Essentially, the entire miss versus our initial EBITDA guidance can be attributed to the Wood segment.

With Tom Mangas taking over the floor leadership position and with other recent management changes in the business, we’ve taken a fresh look at our strategic options for Wood. As a result of continuing lumber inflation, increasing premiums for pre-dried lumber, and weak mix, we’ve taken a decision to change our approach in this segment. Now, instead of trying to maximize share growth, we’re shifting the manufacturing to volume and mix of products that we store structural attractiveness for the segment.

We'll constrain purchases of pre-dried lumber to select high value species and will significantly limit over time. At current market prices, it doesn't pay to endure overtime costs in the pre-dried premium for lumber.

Finally, we’ll prioritize the manufacturing of higher end products. On top of these actions, we’ll need to continue to drive further price increases to cover lumber inflation. To that end, we executed 6% to 12% increases that took effect earlier this month on selected products. This increase covers lumber inflation through February. If lumber rises beyond current levels, additional actions are going to be necessary.

Hidden within the bad news in the Wood segment is the increased manufacturing capacity we created at our solid wood plants through our lean efforts. These plants can now finish more work than they can dry. And so, within our 2014 capital expenditure plan is about $10 million to increase green lumber drying capacity. This increased capacity will not come online until late this year, so we’ll constrain 2014 output to our current drying capacity, which is lower than 2013 volumes.

If pre-dried lumber prices drop to more normalized premiums versus green lumber, we may resume utilizing this material to drive volume growth. Barring that, 2014 will be a year of giving back some of the share we gained in 2013.

Price increases and mix improvements should result in roughly flat year-on-year wood sales, however, with improving margins. Dave will walk you through more of the details of our quarterly and full year financial performance in a few minutes.

Stepping back for a moment to look at the big picture, 2013 was an important year in the evolution of Armstrong. We took significant steps to position us to benefit from future global growth. We completed and operationalized a new mineral fiber ceiling plant and heterogeneous and homogeneous flooring plants in China. Our Russian ceiling plant is now under roof and beginning to receive equipment with construction completion targeted for year-end.

We announced a $40 million investment in LVT capability to be housed within our Lancaster, Pennsylvania flooring plant. We're making investments in metal ceiling manufacturing in China and have added capacity and capability at our Hilliard, Ohio ceiling facility. At $214 million of capital expenditures, 2013 was the largest organic investment year in Armstrong's 150-plus year history.

With elevated levels of investments continuing through 2014, Armstrong will spend about $750 million on capital expenditures from 2011 through 2014, almost double our normal run-rate. Importantly, these projects have been completed largely on time in aggregate under budget and with an exceptional level of safety.

Also of significance in the fourth quarter the Asbestos Trust and TPG executed an additional secondary offering of 6 million shares of Armstrong stock in November. When coupled with September sale of 12 million shares of which we repurchased 5 million shares the Trust and TPG have reduced combined their ownership of Armstrong from over 50% at the beginning of 2013 to roughly 25% at year-end.

Looking forward to 2014 we expect sales growth to be aided by commercial volume gains for the first time since 2006. However as in recent years we anticipate price and mix to provide the majority of year-on-year sales gain.

In the ceilings business we anticipate volumes to be slightly to be up slightly in the Americas, in Europe despite the recent uptick in residential activity we expect commercial sectors on the continent and in the UK to continue to contract but the overall European region should expand with growth in Russia and the Middle East. Pacific Rim will be up despite a continued weak Australia.

Architectural specialties will contribute to ceiling growth in all geographies. The flooring business will see strong volume gains in the Pacific Rim led by China and we expect modest growth in Europe driven by new products as well as growth in Russia and the Middle East. Commercial flooring in the Americas will be roughly flat with growth in retail with continued challenges in education and healthcare.

Now as you think about North America and commercial construction let me remind you that given our products a new commercial project started today typically doesn't have its floors or ceilings installed for 12 to 24 months. Now as we contemplate the commercial recovery there are several differentiating factors from the wood business I would like you to be aware of. First we typically have much more visibility to turns in commercial construction and residential as illustrated by the lead time of new projects I just mentioned. Second the Resilient Flooring and ceilings businesses have much less volatility in raw materials and a better pricing power than the wood business.

Then finally capacity is available and easier to scale up as ceiling and resilient flooring manufacturing is less labor intensive than wood flooring and their plants are located in more populous regions than the wood plants. So global sales growth in the mid-single-digits we're poised to grow adjusted EBITDA.

Year-on-year manufacturing productivity should return to historical levels. As we anticipate gross margin will improve by 100 to 150 basis points in 2014. The China plants will contribute positive results versus 2013 but Russia and the LVT plant in Lancaster will largely offset these gains. It won't be until 2015 when all plants are operational that we expect tailwinds from these investments.

Inflation is expected to remain a headwind in the wood business, but Tom and the team focused on price realization, limiting pre-dried lumber and driving operational execution. SG&A spend will be up as we continue to invest in our growth opportunities in the emerging markets and Architectural Specialties and as we cope with wage and benefit inflation on a global level.

So with that let me turn it over to Dave to discuss the results and outlook in more detail including our guidance on the first quarter of 2014. Dave?

David S. Schulz

Thanks, Matt. Good morning to everyone on the call. Reviewing our fourth quarter and full year results I will 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 and explanation of our standard basis of presentation.

As you can see while quarterly sales were up 8.1% versus 2012 on a comparable FX basis the various profitability measures and free cash flow were down year-on-year. I will address the drivers of EBITDA and free cash flow on upcoming slides.

We closed the fourth quarter with net debt of $931 million, up from $735 million at the end of 2012. Net debt was impacted by our $260 million share repurchase in September partially offset by 12 months of positive cash generation. Finally our unadjusted return on invested capital on a continuing operations basis was 8.2%, down from prior years as profitability was lower in 2013 and 2012. I will discuss the drivers of profitability when I review the full year numbers.

Slide five details the adjustments we made to EBITDA and provides a reconciliation to our reported net income of $11 million in the quarter. As you can see we have $9 million of cost reduction charges related to severance in our European and Australian flooring manufacturing sites as we right-size capacity for market opportunity. In 2012 we had various small cost reduction initiatives totaling $4 million.

Our typical fourth quarter tax rate is usually quite high due to the large impact of un-benefited foreign tax losses in a seasonally low profit quarter. This was true in the fourth quarter of 2012 when our book tax rate was almost 70%. In 2013 we have fully utilized our Federal bankruptcy NOLs and have engaged in tax planning around R&D credits and domestic production activity deductions.

In the fourth quarter of 2013 we booked a multi-year R&D tax credit and benefited from the favorable year-over-year impact of R&D tax. These planning activities lowered our tax rate to 41% and will provide continued benefits although not of this magnitude going forward.

Moving to slide six, this illustrates our sales and adjusted EBITDA by segment for the quarter. Resilient Flooring sales were down 2%, sales in North America were down driven by modest volume declines. Sales in Europe increased and the Pacific Rim was down as volume growth in China and India were more than offset by declines in Australia and foreign exchange. Overall for the segment price was down slightly while mix was up driven by premium DCT and LVT. Despite lower sales adjusted EBITDA was up $9 million with improvements in all geographies. Although mix gains in manufacturing productive as-well-as SG&A savings in developed markets drove the year-on-year profitability gains.

Wood Flooring sales were up 24%. Volume was up double-digits and price gains were greater than 10%. In the third quarter price increases were just under 9% year-on-year, so you can see that we continue to get traction on pricing. Despite the volume and price gains wood profitability lagged the prior year. Adjusted EBITDA was down $7 million as lumber inflation, manufacturing cost and weak mix continued.

Turning to Building Products, sales were up 10% driven by gains in volume, price and mix. All geographies experienced volume gains. Sales in the Americas were up driven by both the U.S commercial and retail channels. The Europe, Middle East and Africa region saw sales growth in Russia, the UK and the Middle East. Additionally European sales benefited from strong result in the Architectural Specialties business. Pacific Rim sales were up double-digits when excluding the impact of foreign exchange.

India, Australia and Southeast Asia were all up. China mineral fiber sales were up double-digit offset by Architectural Specialties sales which were down against the prior year quarter. Adjusted EBITDA in Building Products increased $1 million versus the fourth quarter of 2012. As Matt mentioned the America saw a record fourth quarter profitability with adjusted EBITDA up over last year as strong sales and production performance offset timing driven increases in SG&A and environmental reserve increase.

European profitability was down despite higher sales driven by cost from our Russian plant construction and SG&A expenses. Asia profitability was up slightly as increased revenues offset higher fixed manufacturing cost from our new plant. The corporate segment was down driven by pension expenses and higher benefits cost.

Slide seven shows the building blocks of adjusted EBITDA from the fourth quarter of 2012 to our current results. As you can see price mix and volume were all positive, our price did not cover inflation due to continued increases in the lumber cost in the wood segment. The inflation headwind was almost entirely due to lumber. Manufacturing cost was slightly negative as headwinds from the wood segment and our plant startup cost more than offset productivity improvements in the ceilings and North American resilient businesses.

SG&A cost were up driven by spending in the emerging markets, architectural specialties, some of the corporate expense items I mentioned earlier and timing relative to other quarters particularly in the ceilings business.

WAVE added $2 million to our year-on-year results primarily driven by the benefit of volume and manufacturing productivity. Our non-cash pension credit is lower in 2013 as we have mentioned throughout the year. Finally depreciation is increasing as we bring our new manufacturing facilities online.

Turning now to slide eight you can see our free cash flow for the quarter versus 2012. Tax earnings were lower than prior year and while working capital was flat in the quarter when compared to 2012 receivables and inventories did not drop as significantly as in the prior year. Capital expenditures were similar to 2012 with this year’s spend in Russia roughly matching last year’s spend in China. Cash interest expense decreased by $3 million as a result of our March refinancing.

Beginning with slide nine, I will discuss year-to-date results. As you can see sales were up 3.9% and would have been up almost 5% if we adjusted for the Patriot divestiture in 2012. Year-to-date sales growth came primarily from our wood flooring and U.S. commercial ceilings business. European flooring in our Australian businesses were down. Operating income, adjusted EBITDA and EPS are all down year-to-date. The outsized drop in EPS per share relative to EBITDA and operating income is driven by a $19 million non-cash charge we took in the first quarter to write down unamortized fees from prior credit agreements. Recall this was part of our March 2013 refinancing and new credit agreement. This negatively impacted EPS for the full year by $0.19.

Slide 10 illustrates our sales and adjusted EBITDA by segment for the full year period. Resilient Flooring sales were down 2%, volumes were down in all regions partially offset by higher price and mix. Adjusted EBITDA was up $6 million for the year driven by strong performance in the Americas. EBITDA was down in the Pacific Rim and Europe due to plant startup cost and volume declines respectively. The year-to-date improvement in the Americas was driven by strong manufacturing productivity gains, better mix, much of it coming from the LVT category and lower SG&A expenses overcoming the lower year-to-date volumes.

Our worldwide Resilient business achieved its highest EBITDA since the emergence from bankruptcy despite historically depressed volumes and investments in the emerging markets. Wood Flooring sales were up 16% and would have been up more than 20% if not for the Patriot divestiture. For the year, wood EBITDA is down $31 million from 2012. Matt detailed the issues in wood so I will not repeat them here.

Building products sales were up 4%. Sales were up in all regions driven by volume gains in Asia and emerging European markets as well as improved price. Adjusted EBITDA in the building product segment increased $16 million. The increase in profitability was driven by the Americas as price, mix, manufacturing productivity and earnings from the WAVE joint venture all improved which more than offset the emerging market expansion expenses in Europe and Asia. The corporate segment was down $22 million driven by global pension expenses, higher benefit cost and outside consulting services.

Slide 11 shows the building blocks of adjusted EBITDA for the year. The bars are all directly the same as the quarters so I won’t dwell on this slide but I do want to reiterate the magnitude of the lumber inflation which accounts for the majority of the $49 million input cost bar.

Slide 12 shows the company generated $68 million of free cash flow for the year, down from $88 million in 2012. Cash earnings were lower, while working capital experienced significant year-over-year improvement driven by accounts payable. Capital expenditures were higher and interest expense lower as a result of our March refinancing.

Slide 13 provides guidance for 2014. We expect sales in the range of $2.8 billion to $2.9 billion, up 5% at the midpoint from 2013 and adjusted EBITDA in the range of $400 million to $430 million, up 12% at the midpoint over 2013. Free cash flow expectations for the year range from $60 million to $100 million.

Slide 14 provides more details of the assumptions in our 2014 guidance. I want to provide some additional comments on some of these factors. Gross margins are expected to increase 100 to 150 basis points as we continue to focus on manufacturing and productivity and the actions that Matt discussed in the Wood business to improve margins. Let me provide some additional perspective on the new plans.

Recall we provided guidance in 2013, that we would have about $15 million of incremental manufacturing cost above 2012 related to the new plants plus about $10 million of additional SG&A as we build out the organization in the emerging markets. We also indicated that the $10 million of incremental SG&A for the emerging markets will continue into 2014. For 2014, we expect an additional $10 million of expenses associated with the Russia Ceilings plant and LVT investments.

These costs are extensionally offset by the incremental benefit of the EBITDA generated from the three new plants in China. We anticipate SG&A will increase 50 basis points in 2014 as we continue to invest in the emerging markets in the Architectural Specialties business.

Lastly I want to comment on the tax rate. We expect our 2014 tax rate to be 44% up versus the 2013 rate and reflecting the impact of losses in our foreign subsidiaries. This is driven by two issues, continued market softness in Europe and the cost of new manufacturing plants in China and Russia. We continue to expect the long-term adjustment ETR to be about 39%.

For Q1 we expect sales to be in the $625 million to $665 million range. At the midpoint this represents a 4% increase over the prior year quarter. We anticipate EBITDA will range from $75 million to $90 million, a 6% increase at the midpoint driven by modest volume, price and manufacturing savings partially offset by inflation and emerging market investments discussed earlier.

With that I’ll turn the call back to Matt.

Matthew J. Espe

Thanks Dave. The other important change we witnessed with Armstrong in 2013 was an example of the organization by some of the initiatives that I discussed at various points in time. With the retirement of Frank Ready, as Head of our Global Flooring business in the fourth quarter we’re able to execute on a series of succession rules that had been planned in advance with our Board of Directors, and transitioned of Tom Mangas from CFO into the Flooring Leadership role.

We were also able to promote Dave Schulz from his position as Vice President of Finance in our Global Ceilings business into the CFO role. These changes as well as promotion of Ellen Romano to the Senior Vice President HR role that happened earlier in the year are great examples of the organizational development actions that have been implemented since 2010, and provide a glimpse of the management depth we’ve been able to build and retain within the company.

So with that we’d be happy to take any questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question comes from Keith Hughes of SunTrust. Your line is open.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc.

Thanks. I wanted to dig into two areas, one just any more detail you can give us on building products in the quarter on how the occurrence of some of the SG&A cost and things like that, the breakout between that and startups. We just would have expected a lot more flow through --?

Matthew J. Espe

Well just a couple of comments and let Vic add, the SG&A expenses invested in the fourth quarter were in emerging markets and Architectural Specialty. So those will largely be in place as we go forward, as we continue to invest for growth in Russia, India, and China. The revenue stream tends to be largely at this point, largely remodeled. So, I think that we will continue to be pretty solid and predictable. Vic?

Vic Grizzle

Yeah, I would just add, I think overall the questions around margin structure, there is no change to the margin structure in the ceilings business going forward. I think the initial SG&A expense is in support of the revenue growth plans that we have in place in emerging markets and architectural specialties, and in both of those cases, we're starting to see the revenue traction there.

The big impact to the margin structure that you saw was around the period expense that Dave outlined in his talking points around the expenses and the additional period expense around our new plant. And that will continue -- the expenses around those plants expire as the plants come online, but the fixed period expense stays with those plants until we can more fully utilize those plants from a volume standpoint.

So that in addition to what we said (inaudible).

Keith B. Hughes - SunTrust Robinson Humphrey, Inc.

Good thank you.

Operator

Thank you our next question comes from George Staphos of Bank of America Merrill Lynch. Your line is open.

George L. Staphos - BofA Merrill Lynch

Thanks, good morning everybody. I just wanted to follow-up on that question on SG&A and then the second part, just talk about return on invested capital. So, the incremental $10 million of SG&A spending this year, does that spending drop off in 2015 or 2016 and then related question, you know return on invested capital I think was roughly around 8% for the year, obviously still reported, unadjusted -- or not an adjusted number, but still it’s way off from the 15% goal. What progress do you think you will make? What makes you confident you will see higher ROIC in 2014? Thank you, guys.

David S. Schulz

George it's Dave Schulz. So first let me address the SG&A. So as we mentioned, we increased our SG&A in the emerging markets by about $10 million in 2013. That spending will continue going forward as we've increased our go-to-market capability. So that is a growing cost, structural going forward. Your question about ROIC, obviously, we did have some of our business units that had results below our expectations during the current year. Moving forward, our focus on margin improvement and sales growth will continue to improve our ROIC.

Operator

Thank you. Our next question comes from Ken Zener of KeyBanc. Your line is open.

Kenneth R. Zener - KeyBanc Capital Markets Inc.

Good morning, gentlemen. So, wood strategy or shift, if you will, it sounds like that's obviously a different approach. Could you highlight how much business, you know, when that began in the fourth quarter or how much business you walked away from? It looks like your growth rates kind of in the high-teens had fallen to about 11%. And then, how does that change from where you are standing today, impact the margin ramp, if you will, in 2014? It sounds like you've taken away a lot of variance since you are selecting business you want, if you could highlight some of those trends? Thank you.

Matthew J. Espe

Yeah, let me -- before I hand over to Tom, just to kind of spread a little context here. We -- the operating assumptions we had at the first half of 2013 was that -- were that wood inflation would abate, we started to see it flatten out, if you remember midpoint for the year, and that the relative premium for pre- kiln dried lumber versus green lumber would normalize. When we entered the third and fourth quarter, we just didn't see that, so we decided it was time for a different approach to the business.

So, as I said in the prepared remarks, we have appointed Tom to lead the floor business. Tom went in, looked at our strategic options and developed -- help develop the strategy really constraining manufacturing capacity to our drying capacity which really virtually eliminates the use of PKD outside as we said some very specific species that are very high end. So that allows us to begin to manage things within our control, we avoid the accelerated premium for PKD and it allows us to take out some of the over time.

So we begin to manage sort of within our manufacturing or drying constrains if you will. That allows us then to begin driving a richer mix into the market as our supply is constrained what we are giving up to your point is a little bit of revenue, little bit of volumes, certainly some of the share we gained last year, what we get in response -- in return is a -- the strategy where we're managing a lot more of the variables, much more business in our control and gives us an opportunity to drive mix improvement.

Thomas B. Mangas

Thanks for that context, Matt. This is Tom Mangas. Thank you, Ken for your question. I would say none of the Q4 results that you see were impacted by the change of strategy, it's something we debated and discussed and decided on in the beginning of December for implementation in the first quarter. We definitely saw a weaker demand environment for wood business in November really across builder channel significantly as they took a step back on some of their weakening numbers as well as in the repair model.

So the lower volumes of the second and third quarter run rates were a factor of consumer and builder demand. To Matt’s point these changes I think are important to restore the structural effect in the wood that is the focus I am taking here and we are preparing to trade off some of the share gains that we enjoyed last year. I mean on a like-for-like basis taking out the Patriot divestiture of the wood business grew 22% last year. I think if you look at any of our peers out there in wood, I don't think anyone of them grew that fast.

So I think we over shot our capability to grow that business as Matt said by driving losses over time and buying PKD. So we are starting in this quarter dialing that back. That said we continue to chase raw materials higher. So we exited the 2013 year with a raw material cost of green lumber only around $765 per thousand [cubic feet] and already through February it’s accelerated to $789.

So we’re going to -- these strategies are essential to restore structural attractiveness. That said if we continue to face an accelerating commodity environment like we continued to face in green lumber today we’ll be chasing it given the way we have LIFO accounting, we’ll always be penalized on the way up with the commodity cost increases and facing lags we roll with selling price increases through. My focus is when this business becomes -- when the external environment normalizes to call it a steady state at whatever level of commodity lumber inputs we have the business construction attractive and it’s on track to deliver on the guidance for ROIC as a segment.

Operator

Thank you. Our next comes from Michael Rehaut of JP Morgan. Your line is open.

Michael Rehaut - JPMorgan

Thanks, good morning, everyone. Just another question if I might on wood, you know you have talked about it and we appreciate all of the detail and the color. You know when you talk about strategic options also what comes to mind is keep it or don't keep it and it seems like you are looking at 2014 with the different leverage you are going to be pulling as if I am interpreting this right a kind of critical year in terms of what you think you may or may not be able to do in terms of restoring some of the profitability.

Is it fair to think that towards the end of the year based on the results you will be making decisions whether or not this is a core business for you or would you be willing to give it a longer time period than that?

Matthew J. Espe

Fair question, this is Matt. You know again some context what we are dealing here with is unprecedented rate of raw material inflation and unprecedented premiums in PKD over the inflation. So you could take a look at our relative performance in the last six months and extrapolate it but what we are dealing with here is something that sort of cuts against the normal cyclical patterns that we are seeing in this business over the last several years.

Our priority right now is to implement the strategies that we have laid out, that Tom spoke about a little bit, capping output within our drying range and within our control, selectively making CapEx investments to expand that drying range, responsibly minimizing the usage of PKD, significantly reducing over time, improving our yields and continuing to drive price over inflation. So that’s really the priority we have today. I would say that I think this leadership team has demonstrated an influential strategic flexibility that allows us to think about any element of our business portfolio as it relates to the core as it relates to broader shareholder benefit.

So while our priority right now is to fix the business, get it back on track you know we’ll certainly there will be a time to think about the broader question you mentioned but right now what we are focused on getting this business back on track.

Thomas B. Mangas

Mike, this is Tom Mangas, just to add a couple of points to that. Only in 2011, in that stable commodity environment we were running an ROIC of about 9% in wood in 2011 and 2012. So it wasn’t too far ago that was pretty close to our company whack. And that was at a sales level that was at trough levels. So our EBITDA margin in 2011 and 2012 at trough sales levels was higher than it was at peak in 2006, the peak sales levels almost 40% lower sales.

So I believe as a market share leader in North America with about a 28 share in Wood business we deserve to have a strong ROCI potential and I think when commodities are rising that’s what makes it tough. I think we may have overstretched for share compounding on our execution last year but going forward I think as a share leader with appropriate pricing and channel management we deserve to have an extremely strong recurring investment capital in a normal -- I think we’re going to look really smart when commodities come down maybe smarter that we really are, but we maybe look a little more foolish on commodities are up maybe a little more foolish than we really are. Thank you.

Operator

Thank you. Our next question comes from Bob Wetenhall of RBC Capital Markets. Your line is open.

Robert C. Wetenhall - RBC Capital Markets, LLC

Hi good morning guys. I want to move past the Wood question, because that horse got beaten to death. Can you talk about the resilient business, I'm just trying to understand you had good margin performance in the quarter but I'm more concerned about the trend because you’ve got 11 consecutive quarters of year-over-year sales decline and I'm kind of understanding what’s causing decline and given some of the research in to that markets do you expect that to turn the corner this year and what’s the upside from a margin standpoint if you start getting top line growth?

Matthew J. Espe

Yeah I think lot of the decline we’ve seen Bob has been most of those market related obviously in North America and Western Europe, accelerated by our exit of the residential flooring business in Western Europe a couple of years ago. We expect to see broad demand for resilient flooring in the commercial segments, strengthen next year or this year, we continue to see or expect little bit of challenge in the healthcare and education markets as well as steel little bit more slower than the others, we anticipate relative strength in the retail segment, by retail proceeds this is for going into stores not sell-through sales in the consumer market and we have very expectations for Western Europe next year. We expect to see continued traction in the emerging markets in primarily in China.

Thomas B. Mangas

And Bob, first you’re right the resilient segment worldwide is down, it's been probably last eight quarters or probably like last ’12. I’ll tell you in 2013, the difficulties in education and healthcare segments were major driver worldwide particularly in Europe, North America.

Number two, we have taken a significant step on stepping back on laminates, our laminates business is driving the bulk of that decline in North America residential side, as we’re not trying there -- we’re competing with at the high end, so a little bit of a taste of what we’re doing in Woods, we’re focusing on higher end, where we can make margin, we have given up some volume and sales growth on laminate residential side of business.

And on the positive side, we are very excited about our ability to innovate in resilient. Our [alternate] product is up 15% this year as the new product reduction it’s winning the hearts and minds of residential consumers. Our LVT business worldwide is up dramatically, in the North America commercial residential segments, we're probably up almost 10% in LVT. So I think there are lot of bright spots where we’re investing and focusing to drive growth and fundamentally this is the manufacturing system that knows how to get productivity.

So despite volumes being down and sales overall worldwide 2% in resilient segment we grew to a record EBITDA level. So I think the incremental margins are real with volume growth. I think that the plants are going to continue to deliver productivity and with incremental volume as education and healthcare recover as we’ve expand in the LVT, as we grow our home metal sheet business in China I think we’re going to love the margins and this is the business on a worldwide basis will have a strong return on invested capital.

Operator

Thank you. Our next question comes from Kathryn Thompson of Thompson Research Group. Your line is open.

Kathryn I. Thompson - Thompson Research Group, LLC

Hi, two part of questions. First on Ceilings and second on Wood Flooring, I will try not to beat the horse too much on that segment. Ceilings how much higher SG&A versus lower gross margin impact overall operating margin related that how are you managing rising energy costs in natural gas going into 2014?

Matthew J. Espe

I didn't get the first part of the question Kathryn I am sorry.

Kathryn I. Thompson - Thompson Research Group, LLC

For ceilings if you look at your overall operating margins for that segment a little bit below our expectation, how much of the higher SG&A versus slightly lower gross margin impact the overall mix operating margin?

David S. Schulz

Kathryn it's Dave Schulz. So overall the SG&A increases to support the emerging markets in Architectural Specialties was the key driver for the margin erosion that you see within Q4.

Kathryn I. Thompson - Thompson Research Group, LLC

Okay, that's helpful. And then on wood flooring jus may be some clarification on feedback that we've gotten from the channel. So is it our understanding that she had a fair amount of or certain amount of volumes tied to big home builders perhaps at lower prices. Could you clarify with the backorders the backlogs of orders that you have is there any different pricing schemes with those products big home builders versus other volumes which will be tied more to the price increases that we saw last year and that are in the market right now.

Thomas B. Mangas

Thank you Kathryn, this is Tom again. So first just s recap we have about third of our business sales into the big box, third into independent distributors for retail and finally a third into builder. The answer is yes in 2011 and '12 in the depth of the crisis and with very anemic volumes the business did met to a couple key builders, some key builders pricing that had a fixed component to it for the year or a couple of years. And that plus the fact that builder mix is weaker mix and those contracts they constrain our ability to take pricing in 2013 and contributed to weaker mix because that's where the volume growth was.

You can be assured that as those contracts roll off we are indexing those guys straight to where the market is. We are very diligently managing to ensure like-for-like pricing across all our channels in order to not have channel conflicts that create reasons for customers switch away from us. So very confident back on track we're not totally out of it in 2014 but we're significantly worked it down and something that I think will continue to work its way out of the system and become less noticeable over time.

Kathryn I. Thompson - Thompson Research Group, LLC

Thank you.

Operator

Thank you our next question comes from Nishu Sood of Deutsche Bank. Your line is open.

Nishu Sood - Deutsche Bank AG

Thanks I wanted to revisit the ceilings margin, if you look at it on a sequential basis or a year-over-year basis or again similar with the expectations or your ceilings EBITDA was about $5 million to $10 million light and so those three things you folks have mentioned the environmental reserve, the SG&A, Dave was just mentioning that SG&A is the main component but there is the architectural specialty the aspect of that as well as the Russian plant start-up.

So I was just wondering if you could provide slightly the environment reserve you haven't commented on that, what amount that was it was 5 million to 10 million it was a pretty big mess against the trend line you had a terrific trend line in that business. Dick did mention that look to underlying economics of this business haven't changed yet. So I just wanted to understand given the magnitude of the deterioration in the EBITDA there how those three things break down in terms of what they affected the recurring nature of them?

Thomas B. Mangas

Again I think in terms of last statement we've talked about $10 million of SG&A being somewhat structural as these are investments in emerging markets that will accelerate revenue growth in those markets as we go forward. We have $15 million associated with the new plant in Russia which is should be a one-year -- those are expenses associated with plant start-up and Dave do you want to comment on the reserve?

David S. Schulz

Sure. So within the fourth quarter as Matt mentioned we had the SG&A investments for the emerging markets in architectural specialties which was sequentially higher and obviously well ahead of prior year.

We also had the investments for our plant startups which for 2013 combined for all of our plants as Matt mentioned we had roughly $50 million of incremental expenses. In Q4 we also saw some of that being part of our Russia plant startup. So as we put the building on the roof we had some incremental expenses that we did not see in the sequential quarter profile.

The third piece that you mentioned was the environmental reserve which we talked about in our prepared remarks. So we did have a sequential increase in environmental reserve related to couple of our facilities here in the United States, those were still relatively modest they did have a slight impact on gross margin.

Operator

Thank you. Our next question comes from Will Randow of Citi Group. Your line is open.

Will Randow – Citi Group

Good morning and thanks for taking my question.

Matthew J. Espe

Good morning.

Will Randow – Citi Group

In regards to CapEx levels you guys are still guiding considerably above where you have been, what do you think mid cycle is today, if you are taking a fresh look and when do you think you will reach kind of more mid-cycle type levels, I am guessing $120 million or so per year?

David S. Schulz

Yeah we sort of said above that level is kind of normal run rate Will. We have the Russia ceiling plant, a vast majority of that was taken care of this year, we have the LVT plant coming online, that's $40 million, that begins this year into next year. So in terms of the -- we are not guiding outside of 2014 but if you think about the timing of those facilities again Russia is down this year, LVT a more modest investment done certainly 2015.

So post that we are not anticipating any additional major CapEx moves so kind of '14, '15, '16 you would see as kind of return back to that normal run rate of about $100 million to $120 million.

Operator

Thank you. Our next question comes from David MacGregor of Longbow Research. Your line is open.

David MacGregor – Longbow Research

Good morning everyone. Just a question on the ceilings business, one of your competitors had talked about pull forward into the fourth quarter from 1Q and I am just wondering if you saw any influence that way in your business, did you take anything from 1Q?

Matthew J. Espe

The short answer is no.

David MacGregor – Longbow Research

Okay. Sorry? You also referenced some inflation in your ceilings business. I wonder if you can just talk about that?

David S. Schulz

Yeah natural gas has continued to rise all throughout the year. It’s up 72% year-over-year. It’s probably the biggest driver we saw in terms of inflation but overall as you know in the Americas business here we’re doing a pretty good job of getting price over inflation and that was no different for us in the fourth quarter.

Operator

Thank you. Our next question comes from Dennis McGill of Zelman Associates. Your line is open.

Dennis McGill - Zelman Associates

Hi, thank you. So following on that last question for the ceilings business fourth quarter the growth there 9%, how did you get at whether there was there was not pull forward and then I guess just kind of relates there was no pull forward seen that acceleration from 2% in the third quarter, what are the big drivers there?

Thomas B. Mangas

Biggest driver on volumes for us was really broad based volume growth. So we had Middle East and Russia good growth as Matt has talked about and then also in Asia both India and China business contributed to the overall volume growth there. It was broad based I think which was different than the third quarter. And again we know pretty carefully in our discussions with our distributors as you know 85% of our business goes through distributors on what’s pull forward and what’s not. As we had pretty strong volume order we wanted to make sure that we were servicing the existing demand in the right way.

So we have a pretty good confidence on a pull forward level, and again the broad based contributions of volume little over 9% growth.

David S. Schulz

Hey, Dennis its Dave Schulz. I just want to comment that recalling the base period we had our Russia go local that was effective at the beginning of Q4 and so we did a capture some of the customs and duties in our pricing which also led to the year-over-year increase primarily of our European business that flows through to obviously the entire LVT segment.

Operator

Thank you. Our next question comes from Eli Hackel of Goldman Sachs. Your line is open.

Eli Hackel – Goldman Sachs

Thank you. Just a question about your investments into China and Russia, I am hearing a lot of comments these days about smaller economies in both of those markets. I wonder if you could give us a recap or remind us of the importance of investing in these markets in the face of economic slowdown in the local economies.

Matthew J. Espe

Yeah that’s a good question, I mean just for context 70% of our revenue comes from North America, 20% from Europe and 10 from Pac Rim so the total in total scale it’s relatively small. We’ve been in China for decades we have a very strong team there. We are making significant in-roads in contributions in the industry to driving conversion from most in the mineral fiber ceilings from dry wall mineral fiber ceilings and resilient flooring from ceramic to resilient flooring.

So we think that as market evolves and emerges these investments and their support demands that is sort of largely in process if you will, we have ceilings plant here for 10, 15 years it’s been sold out for the last five or six. We’ve been shipping resilient floorings from Western Europe and Australia.

So we imagine the margin deterioration on that kind of supply chain. So we think our investments are responsible we think it addresses the current size of the market the trends of the market. Clearly China is not as robust as growth engine as it was two years ago, but still significantly it’s a significant market with very attractive overall growth rate. And within the macro looking at China our targeted market segments' education, healthcare, transportation continue to be the priority for the investments.

So we think we’re well positioned, we think our product lines in both businesses are very diagonal, very strong value proposals in to the target market segment.

Operator

Thank you. Our next question comes from Stephen Kim of Barclays. Your line is open.

Stephen S. Kim - Barclays Capital

Thanks very much guys. My question could be broadly by characterized under mix shift questions. In Ceilings I was curious as to what you could comment whether there is any discernible mix that should be seen there? And in the context with that I think you said architectural specialty sales were down in the quarter I just wanted to follow up understand how that rolls into it?

And the on the Wood side, you talked about your strategy being willing to accept some lower share and then your different pricing scheme in builder I'm wondering if we should be expecting that your mix will benefit from perhaps some less builder sales and or if you anticipate an improving mix in some other way with the share?

Matthew J. Espe

Well, it's -- we will tackle the ceilings, mix, specialty and I’ll turn it over to Tom for the wood specialty.

David S. Schulz

Yeah in overall broadly speaking worldwide level mix was lesser of a contributor but a positive contributor, a lesser of a contributor than prior years. And a little bit of color around that in the U.S. we continue to have very strong mix as we continue to drive specifications around the higher value products in our portfolio, customers are moving in that direction, and really like the new products that we’re introducing at that level and architectural specialty overall contributes to a higher level mix.

In Europe we saw mixed shift downward based on the market price in the overall country mix and Europe and then Asia mix was overall flat. So overall a little bit of the U.S. gains and mix was offset by a weaker mix in Europe which we believe is a temporary phenomenon based on the current country mix there.

Thomas B. Mangas

So just 2013 mix was a significant drag, if you look at the K talks about us having $12 million of improved price and mix on the whole year. Price was a significant gain, mix was a significant dilution. So to your point, yes I am counting on mix to be a significant driver of profit improvement and I'm treating price and mix as equivalent. So I do think that customers who are benefiting from order shipment, benefiting from usually low prices because of contractual agreements, they get a little sticker shock and they will come along with us, they’ll drop off that will be show in our P&L as a mix gain.

And clearly part of our strategy is to recover price, commodity increases with price and mix and so I do think we will see that trend reverse in 2014.

Matthew J. Espe

Yeah and in summary Steve, A, ceilings mix driven by geography predominantly and wood mix driven by customer segment predominantly.

Thomas Waters

Steve, this is Thomas Waters just one more point U.S. specifically about our architectural specialty and you commented that you thought you said it was down in the quarter, it was not in the quarter it was up pretty much the same run-rate that it has been up quarter-over-quarter throughout the year.

David S. Schulz

It's Dave Schulz so we had mentioned in our prepared remarks that one of the reconciling items within Asia sales with the architectural specialties in China was down year-over-year. But we had significant growth in architectural specialties worldwide versus the prior quarter.

Operator

Thank you. Looks like we have time for one more question from Justin Bergner of Gabelli and Company. Your line is open.

Justin Bergner - Gabelli and Company

Good morning everyone and thank you for taking my question. Most have been answered already. First quick question was in the wood segment the headwinds associated with pre-dried lumber over time and builder contracts sort of when over the course of 2014 should we see those headwinds as having mainly ceased in terms of the quarterly build over 2014?

Thomas B. Mangas

Hi, this is Tom Mangas again. Thanks for your question Justin. So we have implemented that strategy, as I described we talked about in December we put it in effect in January. So it is in effect now. Obviously we're living with contracts. We have contracts they will roll off naturally with the change in PKD strategy and the overtime strategy was built across our plants in the month of January as Matt said at the beginning and that continues to wade through. And that's critical because as I said commodity inflation continues to accelerate.

So we continue to chase higher commodity, lumber inflation. We've taken our price increases our price increases were effective in February. So we have implemented those strategies in the first quarter, I think you will start to see yield in the fourth quarter -- in the first quarter but again continue to face that same level of headwind as I said we exited the year around $760 per 2,000 [inaudible] an hour 789 so that $30 increase across lumber which will continue to put pressure particularly given our variance accounting.

Operator

Thank you. I am not showing any of those questions in the queue. I would like to turn the call back over to management for any further remarks.

Matthew J. Espe

Thank you very much. We appreciate everybody's interest today. We are optimistic about our prospects for 2014 as we continue to invest significantly but responsibly in emerging markets, as we continue to manage things in our control, price mix, manufacturing capacity, we have very strong businesses in our global resilient flooring business in our building products business, in our architectural specialty with an evolution of our strategy in the wood business that we think we'll drive more margin enhancement as we go through 2014.

So thank you very much for your interest and we'll see you soon.

Operator

Ladies and gentlemen, thanks for participating in today's conference. This concludes today's program. You may now disconnect. Everyone have a great day.

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