Armstrong World Industries Inc

Ladies and gentlemen, thank you for standing by and welcome to the Q3 2019 Armstrong-Wald Industries, Inc. earnings conference call. At this time, all participants are in the listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Tom Walters, VP of Corporate Finance.

Thanks. Good morning 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 armstrongceilings.com. With me today are Vic Grizzle, our CEO, and Brian McNeil, our CFO. Hopefully you have seen our press release this morning, and both the release and the presentation Brian will reference during this call are posted on our website in the investor relations section. I advise you that during this call we will be making forward-looking statements that involve risks and uncertainties. Actual outcomes may differ materially from those expected or implied. For a more detailed discussion of the risks and uncertainties that may affect Armstrong World Industries, please review our SEC filings, including the 10-Q filed earlier 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 this presentation. Both are available on our website. With that, I'll turn the call over to Vic.

Thanks, Tom, and good morning, everyone. It's good to be with you today to review our third quarter results. Another strong quarter and a record EBITDA quarter for the company. Sales grew 6%, adjusted EBITDA improved 13% to $114 million, and margins expanded 250 basis points. Year-to-date sales were up 8%, adjusted EBITDA is up 15%, and margins have expanded 240 basis points. With these solid results, we remain confident in our full-year adjusted EBITDA guidance and And as we tighten the guidance range, we are slightly raising the midpoint. Now, in a moment, Brian will walk you through the details of the results by segment, but I first want to touch on a few of the key takeaways. In the mineral fiber segment, average unit value, or AUV as we refer to it, was up more than 2 percent, with both like-for-like pricing and mixed improvements positively contributing in the quarter. As we previewed with you, price realization in the quarter continued to normalize from the higher increases we reported earlier in the year. It's also worth noting that positive price and mix in the quarter was on top of the strongest price performance quarter of 2018. In the quarter, price increases once again outpaced input costs. On the mixed side, we continue to see above-market performance from our new product innovations, Sustain, Total Acoustics, and DesignFlex. Year-to-date, mineral fiber AUV is up 6%, and we remain confident in once again delivering AUV growth in the 5% to 7% range for the full year. consistent with both our historical average and our guidance. Mineral fiber volume was positive in the quarter and continues the favorable sequential quarterly trend we outlooked earlier in the year. Broadly speaking, commercial activity in the U.S. remains favorable, with both bid activity and backlogs remaining positive, despite a continuation of uneven R&R activity across the various verticals. New construction and larger remodel projects continue to trend favorably broadly across the U.S., And the education sector in particular was positive throughout the summer, much as we had anticipated. However, in total, volume came in below our expectations. Canada and the big box channels remained softer than expected, although improving, but not yet back to the expected levels. There's unique political and economic issues in Canada, and inventory balancing in the big box channels are all working their way through, but again, slower than initially expected. Also, to a lesser extent, smaller project size R&R activity in the U.S. retail and healthcare verticals continue to be softer and uneven across the regions. Canada, Latin America, and the big box channels represent the majority of our year-to-date drag-on volumes. Our teams have been working hard to compensate the unique circumstances in each of these channels, and I'm pleased with the work completed in the big box channel and in the Latin America channel that would drive improvements in Q4 and into 2020. Adjusted EBITDA margins expanded in the mineral fiber segment. Our operations teams continued to execute at a high level and delivered a great quarter. Mineral fiber gross margins expanded 140 basis points. Now, last quarter, I introduced you to our plant reliability metric. It's a multi-input measure of manufacturing performance that captures things like uptime, yield, and throughput. And I reported that it was trending near all-time highs. Well, in the third quarter, this trend not only continued, but our teams broke the plant reliability record, resulting in an outstanding 5% productivity improvement. This is a reflection of the hard work and expertise of the people in our plants. And it's also a demonstration of early results of our digital factory initiatives, which is a subset of our overall digitalization strategies. Margin expansion was also driven by favorable price over inflation, mixed gains driven by our innovation, and a strong quarter at our Wave Joint Venture. Equity earnings from our Wave Joint Venture were up 16% in the quarter, helped by strong sales of higher value component products and non-traditional grid items that improved Wave's overall sales mix. Turning now to our architectural specialty segment, where we had another strong quarter, Sales were up 23%, marking the sixth time in the last seven quarters that sales growth has exceeded 20%. Our teams continue to leverage best-in-class capabilities to win more projects and outpace market growth. ACGI, our newest acquisition, contributed $7 million in the quarter. Our ACGI integration efforts are ahead of plan, and we are gaining early traction by adding ACGI's exciting wood products and capabilities to the Armstrong sales platform. Overall, the base AS business, which includes our 2018 acquisitions of plaster form and steel ceilings, remains on track to grow more than 15% as we got it at the beginning of the year. Our backlog going into the fourth quarter and 2020 remains strong and supports the continuation of this trajectory. EBITDA margins and architectural specialty segment expanded to 24% in quarter. I was particularly pleased that all of the acquired companies improved EBITDA margins sequentially in the quarter. All four acquisitions continued to run ahead of their financial business cases, further validating that we are acquiring good businesses, integrating them well, and driving sales and operating improvements on the Armstrong platform. Now, at our investor day, we used the Tecnam acquisition to illustrate how we take smaller subscale regional businesses and scale them on the Armstrong platform. These acquisitions are typically sales growth constrained and are operating with EBITDA margins below our segment average. We noted that margins can often decline in our first year of ownership as we bring the businesses up to our operational standards. And after an initial year of integration and investments, we generate leverage via sales growth from our spec writing capabilities and participating in our best-in-class distribution network. We also drive operational efficiencies by bringing our manufacturing and lean expertise to their operations. Both of these efforts result in meaningful margin expansion, which is exactly what we're seeing at Technum. Year-to-date, Technum's EBITDA margin is 31%, an improvement of over 400 basis points from 2018, and almost double from when we acquired them in 2017. We remain confident that this path to enhanced profitability is repeatable across our more recent acquisitions. Also within the architectural specialty segment, we are pleased to announce another acquisition. As you may have seen in our press release, we have entered into an agreement to purchase MRK Industries, a manufacturer of specialty metal ceilings and walls. We expect this transaction to close in the fourth quarter. We know MRK and the management team well, as they have been a key supplier to us for several years now, including supporting the success of the Grand Central Terminal project in New York City. MRK's unique capabilities and management know-how will be a great asset to our architectural specialties business. As an existing supplier, MRK won't be a material contributor to our top line, at least in the short term, but their unique manufacturing and design capabilities will enhance the overall architectural specialty segment margins. In the quarter, we continue to advance our digitalization initiatives beyond the manufacturing work I previously mentioned. We are working to drive speed from the eyes of our customer, scalability in the architectural specialties business, and to create a frictionless design and purchase experience. As part of our fall launch, we are not only introducing new products, we are also rolling out new digitally-enabled solutions. We have added new Revit families to our website for the design flex products, and later this quarter, we will introduce a new digitally-enabled solution called ProjectWorks, a service providing a collaborative platform that will benefit all of our customers, from designers, builders, tenants, and even to our distribution partners. Project Works provides design visuals, budgetary pricing, bill of materials, and installation instructions to all projects' stakeholders on one single platform. Now this work can be done in minutes instead of days. This will further Armstrong's competitive advantage for new construction and major renovation projects. Project Works is the next step in our customer-facing technology journey that began with one quote, common portal for real-time quotations, that progressed to quote-to-order, which automated the order process, and now Project Works, an all-in-one design-to-delivery platform. This is an exciting, industry-leading, technology-enabled capability. You can expect to hear more about this and other customer-facing technologies in the coming quarters as we continue on our path to becoming the easiest company in the building product space to do business with. Now let me pause and I'll turn the call over to Brian for more details on the financials.

Brian? Thanks, Vic. Good morning to everyone on the call. Today I'll be reviewing our third quarter results, but before I begin, as a friendly reminder, I'll be referring to the slides available on our website, And slide three details our basis of presentation. Beginning on slide four, for our third quarter results, sales of $277 million were up 6% from prior year. Adjusted EBITDA increased 13%, and margins expanded 250 basis points. Adjusted diluted earnings per share of $1.38 grew 20% as profitability increased, and we lowered our share count. With regard to taxes, our quarterly as-reported tax rate of 15% was impacted by the $25 million gain we realized on the sale of our half of the Wave International businesses. We've adjusted this gain from our adjusted EPS calculation, resulting in a 19.7% quarterly tax rate. For the year, we are anticipating a rate of just below 25%. Adjusted free cash flow improved by $25 million, or 34%, over the prior year. Cash earnings improved significantly and offset higher CapEx and cash interest. Net debt is $58 million higher than last year, driven by the acquisition of ACGI, share repurchase activity, and the initiation of a regular quarterly dividend a year ago. In the quarter, we repurchased $33 million of stock. Since the inception of the repurchase program, we've bought back 8.7 million shares at a cost of $512 million for an average price of $58.94. Currently, we have over $188 million remaining on our share repurchase program, which runs through October 2020. Turning now to slide five, adjusted EBITDA increased $14 million as volume growth in the architectural specialty segment was coupled with AUV gains, strong manufacturing performance, and a solid quarter from wave in our mineral fiber segment. Input cost inflation, including natural gas and freight, was slightly favorable for the quarter, while SG&A spending rose as we have taken on the go-to-market and administrative expenses associated with ACGI and made additional investments in capability support AS growth. SG&A as a percent of sales declined and add it to our EBITDA margin expansion. Slide 6 shows adjusted free cash flow performance in the quarter versus the third quarter of 2018. Cash earnings grew 35% and offset modest increases in income tax, payables, CapEx, and cash interest. Slide 7 begins our segment reporting. In the quarter, mineral fiber sales grew $6 million, or 3%. AUV gains including both like-for-like pricing and continued mix improvements. Volume was up 1% in the quarter as volume in the education vertical improved. Adjusted EBITDA was up $11 million, or 13%, as margins expanded 400 basis points. AUV gains, strong performance from our manufacturing operations, and a solid quarter for WAVE were the key drivers of earnings growth. SG&A expenses were also lower in the quarter, even as we've now lapped our cost-saving initiatives in 2018. Moving to architectural specialty segment on slide eight, quarterly sales increased 23%. Base sales, which includes the plaster form and steel ceilings businesses acquired in 2018, grew 8%, and the ACGI acquisition contributed the rest. Adjusted EBITDA NAS was up 18% in the quarter, as sales gains were partially offset by the fixed cost of acquisitions. EBITDA margins contracted 100 basis points in total and were driven by a 310 basis points headwind related to the acquisitions. Turning now to slide 9, for the first half of 2018, sales of $791 million were up 8%, and adjusted EBITDA increased 15%, driving margin expansion of 240 basis points. Adjusted diluted earnings per share of $3.66 grew 22%, primarily driven by increased profitability. Year-to-date, adjusted free cash flow grew $25 million, or 17% ahead of last year. Slide 10 is the bridge of our results for the first nine months of the year. Strong AUV performance in the mineral fiber segment remains the key driver to our increased profitability in 2019. Coupled with volume gains and architectural specialty segment, solid manufacturing performance, increased profitability at wave and lower SG&A spend drove adjusted EBITDA up 15%. I'll remind you that manufacturing and SG&A both benefited from the restructuring actions we took in the middle of 2018. These savings, as well as manufacturing productivity, have more than offset the cost embedded in acquiring acquired businesses, and organic investments in AS capabilities. Slide 11 displays the drivers of adjusted free cash flow for the first nine months of the year. Operating cash flow benefited from cash earnings, which were up 22%, and lower working capital, which offset higher income tax payables, which were impacted by the $20 million tax refund we received last year. We remain on track to deliver $225 million to $235 million of adjusted free cash flow for the year, a 9% increase at the midpoint when excluding the special dividend from waive in the base period. Slide 12 updates our guidance for the year. We've narrowed our sales range growth to plus 7% to 8%, and we are tightening and raising the range of our EBITDA and EPS guidance and reaffirming our free cash flow range. Before turning the call back to Vic, there are three non-operating finance items I'd like to call your attention to. First, as you saw from our press release last week, our Board has declared a quarterly dividend of $0.20 per share, an increase of 14% from our prior quarterly dividend. This increase is consistent with growth in free cash flow and is an indication of the Board and management's confidence in our strategy and value creation model. Second, we completed a refinancing of our credit agreement on September 30. The terms of this new $1 billion facility will provide approximately $8 million in annual after-tax interest savings beginning next year. 2019 interest expense is essentially unchanged from prior guidance as Q4 savings are offset by refinancing fees. In addition, This new structure includes a $500 million revolver up from our previous $200 million revolver, providing us with significant liquidity and flexibility. This new agreement extends maturities three years to September 2024 and correspondingly reduces amortization of principal. Third, with the completion of the sale of our international businesses to Knopf, we have removed all the assets and liabilities of these discontinued businesses from our balance sheet. We still maintain a payable to waive for the remaining portion of their proceeds. We expect this payable to be settled by the first quarter of 2020 when we finalize the working capital and other standard closing adjustments with Knopf. To close, I'm pleased with how the business is operating and the results we've been able to deliver so far this year with sales up 8% and adjusted EBITDA up 15%. I remain confident that we have the plans in place to deliver high single-digit sales growth and double-digit adjusted EBITDA growth consistent with our value creation model. With that, I'll turn it over to Vic.

Thanks, Brian. As Brian mentioned, we have concluded the sale of our EMEA and Pacific Rim businesses to Knopf. This milestone completes our pivot to an America's only ceilings and specialty walls business that we announced back in November of 2017. Beginning with that announcement, the Armstrong team has been transitioning our focus to maximizing the opportunity for profitable growth and free cash flow generation right here in this high-quality America's business. As we finalize closing adjustments and taxes, we now expect to realize approximately $290 million of cash from the transaction, up from the original $250 million we outlooked at signing and our most recent projection of $280 million. I want to take this opportunity to thank our former colleagues for their hard work, their commitment to making the Armstrong brand a global leader in sealing solutions, and most importantly, for the positive attitude they brought with them each and every day throughout this process. We wish them all well. Now, since our last quarterly release, there's been lots of positive activity here at Armstrong. We delivered yet another quarter of double-digit adjusted EBITDA growth and strong free cash flow. We grew the architectural specialty segment by more than 20% again. We closed on the sale of our international businesses, ultimately delivering the $290 million of cash to shareholders. We refinanced our credit agreement, which will drive $8 million in annual interest savings. We repurchased $33 million of our stock. We announced a 14% increase in our quarterly dividend and we signed yet another architectural specialties acquisition. We are excited about our focus as an America ceiling and specialty wall company and the momentum this has created. There is no more competition for our time, our energy, and our resources. We can focus all of them right here at home in the Americas. We expect to finish the year strong and deliver another year of double-digit EBITDA growth, strong cash flow generation, and top-line momentum. Armstrong remains committed to being the standout leader in innovative products and digital solutions to provide the best possible experience for our customers, and we are committed to making a difference in the spaces where people live, work, learn, heal, and play. And with that, we'll be happy to take your questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Keith Hughes from SunTrust. Please go ahead.

Keith Hughes Thank you. Just a question on the environment. We've seen a few data points of non-residential construction, specifically seeing some weak patches. Could you give us any sort of feel, have you seen any of this in your business, any projects being delayed, and particularly given the revenues were a little lighter than expected in the quarter?

Yeah, Keith, you know, the volume softness really was outside the U.S. that we saw for the most part. I'll tell you, the third quarter market environment and the conversations that I've been having in the field feel pretty much the same as we've experienced this whole year, really the past seven or eight quarters. New construction and large remodel projects continue to be favorable with bid activity. As I mentioned in my prepared notes, and the backlogs. I was in the field several times this quarter, and everybody I talked to said the bid activity continues to be really good and that they're very happy with their backlogs going into the fourth quarter and even into next year. So that part of the market feels about the same, and I would say on the R&R side, which is less visible, Keith, as you know, that kind of shows up through distribution and That continues to be lumpy, as it has been for the last seven or eight quarters. Certain verticals turning on and turning off, and that being a little bit uneven and lumpy. And again, that's kind of pretty much what we saw throughout the third quarter as well, with the exception of education, as I mentioned. The education sector did have a better R&R activity than we've had in the prior years, so that was good to see.

Okay, thanks. And final question. The margins in mineral fiber were outstanding in the quarter. You talked about some of the productivity improvements. Is this the kind of situation that the changes in savings you've made, does that have legs over the next several quarters? Should we continue to see those margins move up?

Yeah, I think there's a couple drivers there, right, Keith, on the margin line. We continue to get favorable price mix with moderate inflation. So I think that's part of the help there. But our manufacturing and operating teams just did a fantastic job on the productivity side. They continue to drive the productivity initiatives, and then as I indicated, some of the early gains from this digital effort that we're putting in place in our manufacturing operations is already yielding some dividends. I've said this before. I think that We've got a long ways to go with our lean manufacturing initiatives in terms of driving overall productivity. But now that we're adding this digital component and getting smarter with the use of digital technology and how to run the plants and keep them up and running, I think there's a longer runway here for continued productivity gains as we go. And I'm more confident in that than I have been in the past. I think there's a good long runway that we should count on some continued productivity improvements here.

Okay, thank you.

Thanks Keith.

Thank you. Our next question comes from Stephen Kim from Evercool ISI. Please go ahead.

Yeah, thanks very much guys. Just wanted to follow up on Keith's question there. In the queue, I think you provided about $3 million, if I'm not wrong, Brian, from what looked like manufacturing productivity. I was curious how much of that was tied to last year's plant closure and how much from some of these exciting digitalization initiatives that you've got going on.

Brian, you want to take the first part of that?

Yeah, so Stephen, the three of that, the three was in mineral fiber and that's being driven by two things. One, the digitalization effort we mentioned, and two, really a good focus. Vic mentioned a few times, as we get focused on this America's Only business and our R&D team gets focused there, the teams at the plant are really executing well on some of the capital projects we've implemented there. So no benefit from the carryover, the restructuring. I see. Got it. That's encouraging.

Vic, were you going to add something on that?

You know, I think he covered the second part of your question. Again, let me just qualify it. I think the digital component of the overall productivity was obviously a smaller component, but it was material and worth calling out because I believe it's an indicator for what we can see going forward. But it was a smaller part of the overall productivity number.

Yeah, no, that's fine. All right. All right. I wanted to just, from a housekeeping perspective, make sure that we understood the impact of days. Was there an extra shipping day in the quarter or not? And then broadly on project works, I'm kind of interested in hearing a little bit more about that. One of the things that we've seen with building information modeling management software, I guess I should say, is the issue of adoption and the willingness of counterparties to get involved in the learning process that is required to use some of these programs. So I was curious as to if there was anything about your rollout that was going to be targeted, something that you think will enable you to have your clients adopt Project WORKS in a way that would be perhaps better than maybe some of what we've seen else in previous attempts from others.

Hey, Steve, this is Brian. I'll take the shipping day. Yes, we did have one extra shipping day, and as you look forward into Q4, there's no change in shipping day, so one extra day in Q3. Got it.

Thank you. Yeah, Steve, on the project works, we're really excited about this. Architects are demanding more and more 3D modeling and Revit models that will allow them, it's productivity for them, right? If they can take a lot of our systems in a 3D model, they can plug in, you know, kind of cut and paste, if you will. It just drives productivity for them. So that's really important for them to do that, especially around the details where grid and tile interface. So we've been working on this for some time. What Project Works is going to do, though, is on a single platform. And so, again, for all the stakeholders in the value chain to see is along the design journey how things are changing. And so it helps with the communication and, of course, the lapse in time that happens over many days a lot of times and getting some of these things and these details worked out because everybody can see them on the same platform. That's going to, I think, improve the use of, more BIM and building information models that you were referring to, and the Revit files in the upfront process for communication all the way through to the installer. So, again, it's a start. It's on our DesignFlex platform to begin with, which has some complication to it, so this is really going to decomplicate, if you will, that system. So we're excited about it. It's a beginning and something for us to build on.

Great. Sounds like a good idea. Thanks, guys.

Thank you. Thank you. Our next question comes from John Lovallo from Bank of America. Please go ahead.

Hey, guys. Thank you for taking my questions. The first one is maybe just following up on Keith's initial question. about the potential for slowing commercial activity on the new construction side. It's encouraging that you're not seeing anything, but what are some of the early signs that you'd be looking for that might indicate that things are softening a bit?

Yeah, John, I'll just reiterate again. We're not seeing a slowdown on that side, and it's really hard to tease out new construction activity on a broad scale basis and large remodel projects. So you can appreciate that. They're both highly specified projects. So we're not really seeing a slowdown there. Of course, we get asked about this a lot and we're looking for it, but we haven't seen it. So I want to be very transparent about that. We would be looking for, certainly in our conversations with our contractor customers as well as our distributors, is what's happening on the bid side. And if the bid activity starts to slow down, I think that would be an early indication that we might be starting to see some of the lagging coming into the system. Again, reporting from our contractors and distributors so far, the bid activity remains robust.

Okay, that's helpful. And then as a follow-up, it sounded like your commentary on LATAM may have been, you know, a little bit more constructive this quarter than in the past. and it sounded like you might even see some improvement in the fourth quarter. Am I reading that messaging correctly?

Yeah, that's right. I think we've seen, you know, from the first quarter, we've seen sequential improvement in LATAM, and I know the teams have been working some other plans down there to accelerate the improvement. So I expect that to continue to improve. I think you're reading that right.

Okay. Thanks, guys.

Yeah. Thanks, Sean.

Thank you. Our next question comes from Michael Wood from Nomura Institute. Please go ahead.

Michael Wood Hi. Good morning. I just wanted to ask about the implied fourth quarter guidance with your full year numbers. If I'm calculating correctly, the mineral fiber volume growth looks kind of in the flat to down high single digits range year over year. Just curious what some of the variables that would occur whether impacting if that would fall in the high or low end of the range.

Yeah, Mike, it does, I think you may have misspoke. You said flat to high single digits, just to correct that for everybody. I think you meant flat to low single digit, right, down? Just to be clear.

Yeah, yeah, yeah.

Yeah, okay, just to be clear on that. And I think that's right. I think we expect in the fourth quarter a bit of a continuation of what we saw in the third quarter with some improvement in some of the areas, like I was saying, in LATAM in particular. But Continued good AUV growth, good architectural special growth. I'm expecting another near 20% growth quarter in architectural specialties. But overall, it's going to be a strong double-digit EBITDA quarter for us. So I think you can pretty much expect that, depending on how much improvement we get in LATAM and the retail channels, which have been the headwinds on volume, I think you've got the range about right for what we expect. And that's part of the implied guidance in the fourth quarter.

And can you give us a little bit better bridge on the third quarter price number? I think last quarter you mentioned that you were expecting roughly equal contribution from price and mix to AUV. I think based on your comments, the mix was the majority of the increase. So can you just talk about, you know, the breakdown there, maybe what LATAM and retail contributed?

Well, on the price mix... They were pretty close, a little more mixed than price in that bucket. And, again, I think we saw improvements, and we're not breaking them out individually, Mike, but we saw improvements in both the retail and LATAM in the quarter, just not to the level that we expected when we were talking to you in July.

Great. Thank you.

You bet. Thank you. Our next question comes from Katherine Thompson from Thompson Research Group. Please go ahead.

Hi. Thank you for taking my questions today. Just a quick follow-up on guidance. Always appreciate the pittance in getting to the point with the outlook. But that said, could you just clarify the puts and takes on the Titan guidance? More specifically, how much did lingering issues from the first half carry into the second half impacting the outlook versus any other changes fundamentally currently. Thank you.

Yeah, Catherine, the guidance you're referring to is on the revenue side. We adjusted to the low end of our range, and it's really mineral fiber volume. And the majority of that, the vast majority of that, are the headwinds that we talked about from earlier in the year around Canada, LATAM, and then the big box channels. Those continue to be the primary headwinds for us going into the second half of the year, going into the fourth quarter. And I think that that continues to be our issue. Again, the U.S. market overall continues to be as expected. And, again, we're working through those issues and those other channels.

Okay. Thanks. And then just another follow-up on mineral fiber, understanding that, The second half had tougher optics related to pricing just because of two price increases last year for the first half benefiting from these efforts. Should we expect a similar type flow-through for pricing that we saw in Q3 and Q4, or is there anything else we should take into consideration looking forward?

Yeah, I think your point is something important, which is Well, we had outlook from the first half of this year. We would be copying our best price realization, which happened in the second half of 2018. Third quarter was our best price realization quarter, and fourth quarter was still very good. So we'll be copying a very good price quarter from last year again, but not as good as the third quarter. So I would expect that the AUV fall through – should be similar to slightly better than what you saw in the third quarter, in the fourth quarter.

Great. Thank you so much.

You're welcome. Thank you. Our next question comes from Ken Zenner from KeyBank Capital Markets. Please go ahead.

Good morning, gentlemen.

Hey, Ken. Good morning, Ken.

So about this time last year, I asked if you guys could grow without getting tile units. You said yes. and you did it this year quite well, which has showed up in your valuation. So I guess my question is, can you lay out a similar path for EBITDA dollar growth at FY20 as FY19? And Brian, if you could be specific or repeat probably what you already said, which is that you saw no benefit, I think, in the third quarter from last year's plan closures or any one-time SG&A benefits, because I think that's Certainly one of the cases that the bears have made is that the leverage you got this year in EBITDA was tied more to these one-time benefits rather than sustainable efforts. That's what the market's trying to figure out. If you could expand on that, please.

You want to go first, and then I'll follow up with the mineral fiber.

Yeah, so, Ken, I mean, I think this quarter three is just another good example of the strong productivity in manufacturing. You'll see on our earnings call deck that we've got over $3 million of productivity from the plants. It was over 5%, as we mentioned in our prepared remarks. You know, I can't underemphasize the value of focus. And what I mean by that is our plants, our teams there, are prioritizing productivity. and really focus on running the plants well, executing against our value-added capital expenditures there, and then a little bit of help from the digital side. So it's sustainable. It's very good productivity. Also in the quarter, you saw a nice benefit from WAVE as we managed price and the input cost of steel year over year there. So WAVE was up 16% in the equity earnings. That added another $3 million to the mineral fiber segment. So I think these are sustainable items that aren't benefiting from last year's restructuring. We're pretty well done with the benefits of those through the first two quarters.

And I think, Ken, to your point, we're demonstrating that in the absence of wherever the headwinds come from, whatever channel they come from, we're able to offset them with good AUV improvement, the mix-up that's going on from our innovation work, and then the productivity that Brian highlighted. So I think there's definitely a track record there now that we can grow without mineral fiber volume growing. But with that said, mineral fiber volume growth is important to us. And we have initiatives around driving mineral fiber volume, and we do believe that we can drive mineral fiber volume. So that's going to continue to be something we focus on and work on. But in the absence, you know, again, based on the portfolio mix of mineral fiber, we can demonstrate – we have demonstrated and we continue to demonstrate we can grow EBITDA through these other levers.

I do appreciate that because that's something people have been talking about. So, just a secondary question. You know, I know you guys have talked about 60 days of visibility and non-new project-based demand. So, if you could just revisit – I understand – guidance now. But, you know, Brian or Vic, what gave you confidence to stick with the implied second half unit gains when you guys reported the second quarter? And given that you had to revise down, would you perhaps do that again? Or what were the factors that were really driving that? Because I think people anticipated this downward revision, but why didn't you guys kind of just do it then?

Well, because I think we thought Canada was going to bounce back faster than it has. In fact, Canada hasn't bounced back yet. So I think that was really the biggest miss in our outlook in where we sat in July. And then LATAM and the retail channel, we thought there was more lift there based on, again, what we were hearing from those markets that we thought that we would recover faster. Now we're recovering, but it's just not at the rate that we thought And we certainly thought we could hit the low end of the range, you know, with a little bit of improvement in LATAM and in the big box channel, as well as, you know, Canada Bouncing Back. So I think that's where we came up short versus our expectations.

Thank you.

Thanks, Ken.

Thank you. Our next question comes from Phil NG from Jefferies. Please go ahead.

Hey, good morning, guys. Hey, Phil. You know, Appreciate your AS business tends to be a little lumpier in nature, and you're lapping, obviously, some really tough comps. But organic growth did decelerate quite a bit in the first half, so I'm just trying to gauge if this is more of a timing dynamic or growth has moderated.

No, no, I think this is timing, Phil. I mean, we, you know, quarter to quarter you can get some project lumpiness, but I remain confident that we're going to grow that business more than 15%. The core part of that business, 15%. and then the acquisitions on top of that. So we don't really see any slowing. I love what I see in the backlog right now, and not only for the fourth quarter, but going into next year. So no slowdown there.

Okay, that's great. And then just one more question on AS. I appreciate you're making investments, and there's an integration component when you make these deals, and no complaints on my end. I mean, you've seen the growth, but margins have taken a step back this year. Do you expect some of those investments to kind of level off when we think about 2020 and margins kind of tick back up, or it's going to be like a multi-year process?

Well, the core part of that business, Phil, the margins have expanded. What the headwind you're seeing on the overall segment is the new acquisitions, which come in at lower margins. So that's kind of providing a drag and a headwind. But I'm very pleased with how even the new acquisitions in 2018, along with Tectum that I highlighted in my prepared remarks and the base business, has expanded margins. They continue to get more and more productive. So I'm very pleased with how the margins are expanding in that business. And if there's new acquisitions that we're adding on top, they'll work their way out per our track record. Got it. All right. Thanks a lot.

All right. Thanks, Bill. Thank you. Our next question comes from Garrick Schmoys from Longbow Research. Please go ahead.

Thanks. First question is just on mineral fiber pricing. Just wondering if you can comment on the August price increase, how much traction do you think you've got? And just also, just to be clear on the pricing cadence, you know, was that really just a function of the tougher comparison, or was there any change in underlying pricing?

Yeah, no, I think, Garrett, as we highlighted, we were coming into the base period where we had the highest price realization in last last year's cycle. Again, we had more inflation in 2018, so we were aggressively driving more and more pricing in the marketplace to cover that inflation. And so a bit of that is the base period as we had outlooked. There's no change in the pricing. We're continuing to run the play as we have always run, and there's lots of puts and takes with every price increase given the project nature of the business. But I would say there's no change in that pricing environment.

Okay. And the August price increase, was the level of traction consistent with prior August price increases?

It's consistent with past price increases. That's correct.

Thanks. And my follow-up actually is on inflation. I think coming out of the second quarter, you had thought inflation was going to track maybe around 2.5% to 3%. It was a little bit lower than what you thought at the beginning of the year. Is that still a good number to use, or have you seen any changes on your inputs?

Hey, Gary. It's Brian. So, yeah, inflation is trending down. As you'll see that we had favorable input costs, which includes raw materials, energy, and freight. But when you bring in the labor component of that and look at total cost of goods sold, we're still tracking price over inflation, but inflation is definitely coming in at the lower end of our range.

Okay. Thank you. Thank you. Thank you. Our next question comes from Justin Spare from Zellman. Please go ahead. Good morning.

Thank you, guys. Just first, looking at the volume drag from Home Depot, I guess the home centers in Canada in the third quarter, I know it's something you mentioned in the first quarter, and I thought it was getting remedied in the second quarter, but how much impact in your full-year volume guidance at Mineral Fiber from those discrete headwinds, and how big are those businesses within your overall Mineral Fiber business?

Yeah, we've outlooked that part of our business, is about 20% of our sales and about 30% of our volume. So I'll give you some relative size of that. What we had outlooked is that those businesses would sequentially improve. They did in second quarter and then again in the third quarter, but just not at the rate at which we had expected. And so when you look at it in total, of the mineral fiber volume drag, the majority, the vast majority of that drag has come from That's that part of the market. So that part of our business. So without breaking out and give a very specific number, but you can take from this that the vast majority of the headwind here on volume has been from those three.

Okay. Okay. And then separately, just the implied organic growth into the fourth quarter and for the full year. for architectural specialty segment. I want to look at that stripping out ACGI, plaster form, and SCI. I think we're estimating roughly $36 million for the year, plus or minus. And year-to-date, I think you've disclosed in your queue, it's about $27 million. So if we were to strip that out, what's the organic growth profile that you're looking for for the full year and for the fourth quarter?

Yeah, I think we're on our guidance for that part of the business growing greater than 15%. And I think you can expect a very similar performance in the fourth quarter.

Yeah, but I think we have a little bit of a different definition because the year-to-date organic growth is trending below that. And so I just wanted to make sure we're on the apples-to-apples so we don't overestimate for next quarter. But our apples-to-apples definition is you grew a little under 4% organically in the third quarter, and you're up roughly – I don't know, 7% year-to-date. If we were to look at it on that definition, stripping out that M&A that carried over that's not organic from last year and earlier this year from M&A, what are you anticipating for that kind of organic growth definition for the fourth quarter?

So, Justin, the definition that we've guided to is our base business with the acquisitions already completed. So, that would have been plaster form and steel ceilings in that base period. That's what we've guided to and outlook, and we're on track to deliver that number. So, if you look at the third quarter, there is no contribution from the inorganic activity in plaster form and steel ceilings. They were closed in the late second quarter.

Right, so I think you communicated $9 million in your queue in terms of acquired revenue that's not organic. And so I'm just looking at it from that standpoint. I don't want to beat a dead horse here, but I just want to make sure we're hearing you clearly in terms of the organic growth cadence you're expecting implied in the fourth quarter.

Yeah, the inorganic that we're implying, again, includes steel ceilings and plaster form materials. They're past their anniversary in terms of contributions, so they're in the base. And that's what we've guided to. So that's the greater than 15% guidance that we're providing out there.

Now, in the guidance that you mentioned, MRK is not being that additive, at least near term. But what were the intercompany sales of MRK to AWI in that $14 million revenue definition?

Yeah, we didn't break that out totally, but you can pretty much count on the majority of those were Armstrong sales, intercompany sales.

Got it.

So that deal is not closed yet. That deal closed in the fourth quarter. It's not closed yet, and so we certainly haven't outlooked anything in our projections so far. Excellent. Thank you, guys.

Okay.

Thank you.

Thank you. Our last question comes from Yves Brumhead from BNP Pro E-Bus. Please go ahead.

Good morning, gentlemen. Two questions, if I can. The first one, I think you mentioned the fact that you had some lumpy R&R verticals. I just wanted to understand which vertical you're referring to. And also, I'd be interested to understand if there's any differences between regions across the U.S. in terms of the end market developments. And my second question is on your 10Q, you highlighted a $4 million decline in manufacturing costs in Q319. Could you help us to understand what exactly are the input costs that are falling and how we should think about those going forward given the fall in energy prices that seem to be continuing? Thank you very much.

Brian, I'll let you take the third part of that. Sure. As far as the verticals, I called them out in terms of the lumpiness and uneven. It's been the retail and the healthcare verticals for the most part. Office continues to be, and education, as I outlined, continues to be positive. So the lumpiness is really coming, and actually the unevenness in terms of their participation has been the retail and health care. And across the U.S., I'd say there's no regional standouts. It's very – the activity is very – consistent and broad-based on the new construction and large remodel projects across the U.S., the majority, the vast majority of our regions across the U.S. were positive in a quarter. So, again, you can have, it's never 100%, so that's very encouraging, the fact that the vast majority of our territories were positive in a quarter. So, Brian, you want to take the other part?

And, yes, when you get a chance to look at our earnings call deck, you'll see it on page 7. Input costs, which includes the benefit from energy, freight, and raw materials, was roughly $1 million beneficial in the quarter versus a year ago. And the rest of it, the other three, was all driven by that productivity, which in that manufacturing line, we have labor inflation that's being offset by productivity.

Okay, thanks. So how should we think – sorry, but the – the energy and input cost, therefore, going forward? Because if I look at how gas and electricity and the energy component is looking like going forward, it does seem that you should have quite more tailwind actually going forward. Is that correct?

That's correct. Largely, remember, energy is roughly 10% of our total cost of goods sold, so it's a small piece, but we are seeing favorability in the energy part of our P&O.

All right, great. Thank you so much.

Thank you. Great.

Thank you. This concludes our Q&A session. At this time, I'd like to turn the call back to Vic Griesel, President and CEO, for closing remarks.

Yeah, I just want to say thanks, everybody, for joining today. Again, I think we had a really strong quarter. One of the things that didn't come out I wanted to just mention again is the mineral fiber volume growth at the high end of the portfolio remained very strong in the high single-digit level And it just further demonstrates that the innovation that we're bringing to market is the innovation that architects want to specify and use in creating the base for future renovations. So we're really encouraged by that, along with all the other things that we mentioned on the call. So thank you again for joining. Look forward to finishing the year very strong and talking to everybody in February. Thank you again.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Good day.