Armstrong World Industries Inc

Good day, and thank you for standing by. Welcome to the second quarter 2023 Armstrong World Industries earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Theresa Womble, VP of Investor Relations and Corporate Communications. Please go ahead.

Thank you, and welcome everyone to our call this morning. Today, we have Vic Grizzle, our CEO, and Chris Calzaretta, our CFO, to discuss Armstrong World Industries' second quarter 2023 results and rest of year outlook. To accompany these remarks, we have provided a presentation that is available on the investor section of the Armstrong World Industries website. Our discussion of operating and financial performance will include non-GAAP financial measures within the meaning of the SEC Reg G. A reconciliation of these measures with the most appropriate comparable GAAP measure is included in the earnings press release and in the appendix of the presentation issued this morning. Both of these are available on our investor relations website. During the call, we will be making forward-looking statements that represent our view of our financial and operational performance as of today's date, July 25th, 2023. These statements involve risks and uncertainties that may differ materially from those implied or expected. We provide a detailed discussion of the risks and uncertainties in our SEC filings, including the 10Q filed earlier this morning. We undertake no obligation to update any forward-looking statement beyond what is required by applicable securities law. Now, I will turn the call over to Vic.

Thank you, Theresa, and good morning, everyone, and welcome to our earnings call. We have lots of exciting things going on at the company, including a strong quarter of execution and the acquisition of Boke Modern, which we announced yesterday. So, let's jump right in. On a total company basis, we generated 10% year-over-year adjusted EBITDA growth on 1% net sales growth in the quarter, despite soft market conditions and continued economic uncertainty. These results helped increase our year-to-date adjusted free cash flow to $103 million, a 60% increase from 2022 results. Both the mineral fiber and architectural specialty segments contributed to this strong earnings and free cash flow growth. and both segments delivered meaningful EBITDA margin expansion. These are solid results, and I'm pleased with how our team is executing thus far in 2023, managing softer market conditions while increasing profitability and continuing to deliver on our growth initiatives. In our mineral fiber segment, sales ended the quarter essentially flat to 2022 levels. Strong AUV performance of 7% offset a decline in sales volume. As mentioned on our first quarter call, we expected market demand to be softer versus prior year, and we had highlighted first quarter restocking activity in the home centers that would begin reversing out in the second quarter. Also, you may remember the second quarter last year was impacted by the unusual timing of our July 1st price increase versus our typical August timing. Overall, we believe that sequentially underlying market demand was modestly soft, than the first quarter. Relevant indicators for our primary sectors were mixed overall in the quarter. Dodge bidding activity softened. ABI declined but remained in positive territory. Office vacancies continued to rise but at a slower pace. And commercial leasing activity improved in the quarter for the first time in four quarters. And now that we've begun the second half, on the ground sentiment has slightly improved with verticals like transportation, healthcare, and education remaining active, partially offsetting soft replacement activity and tenant improvement work in the office vertical. The fact that we sell into a variety of verticals is important for us. The office vertical, which has been the most challenged area, represents about 30% of our sales, similar to the education vertical, followed by healthcare, retail, and transportation. They rarely move up or down at the same rate, and this has helped cushion our business from cyclical swings, and we believe that it positions us well in this current environment. Another highlight of the quarter was our mineral fiber AUV performance of 7%. This result was driven primarily by like-for-like pricing. As we've often noted, our ability to consistently achieve price is an important part of our value creation model. We've captured our normal price realization for the increase that we announced earlier in 2023. It has helped offset the inflation on raw materials we're experiencing. Our industry-leading value proposition, enabled by the work of our sales team staying close to our customers, and the efforts by our plants and customer service teams to maintain our best-in-class service levels, and our new product innovation have all contributed to our consistent ability to earn our prices in the marketplace. I would also like to highlight that our healthy spaces and digital growth initiatives were a positive contributor to mineral fiber sales in the quarter. Sales growth in our Health Zone product line continued at elevated levels, and our sales through our online marketplace, Canopy, doubled from 2022 levels. Both of these helped offset some of the negative impacts from the overall lower market activity. Another highlight for the mineral fiber segment is that our plants did very well with delivering productivity gains despite lower volumes in the quarter. The great work by our plant teams demonstrates another of the core value creators for Armstrong, which is operational excellence in all parts of the cycle. Our ability to consistently generate manufacturing productivity while maintaining best-in-class quality and service throughout our network contributed to mineral fiber margin expansion this quarter and has been a hallmark of our company's success. These efforts, along with our continued growth in AUV, helped push mineral fiber quarterly adjusted EBITDA margin above 40% for the first time since 2021. Now moving on to architectural specialties. Sales for this segment accelerated from first quarter results and were up 6% from a strong 2022 level. We continue to see good activity in verticals like transportation, healthcare, and education. Our order intake for the quarter and architectural specialties reached a historical high in the quarter. Importantly, we're also driving EBITDA growth and margin expansion in this important growth segment. We're now seeing the benefits from the investments that we've made in the businesses where we've acquired and are achieving the expected operating leverage on increased sales volumes. Last, before I turn it over to Chris, I would like to briefly illustrate how our investments across the segments work together to deliver value for our customers and grow our business through a successful project involving a hospital that we recently completed in Colorado. This was a sizable project with typical complexities that required many different solution types to achieve the design intent of the architect. The project began with the architect employing the use of ProjectWorks, our pre-construction design service platform. The architect was able to input the project requirements and develop a layout in Project Works that enabled multiple iterations to optimize the design intent and cost and do it quickly and efficiently. This project ultimately required a mix of 28 different Armstrong products across both our segments. This included sustained smooth wide acoustical tile, including our health zone products, as well as a variety of grid and architectural specialty products including our Metalworks blades. The project ended up being a very strong specification for AWI, since no other single manufacturer could offer the complete suite of products digitally enabled by our proprietary design platform. This is a great example of how valuable the breadth of our portfolio products and our innovative services can be for our customers, making it easier for architects to specify more Armstrong products in more spaces, leading to stronger specifications and greater AUV growth. Now I'll pause and turn it over to Chris for some more details on our financials. Chris? Thanks, Vic, and good morning to everyone on the call. As a reminder, throughout my remarks, I'll be referring to the slides available on our website in slide three, which details the basis of presentation. On slide six, we discuss our quarterly mineral fiber segment results. Mineral fiber sales were essentially unchanged from the prior year, as AUV growth of 7% was offset by lower volumes. AUV performance this quarter was driven by like-for-like pricing, while mix was essentially flat, with positive product mix being offset by timing-related channel mix headwinds. Our Q2 mineral fiber AUV result gives us confidence that we are on track to deliver above average historical performance for the full year. The decrease in volume during the quarter was driven primarily by softer market demand, and to a lesser extent, the timing of year-over-year announced price increases, and the resulting impact on sales that Vic mentioned earlier, in addition to the expected weaker home center sales from inventory build that we noted in our April call. Mineral fiber segment adjusted EBITDA grew by $6 million, or 7%, and adjusted EBITDA margin expanded by 260 basis points as compared to the prior year. AUV fall through was above historic levels and a key driver in expanding EBITDA margin. Wave equity earnings were also favorable as compared to the prior year, driven by price overinflation. Our mineral fiber plants continued to execute well in the quarter and delivered meaningful productivity gains ahead of their targets. Partially offsetting these gains were headwinds from lower volumes and higher input costs. While we experienced energy and freight cost deflation versus the prior year, raw materials remain inflationary. SG&A in the quarter was essentially unchanged versus the prior year as modest increases in selling expense in support of our digital initiatives were partially offset by the benefits from our previously announced cost savings initiative. On slide seven, we discussed our architectural specialties or AS segment results. With sales growth across most product categories, the rate of growth in the quarter improved sequentially from Q1 and is a better reflection of the growth we expect to see for the full year. We continue to see strong transportation bidding activity and are keeping a close eye on order intake and backlogs. We're particularly pleased with the order intake and backlog levels for our metal products, which are both up more than 20% versus the same time last year. This activity supports our excitement and investment in this growing category through our recently announced acquisition of Boke Modern for initial cash consideration of about $14 million. Vic will share some additional thoughts on this acquisition in a few minutes. AS adjusted EBITDA margin took a step up in Q2 both sequentially and versus the prior year period, expanding 360 basis points versus the prior year through operating leverage on increased sales. We continue to leverage SG&A as we grow and expand EBITDA margins in this segment. Slide 8 shows our second quarter consolidated company metrics, where benefits from improved AUV, wave equity earnings, and lower manufacturing costs more than offset headwinds from lower volumes, increases in input costs, and higher SG&A expenses. Consolidated adjusted EBITDA margin expanded 260 basis points, with adjusted EBITDA up 10%. Adjusted diluted net earnings per share increased 7% versus the prior year, and adjusted free cash flow increased $28 million, or 64% versus the prior year. Slide 9 highlights our consolidated company metrics through the first six months of the year, where we grew adjusted EBITDA by 10% and expanded margins 130 basis points. These strong results reflect the execution, operational efficiency, and cost control discipline of the entire AWI team, despite market headwinds. Adjusted diluted net earnings per share increased 9% versus the prior year period. and adjusted free cash flow increased about $40 million, or 60% versus the prior year. Slide 10 shows our year-to-date adjusted free cash flow performance versus the prior year. The increase was driven by working capital improvement, primarily in inventory and receivables, and an increase in waived dividends. This was partially offset by higher capex and higher cash interests. We are proud of this year-over-year improvement through the first half of the year and remain focused on driving full-year free cash flow growth to fund all of our capital allocation priorities. Recall that our first capital allocation priority is to invest in our business where we see the highest returns. Next, we target strategic acquisitions such as Vogue Modern that offer unique, specifiable attributes and capabilities that leverage the strengths of our business. Last, we seek to return excess cash to shareholders. In the second quarter, we repurchased $30 million of shares, and since the inception of the share repurchase program in 2016, we have repurchased a total of 13.2 million shares for about $908 million. We ended the second quarter with $292 million remaining under the existing authorization. Last week, we announced an increase in our existing share repurchase program, adding an additional $500 million to the authorization and extending the program through 2026. This decision reflects confidence in our ability to generate adjusted free cash flow and our commitment to fund all of our capital allocation priorities to create long-term shareholder value. Slide 11 shows our full year guidance. Improved visibility for the second half of the year has removed the worst-case market downturn scenario from our expectations. And as such, we are modestly updating our full year 2023 guidance for sales, adjusted EBITDA, and adjusted diluted EPS. And as I just mentioned, with the expectation of continued strong cash flow generation, we are raising the midpoint of our adjusted free cash flow guidance with an updated range of $240 to $250 million with a midpoint free cash flow margin of about 19%. Looking ahead, recall that in the second half of 2023, we will be lapping a period of lower SG&A incentive compensation in the prior year, as well as continuing investments to support our digital initiatives in the current year. Additional assumptions are available in the appendix to this presentation. And now I'll turn it back to Vic for some additional thoughts before we take your questions. Thank you, Chris. At the halfway point in the year, I'm pleased with where we are, and I believe we're well positioned to deliver on our outlook for 2023. The resiliency of our AUV growth, our productivity gains, and now the meaningful contributions from our digital and healthy spaces initiatives, when we need them the most in a weaker market environment, are clearly shining through. Our digital initiatives are on track to be EBITDA positive for the second half of the year. And as of yesterday, sales through Canopy have already surpassed total 2022 sales results. Our Healthy Spaces products are also gaining traction with sales up over 20% on a year-to-date basis, and we're pleased with the regulatory support they are gaining. Many of you may have read about the two new bills lawmakers are bringing forward in New York City that would require the city to create standards to measure, monitor, and report and enforce air quality inside schools and municipal buildings. These are bills that have been in the works since the pandemic But due to the Canadian wildfires and the impact on air quality inside buildings, these bills have been accelerated. These proposals follow recently updated guidance on ventilation and buildings from the Center for Disease Control and Prevention and adopted by ASHRAE that the air and space spaces be changed five times per hour to help reduce the number of pathogens in the air. These are all positive trends that support our Healthy Spaces Growth Initiative and the role ceilings can play in creating healthy spaces. Overall, I attribute our year-to-date results to two things. Number one, our team's strong execution being demonstrated through the up and the down cycles. And number two, the resiliency of our business's core attributes, namely our strong market position in this uniquely attractive ceiling and wall category, our best-in-class exclusive distribution partners, Our ability to deliver consistent AUV growth and our proven ability to achieve consistent annual manufacturing productivity gains all contribute to the extraordinary resilience of our company and our ability to expand margins and deliver free cash flow growth in all parts of a normal cycle. This resilience and the resulting free cash flow growth allows for the deployment of free cash flow for both direct returns to our shareholders as well as on the growth initiatives and complimentary acquisitions that deliver profitable growth. Just last week, as Chris mentioned, our board of directors approved a $500 million increase to the share repurchase authorization, a shared confidence in our ability to sustain strong free cash flow into the future. And our acquisitions continue to help us build the broadest portfolio of specialty architectural solutions in the industry, and importantly, get Armstrong Solutions into more projects and into more spaces. And our latest acquisition, Bulk Modern, we announced yesterday, does exactly that. Bulk is a growing and profitable business focused on the design and engineering of architectural metal solutions for a wide variety of applications that are a natural extension of what we're doing in architectural specialties. Their solutions have patented designs that deliver project efficiency benefits by reducing material usage and installation. The work they do will help us respond to the desire among architects and designers to have a seamless flow between the interior and exterior look of a building. Additionally, their facades and rainscreens not only add aesthetic interest, but they also reduce the energy load of the building by deflecting solar heat. This will be an increasingly desired design attribute as the embodied carbon and emissions of buildings becomes more and more in focus. We're pleased to welcome them to the AWI family and we have every confidence that we will be able to leverage our platform to accelerate their growth and increase their profitability. We're excited about the momentum overall in architectural specialties. Our expanding portfolio truly distinguishes us from our peers in terms of being a single source provider for complex projects, such as those in the transportation vertical. And we continue to see increasing bidding activity for airport projects. This increase in demand has been fueled by the recent infrastructure bill, which includes $5 billion in spending specifically for airports. We've previously discussed our significant win at the Pittsburgh airport, but recently we've also been awarded jobs at the Seattle-Tacoma airport and the airport in El Paso. Today, we're tracking at least 200 more airport projects, ranging from new terminals at JFK in New York and Chicago's O'Hare to work in Nashville, Orlando, and Jacksonville, just to name a few. These opportunities are growing and often involve a wide range of materials from mineral fiber, wood, metal, and more of Armstrong's complete portfolio. Given the scale and complexity of these projects and now Armstrong's size and capabilities, we expect a tailwind from transportation to last beyond 2026. I think it's fair to say that five years ago, we wouldn't have been able to compete for these types of projects. We wouldn't have had the right portfolio or the capability to do it. With the capabilities that we've added now, with our unmatched scale, we are well positioned to capture the opportunity in front of us. With that, we'll be happy to take your questions.