Armstrong World Industries Inc Q1 FY2021 Earnings Call

Good day and thank you for standing by. Welcome to the Armstrong World Industries, Inc. First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today Tom Waters, VP of Corporate Finance. Please go ahead.

Thank you. 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.

Thanks, Tom, and good morning, everyone. It's good to be with you today to review our first quarter results. A solid start to what we expect will be a robust year of growth for Armstrong. Overall in the quarter, we continue to see sequential improvement and the recovery of our markets. Our total company daily shipping rate sequentially improved and accelerated through the end of the quarter and that acceleration has continued nicely into April. This first quarter comparison is against the last of the pre-COVID market conditions as we saw very little impact from COVID in our base period. In this first quarter of 2021, adjusted revenue of $253 million increased 2% from prior year, driven by sales of our 2020 acquisitions, which more than offset COVID-driven volume reductions in our organic business. Adjusted EBITDA of $85 million declined 12% from the prior year driven by COVID-related volume declines, continuing investments in our growth initiatives and the resumption of spending that was deferred when the pandemic hit. The Mineral Fiber business has started the year as we expected. Our Mineral Fiber daily shipping rate posted a third consecutive quarter of sequential improvement as people return to work and markets continue to reopen. Like-for-like pricing exceeded input cost inflation, top-line mix was positive as sales of our premium products continue to outpace the rest of our product offerings, and channel mix was once again a headwind, although to a lesser extent driven by relatively strong sales in the lower-price-point home center channel.

Thanks, Vic. Good morning to everyone on the call. Today I will be reviewing our first quarter 2021 results and our guidance for the full year. But before I begin, as a friendly reminder, I'll be referring to the slides available on our website and slide 3 details our basis of presentation. On slide 4, we'll begin with our consolidated first quarter results. Adjusted sales of $253 million were up 2% versus prior year. These adjusted sales include approximately $700,000 of purchase accounting adjustments related to our 2020 acquisitions. This is the last quarter for this adjustment. Adjusted EBITDA fell 12% and EBITDA margins contracted 520 basis points. As Vic stated earlier, this contraction was expected given the pressure that persists this quarter from COVID-related demand declines, the investments we continue to make in our growth initiatives and the fact that we have reinstituted the costs we temporarily cut last year.

Thanks, Brian. Before we get to some Q&A, I want to touch on a few important initiatives in the company, namely ESG, Healthy Spaces, and our new digital platform Kanopi by Armstrong. On our last call I mentioned that ESG would be an area of focus for us in 2021 and beyond. As we build on our history of community engagement and corporate responsibility, it's increasingly important to all our stakeholders and it has a natural fit with our mission, our history, our culture and our strategy. As many of you have seen earlier this month, we launched a redesigned sustainability section of our website that reflects our three pillars of focus: People, planet and product, and establishes our 2030 goals in these areas.

Thank you. Our first question comes from Kathryn Thompson with Thompson Research. Your line is now open.

Hi. Thank you for taking my questions today. Helpful color in terms of what we're seeing in March and April and how we should think about stair-stepping given some unusual comps. One thing, if you could give just a little bit more clarity on residential — new construction versus repair in your model. Given the launch of your Healthy Spaces product, I would imagine you're seeing greater demand there. But I really want to get a better understanding of how much of growth is being contributed by new construction versus retrofit, which is in a pretty unusual environment?

Yeah. I think, Kathryn, the current activity is reflective of what new construction activity will be 18 months out. What we're actually experiencing now in terms of sales, revenue, or opportunities to ship into today is what was laid in 2020, or what was not laid in 2020. So this year, new construction activity from a sales standpoint is going to be a slight headwind. With that said, the bidding activity for new construction was positive in the quarter versus prior year. This is the first time we've seen new construction activity be positive in the last several quarters, so that's an encouraging sign. Most of the activity we're developing and selling into for 2021 is on the renovation side. Several of the projects that were delayed last year are starting to get released now. That really occurred in the latter part of the first quarter and we expect to see that continue into the second quarter. The bigger part of our business — about 70% — is from renovation and large remodel projects. That's an encouraging sign for us on the activity front. On the new construction side, again, the fact that we're starting to see more activity there bodes well for the second half, or even into 2022.

Okay. And the follow-up question is on SG&A in the quarter. I really just wanted clarification of how much the increase was due to the ramp-up of your December acquisition, which I believe closed mid-December, structurally higher SG&A from the three acquisitions completed in 2020, and the higher incentive compensation that you noted in your release. I want to parse out how much is more one-time versus structurally higher costs going forward.

Yes. I'll let Brian comment on some of the details of that, Kathryn. But overall SG&A was as expected. We made a conscious decision last year to continue our investments in the growth initiatives that I talked about — Healthy Spaces, the new digital platform Kanopi by Armstrong, and our Architectural Specialty capacity and capabilities. We've continued our investments in those, and those are reflected in our first quarter numbers. We also resumed temporary cost cuts that were in place in 2020. So SG&A was very much as expected and on track with what we intended from our growth initiatives. Brian, do you want to add any color to that?

Yes, sure. As you further break that down, Kathryn, roughly $6 million to $7 million was around incentives and deferred compensation and that's more of a temporary item that we reduced last year and it didn't repeat here in Q1. About $3 million of it is coming from the 2020 acquisitions. The remainder is the growth investments we're making to support Architectural Specialties and Kanopi and Healthy Spaces.

Okay, perfect. And before I part I wanted to say congrats to Tom for all your efforts with IR at Armstrong. We're going to miss you and I'm going to miss our big word challenge. Best of luck in retirement.

Thank you for that, Kathryn.

Thank you. Our next question comes from John Lovallo with Bank of America. Your line is now open.

Hey guys. Thank you for taking my questions as well. The first one, Brian, if I heard you correctly, I think you said April Mineral Fiber volume was up 58% year-over-year. Just curious if you could remind us of the monthly volume cadence on a year-over-year basis in 2Q 2020. So April, May, June in 2Q 2020 on a year-over-year basis.

Yes, John, that's one of the reasons I referenced that April was above 2019. I'm encouraged to see that the sales rate per day exceeded two years ago before we had the COVID impact. Roughly last year Mineral Fiber sales were down in the 50% range, so it's a nice pickup and encouraging that we're seeing that in April.

Got you. I could follow up with you, but I was curious month by month. The second question is AUV — obviously it returned to positive territory in the quarter which was encouraging and ahead of our expectations. Curious if this was ahead of your expectations, and the level of confidence you have that we're sort of through the worst of the pressure at this point.

No, this was as expected. We had talked last year about the underlying driver of our AUV being territory mix that was very unnatural and caused by the unevenness of the COVID impact on some of the major cities and shutdowns. That was transitory. The underlying driver of mix over the last 10 years has been product mix, and that remained positive in 2020. As territory mix worked its way through in Q1, product mix started to show through and drive AUV. It's exactly where we expected it to be and we think it will continue to improve from here with the backdrop of inflation helping with our like-for-like pricing. Territory mix has normalized itself as demonstrated in Q1. Channel mix remained a slight headwind but is subsiding. Given our guidance and easier comps in Q2 and Q3, we're trending toward the high end of that range.

Great. Thanks very much, guys.

Thank you. Our next question comes from Susan Maklari with Goldman Sachs. Your line is now open.

My first question is just going back to the order trends that you are seeing there. Can you give us some sense of what end markets those orders are coming from? Any color on the geographies as well? And some context on that activity and how to think about where it's coming from?

Yes, Susan. Let me start with geography. We have seen better demand from the southern part of the United States sooner, as those markets opened earlier than the Northeast and some parts of the Northwest. So Florida, Georgia, Texas and similar areas were out in front. That trend is transitory; the Northeast including New York City and California are improving nicely. I see the rest of the country catching up. On verticals — education, office — we see a bounce back uniformly across these sectors. In 2020 everything was shut down uniformly, so the recovery is more uniform now. Bidding activity in education and health care is trending upward nicely and is ahead of some other sectors, which may reflect additional funding driving activity in those two sectors. We'll see how that unfolds in Q2 and Q3.

It does feel like there's a lot of focus on education and improving schools. My next question is on inflation. I know you talked about transportation expense increasing. Can you give us color on how that will flow through for the balance of the year? Do you expect further increases? And how do you think about that against your normal cadence of pricing? You mentioned moving your second price increase earlier; how many increases are you thinking about for this year and how should we expect them to come through?

We pulled our second price increase forward. We typically do it in August, but we brought it into May and it is a bit heavier than normal — a 10% price increase to reflect what we expect in inflation so we can stay ahead. Whether we take another increase will depend on the summer months and whether inflation accelerates. We would not be afraid to go out with another price increase to stay in front of inflation. Our 7% increase in February was effective; that was also heavier than normal. I expect good success with the 10% in May and we'll see where we go from there. The highest inflation levels we're seeing are in our WAVE business with steel costs, which started rising last August. WAVE has implemented price increases regularly to stay ahead of steel inflation. The same selling organization raises prices on both ceiling tiles and grid systems, so I'm confident we'll manage pricing effectively.

Okay. That's very helpful color. Thank you, and good luck with everything.

Thank you, Susan.

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

Good morning, everybody.

Hi, Ken.

When you say Q2 is above Q2 2019, that's good. When you think about product mix versus regional mix fading in the second half, is it correct to think of product mix being driven by regional mix?

No. Product mix is an underlying trend across all territories and it was positive last year. Territory mix, where markets like New York and California were harder hit and carry higher-value products, caused a negative mix effect. That has normalized in Q1.

There are many things happening. It appears share gains are improving. You guys are disciplined on price. As I drove to get my second shot a couple of weeks ago, northern California seemed to be building a lot in exurbs. You've focused on schools, but stepping back, could demand in suburbs and exurbs create a bigger opportunity — with infrastructure spending and potential migration out of cities? Could this create more new construction and renovation that benefits you?

Yes, Ken, we see that trend. There's coverage about folks moving from cities to lower-cost suburbs. There isn't enough capacity and infrastructure in those areas to house all incoming people, which will create opportunities for renovation and new construction. Historically, most commercial construction since the financial crisis has been in inner cities, not suburbs. We view suburban migration as an opportunity for renovation and new construction. Also, inner-city capacity will be filled by someone else, creating latent renovation demand there. Net-net, we believe this migration is a positive trend and a tailwind for the category.

Maybe to put that in context with volumes down in 2020 and the long-term decline in Mineral Fiber since 1999, could there be a cyclical trough and then renewal for Mineral Fiber if jobs move to places like Florida or North Carolina? Could that affect product mix if projects shift from high-end urban jobs to suburban projects?

We don't see a change in the mix whether the project is in suburbs or inner cities. Companies will maintain a standard of interior quality — acoustics, lighting, and now Healthy Spaces considerations. Ceilings play an important role in delivering higher-quality air and interior design solutions, which is a catalyst for the ceilings category overall. Net-net this is a tailwind opportunity for the category.

Well, thank you very much and Tom, thank you for all of your help over the years.

Thank you. Our next question comes from Keith Hughes with Truist. Your line is now open.

Okay, thank you. Question on Architectural Specialties. You talked a lot about sales pace and Mineral Fiber. What does it look like in Architectural Specialties, and how do you stand in April on a two-year basis in that business outside of acquisitions?

The order rate has been terrific. Coming into Q1 we saw some projects delayed, so we landed about where we expected given those signals. However, we had strong order intake — March was a record month for order intake in Architectural Specialties, which is a strong signal that projects are not being canceled. Our backlog is in one of the better positions at this time of year that I can remember for what we expect to deliver for the year. That gives us confidence that projects delayed out of Q1 will pick up in Q2 and Q3. We continue to win in this space, integrate acquisitions, and that gives us credibility with the architectural design community to win specifications that drive pricing and margin structure in this category.

Okay. And final question on raw materials: aside from steel in WAVE, where is the most inflation coming from for inputs to tiles themselves?

The greatest impact across both businesses outside of WAVE is on packaging, where lumber is a big part and lumber has seen significant volatility. Packaging and freight are the two highest levels of inflation we're seeing across the business. Brian, do you want to add to that?

Yes, Keith. Previously we discussed total cost of goods sold inflation in the $2 million to $2.5 million range; we're now looking at $3 million to $3.5 million across both businesses. So while it's picked up, that's been the basis for us pulling forward our pricing activity.

And that $3 million to $3.5 million excludes WAVE — correct?

That's correct.

Okay. Thank you.

Thank you. Our next question comes from Stephen Kim with Evercore ISI. Your line is now open.

Yes, thanks very much guys. I wanted to pick up on your commentary about the April shipments — you mentioned April was higher than 2019 which is attention-getting. Given your exposure to cities like New York, have those REIT areas fully participated in that improvement, or is April underpowered because those areas haven't fully come back yet? Some clarity around that would be helpful.

Stephen, it's one month, and 2019 is a key marker for when the market is back to pre-COVID conditions. April's result is an important milestone and we like the trend and the acceleration from March into April. Not all of our seven key territories, like New York City, are fully participating yet; there's still healing in those markets and more to go. California and New York in particular are still healing. We're encouraged by bidding activity and conversations with customers in those regions, but we're in the early days.

Sure. My second question relates to open plenum design. There's growing awareness of the need to treat occupied air, which makes open plenum more difficult. To the degree that awareness persists, open plenum could lose share and your business could gain share back. Have you seen anything concrete beyond that high-level thinking?

Even before COVID, we saw the pendulum swing away from no ceiling at all because of acoustical performance in open plenum designs. That created opportunity for Architectural Specialties to provide open-looking products like linears that provide acoustical solutions. This situation adds scrutiny on energy efficiency and the ability to treat air year-round. It's too early to say what will happen to the category overall, but I believe this is an opportunity for ceilings to play a more important role in open plenum designs, and we're encouraged by that.

Absolutely. Thanks, and Tom, congratulations.

Thanks, Stephen.

Thank you. Our next question comes from Phil Ng with Jefferies. Your line is now open.

Hi guys. The renovation activity that's coming back, perhaps delayed from last year — have you seen customers adopt Healthy Spaces products that you've been rolling out? Are you seeing more retrofitting to improve air ventilation or social distancing?

The renovation activity we're seeing now consists largely of projects already in the pipeline moving forward. Some of those specifications have been changed to our new products to gain the benefits of Healthy Spaces, which has given us a lift early on as larger projects go through specification. We're getting good traction and lots of strong conversations across all verticals, including restaurants.

Thanks. In terms of backlogs and bidding activity improving, can you quantify how much that is up in Q1 versus Q4? And when do you expect the handoff from the bidding improvement to offset headwinds from the new construction timing issues — mid-2022 or sooner?

Roughly, bidding activity improved in the single-digit positive range versus prior year and was much better than Q4. Bidding can be six to 18 months out depending on project size. Some large projects are 24 months out before they need ceilings; smaller ones can be three to six months. On average, an 18-month window is a good proxy across project types and verticals.

Super helpful. Appreciate it, and good luck.

Thank you. Our next question comes from Garik Shmois with Loop Capital. Your line is now open. Jeff Stevenson is on for Garik today.

Hi. This is Jeff Stevenson on for Garik today. Thanks for taking my questions. My first is how should AUV improvement look for the rest of the year between like-for-like price and mix?

Normally we see about a half-and-half contribution from like-for-like pricing and mix. Our outlook is currently 4% to 6%, and as I indicated earlier, we're closer to the high end of that range given where we are at the end of Q1. Normally it's about half and half, but this year, given the territory mix headwinds in 2020 that won't repeat, we could see a bit more contribution from mix toward the end of the year than like-for-like pricing. I still expect strong like-for-like pricing performance given the inflationary backdrop.

Could there be upside from the higher-than-usual May increase, especially if higher-priced Northeast markets come back faster than expected?

The range we're outlooking is still appropriate. We'll watch the inflationary backdrop and how key markets like New York and California bounce back in the second half. Given those uncertainties, the range is appropriate, though we're trending to the high end.

Okay. Thanks for taking my questions.

Thank you. Our next question comes from Yves Bromehead with Exane BNP Paribas. Your line is now open.

Good morning and thank you for taking my question. I have two. First, can you clarify what the one-off cost was exactly on the AS side? I think you mentioned $6 million to $7 million in incentives and $3 million on acquisition in Q1. Just wondering if I have the correct numbers and how to think about those going forward.

Yes. The one-off costs I referenced really hit the Mineral Fiber EBITDA bridge. On Architectural Specialties you have a combination of additional SG&A from the acquisitions and then investments happening to support growth, so those are less temporary. On Mineral Fiber, the $6 million to $7 million was more temporary for Q1.

Okay. Thank you. My second question on Architectural Specialties: what size of the market would you like to achieve going forward? How much could specialty revenue hit in five years assuming continued external growth, and what margin could this division achieve once growth investments are done?

We've been public around the size of the specialty segment being in the neighborhood of $1 billion for the Americas, and that's a good proxy to think about. We're relatively early in penetrating that market, and we expect to grow double digits annually in that space with plenty of penetration and organic growth opportunities. As we get better and more efficient, margins should continue to improve. This is a different business and manufacturing model than Mineral Fiber, so we don't expect Mineral Fiber-level EBITDA margins. Over time we expect Architectural Specialties to be in the mid-to-high 20s percentage range of EBITDA margin, which would be among best-in-class in building products.

Yes. Thank you. And again, good luck on your retirement, Tom.

Okay. Thank you.

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

Yes. Good morning, everyone.

Hi.

Given the encouraging indications on orders and bidding, how are you thinking about investment in the marketing organization? Do you begin adding spec writers here, or do you wait to see if this has legs? How does that investment profile look for the balance of the year?

We've been investing in go-to-market capability even in 2020, especially around Architectural Specialties where you need more project management and designers to support projects. It's an ongoing build of capacity and capability. We have one selling organization that sells both Mineral Fiber and Architectural Specialties, which is a leverage point with the architectural and design community. When we add capability, it's often subject matter experts, designers, and project managers to support the field sales organization. We're feathering that in as we go, and our backlog gives optimism that this will continue through the year.

Do you have expansion of that selling organization built into your guidance for this year?

Yes, we do.

That's helpful. You mentioned education and healthcare bidding was strong. Is that mostly remodel activity or is there a meaningful new component to that?

For the most part, it's alterations and renovation activity, though we are seeing some new activity as well, which is encouraging. New activity is an 18-month feed into the pipeline for larger projects, but primarily it's renovation and major renewal projects.

Maybe a more pointed question on infrastructure: are you a beneficiary of an infrastructure bill and how so?

Absolutely. Historically commercial construction comes along with infrastructure investment, and in this case the focus on schools and the education system is encouraging for us because we have a strong presence there. New construction and renovation activity from infrastructure funding would be a benefit. Architectural Specialties would also benefit from airports and subway projects tied to infrastructure.

Are many of the projects you're seeing come back dependent on an infrastructure bill, or are they moving forward on their own merits?

I think they're moving forward on their own merits. Many of these projects were delayed from last year and are now moving forward as part of the early days of the recovery.

Okay. Great. Thanks very much. And good luck, Tom.

I'm not showing any further questions at this time. I would now like to turn the call back over to Vic Grizzle for closing remarks.

Thank you. I just want to thank everybody for joining today. Again, solid start to the year, really ahead of our internal expectations, and the market recovery in the commercial space seems to be well underway. I'm really encouraged by the investments we made last year that have put us in a terrific position to capture whatever this market opportunity offers in the coming quarters. We're excited about it, and we thank you again for your interest. We look forward to talking to you next quarter.

This concludes today's conference call. Thank you for participating. You may now disconnect.