Good morning, ladies and gentlemen, and welcome to the Q2 2021 Armstrong World Industries, Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call may be recorded. I would now like to turn the conference over to your host, Ms. Theresa Womble, Director of Investor Relations.

Thank you, Ashley, and welcome, everyone. On today's call, Vic Grizzle, our CEO; and Brian MacNeal, our CFO, will discuss Armstrong World Industries' second quarter 2021 results, rest of year outlook and strategic progress. Our discussion of operating and financial 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 measure is included in the earnings press release and in the appendix of the presentation we issued this morning. Both are available on our Investor Relations website.

Thanks, Theresa. You all recognized a new voice on the phone this morning, Theresa Womble. It's really great to have her. She is backfilling Tom Waters, who retired last quarter. So welcome, Theresa. And thank you all for joining our call today. It's good to be with you to review our second quarter results. It's been a challenging 16 months since the onset of the pandemic, and I want to begin by thanking the 2,800 employees at AWI for their dedication, agility and excellent execution during these trying times. It's because of their excellent work that AWI is so well positioned to capture the current market recovery. The results we posted this morning mark a strong recovery from last year's second quarter when the pandemic was accelerating, and many markets were effectively shut down by government mandates. On a year-over-year basis, second quarter consolidated net sales grew 38%, driven by a 32% increase in Mineral Fiber sales and a 59% increase in Architectural Specialties sales. We generated $100 million of adjusted EBITDA, which was a 44% increase from prior year results, and our adjusted EBITDA margin expanded 160 basis points. Now this is a particularly impressive margin performance given persistent inflationary pressures and the investments we are making in people, innovation and technology in support of our strategic priorities and to serve the growth we see ahead for the rest of 2021 and beyond. On the strength of these results and the expected continuation of the market recovery in the back half of the year, we have updated and increased our 2021 guidance. Before Brian gets into the financial details, I'll provide some insights into market developments this quarter and the drivers behind the strong momentum we have heading into the back half of the year.

Thanks, Vic. Good morning to everyone on the call, and welcome, Theresa. Today, I'll be reviewing our second quarter 2021 results and our updated 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.

Thanks, Brian. And as Brian was alluding to, we're very pleased with how our business has performed so far in 2021. And with the continued recovery of the broader market, we have reason to be more optimistic and positive about the outlook for the rest of the year. Before we get into our Q&A session, I'd like to share some thoughts on the progress we've made on the key pillars of our strategy. The work we've been able to accomplish despite the challenges of the pandemic has put us in a strong position to capture the opportunities emerging as the economy recovers. The cornerstone of our strategy has been revitalizing the demand for Mineral Fiber products while improving the AUV generated by these products. To this end, we are certainly glad to see people starting to return to offices, schools and restaurants, although we continue to monitor the evolving dynamics of this pandemic. The Kastle's back-to-work index at the end of the second quarter hit its highest mark since March of last year when the pandemic really took hold in the U.S. We're seeing employers, owners, architects, designers and occupants rethinking and redesigning their spaces to meet new emerging demands for what now defines a healthy and safe place. The trends of densification are reversing and the focus on air quality has been redefined and changed forever. These new forces on interior spaces are creating additional renovation and new construction opportunities for Armstrong because ceilings play a critical role in achieving this newly defined level for healthy spaces. And our innovative healthy spaces products are gaining traction. We just recently received the largest order yet for our 24/7 Defend family of products from a large school district in Florida. The VidaShield products ordered are specifically designed to support improved indoor air quality with technology that's endorsed by the CDC to remove airborne pathogens in a format integrated directly into the ceiling. Our Living Lab, which we recently opened at our headquarters campus, showcases partnerships and is a vehicle to drive new innovation for healthy spaces. This lab allows for design and product experimentation as well as the collection of important data to demonstrate the benefits of various designs, products and solutions for total indoor environmental quality. The lab demonstrates how to bring a holistic approach to indoor environmental quality by focusing on optimal lighting, thermal and acoustical conditions as well as air quality. Ceilings is what brings these together and is the hallmark of how healthy spaces are defined, a building that supports the physical, psychological and social health and well-being of people. We also continue to make progress with our digital efforts with another quarter of sequential growth from the Kanopi and ProjectWorks platforms. The speed and cost advantages these digital platforms offer customers are not only industry leading, but they represent a step change in design outcomes for both architects and contractors. The progress we've made with these digital platforms is important to support our long-term growth in Mineral Fiber. Growing through Architectural Specialties and creating more scale in that business is also a key strategic priority for us. We have made solid progress in integrating our 2020 acquisitions, while organically, we continue to increase our level of penetration. Through a broader array of specialty products and capabilities, we are extending our reach into more spaces and commercial buildings. And even with the recent delays in major new construction projects, we continue to expect double-digit top line growth and margin expansion in this business. And finally, maintaining a disciplined approach to capital allocation rounds out our priorities. While we acted prudently at the start of the pandemic to preserve cash, we maintained our number one priority of investing back into our business when strategically important innovation and acquisition opportunities emerged. And we have made these investments while still providing direct returns to shareholders through our dividend and share buyback programs. With confidence in our strong cash flow going forward, we have both the capability and the intent to maintain the balance of all these capital allocation priorities. Our team is focused and committed to these strategic priorities and to the overall purpose of the company, making a positive difference in the spaces where we live, work, learn, heal and play. The dedication of our employees, coupled with our best-in-class distribution network and our partner relationships, remain a unique form of competitive advantage, helping us deliver the best products for our customers and strong returns for our shareholders. While we continue to monitor evolving pandemic conditions, Armstrong is well positioned for a strong future ahead. And with that, we'll be happy to take your questions now.

And your first question comes from Kathryn Thompson from Thompson Research.

Inflation has been the topic of the year and appreciate the color on the pricing actions you have so far. But thinking about really realizing the full effect of these, is this realistically to start hitting late in '21 and more into '22? And then also along that line, with the price increases, given you're starting to see more renovation, which is generally a higher price point, are you seeing changes in mix and also the price increases from a mix standpoint?

Kathryn, thank you for the question. Yes, I think pricing has been something in our Mineral Fiber business and particularly in our grid business through WAVE. We have a track record of staying ahead of that, being able to anticipate and then stay ahead of it. And I think our first half performance on our price initiatives and the realization of those initiatives have demonstrated we continue to stay ahead of inflation. Our price increase in August, I think, should reassure everyone that we'll stay ahead of the inflation that's anticipated to continue into the second half of the year. And when we talk about these price increases, and again, based on history, the price increases are across the entire product portfolio. So at the low end, the mid and then the high end of the product portfolio, we get similar price realization. So no matter what the mix of products happens to be in a more renovation-rich environment, which we're entering now, we should have similar price realization expectations in all of those environments because we get it across the entire portfolio. So that's something we're counting on, and I don't expect any price mix impacts from our price realization efforts that way. I will mention that on the overall mix, last year, we talked about product mix being a positive, but it was overshadowed by the territory mix. And what we saw in the second quarter and what we expect to continue to see in the second half is the territory mix, which was the bad actor and the overshadow last year from the unnatural dynamics of shutting down these key markets. Those continue to heal, and we got a nice benefit from that in the second quarter, and I think those are going to continue to heal by the activity we see in the second half.

Okay. That's helpful. Then there's a wide variety of different bottlenecks in the value chain, but also shortages of certain supplies and materials, including aluminum and others. Are there any types of raw material shortages that you're seeing and are having to work around?

Across our business, we haven't seen or felt that impact. We're monitoring the steel for our grid business very closely, and we're managing that very well. So we don't believe that's a risk into the business, but we're watching it very carefully. Again, across our business, we have not seen supply chain issues in service levels. Again, very proud of the fact that we're able to maintain our lead times and deliver on time and not be part of the issue that I think a lot of our customers are experiencing at the moment.

Okay. And then final question. What is the biggest difference sequentially when you think about how you've been managing the business? And taking a step back, what is it that gives you confidence looking forward in the next 12 to 18 months?

Yes. Thanks, Kathryn. Again, I think we expected renovation activity to bounce back this year. We had been talking about when new construction activity historically goes down into negative territory, renovation activity picks up and moves into positive territory. That's been true in eight of the last nine recessions. And again, you have to go back decades to get to nine recessions. So that has been historically the norm, and we expected that to happen again this year, and that's exactly what we're experiencing. So when I look at the renovation activity coming back in 2021, number one, as expected, but when I see the strength of it in the bidding activity, which I'm watching very closely as a leading indicator to future demand, the bidding activity in the second quarter was a step change from what was seen in the first quarter, number one. But also when I go back and look at Q2 of '20, and I look at how much the bidding activity fell off and compare it to how much it picked up in the second quarter, again, it was a step change different to not only rebound from where it was, but it's even stronger than what it was on the downside. So that's a leading indicator for us for confidence into the second half and certainly into 2022. And then I'll point to one other thing. Our backlog in the Architectural Specialties business, which, Kathryn, you know well, we have our best visibility there in terms of projects. And our backlog in our Architectural Specialties businesses has built on the record level we had in the first quarter. So sitting here for the second half, we have more backlog and better positioning than we've ever had for our second half expectation. Again, that's providing some additional optimism that the recovery is well underway.

Your next question comes from Susan Maklari with Goldman Sachs.

My first question is thinking about the mix across the different verticals. I know that you talked about the sequential increase that you've seen in office and retail in the second quarter. But when we think about the comps in there and all the moving parts that have kind of come together over the last year, can you talk about which verticals are seeing the most growth? Which ones still have some more incremental room to improve over time? And just kind of where things are falling and your expectations for that as we go through the second half and then into '22?

Yes. Susan, across all the verticals, let me just step back. The reference you made to retail and office was in the bidding activity, and it really was a standout improvement in bidding activity in those two areas. So that being said, what we saw in the second quarter was actually a bounce back across all the verticals, fairly uniform. I reported on this in the first quarter too that we—which makes sense when you think about it—everything was uniformly shut down last year. It wasn't necessarily a segment-by-segment shutdown; it was across the entire industry. And so I think, naturally, we're seeing some uniformity in the bounce back as projects that were delayed have resumed, and we're starting to see those in the pipeline. Last year we were watching for cancellations of projects, and we reported on seeing very few cancellations. So it stands to reason that those projects that didn't get canceled should be resumed, and that's really what we're experiencing on a uniform basis in the first half of this year. Going forward, it's interesting and it's nice to see office kind of outperforming, if you will, in the bid activity along with retail.

Okay. That's very helpful color. And then as a follow-up, I know you made some comments around some of the new product introductions, healthy spaces, those kinds of things that you've put out there, and it sounds like they are getting some momentum. But can you just talk to how those are contributing to some of this volume growth that you're seeing coming through? Any indicators in terms of either actual orders or the bidding activity that's coming in? And how we should be thinking about their contribution to the business going forward?

Yes, it's on the fringes, really. It's a marginal contribution relative to the overall size of the business. I'm very pleased with the month-to-month growth that we're seeing there. So they're not meaningful contributors in the first half of this year. And I would expect for 2021 it's probably not a meaningful level. The big driver here is the uptick in renovation activity, and that is the single biggest driver and will be for the rest of the year.

Okay. One last one: this quarter, you didn't mention anything on channel mix, which in the past has been a pressure in the business. Is it fair to say that that's really kind of alleviated itself and things have started to normalize from a channel perspective in the second quarter?

I think that's right. That's the right conclusion. It was really not a meaningful contribution plus or minus.

Your next question comes from Phil Ng with Jefferies.

Your volume guidance for Mineral Fiber seems pretty conservative, given the momentum you're seeing in the business well into July. You have some easy comps. So what's driving your expectations for essentially flattish volumes in the back half, if we look at the midpoint of your guidance? Are there any things that we need to be mindful of, the uptick you're seeing in R&R being offset by new construction? Any color would be helpful, Vic.

Okay. Yes, Phil, I think there's still some chop that we're seeing. We had levels above 2019 in April, and then May and June kind of normalized. July is at or above 2019 levels. So we're seeing a little bit of unevenness across the market. I think we're factoring some of that chop into our outlook for the second half. Although I wouldn't undervalue the acceleration we are planning for the second half of the year; we do expect some acceleration in Mineral Fiber in the second half. But we do have some expectation for some early chop until we get to the later parts of the year. As I stated in my remarks, we expect to be at 2019 or above exiting the year.

Is the choppiness more on the new construction business, which has a lag factor from last year, right? So it sounds like R&R has been pretty solid.

It's really across geographies as well as across construction types. So I wouldn't just put it in the bucket of new construction. Obviously, we knew the headwind that we didn't have the starts last year to be selling into this year, but the renovation activity is more than offsetting that as we outlooked.

Thinking out to 2022, you mentioned a step change in bidding activity in 2Q. Is that more on the Mineral Fiber side of things? And when should we expect that to flow through to volumes?

We look at the bidding activity across construction types on a value basis as well as a number basis. So it's really for the entire business, not just Mineral Fiber, but it certainly pertains to Mineral Fiber as well. The lag on these starts ranges from 6 months to 24 months, depending on the size of the projects, and an 18-month average is a reasonable way to think about it. Bidding activity could have some impact in the second half, but certainly in 2022.

AUV accelerated nicely in the quarter, and you're implying a nice pickup in the back half. Any color in terms of the split between mix and pricing? And does your guidance factor in the August price increase?

Yes. We're running around that historical split of roughly 50/50 mix versus price. In inflationary times, we tend to get a little bit more price than mix, so we might end up a little more than 50/50 toward the end of the year with our August price increase. We're running pretty close year-to-date at about a 50/50 mark, so that's not a bad proxy to continue to use. And yes, we've factored the August increase into our guidance. It's considered in there.

Your next question comes from Adam Baumgarten with Zelman.

On AUV, the midpoint of guidance for the year would imply a very modest but slight deceleration on a year-over-year basis despite easier comps and price increases. Is that offset by mix normalizing in the back half? Just curious why it wouldn't accelerate further given initiatives and price increases.

We had probably our best mix contribution in the second quarter with the territories correcting themselves and no meaningful channel mix headwind. I think that's a good way to think about it: mix is going to normalize a bit in the back half as we had some improvement in those seven key territories that were an overhang on mix in the second half of last year. We expect to get more price realization in the back half to stay ahead of inflation.

I'd be curious if you could give more color on some of the acquisitions and the performance being below expectations. Is that end-market related? Are there supply constraints? Any more color around the slight underperformance?

Let me start by saying we're very pleased with the performance of those acquisitions. They're growing double digits in the face of the pandemic. They had a very strong year last year, and they're growing double digits on top of that this year. Contextually, that's how we think about these acquisitions and how they're performing. Remember, the earn-out structure we put in place was for some stretch numbers that had risk to them given the pandemic and the pace of recovery—nobody could guess that. So we put an earn-out structure that pushed risk toward the sellers. As Brian can comment on the accounting, they are not reaching those stretch levels, but they're performing very well at double-digit growth despite the pandemic.

Lastly, what are you seeing in education and government markets? We've heard things are picking up given some of the surpluses state and local governments have, and some of that may be going toward schools. Any color on education and institutional segments?

The activity and bidding activity are there. I would say we've not seen an abnormal contribution from education or institutional spending so far. I think that's still coming. They are still working through what design modifications they're going to make in schools and other institutions. We're seeing good activity there, but I wouldn't say we've seen a step-up in activity based on government stimulus yet.

Your next question comes from Stephen Kim with Evercore ISI.

Vic, what do you think the potential impact of the delta variant or another variant over the next 6 to 12 months might be? There could be negatives like additional delays in project work, but there could also be positives as it reinforces the need for healthier spaces. Reflecting back on how the initial wave of COVID played out, would a variant be net positive or net negative for your business?

It's an interesting question. If you go back to last year, markets were essentially shut down: construction sites were shut down and activity came to a halt. That's not a scenario we would be planning for or expecting from a variant now; I don't sense any appetite out there to go that far. That said, we're watching it very closely because depending on local regulations, we could see impacts on the rate and pace of job sites being completed or resumed. The positive side is it reinforces the need for healthy spaces and how we must make spaces healthy enough so people can return and continue to function even with variants. So we're balanced on it but watching closely for impact on the rate and pace of construction activity in the back half of the year.

I wanted to ask about the investments that run through SG&A in the bridge. Could you give a general sense of the split between temporary cost reversals and actual investments? And secondarily, are you seeing the geographic improvements you talked about across your business, including New York City specifically?

Yes. On the territories, all seven of them improved, including New York City. In fact, New York and California both improved nicely in the quarter. Those are two very big markets for us, so it's good to see it.

Stephen, good question. As you look at Page 5, our EBITDA bridge, we've got $18 million higher SG&A. $5 million of that is coming from the 2020 acquisitions, $6 million from temporary cuts we made last year in 2020 coming back in—others may recall we said it's about $5 million a quarter so it rounded to $6 million in this quarter—and another $7 million at the total company level in investments around growth, digital and healthy spaces.

Is that $7 million level of investments something we should expect for the next couple of quarters?

Yes, it will stay no higher than that $7 million, but around that number.

Your next question comes from Ken Zener with KeyBanc.

Brian, you talked about normal seasonality in your prepared remarks. Normal seasonality implies Q3 is up from Q2. Is that what you're communicating so that Q4 rolls off at a normal level?

Yes, Ken, dead on. Q3 typically is our strongest quarter, and we would expect to see that pick up some and Q4 be proportionately lower—back to its normal percentage of the year.

Vic, you made comments around exiting FY '21 above FY '19. Could you be specific? Are you referring to sales, margin, or something else?

Sure, Ken. That's a daily shipping sales rate, and we are tracking that as a proxy for when the market gets back to full recovery and when we're back to building on that platform for future growth. That's the proxy we've been using. It's really focused on Mineral Fiber because that represents the broader part of the market versus the overall—our overall sales per shipping day rate is already above 2019 because of the growth in AS and the acquisitions, but we use the Mineral Fiber daily shipping rate as a proxy for market health.

You discussed price increases—three big increases here. Is this nearly a record actual price increase for you in Mineral Fiber?

Yes, it's pretty close. We had a cumulative similar number in the past, maybe not as high in 2018 when we had rapid inflation based on steel tariffs in particular. So yes, it's up there.

Are you seeing share shifts given capacity constraints in the industry, or is this more demand-driven?

I think this is really renovation activity driving what we're seeing right now rather than significant share moves. We're doing a good job servicing our customers, holding onto specifications and winning new specifications, and that helps pricing and margins because you don't have plant and supply chain inefficiencies. We're well positioned, and this is a reflection of our innovation and a market recovery tailwind.

Your next question comes from Garik Shmois with Loop Capital.

Just wondering if you could provide more color on the increase in bidding you're seeing in retail and office. Is this mostly on the renovation side? Is it a function of people returning to work and retail being used differently, or is it more a return of normal activity that would've happened absent COVID?

It's pretty broad-based; all verticals were positive, which is encouraging. It's not surprising because everything was shut down and delayed last year, so there's some catch-up. Retail and office were stronger than others in bidding, and when you split it by new construction versus alterations and renovation, it was meaningfully higher on alteration and renovation activity. That reflects what we'd expect when new construction is down—higher rates of growth in alterations and renovation. There's a combination of pent-up demand from work that didn't get done in 2020 plus recovery and people returning to offices and schools. Owners are doing things to create healthier environments for people to return, and that contributes to higher activity across the board, particularly in renovations.

Given inflation and the price increases you're pushing plus inflation across other building product categories, at some point might the strong bidding environment be hindered by inflation?

We're watching for that, but I haven't seen a hint of it. Right now, this looks much more like supply chain and product availability driving the rate and pace rather than cost inflation. We should continue to watch, but I don't sense inflation is the primary driver affecting bidding activity today—availability seems to be the bigger issue.

At this time, there are no further questions. I will now hand the call back to Vic Grizzle, CEO, for closing remarks.

Yes. I just want to thank everybody again for joining our call today. We're pleased with where we are at the halfway mark of the year and really a transition year out of a pandemic as the market opens back up with some unevenness and chop as we discussed on the call. I like where we're positioned. We're investing into a market recovery tailwind, and we're excited about getting this market fully open and taking advantage of our strong position coming out of the pandemic. Thank you all for your attendance and interest, and we look forward to talking to you next quarter.

That concludes today's conference. Thank you for your participation. You may now disconnect.