Earnings Call Transcript - AWI Q3 2025

Operator, Operator

Thank you all for being here and welcome to the Third Quarter 2025 Earnings Call for Armstrong World Industries, Inc. I will now hand it over to Theresa Womble, Vice President of Investor Relations and Corporate Communications. Please go ahead.

Theresa Womble, Vice President of Investor Relations and Corporate Communications

Thank you, Nicole, 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 third quarter 2025 results and rest of year outlook. We have provided a presentation to accompany these results that is available on the Investors section of the Armstrong World Industries website. As a reminder, our discussion of operating and financial performance will include non-GAAP financial measures within the meaning of the SEC Regulation G. A reconciliation of these measures with the most directly comparable GAAP measures is included in the earnings press release and in the appendix of the presentation we issued this morning. Again, both are available on the Investor Relations website. During this call, we will be making forward-looking statements that represent the view we have of our financial and operational performance as of today's date, October 28, 2025. These statements involve risks and uncertainties that may differ materially from those expected or implied. We provide a detailed discussion of the risks and uncertainties in our SEC filings, including the 10-Q we issued 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.

Victor Grizzle, CEO

Thank you, Theresa, and good morning, everyone, and thank you for joining our call today to discuss our third quarter 2025 results, the progress we are making on our initiatives to deliver consistent profitable top line growth and our expectations for the remainder of the year. Today, we announced record-setting third quarter net sales and earnings results with strong Mineral Fiber average unit value, or AUV, a second consecutive quarter of Mineral Fiber volume growth and double-digit net sales growth in Architectural Specialties. On a consolidated basis, we delivered year-over-year top line growth of 10%, resulting in record-setting quarterly net sales with robust performance in both our Mineral Fiber and Architectural Specialties segments. Consolidated company adjusted EBITDA increased 6%, while adjusted net earnings per share increased 13%, along with strong double-digit free cash flow growth in both the quarter and in the year-to-date period, allowing for execution across all our capital allocation priorities. This includes the increase in our quarterly dividend of 10% we announced last week, and our latest Architectural Specialty acquisition of a Canadian wood sealing manufacturer, Geometrik. These results were driven by our differentiated and resilient business model, along with solid operational and commercial execution across our enterprise that once again allowed us to overcome lingering market softness and some timing-related cost headwinds. I want to take this opportunity to thank our teams across the company that continue to execute at the highest level that make these consistently strong results possible. So thank you. Like the last several quarters, we have remained laser-focused on operational efficiency, commercial execution and our growth initiatives as we continue to navigate a dynamic and uncertain macroeconomic backdrop. These efforts not only contributed to strong top line growth, but also continue to support our industry-leading profit margins even as we dealt with timing-related costs this quarter. While Chris will discuss these in a bit more detail, it's worth noting without these timing-related expenses, we would again have expanded EBITDA margin in the Mineral Fiber segment and at the total company level, and we remain poised to deliver margin expansion for the full year on both of these metrics. Despite these timing-related expenses, with our consistent underlying execution, the building blocks of Armstrong's formula for profitable growth remain strong and on full display in the third quarter. And as a reminder, what these building blocks are, they include: first, our focus on delivering consistent AUV growth in Mineral Fiber, all driven by the innovation and quality that feeds the category dynamics to mix up and our best-in-class service levels supported by technology that help us earn our pricing in the marketplace. Secondly, our laser focus on achieving consistent annual productivity gains throughout our operations. Thirdly, our investments to expand our product offerings and capabilities to continue our successful penetration in the Architectural Specialties segment. And lastly, our investments in digital growth initiatives like Project Works and Canopy that drive volume, AUV and contribute to margin expansion. In the third quarter in our Mineral Fiber segment, net sales increased 6% versus 2024 results, primarily driven by strong AUV growth and positive contribution from sales volumes. This marks the first time since 2022 that we reported back-to-back quarters of Mineral Fiber volume growth. This volume result was slightly ahead of our expectations as demand conditions in our markets remain relatively stable compared to our expectation of a modest slowdown expected mostly in the more discretionary type renovation activity. That said, the most notable volume growth driver was strong commercial execution and the contribution from our growth initiatives continuing to gain traction, enabling above-market growth rates as well as positively contributing to our strong AUV performance. Adjusted EBITDA in the Mineral Fiber segment also grew 6%, reaching a third quarter record and a continuation of our strong performance in 2025. On a year-to-date basis through September, Mineral Fiber EBITDA has increased 9% with margins expanding 160 basis points on a year-over-year basis in overall flattish market conditions. Importantly, we continue to expect strong Mineral Fiber adjusted EBITDA margin performance for the full year of approximately 43%, which would be the highest full year result since our last high watermark in 2019. Now before moving to discuss Architectural Specialties results, I'd like to take a moment to highlight some of the ongoing efforts within our Mineral Fiber plants that contributed to our results as they have all year. First, we continue to generate solid productivity gains in our operations at a similar rate as in the second quarter, and this helped partially offset the timing-related expenses I mentioned earlier. We also continued our execution at a high level on quality and service. One measure we use to gauge our quality and service to customers at our Mineral Fiber plants is called our perfect order measure that combines 6 different metrics that determine a perfect order in the eyes of our customer. The way it works is if any line item on a customer order misses any of these metrics, it's a 0 on the scale of 100% perfect order. These metrics include things like accurate order fill rates and on-time delivery and billing quality. It's a tough measure and rightly so as this is what our customers expect and are willing to pay for. I'm pleased to report that our plant teams delivered a record result in this measure this quarter. It's service and quality results like these that build customer trust and loyalty that enables the retention of customers and pricing support for the value that we create. Now moving to the Architectural Specialties segment. Our third quarter net sales in this segment increased 18%, driven by the benefits of both our 2024 acquisitions, 3form and Zahner, along with solid organic growth. Adjusted EBITDA for the segment increased 10%, generating an adjusted EBITDA margin of approximately 19%. On an organic basis, adjusted EBITDA margins for the segment remained in line with our long-term target of 20% for the second quarter in a row despite these timing-related expenses mentioned earlier. I'm pleased with how we continue to leverage our Architectural Specialties network and together with our new acquisitions and the benefits of more Architectural Specialty products incorporated into our Project Works platform, we continue to improve our ability to win more projects. And this is most evident in the continuation of double-digit growth in orders and backlog for our Architectural Specialty products. We're also excited to welcome another acquisition, Geometrik, to our growing portfolio of products and solutions. Based in British Columbia, Canada, Geometrik is a leading designer and manufacturer of wood acoustical ceilings and wall systems that expands the variety of wood species we can offer our customers. With 9 complementary wood species across multiple products, including highly sought-after Western Hemlock, this company strengthens our wood portfolio and adds geographic diversification to our manufacturing footprint. Geometrik's on-trend products and design expand our portfolio with more of the warm wood looks and biophilic designs that are in high demand from architects and owners. Their Western Canadian production location also enhances our ability to serve our customers in Canada and on the West Coast. We're excited to welcome the Geometrik team to Armstrong's industry-leading specialties platform. Along with our acquisitions, we continue to be delighted by how our digital initiatives are progressing and making a positive contribution to both our segments. I mentioned Project Works earlier as it continues to gain traction with architects, designers and contractors by quickly providing visualization of complex designs, eliminating the waste in the design process and providing a complete bill of goods for clear and simple ordering. With increasing demands on limited construction labor availability, Project Works provides significant productivity value to our customers and strengthens our ability to hold on to project specifications throughout the construction process and ultimately improves our win rates in the market. Again, in both the Mineral Fiber and Architectural Specialties segments. Another one of our digital initiatives contributing nicely in the quarter is Canopy. Canopy, like Project Works, benefits both our business segments by providing an easy way for smaller customers to access a wide range of products through an online education and selling platform. And I'm pleased to share that the Canopy platform had both record sales and EBITDA in the quarter and continues to be a key differentiator for Armstrong. Now I'll pause and turn it over to Chris for more detail on our financial results.

Christopher Calzaretta, CFO

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. And please note that Slide 3 details our basis of presentation. Beginning on Slide 6, we summarize our third quarter Mineral Fiber segment results. Mineral Fiber net sales were up 6% in the quarter, primarily driven by favorable AUV of 6% and a slight increase in volumes. The growth in AUV was primarily due to favorable like-for-like pricing with a modest contribution from mix. The benefits of increased volumes and favorable mix were driven by the strong execution of our commercial sales organization, along with benefits from our growth initiatives. Mineral Fiber segment adjusted EBITDA grew by 6% and adjusted EBITDA margin was 43.6%. Q3 Mineral Fiber EBITDA growth was primarily driven by the fall-through of AUV, contribution from our WAVE joint venture on strong price/cost benefits and slightly higher Mineral Fiber volume versus the prior year. As Vic mentioned, our results were negatively impacted this quarter by some timing-related discrete costs in both segments. In Mineral Fiber, these costs primarily related to an increase in medical claims above our normal run rate, which mainly impacted manufacturing costs. In addition, our strong year-to-date financial performance and updated full year outlook resulted in higher incentive compensation in the quarter, which primarily impacted SG&A. We do not expect the third quarter SG&A results to be indicative of our go-forward run rate. As a result of these in-quarter cost headwinds, Mineral Fiber adjusted EBITDA margin compressed 30 basis points over the prior year. For the Mineral Fiber segment, the total discrete costs in the quarter represented approximately $5 million of an outsized headwind, which is reflected in both manufacturing and SG&A expenses. Excluding this cost headwind, adjusted EBITDA margin in the Mineral Fiber segment would have expanded in the quarter versus the prior year period. On Slide 7, we discuss our Architectural Specialties or AS segment results, where we highlight net sales growth of 18%. This growth was driven primarily by contributions from our 2024 acquisitions, 3form and Zahner, both of which continue to perform better than expected as well as a 6% increase in organic sales, driven by growth across most of our specialty product categories. AS segment adjusted EBITDA grew 10% with an adjusted EBITDA margin of approximately 19%, which includes the dilutive impact of our recent acquisitions. On an organic basis, we are pleased to have achieved an adjusted EBITDA margin of approximately 20%. Q3 AS EBITDA growth was driven by the benefit of higher net sales, partially offset by higher manufacturing costs as well as an increase in SG&A expenses. Higher SG&A expenses were primarily due to our 2024 acquisitions in addition to an increase in selling expenses, driven primarily by higher net sales as well as additional investments in selling capabilities. Slide 8 highlights our third quarter consolidated company metrics. We delivered 10% sales growth and 6% adjusted EBITDA growth with total company adjusted EBITDA margin compression. Additionally, adjusted diluted net earnings per share grew 13%. Incremental volume from both segments, strong AUV performance, and solid equity earnings from WAVE drove our adjusted EBITDA growth in the third quarter versus the prior year period. These benefits more than offset higher SG&A expenses, which were primarily driven by our 2024 acquisitions as well as the previously mentioned impact of discrete costs in the quarter. At the total company level, the total discrete costs in the quarter were approximately $6 million, which impacted both manufacturing and SG&A expenses. Excluding this cost headwind, adjusted EBITDA margin at the total company level would have expanded slightly in the quarter versus the prior year period. Turning to Page 9. We highlight our year-to-date consolidated company metrics, which reflect double-digit net sales and adjusted EBITDA growth with margin expansion. Through the first 9 months of the year, with sales up 14% and adjusted EBITDA up 15%, margins expanded 20 basis points versus the prior year period, which includes the year-to-date dilutive impact of our 2024 acquisitions. Adjusted diluted net earnings per share increased 21% and adjusted free cash flow increased 22%. The drivers of year-to-date adjusted EBITDA growth are similar to the previously mentioned third quarter drivers. Slide 10 shows our year-to-date adjusted free cash flow performance versus the prior year. The 22% increase was driven primarily by higher cash earnings, lower income tax payments, and dividends from our WAVE joint venture, partially offset by an increase in capital expenditures as we continue to invest back into the business. Our demonstrated ability to consistently deliver strong adjusted free cash flow allows us to execute on all of our capital allocation priorities. As a reminder, these are: first, to reinvest back into the business with a disciplined focus on opportunities that deliver high returns. Among our year-to-date investments was the enhancement of manufacturing capability at one of our Mineral Fiber plants to support the growth of our Templok Energy Saving Ceiling offering. Target investments such as these underscore our commitment to executing our growth strategy while maintaining a balanced capital allocation approach. Our second capital allocation priority is to execute strategic acquisitions and partnerships that add unique attributes or capabilities to our business that will create value. Recently, in the third quarter, we acquired the issued and outstanding shares of Geometrik for a purchase price of $7.5 million, subject to customary post-closing adjustments for working capital and future earn-out potential. Lastly, our third priority is to provide direct returns to shareholders through dividends and share repurchases. On this front, then as Vic mentioned last week, we announced a 10% increase to our quarterly dividend, marking the seventh consecutive annual increase since the inception of our dividend program in 2018. This increase reflects our Board of Directors' continued confidence in our growth strategy and ability to consistently generate strong adjusted free cash flow. Additionally, in the third quarter, we provided a direct return of $40 million, comprised of $13 million in dividends and $27 million of repurchased shares. As of September 30, 2025, we have $583 million remaining under the existing share repurchase authorization. With a healthy balance sheet and ample available liquidity, we remain well positioned to execute our strategy. Slide 11 shows our updated full year 2025 guidance. With strong year-to-date net sales and adjusted EBITDA growth and stabilizing market conditions, we are raising our full-year guidance across all key metrics. We are pleased with the full year double-digit growth outlook for net sales, adjusted EBITDA, adjusted diluted net earnings per share, and adjusted free cash flow. We now expect full year Mineral Fiber volume to be flat to down 1%, an improvement from our prior expectation of flat to down low single digits due to stabilizing market conditions. We expect AUV growth of approximately 6%, modestly lower than prior expectations on slightly stronger Big Box volume than expected in the third quarter. Additionally, we expect full year AS sales growth to be approximately 29%, driven by robust contributions from our 2024 acquisitions, coupled with high single-digit AS organic growth. We continue to expect full year margin expansion in both segments with a Mineral Fiber adjusted EBITDA margin of approximately 43% and an AS adjusted EBITDA margin of approximately 19%, with an organic adjusted EBITDA margin of approximately 20%. Additionally, we now expect full year adjusted free cash flow growth of $342 million to $352 million or 15% to 18% over the prior year. Our improved outlook for adjusted free cash flow growth is primarily driven by higher expected net cash provided by operating activities, excluding an approximately $21 million full year cash tax benefit related to the tax reform bill that was passed in July. As a reminder, this one-time cash tax benefit relates to unamortized research and development tax credit fully recognizable under the Act in 2025 and is excluded from our full year adjusted free cash flow guidance reconciliation, which is a normalized metric. Note that sales, adjusted EBITDA, and cash flow contributions from our recent acquisition of Geometrik are not expected to be material for the full year. With our strong year-to-date results and robust full year outlook, we are confident that we will finish 2025 strong and enter 2026 with momentum. And now I'll turn it back to Vic for further comments before we take your questions.

Victor Grizzle, CEO

Thanks, Chris. 2025 is proving to be another strong performance year for Armstrong as we've successfully navigated uncertainty at the macroeconomic level and its ripple effect on our end markets. It's been a challenging year to call in terms of the level of market activity. As you all will recall, in February, we were expecting the market to be softer in the first half of the year, given the transition to the new administration and its potential new policies and then a modest pickup in the back half once there was more clarity around what these new policies would be. However, beginning in April and through the second quarter, the macroeconomic outlook became cloudier as the impact of more significant tariffs increased the level of uncertainty, which led us to modestly adjust our volume outlook for the back half of the year. Now sitting here today, we have not seen the anticipated modestly softer market conditions, but rather more of the same flattish kind of stabilizing market conditions. The Dodge first-time bidding activity data in terms of the number of projects continues to be at lower levels. However, the value of projects being bid overall has increased ahead of inflation and was up nicely in the quarter. A look at actual starts, which reflects how much of this bidding activity turns into actual projects was mostly flat and coincides with the overall market conditions that we're currently experiencing. Looking at specific verticals, a recent research from JLL provides some positive signs for the office market. After 2 years of stabilization and signs of leasing footprints beginning to expand, U.S. office vacancy rates declined in the third quarter for the first time in 7 years. Their research notes that as occupancy of Class A offices increases, the need for renovating Class B office space is expected to accelerate. Factors influencing these trends include a continuation of return to office mandates and the potential for lower interest rate environment. While we've discussed that New York and cities across the Sunbelt have been quicker to recover, their research now shows strengthening across more regions in the U.S. And this is encouraging data for the office vertical that represents about 30% of our demand profile. The transportation vertical remains strong from a bidding and start perspective. An additional tranche of funds was recently released by the federal government, specifically for airport projects, and we continue to expect airports and other transportation hubs to be a multiyear opportunity for Armstrong. Within these stabilizing market conditions, our Architectural Specialties segment is experiencing broad-based strength in quoting and ordering, which in part is driven by Armstrong's ability to provide the broadest portfolio of specialty products with our industry-recognized commitment to service and quality. In addition, we're continuing to see benefits from the sales and marketing optimization program that I mentioned last quarter. We've strategically realigned the commercial team to drive greater efficiency and unlock selling capacity to better serve both our A&D customers and our distribution partners and more effectively sell our industry-leading product portfolio. These changes alongside our ongoing innovation and growth initiatives are contributing to strong performance, delivering above-market performance. In terms of recent product innovation, we continue to be excited by the opportunity for our Templok Energy Saving Ceiling products to drive future growth. With Templok's innovative use of phase change materials, these ceiling products help regulate temperature in buildings and can meaningfully reduce the energy used for cooling and heating. We've also completed some successful validation projects, including a pilot project with the Palm Springs Unified School District in California using Templok. The results were compelling. Classrooms equipped with Templok experienced a measurable reduction in cooling energy demand and a nearly 2-hour delay before air conditioning was needed. Findings like these across the country and in various verticals, including education, health care, and offices are validating the energy-saving potential of our technology and reinforce our belief that Templok could ultimately become the standard across the ceiling category. As the innovation leader, we are committed to continue to innovate to make these energy-saving products even better and more cost-effective. This month, we launched an upgraded Templok product line that is now part of our sustained portfolio of products that meets the industry's most stringent sustainability requirements. In addition, the latest version of Templok has improved passive heating and cooling capacity at a higher fire rating and increased thermal comfort attributes. This makes it even more attractive and specifiable by architects and designers and more compelling for building owners and operators. In the quarter, as Chris mentioned, we also completed a capital project at our Macon, Georgia plant to expand production capacity for this new upgraded version of the product. In closing, with the strong results achieved thus far in 2025, we are expecting continued momentum and a strong close to the year. As our financial guidance indicates, we expect 2025 to be another record year with double-digit top and bottom line growth as we once again outperformed the market. Our consistent AUV growth, Architectural Specialties penetration, innovation leadership, and productivity gains remain our building blocks for profitable growth. And these building blocks, coupled with a healing office vertical and ongoing contributions from our growth initiatives positions us well for another year of profitable growth in 2026. And with that, now we'll be happy to take your questions.

Operator, Operator

Your first question comes from the line of Susan Maklari with Goldman Sachs.

Susan Maklari, Analyst

Nice job on the quarter, Vic. My first question is, can you talk a bit about the benefit that you're seeing from the new products, how that's helping the mix component of that AUV in there? And also how that's coming through in terms of the strength of quoting and bidding activity that you talked to in your comments?

Victor Grizzle, CEO

Yes. Susan, we are performing exceptionally well at the high end of our portfolio. Even in recent years, our innovations related to the smoother, wider look and enhanced acoustical performance have been impactful, and we expect this to continue in 2025. We are experiencing growth close to double digits at the high end of our portfolio. This reaffirms that the technology we are introducing to the market at the high end, where our products are most specified, is where we are thriving through our innovations. This is particularly true for our Mineral Fiber segment, as that's how we assess our mix. In the Architectural Specialty segment, while we evaluate mix differently due to its custom nature, the innovations in metal, wood, turf, and felt products are significantly impacting our business, leading to double-digit growth in orders and backlog in Architectural Specialties. This growth is crucial as our new products are essential for winning large renovation projects and new constructions. I'm very pleased with how our innovations are enhancing our mix in both the Mineral Fiber and Architectural Specialty segments. The double-digit growth in our Architectural Specialty segment in both orders and backlog is promising, especially given that the overall market isn't expanding at that rate. This indicates our strong penetration and participation in the market.

Susan Maklari, Analyst

Yes, absolutely. That's great. Are you there?

Victor Grizzle, CEO

Yes, Susan, we can hear you.

Susan Maklari, Analyst

Okay. Sorry, I thought I lost you for a second. No, that all sounds really good. And I guess building on that, right, Architectural Specialties is getting close to that 20% margin target that you've had out there. Can you talk about the forward trajectory of that as we continue to see these acquisitions coming through? And how we should think about where that can go over the course of the next year if the environment does stay more challenging like it is today?

Victor Grizzle, CEO

I'm really proud of how our teams have driven improvements in Architectural Specialties over the last four years, consistently impacting operating leverage and successfully pricing our products in the marketplace. Despite some timing-related headwinds, we are currently at a 20% organic growth level and expect to maintain that for the first time post-pandemic. As our Architectural Specialty business grows, we can offset more acquisitions organically. Most of our acquisitions tend to be dilutive until they scale on our platform, allowing us to achieve operating leverage of 20% or more. Looking ahead, we believe we are in a strong position as long as we have double-digit growth opportunities in the market. We aim to grow without sacrificing margins, as long as that growth trajectory remains positive, and we anticipate it will for several years. We prefer to maintain growth above 20% but are not focused on pushing much higher at the cost of growth. This will guide our business strategy.

Operator, Operator

Your next question comes from the line of Tomohiko Sano with JPMorgan.

Tomohiko Sano, Analyst

My first question is EBITDA margin pressure. So while sales and EPS was strong, both consolidated and segment EBITDA margins declined year-over-year in 3Q. Could you elaborate on the timing-related cost headwinds such as higher incentive compensation and medical costs and how you expect these to trend in 4Q and into 2026, please?

Victor Grizzle, CEO

Yes. Chris, do you want to take that?

Christopher Calzaretta, CFO

Sure. On the SG&A front, I want to emphasize our approach to cost control and maintaining that mindset even as market conditions stabilize. In the quarter, we observed increased SG&A costs in the Mineral Fiber segment, primarily due to higher incentive compensation costs from both our annual and longer-term incentive plans. These costs were influenced by our year-to-date financial performance and our updated outlook for the full year that I mentioned earlier. I want to clarify that we do not anticipate the SG&A results for the third quarter in Mineral Fiber to reflect our future run rate. Vic mentioned the need to leverage our investments, and that continues to be our goal. We aim to achieve operating leverage from our SG&A investments and remain cautious about the pace of our spending. The incentive compensation costs we incurred were largely timing-related and were notably high in the third quarter. Regarding your question about medical costs, we are self-insured, meaning that any higher medical claims directly affect our profit and loss. In the third quarter, we experienced an increase in several high-cost claims, which exceeded our usual medical expense trends. Though medical expenses are part of our regular operations, the scale and nature of what we encountered in Q3 were unusual. It would be rare to see such a high level of medical claims in consecutive quarters.

Tomohiko Sano, Analyst

And my follow-up is, Vic, macro end market trends. You talked about office and also on transportation mainly. But could you talk about education, health care and data centers and those kind of verticals into Q4 and 2026 expectations, please?

Victor Grizzle, CEO

The Education and Health care segments have remained stable throughout the year, with no significant changes observed. Health care is showing slight growth in both new construction and renovation forecasts. Overall activity levels in these sectors are stable. The data center opportunity remains strong, and we are actively engaging in it with our new product launches, including tile products and grid products we've previously discussed. We are also introducing additional structural grid products aimed at this market, which presents exciting growth potential. This is along with the positive developments we're seeing in transportation and early signs of improvement in the office sector.

Operator, Operator

Your next question comes from the line of Keith Hughes with Truist Securities.

Keith Hughes, Analyst

Yes, I'm here. I have a question about the SG&A expenses related to health care. Do you expect those to decrease over the next quarter or two to a level more consistent with what we've seen in the past? Is that the message you're conveying?

Christopher Calzaretta, CFO

Yes. I think, Keith, it's fair to assume that both on the incentive comp and the medical side that they'd be kind of more at a normal run rate. Again, very atypical to see the outsized impact that we saw in medical this quarter. And again, that wasn't tied to a specific operation or event. But yes, to your point, not the expectation going forward.

Keith Hughes, Analyst

And what's the outlook for manufacturing costs in the next few periods? Or is inflation starting to creep in to the inputs?

Christopher Calzaretta, CFO

Yes. I'd say on the manufacturing side, I mean, for sure, we have inflation, but our ability to continue to drive productivity in our plants remains one of the value creation drivers and building blocks of the business. So I'd expect more of a run rate that we saw through the first couple of quarters of this year. Again, continued strength in both a continued cost control mindset across the enterprise, coupled with our productivity programs and productivity gains.

Keith Hughes, Analyst

Okay. And final question for Vic. I hear you what you're saying on the office and the Class C moving to Class A. Has that started to occur yet in quantities that are moving the numbers? Or is office still a lagging category?

Victor Grizzle, CEO

It appears there is considerable ground-level activity, shifting from some of the bidding and startup activities we've been monitoring. Feedback from our regional teams indicates an uptick in tenant improvement projects. We seem to be at the initial stages of this trend. I would not characterize these as significant changes; they represent a stable phase for now, with some emerging signs of improvement that could develop by 2026.

Operator, Operator

Your next question comes from the line of Adam Baumgarten with Vertical Research Group.

Adam Baumgarten, Analyst

Question on the AUV, just on the home center mix. It sounds like that impacted year-over-year mix benefits in the quarter. I know you said it was positive but maybe less so than it's been in prior quarters. I guess do you expect that mix headwind to abate in the fourth quarter? And then if we think about the August price increase starting to flow through, should you see some level of year-over-year AUV improvement in the fourth quarter?

Victor Grizzle, CEO

Yes, you're correct, Adam. The retail business has a limited range of products and a lower average unit value. So, when we see increased strength in that channel, it can negatively affect the overall product mix. However, these products remain profitable and contribute positively to our bottom line, so we appreciate the volume. That said, it can lower our average unit value, which we saw in the third quarter. We don't anticipate this trend will carry into the fourth quarter, although sometimes it's difficult to predict due to inventory replenishment or reductions we've discussed in previous quarters. But at this point, we don't expect these issues to persist into the fourth quarter.

Christopher Calzaretta, CFO

And I would just add on to that and say we still expect a strong AUV quarter in Q4. Again, that was the Big Box that we mentioned in the third quarter kind of pressured the full year outlook, if you will, but still expecting a strong Q4 and about 6% AUV for the full year.

Adam Baumgarten, Analyst

Okay, understood. Changing topics to AS. Considering the strong backlog and order situation you've mentioned, along with some visibility on larger projects, are we still anticipating growth next year? Additionally, could you provide more insight into the end markets and what specifically excites you about 2026 at this time?

Victor Grizzle, CEO

Yes. I mean what's encouraging, Adam, in our order rate and our backlog build is not just for the rest of the year, which it is contributing to the rest of the year and our confidence for the rest of the year, but how it's building for '26. So yes, we would expect to continue to grow in 2026. Again, almost irrespective of what the market is doing because, as you know, most of our growth there is really through penetration, really taking share. So our expectations and the way it's building in our backlog, we would expect growth in '26.

Operator, Operator

Your next question comes from the line of Rafe Jadrosich with Bank of America.

Rafe Jadrosich, Analyst

I wanted to follow up on some comments regarding the office sector, which has clearly been a challenge for around seven years. Can you discuss whether there might be improvements ahead and if we could expect any benefits in average selling price or margins, particularly for Class A properties or regionally? Are you noticing any positive signs in areas like San Francisco or New York, and do those hold any significance?

Victor Grizzle, CEO

I believe the data is indicating a shift beyond just the major cities and the Sunbelt. The South has emerged as an early recovery zone for the office segment. Research shows that this recovery is much wider now, with positive activity being observed in 18 regions across the country, particularly in leasing, which in turn boosts renovation activity in the market. This is encouraging. As I mentioned earlier, we are still in the early stages of seeing these developments translate into the marketplace, but the indicators are positive and backed by the forecasts we are reviewing.

Rafe Jadrosich, Analyst

Got it. Okay. And then I understand that like sort of it's tough to give a volume outlook into '26. But wondering if you have any at least directional visibility on cost inflation, AUV, SG&A, any of those points as we think about trends into next year? A just like specific puts and takes?

Christopher Calzaretta, CFO

Yes. Rafe, it's Chris. I'd say at this point, we're still preparing our modeling and going through assessing the market, et cetera, for 2026. But if I could take a step back and just talk a little bit about the building blocks of the business and what we've talked about in terms of AUV growth, our ability to continue to drive productivity and really how we're thinking about SG&A investments and margins next year. I'd say our thinking and the mindset really hasn't changed. I think those value creation drivers are in place. We'll continue to invest and invest back into the business where there are the highest returns. And I think we'll absolutely be thinking about EBITDA growth and margin expansion heading into next year. But absent that, too soon to formulate any more details around the specific inputs of those. But I'd be thinking about the value creation drivers of this business on a relatively consistent basis going forward. Vic, I don't know if you want to add anything more.

Victor Grizzle, CEO

I think that's well said.

Operator, Operator

Your next question comes from the line of Brian Biros with Thompson Research Group.

Brian Biros, Analyst

Last quarter, your outlook was for a slightly softer second half kind of driven by that uncertainty with discretionary commercial work expected to slow. A lot of commentary today around market stabilizing here. Can you just help compare the current outlook to your expectations from 3 months ago, kind of what stabilizing really means in this scenario? And I guess really just what is driving that kind of positive change from uncertain to stable?

Victor Grizzle, CEO

Thank you for the question, Brian. It's a relevant point because, as we discussed, our visibility regarding smaller, discretionary renovation activities is limited. These projects do not typically involve architects and are generally smaller, showing up in distribution. To be transparent, we have had uncertainty in predicting these activities because they are highly discretionary and can be sidelined quickly in a fluctuating market. We experienced this in 2022. With expectations for lower economic activity and GDP in the latter half of the year, we anticipated additional uncertainty that would impact discretionary renovation activities. However, some economic indicators have been revised upwards, and we have not seen the slowdown in discretionary work that we expected. There has been only a slight softening, but not as significant as anticipated. Encouragingly, in this quarter, we've seen a positive contribution from our growth initiatives. Despite a relatively stable market, these initiatives are making an impact on our volume. As we enter the fourth quarter, we continue to see stability in the discretionary renovation activity pipeline. We're projecting the remainder of the year will reflect the stable conditions we've experienced all year, allowing us to expand margins and grow our earnings and revenue by double digits.

Brian Biros, Analyst

Good to hear. For my second question, can you elaborate on the Mineral Fiber margins, which appear stronger this quarter despite the discrete expenses? I'm curious to understand that number in more detail. You mentioned some drivers, but could you provide more context regarding the margin level relative to the volume and how it compares historically? I believe this is a positive outcome considering the lower volume base, so any additional insights on your perspective would be appreciated.

Victor Grizzle, CEO

Yes, that's a great question. Let me address that, and Chris can provide further insights. Despite some unusual expenses that Chris mentioned, we achieved a 44% EBITDA margin in the Mineral Fiber segment, which is impressive. For the remainder of the year, we expect to finish at 43%, matching our highest level before the pandemic in 2019. We're encouraged by the underlying performance of the business. The key factors contributing to this are ensuring good price realization to more than offset market inflation, selling a richer mix of products, and driving significant productivity gains in our plants to counteract inflationary costs. This combined effort leads to strong margin performance, which we anticipate will continue. Chris, feel free to add anything else.

Christopher Calzaretta, CFO

Yes, absolutely. You hit on all the key building blocks. The only additional item to mention there in terms of Mineral Fiber EBITDA margins is the contribution from WAVE equity earnings expected to grow about 6% this year. So again, with that contribution, really pleased with the overall EBITDA margin for the Mineral Fiber segment.

Operator, Operator

Your next question comes from the line of Garik Shmois with Loop Capital.

Zack Pacheco, Analyst

This is Zack Pacheco on for Garik. Maybe just one more on the Mineral Fiber margin over 43%, that pre-pandemic level. Do you guys kind of see a natural cap getting over that through maybe just the industry dynamics or your level of investment? Or how do you kind of view taking that next step above that pre-pandemic level?

Victor Grizzle, CEO

Yes, it's a common question we receive. We keep referring back to the fundamental factors driving our margins. This serves as a solid indicator of our operational efficiency. It’s important to ensure that we are pricing our products adequately to offset inflationary pressures while enhancing productivity at our plants. We are also focused on innovation to introduce higher-margin and more valuable products to the market. As long as we maintain these foundational elements and continue our commitment to invest in them, we anticipate achieving greater efficiency and higher margins moving forward.

Zack Pacheco, Analyst

Understood. And then just quickly an update on the Geometrik acquisition from earlier in the quarter and kind of just the M&A environment in general as you guys see it.

Victor Grizzle, CEO

You bet. Yes, the Geometrik is a great add for our business, our Architectural Specialty business and in particular, for the Wood platform, which is one of the fastest-growing platforms in the Architectural Specialty business. It's an exciting on-trend look and feel that architects and owners are looking for. And this really adds two real dimensions of competitive advantage. Number one, the extension of the product portfolio to include a greater number of species, really on-trend type species in our wood portfolio. And it gives us a geographic advantage also by being out West. So it's a really great add to the portfolio. And we like these kinds of acquisitions that bring competitive advantage, additional capabilities for us to bring into the architects' offices with the rest of our portfolio. So it's a good example. It's on the smaller side, but we're open for business in terms of our acquisitions. We have a dedicated team that's getting up every day and it's working our pipeline. And we believe there's more of these bolt-on type acquisitions out there for our Architectural Specialty business. So more to come on that front as well.

Operator, Operator

Your next question comes from the line of John Lovallo with UBS.

John Lovallo, Analyst

I guess the first question is just on the Mineral Fiber volumes up slightly in the quarter. How do you think the performance there compared to the underlying market?

Victor Grizzle, CEO

It's really difficult to pinpoint an exact number on that. However, when the markets are stable, they typically fluctuate by about 1 or possibly 0.5 points in either direction. What we do know is that the growth initiatives and the volume contributions from these initiatives were significant contributors to the overall positive results we saw this quarter. The markets remain somewhat soft, so these stable conditions likely reflect the lower market activity we've been experiencing throughout the year. That’s the best way I can explain the overall market performance.

John Lovallo, Analyst

Okay. Got it. And then sticking on Mineral Fiber, it looks like sales to the distribution channel were actually very strong, up 9% year-over-year. What drove this kind of relative strength compared to the other channels?

Christopher Calzaretta, CFO

Yes. I'd say, John, just to continue to point to our strong commercial execution, really, again, coupled with the initiatives that Vic mentioned, we continue to be pleased with the level of performance there in the quarter and are excited about just the way that we've executed in that particular part of the market.

Operator, Operator

Your next question comes from the line of Philip Ng with Jefferies.

Philip Ng, Analyst

A question for Chris. Can you give us an update how you're thinking about inflation broadly for the full year, some of the major inputs and whatnot and the pace in the back half? And then in terms of productivity, you sounded pretty upbeat about what's still in front of you. Should we expect a pretty consistent steady dose of productivity that you still have available for 2026 to kind of tap into?

Christopher Calzaretta, CFO

Sure. Yes, thanks for the question, Phil. Yes, I'll take the second part of that first. In terms of productivity, yes, pleased with our level of productivity in our plants, certainly year-to-date in the quarter and what we're expecting for the full year. And going back to our comments around the value creation drivers and the building blocks of the business, I feel very confident about our ability to continue to get those productivity gains on a go-forward basis. From an inflation perspective, just a reminder in terms of call it, the categories of inflation. In Mineral Fiber, about 35% of our inflation of COGS is raw materials and then energy is about 10%, and freight is about 10%. So from a total input cost perspective for the full year, we're outlooking low single-digit inflation with freight about flat compared to prior year, raws in that low single-digit inflation range and then energy in that low double-digit inflation range. So hopefully, that gives you a little bit more color around the bits and pieces of how we're thinking about inflation on a percentage basis versus prior year for '25.

Philip Ng, Analyst

And Chris, any big nuances in front half versus back half in terms of some of those inflation components, if it's moderating or it's been pretty steady all year?

Christopher Calzaretta, CFO

Yes, I'd say slightly moderating a bit in the back half but not significantly.

Operator, Operator

Your next question comes from the line of Philip Ng with Jefferies.

Victor Grizzle, CEO

Yes. I think that's well said.

Operator, Operator

Your final question comes from the line of Stephen Kim with Evercore ISI.

Aatish Shah, Analyst

This is Aatish speaking on behalf of Steve. I have a quick question. You mentioned it briefly in your prepared remarks, but could you elaborate on the digital initiatives and how their impact has grown and evolved over time, including any lessons learned?

Victor Grizzle, CEO

Yes. I would like to begin with Project Works, which is an automated software platform designed to streamline the ceiling design process by integrating long-established design rules. This platform enables architects to quickly create iterations of various designs, serving as a significant productivity tool. As we introduce more products to the platform, architects are discovering how it can meet their requirements. Additionally, since this automated platform relies on historical data, it generates very precise bills of materials that help predict project costs and facilitate ordering for contractors. For complex projects that involve numerous components, we can accurately determine the quantity needed, which is highly beneficial for contractors as it eliminates guesswork. The Project Works platform continues to gain traction, with increasing numbers of users and activity every quarter. Our data suggests that projects utilizing Project Works experience a higher win rate compared to those that do not, highlighting the value we provide to architects and contractors. We are encouraged by its growth within the communities we serve. Canopy is another initiative that aims to assist smaller customers who often struggle to understand how to repair or replace their ceilings. It guides them through an educational process that ultimately leads to placing an order. This platform has proven to be very effective, and we are committed to enhancing the customer experience quarterly. I am particularly pleased with its performance, not only achieving record top-line results but also delivering exceptional profitability, as indicated by record EBITDA levels that contribute to the overall business. These two digital initiatives represent a deeper commitment, and we continue to see strong operating leverage from both investments.

Operator, Operator

With no further questions in the queue, I will turn the call back over to Vic Grizzle for closing remarks.

Victor Grizzle, CEO

Great. Thank you, and thank you all for joining our call today. Again, we're on track to have another record year in 2025. Really pleased with both double-digit top and double-digit bottom and maybe mostly the traction that we're getting with our investments and the way that we're expanding margins in the business. So we're excited for finishing the year strong and setting up what is going to be another exciting year in '26. Thank you again for joining our call.

Operator, Operator

Thank you again for joining us today. This concludes today's conference call. You may now disconnect.