Armstrong World Industries, Inc. (NYSE:AWI) Q4 2023 Earnings Call Transcript

Armstrong World Industries, Inc. (NYSE:AWI) Q4 2023 Earnings Call Transcript February 20, 2024

Armstrong World Industries, Inc. beats earnings expectations. Reported EPS is $1.22, expectations were $1.03. AWI isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Thank you for standing by, and welcome to the Q4 and Full Year 2023 Armstrong World Industries Earnings Conference Call. I would now like to welcome Theresa Womble, VP of Investor Relations and Corporate Communications to begin the call. Theresa, over to you.

Theresa Womble: Thank you, and good morning to everyone on our call. On today’s call, Vic Grizzle, our CEO and Chris Calzaretta, our CFO, will discuss Armstrong World Industries’ fourth quarter and full year 2023 results and 2024 outlook. To accompany these remarks, we have provided a presentation that is available on the Investors section of the Armstrong World Industries website. 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 measures is included in the earnings press release and in the appendix of the presentation issued this morning. Both are available on the Investors section of the website.

During this call, we will be making forward-looking statements that represent the view we have of our financial and operating performance as of today’s date, February 20, 2024. 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, which include the 10-K filed earlier this morning. We undertake no obligation to update any forward-looking statement beyond what is required by applicable securities law. I will now turn the call to, Vic.

Vic Grizzle: Thank you, Theresa, and welcome everyone to our call today. I’m delighted to have this opportunity to discuss our 2023 results and our expectations for 2024. For those of you who’ve been following us for a while, I’m sure you’ll appreciate the sentiment of what a difference a year makes. We began 2023 with a rather cautious view as many did, with expectations of a negative market backdrop with high-levels of uncertainty, and in particular in the back half of the year. We’re also coming off of 2022 results that were pressured by several factors like rapidly rising inflation, higher interest rates and overall economic uncertainty. Despite these factors and with softer office demand, the economy in our markets overall fared better-than-expected in 2023.

Better-than-expected markets along with our team’s consistent and steady execution helped deliver our strong results for both the quarter the year. On a total company basis for the full-year, we delivered record setting net sales of $1.3 billion which was a 5% increase from full-year 2022 results. Our adjusted EBITDA grew 12% to $430 million representing 200 basis points of improvement in our adjusted EBITDA margin. This result was also 7% greater than our prior record for adjusted EBITDA of $403 million set back in 2019. On an adjusted diluted EPS basis, we delivered growth of 12% and our adjusted free cash flow of $263 million grew 19% above prior year results. We are pleased with these strong results as they represent an ongoing demonstration of Armstrong’s resilient business model with its strong market position, a diverse and balanced set of end-market verticals and attractive growth initiatives.

These attributes allow the Company to deliver revenue and earnings growth with margin expansion even in soft market conditions. These results also reflect the work of more than 3,000 employees who are passionate about our mission and our customers, who drive our strategy, develop and execute the quality and the productivity projects in our plants and ensure we maintain our best-in-class service levels for our customers. We want to thank them for the great work that they do. In our Mineral Fiber segment, our fourth quarter sales increased 2% on flat sales volume versus prior year, which was better than expected due to the better-than-expected market conditions and retail sales. For the full year, with strong AUV and solid contributions from our WAVE joint venture, our Mineral Fiber segment delivered 5% net sales growth and 10% adjusted EBITDA growth with almost 200 basis points of adjusted EBITDA margin expansion, reaching a margin for the full-year of just over 39%.

Our plants also operated well in the quarter as evidenced by strong quality and service levels and for the full-year had strong productivity results and safety performance. Now before moving to Architectural Specialties, I’d like to call attention to the positive impact we’re getting from our growth initiatives. We estimate that these growth initiatives drove more than 1% to our Mineral Fiber volume growth for the full-year and helped offset market weakness. These initiatives include the digital selling platform Canopy by Armstrong and the automated design platform ProjectWorks as well as our Healthy Spaces initiatives. Sales through the Canopy platform continues to ramp and similar to the third quarter, Canopy was EBITDA positive in the fourth quarter.

This cost effective selling platform is allowing us to access the 60% of the installed-base for Mineral Fiber that has limited access to the know-how and solutions for renovating their ceilings. The easy-to-use platform is creating more awareness of the many options for renovating with our large portfolio of solutions and is bringing a wide variety of new customers to Armstrong and our distribution partners. Our ProjectWorks automated design service continues to advance nicely as well. This is a unique capability within our industry and is accelerating the speed and efficiency of customer project collaboration. ProjectWorks addresses the growing challenge architects and designers face in compressed completion cycles and higher number of projects to complete with the same number of architects on staff.

In addition, ProjectWorks helps contractors and ultimately the project owners reduce costs by eliminating waste through optimization of the design and the bill of materials. We’re excited to get in front of more and more architects and designers and contractors and to expand the number of products that are incorporated on this platform. We are clearly over the right target here, and differentiating what we bring to projects beyond just great products. And finally, our Healthy Spaces product portfolio continues to outpace our overall Mineral Fiber growth as these products gain traction in sectors like education and office verticals outside the original intended healthcare spaces. In 2023, sales of these products grew double-digits and contributed to both volume and AUV growth.

Overall, we remain pleased with the progress of our growth initiatives and the positive impact they are making on Mineral Fiber volume growth. Now turning to Architectural Specialties, we delivered 4% sales growth in the quarter and 5% sales growth for the year with contributions from recent acquisitions. We also continued to grow earnings for the segment and made progress toward improving profitability with adjusted EBITDA increasing 27% versus the prior year with margin expansion of 330 basis points. This marks the seventh time in the last eight quarters that this segment has delivered period-over-period EBITDA margin expansion. For the full year, Architectural Specialties EBITDA margin expanded more than 200 basis points. With improved operating performance throughout 2023, we remain on our path to our target of 20% EBITDA margin for the Architectural Specialties segment.

Further supporting the organic growth in this segment, we remain encouraged by the quoting and bidding activity with airport projects across the country. Through the Bipartisan Infrastructure Law passed in 2021, approximately $15 billion in federal funds has been earmarked for airport infrastructure development with $9 billion allocated through 2024. As we’ve mentioned, these are larger and more complex projects, typically with multiple product types sought by the architects and designers. With the largest portfolio of Mineral Fiber and specialty ceiling and wall products, we are uniquely positioned to capture these opportunities, and we expect the transportation vertical to provide a nice tailwind in the Architectural Specialties segment for the next several years to come.

Now I’ll pause and turn it over to Chris, for some more detail on our financial results and our 2024 outlook. Chris?

Chris Calzaretta: 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 Slide 3, which details our basis of presentation. On Slide 6, we discuss our fourth quarter Mineral Fiber segment results. Mineral Fiber sales grew 2% in the quarter, primarily driven by AUV, which represents a combination of like-for-like pricing and mix. In the quarter, AUV growth was driven by favorable like-for-like pricing, partially offset by unfavorable mix. We continue to deliver strong price realization in-line with expectations, but mix was a headwind, largely due to mix dynamics within our channels, which we believe are timing-related. AUV remains a core value driver for the Mineral Fiber segment and despite mix pressure in 2023 we delivered full-year AUV growth of 5% which is in-line with our historical average.

Mineral Fiber volumes were essentially flat in the quarter as contributions from our growth initiatives offset a softer market. While Mineral Fiber volumes were flat compared to the prior year, they were ahead of our guidance expectations as the market in the fourth quarter was broadly more resilient than we expected. Additionally, sales volumes to retail customers were also better-than-expected. While retail sales provided upside to our volume expectations, it also contributed to an AUV headwind in the form of channel mix versus our outlook. Mineral Fiber segment adjusted EBITDA grew by $3 million or 3% and adjusted EBITDA margin expanded by 50 basis points in the fourth quarter. The fall through of AUV and the contributions from WAVE equity earnings were the primary drivers for margin expansion versus the prior year period.

As expected, manufacturing costs were higher than prior year due to the lapping of a strong prior year period where we saw both outsized productivity and cost control gains. This was offset by lower input costs as raw materials remained inflationary but were more than offset by energy and freight deflation. Input costs in the quarter also included a benefit from favorable inventory valuation impacts related to the timing of moderating input costs flowing through the P&L. SG&A increased $7 million versus the prior year, which was in-line with our outlook. This increase versus the prior year period was primarily due to higher current year incentive compensation combined with the lapping of a benefit in the prior year, as well as higher promotional selling expenses in support of topline growth.

Our teams continue to maintain a disciplined approach to cost control on our discretionary spending as we navigated soft market conditions. WAVE equity earnings grew $4 million as compared to prior year with favorable EBITDA margins and slightly higher volumes. Volumes were better-than-expected largely due to more supportive market conditions. On Slide 7, we discuss our Architectural Specialties or AS segment results. Sales growth of 4% in the quarter was led by contributions from our recent acquisitions, which offset project related timing impacts. As a reminder, AS revenue is more impacted by project timelines than Mineral Fiber, so quarters can tend to be lumpy and project scheduling or delays can have outsized impacts quarter-to-quarter.

A highlight in the quarter for AS was the segment’s adjusted EBITDA margin of 18.4% which expanded 330 basis points from the prior year period. This marks the third consecutive quarter with over 300 basis points of adjusted EBITDA margin expansion and resulted in a full-year adjusted EBITDA margin of 18.1% for the segment, expanding over 200 basis points versus the prior year. As Vic noted earlier, we continue to be encouraged by this progress and remain well on our way to the 20% EBITDA margin level that we believe we can return to in this segment. Slide 8 shows our fourth quarter consolidated total Company metrics, where benefits from higher volumes, improved AUV and higher WAVE equity earnings were partially offset by increased SG&A. Input costs to manufacturing largely offset each other.

Consolidated adjusted EBITDA margin expanded 130 basis points with adjusted EBITDA up 7% and adjusted diluted earnings per share up 13% versus the prior year period. Our 31.4% adjusted EBITDA margin was the strongest fourth quarter result since 2019, and we remain focused on continuing to drive adjusted EBITDA margin expansion. Slide 9 highlights our full-year consolidated Company metrics. We grew adjusted EBITDA by 12% and expanded margins 200 basis points. Adjusted diluted earnings per share also increased 12% versus the prior year period, and adjusted free cash flow increased $42 million or 19%. I’m proud of the work that our teams have done throughout the year to deliver double-digit adjusted EBITDA growth, margin expansion and double-digit adjusted free cash flow growth in a soft market.

Slide 10 shows our year-to-date adjusted free cash flow performance versus the prior year. The 19% increase was driven primarily by working capital improvement and higher cash earnings, partially offset by an increase in capital expenditures, lower dividends from WAVE and higher cash interest. Recall that in the fourth quarter of 2022, we received a $25 million special dividend from WAVE that did not repeat in 2023. Excluding that special dividend in the prior year, we grew adjusted free cash flow by a robust 34%. The ability to consistently drive free cash flow generation even in a soft market is one of the key strengths of Armstrong, a key strength that fuels a healthy balance sheet, advances innovation and enables us to execute on all of our capital allocation priorities.

These priorities remain unchanged as we first look to invest back into the business by way of productivity and growth projects where we generate the highest returns. Second, we target acquisitions and partnerships with differentiated and specifiable products and solutions that strengthen our broad product portfolio. And third, we provide value to shareholders through a growing dividend and share repurchases. And looking back on 2023, we delivered on all three. In Q3, we noted the ongoing investment to expand our metal capacity and capabilities within our AS business to maximize returns in a growing category. In July, we completed the acquisition of BOK Modern which is already providing incremental sales and EBITDA. And in October, we increased our dividend by 10%, the fifth consecutive annual increase since dividend inception in 2018 and still we continue to repurchase shares throughout the year.

In the fourth quarter, we repurchased $35 million of shares and for the full-year, we repurchased $132 million. Since the inception of our share repurchase program in 2016, we have repurchased a total of 14.2 million shares for $983 million or approximately a quarter of our total shares outstanding since the end of 2015. As of the end of 2023, we have over $700 million remaining under the existing authorization. This disciplined and balanced approach to capital deployment continues to create value for our shareholders. Slide 11 shows our full-year 2024 guidance. We expect to carry the momentum of solid execution and focus on margin expansion from 2023 into 2024. We expect total Company net sales growth in the 3% to 6% range. We expect our growth initiatives to partially offset modestly lower market demand, resulting in Mineral Fiber volume down in the low-single-digit range.

We expect Mineral Fiber AUV to be in-line with our historical average of mid-single digits, returning to a more balanced split of price and mix and contributing to EBITDA margin expansion. We also expect manufacturing productivity and normalizing levels of inflation in 2024. And paired with continued efforts for AS to penetrate a fragmented market and expand margins, we expect total Company adjusted EBITDA growth in the 5% to 9% range. We expect adjusted diluted EPS and adjusted free cash flow to grow at a rate similar to adjusted EBITDA. Please note that additional assumptions are in the appendix of this presentation. We anticipate 2024 to be similar to 2023, albeit with less market uncertainty. Our teams remain laser focused on delivering profitable growth, margin expansion and adjusted free cash flow growth despite modestly softer market conditions.

I’m excited to further this momentum as we continue execute our strategy and create value for our shareholders. And now I’ll turn it back to Vic, for further comments before we take your questions. Vic?

Vic Grizzle: Thanks, Chris. And before we get to your questions, I’d like to take a moment to share a few highlights from Armstrong’s proven ability to consistently and steadily invest back in our business and innovation through all parts of the cycle. In January, we announced a new partnership with McKinstry, an innovative leading construction and energy services company, to tackle another challenging aspect of construction today, the waste and inefficiency in the installation of systems, devices, and components needed to meet today’s tenant requirements. With an equity investment in Overcast Innovations, an early stage McKinstry venture, we’re co-developing plug-and-play systems that streamline this increasingly complex process.

This represents an integrated approach that goes well beyond ceiling tiles. Overcast works with architects to integrate HVAC, lighting, audiovisual components, sensors, and other ceiling equipment into factory manufactured architectural ceiling solutions. The partnership and investment are expected to accelerate Overcast growth through access to Armstrong’s portfolio of ceiling solutions and go-to-market platform. By bringing together industry leading Armstrong ceiling systems with Overcast pioneering integrated modular ceiling design, we can offer unique and sustainable solutions. Another area of focus has been innovation in our Healthy Spaces initiative and has evolved over time to include the energy efficiency and overall thermal comfort of commercial buildings.

As you may know, buildings are responsible for nearly 40% of global energy consumption and in the U.S. alone, this energy consumption represents nearly 75% of all electricity used and 35% of the nation’s carbon emissions. Importantly, over 50% of that energy consumption is used to heat and cool buildings. As part of our research and development efforts, we have focused on how ceilings can play a significant role in creating healthier and more sustainable spaces and enable energy efficiency for more sustainable buildings, and ultimately accelerate the efforts of building owners and operators to achieve their net zero energy aspirations. As we announced in December, Armstrong has acquired the technology to integrate Phase Change Material or PCM into our ceiling tiles to improve their thermal mass and thereby reduce the energy consumption of commercial buildings by as much as 15%.

This performance is enabled by the heat absorption and release properties of PCM that can shorten the heating and cooling cycles to save energy. This technology enabled us to introduce Ultima Templok, the first of its kind and the first of what we expect to become a broader portfolio of energy saving ceiling tiles. Ultima Templok brings the same smooth white look, the same superior acoustical performance that our customers enjoy today, but now in a package that also saves energy. This is the first ceiling tile that will pay for itself over time. Our first customer for this new energy saving ceiling solution is the U.S. Department of Energy as part of an ongoing government study of new innovative technologies that offer energy efficiency and decarbonization benefits.

Needless to say, this is an exciting innovation for the entire ceiling category and a brand new way for building owners and operators to reduce energy costs and to make their buildings more sustainable. Our ongoing focus on innovation is a key element of our strategy that provides a unique value proposition to all of our customers. Our innovation continues to add value and new attributes to the ceiling category, making ceilings more relevant and valuable to architects and designers and building owners, and it ultimately positions Armstrong well to consistently grow the AUV of our products and enhance our overall competitive advantage. And finally to wrap, despite expecting a modestly softer demand year ahead, we are carrying some good momentum into 2024.

We demonstrated our unique resilience in 2023 by delivering profitable growth in a challenging market and with modestly softer market conditions in 2024, we expect to do more of the same. The resilience of this business has been a hallmark for many years. And since the 2020 pandemic, we have generated sales and earnings growth each year even though the commercial construction markets have not fully recovered. This growth enables our ability to consistently invest back in the business to drive innovation into the market and fuel future growth. All this in addition to providing direct returns to our shareholders through dividends and share repurchases, again, even during weaker economic times. So with that, we’ll stop here and be happy to take your questions.

Operator: The floor is now open for your questions. [Operator Instructions] Our first question comes from the line of Garik Shmois with Loop Capital Markets. Please go ahead.

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Q&A Session

Garik Shmois: Hi, thanks and congrats on the quarter. I’m hoping you could speak a little bit as to what you’re seeing so far, in the first quarter, we’ve been hearing from other companies, that weather had been a little bit of a headwind, not sure if that’s impacting you and then maybe speak to, how you expect, the slope of the year to progress both for sales and margins, anything to take in account there?

Vic Grizzle: Yes. Garik, on the direct part of your question, we’ve not seen any measurable impact on weather on the business in the first six weeks of the year here so far. So, let me answer that directly. What we’re seeing in the marketplace and what we expect to see to start back with the third quarter of last year, we saw a market that again was better than what we were expecting. And then in the fourth quarter, we saw a very similar market condition than that we saw in the third quarter. So, as we outlook the halves of the year in 2024, we kind of expect that the first and second quarter, the first half of this year to be fairly similar to what we saw in the back half. It seems to be just kind of at this level, just progressing along at this level.

In the back half is where we have more uncertainty again with the lag effect of our business and the lag effect of higher interest rates, overall slower economic activity that’s expected. We see that that could potentially hit the discretionary part of our business and we might see some softer market conditions and softer volumes in the back half of the year. That’s our current outlook. Again, there’s some uncertainty with regards to exactly what we’re going to see. And as Chris mentioned in his prepared remarks, we don’t see the same kind of, variation in the potential outcomes as we did going into ‘23, but still there’s some uncertainty about what is the overall economic activity going to look like. So, kind of, a first half as we’ve been seeing, recently in recent quarters, maybe a little bit modestly softer conditions in the back half.

Garik Shmois: No. Thanks for that. I wanted to follow-up on capital allocation, just given your strong free cash flow position, balance sheet is in good shape, just thoughts on priorities and maybe speak to the M&A environment as well?

Chris Calzaretta: Yes. Hey, Garik. It’s Chris. I’ll take that. And then, Vic, you wanted to add on a little bit on the M&A side. Yes. I mean, our approach to capital allocation priorities remain unchanged. I mean, we invest back into the business first, where we see a lot of our highest returns. And then, second, seek to grow, by way of inorganic growth to create shareholder value. And returning cash to shareholders continues to be our last priority, our third priority. And, we continue to flex with share repurchases. And as you’ve gone through, our strategic planning and long-term planning for the business, we believe that there’s value creation there and following those disciplined capital allocation priority steps, they remain unchanged and, believe that they’re the best way to continue to deploy capital for the Company.

Vic Grizzle: And to point Chris’ point, our second priority is the use of free cash flow to bolt-on acquisitions that add capabilities to the Armstrong platform, to accelerate where we’re trying to go and especially in this fragmented specialties category. We still believe there’s lots of opportunity there. We continue to pursue those opportunities. I would say we’re very active. Our pipeline is very active and fluid. I think a lot of the questions that we get are around how interest rates and so forth may be affecting our pipeline. Again, a lot of these companies that we’re working with or trying to get closer to are not in a sale process and so are not affected really by interest rates or the interest rate environment. So, we continue to build these relationships with targeted companies that we think would add a lot of value by being on the Armstrong platform, and we’ll continue to build those third-party relationships with those that we think we don’t need to own the assets and we can use our capital elsewhere.

So we remain active. We still believe that there’s a good set of opportunities for us to go faster in the Specialty segment through these acquisitions, and we’ll continue to build that pipeline and hopefully get some of those across the finish line.

Garik Shmois: Makes sense. Thanks again. I’ll pass it on.

Vic Grizzle: Yes. Thank you.

Chris Calzaretta: Thank you.

Operator: Our next question comes from the line of Philip Ng with Jefferies. Please go ahead.

Philip Ng: Hey, guys. Strong finish to the year, so congrats to the team. So Vic, it’s good to hear that demand is off to a pretty solid start in the first half. Any color on how orders and bidding activity have trended lately, particularly in some of the more challenged end-markets like office and retail? Are you starting to see those activity, or bottom out here? And you commented about how the back half could be a little more weaker? Is that informed by your customers or you’re just kind of baking in some conservatism?

Vic Grizzle: Yes. So first of all, Philip on the bidding activity, fourth quarter bidding activity was positive. And it was kind of choppy all throughout the last year as we reported in 2023. I would say overall bidding activity for the year was stable, with the Q4 again being positive. Interesting enough, as much as office gets talked about, I think it’s worth noting that the office bidding activity was positive in 2023 in both the number of projects and the value of projects. We think this is another signal of this sector in particular stabilizing along with some of the other things that we talked about in our third quarter with leasing volumes, increasing 14% in the quarter. The supply at the high-end continues to get tighter both in the Class A and A plus part of the marketplace back to office mandates of 90% of the Fortune 100 employees are now back in the office an average of three days a week.