ARMSTRONG WORLD INDUSTRIES INC 10-Q

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS O F FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion should be read in conjunction with the financial statements, the accompanying notes, the cautionary note regarding forward-looking statements and risk factors included in this report and our Annual Report on Form 10-K for the year ended December 31, 2023. OVERVIEW AWI is a leader in the design, innovation and manufacture of ceiling and wall solutions in the Americas. We manufacture and source products made of numerous materials, including mineral fiber, fiberglass wool, metal, wood, felt, wood fiber, and glass-reinforced-gypsum. We also manufacture ceiling suspension system (grid) products through a joint venture with Worthington Enterprises, Inc. (“Worthington”) called Worthington Armstrong Venture (“WAVE”). Acquisitions and Investments in Unconsolidated Affiliates In January 2024, we entered into a strategic partnership and equity investment in Overcast Innovations LLC (“Overcast”) with McKinstry Essention, LLC whereby we contributed $5.5 million in exchange for a 19.5% ownership interest in Overcast, with future rights to increase our ownership interest. Overcast is a solutions company offering prefabricated ceiling cloud systems, modular grid platforms and engineering design services to reduce waste and inefficiencies in the built environment. Our investment and equity earnings in Overcast are included in our Unallocated Corporate segment. In October 2023, we acquired a portion of the business and certain assets of Insolcorp, LLC (“Insolcorp”), based in Albemarle, NC, used to develop, test and manufacture energy saving products deployed in building and roofing installations. The acquired operations, assets and liabilities of Insolcorp are included in our Mineral Fiber segment. In July 2023, we acquired all of the issued and outstanding stock of BOK Modern, LLC (“BOK”), based in San Rafael, CA. BOK is a designer of metal facade architectural solutions. The acquired operations, assets and liabilities of BOK are included in our Architectural Specialties segment. Manufacturing Plants As of March 31, 2024, we operated 16 manufacturing plants, including 14 plants located within the U.S. and two plants in Canada. This excludes our St. Helens, Oregon mineral fiber manufacturing plant, which was closed in the second quarter of 2018 and was classified as an asset held for sale as of March 31, 2024. WAVE operates seven additional plants in the U.S. to produce suspension system (grid) products, which we use and sell in our ceiling systems. Reportable Segments Our operating segments are as follows: Mineral Fiber, Architectural Specialties and Unallocated Corporate. Mineral Fiber – produces suspended mineral fiber and soft fiber ceiling systems. Our mineral fiber products offer various performance attributes such as acoustical control, rated fire protection, and energy efficiency, along with other health and sustainability features and aesthetic appeal. Ceiling products are primarily sold to resale distributors, ceiling systems contractors and wholesalers, and retailers (including large home centers). The Mineral Fiber segment also includes the results of WAVE, which manufactures and sells suspension system (grid) products and ceiling component products that are invoiced by both AWI and WAVE. Segment results relating to WAVE consist primarily of equity earnings and reflect our 50% equity interest in the joint venture. Ceiling component products consist of ceiling perimeters and trim, in addition to grid products that support drywall ceiling systems. For some customers, WAVE sells its suspension system products to AWI for resale to customers. Mineral Fiber segment results reflect those sales transactions. The Mineral Fiber segment also includes all assets and liabilities not specifically allocated to our Architectural Specialties or Unallocated Corporate segment, including all property and related depreciation associated with our Lancaster, PA headquarters. Operating results for the Mineral Fiber segment include a significant majority of allocated Corporate administrative expenses that represent a reasonable allocation of general services to support its operations. Architectural Specialties – produces, designs and sources ceilings, walls and facades primarily for use in commercial settings. Products are available in numerous materials, such as metal, wood and felt, in addition to various colors, shapes and designs. These products offer various performance attributes such as acoustical control, rated fire protection and aesthetic appeal. We sell standard, premium and customized products, a portion of which are sourced from third-party producers. Architectural Specialties products are sold primarily to resale distributors and direct customers, primarily ceiling systems contractors. The majority of this segment’s 22 Management’s Discussion and Analysis of Financial Condition and Results of Operations revenues are project driven, which can lead to more variability in sales patterns. Operating results for the Architectural Specialties segment include a portion of allocated Corporate administrative expenses that represent a reasonable allocation of general services to support its operations. Unallocated Corporate – includes certain assets, liabilities, income and expenses that have not been allocated to our other business segments and consists of: cash and cash equivalents, our Overcast investment and related equity earnings/losses, the net funded status of our U.S. Retirement Income Plan (“RIP”), the estimated fair value of interest rate swap contracts, outstanding borrowings under our senior secured credit facility and income tax balances. Factors Affecting Revenues For information on our 2024 net sales by segment, see Notes 2 and 3 to the Condensed Consolidated Financial Statements. Markets. We compete in the building product markets of the Americas. We closely monitor publicly available macroeconomic data and trends that provide insight into commercial construction market activity, including, but not limited to, gross domestic product, office vacancy rates, the Architecture Billings Index, new commercial construction starts, state and local government spending, corporate profits, and retail sales. The Company continues to monitor the impacts of geopolitical events, none of which had a material direct impact on our financial condition, liquidity or results of operations the first three months of 2024 or 2023. Several factors and trends within our markets affected our business performance during the first quarter of 2024 compared to the first quarter of 2023. For the three months ended March 31, 2024, sales volumes decreased $4 million compared to the prior-year period, due primarily to prior-year period inventory level increases at our home center customers that did not occur in the current-year period, partially offset by a $3 million contribution from the July 2023 acquisition of BOK. Average Unit Value . We periodically modify sales prices of our products due to changes in costs for raw materials and energy, market conditions and the competitive environment. Typically, realized price increases are less than announced price increases because of project pricing, competitive adjustments and changing market conditions. We also offer a wide assortment of products that are differentiated by style, design and performance attributes. Pricing and margins for products within the assortment vary. In addition, changes in the relative quantity of products purchased at different price points can impact year-to-year comparisons of net sales and operating income. Within our Mineral Fiber segment, we focus on improving sales dollars per unit sold, or average unit value (“AUV”), as a measure that accounts for the varying assortment of products and like-for-like pricing impacting our revenues. Favorable AUV contributed approximately $20 million to our total consolidated net sales for the three months ended March 31, 2024 compared to the same period in 2023. Our Architectural Specialties segment revenues are primarily earned based on individual contracts that include a mix of products, both manufactured by us and sourced from third parties, which varies by project. As such, we do not track AUV performance for this segment, but rather attribute most changes in net sales to volume. During the first quarter of 2024, we implemented price increases on Mineral Fiber ceiling products and WAVE implemented price increases on grid products. Future pricing actions may be implemented based on numerous factors, including the rate and pace of inflation and its impact on our business. Seasonality . Historically, our sales tend to be stronger in the second and third quarters of our fiscal year due to more favorable weather conditions, customer business cycles and the timing of renovation and new construction projects. Factors Affecting Operating Costs Operating Expenses. Our operating expenses are comprised of direct production costs (principally raw materials, labor, and energy), manufacturing overhead costs, freight, costs to purchase sourced products and selling, general and administrative (“SG&A”) expenses. Our largest raw material expenditures are primarily for fiberglass, perlite, recycled paper, and starch. Other raw materials include clay, felt, pigment, wood, and wood fiber. We manufacture most of our mineral wool at one of our manufacturing facilities. We use aluminum and steel in the production of metal ceilings by us and by WAVE. Finally, natural gas and packaging materials are also significant input costs. Fluctuations in the prices of these inputs impact our financial results. In the first quarter of 2024, lower energy and freight costs positively impacted operating income by $2 million compared to the same period in 2023. 23 Management’s Discussion and Analysis of Financial Condition and Results of Operations Acquisition-Related Expenses and Losses In connection with our acquisitions of Insolcorp in October 2023, BOK in July 2023 and Arktura LLC (“Arktura”) in December 2020, we recorded certain acquisition-related expenses, gains and losses to operating income in the three months ended March 31, 2024 and 2023, summarized as follows (dollar amounts in millions): Three Months Ended March 31, 2024 2023 Affected Line Item in the Condensed Consolidated Statements of Earnings and Comprehensive Income (Gain) related to change in fair value of contingent consideration $ (0.3 ) $ - (Gain) related to change in fair value of contingent consideration Deferred cash and restricted stock expenses - 1.3 SG&A expenses Net (positive) negative impact to operating income $ (0.3 ) $ 1.3 The change in fair value of contingent consideration was related to our BOK and Insolcorp acquisitions, and was remeasured quarterly during each acquisition's earn-out periods. See Note 14 to the Condensed Consolidated Financial Statements for further information. Expenses related to the deferred cash and restricted stock awards for Arktura’s former owners and employees were recorded over their respective service periods, as such payments were subject to the awardees’ continued employment with AWI. The Company and the former owners of Arktura mutually agreed upon the separation of their service effective in the fourth quarter of 2023. Depreciation of fixed assets acquired and amortization of intangible assets acquired have been excluded from the table above. Employees As of March 31, 2024 and December 31, 2023, we had approximately 3,100 full-time and part-time employees. RESULTS OF OPERATIONS Please refer to Note 2 to the Condensed Consolidated Financial Statements for a reconciliation of operating income to consolidated net earnings before income taxes. CONSOLIDATED RESULTS (dollar amounts in millions) 2024 2023 Change is Favorable Three Months Ended March 31, Total consolidated net sales $ 326.3 $ 310.2 5.2 % Operating income $ 86.1 $ 70.2 22.6 % Consolidated net sales for the first quarter of 2024 increased 5.2% over the prior-year period primarily due to favorable AUV of $20 million, partially offset by lower volumes of $4 million. Mineral Fiber net sales increased $11 million and Architectural Specialties net sales increased $5 million over the prior-year period. The increase in Mineral Fiber net sales was primarily driven by favorable AUV, partially offset by lower sales volumes. Architectural Specialties segment net sales improved primarily due to contributions from the acquisition of BOK and increased custom metal project net sales. Cost of goods sold in the first quarter of 2024 was 61.9% of net sales, compared to 63.9% for the same period in 2023. The year-over-year decrease in cost of goods sold as a percent of net sales was driven primarily by favorable AUV performance, improved manufacturing productivity and lower input costs. SG&A expenses in the first quarter of 2024 were $65.7 million, or 20.1% of net sales, compared to $62.7 million, or 20.2% of net sales, for the same period in 2023. The year-over-year increase in SG&A expenses was driven primarily by a $2 million increase in selling expenses related to the acquisition of BOK and investments in our Architectural Specialties segment, in addition to an increase in deferred compensation related charges. The prior-year period also included severance costs of $3 million that did not repeat in the current-year period. Equity earnings from unconsolidated subsidiaries were $27.2 million in the first quarter of 2024, compared to $20.8 million in the first quarter of 2023. WAVE equity earnings were $27.4 million in the first quarter of 2024, while Overcast equity losses were $0.2 million. The $6.6 million increase in WAVE equity earnings was primarily driven by the benefit from higher sales volumes and favorable AUV. See Note 7 to the Condensed Consolidated Financial Statements for further information. 24 Management’s Discussion and Analysis of Financial Condition and Results of Operations Interest expense was $9.0 million in the first quarter of 2024 compared to $8.7 million in the first quarter of 2023. The increase in interest expense was primarily due to higher interest rates on floating rate debt and increases in finance lease liabilities, partially offset by lower average debt balances. Other non-operating income, net, was $3.1 million in the first quarter of 2024 compared to $2.4 million in the first quarter of 2023. The increase in other non-operating income, net, was primarily driven by the non-service cost components of postretirement net periodic benefit costs. Income tax expense was $20.3 million in the first quarter of 2024 compared to $16.6 million in the first quarter of 2023. The effective tax rate for the first quarter of 2024 was 25.3% compared to 26.0% for the same period of 2023. The decrease in the effective tax rate was primarily due to an increase in our valuation allowance for capital loss carryforwards recorded in the first quarter of 2023. Total Other Comprehensive Loss (“OCL”) was $0.9 million in the first quarter of 2024 compared to $2.1 million in the first quarter of 2023. The change in OCL in the first quarter of 2024 compared to the same period in 2023 was primarily driven by derivative gains/losses. Derivative gain/loss represents the mark-to-market value adjustments of our derivative assets and liabilities, and the recognition of gains and losses previously deferred in Accumulated Other Comprehensive Income. Partially offsetting the reduction in OCL due to the change in derivative gains/losses was an increase in OCL from pension and postretirement adjustments and foreign currency translation adjustments. Pension and postretirement adjustments represent the amortization of actuarial gains and losses related to our defined benefit pension and postretirement plans. Foreign currency translation adjustments represent the change in the U.S. dollar value of assets and liabilities denominated in foreign currencies. Amounts in the first quarter of 2024 and 2023 were driven primarily by changes in the Canadian dollar. REPORTABLE SEGMENT RESULTS Mineral Fiber (dollar amounts in millions) 2024 2023 Change is Favorable Three Months Ended March 31, Total segment net sales $ 239.6 $ 228.4 4.9 % Operating income $ 79.2 $ 63.8 24.1 % Net sales increased $11 million in the first quarter of 2024 due to $19 million of favorable AUV, partially offset by $8 million of lower sales volumes. The improvement in AUV was driven by favorable like-for-like price and favorable mix. The decrease in volumes was primarily driven by prior-year period inventory level increases at our home center customers that did not occur in the current-year period. Operating income increased in the first quarter of 2024 primarily due to a $13 million benefit from favorable AUV, a $7 million increase in WAVE equity earnings and a $3 million decrease in manufacturing and input costs, partially offset by a $5 million decrease from lower sales volumes. Operating income was also negatively impacted by a $2 million increase in SG&A expenses, which included increases in deferred compensation related charges and higher depreciation, partially offset by the benefit from severance expense recorded in the prior-year period. Architectural Specialties (dollar amounts in millions) 2024 2023 Change is Favorable Three Months Ended March 31, Total segment net sales $ 86.7 $ 81.8 6.0 % Operating income $ 7.7 $ 7.2 6.9 % Net sales increased $5 million primarily driven by the contribution of BOK and increased custom metal project net sales. Operating income increased in first quarter of 2024 primarily due to a $4 million margin benefit from increased sales, driven primarily by improved custom project margins, and a $1 million reduction in acquisition-related expenses. These increases were partially offset by higher manufacturing costs and selling expenses due in part to the acquisition of BOK and additional investments in selling capabilities. Unallocated Corporate Unallocated Corporate operating loss was $1 million in the first quarter of 2024 and 2023. 25 Management’s Discussion and Analysis of Financial Condition and Results of Operations FINANCIAL CONDITION AND LIQUIDITY Cash Flow Operating activities for the first three months of 2024 provided $26.4 million, compared to $26.2 million for the first three months of 2023. The favorable change in the first quarter of 2024 compared to the same period in 2023 was due to higher cash earnings and the absence of contingent consideration payments in excess of acquisition-date fair value, offset by unfavorable working capital changes in accounts receivable, accounts payable and accrued expenses. The unfavorable changes in working capital were timing related, and for accrued expenses, also driven by the impact of changes in incentive compensation accruals. Net cash provided by investing activities was $5.9 million in the first three months of 2024, compared to $1.5 million of cash used in the first three months of 2023. The favorable change in the first quarter of 2024 compared to the same period in 2023 was due to decreased purchases of property, plant and equipment, proceeds received from company owned life-insurance policies, and an increase in WAVE dividends. These increases were partially offset by cash paid for our first quarter of 2024 equity investment in Overcast. Net cash used for financing activities was $33.1 million in the first three months of 2024, compared to $34.7 million in the first three months of 2023. The favorable change in the first quarter of 2024 compared to the same period in 2023 was primarily due to a decrease in repurchases of outstanding common stock and lower payments of acquisition-related contingent consideration, partially offset by increased repayments on borrowings under our credit facility. Liquidity Our liquidity needs for operations vary throughout the year. We retain lines of credit to facilitate our seasonal cash flow needs, since cash flow is historically lower during the first and fourth quarters of our fiscal year. We have a $950.0 million variable rate senior credit facility, which is comprised of a $500.0 million revolving credit facility (with a $150.0 million sublimit for letters of credit) and a $450.0 million Term Loan A. The revolving credit facility and Term Loan A are currently priced at 1.375% over the Secured Overnight Financing Rate (“SOFR”), plus a 10-basis point adjustment. The revolving credit facility and Term Loan A mature in December 2027. We also have a $25.0 million bi-lateral letter of credit facility. As of March 31, 2024, the total principal balances outstanding under our senior credit facility were $444.4 million under Term Loan A and $140.0 million under the revolving credit facility. The senior credit facility includes two financial covenants that require the ratio of consolidated earnings before interest, taxes, depreciation and amortization (“EBITDA”) to consolidated cash interest expense minus cash consolidated interest income to be greater than or equal to 3.0 to 1.0, and requires the ratio of consolidated funded indebtedness, minus AWI and domestic subsidiary unrestricted cash and cash equivalents up to $100 million, to EBITDA to be less than or equal to 3.75 to 1.0 (subject to certain exceptions for certain acquisitions). As of March 31, 2024, we were in compliance with all covenants of the senior credit facility. The Term Loan A is currently priced on a variable interest rate basis. The following table summarizes our interest rate swaps (dollar amounts in millions): Coverage Period Notional Amount Risk Coverage Trade Date November 2023 to June 2024 $ 50.0 USD-SOFR September 18, 2023 March 2021 to March 2025 $ 100.0 USD-SOFR November 28, 2018 November 2023 to December 2025 $ 50.0 USD-SOFR October 23, 2023 March 2024 to June 2026 $ 50.0 USD-SOFR March 25, 2024 November 2023 to December 2026 $ 50.0 USD-SOFR October 10, 2023 March 2024 to June 2027 $ 50.0 USD-SOFR March 27, 2024 November 2023 to November 2027 $ 50.0 USD-SOFR September 29, 2023 Under the terms of our interest rate swaps above, on a monthly basis, we pay a fixed rate and receive a floating rate based on SOFR. As of March 31, 2024, these swaps are designated as cash flow hedges against changes in SOFR for a portion of our variable rate debt. 26 Management’s Discussion and Analysis of Financial Condition and Results of Operations We utilize lines of credit and other commercial commitments to ensure that adequate funds are available to meet operating requirements. Letters of credit are currently arranged through our revolving credit facility and our bi-lateral facility. Letters of credit may be issued to third party suppliers, insurance companies and financial institutions and typically can only be drawn upon in the event of AWI’s failure to pay its obligations to the beneficiary. The following table presents details related to our letters of credit facilities (dollar amounts in millions): March 31, 2024 Financing Arrangements Limit Used Available Bi-lateral facility $ 25.0 $ 7.7 $ 17.3 Revolving credit facility 150.0 - 150.0 Total $ 175.0 $ 7.7 $ 167.3 As of March 31, 2024, we had $69.6 million of cash and cash equivalents, $52.2 million in the U.S. and $17.4 million in foreign jurisdictions, primarily Canada. As of March 31, 2024, we also had $360.0 million available under our revolving credit facility. We believe cash on hand and cash generated from operations, together with borrowing capacity under our credit facility, will be adequate to address our near-term liquidity needs based on current expectations of our business operations, capital expenditures, acquisitions and scheduled payments of debt obligations. CRITICAL ACCOUNTING ESTIMATES There have been no material changes to our critical accounting estimates disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023. 27 ITEM 3. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK For information regarding our exposure to certain market risks, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” in our Annual Report on Form 10-K for the year ended December 31, 2023.