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, 2024. OVERVIEW AWI is an Americas leader in the design, innovation and manufacture of interior and exterior architectural applications including ceilings, specialty walls and exterior metal solutions. We manufacture and source products made of numerous materials, including mineral fiber, fiberglass, metal, felt, wood, resin, wood fiber and glass-reinforced-gypsum. We also manufacture ceiling suspension system (grid) products through a joint venture with Worthington Enterprises, Inc. called Worthington Armstrong Venture (“WAVE”). Acquisitions and Investments in Unconsolidated Affiliates In December 2024, we acquired all the issued and outstanding stock of A. Zahner Company (“Zahner”), based in Kansas City, Missouri. Zahner is a designer and manufacturer of exterior metal architectural solutions. The operations, assets and liabilities of Zahner are included in our Architectural Specialties segment. In April 2024, we acquired all of the issued and outstanding membership interests in 3form, LLC (“3form”) based in Salt Lake City, Utah, from Hunter Douglas, Inc. 3form is a designer and manufacturer of architectural resin and glass products used for specialty walls, partitions and ceilings. The operations, assets and liabilities of 3form are included in our Architectural Specialties segment. In January 2024, we entered into a strategic partnership and equity investment in Overcast Innovations LLC (“Overcast”) with McKinstry Essention, LLC whereby we acquired 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. Manufacturing Plants As of March 31, 2025, we operated 20 manufacturing plants, including 18 plants located within the U.S. and two plants in Canada. 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 fiberglass 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, including all property and related depreciation associated with our Lancaster, Pennsylvania 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 – designs, produces and sources specialty ceilings, walls, and other interior and exterior architectural applications including ceilings, specialty walls and exterior metal solutions primarily for use in commercial settings. Products are available in numerous materials, such as metal, felt, wood, resin and glass, wood fiber and glass-reinforced-gypsum in various colors, shapes and designs. These products offer a range of design options and performance attributes such as acoustical control, rated fire protection, light, aesthetic appeal, energy conservation and building performance. 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. This segment’s revenues are primarily project driven, which 24 Management’s Discussion and Analysis of Financial Condition and Results of Operations 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 2025 and 2024 net sales and disaggregated expenses by segment, see Note 2 to the Condensed Consolidated Financial Statements. For information on our segments’ 2025 and 2024 net sales disaggregated by major customer groups, see Note 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 recent tariff announcements and geopolitical events, including but not limited to, conflicts in Ukraine and the Middle East, none of which had a material direct impact on our financial condition, liquidity or results of operations in the first three months of 2025 or 2024. Several factors and trends within our markets affected our business performance during the first quarter of 2025 compared to the first quarter of 2024, most notably a $41 million increase in net sales due to our December 2024 acquisition of Zahner and April 2024 acquisition of 3form. Also contributing to the increase in net sales was a $10 million increase in organic Architectural Specialties net sales, driven primarily by increased custom project revenues, offset by a $10 million decrease in net sales due to lower sales volumes in our Mineral Fiber segment. 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 $16 million to our total consolidated net sales for the three months ended March 31, 2025 compared to the same period in 2024. Our Architectural Specialties segment revenues are primarily generated by 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 all changes in net sales to volume, including gross to net sales adjustments. During the first quarter of 2025, we implemented price increases on Mineral Fiber ceiling products and WAVE implemented price increases on grid products. Future pricing actions for Mineral Fiber, Architectural Specialties and WAVE products may be implemented based on numerous factors, including the impact of announced tariffs and 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, tariffs and selling, general and administrative (“SG&A”) expenses. 25 Management’s Discussion and Analysis of Financial Condition and Results of Operations Our largest raw material expenditures are primarily for fiberglass, perlite, recycled paper, and starch. Other raw materials include clays, felt, pigment, resin and glass, wood and wood fiber. We manufacture substantially all of our mineral wool at one of our manufacturing facilities. We use aluminum and steel in the production of metal building products by us and by WAVE. Finally, natural gas and packaging materials also represent significant input costs. Fluctuations in the prices of these inputs impact our financial results. In the first quarter of 2025, higher energy and raw material costs negatively impacted operating income by $1 million compared to the same period in 2024. Employees As of March 31, 2025 and December 31, 2024, we had approximately 3,600 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) 2025 2024 Change is Favorable Three Months Ended March 31, Total consolidated net sales $ 382.7 $ 326.3 17.3 % Operating income $ 98.5 $ 86.1 14.4 % Consolidated net sales for the first quarter of 2025 increased 17.3% over the prior-year period due to higher volumes of $41 million and favorable AUV of $16 million. Architectural Specialties net sales increased $51 million and Mineral Fiber net sales increased $6 million over the prior-year period. Architectural Specialties segment net sales improved primarily due to a $41 million contribution from the acquisitions of Zahner and 3form and increased organic custom project net sales. The increase in Mineral Fiber net sales was primarily driven by favorable AUV, partially offset by lower sales volumes. Cost of goods sold in the first quarter of 2025 was 60.8% of net sales, compared to 61.9% for the same period in 2024. The year-over-year decrease in cost of goods sold as a percent of net sales was driven primarily by favorable AUV margin benefit, favorable inventory valuation impacts, improved manufacturing productivity and favorable margin benefits from the acquisition of Zahner and 3form. SG&A expenses in the first quarter of 2025 were $78.0 million, or 20.4% of net sales, compared to $65.4 million, or 20.0% of net sales, for the same period in 2024. The increase in SG&A expenses was primarily driven by a $14 million increase related to the acquisitions of Zahner and 3form and a $2 million increase in selling expenses. These increases were partially offset by a $4 million increase in company-owned officer life insurance gains related to deferred compensation plans. Equity earnings from unconsolidated subsidiaries were $26.6 million in the first quarter of 2025, compared to $27.2 million in the first quarter of 2024. WAVE equity earnings were $26.8 million in the first quarter of 2025, compared to $27.4 million in the first quarter of 2024. The decrease in WAVE equity earnings was primarily driven by the negative impact of lower sales volumes, partially offset by favorable AUV. See Note 8 to the Condensed Consolidated Financial Statements for further information. Interest expense was $8.5 million in the first quarter of 2025 compared to $9.0 million in the first quarter of 2024. The decrease in interest expense for the first quarter of 2025 in comparison to the same period in 2024 was primarily due to lower average debt balances, partially offset by higher average effective interest rates. Other non-operating income, net, was $0.7 million in the first quarter of 2025 compared to $3.1 million in the first quarter of 2024. The decrease in other non-operating income, net, for the first quarter 2025 in comparison to the same period in 2024 was primarily driven by the non-service cost components of pension and postretirement net periodic benefit costs. Income tax expense was $21.6 million in the first quarter of 2025 compared to $20.3 million in the first quarter of 2024. The effective tax rate for the first quarter of 2025 was 23.8% compared to 25.3% for the same period of 2024. The decrease in the effective tax rate was primarily due to the benefit of federal investment tax credits, a reduction in our valuation allowance for capital loss carryforwards and other favorable permanent adjustments. Total Other Comprehensive Loss (“OCL”) was $0.6 million in the first quarter of 2025 compared to $0.9 million in the first quarter of 2024. The change in OCL in the first quarter of 2025 compared to the first quarter of 2024 was due to pension and postretirement adjustments and foreign currency translation adjustments, partially offset by lower interest rate swap derivative losses in 2025. 26 Management’s Discussion and Analysis of Financial Condition and Results of Operations 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. Foreign currency translation adjustments in 2025 and 2024 were driven primarily by changes in the Canadian dollar. Derivative losses represent the mark-to-market value fair adjustments for our derivative assets and liabilities, and the recognition of gains and losses previously deferred in Accumulated Other Comprehensive Income. REPORTABLE SEGMENT RESULTS Mineral Fiber (dollar amounts in millions) 2025 2024 Change is Favorable Three Months Ended March 31, Total segment net sales $ 245.1 $ 239.6 2.3 % Operating income $ 84.5 $ 79.2 6.7 % Net sales increased $6 million in the first quarter of 2025 compared to the prior-year quarter due to $16 million of favorable AUV, partially offset by $10 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 softer demand from our home center customers, and the impact of one less shipping day compared to the prior year period. Costs of goods sold during the first quarter of 2025 was $148 million, or 60.4% of net sales, compared to $146 million, or 60.8% of net sales, in the prior year period. Gross profit increased $3 million, or 3.4%, compared to the prior year period. The year-over-year increase in gross profit was driven primarily by an $8 million benefit from favorable AUV and a $2 million decrease in manufacturing costs driven primarily by improved productivity, partially offset by higher input costs. These increases were partially offset by a $7 million negative impact from lower sales volumes. SG&A expenses during the first quarter of 2025 were $39 million, or 16.1% of net sales, compared to $42 million, or 17.6% of net sales, in the prior year period. The year-over-year decrease in SG&A expenses was primarily driven by a $4 million increase in company-owned officer life insurance gains related to deferred compensation plans, partially offset by an increase in selling expenses. Equity earnings from our WAVE joint venture were $26.8 million in the first quarter of 2025, compared to $27.4 million in the prior year period. The decrease in WAVE earnings was primarily driven by the negative impact of lower sales volumes, partially offset by the benefits of favorable AUV. Architectural Specialties (dollar amounts in millions) 2025 2024 Change is Favorable Three Months Ended March 31, Total segment net sales $ 137.6 $ 86.7 58.7 % Operating income $ 14.8 $ 7.7 92.2 % Net sales increased $51 million in the first quarter of 2025, driven primarily by a $41 million increase from the acquisitions of Zahner and 3form, in addition to increased organic custom project net sales. Costs of goods sold during the first quarter of 2025 was $84 million, or 61.3% of net sales, compared to $56 million, or 64.5% of net sales, in the prior year period. Gross profit increased $22 million, or 72.7%, compared to the prior year period due to a $27 million benefit from the higher net sales, partially offset by a $5 million increase in manufacturing costs. The acquisitions of Zahner and 3form contributed a $17 million benefit to gross profit, with the remaining increase driven by improved operating leverage and custom project margins. SG&A expenses in the first quarter of 2025 were $38 million, or 27.9% of net sales, compared to $23 million, or 26.6% of net sales, in the prior year period. The increase in SG&A expenses was primarily driven by a $14 million increase related to the acquisitions of Zahner and 3form. Unallocated Corporate Unallocated Corporate operating loss was $1 million in the first quarter of 2025 and 2024. 27 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 2025 provided $41.0 million, compared to $26.4 million for the first three months of 2024. The favorable change in cash from operating activities was primarily due to higher cash earnings, partially offset by unfavorable timing related working capital changes in inventories, accounts payable and accrued expenses. Net cash provided by investing activities was $6.0 million in the first three months of 2025, compared to $5.9 million in the first three months of 2024. The change in cash in the first three months of 2025 compared to the same period in 2024 was primarily due to the prior-year first quarter investment in Overcast that did not recur in the current-year period, mostly offset by increased purchases of property, plant and equipment. Net cash used for financing activities was $43.6 million in the first three months of 2025, compared to $33.1 million in the first three months of 2024. The unfavorable change in cash was primarily due to an increase in repurchases of outstanding common stock. 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. As of March 31, 2025, the revolving credit facility and Term Loan A were 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, 2025, the total principal balances outstanding under our senior credit facility were $421.9 million under Term Loan A and $100.0 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, 2025, 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. We use interest rate swaps to minimize the fluctuations in earnings caused by interest rate volatility associated with our senior credit facility. The following table summarizes our interest rate swaps (dollar amounts in millions): Coverage Period Notional Amount Risk Coverage Trade Date November 2023 to December 2025 $ 50.0 USD-SOFR October 23, 2023 March 2025 to March 2026 $ 50.0 USD-SOFR March 27, 2025 March 2024 to June 2026 $ 50.0 USD-SOFR March 25, 2024 March 2025 to September 2026 $ 25.0 USD-SOFR March 27, 2025 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 June 2024 to June 2028 $ 50.0 USD-SOFR June 26, 2024 Under the terms of our interest rate swaps, we pay a fixed rate monthly and receive a floating rate based on the SOFR. These swaps are designated as cash flow hedges against changes in SOFR for a portion of our variable rate debt. 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, 2025 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 28 Management’s Discussion and Analysis of Financial Condition and Results of Operations As of March 31, 2025, we had $82.8 million of cash and cash equivalents, $68.5 million in the U.S. and $14.3 million in foreign jurisdictions, primarily Canada. As of March 31, 2025, we also had $400 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, 2024. 29 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, 2024.