Q3 2022 Armstrong World Industries Inc Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the Q3 2020 to Armstrong World Industries, Inc. Earnings call. At this time, all participants are in listen mode.
After the Speakers' presentation there'll be a question and answer session to ask a question during the special need to press Star one on your telephone I would now like to turn the call over to your host Theresa Womble, Vice President Investor Relations you may begin.
Thank you, Kevin and welcome to everyone on the call. This morning.
Today, we'll hear from Vic Grizzle, our CEO and Chris <unk>, our CFO , who will discuss Armstrong World Industries third quarter 2022 results and rest of your outlook.
Long with progress on our growth initiatives, our discussion of operating and financial performance will include non-GAAP financial measures within the meaning of SEC Reg G. A.
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 also issued this morning, both are available on our 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 25th 2022.
These statements involve risks and uncertainties that may differ materially from those expected or implied we provide a detailed discussion of these risks and uncertainties and our SEC filings, including the 10-Q filed earlier. This morning, we undertake no obligation to update any forward looking statement beyond what is required.
By applicable Securities law.
For those of you know are following along please turn to slide four on our presentation as we turn the call over to Beth.
The Risa and good morning, everyone. Today, we reported solid topline growth of 11% for the third quarter versus the prior year.
Mineral fiber net sales, increasing 9% and architectural specialty net sales up 18%.
Adjusted EBITDA increased 5% year over year, and our consolidated EBITDA margin performance improved sequentially.
As we noted in our press release. This morning, we achieved this growth while facing continued headwinds on input costs and softening market conditions.
Softening was primarily felt and discretionary renovation work that limited our mineral fiber unit sales growth to just 1%.
This pause in discretionary work developed throughout the quarter.
And was experienced mostly in our independent distribution sales channel.
We saw impacts on both mineral fiber and grid sales and.
In contrast, we had good performance in our retail in Latin America channels, which resulted in an unfavorable mix that pressured <unk> performance in the mineral fiber segment.
Supply chain issues improved in the quarter, but labor constraints continued constraining construction capacity and perpetuating elongated project timelines.
And as expected new construction activity remained a headwind in the quarter.
However, as the quarter progressed, we experienced the impact of greater economic.
Uncertainty at higher interest rates on commercial construction activity.
This unexpected slowdown appeared to track the decline in overall economic sentiment.
Such as weaker GDP estimates a deceleration in commercial construction indicators and.
And expected further moderated inflation.
This backdrop presented opportunities for projects to pause and many did.
Despite softer than expected market conditions, However, I'm very pleased with how our teams are executing and how our plants are operating their efforts are responsible for driving strong productivity as we continue on our lean manufacturing journey.
Our teams are also.
Maintaining a best in class customer service level and our sales teams have worked diligently to execute well on our pricing initiatives.
In the architectural specialty segment.
Excuse me.
We continue to generate strong topline growth and bottom line performance in the quarter.
Our team delivered a third consecutive quarter of record setting sales and generated $16 million of EBITDA was the highest earnings quarter on record for the segment and a 20% increase from last year's result.
Importantly, EBITDA margins expanded above 17% continuing its sequential margin improvement on our way back to 20%.
Although sales strength was broad based across all material groups and verticals within architectural specialties. We are particularly pleased with the growth achieved by our most recent acquisitions turf our tour and moes each generated double digit sales growth in the quarter.
Turf, specifically delivered year over year sales growth of more than 40% in quarter, while expanding their margins.
These are outstanding results and further demonstrate the synergies possible for these smaller but highly capable companies on the Armstrong platform.
New order intake in the quarter remained strong ourselves and supportive of our double digit growth expectation for the full year and continued strength in 2023.
We've seen robust quoting activity and education and transportation.
With solid wins in both of these verticals.
The activity on transportation projects includes a mix of new construction and major renovation projects.
Our recent investments in new product development and metal Wood and tectum has also strengthened our ability to get specified into more projects into more spaces.
And ultimately drive additional growth.
The breadth of our portfolio with our expanded design capabilities and now our size and scale.
We're clearly establishing our leadership in this most important growth segment.
With that I'll pause and hand, it over to Chris for some more details on our financial results, Chris Thanks, Vic and good morning to everyone on the call I'm very excited to be in my new role as CFO and I'm grateful to have this opportunity to lead such a talented team having spent the past four and a half years here at Armstrong I continue to be impressed with this organization and I'm excited about the future of this.
<unk>.
As I review, our third quarter 2022 results as well as our updated 2022 guidance. Please keep in mind that I'll be referring to the slides available on our website and slide three that details our basis of presentation.
On slide five we begin with our consolidated third quarter results as Vic mentioned net sales of $325 million were up 11% versus the prior year driven by sales growth in both segments.
Adjusted EBITDA increased 5% and adjusted EBITDA margin contracted 180 basis points.
Adjusted diluted earnings per share increased to $1.36 or 16% driven by higher adjusted earnings a decrease in the effective tax rate and a reduced share count from the prior year I'm.
I'm happy to report that in the third quarter, we repurchased $60 million of shares. This represents a continued step up of the increased buybacks. We made in the second quarter and brings our year to date share repurchase total to $145 million.
Last week, we also announced a 10% increase in our quarterly dividend, which marks our fourth annual increase in our quarterly dividend since we instituted the dividend in 2018.
This recent increase in share repurchase and dividend activity reflects our commitment to our capital allocation priorities, which remain unchanged first reinvesting into the business.
Strategic acquisitions and partnerships and third returning cash to shareholders via a stable dividend and a flexible repurchase program.
Since the inception of the share program in 2016, we have repurchased 12 1 million shares for a total of about $831 million.
As of the end of Q3 2022, we have $369 million remaining under our repurchase program, which runs through December 2023 when.
When including our dividend payments, we have returned to just shy of $1 billion to shareholders through both repurchases and dividends since 2016.
Slide five also shows our third quarter adjusted EBITDA bridge versus the prior year.
The 5% increase in adjusted EBITDA was driven primarily by favorable <unk> performance and an increase in sales volumes, which was partially offset by increased levels of inflation.
Favorable <unk> was driven primarily by positive like for like pricing and partially offset by negative mineral fibre channel mix.
Both mineral fiber volume and sales growth contributed in the quarter with mineral fiber volume growth driven by year over year increases in our retail and Latin America channels, which partially offset decelerating market conditions.
EBITDA margin was compressed by continued inflation on raw material energy and freight costs.
<unk> equity earnings remained under pressure by lower volumes during the quarter due to inventory destocking in grid and softer market conditions.
On slide six we summarize our mineral fiber segment results.
Third quarter net sales increased 9% year over year, driven by favorable <unk> of 8% and 1% of volume growth.
First on AAV, we experienced double digit like for like pricing in the quarter versus prior year on the heels of our July one price increase this was offset by negative channel mix.
And while we were pleased that mineral fiber volumes were positive in the quarter. We were disappointed by the deceleration of demand in certain key markets, which contributed to the negative channel mix.
On a positive note we saw sequential improvement in our price over inflation dollar realization and important step to expanding mineral fiber margins.
We talked last quarter about a temporary squeeze on mineral fiber margins.
As the rate and pace of inflation hindered our ability to maintain our gross margins, we expect to get back to our historical realization rate in the coming quarters as the rate and pace of inflation moderates compared to what we experienced this year.
These factors also impacted our mineral fiber EBITDA results, which increased by $3 million or 3% year over year.
While <unk> was a strong contributor of $16 million to EBITDA results, it was lower than our expectations and sequentially lower than Q2 results due to the negative channel mix, we experienced inflation.
<unk> remained a headwind for us the two biggest drivers of that input cost inflation for raw materials and natural gas within our energy spend.
We are hopeful that inflation overall will continue to moderate in the coming months, but natural gas prices, specifically have been volatile and such volatility could continue into the winter.
And last wave equity earnings were negative in the quarter compared to the prior year driven by weaker volumes. The team at wave continued to price ahead of inflation during the quarter.
While steel costs have leveled off over the past several months, we expect these lower steel price levels to flow through our results starting in Q4.
On slide seven we discuss our architectural specialties or <unk> segment results.
<unk> continued to execute and deliver sales growth posting a year over year increase of 18% for the quarter for the third quarter.
Similar to the first six months of 2022 sales growth was driven by improved performance from recent acquisitions compared to the prior year period, and an increase in custom project sales.
Adjusted EBITDA increased 20% and adjusted EBITDA margins expanded 30 basis points versus prior year.
Driving the increase in adjusted EBITDA is the fall through from the increased sales levels.
Manufacturing costs were higher compared to the prior year commensurate with higher sales levels SG&A expenses were slightly higher than the prior year due to continued investments in support of increased sales growth we.
We expect a S EBITDA margins to continue to expand in Q4 versus prior year.
Slide eight shows year to date adjusted free cash flow performance versus the prior year.
The 10% decline in adjusted free cash flow resulted primarily from negative working capital changes in accounts payable and accrued expenses and inventory <unk>.
Primarily due to timing in addition to an increase in income tax payments. These.
These items were partially offset by higher cash earnings.
Okay.
Slide nine.
Shows our year to date consolidated metrics, we delivered strong top line growth of 13% versus the prior year.
While adjusted EBITDA remained pressured.
The majority of the contraction in EBITDA margin resulted from higher costs and negative wave equity earnings versus the prior year.
Adjusted diluted earnings per share increased 11% and as previously mentioned adjusted free cash flow declined by 10%.
Looking at the year to date EBITDA bridge favorable AAV and positive volumes were partially offset by higher inflation increased SG&A expenses and lower wave equity earnings.
As we move to slide 10, you'll see our updated full year guidance for 2022 wire will highlight a few revisions.
We now expect mineral fiber <unk> of between 11, and 12% a downward revision from our previous range driven by our third quarter channel mix headwind.
And mineral fiber volume to be about negative 2% versus the prior year to reflect weaker market conditions.
Our sales guidance is increasing to greater than 15% as the business continues to execute and perform at a high level.
The a S segment will face a more difficult comparison in the fourth quarter as we were beginning to lap improved performance for this segment in the prior year period.
Moving to adjusted EBITDA and EPS, we've lowered our guidance range is primarily due to the softer market conditions, which we expect to continue for the remainder of 2022.
Adjusted free cash flow guidance revisions are driven mostly by working capital headwinds, which we expect to improve in the fourth quarter.
We expect free cash flow as a percentage of sales to be in the 17% to 18% range for the full year 2022.
Finally, we are maintaining focus on our strategic initiatives and our long term growth strategy as we look forward, while diligently controlling our costs and making adjustments as needed given the evolving evolving market landscape.
With that I'll turn it back over to Vic to wrap up before we take your questions. Thank.
Thank you, Chris and before I move to the Q&A session I'd like to provide a few additional thoughts on our digital and healthy spaces initiatives.
Momentum for the canopy by Armstrong are online and then platform continues to build spent two years now since we launched the platform and the breadth of capability added in just a short amount of time is simply impressive. The results are demonstrating this platform's ability to attract new repair and replace customers.
Year to date sales through canopy have increased nearly 400% from prior year.
The number of orders on the site has increased at a similar rate and were up 44% sequentially from the second quarter.
And we're also pleased to see new users continue to grow.
With more double than the number of users from 2021.
Project works are automated design service continued to make progress as well, but project works. We're further building customer loyalty and trust by offering this unique capability to streamline the entire design to pre construction process.
All in on average and 48 hours or.
We're providing this service to more and more architects and contractors and achieving higher win rates as a result of this.
What's exciting to see from these digital initiatives is how they are further differentiating us in the ceilings category.
Enabling the next level of innovation and are creating higher levels of customer loyalty and most importantly, these initiatives are adding incremental sales for both our mineral fiber and architectural specialties segments.
Turning to healthy spaces, we continue to get confirmation of the need and desire for healthy indoor spaces.
As broadly defined as healthier air comfort and sustainability.
High performing healthy buildings off offer occupants high indoor environmental quality, while reducing energy usage and carbon footprints. We believe our sealing solutions have an important role to play in helping owners and occupants achieve healthier spaces.
We're tackling this opportunity through around innovative products like Healthsouth era shore and total acoustics and we are.
Aging and partnerships to enhance our product development efforts and extend our reach into this new space.
On this front I'm excited to announce a new partnership with a leading air quality sensors company called aware.
Where is the developer of the innovative indoor environmental quality sensors that empower users to monitor and mitigate risks to indoor environmental quality.
Their sensors can measure seven key indoor environmental quality parameters, such as particulates, and dlcs acoustics and light and others.
We've been using aware sensors, and dashboards and our living lab at our corporate headquarters for some time now.
And are excited about the value of this data provides and solving for healthier spaces.
Now in the process of conducting pilot programs with a variety of school districts were aware sensors will help schools identify and then improve indoor environments and overall enhance the learning experience for their students. We believe this tool is critical to the customer education process and ultimately should help spur demand for our healthy.
<unk> solutions.
This partnership adds to those we've announced earlier in 2022, such as our expanded relationship with price industries and our partnership with nine foundations I look forward to updating you on our progress with all of these efforts in the coming quarters.
Now before getting to your questions.
I'd like to take a step back and just share how we think about our business in light of the macroeconomic conditions, we are about to face.
Our business is steady and resilient.
This comes from a variety of factors, including the portfolio effect of both the diverse set of vertical markets, we serve and the types of projects that make up the demand profile for our products.
Our vertical span from education to office to health care retail and transportation and very rarely are all of these verticals moving in the same direction at the same time.
Add to that the various project types from new construction to large renovation to smaller repair jobs all on different time schedules.
The dynamics of this diverse set of factors dampens, the peaks and troughs throughout the cycle, providing for a steady stable business.
Longer term our targets remain unchanged, we are an attractive set of growth initiatives, including our digital and healthy spaces initiatives that are driving incremental growth for both mineral fiber and architectural specialties. We.
We see opportunities for continued growth in the mineral fiber AAV rates above our historical rate of 5% supported by our innovation and our new specification work.
And we expect market tailwind for delayed renovation activity due to the pandemic and now recessionary pressures that should propel neuro fiber volumes back to 2019 levels.
Aside from the timing of the market tailwind, we believe our long term value creation targets are achievable as we always do we will continue to assess and evaluate our macroeconomic conditions and make adjustments.
But all in all I remain excited about the long term growth potential for Armstrong.
And with that I will turn the call over to the operator and open it up for questions.
Ladies and gentlemen, if you have a question or a comment at this time. Please press star one on your Touchtone telephone, we will pause for a moment, while we compile the Q&A roster.
Our first question comes from Joe <unk> with Deutsche Bank. Your line is open.
Yes, good morning, everybody. Thanks for taking my question.
Good morning, Joe.
Yeah, so within our mineral fiber wondering if we could just put a finer point on the AAV you talked about double digit like for like price is there a way we can get a little closer on what that number is and maybe what the negative customer and channel mix was and then just secondarily did you see any noteworthy product mix within that is.
Well.
Yes, let me hit the product mix I'll go back to the EV or product mix was.
Unaffected by the overall mix pretty much as we would've expected it's typically positive.
But it was flattish to positive in the quarter. So no contribution to the overall mix from product mix.
Architects and contractors continue to request and want the latest and greatest product set that come at higher price points. So.
But on the AUC question overall, we did continue to get double digit like for like pricing in the quarter.
We got good realization from our July one.
Increase.
The the mix.
Really came from channel mix as we as we talked about our retail in Latin America channels that.
At.
Considerably lower price points.
Offsetting good double digit like for like pricing.
I would size that that channel mix for you in that middle.
Middle single digit.
The area that.
To help with understanding the price realization on the July price increase so again, we got we're happy and pleased with our our price realization.
Overall, just offset with some unexpected channel mix.
Okay, great that's encouraging.
Based on those recent price increases.
The healthy <unk> guide for <unk>.
As well as your expectation for moderating inflation from here.
Do you have an estimate maybe on EBITDA, how much price cost favorability you could be carrying into the first half of next year.
Do you want to comment on that Chris or you want me to take it you won't take it okay. So.
From here. So if you see sequentially from second quarter to third quarter were catching up to the inflation curve with our pricing.
I expect that to continue into the fourth quarter. So we should get some margin expansion continue the fourth quarter and then of course, it's really tough sitting here today to call the inflation curve for next year, but as you know we.
We tend to hold onto our pricing at all parts of the cycle and I would expect us to perform in that that way next year. So.
The answer to your question really becomes a function then of what your expectations are and inflation I think sitting here today, we expect it to start to rollover and be more favorable in the fourth quarter.
How much that grows into next year I think we have to wait until February and we'll do a better job I think in outlook in sizing it for you.
Okay understood. Thanks, a lot.
Yeah, you bet or number for next question.
Our next question comes from Keith Hughes with <unk>. Your line is open.
Thank you.
I wanted to get some more detail on your commentary of deceleration in the quarter. It's obviously going to show up in your fourth quarter volume Guide can you can you talk a little more of these projects just being delayed or you're seeing outright cancellations and if theres any sub segment that really stands out where this is the most pervasive.
Yes, it's a good question, because we really try to pay attention to what's being delayed versus canceled.
So it's a good question. Thank you for that Keith we don't see cancellations, we have not that we continue to track that actually from the pandemic on we've been tracking how much of this is cancellations versus delayed.
Coming off of May and June we had mid to upper single digit volume growth and the growth trajectory that we were on in May and June is what we were expecting.
In the third quarter.
And obviously that moderated throughout the quarter.
And where it showed up as in these discretionary projects once that people could hold or they could wait or they could delay very easily.
Those are the ones that we saw really take a pause.
And the major renovation projects the new construction projects, even some of those midsized work that was already begun or started that was not the issue. We those were continuing those are continuing on completion cycles as as they were expecting too.
Where we saw is in this flow part of our business, we saw that softened dramatically throughout the quarter and again I pin it on two things Keith one is.
There is clearly a level of uncertainty out there people who could wait are waiting.
Because of that uncertainty and number two I think the market is starting to recognize that.
Inflation is turning over so everybody that got quotes and sticker shock on the cost of their renovation projects.
Could see now that this could buy waiting three to six months or maybe another year.
They could wait this out and get a better price for their renovation projects. So it felt like those people who could wait.
Jos to wait and we really felt that in the third quarter.
And.
Along those lines for your next quarter or two of production do you feel I know, there's not a lot of mineral fiber inventory in the channel are you, but do you feel like youll have to slow production down below demand to prevent preventable.
Only on the edges here I think.
The type of adjustments, we're talking about from the third quarter to the fourth quarter.
Are really around the fringes of our production cycle. We can manage this on a day to day basis. So I don't see any major corrections on the manufacturing floor at this point okay. Thank you.
You bet.
<unk>.
Our next question comes from Kathryn Thompson with Thompson Research Group. Your line is open.
Hey, Good morning. This is actually Brian Biros on for Catherine. Thank you for taking my questions today.
First of all and I guess building on the.
Question from.
Previously I guess when did you really see that pace change and growth.
And I guess, what are you seeing going forward into Q4 and early 2023. It seems like maybe July timeframe was.
When you started to see the deceleration really start based on your earlier comments I guess just since then has it accelerated or are they kind of just all come at once and is it kind of steadied out basis, how has that trended since July .
Yeah.
Yes, it really decelerated throughout the quarter, we had a really strong first half of July .
Which by the way it was coming off of a July one price increase so there was some pretty good strength in.
In the first part of July and the face of that price increase that was encouraging.
Really put it on towards the end of July and then a little more in August and then a little more in September at kind of again, it followed a bit of the sentiment curve that we were all kind of experiencing with the reductions in.
Economic activity outlook.
And a deceleration of some of these indicators that we've all been watching although they stay positive they were decelerating.
So I hope that answer your question, but I would say really toward the end of July and then.
We saw our first signal, but then in August and September where we got the validation of that.
Does that answer the question. Thank you.
And follow up with how is the the retail channel reacting to the deceleration you've been talking about and the independent distribution channel is it kind of isolated over in the independent one and probably won't bleed into the retail side or is it maybe a leading indicator of how things.
Things happen in first here, but then it'll bleed into the rest of the channels going forward. What are you hearing from the retail side.
They kind of move to take it kind of moved together typically what makes it choppy on the retail side as as you've heard before is some of these load ends.
And inventory drawdowns that we get a little bit more lumpiness in the retail channel, but the retail channel for the most part is serving the small contractor.
As you know so really the the lighter contractor work.
So they kind of moved together and I wouldnt try to separate that theyre seeing one market versus another market, but it can be more lumpy.
Quarter to quarter.
Alright, thank you.
Uh-huh hormone.
One moment for our next question.
Our next question comes from Garik <unk> with loop capital Your line is open.
Oh, hi, Thanks for taking my question I'm, just wondering if you could speak a little bit more broadly just from prior periods of economic deceleration I think you've mentioned that your volumes remain relatively stable. So I'm just kind of curious.
We're not talking about 2023 formally.
In this new period.
Or would you anticipate your volumes in mineral fiber generally to behave would you expect it to be.
Relatively stable or.
The recent deceleration.
I'll give you some pause to that outlook.
Okay.
No I think with the deceleration you still saw mineral fiber volume growth positive in the quarter.
And if you go back 10 years.
95% of the data points fall within a plus or minus 2%.
Range, So I think.
But there is.
As I was saying in my prepared remarks, I mean, you get the peaks and troughs cutoff.
The portfolio effect that the diversity of types of projects that we're on as well as the verticals in which we're in.
That shouldnt change.
It did change of course was during the pandemic when everything was across the board was shut down and then of course, there was nothing there was no portfolio effect there.
And then a garden variety recession, you would expect some of the verticals to be.
Still positive and some of them to be more negative in that portfolio effect I think plays out I would expect no change there in terms of the portfolio effect of the diversity of our end markets and types of projects we're in.
Got it thanks for that I'm, just wanted to ask on the architectural specialties, if you've noticed any change.
The environment there.
Well that market as you know is.
Yes.
BB being specialty in incentives, but very much a project based business. So.
I think the difference in that business frankly is not so much on the market side, but I think where we're Armstrong is playing we're playing in so many different spaces within the same commercial buildings for.
Playing in more of the commercial buildings and we're winning more work I think those are the real drivers behind the architectural specialty business, our again, our breadth of our portfolio and the capability that we have there is just pulling us into more areas.
So again.
Project nature of that business will give us a little bit more visibility.
And what's going on that business than some of the flow parts of the mineral fiber business that we have.
Contrast that with.
Understood. Thank you.
Hmm.
One of them are for next question.
Okay.
Our next question comes from Philip <unk> with Jefferies. Your line is open.
Hey, good morning, guys.
You've called out double digit.
Good morning, everyone, you called out double digit bidding activity for some time now and I think sometimes it's last year, but demand has certainly been a little choppy this year with a weaker macro backdrop, how much line of sight at this point do you have in 2023.
Comfortable that with that backlog that volumes could be up next year mineral fibers or how should we think about it at this point.
Yes, the <unk>.
Getting activity that youre, referring to.
<unk> is really its a first time bidding activity. So it's a really good future indicator maybe.
18 to 24 months out of projects that could be on the horizon. One of the things that we we talked about fill with that data is that that data was not translating into real projects on the ground right. We werent seeing it in the Dodge start data, we werent seeing it on the ground in terms of.
Of new new projects.
Which really spoke to the constraints that were in the marketplace around supply chain and labor issues that were just not allowing I think either that or the high inflation that people were saying just wasn't allowing that business to land.
So I still think that that business is out there those are strong I think market signals around the demand for our commercial construction activity that's out there.
But how it lands into 2023 of 2024, I think is still too.
It's too.
Uncertain to call.
But I'm encouraged by that signal out there and we'll have to see again, how the supply chain the labor constraints ease.
And I think thats rolling over inflation is a very important dynamic to how much of that gets realized into real work in 2023, I think we'll have a better outlook and better feel for that.
When we get to February .
Gotcha and with growth coming through a little slower than expected how much of a lever is throttling back investments, which you've been investing the last few years.
<unk>.
To comment on when you kind of expect that to kind of come through certainly your <unk> implied guidance is encouraging I mean demand down in mineral fiber still expecting margins to be up so part of that I assume is price cost, but help us think through maybe next year. If demand is weaker again your ability to kind of drive margin expansion and from throttling back investment in.
Price cost.
Yes.
I would say.
Throttling back.
Our expenses.
Expenses, we may not throttle back our and on our investments we made throttle back our costs in other areas. So broadly speaking I think we do a really good job of <unk>.
Finding places to control our costs. So that we can be right sized for the market environment that we're in so we can expand margins and really let that price over inflation flow through.
In the business.
So.
Again, we're going to be very prudent managers of our expenses and make sure that we're setting this business up to expand margins going forward.
As we have really throughout parts of the cycle, yes. Thanks Bill.
One moment for our next question.
Our next question comes from Susan Mcclary with Goldman Sachs. Your line is open.
Thank you good morning, everyone.
I suppose I Susan.
So my first question is you know as we do think about the setup into 'twenty three and the potential that some of this inflation does roll over and perhaps some of your underlying customers are waiting for that to come through youre thinking about price versus volume in mineral fiber understanding that there is no precedent necessarily to take that pricing down but given the magnet.
And the number of increases that we've seen in the last two years.
Do you think about the tradeoff between those two.
Well I think I think about it this way that and our teams have done a terrific job in managing the spread.
At the gross margin level right. So.
As you know we have a history of holding our price even in deflationary periods.
And of course, we need to get more price in those inflationary periods.
But we manage the business for the spread at the gross margin level.
So that we can fund these investments can perpetuate.
Our business model, that's how we think about it and I think we will continue to manage that next year based on the macroeconomic environment we.
We face so that we're managing the price cost equation to expand margins at the gross margin level.
Okay.
Then.
As we think about capital allocation can you give just an update on the M&A pipeline anything that youre seeing there any changes and then how are you thinking overall just about capital allocation your interest in buybacks versus perhaps some of the other opportunities.
Yes, I think.
And Chris I'll, let you comment on this is just like but just.
In terms of the business development effort.
Again, we have a fully staffed team and we're.
They are hard charging it every day.
I'll review this periodically the team so I'm very engaged in what they're working on I am very encouraged by what they're working on I still.
I'm hopeful that.
Even some of the smaller deals we're working on we can get done here in the near future.
So we're active here Susan I think this.
This is a timing thing that we don't control frankly. These these companies are not on the market for sale in a bidding process on a timeline. We we really are working the relationships and the partnerships are precursors.
To buying these companies, but we continue to be active here, our pipeline continues to be robust and healthy here.
I think it's fair to expect more from us in this area.
Okay. Thank you and good luck.
Thank you Susan one.
One moment for our next question.
Okay.
Our next question comes from roughly <unk> with Bank of America. Your line is open.
Hi, Good morning, it's Rafe thanks for taking my question.
Vic I just wanted to follow up on a comment.
The comment you just made on pricing.
<unk> historically.
Pretty consistently increased pricing on mineral fiber and your comments there were sort of talking about raising price each year.
To maintain a certain gross margin level.
Make sure I understand is there a change in terms of the way youre thinking about pricing going forward relative.
Relative to cost or do you expect to kind of maintain the same cadence of price increases going forward.
Yes, no change to be really clear there is no change in how we're thinking about that.
And how we expect to manage it.
Okay I appreciate the clarification and then.
Whats the outlook for inflation.
For this year, maybe like relative to maybe where it was a quarter ago and then you commented that the natural gas materials has been the biggest headwind too.
To your input cost.
You can obviously see that in like natural gas prices have come down quite a bit.
In the last 90 days, so when would we start to see some of this.
Some of the relief on input costs start to flow through your P&L.
Hey, Ralph this is Chris Thanks for the question, yes for the for the year I mean for mineral fiber, we're out looking high single digit inflation rate and I mean, you really identified it well.
The wildcard in kind of the variability is around natural gas pricing. So we expect overall inflation to slightly moderate a bit as we finish out the year, but the volatility really remains with what happens with natural gas you kind of saw how it spiked up in in the latter part of the third quarter.
If the prices as they've come down continue to tick down I think we have some potential upside there, but that became that theres really the wildcard and one that we continue to monitor pretty closely.
Natural gas prices kind of stay.
When would you expect that to start to be a benefit to your peer margins.
Yes, I think that that'll be part of something that wed look at as we head into 2023 and again, there's a lot of variability in that natural gas market. So.
I would say is as we as we finish out the year and head into 'twenty, three that will give us a better insight into <unk>.
Overall inflation profile.
Okay, great. Thanks.
One moment for our next question.
Our next question comes from John Lovallo with UBS. Your line is open.
Hey, guys. Thank you for taking my questions.
The first one is it seems like the <unk> guide, maybe implying an improvement in channel mix.
Are you seeing that already or if not sort of gives you the confidence that that's going to happen.
Yes, I think in the month of October we can say, we're saying what we're out looking it's consistent with what we're out looking in the month of October .
So, yes, I think again as you know.
You've heard us John before on some of these load ins or.
Lumpiness in some of the orders.
It rarely happens two quarters in a row as you know so I.
I think what we experienced in third quarter is a bit of an AR.
An unusual situation.
And.
And what we're seeing in October is reinforcing that.
Got you Okay. And then you meant you called out education as being one of them one of the strong parts of the business in the quarter.
My mind that that is.
A natural candidate for healthy spaces. So I'm, just curious if youre seeing any.
Improved penetration or.
Desire for healthy spaces in that education segment.
Yeah overall, our activity in the in the summer and.
In the third quarter.
Well it was a strong area for us in terms of activity.
We closed a lot of business in that area were tracking.
I mean.
<unk> the number of projects, we're tracking and healthy spaces.
So yes.
Yes, I think you're right I think this is an area that's rich theres all kinds of things going around now.
Beyond Covid.
At our healthy space solutions can really help the classrooms with and we're excited about that Theres a lot more engagement, obviously theres still a lot of money to be spent here less than 20% of the extra funds had been spent so far so theres plenty of money out there.
The education to support the upgrades that.
Around healthy spaces in particular.
Thanks Vic.
Yes.
Before I answer your question.
Our next question comes from Dan Oppenheim with Credit Suisse. Your line is open.
Great. Thanks, very much I was wondering if you can talk just.
A little bit on the specialty side.
Talked about winning more buildings and we're seeing the margins growing so clearly speaks to the offering that you have there.
Wondering you talked about the margins in terms of.
Further expansion in the fourth quarter, how do you think about the potential in terms of what can happen then in 'twenty three on that.
Yes, I think the.
I mean, our teams are doing a terrific job in selling the the new design.
<unk> capability that we have the depth of our capability and the breadth of the portfolio.
To take care of more spaces within these buildings for for architects and.
It's really exciting and so we're getting some good leverage right with that increased activity on our plants, but within our plants. Our teams are doing a good job in controlling costs and driving productivity doing the things that we need to do to get good operating leverage at the plant level. Both of those are real drivers I think for us to continue to expand the margins.
And as I said, we're well on our way to getting back to that 20% EBITDA level that that we've established is where we want to run this business.
I'm not trying to optimize margins too quickly.
At the expense of growth. This is a real strong growth engine for us, but at that 20% EBITDA level for the quality of those the quality of that growth. So.
Well on our way to getting back to that 20% level.
Great. Thanks, and that should continue into 'twenty three I guess that was that was your question right that should continue into 2023.
Great. Thanks.
One of them are for next question.
Our next question comes from Stephen King with sorry, Stephen Kim with Evercore ISI.
Thanks, very much guys.
Yes, I think you guys mentioned that across your segments retail Latam education, and transportation were pretty strong.
Just curious how those specific segments trended throughout the quarter and entering <unk>.
Does it maintain its turning that they maintain their strength, but did you see the weakness broadened across categories or segments.
As the quarter progressed.
While we naturally see a falloff in education toward the end of the quarter. So it would be really hard to tease out how much that was just the seasonality of kids getting back into classrooms in September .
But I would say the biggest.
Maybe the standout was around.
Office and health care, where we saw some of the softness in the renovation work.
So.
Again.
From the beginning of the quarter to the end of the quarter I would say those probably stood out the most.
Okay got you that makes sense and then secondly, I think you talked about.
A little bit about inventory levels I think you talked about in grid. For example, there was some inventory destocking.
Anything else that sort of call out there.
And whether or not.
There was a.
You have.
Any concerns I think you had talked about in <unk> that your inventory levels in Utah, we're pretty new.
Distribution were pretty normal and so.
Was curious as to whether or not there's been any change in that.
No I think inventory levels.
From what we're hearing from our distribution partners are at comfortable levels again, I think in the third quarter going into the third quarter, everybody felt pretty good about their inventory levels.
Based on an outlook of stronger volume growth and I think when the signal from the market was hey, theres less volume growth here.
In effect and the grid part of the business in particular ended up Destocking more.
On a on a weaker market condition than they were expecting.
So again remember all last year in 2021.
They were either there was nine price increases because of the steel inflation. They were accumulating a lot more volume on the grid side than they were tile side.
So.
But again comfortable with that.
Given the growth outlook in the third quarter, Unfortunately that moderated throughout the quarter end.
And.
In effect, we felt that more on the grid business because in effect it became a bit of destocking.
Yes that makes sense, okay. Thanks, a lot.
Yes. Thank you.
One of them are for next question.
Our next question comes from Adam Baumgarten, with Zelman and Associates. Your line is open.
Hey, good morning, everyone.
Maybe just sticking with mineral fiber volumes in October are they consistent with the implied mid to high single digit decline for <unk> as a whole are you expecting November and December to decelerate further in that guidance.
Yes, I think the big the.
The Big thing here is what we saw last year were Anniversarying remember, we moved our price increase this year from February to January .
That brought more <unk> volume into the month of December than we typically have so.
Youre going to see us anniversarying that event in December so I would expect more of that delta year over year to be in December .
Okay got it.
And then just I think you mentioned that new construction was still a headwind in the quarter do you expect that to flip to a tailwind at some point in 2023.
Well the the actual starts this year are forecasted to be positive.
So.
There are way off their forecasting originally they were at the mid single digit levels.
Forecasted from the dust starts a.
We don't believe that that's actually what's happened is much less than that.
Although still positive.
So we'll have to see I think macro conditions may drive the actual start.
And continuation of that activity and next year again sitting here today, it would be really hard.
To say, that's going to be much of a tailwind.
If at all next year.
Okay got it and then just maybe one more quick one.
In the presentation, you called out on the mineral fiber margin bridge inventory valuation as a headwind can you just give some more detail around that.
Yeah, Hey, Adam This is Chris yes inventory valuation think about it more in terms of call it inflation running through.
Inventory levels in Flushing through on the P&L due to valves.
Okay got it. Thank you so really really more yes inflation timing related.
One moment for our next question.
Our next question comes from Kenneth <unk> with Keybanc capital markets. Your line is open.
Good morning, Vic Chris.
Okay, Hi, Ken Hi, good morning.
So obviously your business a lot steadier than the.
Kind of concerns we're seeing in the broader economy, but with different themes post COVID-19 or since Covid is the regional dynamic obviously, you're big in the northeast based out in San Francisco, where the Salesforce tower.
Big clients at a point in time and largely empty.
So could you maybe take a step back I understand the healthcare and the education all of these trends, but are we seeing something pretty different in terms of the occupancy rates by region.
As opposed to the very strong growth, we've seen in places like Texas, and Florida versus traditional markets and I know a lot of them.
His replacement.
In your portfolio, but can you talk about anything that you might.
Be thinking about a little bigger picture staff in terms of what we've seen geographically in our country. Thank you.
Yeah I think.
The.
Back to the office.
Rate and pace.
Overall nationally has has stalled out as we all know watch very carefully but to your point it is uneven.
Bye Bye territory, certainly out where you are Canada west it's clearly lagged from what we see in New York City or in Boston.
And in Dallas, So theres definitely some some disparity there, but if you get back to these.
<unk>.
Whether these built these buildings will be occupied the question is when and how big is the lag until two.
To when they'll be occupied because that's what drives the ti work that I think youre referencing here in terms of how we think about the demand profile from office in particular.
We've seen it in other areas. It goes faster, but then it drives the Ti work that were.
It's important to the overall demand profile.
We expect this to continue to move forward and to gain traction just like we have in other parts of the country and places like the west where it's it's still lagging.
We're not we're not we're.
We're not giving up on that as a market opportunity just because of some of the lags here. We still believe that those are strong renovation opportunities for us. The question is the lag.
How long will it take for these buildings to be reoccupied, whether by the existing tenants or the next generation tenants that come behind them again, just like we have seen in some of these other cities.
New York for example.
So we're thinking we're thinking this renovation activity is pent up demand not lost demand.
Right no that makes sense.
Yeah.
Footprint of buildings, you are servicing in place already.
Notice about the regional differences.
I guess thanks.
Obviously, we had some mix in the quarter and stuff and you guided for mineral wall in the fourth quarter to be down but from the pricing perspective, which is the larger components.
Sure.
Does it seem as though because we've constantly had these price increases that were basically.
It would just be all else equal from today, it'll really have price increases through.
Decelerating from where we are now into the back half of next year would be a reasonable assumption not making any inflation forecast.
Well I think it's reasonable to expect if I may.
We've had ramp we've had two years right of just unprecedented levels of inflation, so you've had unprecedented levels of pricing.
If inflation moderates next year.
And gets back to a more normal inflationary rate than our pricing initiatives should.
To reflect a more normal.
Inflationary environment, I think Thats, a fair assumption too.
To pair together.
Yes, just trying to normalize.
The strong pricing that we've had.
You very much.
Thank you Kenneth.
Showing any further questions. This time I turn the call back over to Vic Grizzle, President and CEO for any closing remarks.
Yes. Thank you again, thank you all for joining US again disappointing third quarter results for us but.
As I said I'm proud of our team and how we're executing for executing well on those things we can control I believe our ROE over the right initiatives for the long term success of the company and we continue to be very excited about the value creation opportunity. That's in front of us. So again. Thank you for joining us today, and we'll look forward to talking to you at our next call.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.
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