Armstrong World Industries Inc

NYSE:AWI

Earnings Call Transcript 2022-Q2

[Operator]

Good day and thank you for standing by. Welcome to the Armstrong World Industries Second Quarter 2022 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Theresa Womble, Vice President, Investor Relations and Corporate Communications. Please go ahead.

[Theresa Womble, Director of Investor Relations]

Thank you, Carmen and welcome, everyone. On today's call, Vic Grizzle, our CEO; and Brian MacNeal, our CFO, will discuss Armstrong World Industries' second quarter 2022 results and rest-of-year outlook, along with some notable progress on our growth initiatives. Also joining us today for the Q&A session is Chris Calzaretta, who will take over the CFO role effective August 1, as Brian moved into his retirement.

Our discussion of operating and financial performance will include non-GAAP financial measures within the meaning of SEC Reg G. A reconciliation of these measures with the most directly comparable GAAP measure is included in the earnings press release and in the appendix of the presentation issued this morning. Both of these are available on the Investor Relations website at armstrongworldindustries.com. 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, July 26, 2022. These statements involve risks and uncertainties that may differ materially from those expected or implied. We provide a detailed discussion of the risks and uncertainties in our SEC filings, including the 10-Q filed earlier this morning. We undertake no obligation to update any forward-looking statement beyond what is required by applicable securities law.

Now for those of you following along with our presentation, please turn to Slide 4 as we turn the call over to Vic.

[Vic Grizzle, President & Chief Executive Officer]

Thank you, Theresa and good morning, everyone. This morning, we reported overall mixed results with strong sales growth of 15%, while EBITDA grew 2%. Our net sales growth resulted from double-digit year-over-year growth for both our Mineral Fiber and Architectural Specialties segments. And within the Mineral Fiber business, we delivered strong AUV performance of 12% and 1% volume growth.

As we outlooked in our first quarter call, we experienced a continuation of destocking activity into the month of April at key U.S. distribution partners that dampened our overall Mineral Fiber volume growth versus actual market levels. Also as we outlooked, this destocking activity ended in April and sales volumes normalized in May and June, in fact, accelerated through the end of the quarter. The sales activity in the back half of the quarter were more in line with what we see as underlying market conditions.

While we are encouraged by our strong sales growth, our EBITDA performance lagged, specifically within the Mineral Fiber segment. This segment was impacted by an acceleration in inflation in the quarter above, what was expected, particularly in the terms of natural gas. While our overall cost inputs tend to be fairly stable, it is possible to experience a margin squeeze during a short period of time, such as a quarter, when the rate and pace of inflation is extreme. This is what we experienced in the second quarter, with June recording the highest rate of inflation since 1981 and the most rapid monthly increase since 1983.

Now to size this for AWI, between energy and freight, costs doubled from the rate we experienced in the first quarter. This margin squeeze experienced in the first quarter is temporary until our pricing actions launched on July 1 can catch up.

As most of you know, we have a proven track record of staying ahead of inflation with our pricing discipline. Given the rapid increase, we did not achieve our typical fall-through rate. However, it is worth calling out that even in this rare situation of extraordinary inflation, we were able to cover inflation from a dollars perspective. Our January price increase was sized for a continuation of the rate of inflation we experienced in the first quarter. But after the invasion of the Ukraine and -- at the end of February and the sanctions that followed, the trajectory of energy costs changed significantly across the world. Again, as extraordinary as these events are, we believe this is a temporary squeeze on our margins and that with our July price action, we expect to return to our historical fall-through rate performance.

Now with all that said, overall market indicators continue to be positive and the underlying performance of the ceilings category has developed largely in line with our initial expectations for the year. While we experienced a headwind from inventory reductions through April, reported sell-through rates of our products at distribution has grown in the low- to mid-single-digit range. And as a leading indicator of commercial activity, commercial bidding activity remains at double-digit growth levels. Further to that, the Architectural Billings Index has also been at expansionary levels for several quarters and aligns with what our sales folks are experiencing with a strong uptick in in-person meetings with the architectural and design community. These are all positive signs for a continued market recovery.

Project delays have continued, along with the overall elongation of the construction project completion cycle, driven by continuing supply chain disruptions, availability of skilled labor and accelerating inflation. While material availability on job sites has improved, labor availability has emerged as more of the primary driver for longer completion cycles.

Before I move on to the Architectural Specialties segment, I would like to highlight the fantastic job our Mineral Fiber production plants are doing. With a choppy volume flow from April to June, the plant team safely managed through this while maintaining high customer service levels, while also delivering on our productivity targets in the quarter. This is especially critical in this inflationary environment that we're in.

Our plant teams also made terrific progress toward our 2030 sustainability goals. A good example of that is a project that came online in March at our Macon, Georgia plant. This is our largest Mineral Fiber plant that we operate and one of the key raw materials we use is recycled waste paper, like recycled news prep. And some of you may know that pricing for this recycled paper has been increasing as supply declines in a digital world.

Over the past 12 months, we've been working with urban consumer products who operate a nearby consumer tissue plant on an opportunity to use 100% of their tissue fiber waste stream in the manufacturing of our mineral fiber ceiling tiles. This work was completed in March. And with a minor investment in material handling costs, we now have a local source for 15% of our recycled paper needs and in the process, are eliminating 30 million pounds of landfill waste annually. This is a win-win for both companies and the planet as we work to reduce our environmental impacts, diversifying our supply chain to reduce risk and lowering our costs.

Now turning to our Architectural Specialties segment. We delivered another excellent quarter of sales and earnings growth. Net sales for Architectural Specialties products grew 20% from 2021 second quarter level, marking the second consecutive quarter of record-setting sales. Fueling this growth has been continued strength in our newer acquisitions, as well as in our base business, particularly in our felt products. We're very pleased to see how our recent acquisitions are benefiting from the leverage on our national selling platform, particularly at Arktura and Turf. Combined sales of Arktura and Turf grew greater than 50% for both the quarter and the year-to-date period.

I'd also like to highlight the promise of Tectum this quarter. These unique Aspen fiber products are not only highly functional and aesthetic but they are highly sustainable, too. Over the past 12 months, we have focused on expanding our Tectum portfolio with six new product families and increasing the marketing efforts around these products. These efforts combined by strong production execution resulted in a record-setting sales quarter for Tectum. It's a strong testament to the growth model in place for our AS business, as we bring together our design, innovation and manufacturing know-how with our best-in-class distribution model to drive profitable growth.

Second quarter adjusted EBITDA for Architectural Specialties increased 35% year-over-year and the adjusted EBITDA margin for the segment expanded 160 basis points. We remain well on our way to reaching our 20% EBITDA margin goal in 2023.

Now finally, in Architectural Specialties, order intake in the quarter remained strong, more than keeping up with the orders shipped in the quarter. This provides us good visibility to a solid second half of the year.

Now, Brian, for the final time here at AWI, before he begins his retirement, will provide more details on the financials. Brian?

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thanks, Vic. Good morning to everybody on the call. As I review our second 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 3 provides details on our basis of presentation.

On Slide 5, we begin with our consolidated second quarter results. Net sales of $321 million were up 15% versus prior year driven by sizable sales growth in both segments. Adjusted EBITDA increased 2% or $2 million and adjusted EBITDA margins contracted 390 basis points and I'll be providing more color on that in a few minutes. Adjusted diluted earnings per share increased to $1.29 or by 11%, driven by a decrease in the quarterly tax rate, reduced share count and an increase in adjusted net income versus the prior year.

Sticking with the share count for a moment. In the second quarter, we repurchased $55 million of shares. This reflects a step-up of about 80% from the first quarter. Along with a stable dividend, we continue to view flexible share repurchases as an important component of our capital allocation priorities behind, first, reinvesting in the business; and second, strategic acquisitions and partnerships. Since the inception of the share program in 2016, we have repurchased 11.4 million shares for a total cost of about $771 million. As of the end of Q2 2022, we have $429 million remaining under our repurchase program which runs through December 2023.

Slide 5 also shows our adjusted EBITDA bridge versus the prior year for the second quarter. The 2% increase in adjusted EBITDA was driven primarily by favorable AUV performance and an increase in sales volumes which was partially offset by accelerated inflation, investments in SG&A and a decrease in WAVE equity earnings. Favorable AUV was driven primarily by positive like-for-like pricing and the volume increase was driven by both Mineral Fiber and AS. Comprising the -- Compressing the EBITDA margins was accelerating inflation from higher raw materials, energy and freight costs. Although negatively impacting the EBITDA margin was the increase in SG&A expenses which was driven by investments in selling expense to support company-wide growth initiatives, in addition to increased incentive comp expense, the decrease in WAVE equity earnings was driven by higher steel cost inflation, partially offset by favorable price.

Slide 6 summarizes our Mineral Fiber segment results. Second quarter net sales increased 13% compared to the prior year, driven primarily by favorable AUV of 12%. Mineral Fiber sales volumes were also positive in the second quarter. Although we are now fully on the other side of the distributor inventory adjustment for Mineral Fiber, the extent of the negative impact to the start of the second quarter was greater than we expected. After this headwind normalized, volumes turned positive and strengthened both sequentially throughout the quarter and versus prior year. The positive AUV result was driven mostly by like-for-like pricing.

Moving to Mineral Fiber EBITDA. You'll see adjusted EBITDA decreased by $1 million or 2%. The main drivers behind the decrease are similar to the company level, heightened inflation, higher SG&A expense and lower WAVE equity earnings. We, like many other companies, saw inflation accelerate for our raw materials in addition to significant swings in energy prices, namely natural gas. This acceleration of inflation was a large driver of our recently announced mineral fiber price increase of 17% that took effect July 1. SG&A was higher than prior year as we continue to invest in support of our growth initiatives in addition to an increase in incentive comp. WAVE equity earnings were softer due to higher steel costs flowing through the P&L which was partially offset by positive price. Partially offsetting these headwinds were favorable AUV, benefits from higher sales volumes and manufacturing productivity.

Moving to Slide 7. You'll see second quarter results for our Architectural Specialties or AS segment. AS continues to execute and build on quarterly momentum to deliver another record sales quarter with year-over-year increase of 20%. The increase in sales was driven by improved performance from recent acquisitions compared to the prior year period, positive impacts from recent pricing actions and an increase in custom project sales. Adjusted EBITDA was up 35% and adjusted EBITDA margins expanded 160 basis points versus prior year. Driving the increase in adjusted EBITDA is the fall-through from the increased sales volumes. SG&A expenses were slightly higher than prior year due to investments in recent acquisition, selling capabilities and increases in incentive compensation. We remain on our trajectory to end the year with a nice step forward in achieving our 20% EBITDA margin by the end of 2023.

Slide 8 shows year-to-date adjusted free cash flow performance versus the prior year. The 26% decline in adjusted free cash flow is driven primarily by working capital impacts, mostly receivables and inventories in addition to lower dividends from the WAVE joint venture. We believe most of these working capital impacts are timing-related and should normalize by the end of the year. WAVE dividends are expected to increase in the second half as they drive price over inflation.

Slide 9 shows our year-to-date consolidated metrics and shares a similar story as the quarter. Strong top line growth of 13% versus the prior year, while adjusted EBITDA was pressured by higher costs, driving the contraction in EBITDA margin of 340 basis points. Adjusted diluted earnings per share increased by 9%. And as previously mentioned, adjusted free cash flow declined by 26%. Looking at the year-to-date EBITDA bridge, favorable AUV and positive volumes were partially offset by inflation, increased SG&A expenses and lower WAVE equity earnings.

Before I move on to the full-year guidance, let me take a minute to address the recent AFI bankruptcy. AWI was not part of the bankruptcy and subsequent asset sale process. Contractually, we have a right to consent to assignment of AFI's rights under the Armstrong Trademark License Agreement which has been in place since 2016 separation. AFI filed a lawsuit to ensure that it stayed on pace with the rapid time line of the bankruptcy process. The judge's ruling and the subsequent settlement by the parties permit the buyers of AFI's assets to step into the shoes of AFI under the Trademark License Agreement, subject to the same brand and quality standards that have been in place for AFI.

Subject to the bankruptcy judge's approval of the settlement, this lawsuit is behind us and we are glad jobs were preserved in Lancaster, Pennsylvania and elsewhere.

As we move to Slide 10, you'll see an updated full-year guidance for 2022 but we will highlight a few changes. We've kept our net sales midpoint unchanged but now expect Mineral Fiber AUV of 11% to 13% increase versus prior year and Mineral Fiber volume of 0% to 2% increase versus prior year. The reduction of Mineral Fiber volume reflects the larger-than-expected impact from the distributor destock in the beginning of the second quarter and the expected sustained elongation of the commercial project completion time lines. Our growth initiatives continue to perform in line or better than expectations. Our AS sales guidance remains unchanged at greater than 10%. The AS segment will face more difficult comparison periods in the second half of the year.

Moving to adjusted EBITDA. We trimmed $10 million off the top end of the range to reflect our year-to-date inflationary impacts which again accelerated in this quarter. For adjusted diluted EPS, we've increased the bottom range of the guide by $0.10 as a result of lowering the expected tax rate to 24% and decreasing our assumption in average diluted shares outstanding at the end of the year.

Adjusted free cash flow guidance remains unchanged. Although we're lowering our capital expenditure assumption by $15 million as a result of supply chain timing challenges and procuring necessary equipment. And lastly, as previously announced, in just a few days, I will be handing over the CFO responsibilities off to Chris Calzaretta as I depart AWI for retirement. I've had the privilege of working closely with Chris over the past four years and I'm confident that Chris is the right person to lead our teams and employees on our journey to create value for all stakeholders.

It's been an honor to serve as the CFO of Armstrong World Industries and I look forward to the continued success of the company. With that, I'll turn it over to Vic to wrap up before we take questions.

[Vic Grizzle, President & Chief Executive Officer]

Thanks, Brian. And before we get to your questions, I would like to share a couple other milestones and developments on our growth initiatives. First, I'm happy to highlight the progress across our digital initiatives and particularly with Canopy by Armstrong, our digital selling platform for reaching the underserved portion of the market. The ramp of sales activity in Canopy has been very encouraging as we continue to see order numbers and order value increase sequentially.

Quarterly net sales through Canopy has grown at a 50% rate since the first quarter of 2021. We're also encouraged by the repeat customer order flow which has more than doubled compared to the first quarter of 2022. These are solid proof points supporting our belief that there exists untapped demand in the renovation part of the market. As we continue to evolve our marketing efforts and add new products to the platform, we see more and more examples of customers who want this easy, accessible option. We also continue to extend our capabilities through strategic partnerships. In early July, we announced an expanded partnership with Price Industries, focused on accelerating the development of holistic solutions to promote healthy indoor spaces. Price Industries has decades of leadership in the innovation and manufacture of air devices and systems that promote indoor air quality and thermal comfort. This makes them an excellent partner as we pursue solutions that support indoor environmental quality.

An early result of this partnership is a new product called StrataClean IQ. Now we spend 90% of our time indoors and with the new focus on healthy buildings in clean air, innovative products that support indoor health and environmental quality are more relevant than ever. The StrataClean IQ filtration system addresses these needs by providing an in-ceiling air purification solution that fits seamlessly into our suspended ceiling system. It uses proven MERV 13 filtration to capture airborne bacteria, viruses, mold and particulates. It's also a quieter and more energy-efficient solution than floor-based air filtration products. This is a great addition to our portfolio of healthy space products and we are excited to introduce it to our customers in all vertical segments.

The strong positive interactions we're having with customers continue to reinforce our enthusiasm around healthy spaces and sustainable product innovations, as well as our digital efforts. We certainly saw this support while attending the country's largest annual gathering of architects and designers, the American Institute of Architects Conference held in June. Here we not only featured our StrataClean IQ but a whole range of innovative, sustainable and high-design solutions. I'm confident that we have our teams focused on solving the right problems to make a positive difference in the spaces where we live, work, learn, heal and play.

Now that difference starts with the leaders of our company and I echo Brian's thoughts on elevating Chris to the CFO role. Over the past four years, he's been a proven leader of our finance team, working in tandem with Brian to implement our growth strategy and support the creation of our current growth initiatives. I'm delighted to be working with Chris moving forward. And I'd like to take this opportunity to thank Brian for his countless efforts over the years and for his dedicated service to AWI. He's been a strong business partner for me. We know Brian will be watching the growth of AWI very closely from the sidelines.

And with that, I'll turn the call over to the operator and we'll be happy to take your questions.

[Operator]

[Operator Instructions] Our first question is from Susan Maklari with Goldman Sachs.

[Susan Maklari, Goldman Sachs]

Congratulations to both Brian and Chris.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thanks, Susan.

[Chris Calzaretta, Incoming Chief Financial Officer]

Thank you, Susan.

[Susan Maklari, Goldman Sachs]

My first question is, it's encouraging to hear you talking about demand holding up as well as it has the level of bidding activity and in-person meetings, all those efforts. But as we think about the macro potentially shifting, can you talk to any of the early signs that you're watching just to keep an eye on things and how things could perhaps progress as the broader economic backdrop flows?

[Vic Grizzle, President & Chief Executive Officer]

Yes. we pay attention to a lot of the things that you've mentioned, including the sentiment market, right? We're talking to our distributors and distribution partners. We're talking about our -- to our contractor customers often, triangulating, right, on what we see in the data in terms of bidding activity and what they're seeing in the marketplace. Of course, with the other indicators like ABI and some of the other macro indicators, trying to triangulate to what's going on. So we've not seen a slowdown in the activity, both the sentiment kind of read on the activity in the marketplace so far. The bidding activity, again, continues to be very robust across all the verticals, frankly. So we're not seeing anything. But just like you are and I'm sure everybody, hearing about the concern and the talk around a potential recessionary environment, I think when we think about a recessionary environment for AWI or we go back and look at history, you can see that there's quite a lag on commercial construction activity relative to residential activity for one example. But also as the markets move into a recessionary period, commercial construction activity tends to lag overall economic activity.

So again, we're going to be triangulating all those things. Our market outlook for the second half, Susan, hasn't -- as you can tell, has not factored in us banking on a recessionary market condition in the second half of this year.

[Susan Maklari, Goldman Sachs]

Yes. Okay, that's very helpful. My follow-up question is focusing on Architectural Specialties specifically. You highlighted in your commentary the really nice growth that you've seen from a lot of those acquisitions that you've done in the last couple of years. When you look out, how do you think about the runway that still remains there? And maybe just the overall trajectory of some of that coming through.

[Vic Grizzle, President & Chief Executive Officer]

Yes. I mean, obviously, a really strong first half in Architectural Specialties that we talked about. Our base business, you mentioned that the acquisitions that I highlighted are acquisitions -- are recent acquisitions and contributing to that. But also our base business, our core business has done very well and I highlighted Tectum as one of them. But when I look at the forward look, this is one of the businesses where we have the best visibility because of the project nature of that business. So when I look at our order rates and I start to see the order rates not only filling out for the back half of the year but I see them spilling into '23 and into '24, that's an encouraging, I think, indicator for us on the activity and the strength of the runway for this business. So we'll continue to watch that as it develops over the next six months or so as we look into '23. But I like the build that we're already seeing for 2023.

[Operator]

[Operator Instructions] Our next question is from Phil Ng with Jefferies.

[Phil Ng, Jefferies]

Brian, thanks for all the great help and insight over the years. And Chris, congrats and looking forward to working more with you going forward.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thanks.

[Chris Calzaretta, Incoming Chief Financial Officer]

Thank you.

[Phil Ng, Jefferies]

I guess, my first question would be the July price increase on Mineral Fiber. What's the reception been? And just based on the expectation you have for AUV, do you expect your margins to be up year-over-year in Mineral Fiber in the back half and then pull through, kind of normalize in 3Q? And then separately, on the WAVE side, you saw some compression on price cost with steel moving higher. Do you expect that to be kind of flushed out by 3Q as well?

[Vic Grizzle, President & Chief Executive Officer]

Let me take the sentiment around the price increase, then I'll let Brian comment on the margin side of it. The reception has been, I would say, as usual with our price increases in this inflationary -- with this inflationary backdrop. I think everybody is still feeling a strong inflationary set of conditions. And other building products are raising prices well. So I would say the receptivity of this price increase has been similar to prior price increases. And it's obviously sized up relative to the rate and pace of inflation that we saw in the second quarter and I think that others are experiencing as well. So that's kind of the sentiment around it. I would just -- a little color on that, I would just say, in the month of July, we have seen an acceleration on price realization as expected and as needed to cover the rate and pace of inflation right now.

Brian, on margins, do you want to touch on that?

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Yes, Phil. So obviously, Mineral Fiber specifically, Q1 gross margins expanded. Q2, they were under some pressure, although we did get price dollars over inflation dollars, just not as good a fall-through. We fully expect that to return to its normal fall-through in the second half. And so for the year, Mineral Fiber gross margins should expand. On the WAVE side, similar story, getting price over inflation in the back half, the highest impact of steel cost flew -- flowed through the P&L in Q2 and we expect that to come down over the back half. So we'll continue to get that price over inflation in the back half.

[Phil Ng, Jefferies]

Okay. Helpful. And I'm sure -- I mean, I get this question a lot on how your business would hold up in a recession. And Vic, you guys have done a great job in cleaning up your portfolio in recent years. And then due to some of the lag you kind of talked about with the bottlenecks in labor and supply chain and then certainly commercial activity. If we did head into, like, a moderate recession in 2023, do you have enough levers to grow EBITDA next year? I think Brian's walked me through some of the mechanics and it sounded pretty -- your business would be pretty resilient with this renewed portfolio. But help us kind of think through that backdrop.

[Vic Grizzle, President & Chief Executive Officer]

Yes, I think the short answer is yes to that. And we've obviously done our own modeling internally to understand what that might look like under different conditions and so forth. So we have our normal levers to pull on that. But also, remember, if you look back at past recessions and what's happened, usually new construction is what you see the biggest impact on which is about 30% of our business. The other 70% of our business is renovation, you get an uptick in renovation. And that's been our experience in seven of the last eight recessionary periods. So, yes, I think we'll see less of a downdraft in a recessionary period. And of course, it's all correlated to how deep the downturn is. And of course, nobody can call that sitting here today. But we do have the levers to pull and one of the things on AUV. Our AUV continues to be positive in down cycles based on the industry mix-up as well as our ability to hold pricing. So again, those levers plus with the cost levers that we've demonstrated in past recessions, give us the confidence we have levers to pull to continue to grow EBITDA in a downturn.

[Operator]

And our next question is from Garik Shmois with Loop Capital.

[Garik Shmois, Loop Capital]

Congrats, of course, to Brian and Chris. I wanted to ask first on Mineral Fiber sales volumes and you talked about how they improved in May and June to reflect more underlying market conditions. Just wondering if you could dig in a little bit more as to kind of what that means. Is that the low to mid-single digit growth that you talked about a softer distribution? Or are you seeing maybe a little bit more of a snapback as volumes accelerated?

[Vic Grizzle, President & Chief Executive Officer]

Yes. No, I think as we reported in the first quarter, low to mid-single-digit sell-through rates through distribution, we saw a very similar level in the second quarter as well. So I'd say no acceleration but no deceleration in the second quarter versus the first quarter. And if you look at our outlook for the rest of the year, again, we're not counting on an acceleration of market activity or a deceleration of market activity.

[Garik Shmois, Loop Capital]

Got it. And then I guess just my follow-up question is just on the full year guidance and what's implied in the second half of the year to hit the full year. It looks like you need roughly $40 million of EBITDA growth to hit the midpoint of your guidance. And just given the inflationary impacts that you're seeing, given the steady, I guess, volume growth, you got the price increase in July, I'm just kind of curious, I know you don't provide quarterly guidance per se but if you could help frame the slope of the EBITDA recovery in the second half of the year to get to the midpoint of your guidance, that would be helpful.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Garik, it's Brian. So seasonality-wise, Q3 is our biggest quarter. And so that, to your point, that roughly $40 million, a higher percentage of that will come in Q3. But as you step back and look at kind of first half, second half, it's clearly getting that price over inflation and then the volume piece where we don't see the headwind in the second pier from a shipment standpoint from the inventory destock that happened through the first four months of this year.

[Operator]

[Operator Instructions] Stephen Kim with Evercore ISI.

[Stephen Kim, Evercore ISI]

Congrats, Brian and Chris. And best of luck, Brian, with everything.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thank you.

[Stephen Kim, Evercore ISI]

My first question relates to the inventory levels, basically, at distribution. I'm just curious if you still believe that the dynamics that we saw play out earlier this year, sort of a one-hit wonder, whether there's any reason to think that because of the cadence of your price increases that we might see some behavior like this repeat as we get into next year. And I guess my question embeds an assumption that your price increases have moved to a different cadence. Like, is there any reason to think that you would move back to the cadence that you previously had, had? I think August was more typical than this July and similarly January and first of December. And then secondarily, if you don't move back to that level, why wouldn't we expect to see kind of a similar behavior on the part of distribution partners next year?

[Vic Grizzle, President & Chief Executive Officer]

Yes. So first of all, on the inventory levels, I can tell you, there's been lots of conversations between us and our distribution partners on getting to these normalized inventory levels. They've assured us that they're at those levels now. Again, what we saw in May and June would reflect -- they believe that to be true. We were back to some -- their normal buying patterns, if you will. So I believe that to be true sitting here today. And I -- again, based on real conversations with our distribution partners, that's the case. And again, I'm seeing the behavior that would support that position.

On the cadence of price increases, yes, I think when we get back to our normal, more normalized inflation, deflationary periods and cycles, I think we could move back to our normal cadence of price increases. February is typical early in the year and then midyear around in the August time frame. There's no reason why we wouldn't get back to that cadence. Of course, we had to pull it forward as much as we could give the rate and pace of inflation we were experiencing on energy, in particular, early in the second quarter. So again, we try to drive the size of these increases relative to the inflationary environment we're in. The cadence of these price increases has been driven by the need for greater price realization given the rate and pace of hyperinflation that we've seen in last year and then again this year.

The buy ahead of this, again, I think, we didn't see the same level of buy head in July. We did see our normal, if you would, normal course buy ahead on that but nothing outsized that would say we're going to be back into this need to destock in our distribution channels again. Again, there's a lot more transparency and visibility around that with our distribution partners to avoid, really, a massive destocking that happened in the first four months of this year. We obviously want to work together to avoid that again.

Does that answer all of those questions embedded in there?

[Stephen Kim, Evercore ISI]

Yes, that was a very helpful answer. Second question relates to the strategic partnership that you announced earlier this month. Just, number one, I was wondering if you could give a little bit of more detail in terms of the nature of that partnership from a -- to whatever degree you can explain what the economic impact that might be walking there. To a lay person, it just seems to make all the sense in the world to have AQ environmental quality handled above. But I'm not sure what the barriers to that being fully adopted and implemented as norm might be. And so I was curious if you could maybe share a little bit with us sort of how you see this development progressing? Is there any particular milestone that might be particularly represented as norm might be? And so I was curious if you could maybe share a little bit with us sort of how you see this development progressing. Is there any particular milestone that might be a particular -- represent a tipping point for this technology? And who are the early adopters of this that you see as potential customers?

[Vic Grizzle, President & Chief Executive Officer]

Well, first of all, the Price Industries partnership is the beginning, we believe, of an expanded partnership level with them. It certainly involves some co-development of products that go into the ceiling -- go into our particular ceiling system to make it easily integrated into the ceiling. So we're excited about that with their expertise and filtration products and air quality products, temperature control, all the things that we've defined in our healthy spaces definition under IEQ, as you've referenced. What's really important and what's key to this and I think you were getting this, Stephen, with your question is the work that has to be done to make these types of solutions permanent and part of our interior spaces has to be in the design process. So the early innings of this, people bought floor-based units. I mean, we all saw them, right? They were standing in the corner or sitting in the middle of the room. Again, those were quick reactions as patches or bandages as we call them sometimes.

But these permanent solutions, like, we're working on with Price and other partners are to be integrated into the overall architectural design process, the mechanical engineering process that make these permanent solutions. And that's the key to the success here. It takes a little bit longer as we're experiencing. But these kind of partnerships are exactly what we need to have the right skill sets and the right product solutions to go into this design process with. So this is the beginning, I think, of an expanded partnership and other partnerships that we're exploring as well.

[Operator]

[Operator Instructions] Our next question is from Rafe Jadrosich with Bank of America.

[Rafe Jadrosich, Bank of America]

It's Rafe and I'll add my congrats to Brian and Chris.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thanks, Rafe.

[Rafe Jadrosich, Bank of America]

I just wanted to follow up on some of the comments on the margin guidance. It obviously implies a significant improvement in the second half of the year relative to the first half. It seems like the inflationary pressure is still there, like natural gas prices have spiked again here. Can you just talk about the type of inflationary pressure in SG&A you're assuming in the second half relative to the first half of the year?

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Sure, Rafe. So two couple of different parts there, right? So there's manufacturing inflation on input costs like energy, gas, as you call it out, raws, freight. We see some parts of that. Not -- maybe not necessarily gas but gas has been very volatile. But some parts of that inflation profile, the back half starting to come down some. And then as you look at the SG&A side, their investments is not really being driven by inflation. And so as we start to wrap some of the investments a year ago that we made in the back half, that expense and SG&A starts to come down year-over-year, that rate of investment. So those combinations of that with the additional price that we announced and the realization of that gives us confidence in the margin in the back half.

[Rafe Jadrosich, Bank of America]

Got it. Okay. That's really helpful. And then I wanted to just ask about the trends you were talking about sort of at retail with your distributors, actual sellout trends. Can you just discuss how that's gone kind of year-to-date and sort of how that now the channel inventory appears sort of healthier and more balanced, how that -- the channel sellout trends compared to your guidance for the second half of the year?

[Vic Grizzle, President & Chief Executive Officer]

Yes. Let me take that and I'll repeat back what I was saying. What we saw in the second quarter is very similar to what we saw in the first quarter while they were doing the destocking and we looked at the point of sale or the sell-through data from a distribution. It was in that low to mid-single-digit level. Again, we saw that again in the second quarter. So no acceleration or deceleration. Our outlook in the second half is consistent with what we've seen in the first half from our distributors in their sell-through data. And again, consistent with what we saw in May and June and again, we're seeing again in July, it's consistent with that. So we're not counting on in our outlook or guidance, any acceleration based on what we see in the first half, or deceleration from what we've seen in the first half.

[Operator]

[Operator Instructions] Our next question is from Keith Hughes with Truist Securities.

[Keith Hughes, Truist Securities]

I guess, a question on the input costs on Mineral Fiber. It was a negative $14 million in the second quarter. Are you anticipating a similar pace to that in the second half of the year per quarter? Or is there some FIFO stuff going on that make it worse in the second?

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Yes, Keith, it's Brian. So yes, there's always FIFO in that line. But that's not the biggest driver. It's really, we do anticipate some of that inflation coming down. As we mentioned, gas did accelerate in the quarter. It was almost twice the rate that we thought -- that we saw in Q1. But then similarly, we're seeing some raws and even freight start to come down some. So we would not expect that negative 14% from Mineral Fiber for the next back half for each of the two quarters.

[Keith Hughes, Truist Securities]

And a similar question on WAVE. Some of the steel prices have been coming off here. Do you anticipate the WAVE contribution will turn positive in the second half of the year?

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Yes, very similar. Our highest cost steel was flowing through in Q2 and then a very similar dynamic where the price wasn't enough to cover that inflation and we expect that fuel cost in Q3s and Q4s [ph] to come down while we continue to realize that price.

[Keith Hughes, Truist Securities]

Okay, great. That's all for me. And Brian, thank you and for all your hard work and good luck in your retirement.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thanks, Keith.

[Operator]

[Operator Instructions] We have a question from John Lovallo with UBS.

[John Lovallo, UBS]

First, I guess, on the 20% margin in Architectural Specialties by the end of 2023. Can you just help us, remind us of some of the levers there? And can you get there, do you think, while still being acquisitive in that segment?

[Vic Grizzle, President & Chief Executive Officer]

Yes, John, some of the levers we're pulling there is around price over inflation, not too dissimilar. We obviously have inflation there. So we have to get ahead of that with -- and we are. In our backlog, we've got really good pricing initiatives to make sure that we're ahead of the inflation there. We're also just getting more efficient. And some of these plants driving productivity or realizing some of the productivity investments we've been making early on in some of these acquisitions. So it's a combination of those two things that are really the main drivers. Again, some volume leverage is helping as well, right, as we continue to grow at double-digit growth levels, we're getting good operating leverage.

So again, I would say your question is -- the second part of the question is around acquisitions. It certainly all depends on the performance, the starting performance of the businesses that we buy, right, if they're dilutive or accretive to that. So I'll leave it at that and just say we'll have to wait and see. We won't be buying companies -- making a decision of buying companies based on that because we know what we can do with these companies. Once they get on the Armstrong platform, we can improve their profitability. We'll be continuing to look for unique specifiable features and capabilities that these companies have.

[John Lovallo, UBS]

Okay, got you. And then on the CapEx reduction, I think the $15 million, I think you mentioned that, that was project timing. Can you help us with what sort of projects were delayed into 2023?

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Yes, John. It's a combination, quite frankly, of some maintenance and some return-seeking type of investments. It's really a function of some of the supply chain and getting the parts and the equipment we need to complete those projects. So again, we're -- consistent with what we said at Investor Day, we expect to be spending roughly $95 million in CapEx going forward.

[John Lovallo, UBS]

Okay, great. And good luck, Brian.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thanks, John.

[Operator]

[Operator Instructions] And our next question is from Kathryn Thompson with Thompson Research Group.

[Kathryn Thompson, Thompson Research Group]

And Brian, it's been a pleasure working with you and best of luck for your nice chapter.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thanks, Kathryn.

[Kathryn Thompson, Thompson Research Group]

First is just a clarification on the guidance given. Free cash flow guidance essentially stayed the same but the CapEx was taken a little bit. Could you clarify the bridge, the difference between these 2?

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Sure, Kathryn. Some of that -- while working capital, I called out in this -- in my prepared remarks, was a headwind through the first half, we expect that to lessen in the back half. But we're also being mindful of making sure we maintain the service given some of the choppiness in the demand side. So probably a little bit of working capital headwind offsets that little bit of CapEx reduction. And then as you saw, we did move our EBITDA midpoint down roughly $5 million.

[Kathryn Thompson, Thompson Research Group]

Okay, helpful. And as we -- I know there have been quite a few questions just on the outlook and the dreaded R word, recession. But I guess that backdrop, when you -- you've done a great job of changing the mix of your business with Architectural Specialties and Mineral Fiber, could you give us a look in terms of relative performance of your specialties business versus Mineral Fiber based on prior economic downturns?

[Vic Grizzle, President & Chief Executive Officer]

Yes. Because of the Architectural Specialties business has, really, a share gain component to it, a strong share gain component to it, what we have seen in the last recession, you really just go back to 2020, right, when we had, really, a steep downturn in the market. We were -- our sales were flat in 2020 in Architectural Specialties, while everything else in the market was down considerably, including our Mineral Fiber businesses. So it has some resilience because of this share gain component as we continue to penetrate these new categories and new product type categories with our acquisitions. So it is a more project-intensive business. It does seem to be skewed more to new construction and major renovation. I think what we're learning again here, a lot more major renovation work than new construction, I think, is what we're finding in the Architectural Specialties business that's propelling a lot of the growth that we're seeing recently.

Again, if you look at -- in 2020, new construction activity was down 20%. And then in '21, it was down another 6%. During these periods of time, Architectural Specialties continue to grow, again, flat in 2020 but double digit in '21 and we're on track to do another double-digit in '22. So there's some resilience here back to this -- the share gain dimension of the business.

[Kathryn Thompson, Thompson Research Group]

Great. Again, Brian, best of luck.

[Brian MacNeal, Senior Vice President & Chief Financial Officer]

Thanks.

[Operator]

[Operator Instructions] Our next question is from Daniel Oppenheim with Credit Suisse.

[DanielOppenheim]

Great to hear in terms of some of the comments here on the share gains in that -- the growth. Just wondering a little bit more in terms of some of the trends with the price increase, just given sort of the choppy environment and such, you talked about how in July, you've seen more in the way of price realizations. But wondering then in terms of the growth in volume, are you seeing that consistent with what you saw in May and June as the sense normalized? Or how would you characterize July relative to June?

[Vic Grizzle, President & Chief Executive Officer]

Yes. So the question around volume in July is consistent. So to answer the question first, it's consistent with what we're seeing and what we saw in May and June. So the outlook that we have for the second half, what we're seeing in July is consistent with our outlook that we have for the second half. And frankly, again, it's what we've seen in sell-through rates in the first half of the year. So I think that was the body of your -- main of your question. Yes, we are seeing some price acceleration into July, as you would expect, right, with a larger price increase to July 1st.

[Operator]

All right. And I'm not showing any further questions in the queue. I will turn the call back to Vic Grizzle for closing remarks.

[Vic Grizzle, President & Chief Executive Officer]

Yes. Again, thank you, everybody, for joining and for your questions. I just want to give one more final shout-out to Brian and congratulate him and thank him again for the great contributions to the company and just look forward to working with Chris. I just want to wish you all a safe and enjoyable summer.

Look forward to talking to you in a few months. Thank you.

[Operator]

And this concludes today's conference call. Thank you for participating and you may now disconnect.