Apogee Enterprises, Inc. (APOG) Q3 2022 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the Apogee Enterprise Fiscal 2022 Third Quarter Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to your speaker for today, Jeff Huebschen, you may begin.

Thank you, Towanda. Good morning, and welcome to Apogee Enterprises Fiscal 2022 Third Quarter Earnings Call. With me today are Ty Silberhorn, Apogee's Chief Executive Officer; and Nisheet Gupta, Chief Financial Officer. I'd like to remind everyone that there are slides to accompany today's remarks. These are available in the Investor Relations section of Apogee's website. During this call, we will reference certain non-GAAP financial measures. Definitions of these measures and a reconciliation to the nearest GAAP measures are provided in the earnings release we issued this morning, which is also available on our website. I'd like to remind everyone that our call will contain forward-looking statements. These reflect management's expectations based on currently available information. Actual results may differ materially. More information about factors that could affect Apogee's business and financial results can be found in today's press release and in our SEC filings. And with that, I'll call -- I'll turn the call over to you, Ty.

Thanks, Jeff, and thanks, everyone, for joining us this morning. Today, I'll share some highlights from the third quarter and provide an update on how we're executing our new strategy. Following my comments, Nisheet will provide more details on the quarter and our full year outlook. Then, of course, we'll be ready to take your questions. Let's start with the third quarter highlights, which are on Page 4 of our slide deck. I'm proud of our team's efforts, which delivered a solid performance this quarter. We continued our positive momentum, delivering margin expansion and adjusted earnings growth compared to last quarter. Margins and adjusted earnings have now improved sequentially each of the past 2 quarters. This was led by continued strong performance in Architectural Services. Services revenue reached a record $92 million in the third quarter and continued to deliver strong profitability with 10% operating margin in the quarter. In addition, we won several new project awards during the quarter, continuing to build our project pipeline for the coming years. We are also seeing encouraging progress in our other segments. Large-Scale Optical continued its recovery with 8% year-over-year growth. In Framing Systems, we achieved solid year-over growth and margin expansion. Through 3 quarters, Framing's adjusted margins have improved by 40 basis points compared to last year. We've reached these gains even as we continue to face significant supply chain and inflation headwinds. The pricing actions we've taken in response to inflation are beginning to offset some of those higher costs. We are also realizing the benefits from our restructuring actions and our relaunch of Lean to drive plant productivity. We expect Framing will make further margin progress during the fourth quarter. Architectural Glass had adjusted operating margin of 3%. Now this is still a long way from what we believe the Glass segment can deliver, but it was meaningful progress compared to the second quarter, and we saw solid productivity gains materialize in the final month of the quarter. Turning to cash flow and the balance sheet. Our financial position remains very strong. We had $28 million of free cash flow in the quarter. Year-to-date, we have now generated $73 million of free cash flow, which is more than 180% of adjusted net income. With this strong cash flow, we continue to return capital to shareholders and we improved our already healthy financial position. We achieved these results in what is still a challenging operating environment. COVID continues to impact our broader markets and like many companies, inflation remains a significant challenge. We have seen meaningful cost increases for freight, aluminum, glass, paint and other materials used in our operations. We also continue to experience challenges in our supply chain and in some cases, these disruptions have impacted our service to customers. Throughout the year, we have taken actions to mitigate inflation and these supply chain issues. These actions are beginning to have a positive impact on our results. We continue to focus on improving execution. We're closely managing our controllable costs. We've adjusted our pricing where appropriate. And we're working to pull forward the benefits from our restructuring actions as quickly as possible. We expect to make further incremental progress in the fourth quarter. This gives us the confidence to narrow our full year earnings guidance to the higher end of our previous range. Just 3 weeks ago, we hosted our Investor Day, and I'd like to thank everyone who attended either in person or virtually. During that Investor Day, we outlined our new enterprise strategy to deliver profitable growth and improved return on invested capital. As highlighted in Slide 5 of today's deck, our strategy has 3 pillars. First, we are working to become the economic leader in our target markets with clear go-to-market strategies, differentiated offerings and competitive cost structures to enable us to be a top margin generator in our target markets. Second, we will actively manage our portfolio to drive higher margin and ROIC performance. We will accomplish this by scaling and expanding our top-performing businesses, actively addressing underperformers and investing to add new differentiated offerings to drive growth. And third, we will strengthen core capabilities and platforms. The foundation of which is building an operating model that will deliver greater efficiencies, more scalability and enable sustained profitable growth. Now during the third quarter, we made progress in each of these 3 pillars. We continue to execute the restructuring and cost actions we announced in August. The realignment of framing systems is nearly complete, moving from what had been 6 decentralized business units to a more integrated business that better leverages the scale and capabilities of the combined organization. These changes are bringing more clarity to our go-to-market approach and are also enabling improved execution, reduce costs, which in turn will generate higher margins. We are also making progress in Architectural Glass. At the end of the quarter, we completed the sale of our facility in Statesboro, Georgia. We also wrapped up operations at our Dallas location. All production has been successfully transitioned to our flagship Glass facility in Minnesota. We did all of this while maintaining high levels of service and delivery for our customers. These actions position us to pursue our strategy of focusing on premium offerings for Glass, where we can differentiate and deliver more value for customers. We are also accelerating improvements in Glass segment's cost structure and driving productivity to improve margins. We're on track to transition our Sotawall business from Framing Systems to the Services segment. We expect this will be completed early next fiscal year, and this move will unify our offerings for complex curtain wall projects and will enable improved operational performance for Sotawall. We're moving forward with our enterprise transformation efforts. So we have several projects underway to strengthen core processes and systems. This will provide new digital and back-office capabilities across several functional areas, allowing us to support the businesses more efficiently. We are beginning to deploy elements of these new systems now and we expect to make further progress in the coming quarters. Finally, we took important steps to reinvigorate our Lean and continuous improvement program. We added a new leader to head those Lean efforts with an initial focus on Architectural Glass, where we are seeing promising early results. In the coming quarters, we will expand our Lean toolkit to other parts of the business, with our ultimate goal of embedding Lean into the culture of how we work and further develop our talent. We are still in the early stages of executing our new strategy. And over the next several quarters, we will continue our strategic pivot, positioning Apogee to create peak value for all stakeholders, driving toward our long-term financial goals. I'm excited about the path we see ahead for Apogee, and I am confident we can achieve the goals that we've set for ourselves. With that, let me turn it over to Nisheet to provide more details on the quarter and our outlook.

Thank you, Ty, and good morning, everyone. This was a positive quarter for Apogee on several fronts. We sustained the momentum in our business. We continue to generate strong cash flow and we made further progress on our enterprise transformation. Let me provide some more details on the quarter. Starting with consolidated results on Page 6 of our earnings presentation. Total revenue grew 7%. This was led by growth in Architectural Services and Framing Systems. Large-Scale Optical also posted solid growth. As expected, volumes were lower in Architectural Glass, reflecting the lower order volume in that segment over the past year. The quarter included $3.4 million of pretax restructuring costs. These are related to the actions we announced in August. The restructuring costs reduced our reported gross margin in the quarter by approximately 100 basis points. Year-to-date, we have incurred $24.2 million of restructuring costs. Of this, $7.5 million have been cash expenses and the remainder were noncash charges. We anticipate another $2 million to $3 million of cost in the fourth quarter. We are pleased with how our teams have executed the restructuring. Restructuring costs are tracking below our initial estimates, and we are accelerating some of the cost savings. We remain on track to be complete with our restructuring in the first quarter of fiscal 2023. Excluding the restructuring costs, adjusted operating income was $21.1 million. This was down from $31.8 million in the last year's third quarter. As a reminder, last year's third quarter included a $7.4 million upside related to a new market tax credit in the Glass segment. Also, the temporary cost actions we took in response to COVID added another $7 million of operating income in last year's third quarter. Inflation also continued to be a significant headwind in the quarter. The gross impact of inflation in the third quarter was $21 million. We were able to offset $12 million of this through pricing actions for a net inflation impact of $9 million. Fiscal year-to-date, the net impact of inflation has been $29 million. We expect inflation pressures will persist in the fourth quarter and into our next fiscal year. However, as we move forward, we expect our pricing and cost actions will offset a larger portion of inflation headwinds. Between the new market tax credit, reversal of temporary cost actions and inflation, we faced over $23 million of year-over-year headwinds in this quarter. We were able to offset over $12 million of this through benefits of our restructuring cost actions of procurement savings and improved sales mix. As we move into the fourth quarter and next year, I am confident we will continue to drive incremental margin gains. Let me shift to the nonoperating items on the income statement. Net interest expense was down $1 million, driven by lower debt balances. The quarter included $3 million pretax impairment charge. This was related to a minority investment in a glass technology company. This write-off represents the entire value of Apogee's investment in this company. Our tax rate was 21.7% compared to 23.5% in last year's third quarter. Over the long term, we expect an average tax rate of approximately 24.5%, but this can vary from quarter-to-quarter. Finally, our share count continues to trend lower due to stock repurchases. Putting it all together, we reported GAAP net income of $0.44 per share. Excluding the restructuring and impairment costs, adjusted earnings came in at $0.63 per diluted share. While earnings were lower year-over-year, this was a nice sequential improvement with $0.53 per share in the second quarter. Let's turn to segment results, which are on Slide 7. Starting with Architectural Framing Systems, Framing revenue grew 11% compared to last year. This was primarily driven by pricing actions we have taken to offset inflation. Operating margin was 7%. That is a 170 basis point improvement compared to last year. The margin gains were driven by improved pricing and benefits from our restructuring and cost actions, which offset the impact of inflation. Moving to Architectural Glass. Revenue was down 12%. As expected, this was primarily driven by lower volumes. We have had a few new projects awards in the last year, while non-residential construction has been in a downturn. We are also strategically shifting away from some lower-margin sales. The lower volume was partially offset by a more favorable mix. Glass results included $3.5 million of restructuring costs. Excluding the restructuring costs, adjusted operating income was 3%. As mentioned earlier, last year's quarter included $7.4 million of operating income related to new market tax credit. Glass margins improved sequentially compared to 0.5% in the second quarter. We are beginning to achieve cost savings from restructuring as well as productivity gains from our Lean program. Margins also benefited from an improved sales mix. In Architectural Services, revenue grew 20% to $92 million. This was a new record for the segment. Operating margin was strong at 10%. Services continue to have solid project execution. However, margins were lower than last year due to a less favorable project mix. We're also encouraged by the strong order flow in Architectural Services. Net order flow has increased each of the past 4 quarters and backlog held steadily at $572 million. Turning to Large-Scale Optical, revenue of $27 million grew 8% compared to last year's third quarter. This was primarily driven by more favorable sales mix. Adjusted margins were solid at 21.9%. Margins were lower than last year's third quarter driven by onetime costs from expedited freight, which offset the benefit from improved sales mix. Finally, our corporate cost increased this quarter to $6.9 million. This was driven by increased health care costs. Turning to Page 8. Our cash flow and balance sheet remain strong. Cash flow from operations in the quarter was $31 million. This brings year-to-date cash flow from operations to $86 million. We are on pace to have another very strong year of cash generation. Cash flow is lower than last year, which was a record year for cash flow. Year-to-date, CapEx of $13 million is below last year's level. We slowed some investment as we completed our enterprise strategy work earlier this year. Based on year-to-date spending, we now expect full year CapEx of approximately $25 million. This is down from our previous estimate of approximately $35 million. Now that we have completed our strategy work, we expect CapEx will ramp up in the coming quarters as we invest in high-return projects to advance our strategy. We continue to return cash to shareholders. Year-to-date, we have returned $44 million from share buybacks and dividends. All buybacks have reduced our outstanding share count by 3% compared to last year. Our balance sheet remains very strong. Net debt is down to $85 million. We have no significant debt maturities until June of 2024 and we have no borrowings on our $235 million revolving credit facility. This strong financial position provides significant flexibility as we begin to execute our new strategy. Now turning to our outlook for the rest of fiscal 2022, which is on Page 9 of our presentation. As Ty mentioned, we are narrowing our full year guidance. We now expect full year adjusted earnings between $2.25 to $2.40 per share. As a reminder, this guidance excludes the impact of restructuring and impairment costs. We expect cost inflation and supply chain challenges will continue in the fourth quarter. We are working to mitigate these headwinds by adjusting pricing to offset inflation, continue to focus on execution, closely managing controllable costs and working to accelerate the benefits from our restructuring. These actions should drive further sequential progress in the fourth quarter which gives us confidence in the full year outlook. In the fourth quarter, we also expect to realize a pretax gain of approximately $19 million related to sale of Architectural Glass facility in Statesboro, Georgia. We intend to exclude this gain from our adjusted results. I would like to wrap up by acknowledging our team's efforts this quarter. We have made great progress on restructuring actions we announced in August. And we have continued to build momentum in creating a backbone of core capabilities and platforms. Apogee's transformation is well underway, and our teams are working hard to make Apogee a top-performing company. With that, I'll turn it back over to Ty for some concluding remarks.

Thanks, Nisheet Gupta. To summarize, we are very encouraged by the progress this quarter. Our entire team is focused on executing our new strategy. Despite some significant near-term headwinds, the work we are doing is beginning to show in our financial results. We sustained our momentum, delivering another quarter of sequential earnings growth. Our restructuring plans are progressing ahead of schedule, allowing us to accelerate those cost benefits. The pricing adjustments we made in response to inflation combined with our cost actions are beginning to offset the impact of those higher costs. And I'm particularly pleased by the early progress we've made with relaunching our Lean and continuous improvement program. We expect to make further gains in the fourth quarter as we continue to execute our strategic pivot. I'm confident that the actions we are taking now will position Apogee for sustained profitable growth in the coming years. With that, we are ready to take your questions.

[Operator Instructions]. Our first question comes from the line of Chris Moore with CJS Securities.

Interesting inflation discussion, I appreciate the detail. You talked about framing revenue added by kind of the flow-through pricing actions to offset some of the inflation. So first of all, is that both the quick and the long lead time where the pricing is being increased?

Yes. It's both, Chris, as we look at that, the moves that the Framing team has been making in the last couple of quarters. Part of the challenge we've had in kind of catching up to those inflationary pressures was due to some of the longer lead time items in that business and some of the shorter-term items, they're able to get some of that pricing through. But we're seeing that they've made progress each month of the quarter, they started to close those gaps.

Got it. So just so I understand the mechanics. When you sign a contract on the long lead time stuff, do you prebuy the aluminum at that point in time? Or how does that work?

Yes, Chris. So if you think about our Architectural Services business, we have enough lead time for us to be buying in advance with hedging on aluminum and commodities like those. For shorter lead times, which are like 6 months, 3 months in the Framing segment, the opportunity for locking in pricing is limited. What our team in procurement is doing is they're really going back to the vendor as soon as you know about the orders and locking in the supply chain and volumes we need. Right now, Chris, the challenge is really to get the volumes in place more than pricing sometimes. So I would say Framing segment, less on locking in pricing, Services segment more working towards locking in pricing for long-term contracts.

Got it. That's helpful. And when you look at pricing overall, is it the Framing that is kind of the biggest issue still moving forward in terms of that catch-up?

Yes. Framing and because of the short cycle times, they have had, by far, the biggest headwinds on material cost inflation. So they've had the most work to do, and they have a mix, right? They do have some stuff that's kind of medium-term and a little bit of longer term. So that's where we've seen the bulk of the headwinds. It's also where we've seen the bulk of the price realization, as you might expect, as they're trying to close that gap. So the driver for top line, as Nisheet commented on was, in fact, pricing. If we look at volumes, volumes were still down slightly, which is what we expected given where the market, as we see it as just bottoming. So what has been driving that top line revenue number for framing the last couple of quarters is really around the price actions.

Got it. And the next one really goes probably back more towards some of the Investor Day stuff that we talked about. So the target operating margin is 10% plus by fiscal '25. And I'm just trying to understand better how you view -- is that -- Is that a mid-cycle target? Or kind of -- in the past, we had talked about that 1,000 basis point increase trough to trough. Here, this 10% plus is that mid-cycle? Or maybe you can just help me understand a little bit better on that.

Yes. I would say, Chris, as we looked at that, we're kind of putting that as a minimum that we want to achieve. Now if there is a significant downturn like we saw with -- when the pandemic started nearly 2 years ago. We want to be in a better position that we don't see as big a drop in our margins, but that's something that might pull us down below that 10%. But then also in a very strong cycle, we would expect that we'll be achieving comfortably above that 10%.

Our next question comes from the line of Eric Stine with Craig-Hallum.

So maybe just a follow-up on that last question, just -- and I do appreciate you quantifying the impact on the materials cost side for the year but also 3Q. Is it fair to say, though, I mean it seems like you feel that potentially the worst of it happened in the third quarter. Now maybe that is not the case, but I'd love your thoughts, given all the steps you're taking, how long you think until you kind of get ahead of this?

Yes. So if you think about the inflation and net inflation, we saw the quarter 2 being 1 of the highest of the 3 quarters. And as we move into quarter 3, we are already seeing an improvement on net inflation. And as we had indicated in our quarter 2 earnings release, by end of Q4, we will have enough price increase to offset the inflation and we close enough to the gross inflation.

Got it. Okay. That's helpful. Maybe just turning to Framing, if I'm not mistaken, I think you had the highest orders there since before COVID. And I know some of that might be prices. But just curious your thoughts on that. I mean, do you think this is the start of some of the operational steps you're taking there and would love to get your thoughts on whether you think that's sustainable?

Yes. As we look at Framing, so just as I answered earlier for Chris, we look at volumes will take price effect out on top line. Volume was still negative, but improving sequentially as we went quarter-to-quarter. That ties out with what we talked about at Investor Day is we do see the market as kind of bottoming at this point. We know there's still a lot of puts and takes and questions with Omicron variant now for COVID, et cetera. But we're still looking at a positive growth in the market as we step into our fiscal '23 or our calendar '22. The actions they've taken on price as well as cost. So they've been working on costs, obviously, from a restructuring side. They have started reinvigorating their Lean activities. So we think both of those even absent of meaningful volume growth, they still have the potential to continue on that margin improvement path.

Got it. So maybe last one for me. Obviously, the ABI, the trend has been quite good. A few days ago, though, the AIA commentary was a bit cautious. It was talking about that potentially, it was a rebound from COVID in it, that rebound is coming to an end this cycle, which was kind of interesting commentary given the trends in the market. Clearly, it sounds like you think that things have bottomed. So just curious if you could kind of bridge the 2, your view and that view that I just referenced.

Sure. And I think if we looked at those numbers, ABI and a couple of others that tick down a bit in November, they were still in the expansionary area. It's how we looked at those numbers. And I think we see it more indicative of that. There's going to be some bumps as we go through this recovery. But still, we look at right now, everything points to -- we're kind of bottoming at this stage. And when we look at activity, we're pointing towards volume growth as we go into our fiscal '23. So nothing has changed with that. We could see some lumpiness quarter-to-quarter across all those metrics, but that's how we're viewing the market right now.

Our next question comes from the line of Julio Romero with Sidoti & Company.

Can you talk about the CapEx ramp you referenced that you expect in the out quarters of fiscal '23 and beyond? And what type of high-return projects? And would they be focused on the -- I think you talked about at your Investor Day about allocating more resources to services and LSO. Would those be the segments that your CapEx would be focused in?

Yes. So as you've seen in the last 2 years, Julio, we have in fiscal '21, because of COVID, we had curtailed CapEx, and there were certain investments we had to do that we had to curtail given the environment in pandemic. In fiscal '22, we limited our CapEx as we were working on our strategy to understand where exactly we should be investing. So those are 2 years where the business has not invested beyond the maintenance capital, so to speak. So now is the time where we now have our strategy clear, and we would like to invest and go back to that $25 million to $35 million range as a normal CapEx of this company over the coming years. When you think about the segments, each of these segments have opportunities and strategic growth ideas that they will be investing CapEx on. I would say Services, as you asked the question, Services may not have the highest of those CapEx investments. But other -- all of our other segments have good opportunities to invest in CapEx.

Yes. And I would add to that, Julio. Kind of tying back to Investor Day, and Services is generally a low capital invested business. Our LSO business continues to see strong growth. They've actually seen some positive shifts in buying behavior as well as they talked about the need to expand and diversify that business. So those are areas we would be looking at potential capital investments for them. Within Framing, our storefront and finishing business is a good performing business. There's likely some capital needs that would allow them to expand as the markets recover so that they can fuel some profitable growth for us that would be accretive to the company. And then when we look at Glass in the window and wall portion of Framing, our capital there is really going to still be focused on short-term quick payback, really still helping them drive margin improvement. Do we get comfortable that we're at a sustainable margin level that we need those businesses to perform before we would invest any meaningful capital to add capacity or volume and capability.

Okay. That's really helpful. I appreciate the run down by segment there. And I guess on LSO, can you maybe talk about some of the short-term freight costs you saw in the quarter and if those are expected to kind of persist into the fourth quarter? And then secondly, how do you view -- like fourth quarter, you usually have a typically strong margin in LSO. So how do you view kind of fourth quarter LSO margin to shape up?

Yes. I would say that the third quarter expedited freight costs in LSO segment was a one-off. There has been significant demand in the marketplace given the holiday season, and we want to make sure we seize the opportunity where we could. I would not expect that expedited shipment freight costs to continue in Q4. What's the second part of the question, Julio can you repeat the second question again?

Sure. Yes. Typically, you have a strong fourth quarter margin in LSO and just wanted to get your view on how you view that shaping up?

Yes. I would say LSO's margin in fourth quarter are going to be consistent with prior year quarters. We are mid-20s is what we look at in LSO, and they will be back at that level.

[Operator Instructions]. Our next question comes from Will Dezellem with Tieton Capital.

I'd like to circle back to the lean initiative. And since Glass is the first segment to restart the Lean initiative. Are you anticipating that they will also be the first to complete their restructuring process? Or do they simply have more to do and it will take longer.

Well, both Framing and Glass, the bulk of the restructuring efforts really have come through at this point. There's still a little bit to do in Q4, as Nisheet commented on. So getting those costs behind us as we close out the year, I think both Framing and Glass will have that in place. Where the Lean efforts have focused in on Glass, we just prioritize rather than trying to do a little bit of everything everywhere. We really wanted to focus. And we saw the margin improvement opportunity that we had in Glass and the fact that we wanted to consolidate that footprint so that we could really focus on more of the midsized projects in kind of the premium market side of that business. That's where we wanted to focus our initial efforts there and really drive it on productivity on the production floor. So that work is flowing through. We actually, as I commented, we saw a very strong last month of the quarter from Glass as some of those productivity improvements started to take hold, and we expect we'll see that build in the fourth quarter and then as we go into the first quarter of next year from a margin perspective on Glass.

I'm sure no further questions in the queue. I will now turn the call back over to Ty Silberhorn for closing remarks.

All right. Well, thank you. Thanks for joining us today. And as we talked about, we remain focused on executing the new strategy to create peak value for all of our stakeholders. I'm hoping all of you will have a safe healthy, wonderful happy holidays and a joyful new year. Thanks, and have a great rest of your week.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.