Apogee Enterprises, Inc.

Good day, and thank you for standing by. Welcome to the Apogee Enterprises Fiscal 2023 Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star 1 and 1 on your telephone. You will then hear an automated message advising that your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to our speaker today, Jeff Hibshon. Please go ahead.

Thank you. Good morning, everyone, and welcome to Apogee Enterprises Fiscal 2023 Third Quarter Earnings Call. With me today are Ty Silberhorn, Apogee's Chief Executive Officer, and Mark Ogdahl, Interim 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. Descriptions of these measures and a reconciliation to the nearest GAAP measures are provided in the earnings release and slide deck we issued this morning. As a reminder, the prior year results for the architectural framing systems and services segments have been recast to reflect the move of the SOTOWALL business from framing into services. Pro forma segment results reflecting this change are included in our earnings slide deck. I'd also like to remind everyone that our calls 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 RCC filings. And with that, I'll turn the call over to you, Ty.

Thanks, Jeff. Good morning, everyone joining us online. This is another great quarter for Apogee with double-digit revenue growth, significant margin expansion, and strong cash flow. I'm very proud of the team's execution this quarter and the progress that they've delivered this fiscal year. This morning, I'll discuss highlights from the quarter and how our strategy is driving sustainable improvements in our business, and the opportunities we see for further gains. Then I'll turn it over to Mark for more details on the quarter and our outlook before we take your questions. Let's start with our third quarter highlights, which are on page four in our presentation. Revenue was up 10% this quarter. This was led by Framing Systems, which has posted double-digit growth each quarter this fiscal year. It was also encouraging to see solid revenue growth in the glass segment. As a reminder, it's been over a year since we announced the closure of our state's borough and velocity locations, and we're starting to see the early benefits from our mix shift to more premium products in glass. Overall, operating margin came in at 9.4 percent this was up more than 300 basis points compared to adjusted operating margin in last year's third quarter in the years since our investor day we've made tremendous progress toward our goal of delivering annual operating margins greater than 10 percent like the past few quarters margin gains were driven by effectively managing the balance of pricing relative to higher operating costs, improved operational execution and productivity gains, and sustained savings from last year's restructuring actions. With the strong top-line growth and margin expansion, adjusted earnings per share were up 70%, coming in at $1.07. This was another record for adjusted EPS, beating the previous record that we set last quarter. We were also pleased with our cash flow, as we generated 54 million cash from operations. This was a strong result, following the softer-than-normal cash flow in the first half of the fiscal year. We still have work ahead of us to improve our working capital, but the third quarter was very encouraging. and we expect further progress in Q4. These strong results continue the trends from the first half of the fiscal year. Through executing our strategy, we have made sustainable improvements in our business. As a reminder, an overview of our three pillar strategy is shown on page five of our presentation. We began implementing this strategy in the late summer of 2021. Since then, our team has made tremendous progress. Across the company, we're building a results-driven culture focused on improving operational execution and providing exceptional value for our customers. We've made fundamental improvements to our cost structure, especially in framing systems and glass. We have established renewed energy around productivity through our lean initiatives. We strengthened our focus on differentiated products and services, and we've improved our approach to managing the balance between our costs and pricing while staying competitive in the marketplace. Most importantly, we are building the capabilities to enable sustained profitable growth in the years ahead. These initiatives include revitalizing our talent development programs, driving process standardization across the enterprise, and strengthening our M&A capabilities. Through all these efforts, we are transforming Apigee into a higher performing, more resilient company. Since launching our new strategy last year, we've raised the bar on margins and earnings, establishing a new baseline of performance as shown on page six of the presentation. With this stronger foundation, we're excited about Apigee's future. We've already made significant progress toward the financial goals we set during our investor day last year, and I'm confident that we will drive further advancement in the quarters ahead. We are still in the early stages of our journey with lean and the development of the Apigee management system. And these efforts have the potential to still drive meaningful productivity gains for the next few years. We are also early in our efforts to shift our sales mix. We are pivoting toward more differentiated products and services that support our goal of becoming an economic leader. Over time, this shift should lead to a more resilient business model with sustainable opportunities for profitable growth. We are also pursuing several other important opportunities to drive organic growth. These include investments to scale and grow the services segment, capacity investments to enable growth in large-scale optical, and geographic expansion in both framing systems and architectural services. Finally, our strong balance sheet and cash Cash flow provides the flexibility for value creating capital deployment. We are stepping up investments in higher return capital projects. We're building a pipeline of M&A candidates along with the processes and team that we will need to evaluate and integrate any potential acquisitions. We will also continue to return capital to shareholders through a growing dividend and opportunistic share repurchases. And we're committed to maintaining a strong financial position. We have great momentum as we wrap up fiscal 23 and look ahead to the next fiscal year, even if markets should soften. And I'm more confident than ever in our team and the direction of our strategy. With that, let me turn the call over to Mark for more details on the quarter and our guidance.

Thanks, Ty, and good morning all. Q3 was another strong quarter for Apogee as the execution of our strategy continued to drive improved margins and performance. Let me provide more details, starting with the consolidated results on page seven of our presentation. Third quarter revenue grew 10% to $368 million. Like the past two quarters, Growth was primarily driven by inflation related pricing in framing systems. The glass segment also had double digit growth. Operating income increased to 34.8 million and operating margin improved to 9.4%. This was 310 basis points higher than the adjusted margin of 6.3% last year. We've now had four consecutive quarters with adjusted operating margin greater than 8%, putting us well on our way to our margin target of greater than 10%. Looking at the non-operating lines of the income statement, interest expense increased $2 million. This was driven by a combination of higher average debt balance and higher interest rates. The tax rate in the quarter was 24.8%, in line with our expected long-term average rate. our diluted share count was $22.3 million, down 12% from last year due to our share repurchases over the past year. Putting it all together, earnings grew to $1.07 per share of diluted share, up 70% compared to last year's adjusted earnings per share. Let's move on to segment results on slide 8, starting with architectural framing systems. Framing had another very strong quarter, revenue 17%. This was primarily driven by pricing actions taken to offset inflation of raw materials, labor, and other operating costs. Operating income was $22.1 million. This was Framing's third straight quarter with operating income over $20 million, and margins improved to 13.4%. up nearly 500 basis points compared to last year. In the first half of the fiscal year, framing margins benefited by $5 million from the volatility in aluminum pricing and the timing of inventory flows. As we expected, that benefit did not repeat this quarter, and we don't expect it to repeat next year. Framing systems also benefited from an insurance settlement received this quarter. which increased margins by about 30 basis points. Turning to architectural services. Revenue was down 3% on slightly lower volume. Grading margins came in at 5.9%. The segment's margins remain below last year's level, primarily driven by lower profitability on legacy soda wall projects. Margins were also impacted by costs related to investments we're making to enable future growth and scale in services. This mainly involves hiring and developing talent to expand our capacity. Despite the year-over-year decline, we're pleased with the sequential margin trend in services. Third quarter margin was 80 basis points better than Q2, and we expect further sequential improvement in the fourth quarter. Services backlog did decline this quarter, following a large step-up last quarter. As a reminder, services orders and backlog can have significant variability from one quarter to the next, as it is typically driven by a small number of large orders. Backlog remained strong at $741 million, which is above the year-ago level of $722 million. In architecture of glass, the team continued to make terrific progress in its strategic shift. Revenue grew 10% to $81.5 million. This was driven by improved pricing and product mix and reflects our strategic shift away from pure volume towards more premium products. Operating margin continued to trend higher, reaching 9.1%. Adjusted operating margins in glass have now improved sequentially for five consecutive quarters. Margins benefited from pricing that offset inflation, the improved sales mix, and productivity gains from our lean program. Large-scale optical continued to deliver steady performance. Revenue was down slightly, primarily driven by lower retail volumes. Operating income was up $1.1 million in the quarter, with operating margins of 26.7%. This was primarily driven by lower operating costs and increased productivity. As a reminder, in last year's third quarter, LSO had lower than normal profitability, primarily from higher freight costs. This quarter, LSO had $500,000 benefit from a property tax adjustment. Finally, I'll mention a couple of things for corporate costs, which increased by $1 million in the quarter. This was primarily due to higher health insurance costs, as we've seen those steadily increase over the past year. This will likely remain a headwind in the upcoming quarters. Let's turn to cash flow on the balance sheet on page nine. In the third quarter, we had 54.1 million of cash flow from operations. This was an improvement from the previous two quarters, which were impacted by increased working capital requirements. We are now strongly in cash flow positive for the year, and we have continued solid cash flow in the fourth quarter. Year to date, we've had $18 million of capital expenditures. We plan to continue to ramp up capital spending in the fourth quarter. This includes investments to expand capacity in our higher margin businesses, enhance productivity through automation, and deploy improved systems to better support our business. We continue to expect full-year CapEx of approximately $40 million, depending on timing and execution of some larger projects. Other than CapEx, our primary use of cash in the quarter was debt reduction. We paid down $47 million of debt in the quarter. This puts our leverage well below our targeted level of 1.5 of EBITDA. Let me wrap up by discussing our outlook, which is found on page 10. Based on year-to-date results and our expected range of results for the fourth quarter, we are narrowing our full-year earnings guidance to a range of $3.90 to $4.05 per share. At the midpoint, that is 60% growth over last year's adjusted EPS. We now expect full-year revenue growth of approximately 10%. In the fourth quarter, we do expect a step back from our revenue and earnings run rate over the past three quarters. Some of this is driven by our normal seasonality in our business. The winter slowdown in construction activity mainly impacts our framing systems, which is the most profitable of our architectural segments. This year, we are planning extended maintenance shutdowns at a few facilities and framing and large-scale optical segments. This will negatively impact revenue and profitability in the fourth quarter. We also expect interest expense and healthcare costs to remain headwinds in the fourth quarter. Even with these headwinds, we expect to close out the fiscal year with a lot of positive momentum in our business. We are positioned to drive continued progress toward our financial goals in the year ahead. With that, I'll turn it back over to Ty for some concluding remarks.

Thanks, Mark. To wrap up, our team continues the successful execution of our strategy, delivering sustainable financial results. We are transforming Apogee into a higher performing, more resilient company, which is demonstrated by our financial results over the past year. We've raised the bar for both margin and earnings performance, with year-to-date adjusted operating margins improving by 350 basis points and year-to-date adjusted EPS up nearly 100%. Even with this significant progress, we're confident that we have more runway ahead of us to drive further progress toward meeting and exceeding our financial goals in the years ahead. Let me close by congratulating the entire Apogee team on their continued success and wishing everyone an enjoyable holiday season. With that, we are ready to take your questions.

Certainly. As a reminder, to ask a question, you can press star 1 and 1 on your telephone. Please wait for your name to be announced. One moment. And our first question will come from Chris Moore of CJS Securities. Your line is open.

Good morning, guys. Congratulations on actually a great three quarters, but a great Q3. Maybe just start with the revenue growth there. So 10% growth in Q3. Can you give just kind of a rough split between price and volume there?

Yeah, this is Mark. The growth actually this quarter was primarily, in fact, all driven by price because our volume was actually down slightly. So primarily it was price. But remember in glass and AFS, we have stepped away from some profitable, some non-unprofitable work or less profitable work. And those are the primary drivers of our volume shortfall.

Got it. That's helpful. In terms of the services backlog, down a little bit sequentially, that can jump around, as you talked about. During Q2, I know you had project wins in transportation and healthcare. Just wondering if there are any kind of sub-segments that are driving current business and also just kind of the pricing of these new contracts. How would you characterize them?

Yeah, Chris, this is Ty. I would look at it. Again, there's choppiness, as you note yourself, and we've commented that that's been kind of a theme throughout the year. So having a strong couple of months followed by a weak month or two. In this case, it kind of piled up and ended up being a down quarter from a backlog perspective. We continue to have the team's focus on diversifying within that backlog. So, you know, we made a significant step change in kind of the reduction of the exposure to office in that backlog last quarter. The team continues to work to diversify that mix as we go forward. Because we didn't have a lift in backlog, I would say that that mix hasn't materially changed from what we talked to in our Q2.

Got it. That's helpful. Appreciate it. And last one for me, just in terms of the operating margin progression that you're seeing. Assuming fiscal 23 is somewhere in that 9%, range. Just looking at 24, even if markets kind of soften a little bit further, do you still expect any improvement in operating margin 24 versus 23?

Yeah, it's a great question. Of course, we're not ready to talk about fiscal 24, but as I alluded to in my comments, we've made sustainable improvements. in our execution and how we're driving productivity across the organization. Price has been a factor, but that price is also driven by us focusing on higher value product offerings and products and services where we can show the differentiation and the value to our customer base. So as we step into fiscal 24, we still see a lot of runway to continue that work. I still put our lean efforts in the very early stages. Glass has probably made the biggest step change and probably gets tougher for them to drive a significant step up in margin through those lean and productivity efforts. But in our framing business, while they did get some one-time benefits, we don't expect to repeat that roughly $5 million in Q1 and Q2 on inventory valuations. there's a lot of opportunity there to drive significant productivity to offset that and put us in a good position even in a soft market.

That is very helpful. I will leave it there. Thanks, guys.

Thanks, Chris. One moment. Our next question will come from Eric Stein of Craig Halem. Your line's open.

Good morning, everyone. Thanks for taking the questions. Good morning, Eric. So just curious, I know you have the slide where you're talking about a new baseline that you've established, you know, and it's roughly 90 cents a quarter. In the past, and this is, you know, under previous management, you know, there had been a target or thoughts of, you know, what can this business do regardless of the cycle? And so I think, you know, obviously timely given that you're seeing a little bit of softening I mean, is there any way that you think about what that new baseline is beyond where we are currently? But given that you're early in a lot of your initiatives, you know, if you look out a couple of years, do you have sort of a thought of what that new baseline might be, regardless of where things are in the cycle?

Yeah, Eric, it's a great question. I guess I would start with, you know, what we laid out in Investor Day. So our first step is to get the company to greater than 10% EBIT as a whole. And clearly we're tracking to that, you know, this year. And we haven't seen any significant volume lift in the work that we've done to get to this 9% range. So as we go forward, I think we continue to perform I think we've definitely raised the level in terms of if there is softness in the market. We haven't set a number, but we don't see as big a dip. If you go back to those ranges that we guided across the segments, so framing would be the big one, and that's outperforming this year. We had guided to 9% to 12%. They are actually running ahead of that. I think it's realistic that barring a significant fall-off, in the market that would drive volumes significantly down that we're probably going to see them now hover in the higher end of that range as we move ahead. That lifted their baseline bottom performance, if you will, even in a down year. So that 9 to 12 as an example, 9 is in a really soft year. We feel like we've got enough controls in managing our operating costs that even in a material down year that we should be able to, you know, keep to at worst case that 9%. So I think as we're stepping into fiscal 24 and as we start to look at our guidance for that, we'll take an evaluation of where the market, where we think the market is going to play out. And then as we look across the businesses, you know, how we see those ranges performing, you know, in fiscal 24 and at some point probably have to revisit those long-term goals that we laid out a year ago.

Got it. No, that's helpful. And then maybe last one for me, just obviously not ready to call specific ranges for fiscal 24. But in the past, you've talked about kind of visibility beyond backlog bids and process awards, not yet booked, et cetera. So just thoughts on, you know, maybe the confidence that gives you heading into fiscal 24.

Well, one, we'd start with, you know, we referenced FMI as one of the firms that we looked at forecasts, and we talked about wanting to outperform the market and using that as a base. You know, they've had a revision just in the last month or so. They're still calling for growth in calendar 23 of about 4% in non-resi. You know, and that's the bulk of our fiscal 24 would fall into calendar 23. So we see that as a positive. We continue to see choppiness in bid activity and award activity. So that's something that we'll continue to monitor because for us, that would be a leading indicator of, yeah, the market does look like it's still poised for growth as we go into next calendar year, or we start to see some signals that maybe it's softening. Right now, we don't have any data that would argue against that projection by FMI. I mean, it looks to us, just given the backlogs that were built up and the activity that was started in the past year, that we're probably going to still see growth, certainly on a dollar and probably even on a volume basis, but certainly on a dollar basis, that non-resi construction is going to see growth in calendar 23. Okay, thank you.

One moment. And our next question will come from Brent Thielman of DA Davidson. Your line's open.

Hey, thanks. Good morning. Hey, Ty, the strategic shift in the glass business has been a big focus since you came in, and it looks like it's paying off. I'm just interested in the quality of work that you're adding to You know, how buoyant is that kind of new focused market in terms of activity? And maybe just what surprised you as you've taken this initiative on in this segment through the results of the last few quarters?

Yeah, good morning, Brent. That's a great question. You know, this is really the first quarter where we started to see some of the mixed shifts starting to add to the profit performance. I think that is still an opportunity as we go into fiscal 24 for glass, the bulk of the earnings and margin improvements that you've seen this year so far in glass has been through the productivity efforts and sustaining during cost savings benefits that you know we had took a year ago. So as we step into F24, we're seeing good bid quote activity. We're seeing good award activity that is pointing to that mixed shift being a tailwind for the business. And we're not there in terms of, from a glass standpoint, we're interested in seeing that shift occur. So we're not asking them to drive meaningful volume growth. We'll take the positive volume, but we want to continue to see that margin perform by selling those higher value products. And what that'll lead to is a higher average selling price per square foot because they're selling a higher value product at the end of the day. So we started to see the early signs of that and we feel pretty good as we look at what they are starting to build in their award backlog now.

Hey, Ty, is there a way for us to think about, you know, through what you executed in the quarter, what percentage was the higher value sort of product versus maybe still kind of the lower value stuff you're trying to work through the business?

Well, I would say that, you know, just as I commented earlier, I wouldn't break that out per se, but the point being that most of the margin gain you've seen in glass year to date is almost entirely restructuring cost savings benefit and productivity through lean efforts in our Otana facility that is paying dividends. So I think as we step into F24, I think it's going to be tougher for them to make the kind of step-up change they had in margin through productivity. So as we start to go into F24, any kind of margin improvement is probably more so going to be attributed to that mix shift.

Yep. Okay. Helpful. When do you anticipate exiting some of the lower margin markets? soda wall projects. And then when you look at the mix of business being added to the backlog and services, which I assume a lot of that gets executed kind of next year, does the profile of that work kind of support a return to that sort of high single-digit annual margin in the segment?

I think there's two elements in there with respect to soda walls. So, one, If you look at the integration work that we're doing on SodaWall, we believe that we will continue to see some productivity and efficiencies gained through that integration, which is well underway and the bulk of that will be behind us, certainly as we get through Q1 and into Q2 of next year. From a margin degradation perspective, remember that our Harmon brand within services A lot of the jobs being executed this year and at least early onset of our next fiscal year were jobs that were during the very depth of the COVID pandemic when business really started to slow and fall off. So as they were winning that business, there was certainly margin pressure. So we expected the Harmon Core business to have some margin challenges in this fiscal year and a little bit into our fiscal 24. So I think it's a combination of those two things that you're seeing show up, soda wall being the bigger drag. As we move forward, I think we are looking that we should see continued improvement in the margin overall, getting back up into that high single digit. We'll have to see how we do from a productivity and efficiency standpoint, but we're looking now at kind of the jobs that they're winning that are starting to – actually run through fiscal 25 into fiscal 26. And there we're starting to see some of that margin improvement come back because there has been strong demand over the past 12 months as they've gone through that bid activity.

Okay. Just one last one back on framing. It looks like aluminum prices have sort of been re-accelerating here recently. Just curious if the market has been sort of receptive to your ability to push that through, pass that on.

Yeah, we've been very aggressive, but at the same time, making sure that we're staying competitive from a price standpoint. So in many cases, we were actually leading the market in making price adjustments based on those high costs. To our knowledge, it appears that most of the competition has done the same or similar over time. So we feel that we're in a good position now, and we've changed our pricing model, our ability to flex more quickly, especially on the short cycle business. That puts us in a good position to be able to manage this. That said, we also want to stay competitive. We want to make sure that we're winning business and that we are focused to drive volume within framing, particularly in our storefront and finishing business, which has some nice margin profile that we want to make sure that they're continuing to grow. So I think we're in a good spot and don't see any major challenges right now in how we're managing that.

Okay. Thanks, guys. I'll pass it on.

Thanks, Brent.

Again, ladies and gentlemen, if you do have a question, please press star 1 and 1 on your touch-tone telephone. Our next question will come from Julio Romero of Sidoti & Company. Your line is open.

If you could talk about the large-scale optical segment. I know the third quarter can always be tricky. in terms of sales lumpiness? Did you maybe see any lumpiness one way or the other in the quarter that would lead you to have either a stronger or weaker fourth quarter relative to maybe your expectations three months ago?

Well, I think the one thing, good morning Julio, this is Ty. The one thing I'd remind is, as Mark highlighted, they did see a benefit from a tax rebate, from a property tax recovery. So that affected their income for sure in the quarter, and obviously that's not going to repeat. They tend to see a little bit softer Q4 because as you have holiday demand, that's usually pulling in our late Q2 and a chunk of our Q3. So we expect that we naturally are going to see a little bit of softness from a revenue perspective in that business. The other thing I'd highlight is just given how they've performed through the year and we are making some capital investments there, We also expect in Q4 that we're going to take some longer downtime that is in our plan at one of their core facilities for maintenance. I think, you know, in the past couple years, you know, we've done kind of three to five days and not just in LSO. We've got a couple other sites that we're looking to do seven to ten days of maintenance downtime, kind of taking advantage of where we're sitting right now and how we've recovered from an overall service level perspective. So that's going to impact them a little bit. both from a revenue and a margin perspective in Q4.

Okay, that's helpful. If you could talk about the framing segment a little bit and how the window and wall portion performed and maybe just talk about the runway for margin improvement going forward within the window and wall portion of the segment to the extent that you can.

Yeah, so I mean, obviously we don't give any financial details on the business units below the segment level. I will say that within window and wall there, that is one of the areas that we have, you know, walked from some less profitable product offerings. So they've seen some year over year negative volume with respect to that. When we look at framing as a whole, even storefront and finishing, which is performing well, kind of at or above our margin expectations. In both of those businesses, we actually see some significant opportunities with our lean initiative to drive productivity and efficiencies in the facilities. Probably a bigger upside opportunity to help improve margins in our window and wall, but we also see some of that opportunity within storefront and finishing. That's helpful, especially to try and offset some of those one-time gains they had in the first quarter and part of the second quarter of this year.

Great. Thanks for taking the questions and happy holidays. Same to you. Thanks, Julio.

And I'm showing no further questions. I would now like to turn the call back to Ty Silberhorn for closing remarks.

Well, thanks again for joining us today. I want to remind everyone that we'll be back in a few months to wrap up our fiscal 24 and our Q4 earnings call and give you our outlook for fiscal 24. Until then, enjoy the holidays, and I wish everyone a happy new year.

And this concludes today's conference call. Thank you for participating. You may now disconnect. Speakers, please.