Apogee Enterprises, Inc. (APOG) Q3 2010 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 2010 Apogee Enterprises Inc. earnings conference call. (Operator Instructions) I would now like to turn the call over to Ms. Mary Ann Jackson. Please proceed.

Thank you, Veronica. Good morning and welcome to the Apogee Enterprises fiscal 2010 third quarter conference call on Thursday, December 17, 2009. With us on the line today are Russ Huffer, Chairman and CEO and Jim Porter, CFO. Their remarks will focus on our fiscal 2010 third quarter results and the outlook for the current year. During the course of this conference call we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and the current economic environment and are of course, subject to risks and uncertainties which are beyond the control of management. These statements are not guarantees of future performance and actual results may differ materially. Important risks and other important factors that could cause actual results to differ materially from those in the forward-looking statements and projections are described in the company’s Annual Report on Form 10-K for the fiscal year ended February 28, 2009 and in our earnings release issued last night and filed on Form 8-K. Russ will now give you a brief overview of the results and Jim will cover the financials. After they conclude, Russ and Jim will answer your questions. Russ.

Thank you, Mary Ann. Good morning and welcome to our conference call. In difficult market conditions, we achieved solid operating performance as we improved productivity and aggressively managed costs. We earned $0.39 per share on revenues of $179.8 million. Both earnings and revenues were down compared to the prior year period as the non-residential construction market continues to be impacted by tight commercial real estate credit and decreasing employment levels. A number of positive in the quarter were more than offset by low architectural segment capacity utilization and the declining mix of work bid and stronger commercial construction markets. The positives demonstrate our focus on operating well through this challenging cycle and helped us achieve an operating margin of 8.9% compared to 10.3% in the prior year period. They include we executed well, especially in our installation window and picture framing businesses. We continued to improve productivity and we have managed our costs in anticipation of lower revenues. In addition, we also generated approximately $40 million of cash flow from continuing operating activities in the third quarter, strengthening our financial position to weather the tougher times still ahead for Apogee. Turning to the segments, architectural segment revenues declined 28% and operating income decreased 51%. The architectural operating margin was 6.1% compared to 9.0% in last year’s third quarter. Although our markets are down significantly, we believe we are gaining share by winning institutional projects, including stimulus work, capturing most of the large projects that are going forward, winning smaller domestic projects and installation projects in new geographies, as well as growing our international export sales. The architectural backlog was $246.4 million, down from $295 million in the second quarter and $373 million in the prior year period. We have stated that we didn’t believe we were at the bottom of…

Thanks, Russ. Given the difficult market conditions, we are pleased with our third quarter operating performance. We made progress in improving productivity and also closely managed our costs. We earned $0.39 per share versus $0.63 last year. The prior year period of $0.63 included earnings of $0.06 per share for long-term executive compensation expense adjustments, primarily related to lower pay-outs of stock-based incentives, as well as a gain of $0.04 per share in equity and affiliates on the sale of Apogee's minority interest in the auto glass distribution joint venture. Gross margins were up from the prior year while Apogee's operating margin declined. Gross margins were 24.8% in the third quarter, up from 22.9% last year, with great project execution in our installation and window businesses, positive mix in the large scale optical segment, and improved productivity across the board, partially offset by the inability to fully leverage fixed costs over lower volume, primarily at our architectural glass business. Operating margins were 8.9% compared to 10.3% for the third quarter last year. This year’s margin was impacted by the inability to fully leverage fixed costs over lower volume, while last year included the pick-up from the incentive based comp adjustment already noted. The architectural segment operating margin declined to 6.1% from 9.0% the prior year, due to lower capacity utilization, the decline in portion of work bid in stronger commercial construction markets, and the fixed cost burden over these lower volumes. These factors more than offset productivity improvements and cost reductions. We estimate that about 40% of our revenue in the quarter had been booked in stronger markets, an expected decline from 60% in the second quarter. Architectural segment revenues were down 28%, although as Russ said, we believe we are gaining share in institutional, smaller project, and international work.…

Thanks, Jim. I am very proud of our employees and management team. They have been very proactive in managing costs and profitably gaining market share in this troubled economy. Apogee is in great shape to survive the downturn and thrive when markets recover. I’d like to now open it up for the Q&A.

(Operator Instructions) Our first question comes from the line of Tom Hays from Piper Jaffray.

I guess my first question is your guidance seems to imply a gross margin in the fourth quarter around 20%. Would you view this level of gross margin as reasonable to expect under the current pricing and competitive environment as we look towards fiscal 2011?

I’d say, Tom, in terms of the pricing environment, I think that’s consistent with our outlook and one of the key drivers, of course, in our gross margin is capacity utilization. In our Q4, we do have a little bit of a gap in terms of some lower capacity utilization than we expect in fiscal 11 largely in our window and installation business but depending on our ability to fill in and to be able to increase the capacity utilization, is probably the key variable.

Okay, I guess that kind of leads into my next question then -- is based on the declining backlog and you indicated it may fall further, as well as some market weakness. Where do you see utilization bottoming out in the cycle?

Utilization right now is about 55%. I think we will see some minor fluctuations around that. It doesn’t feel like it is going to -- you know, we know that we are now entering this on an annual basis the slowest time of the year and that seems -- so that seems to me to be an indicator, even sort of a floor for what we think we will see in the next year but you have to remember, it’s hard to see -- our visibility in the future is tough but that’s what it feels like today.

Okay, last question and I’ll get back in the queue -- you mentioned this quarter about 40% of the business was delivered in better times, in 2Q it was about 60%. Do you have any outlook as to what you think a fourth quarter number could be?

I’d say Q4 is probably 25% to 30% would be booked in prior times and then it’s essentially used up. There’s probably a few million dollars going into fiscal 11 that were booked back in that time period.

Okay, I appreciate it -- I’ll get back in the queue.

Your next question comes from the line of Eric Stein from Northland Securities. Eric Stein – Northland Securities: I was hoping we could just touch on the backlog and as you talked about, pretty substantial drop -- can you tell us, were there any cancellations in this number?

No cancellations -- we really haven’t seen the cancellation now for some time, for several months -- several quarters, yeah. Eric Stein – Northland Securities: Okay. Then can you just talk about -- I mean, the order level that you experienced in the quarter, I mean, should we think of that sort of level as -- any reason it would be a one quarter anomaly or is that kind of the level we should think about here in the near term?

You have to recall that our order entry can be lumpy and will be lumpy and so we have seen -- this was a quarter where it was down. We also have to remember, and so we could see larger projects come in later, especially some of these stimulus projects could really move this number around. And then we also have to remember the amount of book and bill business -- the book and bill business actually is remaining, because of our efforts, international and smaller projects, is staying pretty steady for us, has not been affected to the same level as the normal, what you normally see flowing through the backlog. So there are offsets. Eric Stein – Northland Securities: Okay, that’s helpful. Maybe last question and then I’ll just jump back into the line -- can you just give us kind of an idea of how much of that backlog is stimulus related?

My hesitation is two-fold -- one is I don’t actually have that number but one of the things that we are seeing is on federal projects, we can pretty clearly tie those activities back to the stimulus bill. We are also successfully winning a number of projects at local county and state levels which are indirectly coming through in terms of how the stimulus funding is flowing through to the states but I’d say we probably have maybe half of that backlog might be tied directly and indirectly to the stimulus.

I would agree with Jim’s assessment. I would also say to you that the timing of the dollars of the stimulus -- the bigger the project, the longer they are going to go, so we will see effects not just in 2011 but into 2012, so those stimulus dollars will be with us for a while. Eric Stein – Northland Securities: Okay, so you said half of your current backlog that you quoted, the 246 approximately is stimulus related in some way, shape, or form?

Yeah, maybe a third to a half. It might be closer to a third.

It’s material -- we just don’t know the exact amount. Eric Stein – Northland Securities: Okay, I appreciate it. Thanks.

Your next question comes from the line of Brent [Tillman] with E.A. Davidson.

Just wondering, on the large scale optical segment, you know, if you look back in fiscal 2009 and what looks to be the case here in fiscal 2009 or 2010, excuse me -- at least on an annualized basis, you’ve been running sort of in the low to mid 20s operating margin for that segment, and I’m just kind of curious as you sort of look out into fiscal 2011, is that a sustainable run-rate in terms of profitability for that segment?

In terms of the low 20s, yeah.

Yeah, okay. And then just trying to get a feel for the backlog but are you finding yourself sort of rejecting more projects out there that you don’t feel meet desired sort of margin levels? And then also -- I mean, are you seeing competition becoming more irrational sort of out there in the bidding environment?

I wouldn’t say that we -- what we see is when we see rational bidding, most of the projects are attractive to us. When we see irrational bidding, and that’s -- you know what, it appears that there is more rational rationality to the marketplace than one would anticipate, so I think we are actually being more successful today gaining share, although albeit at competitive margins, so they are still competitive but that does feel better about what we are doing. I just think that that’s -- it’s just a tough market. It’s harder. There are just fewer projects being bid. That’s just really the bottom line.

Okay, thanks, guys.

Your next question comes from the line of Eric Glover from Canaccord. Eric Glover – Canaccord Adams: You talked a bit about the retrofit market. I was wondering what percentage of your revenue this quarter was retrofit related. And then looking forward to fiscal 2011, what are your expectations for growth on the retrofit market?

Historically we have seen kind of roughly 25% of our business in retrofit. We are seeing a little bit of an increase in that both in terms of our current revenues and in terms of our backlog. Frankly that’s probably a little bit skewed by some of the federal projects that are retrofit in nature. I’m not sure that we are ready to say we are seeing the secular trend towards the drive in retrofit. We’re seeing a little bit of an increase but I think that’s a little bit more tied towards the stimulus as well as economic factors. Eric Glover – Canaccord Adams: Do you think that your retrofit business will grow next year or decline?

Well, I think the retrofit business will remain at least what it is today. I think that what you will see is if the government does indeed put some incentives on retrofit and continues to drive that, then we will see it become more of an important part. There is no question that the retrofit can substantially change the energy consumption on older buildings that are not very energy efficient. There’s a good reason to do those, so we still have to see sort of the money being attracted to that.

We do expect it grow some as a percentage of our revenues next year. Eric Glover – Canaccord Adams: Okay. Thank you very much.

Your next question comes from the line of Robert Kelly from Sidoti.

Just on the year over year change in the operating income for the architectural segment, could you just give us some help on how much cost savings helps you there, productivity, how much offsets those two kinds of issues, material savings as well, provided as far as kind of bridge the change in operating profit year over year?

First of all, for starters, Bob, in terms of the year over year, we do have roughly a half a point impact in operating margin from the pick-up that we had in our compensation adjustment prior year versus this year. But I think in terms of the factors in terms of order this year, I think what we see is capacity utilization partly offset by productivity improvements but not fully offset is probably the key factor. Starting to see some kind of pricing margin pressure flowing in and we’ve started to see the impact of that this quarter but I’d put them in that order.

Okay, great, that’s helpful. And just as far as the sequential movement in backlog, I mean, is there any -- it looks like you saw a drive in demand but is there any sort of seasonality that is causing the sequential drop in 3Q from 2Q?

There is some of that but I wouldn’t -- I would say it’s more the lumpiness that we see coming in that could be more of a factor.

Could you just kind of give us a little more help on the gap that you are seeing in 4Q? Jim had referenced it earlier -- the gap you are seeing I guess in your schedule, is that how we should think of it? Is it just like a one-time event? Just maybe some help there.

Well, I mean particularly where we have a little bit better visibility in our window business and our insulation business because of the lead time visibility that we have on projects. And in those particular businesses, we actually have a number of projects where we are actually have or are concluding those but then the new projects that we have in our pipeline don’t really start to flow until kind of mid-Q1 of next year. Now that’s not the whole business but I mean in terms of kind of a percentage of the mix of business, so we do have a little bit of what we hope is a one-time gap. But based on the visibility that we have in those particular businesses, we do have a little bit of increased excess capacity unique to Q4.

But were you to get some, or be more successful with the quicker turn business, you might be able to sell that gap and that’s kind of where your offset [surprises] have come in the past couple of quarters here? Is that the way to think about 4Q?

In terms of the ability to fill in with quicker turn business, less ability to do that in our installation business, as well as our core engineered part of the window business. You know, we have seen pretty steady demand and good success in the standard window portion of the window business, which is a quicker lead time associated with it. And so we will continue to fill that in but those factors are all included in our outlook.

Okay, and then just as far as new orders and the success you are having in institutional and some of the stimulus driven work, how do those margins compare to the rest of your backlog, the verticals of your backlog, and what proportion are using the value-add, the blast proof, the efficiency -- what have you?

The margins are mixed and certainly there are some that are tougher than others, and we know that they are -- overall they are being compressed from where they were in better market conditions. Value-added is showing up quite a bit though, especially on those most notable projects, value-added, whether it’s blast walls, all energy efficiency, things like that, are showing up and that really helps us to not only win the project but maintain it at some reasonable margin level.

The stimulus projects that frankly we are targeting and going after tend to be projects that include those value-added components, so they are really virtually all or a very high percentage of the include multiple elements of value-added characteristics.

Okay, great. And then just you’ve taken cost down quite a bit here in the last 12 months. What sort of wiggle room do you have for F11 should the market continue to go against you?

We still have some things, we still have some levers to pull, so we are not out of that yet but -- and it’s -- we’ve been -- we just continue to be very aggressive of keeping the organizations right-sized to the business that we have ahead of us.

We continue to look for opportunities in both variable costs as well as fixed costs but we are really keeping our eye on the market because we are as focused on F12 and beyond as we are on F11 and want to make sure that we maintain the appropriate infrastructure to really grow when the market recovers.

Yeah, we are not going to pull back on bringing new products, R&D, or keeping our facilities modern.

So at this point, it would be more on the variable side, yet you wouldn’t --

Right.

Okay, great. Thanks.

And some on the fixed side.

Your next question comes from the line of Michael Martin from the Small-Cap Report.

I just wonder if you could give us a little more color on the stimulus portion of the backlog. Is it likely that that percentage of the backlog will increase here? I mean, it seems that there’s a chance that the overall stimulus program spending could accelerate over the next year. Is that in your thinking?

Certainly if that spending does increase, we would anticipate being able to increase our business associated with that. We feel that we are able to win an increasing market share relative to what we have won generally in the past on these stimulus projects and we would expect to be able to continue to do that. We have not seen -- we are not aware that there would be a significant increase in that rate, at least we’ve not been made aware of it as yet.

Okay. Thank you very much.

Your next question comes from the line of Tyson Bauer from Wealth Monitors Inc.

A quick question in regard to your bidding margins, especially on the architectural side -- can you give us a comparison kind of how those are going? You talked about utilization capacity wise but in these bidding of those margins, how that compares to the last trough that you went through a few years ago?

I would say that so far we have been able to offset more of the decrease in bidding margin than we did in the last trough, and that’s been just a great accomplishment by our people and their ability to keep after decreasing their costs and increasing productivity. I think that we have an opportunity to continue that but it just depends on what direction the market takes. As we look at it today, we think we are going to be okay. We think we are going to be able to continue to offset some portion of that.

Given the gap you’ve talked about in the fourth quarter, and the guidance that you gave with [inaudible] on the different ranges, is earnings profitability then in question for Q4 and walking into Q1, and then we’ll see how things develop from that point forward?

I think as you do the numbers and as you’ve done that, you’ve been able to certainly see that that’s a possibility and I think it’s important for us to recognize that that’s a possibility but at this point in time, we also feel that our opportunities are better and give us the opportunity to still look at being profitable both fourth quarter and into next year.

Okay, and last question for me -- I see in November you made another round of headcount cuts at manufacturing facilities. Are you pretty much down to your -- as low as you can go or depending on how the market goes, is there more room for further cuts?

Certainly as the market goes, there would be room for more cuts. We would like to think that we are -- we are always trying to look ahead and make sure we are aligned for what we have in front of us and that’s what we see today, so as that may change, then we would be able to make some additional -- it doesn’t -- it feels reasonable at this point in time. That’s the best way I can describe it. We just don’t have that long-term visibility we used to have.

All right. Thanks a lot, gentlemen.

Your next question comes from the line of Frank [Bisk] from Pilot Advisors.

Could you just refresh me -- how much of your business in architectural is international?

International last year was about -- in 09 was about $20 million, 20, 25. This year it will be around 35, mid 30s. We think we can grow that again next year. It’s a small number but we think we can grow that and it will be a material portion of our glass fabrication business next year.

And that’s mostly Asia?

Mostly Asia, some South America, a little bit Middle East, occasional projects in Europe or Eastern Europe.

Okay, very good. Thank you, and then lastly just talking more about stimulus and I guess as we look forward, can you just kind of talk about what you are seeing or what the government is talking about? I guess you’ve gotten some decent stimulus work. I guess that’s not coming to an end and maybe just explain why, what’s out there, or what stimulus dollars have not been spent, et cetera?

I think what we are seeing in our markets is similar to what you are seeing I think kind of broadly reported is that there is still less than half of the stimulus dollars that have been spent or even awarded, and so we actually still see a number of projects in the pipelines, many that have actually been in the bidding process and not awarded, but also several of them that we know are on the boards but haven’t gone on to bid yet.

Okay, great. Thanks a lot, guys.

There are no further questions. I will now hand the call over to Mr. Russ Huffer for closing remarks.

Thank you for your time today and again, we appreciate it and we feel that we are in a great position to move ahead. Have a great day. Happy Holidays.

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect.