Apogee Enterprises, Inc. (APOG) Q3 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Q3 Fiscal 2013 Apogee Enterprises Inc. Earnings Conference Call. My name is Kirstie, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. I'd now like to turn the call over to Ms. Mary Ann Jackson. Please proceed.

Thank you, Kirstie. Good morning, and welcome to the Apogee Enterprises fiscal 2013 third quarter conference call on Wednesday, December 19, 2012. With us on the line today are Joe Puishys, CEO; and Jim Porter, CFO. Their remarks will focus on our fiscal 2013 third quarter and our outlook for the remainder of fiscal 2013. 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 risk 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 March 3, 2012, and in our press release issued yesterday afternoon and filed on Form 8-K. Joe will now give you a brief overview of the results, and then Jim will cover the financials. After they conclude, Joe and Jim will answer your question. Joe?

Thank you, Mary Ann. Good morning, everyone, and welcome to our third quarter fiscal '13 conference call. I'm very pleased with our third quarter earnings, which were certainly better than expected. We earned $0.28 a share, up 40% from the $0.20 per share earned in the prior year, same period. Our net earnings, which were up 45%, came in even stronger than we had forecasted as the architectural segment successfully executed a more favorable mix of complex work in the quarter. Operations at all 6 business units also performed well in the quarter, contributing to our better-than-expected results. At the same time, we achieved 9% revenue growth in the third quarter even though our end markets have yet to improve. As a result of our third quarter performance, we have increased our outlook for fiscal 2013 to earnings per share of $0.62 to $0.67 a share range from continuing ops on revenue growth of 5% to 6%. Apogee's year-to-date earnings from continuing operations are $0.51 per share, compared to $0.06 a share in the first 9 months of fiscal '12. Revenue growth year-to-date is just over 5%. We've been able to show strong profitable growth in fiscal 2013 through share gains, pricing, improved mix and good operational performance, all without help from our end markets. Apogee's architectural segment continue to show significant improvement in this quarter. All 5 business units in this segment grew operating income in the quarter, contributing to year-over-year segment operating margin improvement of 310 basis points. The improvement resulted from higher architectural glass pricing, improving installation margins, better mix and good operational performance. Within the architectural segment, revenues grew 11%. All of the architectural businesses grew year-on-year, with the installation business showing the greatest growth. And I am pleased with the conversion on this incremental revenue to income in the architectural segment of 35%, with all 5 business units converting well. Our architectural segment backlog held at $300 million from the second quarter, as we grew revenues in this segment by double digits. I am particularly encouraged that our bidding activity continues to be good. And that we're look -- that we are looking at more complex projects that lead to better margins. In Large-Scale Optical segment, picture framing business, revenues and earnings, which were up year-to-date, even though third quarter results were down compared to a very strong prior year period. Although the quarter was impacted by the timing of customer promotions, the segment operating margin was 30.3%. Our capital expenditures have increased this year as we focused on productivity and growth investments. And in some cases, we've taken advantage of strategic opportunities on equipment purchases that will support our future growth. Year-to-date, we've invested $21.3 million, compared to $6.2 million in the first 9 months of the last fiscal year. Our cash and short-term investments position stands at $75 million, an increase of almost $30 million year-on-year after capital investments for the aforementioned productivity and growth. Turning to our outlook. As I noted in my opening remarks, our continuing operations' earnings outlook for fiscal 2013 has been increased to $0.62 to $0.67 per share for the full year after stronger-than-expected third quarter earnings. We've also articulated a more specific outlook for revenue growth and we expect to be up 5% to 6% for the year, again, outperforming our end markets. McGraw-Hill has pushed out the expected recovery of the U.S. non-resi construction markets to the middle of our fiscal '14, which is the second half of calendar year '13. For the full year, we expect to spend about $30 million in capital for investments to drive productivity, growth and capabilities. At the same time, we continue to look for long-term investments to support our future growth and capabilities. I am optimistic about our longer-term opportunities. I believe that our focus on operational improvements, as well as our strategies to grow through new geographies, new products and new markets, will allow Apogee to continue to deliver improving results. Jim Porter will now cover our financials in more detail. Jim?

Thanks, Joe. We had a strong third quarter performance and continued weak end markets. We earned $0.28 per share, compared to $0.20 per share last year, exceeding our prior year performance, again, as we expected. Apogee's gross margin improved 230 basis points to 22.2%, up from 19.9% in the third quarter of last year. The improvement was driven by the architectural segment, where we had a number of positive things going on: Higher architectural glass pricing, improving installation project margins, a more value-added and complex mix of work, higher capacity utilization and solid operational performance. Gross margin is up about 170 basis points sequentially from the fiscal 2013 second quarter as a result of better mix of value-added products and projects, flow of installation projects, along with slightly higher capacity utilization. Our architectural segment had third quarter operating income of $5.8 million, an increase of more than $5 million from earnings of about $600,000 in last year's third quarter. Segment revenues grew 11%. All architectural businesses grew, with the largest increase from our installation business, which has been gaining shares that expanded into new domestic geographies. Third quarter architectural segment capacity utilization ended at about 64%, up slightly from 63% in the second quarter and from 60% in the prior year period. As our capacity utilization increases with architectural segment growth, we are better leveraging our fixed assets and have the opportunity to expand our margin. At $300 million, we essentially maintained the value of our second quarter architectural backlog. Segment revenues grew double digit in the third quarter. And we replaced these revenues and backlog with a good level of new orders. Our backlog remains at the highest level in over 3 years. And on top of that, we continue to see good bidding activity. We feel good about the backlog level and continue to believe that it is on an upward trend and improving margins. As usual, I want to remind you that our business can have lumpy order intake activity, so we don't require sequential backlog growth each quarter to be consistent with the longer-term trend. Our backlog mix at the end of the third quarter changed slightly from the second quarter as we saw a positive shift of approximately 5 percentage points from the institutional sector to the office sector. The institutional sector, education, healthcare and government declined slightly to just over 55% of the backlog as we progressed on existing projects. Healthcare projects make up a much larger portion than education and government work. At the same time, the office sector increased to just over 30% of the backlog. Multi-family residential, including high-end condos and apartments, is under 10%. While hotel, entertainment, transportation and retail are roughly 5% of the backlog. Regarding the timing of the backlog, approximately $111 million, or 37% of our backlog, is expected to be delivered in the fourth quarter of this year. And approximately $189 million, or 63% of the backlog, is expected in fiscal 2014. We have some nice visibility into the next fiscal year, which is slightly better than it was at this time last year. Our Large-Scale Optical segment continued to make significant contributions to Apogee's performance. There was a small decline in both revenues and operating income in the third quarter. This part of Apogee's business is impacted by the timing of retail promotional activity. In addition, we have roughly 15% of our Large-Scale Optical sales are the customers in the Northeast. And we did see some impact from the super storm, so quantifying it with specificity is difficult. All that said, we remain enthusiastic about the overall performance and potential of this business. Revenues for the Large-Scale Optical segment were $21.6 million, down 5%, and operating income was $6.6 million, down 12%. But operating margin was 30.3%, compared to 32.5% in the prior year period. Our cash and short-term investments at the end of the second quarter totaled $75 million, compared to $68.3 million at the end of the second quarter and $79.3 million at the end of fiscal 2012. We have a positive free cash flow of $6.9 million during the third quarter, compared to $7.4 million in the prior year period, when capital expenditures were quite low. Our year-to-date free cash flow is slightly positive at $1.8 million, significantly better than last year, with the higher level of capital expenditures in the current year. We define free cash flow as net cash flow provided by operating activities minus capital expenditures. Our noncash working capital was $59.9 million, compared to $44.4 million at the end of fiscal 2012 and $70.9 million in the prior year period. Our team continues to effectively manage working capital with our days working capital at 43 days, compared to 50 days in the prior year period. We define noncash working capital as current assets, excluding cash and short-term investments, less current liabilities. While days working capital is defined as looking at our controllable working capital assets and liabilities, accounts receivable, inventory and accounts payable. Now I'll turn to our outlook. As Joe noted, with our strong third quarter earnings, we are increasing our full year guidance for earnings from continuing operations to $0.62 to $0.67 per share, up from $0.56 to $0.64 per share. The outlook from McGraw-Hill for our specific end markets continues to be slightly negative for our full fiscal 2013. Despite that, we are continuing to expect 5% to 6% revenue growth for the year as our architectural businesses maintain share gains, including the domestic geographic growth at our installation and storefront businesses. This implies a fourth quarter sequential decline from the third quarter, but continues to show growth over last year. And this outlook is based on the visibility that we have of estimated project timing. We continue to expect full year gross margins of approximately 21%, which is where we're at year-to-date. We anticipate a tax rate of approximately 33% for the full year. I would like to note that last year's fiscal 2012 fourth quarter earnings of $0.11 per share included a tax benefit of approximately $0.05 per share from resolution of discrete items. We are not expecting similar benefits in the fourth quarter of the current year. We continue to expect to generate positive free cash flow for fiscal 2013 after spending approximately $30 million for the full year on capital. Depreciation and amortization should be approximately $27 million. Apogee's balance sheet remains very strong. I'm encouraged by our strong execution to date, and I look forward to continuing year-on-year growth as we conclude fiscal 2013. I also look forward to future opportunities that will leverage Apogee's strong financial position, leading products and services and operational and strategic initiative. I want to extend best wishes for a great holiday season to everybody. Joe?

Thank you, Jim. Kirstie, if you could please offer the participants the opportunity to call and repeat the instructions for getting a question for me or Jim. Thank you.

[Operator Instructions] And stand by for your first question, which comes from the line of Bob Kelly from Sidoti & Company.

Just a question -- you talked about the visibility into F '13 is a little bit better than it was coming into F '12. What does that mean specifically, just as far as what you have in backlog? Are you hearing something different from your customers this year compared to last?

Yes. It's primarily -- it's really a combination. But primarily, when we look at our backlog, what's in our backlog, looking out into next year, both in terms of the value of the backlog as well as in the margins in the backlog, I think our view, as bidding continues to be good, I would say it's probably more consistent at this point last year, but really the backlog value.

Okay, great. And then just as far as the low margin installation work that you've referenced in prior quarters, are we still running that off? Are we -- has that completed? And then a project that goes into backlog during your fiscal third quarter, how does that compare margin-wise to what was added, say, a year ago?

Bob, the trend continues with similar year-over-year comps. The third quarter margin and backlog which was up about $1 million, as Jim noted and I noted, about $300 million, essentially flat. A significant portion of that is the installation business. The margins and backlog in that business are up a couple of hundred basis points from the same backlog last year. That's a similar story from the prior quarter when we compare that. So we continue to see improvement in the range of 100 to 300 improvement in basis points, trending slightly better as we move forward. So we are beginning, obviously, to see some impact on revenues, but we're on the front end of that improvement.

Okay, fair enough. And then just as far as -- during the Analyst Day in November, you talked about some productivity enhancements. Would that -- would those -- I know we're early on in those projects. When they start to payback for you, are they additive to the kind of the plus 100 to 300 backlog improvement? I mean, is that the way to think about the productivity enhancements?

We're targeting approximately 100 basis points a year in operating income enhancement from operational improvements. They -- that's all-in. Meaning, productivity investments we're making through capital, through automation, as well as through our Lean Sigma initiatives. So bottom line is, our target is about 100 basis points of margin a year from operational enhancements.

Right. No, I understand that. I'm just -- that's over and above -- it sounds like all else held equal. Your architectural backlog or the margins that you're going to run through the P&L are anywhere is from 100 to 300 basis points better than a year ago. The...

Yes, additive. It's additive to that.

Again, the margin and backlog primarily driven by our projects business, which we really don't have significant operations there.

Your next question comes from the line of Brent Thielman from D. A. Davidson.

It seems like LSO had some isolated events that sort of impacted Q3. And I was just wondering, in your guidance, are you expecting sequentially lower contributions from that business in Q4, like we'd typically see? Or do you think it actually could be a little bit better?

I'll answer at a high level, we did not find the third quarter a trend. It is a seasonal business. Last year, our first half was -- our second half was much stronger than our first half, so our comps are harder in the second half than the first. Year-to-date, that's a business that's up mid-single digits as well, and the operating margins are improving. The third quarter is not a trend. Whether or not we'll beat the fourth quarter, again, it's a business where we don't have a backlog and it all depends on how the promotions work at our customer level. But I have no concerns about that business.

And Brent, despite being slightly below last year, we do anticipate the normal seasonality to hold, which means Q3 is stronger than Q4.

Your next question comes from the line of Tom Sepenzis from Northland.

I'm just curious in terms of the guidance, the range that you've given of $0.62 to $0.67, obviously, up from the prior range, but it does look like that the -- that would kind of dictate an $0.11- to $0.16-quarter in the February quarter, which is below the current consensus of $0.19. I just want to make sure that I'm reading that correctly.

Yes, you're reading it correctly. We are projecting improvement year-over-year. Jim pointed out correctly that we did have some tax pickup last year. We certainly talked about that a year ago. We wanted to remind folks so that they remember the year-over-year improvement is actually slightly better than what's on paper. But I think you've read it correctly.

Okay, great. So there's nothing in the business that's causing that. That's mainly just due to the tax implications on, from -- that you're not benefiting from this year?

We -- I would say the business results are allowing us to increase our guidance and to basically count on another quarter of year-over-year improvement. I guess the debate is how much, and we've given you what we believe.

Yes. And Tom, as you know, I mean, the biggest uncertainty in our business is just the timing of activity on construction projects. And that impacts both what's actually going to end up flowing in Q4. And then there's a lot of variation within the mix of the actual projects too. And so it's really just the variation in our outlook is really more a function of the work that we have visibility to and how the timing of it actually flows.

And Tom, I would just like to add for you and probably the whole audience, my view of what will happen come the end of this count fiscal year, with regards to tax increases and spending, is no more accurate than anyone else's, including yours. But I'm a firm believer that if we can get some certainty, whatever the news is right now, the key word is that the end markets are uncertain, and uncertainty leads to people sitting on the bench. We certainly feel there is pent-up demand and there is clearly projects that are on hold. I think with certainty, the economy will begin to improve, regardless of the results. So again, with all those variables out there, we cannot predict what's going to happen in our end markets, but we do expect a soft first half next year to give to you. And hopefully, the second half will start to see a possible buildup in our architectural side.

Great. And can you just talk a little bit more obviously, you've had some a pretty good success in the installations business, and I'm just wondering how much Brazil is weighing on that? But maybe if you could provide us a little bit of commentary on what you're doing down there in South America, that would be helpful.

We don't do business in South America or, in fact, outside the United States on the installations side. We do have our glass fabrication business in Brazil, which was acquired approximately 2 years ago. And that business continues to perform well and is continuing to drive year-over-year increases. Jim is pretty familiar with the Brazil market. It does -- the economic indicators in Brazil, although they kind of ebbed and flowed a little bit this year, it's certainly better than the economic indicators here, and our end markets continue to show improvement in Brazil for the architectural glass business.

I would just like to add, Thomas, as you -- I mean as Joe said, it's a great end market. Our business continues to perform well down there. And actually, in local currency, it's growing nicely. We do have some headwinds from an exchange rate perspective, that's just the smaller part of our business today, but things are going well. We're excited about it.

So then most of the growth in the installations has been in the Southwest and Texas area? Is that fair?

No, that's a contributor to the growth. But it's really growing both in existing markets and in new markets. And new markets includes Texas, but our strategy in that business has also been to pursue attractive projects even if they're outside our core markets. For example, we've got some attractive work going on in New Orleans today, too. So it's both current and new market.

[Operator Instructions] Your next question comes again from Bob Kelly from Sidoti & Company.

I wanted to get a follow-up in. As far as what you have in backlog from some of the new product and the new market initiatives that you outlined during the November Analyst Day, could you help us out where you are with the retrofit opportunity pushing more demand with the ESCOs? What maybe percent of the growth in backlog is coming from new product introduction?

Yes, 2 questions there, Bob. The retrofit initiative is obviously, one of my top priorities. We're just in the infancy of that. We have hit -- got on the scoreboard with several projects, but they are insignificant to the total $300 million backlog. But we are starting to gain traction. I do believe for fiscal '14, it'll have a bigger impact and we'll be calling that out. New products, we had been a little bit behind on new product introductions. So again, our activity level now, which is really as high as it's been in quite a long time, is beginning to gain traction. And dollar wise, it helps to contribute. It's again a small, probably less than 15% of the backlog. But if things we're introducing are more complex, whether it be hurricane or glass products, new coatings and new capabilities, that drive more attractive margins. So the impact on margin is the key here as opposed to the dollar value.

Your next question comes from the line of Jon Braatz from Kansas Capital.

Joe, you talked a little bit about improving the mix of business, higher value-added products. When you look at the backlog, today about $300 million, I think it was, how would you characterize sort of that $300 million in terms of higher value products and compared to maybe where you might have been a year ago?

We have different tiers of products and complexity in most of our businesses, and we've moved the needle on that. It's hard to give you an answer on the number. But of the $300 million, I would say single-digit percentage point improvement in complexity. But that's a general statement because complexity for our glass business might be having a digital print capability, which we didn't have. And that is significant. Maybe a different finish in our aluminum business, which is less significant, but very important to that business. So it's definitely moving in the right direction.

Okay. How much more of a margin do you earn on those more complex projects? Is it a couple of -- I mean, a couple of hundred basis points? Or can you give us a sense on what...

In the installation business, a couple of hundred basis points. 300 basis points is a reasonably accurate number to say a more complex project, where you'll have fewer competitors, more of the national players and fewer of the local installers in the products business. Again, we're probably talking in the 100 to 500 basis points in margin enhancement.

Your next question comes from the line of Alan Brochstein from AB Analytical Services.

Let me echo, a great quarter. I just had a question about the LSO business. Early in your tenure, you talked about a real opportunity to expand to Europe. I was just wondering if you could update us how that's playing out so far?

Sure. As I told you, I love this business. We have a very good presence in the U.S. and incredibly strong relationships with our customer base. That business, too, continues to launch new products, which help drive a better mix. We did enter Europe this year. We now have approximately a few -- a little bit more than one dozen distributors signed up. And we expect to pick up a couple million dollars of revenue, I'll use a round number, so relatively small to the total scheme, but not insignificant to that business. And we believe that will continue to grow. The market is smaller than the U.S. But it's still a significant market, so we're off to good start. We have locked up our logistics capabilities through distribution and warehousing. And we continue to add distributors and we have brought on a couple of executives this year to help drive growth in that business, which I'm confident we will.

And as Joe said, we've really increased our presence and our penetration, keep in mind it's in the context of a very difficult economic environment, where discretionary spending is impacted. But I think we're establishing a nice platform for that market.

Fantastic. And then another question. As far as acquisitions, what's the likelihood that you guys will do an acquisition in fiscal '14? And do you have any that you're looking at now?

We have a strong pipeline of opportunities we're looking at in several of our businesses. I would be -- that would be inappropriate on my part to say we'd get a deal done. I would -- we have the capacity, I'd said it before. I'll walk away from 10 good deals before I do a bad one, so we will be smart in how we go about this. The team is active. Yes, there are properties we're looking at. But of course, the odds of getting a deal done are always low. And a lot of properties have not been performing well in a down market and a lot of people don't like to sell at the bottom of the barrel. So it does take a leap of faith that things will get better, and so we're very aggressive and looking at opportunities. We'll be very cautious and conservative in valuation. So I cannot predict whether we'll get a deal done, but we're certainly active. And even if we don't get a deal done, Alan, we learn a ton with the process.

And do you think it would be more likely that this would be more international expansion or domestic? Or it's -- or either?

Alan, I really can't comment on that. We are not locked in on one region, I'll just say that.

We have no further questions queued at this time. I'd now like to turn the call back over to Joe Puishys for closing remark.

Okay, Kirstie. This is Joe. Listen, everybody. Thank you for listening in to our call and hearing our story. We appreciate your time and attention here and Jim and I will get back to the business and continue to drive growth. So thank you for your attention today. Bye-bye.

Thank you. And thank you for your participation in today's conference. This does conclude the presentation. You may now disconnect. Good day.