Apogee Enterprises - Q1 2024

Transcript

Operator (participant)

Good day, thank you for standing by. Welcome to the first quarter 2024 Apogee Enterprises Earnings Conference Call. At this time, all participants are in a listen-only mode. After the presentation, there will be a question and answer session. To ask a question during the session, you'll need to press star one one on your telephone. You'll hear an automated message advising your hand is raised. To withdraw your question, please press star one one again. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your speaker today, Jeff Huebschen, Vice President of Investor Relations. Please go ahead.

Jeff Huebschen (VP of Investor Relations and Communication)

Thank you, Liz. Good morning, and welcome to Apogee Enterprises fiscal 2024 first quarter earnings call. With me today are Ty Silberhorn, Apogee Chief Executive Officer, and Matt Osberg, 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 and slide deck we issued this morning. I'd also 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.

With that, I'll turn the call over to you, Ty. Thank you, Jeff. Good morning, everyone. Well, Apogee's team delivered yet another strong quarter. Our strategy and strengthening operational execution continue to drive results. This morning, I'll cover highlights from the quarter, how our strategy is driving sustainable improvements in our business, and our progress on this year's priorities. I'll turn it over to Matt for more details on the quarter and our outlook. The first quarter was a solid start to our fiscal year, continuing the positive trends we've established over the past several quarters. We delivered top and bottom line, sustained operating margins at 9.3% and had a strong cash flow quarter, with cash from operations significantly higher than last year's first quarter. These improved financials are underpinned by the strengthening operational execution across our businesses.

We are successfully managing the things that we can control. We're driving sustainable improvements through the Apogee Management System. We're maintaining a strong focus on cost management. We're improving key processes and systems across the company, and we're bringing more rigor and focus to how we are managing the business. Looking at the segments, Architectural Glass. Our glass team continued their impressive consecutive quarter sequential. I'll have more to say about the transformation of our glass business in a moment. Large-Scale Optical also had solid quarters, with strong execution, offset inflation, and improved sales mix as we continue to emphasize differentiated product offerings. Results in architectural services came in below our expectations. Work through a transition to better position the business for long-term growth and manage lower than expected profitability. We remain confident in our potential of the business.

Our Harmon brand is a recognized leader in its industry, with a strong market position and broad set of capabilities. As a reminder, in recent years, Services has outperformed its market, and we're confident we will see improved performance as we move through this fiscal year. Even with the softer than expected results in services, the first quarter was a strong start to our fiscal year, with our glass business outperforming the market due to their shift to premium and their continued operational execution. We are well positioned to build on our success from this quarter and increasing our full-year earnings outlook. Our improved performance continues to be driven by our 3 pillar strategy, referenced on slide 5 in our presentation. The performance of Architectural Glass over the past 2 years is a great case study of our strategy at work. Page 6 highlights the glass segment's transformation.

Operating under the Viracon brand, our glass business has long been an industry leader. We have a reputation for quality and service, deep relationships with customers and influencers, and a wide range of capabilities, including proprietary products. Even with those strengths, the glass segment had underperformed its potential. Through our strategy work, we identified two imperatives for change. We needed to build a more competitive cost structure, sustaining it with productivity, and we needed to shift our focus to the premium segment of the market that recognizes the value we provide. The team has achieved tremendous success in both areas. We've driven sustainable productivity improvements through the deployment of the Apogee Management System, our approach to lean and continuous improvement. Additionally, our facility rationalization reduced our overall cost structure without impacting our ability to serve customers in our target markets.

We repositioned the business as a leader in premium solutions, we aligned the entire organization to better serve this market. This included changes to our sales organization, leveraging innovation and partnerships to deepen our product offerings, and driving improvements in quality, service, and delivery to outperform customer expectations. This shift in market focus has led to a more favorable sales mix, improved pricing for the value we offer our customers, and new growth opportunities. The progress with our strategy is evident in our financial results. The team has delivered impressive margin gains and positioned the business now as an economic leader. Based on this progress, we are increasing our target margin range for glass, as shown on slide 7. Our new target margin range is 10%-15% on a full year basis, compared to our previous range of 7%-10%.

It's very encouraging that this quarter, 3 of our 4 business segments delivered margin above the target ranges we set at our Investor Day, especially given that we are still early in our AMS journey. As we move through fiscal 2024, our strategic framework positions us for further progress toward our financial targets and positions us to outperform throughout the market cycle. While overall non-residential construction activity remains healthy today, there are reasons for a somewhat cautious view of the market as we move forward. Higher interest rates, along with overall economic uncertainty, may impact construction activity for at least some period. However, through our team's efforts, we are transforming Apogee into a higher-performing, more resilient company. I'm confident that we will drive further performance gains as the year progresses.

Page eight outlines our priorities for the fiscal year, which we introduced last quarter, and this is where we will continue to focus for the remainder of the year. Our entire team is aligned on driving further progress to advance our strategy and to deliver continued performance. Now, I'd like to introduce Matt Osberg. Matt joined us in late April, and I'm very excited to have him as part of the team. He brings terrific experiences and perspectives, and he's established a strong record of creating value throughout his career. Let me turn it over to Matt to provide more details on the quarter and our outlook.

Matt Osberg (EVP and CFO)

Thanks, Ty. Good morning, everyone. I'm very excited to be part of the Apogee team and the opportunities we have as a company to continue to drive shareholder value. I look forward to speaking with many of you in the coming quarters. Before I review the results for the first quarter and our updated fiscal 2024 outlook, I want to take the chance to recognize Mark Augdahl for the work he did in the interim CFO role. Mark did a fantastic job leading the company through a time of transition. He has been extremely valuable to me as I have onboarded with the company. Great job, Mark. Thank you. Now, turning to our results for the quarter. The first quarter was a strong start to our fiscal year, building on the momentum established last year.

Consolidated net sales grew 1.4% to $361.7 million. The increased sales were primarily driven by strong growth in glass, which was up 27.5% compared to the prior year. As expected, this was partly offset by a net sales decline of 13.5% in services, 14% in the first quarter of fiscal 2023. Consolidated operating income increased 1.7%, primarily driven by strong sales and margin improvement in glass. The glass segment's operating margin was 17%, over a 10 percentage point improvement compared to the first quarter of last year, and reflects the impact not only of higher volume, but also benefits from pricing and mix as we execute our strategic shift to emphasize premium, high-performance products.

This result also demonstrates the significant operational progress that has been made with our initial deployment of AMS. At a consolidated level, the Glass margin improvement was offset primarily by segment margin declines in Framing and Services. As a reminder, in the first quarter of last year, Framing had an approximately $4 million benefit related to the timing of pricing actions and inventory flows. Last spring, as aluminum prices spiked, we were able to realize the benefit of higher selling prices as we worked through lower-cost aluminum inventory. Setting aside this benefit, the Framing operating margin this quarter was roughly in line with the prior year. Services had an operating loss of $0.6 million, primarily due to lower estimated profitability levels on a select number of projects that are nearing completion.

The impact of lower project volume and approximately $1 million of severance costs as we continue to execute our strategic transition in the services business. As Ty mentioned, we remain confident in the service's long-term potential and expect the operating performance trend to improve as the year goes on. Diluted EPS grew 5% to $1.05, primarily driven by higher operating income, a lower effective tax rate, and a lower diluted share count, which reflects the benefit of our share repurchase activity. This was partially offset by higher interest expense, primarily due to higher interest rates. Our tax rate in the quarter was 25%, roughly in line with our long-term rate assumption of 20%. Turning to our cash flow and the balance sheet.

We generated $21.3 million, an improvement of $52 million over the first quarter of last year. This was primarily driven by first quarter of last year, had unfavorable working capital impacts related to sales growth and inflation. Is typically our lowest quarter for cash flow. Capital expenditures, $7.4 million in the first quarter, primarily relating to investments to expand capacity in our higher-margin businesses, enhance productivity through automation, and deploy improved systems to better support our business. We also returned over $10 million in cash to shareholders through dividends. Our balance sheet remains very strong, with net leverage ratio one time trailing twelve-month EBITDA, and no significant debt maturities until 2027.

Looking at backlog trends for the quarter, backlog for framing was $221 million, compared to $243 million in the fourth quarter of last year. Several factors are impacting framing backlog. First, we've improved service levels for our short lead time products, so we are converting backlog into sales more quickly. Second, as a part of our strategic shift, we continue to move away from lower-margin sales that we would have pursued in the past. Finally, we continue to see choppiness in bidding and award activity. Services finished the quarter with $709 million in backlog. This was a slight sequential decline compared to the fourth quarter of last year, but 4% higher than the first quarter of prior year.

Turning to our updated fiscal year outlook, we are pleased to be able to increase our full-year diluted EPS outlook to a range of $4.15-$4.45, primarily reflecting our strong first quarter results and an improved outlook for our second quarter. This updated outlook implies growth at the bottom of the range of approximately 4% and EPS growth at the top of the range of approximately 12%, compared to last year's EPS of $3.98. Our outlook includes our continued expectation of net sales for the year to be flat to slightly down, reflecting lower volumes in services and framing, partially offset by growth in glass. Our outlook range contemplates the latest market forecasts, which point to a potential slowdown in non-residential construction in the second half of our fiscal year.

Despite our sales outlook, we expect to drive EPS growth through expanded operating margins. Although the 17% operating margin in glass this quarter is likely not sustainable for the full year, we are increasing our margin expectations for glass to be in the 10%-15% range for the year, which is well above last year's level. Services margins should improve as we move through the year, but are expected to fall short of their 7%-9% target range. Although framing margins are projected to decline compared to prior year, we expect margins near the top of its 9%-12% range. Finally, we expect LSO margins to be slightly down compared to last year. We continue to expect an average tax rate of approximately 24.5% and full-year capital expenditures of $50 million-$60 million.

We also expect both operating and free cash flow growth for the year. As a reminder, fiscal 2024 is a 53-week year with an extra week of operations in the fourth quarter. For the full year, the extra week will add approximately 2 percentage points of growth to revenue. In closing, I am pleased with our first quarter performance and ability to raise our outlook for the year. Advancing our strategic objectives is driving improved profitability, even in a year with sales growth headwinds. This improved profitability will position us to better outperform throughout the market cycle. Additionally, our strong cash flow and low leverage position are enabling us to deploy capital to invest in our business and return cash to shareholders through dividends and share repurchases. We also continue to look for accretive acquisition opportunities that would accelerate our growth and profitability.

I am glad to be part of the Apogee organization and excited to contribute to the work the team is doing to drive value for all our stakeholders. With that, I'll turn it back over to Ty for some concluding remarks.

Jeff Huebschen (VP of Investor Relations and Communication)

Thanks, Matt. To wrap up, I want to reiterate how proud I am of the team for delivering another strong quarter and a great start to our fiscal year. We continue to make progress, advancing our strategy and improving operational execution. I'm particularly happy with the performance of our glass segment and our increased long-term outlook for that business. Through our team's efforts across all of Apogee, we are well-positioned to continue our progress in the coming quarters. With that, we are ready to take your questions.

Operator (participant)

As a reminder, to ask a question, please press star one on your telephone and wait for your name to be announced. To withdraw your question, please press star one again. Our first question comes from the line of Chris Moore with CJS Securities.

Chris Moore (Senior Analyst)

Hey, good morning, guys. I'm not sure, the line cutting in and out a little bit, but hopefully you can hear me.

Jeff Huebschen (VP of Investor Relations and Communication)

We hear you, Chris. Good morning.

Chris Moore (Senior Analyst)

All right. Terrific. Good morning. Yeah, maybe we could just start with glass. Obviously, you know, revenue and margins way above what we were expecting, the highest glass revenue since, I think, Q4 2020. I get that, you know, kind of the better mix and pricing, but you also, Ty, talked about, you know, more growth opportunities. Maybe just expand on that a little bit.

Jeff Huebschen (VP of Investor Relations and Communication)

Well, I think as we've repositioned that business, Chris, with that focus on the premium side of the market, it's gotten that business back to really focusing on where they can differentiate from a competitive standpoint. If you look at it from a top-end volume level, there's volume growth, obviously, in that, but what it's allowing them to do is sell higher value-added product offerings, which obviously, as a result of that, they're able to command a higher price per square foot for those products, and they see the opportunity to build on that throughout the rest of the year.

They're getting a benefit of a volume lift as they focused in on parts of the market where that story holds up better from a differentiation standpoint, and they're able to sell things at a higher price, as well as sell things with additional, higher value add propositions in those product offerings, them to not only get the price accordingly, but also that helps us with our margin performance. Layering on top of that, from a productivity standpoint, the team has done exceptionally well. If you'll recall, we said as we closed out last year, you know, it's gonna be harder to take the big, giant steps forward on the productivity side to drive that margin, and we would need to see the mix shift come through.

We're seeing that mix shift coming through, and that's looks good as we look out for the rest of the year.

Chris Moore (Senior Analyst)

Got it. No, that's helpful. I mean, how do you think about the total addressable market in glass currently versus, you know, maybe a couple of years ago? Is it significantly smaller and you're just gonna get a bigger share of it, or just any thoughts there?

Jeff Huebschen (VP of Investor Relations and Communication)

Well, I think from a broader market perspective, non-resi construction continues to hold up. I mean, obviously there's talk and there's concerns about how that plays out as calendar 2023 closes out and we get into calendar 2024. When we worked through our strategic plan, we didn't want the teams to talk about their market opportunity by going down smaller and smaller and defining smaller pieces of the market. We actually wanted them to continue to look at the broad market, but then point their energy and efforts to where they could capture the most value. We would still define it as we're playing in that, in that larger, broader market from a glass glazing opportunity. However, we're being much more focused and selective about what we go after. We've got solid growth, top, as well as volume growth this quarter.

They're positioned to do that, in terms of the volume growth and top line growth through the year. I would say they're outperforming the market on from a growth perspective right now, but they're doing it in a segment of the market where we can capture the value.

Chris Moore (Senior Analyst)

Got it. That is very helpful. Maybe just one last one for me. On the challenges on services. You know, you called out the impact of lower estimated profitability on certain projects, and I think that the comment was most of those will be running off in fiscal 2024. Is that a fair way to look at it?

Jeff Huebschen (VP of Investor Relations and Communication)

Yeah. Remember, we had this combination of two things. Sotawall's been integrated into that business now, so everything's operating under the Harmon brand. We knew our fiscal 2024 was going to be a challenge because these are jobs won in calendar 2020 and 2021, so there was lower volume available to win on top of margins were squeezed. Layer in some of the Sotawall projects that we are running through this fiscal year, those get behind us. A few of those Harmon jobs that we had in Q4 and we had a handful in Q1 we've had to take, you know, some write-downs on those projects just with how they're performing. Because those were won in calendar 2020 and 2021, they were already tight on margins.

As we looked at the quarter, you know, it performed, I would say, a little worse than we expected. Remember, services, kind of their Q1 is their low point, they go up from there. We do see that we do have confidence that trend will occur, that we'll see improvements in Q2 and then as we move forward through the year.

Chris Moore (Senior Analyst)

Very helpful. Thanks, guys. I'll jump back in line.

Operator (participant)

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

Eric Stine (Senior Research Analyst)

Hi, Ty. Hi, Matt. Can you hear me? Line's breaking up a little bit.

Jeff Huebschen (VP of Investor Relations and Communication)

Yep. Good morning, Eric.

Eric Stine (Senior Research Analyst)

Okay. Good morning. I guess I'll go a little bit more, you know, high level here. I mean, obviously, execution, especially in glass, has been great. You know, but when you think about what the market looks like, you know, as you mentioned, some uncertainty here, second half of this year and into next year, I mean, what do you see as the biggest headwind? I mean, is it, and maybe it's a combination of all of them, but interest rates, you know, lending standards? You know, I'd love your thoughts on kind of the shift, the, the work from home shift, which, you know, seems like it's gonna, you know, stay in place. I mean, just, how do you kind of judge all of those factors as you look forward?

Jeff Huebschen (VP of Investor Relations and Communication)

Well, Eric, I would say, as we've looked out at that, it's the same that you're hearing in the broader market discussions. I think interest rates as well as lending is going to have some impact on non-resi construction. How that plays out or exactly when that occurs, I mean, we continue to see choppiness. You know, we've had a few quarters in a row now where we just see a lot of choppiness in bid, in award activity. That's why, you know, as we've looked at this and said, "Hey, we're rolling up our guidance for the year, but we're still trying to be cautious about the back half." And that's reflected in our guidance.

When you look at our shorter cycle business, you know, we've pointed to the fact we think framing will now be down on a year-over-year basis from a revenue perspective. There's a, I would say, two factors to think about for framing. Number one, last year, you know, they came in building backlog, and that is a 60% of business is quick turn. Building backlog for them was actually a negative. It means our service levels were dropping and our lead times were pushing out. That was typical for the industry at that point in time. They did have some tougher comps, I would say, on the top line in their Q2 and Q3, because that's when they finally started catching up and started to work that backlog down.

We're reflecting that while we continue to see choppiness, you know, I would say it's gotten a little bit choppier in our visibility there. We think now that business will probably be slowing, which is why we've said that we expect it to now have a year-over-year decline in revenues.

Eric Stine (Senior Research Analyst)

Got it. Maybe, you know, one other thing is, you know, seeing more talk of kind of the market, non-res, you know, splitting in two a little bit from the standpoint of, you know, public sector, quite strong, lots of investment there for obvious reasons. Private sector, you know, again, challenging for the reasons you just discussed. You know, maybe thoughts on that dynamic and how it, you know, how that would apply to your backlog. Maybe, you know, current state of your backlog mix, that sort of thing.

Jeff Huebschen (VP of Investor Relations and Communication)

Yeah. Well, while there was sequential small drop, year-over-year, we're still up. If you look at the services backlog, it's still very strong, near record highs. We have been working to diversify our mix since we launched our strategic plan 2 years ago, That is showing up in that backlog. We don't, you know, present or share that specific data. I think I've commented a couple of times now in these quarterly calls. Our percent of office in our backlog, whether you look at our services business or our glass business, it's down significantly. That's a reflection, yes, that market is softer, although we do continue to see owner-occupied Class A office space. We still are seeing projects be let and awarded and go, given the green light.

That has been an effort to diversify our mix, knowing there's a question over what's the sustainability for office being a driver for non-res construction. The teams have been working to specifically target other areas in healthcare, institutional, transportation. Airport terminals has been a heavy focus, which has government funding behind it for both glass and services, and it is showing up in that backlog mix.

Eric Stine (Senior Research Analyst)

Got it. That's helpful. Maybe last one for me, I'll just sneak it in. I know you've talked about kind of taking the portfolio approach on the M&A, and certainly, as you continue to make progress on some of the operational initiatives and, you know, and feeling more and more confident there, maybe just an update on that process, whether there are some things you feel like you can fill in, or just how we should think about that.

Jeff Huebschen (VP of Investor Relations and Communication)

Yeah, I mean, as we've said, that is part of our growth levers. It will be a meaningful growth lever for us as we move forward. We want to grow organically, obviously, with the right mix. Inorganic is a way that we will obviously drive accelerated growth. We've put the processes in place. We have the team in place. We have active pipeline from an M&A perspective. Part of that active portfolio management, that is a regular part of our operating rhythm, so.

Eric Stine (Senior Research Analyst)

Okay, thank you.

Operator (participant)

As a reminder, that is star one one to ask a question. Our next question comes from Julio Romero with Sidoti.

Julio Romero (Equity Research Analyst)

Great, thanks. Good morning, Ty, and welcome, Matt. You know, I appreciate the segment commentary regarding the outlook. You guys said regarding glass, that, you know, 17% is likely not sustainable, but should still end up in that 10%-15% range for the year. Can you speak to maybe how the glass margin trends over the next few quarters? Do you maybe expect, you know, more of a stronger margin in the second quarter, and then relative, you know, maybe a glide down sequentially in the third or fourth? Talk about how that glass margin should trend.

Matt Osberg (EVP and CFO)

Yeah. Thanks, Julio. Appreciate the question, and happy to be talking to everybody this morning. As you think about, our outlook and just kind of, I know you asked specifically on glass, but think about it from kind of the top, right? We talked about our ability to raise our outlook for the year, primarily based on the performance we had in our first quarter and some of our increased expectations in Q2. I would say that, you know, a lot of that increased confidence in the second quarter is going to be driven by glass.

As you think about, you know, how that would phase out, you know, I think we've seen, you know, probably a high point for the year in the first quarter, but we'll still see, I think, some strength in Q2, and then that continuing to maybe normalize throughout the back half of the year and, you know, get into that range that we talked about.

Julio Romero (Equity Research Analyst)

Got it. That's very helpful. Then just thinking about, you know, the cash flow in the first quarter was pretty strong. Just talk to the expectations for cash flow for fiscal 2024.

Matt Osberg (EVP and CFO)

Yeah, you probably heard in my script, we talked about, you know, operating cash flow and free cash flow growth for the year. The big improvement we had in Q1 was primarily driven by, I would say, you know, unusual activity in working capital in the first quarter of last year. We're very pleased to have the improvement that we did in Q1 on its own, with a strong cash flow start to the year. We expect to be able to, you know, continue to deliver cash flow throughout the quarters.

We said this is usually the lowest cash flow quarter for the year, so you'd expect sequential improvement as we move through the year from where we are in Q1, and getting to a place where we have, you know, good cash flow for the year, and we've got growth, both in operating and free cash flow for the year.

Julio Romero (Equity Research Analyst)

Really helpful. I'll pass it on. Thanks.

Matt Osberg (EVP and CFO)

Thanks, Julio.

Operator (participant)

That concludes our question and answer session. I'd like to turn the call back to Ty Silberhorn for closing remarks.

Matt Osberg (EVP and CFO)

All right. Well, again, I would like to recognize the strong efforts of our team in delivering a great start to the year and our ability to build on that. We're excited to share that progress with you as we go through the next few quarters. Thanks for joining us today, and I hope everyone has a great weekend.

Operator (participant)

This concludes today's conference call. Thank you for participating. You may now disconnect.