Earnings Call Transcript - APOG Q1 2024

Operator, Operator

Good day, and thank you for standing by. Welcome to the First Quarter 2024 Apogee Enterprises Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Jeff Huebschen, Vice President of Investor Relations. Please go ahead.

Jeff Huebschen, Vice President of Investor Relations

Thank you, Liz. Good morning, and welcome to Apogee Enterprises Fiscal 2024 First Quarter Earnings Call. With me today are Ty Silberhorn, Apogee's 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. And with that, I'll turn the call over to you, Ty.

Ty Silberhorn, CEO

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. Then 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 results, 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 strengthening operational execution across our businesses. We are successfully managing the things that we can control. We're driving sustainable product 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, our Architectural Glass delivered solid results. Our glass team continued their strong momentum with an improved sales mix as we emphasize differentiated product offerings. Results in Architectural Services came in below our expectations as we transition to better position the business for long-term growth and manage lower-than-expected profitability. We remain confident in our potential in this business. Our Harmon brand is a recognized leader in its industry with a strong market position and a broad set of capabilities. 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 products and their continued operational execution. We are well positioned to build on our success from this quarter and improve our full-year earnings outlook. Our improved performance continues to be driven by our three-pillar strategy referenced on Slide 5 in our presentation. The performance of Architectural Glass over the past two 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 strategic work, we identified two imperatives for change. We needed to build a more competitive cost structure while 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 has 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, aligning 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 exceed 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 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% to 15% on a full-year basis compared to our previous range of 7% to 10%. It's very encouraging that this quarter, three of our four business segments delivered margins 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 allows us to outperform throughout the market cycle. While overall nonresidential 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 8 outlines our priorities for the fiscal year, which we introduced last quarter, and 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 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 experience and perspectives and has 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.

Matthew Osberg, CFO

Thanks, Ty, and 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, and he has been extremely valuable to me as I have onboarded with the company. Great job, Mark, and 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. 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 of higher volume, as well as 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 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. Turning to our cash flow and the balance sheet. We generated $21.3 million in cash flow from operations, an improvement of $52 million over the first quarter of last year. This was primarily driven by improved working capital efficiency. The first quarter of last year had unfavorable working capital impacts related to sales growth and inflation. Capital expenditures of $7.4 million in the first quarter primarily related 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 and share repurchases. Our balance sheet remains very strong with a net leverage ratio below two times trailing 12-month EBITDA and no significant debt maturities until 2027. Looking at backlog trends for the quarter, backlog in 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, allowing us to convert backlog into sales more quickly. Second, as 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 the prior year. Turning to our updated fiscal year outlook, we are pleased to increase our full-year diluted EPS outlook to a range of $4.15 to $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 $3.90. 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 forecast, which indicates a potential slowdown in nonresidential 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% to 15% range for the year, which is well above last year's level. Services margins should improve as we progress through the year but are expected to fall short of their 7% to 9% target range. Although Framing margins are projected to decline compared to the prior year, we expect margins near the top of its 9% to 12% range. We also 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 to $60 million. We also expect both operating and free cash flow growth for the year. If you remember, 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'm 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.

Ty Silberhorn, CEO

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 in 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, Operator

Our first question comes from the line of Chris Moore with CJS Securities.

Christopher Moore, Analyst

The line is cutting in a little bit, but hopefully you can hear me.

Ty Silberhorn, CEO

We hear you, Chris.

Christopher Moore, Analyst

All right. Terrific. Yes, maybe we could just start with Glass. Obviously, revenue and margins way above what we were expecting, the highest Glass revenue since, I think, Q4 20. I get that kind of the better mix and pricing, but you also, Ty, talked about more growth opportunities. And maybe you could just expand on that a little bit.

Ty Silberhorn, CEO

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. So 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. So they're getting a benefit of a volume lift as they focused 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 for 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. And if you'll recall, we said, as we closed out last year, it's going to 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 looks good as we look out for the rest of the year.

Christopher Moore, Analyst

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

Ty Silberhorn, CEO

Well, I think from a broader market perspective, non-residential construction continues to hold up. I mean, obviously, there's talk and there's concerns about how that plays out as calendar '23 closes out and we get into calendar '24. And 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. So we would still define it as we're playing in that larger, broader market from a Glass glazing opportunity. However, we're being much more focused and selective about what we go after. So we've got solid growth, top, as well as volume growth this quarter.

Christopher Moore, Analyst

Got it. That's very helpful. Maybe just one last one for me on the challenges on Services. So 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 '24? Is that a fair way to look at it?

Ty Silberhorn, CEO

Yes. It was a combination of two factors. Sotawall has now been integrated into the business, and everything operates under the Harmon brand. We anticipated that fiscal '24 would pose challenges since the jobs were secured in calendar '20 and '21, resulting in lower volume opportunities and squeezed margins. Additionally, we have some Sotawall projects running through this fiscal year, which will be behind us soon. We also experienced some write-downs on certain Harmon projects from Q4 and Q1 due to their performance issues, which were tied to margins from those earlier jobs. The quarter underperformed our expectations. However, it's important to note that Services' Q1 is typically their low point, and we expect to see improvement in Q2 and onwards throughout the year.

Operator, Operator

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

Eric Stine, Analyst

Matt, can you hear me? My line is breaking up. I guess I'll take a broader approach here. Execution, especially in Glass, has been impressive. However, considering the current market conditions, as you noted, there is some uncertainty for the second half of this year and into next year. What do you see as the biggest challenges? Is it possibly a mix of various factors such as interest rates and lending standards? I would appreciate your insights on how the work-from-home trend, which appears to be persistent, impacts these considerations. How do you evaluate all of these elements as you look ahead?

Ty Silberhorn, CEO

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 are going to have some impact on non-residential construction. How that plays out or exactly when that occurs, I mean we continue to see choppiness. We've had a few quarters in a row now where we just see a lot of choppiness in bid, in award activity. So that's why 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, we've pointed out that we think Framing will now be down on a year-over-year basis from a revenue perspective. There are, I would say, two factors to think about for Framing. Number one, last year, they came in building backlog, and that is over 60% business is quick turn. So building backlog for them was actually 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. So they did have some tougher comps on the top line in their Q2 and Q3 because that's when they finally started catching up and starting to work that backlog down. We are reflecting that, while we continue to see choppiness, I would say it's gotten a little bit choppier in our visibility there. We think now that, that business will probably be slowing and which is why we've said that we expect it to have a year-over-year decline in revenues.

Eric Stine, Analyst

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

Ty Silberhorn, CEO

Yes. Well, while there was a sequential small drop year-over-year, we're still up. And 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 two years ago, and that is showing up in that backlog. We don't present or share that specific data. I think I've commented a couple of times now in our quarterly calls. Our percentage of office in our backlog, whether you look at our Services business or our Glass business, is down significantly. That's a reflection of the market being softer, although we do continue to see owner-occupied Class A office space. We are still seeing projects being awarded and approved. But that has been an effort to diversify our mix, knowing there's a question over the sustainability of the office sector as a driver for non-residential construction. So the teams have been targeting other areas in healthcare, institutional, and transportation, such as airport terminals, which has government funding behind it for both Glass and Services, and it is showing up in that backlog mix.

Eric Stine, Analyst

Got it. That's helpful. Maybe the last one for me, I'll just sneak it in. I know you've talked about taking the portfolio approach on the M&A, and certainly, as you continue to make progress on some of the operational initiatives and feel 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?

Ty Silberhorn, CEO

Yes. 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. So we want to grow organically, obviously, with the right mix. Inorganic is the way that we will obviously drive accelerated growth. So we put the processes in place. We have the team in place, and we have an active pipeline from an M&A perspective. So part of that active portfolio management is a regular part of our operating rhythm.

Operator, Operator

Our next question comes from Julio Romero with Sidoti.

Julio Romero, Analyst

Welcome, Matt. I appreciate the segment commentary regarding the outlook. You guys said regarding Glass that 17% is likely not sustainable, but should still end up in that 10% to 15% range for the year. Just can you speak to maybe how the Glass margin trends over the next few quarters? Do you maybe expect more of a stronger margin in the second quarter and then relative to maybe a glide down sequentially in the third or fourth? Just talk about how that Glass margin should trend.

Matthew Osberg, CFO

Thank you, Julio. I appreciate the question and I'm glad to be speaking with everyone this morning. As you consider our outlook, I want to note that while you specifically asked about Glass, it's important to look at the bigger picture. We have raised our outlook for the year primarily due to the strong performance in our first quarter and our increased expectations for Q2. A significant portion of our confidence in the second quarter is related to Glass. Looking ahead, we may have seen the peak in the first quarter, but I anticipate that we will experience some strength in Q2. Following that, we could see a normalization in the latter half of the year, aligning with the range we previously mentioned. Yes. You probably heard in my script, we talked about operating cash flow and free cash flow growth for the year. The big improvement we had in Q1 was driven by, I would say, unusual activity in working capital in the first quarter of last year. So 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, and we expect to continue to deliver cash flow throughout the quarters. Remember, 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 and getting to a place where we have good cash flow for the year. We've got growth in both operating and free cash flow for the year.

Operator, Operator

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

Ty Silberhorn, CEO

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. So 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, Operator

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