Earnings Call Transcript - ROCK Q3 2023

Operator, Operator

Greetings. And welcome to the Gibraltar Industries Third Quarter 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Carolyn Capaccio of LHA. Thank you. You may begin.

Carolyn Capaccio, Host

Thanks, Christine. Good morning, everyone, and thank you for joining us today. With me on the call is Bill Bosway, Gibraltar Industries’ Chairman, President and Chief Executive Officer; and Tim Murphy, Gibraltar’s Chief Financial Officer. The press release that was issued this morning, as well as a slide presentation that management will use during the call are both available in the Investors section of the company’s website gibraltar1.com. Gibraltar’s earnings press release and remarks contain non-GAAP financial measures, tables of reconciliation of GAAP to adjusted financial measures can be found in the earnings press release that was issued today. Also, as noted on slide two of the presentation, the earnings press release and slide presentation contain forward-looking statements with respect to future results. These statements are not guarantees of future performance and the company’s actual results may differ materially from the anticipated events, performance or results expressed or implied by these forward-looking statements. Gibraltar advises you to read the risk factors detailed in its SEC filings which can also be accessed through the company’s website. Now, I will turn the call over to Bill Bosway. Bill?

Bill Bosway, CEO

Thanks, Carolyn. Good morning, everyone, and thank you for joining today’s call. We will start with an overview of the third quarter results, and Tim is going to take you through our financial performance, and then I will walk you through our updated 2023 outlook. Then we will open the call for your questions. So let’s start by turning to slide three, titled the third quarter results, third quarter 2023 results, sorry. Our focus on driving quality of earnings in 2023 continues to pay off in our delivery of higher profitability and strong cash flow duration. We executed well in the quarter, continuing our momentum from the first half of the year. We continue to experience solid end-market demand. We also expanded our market participation, particularly across our Residential and Infrastructure businesses. In both our Renewables and AgTech businesses, we did experience some delays in the start dates of contracted active projects, and those projects have since begun or shifted to either the fourth quarter or into early 2024. As well, during the quarter, on an adjusted basis, we increased operating income 19%, EPS 23%, and free cash flow increased to 23% of net sales. We continue to accelerate our 80/20 initiatives across product lines and operations and also optimize our supply chain management with market price actions. Our improvement in operating margin and working capital continues to drive solid cash generation performance. In all, our results indicate we expect our momentum to continue in the fourth quarter and support strong full year performance in 2023. As a result, we are changing our guidance for 2023. We are narrowing our net sales outlook and raising our outlook for both profitability and EPS, which we will review shortly. Now let’s turn to slide four for an update on the solar market. Our demand pipeline in Renewables is very active, and bookings continue to grow as the industry navigates through three basic issues: module supply, permitting delays, and clarity on the final rules governing IRA tax benefits. First, let’s start with module supply. It is improving as additional module suppliers are having more consistent success importing through the UFLPA process and this is encouraging; yet, we need to see additional progress as we close out 2023 and move into 2024. Also related to module supply, the Department of Commerce issued its final ruling in August on its AD/CVD investigation. The DOC final report indicated three of the eight module suppliers were found not to be circumventing and as a result are able to export to the U.S. without duty. The report also confirmed that module suppliers using non-China wafer supply are also not subject to duty. The DOC also implemented the administration’s tariff waiver, which is in effect until early 2024 and may be reevaluated at that time. Because of the administration’s waiver, the DOC investigation results are a little less concerning relative to the UFLPA importation process. Secondly, delays in obtaining permits for projects remain an issue. Although, customer supply and permitting is a challenge in the near-term, we are confident this situation will continue to improve as local government agencies ramp capacity to improve the approval process for our permit applications. Finally, customers are anxiously awaiting final guidelines from the Department of Treasury on how to secure additional tax incentives under the Inflation Reduction Act. Tax credits directly affect project economics and returns, and we are seeing some customers with projects in process pause and/or defer additional projects until they have a clear understanding of how to realize incremental tax benefits. We expect the industry to work through these challenges and as AEs improve, our customers will be in a better position to execute current demand and properly plan to support a robust demand pipeline as expected going forward. With that, I will turn it over to Tim for a review of our results.

Tim Murphy, CFO

Thanks, Bill, and good morning, everyone. I will take you through our consolidated and segment results starting on slide five. Adjusted third quarter sales were flat at $390 million, timing shifts of the active projects in Renewables and AgTech business, as well as price management initiatives in the Residential business, were positively offset by revenue from recent acquisitions and market participation gains across the business. Backlog at quarter end was $375 million, up approximately 5% versus the third quarter of 2022. Demand and order flow remained strong heading into the fourth quarter. Adjusted operating income and adjusted EBITDA dollars increased 19% and 18%, respectively, in the third quarter, with adjusted EPS up 23%. Margin improvement in the quarter was driven by solid execution, additional 80/20 initiatives, productivity, and price cost management. Weighted average shares outstanding decreased 3.4% from the third quarter of 2022 to 30.7 million shares in the third quarter of 2023 and there were no share repurchases in the quarter. Now let’s review each segment starting with slide six, the Renewables segment. Segment net sales decreased 4.2% as customers' start dates of contracting and active projects were impacted by delays in both global permitting and final Inflation Reduction Act Tax credit guidelines. The rate of decline is slowing compared to prior quarters, as module availability continues to improve as the module importers climb up the UFLPA enforcement learning curve. Bookings of new orders remain robust, with year-over-year backlog growing 13.3%. And as Bill mentioned, some customers are waiting to sign contracts until the Department of Treasury issues IRA tax credit guidance, and our pipeline remains very strong. As a reminder, our backlog consists only of signed contracts with deposits. We do not include purchase orders without a signed contract and deposit, MSAs without specific work orders, or verbal agreements with customers in our new bookings and backlog. Segment profitability again improved, with adjusted operating and EBITDA margins of 16.7% and 18.9%, respectively, increasing 380 basis points and 390 basis points from last year. Our team executed well with supply chain productivity, field operations efficiency, and solid price cost management. Assuming industry dynamics remain constant with improving module importation and continued delays in local permitting, we expect relatively flat sales in the fourth quarter, with net sales in the second half accelerating from the first half. Let’s move to slide seven to review our Residential segment. Segment sales increased 5.6% from last year, and recent acquisitions added 8.8% growth, while organic sales decreased 3.2%, driven by prior quarter price adjustments in response to decreasing commodity prices and 80/20 initiatives we took to phase out less attractive product lines. Volumes built according to normal seasonality in the third quarter, and we benefited from increased participation with new and existing customers, and from having expanded into new regions. Both of our recent acquisitions are performing to our expectations. Demand remains at normal levels in the fourth quarter with the expectation of normal seasonal inventory reductions at our customers, and we expect to continue to grow participation. Adjusted operating and EBITDA margins of 18.8% and 22%, respectively, expanded 200 basis points and 220 basis points through increased volume, improved price cost alignment, implementation of additional 80/20 initiatives, and favorable product line mix. Quality Aluminum Products margin performance continues to improve towards Gibraltar levels as the integration continues. We expect continued year-over-year margin improvement in the fourth quarter through improved price management, increasing participation gains mix, and the contribution of the two acquisitions we made over the past year. Let’s move to slide eight to review our AgTech segment. Adjusted net sales decreased 26% as new product construction starts were delayed in the quarter. We began a large project, which continued to drive improving results beginning in September. Orders continued to accelerate in the quarter, driving backlog of 9.4% sequentially. On a year-over-year basis, backlog decreased as a few customers worked through project redesigns. We expect increasing activity to drive revenue acceleration in the fourth quarter. Segment adjusted operating and EBITDA margins of 5.6% and 8.1%, respectively, decreased 510 basis points and 540 basis points on lower volume as the timing of net sales shifted into the fourth quarter from the third quarter. Margins improved in September with project starts and are continuing into the fourth quarter, and we expect volumes from new project execution underway to drive improved results in the fourth quarter. Let’s move to slide nine to review our Infrastructure segment. Segment sales increased 22.5% driven by solid end-market demand and market participation gains. Backlog increased 6.2% year-over-year. Market activity remained strong, including from commercial customers and airports, and the Infrastructure Bill continues to provide strong tailwinds. Our momentum continues into the fourth quarter, and we expect to leverage these strong trends by increasing market participation through the remainder of the year. Segment adjusted operating income increased 146%, and adjusted operating and EBITDA margins of 25.6% and 29.1%, respectively, improved 1,300 basis points and 1,230 basis points, driven by strong execution, price cost alignment, 80/20 initiatives, additional productivity investments, supply chain efficiency, and product line mix. The Infrastructure team continues to execute very well, and we expect to report a strong year of growth and expanding profitability for this segment. Let’s move to slide 10 to discuss our balance sheet and cash flow. At September 30th, we had cash on hand of $86 million and $396 million available on our revolver. During the quarter, we generated $93 million of cash from operations through a combination of margin improvement and $43 million generated from reductions in working capital. We collected cash from accounts receivable and inventory reductions, and benefited from increases in accounts payable and other liabilities. Inventory is getting closer to normal levels as in-stock positions and supply from the balance. As a result, our frequent cash flow generation during the third quarter was again exceptionally strong at 23% of sales. Free cash flow in the nine months of the year benefited from approximately $84 million of reduction in investment in working capital, reversing the prior two years' impact from the increased working capital investments we managed through the pandemic era supply chain challenges. We expect strong cash flow for the remainder of the year. There were no share repurchases in the quarter, and we paid down the outstanding balance on our revolver. Therefore, we ended the quarter with an unlevered balance sheet. We will continue to focus our capital allocation on organic growth, selective high-quality M&A, and opportunistically returning value to shareholders through our share repurchase program. These investments will be funded through generated cash and supplemented as needed by the use of our revolver, depending on the timing of any M&A or repurchases. Now, I will turn the call back to Bill.

Bill Bosway, CEO

Thanks, Tim. Let’s move to slide 11 to review our 2023 strategy and priorities. Our focus on five basic initiatives is driving solid performance and will continue to do so as we finish 2023. First, we are focused on driving growth, quality of earnings, margin improvement, and strong cash performance. Secondly, we will continue to execute 80/20 initiatives, win more participation, and drive service levels higher. Thirdly, we will stay the course with investments in our digital transformation to help scale our businesses with both speed and agility. Fourthly, we will strengthen our organization with the addition of experience and competency with a structure that drives more focused scalability and accountability. And lastly, we will conduct business in the right responsible way every day. Now let’s turn to slide 12 and review our revised 2023 guidance. Given our results to date and momentum heading into the fourth quarter, we are adjusting our guidance as follows: We are narrowing our consolidated net sales range to between $1.37 billion and $1.4 billion, compared to $1.38 billion in 2022; we expect GAAP operating margin to be between 11.2% and 11.4%, compared to 9.4% in 2022; and adjusted operating margin to be between 12.6% and 12.7%, compared to 10.9% in 2022. We expect GAAP EPS to be between $3.51 and $3.71, compared to $2.56 in 2022, and adjusted EPS to be between $4.05 and $4.15, compared to $3.40 in 2022. Finally, we expect free cash flow to exceed 14% of sales for the year, which compares to 6% in 2022, driven by higher margins and working capital performance. We expect to execute well in the fourth quarter and are relatively well-positioned going into 2024. Our team continues to execute and remains focused, and they are really excited for what we do and how we do it, and they deserve all the credit for our results. The team is also very proud we are able to raise our profitability EPS guidance for the second time this year. So a big thank you to our team. We look forward to delivering a strong finish to a good year. Now let’s open the call, and we will take your questions.

Operator, Operator

Thank you. Our first question comes from the line of Dan Moore with CJS Securities. Please proceed with your question.

Dan Moore, Analyst

Thank you. Good morning, Bill. Good morning, Tim, and congrats on another really solid quarter. Maybe start with Residential. As we look beyond Q4, are you seeing any change in tone in the overall market, up or down? And secondly, your performance and participation gains, obviously, very impressive year-to-date. How do we think about that going forward? Does it create tough comps or is that momentum you have created kind of easier to continue to drive participation and share gains? Thanks.

Bill Bosway, CEO

Yeah. So, Dan, we haven’t really seen a major shift. As you know, we've talked in the past, we get visibility for the out sales from our big box retailers in particular. I think we continue to see the growth that we have been seeing all year, adjusted for the seasonality, and it’s back in the marketplace. So we feel like there’s a relatively solid continuation of what we have been seeing going forward. Regarding participation, that’s a combination of working with existing customers, again, eating a little bit bigger piece of the pie, and some new opportunities that we are pursuing today. Another big push there is picking up new customers that we traditionally haven’t had as much with, and I think we are hitting both of those pretty well. I think that will carry us into 2024 with decent momentum. As I said, we are on solid footing entering the year, and we are in the middle of putting our plans together as we speak. In fact, we will meet with the teams all next week to get our first really hard look at 2024, but from a Residential perspective, we feel pretty solid about going into next year.

Dan Moore, Analyst

And a similar question, maybe with a little bit more focus on the margin in AgTech. Maybe talk about, Tim, the opportunities you have and the cadence for continuing to improve margins as we look out and what are your expectations in terms of timeframe for getting back to those more low double-digit, low-teens margins that we have seen previously?

Tim Murphy, CFO

Yeah. So we had a project that we thought was going to start pretty much at the beginning of the second quarter, and it got delayed a few months. I apologize, the beginning of the third quarter. It got delayed and started up in September, running as expected. Heading into the fourth quarter, we have got more normalized volume, and you should see margins begin to recover there. There’s a lot of work in the pipeline that we are excited about, though it’s not in hand yet. It’s hard to say when; we will know more over the next few months and get ready for our plans there. But in general, our expectation is always to grow the top line and expand margins; that’s my expectation for each of the businesses every year.

Dan Moore, Analyst

Helpful. Given that obviously strong free cash flow and liquidity position, maybe just talk about your priorities for capital allocation over the next several quarters. Specifically, in this market, are you seeing more opportunities in the M&A funnel? Thanks again for the color.

Bill Bosway, CEO

Yeah. I think that maybe the M&A funnel will begin to open up a little bit more. Although, we made acquisitions, we made two in the last sort of 14 months from here. I think it’s active; we are always pretty active in that space and we are really selective. There are combinations of things that are available, things that make sense for us, but I think we will continue to focus there. Certainly, when we can invest in safety or productivity internally, although that’s not a huge use of capital. I don’t see any real change to that. And then the share repurchase program, when appropriate, we utilize there. I will also remind everyone, right, this year we are outperforming on free cash flow, sort of making up for that big investment in working capital we had to make in 2021 and 2022 as we dealt with that supply chain. I think I said $84 million of our cash flow is really owing to the investment that we made in working capital. Our margins are much better than they were a year ago, and that’s obviously going to increase cash flow.

Dan Moore, Analyst

Very good. Thank you again. I will jump back with any follow-ups.

Operator, Operator

Thank you. Our next question comes from the line of Walt Liptak with Seaport Global. Please proceed with your question.

Walt Liptak, Analyst

Hey. Good morning, guys. Good quarter. I wanted to ask about the Renewables segment. You called out a number of different issues. I wonder if you could rank those. Did any of them get worse or are they all getting better? Just how did things change during the quarter, like the permitting delays? You guys mentioned that last quarter, and I don’t know how long that takes or how long we will be talking about that as an issue. But I wonder if you can go through in rank, and then if things are getting better or worse?

Bill Bosway, CEO

Yeah. Well, I’d say, the module supply is still a little bit of a challenge but it’s getting better literally month to month. We continue to see progress and we’ve seen that all year. If you think about our business, you don’t really sign contracts if you don’t have the panel. The fact that our backlog continues to grow indicates customers are getting more confident that they can get their hands on panels, which is just a function of the panel manufacturers having more consistent success getting through the UFLPA process. So that’s getting better. Permitting, I think is holding steady with how we discussed it last quarter. It’s still an issue, and it’s really down to the individual projects, so it’s hard to tell you how it will be across each license. Some of those start to open up, but I think we see a few of these government offices trying to catch up, and that’s what we hear from our customers, and they are working hard on it every day. I’d say that’s probably the number one thing right now. The number one would be that. What’s crept into the equation is the third item, which is the IRA incremental tax benefits or the additional tax benefits from the IRA, and that’s really dependent on the Department of Treasury finalizing the rules. What’s really clear today is, prior to the IRA, you had a steady investment tax credit. To get the extra ones above that is when you start getting into a few additional requirements like local manufacturing, Made in America, etc. We think the industry is still waiting for the final rules from the Treasury. So number one is permitting, number two would be the incremental tax credit opportunity being delayed, and number three is a module supply. That’s how I would rank them today.

Walt Liptak, Analyst

Okay. Great. You broke up a little bit. I think I got most of it. As we are thinking about that IRA and the final ruling, should we expect that maybe going into the spring construction season that the IRA rulings are behind us and some of those benefits will show up in terms of more orders, as the industry gets back on its feet?

Bill Bosway, CEO

Yeah. I think that’s a fair assessment. As soon as we get clarity, that will boost investment returns as you get those incremental benefits, which in turn will help offset similar inflationary pressures that the industry has dealt with the last couple of years. A lot of customers right now feel like they are in a bit of a holding pattern because it felt like the guidelines were coming soon, so they pause their projects because they didn’t want to miss out on those opportunities. So getting that clarity will facilitate more activity going into the construction season in Q2, Q3, and Q4 for Renewables as an industry and for us.

Walt Liptak, Analyst

Okay. Great. Lastly, in Renewables, with regards to community solar discussions, can you talk about how the returns for these projects have changed considering supply chain issues, rising inflation, labor costs, and now the offsets from the IRA?

Bill Bosway, CEO

Yes. First, whether it's community or utility, the question is the same. The factors you consider when investing relate to negotiating the right TPA or Power Purchase Agreement. Developers have worked diligently, and as inflation has risen, they have secured higher price points on their PPAs. As energy prices go up, everything is interconnected; solar has also been able to increase its generation costs, which will ultimately be passed on to consumers. Therefore, rising prices are happening regardless of energy generation methods. The introduction of the IRA and the associated tax benefits can significantly impact this, so these two factors help offset the increased costs. We're still observing new players entering the industry, and demand continues to be robust, which gives me confidence that the overall economics remain favorable.

Walt Liptak, Analyst

Okay. Great. Thank you for that answer. One last one on Residential. You mentioned seasonal inventory level adjustments; how should we gauge that? Is there going to be a bigger than normal inventory correction?

Bill Bosway, CEO

No, I think it actually happened last year at the same time. This year, it’s just a reflection of a normal demand environment. So our point is not that there is a correction because everyone’s overloaded. Traditionally, this is the time of year construction slows, so inventory typically also decreases as we approach the end of the construction cycle and ramp up for the following year. This year reflects normal seasonal patterns as opposed to any post-pandemic corrections. We’re really just back to routine seasonality in the Residential business over the last decades.

Operator, Operator

Thank you. Our next question comes from the line of Julio Romero with Sidoti. Please proceed with your question.

Julio Romero, Analyst

Good morning. How are you guys doing?

Bill Bosway, CEO

Good. How are you?

Julio Romero, Analyst

Good. I guess, my question is, can you talk about your efforts to make the Renewables segment less volume-dependent and operational improvements you've pursued?

Bill Bosway, CEO

It’s a good question. We made a decision a couple of years ago as demand was decreasing in the industry; we saw it as an opportunity to scale our business differently, enabling us to have more levers for profitability. When volume does come back, we should be in a better position to convert. Specifically, we look at our quote-to-cash processes and ensure that our business systems are tightly integrated, from estimating through production and field installation. Digitization of our operations has been crucial in construction-oriented businesses like Renewables, allowing us to be more scalable and minimize mistakes on construction projects. Additionally, we ensure close links with our supply chain and manufacturing to protect our margins against inflation. This is especially important in our project quote process, enabling us to lock down actual input costs effectively. Lastly, we consider the product mix and its impact on margin, adjusting to ensure optimal performance. We have undertaken substantial work across these areas in an environment of reduced volume. As industry headwinds ease and volume returns, we should be better positioned to convert than two years prior. So, while that was a long answer, it reflects the work we have undertaken.

Julio Romero, Analyst

Thank you for the color. That makes sense. Secondly, have permitting delays abated at all, and what do you hear from customers about local government offices ramping up capacity to alleviate the bottlenecks?

Bill Bosway, CEO

It’s slightly unchanged from last quarter; it depends on the specific project, as our customers are working throughout the country. It’s hard to give a general answer. The permitting process remains the number one challenge for our customers, but they’re optimistically working through it. The delay is more about local capacity, and as municipalities increase staff and resources, we believe it will improve.

Julio Romero, Analyst

Thank you. On AgTech, where do we stand on the $30 million produce project you signed last quarter, and what are the thoughts on how big Phase 2 can be?

Bill Bosway, CEO

That was the project Tim referenced, which we expected to start at the beginning of the quarter but began in September, running as planned. You will begin to see that reflected in Q4. Phase 2 is expected to be larger by about $10 million to $20 million, and we will start working on that halfway through next year.

Julio Romero, Analyst

Thank you for taking my questions.

Operator, Operator

Thank you. Mr. Bosway, it appears we have no further questions at this time. I would like to turn the floor back over to you for closing comments.

Bill Bosway, CEO

Okay. Thank you and thank you everyone today for joining us. We expect to present in November at UBS Industrials Conference, as well as the BofA Clean Energy Conference and in January at the CGS Winter Conference in addition to some other marketing activities. We look forward to updating you on our progress when we report our full-year results. Thank you again and have a great day.

Operator, Operator

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.