Apogee Enterprises Inc (APOG) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second quarter 2007 Apogee Enterprises, Incorporated earnings conference cal. My name is Candace and I'll be your coordinator for today. [OPERATOR INSTRUCTIONS]

I would now like to turn the presentation over to your host for today's conference, Director of Investor Relations, Ms. Mary Ann Jackson. Please proceed, ma'am.

Thank you, Candace. Good morning and welcome to the Apogee Enterprises fiscal 2007 second quarter conference call on Thursday, September 21. With us on the line today are Russ Huffer, Chairman and CEO, Jim Porter, CFO, and Mike Clauer, Executive Vice President. Their remarks will focus on our second quarter results and the outlook for fiscal 2007.

During the course of this conference call we will make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and the current economic environment, and are, of course, subject to risks and uncertainties which are beyond the control of management. These statements are not guarantees of future performance, and actual results may differ materially. Important risks and other important factors that could cause actual results to differ materially from those in the forward-looking statements and projections are described in the Company's annual report on Form 10-K for the fiscal year ended February 25, 2006, and in our earnings release issued last night and filed this morning on Form 8-K. The information in this conference call related to projections or other forward-looking statements may be relied upon, subject to the previous Safe Harbor statement, as of the date of this call and may continue to be used while this call remains on the Apogee website. Russ will now give you a brief overview of the results and then Jim will cover the financials. After they conclude, Russ, Jim, and Mike will answer your questions.

Russ?

Good morning, and welcome to our conference call. We are pleased with our second quarter results, especially in the architectural segment. Our core architectural segment achieved significant earnings growth in the quarter, and continues to improve operating margins. We are feeling good about the strength the architectural business is bringing to Apogee's performance this year. Overall revenues increased 9% while EPS grew 30% to $0.26 per share, up from $0.20 per share in the second quarter of last year. As anticipated, the quarter includes $0.04 per share from the net proceeds of a class-action lawsuit settlement with a flat glass manufacturer. The proceeds are included in the segment's operating income. We also had a $0.01 per share expense in the quarter for incremental stock-based compensation. Our operating margin grew to 5.6%, or 4.6% without the flat glass settlement, from 4.4% in the prior year period.

We continue to gain momentum in the architectural segment. Revenues were up 15%, due primarily to higher architectural glass volume and pricing, and increased job flow in the installation business. Architectural operating income, excluding the flat glass proceeds, doubled compared to the prior-year period as pricing and manufacturing operations continued to improve. Backlog again grew significantly. It increased approximately $30 million in the quarter to $391 million from $360 million in Q1. A year ago the backlog was $276 million. We expect to deliver almost 60% of our backlog this year, with the remainder flowing into fiscal 2008. Our architectural businesses are focused on meeting the growing demand for products and systems driven by the strong commercial construction industry, as well as our success in penetrating energy-efficient hurricane and blast markets. Work on our new architectural glass fabrication plant in Utah continues on schedule. We are looking forward to startup in the first quarter of our next fiscal year so we will have additional value added glass capacity available.

We are redeploying people in our installation business to markets with higher demand. In addition, we are expanding production capacity for standard windows. While we anticipated the decline in the large-scale optical segment performance, compared to the especially strong prior-year period, it was slightly greater than expected. I want to assure you that this remains an attractive business for Apogee. Our framing business continues to convert the custom framing market to value-added glass products. Segment revenues were down 24% from the strong prior-year period. As you may recall, last year's second quarter had an unusually high value-added product mix due to significant national retail customer inventory and promotional programs, which disproportionately impacted the second quarter compared to the rest of the year. The current quarter was impacted by a less favorable value-added product mix, a softer retail environment, and lower pre-framed art sales.

Large-scale up -- optical operating income dropped 62% from the prior-year period, primarily due to a less favorable product mix, and the margin declined to 10.2%, or 8.1% excluding flat glass proceeds, from 20% in last year's second quarter. The current quarter operating margin was in line with our full-year expectation. Auto glass segment revenues declined from the prior year, as had been anticipated due to lower sales of after-market automobile windshields.

Next I'll cover our outlook for the remainder of fiscal 2007. Our strong first-half performance, thanks to continuing improvement in our architectural segment, positions us for solid earnings growth in fiscal 2007. We are maintaining our fiscal 2007 earnings guidance range of $0.88 to $0.94 per share, which includes $0.05 per share for the noncash expensing of options. After adjusting for the option expense and the fiscal 2006 impact of one-time net tax benefits of $0.07 per share, we expect earnings growth of 19% to 27% in fiscal 2007. Our strong architectural backlog and bidding activity, combined with robust non-residential construction markets, give us confidence in this outlook. We've been hearing about a decelerating U.S. economy and possibly a soft landing in 2007, but at this point, we are seeing no impact on our architectural business. The markets we serve, office, education, health care, and institutional, remain strong, despite higher interest rates and raw material pricing. Industry forecasters, including McGraw-Hill Construction, concur.

Job growth, which helps maintain demand for commercial space, is still occurring. Also, the financial position of state and local governments has strengthened, supporting construction for a number of institutional markets. The health care market, also, is doing well, because it has become more efficient to build new state-of-the-art facilities than renovate old, outdated ones. We also expect the green building movement, which includes energy efficiency, to continue to help our architectural businesses. Our glass products and systems provide very high levels of energy efficiency for buildings. More and more buildings are gaining leadership in energy and environmental design, or LEED, certification for sustainable green design, including the recently completed World Trade Center 7 building, which has our glass. Federal tax incentives also are encouraging use of energy-efficient glass in buildings.

Recently, an industry forecaster, the Freedonia Group, stated that they expect almost 9% annual growth in solar-control advanced glass products, such as our Low-E and reflective energy-efficient glass, through 2010. Apogee's expertise in strengthened hurricane and blast-resistant glass systems also supports our outlook and ability to provide distinctive solutions for commercial buildings. We get frequent questions on our exposure to the condominium market, which is reported to be slowing. Approximately 25% of our backlog is for a relatively small number of condominium projects. We are being asked to bid on future projects, and continue to be cautious and selective in taking on condominium work.

Turning to our outlook for the large-scale optical segment, we've taken our revenue guidance down slightly. We are seeing some reduced demand due to softness in national retail accounts, partially offset by increases in picture-framing glass sales to distributors. In addition, as certain markets adjust their value-added offerings, it is resulting in a less favorable product mix in fiscal 2007 compared to the prior year. Our framing business continues to be a good one for Apogee. Only 20% of the custom-framing market is using value-added glass, and we are the clear product and marketing leader. There remains great potential for our products that reduce fading and reflectivity of framed pictures in art. As we expected, we received net proceeds of $1.8 million from a flat glass settlement in the second quarter. These proceeds are included in our current earnings outlook, and are somewhat offset by higher health care costs for the year under our self-insured program. I'd like to note that, in the second quarter, our health care costs improved from the unusually high levels we experienced in the first quarter.

Before I turn to Jim to comment on the financials, I want to reiterate that we're feeling good about the year and the momentum we're building in our architectural segment. Jim?

Thanks, Russ. Good morning and welcome to our conference call. We are pleased with our first-half performance in our architectural segment. It positions us for a strong fiscal 2007, for meeting our architectural segment operating margin guidance for the year and is another step of getting back to our prior-peak architectural margin of 7% in another two years. Our architectural segment was the driver of our 30% earnings increase to $0.26 per share from $0.20 per share in the prior-year period. Our markets are strong, so we continue to improve our operational performance. The earnings per share reconciliation between the current earnings of $0.26 per share and the $0.20 per share earned in the prior-year period is the architectural segment core operation added $0.11 per share. The large-scale optical segment was down $0.08 per share from a strong second quarter last year. Combining the auto glass segment with the income from our PPG Auto Glass joint venture, reported in equity in affiliates, this business was flat with the prior year. Other items in the quarter were net proceeds of $0.04 per share from settlement of a class-action lawsuit with a flat glass manufacturer, and a charge of $0.01 per share for incremental stock-based compensation.

Our architectural segment performance continued to improve. Our operating margin was 5.6%, or 5.0% excluding the flat glass settlement. This compares to 2.8% in the prior-year period and 3.4% in this year's first quarter. We benefited from improved pricing and operational performance. Our backlog again increased in the quarter to $391 million, our strongest backlog position ever. Our backlog by key markets breaks out as approximately 30% to 35% institutional, which combines the education, health care, and government building segments; 25% to 30% office; 25% condominiums; then 10% entertainment and hotel projects.

We anticipated a difficult comparable for our large-scale optical segment due to last year's unusually strong second quarter. The segment showed a significant decline in the current quarter versus the prior-year period, with an operating margin of 10.2% compared to 20.6% last year. In last year's second quarter, we called out that timing and product mix resulted in the shift of volume and margin into that quarter from the second half of fiscal 2006. The change in national account promotional schedules in Q2 last year, along with channel fill for a new package size for higher value-added products, drove this ship last year. The operating margin for the second half of last year was 15.8%, well below the high of that second quarter. In the current year, we had expected a less favorable product mix and lower sale for the large-scale optical segment, with fewer customer promotional activities this year. We saw a softer retail environment and lower pre-framed art sales than anticipated in the fiscal 2007 second quarter, but we continue to see conversions to value-added picture framing products.

At the end of our second quarter, our long-term debt declined to $56.5 million from $59.9 million at the end of the first quarter. This is up from $45.2 million at the end of the prior year. Debt has increased from year end, as expected, to fund working capital needs and capital expenditures. Noncash working capital was $88.8 million, down slightly from the first quarter but up from year end, driven by growth working capital requirements, including increases in receivables and inventory. Capital spending year to date was $16.1 million. Our tax rate for the quarter was 35.9%.

I'll turn to our outlook for fiscal 2007. We continue to feel good about the current year. Our earnings guidance range continues at $0.88 to $0.94 per share, strong core earnings growth compared to last year. The increase we've made in our architectural segment revenue outlook has been somewhat offset by a decrease in revenue expectations for the large-scale optical segment. Performance within the earnings per share guidance range will be determined by actual timing of job flow. Architectural segment revenue growth expectations have increased to a range of 17% to 21% from the previous guidance of 14% to 18% growth. Our third quarter tends to be stronger than the fourth quarter in architectural, with some geographic seasonality. Our record backlog of work, of which almost 60% is scheduled to be completed this fiscal year, along with our continued strong bidding and in-bound order activity, give us confidence in these higher growth rates. Our backlog projects have an improving margin, despite an overall increase in construction material costs.

In addition, we continue to improve our operational performance and benefit from architectural glass price increases. We are positioned to attain our architectural segment operating margin range of 4.5% to 4.7%. Year to date, our margin was 4.5%, or 4.2% without the flat glass settlement. We expect continuing improvements in operating margins for the balance of the year. Our fiscal 2007 outlook is for our architectural operating margin to be more than one percentage point greater than in fiscal 2006. Our ongoing improvements in margins put us on track to reach our prior peak architectural margins of approximately 7%. This supports our longer-term growth goals of 8% top line and 20% bottom line improvement through fiscal 2010.

Our outlook for the large-scale optical segment has declined slightly. We're anticipating lower than previously expected demand for picture framing and pre-framed art products for the year due to softness in certain retail markets. At the same time, we continue to see less favorable overall mix of value-added framing and pre-framed art products compared to fiscal 2006. We expect our fourth quarter to be stronger than the third quarter in this segment. The large-scale optical segment remains a solid business for Apogee, one that is a well-respected leader in its industry. Value-added framing products are valued by retail customers, and we continue to see success with conversion. We're also exploring other opportunities in market niches where products add value and are under-utilized.

I'm going to briefly cover cash flow for the full-year fiscal 2007. Other elements of our guidance are in our news release. We're estimating EBITDA, earnings before interest, taxes, depreciation, and amortization, from continuing operations of 57 to $60 million. We estimate net cash provided by continuing operations of 40 to $50 million for the year. Capital expenditures are projected to be approximately 40 to $45 million. This includes $25 million of the planned $30 million total cost for the third architectural glass plant. We anticipate this will give us neutral to slightly positive free cash flow, and we define free cash flow as net cash flow provided by operating activities minus capital expenditures. Including our normal ongoing dividend program, we project year-end debt will range from 50 to $60 million. As Russ stated, we believe our businesses are well positioned to deliver strong performance in fiscal 2007, allowing us to achieve solid growth in core operational areas.

Thanks. Russ?

Thanks, Jim. I'd like to go ahead and open the call for questions.

[OPERATOR INSTRUCTIONS] Our first question comes from the line of Steve Denault of Northland Securities. Please proceed, sir.

Good morning, everybody.

Morning, Steve.

Morning.

In reference to the [inaudible] architectural operating margins, did you say within two years?

Two more fiscal years after this year.

Okay. So by fiscal'09?

At the end of '09, right.

So the assumption is by the end of '09 you'll hit that level, but you wouldn't realize that level for the full year?

We have the potential to realize that for the full year under current -- if current market conditions hold through that time period.

Okay. In terms of upping your top-line expectations for architectural, what is it? Is it a function of the nonres market accelerating, or is -- are you realizing more success from a market share standpoint in terms of winning contracts?

I think that a lot of our growth is -- is in -- you have to sort of peel onion back, but we have been continually improving our capacity within our glass fabrication, so we've gotten growth out of that. There has been demand there that was unserved, so as we develop improved capacities, we're able to do that. We're also going to expand our standard window line capacities, and that's good. And then we have sort of things that are -- you know, projects getting a little larger, so you're able to leverage your assets and engineering and project management capacity over more dollars. So -- so you have several things that are driving this, and clearly within a market that continues to show modest growth.

Steve, this is Jim. I'll just add to it. I mean, the market demand is there to support our growth. And so, for us it's a combination of increasing capacities to service it, as well as executing some of our strategic initiatives, which would be expanding into standard windows in our window business as well as, you know, targeted focus in our installation business.

Okay. You made reference on [LSO] side the picture framing glass sales to distributors. Is the implication there that you're able to -- you're expanding your reach in terms of number of picture framing shops that are offering your product?

What we're doing is we're seeing a mix shift to more -- continue to see a mix shift from clear glass to value-added glass and then up the value-added chain, in -- in more broadly within the distribution market.

Yes, our current focus, Steve, is more about converting existing customers, both at the distribution level and at the frame shop level, from either nonvalue added or to value added or at a higher value added. The upside potential in that business, you know, relates to grabbing additional share in that business.

Okay. Thank you.

Our next question comes from the line of Tyson Bauer of Wealth Monitors. Please proceed.

Good morning, gentlemen. A couple of quick questions. You mentioned that you had improved health care costs from Q1 relative -- Q2 relative to Q1. Have they improved enough or do -- are they trending to a lower number to reach your original budgeted level for the second half of this year?

They're reflecting normal inflation within the health care categories, more so trending toward that than they are the -- the -- we did not have a repeat of the significantly large claims that we had in the first quarter, so it's more of a normalized -- health care costs are going to go up. They're going to go up for everybody. Doesn't matter what you have, so that's what it's reflecting. So it's more normalized.

Okay. So we should get back to a more normalized state for the second half?

Well, we certainly are watching and monitoring that. But if you get into this particular category, self-insured companies, it is hard to have visibility into extraordinary cases. We -- you know, the trends -- the normal trends we see and we understand. We think those are covered. It's the extraordinary that's always the outlier.

And, Steve, just to clarify -- it's Jim. We do expect it to normalize, but it is at a little bit higher level. You know, in Q1 we experienced both higher-than-expected health care costs plus an unusual level and in Q2 we had none of the unusual level. A little bit better than, you know, Q1, but still seeing higher than originally anticipated levels of health care costs.

Can you give us more color on -- we've seen what you're able to produce as far as margins. You have a very robust backlog. What kind of pricing ability and margins are you looking at in your backlog, and also what you're able to bid today as it relates to, say, six months or a year ago? And are you able to get further expansion on those margins more quickly on the fabrication side in the architectural division or more from the installation?

You've go several questions in there, Tyson. In general, we -- the backlog that we have and the margins in the backlog support our projections and our belief in the continued improvements that we are -- that we have outlined. So -- so we are -- clearly we understand what's in the backlog and what's happening, and that supports our belief that we're going to see improvement. So -- so that's -- that's more of the data-driven point. The markets, themselves, are giving us the ability to be more selective in contract and more selective in window manufacturing, which helps us with efficiencies and, therefore, helps us generate a higher margin in those businesses. In glass fabrication, we believe we've seen significant price increases already. We continue to be focused on opportunities there, and we believe that where we are today is clearly sustainable, and we -- and our backlog encourages us to believe that it is -- it's still improving. And I -- I think that's -- that's probably -- that's probably where -- you know, it leaves us with a very good position and a very good attitude about pricing.

Okay. So you're able to bid at a higher level than what is currently in your backlog?

In some businesses, Tyson. This is Jim. You know, I think, as we've talked in the past, our fabrication business probably has the quickest ability to translate that pricing into business. And so our current revenues are showing some of the improved pricing that we've seen in the architectural business. In our window and installation business, those are longer lead times, in terms of the improved pricing or margin conditions able to flow through that business, and we're starting to see that. But that's where, you know, in our backlog we see the margin improvement, you know, happening, you know, going forward in that part of the business.

[Something else], a lot of the rationale you've given for the decline in revenue and also margin has been a lot of demand-driven forces or -- or basically decisions made by yourselves to try to gain market share, and this is a -- a way to do that as far as on a more global look at this. Are there any supply forces that would also be creating a more hostile environment? Is it getting more crowded in the space?

No. We're -- we're not seeing any change in the competitive environment.

So this is completely driven by your own strategic initiative?

Well, I mean, it's combined with, you know, what's happening from a customer market perspective. as well as our own strategic initiatives. I mean, I think, really the driver in the mix things that we're seeing this year are probably more customer driven. And as I think we talked in Q1, probably the biggest driver was customers that are either introducing additional products or switching their products -- product mix within value-added products. So it's still carrying value-added products, but adding additional not -- lower value-added products in their mix and it's having a cannibalization effect on the higher margin products. So -- and then we are seeing, you know, as we've said, some overall softness in the market. So it's really more -- you know, the strategic element is partnering with our customers, but it's really being driven by some of the customers.

I'll give you just a slightly different twist. We have great relationships. We have terrific positions in the LSO market. We're very excited that we continue to see this business be a viable part and contribute at significant levels to the Company. What we see short term is that we see some changes in inventory, changes in product mixes within the higher value added that we believe is resetting -- some of our customers are resetting their lineup. We would then expect, once that's reset, that we would then see growth in the higher value-added category again as we move forward. So -- so there are -- there are several moving things going on. I think these thing are very healthy, and I think they're going to, long term, be a significant benefit to the Company.

Thank you, gentlemen.

Our next question will come from the line of Cliff Walsh of Sidoti & Company. Please proceed.

Morning, everyone.

Morning, Cliff.

Can you comment on the new plant, how that's progressing and just maybe give us a quick update there?

Yes. This is Russ. Hi, Cliff. Yes, the new plant's moving along on schedule. We are feeling very good about the timeline and capital costs associated with it, and at this point in time we have not changed our beliefs. We think we'll be up and running somewhere mid first quarter of next fiscal year, so early in the -- early in the first quarter next year. And it looks -- it looks good so far.

Okay. And with respect to the break down of the backlog -- you went through that with the percentages -- I missed the first couple. Can you kind of go through them again?

Sure, Cliff. Basically it's about 30% to 35% institutional, and in that we combine our educational and health care, and government segments. Office is about 25% to 30%. Condominiums about 25%. And then entertainment and hotel about 10%.

Okay, great. And with respect to LSO, you talked about the, you know, customer shifting there, their product mix. Russ, do you have a timeframe as to when you think that'll be done and the growth will come back in that market?

I -- I think that we're looking at probably a continual mix over the next several quarters. But I think that, as that happens, everyone will be resetting and -- and our strategies are going to remain the same. We think that we've got great relationships, great abilities to help our customers improve their business, and we will continue to do that. And I think that'll reflect in a continued growth and improvement of the mix and margins in that business in our favor.

Okay. Great. Thank you very much, guys.

[OPERATOR INSTRUCTIONS] Our next question comes from the line of John Walthausen. Please proceed.

Yes, good morning.

Morning, John.

In looking at the cash flow statement, you know, because we only have the abbreviated balance sheet, you don't have any significant cash from operations in the -- in the first half. Can you talk about what the uses of cash are that are absorbing your income?

Sure, I mean for the first half of the year it's really working capital growth. And within that, some of that is business growth, and then some of that is seasonal. I think we might have talked about a little bit in the first quarter, which is, we do have -- our first quarter had things, incentive payments, pension playment -- payments, tax payments. And then, because of our fiscal year, we actually had two dividend payment, where the cash actually fell in our first quarter of this year.

Right. But, of course -- well, dividend payments. I'm just really just talking about the cash flow from operations line.

Right so -- right, other than dividends, the other items are going to be --

Yes. And of course, the seasonality would apply to last year, and last year you threw off $11 million, this year one, so it's a significant decline, even though income and, of course, depreciation and stock-based compensation, all those things are all -- are all up. So, you know, a change in operating assets seems to be the big one. And the $20 million seems large for just growth in sales. Was there -- is there more than that? Are there some areas that were building up inventory for one reason or another?

No. I mean, you know, it really is going to break down approximately -- and these are going to be approximate -- about half of it really is receivables and inventory, with receivables being the primary component. But in the other half, the items, incentive reduction and liability associated with the incentive pension and tax payments.

Okay. And then on the discussion a few questions ago about margins in the glass details, there were a lot of details and I didn't fully grasp the jist of it. But it looks to me as though your guidance for the year suggests that, I guess, we did on an adjusted basis 5% operating margins in the group in the second quarter and it looks like that for the balance of the year. Is that -- is that correct, and does that represent what the business, as is properly -- as is constituted now would tend to achieve in good times?

Well, you know, actually -- well, we've articulated it as we see the ability to get this business back to the 7% operating margins we saw in our last peak, and we see, really, kind of a continuous improvement to get to that point. And so, you know, we've got a couple quarters in a row of improvement. You see the comparison to last year, and you'll see -- you know, we're at -- for the first half of this year, a little over 4%. And so to get to 4.5% for the full year, we're going to see, you know, like you said, the five level for the balance of this year. And we should see, as we see the improved operating performance and the improved margins in our backlog flowing through into next year, you know, kind of a gradual improvement from that.

Okay. I mean, it's surprising because, yes, this is a sort of, I guess, seven quarters of, you know, positive book-to-bills that it takes that long. Yes. I don't remember in other recoveries that it takes that long to get the margins up. Is there something that's different about this cycle or the way you're approaching it?

I think our backlog is spread out over a little longer period than it was in prior times, and so you've had some lower margin jobs that have impacted us. And as we've reported earlier on those, those are running through the system and are pretty much gone now. There's still some, but not -- not nearly what there was.

Right. We're probably seeing a little bit faster improvement of that in the glass fabrication side. The installation and window side, those are longer lead time in nature. And I'd suggest what might be a little different than. maybe, last cycle is, I think our average job size is a little bit larger, which means they also are spread over a longer timeframe for those jobs to flow through in term of from our backlog into our revenue.

Okay. I guess -- to me that implies to two thing, so correct me if I'm making the wrong assumption. That, one, the good news is going to be that when the shoe drops and nonres construction drying up, you're business won't dry up as quickly as it has. And also, that the commitment of working capital per dollar of sales is going to grow because of the larger size and complexity of the jobs?

Well, we -- I certainly agree with you on the first. I think I need to think about the second just -- not much.

Yes, I don't -- I don't know that that would necessarily be true. I mean, some of it depends on how we're able to negotiate the contracts, and sometimes it's mixed. For example, government projects tend to have a little bit bigger working capital drain than office projects, for example.

Okay.

Yes.

Okay. Good. We'll watch that. Okay, thanks.

Thanks, John.

[OPERATOR INSTRUCTIONS] At this time, sir, I do show no questions in the queue. I'll turn it back to you for any closing remarks.

All right. Thank you and thanks for the questions today. We clearly feel like that we're in a great position with all of our businesses, our architectural and LSO businesses, in particular. And thanks for dialing in.

Thank you for your participation, ladies and gentlemen. You may now disconnect. Have a wonderful day.