Apogee Enterprises Inc (APOG) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen and welcome to the second-quarter 2017 Apogee Enterprises earnings conference call. (Operator Instructions). I would now like to introduce your host for today's conference, Ms. Mary Ann Jackson. Ma'am, you may begin.

Thanks, Tamara. Good morning and welcome to the Apogee Enterprises fiscal 2017 second-quarter conference call on Thursday, September 15, 2016. With us on the line today are Joe Puishys, CEO and Jim Porter, CFO. Their remarks will focus on our fiscal 2017 second quarter and our outlook for fiscal 2017.

During the call, we will discuss non-GAAP financial measures when talking about Apogee's performance. You can find definitions for these non-GAAP financial measures in our press release. Our call also contains forward-looking statements reflecting 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 our SEC filings. Joe will now give you a brief overview of the results and then Jim will cover the financials. After they conclude, Joe and Jim will answer your questions. Joe.

Thank you. Good morning, everyone and welcome to Apogee's conference call. With our second-quarter performance, we had outstanding results -- revenue is growing 16%; gross margin, up 240 basis points to 26%; operating margin up 260 basis points to 11.9%; and earnings per share up 54% to $0.77. I'm also pleased that our LEAN initiative is paying dividends and I will talk more about that in a few minutes.

In addition, with our operating income up 47%, we've delivered 20 straight quarters of substantial double-digit operating income growth bringing us to corporate records for revenue, profit and margins and more to come. Building on our strong performance year to date and expectations that this level of performance will continue in what is a healthy commercial construction market -- I will discuss that in a few moments -- we are once again increasing our full-year EPS outlook to $2.80 to $2.90 per share, up from $2.70 to $2.85 per share in the prior guidance. We've narrowed the range and raised both ends of the guidance.

The strength we've been seeing in all of our nonresidential construction end markets is evident in the results from our architectural segments. All three segments in architectural grew revenues and operating income, with operating margins all increasing at least 200 basis points and top-line growth rates ranging from 7% to 49%.

Turning to the backlog, backlog grew sequentially and year-on-year in architectural glass and framing systems. The decline in the consolidated backlog resulted from the inconsistent timing of committed architectural services segment projects progressing to signed contracts at which point they enter our backlog. This business continues to have an impressive pipeline of active bids and awards.

As Jim reminds you every quarter, the architectural services projects business has lumpy quarter-to-quarter revenues and backlog. This trend was evident as service revenues were up 49% in the quarter when no significant projects entered the backlog. I too would like to see revenues and earnings here more level, but this is not the projects world. A challenge for a public company, yes. Although lumpy results are a challenge, this business remains a gem and it's our highest ROIC segment and we manage this business for the long term.

Our services installation business is operating at the desired capacity as we somewhat temper growth to focus on margin enhancement. Operating margin in the quarter was up 500 basis points to 8% and year to date is up 450 basis points to 6.7%. This year-to-date margin level is 3 times better than the operating margin for the full year in fiscal 2014 just 2.5 years ago. I'm proud of this improvement, as we are doing what we said we would do in the installation business.

I will make a few comments now on the other segments before turning to the outlook for the balance of the year. In architectural glass, strong US volume and improved mix drove 7% top-line growth. Operating income was up 43% and operating margin expanded 240 basis points to 9.7%, an approximate level we expect to see for the full year. In spite of the declines in international -- that would be our Brazilian business -- and exports from the US due to the strength of the dollar, our US business achieved solid growth.

The architectural framing segment had 14% top-line growth with increased volume in all four segment businesses along with improved pricing and mix. The margin for this segment expanded over 200 basis points to 14.1%. We have gained share through our NPI -- that's new product introduction -- and geographic expansion and coupled that with best-in-class service and quality to gain this share.

The large-scale optical segment continues to operate well, although revenues and operating income were down in the quarter compared to the prior year period on the timing of customer orders, as well as new market investments. We project both top and bottom-line growth in the large-scale optical segment in the second half of the year. We also continue to develop new markets to leverage our core intellectual property on new products in this segment.

Now let me cover our outlook for fiscal 2017. Our backlog level supports our growth outlook for fiscal 2017 and beyond and we feel bullish about our end-market commercial construction markets as we did at the end of the first quarter. Nothing has changed in terms of bidding activity in our architectural businesses. We continue to expect mid-single digit growth in US commercial construction markets for fiscal 2017, as market activity, the Architecture Billings Index, office employment and office vacancy rates all show positive momentum.

Specifically, the ABI has been at 50 or better for 21 of the last 24 months indicating reliable, manageable, sustainable growth in architectural activity. There have now been almost 80 straight months of private sector job growth in the United States. The US office vacancy rate, as reported by CBRE, continued to decline in the second calendar quarter and we are now down to 13%, the lowest level for vacancy in several years.

The Dodge Momentum Index, a monthly measure of the first or initial report for nonresidential building projects in planning grew 1.3% in August making it the fifth consecutive month that the Momentum Index has increased, marking the longest such streak since the end of 2012. The Momentum Index is currently 16% above the same month a year ago, reflecting this growth by major sector, institutional planning up 22% and commercial planning up 11%. And according to Dodge, both sectors are showing such improvement and suggest that developers are shrugging off sluggish economic data and uncertainty surrounding the elections and moving ahead with plans for new projects.

As I highlighted earlier, we are increasing our earnings-per-share outlook for fiscal 2017 to $2.80 to $2.90 a share, up from $2.70 to $2.85 as a result of continued market strength, as well as our solid operational performance and productivity driven by our LEAN efforts. We are maintaining our outlook for approximately 10% revenue growth this fiscal year.

With our internal market visibility and external metrics moving in the right direction, we see US nonresidential market growth at least through fiscal 2020. We are reaffirming our longer-term outlook that we have provided for fiscal 2018. We are expecting revenues of $1.2 billion to $1.3 billion at an operating margin of 12% to 13% in fiscal 2018. We have been doing what we said we would do, and I am optimistic about Apogee's stated growth outlook for fiscal years 2017, 2018 and beyond. Jim will now cover the financials.

Thanks, Joe. Good morning. We had a great second quarter. Revenues were up 16%. As we said last quarter, we expected strong sequential growth in revenues for the second quarter and they were even slightly better than we anticipated. Operating income of $33 million was up 47% and earnings per share of $0.77 were up 54% on strength in our architectural segments and excellent operational performance across all four segments.

I'd like to add a bit more detail on the quarterly segment results. In architectural glass, second-quarter revenues were up 7% on strength in our US business, as well as improved pricing and mix. We expect mid-single digit growth for the full year in architectural glass although year-to-date revenues were flat. Operating income was up 43% to $9.6 million and the operating margin grew to 9.7%. Architectural glass is driving nice productivity improvements while seeing positive product mix and pricing along with leverage on the volume growth. We are expecting an operating margin of roughly 10% for the full year.

Second-quarter architectural services revenues grew 49% as project timing drove revenue in the quarter. We had expected a step increase in revenues this quarter, which we saw. The timing of project activity drove slightly higher revenues than we had expected. As Joe discussed, this architectural projects business segment has quarter-to-quarter variation in revenues and backlog. Year-to-date revenues are up 30%, although we continue to expect full-year growth in the upper single digits in architectural services, which obviously implies a lower second half just driven by project timing.

Segment operating income in the quarter was $6.2 million, up significantly and the operating margin grew to 8%. We benefited from leverage on the strong volume in architectural services both in the field and in operations on projects with better margins and great project execution.

In architectural framing, revenues were up 14% as we had volume increases in all of the operating businesses in this segment. As Joe mentioned, we are continuing to drive growth by delivering premium quality and service to customers along with growth in new geographies and with new products.

Operating income grew 34% to $13 million and operating margin increased to 14.1% as a result of improved operational performance, volume growth and lower material costs. Large-scale optical revenues declined slightly compared to the prior-year period due largely to the timing of customer orders. Operating margin was 23.7% compared to 25.1% due to lower volume and mix and investments related to new market development. I will remind you that relatively small incremental expenses for strategic activities like developing new markets have a bigger operating margin impact in this smaller segment. Operational performance in this segment remains strong and we expect top and bottom-line growth for the full year.

The second-quarter backlog of $447.7 million was down 13% from the prior-year period and 12% from the first quarter. Joe provided some detail on the backlog status, but I will echo his reminder that our business does have lumpy order intake so we don't require or necessarily expect sequential backlog growth each quarter to be consistent with the longer-term trend and our expectations for top-line growth.

Our backlog mix at the end of the second quarter continues to reflect strength in the office sector. The office sector is approximately 55% of the backlog. The institutional sector is 20% to 25% of the backlog, down slightly from 25% to 30% in the first quarter. The sector is more balanced between education, healthcare and government projects than it has been in recent years and has seen bidding activity growth.

Multi-family residential, including high-end condos and apartments, is approximately 15% of the backlog, up slightly from 10% to 15% in the first quarter. And hotel, entertainment, transportation is approximately 5% of the backlog, down slightly from a range of 5% to 10% last quarter. The change in the mix of backlog that we saw this quarter is really just a result of the mix of project revenue and order activity in the quarter. We continue to see good end-market conditions across all sectors.

Regarding the timing of the backlog, approximately $281 million or 63% of our backlog is expected to be delivered yet in fiscal 2017, and approximately $167 million or 37% in fiscal 2018. This level of backlog does not change our outlook for the business. In the quarter, we had positive free cash flow of $28 million compared to $31 million in the prior-year period with strong earnings and good working capital performance. The current year capital expenditures are higher as planned as we invest primarily in capabilities and productivity across our businesses.

Non-cash working capital was $86.5 million for the second quarter. We continue to have very strong days working capital management with our DWC at 45 days in the second quarter. The tax rate for the second quarter was 32.9% compared to 34.2% in the prior-year period. Since the R&D tax credit was made permanent by Congress in our fourth quarter last year, we now recognize that benefit throughout the whole year.

I will turn now to our outlook. Our fiscal 2017 full-year outlook continues to be for a year of nice growth, strong margins and a double-digit increase in earnings per share based on our performance trend and the visibility we have in our markets. As Joe noted, we are increasing our earnings-per-share outlook to a range of $2.80 to $2.90 per share as a result of solid operational performance and productivity expectations for the full year in good nonresidential construction end markets.

We've maintained our outlook for approximately 10% full-year revenue growth. Based on our visibility, we continue to anticipate relatively balanced revenues the rest of the year, with the third quarter expected to be just a little stronger than the fourth quarter. We expect second-half year-on-year growth for all segments except for architectural services.

We've increased our outlook for gross and operating margins. We expect the full-year gross margin to be approximately 26.5% and the full-year operating margin to be approximately 11.3%. For fiscal 2017, we expect full-year depreciation and amortization of $33 million and we anticipate the full-year tax rate will be approximately 33%. We expect to generate positive free cash flow for the balance of the year and full year. Our priority for use of cash remains focused on finding attractive investments to grow our business. We are actively working our M&A pipeline. We are expecting our fiscal 2017 capital expenditures of approximately $70 million for additional capabilities, productivity, automation and some capacity. This is an increase from our previous outlook of $60 million in part due to the timing of payments related to our investment for architectural glass oversize capabilities. At the same time, we will maintain our dividend and continue to evaluate repurchasing stock to offset dilution from our compensation programs.

In summary, we had a great second quarter and have solid performance trends that position us to grow to record levels in fiscal 2017. We have good market and operating momentum and solid strategies that we continue to believe position us to deliver on our longer-term revenue and profit goals. Joe.

Jim, thanks. Before I turn to your questions, I would like to comment on one of my key initiatives that I brought to Apogee five years ago, that being operational excellence and LEAN. Apogee's improved margins result in part from introducing proprietary new products and lowering costs through a culture of LEAN continuous improvement. In addition to cost productivity, continuous improvement has increased marketshare at several business units by providing best-in-class leadtime and quality. We began our LEAN journey in 2012 by creating a core of LEAN experts at our corporate office. This team developed a curriculum of LEAN fundamentals, including workplace organization, visual management, problem solving and Kaizen.

With this small beginning, our core experts proceeded to pyramid their LEAN expertise and best practices to our 21 manufacturing locations across our seven business units. Fast-forward to today and you will find every single Apogee business unit has developed their own LEAN leadership and they continue to drive our LEAN tools and culture down to the supervisory and team leader level at every site.

Our LEAN systems provide rapid frontline response to unexpected conditions in an eight-step problem-solving process often referred to as A3, a format for collective problem-solving. Today, eight-step and Kaizen events are performed across the Company on a daily basis. Apogee's continuing improvement initiative was created as operational excellence primarily focused on the shop floor.

Given our great success we've experienced within our manufacturing sites over the past four years, our Apogee LEAN team has expanded our core curriculum to include 25 new dimensions of excellence to be addressed over the next 10 years across all aspects of operations. We have rebranded this initiative as Apogee LEAN Enterprise because it includes companywide continuous improvement in administrative functions such as accounting, engineering, HR, marketing and our supply chain.

Our goal is to become the preferred supplier in each of the business segments we serve by continuously improving our customer experience from their first contact to product delivery. My annual goal-setting includes objectives for cost productivity and continued LEAN implementation. These goals are shared by every business unit president and their direct reports. A significant portion of executive year-end compensation has been tied directly to attaining their target for cost productivity. This system of goal-setting has created awareness and accountability for continuous improvement across all of Apogee. I continue to expect at least 50 to 70 basis points of margin expansion annually from our LEAN efforts for the foreseeable future.

With that, Tamara, I would like you to open up the call for questions, please. Thank you.

Thank you. (Operator Instructions). Michael Conti, Sidoti.

Yes, so just on the architectural services side, obviously strong revenue growth although coming from an easier comp, but how should we think about the sustainability of the margins in that business given what you are guiding to us for the foreseeable -- I guess the second half of this year in terms of revenue growth?

Yes, Mike, even though the second half -- our first half is stronger, obviously, we are at 30% year-to-date revenue growth. We are projecting mid to upper mid-single digit growth for the full year. Our operating margins in the second half will continue to expand, so the full year will be several hundred basis points better for the full year and the backlog we have -- we have good visibility to the projects that will ship at this point. We pretty much have everything in hand that we need to ship for the year and install for the year, so we have really good visibility to our margins. So, bottom line is, although Jim mentioned second half won't be as strong as the first half on a year-over-year comp basis, we will continue to have margin expansion on a year-over-year basis, so the trend will continue.

Got it. Okay. And then --.

Mike, let me just say we also expect solid performance from that business next year as well.

Got it. Great. And then there's been some talk about glass supply constraints and glass price increases. Can you just talk about any pricing opportunities of your own and then maybe perhaps any lag time to push forward pricing over the next couple of quarters?

Yes, the long-awaited glass shortage never happened. It's frankly a non-issue for us. We are not seeing any significant movement on input costs on glass. Our projects are all forward-purchased, so it's a non-event for us, but we do not expect over the next three years to have any issues with attaining glass supply. We have strategic partnerships across North and South America, so pretty much a non-issue, Mike.

Got it. Okay. And then just looking out to fiscal 2018, just the revenue goal of $1.2 billion to $1.3 billion, that suggests growth of 12% to 20% and you haven't hit the 20% top-line growth since fiscal 2015, which was due to a surge in orders on the framing side, but can you just talk about which segment or drivers, whether it's product mix, pricing or maybe the retrofit initiative that would get us to the top end of that range?

Yes, so we are continuing to maintain a range as we are only halfway through this year and we do our annual operating plan in January; present to our Board in February just before we launch the new fiscal year. So I'm not ready to hone in on an exact number. We do feel confident of strong growth. We've had a consistent achievement over the last five years of outperforming our end markets by an average of 5% because of our geographic expansion and our NPI. We will continue to expand our geographies in virtually all of our four segments, and I agree that the upper end of that is going to require substantial year-over-year revenue, but I think we've proven we can do that. And over the long term, I am confident we will be in that $1.2 billion to $1.3 billion range.

Great. Thanks. I will hop back in queue.

Samuel Eisner, Goldman Sachs.

So just going through the glass commentary, I think you commented that margins were going to be around 10% for the year. Historically, you guys have a sequential increase into the back half of the year in terms of your margins over the last few years. So I'm just curious if there's anything that we should be mindful of entering the back half of the year as it relates to your glass margin because I think the first half you are basically doing 10% and you are effectively guiding for that in the back half of the year. So curious if there's anything in that sequential second-half margin that we should be mindful of.

No, Sam, I certainly expect a strong second half from the business. I think you know we got, at least on a year-over-year comp basis, off to a slow start when we were down mid-single digits in the first quarter. We were up 7% in the second quarter, so we are kind of back to parity. We will have strong growth for the full year, so the second half is going to be very, very solid.

You are right, we are guiding to something like 10% for the full year. There is no hidden message in that, Sam, that performance is going to deteriorate. We've had, frankly, extremely strong operational performance, hence my comment to try to make you all understand that we are not just volume and mix. We have a lot going on in LEAN. Clearly, there's opportunity and risk to every forecast. I feel very, very good about that business. I think Q3 will be a very solid quarter.

Let me just say we have less -- we don't have as much visibility into the fourth quarter in that business as we do on our long leadtime installation business, but we have a pretty good feeling for how the year will go and we will have growth and solid operating performance. So if I can beat the 10% we talked about, we certainly will.

That's helpful there. And then you've commented on prior conference calls regarding pricing. I know you commented just before about availability of the raw material of glass, but as far as pricing of glass in the market, can you talk a bit about what you are seeing from a competitive standpoint there? I think you've commented in the past about how a strong dollar has helped some foreign competition benefit in the local market, particularly related to long leadtimes as well. So perhaps you can address the pricing question as it relates to your glass business.

So I will let Jim actually get into pricing, but let me just say you are right. We did highlight that the strength of the dollar has certainly opened the door in areas like New York in particular for European competitors. We have seen some let's call it offshore fatigue where folks think they can save a dollar upfront, but the long leadtimes, the premium cost of freight and delivery when there's any problem at the construction site offset that. So we are feeling good about the trend on that, and we in turn move to try to do more business than let's say the mid-size markets for our glass business and we've been extremely successful. We've certainly maintained margins in that segment and we continue to -- I don't think I called out price, but we definitely had a little bit of year-over-year price favorability in the glass segment along with volume and mix and Jim will comment further on that.

We are not exporting much in that business where in the past we would export $20 million to $30 million a year. That's mostly dried up. We understand that. We've completely offset that with other projects in the US and although our Brazilian operation is a slight headwind to our glass segment results, that business performed very well and we've begun exporting from that business. It's not enough to offset the strength of the dollar and the door that's opened for European competitors, but it's making a difference for us and it has helped us offset the poor economy in Brazil. And, frankly, we continue to weather the storm in Brazil pretty nicely and it's de minimis to our overall Apogee results, but we are doing well down there.

I will just add a couple of comments, Samuel. As it relates to architectural glass, we are seeing benefits of price and mix in fiscal 2017 and you know we really combine product mix with price together because the more we can move towards differentiated products that works to our advantage and in good times, you see more architectural influence, more Class A type work that leads to our benefit.

And then just as it relates to that competitive pricing, we continue to see the international competition that we have been seeing. Frankly, the pricing there hasn't changed. It's rational other than the fact that they have an FX benefit that they are taking advantage of.

That's helpful. Maybe just the last one, a two-part question. One, what was the percentage of the backlog in the second quarter that was services? I know you disclosed it in the Q and I think you gave some information about sequential growth in glass and framing backlog, but I'm just curious what the percentage of services backlog was for the quarter.

I'm sorry. In the second quarter?

Yes.

Yes. Roughly 50%, just over 50%.

So, to that, given that, we are now -- and I apologize, this is a little bit of a setup question here -- but you are now three quarters in a row where book to bill within your services business alone has been less than 1 times. And so I am curious how you think about that. I recognize that your comments are regarding timing in the recent quarter, but if it's in a 50% to 60% range for services that would imply a less than 1 book to bill and again, fourth quarter, you had that, first quarter you had that and now second quarter. So is there something more going on here than strictly timing? Is it project selectivity where you are really drawing that down? Is there something market-related? I recognize there are some macro comments, but perhaps you can give me some comments about what your customers are saying, particularly as it relates to that services business because it does seem to indicate that things are a little bit more negative than what you guys are ultimately saying. Thanks.

Sam, I understand, and my fear is that people will overcook the data on the backlog in services. I suppose I understand that. I have no desire to go to jail. I don't misrepresent the business. There is nothing unusual going on. Nothing changed from last quarter to this quarter other than a lot of projects have not entered backlog, but we didn't lose any projects. I had one project that's gone on hold that I thought would come into backlog in the second quarter, but it doesn't change the narrative and we haven't lost that project and we do believe that large project will go forward.

The bottom line is -- Jim and I have been saying it for a while -- we like that business where it is. It's about a $250 million business, slightly more one year; slightly less the next, but it's about a $250 million business. I'd like that to get to double-digit operating margins. I'd rather be a $240 million, $250 million business at 10% OM than a $500 million business. I could easily take on work at low margin. We are probably outperforming every other large glazer in the country right now and we are doing that because we are being very, very selective on our projects.

We have not yet seen a downturn in margins, but we continue to be very selective. And I would say for the rest of the year, depending on the timing of orders, our backlog might increase in that business, it might not, but nothing has changed in that business in the last three quarters. Although the book to bill in that business has been lower, some of that was due to a run-up in the prior year and we've had extremely -- we had a combination of an order that slipped out of the quarter and very, very strong revenues, just slightly stronger than our plan, but admittedly we had a little bit stronger orders and our performance on the job site has been good. Don't overcook it. We are comfortable that business is doing exactly what we want it to do.

Got it. That's great. I will hop back in queue. Thanks, guys.

(Operator Instructions). Chris Moore, CJS Securities.

Maybe we could go back to glass again just for a second. I understand that the margins for the rest of fiscal 2017 will be in the 10% range. I guess the question is for beyond that. What would have to happen to get those margins back in the 11% to 12% range?

Well, we do expect to continue to grow margins in that business and we will do that through volume growth. We are anticipating that, as we build our fiscal 2018 plan, there will be top-line volume growth. We will continue to drive a favorable mix. You all know we've been investing a lot of money and capability for that business with our oversized glass. We've already won business that will be revenued in 2018. I can assure you the pricing on glass that's nearly 240 inches long and 130 inches wide -- you can quickly do the math in your head on how large that is -- that is more attractive than today's pricing, so that will continue to help our margins.

We've got productivity investments. We mentioned an investment of over $60 million in our largest facility to implement this oversize. That was less than half the investment. The other half is through automating. Those of you, many of you on this phone that I've already talked to this morning have visited our factory and know five years ago we had too many people handling our glass as it went from operation to operation. We have substantially reduced that and we have a long way to go, and that's a significant amount of what that investment we are making now that goes online at the very beginning of fiscal 2018.

So volume and markets continue to be favorable for that business for next year. And, again, we are working on architects on bidding on that work now. Our new capabilities in oversize and our productivity, yes, I expect margin enhancement in that business next year.

Got you. And some of this obviously what you said will relate to the framing, but 14.1% very strong quarter. Is there a lot of room to improve margins on the framing side?

Yes, absolutely. The framing system segment -- some of it is our comps too. We had -- I think if you remember last year -- we had -- I was talking about Canada underperforming. That business has been a star. They have turned their business around, yet we are still in our own territory, so we are not spiking the football. We've got a long way to go, but I still believe we have significant tailwinds to improve that business. The framing system segment is the most fragmented segment of all four of our operating segments and allows us the ability to continue to gain share, namely through our ability to be a dependable supplier and outflank our competitors with delivery. So I believe we will continue to see growth in revenue and margin in the framing system segment.

Got you. Okay. That's helpful. Thanks, guys.

Thank you. I'm showing no further questions at this time. I would like to turn the conference back over to Mr. Joe Puishys for any final remarks.

Okay. Thank you, Tamara and I know many of you we will be talking to over the next day or two and we'll look forward to those conversations. I thank you for your attention today. I look forward to talking to you with some more good news at the end of the third quarter. Have a great day, everyone.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.