Business context and reporting period
Apogee Enterprises, Inc. designs, manufactures and installs glass, aluminum framing and related systems for commercial buildings, and produces value-added glass and acrylic products. This Form 10-Q covers the third quarter and first nine months of fiscal 2019, ended December 1, 2018; comparisons are with periods ended December 2, 2017.
Financial performance and liquidity
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Net sales | $357.7 million | $356.5 million | $1,056.4 million | $972.7 million |
| Gross profit / margin | $84.1 million / 23.5% | $91.6 million / 25.7% | $249.3 million / 23.6% | $247.9 million / 25.5% |
| Operating income / margin | $31.4 million / 8.8% | $34.5 million / 9.7% | $82.1 million / 7.8% | $86.4 million / 8.9% |
| Net earnings | $21.9 million | $23.6 million | $57.8 million | $57.2 million |
| Diluted EPS | $0.78 | $0.82 | $2.04 | $1.98 |
- Q3 sales were nearly flat (+0.3%), while net earnings fell about 7%. Nine-month sales rose 8.6% and net earnings increased about 1%.
- Operating cash flow was $70.6 million for the nine months, versus $66.2 million a year earlier. Capital expenditures were $33.9 million.
- At December 1, 2018, cash and cash equivalents were $15.0 million, with $26.4 million of restricted cash. Current assets were $372.8 million and current liabilities $212.6 million.
- Long-term debt was $232.7 million, including $211.5 million outstanding under the $335 million revolving facility. The company had $25.1 million of letters of credit reducing facility availability and was compliant with its financial covenants.
- Dividends paid in the first nine months were $13.2 million ($0.4725 per share); share repurchases totaled $23.3 million. The company repurchased a further $14.9 million of shares after quarter-end.
Material changes versus the prior comparable periods
- Margins weakened despite higher year-to-date revenue. Management attributed the decline primarily to higher costs, reduced productivity and quality costs in Architectural Glass, and lower-volume operating leverage in Architectural Framing Systems. Lower SG&A as a percentage of sales partly offset the pressure.
- Architectural Services was the strongest growth and profit contributor: Q3 sales rose 48.4% and operating income increased to $8.7 million from $2.5 million, supported by project execution and volume leverage.
- Architectural Framing Systems Q3 sales fell 6.6% and operating income fell 30.1%, reflecting project timing delays and reduced-volume leverage. Nine-month sales grew 11.4%, partly because EFCO was included for the full period, but margin declined.
- Architectural Glass nine-month sales declined 9.8% and operating income fell 68.0%. The segment faced labor-cost, productivity and quality challenges while ramping production. Management reported progress in Q3 and expected improvement to continue into early fiscal 2020.
- Large-Scale Optical Q3 sales declined 10.1%, while nine-month operating income increased 5.5%, helped by operational performance and an insurance recovery.
- ASC 606 revenue recognition was adopted from March 4, 2018 using the modified retrospective method. It increased opening retained earnings by $3.0 million and affected reported sales and contract balances. For the first nine months, reported sales were $1,056.4 million versus $1,042.6 million without adoption; reported net earnings were $57.8 million versus $55.6 million without adoption. Prior-year figures were not restated.
- The effective tax rate declined to 23.5% in Q3 and 23.8% year to date, primarily reflecting the Tax Cuts and Jobs Act, versus 29.1% and 31.7%, respectively.
Outlook, risks and unusual items
- Management’s fiscal 2019 expectations: revenue growth of 6%–7%, operating margin of approximately 8.4%, diluted EPS of approximately $3.00, adjusted operating margin of approximately 8.7%, adjusted diluted EPS of approximately $3.13, and capital expenditures of approximately $60 million. Adjusted measures exclude $3.8 million after tax ($0.13 per diluted share) of short-lived acquired-intangible amortization.
- Backlog was approximately $392 million in Architectural Framing Systems and $419 million in Architectural Services at quarter-end. The transaction price for unsatisfied performance obligations was approximately $706.3 million, expected to be recognized over time.
- Management expects liquidity to be adequate for working capital, planned capital expenditures and dividends for at least the next 12 months, citing operating cash generation and revolving-credit capacity.
- Risks include continued Architectural Glass operating difficulties; project timing, execution and installation exposures; and uncertain costs on fixed-price contracts. The company reported $163.2 million of purchase obligations, $71.3 million of undiscounted operating lease commitments, and surety/performance bonds with $478.8 million face value. It said it had made no payments under existing-business bonds.
- A purported securities class action filed in November 2018 and a derivative lawsuit filed in December 2018 concern alleged misleading disclosures about the business, particularly Architectural Glass. The company intends to defend the matters and said it could not estimate potential loss. It also reported $1.2 million of environmental liabilities and $5.3 million of unrecognized tax benefits.
- Other notable items: two New Markets Tax Credit transactions generated $8.9 million of net proceeds in operating cash flow, with related restricted cash and recapture conditions; the company expects a material right-of-use asset and lease liability upon adopting the lease standard in fiscal 2020, but does not expect a significant effect on earnings or cash flow.
Important facts for investors to verify
- Whether the Architectural Glass segment’s labor, productivity and quality improvements persist and restore margins.
- How reported growth and contract assets evolve under ASC 606, including the effect of substantial revenue recognized before billing.
- Whether fiscal 2019 revenue, margin, EPS and capital-spending expectations remain achievable, especially given weaker Q3 profitability.
- Debt, covenant headroom, facility availability after letters of credit, and cash needs for purchase commitments and capital projects.
- Developments in the class action and derivative litigation, including any estimate of potential exposure.