Simpson Manufacturing Co., Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods unless noted. Financial amounts are in U.S. dollars; millions are used below unless stated otherwise.
Business context
Simpson designs, manufactures and sells building construction products, principally wood construction products, with operations in North America, Europe and Asia/Pacific. North America generated 81.7% of Q3 sales. Management attributed regional growth mainly to higher volumes and improved North American economic activity; the business is seasonal and exposed to construction activity, weather, material costs and foreign exchange.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net sales | $209.3 | $195.6 | $585.5 | $545.2 |
| Gross profit | $95.6 | $89.9 | $269.2 | $243.8 |
| Gross margin | 45.6% | 46.0% | 46.0% | 44.7% |
| Operating income | $32.2 | $30.9 | $84.0 | $69.6 |
| Net income | $20.6 | $20.0 | $53.2 | $43.3 |
| Diluted EPS | $0.42 | $0.41 | $1.08 | $0.89 |
- Q3 sales rose 7.0%; nine-month sales rose 7.4%. Q3 North America sales increased 8.8%, Europe 2.2%, while Asia/Pacific declined 18.5%. Nine-month sales grew in all three segments.
- Q3 gross margin declined 0.4 percentage points, with higher overhead and European warehousing and labor costs cited. Nine-month margin improved 1.3 points, mainly reflecting lower costs as a share of sales in North America and Europe.
- Q3 selling expense increased 14.4% and R&D/engineering expense increased 5.3%; general and administrative expense rose 3.6%. The filing attributes expense increases to staffing, compensation, professional fees, foreign exchange and other items.
- Foreign-currency translation reduced comprehensive income by $15.9 million in Q3 and $17.1 million for the first nine months.
Cash flow, liquidity and capital
- Nine-month operating cash flow was $49.2 million, down from $71.9 million. Higher receivables and inventory uses, among other working-capital movements, contributed to the decrease.
- Investing cash outflow was $17.2 million, including $17.5 million of capital expenditures. Management estimated full-year 2014 capital spending of $21–$23 million.
- Financing cash outflow was $19.2 million, including $19.1 million of dividends and $3.0 million of share repurchases, partly offset by $4.2 million from stock-option exercises.
- Cash and equivalents were $258.2 million at September 30, 2014; working capital was $505.8 million. Current assets of $610.3 million and current liabilities of $104.5 million imply a current ratio of approximately 5.8x.
- Reported line-of-credit and notes-payable balance was $38,000. Total available credit was $304.4 million, including a $300 million revolving facility expiring in July 2017. The company reported compliance with financial covenants.
- Cash held outside the United States was $92.8 million and could incur additional tax if repatriated. The company said it did not plan to repatriate it.
Material changes and unusual items
- Germany reporting-unit goodwill of $492,000 was fully impaired following lower expected sales from former Bierbach customers and increased competition. The related contingent-consideration liability was reduced by $0.4 million, recorded as a gain.
- Withdrawal from a multi-employer defined-benefit pension plan resulted in a $3.0 million liability and expense. The plan administrator demanded annual payments of $145,400 in perpetuity; the company discounted the estimate at 5% and expects to reassess it quarterly.
- A first-quarter out-of-period adjustment increased gross profit by $2.3 million, operating income by $2.0 million and net income by $1.3 million. Management stated it was not material to the current or prior periods.
- Nine-month gross margin included the pension charge and a favorable $2.5 million workers’ compensation expense correction, as described by management.
Outlook, risks and contingencies
- Management estimated full-year 2014 gross margin of 45%–46%, effective tax rate of 37%–39%, and capital spending of $21–$23 million; it expected steel prices to remain flat through year-end.
- Management expected Europe’s recent sales weakness to continue through the remainder of 2014, while anticipating an operating profit for the Europe segment for the year. It expected Asia/Pacific to report operating losses in 2014 and 2015.
- The company said operating cash and available borrowing capacity should cover working capital and planned capital expenditures for the next 12 months. Growth or acquisitions could require additional financing, which might not be available on reasonable terms.
- Four Hawaii lawsuits concern alleged premature corrosion of strap-tie holdown products. A tentative settlement in principle was reached through mediation, but final documents and conditions remained outstanding. The company said an unfavorable outcome could result in uninsured liability substantially exceeding the tentative settlement; any possible excess could not be reasonably estimated. A separate Nishimura case was closed following summary judgment, subject to appeal.
- Disclosure controls were deemed ineffective because material weaknesses in controls over goodwill valuation and indefinite-lived in-process research and development impairment assessments remained unremediated at September 30. Management planned remediation by the fourth quarter of 2014 and stated the interim financial statements fairly presented results in all material respects.
- Management cited construction and economic conditions, customer and supplier health, competition, material and manufacturing costs, currency movements, and product acceptance among risks. It also cautioned that quarterly results are seasonal and interim results are not necessarily indicative of future periods.
Important facts for investors to verify
- Whether the Hawaii litigation settlement became final, its conditions and any remaining uninsured exposure.
- Progress and completion of remediation for the disclosed internal-control material weaknesses.
- Whether the $145,400 annual pension withdrawal payments and $3.0 million liability change as the plan’s duration and discount assumptions are reassessed.
- Actual full-year 2014 gross margin, tax rate and capital expenditures versus management’s estimates, and whether European weakness and Asia/Pacific losses persisted.
- Cash-flow conversion and working-capital trends, particularly receivables and inventory, alongside foreign-currency effects and the availability of the stated credit capacity.