Simpson Manufacturing Co., Inc. — Q3 2017 Form 10-Q
Reporting period: Three and nine months ended September 30, 2017. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Business context
Simpson designs, manufactures and sells building construction products, principally wood and concrete construction products. It reports North America, Europe and Asia/Pacific segments. Management’s stated priorities include organic growth, expanding in Europe and concrete products, and developing software solutions.
Financial performance
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net sales | $262.5 | $231.0 | $745.3 | $660.5 |
| Gross profit | $119.9 | $113.5 | $343.6 | $317.5 |
| Gross margin | 46% | 49% | 46% | 48% |
| Income from operations | $46.7 | $45.8 | $114.5 | $113.3 |
| Net income | $28.2 | $29.8 | $79.5 | $72.3 |
| Diluted EPS | $0.59 | $0.62 | $1.66 | $1.49 |
Q3 sales rose 14%; acquired businesses contributed $15.8 million, or half of the increase. North America sales increased 8% and Europe sales 50%, with European growth substantially acquisition-driven. For the first nine months, sales rose 13%, including $43.4 million from recent acquisitions. Q3 operating expenses were under 28% of sales, down 104 basis points year over year, which management attributed mainly to lower stock-based compensation and cash profit-sharing expense.
Despite higher sales and gross profit, gross margin declined, partly because acquired businesses had lower margins and North American material, factory, overhead and labor costs increased. Q3 net income declined primarily because a $2.1 million adjustment reduced the previously recorded bargain-purchase gain on the Gbo acquisition. Nine-month net income increased, with the $6.3 million bargain-purchase gain contributing approximately $0.13 to diluted EPS.
Cash flow, liquidity and capital allocation
- Nine-month operating cash flow was $84.6 million, versus $66.9 million. The filing cites net income and noncash items as sources, partly offset by working-capital movements, including a $40.6 million increase in receivables.
- Investing cash outflow was $62.8 million, including $45.1 million of capital expenditures and $27.9 million of net acquisition spending, partly offset by $9.6 million in proceeds from the Gbo Poland sale.
- Financing cash outflow was $49.3 million, including $27.0 million of dividends and $20.0 million of share repurchases. Cash declined by $22.4 million to $204.2 million during the nine months.
- Working capital was $479.0 million at September 30. The company had no outstanding debt and reported $304 million of total available credit, including its $300 million primary revolving facility. Capital lease obligations were approximately $3.9 million.
- The board increased the share-repurchase authorization to $275 million, extended through December 31, 2018; approximately $201.5 million remained available. Dividends declared were $0.81 per share for the first nine months; a further $0.21-per-share dividend was declared for payment in January 2018.
Outlook, management commentary and notable items
- For full-year 2017, management estimated gross margin of 45%–46%, depreciation expense of $28–$29 million, amortization expense of $6–$7 million, and an effective tax rate of 35%–36%. It expected steel prices to remain stable for the rest of 2017.
- The October 30, 2020 Plan targets approximately 8% organic net-sales compound annual growth from 2016 through 2020, operating expenses of 26%–27% of sales by 2020, and a 30% reduction in raw-material and finished-goods inventory over three years. These are targets, not reported results.
- Management expected U.S. single-family housing starts to grow at a mid- to high-single-digit rate over the next few years, while noting seasonality and exposure to construction activity, weather, steel costs, competition and foreign exchange.
- The SAP ERP implementation was described as on track and on budget. Estimated total cost through 2019 is $30–$34 million; management expected first locations to go live in Q1 2018. Annual operating expenses are expected to rise during implementation and afterward through 2024.
- Management reported plans to reduce 25%–30% of product SKUs and target a 30% reduction in raw-material and finished-goods inventory over three years. The North American factory-consolidation project was reported as complete for planned production moves, with utilization around 60% versus approximately 45% at the start and estimated annual savings of about $3 million.
- A fourth-quarter 2017 workforce reduction was expected to generate $3.0–$3.5 million of severance charges. This was disclosed as a subsequent event.
- Gbo Poland was sold for approximately $10.2 million, with a reported $0.4 million gain; the Gbo Romania sale closed October 31, 2017. The company retained Gbo operations in Sweden and Norway.
- Gentry Homes demanded reimbursement after settling homeowner claims for approximately $90 million involving alleged corrosion of products supplied by the company. Simpson said it admitted no liability, could not estimate the likelihood or range of loss, and intended to defend any claims; it believed insurance might cover all or part. Simpson was not a party to the related arbitration or, as of the filing date, a legal proceeding brought by Gentry. A separate Hawaii class action could potentially involve Simpson products, but the company was not then a party.
- The company reported no legal proceedings it expected to have a material adverse effect, while acknowledging litigation outcomes are uncertain. It also reported no off-balance-sheet arrangements and no material change in risk factors from its 2016 Form 10-K.
Important facts for investors to verify
- Whether sales growth and margin performance persist as acquisition contributions and lower-margin acquired businesses affect results.
- Progress toward 2020 Plan targets, particularly organic growth, expense reduction and inventory reduction.
- Actual SAP implementation costs, timing, operational effects and resulting expense levels.
- Developments in the Gentry demand and potential corrosion-related claims, including insurance coverage and any ability to estimate exposure.
- Capital spending, cash conversion and working-capital trends, especially receivables and inventory.
- Fourth-quarter severance charges and the company’s subsequent operating performance following workforce reductions.