Simpson Manufacturing Co., Inc. quarterly report, Q3 FY2016

Business context and reporting period

Simpson Manufacturing Co., Inc. designs, manufactures and sells building construction products, principally wood-construction connectors and fasteners and concrete-construction products. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016, compared with the corresponding 2015 periods. Results are seasonal and interim results are not necessarily indicative of full-year performance.

Financial and operating performance

Third-quarter sales rose 7% year over year and net income rose 38%. For the nine months, sales increased 8% and net income increased 36%. North America was the main growth driver: sales rose 7% in Q3 and 10% year to date. Europe sales rose 6% in Q3 and 3% year to date; Asia/Pacific sales were down 34% year to date, primarily reflecting sales-office closures. Wood construction products represented 84% of Q3 sales and 85% of year-to-date sales.

Operating margin increased to approximately 19.8% from 16.3% in Q3 and to 17.2% from 14.2% year to date. The Q3 effective tax rate was 34.8%, versus 38.4%; the nine-month rate was 35.9%, versus 38.4%. Management attributed the lower rates primarily to reduced Asia/Pacific operating losses for which no tax benefit was recorded.

Operating cash flow for the first nine months was $62.9 million, down from $72.3 million. Investing activities used $34.0 million, including $29.9 million of capital expenditures and the MSD acquisition. Financing activities used $71.9 million, primarily for $53.5 million of share repurchases and $24.2 million of dividends. Cash declined by $40.1 million from year-end 2015 to $218.7 million.

At September 30, 2016, current assets were $593.0 million, current liabilities $117.4 million, and working capital $475.6 million. Total assets were $984.3 million and stockholders’ equity $861.1 million. The company reported no outstanding debt; it had $303.9 million of total available credit, including its principal $300 million revolving facility, extended to July 2021. The company was in compliance with its financial covenants. Cash held in foreign currencies was $88.2 million and could incur additional tax if repatriated; management had no current plans to repatriate it.

Material changes and unusual items

• Gross-margin gains reflected lower material and labor costs and improved factory overhead absorption, particularly in North America. Steel prices had risen since the start of 2016.
• Q3 research and engineering expense fell 22%, partly because Q3 2015 included a non-recurring $4.1 million software-project write-off.
• Operating expenses increased in areas including selling and general and administrative costs, driven by personnel, profit sharing, software fees and professional costs.
• In August 2016, the company acquired Belgian company Multi Services Découpe S.A. for $6.9 million; cash paid net of acquired cash was $5.4 million. The acquisition was not material to consolidated results.
• Share repurchases totaled $53.5 million for the nine months. A $125 million repurchase authorization runs through December 2017; the $50 million accelerated repurchase program was finally settled in November.
• The company early-adopted accounting standards for deferred-tax presentation and inventory measurement; management reported no material financial-statement effect from the inventory standard.

Outlook, management commentary and risks

• Management said sales growth moderated in Q2 and Q3 after above-average growth in late 2015 and Q1 2016, and was uncertain whether moderate growth would continue through the rest of 2016 and Q1 2017.
• Management estimated full-year 2016 gross margin of approximately 47%–48%, an effective tax rate of 36%–37%, and capital spending of $42–$45 million. Estimated depreciation was $22–$23 million and amortization approximately $6 million.
• A North American price increase, largely associated with higher steel costs, was scheduled to take effect late in Q4 2016. Management said steel-price movements could pressure margins if cost increases cannot be recovered through pricing.
• A multiyear factory-efficiency plan aims for 75% utilization on two full shifts. About 40% of targeted high-volume connector production had been relocated by September 30; management estimated eventual annual savings of approximately $3 million.
• A planned SAP ERP replacement is expected to cost approximately $30 million over three to four years and increase annual operating expenses during implementation from 2017 to 2019. Once fully implemented, management anticipates annual savings approximately equal to 1% of net sales.
• Management expected Europe to report an operating profit in 2016 and Asia/Pacific to break even or earn a small operating profit. It cited uncertainty from economic and political conditions, including the UK’s vote to leave the EU.
• Principal risks include construction cycles and seasonality, customer and product acceptance, steel and other input costs, competition, foreign exchange, acquisitions, product-liability claims and litigation. The company does not currently hedge foreign-exchange exposure; it estimated a 10% currency move in any one operating country would not materially affect consolidated net income.
• The company reported no legal proceeding expected to have a material adverse effect, while noting that claims and product failures can involve inherent uncertainty. No off-balance-sheet arrangements were reported.

Investor verification points

• Verify whether subsequent-quarter sales, pricing and steel costs supported management’s uncertain near-term growth outlook and 47%–48% full-year gross-margin estimate.
• Track operating cash conversion and working-capital investment, particularly the nine-month increases in receivables and inventory.
• Assess execution, cost and timing of the SAP implementation and factory relocations against anticipated savings.
• Review the effect of the $125 million repurchase authorization, dividend commitments and acquisition spending on cash balances and capital allocation.
• Monitor Asia/Pacific and Europe performance, foreign-currency effects, and any changes in product-liability or litigation exposures.