Simpson Manufacturing's (SSD) CEO Karen Colonias on Q2 2016 Results - Earnings Call Transcript

| About: Simpson Manufacturing (SSD)

Simpson Manufacturing Co., Inc. (NYSE:SSD)

Q2 2016 Earnings Conference Call

July 29, 2016 09:00 ET

Executives

Tom Fitzmyers - Vice Chairman

Karen Colonias - CEO

Brian Magstadt - CFO

Analysts

Tim Wojs - Robert W. Baird

Steve Chercover - DA Davidson

Daniel Moore - CJS Securities

Operator

Good morning, ladies and gentlemen, and welcome to the Second Quarter 2016 Simpson Manufacturing Company Incorporated Earnings Conference Call.

In this conference call, the company may discuss forward-looking statements such as future plans and events. Forward-looking statements, like any prediction of future events, are subject to factors, which may vary and actual results might differ materially from these statements. Some of such factors and cautionary statements are discussed in the company's public filings and reports. Those reports are available on the SEC's or the company's website. Please note, today's call may be being recorded.

I will now turn the conference over to Tom Fitzmyers. Please proceed.

Tom Fitzmyers

Thank you, thanks everyone. Good morning and welcome to the Simpson Manufacturing Company, second quarter 2016 earnings call. Our earnings press release was issued yesterday. It is available on our website at simpsonmfg.com. Today's call is also being webcast and a replay of that webcast will be available on our website. As usual, joining me for today's call are Karen Colonias, Simpson's CEO; and Brian Magstadt, Simpson's CFO. I will start, followed by Karen and Brian, and then we will be delighted after that to take your questions.

North America had a good sales quarter of nearly 8% compared to last year based on an increase in housing starts and construction activity in most of the region. Our European sales were flat compared to last year's Q2. With minimum foreign exchange effects, we like many companies are waiting to see what the Brexit vote implications will be for our business.

But as a reminder, our 2015 net sales in the UK was slightly less than 3% of consolidated net sales. As we mentioned before we estimated about 55% to 65% of our total company with product sales are dependent on housing starts. North America operating profits were up $6.1 million due to increased growth profits partially offset by the increase of operating expenses.

Europe was down again last year. Asia Pac improved due to cost recorded last year related to the wind down of the Asia sales offices which did not reoccur this year. We continued to have very strong financial position with $246 million in cash, $300 million unused credit facility which was just renewed and this gives us great flexibility and the capability to continue investing in our long term strategy.

Before I turn the call over to Karen I also wanted to mention that our Board of Directors has declared a quarterly dividend of $0.18 per share. Karen?

Karen Colonias

Thank you Tom. In an effort to ensure we are the most cost effective manufacturer in North America, we have started to transition our high volume connector production out of the Riverside branch to our other major manufacturing locations in North America. The complete transition will take a couple of years. This will allow us to use our equipment more efficiently and to strike for a goal of 75% utilization on two full shifts.

Riverside will remain one of our major sales & distribution locations. We share our manufacturing & the special facility to continue to meet our commitment of service and availability to our customers in the South West region. Once the transition is completed we expect to see over $3 million in annualized savings. For the past 18 months, we have done extensive review of commercial ERP systems.

Our current home grown system although perfect for what it was designed to do can no longer keep up with our geographic growth and our product diversity. The Board has approved our implementation plan for SAP which will become our global enterprise platform. This is a 3 to 4 year plan of approximately $30 million. Some of the spend will be capitalized.

Although a short term increase in operating expense, once fully implemented, we anticipate annual savings around 1% of sales through new business analytics, improved inventory management, and improved purchasing and reducing operating cost as we grow.

Our truss specialists have been actively presenting our Truss design and manufacturing excuse me management software and are working on converting customers. We have converted a number of small component manufacturers since the release and are making good progress. Truss sales, although small were up just over 14% from Q2 up to 15 and year-to-date those sales are up 22%.

As a reminder, our current software design features allow us to approach about one-third of the US Truss market. To continue being engaged with M&A firms in North America and Europe, working to find out acquisitions to help us meet our long term growth strategy. We spent a little money in Q2 evaluating a couple of the companies but as of now we do not have anything to announce.

And I would now like to turn the call over to Brian who will give some additional financial information.

Brian Magstadt

Thanks Karen. As Tom mentioned, exchange rates had minimal effect on Q2 comparable sales. But there was about $1 million of foreign exchange cost in operating expenses to account for unrealized losses on payables denominated in foreign currency primarily for the UK operations as the Pound moved against other currencies at the end of the quarter.

The margin differential of wood to concrete products is about 13% points this quarter compared to 15% Q2 last year due to concrete product gross margin increasing at a higher rate than wood product gross margins both on increased sales. Those factors led to a Q2 2016 gross profit margin of 48.5% up from Q2 last year 45.4%. As noted in the press release we believe the estimated gross margin will be 46% to 47.5% range for 2016 depending on how the rest of the year goes.

Total operating expenses with your R&D and Engineering, selling and admin as a percent of sales was up about 170 basis points in the quarter compared to last year as the company incurred expenses related to those unrealized foreign exchange losses previously noted.

Increased cash front sharing on higher operating income and legal and professional fees if the company works to deliver on a long term strategic initiatives. Regarding taxes, the tax-rate of 35.8% for this year Q2 is down from 38.5% last Q2 primarily related to lowered foreign losses and the R&D tax credit which was made permanent at the end of 2015.

We believe the annual effect of tax rate for 2016 will be between 37% and 38%. Q2 2016 CapEx was about $13 million primarily for improvements and our new chemical facility that we announced last year as we are continuing to build out the move of our two existing chemical facilities anticipated for late 2016.

We also invested in manufacturing equipment and software development. We estimate total 2016 CapEx to be in the $50 million to $55 million range assuming we complete all projects this year and that includes the expansion of our facility in Texas for greater warehouse and office trained centered capacity that we announced last quarter.

For 2016 depreciation and amortization expense is expected to be in the $29 million to $31 million range of which depreciation is $23 million to $25 million. Before we turn it over to questions I would like to remind you that if you would like further information, please contact Tom at the phone number listed at the press release. Also listen for our quarterly report on our Form 10-Q to be filed next week. We would like to now open it up for your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question is from Tim Wojs from Robert Baird. Please go ahead your line is open.

Tim Wojs

Hey everybody, good morning.

Karen Colonias

Hi Tim.

Tim Wojs

My first question is around gross margin and steel and maybe how we should think about it. You know you raise the top end of the gross margin guidance and I expect that because of strong margins in Q2 but it's still a pretty wide range for the second half of the year so could you talk us to a little bit about your outlook for steel and how we would get to the low end of the margin range and maybe the high end of that margin range?

Brian Magstadt

Hey Tim, it's Brian. Thanks for the question. I would say that the uncertainty in that wide range is due to the steel pricing that's in the marketplace. As you probably noticed steel has taken up a pretty big run up over the last 6 months. So, that's what's creating that uncertainty there.

Tim Wojs

Okay, how do we, do you guys pre-buy any steel earlier this year when prices were pretty low?

Brian Magstadt

Yes, we have had, I wouldn't say any significant buys, I mean we have inventory throughout the, over the last months to take us through a little bit further but depending on the specific material there weren't any major buys in the last quarter. So as we look at what we have on hand and what we are bringing in, you know obviously we are bringing in material at higher amounts, at higher costs. Again, that's I think where the uncertainty is coming from in my mind.

Tim Wojs

Okay, I guess it suffices status, if steel price stay the same today, can gross margins be up on a year-over-year basis in the second half of the year ending 2017 and how do you guys think about pricing? Is the market strong enough right now to be able to push through some pricing to offset the inflation?

Karen Colonias

Hey, Tim this is Karen. Obviously a lot of information out in the industry about what's going on with the fuel prices and of course it's mainly due to the new tariffs that have been put in place for steel that's been coming in outside of the US market. You know certainly many companies in the building materials have steel as predominant material. We have seen price increases that have been announced for them and we certainly are analyzing that and we will have to make some decisions as to what we might need to do in that front.

Tim Wojs

Okay. I guess maybe switching to the SAP implementation that you talked about. Could you just give us an idea, I know it's still early days but just an idea of what we should expect in terms of how much of that $30 million is went through CapEx, how much of that hits the expense line and maybe the timing of that? Will we see any expenses that's hitting 2016 or is that more as we get into the second half of 2017 that you start to see the actual expense items?

Brian Magstadt

Yes Tim, its Brian. I would say maybe a little bit spend towards the end of 2016. We have actually, as part of our readiness and evaluation we have been spending a little bit of money to evaluate the various systems and the likes. But as the project is now moving forward, we may capitalize a little bit towards the end of this year regarding licenses that we may need to acquire or equipment that may need to support that. But I would say that the spend would largely begin next year and of that total that Karen noted by the ballpark, an approximate capitalized peace. Maybe about a third, maybe a little more. And of course it's capitalized it's going to run through the P&L at some point and it's got a pretty short depreciable life and that will take it out couple of years but not too significantly.

So, I would say that as we go through the phases of implementation that 2017, 2018 are probably the heavier years, as we look at that and as we bring more locations on the work hopefully just continues to roll and we are not having to spend as much on those subsequent phases if you will.

Tim Wojs

Okay and these are pretty large implementations, can you give us a sense for how much is the standard ERP? I know the complications typically arise when you start making any sort of customization so, I guess how customized is this system and just the confidence that this is a pretty kind of slow implementation process and hopefully not see a lot of implementation head winds?

Karen Colonias

Yes, Tim I think we have had a team of over 50 people here from Simpsons from both our North America branch as well as our international branches. We have looked at bringing people from operations, finances, inside sales and the warehouse, everybody that would be directly impacted by the new ERP system and as I mentioned we have spent about 18 months analyzing first of all what system is the best for us and certainly the team came up with the SAP system.

And yes, this year as Brian mentioned we have spent a significant amount of time and what they call readiness which is really looking at the exact operations that we do at the Simpson locations and how will they work on the SAP platform. You mentioned customization, the idea is not to customize but to use the off the shelf program. If we start customizing we really do loose some efficiencies and certainly that has been our message as we have been really communicating significantly with the entire company on why we are bringing this product in and what it will do to help us be more efficient in all aspects of our company. So we are not looking at customizing, typically that creates a few head winds when we do customizing so I think again we have done a good job of the last 18 months getting key people engaged. We have a very key team that would be working on this project full time. We have spent quite a bit of time with an implementer and they specialize in manufacturing companies.

So I think we have one a good job with the due diligence with this project. No ERP implementation is easy but I really applaud our group, I think they have done a lot of great ground work and we will be rolling this out in about 4 different waves. And that's really timing. Obviously, the first wave will take the longest and then we anticipate each one after that should be a little bit shorter so, can't say we won't have any head winds but I think we have done a really great job and the team has done an excellent job of thinking of all the things that may come into place and I think more importantly the communication with the employees on why we are changing and what the benefits will be in getting their engagement and involvement in the project.

Tim Wojs

Okay, that's helpful. I appreciate the color there and then last one from me and I will hop back in but the $3.2 million of professional legal expenses in the quarter, was that all associated with potential acquisitions?

Brian Magstadt

Tim its Brian. Not all of it, I would say it was a fraction of that, was. As broke it up we were looking at acquisition opportunities but we just talked about the SAP readiness as part of that. We have done some shareholder engagement so we have had a little spend around there and then just an increase in legal expense just related to nothing major but few different things that add up. So of that total that you quoted, maybe a quarter of that was for the acquisition type activities.

Tim Wojs

Okay. And are those just given what you are doing structurally with changing, merging Riverside with a couple of other locations and the SAP rollout, all those acquisitions kind of table them out given a lot of the operational stuff that you are doing internally and then anything you can add about what the shareholder engagement activities were?

Karen Colonias

Let me talk about the Riverside and SAP. We are still, we have not tabled our look for the acquisitions that can help our long term growth strategy so we are still actively looking at those. And certainly lot of acquisitions take a long time to come to fruition and evaluate so we are still very active on looking for acquisitions. We have a great team that is helping us from the manufacturing side with the Riverside transition and again that's well under way and I already mentioned the SAP team. So, we have really got good teams working on both those projects but they are not hindering or slowing down what we are trying to do from an acquisition stand-point.

Tim Wojs

Okay.

Brian Magstadt

And Tim, it's Brian on the shareholder engagement. Last year or at the last annual meeting we had a low say on both results so we wanted to get out and talk. We have been getting out and talking to the governance teams of shareholders specifically around our compensation programs or our governance programs and giving feedback and listening and taking that information back to our board and various other folks that would help us work through what those programs are. So that's really where the shareholders engagement efforts were.

Tim Wojs

Okay, I will hop back. I will see you guys next week.

Brian Magstadt

Thanks, Tim.

Operator

Thank you Tim. [Operator Instructions] We will take our next question from Steve Chercover from DA Davidson. Your line is now open.

Steve Chercover

Thanks and good morning.

Karen Colonias

Good morning.

Steve Chercover

It seems like despite your efforts to diversify, your sales are now, as much as ever wood oriented in North America so I mean the last cycle of that seems scary. I am wondering if this time around you are happy to be in the safe haven.

Karen Colonias

I think, obviously Steve you know our core, we built this company over the last 60 years on that connector business and what we can provide to the industry from wood construction. We have obviously added to that, if you look at our revenue, at one point 2 million housing starts versus where it was 2.1 million housing starts, you will see that our revenue is certainly approaching the same level. And I believe that because we have our additional product line of fasteners and the truss business as well as what we are doing in the concrete space. So, as healthy storage increases, obviously is a great thing but it's also creates a little bit more difficulty in diversification but I do believe that what we are doing in the concrete side, we are much better positioned for looking at construction products in commercial markets as well concrete repair markets. So nice to see how things start going up and certainly that's our huge focus but I also think we are in a much better position from a balance as we look at being able to spread geographically as well as different product lines.

Steve Chercover

All right, thanks and one other quick one. It's been five years since MiTek bought USP and I am just wondering how the competitive landscape has evolved and what your relative market share is currently?

Karen Colonias

Yes, I think our sales team and our support groups do work very hard every single day to keep our margins and our market share. We still see MiTek has a very good software program and so from a truss standpoint it's a tough push for us to compete against them but I think we have got a good product on the market now that's helping us penetrate that space a little bit. We still see them using software sort of as a key selling aspect and trying to basically bundle truss plates and software along with the USP connectors. And I think that's their strategy on how they are going to market. We have been able to I think hold most of our market share and that's really just a function of what we built our company on and that's that customer service and so as I mentioned and I talked about it a lot.

Pricing is an interesting thing but you need product availability, you need to be able to support the customer. You need 24 hour turnaround on special and those are all the things that we have really put in place to continue to service those customers and I think they have rewarded for that by staying loyal to our product line.

Steve Chercover

Okay, thank you.

Karen Colonias

Thank you Steve.

Operator

Thank you. [Operator Instructions] Looks like Tim Wojs from Baird does have another question for us.

Tim Wojs

Hey guys, just a follow up. I guess through the quarter from a demand perspective, how is the -- I think last quarter you said April maybe was kind of the 4% range and you ended growth year at 6% for that quarter so just curious how the monthly demand progressed through the quarter. And I noticed the Home Centre was down over here for the first time in a couple of years, is it just hiding there or is it something more structural than home centers?

Karen Colonias

Yes, Tim I will just address the Home Centre piece first. I think it's definitely a climbing issue, the Home Centre was up pretty significantly in the first quarter. I think it probably pulled some of the second quarter into the first quarter business but certainly on a year-to-year basis we are still up in the Home Centre space and actually that's sort of a similar timing with the rest of the connector product line. We had a very significant increase in our revenue in the first quarter and as we mentioned we believe that pulled a little bit of second quarter into first quarter and so that's I think what you are seeing as again you look from the first quarter into the second quarter.

Tim Wojs

Okay, thanks.

Karen Colonias

Thank you.

Operator

Thank you. Our next question comes from Daniel Moore from CJS Securities. Your line is open.

Daniel Moore

Good morning.

Karen Colonias

Good morning Dan.

Brian Magstadt

Good morning Dan.

Daniel Moore

Wanted to shift back to the ERP implementation. Karen I think mentioned targeted cost savings about 1% of revenue that implies very healthy soft of 25% to 30% pre-tax IRR on $30 million of spend so maybe can you give us a little bit more granularity on what the key drivers and the magnitude of cost savings you expect once it's all implemented?

Karen Colonias

Sure, our system, again we mentioned our ERP system got blue screen and it was developed about 30 years ago really with the connector business in mind and although it's been a great system and it's certainly served us very well, as we grow and have different crunching issues and as we look at different product lines, it just is not really designed for where Simpson is today so we are certainly looking at the opportunities for efficiencies. We can look across the entire company looking at inventory. We can't really do that today. We will be able to look across the entire company and see from the stand point of metric associated with sales in different regions, different products. If you think we use blue screen for our operating systems from a finance standpoint, we use AX right now.

So certainly have a better tie-in with both operations and finance to help us from closing the books sooner to little more consistency across all our branches from our auditing standpoint. Consistency from the standpoint of joint purchasing so there's many pieces that we believe would see cost savings and one of the key things is that we have we believe as we grow the system will help us not need to add additional people because it is more efficient in how we are all connected so we will be able to grow with not a huge increase in employees because of the efficiencies of the system. Again right now we have a lot of hand operations that have to go through our systems today.

Daniel Moore

Appreciate it and going back to the gross margins as well. Obviously very healthy increases. Can you [ph] or part of it but can you either rank order or quantify increased absorption mix or input costs with the major drivers of the margin improvement were in the quarter?

Brian Magstadt

Volume definitely helps as we noted in the release. As a percent of sales material and labor help. Those were some of the key drivers there and as we noted in the prepared remarks the mix of within concrete and wood and concrete margin improving little bit better than wood although wood improved as well, helped drive that gross margin in the quarter.

Daniel Moore

And then as a follow-up, the concrete mix, is it absorption, is it pricing? What's kind of driving the uplift in margin there?

Brian Magstadt

I would say mostly absorption. It being more efficient in the manufacturing and delivery of those products.

Daniel Moore

Okay, and last one, I will leave it at that. Any more granularity at this stage you might be able to provide a point to in terms of the potential revenue impact, maybe in 2017 provide a truss or fiber reinforced polymers?

Karen Colonias

I think it's pretty early again as we mentioned the we sort of in our year looking closely at the truss software that's out and certainly I mentioned in last quarter we have got our report on that Carbon Fiber now so, we will have a little bit better feel as to where that might be as we finish 2016.

Daniel Moore

Okay, thank you again.

Karen Colonias

Thanks Dan.

Operator

It looks like we don't have any further questions at this time. I will turn the call back over to you.

Karen Colonias

Great, thank you.

Brian Magstadt

Thanks, everybody.

Tom Fitzmyers

Thanks.

Operator

This does conclude today's program. Thank you for your participation. You may disconnect at any time.

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