Jul 28, 2017
Executives
Tom Fitzmyers - Vice Chairman Karen Colonias - President and Chief Executive Officer Brian Magstadt - Chief Financial Officer, Treasurer and Secretary
Analysts
Tim Lange - Robert W Baird Steve Chercover - DA Davidson Chris Moore - CJS Securities
Operator
Good morning, ladies and gentlemen. And welcome to Simpson Manufacturing Company Second Quarter 2017 Earnings Conference Call.
On this 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 may differ materially from these statements.
Some of these factors and cautionary statements are discussed in the company’s public filings and reports, which are available on the SEC’s or the company’s corporate website. Please note that the company's earnings press was issued yesterday at approximately 5 O'clock PM Eastern Time.
It is available on the company' website at www.simpsonmfg.com .Today’s call is being webcast and a replay will be available on the company's website. Now, I would like to turn the conference over to Karen Colonias, Simpson's President and Chief Executive Officer.
Karen Colonias
Thanks Kim, and good morning, everyone. I'll begin by walking you through some highlights from the second quarter of 2017.
And then I'll turn it over to our CFO, Brian Magstadt to walk you through the financials and our future outlook in greater detail. Second quarter consolidated net sales were up 14% year-over-year to $263 million, primarily due to our recent acquisitions, driving growth in Europe, as well as increased sales volumes and average net sold unit prices in North America.
The US housing and remodeling markets are continuing on path to a slow but steady recovery. And we believe US housing starts which were a leading indicator for roughly 60% of our business, should continue to improve at a high single digit rate on an annual basis over the next few years.
Our consolidated gross profit margin was 47% reflecting 150 basis points decline over the prior year, due primarily to our recent acquisitions in Europe which have a lower gross margin than our consolidated business, as well as increased fixed factory and tooling overhead cost in our legacy businesses. Our ability to achieve industry leading margins from both a gross profit margin and operating income margin standpoint is due to the high level of value added services that we provide to our customers.
These differentiators includes strong brand recognition, extensively tested solutions that are state of the art test lab, deep 40 year relationship with engineers who get our product specified on the blueprint and pull through to the job site. Product availability with delivery in usually 24 hours or less, active involvement with code officials to improve building codes and construction practices, and strong customer support through education for engineers, builders and contractors to demonstrate ease of use and efficiency of our product.
As most of you know, Simpson Manufacturing Company was founded over 60 years ago. And paved the way to become an industry leader in engineered solution for wood construction products.
Within industry leading position in the US connector market, the wood construction products are core to our operations. And as such we remain dedicated to continue to grow our offerings in the single and multi-family residential and commercial space.
Also, over the past 10 years we've had success in extending our product offerings into fasteners which is enabled us to grow our wood product construction line as well as provide us with a multi product solutions for engineers incorporate in both our connectors and fasteners together for a stronger connection. In addition to focusing our core wood products business, we've continue to make solid progress on our three growth initiatives during the quarter.
These include ongoing development of our truss software product offering, continuing to scale our operations in Europe, as well as increase our market share and operating profit, greater product diversification through growing our share in concrete repair and protection offering. On the wood side, we believe one of the biggest opportunities we have is in a truss space.
We've made positive strides in the ongoing development of our truss software product offerings which is crucial to this endeavor. From a market size perspective, we estimate Simpson's current share of the roughly $500 million to $600 million truss market at approximately 2% to 3%.
Importantly, the market opportunity for truss is roughly the same size as our entire wood connector business. We worked hard to understand the needs of our customers as well as their pain point in order to differentiate and make them more efficient through the use of our software.
Our software solution is not only modular and that designers can choose to use whichever models are most relevant to them, but it's also cloud based which lessens the possibility for lost work and ensures the software is available for any device 24x7. Our truss specialists have continued to convert and train customers on our truss design and management software.
And during the second quarter we converted 15 small and medium sized components manufactures which is our target customer. With an additional 15 to 20 scheduled for the second half of 2017.
As a reminder, the second and third quarters are the busiest time of the year for the construction industry. So we expect to convert the most customers during the off season in the fourth and first quarters of each year.
As discussed on prior calls, the associated R&D spend with our truss initiative has been approximately $8 million per year which we believe we should be able to leverage once we begin to recognize a more meaningful amounts of revenue from the truss business. We expect to provide more details around our future outlook for truss as well as our path to profitability for this initiative by year end.
Turing to Europe, we've been continuing our focus to gain share in this market while simultaneously working to improve our operating profits and margin to be more comparable with other European peers in this space. While Europe has been contributing to our bottom line results, we've been working on various initiatives to turn Europe into a more profitable part of our business.
The acquisition of Gbo Fastening Systems in particular has helped us to extend our product offering in Europe to address our customers' need and looking for a larger, more complete product offering. Specifically, Gbo is helping fastener product into Western Europe as well as our connector products in to Nordic region.
Our market strategy for Europe is the same as North America, to sell engineered solutions rather just products, while continuing to build our reputation as a tested and trusted brand in Europe. Europe presents an attractive opportunity to grow both our wood and concrete products.
Moving on to our third initiative of greater product diversification through growing our share in concrete repair and protective offerings. Outside of North America, the majority of the world's built structures with concrete.
The need to repair and protect aging structures such as bridges, parking structures and peers is eminent. The challenge in the concrete space has been replicating our wood model through strong relationships with engineers and specifier in order to get our products pull through the job site.
In addition, demonstrating our tested solutions versus just selling products is not only the cornerstone of our business model but it is crucial for this test of this opportunity. Unlike the wood market, project in a concrete space are job based.
So there is no leading indicator such as housing starts for roughly 15% of our business that is concrete. This is a desirable factor from a diversification standpoint.
In that the less reliant we are on US housing starts for growth, the better we expect our business should be able to perform throughout all industry cycles. We look forward to providing more details around our concrete initiative by the end of the year.
An additional highlight during the quarter includes our previously discussed plan to move some of our high volume production out of our plant in Riverside, California, to our other tree connector manufacturing locations, in an effort to improve our operating efficiencies as well as to ensure we are operating as cost effectively as we can. As of today, we are about 12 months of schedule and we plan to complete this project by the end of third quarter of 2017.
We are currently tracking at 60% utilization, up from 45% when we began this initiative with the goal of 75% utilization on two full shifts. We've also been working with Home Depot on the rollout of our mechanical anchor products into 1900store locations.
The rollout is expected to continue throughout 2017 and into 2018. As discussed on our last call, once completed we expect this opportunity will meaningfully contribute to our concrete business line going forward.
Our SAP implementation has been progressing both on track and on budget as we worked to complete the first to four phases in our multiyear project through 2019. The associated costs with this endeavor are estimated to amount to $34 million over the next three years.
SAP is being integrated in an effort to improve business analytics, inventory management and purchasing as well as to generate overall productivity. Turing to M&A.
Both our recent acquisitions Gbo Fastening Systems and CG Visions have been performing well. Both acquisitions are now about five months into the integration process and are tracking towards plan.
The acquisition of CG Visions is enabling us to build closer partnerships with builders by offering software and services to help them control their cost and increase efficiencies at all stages of the home building process. Just last month, we showcased the CG Visions software to our target audience of mid and large size builders at the Pacific Coast Builders Conference held in San Diego.
Initial feedback was very positive and we look forward to presenting the CG platform to additional builders in the future. The acquisition of Gbo Fastening Systems, one of Europe's leading manufactures of fastening solutions helped increase our share in wood connector products for the Nordic region and into Western Europe.
We are currently working on sales and marketing plans for a complete fastener line and expect we'll be ready to introduce this to buying groups by year end. In regards to capital allocation.
We continue to have a strong financial position which affords us the flexibility and capability to continue investing in our long-term strategy to increase stockholder value and to return capital through our valued stockholders. Last year, we outlined a strategy to return 50% of our cash flow from operations to stockholders via quarterly cash dividend and/or stock repurchases.
During the quarter, we paid out $8.6 million in quarterly cash dividends, as well as entered into a $20 million accelerated share repurchase agreement. We remain debt free so we have an untapped $300 million revolver available to us should we need -- should the need arise to take on additional leverage in the future especially in the case of a larger acquisition.
We'll also remain focused on investing in our existing business to grow organically. In summary, we remain confident in our long-term strategy for growth.
We have many initiatives that we are diligently working on and that we realize these efforts, we'll take some time to bear fruit, we look forward to be enable to share with you some additional targets to best measure our progress on these initiatives going forward by year end. Before I conclude, I want to announce our former Chairman Tom Fitzmyers, officially retired from the Board as of our Annual Meeting of the stockholder on May 16.
And we'd like to thank him for his many contributions. We also elected a new independent director, Michael Bless at the annual meeting and we look forward to benefiting from his experience and insights.
I now like to turn the call over to Brian who will discuss our second quarter financial results in detail.
Brian Magstadt
Thank you, Karen. And good morning, everyone.
I am pleased to discuss our financial results with you today. Our first quarter consolidated net sales for the second quarter of 2017 were $263 million, up 14% compared to $230 million in the second quarter of 2016.
Net sales in the second quarter included $15 million from our recent acquisitions of Gbo, CG Visions and MS Dêcoupe and were further driven by strong sales to contractor distributors, dealer distributors, home centers and lumber dealer, primarily due to increased home construction activity in average unit sale prices. Within the North America segment, net sales increased 9% year-over-year primarily due to increased sales volume on improved economic activity, as well as increases in average net sales unit prices.
In Europe, net sales increased 47% largely as a result of the recent European acquisition of MS Dêcoupe and Gbo, though were partially offset by the negative effect of foreign currency translation. As a percentage of net sales, wood construction products including connectors, truss plate, fastening systems, fasteners and shearwalls, represented 85% in the second quarter compared to 86% in the prior year quarter.
Concrete construction products including adhesives, chemicals, mechanical anchors, powder actuated tools and reinforcing fiber materials represented 15% of total net sales in the second quarter of 2017 compared to 14% in the prior year quarter. Our consolidated gross profit increased 11% to $123.5 million from $111.5 million in the second quarter of 2016, resulting in a consolidated gross profit margin of 47%, down 150 basis points from the prior year period.
As Karen mentioned, despite this year-over-year decline due both to the impact of our recent acquisitions and increased fixed overhead cost in the remainder of business, our ability to achieve an industry leading gross profit margin is directly attributed to our unique solutions and value added services. On a per segment basis, our gross profit margin in North America decreased slightly to 49% from 50% in the prior year quarter.
In Europe, our second quarter gross profit margin decreased to 37% from 41% in the year ago period primarily due to the recent Europe acquisitions. These gross profit margins averaged 25% for the quarter.
From a product perspective, our gross profit margin on wood products was 48.4% compared to 49.6% in the prior year quarter. And was 35% for concrete products compared to 37% in the prior year quarter.
Now turning to our second quarter cost and operating expenses. Consolidated research and development and engineering expenses increased 16% year-over-year to $13.3 million, primarily due to the recently acquired businesses as well as higher personnel and software licensing cost from the recent acquisitions.
As Karen explained, included in research and development and engineering expense is approximately $8 million per year recognized ratably for the ongoing development of our truss software initiative. Consolidated selling expenses increased 15% year-over-year to $28.5 million, primarily due to the recently acquired businesses, as well as higher advertising and personnel expenses.
Selling expenses in North America increased $2 million and in Europe increased by $1.6 million compared to the prior year quarter. General and administrative expenses increased 5% year-over-year to $36.6 million, primarily due to the recently acquired businesses, coupled with increased personnel, software licensing and legal and professional fees which were partly offset by decreases in cash profit sharing expense and in stock based compensation.
General and administrative expenses in the North America segment increased $2.4 million and in Europe increased by $0.2 million compared to the prior year quarter. We are intently focused on reducing our total selling, general and administrative expenses as a percentage of net sales which were under 30% for the quarter, down 118 basis points from the prior year quarter.
While we do not expect SG&A as a percentage of net sales to be reduced to the 22% level we achieved in 2006, we are focusing on ways to be able to better leverage our expenses as we begin to monetize our various strategic initiative. As you may recall back in 2006, we operated as a one product company and over the past 11 years we've made this strategic decision to diversify our offerings in order to be able to perform throughout all industry cycles and be less reliant on US housing start for growth.
We are now a more complex, two product line company with wood construction products that include connectors, fasteners and truss plate products. In our concrete construction products which include anchors and concrete repair products which come with additional overhead and resources needed to operate including our highly valuable sales force that enables us to attain industry leading gross profit and operating margin.
In addition, we've always placed the significant emphasis on research, development and engineering as we aim to continue to be a thought leader in the industry, addressing evolving building codes and providing end-to-end product systems for our customers. Total expenses included $50,000 gain on disposable of assets.
As a result, our consolidated income from operations increased 10% year-over-year to $45.1 million compared to $45.9 million in the second quarter of 2016. In North America, income from operations increased 5% year-over-year to $42 million and in Europe it increased 118% to $4.1 million.
On a consolidated basis our operating margin decreased slightly to 17%, down approximately 60 basis points from the second quarter of 2016, primarily due to the recent acquisition which contributed less than $100,000 in losses from operations including purchase accounting expenses such as intangible amortization. We believe a 17% operating income margin is still a solid level and as Karen mentioned, it directly reflects the investments and value added services we are able to provide to our customers.
Our effective tax rate increased to 37.2% from 35.8% in the second quarter of 2016, as a result net income for the quarter was $28.2 million or $0.59 per diluted share compared to net income of $26.2 million, or $0.54 per diluted share in the prior year quarter. Turning to our balance sheet and cash flow.
At June 30, 2017 cash and cash equivalent totaled $141 million, down from $167.1 million at March 31, 2017. Capital expenditures were approximately $16.6 million for the quarter and were primarily related to ongoing efforts to complete the Texas facility expansion and for improvements in the new chemical facility in West Chicago.
During the quarter, we also completed a project in our production and warehousing facility in Poland to support improvements and capacity. We also invested in additional manufacturing equipment and software development and capitalize certain cost related to the ERP project.
We remain debt free with only a small portion of capital leases amounting to approximately $2 million. On July 13, our Board of Directors declared a quarterly dividend of $0.21 per share for stockholders of record as of October 5 which will be payable on October 26.
We also repurchased 425,000 shares during the quarter at an average price of $41.28 or a total of $17.5 million as part of $20 million accelerated share repurchase agreement to be completed in the third quarter of 2017. The remaining amount authorized under our repurchase program which expires at the end of 2017 is $51 million.
Going forward, we'll continue to invest in our business both organically and via acquisitions, as well as aggressively return capital to our stockholders in the form of quarterly cash dividends and/or buying shares back in our stock in 2017 and beyond. Before we turn it over to questions, I'd like to briefly discuss our outlook for the full year ending December 31, 2017.
As such, we are reiterating our previously provided guidance for consolidated gross profit margin which we continue to expect will be in the range of 45% to 46%. We are slightly revising our outlook upward for depreciation and amortization expense which is expected to be in the range of $32 million to $34 million of which $26 million to $27 million is pure depreciation.
Capital expenditures are still expected to be in the range of $50 million to $55 million which includes the completion of our Texas facility expansion and new chemical facility in West Chicago by year end. And lastly, we continue to expect our annual effective tax rate to be in the range of 34% to 36%.
In summary, our second quarter financial results were fundamentally strong reflect the various investments we've been making in our business. Including truss software in Europe with the associated recent acquisitions and by working to deepen our foothold in the concrete repair and protection space.
In addition to various others cost necessary to improve our company. These initiatives have yet to fully materialize and reflect the operating leverage and earnings power that Simpson Manufacturing strives to achieve despite maintaining an industry leading gross profit margin and EBIT margin.
Over the coming quarters, we plan to provide additional metrics and targets to help our investors to better measure our success and progress on these initiatives. And we look forward to keeping you updated.
Thank you for listening today. We now like to open up the call for questions.
Operator?
Operator
[Operator Instructions] Our first question today is coming from Tim Lange from Robert W Baird. Please proceed with your question.
Tim Lange
Good morning, everybody. So first question I had Brian maybe just on the gross margin of 45% to 46%.
It was a little unclear in the press release just with the commentary around what you thought steel prices might do in the third quarter. So is there a way to think about how we should benchmark steel -- if we kind of snap the line today and assume that, that steel remains where it is, is that what you've included in the 45% to 46% gross margin guidance?
Brian Magstadt
Correct, yes.
Tim Lange
So if it fluctuates then guidance will change.
Brian Magstadt
Correct. And there is some potential volatility with trade issues on steel in that market.
So we anticipate that there could be vitality but modeling somewhat flat market is where we are coming out on that gross margin.
Tim Lange
Okay, okay, that's helpful. And then you guys gave gross margin and a couple of below the line items, any commentary on what you might think sales growth could be in 2017?
Karen Colonias
Hi, Tim. Karen, yes, I think we are seeing pretty similar when we look at the housing start sort of -- they are tracking mid to high single digits and as we pointed out we sort of track 60% of our business in parallel with this housing start.
We are seeing a little bit better revenue standpoint from the Europe entities. And so I think that's again sort of that close tracking to where we are with housing start with the reasonable approach.
Tim Lange
Okay, okay. And then I know you guys don't want to give any numbers specifics today on some of the longer-term targets or metric but is there way that maybe you could give us a preview of what you actually may give us in terms of -- if it's going to be longer term margin targets or EPS targets or just added color on the initiatives I think that would be helpful for everybody.
Karen Colonias
Yes. So we plan to give some firm metrics in some areas in some time -- timeframe associated to meet those metrics.
And probably some more color on some of our other initiatives. And as we mentioned in the release, we'll have those put together and out to the shareholders and investing community here before the year is out.
Still working through lot of the details obviously with our operational people.
Operator
Thank you. Our next question today is coming from Steve Chercover from DA Davidson.
Please proceed with your question.
Steve Chercover
Thanks. Good morning, everyone.
Few questions. So first of all, truss has been and remains as exciting opportunity and obviously there is a huge amount of growth.
So, a, what is your target market share of that $500 million to $600 million market? And secondly beyond Mitek, can you identify a few of the competitor so we can track the space?
Karen Colonias
Sure. So competitors in the truss space, we believe Mitek would have the largest share of that market space and we would estimate that to be around 70% maybe little bit higher than that.
The next largest competitor would be ITW. And then there is small competitor called Eagle and then we have our product lines.
So really a pretty small group with couple of those having very large market share. When we come out with some of those financial details and that color will have you a better idea of what we are proposing we believe our market share opportunities are in that space.
Steve Chercover
Okay. Thanks for that, Karen.
And then with respect to acquisitions, how quickly do you rebrand the product lines in the Simpson name? Does Simpson have the same brand equity in Europe it has here in North America?
Karen Colonias
Yes, that's a great question, Steve. Depending on what the product is really a function of how quickly we may rebrand it?
So we don't have a set particular method. In Europe for example, we acquired S&P Clever which is our concrete business and we acquired that about six years ago.
So that is not rebranded, that is S&P Simpson company because the S&P had a very good brand name in that space. And so we want to take advantage of that outset.
We had purchased, obviously when we acquired that company. If we look at some other companies, other activities in the US, most of the companies we've acquired in the US, we've rebranded Simpson.
When we think of CG Visions, we have again branded that as CG Visions of Simpson Strong-Tie Company because again they have a great name in the software area for builders. So we don't really have a sort of set process.
It just depends on what the acquisition is and where the product is.
Steve Chercover
Okay. That makes sense.
So if you don't rebrand because they already have their brand so to speak you might put your logo on it so that you also get a little bit of tie end.
Karen Colonias
Correct. Correct.
So if the company we've acquired or the product we acquired has good brand recognition, if it is a trade brand we might just keep that as the product name. But if it's for example S&P, I already said as example, again that's the company name and it's much more known in the concrete space so we'll just put it as a Simpson Strong-Tie Company when we put our marketing literature out.
Steve Chercover
Got you. Okay, two more.
Good to see you are getting handle on SG&A again 22% isn't the target but is there a target?
Karen Colonias
Yes, and see that's another thing we'll be looking at it when we come out for some specific metrics where we believe that targeted SG&A can get to. As we mentioned, we have put the foundational things in place needed for the truss initiative as well as our concrete initiative.
And so we are starting to see some improvement in the revenue and that's helping offset and sort of reduce that SG&A as a percent of sales and we expect to continue to see that trend.
Steve Chercover
Great. Final question.
And not to be too neat picky but I guess I am the old timer around here so back in 2006 as I recall you had what was Dura-Vent, I think Brian said you are a one segment company. So I am wondering do you say that because it was kind of metal bending geared towards housing as opposed to concrete.
Why was-- I thought that was a separate segment.
Brian Magstadt
No, good question. And I should clarify and thank you for bringing that up.
Thinking about once we decided to sell after event we recasted the financials under our continuing operations model. So thinking about Strong-Tie only.
So, yes, you are correct in that. Simpson Manufacturing previously had the venting business and the connector business.
I was referring only to the Strong-Tie business.
Operator
Thank you. Our next question today is coming from Dan Moore from CJS Securities.
Please proceed with your question.
Chris Moore
Hey, good morning. It's actually Chris Moore for Dan.
Yes, maybe just talk about the SAP invitation a bit more, I know you said $34 million over the next three years. Has spending peaked at this point in time and are there some key milestones that we should be looking for over the next three years?
Brian Magstadt
Hi, Chris. It's Brian.
So as we are looking at that project it is on track and on plan. And as we have projected out those cash flows, certain cash flows get capitalized earlier in the project.
And then as we move more into training and go-live we'll have expenses running through the P&L. So today we are more in the capitalization phase.
As our first location -- we looked at bring our first couple locations on live in early 2018. The expenses will move more into or the spending will move into more into expense.
For example, training is an expense item versus a capitalization item so today I'd say we are more in the capitalization of spending phase versus the expense.
Chris Moore
Got you. Got you.
And maybe can you just update us a little bit on the M&A pipeline?
Karen Colonias
Hi, Chris. This is Karen.
As we stated before we are looking for things that fit within our strategic initiative really expanding in our fastener line. Some things in a concrete space and certainly in Europe we like to be able to increase that market share by acquiring some more connector companies.
Today, we still have outside advisors looking for businesses for us, as well as we have a group of people here at Simpson that work in M&A. Pipeline seems to be a little bit slower than normal.
I think a lot of people are kind of interested in what's going on from tax initiatives and things at the government. So still very active and looking I'd say things have slowdown a little bit as far as companies that are fitting the model that we are interested in.
Operator
Thank you. That does conclude today's teleconference.
You may disconnect your line at this time. And have a wonderful day.
We thank you for your participation today.