Thomas J. Fitzmyers - Chairman, Member of Acquisitions & Strategy Committee, Director of Simpson Dura-Vent Company Inc and Director of Simpson Strong-Tie Company Karen W.

Colonias - Chief Executive Officer and President Brian J. Magstadt - Chief Financial Officer, Treasurer and Secretary

Peter Lisnic - Robert W. Baird & Co.

Incorporated, Research Division Arnold Ursaner - CJS Securities, Inc. Peter Goodson

Thanks, everyone. Good morning, and welcome to Simpson's fourth quarter earnings call.

For 2012 earnings, press release was issued yesterday. It is available on our website at simpsonmfg.com.

Today's call is also being webcast, and that webcast will be available on our website, as will a replay of this call. Joining me in Pleasanton for today's call are Karen Colonias, Simpson's Chief Executive Officer; and Brian Magstadt, Simpson's Chief Financial Officer.

I will start, followed by Karen and then Brian, and we will be delighted after that to take your questions. As you see in the press release, we've added additional information about segment sales and profits, which we have previously discussed on the earnings call, and report of our quarterly and subsequent annual report filings.

Housing starts are up, and we expect to benefit from that increase. But unlike lumber or other products that have a more direct correlation to starts, our products are used to a greater extent in code based areas that are subject to national forces, such as seismic or wind events.

And our construction process is a sequential process. We start with the foundation first, then the walls and then the roof system, and our products flow into a project or a house according to those schedules.

The quarter was mixed, which we are not very happy about. We had a decent fourth quarter for sales and profits in North America, but those profits were offset by losses in Europe and Asia Pacific.

Sales in North America benefited from the acquisitions by $4-point million, and in Europe, by $4.6 million in sales. Offsetting those increases was the effectively lost Lowe's business, which we guess was between $3 million and $4 million.

Few -- 4 home center sales were down 23% -- excuse me, because of Lowe's. However, our largest customer, the Home Depot, and our other home center customers, were flat for the quarter.

Regarding the operating profits, the acquisitions in North America resulted in a loss of $4.6 million, but were somewhat offset by profits of the European acquisitions by $800,000. The total acquisition operating loss is greater than the Q3 loss by $900,000 due to adjustments related to inventory and depreciation and reduced manufacturing overhead absorption late in the quarter.

After considering the $4.1 million in quarterly, atypical loss is related to shutting down Liebig, Europe was still down compared to last year. Asia was also affected because of the transfer pricing adjustment in Q4 2011 that benefited that quarter but did not occur in Q4 of '12.

The summary of these results is reflective of our commitment to long-term strategy and the necessary steps we have taken to ensure that we have the right products in the right markets so that we can earn long-term profits. We continue to be very strong financially, which gives us lots of flexibility.

Karen?

Thank you, Tom. Looking back on 2012, we have made considerable progress towards achieving our strategic goals.

Those goals are to strengthen our core wood products and expand our global footprint to be less dependent on U.S. housing starts.

We continue to invest in our plated truss software development. We're adding industry-requested features and improvements while, at the same time, aligning our plated truss production capacity to serve and meet the customer needs.

In December, we acquired the Keymark software development team. This replaced the development contract.

We now have our own developers, which we expect to enhance our efforts. The cost of these new employees, net of the software license revenue, is expected to be smaller than what we were paying in the development contract for 5 years.

After that time, we'll be better off, as we will not be amortizing intangible assets related to the purchase. On the concrete product side, which includes Fox, CarbonWrap and S&P, we're seeing profits in Europe from S&P.

We are close to roll-out of the other 2 lines in our North America branches, and we should begin seeing increased sales to help offset our continued investment in those operations. Europe remains a challenge for us.

We sold the Liebig heavy-duty mechanical anchor assets. This included inventory, some equipment and code approvals.

We terminated the employees at the Irish factory and the sales and support staff throughout Europe. And this resulted in recording a loss for those transactions totaling $4.1 million in the quarter.

Liebig's operations were losing $4 million to $5 million annually, so we will not have those losses, and this will help our European profits. We still need to sell the real estate and may take a loss on that.

The land and building are carried today at $2.7 million. Although we have taken steps to improve the results in Europe, 2013 will be a challenging year due to continuing economic uncertainty.

To repeat from prior calls, we manage our business from geographic segment perspective. You've seen that in our recent 10-Qs and 10-Ks.

Within those regions, we have 2 broad product categories: wood construction products and concrete construction products. Wood products are comprised of connectors, fasteners, shearwalls and truss plates.

Concrete includes adhesives, mechanical anchors, specialty chemicals and other repair and strengthening products. The plated truss business falls under our wood construction, while Fox, CarbonWrap and S&P are categorized in concrete.

For Simpson, these new product lines are essential to help us diversify our product offering. The new acquisition brings products that are highly specified and have worldwide applications and will increase our margins in the concrete construction products.

As always, we are dedicated to our core products, and we work hard every day to ensure that we continue to meet our customer needs for service, support and product availability. We are spending considerable time and resources to integrate these new operations.

The process is never easy, but we have a strong belief that these additions will add long-term value for the company and help us meet our strategic objectives. We are a little over 12 months into multiple integration efforts, and we feel we are on track with our plans.

Integration doesn't necessarily mean profits, as we need sales to get there. While S&P is profitable, the others will take more time.

I'll now like to turn this over to Brian for some additional financial information.

Q4 2012 gross margin, as you've seen in the press release, was 38.2%, compared to 42.0% Q4 last year. Excluding the Liebig severance and loss on sale of inventory, which were the only significant atypical charges in the quarter, the gross margin for Q4 '12 would have been 39.8%.

The relative sales mix of the 2 product groups affected gross margins, and that we sold more lower-margin concrete products relative to the total 17% this quarter, compared to last Q4, 12%. Compare that to the higher-margin wood construction products, which went to 83% of total this quarter as compared to 88% last Q4.

The margin differential of wood to concrete products is 22% this quarter, compared to 15% last Q4. But excluding the Liebig atypical charges, the differential would have been 11%.

We're expecting the 2013 gross margin to be in the 42% to 43% range. We continue to invest in our new acquisitions, and that is evident in the R&D and engineering spending with $1.5 million in the quarter going toward developing the plated truss software offering, and that's consistent with what we've mentioned in prior quarters as you expect the run rate going forward.

Excluding expenses related to the acquisitions, our SG&A would have been a couple of points lower this quarter, and a point lower than last Q4. Stock compensation, which includes stock options and restricted stock, was $3.2 million in Q4 2012 versus $3 million last year in the last Q4.

The charge is subject to the underlined stock price until grant date, which largely contributed to the increase from Q3 of 2012. Our share price increased nearly $4 per share from the end of Q3 to Q4.

Cash profit sharing, as a function of operating income and return on assets, decreased $500,000 compared to last year Q4. The amount of the cash profit sharing decrease included in operating expenses, was about $300,000 in Q4.

Taxes. As you could see in the press release, we had a significant tax benefit related to the Liebig Irish operation, totaling $9.9 million.

We also -- excuse me, we also had nondeductible items, such as goodwill impairment and some foreign losses. If we exclude these 3 factors, the tax rate would have been about 50% in Q4, and the annual rate would have been about 43%.

Looking ahead to 2013, we're expecting the effective rate to be 41% to 42%. 2013 CapEx is looking to be around $29 million, which includes about $6 million that was planned for 2012, but which we're planning to roll over to this year.

2013 depreciation and amortization expense is expected to be -- to total $26 million, of which $20 million is for depreciation. The CapEx related to recent acquisitions is $4.2 million for the year, for 2012.

Amortization expense in the quarter increased by nearly $1.2 million compared to the prior year, all an admin expense due primarily to the recent acquisitions. Before we turn it over to questions, I'd like to remind you that if you'd like further information, please contact Tom at the phone number listed on the press release.

Also, look for our Form 10-K to be filed at the end of February. We'd like to now open it up to your questions.

I was just wondering if we could talk a little bit about your -- obviously, with the heavy mechanical business now gone. Just kind of what are the expectations for profitability improvement outside of the benefit of that business being out of the mix?

How do you foresee that the trend and profitability in Europe as we kind of migrate through '13 and then longer term?

Well, certainly, although Europe is under some economic tough times right now, our manufacturing and our sales group in Europe are doing everything they can to take our products in various different areas, similarly just how we did in the U.S. markets.

So we're looking at different applications for our fastener line, as well as we are looking at the opportunity to sell our lightweight anchor lines and our fastener lines in conjunction with our connectors. So a big plan that they have in Europe is to sell a systems approach, getting the sales from not only the connector line but also the concrete anchor, as well as the wood fasteners.

And this is something that they're putting in place and rolling out through 2013 at our distributor levels. So this is the plan they have in which to get more sales.

I think Europe will be tougher in 2013 than they were in 2012, as they're certainly seeing slowdowns on -- not only housing but any potential government projects, where we might be able to use some of our concrete products. So I think they're in for a very tough year in 2013.

Not that they're not working hard, again, to do everything possible to gain our sales.

Okay. And let me, maybe I could ask the question another way.

In terms of -- that sounds a bit like what I would classify as a volume problem. How do feel about the cost structure there?

Are you -- do you feel comfortable that you've got the right cost structure in place? Are there more leverage that you can pull or need to pull?

Or is it just simply, once you start to get volume flowing through there that you'll see the profitability ramp up?

Well, it's always great to get volume and reduce our cost structure. And certainly, the producing branches are putting Lean initiatives in place just as we've done in the U.S.

market. That's helping for our cost structures.

We're always extremely looking on how we purchase our raw materials. A lot of the products that we sell in Europe are buyouts.

We have supply-chain groups that we use to help us get our best costing on buyout items. So those are also areas that we're looking at on a daily basis to see how we can have improvements.

Okay. All right.

And then second question, if I could just flip topics. The pricing pressure that you alluded to, again, in the press release this quarter, can you give us a feel for exactly where that's occurring and the magnitude?

I know you've talked about it a little bit in the past, but I was just trying get a sense as to whether or not anything's moved there and how that sort of translates another 42% to 43% gross margin guidance that you gave for 2013?

Yes, Peter, this is Tom. We have experienced pricing differential for many, many years.

And that's been the primary way that the competition has tried to compete with us. After the '08 period, many of our customers, as everyone knows, suffered very difficult times.

And so we, over that period, including today, put special programs together to really assist them, to help them from a profitability standpoint get through this difficult period. Recently, the price competition has seemed to increase in some areas but not others.

And consequently, we lowered our prices on some specific products and some specific geographic areas on a bit more formal basis. Going forward, it's hard to forecast what might happen with respect to that because, as I say, we've had this pricing differential for as long as I can remember.

And it kind of waxes and wanes, depending on economic activity. If starts are up substantially, then the issues change to availability and flexibility and timing on delivery.

So it's really hard to forecast going forward, but we are hopeful that as starts pick up and we participate in those, in the areas where the use of our products is the strongest, then that will make it a difference and help support the margin that Brian mentioned earlier.

Let me try to follow up immediately with the question you were just asked. You highlighted higher steel costs competitor pricing, and we also expect a greater percent of your mix to come from concrete, which is lower margin.

I'm still a little unclear where we're going to get 200 to 300 basis points of gross margin improvement.

Well, we're seeing the effect of not having the Irish operation, and that's been a drag there, as I mentioned. Potentially, we're looking at some increased absorption due to volume.

So -- but it could also be a greater mix of regional, more in the U.S. versus -- or North America versus Europe.

So a mix geographically as well.

Got it. I guess, my question for you, Brian, also, is have you attempted or can you try to help us put together what I'm going to call a normalized EPS, even for Q4, given all the onetime items you have, the tax issues?

What's your best sense of kind of the EPS X-ing thing out all the nonrecurring onetime items?

Just to clarify, we're talking what EPS would have looked like in Q4? Okay.

Give me just a moment. Look, we mentioned the -- we had the $4.1 million related to Liebig.

I'm not sure if we consider the goodwill impairment atypical. It doesn't seem like it's been atypical for us over the last 4 or 5 years, but if we take the goodwill out, we would have had pretax income of about $5.5 million; taken a -- tax rate, 50% on that.

So 2.7 -- probably $2.7 million, $2.8 million on the net income line. So that's about where we would ballpark Q4 had we not had any of those atypical or the goodwill and had a normalized tax rate of that 50%.

Okay. I know you've mentioned that, Karen mentioned it in her prepared remarks about the Keymark transactions, so I guess I have a few questions related directly to that.

In the previous relationship you had, whatever their costs were, you were paying a multiple of the actual costs incurred. Was that included in Simpson's R&D?

Yes.

So is it fair to say that now that you own it, if you -- if the dollars paid to the 39 research people stay essentially flat, wouldn't your reported expense come down by whatever that multiple was? And what sort of potential saving might this drive -- might this lead to for the R&D line in 2013?

So the -- to add a little color to that, so yes, we would have the expense of the 39 people. But the -- we also, for a time period, and we're estimating 3 to 5 years as amortizing part of that $9.1 million that we spent to Keymark.

So that will flow through the expense line as well. So our guess is that it'll be a push for 3 to 5 years, and then after that, amortization period is over.

Then that's when we would start to see the benefit of having the software development group owned directly. Does that make sense?

It does. And having them directly under your ownership, do you hope or expect that to accelerate the timing of the software rollout for the trusses?

Yes, this is Karen. One of the key initiatives that the company has is getting this truss opportunity, and that's the software as well as the plates associated with that truss business, getting that to market as soon as possible.

And now that we have the -- our software development team in Boulder, we have much better opportunity to, certainly, control the things they work on and prioritize what they're working on. So we are, on a daily basis, have an integration group here at Simpson working with the Boulder Group to be sure we are tracking the right direction, so that we can get our software offering to market -- a better offering to market as fast as possible.

Okay, if I may follow up with one more. Specifically on the software, you have, obviously, been beta testing it at some of our your customers.

It's critical that you have it in place for the season kind of by March or April. Is that a realistic timetable for the software?

Well, there are releases that come out with the software on a -- about a every 8-week time frame. We put new releases out, which have improvements and enhancements to them.

We do have several customers who are currently using our software, and we are getting more customers every day as we have our sales force out, determining which is a good match for the point that the software's at currently. So again, it's a moving target.

As the software improves, it gives us the opportunity to show that software and work to convert more customers.

So I appreciate you've been very upfront about competitive pressures here and kind of why wood products are struggling despite the growth in home starts. And I'm trying to think about, is there a way to quantify this?

USP, MiTek, I guess, has been growing a lot. You guys have been, maybe, seeding some share.

Do you track their sales at all? Like do you have any sense of how much market share has gone to them and at what pace market shares have been moving over the past year?

Other than the Lowe's business, we are not aware of much that's changed. In some sectors, we make our market shares increasing.

We don't have a highly formal way of measuring that because our products are used in so many different ways with residential, commercial, DIY. It flows through a lot of different channels.

And we have about 15,000 different locations in the countries that we sell either directly or indirectly to and through. So we have a lot of data that it's...

It's hard to get the other guys' data.

Right. It's really hard to get the other guys' data.

They're not a public company from a reporting standpoint at that level.

When you talk to customers, do you hear -- do you do any surveys of customers to understand anything about kind of purchasing shifts and -- or surveys of distributors, maybe?

We're pretty plugged in, we think, to the -- our customer base and they're -- they certainly are very informative about market conditions. So we have a lot of data that we're -- from them, on a direct basis.

And there's jobs that we compete on, there's some level of competition with different sectors. It's -- somewhat different, for example, it might be different with co-ops than it -- than it could be with some original equipment manufacturers that we sell to.

So we don't have a very precise answer. And you almost have to follow a truck leaving Home Depot, a pickup truck, to find out where it's going.

Is it going to wind up at -- as a pick up to continue a job for a large builder or is it going to wind up as a deck in somebody's house that they've owned for a number of years. It's just difficult to tell.

Okay. And then after the price cuts you've taken here, where do you think your price -- your average price on a comparable product falls compared to USP, MiTek?

Well, it's a very large differential. There's other competitors in the marketplace, too.

So the pricing differential, over the years, has ranged in the 20% to 30% area, and that depends on the market, the product. And we have a lot of proprietary products that are cost effective from an installation standpoint that aren't directly comparable, so you'd have to look at installed costs, too, to look at that pricing differential.

So there's a lot of complexity to it.

Okay. And in a way, did you have it like if -- are there -- there was just no way to generalize.

But I mean, there are like-for-like products, right? Like they're switching you out, they're buying a USP product.

Well, they -- we don't necessarily know what that product is being sold for. So they don't tell us that, yes.

Well, thank you very much. Okay.