Simpson Manufacturing Co., Inc. Q3 FY2021 Earnings Call

Greetings. Welcome to the Simpson Manufacturing Co., Inc. Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note that this conference is being recorded. I will now turn the conference over to Madeleine Crane, Investor Relations. You may begin.

Good afternoon, ladies and gentlemen, and welcome to Simpson Manufacturing Company's third quarter 2021 earnings conference call. Any statements made on this call that are not based on historical facts are forward-looking statements. Such statements are based on certain estimates and expectations and are subject to a number of risks and uncertainties. Actual future results may vary materially from those expressed or implied by the forward-looking statements. We encourage you to read the risks described in the company’s public filings and reports, which are available on the SEC’s or the company’s corporate website. Except to this extent required by applicable securities laws, we undertake no obligation to update or publicly revise any of the forward-looking statements that we make here today, whether as a result of new information, future events, or otherwise. Please note that the company’s earnings press release was issued today at approximately 4:15 PM Eastern Time. The earnings press release is available on the Investor Relations page of the company’s website at ir.simpsonmfg.com. Today’s call is being webcast, and a replay will also be available on the Investor Relations page of the company’s website. Now, I would like to turn the conference over to Karen Colonias, Simpson’s President and Chief Executive Officer.

Thanks, Madeleine. Good afternoon, everyone, and thank you all for joining us today. I'd like to provide a high-level overview of our third quarter financial results and the associated performance drivers. I will then wrap up by summarizing our key growth initiatives. Brian will then walk you through our financials and full year 2021 business outlook in greater detail. Our third quarter net sales of $396.7 million were once again very strong and increased 8.9% over the prior year period. Sales growth was primarily driven by product price increases to offset rising raw material costs. While the macroeconomic landscape remained challenged throughout the third quarter due to ongoing global supply chain constraints, limited steel availability, and a tight labor market, we continued to deliver on the key elements of our business model to ensure our customers' needs were met. This includes, but is not limited to, ensuring the availability of our trusted product solutions, typically within 48 hours or less. To date, we have implemented four price increases in 2021: in early April, mid-June, mid-August, and our fourth price increase in mid-October. These price increases ranged from mid-single digit to mid-teens depending on the product mix for certain of our wood connector, fasteners, and concrete products in the United States. Looking at our sales results in greater detail, although third quarter net sales benefited primarily from a full quarter of the first two price increases, our top line moderately declined by 3.3% compared to the second quarter of 2021, predominantly due to decreases in sales volumes from our home center channel, which I'll discuss in more detail shortly. These price increases were a primary contributor to another quarter of strong gross margins, which increased to 49.9% from 47.9% in the prior quarter and 47.6% in the same period last year. As a result, our income from operations improved to $100.6 million and led to strong earnings per diluted share of $1.70. As we highlighted in our last call, we currently anticipate significant gross margin compression beginning in fiscal 2022 as we continue to acquire higher priced raw materials, thereby raising our average cost of steel on hand. Brian will discuss this impact in more detail during his remarks. Turning back to our sales performance, we experienced declining sales volume during the third quarter throughout the various forms of distribution channels we serve, including our home center channel and other distribution channels to contractors and lumber yards. As a reminder, the home center channel includes both our home center and co-op customers and is where we see much of our repair, remodel, and DIY business. We experienced a slowdown in this channel during the third quarter, as we believe there may be a releveling of inventory for our customers. Additionally, our sales reflected, as expected, a decline year-over-year related to the return of Lowe's as a home center customer. As you may recall, we experienced elevated volumes in both Q2 and Q3 of 2020 as we loaded in our products at the Lowe’s locations, resulting in a difficult comparison for both quarters this year. We expect volume levels in the home center channel to normalize in the fourth quarter as demand increases, and we pass the elevated volumes from last year's product roll-in into Lowe's. Similar to the home center channel, we experienced a modest volume decline in our other distribution channels to contractors and lumber yards during the quarter. We are confident that this decline in volume is not due to a loss of customer or market share, and attribute this primarily to customers adopting a more cautious stance regarding their inventory levels, given tightening labor and supply chain conditions and the potential impacts on the building industry. With that said, U.S. housing starts continued to show promise, improving by 19.5% during the first nine months of 2021 versus the comparable period last year. And finally, in Europe, our third quarter sales improved over the prior year on a local currency basis, primarily due to strengthening demand compared to the same period last year, where we experienced government-mandated COVID-19 related closures, and to a lesser extent from price increases. Sales in Europe also improved from our ability to continue meeting our customers' needs due to our solid inventory management practices amid broader supply chain shortages. I'll now turn to a high-level discussion on our key growth initiatives, which we first unveiled in late March of this year. We are focused on growing in the OEM repair, remodel, DIY, and mass timber markets, where we are striving to be a leader in engineered load-ready construction fastening solutions, given that each of these markets has a broader product opportunity within the fastening solutions. We're also focused on building our presence in concrete construction as well as structural steel, which is a new market for Simpson. While we are looking to grow our presence in each of these key growth areas, it's important to realize that we already have existing products, testing results, distribution, and manufacturing capacities in place for all five of these initiatives. To bolster our growth, we remain focused on organic opportunities through expansion into new markets within our core competencies of wood and concrete products, as well as inorganic opportunities through licensing, purchasing intellectual property, and traditional mergers and acquisitions. While we are pleased that we are continuing to build out these product lines and gain new customer wins to improve our market share, we recognize this will be a multi-year endeavor to ensure we have the proper testing, the validation of our product lines, and to ensure we provide our customers with the highest quality solution sets to build safer, stronger structures. Currently, each of our key growth initiatives remains in different phases of implementation. However, we believe that these are the right areas to pursue to position Simpson for above-market growth based on our ability to execute, given the core tenets of our business model that include our strong, longstanding relationships with top builders, engineers, contractors, code officials, and distributors, as well as our significant engineering expertise and our ongoing commitment to testing, research, and innovation. Finally, we are working to become a leader in the building technology space, which incorporates all of our key growth initiatives. As we continue to develop innovative new tools and solutions for our customers to help with design and options management, we'll also be able to easily specify the right Simpson solution for the job, helping to drive enhanced growth across our business. Our strong earnings and effective working capital management have enabled us to continue generating strong cash flow to fuel our growth and stockholder return priorities. In regard to growth, we are dual focused on both organic growth and mergers and acquisitions. To facilitate growth organically, we're investing in areas such as engineering, marketing, and sales personnel, as well as testing capabilities across all areas of our business, including the aforementioned five adjacencies, where we are looking to expand. We may also invest in facility expansions to support our growth. In regards to mergers and acquisitions, we are broadly focused on product line expansions in order to develop complete solutions for the markets in which we operate. This may also include opportunities that support our key growth initiatives. In summary, despite broader market challenges, we are very pleased with our continued strong results, both financially and operationally for the third quarter. I want to express my gratitude to all our Simpson Strong-Tie employees for your commitment to health, safety, and outstanding customer service to successfully manage through the broader supply chain constraints and keep our customers up and running. Thank you for your time and attention. And now I'd like to turn the call over to Brian, who will discuss our third quarter financial results and our 2021 outlook in greater detail.

Thank you, Karen, and good afternoon, everyone. I'm pleased to discuss our third quarter financial results with you today. Before I begin, I'd like to mention that unless otherwise stated, all financial measures discussed in my prepared remarks today refer to the third quarter of 2021, and all comparisons will be year-over-year comparisons versus the third quarter of 2020. Now turning to our results, as Karen highlighted, our consolidated net sales increased 8.9% to $396.7 million. Within the North America segment, net sales increased 6.8% to $338.6 million, primarily due to product price increases that took effect through the third quarter of 2021 in an effort to address rising material costs and were partially offset by a decline in sales volumes, primarily in our home center channel. In Europe, net sales increased 22.5% to $54.8 million, primarily due to higher sales volumes compared to last year's COVID-19 related slowdown. Europe's sales also benefited by approximately $900,000 of positive foreign currency translations resulting from some European currencies strengthening against the United States dollar. Wood construction products remained consistent at 85% of total sales, and concrete construction products also remained consistent at 15% of total sales. Consolidated gross profit increased by 14.3% to $198 million, which resulted in another strong gross margin quarter at 49.9%. Gross margin increased by 230 basis points primarily due to the aforementioned price increases, which were partially offset by higher material costs. On a segment basis, our gross margin in North America increased to 52.1% compared to 48.9%, while in Europe, our gross margin declined slightly to 37.7% compared to 37.9%. From a product perspective, our third quarter gross margin on wood products was 50.2% compared to 48% in the prior year quarter, and was 44.6% for concrete products compared to 42.1% in the prior year quarter. Now turning to our third quarter costs and operating expenses. As a reminder, last year, we implemented various cost-saving measures and other actions in light of the uncertainty surrounding the impact of the COVID-19 pandemic. As a result, total operating expenses were $97.4 million, an increase of $15.4 million, or approximately 18.8%. As a percentage of net sales, total operating expenses were 24.6% compared to 22.5%. Research and development and engineering expenses increased by 18.5% to $14.6 million, primarily due to increased salaries and expenses on patents. Selling expenses increased 19.3% to $35.1 million due to increased salaries, commissions, and travel expenses. On a segment basis, selling expenses in North America were up 18.9%, and in Europe, they were up 22.4%. General and administrative expenses increased 18.6% to $47.8 million, primarily due to increased salaries, variable compensation, and travel expenses. Our solid top-line performance combined with our stronger Q3 gross margin helped drive a 10.2% increase in consolidated income from operations to $100.6 million, compared to $91.3 million. In North America, income from operations increased 11% to $97 million, primarily due to the increase in gross profit, partly offset by higher operating expenses. In Europe, income from operations increased 23.8% to $7.5 million, primarily due to the increase in sales volumes and gross profit. On a consolidated basis, our operating income margin of 25.4% increased by approximately 30 basis points from 25.1%. Our effective tax rate decreased slightly to 26.1% from 26.2%. Accordingly, net income totaled $73.8 million, or $1.70 per fully diluted share, compared to $67.1 million or $1.54 for fully diluted share. Now turning to our balance sheet and cash flow. Our balance sheet remained healthy with ample liquidity to operate our day-to-day operations. As of September 30, cash and cash equivalents totaled $294.2 million, a decrease of $17.3 million compared to September 30, 2020. As of September 30, 2021, the full $300 million on our primary credit line was available for borrowing, and we remain debt-free. Our inventory position of $385.5 million at September 30 increased by $75.3 million from our balance at June 30, primarily due to the increases we saw in steel prices over the first nine months of the year. We continue to be highly selective regarding inventory purchases through careful management and purchasing practices, while at the same time ensuring we maintain ample product availability in order to provide our customers continued high levels of customer service and on-time delivery standards, which are key cornerstones to our value proposition. As a result of our improved profitability and effective working capital management, we generated strong cash flow from operations of $40.5 million for the third quarter of 2021. Turning to capital allocation, we remain dedicated to supporting the growth of our business, as well as providing strong capital returns to our stockholders through both dividends and share repurchases. Our strong cash generation enabled us to invest $12 million for capital expenditures during the quarter, as well as pay $10.9 million in dividends and repurchase 222,060 shares of our common stock at an average price of $108.64 per share, for a total of $24.1 million. On October 19, 2021, our Board of Directors declared a quarterly cash dividend of $0.25 per share. The dividend will be payable on January 27, 2022, to stockholders of record as of January 6, 2022. As of September 30, 2021, we had $75.9 million of our share repurchase authorization available, which remains in effect through the end of 2021. Given our confidence in our business and our expectation that our strategic initiatives will continue to drive improved operational performance and a higher return on investment capital, we expect to remain both active and opportunistic regarding share repurchase activity. Finally, I'd like to discuss our 2021 financial outlook. Based on business trends and conditions as of today, October 25, we are updating certain elements of our guidance for the full year ending December 31, 2021, as follows. We are updating our operating margin outlook to be in the range of 20% to 22% from our previous estimate of 19.5% to 21%. Our current outlook reflects three quarters of actual results, as well as our latest expectations regarding demand trends, raw material input costs, and operating expenses. We are reiterating the remaining elements of our outlook for fiscal 2021 as follows. We continue to expect our effective tax rate to be in the range of 25% to 26%, including both federal and state income tax rates. Our capital expenditures outlook remains in the range of $55 million to $60 million, including approximately $15 million to $20 million that will be used for safety and maintenance capital expenditures. At this time, only a small amount of our capital expenditures spend is related to implementing our key growth initiatives. Further, I'd like to provide some additional color on our margin expectations for fiscal 2022. Based on our current expectations, we are anticipating continued raw material cost pressure for the remainder of 2021 and into fiscal 2022. Our gross margins thus far in 2021 reflect an average cost of steel sourced prior to and during the increasing steel price market. As we work through our on-hand inventory and continue to buy raw materials at these much higher prices, our anticipated costs of goods sold are expected to increase significantly in late 2021 and into 2022. Even if prices for raw materials begin to decline, this will adversely affect our margins, as the impacts from averaging raw material costs typically lag our price increases. As a result, based on our updated fiscal 2021 operating margin outlook, we currently expect our operating margin for the full year of 2022 to decline by approximately 400 to 500 basis points year-over-year. However, despite near-term macroeconomic pressures, we continue to believe we can maintain an industry-leading operating margin in the high teens range annually in the long term, which is a key goal of our five-year company ambitions. In summary, we were pleased with our strong third quarter financial results and remain focused on executing against our strategic, operational, and financial initiatives. We believe our industry-leading position, geographic reach, and diverse product offerings combined with our strong balance sheet and liquidity position give us confidence in our ability to maintain operational excellence to support current and future demand trends. We look forward to updating you on our progress in the coming quarters. With that, I'd like to turn the call back to Karen for some closing remarks.

Thanks, Brian. Again, we are very pleased with our third quarter financial and operational results that we've achieved despite ongoing macroeconomic challenges. While we cannot control elements of the economy, we are dedicated to managing the key areas of our business that we can control, and we remain confident in our ability to execute on our five-year company ambitions. These include strengthening our values-based culture, being the partner of choice in all aspects of our business, and being an innovative leader in our product categories to continue our above-market growth relative to U.S. housing starts while maintaining an operating income margin and return on invested capital targets within the top quartile of our proxy peers. I want to thank you again, and thank all our employees, customers, suppliers, and stockholders for your continued support of Simpson Strong-Tie. With that, I'd like to open up the call for questions.

Thank you. At this time, we'll be conducting a question-and-answer session. Our first question comes from the line of Tim Wojs with Baird.

Maybe just to start if, in North America, if you could maybe true up a couple numbers for me. I guess the first piece is what was the contribution from pricing in the quarter?

That was, give me just a second here, about $75 million, Tim.

Okay. And is that if you kind of look at the four price increases that you've implemented, what would you think run rate kind of pricing should be on a quarterly basis once everything's fully effective?

Good question because the third price increase that took effect was halfway through the quarter. And of course, we've got the fourth one that's just very recently taken effect. I'd say about $100 million all-in, of course that is comparing it to prior to any price increase. So as we start lapping quarters here, we're going to start lapping quarters with price increases in them. But $100 million all-in versus no fresh increase. That makes sense?

Okay. That makes sense. That's helpful. Thank you. And then, I guess on the home center business, is there a way to kind of indicate how much that business was down in dollars?

We experienced a significant decline in comparability. This was partly due to the performance from last year, as mentioned earlier. Additionally, we believe that home center customers were working on inventory adjustments during early July and August, as they had a strong inventory level leading up to the end of Q2. While I don't have a specific dollar figure to provide, a substantial part of the volume decline in the quarter was associated with the home center channel. The comparison is challenging because of last year's extensive DIY projects and the inventory adjustments that we think were occurring. By the end of the quarter, we believe that more typical buying patterns resumed, likely continuing into September. Looking ahead, we expect purchasing behaviors through home centers to normalize.

What about October? If we look at your volume numbers, either overall or broken down by home center and legacy distribution, did you see any improvements in October? It seems the core distribution channel was somewhat down in the third quarter. Has that begun to recover as we move into the fourth quarter?

Yes, Tim. We're seeing some nice growth in early, obviously, we're early in the fourth quarter. But as Brian mentioned, we saw the home center business kind of pick up a little bit to become more normal buying in September, continuing through October. And as we also mentioned, our other means of distribution, really contractor distributors, lumber yards. They were also pretty slow in the first couple of months of Q3, and we're seeing that pick up again, also.

Got you. Okay. And then just the last question I had on lead times. Where are your lead times today, in terms of when customers are ordering, how quickly you're able to fulfill those orders? And how has it changed over the last six to nine months? Has there been a lot of ups and downs? Or you've been pretty consistent on lead times?

Yes. As you know, we think our availability of product and lead time is a very large differentiator for us. So we're still north of 97% on lead times on the majority of a product that a customer would order. It doesn't mean that if there was a special or something that might take a little bit longer, but we're still running a little north of 97% in that 24 to 48-hour lead time. And that's a key differentiator for us.

Yes. So basically, would you agree with the statement that your customers don't necessarily feel the need to over-order or stock in the sense that they know your lead times are pretty good. And so they're not necessarily, a lot of their orders are actually reflective of end market demand for any sort of inventory build?

Yes, I believe we've done a great job since the 2008 downturn. Our customers feel confident that they don't need to keep large inventories because we can fulfill their orders quickly. We haven't seen a significant change in this behavior; customers aren't adding extra inventory. This reflects our success in lean manufacturing, allowing us to meet customer needs and fill orders within a 48-hour timeframe at a 97% to 98% fulfillment rate.

Thank you. Our next question comes from Daniel Moore with CJS Securities.

I'm curious, since we are in our fourth round of price increases, are you observing any impact on customer demand after several significant price hikes over the past six to twelve months? It doesn't seem like it, especially with the pickup in demand in September and October.

Yes. I think, Dan, those price increases we're seeing in all construction materials, and of course, we focus on anything associated with steel. So as they see price increases with anything really associated, I always refer to garage doors and appliances, obviously our products. What's really been the huge driver for us has been the availability of product. We mentioned we've heard from our customers that we've been one of their best suppliers in this really tight market from a supply chain standpoint. We've heard from some of our competitors' customers that they'd like to get some product from us. So I think we've gained just a little bit of market share, especially in our European market by being able to meet those needs and have that inventory. But it's really been a supply issue rather than focus so much on pricing. Not to say from our salesmen standpoint that it's easy to get a price increase through. It's always a difficult thing, but it's so highly publicized in the market space that our customers understand why we're having to have these price increases.

It’s helpful. And I think you mentioned this in the prepared remarks, but your increased inventory levels, how much does that reflect just pricing versus quantity? And at this stage, do you feel pretty comfortable about your ability to procure, so you don't need to strategically continue to build inventories in terms of actual volumes, any commentary there?

Hey, Dan. The majority of the increase is price-related on the inventory.

I would say that our purchasing team has done an excellent job ensuring we have enough steel to meet customer needs. However, it’s currently a balancing act. We need to maintain adequate steel supply for fulfilling orders while avoiding overstock in case of price decreases. The steel industry seems to be slowing down a bit; although prices haven’t dropped, the rate of increase has slowed. We’ll see how this trend develops. Most industries expect some new steel mill capacity to become available, which was initially projected for the fourth quarter but is now expected in late first quarter. This should provide some relief. We are cautiously trying to balance customer needs while managing our steel inventories.

Perfect. Maybe just one more kind of high level, just as you look around the country, are you seeing any changes in building codes and standards in any particular areas that could potentially impact your revenue or competitive positioning over the coming years?

We actually, I think this is kind of early on, but this build to rent concept, we have had some of those owners of those buildings contact us about building to a resiliency standard versus a life safety standard. Resiliency, meaning that they're going to hold on to that building for quite a long time as they continue to rent it. And so they want the building to be able to be occupied after any sort of natural disaster. So it's just starting, but that's quite interesting for us, because it means typically, you would put more of our content into a house built from a resiliency standpoint versus a house built from a life safety standpoint. And just on the tip of the iceberg of seeing what happens with this.

Thank you. Our next question comes from the line of Kurt Yinger with D.A. Davidson.

Just starting off, when we think about the increase in the operating margin outlook, kind of back to the prior range after the strong Q3. Just curious, what were the biggest upside surprises in terms of the performance in the quarter relative to your expectations, because it sounds at least like volume was pretty challenging and you hadn't kind of yet benefited from the four price increases. So just curious, what was better than expected there?

Yes. Part of it is the price increase in relation to the use of the associated inventory and the timing of that. I think we also observed some additional strength in the European margin. Additionally, the forecast for expenses for the remainder of the year, including which projects would begin and continue, played a role. At the six-month mark, we were making estimates, and now with three more months behind us and only three months left in the year, we have gained greater insight into how to bring the operating margin back up to the higher end of the range.

Got it. Okay. And then, historically, Simpson has had a premium price position relative to peers, and it would seem that the value proposition is there currently, perhaps even more so than it's been in the past? Is where your pricing today? Is that consistent with where you've been historically? And how does kind of competitive positioning factor into your decision-making process around price at a time when inputs are rising so meaningfully?

And I think, Kurt, you mentioned a key point to us. From the standpoint of the services that we provide for our product. As we talked about, this on-time delivery, we talked about large SKU mix, our customer service both inside and our outside sales team, as well as our engineering that we really pride ourselves on. Again, as we talked about, we don't want to sell on price, we want to sell on all the services, and that's really where you see that pricing premium. I would say today, we still probably have that pricing differential in place. And as I mentioned, what's key to our customers is the availability of the product. We never want to be the vendor that shuts the job site down because we didn't have product available for those customers. And I think it's been really well appreciated as we're in times of a tight supply chain.

Right. Makes sense. Okay. And then just the last one for me. I didn't hear it in the prepared remarks. But I'm just curious whether sourcing from overseas has been a challenge for you guys, at least in the last few years. I think North America fasteners production capabilities have been something that's been of interest, given everything that's going on, is that still a priority? And is that something where you would look to M&A or something you can maybe build out organically?

Yes. It's a great question. As we've mentioned, our fastener business is one of our fastest growing, has been for probably over the last three to four years. We domestically manufacture at a Simpson facility about 35% of our fasteners, and we buy the other 65% offshore, basically, in Taiwan. A typical lead time before this year would have been maybe three to six months to get a product. We are now running about 10 to 14 months lead time on those products out of Taiwan. And that certainly makes it very difficult when we think about forecasting and also having that inventory on hand. So as we talked about in the past, we're very interested in trying to grow through either acquisition or organically more control of our capabilities of manufacturing that product and a little less dependent on buying out of that product. So certainly, it's on our radar and something that we're constantly looking for.

Do you have extra space at the current facility, or would expanding organically require a new location?

We have established additional local manufacturing over the past few years in an existing factory in the U.S. By reorganizing and optimizing our space, we have been able to bring more production in-house. We also apply lean principles to maximize efficiency. However, we are approaching a point where we may need to increase our facility footprint in these locations. We have always emphasized the importance of local production to quickly meet customer demands, and while we have built up our local production capabilities, significant growth in this area will require investments in our facilities.

Thank you. Our next question comes from the line of Julio Romero with Sidoti & Company.

So I wanted to dig a little more into the channels in North America other than the home centers. Think you mentioned the volume headwinds in contractors and lumber yards. There may have been some different drivers, then that drove the decline in those channels, then what happened in the home centers. I believe you mentioned more of a cautious stance because of their own labor and supply constraints. So I was hoping you could speak a little more to that. And if you've seen and have those labor and supply issues alleviated in those channels at all?

Yes, it's a great question. And we certainly saw and heard from some of our customers in the slowdown on that new construction standpoint. Just because, one pricing of lumber, which is now gone down, but pricing of lumber was very high, unable to complete structures because of supply chain issues, again, whether that be doors or windows, appliances, faucets, sinks, it didn't really matter. But unable to complete the structure. And so we definitely saw that slowdown in that space. We have now seen as we came out of third quarter in September. And as we're looking at fourth quarter with where we are so far in early October, an uptick in those markets, just as we've seen an uptick in that home center buy also.

Great. Would you say that the increase is similar to what you've observed in home centers, whether on a percentage basis or however you choose to address it?

Yes, I think the cyclicality of our market is quite clear. From the home center perspective, we are observing what could be called a typical increase in activity from our contractors, distributor lumberyards, and the home center. There have been no unusual trends, at least over the past 60 days.

And that's relative to the prior same period.

Right. Relative to Q4.

At this point, we have reached the end of the question-and-answer session. This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation and have a great day.