Simpson Manufacturing Co., Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Each of the terms the “Company,” “we,” “our,” “us” and similar terms used herein refer collectively to Simpson Manufacturing Co., Inc., a Delaware corporation, and its wholly-owned subsidiaries, including Simpson Strong-Tie Company Inc., unless otherwise stated. The Company regularly uses its website to post information regarding its business and governance. The Company encourages investors to use http://www.simpsonmfg.com as a source of information about the Company. The information on our website is not incorporated by reference into this report or other material we file with or furnish to the Securities and Exchange Commission (the "SEC"), except as explicitly noted or as required by law. The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of the Company’s consolidated financial condition and results of operations. This discussion should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and notes thereto included in this report. “Strong-Tie” and our other trademarks appearing in this report are our property. This report contains additional trade names and trademarks of other companies. We do not intend our use or display of other companies’ trade names or trademarks to imply an endorsement or sponsorship of us by such companies, or any relationship with any of these companies. CAUTIONARY NOTE ABOUT FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements generally can be identified by words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “target,” “continue,” “predict,” “project,” “change,” “result,” “future,” “will,” “could,” “can,” “may,” “likely,” “potentially,” or similar expressions that concern our strategy, plans, expectations or intentions. Forward-looking statements include, but are not limited to, statements about future financial and operating results, our plans, objectives, business outlook, priorities, expectations and intentions, expectations for sales and market growth, comparable sales, earnings and performance, stockholder value, capital expenditures, cash flows, the housing market, the home improvement industry, demand for services, share repurchases, the integration of ETANCO, our strategic initiatives, including the impact of these initiatives, on our strategic and operational plans and financial results, and any statement of an assumption underlying any of the foregoing and other statements that are not historical facts. Although we believe that the expectations, opinions, projections and comments reflected in these forward-looking statements are reasonable, such statements involve risks and uncertainties and we can give no assurance that such statements will prove to be correct. Actual results may differ materially from those expressed or implied in such statements. Forward-looking statements are subject to inherent uncertainties, risks and other factors that are difficult to predict and could cause our actual results to vary in material respects from what we have expressed or implied by these forward-looking statements. Important factors that could cause our actual results and financial condition to differ materially from those expressed in our forward looking statements include, among others, the prolonged impact of the COVID-19 pandemic on our operations and supply chain, the operations of our customers, suppliers and business partners, and the successful integration of ETANCO and those discussed under Item 1A. Risk Factors and Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. Additional risks include: the cyclicality and impact of general economic conditions; changing conditions in global markets including the impact of sanctions and tariffs, quotas and other trade actions and import restrictions; the impact of pandemics, epidemics or other public health emergencies; volatile supply and demand conditions affecting prices and volumes in the markets for both our products and raw materials we purchase; the impact of foreign currency fluctuations; potential limitations on our ability to access capital resources and borrowings under our existing credit agreement; restrictions on our business and financial covenants under our credit agreement; reliance on employees subject to collective bargaining agreements; and or ability to repurchase shares of our common stock and the amounts and timing of repurchases, if any. We caution that you should not place undue reliance on these forward-looking statements, which speak only as of the date of this report. Except as required under the federal securities laws or the rules and regulations of the SEC, we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise. Readers are urged to carefully review and consider the various disclosures made by us in this report and in our other reports filed with the SEC that advise of the risks and factors that may affect our business. 25 Overview We design, manufacture and sell building construction products that are of high quality and performance, easy to use and cost-effective for customers. We operate in three business segments determined by geographic region: North America, Europe and Asia/Pacific. Recent Developments In 2021, we unveiled several key growth initiatives that we believe will help us continue our track record of achieving above market revenue growth through a combination of organic and inorganic opportunities. Our organic opportunities are focused on expanding the markets for wood and concrete structural connections and solutions. These key growth initiatives will focus on the OEM, repair and remodel or do-it-yourself, mass timber, concrete and structural steel markets. In order to grow in these markets, we aspire to be among the leaders in engineered load-rated construction building products and systems and building technology while leveraging our engineering expertise, deep-rooted relationships with top builders, engineers, contractors, code officials and distributors, along with our ongoing commitment to testing, research and innovation. Importantly, we currently have existing products, testing results, distribution and manufacturing capabilities for our key growth initiatives. Although these initiatives are all currently in different stages of development, our successful growth in these areas will ultimately be a function of expanding our sales and/or marketing functions to promote our products to different end users and distribution channels, expanding our customer base, and potentially introducing new products in the future. We also highlighted our five-year ambitions in 2021, which are as follows: • Strengthen our values-based culture; • Be the business partner of choice; • Strive to be an innovative leader in the markets we operate; • Continue above market growth relative to the United States housing starts; • Remain within the top quartile of our proxy peers for operating income margin; and • Remain in the top quartile of our proxy peers for return on invested capital. We have made progress towards our key growth initiatives that were first announced in 2021. Select highlights that include both organic and inorganic growth from 2022 and 2023 were: • Acquiring ETANCO which has resulted in additional scale for our European operations and was accretive to earnings in the first quarter of 2023; • Increasing our number of commercial market customers as well as launching new structural steel products; • Growing across all OEM customer types, while continuing to develop the market for mass timber: • Expanding our wood product line by acquiring intellectual property; • Continuing to invest in venture capital funds and other companies focused on the home building industry and related new technologies; and • As part of our Partner of Choice initiative, we anticipate completing our path-to-market customer transition by the end of this year. As we make progress on our key growth initiatives, we believe we can continue our above market growth relative to U.S. housing starts in fiscal 2023 and beyond. These examples further emulate our Founder, Barclay Simpson’s, nine principles of doing business, and more specifically the focus and obsession on customers and users. Factors Affecting Our Results of Operations The Company’s business, financial condition and results of operations depends in large part on the level of United States housing starts and residential construction activity. Though single-family housing starts increased in prior years, we have seen demand decline recently due to supply-chain factors, unfavorable economic conditions, including rising interest rates, inflation, and recession fears, resulting in lower new home starts and completions. However, the Company also supplies product used in multifamily housing construction, which increased in the first quarter of 2023 compared to last year. During 2021, we passed four price increases to our customers to offset significantly higher material costs arising from supply constraints. During the first quarter of 2023, we gave back some of the increase in product prices in response to marginally lower raw material costs, while a tight labor market and unusually wet winter in the western region of the United States could further negatively affect operating margins for 2023 as compared to 2022. 26 Unlike lumber or other products that have a more direct correlation to United States housing starts, our products are used to a greater extent in areas that are subject to natural forces, such as seismic or wind events. Our products are generally used in a sequential progression that follows the construction process. Residential and commercial construction begins with the foundation, followed by the wall and the roof systems, and then the installation of our products, which flow into a project or a house according to these schedules. In prior years, our sales were heavily seasonal with operating results varying from quarter to quarter depending on weather conditions that could delay construction starts. Our sales and income have historically been lower in the first and fourth quarters than in the second and third quarters of a fiscal year. Due to efforts in diversifying our global footprint, most notably with our acquisition of ETANCO, sales from our product line, customer base and customer purchases are becoming less seasonal. Political and economic events such as rising energy costs, volatility in the steel market, stressed product transportation systems and increasing interest rates can also have an effect on our gross and operating profits as well. Changes in raw material cost could impact the amount of inventory on-hand, and negatively affect our gross profit and operating margins depending on the timing of raw material purchases or how much sales prices can be increased to offset higher raw material costs. Business Segment Information Historically our North America segment has generated more revenues from wood construction products compared to concrete construction products. Our wood construction product sales decreased 9.9% for the quarter ended March 31, 2023 compared to March 31, 2022, mostly due to lower sales volumes, and our concrete construction product sales increased 6.3% over the same periods, due to product price increases in an effort to offset rising raw material costs, partly offset by lower volumes. Previously announced decreases for pricing on certain of our wood products for 2023 will likely negatively affect 2023 net sales compared to 2022. We currently anticipate compression of our operating margin for fiscal 2023 compared to 2022 due to the effects of our product price decreases and increases in operating expenses, partly offset by lower average priced steel in cost of sales relative to much of the prior year. During 2022, we reviewed the footprint for our U.S. operations with assistance from a third party. As a result, we identified opportunities to expand our facilities in the U.S. We believe that this expansion will improve our overall service, production efficiencies and safety in the workplace, as well as reduce our reliance on certain outsourced finished goods and component products and continue to ensure we have ample capacity to meet our customer needs. These investments reinforce our core business model differentiators to remain the partner of choice as we continue to produce products locally and ensure superior levels of customer service. Facility investments have already started in 2022 with the announced expansion of the Columbus facility, expected to be completed in 2024 while additional facility expansions are being considered. Europe sales increased 141.4% for the quarter ended March 31, 2023 compared to March 31, 2022, primarily due to the acquisition of ETANCO, which contributed $80.0 million in net sales, along with product price increases, offset by lower volumes and the negative effect of approximately $2.8 million in foreign currency translation due to a weakening United States dollar. Wood construction product sales increased 129.4% for the quarter ended March 31, 2023 compared to March 31, 2022 with ETANCO contributing $64.8 million to that increase. Concrete construction product sales are mostly project based, and sales increased 215.5% for the quarter ended March 31, 2023 compared to March 31, 2022 with ETANCO contributing $15.2 million. Europe gross profit of $46.6 million included $30.6 million from the acquisition of ETANCO. Europe reported income from operations of $14.8 million for the quarter ended March 31, 2023 compared to a loss from operations for the quarter ended March 31, 2022. ETANCO contributed operating income of $9.4 million for the current quarter, which was net of $4.2 million of amortization expense on acquired intangible assets and acquisition and integration costs were lower by $5.5 million. We expect to incur additional costs in 2023 as originally planned, to continue integrating ETANCO. The Company has begun to benefit from some of the previously identified synergies and we believe remains well positioned to benefit meaningfully from other synergies, subject to changing macroeconomic circumstances, which will delay some of the synergy opportunities. Our Asia/Pacific segment has generated revenues from both wood and concrete construction products, which we believe is not significant to our overall performance. Business Outlook The Company has updated its financial outlook for the full fiscal year ending December 31, 2023 based on one quarter of performance to reflect its latest expectations regarding demand trends, raw material costs and operating expense as of April 24, 2023 as follows: 27 • Operating margin is now estimated to be in the range of 19% to 21%. • Annual interest expense on the $577.5 million outstanding under the Amended and Restated Credit Facility as of March 31, 2023, is expected to be approximately $9.7 million, including the benefit from interest rate and cross currency swaps. • The effective tax rate is estimated to be in the range of 25% to 26%, including both federal and state income tax rates and assuming no tax law changes are enacted. • Capital expenditures are estimated to be in the range of $90.0 million to $95.0 million, including the expected spend of $22.0 million to $25.0 million on our previously announced Columbus, Ohio facility expansion, with the balance of that project to be spent in 2024. • The Company has made solid progress on its efforts to integrate ETANCO into its operations and to realize previously identified offensive and defensive synergies in the years ahead. However, these efforts will continue to result in additional costs in 2023 that have been planned since the Company announced the transaction. Results of Operations for the Three Months Ended March 31, 2023, Compared with the Three Months Ended March 31, 2022 Unless otherwise stated, the below results, when providing comparisons (which are generally indicated by words such as “increased,” “decreased,” “unchanged” or “compared to”), compare the results of operations for the three months ended March 31, 2023, against the results of operations for the three months ended March 31, 2022. Unless otherwise stated, the results announced below, when referencing “both quarters,” refer to the three months ended March 31, 2022 and the three months ended March 31, 2023. 28 First Quarter 2023 Consolidated Financial Highlights The following table shows the change in the Company's operations from the three months ended March 31, 2022 to the three months ended March 31, 2023, and the increases or decreases for each category by segment: Three Months Ended Three Months Ended Increase (Decrease) in Operating Segment March 31, North Asia/ Admin & March 31, (in thousands) 2022 America Europe Pacific All Other 2023 Net sales $ 493,570 $ (32,401) $ 72,764 $ 497 $ — $ 534,430 Cost of sales 256,789 (20,004) 43,613 1,021 135 281,554 Gross profit 236,781 (12,397) 29,151 (524) (135) 252,876 Research and development and other engineering expense 15,866 4,120 874 (113) — 20,747 Selling expense 36,836 3,954 7,827 65 (15) 48,667 General and administrative expense 53,774 887 10,066 220 (1,240) 63,707 Total operating expenses 106,476 8,961 18,767 172 (1,255) 133,121 Acquisition and integration related costs 6,951 — (5,509) — — 1,442 Net loss (gain) on disposal of assets (1,083) (24) 1,052 5 — (50) Income from operations 124,437 (21,334) 14,841 (701) 1,120 118,363 Interest income (expense), net and other (212) 125 (2,750) 5 2,262 (570) Other & foreign exchange loss, net (216) 1,736 100 (563) (1,455) (398) Income (loss) before income taxes 124,009 (19,473) 12,191 (1,259) 1,927 117,395 Provision for income taxes 29,433 (3,925) 4,049 (350) 234 29,441 Net income (loss) $ 94,576 $ (15,548) $ 8,142 $ (909) $ 1,693 $ 87,954 Net sales increased 8.3% to $534.4 million from $493.6 million primarily due to ETANCO which contributed $80.0 million in net sales, offset by lower sale volumes in North America. Wood construction product sales, including sales of connectors, truss plates, fastening systems, fasteners and shearwalls, represented 85% and 88% of the Company's total sales in the first quarters of 2023 and 2022, respectively. Concrete construction product sales, including sales of adhesives, chemicals, mechanical anchors, powder actuated tools and reinforcing fiber materials, represented 14% and 12% of the Company's total sales in the first quarters of 2023 and 2022, respectively. Gross profit increased 6.8% to $252.9 million from $236.8 million primarily due to $30.6 million of gross profit from ETANCO at a 38.3% gross margin which resulted in a consolidated gross margin of 47.3% compared to 48.0% last year without ETANCO. From a product perspective, gross margin decreased to 47.1% from 48.1% for wood construction products and increased to 47.1% from 46.9% for concrete construction products, respectively. Research and development and engineering expense increased 30.8% to $20.7 million from $15.9 million, primarily due to increases of $2.8 million in personnel costs, $0.5 million in professional services, $0.3 million in travel related costs, $0.3 million in depreciation and amortization and $0.2 million for cash profit sharing. Selling expense increased 32.1% to $48.7 million from $36.8 million, primarily due to increases of $7.0 million in personnel costs and commissions, $1.7 million in travel related costs, $1.1 million in professional fees, and $0.8 million in advertising and trade shows, offset by a decrease of $0.6 million for cash profit sharing. General and administrative expense increased 18.5% to $63.7 million from $53.8 million, primarily due to increases of $5.3 million in depreciation and amortization, $3.0 million in personnel costs, $1.1 million for bad debt expenses, $1.1 million in computer and software expenses net of amounts capitalized, and $0.8 million in travel related costs, offset by a decrease of $1.3 million in cash profit sharing and $0.8 million in professional and legal fees. Acquisition and integration costs related to ETANCO were $5.5 million lower. 29 Our effective income tax rate in creased to 25.1% from 23.7%. Consolidated net income was $88.0 million, which includes the operating results from ETANCO, compared to $94.6 million. Diluted earnings per share was $2.05 compared to $2.18. Net sales The following table shows net sales by segment for the three months ended March 31, 2023 and 2022, respectively: North Asia/ (in thousands) America Europe Pacific Total Three months ended March 31, 2022 $ 438,731 $ 51,451 $ 3,388 $ 493,570 March 31, 2023 406,330 124,215 3,885 534,430 Increase (decrease) $ (32,401) $ 72,764 $ 497 $ 40,860 Percentage increase (decrease) (7.4) % 141.4 % 14.7 % 8.3 % The following table shows segment net sales as percentages of total net sales for the three months ended March 31, 2023 and 2022, respectively: North America Europe Asia/ Pacific Total Percentage of total 2022 net sales 89 % 10 % 1 % 100 % Percentage of total 2023 net sales 76 % 23 % 1 % 100 % Gross profit The following table shows gross profit by segment for the three months ended March 31, 2023 and 2022, respectively: North Asia/ Admin & (in thousands) America Europe Pacific All Other Total Three months ended March 31, 2022 $217,919 $17,453 $1,448 $(39) $236,781 March 31, 2023 205,522 46,604 924 (174) 252,876 Increase (decrease) $(12,397) $29,151 $(524) $(135) $16,095 Percentage Increase (decrease) (5.7) % 167.0 % * * 6.8 % * The statistic is not meaningful or material. The following table shows gross margin by segment for the three months ended March 31, 2023 and 2022, respectively: North America Europe Asia/ Pacific Admin & All Other Total 2022 gross margin percentage 49.7 % 33.9 % 42.7 % * 48.0 % 2023 gross margin percentage 50.6 % 37.5 % 23.8 % * 47.3 % * The statistic is not meaningful or material. 30 North America • Net sales decreased 7.4%, primarily due to lower volumes. • Gross margin increased to 50.6% from 49.7%, primarily from lower raw material costs, partially offset by higher factory and tooling, warehouse and freight costs, as a percentage of net sales. • Research, development and engineering expenses increased 27.8%, primarily due to increases of $1.5 million in personnel costs, $0.5 million in professional fees, $0.3 million in travel related costs, $0.2 million depreciation and amortization and $0.2 million for cash profit sharing. • Selling expense increased 12.8%, primarily due to increases of $2.0 million in personnel costs and commissions, $1.1 million in travel related costs, $1.0 million in professional fees, $0.5 million in advertising and trade show costs, and $0.2 million in stock compensation, offset by a decrease of $0.8 million in cash profit sharing. • General and administrative expense increased 2.4%, primarily due to increases of $0.8 million in personnel cost, $0.8 million bad debt expense, $0.9 million in computer and software expense net of amounts capitalized, $0.5 million in travel rated costs, and $0.4 million in stock compensation, offset by decreases of 1.1 million in professional fees and $0.9 million for cash profit sharing. • Income from operations decreased by $21.3 million due to the factors discussed above. Europe • Net sales increased 141.4%, primarily due to ETANCO, which contributed $80.0 million in net sales, partly offset by lower volumes and the negative effect of approximately $2.8 million in foreign currency translation. • Gross margin increased to 37.5% from 33.9%. Europe gross profit of $46.6 million included $30.6 million from ETANCO which contributed 38.3% gross margin. • Income from operations increased by $14.8 million, which includes ETANCO's operating income of $9.4 million which is net of $4.2 million of amortization expense on acquired intangible assets, and $1.4 million in integration costs. Asia/Pacific • For information about the Company's Asia/Pacific segment, please refer to the tables above setting forth changes in our operating results for the three months ended March 31, 2023 and 2022. Effect of New Accounting Standards See "Note 1 Basis of Presentation — Accounting Standards Not Yet Adopted ” to the accompanying unaudited interim Condensed Consolidated Financial Statements. Liquidity and Sources of Capital We have historically met our capital needs through a combination of cash flows from operating activities and, when necessary, borrowings under our credit agreements. Our principal uses of capital include the costs and expenses associated with our operations, including financing working capital requirements and continuing our capital allocation strategy, which includes supporting capital expenditures, paying cash dividends, repurchasing the Company's common stock, and financing other investment opportunities. On March 30, 2022, the Company entered into an Amended and Restated Credit Agreement to finance a portion of its acquisition of ETANCO, which provides for a 5-year revolving credit facility of $450.0 million, and for a 5-year term loan facility of $450.0 million. As of March 31, 2023, the Company had borrowings of $150.0 million under the revolving credit facility and $427.5 million under the term loan facility, and has $300.0 million available to borrow under the revolving credit facility. We believe that our cash position and cash flows from operating activities are sufficient to meet our cash flow needs for 31 the foreseeable future, including repayments of amounts of outstanding debt under the Amended and Restated Credit Agreement. As of March 31, 2023, our cash and cash equivalents consisted of deposits and money market funds held with established national financial institutions. Cash and cash equivalents of $62.5 million are held in the local currencies of our foreign operations and could be subject to additional taxation if repatriated to the United States. The Company is maintaining a permanent reinvestment assertion on its foreign earnings relative to remaining cash held outside the United States. The following table shows selected financial information as of March 31, 2023, December 31, 2022 and March 31, 2022, respectively: As of March 31, As of December 31, As of March 31, (in thousands) 2023 2022 2022 Cash and cash equivalents $ 252,541 $ 300,742 $ 984,372 Property, plant and equipment, net 369,089 361,555 265,675 Goodwill, intangible assets and other 880,845 863,841 169,474 Working capital excluding cash and cash equivalents 639,334 529,945 496,659 The following table provides information on how cash was used or provided during the three-month periods ended March 31, 2023 and 2022, respectively: Three Months Ended March 31, (in thousands) 2023 2022 Net cash provided by (used in): Operating activities $ 2,958 $ 44,679 Investing activities (27,043) (17,081) Financing activities (23,817) 650,600 Cash flows from operating activities result primarily from our earnings before non-cash items such as depreciation, amortization and stock-based compensation, and are also affected by changes in operating assets and liabilities which consist primarily of working capital balances. Our revenues are derived from manufacturing and sales of building construction materials. Our operating cash flows are subject to seasonality and are cyclically associated with the volume and timing of construction project starts. For example, trade accounts receivable are generally lowest at the end of the fourth quarter and increases during the first, second and third quarters as construction activity ramps in markets we serve. During the three months ended March 31, 2023, operating activities provided $3.0 million in cash, as a result of $88.0 million from net income plus $25.1 million non-cash expenses such as depreciation, amortization, and stock-based compensation. This amount was partly offset by $110.1 million used for the net change in operating assets and liabilities, including increases of $70.0 million in trade accounts receivable and $16.9 million in inventory, as well as by a decrease of $13.2 million in other current liabilities. Cash used in investing activities of $27.0 million during the three months ended March 31, 2023 was mainly for capital expenditures and acquisition related activities. Our capital spending for the three months ended March 31, 2023 and March 31, 2022 was $18.8 million and $17.8 million, respectively, which was primarily used for machinery and equipment purchases and software in development. Based on current information and subject to future events and circumstances, total approved capital spending for 2023 will be in the $90.0 million to $95.0 million range including the expected spend of $22.0 million to $25.0 million on our previously announced Columbus, Ohio facility expansion, with the balance of that project to be spent in 2024. Other capital spending is earmarked for both maintenance and growth to maximize efficiencies and invest in our key initiatives. Our acquisition activities were primarily in support of the building technology services and acquiring intellectual property. Cash used in financing activities of $23.8 million during the three months ended March 31, 2023 consisted primarily of $11.1 million used to pay dividends to our stockholders, $7.4 million used to pay income taxes on behalf of employees for shares withheld with respect to their vested restricted stock units and $5.6 million used for debt repayment. 32 On April 26, 2023, the Company's Board of Directors (the "Board") declared a quarterly cash dividend of $0.27 per share payable on July 27, 2023, to the Company's stockholders of record on July 6, 2023. Since the beginning of 2019 to the quarter ended March 31, 2023, we have returned $417.0 million to stockholders, which represents 55.5% of our free cash flow and includes repurchasing over 3.1 million shares of the Company's common stock, which represents approximately 6.8% of the outstanding shares of the Company's common stock at the start of 2019. Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements as of March 31, 2023.