Greetings, and welcome to the Simpson Manufacturing Q2 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Kim Orlando with ADDO Investor Relations. Please go ahead.

Good afternoon, ladies and gentlemen and welcome to Simpson Manufacturing Company's second quarter 2018 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 or the company's corporate website. 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 company's website, at www.simpsonmfg.com. Today's call is being webcast and a replay will also 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.

Thanks, Kim, and good afternoon, everyone. I'm pleased to discuss our second quarter results with you today. We had an excellent second quarter with our net sales of 17% year-over-year to $308 million. Positive demand trends primarily drove this increase and resulted in high growth in sales volumes throughout almost all areas of our company. This demand was supported by strong North American housing starts. We do not believe our growth in the second quarter sales volume was a result of significant pre-buying activity in advance of the 11.5% average price increase for the majority of our U.S. wood connector products which became effective on July 1. After announcing the price increase, we provide our customers with a notification period and a clause that prohibits significant pre-buying in order for us to properly manage our inventory levels. So far in the third quarter, demand remains strong, a further indication that significant pre-buying did not occur. U.S. housing starts, which are a leading indicator for approximately 60% of our business, increased in the mid-single digit range for the second quarter versus comparable period last year. Importantly, housing starts were more active in the western and southern regions of the U.S. with substantial activity on the West Coast and in the State of Florida. This is very significant for Simpson as we supply more meaningful amount of content into homes in these areas, which have stricter building design requirements due to wind and earthquake concerns compared to other regions of the United States. We continue to expect U.S. housing starts will increase at an annual mid-single digit rate over the next few years with repair and remodel market also expected to grow at a similar rate. Sales in Europe were also healthy due to improving economic conditions in the Western regions, which…

Thank you, Karen, and good afternoon, everyone. I'm pleased to discuss our second quarter financial results with you today. Our consolidated net sales for the second quarter of 2018 were $308 million, up 17% compared to $263 million in the second quarter of 2017. Within the North America segment, net sales increased 20% year-over-year to $259.8 million, primarily due to higher sales volume versus the second quarter of 2017 as a result of increased home construction activity in the U.S., and solid demand trends in all areas of our business. In Europe, net sales increased 1% year-over-year to $45.8 million due to increased sales volume as well as positive impacts from foreign currency translation. As Karen mentioned, our second quarter net sales in Europe were partially offset by reduced sales volume due to the 2017 sale of Gbo Fastening Systems' Poland and Romania subsidiaries, which contributed $4.3 million in net sales for the second quarter of 2017. Wood construction products represented over 84% of total net sales in the second quarter of 2018 compared to 85% in the second quarter of 2017. Concrete construction products represented nearly 16% of total net sales in the second quarter of 2018 compared to 15% in the year-ago period. Our second quarter consolidated gross profit increased 15% to $141.5 million from $123.5 million in the second quarter of 2017, resulting in a consolidated gross profit margin of 45.9%. Compared to the second quarter of 2017, our gross profit margin declined by approximately 110 basis points, primarily due to increased raw material costs. Currently, we do not anticipate the margin pressure experienced as a result of higher steel prices in the first half of the year will impact our full year 2018 gross profit margin guidance of 45% to 46%. On a per segment basis,…

Thank you. [Operator Instructions] Our first question comes from the line of Daniel Moore with CJS Securities. Please proceed with your question.

Afternoon, Karen and Brian, thanks for taking my questions.

Good afternoon, Dan.

Good afternoon, Dan.

So obviously, impressive growth in North America on the connector side of the business. Maybe just kind of break out – I know it's mostly volume, but volume versus price. And you called out California and Florida, it's quite a wide spread of your growth versus overall housing starts. So maybe just a little bit more color on what's driving that outperformance?

Sure. So as we mentioned, Dan, the price increase went into effect really beginning third quarter. So most of this was volume growth driven and as we’ve discussed in the past, when we look at housing starts, we look at the geographic location of those starts. And certainly, anything that's on the coastal areas going up the West Coast where we have seismic conditions, we put substantially more content into those houses than we would in-house that might be in the Midwest. So because there was substantial house-building and housing growth in both the Western States and certainly, the Southeast going up the coast there – the Gulf Coast up to Florida, where we have hurricane areas, we again put a lot more content into those houses. So it's the geographic location where the houses are being built that greatly helps us as we looked at our growth in Q2.

Very helpful, and looking at – shifting to the price increases, just – obviously, just went a few weeks ago, but any pushback at this stage, feel comfortable in pushing those through and given where steel prices are today, are there additional pricing increases planned or expected later in the year?

Well, as we’ve talked about actually probably for quite a while, the tariffs are pretty highly publicized. So anybody that's using steel or aluminum to produce their parts have had to put some price increases through and it's really associated with the tariffs that have all been put in place. The real change that happened between Q1 and Q2 is that the tariffs are also now going to be in Europe, Canada and Mexico. And so even though we don't buy steel from any of those areas, that gives credence to really keep those high prices of steel in place. And so we think that will probably stay pretty flat or slightly up as we go forward into Q3.

Very helpful. Lastly, sticking with the demand side, concrete, you alluded to an increasing demand in Europe from some government customers. Maybe just provide us a little bit color there and obviously congrats on the strong performance in the quarter.

Yes, thanks Dan. In Europe, our concrete business is really particularly job-based. We do a lot of work with roadways. We’ve got some product that works to help strengthen roadways. And those are the types of government projects that have been led based on the economic conditions. And so what we're really seeing is our concrete products, whether that be in strengthening bridges and buildings, and roadways, we're seeing more of those jobs being led and you're seeing that increase in the revenue and also help on that gross margin increase that we’re seeing in Europe.

Our next question comes from the line of Tim Wojs with Robert W. Baird & Company. Please proceed with your question.

Hey, everybody. Good afternoon.

Good afternoon Tim.

Hi Tim.

Nice shot on the results. I guess my first question maybe to dovetail a little bit on the last ones. Is there a way to think about just from a content perspective if you look at your kind of coastal regions relative to Canadian national average, what the content – just an approximation of what the content might look like on either a dollar basis or a percentage basis?

Well, we don't really give that information. We take a look obviously at the content that again in a high wind area or a seismic area. And what I’ve mentioned in the past is if I take some – a house is built in the Midwest or in Iowa we might have about $50 worth of content in that house. Typically, it would be the hurricane type attaching the roof rafters to the top plates. But if I take that same house and I put it in Florida or in the California coast, I could have well over $5,000 worth of content. So it's a pretty significant difference and it's really driven by the fact that those natural disasters require a higher design standard and when we have higher design standard, more of our products will be put into those properties.

Okay. I guess on the pricing increased realization, I mean, it's been a while since we have such a substantial kind of increase in pricing. So what's the right way to think about how much of that 11.5% actually gets realized?

Well, as you know, there's always a little bit of a stagger. We give our customers a 50-day notification and that's really to help them get pricing into their systems. But again, there's always going to be a slightly small stagger from our customers. But we do believe that we'll see that price increase realized as we continue here through third and fourth quarter.

Okay. And then two other ones, free cash flow. So free cash flow looks like in the first half is maybe positive $36 million or so. And I think – I mean, that's more free cash flow you’ve generated in some years. And so I think normally you generate a large majority of your cash flow in the second half of the year. So my question is could free cash flow be substantially above earnings in kind of 2018? Is that the right ballpark for us?

Hey, Tim, it’s Brian. I would say that you’re right. The free cash flow historically has been higher in the second half of the year. I don't know that it go as far to say that it would be significantly higher than earnings, but I would anticipate it being higher than it has been in the prior year's due to the higher earnings, the fewer – lower dollar estimated capital expenditures that we have this year versus prior years. But directionally I would – that's where we're thinking.

Okay. And working capital should be flat to down on a year-over-year basis?

I don't know that I could answer that question right now at this point.

Okay, but inventory should be down year-over-year?

Inventory should be but one of the interesting things about inventory is in the steel markets, availability is tougher now than it has been. I guess, recently it's been tough, but historically. So as we – our approach by our steel vendors and if there's an opportunity to make some opportunistic purchases there, we may do that. So it's hard to say they're on inventory, but as you see at least Q2 this year versus Q2 of last year, we're down about $7 million even on increased revenues and increased cost of sales.

No, I thought the inventory performance is really good. So yes, I was just trying to think about how much we can see – I maybe talk to you with that – about that offline. And then the last one is just on a year-over-year basis, could you just remind us what the annual severance expenses are in 2018 and what your expecting annual SAP expenses to be in 2018?

Well, the severance, the – it's about $2 million, including some amounts in cost of sales as well as the amount Karen noted in operating expenses. I don't have the SAP total number for you right now, though I would estimate it to be in the $8 million to $9 million total expense, including amortization of amounts that we've capitalized in prior quarters.

Great, that’s it from me.

That's where our best estimate is today.

Okay, okay. Thank you. Good luck on the second half of the year. Thanks.

Thanks Tim.

[Operator Instructions] Our next question comes from the line of Steve Chercover with D.A. Davidson. Please proceed with your question.

Thanks. I try never to say this but great quarter.

Thanks Steve.

Thanks Steve.

So I'm still – I guess, a little perplexed. I don't think housing starts in the West or in the Southeast where we have got seismic or wind events were up mid-teens. So was there some sort of code enforcement that became more pronounced maybe following the hurricanes? Like, all of a sudden these inspectors and people started to say you got to put this stuff in?

No, there hasn’t really been a code change from the hurricanes that occurred last year, but we’re definitely, again, you’re seeing a more push on both multi-family and single family in these more natural disaster type of areas. And then we have also gained a little bit of market share on our connector line also.

Yes, that was my next question. What do you reckon your share might be in coming from where to where?

Well, we’ve always thought our market share was somewhere around the 70% to 75%. We certainly can track the houses in the content we put in houses, and so we think we gained a little bit of market share just on some customers that we’ve picked up.

Okay. And then where there any significant victories beyond? I mean, it sounds like Home Depot was actually going a little slower than anticipated on the anchor systems?

Well, a little bit slower on the anchors and that’s really a function that – typically, when we put a product into Home Depot we’re displacing another vendor. And in this case, we are not really displacing a vendor. And so that’s why it’s taking a little bit longer. In that there has to be a little bit of a reshuffle of the shelf space to be able to get this in. So we still feel confident that the commitment it’s just going to take a little longer than we anticipated. But I think overall that Home Depot is doing a great job for us. And certainly, as you see, repair remodel and housing starts again, those are all positives as we sell some our products to the Home Depot locations.

And then in the current quarter, it sounds like the volume trends remain solid. I don’t want to say mid-teens, but double-digit and then be get phase in of the 11.5% price hike?

Yes. So, we’re – like you said, the pricing increases is in effect. We are seeing pretty solid revenue numbers as we started here in the third quarter, a little early to know how the full quarter is going to go, but certainly have seen some nice numbers as we’re running through July.

An obscenity were to prevail and we hope it does on the trade fund and maybe some of the tariffs on steel would have to dissipate, there’s no – you don’t have to give back the price hikes on steel. It’s not there’s a price escalator and/or deflator, is there?

Yes. The way steel pricing works, of course, one of the things that we think is because the tariffs are – there was sort of a grace period where the tariffs were not impacting steel coming from Canada, Mexico and Europe. And when that period – when that grace period is gone, which actually happened about six weeks ago, we think that that means that you’re steel pricing will be pretty firmly in place because there’s tariffs on all steel coming in from anywhere now. And as far as our steel pricing, again, it takes us about 60 days to implement a steel price, so the customers have plenty of time to put it into their systems. And certainly, if there was some dramatic decrease in the cost of steel, we would have to make some adjustments on the downside. But our best estimate at this point is that those steel prices will probably remain very strong through third quarter and then we’ll see kind of how things are progressing from there.

And would 11.5% be sufficient to offset the steel prices that are currently being absorbed?

When we look at all the steel prices, as we talked about, we have fairly unique steel. And so the data that comes out, gives you a couple of data points when you look at some of the steel pricing increase, but we do have very specific galvanization that we put on our steel. We have very specific yield [indiscernible] structural value that we need on our steel. So we have to look at that particular steel that we are buying and we do believe that the 11.5% will help – will cover those steel price increases that we’ve really been seeing over the past few months.

Okay. And then last one with respect to truss plates, you got 24. You said a couple of dozen new programs that are in the process of being implemented. When those are in, how close does that get you towards your 20% market share of the market? I’m sure there’s still a lot to go.

Yes, still a lot to go. As we mentioned from the component manufacturers, you really have the opportunity to convert those customers in fourth quarter and first quarter. Actually because that’s the – it’s not the busy part of the season. So in second and third quarter, we’re really completing those implementations of customers that we have brought on board. We are making sure that we have got support, and as we mentioned, we just released a new software – excuse me, a new revision to get more efficiencies in those softwares. So there’s still ways from meeting that 20% market share, but definitely tracking in a very positive direction on truss revenue.

Okay. So my last question is to finish that train of thoughts. What do you reckon is it takes to get to 20%, is that a five-year endeavor?

No, I think we’ll be hitting that target sooner. You got to remember that you kind have this layering effect because you’re not getting these customers for a full year. So only this year are we getting the full revenue from customers that we put in place last year, and so you’ll have this layering effect as you go throughout the year. And again, we are very happy with what we have seen. Customers have been very responsive. They like the direction we are going. They like the feature set. They like the support we’re providing them. So we are seeing some nice trends on converting those customers. So I think that 20% is not out five years, I couldn’t give the exact time, but it should be sooner than that five-year time frame.

Terrific. Okay, thanks. We will see in a few weeks.

Great. Thanks, Steve.

This is Brian. I wanted to clarify, earlier a question was around the total SAP for 2018. I would – actually, again, would estimate a little bit higher than my prior comment, I mentioned $8 million to $9 million. It could be $9 million to $10 million for SAP on a total. So I just wanted to clarify that for the call.

Our next question is a follow-up from Daniel Moore with CJS Securities. Please proceed with your question.

Thank you, again. Just thought I should shift gears for a moment to the expense line items, R&D. Do you expect to continue to decline in terms of actual dollars or is 2Q a reasonable run rate for the remainder of the year and one quick follow-up.

I’d anticipate – this is Brian, Dan, for 2018 that our R&D and engineering specifically that run rate might – would be about right. I would say overall operating expenses probably be approximately 2% to 3% higher in fiscal year 2018 versus 2017.

Got it. So, including selling expense as well?

Yes. And G&A and the like, exactly; severances and the amount that we have gone over on SAP?

That’s very helpful, okay. And then lastly, at the risk of try to pin down too hard, Karen, just wanted to misinterpret your commentary around volume trends into Q3, and I know it’s still early, but are you indicating – in the commentary saying that there wasn’t pre-buying. All your indicating that we are continuing to grow just positives in line with the market or something similar to the type of growth rates that we saw in Q2, and again, I realized it’s just one month? Thank you.

Yes, Dan, we’re looking at as we mentioned when we put that price increase, we gave our customers a timeframe and then we also put a limitation on what they can pre-buy to try and beat the price increase. So as we look at how July is trending, we’re really looking to see we have our downfall from people pre-buying and that is we are not seeing that. So that’s really the indication that we have so far, too early in the quarter to be able to do too much prediction beyond that point.

Understood. Appreciate the color.

Great. Thanks, Dan.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.