Simpson Manufacturing Company - 10-Q quarterly report FY

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

Simpson Manufacturing Co., Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Simpson Manufacturing Co., Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Simpson Manufacturing Co., Inc. and Subsidiaries

Condensed Consolidated Statements of Stockholders’ Equity

for the nine months ended September 30, 2003 and 2004 and December 31, 2003

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Simpson Manufacturing Co., Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(Unaudited)

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Simpson Manufacturing Co., Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1.             Basis of Presentation

Interim Period Reporting

The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and footnotes required by accounting principles generally accepted in the United States of America have been condensed or omitted. These interim statements should be read in conjunction with the consolidated financial statements and the notes thereto included in Simpson Manufacturing Co., Inc.’s (the “Company’s”) 2003 Annual Report on Form 10-K (the “2003 Annual Report”).

The unaudited quarterly condensed consolidated financial statements have been prepared on the same basis as the audited annual consolidated financial statements and, in the opinion of management, contain all adjustments (consisting of only normal recurring adjustments) necessary to state fairly the financial information set forth therein, in accordance with accounting principles generally accepted in the United States of America. The year-end condensed consolidated balance sheet data were derived from audited financial statements, but do not include all disclosures required by accounting principles generally accepted in the United States of America. The Company’s quarterly results may be subject to fluctuations. As a result, the Company believes the results of operations for the interim periods are not necessarily indicative of the results to be expected for any future period.

Revenue Recognition

The Company recognizes revenue when the earnings process is complete, net of applicable provision for discounts, returns and allowances, whether actual or estimated based on the Company’s experience. This generally occurs when products are shipped to the customer in accordance with the sales agreement or purchase order, ownership and risk of loss pass to the customer, collectibility is reasonably assured and pricing is fixed and determinable. The Company’s general shipping terms are F.O.B. shipping point where title is transferred and revenue is recognized when products are shipped to customers.  In instances where title does not pass to the customer upon shipment, (F.O.B. destination point), title is transferred and the Company recognizes revenue upon delivery or customer acceptance, depending on terms of the sales agreement. Service sales, representing aftermarket repair and maintenance and engineering activities, though significantly less than 1% of net sales and not material to the financial statements, are recognized as the services are complete.

Treasury Stock

The Company records treasury stock purchases under the cost method whereby the entire cost of the acquired stock is recorded as treasury stock. Upon retirement, the resulting gains or losses are credited or charged to retained earnings.

Net Income Per Common Share

Basic net income per common share is computed based upon the weighted average number of common shares outstanding. Potentially dilutive securities, using the treasury stock method, are included in the diluted per-share calculations for all periods when the effect of their inclusion is dilutive.

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The following is a reconciliation of basic earnings per share (“EPS”) to diluted EPS:

The dilutive securities in the tables above exclude stock options that would be anti-dilutive.

Accounting for Stock-Based Compensation

The Company maintains two stock option plans under which the Company may grant incentive stock options and non-qualified stock options to employees, consultants and non-employee directors. Stock options have been granted with exercise prices at or above the fair market value on the date of grant. Options vest and expire according to terms established at the grant date.

Statement of Financial Accounting Standards (“SFAS”) No. 123, “Accounting for Stock-Based Compensation,” encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans based on the fair value of options granted. In December 2002, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure,” which amends SFAS No. 123. SFAS No. 148 requires more prominent and frequent disclosures about the effects of stock-based compensation.

As of January 1, 2003, the Company adopted SFAS No. 148 and SFAS No. 123 and used the prospective method of applying SFAS No. 123 for the transition. For stock options that have been granted prior to January 1, 2003, the Company will continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, because the grant price equaled or exceeded the market price on the date of grant for options issued by he Company, no compensation expense has been recognized for stock options granted prior to January 1, 2003. For the three months ended September 30, 2004 and 2003, the Company has recognized after-tax stock option expense of approximately $651,000 and $232,000, respectively. For the nine months ended September 30, 2004 and 2003, the Company has recognized after-tax stock option expense of approximately $2,108,000 and $712,000, respectively.

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Had compensation cost for the Company’s stock options for all grants been recognized based upon the estimated fair value on the grant date under the fair value methodology prescribed by SFAS No. 123, as amended by SFAS No. 148, the Company’s net income and earnings per share would have been as follows:

The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and the Company’s experience.

Stock Spilt Effected in the Form of a Stock Dividend

In September 2004, the Company’s Board declared a 2-for-1 stock split to be effected in the form of a stock dividend of its common stock. The record date is November 1, 2004, and the additional shares will be distributed on November 18, 2004.  All of the share and per share numbers have been adjusted to reflect the stock split.

Reclassifications

Certain prior period amounts have been reclassified to conform to the 2004 presentation with no effect on net income or retained earnings as previously reported.

2.             Trade Accounts Receivable, net

Trade accounts receivable consist of the following:

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3.             Inventories

The components of inventories consist of the following:

4.             Property, Plant and Equipment, net

Property, plant and equipment, net consists of the following:

5.             Investments

As of September 30, 2004, the Company held a 35.0% investment in Keymark Enterprises, LLC (“Keymark”). The Company believes that the carrying value of its investment in Keymark exceeds its fair value and therefore has written down the value of its investment to zero.  Prior to the equity interest in Keymark, the Company had an agreement with Keymark’s predecessor to incorporate and specify the Company’s products in its software and to add some functionality to the software. The amounts paid in 2002 and 2001 (see Note 12 to the consolidated financial statements in the Company’s 2003 Annual Report) were payments made by the Company under the agreement as well as $15,000 to exercise an option included in the agreement giving the Company its initial 30% equity in Keymark’s predecessor. In 2003, the Company paid $500,000 for the additional 5% share but does not have have any additional funding requirements. In accordance to the criteria set forth in FASB Interpretation No. 46, the Company has concluded that it is not required to absorb any of the losses of Keymark beyond its initial investment nor does it have the ability to exert significant influence on Keymark’s operating and financing policies.

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Available-for-Sale Investments

The Company’s investments in all debt securities are classified as either cash and cash equivalents or available-for-sale investments. As of September 30, 2004 and 2003, the Company’s investments were as follows:

Of the total estimated fair value of debt securities, $37,894 and $900,000 was classified as cash equivalents as of September 30, 2004 and 2003, respectively, and $21,395,466 and $24,449,420 was classified as short-term investments as of September 30, 2004 and 2003, respectively.

As of September 30, 2004, contractual maturities of the Company’s available-for-sale investments were as follows:

During the nine months ended September 30, 2003, there were realized gains of $2,129 related to the sale of available-for-sale investments.

6.             Accrued Liabilities

Accrued liabilities consist of the following:

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7.             Debt

Outstanding debt at September 30, 2004 and 2003, and December 31, 2003, and the available credit at September 30, 2004, consisted of the following:

As of September 30, 2004, the Company had one outstanding standby letter of credit in the amount of $845,430 to guarantee performance on the Company’s leased facility in the United Kingdom.

8.             Commitments and Contingencies

Note 9 to the consolidated financial statements in the Company’s 2003 Annual Report provides information concerning commitments and contingencies. From time to time, the Company is involved in various legal proceedings and other matters arising in the normal course of business. The Company does not believe that the outcomes of currently pending matters will have a material adverse effect on the Company’s financial condition, cash flows or results of operations.

The Company’s policy with regard to environmental liabilities is to accrue for future environmental assessments and remediation costs when information becomes available that indicates that it is probable that the Company is liable for any related claims and assessments and the amount of the liability is reasonably estimable. The Company does not

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believe that these matters will have a material adverse effect on the Company’s financial condition, cash flows or results of operations.

Corrosion, hydrogen enbrittlement, stress corrosion cracking, hardness, wood pressure—treating chemicals (such as copper), misinstallations, environmental conditions or other factors can contribute to failure of fasteners and connectors. On occasion, some of the fasteners that the Company sells have failed, although the Company has not incurred any material liability resulting from those failures. The Company attempts to avoid such failures by establishing and monitoring appropriate product specifications, manufacturing quality control procedures, inspection procedures and information on appropriate installation methods and conditions.  The Company subjects its products to extensive testing, with results and conclusions published in Company catalogues and on its website (see www.strongtie.com/info).   Based on test results to date, the Company believes that if its products are appropriately selected and installed in accordance with the Company’s guidance, they may be reliably used in appropriate applications.

9.             Segment Information

The Company is organized into two primary segments. The segments are defined by types of products manufactured, marketed and distributed to the Company’s customers. The two product segments are connector products and venting products. These segments are differentiated in several ways, including the types of materials used, the production process, the distribution channels used and the applications in which the products are used. Transactions between the two segments were immaterial for each of the periods presented.

The following table illustrates certain measurements used by management to assess the performance of the segments described above as of or for the following periods:

Cash collected by the Company’s subsidiaries is routinely transferred into the Company’s cash management accounts and, therefore, has been included in the total assets of the segment entitled “All other.” Cash and cash equivalent and short-term investment balances in the “All other” segment were approximately $79,866,000, $137,218,000 and $139,021,000 as of September 30, 2004 and 2003, and December 31, 2003, respectively.

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10.           Subsequent Events

In October 2004, the Company completed the acquisition of the assets of Quik Drive, U.S.A., Inc. and Quik Drive Canada, Inc. and 100% of the equity of Quik Drive Australia Pty. Limited (collectively “Quik Drive”). Quik Drive manufactures collated fasteners and fastener delivery systems which are marketed in the U.S., Canada, Australia and New Zealand.  The cost (subject to post-closing adjustments) of the acquisition was $30.0 million in cash and $5.0 million in stock (which was not and will not be registered under the Securities Act of 1933 and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements).

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Results of Operations for the Nine Months Ended September 30, 2004, Compared

with the Nine Months Ended September 30, 2003

In the first nine months of 2004, net sales increased 27.8% to $530.3 million as compared to net sales of $414.8 million in the first nine months of 2003. Net income increased 35.3% to $63.9 million in the first nine months of 2004 as compared to net income of $47.3 million in the first nine months of 2003. Diluted net income per common share was $1.31 in the first nine months of 2004 as compared to $0.94 in the first nine months of 2003.

In the first nine months of 2004, sales growth occurred throughout North America and Europe. The growth in the United States was strongest in the southern, western and northeastern regions. Simpson Strong-Tie’s sales increased 30.0% over the first nine months of 2003, while Simpson Dura-Vent’s sales increased 12.8%. Lumber dealers, dealer distributors and contractor distributors were the fastest growing Simpson Strong-Tie sales channels. The sales increase was broad based across most of Simpson Strong-Tie’s major product lines. Engineered wood products and seismic and high wind products had the highest percentage growth rates in sales, while core products showed solid growth. Sales of Simpson Dura-Vent’s gas vent, chimney, and pellet vent products increased compared to the first nine months of 2003, while sales of its Direct-Vent products were flat.

Income from operations increased 35.1% from $76.6 million in the first nine months of 2003 to $103.5 million in the first nine months of 2004 and gross margins increased from 40.2% in the first nine months of 2003 to 40.8% in the first nine months of 2004. This increase was primarily due to improved absorption of overhead costs resulting from increased sales volume, partially offset by an increase in material costs, mainly steel, the cost of which continued to increase during the first nine months of 2004 as discussed above.

Selling expenses increased 17.4% from $36.3 million in the first nine months of 2003 to $42.6 million in the first nine months of 2004, primarily due to increased costs associated with the addition of sales personnel, including those related to the acquisition in May 2003 of MGA Construction Hardware & Steel Fabricating Limited and MGA Connectors Limited (collectively, “MGA”) in Canada, and increased promotional activities totaling approximately $5.1 million. General and administrative expenses increased 30.7% from $53.9 million in the first nine months of 2003 to $70.5 million in the first nine months of 2004. This increase was primarily due to an increase in cash profit sharing of approximately $9.6 million, as a result of higher operating income, and an increase in pre-tax stock compensation expenses of approximately $2.5 million. The increase was also partially due to higher legal expenses of approximately $1.8 million and to increased administrative overhead costs totaling approximately $1.7 million, including those related to the acquisition of MGA. In addition, in the first quarter of 2004, the Company donated $0.5 million to a university in central California to help fund the research and development of innovative construction practices. The tax rate was 38.4% in the first nine months of 2004, down from 38.9% in the first nine months of 2003. The decrease was primarily due to tax credits in an enterprise zone related to the expansion of the Company’s facilities in Stockton, California, and tax credits related to research and development costs.

The Company recently was informed of a consumer alert issued on October 21, 2004, by the fraud division of the office of the Contra Costa County, California, District Attorney, regarding the corrosion of some types of connectors and fasteners when used with some types of pressure-treated wood. A local television news program reported on this matter on the same day. The Company subjects its products to extensive testing, including their use with pressure-treated wood. The Company publishes its conclusions and guidance in its catalogues and on its web site (see www.strongtie.com/info). Based on its test results to date, the Company believes that if its products are appropriately selected and properly installed in accordance with the Company’s guidance, they may be reliably used in appropriate applications with pressure-treated wood.

Liquidity and Sources of Capital

As of September 30, 2004, working capital was $279.0 million as compared to $278.2 million at September 30, 2003, and $269.5 million at December 31, 2003. The increase in working capital from December 31, 2003, was primarily due to an increase in inventories of approximately $57.7 million. In total, the value of inventory increased 54.3% from December 31, 2003, approximately half of which was attributable to rising prices.  Raw material prices were up approximately 45.7% while raw material quantities, mainly steel, were up 38.0% from December 31, 2003.  There was also an increase in the Company’s trade accounts receivable of approximately $47.6 million.  Net accounts receivable increased by 72.1% from December 31, 2003.  The increase is due primarily to increased prices and sales volumes.  The Company increased prices a total of approximately 15% during the nine-month period ended September 30, 2004.  In addition, sales volumes are typically greater in the second and third quarters compared to the first and fourth quarters.  Offsetting these factors was a decrease in cash, cash equivalents, and short-term

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investments of approximately $56.3 million, primarily due to the repurchase for approximately $31.3 million of the Company’s common stock, and an increase in trade accounts payable of approximately $22.0 million. Accrued liabilities increased by approximately $13.5 million, primarily as a result of higher accrued rebates and for the dividends declared in the third quarter of 2004 and payable in October 2004 and  January 2005. Accrued cash profit sharing, which is based on operating income, also increased, by approximately $6.9 million. The balance of the change in working capital was due to the fluctuation of various other asset and liability accounts. The working capital change and changes in noncurrent assets and liabilities, combined with net income and noncash expenses, including depreciation, amortization and stock-based compensation charges, totaling approximately $82.8 million, resulted in net cash provided by operating activities of approximately $10.7 million. As of September 30, 2004, the Company had unused credit facilities available of approximately $27.2 million.

The Company used approximately $8.0 million in its investing activities. Approximately $30.9 million was used for capital expenditures and approximately $0.6 million was used to acquire 100% of the shares of ATF Furrer Holz GmbH (“ATF”), in Switzerland. ATF distributes a line of hidden connectors in some European countries.  This was offset by the net sales and maturities of available-for-sale securities of approximately $23.3 million. Approximately $13.2 million of the capital expenditures comprised real estate and related purchases, primarily for the construction of the Company’s new manufacturing facility in McKinney, Texas. This facility is expected to be completed around the end of 2004. The anticipated additional costs to complete this facility are expected to be approximately $6.0 million.  In addition, the Company expects to spend approximately $7.1 million for equipment and furnishings for this facility.  In August 2004, the Company entered into an agreement to purchase the Columbus, Ohio, facility which is currently leased from a related party.  The purchase price is approximately $4.0 million and is expected to be completed in 2005.  The Company expects its total capital spending to be approximately $45.0 million for 2004.

In October 2004, the Company’s subsidiary, Simpson Strong-Tie, completed the acquisition of the assets of Quik Drive, U.S.A., Inc. and Quik Drive Canada, Inc. and 100% of the equity of Quik Drive Australia Pty. Limited (collectively “Quik Drive”). Quik Drive manufactures collated fasteners and fastener delivery systems which are marketed in the U.S., Canada, Australia and New Zealand. The cost (subject to post-closing adjustment) of the acquisition was $30.0 million in cash and $5.0 million in stock (which was not and will not be registered under the Securities Act of 1933 and may not be offered or sold in the United States absent registration or an applicable exemption from registration requirements).

The Company’s financing activities used net cash of approximately $35.9 million, $31.3 million of which was used for the repurchase of 1,150,854 shares of its Common Stock as part of the $50.0 million that the Company’s Board of Directors authorized in December 2003 to reduce the dilutive effect of recently granted stock options.  In addition, the Company repaid approximately $4.3 million of its debt at its European subsidiaries. Other uses of cash for financing activities included the payments of cash dividends in both April and July 2004. In both July and September of 2004, the Company’s Board of Directors declared cash dividends to be paid in October 2004 and January 2005, respectively. Each dividend is $0.05 per share totaling approximately $2.4 million each. Approximately $3.4 million was provided by the issuance of common stock.

The Company believes that cash generated by operations and borrowings available under its existing credit agreements will be sufficient for the Company’s working capital needs and planned capital expenditures over the next twelve months. Depending on the Company’s future growth and possible acquisitions, it may become necessary to secure additional sources of financing.

The Company believes that the effect of inflation on the Company has not been material in recent years, as inflation rates have remained relatively low. However, recent increases in the price of steel, the Company’s main raw material, and the possibility of further increases may adversely affect the Company’s margins if it cannot recover the higher costs through price increases.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, the Company is involved in various legal proceedings and other matters arising in the normal course of business. The Company does not believe that the outcomes of these matters will have a material adverse effect on the Company’s financial condition, cash flows or results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

On April 22, 2004, the Company announced its intention to begin to repurchase up to approximately 1,150,000 shares of its Common Stock in the open market in order to reduce the dilutive effect of recently granted stock options. The repurchase program is part of the $50.0 million that the Company’s Board of Directors authorized in December 2003. This authorization will remain in effect through December 31, 2004. The following table presents the monthly purchases by the Company during the third quarter of 2004:

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Submission of Matters to a Vote of Security Holders.

None.

Item 5. Other Information.