Simpson Manufacturing Co., Inc. - Annual Report: 2004 (Form 10-K)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

 

Simpson Manufacturing Co., Inc.

(Exact name of registrant as specified in its charter)

 

Delaware		94-3196943
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
4120 Dublin Boulevard, Suite 400, Dublin, CA 94568
(Address of principal executive offices)
Registrant’s telephone number, including area code: (925) 560-9000
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, par value $0.01		New York Stock Exchange, Inc.
(Title of each class)		(Name of each exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act:
None
(Title of class)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes     ý     No     o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   o

 

As of June 30, 2004, there were outstanding 47,647,902 shares of the registrant’s common stock, par value $0.01, which is the only outstanding class of common or voting stock of the registrant. The aggregate market value of the shares of common stock held by nonaffiliates of the registrant (based on the closing price for the common stock on the New York Stock Exchange on June 30, 2004) was approximately $1,009,063,247. As of March 7, 2005, 47,988,044 shares of the registrant’s common stock were outstanding.

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes     ý     No     o

 

Documents Incorporated by Reference

 

The information called for by Parts II and III is incorporated by reference to the definitive Proxy Statement for the Annual Meeting of Stockholders of the Company to be held May 3, 2005, which will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2004.

 

 

This document contains forward-looking statements, based on numerous assumptions and subject to risks and uncertainties. Although the Company believes that the forward-looking statements are reasonable, it does not and cannot give any assurance that its beliefs and expectations will prove to be correct. Many factors could significantly affect the Company’s operations and cause the Company’s actual results to be substantially different from the Company’s expectations. Those factors include, but are not limited to: (i) general economic and construction business conditions; (ii) customer acceptance of the Company’s products; (iii) materials and manufacturing costs; (iv) the financial condition of customers, competitors and suppliers; (v) technological developments; (vi) increased competition; (vii) changes in capital market conditions; (viii) governmental and business conditions in countries where the Company’s products are manufactured and sold; (ix) changes in trade regulations; (x) the effect of acquisition activity; (xi) changes in the Company’s plans, strategies, objectives, expectations or intentions; and (xii) other risks and uncertainties indicated from time to time in the Company’s filings with the Securities and Exchange Commission. Actual results might differ materially from results suggested by any forward-looking statements in this report. The Company does not have an obligation to publicly update any forward-looking statements, whether as a result of the receipt of new information, the occurrence of future events or otherwise.

 

PART I

 

Item 1. Business.

 

Background

 

Simpson Manufacturing Co., Inc. (the “Company”), through its subsidiary, Simpson Strong-Tie Company Inc. (“Simpson Strong-Tie” or “SST”), designs, engineers and is a leading manufacturer of wood-to-wood, wood-to-concrete, wood-to-masonry connectors, screw fastening systems and collated screws, and pre-fabricated shearwalls. SST also offers a full line of adhesives, mechanical anchors and powder actuated tools for concrete, masonry and steel. The Company’s subsidiary, Simpson Dura-Vent Company, Inc. (“Simpson Dura-Vent” or “SDV”), designs, engineers and manufactures venting systems for gas, wood, oil and pellet burning appliances. The Company markets its products to the residential construction, light industrial and commercial construction, remodeling and do-it-yourself (“DIY”) markets. The Company believes that SST benefits from strong brand name recognition among architects and engineers who frequently specify in building plans the use of SST products, and that SDV benefits from strong brand name recognition among contractors, dealers, distributors and SDV’s relationships with original equipment manufacturers (“OEMs”) to which SDV markets its products. The Company has continuously manufactured structural connectors since 1956. See Note 14 to the Company’s Consolidated Financial Statements for information regarding the net sales, income from operations, depreciation and amortization, capital expenditures and acquisitions and total assets for the Company’s two primary segments.

 

Connectors produced by Simpson Strong-Tie typically are steel devices that are used to strengthen, support and connect joints in residential and commercial construction and DIY projects. SST’s Anchor Systems product line is included in the connector product segment. SST’s connector products enhance the safety and durability of the structures in which they are installed and can save time and labor costs for the contractor. SST’s connector products contribute to structural integrity and resistance to seismic, wind and other forces. Applications range from commercial and residential building, to deck construction, to DIY projects. SST produces and markets over 5,000 standard and custom products.

 

Simpson Dura-Vent’s venting systems are used to vent gas furnaces and water heaters, gas fireplaces and stoves, wood and oil burning appliances and pellet stoves. SDV’s metal vents, chimneys and chimney liner systems exhaust combustion products to the exterior of the building. SDV designs its products for ease of assembly and safe operation and to achieve a high level of performance. SDV produces and markets approximately 2,400 different venting products.

 

The Company emphasizes continuous new product development and often obtains patent protection for its new products. The Company’s products are marketed in all 50 states of the United States and in Europe, Canada, Japan, Australia, New Zealand, Mexico and several countries in Central and South America. Both Simpson Strong-Tie and Simpson Dura-Vent products are distributed to home centers, through wholesale distributors and to contractors and dealers. Simpson Dura-Vent also sells to OEM manufacturers.

 

The Company has developed and uses automated manufacturing processes. Its innovative manufacturing systems and techniques have allowed it to control manufacturing costs, even while developing both new products and products that meet customized requirements and specifications. The Company’s development of specialized manufacturing

 

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processes has also permitted increased operating flexibility and enhanced product design innovation. The Company has developed a quality management system that employs numerous quality-control procedures. The Company has 16 manufacturing locations in the United States, Canada, France, Denmark and England.

 

The Company is a Delaware corporation organized and merged with its predecessor company in 1999. The Company serves as a holding company for Simpson Strong-Tie and its subsidiaries and for Simpson Dura-Vent.

 

Industry and Market Trends

 

Based on trade periodicals, participation in trade and professional associations and communications with governmental and quasi-governmental organizations and with customers and suppliers, the Company believes that a variety of events and trends have resulted in significant developments in the markets that the Company serves. The Company’s products are designed to respond to increasing demand resulting from these trends. Some of these events and trends are discussed below.

 

Natural disasters throughout the world have focused attention on safety concerns relating to the structural integrity of homes and other buildings. The 1995 earthquake in Kobe, Japan, the 1994 earthquake in Northridge, California, the 1989 Loma Prieta earthquake in Northern California, Hurricanes Hugo in 1989 and Andrew in 1992 and a series of hurricanes in 2004 in the Southeastern United States, and other less cataclysmic natural disasters, damaged and destroyed innumerable homes and other buildings, resulting in heightened consciousness of the fragility of some of those structures.

 

In recent years, architects, engineers, model code agencies, contractors, building inspectors and legislators have continued efforts to improve structural integrity and safety of homes and other buildings in the face of disasters of various types, including seismic events, storms and fires. Based on ongoing participation in trade and professional associations and communications with governmental and quasi-governmental regulatory agencies, the Company believes that building codes are being more uniformly applied around the country and their enforcement is becoming more rigorous.

 

Recently, there has been consolidation among several of the Company’s customer groups. The industry has experienced increased complexity in home design and builders are more aggressively trying to reduce their costs. The Company has responded to these trends by marketing its products as systems, in addition to individual parts. In some cases, systems marketing is facilitated by the use of sophisticated design and specification software.

 

The requirements of the Endangered Species Act, the Federal Lands Policy Management Act and the National Forest Management Act have reduced the amount of timber available for harvest from public lands. Over the past several years, this and other factors have led to the increased use of engineered wood products. Engineered wood products, which substitute for strong, clear-grained lumber historically obtained from logging older, large-diameter trees, have been developed to conserve lumber. Engineered wood products frequently require specialized connectors. Sales of Simpson Strong-Tie’s engineered wood connector products have increased significantly over the past several years.

 

Concerns about energy conservation and air quality have led to increasing recognition of the advantages of natural gas as a heating fuel, including its clean burning characteristics. Use of natural gas for home heating has been increasing in the United States over a number of years. Simpson Dura-Vent markets a line of products designed to vent natural gas burning appliances

 

The Company continues to develop its distribution through home centers throughout the United States. The Company’s sales to home centers increased significantly in 2003 and 2004, although sales were up only slightly in the fourth quarter of 2004. See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Business Strategy

 

The Company designs, manufactures and sells products that are of high quality and performance, easy to use and cost-effective for customers. The Company provides rapid delivery of its products and prompt engineering and sales support. Based on its communications with customers, engineers, architects, contractors and other industry participants, the Company believes that its products have strong brand name recognition, and the Company seeks to continue to develop the value of its brand names through a variety of customer-driven strategies. Information

 

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provided by customers has led to the development of many of the Company’s products, and the Company expects that customer needs will continue to shape the Company’s product development, marketing and services.

 

Specification in architects’ and engineers’ plans and drawings influences which products will be used for particular purposes and therefore is key to the use of the Company’s products in construction projects. The Company encourages architects and engineers to specify the installation of the Company’s products in projects they design and supervise, and encourages acceptance of the Company’s products by construction contractors. The Company maintains frequent contacts with architects, engineers and contractors, as well as private organizations that provide information to building code officials, both to inform them regarding the quality, proper installation, capabilities and value of the Company’s products and to update them about product modifications and new products that may be useful or necessary. The Company sponsors seminars to inform architects, engineers, contractors and building officials on appropriate use and proper installation of the Company’s products. Additionally, the Company maintains relationships with home builders throughout the country to promote the use of its products.

 

The Company seeks to expand its product and distribution coverage through several channels:

 

Distributors. The Company regularly evaluates its distribution coverage and service levels provided by its distributors and from time to time modifies its distribution strategy and implements changes to address weaknesses and opportunities. The Company has various programs to evaluate distributor product mix and conducts promotions to encourage distributors to add Company products that complement the mix of product offerings in their markets.

 

Through its efforts to increase specifications by architects and engineers, and through increasing the number of products sold to particular contractors, the Company seeks to increase sales to channels that serve building contractors. The Company continuously seeks to expand the number of contractors served by each distributor through such sales efforts as demonstrations of product cost-effectiveness and information programs.

 

Home Centers. The Company intends to continue to increase penetration of the DIY markets by solicitation of home centers. The Company’s Account Managers maintain on-going contact with home centers to work with them in a broad range of areas including inventory levels, retail display maintenance, and product knowledge training. To satisfy specialized requirements of the home center market, the Company has developed extensive bar coding and merchandising aids and has devoted a portion of its research efforts to the development of DIY products.

 

Dealers. In some markets, the Company sells its products directly to lumber dealers.

 

OEM Relationships. The Company works closely with manufacturers of engineered wood products and OEMs in developing and expanding the application and sales of Simpson Strong-Tie’s engineered wood connector products and Simpson Dura-Vent’s gas, wood and pellet stove venting products. SST has relationships with several of the largest manufacturers of engineered wood products, and SDV has OEM relationships with major fireplace and stove manufacturers.

 

While the Company is expanding its established facilities outside of California to increase its presence and sales in these markets, sales of some products may relate primarily to certain regions. For example, sales of SST’s line of shearwalls, which was expanded recently with the introduction of a steel wall, are concentrated in the western region of the United States since their use is primarily intended to resist the effects of seismic forces. Since 1993, the Company has established operations in the United Kingdom, opened warehouse and distribution facilities in western Canada and the northeastern United States, purchased anchor products manufacturers in Illinois and eastern Canada and connector product manufacturers in France, Denmark, Germany and western Canada and acquired the assets of a leading manufacturer and distributor of screw fastening systems and collated screws with manufacturing and distribution operations in Tennessee and distribution in Canada, Australia and New Zealand. The European investments are intended to establish a presence in the European Community through companies with existing customer bases and through servicing U.S.-based customers operating there. The Company also distributes connector and epoxy products in Chile, Mexico, Japan, Australia, China and New Zealand. The Company intends to continue to pursue and expand operations both inside and outside of the United States (see Note 14 to the Company’s Consolidated Financial Statements).

 

A Company goal is to manufacture and warehouse its products in geographic proximity to its markets to provide availability and rapid delivery of products to customers and prompt response to customer requests for specially designed products and services. With respect to the DIY and dealer markets, the Company’s strategy is to keep the customer’s retail stores continuously stocked with adequate supplies of the full line of the Company’s products that

 

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those stores carry. The Company manages its inventory to help assure continuous product availability. Most customer orders are filled within a few days. High levels of manufacturing automation and flexibility allow the Company to maintain its quality standards while continuing to provide prompt delivery.

 

The Company’s product research and development is based largely on needs that customers communicate to the Company. The Company typically has developed 10 to 20 new products annually (some of which may be produced in a range of sizes). The Company’s strategy is to develop new products on a proprietary basis, to patent them when appropriate and to seek trade secret protection for others.

 

The Company’s long-term strategy is to develop, acquire or invest in product lines or businesses that (a) complement the Company’s existing product lines, (b) can be marketed through its existing distribution channels, (c) might benefit from use of the Simpson Strong-Tie and Simpson Dura-Vent brand names, (d) are responsive to needs of the Company’s customers and (e) expand its markets geographically.

 

Simpson Strong-Tie

 

Overview

 

Connectors produced by Simpson Strong-Tie typically are steel devices that are used to strengthen, support and connect joints in residential and commercial construction and DIY projects. These products enhance the safety and durability of the structures in which they are installed and can save time and labor costs for the contractor. SST’s connector products increase structural integrity and improve structural resistance to seismic, wind and other forces. Applications range from building framing to deck construction to DIY projects. SST produces and markets over 5,000 standard and custom products.

 

In the United States, connector usage developed faster in the West than elsewhere due to the low cost and abundance of timber and to local construction practices. Increasingly, the market has been influenced both by a growing awareness that the devastation caused by seismic, wind and other disasters can be reduced through improved building codes and construction practices and by environmental concerns that contribute to the increasing cost and reduced availability of wood. Most Simpson Strong-Tie products are listed by recognized building standards agencies as complying with model building codes and are specified by architects and engineers for use in projects they are designing or supervising. The engineered wood products industry continues to develop in response to concerns about the availability of wood, and the Company believes that SST is the leading supplier of connectors for use with engineered wood products.

 

Metal connectors, anchors and fasteners will corrode and lose load carrying capacity when installed in corrosive environments or exposed to corrosive materials. There are many environments and materials that may cause corrosion, including ocean salt air, fire retardants, preservative-treated wood, dissimilar metals, fumes and fertilizers. The variables present in a single building environment make it impossible accurately to predict if, or when, significant corrosion will begin or reach a critical level. This relative uncertainty makes it crucial that the specifiers be knowledgeable of the potential risks and select a product coating or metal that is suitable for the intended use. Changes in the preservative-treated wood industry have created additional concerns. Effective December 31, 2003, the preservative-treated wood industry voluntarily transitioned from Chromated Copper Arsenate (“CCA-C”) used in residential applications to alternative treatments. Testing has shown that certain alternative replacement treatments are generally more corrosive than CCA-C. SST publishes technical bulletins on subjects such as this and others that affect the installation and use of its products and makes its technical bulletins available on its website at www.strongtie.com.

 

Products

 

Simpson Strong-Tie is a recognized brand name in the markets it serves. SST manufactures and markets products that strengthen the three types of connections typically found in residential and commercial construction:  wood-to-wood, wood-to-concrete and wood-to-masonry. The Company’s connector products, including its pre-fabricated shearwalls, are installed on the continuous load path from the foundation to the roof system. SST also markets specialty screws and nails for proper installation of certain of its connector products. These products have seismic, retrofit and remodeling applications for both new construction and DIY markets. Through its Anchor Systems product line, SST also offers a full line of adhesives, mechanical anchors and powder actuated tools for numerous anchoring applications in concrete, masonry and steel. With the addition of the Quik Drive product line, SST now also offers screw fastening systems and collated screws for various construction applications.

 

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Most of Simpson Strong-Tie’s products are listed by recognized model building code agencies. To achieve such listings, SST conducts extensive product testing, which is witnessed and certified by independent testing engineers. The tests also provide the basis for publication of load ratings for SST structural connectors, and this information is used by architects, engineers, contractors and homeowners. The information is useful across the range of applications of SST’s products, from the deck constructed by a homeowner to a multi-story structure designed by an architect or engineer in an earthquake zone.

 

Simpson Strong-Tie also manufactures connector products specifically designed for use with engineered wood products, such as wood I-joists. With increased timber costs and reduced availability of trees suitable for making traditional solid sawn lumber, construction with engineered wood products has increased substantially in the last several years. Over the same period, SST’s net sales of engineered wood connectors through dealer and contractor distributors and engineered wood product manufacturers have also increased significantly.

 

New Product Development

 

Simpson Strong-Tie commits substantial resources to engineering and new product development and the majority of its products have been developed through SST’s internal research and development program. SST typically has developed 10 to 20 new products each year. SST’s research and development expense for the three years ended December 31, 2004, 2003 and 2002, was $3,966,000, $3,599,000 and $3,199,000, respectively. In late 2002, SST completed construction of its advanced testing facility in Stockton, California, and testing of multi-story wall systems began there in 2003. As part of the new product development process, SST engineers, in cooperation with sales and marketing staff, meet regularly with architects, engineers, building inspectors, code officials and customers. Several new products derived from existing product lines are developed annually. SST developed and introduced a line of pre-fabricated steel shearwall products primarily for the new construction market and a new line of collated fasteners and fastener tools. SST also has expanded its line of chemical and mechanical anchor products and powder actuated tools. The Company believes that existing distribution channels are receptive to product line extensions, thereby enhancing SST’s ability to enter new markets.

 

Sales and Marketing

 

Simpson Strong-Tie’s sales and marketing programs are implemented through SST’s branch system. SST currently maintains branches in Northern and Southern California, Texas, Ohio, Canada, England, France and Denmark. Each branch is served by its own sales force, as well as manufacturing, warehouse and office facilities. Each branch is responsible for a broad geographic area. Branch managers have significant autonomy in managing their operations. Each is responsible for setting and executing sales and marketing strategies that are consistent with the markets that the branch serves and the goals of the Company. Each domestic branch is an independent profit center with cash profit sharing bonus and stock option programs based on its own performance. At the same time, the domestic branches closely integrate their manufacturing activities to enhance product availability. Branch sales forces in the U.S. are supported by marketing managers in the home office in Dublin, California. The home office also functions to coordinate issues effecting customers that operate in multiple regions. The sales force maintains close working relationships with customers, develops new business, calls on architects, engineers and building officials and participates in a range of educational seminars.

 

Simpson Strong-Tie sells its products through an extensive distribution system comprising dealer distributors supplying thousands of retail locations nationwide, contractor distributors, home centers, lumber dealers, manufacturers of engineered wood products, and specialized contractors such as roof framers. In recent years, sales to home centers have been one of the Company’s fastest growing distribution channels. A large part of that growth was sales to The Home Depot, which acquired White Cap Construction Supply, Inc., a contractor distributor, in 2004. Sales to The Home Depot exceeded 10% of the Company’s consolidated net sales in each of the last three years (see Note 14 to the Company’s Consolidated Financial Statements and “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations”). The loss of this customer would have a material adverse effect on the Company. SST’s DIY and dealer products are used to build projects such as decks, patio covers and garage and organization systems.

 

Simpson Strong-Tie dedicates substantial resources to customer service. SST produces numerous publications and point-of-sale marketing aids to serve specifiers, distributors, retailers and users for the various markets that it serves. These publications include general catalogs, as well as various specific catalogs, such as those for its Anchor System products. The catalogs and publications describe the products and provide load and installation information. SST

 

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also maintains several linked websites centered on www.strongtie.com, which include catalogs, product and technical information, code reports and other general information related to SST’s product lines and promotional programs.

 

Simpson Strong-Tie’s engineers not only design and test products, but also provide engineering support for customers. This support might range from the discussion of a load value in a catalog to testing a unique application for an existing product. SST’s sales force communicates with customers in each of its marketing channels, through its publications, seminars and frequent calls.

 

Based on its communications with customers, Simpson Strong-Tie believes that its products are essential to its customers’ businesses, and it is SST’s policy to ship products within a few days of receiving the order. Many of SST’s customers serve contractors that require rapid delivery of needed products. Home centers and dealers also require superior service, because of fluctuating demand and to serve the needs of a broad base of customers. To satisfy these requirements, SST maintains high inventory levels, has redundant manufacturing capability and some multiple dies to produce the same parts. SST also maintains information systems that provide sales and inventory control and forecasting capabilities throughout its network of factories and warehouses. SST also has special programs for contractors intended to ensure the prompt manufacture and delivery of custom products.

 

Simpson Strong-Tie believes that dealer and home center sales of SST products are significantly greater when the bins and racks at large dealer and home center locations are adequately stocked with appropriate products. Various retailers carry varying numbers of SST products and SST’s Account Managers are engaged in ongoing efforts to inform retailers about SST’s merchandising programs and the appeal of the SST brand.

 

Simpson Dura-Vent

 

Overview

 

Simpson Dura-Vent’s venting systems are used to vent gas furnaces and water heaters, gas fireplaces and stoves, wood and oil burning appliances and pellet stoves. SDV’s metal vents, chimneys and chimney liner systems exhaust the products of combustion to the exterior of the building and have been designed for ease of assembly and safe operation and to achieve a high level of performance. SDV produces and markets nearly 2,400 different venting products.

 

The clean burning characteristics of natural gas have gained public recognition, resulting in increased market share for gas appliances in the new construction and the appliance replacement markets. As a result, Simpson Dura-Vent has developed venting systems, such as Direct-Vent, to address changes in appliance technology. Fluctuations in natural gas prices, however, affect demand for gas appliances. Historically, sales of wood and pellet burning stoves, considered alternative energy sources, have increased during periods of high oil and natural gas prices and energy shortages while sales of gas burning appliances have tended to decline.

 

Simpson Dura-Vent’s objective is to expand market share in all of its distribution channels, by entering expanding markets that address energy and environmental concerns. SDV’s strategy is to capitalize on its strengths in new product development and its established distribution network and to continue its commitment to high quality and service. SDV operates manufacturing and warehouse facilities in California and Mississippi.

 

Products

 

Simpson Dura-Vent is a leading supplier of double-wall Type B Gas Vent systems, used for venting gas furnaces, water heaters, boilers and decorative gas fireplaces. SDV’s Type B Gas Vent product line features heavy-duty quality construction and a twist-lock design that provides for fast and easy job-site assembly compared to conventional snap together designs. The twist-lock design has broader applications and has been incorporated into SDV’s gas, pellet and direct vent product lines. SDV also markets a patented flexible vent connector, Dura/Connect, for use between the gas appliance flue outlet and the connection to the Type B Gas Vent installed in the ceiling. Dura/Connect offers a simple twist, bend and connect installation for water heaters and gas furnaces.

 

Consumer concerns over the rising costs of natural gas and home heating oil in 2003 and 2004 increased demand for alternative fuel appliances. This has resulted in increased demand for SDV’s all-fuel chimney and pellet vent products. The gas fireplace market has evolved into two basic types of fireplace: top-vent fireplaces that are vented with the standard Type B Gas Vent and direct-vent fireplaces that use a special double-wall venting system. SDV’s direct-vent system is designed not only to exhaust the flue products, but also to draw in outside air for combustion,

 

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an important feature in modern energy-efficient home construction. The direct-vent gas fireplace systems provide ease of installation, permitting horizontal through-the-wall venting or standard vertical through-the-roof venting. SDV has established relationships with several large manufacturers of gas stoves and gas fireplaces to supply direct-vent venting products. In 1996, SDV expanded its direct-vent product line to include both co-axial and co-linear direct vent systems for venting gas stoves and gas inserts into existing masonry chimneys or existing factory-built metal chimneys.

 

New Product Development

 

Simpson Dura-Vent has gained industry recognition by offering innovative new products that meet changing needs of customers. SDV representatives serve on industry committees concerned with issues such as new appliance standards and government regulations. SDV’s research and development expense for the three years ended December 31, 2004, 2003 and 2002, was $518,000, $464,000 and $460,000, respectively. SDV also maintains working relationships with research and development departments of major appliance manufacturers, providing prototypes for field testing and conducting tests in SDV’s testing laboratory. SDV believes that such relationships provide competitive advantages. For example, SDV introduced the first direct vent system for direct vent gas appliances. In 2003, SDV developed stainless steel flexible relining systems for masonry chimneys. These systems are used to resize and retrofit masonry chimneys to accommodate wood burning and pellet burning fireplace inserts. In 1999, SDV introduced DuraTech, a twin-walled insulated chimney system for use on wood burning stoves, fireplaces and oil fired appliances. This product line has been designed and manufactured to a new standard of excellence. It is constructed from stainless steel and incorporates blanket insulation for enhanced safety and efficiency. In 2004, SDV completed testing for a new chimney product line, Dura-Plus HTC, which is designed to meet Canadian standards for chimney systems and will be marketed in Canada beginning in 2005.

 

Sales and Marketing

 

Simpson Dura-Vent’s sales and marketing programs are implemented through company sales and marketing staff and a network of independent manufacturer’s agents. SDV markets venting systems for both gas and wood burning appliances through wholesale distributors in the United States, Canada and Australia to the HVAC (heating, ventilating and air conditioning) and PHC (plumbing, heating and cooling) contractor markets, and to fireplace specialty shop distributors. These customers sell to contractor and DIY markets. SDV also markets venting products to home center and hardware store chains. SDV has established OEM relationships with several major gas fireplace and gas stove manufacturers, which SDV believes are leaders in the direct-vent gas appliance market (see “Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations”).

 

Simpson Dura-Vent responds to technological changes occurring in the industry through new product development and has developed a reputation for quality and service to its customers. To reinforce its reputation for quality, SDV produces extensive sales support literature and advertising materials. Recognizing the difficulty that customers and users may have in understanding new, complex venting requirements, SDV publishes a venting handbook to assist contractors, building officials and retail outlets with the science of proper venting. Advertising and promotional materials have been designed to be used by distributors and their customers, as well as home centers and hardware chains.

 

To enhance its marketing effort, SDV has developed a website, www.duravent.com, that includes product descriptions, catalogs and installation instructions, as well as a direct link to SDV’s customer service and engineering departments.

 

Manufacturing Process

 

The Company has concentrated on making its manufacturing processes as efficient as possible without compromising quality or flexibility necessary to serve the needs of its customers. The Company has developed and uses automated manufacturing processes. The Company’s innovative manufacturing systems and techniques have allowed it to control manufacturing costs, even while developing both new products and products that meet customized requirements and specifications. The Company’s development of specialized manufacturing processes also has permitted increased operating flexibility and enhanced product design innovation. The Company sources some products from third party vendors, both domestically and internationally.

 

The Company is committed to helping people build safer structures economically through the design, engineering and manufacturing of structural connectors, pre-fabricated shearwalls, anchors and related products. To this end, the

 

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Company has developed a quality management system that employs numerous quality-control procedures, such as computer-generated work orders, constant review of parts as they are produced and frequent quality testing (see “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations”). Since 1996, Simpson Strong-Tie’s quality management system has been registered under ISO 9001, an internationally recognized set of quality-assurance standards. SST achieved registration under the new ISO 9001-2000 standard for its operations in North America and England in the first quarter of 2003. The Maple Ridge, B.C., and Stockton, California, locations achieved registration in 2004 and the Denmark location achieved registration in early 2005, joining 12 other locations in North America and England that were previously registered. In 2005, SST expects to achieve ISO 9001 registration for its operations in France and expects to begin the registration process for Quik Drive’s Gallatin, Tennessee facility. The Company believes that ISO registration is becoming increasingly important to U.S. companies.

 

Simpson Strong-Tie operates manufacturing and warehouse facilities in California, Texas, Ohio, Florida, Connecticut, Illinois, Washington, Tennessee, Nevada, British Columbia, Ontario, England, France, Denmark, Germany, Australia and Poland. SST also stocks its products in Scotland, Austria and Chile. Most of SST’s products are produced with a high level of automation, using progressive dies run in automatic presses making parts from coiled sheet steel at rates that often exceed 100 strokes per minute. SST estimates that it produces over one billion product pieces per year. Most of SST’s products (SKUs) are bar coded with UPC numbers for easy identification, and nearly all of the products sold to home centers are labeled with bar codes. SST has significant press capacity and has multiple dies for some of its high volume products because of the need to produce these products close to the customer and to provide backup capacity. The balance of production is accomplished through a combination of manual, blanking and numerically controlled (NC) processes which include robotic welders, lasers and turret punches. This capability allows SST to produce products with little redesign or set-up time, facilitating rapid turnaround for customers. New tooling is also highly automated. Dies are designed and produced using computer aided design (CAD) and computer aided machining (CAM) systems. CAD/CAM capability enables SST to create multiple dies rapidly and design them to high standards. The Company is constantly reviewing its product line to reduce manufacturing costs, increase automation, and take advantage of new types of materials. For example, in recent years SST has introduced multiple products made from an engineered composite plastic, the AnchorMate, the StrapMate and the Anchor Bolt Stabilizer.

 

Simpson Strong-Tie also manufactures chemical anchoring products at its facility in Addison, Illinois. The chemicals are mixed in batches and are then loaded in two-part dispensers. These dispensers mix the product on the job site since set up times are usually very short. In addition, SST purchases a number of products, primarily fasteners, powder actuated tools and accessories and certain of its mechanical anchoring products, from various sources around the world. These purchased products undergo inspections on a sample basis for conformance with ordered specifications and tolerances before being distributed.

 

Simpson Dura-Vent operates manufacturing and warehouse facilities in California and Mississippi. SDV produces component parts for venting systems using NC-controlled punch presses equipped with high-speed progressive and compound tooling. SDV’s vent pipe and elbow assembly lines are automated, to produce finished products efficiently from large coils of steel and aluminum. UPC bar coding and computer tracking systems provide SDV’s industrial engineers and production supervisors with real-time productivity tools to measure and evaluate current production rates, methods and equipment.

 

Most of the Company’s current and planned manufacturing facilities are located in geographic regions that have experienced major natural disasters, such as earthquakes, floods and hurricanes. For example, the 1989 Loma Prieta earthquake in Northern California destroyed a freeway and caused other major damage within a few miles of the Company’s facilities in San Leandro, California, and the earthquake in Northridge, California, in January 1994, destroyed several freeways and numerous buildings in the region in which the Company’s facilities in Brea are located. The Company has developed a disaster recovery plan, but it does not carry earthquake insurance on its buildings or its equipment. Other insurance that it carries is limited and not likely to be adequate to cover all of the Company’s resulting costs, business interruption and lost profits in the event of a major natural disaster in the future. If a natural disaster were to render one or more of the Company’s manufacturing facilities totally or partially unusable, whether or not covered by insurance, the Company’s business and financial condition could be materially and adversely affected.

 

9

 

Regulation

 

The design, capacity and quality of most of the Company’s products and manufacturing processes are subject to numerous and extensive regulations and standards promulgated by governmental, quasi-governmental and industry organizations. Such regulations and standards are highly technical and complex and are subject to frequent revision. The failure of the Company’s products or manufacturing processes to comply with any of such regulations and standards could impair the Company’s ability to manufacture and market its products profitably and could materially and adversely affect the Company’s business and financial condition.

 

Simpson Strong-Tie’s product lines are subject to federal, state, county, municipal and other governmental and quasi-governmental regulations that affect product design, development, testing, applications, marketing, sales, installation and use. Most SST products are recognized by building code and standards agencies. Agencies that recognize Company products include the International Code Council (ICC), the City of Los Angeles, the State of Florida, the State of Wisconsin, and the California Division of the State Architect. These and other code agencies adopt various testing and design standards and incorporate them into their related building codes. With the adoption of the International Residential Code (2000 and 2003) and the International Building Code (2000 and 2003), these standards have become more uniformly applied and are recognized throughout most of the country. SST considers code recognition to be a significant marketing tool and devotes considerable effort to obtaining and maintaining appropriate approvals for its products. SST believes that architects, engineers, contractors and other customers are less likely to purchase structural products that lack the appropriate code acceptance if code-accepted competitive products are available. SST actively participates in industry related professional associations to keep abreast of regulatory changes and to provide information to regulatory agencies.

 

Simpson Dura-Vent operates under a complex regulatory environment that includes appliance and venting performance standards related to safety, energy efficiency and air quality. Gas venting regulations are contained in the National Fuel Gas Code (“NFGC”), while safety and performance regulations for wood burning appliances and chimney systems are contained in a National Fire Protection Association standard (“NFPA 211”). Standards for testing gas vents and chimneys are developed by testing laboratories such as Underwriter’s Laboratories (“UL”) in compliance with the American National Standards Institute. Clean air standards for both gas and wood burning appliances are regulated by the Environmental Protection Agency (“EPA”). Energy efficiency standards are regulated by the Department of Energy (“DOE”) under the authority of the National Appliance Energy Conservation Act. Under this act, the DOE periodically reviews the necessity for increased efficiency standards with respect to gas furnaces and gas water heaters. A substantial percentage of SDV’s Type B Gas Vent sales are for gas furnaces and gas water heaters. Minimum appliance efficiency standards are being considered that could negatively affect sales of Type B Gas Vents, which could materially and adversely affect the Company’s operating results and financial condition if the standards and regulations contained in the NFGC and NFPA 211 are ultimately adopted by national building code organizations such as International Code Council (ICC). In turn, the various building codes could be adopted by local municipalities, resulting in enforcement through the building permit process. Safety, air quality and energy efficiency requirements are enforced by local air quality districts and municipalities by requiring proper UL, EPA and DOE labels on appliances and venting systems.

 

Competition

 

The Company faces a variety of competition in all of the markets in which it participates. This competition ranges from subsidiaries of large national or international corporations to small regional manufacturers. While price is an important factor, the Company competes on the basis of quality, breadth of product line, technical support, service, field support and product innovation. As a result of differences in structural design and building practices and codes, Simpson Strong-Tie’s markets tend to differ by region. Within these regions, SST competes with companies of varying size, several of which also distribute their products nationally.

 

The venting industry is highly competitive. SDV’s competitors include a variety of manufacturers that have operations in USA, Canada and Mexico. Most of its competitors don’t compete in all of SDV’s product lines, and some have additional product lines which SDV does not offer. SDV competes on the basis of quality, service, breadth of product line, technical support, and product innovation.

 

Raw Materials

 

The principal raw material used by the Company is steel, including stainless steel, and is generally ordered to specific American Society of Testing and Materials (“ASTM”) standards.  SST also uses materials such

 

10

 

as epoxies and acrylics in the manufacture of it chemical anchoring products. Raw materials such as aluminum, aluminum alloys and ceramic and other insulation materials, are used by Simpson Dura-Vent, and cartons, which are used by both SST and SDV. The Company purchases raw materials from a variety of commercial sources. The Company’s practice is to seek cost savings and enhanced quality by purchasing from a limited number of suppliers.

 

The steel industry is highly cyclical and prices for the Company’s raw materials are influenced by numerous factors beyond the Company’s control, including general economic conditions, competition, labor costs, import duties and other trade restrictions. Steel prices rose in the latter half of 2003 and in 2004. Steel prices may have reached a temporary plateau at their current level but may go higher in the future. Several factors have contributed to these price increases. The domestic market continues to be heavily influenced by three major U.S. manufacturers. The world market for steel continues to be strong and the value of the dollar remains low. All of these factors could have an adverse effect on the Company’s cost and availability of steel in 2005. The Company might not be able to increase its product prices to correspond to increases in raw materials prices without materially and adversely affecting its sales and profits. See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The Company historically has not attempted to hedge against changes in prices of steel or other raw materials.

 

Patents and Proprietary Rights

 

The Company’s subsidiaries have U.S. and foreign patents, the majority of which cover products that they currently manufacture and market. These patents, and applications for new patents, cover various design aspects of the subsidiaries’ products, as well as processes used in their manufacture. The Company’s subsidiaries are continuing to develop new potentially patentable products, product enhancements and product designs. Although the Company’s subsidiaries do not intend to apply for additional foreign patents covering existing products, the Company has developed an international patent program to protect new products that its subsidiaries may develop.

 

The Company’s ability to compete effectively with other companies depends in part on its ability to maintain the proprietary nature of its technology. There can be no assurance, however, as to the degree of protection afforded by these patents or the likelihood that patents will be issued pursuant to pending patent applications. Furthermore, there can be no assurance that others will not independently develop the same or similar technology, develop around the patented aspects of any of the Company’s products or proposed products, or otherwise obtain access to the Company’s proprietary technology.

 

In addition to seeking patent protection, the Company relies on unpatented proprietary technology to maintain its competitive position. Nevertheless, there can be no assurance that the Company will be able to protect its know-how or other proprietary information.

 

In attempting to protect its proprietary information, the Company expects that it may sometimes be necessary to initiate lawsuits against competitors and others that the Company believes have infringed or are infringing the Company’s rights. In such an event, the defendant may assert counterclaims to complicate or delay the litigation or for other reasons. If the Company were to be unable to maintain the proprietary nature of its significant products, the Company’s business and financial condition could be materially and adversely affected.

 

Acquisitions and Expansion into New Markets

 

The Company’s future growth, if any, may depend to some extent on its ability to penetrate new markets, both domestically and internationally. See “Industry and Market Trends” and “Business Strategy.” Therefore, the Company may in the future pursue acquisitions of product lines or businesses. Acquisitions involve numerous risks, including difficulties in the assimilation of the operations and products of the acquired companies, the diversion of management’s attention from other business concerns, risks of entering markets in which the Company has little or no direct prior experience, and the potential loss of key employees of the acquired company. In addition, future acquisitions by the Company may result in potentially dilutive issuances of equity securities, the incurring of additional debt, and impairment and amortization expenses related to goodwill and other intangible assets, all of which could adversely affect the Company’s profitability. If an acquisition occurs, no assurance can be given as to its effect on the Company’s business or operating results. See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Construction customs, standards, techniques and methods in international markets differ from those in the United States. Laws and regulations applicable in new markets for the Company may be unfamiliar to the Company and

 

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compliance may be substantially more costly than the Company anticipates. As a result, it may become necessary for the Company to redesign products or to invent or design new products in order to compete effectively and profitably outside the United States or in markets that are new to the Company in the United States. The Company expects that significant time will be required for it to generate substantial sales or profits in new markets.

 

Other significant challenges to conducting business in foreign countries include, among other factors, local acceptance of the Company’s products, political instability, currency controls, changes in import and export regulations, changes in tariff and freight rates, and fluctuations in foreign exchange rates. There can be no assurance that the Company will be able to penetrate these markets or that any such market penetration can be achieved on a timely basis or profitably. If the Company is not successful in penetrating these markets within a reasonable time, it will be unable to recoup part or all of the significant investments it will have made in attempting to do so. See “Business Strategy” and “Industry and Market Trends.”

 

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 purchase price, including post-closing adjustments, of the acquisition was approximately $32.0 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). In April 2004, the Company’s Danish subsidiary acquired 100% of the shares of ATF Furrer Holz GmbH (“ATF”), in Switzerland, for approximately $0.6 million. ATF distributes a line of hidden connectors in some European countries. In May 2003, Simpson Strong-Tie Canada Limited, a subsidiary of the Company, purchased MGA Construction Hardware & Steel Fabricating Limited and MGA Connectors Limited (collectively, “MGA”), for approximately $9.8 million in cash. MGA manufactures and distributes throughout Canada and portions of the United States a quality line of connectors used in construction.

 

Seasonality and Cyclicality

 

The Company’s sales are seasonal, with operating results varying from quarter to quarter. With some exceptions, the Company’s sales and income have historically been lower in the first and fourth quarters and higher in the second and third quarters of the year, as retailers and contractors purchase construction materials in the late spring and summer months for the construction season. In addition, demand for the Company’s products and the Company’s results of operations are significantly affected by weather conditions, such as unseasonably warm, cold or wet weather, which affect, and sometimes delay or accelerate, installation of certain of the Company’s products. Political and economic events can also affect the Company’s revenues. The Company has little control over the timing of customer purchases, and sales anticipated in one quarter may occur in another quarter, thereby affecting both quarters’ results. In addition, the Company incurs significant expenses as it develops, produces and markets its products in anticipation of future orders. Because the Company maintains high inventory levels, products typically are shipped as orders are received, and accordingly the Company generally operates with little backlog. As a result, net sales in any quarter generally depend on orders booked and shipped in that quarter. A significant portion of the Company’s operating expenses are fixed, and planned expenditures are based primarily on sales forecasts. If sales fall below the Company’s expectations, operating results would be adversely affected for the relevant quarters, as expenses based on those expectations will already have been incurred. See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

The Company’s principal markets are in the building construction industry. That industry is subject to significant volatility as a result of fluctuations in interest rates, the availability of credit to builders and developers, inflation rates, weather and other factors and trends, none of which is within the Company’s control. Declines in commercial and residential construction may be expected to reduce the demand for the Company’s products. The Company cannot provide any assurance that its business will not be adversely affected by future negative economic or construction industry performance or that future declines in construction activity or the demand for the Company’s products will not have material adverse effects on the Company and its business and financial condition. See “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Product Liability

 

The Company designs and manufactures most of its standard products and expects that it will continue to do so. The Company employs engineers and designers to design and test its products under development. In addition, the Company maintains a quality control system. The Company has on occasion found manufacturing flaws in its

 

12

 

products. In addition, the Company purchases from third party suppliers raw materials, principally steel, and finished goods that are produced and processed by other manufacturers. The Company also has on occasion found flaws in raw materials and finished goods produced by others. Some flaws have not become apparent until after the products were installed by customers. Many of the Company’s products are integral to the structural soundness or fire safety of the structures in which they are used. As a result, if any flaws exist in the Company’s products (as a result of design, raw material or manufacturing flaws or lapses in product quality control) and such flaws are not discovered and corrected before the Company’s products are incorporated into structures, the structures could suffer severe damage (such as collapse or fire) and personal injury could result. To the extent that such damage or injury is not covered by the Company’s product liability insurance, and if the Company were to be found to have been negligent or otherwise culpable, the Company and its business and financial condition could be materially and adversely affected by the necessity to correct such damage and to compensate persons who might have suffered injury. Furthermore, in the event that a flaw is discovered after installation but before any damage or injury occurs, it may be necessary for the Company to recall products, and the Company may be liable for any costs necessary to retrofit the affected structures. Any such recall or retrofit could entail substantial costs and adversely affect the Company’s reputation, sales and financial condition. The Company does not carry insurance against recall costs, and its product liability insurance may not cover retrofit costs.

 

No assurance can be given that claims will not be made against the Company with regard to damage or destruction of structures incorporating Company products resulting from a natural disaster. Any such claims, if asserted, could materially and adversely affect the Company.

 

Environmental, Health and Safety Matters

 

The Company is subject to environmental laws and regulations governing emissions into the air, discharges into water, and generation, handling, storage, transportation, treatment and disposal of waste materials. The Company is also subject to other federal and state laws and regulations regarding health and safety matters. The Company’s manufacturing operations involve the use of solvents, chemicals, oils and other materials that are regarded as hazardous or toxic and the use of complex and heavy machinery and equipment that can pose severe safety hazards (especially if not properly and carefully used). Some of the Company’s products also incorporate materials that are hazardous or toxic in some forms, such as zinc and lead, which are used in some steel galvanizing processes, explosives, such as the gun powder used in its powder actuated tools, and certain of the chemicals used in the manufacture of SST’s acrylic and epoxy anchoring products. The Company believes that it has obtained all material licenses and permits required by environmental, health and safety laws and regulations in connection with the Company’s operations and that its policies and procedures comply in all material respects with existing environmental, health and safety laws and regulations. It is possible that additional licenses or permits may be required, that the Company’s policies and procedures might not comply in all respects with all such laws and regulations or, even if they do, that employees might fail or neglect to follow them in all respects, and that the Company’s generation, handling, use, storage, transportation, treatment or disposal of hazardous or toxic materials, machinery and equipment might cause injury to persons or to the environment. In addition, properties occupied by the Company may be contaminated by hazardous or toxic substances and remedial action may be required at some time in the future. It is also possible that materials in certain of the Company’s products could cause injury or sickness. Relevant laws and regulations could also be changed or new ones could be adopted that require the Company to obtain additional licenses and permits and cause the Company to incur substantial expense. Any such event or contamination could have a material adverse effect on the Company and its liquidity, results of operations and financial condition. See “Regulation.”

 

Employees and Labor Relations

 

As of January 1, 2005, the Company had 2,609 full-time employees, of whom 1,756 were hourly employees and 853 were salaried employees. The Company believes that its overall compensation and benefits for the most part exceed industry averages and that its relations with its employees are good.

 

The Company is dependent on certain key management and technical personnel, including Thomas J Fitzmyers, Michael J. Herbert, Stephen B. Lamson, Barclay Simpson and Stephen P. Eberhard. The loss of one or more key employees could have a material adverse effect on the Company. The Company’s success will also depend on its ability to attract and retain additional highly qualified technical, marketing and management personnel necessary for the maintenance and expansion of the Company’s activities. The Company faces strong competition for such personnel and there can be no assurance that the Company will be able to attract or retain such personnel.

 

13

 

A significant number of the employees at three of the Company’s manufacturing facilities are represented by labor unions and are covered by collective bargaining agreements. Two of the Company’s collective bargaining agreements cover the Company’s sheetmetal and maintenance workers and its tool and die craftsmen in Brea. These two contracts expire in June 2007 and February 2008, respectively. Two other contracts, covering tool and die personnel and sheetmetal workers in San Leandro, expire in June 2007. Simpson Strong-Tie’s Stockton, California, facility is also a union facility. The collective bargaining agreements at this facility expire in September 2007. A work stoppage or interruption by a significant number of the Company’s employees could have a material and adverse effect on the Company and its business and financial condition.

 

Available Information

 

The SEC also maintains an internet site (hrrp://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The Company makes available, free of charge, copies of its recent annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, corporate governance guidelines and code of ethics and the charters of the Audit, Compensation, and Governance and Nominating Committees of its Board of Directors on its website at www.simpsonmfg.com. Printed copies of any of these materials will be provided on request.

14

 

Item 2. Properties.

 

The Company maintains its home office in Dublin, California, and other offices and manufacturing and warehouse facilities elsewhere in California and in Texas, Ohio, Florida, Mississippi, Illinois, Connecticut, Washington, Nevada, Tennessee, Australia, British Columbia, Ontario, England, Scotland, France, Denmark, Germany, Austria and Poland. As of March 1, 2005, the Company’s facilities were as follows:

 

Location		Approximate Square Footage		Owned or Leased		Lessee		Lease Expires		Function
Dublin, California		35,400		Leased		Company		2007		Office
Stockton, California		436,000		Owned						Office, Manufacturing and Warehouse
Stockton, California		25,000		Owned						Research and Development
San Leandro, California		47,100		Owned						Office, Manufacturing and Warehouse
San Leandro, California		71,000		Owned						Office, Manufacturing and Warehouse
San Leandro, California		57,000		Leased	(1)	SST		2009		Manufacturing and Warehouse
San Leandro, California		48,000		Owned						Office and Warehouse
San Leandro, California		27,000		Owned						Manufacturing and Warehouse
Brea, California		50,700		Owned						Office, Manufacturing and Warehouse
Brea, California		78,000		Owned						Office and Warehouse
Brea, California		30,500		Owned						Office, Manufacturing and Warehouse
Brea, California		42,900		Owned						Warehouse
Brea, California		19,200		Owned						Warehouse
Brea, California		20,000		Owned						Warehouse
McKinney, Texas		317,000		Owned						Office, Manufacturing and Warehouse
McKinney, Texas		84,300		Owned						Office, Manufacturing and Warehouse
McKinney, Texas		117,100		Owned						Office and Warehouse
Columbus, Ohio		153,500		Leased	(2)	SST		2005		Office, Manufacturing and Warehouse
Jacksonville, Florida		112,000		Leased		SST		2011		Office and Warehouse
Addison, Illinois		52,400		Leased		SST		2008		Office, Manufacturing and Warehouse
Enfield, Connecticut		55,100		Leased		SST		2008		Office and Warehouse
Kent, Washington		24,000		Leased		SST		2009		Office, Manufacturing and Warehouse
Visalia, California		92,000		Owned						Office, Manufacturing and Warehouse
Tamworth, England		78,100		Leased		SST	(3)	2012		Office, Manufacturing and Warehouse
Glasgow, Scotland		5,000		Leased		SST	(3)	2004		Warehouse
Vacaville, California		125,000		Leased	(4)	SDV		2007		Office, Manufacturing and Warehouse
Vacaville, California		120,300		Owned						Office, Manufacturing and Warehouse
Vicksburg, Mississippi		302,000		Owned						Office, Manufacturing and Warehouse
Fontana, California		17,900		Leased		SDV		2005		Warehouse

 

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Location		Approximate Square Footage		Owned or Leased		Lessee		Lease Expires		Function
Gallatin, Tennessee		48,000		Leased		SST		2009		Office, Manufacturing and Warehouse
Las Vegas, Nevada		6,300		Leased		SST		2007		Warehouse
Vaughan, Ontario		4,500		Leased		SST	(5)	2007		Warehouse
Maple Ridge, British Columbia		36,400		Leased		SST	(5)	2007		Office, Manufacturing and Warehouse
Maple Ridge, British Columbia		2,300		Leased		SST	(5)	2005		Warehouse
Maple Ridge, British Columbia		2,400		Leased		SST	(5)	2005		Warehouse
Langley, British Columbia		19,700		Leased		SST	(5)	2010		Warehouse
Brampton, Ontario		158,000		Leased		SST	(5)	2009		Office, Manufacturing and Warehouse
Odder, Denmark		162,500		Owned						Office, Manufacturing and Warehouse
Syke, Germany		10,300		Owned						Office and Warehouse
Warsaw, Poland		8,300		Leased		SST	(6)	2004		Office and Warehouse
Grossebersdorf, Austria		5,100		Leased		SST	(6)	2006		Office and Warehouse
St. Gemme La Plaine, France		99,000		Owned						Office, Manufacturing and Warehouse
Blacktown, NSW, Australia		3,800		Leased		SST	(7)	2005		Warehouse

 

(1)                      Lessor is Doolittle Investors, a related party. See Note 9 to the Consolidated Financial Statements contained elsewhere herein.

 

(2)                      Lessor is Columbus Westbelt Investment Company, a related party. See Note 9 to the Consolidated Financial Statements contained elsewhere herein. The Company has entered into an agreement to purchase the facility. The purchase price is approximately $4.1 million and the transaction is expected to be completed in May 2005.

 

(3)                      Lessee is Simpson Strong-Tie International, Inc., a wholly-owned subsidiary of SST.

 

(4)                      Lessor is Vacaville Investors, a related party. See Note 9 to the Consolidated Financial Statements contained elsewhere herein.

 

(5)                      Lessee is Simpson Strong-Tie Canada, Ltd., a wholly-owned subsidiary of SST.

 

(6)                      Lessee is Simpson Strong-Tie Sp.z.o.o., a wholly-owned subsidiary of SST.

 

(7)                      Lessee is Quik Drive Australia Pty. Ltd., a wholly-owned subsidiary of SST.

 

The Company’s manufacturing facilities are equipped with specialized equipment and use extensive automation. The Company considers its existing and planned facilities to be suitable and adequate for its operations as currently conducted and as planned through 2005. The manufacturing facilities currently are being operated with one full shift and at most plants with at least a partial second or third shift. The Company anticipates that it may require additional facilities to accommodate possible future growth.

 

The Company plans to expand its facility in Columbus, Ohio, on land adjacent to the current facility. Construction is scheduled to begin in March 2005 and is expected to cost approximately $14.6 million.

 

In February 2005, the Company signed a letter of intent to purchase two buildings in Pleasanton, California, for approximately $9.6 million. The buildings comprise approximately 89,000 square feet and will be used for the Company’s home office, replacing the facility that the Company currently leases in Dublin, California. The Company is currently in the process of due diligence and if that is satisfactorily completed, the transaction is expected to close in August 2005. If this transaction is completed, the Company expects to move in to the new building and vacate its leased property in Dublin, California, in mid-2006. The Company has not finalized its plans at this time, but

 

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anticipates a one-time charge to income in 2005 for the remaining lease payments at the Dublin facility and a noncash charge in 2005 for the unamortized leasehold improvements related to the Dublin facility, which it estimates will total approximately $1.6 million.

 

Item 3. Legal Proceedings.

 

From time to time, the Company is involved in litigation that it considers to be in the normal course of its business. No such litigation within the last five years resulted in any material loss. The Company is not engaged in any legal proceedings as of the date hereof, which the Company expects individually or in the aggregate to have a material adverse effect on the Company’s financial condition, cash flows or results of operations.

 

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

 

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

 

PART II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

The Company’s common stock is listed on the New York Stock Exchange (“NYSE”) under the symbol “SSD.” In November 2004, the Company completed a 2-for-1 stock split, effected in the form of a stock dividend, of its common stock. In August 2002 the Company completed a 2-for-1 split of its common stock. All of the share and per share numbers have been adjusted to reflect these stock splits. The following table shows the range of high and low closing sale prices per share of the common stock as reported by the NYSE and dividends paid per share of common stock for the calendar quarters indicated:

 

 

The Company estimates that as of March 7, 2005, approximately 10,195 persons owned shares of the Company’s common stock either directly or through nominees.

 

In January 2005, the Company’s Board of Directors declared a dividend of $0.05 per share to be paid on April 26, 2005, to stockholders of record on April 6, 2005. The Company currently intends to continue paying dividends quarterly. The Company began declaring quarterly dividends of $0.05 per common share in January 2004. Future dividends, if any, will be determined by the Company’s Board of Directors, based on the Company’s earnings, cash flow, financial condition and other factors deemed relevant by the Board of Directors. In addition, existing loan agreements require the Company to maintain tangible net worth of $250.0 million plus 50% of net profit after taxes for each fiscal year. This requirement may limit the amount that the Company may pay out as dividends on the common stock. As of December 31, 2004, the Company had approximately $115.2 million available for the payment of dividends under these loan agreements.

 

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In December 2004, the Board of Directors authorized the Company to repurchase up to $50.0 million of the Company’s common stock. The authorization will remain in effect through the end of 2005. This replaces the $50.0 million repurchase authorization from December 2003. During 2004, the Company purchased 1,150,854 shares of its common stock for approximately $31.3 million under the 2003 authorization. In November 2003, the Company repurchased 1,000,000 shares of its common stock for $23.53 per share from the Simpson PSB Fund, a related party, for approximately $23.5 million under the 2002 authorization. In December 2004, the Company retired its treasury stock with the excess over the par value of the common stock recorded against retained earnings.

 

The following table sets forth certain information as of December 31, 2004, concerning (a) all equity compensation plans of the Company previously approved by the stockholders and (b) all equity compensation plans of the Company not previously approved by the stockholders.

 

Plan Category		(a) Number of securities to be issued upon exercise of outstanding options, warrants & rights		(b) Weighted-average exercise price of outstanding options, warrants & rights			(c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
Equity compensation plans approved by stockholders		2,802,764	(1)	$	18.60		8,298,678
Equity compensation plans not approved by stockholders		0		N/A			80,600	(2)
Total		2,802,764		$	18.60		8,379,278

 

(1)          On January 1, 2005, and February 14, 2005, options to purchase and additional 518,550 shares and 14,000 shares, respectively, were granted under the Company’s two stock options plans.

 

(2)          As of December 31, 2004, the Company had reserved 200,000 shares of Common Stock for issuance as bonuses under its 1994 Employee Stock Bonus Plan, of which 119,400 shares were issued. On January 1, 2005, and February 1, 2005, an additional 18,800 and 200 shares, respectively, were issued under this plan.

 

In accordance with section 303A.12(a) of the New York Stock Exchange Listed Company Manual, the Company’s Chief Executive Officer submitted to the NYSE an unqualified certification. In addition, the Company filed as Exhibit 31 to its 2003 Annual Report of for 10-K, the Sarbanes-Oxley Act of 2002 Section 302 certification regarding the quality of the Company’s public disclosure.

 

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Item 6. Selected Financial Data.

 

The following table sets forth selected consolidated financial information with respect to the Company for each of the five years ended December 31, 2004, 2003, 2002, 2001 and 2000, derived from the audited Consolidated Financial Statements of the Company (for the year ended December 31, 2000, amounts have been restated for the effect of the accounting change for inventory valuation from the last-in, first-out method to the first-in, first-out method), the most recent three years of which appear elsewhere herein. During 2002, the Company adopted the Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” which requires that goodwill and certain other intangible assets having indefinite lives no longer be amortized to earnings. As of January 1, 2003, the Company commenced expensing its stock options with the adoption of SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” The presentation of the information in the tables below complies with the accounting pronouncements, but is not necessarily comparable with prior years. In November 2004, the Company completed a 2-for-1 stock split effected in the form of a stock dividend of its common stock. Also, in August 2002, the Company completed a 2-for-1 split of its common stock. All of the share and per share numbers have been adjusted to reflect these stock splits. The data presented below should be read in conjunction with the Consolidated Financial Statements and related Notes thereto and “Item 7 – Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere herein.

 

(Dollars in thousands, except per share data)		Year Ended December 31,
		2004			2003			2002			2001			2000
Statement of Operations Data:
Net sales		$	698,053		$	548,182		$	465,474		$	415,863		$	369,087
Cost of sales		417,417			329,902			276,557			257,785			225,628
Gross profit		280,636			218,280			188,917			158,078			143,459
Selling expense		58,869			49,669			44,581			42,230			37,410
General and administrative expense		90,550			70,538			58,253			50,032			44,634
Income from operations		131,217			98,073			86,083			65,816			61,415
Interest income, net		385			999			985			1,587			3,010
Income before income taxes		131,602			99,072			87,068			67,403			64,425
Provision for income taxes		50,094			38,510			35,134			27,619			26,296
Minority interest		—			—			—			(734		)	(1,246		)
Net income		$	81,508		$	60,562		$	51,934		$	40,518		$	39,375
Basic net income per share of common stock		$	1.70		$	1.23		$	1.06		$	0.84		$	0.82
Diluted net income per share of common stock		$	1.67		$	1.21		$	1.05		$	0.82		$	0.80
Cash dividends declared per share of common stock		$	0.20		$	—		$	—		$	—		$	—

 

		As of December 31,
(Dollars in thousands)		2004			2003			2002			2001			2000
Balance Sheet Data:
Working capital		$	268,711		$	269,498		$	238,277		$	194,261		$	168,008
Property, plant and equipment, net		137,609			107,226			97,397			81,410			63,823
Total assets		545,137			461,692			396,401			329,612			279,570
Long-term debt, including current portion		2,976			6,292			6,738			6,673			2,405
Total liabilities		82,212			61,388			47,217			41,495			35,134
Total stockholders’ equity		462,925			400,304			349,184			288,117			243,681

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

This document contains forward-looking statements, based on numerous assumptions and subject to risks and uncertainties. Although the Company believes that the forward-looking statements are reasonable, it does not and cannot give any assurance that its beliefs and expectations will prove to be correct. Many factors could significantly affect the Company’s operations and cause the Company’s actual results to be substantially different from the Company’s expectations. Those factors include, but are not limited to: (i) general economic and construction business conditions; (ii) customer acceptance of the Company’s products; (iii) materials and manufacturing costs; (iv) the financial condition of customers, competitors and suppliers; (v) technological developments; (vi) increased competition; (vii) changes in capital market conditions; (viii) governmental and business conditions in countries where the Company’s products are manufactured and sold; (ix) changes in trade regulations; (x) the effect of acquisition activity; (xi) changes in the Company’s plans, strategies, objectives, expectations or intentions; and (xii) other risks and uncertainties indicated from time to time in the Company’s filings with the Securities and Exchange Commission. Actual results might differ materially from results suggested by any forward-looking statements in this report. The Company does not have an obligation to publicly update any forward-looking statements, whether as a result of the receipt of new information, the occurrence of future events or otherwise.

 

The following is a discussion and analysis of the consolidated financial condition and results of operations for the Company for the years ended December 31, 2004, 2003 and 2002, and of certain factors that may affect the Company’s prospective financial condition and results of operations. The following should be read in conjunction with the Consolidated Financial Statements and related Notes appearing elsewhere herein.

 

Overview

 

The Company’s net sales increased to $698.1 million in 2004 from $465.5 million in 2002. The increase in net sales resulted primarily from increased geographic distribution and a broadening of the Company’s customer base and product lines, both internally and through acquisitions. Net sales increased in 2004 from 2002 in all regions of the United States, with above average rates of growth in the Southeastern portion of the country. In recent years, home centers have been one of the Company’s fastest growing distribution channels. In this channel, the company’s largest customer, The Home Depot, which acquired White Cap Construction Supply, Inc. in 2004, exceeded 10% of the Company’s consolidated net sales in each of the last three years (see Note 14 to the Company’s Consolidated Financial Statements and “Item 1. Business. Simpson Strong-tie, Sales and Marketing”). Expansion into overseas markets also contributed to the net sales growth over the last three years. Sales outside of the U.S. have increased significantly, due in large part to the acquisition of BMF Bygningsbeslag A/S (“BMF”) in January 2001 and to the acquisition of MGA Construction Hardware & Steel Fabricating Limited and MGA Connectors Limited (collectively, “MGA”) in May 2003. Gross profit margin decreased to 40.2% in 2004 from 40.6% in 2002, primarily due to material costs, mainly steel, prices of which had continued to increase through 2003 and into 2004 (see “Item 1. Business. Raw Materials”) though gross margins in 2004 improved slightly as compared to 2003.

 

Results of Operations

 

The following table sets forth, for the years indicated, the percentage of net sales of certain items in the Company’s Consolidated Statements of Operations.

 

		Years Ended December 31,
		2004		2003		2002
Net sales		100.0	%	100.0	%	100.0	%
Cost of sales		59.8	%	60.2	%	59.4	%
Gross profit		40.2	%	39.8	%	40.6	%
Selling expense		8.4	%	9.1	%	9.6	%
General and administrative expense		13.0	%	12.9	%	12.5	%
Income from operations		18.8	%	17.8	%	18.5	%
Interest income, net		0.1	%	0.2	%	0.2	%
Income before income taxes		18.9	%	18.0	%	18.7	%
Provision for income taxes		7.2	%	7.0	%	7.5	%
Net income		11.7	%	11.0	%	11.2	%

 

In November 2004, the Company completed a 2-for-1 stock split effected in the form of a stock dividend of its common stock. Also, in August 2002, the Company completed a 2-for-1 split of its common stock. All of the share and per share numbers have been adjusted to reflect these stock splits.

 

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In December 2004, the Board of Directors authorized the Company to repurchase up to $50.0 million of the Company’s common stock. The authorization will remain in effect through the end of 2005. This replaces the $50.0 million repurchase authorization from December 2003. During 2003, the Company purchased 1,000,000 shares of its common stock for approximately $23.5 from the Simpson PSB Fund, a related party (see Note 12). During 2004, the Company purchased 1,150,854 shares of its common stock for approximately $31.3 million under the 2003 authorization.

 

Comparison of the Years Ended December 31, 2004 and 2003

 

Net Sales

 

In 2004, net sales increased 27.3% to $698.1 million as compared to net sales of $548.2 million in 2003. Net sales of Simpson Strong-Tie’s products increased 29.8% to $614.6 million in 2004 from $473.6 million in 2003, while net sales of Simpson Dura-Vent’s products increased 11.9% to $83.5 million in 2004 from $74.6 million in 2003. SDV accounted for approximately 12.0% of the Company’s total net sales in 2004, a decrease from 13.6% in 2003. The increase in net sales at SST resulted primarily from an increase in sales volume, with approximately 7% of the increase resulting from an increase in average prices. The increase in net sales at SDV resulted primarily from an increase in sales volume, with approximately 4% of the increase resulting from an increase in average prices. The majority of the Company’s sales growth occurred domestically, although sales in Europe and Canada grew at a faster rate than domestic sales. 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 pellet vent, chimney and gas vent products increased compared to 2003, while sales of its Direct-Vent products were flat.

 

Gross Profit

 

Gross profit increased 28.6% to $280.6 million in 2004 from $218.3 million in 2003. As a percentage of net sales, gross profit increased to 40.2% in 2004 from 39.8% in 2003. This increase in gross margins 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 2004.

 

The Company continues to face uncertainty in the cost and availability of steel. Several factors are contributing to this uncertainty. Demand, particularly from China, is still very high and weakness in the U.S. dollar has discouraged foreign steel mills from supplying the U.S. market, despite the lifting of tariffs on certain types of imported steel. In addition, major domestic integrated steel producers have consolidated over the last several years. To mitigate the effect of the rising steel prices and to avoid possible shortages in supply, the Company purchased additional steel at the end of 2003 and in 2004. In addition, the Company had two sales price increases in 2004, and another in January 2005, to offset the rising cost of steel. The Company might not be able to increase its product prices further to correspond to increases in raw materials prices without materially and adversely affecting its sales and profits.

 

Selling Expense

 

Selling expenses increased 18.5% to $58.9 million in 2004 from $49.7 million in 2003, primarily due to increased costs associated with the addition of sales personnel, including those related to the acquisition of MGA and the acquisition in October 2004 of Quik Drive, as well as increased cost associated with promotional activities totaling approximately $5.1 million.

 

General and Administrative Expense

 

General and administrative expenses increased 28.4% to $90.5 million in 2004 from $70.5 million in 2003, but increased only slightly as a percentage of net sales to 13.0% in 2004 from 12.9% in 2003. This increase was primarily due to increased cash profit sharing of approximately $10.3 million as a result of higher operating income, the recognition of stock compensation expenses of approximately $3.2 million, primarily related to stock option expenses recognized in accordance with SFAS No. 123, “Accounting for Stock Based Compensation,” the cost of additional administrative employees of approximately $2.2 million, including those related to the acquisitions of MGA and Quik Drive, and increases in legal and professional services of approximately $2.5 million. The Company believes that the pre-tax stock option expense for 2005 will be approximately $5.7 million related to stock options granted during 2003, 2004 and 2005. In addition, in the first quarter of 2004, the Company donated $0.5 million to a

 

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university in central California to help fund construction of a building to be used for the research and development of innovative construction practices. The Company believes that the after-tax effect of stock option expenses in 2005 will be approximately $3.4 million related to stock options granted during 2003, 2004 and 2005.

 

Interest Income and Expense

 

Interest income is generated on the Company’s cash and short-term investment balances. Interest income was lower in 2004 than in 2003 primarily as a result of decreased cash balances. Interest expense includes debt service and maintenance fees and bank charges.

 

Provision for Income Taxes

 

The Company’s effective tax rate was 38.1% in 2004, down from 38.9% in 2003. The decrease was primarily due to tax credits for research and development and manufacturing investment in an enterprise zone related to the expansion of the Company’s facilities in Stockton, California. The effective tax rates exceeded the federal statutory rate of 35.0% primarily due to the effect of state income taxes, net of the federal benefit.

 

European Operations

 

For its European operations, the Company recorded after-tax net income of $1.5 million in 2004 compared to after-tax net loss of $0.5 million in 2003. The Company’s UK operations recorded a small net loss of $0.1 million in 2004 compared to a net loss of $1.4 million in 2003. The goodwill associated with operations there, carried on the balance sheet at approximately $5.1 million, could be partially or fully impaired if the losses continue. The Company’s operations elsewhere in Europe were profitable for the year.

 

Comparison of the Years Ended December 31, 2003 and 2002

 

Net Sales

 

Net sales increased 17.8% to $548.2 million in 2003 from $465.5 million in 2002. Net sales of Simpson Strong-Tie’s products increased 19.9% to $473.6 million in 2003 from $394.9 million in 2002, while net sales of Simpson Dura-Vent’s products increased by 5.7% to $74.6 million in 2003 from $70.6 million in 2002. SDV accounted for approximately 13.6% of the Company’s total net sales in 2003, a decrease from 15.2% in 2002. The increase in net sales at SST resulted primarily from an increase in sales volume, with approximately 3% of the increase resulting from an increase in average prices. The increase in net sales at SDV resulted from increases in volume and average prices in similar amounts. The majority of the Company’s sales growth occurred domestically, although sales in Europe and Canada, including sales resulting from the acquisition of MGA in May 2003, grew at a faster rate than domestic sales. Lumber dealers, contractor distributors and home centers were the fastest growing connector sales channels. The sales increase was broad based across most of Simpson Strong-Tie’s major product lines. Simpson Strong-Tie’s engineered wood products, Anchor Systems and seismic and high wind related products had the highest percentage growth rates in sales. Sales of Simpson Dura-Vent’s pellet vent, gas vent and chimney products increased compared to 2002, while sales of its Direct-Vent product line decreased primarily due to a significant gas appliance manufacturer that decided to supply certain venting products from internal sources in 2003. Sales of the affected products to this customer were approximately $3.8 million in 2003, down from approximately $6.6 million in 2002.

 

Gross Profit

 

Gross profit increased 15.5% to $218.3 million in 2003 from $188.9 million in 2002. As a percentage of net sales, gross profit decreased to 39.8% in 2003 from 40.6% in 2002, primarily due to materials costs, mainly steel, partially offset by improved absorption of overhead costs.

 

The Company faced uncertainty in the cost and availability of steel. Several factors contributed to this uncertainty. Demand, particularly from China, was very high and this had constrained supplies available to buyers in the United States. Weakness in the U.S. dollar had discouraged foreign steel mills from supplying the U.S. market despite the lifting of tariffs on certain types of imported steel. In addition, major domestic integrated steel producers have consolidated over the last several years. All of these factors had an adverse effect on the Company’s gross profit.

 

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Selling Expense

 

Selling expense increased 11.4% to $49.7 million in 2003 from $44.6 million in 2002. The increase was primarily due to increased costs of approximately $1.6 million associated with the addition of sales personnel, including those related to the acquisition of MGA, and increased costs associated with promotional activities totaling approximately $0.5 million.

 

General and Administrative Expense

 

General and administrative expenses increased 21.1% to $70.5 million in 2003 from $58.3 million in 2002, but increased only slightly as a percentage of net sales to 12.9% in 2003 from 12.5% in 2002. This increase was primarily due to increased cash profit sharing of approximately $4.6 million, as a result of higher operating income, the recognition of stock option expenses of approximately $1.5 million in accordance with the recently adopted accounting standard, Statement of Financial Accounting Standard (“SFAS”) No. 123, “Accounting for Stock Based Compensation,” higher bad debt expense of approximately $1.5 million after consideration of the reversal of the allowance for doubtful accounts in 2002 related to a significant customer, the addition of administrative employees, including those related to the acquisition of MGA, of approximately $1.1 million, increases in professional services of approximately $1.3 million and insurance expenses of approximately $0.7 million.

 

Interest Income and Expense

 

Interest income is generated on the Company’s cash and short-term investment balances. Interest expense includes debt service and maintenance fees and bank charges.

 

Provision for Income Taxes

 

The Company’s effective tax rate was 38.9% in 2003, down from 40.4% in 2002. The decrease was primarily due to tax credits for research and development and manufacturing investment in an enterprise zone related to the expansion of the Company’s facilities in Stockton, California. The effective tax rates exceeded the federal statutory rate of 35.0% primarily due to the effect of state income taxes, net of the federal benefit.

 

European Operations

 

For its European operations, the Company recorded an after-tax net loss of $0.5 million in 2003 compared to after-tax net loss of $0.2 million in 2002. These losses are related to the Company’s UK operations. The goodwill associated with operations there, carried on the balance sheet as of December 31, 2003, at approximately $4.7 million, could be partially or fully impaired if the losses continue. The Company’s operations elsewhere in Europe were marginally profitable for the year.

 

Critical Accounting Policies and Estimates

 

The critical policies described below affect the Company’s more significant judgments and estimates used in the preparation of the Consolidated Financial Statements. If the Company’s business conditions change or if it uses different assumptions or estimates in the application of these and other accounting policies, the Company’s future results of operations could be adversely affected.

 

Inventory Valuation

 

Inventories are stated at the lower of cost or net realizable value (market). Cost includes all costs incurred in bringing each product to its present location and condition, as follows:

 

Raw materials and finished goods – principally valued at cost determined on a first in, first out basis.

 

In-process products and finished goods – cost of direct materials and labor plus attributable overheads based on a normal level of activity.

 

The Company applies net realizable value and obsolescence to the gross value of the inventory. The Company estimates net realizable value based on estimated selling price less further costs to completion and disposal. The Company provides for slow moving product by comparing inventories on hand to future projected demand. Obsolete

 

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inventory is on-hand supply of a product in excess of two years’ sales of that product or a supply of that product that the Company believes is no longer marketable. The Company revalues obsolete inventory as having no net realizable value. The Company has consistently applied this methodology. The Company believes that this approach is prudent and makes suitable provisions for slow moving and obsolete inventory.

 

Comparable inventory values are as follows:

 

		December 31,
(Dollars in thousands)		2004			2003
Gross Inventories:
Raw materials		$	91,910		$	38,822
In-process products		22,235			15,133
Finished goods		83,326			57,434
Less:
Slow moving, obsolete and net realizable value provisions		(4,592		)	(5,186		)
Net inventory valuation		$	192,879		$	106,203

 

The overall increase in the net inventory valuation was $86.7 million. This increase was primarily related to increased quantities of raw material inventory on hand of approximately 55% coupled with a 51% increase in the material inventory prices, primarily related to steel, at December 31, 2004. Finished goods increased by $25.9 million, which was primarily related to increased steel costs and the amount of finished goods the Company maintains to serve its customers’ needs and to avoid potential shortages of products.

 

Activity in the inventory reserve is summarized as follows:

 

		Years ended December 31,
(Dollars in thousands)		2004			2003			2002
Beginning balance		$	5,186		$	6,097		$	3,547
Provisions released following disposal of inventory		(3,376		)	(1,581		)	(976		)
Additional provisions made		2,782			670			3,526
Ending balance		$	4,592		$	5,186		$	6,097

 

A sudden and unexpected change in market demand, building codes or buyer preferences could reduce the rate of inventory turnover and require the Company to increase its reserve for obsolescence.

 

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 the products are shipped to customers. When the Company sells F.O.B. destination point, title is transferred and the Company recognizes revenue on 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 completed. If the actual costs of sales returns, allowances, and discounts were to significantly exceed the recorded estimated allowance, the Company’s sales would be adversely affected.

 

Allowance for Doubtful Accounts

 

The Company assesses the collectibility of specific customer accounts that would be considered doubtful based upon the customer’s financial condition, payment history, credit rating and other factors that the Company considers relevant, or accounts that the Company assigns for collection. The Company reserves for the portion of those outstanding balances that the Company believes it is not likely to collect. Specifically, the Company reserves

 

24

 

accounts receivable balances that are over 90 days outstanding. The Company also reserves 100% of the amount that it deems potentially uncollectible due to a customer’s bankruptcy or deteriorating financial condition. If the financial condition of our customers were to deteriorate, resulting in inability to make payments, additional allowances may be required.

 

Activity in the allowance for doubtful accounts is summarized as follows:

 

		Years ended December 31,
(Dollars in thousands)		2004			2003			2002
Beginning balance		$	1,889		$	1,741		$	3,736
Adjustments, recoveries and write-offs		53			(414		)	(1,046		)
Bad debt charges		455			562			(949		)
Ending balance		$	2,397		$	1,889		$	1,741

 

Liquidity and Sources of Capital

 

The Company’s liquidity needs arise principally from working capital requirements, capital expenditures and asset acquisitions. During the three years ended December 31, 2004, the Company relied on internally generated funds to finance these needs. The Company’s working capital requirements are seasonal with the highest need typically occurring in the second and third quarters of the year. Cash and cash equivalents were $30.9 million and $95.1 million at December 31, 2004 and 2003, respectively. The Company also had short-term investments of $17.0 million and $44.7 million at December 31, 2004 and 2003, respectively. Working capital was $268.7 million and $269.5 million at December 31, 2004 and 2003, respectively. As of December 31, 2004, the Company had approximately $2.9 million in debt outstanding and had available to it unused credit facilities of approximately $27.7 million.

 

The Company had cash flows from operating activities of $22.8 million, $71.1 million and $49.1 million for 2004, 2003 and 2002, respectively. In 2004, cash was provided by net income and noncash expenses, such as depreciation and amortization, noncash compensation related to stock plans and the tax benefit of options exercised, totaling $108.4 million, and increases in accrued liabilities, primarily sales incentives and allowances, accounts payable and accrued profit sharing trust contributions of $17.4 million. These increases were partially offset by increases in trade accounts receivable as a result of higher sales levels, inventories, primarily due to increased quantities of each of the components of the Company’s inventory and higher priced steel, and income taxes payable aggregating approximately $106.9 million. The balance of the cash provided in 2004 resulted from changes in other asset and liability accounts, none of which was material.

 

Cash used in investing activities was $50.2 million, $57.9 million and $44.2 million for 2004, 2003 and 2002, respectively. Cash paid for capital expenditures and asset acquisitions was approximately $46.0 million and $32.5 million, respectively, in 2004, up from $21.3 million and $9.6 million, respectively, in 2003. The increase in asset acquisitions was primarily due to the acquisition of Quik Drive in October 2004. For the investment in capital expenditures, approximately $18.5 million was used to purchase or improve the Company’s real estate, primarily for the Company’s new 317,000 square foot manufacturing and distribution facility in McKinney, Texas. This facility, completed in February 2005, replaces the Company’s existing facilities there. The Company also used approximately $27.4 million to purchase equipment for its facilities, primarily in Stockton and Brea, California and McKinney, Texas. In addition, the Company realized a net amount of approximately $27.6 million from the sale or maturity of its short-term investments, net of purchases. The Company carries these investments at market value and generally believes an other-than-temporary decline in its short-term investments occurs when the fair value of an investment is below the carrying value for two consecutive quarters.

 

The Company has entered into an agreement to purchase, for approximately $4.1 million, the facility it is currently renting from a related party in Columbus, Ohio. The Company is planning to build an expansion facility in Columbus on land adjacent to the current facility for approximately $14.6 million. Construction is scheduled to begin in March 2005. In February 2005, the Company signed a letter of intent to purchase two buildings in Pleasanton, California, for approximately $9.6 million. The buildings comprise approximately 89,000 square feet and will be used for the Company’s home office, replacing the facility that the Company currently leases in Dublin, California. The Company is currently in the process of due diligence and if that is satisfactorily completed, the transaction is expected to close

 

25

 

in August 2005. If this transaction is completed, the Company expects to move in to the new building and vacate its leased property in Dublin, California, in mid-2006. The Company has not finalized its plans at this time, but anticipates a one-time charge to income in 2005 for the remaining lease payments at the Dublin facility and a noncash charge in 2005 for the unamortized leasehold improvements related to the Dublin facility, which it estimates will total approximately $1.6 million.

 

Financing activities used $37.8 million and $21.9 million in net cash in 2004 and 2003, respectively, and provided $2.1 million in net cash in 2002. In 2004, the Company used approximately $31.3 million in cash to repurchase 1,150,854 shares of its common stock to offset the dilution of stock options granted in 2004. This use of cash was partially offset by approximately $4.2 million provided by the issuance of common stock on the exercise of stock options by employees and directors of the Company. During 2004, the Company paid approximately $7.2 million in dividends on its common stock. In January 2005, the Company’s Board of Directors declared a dividend of $0.05 per share, a total of approximately $2.4 million, to be paid on April 26, 2005, to stockholders of record on April 6, 2005. Existing loan agreements require the Company to maintain tangible net worth of $250.0 million plus 50% of net profit after taxes for each fiscal year. This requirement may limit the amount that the Company may pay out as dividends on the common stock.

 

The Company’s contractual obligations for future payments are as follows:

 

		Payments Due by Period
(Dollars in thousands) Contractual Obligation		Total			Less Than 1 year			1 – 3 years			3 – 5 years			More than 5 years
Long-term debt obligations		$	2,976		$	579		$	1,142		$	700		$	555
Operating lease obligations		24,443			5,746			9,937			5,991			2,769
Purchase obligations		13,682			12,454			922			306			—
Total		$	41,101		$	18,779		$	12,001		$	6,997		$	3,324

 

Purchase obligations consist of purchase commitments primarily related to the acquisition of facilities and equipment, consulting agreements, and minimum purchase quantities of certain raw materials.

 

In December 2004, the Board of Directors authorized the Company to repurchase up to $50.0 million of the Company’s common stock. This replaces the $50.0 million repurchase authorization from December 2003. The authorization will remain in effect through the end of 2005.

 

The Company believes that cash generated by operations, borrowings available under its existing credit agreements and other available financing will be sufficient for the Company’s working capital needs and planned capital expenditures through at least 2005.

 

Inflation

 

The Company believes that the effect of inflation on the Company has not been material in recent years, as inflation rates have remained low.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

The Company’s short-term investments consisted of debt securities of approximately $17.0 million as of December 31, 2004. These securities, like all fixed income instruments, are subject to interest rate risk and will vary in value as market interest rates fluctuate. If market interest rates were to increase immediately and uniformly by 10% from levels as of December 31, 2004, the decline in the fair value of the investments would not be material.

 

The Company has foreign exchange rate risk in its international operations, primarily Europe and Canada, and through purchases from foreign vendors. The Company does not currently hedge this risk. If the exchange rate were to change by 10% in any one country where the Company has operations, the change in net income would not be material to its operations taken as a whole. The translation adjustment, recorded in accumulated other comprehensive income, resulted in a gain of approximately $5.5 million in 2004 primarily due to the effect of the devaluation of the U.S. dollar in relation to European and Canadian currencies.

 

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Item 8. Financial Statements and Supplementary Data.

 

SIMPSON MANUFACTURING CO., INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

	Financial Statements
	Report of Independent Registered Public Accounting Firm
	Consolidated Balance Sheets at December 31, 2004 and 2003
	Consolidated Statements of Operations for the years ended December 31, 2004, 2003 and 2002
	Consolidated Statements of Stockholders’ Equity for the years ended December 31, 2002, 2003 and 2004
	Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
	Notes to the Consolidated Financial Statements
	Financial Statement Schedule
	Schedule II – Valuation and Qualifying Accounts

 

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Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of Simpson Manufacturing Co., Inc.:

 

We have completed an integrated audit of Simpson Manufacturing Co., Inc.’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004, and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

 

Consolidated financial statements and financial statement schedule

 

In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Simpson Manufacturing Co., Inc. and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

Internal control over financial reporting

 

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

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Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

As described in Management’s Report on Internal Control over Financial Reporting, management has excluded Quik Drive from its assessment of internal control over financial reporting as of December 31, 2004, because it was acquired by the Company in a purchase business combination during 2004. We have also excluded Quik Drive from our audit of internal control over financial reporting. Quik Drive is a division of Simpson Strong-Tie Company Inc. whose total assets and total revenues represent approximately 7% and 1%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 31, 2004.

 

 

/s/PricewaterhouseCoopers LLP
San Francisco, California
March 11, 2005

 

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Simpson Manufacturing Co., Inc. and Subsidiaries

Consolidated Balance Sheets

 

		December 31,
		2004			2003
ASSETS
Current assets
Cash and cash equivalents		$	30,916,357		$	95,135,885
Short-term investments		17,032,159			44,737,867
Trade accounts receivable, net		89,806,749			66,073,296
Inventories		192,879,318			106,202,713
Deferred income taxes		8,809,071			7,821,198
Other current assets		7,667,288			4,293,705
Total current assets		347,110,942			324,264,664
Property, plant and equipment, net		137,608,800			107,226,319
Goodwill		44,378,861			23,655,860
Other noncurrent assets		16,038,357			6,545,547
Total assets		$	545,136,960		$	461,692,390
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities
Line of credit and current portion of long-term debt		$	579,198		$	1,113,657
Trade accounts payable		32,030,936			22,567,291
Accrued liabilities		27,780,583			15,181,487
Accrued profit sharing trust contributions		7,038,952			6,021,136
Accrued cash profit sharing and commissions		8,209,753			7,459,428
Accrued workers’ compensation		2,760,613			2,423,764
Total current liabilities		78,400,035			54,766,763
Long-term debt, net of current portion		2,396,886			5,177,936
Other long-term liabilities		1,414,831			1,443,440
Total liabilities		82,211,752			61,388,139
Commitments and contingencies (Note 9)
Stockholders’ equity
Preferred stock, par value $0.01; authorized shares, 5,000,000; issued and outstanding shares, none		—			—
Common stock, par value $0.01; authorized shares, 80,000,000; outstanding shares, 47,929,002 and 48,510,588 at December 31, 2004 and 2003, respectively; issued shares, 47,929,002 and 49,144,868, December 31, 2004 and 2003, respectively		479,290			497,792
Additional paid-in capital		79,876,789			63,334,758
Treasury stock		—			(29,426,998		)
Retained earnings		369,154,260			357,916,036
Accumulated other comprehensive income		13,414,869			7,982,663
Total stockholders’ equity		462,925,208			400,304,251
Total liabilities and stockholders’ equity		$	545,136,960		$	461,692,390

 

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

 

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Simpson Manufacturing Co., Inc. and Subsidiaries

Consolidated Statements of Operations

 

		Years Ended December 31,
		2004			2003			2002
Net sales		$	698,053,226		$	548,181,933		$	465,473,959
Cost of sales		417,417,175			329,902,422			276,556,932
Gross profit		280,636,051			218,279,511			188,917,027
Operating expenses
Selling		58,869,241			49,668,567			44,581,335
General and administrative		90,549,974			70,538,012			58,253,069
		149,419,215			120,206,579			102,834,404
Income from operations		131,216,836			98,072,932			86,082,623
Interest income		748,912			1,377,334			1,570,047
Interest expense		(363,640		)	(377,848		)	(584,940		)
		385,272			999,486			985,107
Income before income taxes		131,602,108			99,072,418			87,067,730
Provision for income taxes		50,093,765			38,510,194			35,133,583
Net income		$	81,508,343		$	60,562,224		$	51,934,147
Net income per common share
Basic		$	1.70		$	1.23		$	1.06
Diluted		$	1.67		$	1.21		$	1.05
Weighted average number of shares outstanding
Basic		48,051,819			49,143,516			48,940,134
Diluted		48,918,549			49,990,986			49,615,098

 

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

 

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