Basis of Presentation

Principles of Consolidation

The condensed consolidated financial statements include the accounts of Simpson Manufacturing Co., Inc. and its subsidiaries (the “Company”). Investments in 50% or less owned affiliates are accounted for using either the cost or the equity method. All significant intercompany transactions have been eliminated.

Interim Period Reporting

The accompanying unaudited interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations for reporting on Form 10-Q. Accordingly, certain information and footnotes required by accounting principles generally accepted in the United States of America (“GAAP”) have been condensed or omitted. These interim statements should be read in conjunction with the audited consolidated financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2013.

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

Revisions

The Company revised its September 30, 2013, Condensed Consolidated Balance Sheet to classify $5.6 million of indefinite-lived assets as intangible assets, net, that had erroneously been classified as other noncurrent assets. The Condensed Consolidated Statement of Operations for the three and nine months ended September 30, 2013, was revised to reflect $0.3 million and $0.8 million, respectively, of rental income from properties rented to third-parties as an offset to general and administrative expense rather than as net sales as originally reported in error. With this revision, rental incomes are reported, net of related expenses, in general and administrative expense. These revisions were not considered material to the affected periods.

Out-of-Period Adjustment

In the first quarter of 2014, the Company recorded an out-of-period adjustment, which increased gross profit, income from operations and net income by $2.3 million, $2.0 million and $1.3 million, respectively. The adjustment resulted from an over-statement of prior periods' workers compensation expense, net of cash profit sharing expense, and was not material to the current period's or any prior period's financial statements.

Withdrawal from Multi-Employer Defined-Benefit Pension Plan

Under the Company's collective bargaining arrangement with the tool and die craftsman and maintenance union, the Company has been contributing to a defined-benefit pension plan. In the second quarter of 2014, the Company and the union formally notified the defined-benefit pension plan administrator of their intent to withdraw from the plan. In the third quarter of 2014, the plan administrator responded by issuing a demand letter informing the Company that the annual withdrawal liability payment to be made by the Company was $145,400 and the payments were to be made in perpetuity.

Due to the amount and duration of payments, the Company was required to calculate and record a pension expense and liability based on the annual payments in perpetuity. The liability is included with other long-term liabilities in the Company's Condensed Consolidated Balance Sheet. The Company discounted the payment estimate using a discount rate of 5%, which approximates the credit-adjusted risk-free rate for the Company. The Company adjusted its liability to $3.0 million from the $2.9 million recorded in the second quarter of 2014, and recorded a corresponding defined-benefit expense in cost of sales. On a quarterly basis, the Company will re-evaluate the number of years that payments are required and the discount rate used to calculate the long-term liability and adjust it as facts and circumstances change. All quarterly adjustments to the long-term liability will be charged to cost of sales in the Condensed Consolidated Statements of Operations. Because of the funding status of the plan, the annual withdrawal liability payments will be recorded as interest expense on the long-term liability until such time as a finite debt balance is determined.

Revenue Recognition

The Company recognizes revenue when the earnings process is complete, net of applicable provision for discounts, returns and incentives, 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, collectability is reasonably assured and pricing is fixed or determinable. The Company’s general shipping terms are F.O.B. shipping point, and 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 after-market repair and maintenance, engineering activities, software license sales and services and lease income, though significantly less than 1% of net sales and not material to the condensed consolidated financial statements, are recognized as the services are completed or the software products and services are delivered. If actual costs of sales returns, incentives and discounts were to significantly exceed the recorded estimated allowance, the Company’s sales would be adversely affected.

Net Earnings Per Common Share

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

The following is a reconciliation of basic earnings per common share to diluted earnings per share:



	Three Months Ended September 30,				Nine Months Ended September 30,
(in thousands, except per share amounts)	2014		2013		2014		2013
Net income available to common stockholders	$	20,614	$	20,006	$	53,151	$	43,303
Basic weighted-average shares outstanding	49,010		48,377		48,972		48,482
Dilutive effect of potential common stock equivalents — stock options and restricted stock units	217		174		200		121
Diluted weighted-average shares outstanding	49,227		48,551		49,172		48,603
Earnings per common share:
Basic	$	0.42	$	0.41	$	1.09	$	0.89
Diluted	$	0.42	$	0.41	$	1.08	$	0.89
Potentially dilutive securities excluded from earnings per diluted share because their effect is anti-dilutive	—		—		—		—

Accounting for Stock-Based Compensation

With the approval of the Company’s stockholders on April 26, 2011, the Company adopted the Simpson Manufacturing Co., Inc. 2011 Incentive Plan (the “2011 Plan”). The 2011 Plan amended and restated in their entirety, and incorporated and superseded, both the Simpson Manufacturing Co., Inc. 1994 Stock Option Plan (the “1994 Plan”), which was principally for the Company’s employees, and the Simpson Manufacturing Co., Inc. 1995 Independent Director Stock Option Plan (the “1995 Plan”), which was for the Company's directors who are not employees. Options previously granted under the 1994 Plan or the 1995 Plan were not affected by the adoption of the 2011 Plan and continue to be governed by the 1994 Plan or the 1995 Plan, respectively.

Under the 1994 Plan, the Company could grant incentive stock options and non-qualified stock options. The Company, however, granted only non-qualified stock options under both the 1994 Plan and the 1995 Plan. The Company generally granted options under each of the 1994 Plan and the 1995 Plan once each year. The exercise price per share of each option granted under the 1994 Plan equaled the closing market price per share of the Company’s common stock as reported by the New York Stock Exchange on the day preceding the day that the Compensation and Leadership Development Committee of the Company’s Board of Directors met to approve the grant of the options. The exercise price per share under each option granted under the 1995 Plan was at the fair market value on the date specified in the 1995 Plan. Options vest and expire according to terms established at the grant date. Options granted under the 1994 Plan typically vest evenly over the requisite service period of four years and have a term of seven years. The vesting of options granted under the 1994 Plan will be accelerated if the grantee ceases to be employed by the Company after reaching age 60 or if there is a change in control of the Company. Options granted under the 1995 Plan were fully vested on the date of grant. Shares of common stock issued on exercise of stock options under the 1994 Plan and the 1995 Plan are registered under the Securities Act of 1933.

Under the 2011 Plan, the Company may grant incentive stock options, non-qualified stock options, restricted stock and restricted stock units, although the Company currently intends to award primarily restricted stock units and to a lesser extent, if at all, non-qualified stock options. The Company has not awarded, and does not currently intend to award, incentive stock options or restricted stock. Under the 2011 Plan, no more than 16.3 million shares of the Company’s common stock may be issued (including shares already issued) pursuant to all awards under the 2011 Plan, including on exercise of options previously granted under the 1994 Plan and the 1995 Plan. Shares of common stock to be issued pursuant to the 2011 Plan are registered under the Securities Act of 1933.

The following table represents the Company’s stock option and restricted stock unit activity for the three and nine months ended September 30, 2014 and 2013:



	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands)	2014			2013			2014			2013
Stock-based compensation expense recognized in operating expenses	$	3,041		$	2,959		$	8,781		$	8,644
Less: Tax benefit of stock-based compensation expense in provision for income taxes	1,075			1,087			3,142			3,031
Stock-based compensation expense, net of tax	$	1,966		$	1,872		$	5,639		$	5,613
Fair value of shares vested	$	3,098		$	3,007		$	8,789		$	8,656
Proceeds to the Company from the exercise of stock-based compensation	$	1,551		$	4,557		$	4,178		$	5,333
Tax effect from the exercise of stock-based compensation, including shortfall tax benefits	$	(89	)	$	(337	)	$	(275	)	$	(2,187	)



	At September 30,
(in thousands)	2014		2013
Stock-based compensation cost capitalized in inventory	$	525	$	426

The amounts included in cost of sales, research and development and other engineering, selling, or general and administrative expense depend on the job functions performed by the employees to whom the stock options and restricted stock units were awarded.

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

Fair Value of Financial Instruments

The “Fair Value Measurements and Disclosures” topic of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification™ (“ASC”) establishes a valuation hierarchy for disclosure of the inputs used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows: Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities; Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration, for substantially the full term of the financial instrument; and Level 3 inputs are unobservable inputs based on the Company’s assumptions used to measure assets and liabilities at fair value. A financial asset’s or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The Company’s investments consisted of only United States Treasury securities and money market funds, which are the Company’s primary financial instruments, maintained in cash equivalents and carried at cost, approximating fair value, based on Level 1 inputs. The balances of the Company’s primary financial instruments were as follows:



	At September 30,				At December 31
(in thousands)	2014		2013		2013
Financial instruments	$	98,568	$	87,381	$	117,571

The carrying amounts of trade accounts receivable, accounts payable and accrued liabilities approximate fair value due to the short-term nature of these instruments. The fair value of the Company’s contingent consideration related to acquisitions is classified as Level 3 within the fair value hierarchy and is based on the Company's unobserved inputs and assumptions. In the third quarter of 2014, the fair value of the contingent consideration, related to the acquisition of Bierbach GmbH & Co. KG (“Bierbach”), a Germany corporation, was decreased from $0.8 million to $0.4 million, as a result of not retaining Bierbach's historical customers and increased competition.

Income Taxes

The Company uses an estimated annual effective tax rate to measure the tax benefit or tax expense recognized in each interim period. The estimated effective tax rate was slightly higher in the third quarter of 2014 than in the third quarter of 2013. The effective income tax rate for the first nine months of 2014 was 36.7% as compared to 37.8% for the first nine months of 2013. The decrease in the effective income tax rate was primarily due to reduced operating losses in the first nine months of 2014 in the Europe and Asia/Pacific segments for which no tax benefit was recorded.

The following table presents the Company’s effective tax rates and income tax expense for the three and nine months ended September 30, 2014 and 2013:



	Three Months Ended September 30,						Nine Months Ended September 30,
(in thousands, except percentages)	2014			2013			2014			2013
Effective tax rate	36.0		%	35.2		%	36.7		%	37.8		%
Provision for income taxes	$	11,577		$	10,870		$	30,849		$	26,304

Acquisitions

In February 2013, the Company purchased certain assets relating to the TJ® ShearBrace (“ShearBrace”) product line of Weyerhaeuser NR Company (“Weyerhaeuser”) for $5.3 million in cash. The ShearBrace is a line of pre-fabricated shearwalls that complements the Company’s Strong-Wall shearwall, and is sold throughout North America. The Company’s measurement of assets acquired included goodwill of $0.9 million that has been assigned to the North America segment, and intangible assets of $3.6 million, both of which are subject to tax-deductible amortization. Net tangible assets consisting of inventory and equipment accounted for the balance of the purchase price. The weighted-average amortization period for the intangible assets is 11.3 years.

In November 2013, the Company purchased certain assets related to a connector product line from Bierbach for $1.2 million in cash and a contingent liability of $0.8 million. Bierbach manufactured and sold a line of connectors, primarily in Germany. The Company’s initial provisional measurement of assets acquired included goodwill of $0.7 million, which was assigned to the Europe segment, and intangible assets of $0.6 million, both of which are subject to tax-deductible amortization. Net tangible assets consisting of inventory and tooling accounted for the balance of the purchase price. The provisional measurement of the assets acquired was revised in the third quarter of 2014 to include goodwill of $0.5 million with intangible assets unchanged at $0.6 million. Net tangible assets consisting of inventory and tooling accounted for the balance of the purchase price. Also in the third quarter of 2014, the Company reduced the fair value of the contingent consideration liability from $0.8 million to $0.4 million due to a failure to retain Bierbach's historical customers and increased competition, which resulted in a $0.4 million gain that was reported in general and administrative expenses in the Condensed Consolidated Statements of Operations. The goodwill was fully impaired during the quarter. (See Note 1 "Basis of Presentation - Goodwill Impairment Testing" below).

In the first quarter of 2014, the Company paid $1.1 million in deferred consideration and $0.2 million in contingent consideration related to the acquisition of S&P Clever Reinforcement Company AG and S&P Clever International AG (collectively, “S&P Clever”). The remaining deferred and contingent consideration of $1.5 million is payable in the first quarter of 2015.

Under the business combinations topic of the FASB ASC, the Company accounted for these acquisitions as business combinations and ascribed acquisition-date fair values to the acquired assets. Provisional fair value measurements were made in the first and fourth quarters of 2013 for the acquired assets of ShearBrace and Bierbach, respectively. Adjustments to those measurements may be made in subsequent periods, up to one year from the acquisition date, as information necessary to complete the analysis is obtained. Fair value of intangible assets was based on Level 3 inputs. The Company has completed the measurement process for ShearBrace assets and expects the measurement process for the Bierbach acquisition to be finalized in the fourth quarter of 2014.

Pro-forma financial information is not presented as it would not materially differ from the information presented in the Condensed Consolidated Statements of Operations.

Goodwill Impairment Testing

The Company tests goodwill for impairment at the reporting unit level on an annual basis, in the fourth quarter, or more frequently if events or changes in circumstances indicate that the carrying value of goodwill may not be recoverable. These events or circumstances may include, among others, a significant change in the business climate, legal factors, operating performance indicators such as decreases to sales forecasts, competition, or the disposition or relocation of a significant portion of a reporting unit's assets.

In the third quarter of 2014, the factors that led to the reduction in contingent consideration liability related to Bierbach discussed above resulted in management performing an impairment test to evaluate the recoverability of the Germany reporting unit's goodwill, which consists entirely of goodwill from the Bierbach acquisition. The test resulted in the impairment of all of the reporting unit’s goodwill in the amount of $0.5 million.

The Company performed a two-step impairment test on the goodwill of the Germany reporting unit. In the first step, the Company compared the fair value of the reporting unit to its carrying value. The fair value was estimated using a discounted cash flow model, which considers estimates of projected future operating results and cash flows, discounted at an estimated after-tax weighted-average cost of capital. The discounted cash flow model requires significant judgment involving estimates and assumptions. These estimates and assumptions include revenue growth rates, operating margins and working capital requirements used to calculate projected future cash flows, risk-adjusted discount rates and future economic and market conditions (Level 3 fair value inputs). The Company bases its fair value estimates on assumptions that it believes to be reasonable, but that are unpredictable and inherently uncertain. Actual future results may differ materially from those estimates. Assumptions about the reporting unit’s operating performance in the first year of the discounted cash flow model used to determine whether or not the goodwill related to that reporting unit is impaired were derived from the Company’s 2014 projected annual operating results for the Germany reporting unit. The fair value model considers such factors as macro-economic conditions, revenue and expense forecasts, product line changes, material, labor and overhead costs, tax rates, working capital levels and the competitive environment. Future estimates, however derived, are inherently uncertain. Nonetheless, the Company believes that this is the most appropriate source on which to base its estimates.

As the carrying amount of the Germany reporting unit exceeds its fair value, a second test was performed to measure the amount of impairment, if any, by allocating the reporting unit’s fair value to its assets and liabilities, other than goodwill, and comparing the resulting implied fair value of goodwill with its carrying amount. An impairment charge for the difference was then recorded. The goodwill impairment evaluation performed by management as of September 30, 2014, indicated that the carrying value of the Company's Germany reporting unit exceeded its fair value by more than 32% of the carrying value.

In connection with the impairment of the goodwill, the Company also reviewed associated long-lived assets in Germany, such as property and equipment, and intangible assets, for recoverability by comparing the projected undiscounted net cash flows associated with those assets to their carrying values. No impairment of long-lived assets was required as a result of that review during the third quarter of 2014.

Recently Issued Accounting Standards

In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Codification Update No. 2014-08 (Topic 205 and Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity ("ASC Update No. 2014-08"). ASC Update No. 2014-08 modifies the definition of discontinued operations by limiting discontinued operations reporting to disposals of components of an entity that represent strategic shifts that have (or will have) a major effect on an entity’s operations and financial results. ASC Update No. 2014-08 also requires additional financial statement disclosures about discontinued operations, as well as disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation. ASC Update No. 2014-08 is effective prospectively for years beginning on or after December 15, 2014. The Company expects that the adoption of ASC Update No. 2014-08 will not materially affect its financial position or results of operations.

In May 2014, the FASB issued ASC Update No. 2014-09, Revenue from Contracts with Customers ("ASC Update No. 2014-09"). ASC Update No. 2014-09 supersedes nearly all existing revenue recognition guidance under GAAP. The core principle of ASC Update No. 2014-09 is that revenue is recognized when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASC Update No. 2014-09 defines a five-step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing GAAP. The standard is effective for annual and interim periods beginning after December 15, 2016, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASC Update No. 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). The Company is currently evaluating the effects of adopting ASC Update No. 2014-09 on its consolidated financial statements and has not yet determined the method by which it will adopt the standard.

Other recent authoritative guidance issued by the FASB (including technical corrections to the ASC), the American Institute of Certified Public Accountants and the Securities and Exchange Commission did not or is not expected to have a material effect on the Company’s consolidated financial statements.