(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
The number of shares outstanding of the registrant’s common stock as of May 14, 2009 was 29,856,508.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying notes are an integral part of these consolidated financial statements.
Notes to Unaudited Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Nature of Operations
Building Materials Holding Corporation (BMHC) provides building products and construction services to professional homebuilders and contractors in western and southern regions of the United States. We distribute building products, manufacture building components (millwork, floor and roof trusses and wall panels) and provide construction services to professional builders and contractors through a network of 31 distribution facilities, 43 manufacturing facilities and 5 regional construction services facilities. Based on National Association of Home Builders building permit activity, we provide building products and construction services in 9 of the top 25 single-family construction markets.
Principles of Consolidation
The consolidated financial statements include the accounts of BMHC and its subsidiaries. All significant intercompany balances and transactions are eliminated.
Basis of Presentation
| | · | Interim consolidated financial statements |
These consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to those rules and regulations. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the accompanying notes included in our most recent Annual Report on Form 10-K.
These consolidated financial statements have not been audited by independent registered public accountants. However, in the opinion of management, all adjustments, including those of a normal and recurring nature, necessary to present fairly the results for the periods have been included. The preparation of these consolidated financial statements required estimates and assumptions. Actual results may differ from those estimates.
| | · | Uncertainty regarding Liquidity and Going Concern |
Our consolidated financial statements were prepared assuming we will continue as a going concern which contemplates the realization of assets and the liquidation of liabilities in the normal course of business.
Beginning with the fourth quarter of 2007 and continuing through the first quarter of 2009, we have incurred losses from operations and, during 2008 and the first quarter of 2009, restructuring costs as we downsized our business to match the current environment. We have managed our liquidity during this time with closure and consolidation of underperforming business units and cost reduction initiatives as well as sales of assets. However, the downturn in the housing industry has been deepened by an increase in home foreclosures and reduced consumer confidence from tightened lending standards and rising unemployment, which have created a difficult business environment for homebuilders generally. Our operating performance and liquidity were negatively affected by these economic and industry conditions, which are beyond our control.
These business conditions have not improved during 2009. As of March 2009, single-family housing starts for the U.S. as a whole fell to an annualized rate below 0.4 million and single-family permits in our markets remained at a depressed annualized rate of 0.1 million. We do not believe these business conditions will improve significantly during 2009.
Our actions to align our cost structure with anticipated sales may not be sufficient to fund our operating costs, restructuring costs and debt service requirements. When funds from operations are insufficient, our primary source of funding has been the revolver component of our credit facility. Our amended credit facility provides a $200 million revolver and a $340 million term note maturing in November 2011. Our revolver is subject to borrowing base limitations based on certain accounts receivable, inventory, property and equipment and real estate and may not provide adequate liquidity. As of March 31, 2009, there were $2.3 million borrowings outstanding under the revolver and $313.8 million was outstanding under the term note.
Our credit agreement requires monthly compliance with financial covenants, including minimum liquidity and adjusted earnings before interest, taxes, depreciation and amortization (monthly Adjusted EBITDA). Operating results, particularly income from continuing operations, are a primary factor for these covenants, and our ability to comply with these covenants depends on our operating performance. Lack of compliance with these covenants would constitute an event of default under the credit agreement which, absent any waiver, forbearance or modification, would enable the lenders under our credit agreement to cause all amounts borrowed to become due and payable immediately and to prohibit further borrowings by us under the revolver.
Based on financial information for February 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. In March 2009, we obtained a limited waiver through April 15, 2009 for lack of compliance with the monthly Adjusted EBITDA requirement and we preserved access to limited liquidity permitting us to borrow up to $20 million under the revolver. Previously, we had obtained waivers for financial covenants due to lower than planned operating performance as of both June 2008 and December 2007.
Due to the difficulty of reliably projecting our operating results within the depressed business conditions of the homebuilding industry, we believe that it is likely that we will not be able to meet the financial covenants of our credit agreement during 2009. Also, our independent registered public accounting firm included a going concern explanatory paragraph in their report on our financial statements for 2008, citing among other things, the uncertainty that we would remain in compliance with these financial covenants. The going concern explanatory paragraph constitutes a default under our credit agreement. In April 2009, we obtained a waiver for the going concern explanatory paragraph.
In April 2009, our lenders also agreed to extend the limited waiver through June 1, 2009. In May 2009, the limited waiver was extended through June 29, 2009. This limited waiver continues to waive compliance with the monthly Adjusted EBITDA, forecast and projection requirements of our credit agreement. The limited waiver limits borrowings under the revolver to $20 million and limits capital expenditures to $0.1 million from the date of the extended limited waiver. Lenders approving each of the March, April and May 2009 limited waivers were paid a fee of 0.10% of their revolver commitment and their portion of the outstanding principal amount of the term note.
For March 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. Additionally, as the limited waiver for these financial covenants is less than a year, it is probable we will not be in compliance with these financial covenants within the next year and given there is no amendment or other financing agreement currently in place, the revolver and term note are classified as a current liability in the consolidated balance sheet.
We are anticipating tax refunds of $56 million as a result of net operating losses for 2008. These refunds will be applied to reduce the amount outstanding under our term loan facility to approximately $275 million. The remaining portion of the tax refund will be available for working capital needs after payment of any borrowings under the revolver. We filed for our federal tax refund in April 2009 and our professional advisors have advised us that receipt of the refund is anticipated in mid- to late May 2009.
We are currently negotiating with our lenders to develop debt and capital structures to support our long-term strategic plan and business objectives. We expect that these negotiations may lead to a bankruptcy filing which we anticipate would reflect the agreement of our lenders and would provide for the payment in full of all amounts owing to key vendors and the uninterrupted supply of goods and services to our customers. Equity holders may be substantially diluted or be eliminated in a bankruptcy filing.
There can be no assurance these negotiations will result in debt and capital structures acceptable to us and the lenders or an agreement that would achieve our goals. If these negotiations fail, we would not be able to continue as a going concern and would be forced to seek relief through bankruptcy filing without an agreement of our lenders. We also continue to pursue alternative financing arrangements as well as evaluate other financing options.
We may not be able to meet near-term working capital and scheduled interest and debt payment requirements if cash flows are inadequate from our reduced operating activities or if our access to the revolver portion of our credit facility is restricted because we are unable to reach an agreement with our lenders. Absent any waiver, forbearance or modification to our current credit agreement, we believe our recurring losses from operations, interest and debt burden amid declining sales and potential inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern.
Additionally, our long-term future is dependent on more normal levels of single-family housing starts and our ability to implement and maintain cost structures, including reduced interest and debt that align with single-family housing trends. If this fails to transpire or if we cannot obtain a waiver, forbearance or modification to our current credit agreement or other financing options, we may not be able to continue as a going concern and may be forced to seek relief through a bankruptcy filing.
These consolidated financial statements present separately the financial information for discontinued operations as follows:
| | · | concrete block masonry, concrete services and truss manufacturing in Florida (June 2008) and |
| | · | framing services in Virginia (March 2008). |
As a result of these transactions:
| | · | these operations are presented separately from continuing operations within the caption of discontinued operations and |
| | · | related assets and liabilities are separately classified in the consolidated balance sheet. |
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and contingent assets and liabilities as of the date of the financial statements as well as the reported amounts of sales and expenses during the reporting period. Actual amounts may differ materially from those estimates. The following critical accounting estimates often require our subjective and complex judgment as a result of the need to estimate matters that are inherently uncertain:
| | · | Revenue Recognition for Construction Services |
The percentage-of-completion method is used to recognize revenue for construction services. Periodic estimates of our progress towards completion are made based on a comparison of labor costs incurred to date with total estimated contract costs for labor. The percentage-of-completion method requires the use of various estimates, including among others, the extent of progress towards completion, contract revenues and contract completion costs. Contract revenues and contract costs to be recognized are dependent on the accuracy of estimates, including quantities of materials, labor productivity and other cost estimates. We have a history of making reasonable estimates of the extent of progress towards completion, contract revenues and contract completion costs. However, due to uncertainties inherent in the estimation process, it is possible that actual contract revenues and completion costs may vary from estimates. Revisions of contract revenues and cost estimates as well as provisions for estimated losses on uncompleted contracts are recognized in the period such revisions are known.
| | · | Estimated Losses on Uncompleted Contracts and Changes in Contract Estimates |
Estimated losses on uncompleted contracts and changes in contract estimates are established by assessing estimated costs to complete, change orders and claims for uncompleted contracts. Revisions of estimated losses are recognized in the period such revisions are known.
| | · | Realizability of Net Deferred Tax Asset |
Deferred tax assets and liabilities are recognized for tax credits and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recognized to reduce the carrying amount of deferred tax assets to the amount that is more likely than not to be realized. If it is later determined it is more likely than not that deferred tax assets will be realized, the valuation allowance will be adjusted. Revisions of the valuation allowance are recognized in the period such revisions are known.
Goodwill represents the excess of purchase price over the fair values of net tangible and identifiable intangible assets of acquired businesses. An annual assessment for impairment is completed in the fourth quarter and whenever events and circumstances indicate the carrying amount may not be recoverable. An impairment is recognized if the carrying amount is more than the estimated future operating cash flows as measured by fair value techniques.
| | · | Insurance Deductible Reserves |
The estimated cost of automobile, general liability and workers’ compensation claims is determined by actuarial methods. Claims in excess of insurance deductibles are insured with third-party insurance carriers. Insurance deductible reserves for claims are recognized based on the estimated costs of these claims as limited by the deductibles of the applicable insurance policies. Revisions to insurance deductible reserves for estimated claims are recognized in the period such revisions are known.
The estimated cost of warranties for certain construction services is based on the nature and frequency of claims, anticipated claims and cost per claim. Claims in excess of insurance deductibles are insured with third-party insurance carriers. Estimated costs for warranties are recognized when the revenue associated with the service is recognized. Revisions of estimated warranties are recognized in the period such revisions are known.
| | · | Share-based Compensation |
Our estimates of the fair values of our share-based payment transactions are based on the modified Black-Scholes-Merton model. To meet the fair value measurement objective, we are required to develop estimates regarding expected exercise patterns, share price volatility, forfeiture rates, risk-free interest rate and dividend yield. These assumptions are based principally on historical experience. When circumstances indicate changes in forfeiture rates, revisions to forfeiture rates are recognized in the period such revisions are known. Due to uncertainties inherent in these assumptions, it is possible that actual share-based compensation may vary from these estimates.
Cash and Cash Equivalents
Cash and cash equivalents consist of short-term investments that have a maturity of three months or less at the date of purchase.
Receivables
Receivables consist primarily of amounts due from customers and are net of an allowance for doubtful accounts. The allowance for doubtful accounts reflects our best estimate of probable losses of accounts receivable. We determine the allowance based on known troubled accounts, historical experience and other available evidence.
Inventory Valuation
Inventory consists principally of building materials purchased for resale and is valued at the lower of average cost or market. We participate in vendor rebate programs under which rebates are earned by attaining certain purchase volumes. Volume rebates are accrued as earned. These volume rebates are recorded as a reduction in inventory and recognized in cost of goods sold when the related product is sold.
Unbilled Receivables and Billings in Excess of Costs and Estimated Earnings
The percentage-of-completion method results in recognizing costs incurred and estimated revenues on uncompleted contracts. Unbilled receivables represent revenues recognized for construction services performed, however not yet billed. Billings in excess of costs and estimated earnings represent billings made in excess of estimated revenues recognized. These billings are deferred until the actual progress towards completion indicates recognition is appropriate. Costs include labor and materials as well as equipment costs related to contract performance.
Property and Equipment
Property and equipment are recorded at cost. Cost includes expenditures for major improvements and replacements that extend useful life. Certain costs of software are capitalized provided those costs are not research and development and certain other criteria are met. Capitalized interest was not significant for the period ended March 31, 2009, $0.3 million for the period ended March 31, 2008 and $0.9 million for 2008. Expenditures for other maintenance and repairs are expensed as incurred. Gains and losses from sales and retirements are included in Other expense (income), net as they occur. Depreciation is calculated using the straight-line method over the economic useful lives of the assets. The estimated useful lives of depreciable assets are generally:
| · | ten to thirty years for buildings and improvements, |
| · | seven to ten years for machinery and fixtures, |
| · | three to ten years for handling and delivery equipment and |
| · | three to ten years for software development costs. |
To improve financial returns, we periodically evaluate our investments in property and equipment. As a result, property and equipment may be consolidated, leased or sold. For continuing operations, we recognized a gain of $5.3 million for the period ended March 31, 2009, $3.4 million for the period ended March 31, 2008 and $3.2 million for 2008 from the sales of property and equipment.
Assets Held for Sale
Assets held for sale are measured at the lower of carrying amount or fair value less costs to sell and are no longer depreciated. These assets are being actively marketed for sale at a price that is reasonable in relation to their carrying amounts. Any gain or loss arising from the sale of these assets is included in Other expense (income), net. Assets held for sale are as follows (thousands):
| | | | | | | |
| Property and equipment | | | | | | |
| Land | | $ | 23,611 | | | $ | 26,211 | |
| Buildings and improvements | | | 17,840 | | | | 20,089 | |
| | | $ | 41,451 | | | $ | 46,300 | |
Long-lived Assets
Long-lived assets such as property, equipment and intangibles with useful lives are evaluated for impairment whenever events and circumstances indicate the carrying amount may not be recoverable. An impairment is recognized if the carrying amount exceeds its fair value and when the carrying amount is not recoverable based on the estimated future operating cash flows on an undiscounted basis.
Derivative Instruments and Hedging Activities
We are exposed to certain risks related to business operations, some of which we may seek to manage with derivative instruments and hedging activities. The primary risk managed with derivative instruments is interest rate risk. Interest rate swap contracts are entered into to manage interest rate risk associated with variable-rate borrowings. These interest rate swap contracts are accounted for as cash flow hedges unless effectiveness is not probable.
The fair value of derivative instruments is based on pricing models using current market rates. The fair value of interest rate swap contracts is recorded as an asset or liability and the effective portion of the gain or loss is recorded as a component of Accumulated other comprehensive (loss) income, net, a separate component of equity, and is subsequently reclassified into Interest expense as interest expense is recognized on the term note. The ineffective portion, if any, of the change in the value of the interest rate swap contracts is immediately recognized as a component of interest expense.
Derivative financial instruments are not utilized to hedge other risks or for speculative or trading purposes.
Revenue Recognition
Revenues for building products are recognized when title to the goods and risk of loss pass to the buyer, which is at the time of delivery. The percentage-of-completion method is used to recognize revenue for construction services. Taxes assessed by governmental authorities that are directly imposed on our revenue-producing transactions are excluded from sales.
Shipping and Handling
Shipping and handling costs for manufactured building components and construction services are included as a component of cost of goods sold. Shipping and handling costs for building products are included as a component of selling, general and administrative expenses and were $10.2 million for the period ended March 31, 2009, $14.6 million for the period ended March 31, 2008 and $57.9 million for 2008.
Reclassifications
Certain reclassifications, none of which affected previously reported consolidated results of operations, cash flows or shareholders’ equity, have been made to amounts reported in prior periods to conform to the current period presentation.
Recent Accounting Principles
In May 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles. This accounting principle identifies a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles (GAAP) for nongovernmental entities. This accounting principle was adopted November 2008 and had no impact on our consolidated financial position, results of operations or cash flows.
In March 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities. This accounting principle enhances disclosure for derivative instruments and hedging activities and their effects on consolidated financial position, results of operations and cash flows. Specifically, enhanced disclosures include objectives and strategies for using derivatives, including underlying risk and accounting designation, as well as fair values, gains and losses. This accounting principle was adopted June 2008 and had no impact on our consolidated financial position, results of operations or cash flows.
In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements. This accounting principle eliminates noncomparable accounting for noncontrolling interests. Specifically, noncontrolling interests are presented as a component of equity; consolidated net income includes amounts attributable to both the parent and noncontrolling interest and is disclosed on the face of the income statement; changes in the ownership interest are accounted for as equity transactions if ownership remains controlling; purchase accounting for acquisitions of noncontrolling interests and acquisitions of additional interests is eliminated; and deconsolidated controlling interests are recognized based on fair value consistent with Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations. The accounting requirements were adopted January 2009 and had no impact on our consolidated financial position, results of operations or cash flows.
In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations. This accounting principle requires acquisition accounting (purchase accounting) be applied to all business combinations in which control is obtained regardless of consideration and for an acquirer to be identified for each business combination. Additionally, this accounting principle requires acquisition-related costs and restructuring costs at the date of acquisition to be expensed rather than allocated to the assets acquired and the liabilities assumed; noncontrolling interests, including goodwill, to be recorded at fair value at the acquisition date; recognition of the fair value of assets and liabilities arising from contingent consideration (payments conditioned on the outcome of future events) at the acquisition date; recognition of bargain purchase (acquisition-date fair value exceeds consideration plus any noncontrolling interest) as a gain; and recognition of changes in deferred taxes. This accounting principle was adopted January 2009 and had no impact on our consolidated financial position, results of operations or cash flows.
2. Restructuring
In May 2008, we initiated a comprehensive analysis of our businesses operations to improve cash flow and profitability as well as rationalize our operations for the current conditions of the homebuilding industry. The plan places a priority on positive cash flow, efficient use of capital and higher returns and focuses on closing or consolidating business units in underperforming markets as well as improving business processes. The results of the plan were as follows:
| | · | for the period ended March 31, 2009: |
| | § | closed 6 business units and |
| | § | consolidated 1 business unit with other business units. |
| | · | for the period ended March 31, 2008: |
| | § | no restructuring activity as the plan was not initiated until May 2008. |
| | § | closed 42 business units, |
| | § | consolidated 15 business units with other business units and |
| | § | consolidated administrative functions of information systems, reporting, accounts payable and human resources. |
Our restructuring plans do not include formal severance plans for employees affected by the closures and consolidations of business units or enhancements to administrative functions.
As of March 31, 2009, the estimated cumulative charges expected to be incurred and recognized in (loss) from continuing operations and resulting liability were as follows (thousands):
| | | Impairment of assets | | | Operating lease obligations | | | Total | |
| Estimated charges | | $ | 8,967 | | | $ | 11,387 | | | $ | 20,354 | |
| Changes in estimates, net | | | — | | | | (753 | ) | | | (753 | ) |
| Cash payments | | | — | | | | (535 | ) | | | (535 | ) |
| Non-cash charges | | | (8,967 | ) | | | (3,051 | ) | | | (12,018 | ) |
| | | $ | — | | | $ | 7,048 | | | $ | 7,048 | |
Impairments of assets were determined based on available market data and are recognized in Impairment of assets. Operating lease obligations represent the present value of contractual rental payments offset by estimated sublease income and are recognized in Selling, general and administrative expenses. The liability for restructuring is recorded in the consolidated balance sheet as follows:
| | · | $4.1 million in Other accrued liabilities and $2.9 million in Other long-term liabilities as of March 31, 2009 and |
| | · | $5.6 million in Other accrued liabilities and $4.0 million in Other long-term liabilities as of December 31, 2008. |
Activity related to restructuring plans and the resulting liability were as follows (thousands):
| | | Three Months Ended March 31, 2009 | | | | |
| | | Impairment of assets | | | Operating lease obligations | | | Total | |
| Balance at beginning of period | | $ | — | | | $ | 9,644 | | | $ | 9,644 | |
| Estimated charges | | | 365 | | | | — | | | | 365 | |
| Change in estimates, net | | | — | | | | (753 | ) | | | (753 | ) |
| Cash payments | | | — | | | | (145 | ) | | | (145 | ) |
| Non-cash charges | | | (365 | ) | | | (1,698 | ) | | | (2,063 | ) |
| | | $ | — | | | $ | 7,048 | | | $ | 7,048 | |
| | | Year Ended December 31, 2008 | | | | |
| | | Impairment of assets | | | Operating lease obligations | | | Total | |
| Balance at beginning of period | | $ | — | | | $ | — | | | $ | — | |
| Estimated charges | | | 8,602 | | | | 11,387 | | | | 19,989 | |
| Change in estimates, net | | | — | | | | — | | | | — | |
| Cash payments | | | — | | | | (390 | ) | | | (390 | ) |
| Non-cash charges | | | (8,602 | ) | | | (1,353 | ) | | | (9,955 | ) |
| | | $ | — | | | $ | 9,644 | | | $ | 9,644 | |
Due to uncertainties in the markets of certain business units and inherent in the estimation process, it is possible the actual costs of restructuring may vary from estimates. Revisions of these costs are recognized in the period such revisions are known.
3. Impairment of Assets
Long-lived assets such as property, equipment and intangibles are evaluated for impairment whenever events and circumstances indicate the carrying amount may not be recoverable. An impairment for these assets is recognized if the carrying amount exceeds their fair value and when the carrying amount is not recoverable based on the estimated future operating cash flows on an undiscounted basis.
Similarly, goodwill is evaluated for impairment in the fourth quarter and whenever events and circumstances indicate the carrying amount may not be recoverable. An impairment for goodwill is recognized if the carrying amount is more than the estimated future operating cash flows as measured by fair value techniques.
As a result of our ongoing evaluations of underperforming business units, certain property and equipment specific to these business units were identified as impaired. Impairments recognized in loss from continuing operations were as follows:
| | · | for the period ended March 31, 2009: |
| | § | $0.4 million for certain property and equipment held for sale. |
During the later portion of the fourth quarter of 2008, the leading sources of economic and housing data forecasted deeper reductions in estimated housing starts. Market factors as well as developing regulatory efforts to revive historically low housing starts have been further complicated by the weakening economic conditions of rising unemployment and pessimistic consumer confidence stemming from tightened lending standards and losses in home values and investments. Similarly, tightened lending conditions have impacted the liquidity of our customers.
For impairment testing of customer relationships and covenants not to compete, the carrying amounts exceeded the estimated future operating cash flows on an undiscounted basis. The impairment testing for goodwill indicated the carrying amount exceeded our estimate of enterprise value. Impairments recognized in loss from continuing operations were as follows:
| | · | for the period ended March 31, 2008: |
| | § | no impairments were recognized. |
| | § | $30.2 million for certain customer relationships and covenants not to compete, |
| | § | $14.2 million for goodwill, |
| | § | $6.3 million for certain property and equipment held for sale and |
| | § | $2.3 million for leasehold improvements. |
4. Discontinued Operations
The results of operations and financial position of discontinued operations are separately reported for all periods presented as a result of the following transactions:
| | · | In June 2008, we discontinued concrete block masonry, concrete services and truss manufacturing in Florida. These business units represented approximately 6% of sales. |
| | · | In March 2008, we discontinued framing services in Virginia. This business unit represented less than 1% of sales. |
Assets, liabilities, sales and loss after related income tax expense (benefit) for these operations are separately reported from continuing operations and were as follows (thousands):
| | | March 31 | | | December 31 | |
| | | 2009 | | | 2008 | |
| Assets | | $ | 5,073 | | | $ | 5,659 | |
| Liabilities | | $ | 502 | | | $ | 773 | |
| | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| Sales | | | | | | | | | |
| Building products | | $ | — | | | $ | 485 | | | $ | 2,021 | |
| Construction services | | $ | 17 | | | $ | 12,206 | | | $ | 38,624 | |
| | | | | | | | | | | | | |
| Loss from discontinued operations | | $ | (152 | ) | | $ | (57 | ) | | $ | (22,353 | ) |
5. Net Loss Per Share
Net loss per share was determined using the following information (thousands, except per share data):
| | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| Loss from continuing operations | | $ | (45,068 | ) | | $ | (33,804 | ) | | $ | (192,456 | ) |
| Loss from discontinued operations | | | (152 | ) | | | (57 | ) | | | (22,353 | ) |
Net loss attributable to common shareholders | | $ | (45,220 | ) | | $ | (33,861 | ) | | $ | (214,809 | ) |
| | | | | | | | | | | | | |
| Weighted average shares - basic | | | 29,508 | | | | 28,972 | | | | 29,081 | |
| Effect of dilutive: | | | | | | | | | | | | |
| Share options | | | — | | | | — | | | | — | |
| Restricted shares | | | — | | | | — | | | | — | |
| Warrants | | | — | | | | — | | | | — | |
Weighted average shares - assuming dilution | | | 29,508 | | | | 28,972 | | | | 29,081 | |
| | | | | | | | | | | | | |
| Net loss per share: | | | | | | | | | | | | |
| Continuing operations | | $ | (1.53 | ) | | $ | (1.17 | ) | | $ | (6.62 | ) |
| Discontinued operations | | | — | | | | — | | | | (0.77 | ) |
| Basic | | $ | (1.53 | ) | | $ | (1.17 | ) | | $ | (7.39 | ) |
| | | | | | | | | | | | | |
| Continuing operations | | $ | (1.53 | ) | | $ | (1.17 | ) | | $ | (6.62 | ) |
| Discontinued operations | | | — | | | | — | | | | (0.77 | ) |
| Diluted | | $ | (1.53 | ) | | $ | (1.17 | ) | | $ | (7.39 | ) |
| | | | | | | | | | | | | |
| Cash dividends declared per share | | $ | — | | | $ | — | | | $ | — | |
Potential common shares for options, restricted shares and warrants are generally excluded from the computation of diluted net loss per share if there is a loss from continuing operations for the period. Additionally, certain share options, restricted shares and warrants are excluded from the computation of diluted net loss per share:
| | · | options and warrants with exercise prices greater than the average market value of the common shares (out-of-the-money) and |
| | · | unrecognized compensation expense for restricted shares with after-tax proceeds greater than the average market value of the common shares. |
Options, restricted shares and warrants excluded from the computation of diluted net loss per share will change based on additional grants as well as the average market value of the common shares for the period. These options, restricted shares and warrants that are not dilutive and therefore excluded from the computation of diluted net loss per share were as follows (thousands, except share price data):
| | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| Average market value of shares | | | $0.38 | | | | $5 | | | | $3 | |
| Share options: | | | | | | | | | | | | |
| Exercise price range | | | $5 to $38 | | | | $5 to $38 | | | | $5 to $38 | |
| Not dilutive | | | 2,472 | | | | 2,964 | | | | 2,627 | |
| Restricted shares: | | | | | | | | | | | | |
| Grant price range | | | $15 to $18 | | | | $14 to $42 | | | | $15 to $38 | |
| Not dilutive | | | 103 | | | | 297 | | | | 214 | |
| Warrants: | | | | | | | | | | | | |
| Exercise price | | | $0.47 | | | | — | | | | $0.47 | |
| Not dilutive | | | 2,825 | | | | — | | | | 2,825 | |
6. Noncontrolling Interests
Noncontrolling interests reflects the other owners’ proportionate share in the assets and liabilities of business ventures as of the date of purchase, adjusted by the proportionate share of post-acquisition income or loss. As the operating results of entities with noncontrolling interests are consolidated, noncontrolling interests loss represents the loss attributable to the other owners.
| | · | In June 2008, we acquired the remaining 40% interest in SelectBuild Mechanical for $0.2 million in cash. In October 2004, we formed this venture for an initial 60% interest for $0.3 million in cash. SelectBuild Mechanical provides heating, ventilation and air conditioning services in Las Vegas, Nevada. |
| | · | In January 2008, we were required to purchase the remaining 49% interest in SelectBuild Illinois (RCI Construction) for $8.3 million in cash of which $2.4 million was paid in January 2008 and $5.9 million was paid in July 2008. The fair value of SelectBuild Illinois did not exceed its net book value. As a result, the $5.5 million excess of the purchase price for the noncontrolling interest over the recorded amount for the noncontrolling interest in SelectBuild Illinois was recognized as an expense in Other income, net in December 2007. In January 2005, we acquired an initial 51% interest for $4.9 million in cash. SelectBuild Illinois provides framing services to production homebuilders in the greater Chicago area. |
Assets and liabilities acquired in acquisitions, including payments of amounts retained for settlement periods, were as follows (thousands):
| | | March 31 | December 31 | | | | March 31 | December 31 | |
| | | 2009 | | 2008 | | | | 2009 | | 2008 | |
| Receivables | | $ | — | | | $ | — | | Other accrued liabilities | | $ | — | | | $ | (47 | ) |
| Prepaid expenses and other | | | — | | | | — | | | | | | | | | | |
| Current assets | | | — | | | | — | | Current liabilities | | | — | | | | (47 | ) |
| | | | | | | | | | | | | | | | | | |
| Property and equipment | | | — | | | | — | | Deferred income taxes | | | — | | | | — | |
| Other intangibles, net | | | — | | | | — | | Noncontrolling interests | | | — | | | | (8,528 | ) |
| Goodwill | | | — | | | | — | | | | | | | | | | |
| | | $ | — | | | $ | — | | | | $ | — | | | $ | (8,575 | ) |
7. Intangible Assets and Goodwill
Intangible assets represent the values assigned to customer relationships, covenants not to compete, trade names and favorable leases. Intangible assets are amortized on a straight-line basis over their expected useful lives. Customer relationships are amortized over 7 years and covenants not to compete over 3 years. Amortization expense for intangible assets was $0.8 million for the period ended March 31, 2009, $2.4 million for the period ended March 31, 2008 and $8.9 million for 2008. Intangible assets consist of the following (thousands):
| | March 31, 2009 | |
| | Gross Carrying Amount | | Accumulated Amortization | | Net Carrying Amount | |
| Customer relationships | | $ | 25,300 | | | $ | (7,730 | ) | | $ | 17,570 | |
| Covenants not to compete | | | 1,900 | | | | (1,045 | ) | | | 855 | |
| | | $ | 27,200 | | | $ | (8,775 | ) | | $ | 18,425 | |
| | | December 31, 2008 | |
| | | Gross Carrying Amount | | | Accumulated Amortization | | | Net Carrying Amount | |
| Customer relationships | | $ | 29,074 | | | $ | (10,802 | ) | | $ | 18,272 | |
| Covenants not to compete | | | 4,089 | | | | (3,139 | ) | | | 950 | |
| Favorable leases | | | 382 | | | | (382 | ) | | | — | |
| | | $ | 33,545 | | | $ | (14,323 | ) | | $ | 19,222 | |
Estimated amortization expense for intangible assets is $2.4 million for the remainder of 2009, $3.2 million for 2010, $3.0 million for 2011, $2.8 million for 2012, $2.8 million for 2013 and $4.2 million thereafter.
Goodwill represents the excess of the purchase price over the fair value of net tangible and identifiable intangible assets of acquired businesses. Adjustments to amounts previously reported as goodwill may occur as a result of completing the purchase price allocation to the assets acquired, including intangible assets, and liabilities assumed based on their estimated fair values at the date of acquisition.
An annual assessment for impairment is completed in the fourth quarter and whenever events and circumstances indicate the carrying amount may not be recoverable. An impairment is recognized at the reporting unit if the carrying amount is more than the estimated future operating cash flows as measured by fair value techniques.
Changes in the carrying amount of goodwill were as follows:
| | | Three Months Ended | | | Year Ended | |
| | | March 31 | | | December 31 | |
| | | 2009 | | 2008 | | | 2008 | |
| Balance at beginning of period | | $ | — | | | $ | 14,196 | | | $ | 14,196 | |
| Impairment | | | — | | | | — | | | | (14,196 | ) |
| | | $ | — | | | $ | 14,196 | | | $ | — | |
While goodwill is tested for impairment annually and not amortized for financial statement purposes, goodwill may be deductible for income tax purposes. Certain goodwill is non-deductible. Changes to non-deductible goodwill were as follows (thousands):
| | | Three Months Ended | | | Year Ended | |
| | | March 31 | | | December 31 | |
| | | 2009 | | 2008 | | | 2008 | |
| Balance at beginning of period | | $ | — | | | $ | 3,460 | | | $ | 3,460 | |
| Impairment | | | — | | | | — | | | | (3,460 | ) |
| | | $ | — | | | $ | 3,460 | | | $ | — | |
8. Debt
Long-term debt consists of the following (thousands):
As of March 31, 2009 | | | | | | Notional | | | Effective Interest Rate | |
| | | Balance | | Stated Interest Rate | | Amount of Interest Rate Swaps | | | Average for Quarter | | | As of March 31 | |
| Revolver | | $ | 2,300 | | LIBOR (minimum of 3%) plus 5.25% OR Prime plus 3.25% and 0.50% commitment fee | | $ | — | | | | 7.0 | % | | | 7.0 | % |
| Term note | | | 313,773 | | LIBOR (minimum of 3%) plus 5.25% OR Prime plus 3.25% | | | 123,019 | | | | 11.5 | % | | | 11.5 | % |
| Other | | | 1,275 | | Various | | | — | | | | — | | | | — | |
| | | | 317,348 | | | | $ | 123,019 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| Less: Current portion | | | 316,309 | | | | | | | | | | | | | | |
Less: Unamortized discount | | | 658 | | | | | | | | | | | | | | |
| | | $ | 381 | | | | | | | | | | | | | | |
| As of December 31, 2008 | | | | | | Notional | | | Effective Interest Rate | |
| | | Balance | | Stated Interest Rate | | Amount of Interest Rate Swaps | | | Average for Year | | | As of December 31 | |
| Revolver | | $ | — | | LIBOR (minimum of 3%) plus 5.25% OR Prime plus 3.25% and 0.50% commitment fee | | $ | — | | | | 12.9 | % | | | n/a | |
| Term note | | | 325,759 | | LIBOR (minimum of 3%) plus 5.25% OR Prime plus 3.25% | | | 135,124 | | | | 9.6 | % | | | 11.5 | % |
| Other | | | 1,412 | | Various | | | — | | | | — | | | | — | |
| | | | 327,171 | | | | $ | 135,124 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | |
| Less: Current portion | | | 39,443 | | | | | | | | | | | | | | |
Less: Unamortized discount | | | 719 | | | | | | | | | | | | | | |
| | | $ | 287,009 | | | | | | | | | | | | | | |
In September 2008, we entered into an amendment to our credit agreement with our lenders. The amended credit facility continues to provide a $200 million revolver subject to borrowing base limitations and a $340 million term note maturing in November 2011. However, the April 2009 limited waiver limits borrowings under the revolver to $20 million and may not provide adequate liquidity.
The $200 million revolver is subject to borrowing base limitations and matures in November 2011. The revolver may consist of both LIBOR and Prime based borrowings. In the September 2008 amendment, the variable interest rate for the revolver was increased to LIBOR plus 5.25% or Prime plus 3.25%. Minimum LIBOR interest is 3.0%. Additionally, a commitment fee for the unused portion is 0.50%. LIBOR interest is paid quarterly and Prime interest is paid monthly. As of March 31, 2009, $2.3 million was outstanding under the revolver.
The effective interest rate is based on interest rates for the period as well as the commitment fee for the unused portion of the revolver.
Letters of credit outstanding that guaranteed performance or payment to third parties were $109.0 million as of March 31, 2009. These letters of credit reduce the $200 million revolver commitment.
Total availability under the revolver is subject to a monthly borrowing base calculation that includes:
| | · | 70% of certain accounts receivable, |
| | · | 50% of certain inventory, |
| | · | 25% of certain other inventory, |
| | · | approximately 75% of the appraised value of certain property and equipment and |
| | · | 50% of the appraised value of real estate. |
As of March 31, 2009, the unused borrowing base under the revolver was $49.2 million, however the April 2009 limited waiver limits borrowings under the revolver to $20 million.
The term note matures in November 2011 and is payable in quarterly installments of $0.9 million with the remaining principal of $270.0 million payable in November 2011. In the September 2008 amendment, the variable interest rate for the term note was increased to LIBOR plus 5.25% or Prime plus 3.25%. Minimum LIBOR interest is 3.0%. LIBOR interest is paid quarterly and Prime interest is paid monthly. In addition to the LIBOR and Prime interest rates, the term note includes an additional annual payment-in-kind interest or fee of 2.75% that is payable on the earlier of payoff or maturity. As of March 31, 2009, $313.8 million was outstanding under this term note.
Other long-term debt consists of term notes, equipment notes and capital leases for equipment. Interest rates vary and dates of maturity are through March 2021. As of March 31, 2009, other long-term debt was $1.3 million.
Covenants and Maturities
Our credit agreement requires monthly compliance with financial covenants, including minimum liquidity and adjusted earnings before interest, taxes, depreciation and amortization (monthly Adjusted EBITDA). Operating results, particularly income from continuing operations, are a primary factor for these covenants, and our ability to comply with these covenants depends on our operating performance. Lack of compliance with these covenants would constitute an event of default under the credit agreement which, absent any waiver, forbearance or modification, would enable the lenders under our credit agreement to cause all amounts borrowed to become due and payable immediately and to prohibit further borrowings by us under the revolver.
Based on financial information for February 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. In March 2009, we obtained a limited waiver through April 15, 2009 for lack of compliance with the monthly Adjusted EBITDA requirement and we preserved access to limited liquidity permitting us to borrow up to $20 million under the revolver. Previously, we had obtained waivers for financial covenants due to lower than planned operating performance as of both June 2008 and December 2007.
Due to the difficulty of reliably projecting our operating results within the depressed business conditions of the homebuilding industry, we believe that it is likely that we will not be able to meet the financial covenants of our credit agreement during 2009. Also, our independent registered public accounting firm included a going concern explanatory paragraph in their report on our financial statements for 2008, citing among other things, the uncertainty that we would remain in compliance with these financial covenants. The going concern explanatory paragraph constitutes a default under our credit agreement. In April 2009, we obtained a waiver for the going concern explanatory paragraph.
In April 2009, our lenders also agreed to extend the limited waiver through June 1, 2009. In May 2009, the limited waiver was extended through June 29, 2009. This limited waiver continues to waive compliance with the monthly Adjusted EBITDA, forecast and projection requirements of our credit agreement. The limited waiver limits borrowings under the revolver to $20 million and limits capital expenditures to $0.1 millionfrom the date of the extended limited waiver. Lenders approving each of the March, April and May 2009 limited waivers were paid a fee of 0.10% of their revolver commitment and their portion of the outstanding principal amount of the term note.
For March 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. Additionally, as the limited waiver for these financial covenants is less than a year, it is probable we will not be in compliance with these financial covenants within the next year and given there is no amendment or other financing agreement currently in place, the revolver and term note are classified as a current liability in the consolidated balance sheet.
We are anticipating tax refunds of $56 million as a result of net operating losses for 2008. These refunds will be applied to reduce the amount outstanding under our term loan facility to approximately $275 million. The remaining portion of the tax refund will be available for working capital needs after payment of any borrowings under the revolver. We filed for our federal tax refund in April 2009 and our professional advisors have advised us that receipt of the refund is anticipated in mid- to late May 2009.
We are currently negotiating with our lenders to develop debt and capital structures to support our long-term strategic plan and business objectives. We expect that these negotiations may lead to a bankruptcy filing which we anticipate would reflect the agreement of our lenders and would provide for the payment in full of all amounts owing to key vendors and the uninterrupted supply of goods and services to our customers. Equity holders may be substantially diluted or be eliminated in a bankruptcy filing.
There can be no assurance these negotiations will result in debt and capital structures acceptable to us and the lenders or an agreement that would achieve our goals. If these negotiations fail, we would not be able to continue as a going concern and would be forced to seek relief through bankruptcy filing without an agreement of our lenders. We also continue to pursue alternative financing arrangements as well as evaluate other financing options.
If our leverage ratio is at or above a certain maximum as of September 30, 2010, the monthly Adjusted EBITDA may be replaced with quarterly compliance with a leverage ratio and interest coverage ratio. Operating results, particularly income from continuing operations, are a primary factor for these covenants and our ability to comply with these covenants depends on our operating performance. The significant downturn in single-family housing starts has negatively impacted and may continue to negatively impact our operating performance.
The credit agreement requires certain proceeds and cash flows be applied to the credit facility as follows:
| | § | cash in excess of $25 million. |
| | § | proceeds from certain dispositions, |
| | § | 75% of excess cash flow as defined beginning in 2010. |
Proceeds from tax refunds and certain dispositions are retained in a separate cash account. Cash in excess of $25 million in this separate cash account is to be applied to the revolver or term note. There was no amount in this separate cash account as of March 31, 2009. In the event of default, this cash is restricted and not available for our operating needs.
The amended credit facility continues to restrict our ability to incur additional indebtedness, pay dividends, repurchase shares, enter into mergers or acquisitions, use proceeds from equity offerings, make capital expenditures and sell assets. The amended credit facility is secured by all assets of our wholly-owned subsidiaries.
In connection with the September 2008 amendment, 100% or $2.8 million of unamortized deferred loan costs related to the term note were recognized as interest expense in the third quarter of 2008. We also incurred $3.8 million of costs in connection with the amendment and $2.0 million of these costs will be amortized over the remaining term of the credit facility whereas $1.8 million of these costs were recognized as interest expense in the third quarter of 2008.
In connection with the February 2008 amendment, 60% or $2.4 million of unamortized deferred loan costs related to the previous revolver were recognized as interest expense in the first quarter of 2008. We also incurred $4.9 million of fees in connection with the amendment and these costs were to be amortized over the remaining term of our credit facility. However, in connection with the September 2008 amendment, the remaining $2.6 million of these unamortized costs were recognized as interest expense in the third quarter of 2008.
Scheduled maturities of long-term debt are as follows (thousands):
| 2009 | | $ | 316,246 | |
| 2010 | | | 223 | |
| 2011 | | | 66 | |
| 2012 | | | 65 | |
| 2013 | | | 70 | |
| Thereafter | | | 678 | |
| | | $ | 317,348 | |
Warrants
In connection with the amendment of our credit facility in September 2008, we issued warrants that entitle the lenders to purchase approximately 8.75% or 2.8 million of our common shares at a purchase price of $0.47 per common share, the closing price on the NYSE on September 30, 2008. These warrants may be exercised through September 2015.
The fair value of the warrants of $0.8 million was recorded as a discount on the term note. Amortization of the discount will be recognized ratably through November 2011, the remaining term of our credit facility.
Hedging Activities
In addition to the amendment to our credit facility in September 2008, we amended our interest rate swap contracts to lower amounts and a maturity matching the credit facility. As of March 2009, the interest rate swap contracts effectively converted $123.0 million of variable rate borrowings to a fixed interest rate of 10.6% plus any difference between minimum LIBOR interest of 3.0% and LIBOR, thus reducing the impact of increases in interest rates on future interest expense. Additionally, the notional amount of the interest rate swap contracts will be ratably reduced to zero through the maturity of November 2011.
As of March 2009, approximately 39% of the outstanding variable rate borrowings have been hedged with these interest rate swap contracts. After giving effect to the interest rate swap contracts, total borrowings were 61% variable and 39% fixed. The fair value of the interest rate swap contracts was a liability of $6.4 million as of March 31, 2009. Management may choose not to swap variable rates to fixed rates or may terminate a previously executed swap if the variable rate positions are more beneficial.
Hedge accounting was discontinued in January 2009, as it is not probable future LIBOR interest rates for the remaining term of the interest rate swap contracts will be at or above the minimum LIBOR interest of 3.0% of the term note. In September 2008, we amended our interest rate swap contracts. Monthly settlements are made to ratably reduce the notional amount of the interest rate swap contracts through November 2011. As a result, the following amounts were recognized as Interest expense:
| | · | $0.1 million for the period ended March 31, 2009 for an increase in the fair value of the interest rate swap contracts rather than recorded in Accumulated other comprehensive loss, net, a component of equity. This increase in the fair value was after $1.2 million of notional reduction settlement payments for the period ended March 31, 2009. There were no notional reduction settlement payments for the period ended March 31, 2008. |
| | · | $0.4 million for the period ended March 31, 2009 for amortization of unrealized loss due to increases in fair value of interest rate swap contracts previously accounted for as a cash flow hedge and recorded in Accumulated other comprehensive loss, net. The remaining unrealized loss of $4.1 million in Accumulated other comprehensive loss, net as of March 31, 2009 will be subsequently amortized to Interest expense over the remaining term of our term note. |
| | · | $0.2 million for the period ended March 31, 2009 and $0.9 million for 2008 for amortization of the notional reduction settlement payments previously accounted for as a cash flow hedge and recorded in Accumulated other comprehensive loss, net. The remaining unrealized loss of $2.7 million for notional reduction settlement payments previously accounting for cash flow hedged for 2008 recorded in Accumulated other comprehensive loss, net as of March 31, 2009 will be subsequently amortized to Interest expense over the remaining term of our term note. |
In December 2008, we determined the interest rate swap contracts were not an effective hedge of variable interest due to the recent significant reductions in LIBOR interest rates. As a result of the estimated difference between the LIBOR interest of the interest rate swap contracts and the minimum LIBOR interest of 3.0% of the term note, we recognized $3.0 million of interest expense for the ineffective portion of these interest rate swap contracts for 2008. The effective portion of the interest rate swap contracts of $4.5 million was recorded as an unrealized loss and an unrealized tax benefit of $1.7 million in Accumulated other comprehensive loss, net, a component of equity. A corresponding deferred tax asset for the unrealized tax benefit was eliminated with a valuation allowance as there may be an inability to utilize this deferred tax asset. The remaining unrealized loss of $4.1 million in Accumulated other comprehensive loss, net as of March 31, 2009 will be subsequently amortized to Interest expense over the remaining term of our term note.
The fair value and gains and losses on interest rate swap contracts are as follows (thousands):
| | March 31 | | December 31 | |
| | 2009 | | 2008 | |
| | Balance Sheet | Fair | | Balance Sheet | Fair | |
| | Classification | Value | | Classification | Value | |
| Interest rate swap contracts – | | | | | | | | |
| not designated as cash flow hedge | Other long-term | | | | | | | |
| | liabilities | | $ | 6,411 | | | | $ | — | |
Interest rate swap contracts – designated as cash flow hedge | | | | | | Other long-term | | | | |
| | | | $ | — | | liabilities | | $ | 7,514 | |
The effect of interest rate swap contracts on the consolidated statement of operations is as follows (thousands):
| | Gain (Loss) Recognized in Accumulated Other Comprehensive Loss, Net | |
| | Three Months Ended March 31 | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| Unrealized (loss) gain | | $ | — | | | $ | (8,419 | ) | | $ | 226 | |
| | | Loss Reclassified from Accumulated Other Comprehensive Loss, Net to Interest Expense | |
| | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| Effective cash flow hedge | | | | | | | | | | | | |
| Interest rate swap contracts – active | | | | | | | | | | | | |
| Amortization of unrealized loss | | $ | 384 | | | $ | — | | | $ | — | |
| Interest rate swap contracts – terminated | | | | | | | | | | | | |
| Notional reduction settlement payments | | | | | | | | | | | | |
| Amortization of payments | | | 250 | | | | — | | | | 926 | |
| | | | | | | | | | | | | |
| Ineffective cash flow hedge | | | | | | | | | | | | |
Interest rate swap contracts – active Ineffective portion | | | — | | | | — | | | | 3,022 | |
| | | $ | 634 | | | $ | — | | | $ | 3,948 | |
9. Shareholders’ (Deficit) Equity
Preferred Shares
We are authorized to issue 2 million preferred shares, however none of these shares are issued. Under the terms of our Restated Certificate of Incorporation, the Board of Directors is authorized to determine or alter the rights, preferences, privileges and restrictions of the preferred shares.
Common Shares
Our common shares have a par value of $0.001. We have 50 million shares authorized, of which 29.7 million are issued and outstanding as of March 31, 2009.
Of the unissued shares, 6.0 million shares were reserved for the following:
| Employee Stock Purchase Plan | 1.3 million |
| 2008 Stock Incentive Plan | 1.9 million |
| Warrants | 2.8 million |
Warrants
In connection with the amendment of our credit facility in September 2008, we issued warrants that entitle the lenders to purchase approximately 8.75% or 2.8 million of our common shares at a purchase price of $0.47 per common share, the closing price on the NYSE on September 30, 2008. These warrants may be exercised through September 2015.
The fair value of these warrants was estimated on the date of grant using the modified Black-Scholes-Merton model. The following table presents the assumptions used in the valuation and the resulting fair value as of the date of grant:
| Expected term (years) | | | 5.5 | |
| Expected volatility | | | 64.6 | % |
| Expected dividend yield | | | 0.0 | % |
| Risk-free interest rate | | | 3.0 | % |
| Exercise price | | | $0.47 | |
| Weighted average fair value | | | $0.28 | |
These assumptions to determine fair value are based principally on historical experience. Due to uncertainties inherent in these assumptions, it is possible that actual value received by the warrant holders may vary from the estimate of the fair value of these warrants.
The fair value of the warrants of $0.8 million was recorded as a discount on our term note. Amortization of the discount will be recognized ratably through November 2011, the remaining term of our credit facility.
No warrants have been exercised and all 2.8 million warrants are outstanding and exercisable as of March 31, 2009. Warrants exercised are settled with newly issued common shares. The common shares for warrants are not included in the calculation of basic income per share until exercised, however the common shares for warrants may be included in the calculation of diluted income per share.
Dividends
Cash dividends per common share were as follows:
| | | 2009 | | | 2008 | |
| First quarter | | $ | — | | | $ | — | |
| Second quarter | | | — | | | | — | |
| Third quarter | | | — | | | | — | |
| Fourth quarter | | | — | | | | — | |
| | | $ | — | | | $ | — | |
Our credit facility, amended in September 2008, prohibits the payment of cash dividends on our common shares. The determination of future dividend payments (cash or shares) will depend on many factors, including credit facility restrictions, financial position, results of operations and cash flows.
Our credit facility, amended in September 2008, prohibits the repurchase of our common shares. The determination of future share repurchases will depend on many factors, including credit facility restrictions, financial position, results of operations and cash flows.
10. Employee Benefit Plans
Retirement Plans
· Savings and Retirement Plan
We provide a savings and retirement plan for salaried and certain hourly employees whereby eligible employees may contribute a percentage of their earnings to a trust. Participants may defer up to 75% of their eligible compensation (base salary, annual incentive and long-term incentives) subject to the limitations imposed under the Internal Revenue Code.
Prior to 2009, our matching contributions ranged from 25% of the first 4% to 50% of the first 6% of the participant’s contribution. Matching contributions are established at the discretion of the Compensation Committee of our Board of Directors in the first quarter. Vesting in matching contributions occurs at the rate of 20% per year of service, upon reaching normal or early retirement date, or upon death, disability or certain other circumstances. Matching contributions were temporarily suspended for 2009 and matching contributions of $1.0 million for the period ended March 31, 2008 and $2.9 million for 2008 were made to the trusts based on a percentage of the contributions made by participants.
Participants may direct their contributions and matching contributions through any of the investment options offered, including self-directed brokerage accounts. Investment options are reviewed and may be revised quarterly by an Investment Committee comprised of management and advised by consultants.
· Executive Deferred Compensation
We previously provided a deferred compensation plan for directors, executives and key employees. The objective of the plan was to provide executives and key employees with an additional opportunity to save for their retirement. Executive and key employee participants could defer up to 80% of their eligible compensation (base salary, annual incentive and medium term incentives). Director participants could defer 100% of their compensation. Effective January 2009, the plan was suspended and no participant contributions or matching contributions will be made.
There are no minimum or guaranteed returns. Participants may elect distribution upon reaching a specific age, number of years or separation of service. Distributions may be a lump sum payment or monthly installments over 5 to 10 years.
Matching contributions were the same as the savings and retirement plan matching contribution percentage. Matching contributions were established at the discretion of the Compensation Committee of our Board of Directors in the first quarter. There were no matching contributions for the period ended March 31, 2009 and matching contributions of less than $0.1 million for the period ended March 31, 2008 and $0.1 million for 2008 were made to the trust based on a percentage of the contributions made by participants.
Investments of the deferred compensation plan are held in a custodial account and the assets are subject to the claims of general creditors. Participants may elect to invest their deferred compensation through any of the investment options offered, including our common shares. Investment options are reviewed and may be revised quarterly by an Investment Committee comprised of management and advised by consultants.
| | · | Compensation deferred and invested in third-party investment options is recorded in Other long-term assets and Other long-term liabilities. As the obligation is settled for the value of the underlying investments, changes in the fair value of the investments are recognized in Other income and changes in the fair value of the liability are recognized in Selling, general and administrative expenses. Fair value is based on market quotes. The fair value of these investments was $1.3 million at March 31, 2009 and $4.0 million at December 31, 2008. |
| | · | Compensation deferred and invested in our common shares is recorded as a component of shareholders’ equity. As the obligation is settled for the fixed number of common shares purchased, changes in fair value are not recognized. Rather, purchases and distributions of the common shares are recorded at historical cost. The historical cost of these common shares was $0.1 million or 15,116 common shares at March 31, 2009 and $0.9 million or 107,757 common shares at December 31, 2008. |
· Supplemental Retirement
Additionally, there is a supplemental retirement plan for executives and key employees. The objective of the plan is to provide a supplemental retirement benefit that enables participants to retire at age 65 with 30 years of service at an income level of at least 60% of pre-retirement base salary after considering deferred compensation, predecessor retirement and social security benefits. Effective January 2009, the plan was suspended as no contributions or return will be made to participants except the contribution and return required for the employment agreements of certain executives and no new participants will be added to the plan.
Contributions have typically been 5.5% of net income. Contributions are allocated proportionately to participants based on their base salaries and limited to 30% of a participant’s base salary.
| | · | 65% of the contributions are invested in company-owned life insurance polices for certain participants. |
| | · | 35% of the contributions are made in our common shares and distributed to the savings and retirement plans of certain participants. |
Active participants invested in company-owned life insurance policies receive a return based on long-term corporate bond yields. This return has been approximately 6% and may vary based on changes to this yield. Inactive participants receive a return of 0% to 9% based on their years of service and payment elections. Participants receiving our common shares receive a return of any related dividend.
Contributions and the return are established at the discretion of the Compensation Committee of our Board of Directors in the first quarter. Participants are immediately vested in the contribution.
The Compensation Committee decided to make:
| | · | no contribution or return to participants and no contribution or return was required for the employment agreements of certain executives for the period ended March 31, 2009. |
| | · | no contribution or return to participants and no contribution or return was required for the employment agreements of certain executives for the period ended March 31, 2008. |
| | · | no contributions or return to participants and no contribution or return was required for the employment agreements of certain executives for 2008. |
The cash surrender value of the company-owned life insurance policies approximates the obligation, however the returns, if any, are not fully funded as these returns are dependent upon years of service and payment elections. These life insurance policies fund the obligation to the participants or their beneficiaries over a 5, 10 or 15-year period.
· Management Retention Compensation
In February 2008, the Compensation Committee of our Board of Directors approved management retention agreements for certain executives and key employees. Participants receive common share equivalent units which may be exchanged for the market value of those shares upon vesting two years from the date of grant. Compensation expense recognized for these agreements was not significant for the period ended March 31, 2009, for the period ended March 31, 2008 and for 2008.
Employee Stock Purchase Plan
In February 2008, our Board of Directors adopted the Employee Stock Purchase Plan, as approved by our shareholders in May 2008. The plan amended an employee share purchase plan originally effective October 2000. The plan permits eligible employees to purchase common shares through payroll deductions of up to 10% of an employee’s compensation limited to $25,000 each year. The purchase price of the shares may be 85% or more of the lowest market price on either the first or last day of each three month period ending January, April, July and October. A total of 2 million shares were authorized for issuance, however 0.4 million shares were issued under the previous employee share purchase plan resulting in 1.6 million shares remaining available for this plan. Unissued shares were 1.3 million for the period ended March 31, 2009 and 1.4 million as of December 31, 2008. Compensation expense recognized was not significant for the period ended March 31, 2009, for the period ended March 31, 2008 and for 2008.
Incentive and Performance Plans
In February 2008, our Board of Directors adopted the 2008 Stock Incentive Plan, as approved by our shareholders in May 2008. A total of 2 million common shares were reserved for issuance under the plan.
In addition to the payment of an annual retainer, non-employee directors receive annual share grants with an approximate value of $50,000, based on the closing price of our common shares on the day of grant. There were no grants of equity for the period ended March 31, 2009 and shares of 0.1 million that were restricted from trading for six months were granted to directors for 2008.
There were no grants of equity awards to employees, including all executives, for the period ended March 31, 2009 or 2008. Grants of equity awards are approved by our Compensation Committee at regularly scheduled meetings. Unissued shares were 1.9 million as of March 31, 2009 and December 31, 2008.
Employees and non-employee directors are eligible to receive awards at the discretion of the Compensation Committee. Options, appreciation rights, restricted shares, other share-based awards and non-discretionary awards may be granted under these plans.
Options
| | · | Grants of options under the 2008 Stock Incentive Plan vest ratably over a maximum of 5 years from the date of grant and expire after 10 years if unexercised. Under certain circumstances, some or all of the options may vest earlier. Options are to be awarded with exercise prices equal to the closing share price of our common shares on the date of grant. |
| | · | Grants of options under the 2004 Incentive and Performance Plan vest ratably over 3 to 4 years from the date of grant and expire after 7 years if unexercised. Under certain circumstances, some or all of the options may vest earlier. Options were awarded with exercise prices equal to the closing share price of our common shares on the date of grant. No further grants will be made under this plan. |
| | · | Grants of options under the 2000 Stock Incentive Plan vest ratably through the end of the fourth year from the date of grant and expire after 10 years if unexercised. Under certain circumstances, some or all of the options may vest earlier. Options were awarded with exercise prices equal to the closing share price of our common shares on the date of grant. No further grants will be made under this plan. |
Share-based compensation expense includes the fair value of share options, restricted shares and other share awards and is recognized over the requisite service period. Additionally, tax benefits for share-based compensation payments are reported as a financing activity for the statement of cash flows.
The fair value of each option is estimated on the date of grant using the modified Black-Scholes-Merton model. These assumptions are based principally on historical experience. Due to uncertainties inherent in these assumptions, it is possible that actual share-based compensation may vary from the estimate of the fair value of these options. There were no grants of share options, restricted shared or other awards for the period ended March 31, 2009, for the period ended March 31, 2008 and for 2008.
Activity for option awards was as follows (thousands, except per share data):
| | | Three Months Ended March 31 | | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| | | Shares | | | Weighted Average Exercise Price | | | Weighted Average Remaining Contractual Term (years) | | | Shares | | | Weighted Average Exercise Price | | | Shares | | | Weighted Average Exercise Price | |
Outstanding at beginning of the period | | | 2,627 | | | | $14 | | | | 3.2 | | | | 2,978 | | | | $15 | | | | 2,978 | | | | $15 | |
| Granted | | | — | | | | $— | | | | | | | | — | | | | $— | | | | — | | | | $— | |
| Exercised | | | — | | | | $— | | | | | | | | (1 | ) | | | $6 | | | | (1 | ) | | | $6 | |
| Forfeited | | | (155 | ) | | | $21 | | | | | | | | (6 | ) | | | $26 | | | | (350 | ) | | | $20 | |
Outstanding at end of the period | | | 2,472 | | | | $14 | | | | 2.8 | | | | 2,971 | | | | $15 | | | | 2,627 | | | | $14 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Exercisable at end of the period | | | 2,305 | | | | $13 | | | | 2.6 | | | | 2,414 | | | | $13 | | | | 2,245 | | | | $13 | |
| | | March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| Weighted average grant-date fair value | | | — | | | | — | | | | — | |
| Intrinsic value of options exercised | | $ | — | | | $ | 1 | | | $ | 1 | |
| Fair value of options vested | | $ | 1,957 | | | $ | 4,120 | | | $ | 3,767 | |
The intrinsic value (the difference between our share price on the date of exercise and the exercise price) for options exercised represents the value received by option holders who exercised their options.
As of March 31, 2009, option awards outstanding and exercisable were as follows (thousands, except per share data):
| | | | Options Outstanding | | | Options Exercisable |
| Exercise Price | | | Shares | | | Weighted Average Exercise Price | | Intrinsic Value | | Weighted Average Remaining Contractual Life (years) | | | Shares | | | Weighted Average Exercise Price | | Intrinsic Value |
| | $5 | | | | 534 | | | | $5 | | | | | 1.2 | | | | 534 | | | | $5 | | |
| | $7 | | | | 563 | | | | $7 | | | | | 3.0 | | | | 563 | | | | $7 | | |
| | $8 | | | | 179 | | | | $8 | | | | | 4.1 | | | | 179 | | | | $8 | | |
| | $9 | | | | 260 | | | | $9 | | | | | 1.9 | | | | 260 | | | | $9 | | |
| | $17 to $18 | | | | 351 | | | | $18 | | | | | 4.7 | | | | 184 | | | | $18 | | |
| | $23 | | | | 317 | | | | $23 | | | | | 2.7 | | | | 317 | | | | $23 | | |
| | $38 | | | | 268 | | | | $38 | | | | | 3.4 | | | | 268 | | | | $38 | | |
| | | | | | 2,472 | | | | | | | | | | | | | 2,305 | | | | | | |
| In-the-money: | | | | | | | | | | | | | | | | | | | | | | | |
| Outstanding | | | | — | | | | | | | | | | | | | — | | | | | | |
| Exercisable | | | | | | | | | | $— | | | | | | | | | | | | | $— |
The intrinsic value (the difference between our share price on the last day of trading in March 2009 and the exercise price) for in-the-money options represents the value that would have been received by option holders had they exercised their options. These values change based on the fair market value of our shares.
The fair value of compensation expense recognized for options was $0.2 million for the period ended March 31, 2009, $1.0 million for the period ended March 31, 2008 and $2.8 million for 2008. The common shares for options are not included in the calculation of basic income per share, however the common shares for options may be included in the calculation of diluted income per share.
As of March 31, 2009, there was $1.2 million of unrecognized compensation expense related to these options. This compensation expense is recognized as the requisite services are rendered and is expected to be recognized ratably through March 2011.
Options exercised are settled with newly issued common shares.
Restricted Shares
Grants of restricted shares vest 3 years from the date of grant. Under certain circumstances, some or all of the restricted shares may vest earlier. The fair value of restricted shares is the closing share price of our common shares on the date of grant. Compensation expense is recognized over the vesting period.
Activity for restricted share awards was as follows (thousands, except per share data):
| | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| | | Shares | | | Weighted Average Grant Date Fair Value | | | Shares | | | Weighted Average Grant Date Fair Value | | | Shares | | | Weighted Average Grant Date Fair Value | |
Nonvested at beginning of the period | | | 214 | | | | $26 | | | | 410 | | | | $26 | | | | 410 | | | | $26 | |
| Granted | | | — | | | | $— | | | | — | | | | $— | | | | — | | | | $— | |
| Vested | | | (90 | ) | | | $38 | | | | (110 | ) | | | $23 | | | | (118 | ) | | | $23 | |
| Forfeited | | | (21 | ) | | | $18 | | | | (3 | ) | | | $38 | | | | (78 | ) | | | $27 | |
Nonvested at end of the period | | | 103 | | | | $18 | | | | 297 | | | | $27 | | | | 214 | | | | $26 | |
| | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| Weighted average grant-date fair value | | | $— | | | | $— | | | | $— | |
| Fair value of restricted shares granted | | | $— | | | | $— | | | | $— | |
| Fair value of restricted shares vested | | | $3,391 | | | | $2,516 | | | | $2,761 | |
The fair value of compensation expense recognized for restricted shares was not significant for the period ended March 31, 2009, $0.7 million for the period ended March 31, 2008 and $1.0 million for 2008. The common shares for restricted shares are not included in the calculation of basic income per share until these shares vest, however the common shares for restricted shares may be included in the calculation of diluted income per share.
As of March 31, 2009, there was $0.6 million of unrecognized compensation expense related to these restricted shares. This compensation expense is recognized as the requisite services are rendered and is expected to be recognized ratably through March 2010.
Shares
We issue shares to non-employee directors of our Board of Directors for their services. These shares vest immediately, however trading is restricted for six months from the date of grant. We issued 99,200 shares in May 2008 and recognized compensation expense of $0.1 million for the period ended March 31, 2009, $0.1 million for the period ended March 31, 2008 and $0.4 million for 2008.
The following table summarizes equity compensation information as of March 31, 2009 (thousands, except per share data):
| | Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights | | Weighted Average Exercise Price of Outstanding Options, Warrants and Rights | | Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans |
Equity compensation plans approved by security holders | 2,575 | | $13.23 | | 1,901 |
Equity compensation plans not approved by security holders | 2,825(1) | | $0.47 | | — |
| Total | 5,400 | | $6.55 | | 1,901 |
(1) In connection with the amendment of our credit facility in September 2008, our Board of Directors authorized issuance of these warrants that entitle the lenders to purchase approximately 8.75% or 2.8 million of our common shares at a purchase price of $0.47 per common share, the closing price on the NYSE on September 30, 2008. These warrants may be exercised through September 2015.
Share-based compensation expense is included in Selling, general and administrative expenses since it is incentive compensation issued primarily to our executives and senior management. Share-based compensation expense for options, restricted shares and other share awards was $0.2 million for the period ended March 31, 2009, $1.8 million for the period ended March 31, 2008 and $4.3 million for 2008.
11. Income Taxes
The asset and liability method is used to account for income taxes. Under this method, deferred tax assets and liabilities are recognized for tax credits and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recognized to reduce the carrying amount of deferred tax assets to the amount that is more likely than not to be realized. If it is later determined it is more likely than not that deferred tax assets will be realized, the valuation allowance will be adjusted. Revisions of the valuation allowance are recognized in the period such revisions are known.
Income tax benefit (expense) and effective rates were as follows (thousands):
| | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| | | | | | Effective Rate | | | | | | Effective Rate | | | | | | Effective Rate | |
| Continuing operations: | | | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | $ | 12 | | | | 0.0 | % | | $ | (3,849 | ) | | | (12.8 | )% | | $ | 23,409 | | | | 10.8 | % |
| Discontinued operations: | | | | | | | | | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | $ | — | | | | 0.0 | % | | $ | 3,456 | | | | 98.4 | % | | $ | (1,860 | ) | | | (9.1 | )% |
The significant change in our effective tax rate for continuing operations was the result of uncertainty of our ability to realize deferred tax assets. Deferred tax assets resulted from operating losses and impairments, however valuation allowances were recognized due to the potential inability to realize these deferred tax assets. In assessing the ability to realize deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The scheduled reversal of deferred tax liabilities, loss carryback and carryforward abilities, projected future taxable income, tax planning strategies, cumulative earnings and our industry are considered in making this assessment.
There was no tax benefit associated with exercised options and vested restricted shares for the period ended March 31, 2009 and the tax benefit associated with exercised options and vested restricted share increased taxes receivable $0.3 million for the period ended March 31, 2008 and $0.3 million for 2008. The tax impact for the difference between the fair value and the exercised value for options exercised and the difference between the grant-date value and vest-date value for vested restricted shares are recognized in additional paid-in capital, a component of equity.
Our ability to realize the deferred tax assets could change if estimates of future taxable income change. To the extent taxable income is generated in future periods, these tax benefits may be realized and reduce our effective tax rate in future periods.
12. Financial Instruments
The estimated fair values of cash and cash equivalents, receivables, unbilled receivables, accounts payable and accruals are the same as their carrying amounts due to their short-term nature.
Our amended credit facility provides a $200 million revolver subject to borrowing base limitations and a $340 million term note maturing in November 2011. However, the April 2009 limited waiver limits borrowings under the revolver to $20 million and may not provide adequate liquidity. As of March 31, 2009, there were $2.3 million borrowings outstanding under the revolver and $313.8 million outstanding under the term note. After giving effect to the interest rate swap contracts, the interest for our debt is 61% variable and 39% fixed.
Quoted market prices are not available for our debt. Given the significant downturn in the homebuilding industry and tightening credit from lenders as well as our current negotiations to develop debt and capital structures acceptable to us and our lenders, it is not practicable to estimate the fair value of our debt.
Changes in interest rates expose us to financial market risk. We currently utilize interest rate swap contracts to hedge variable interest rates. As of March 2009, the interest rate swap contracts effectively converted $123.0 million of variable rate debt to a fixed interest rate of 10.6% plus any difference between minimum LIBOR interest of 3.0% and LIBOR. The notional amount of the interest rate swap contracts will be ratably reduced to zero through the maturity of November 2011.
Derivative financial instruments are not utilized to hedge other risks or for speculative or trading purposes.
13. Commitments and Contingencies
Legal Proceedings
We are involved in litigation and other legal matters arising in the normal course of business. In the opinion of management, the recovery or liability, if any, under any of these matters will not have a material effect on our financial position, results of operations or cash flows.
Operating Leases
We lease certain real property, vehicles and office equipment under operating leases. Operating lease expense was as follows (thousands):
| | | Three Months Ended March 31 | | | Year Ended December 31 | |
| | | 2009 | | | 2008 | | | 2008 | |
| Operating lease expense | | $ | 7,082 | | | $ | 7,553 | | | $ | 29,907 | |
| Less: Sublease income | | | (591 | ) | | | (326 | ) | | | (1,741 | ) |
| | | $ | 6,491 | | | $ | 7,227 | | | $ | 28,166 | |
Certain of these leases are non-cancelable and have minimum lease payment requirements as follows (thousands):
| | | Operating Leases | | | Sublease Income | | | Operating Leases, net | |
| 2009 | | $ | 19,477 | | | $ | (1,172 | ) | | $ | 18,305 | |
| 2010 | | | 19,514 | | | | (817 | ) | | | 18,697 | |
| 2011 | | | 12,747 | | | | (385 | ) | | | 12,362 | |
| 2012 | | | 7,573 | | | | (110 | ) | | | 7,463 | |
| 2013 | | | 4,684 | | | | (113 | ) | | | 4,571 | |
| Thereafter | | | 3,461 | | | | (9 | ) | | | 3,452 | |
| | | $ | 67,456 | | | $ | (2,606 | ) | | $ | 64,850 | |
Warranties
We provide limited warranties for certain construction services. Specific terms and conditions for warranties vary from 1 year to 10 years and are based on geographic market and state regulations. Factors for determining estimates of warranties include the nature and frequency of claims, anticipated claims and cost per claim. Estimated costs for warranties are recognized when the revenue associated with the service is recognized. Revisions of estimated warranties are reflected in the period such revisions are determined. Warranty activity is as follows (thousands):
| | | Three Months Ended | | Year Ended | |
| | | March 31 | | | March 31 | | December 31 | |
| | | 2009 | | | 2008 | | 2008 | |
| Balance at beginning of period | | $ | 5,701 | | | $ | 6,805 | | | $ | 6,805 | |
| Provision for warranties | | | (232 | ) | | | 275 | | | | (492 | ) |
| Warranty charges | | | (65 | ) | | | (563 | ) | | | (612 | ) |
| | | $ | 5,404 | | | $ | 6,517 | | | $ | 5,701 | |
14. Fair Values of Assets and Liabilities
Our assets and liabilities measured at fair value are grouped into three levels. The levels are based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:
| | · | Quoted Prices in Active Markets for Identical Assets – valuations for assets and liabilities traded in active exchange markets, such as the New York Stock Exchange. |
| | · | Significant Other Observable Inputs – valuations for assets and liabilities traded in less active dealer or broker markets. For example, an interest rate swap contract is valued based on a model whose inputs are observable forward interest rate curves. Valuations are obtained from third party pricing services for identical or comparable assets or liabilities. |
| | · | Significant Unobservable Inputs – valuations for assets and liabilities that are derived from other valuation methodologies, including discounted cash flow models and similar techniques, and are not based on market exchange, dealer, or broker traded transactions. Valuations incorporate certain assumptions and projections in determining fair value assigned to such assets or liabilities. |
The following assets and liabilities are measured at fair value on a recurring basis (thousands):
| | | | | | Fair Value Measurements at Reporting Date Using | |
| | | March 31 2009 | | | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | |
| Interest rate swap contracts | | $ | (6,411 | ) | | $ | — | | | $ | (6,411 | ) | | $ | — | |
| | | | | Fair Value Measurements at Reporting Date Using | |
| | | December 31 2008 | | Quoted Prices in Active Markets for Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | |
| Interest rate swap contracts | | $ | (7,514 | ) | | $ | — | | | $ | (7,514 | ) | | $ | — | |
Also, from time to time we may be required to measure certain other assets at fair value on a nonrecurring basis. These adjustments to fair value usually result from application of lower-of-cost or market accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis, the following table provides the amount, level of valuation assumptions used to determine each adjustment and the related realized losses (thousands):
| | | | | | Fair Value Measurements at Reporting Date Using | |
| | | December 31 2008 | | | Quoted Prices in Active Marketsfor Identical Assets | | | Significant Other Observable Inputs | | | Significant Unobservable Inputs | | | Year Ended December 31 2008 Gains (Losses) | |
| Other intangibles, net | | $ | 19,222 | | | $ | — | | | $ | — | | | $ | 19,222 | | | $ | (30,218 | ) |
| Goodwill | | | — | | | | — | | | | — | | | | — | | | | (14,196 | ) |
| | | $ | 19,222 | | | $ | — | | | $ | — | | | $ | 19,222 | | | $ | (44,414 | ) |
Other intangibles, net are evaluated for impairment whenever events and circumstances indicate the carrying amount may not be recoverable. An impairment for intangibles with finite useful lives is recognized if the carrying amount is not recoverable based on the estimated future operating cash flows on an undiscounted basis. Our intangibles are principally customer relationships. The present value of estimated future operating cash flows is utilized to determine fair value. Retention rates, margins and discount rates are significant inputs for determining the present value of estimated future cash flows.
| | · | Other intangibles with a carrying amount of $49.4 million were written down to their implied fair value of $19.2 million, resulting in an impairment charge of $30.2 million for 2008. |
Goodwill is evaluated for impairment whenever events and circumstances indicate the carrying amount may not be recoverable. An impairment for goodwill is recognized if the carrying amount is more than the estimated future operating cash flows as measured by fair value techniques. The fair value techniques of enterprise value as well as the present value of estimated future operating cash flows are utilized. Market capitalization based on average common share price, debt and cash are significant inputs for determining enterprise value. An estimate of our weighted average cost of financing sources and future operating cash flows as derived from estimates of revenues, operating expenses and income taxes as well as working capital requirements and capital expenditures are significant inputs for determining the present value of estimated future operating cash flows.
| | · | Goodwill with a carrying amount of $14.2 million was written down to its implied fair value of zero, resulting in an impairment charge of $14.2 million for 2008. |
15. Quarterly Results of Operations (unaudited)
Operating results by quarter for 2009 and 2008 were as follows (thousands, except per share data):
| | | First | | Second | | Third | | Fourth | |
2009 | | | | | | | | | |
| Sales | | $ | 167,499 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | |
Loss from continuing operations(1) | | $ | (45,068 | ) | | $ | — | | | $ | — | | | $ | — | |
Loss from discontinued operations(1) (2) | | | (152 | ) | | | — | | | | — | | | | — | |
| Net loss attributable to common shareholders | | $ | (45,220 | ) | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | |
| Net loss per share: | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | (1.53 | ) | | $ | — | | | $ | — | | | $ | — | |
| Discontinued operations | | | — | | | | — | | | | — | | | | — | |
| Diluted | | $ | (1.53 | ) | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | |
| Common share prices: | | | | | | | | | | | | | | | | |
| High | | $ | 0.61 | | | $ | — | | | $ | — | | | $ | — | |
| Low | | $ | 0.22 | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | |
| Cash dividends declared per share | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
| | | | | | | | | | | | | | | | | |
| 2008 | | | | | | | | | | | | | | | | |
| Sales | | $ | 342,948 | | | $ | 384,620 | | | $ | 364,430 | | | $ | 232,681 | |
| | | | | | | | | | | | | | | | | |
Loss from continuing operations(1) | | $ | (33,843 | ) | | $ | (41,350 | ) | | $ | (35,569 | ) | | $ | (81,757 | ) |
(Loss) income from discontinued operations(1) (2) | | | (57 | ) | | | 9,385 | | | | (9,637 | ) | | | (22,044 | ) |
| Noncontrolling interests loss | | | 39 | | | | 24 | | | | — | | | | — | |
| Net loss attributable to common shareholders | | $ | (33,861 | ) | | $ | (31,941 | ) | | $ | (45,206 | ) | | $ | (103,801 | ) |
| | | | | | | | | | | | | | | | | |
| Net loss per share: | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | (1.17 | ) | | $ | (1.42 | ) | | $ | (1.22 | ) | | $ | (2.78 | ) |
| Discontinued operations | | | — | | | | 0.32 | | | | (0.33 | ) | | | (0.76 | ) |
| Diluted | | $ | (1.17 | ) | | $ | (1.10 | ) | | $ | (1.55 | ) | | $ | (3.54 | ) |
| | | | | | | | | | | | | | | | | |
| Common share prices: | | | | | | | | | | | | | | | | |
| High | | $ | 7.22 | | | $ | 5.09 | | | $ | 2.65 | | | $ | 0.94 | |
| Low | | $ | 3.78 | | | $ | 1.77 | | | $ | 0.47 | | | $ | 0.21 | |
| | | | | | | | | | | | | | | | | |
| Cash dividends declared per share | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
(1) Includes the following impairments: | | | | | | | | |
| | First | | Second | | Third | | Fourth | |
2009 | | | | | | | | |
| Continuing operations | | $ | 365 | | | $ | — | | | $ | — | | | $ | — | |
| Discontinued operations | | $ | — | | | $ | — | | | $ | — | | | $ | — | |
2008 | | | | | | | | | | | | | | | | |
| Continuing operations | | $ | — | | | $ | 8,469 | | | $ | 3,856 | | | $ | 40,690 | |
| Discontinued operations | | $ | — | | | $ | 6,212 | | | $ | 873 | | | $ | 728 | |
(2) Discontinued operations were as follows:
| | · | concrete block masonry and concrete services in Florida in June 2008, |
| | · | framing services in Virginia in March 2008 and |
| | · | three Western Colorado building materials distribution businesses sold in September 2007. |
Item 2. Management's Discussion and Analysis of Financial Condition and Result of Operations
The following discussion should be read in conjunction with the Consolidated Financial Statements and related notes that appear in Item 1 of this Form 10-Q as well as the caption under this item entitled Business Risks and Forward-Looking Statements.
Our Business
We are one of the largest providers of residential building products and construction services in the United States. Under the brand names of BMC West and SelectBuild, we serve the homebuilding industry through six regional operations: Texas, California, Intermountain, Southwest, Northwest and Illinois. In each of these regions, we market and sell building products, manufacture building components and provide construction services to professional builders and contractors.
Our operations are located in metropolitan areas that have historically outpaced U.S. averages for residential building permit activity. We believe we are in homebuilding markets supported by positive long-term population growth, household formation and demographic trends.
Business Environment and Executive Overview
Already under contraction, single-family housing starts declined further in the first quarter of 2009 as home foreclosures increased, lending standards tightened and rising unemployment sapped consumer confidence. According to the U.S. Census Bureau as of February 2009, single-family housing starts for the U.S. as a whole fell below an annualized rate of 0.4 million. Excluding the boom years of 2006 through 2003, single-family housing starts for the U.S. as a whole averaged 1.1 million starts per year since 1990.
Similarly, as of February 2009 annualized single-family permits in our markets fell 46% to 0.1 million from the prior year. The decline was widespread across all our markets for both building products and construction services. Lower sales from weakening buyer demand and increased competition for fewer contracts led to declines in our margins, particularly for construction services. As of March 2009, single-family housing starts for the U.S. as a whole fell to an annualized rate below 0.4 million and single-family permits in our markets remained at an annualized rate of 0.1 million.
This suggests 2009 will be more challenging than 2008 as the decline in housing starts will cause competition to sharpen. As a result, we continue to assess the operating performance of business units and eliminate cost inefficiencies. We continue to believe our employees’ efforts to maintain customer relationships and focus on cost efficiencies are distinguishing factors in our ability to weather this unprecedented downturn in the basic necessity of housing.
Uncertainty of Liquidity
Beginning with the fourth quarter of 2007 and continuing through the first quarter of 2009, we have incurred losses from operations and, during 2008 and the first quarter of 2009, restructuring costs as we downsized our business to match the current environment. We have managed our liquidity during this time with closure and consolidation of underperforming business units and cost reduction initiatives as well as sales of assets. However, the downturn in the housing industry has been deepened by an increase in home foreclosures and reduced consumer confidence from tightened lending standards and rising unemployment, which have created a difficult business environment for homebuilders generally. Our operating performance and liquidity were negatively affected by these economic and industry conditions, which are beyond our control.
These business conditions have not improved during 2009. As of March 2009, single-family housing starts for the U.S. as a whole fell to an annualized rate below 0.4 million and single-family permits in our markets remained at a depressed annualized rate of 0.1 million. We do not believe these business conditions will improve significantly during 2009.
Our actions to align our cost structure with anticipated sales may not be sufficient to fund our operating costs, restructuring costs and debt service requirements. When funds from operations are insufficient, our primary source of funding has been the revolver component of our credit facility. Our amended credit facility provides a $200 million revolver and a $340 million term note maturing in November 2011. Our revolver is subject to borrowing base limitations based on certain accounts receivable, inventory, property and equipment and real estate and may not provide adequate liquidity. As of March 31, 2009, there were $2.3 million borrowings outstanding under the revolver and $313.8 million was outstanding under the term note.
Our credit agreement requires monthly compliance with financial covenants, including minimum liquidity and adjusted earnings before interest, taxes, depreciation and amortization (monthly Adjusted EBITDA). Operating results, particularly income from continuing operations, are a primary factor for these covenants, and our ability to comply with these covenants depends on our operating performance. Lack of compliance with these covenants would constitute an event of default under the credit agreement which, absent any waiver, forbearance or modification, would enable the lenders under our credit agreement to cause all amounts borrowed to become due and payable immediately and to prohibit further borrowings by us under the revolver.
Based on financial information for February 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. In March 2009, we obtained a limited waiver through April 15, 2009 for lack of compliance with the monthly Adjusted EBITDA requirement and we preserved access to limited liquidity permitting us to borrow up to $20 million under the revolver. Previously, we had obtained waivers for financial covenants due to lower than planned operating performance as of both June 2008 and December 2007.
Due to the difficulty of reliably projecting our operating results within the depressed business conditions of the homebuilding industry, we believe that it is likely that we will not be able to meet the financial covenants of our credit agreement during 2009. Also, our independent registered public accounting firm included a going concern explanatory paragraph in their report on our financial statements for 2008, citing among other things, the uncertainty that we would remain in compliance with these financial covenants. The going concern explanatory paragraph constitutes a default under our credit agreement. In April 2009, we obtained a waiver for the going concern explanatory paragraph.
In April 2009, our lenders also agreed to extend the limited waiver through June 1, 2009. In May 2009, the limited waiver was extended through June 29, 2009. This limited waiver continues to waive compliance with the monthly Adjusted EBITDA, forecast and projection requirements of our credit agreement. The limited waiver limits borrowings under the revolver to $20 million and limits capital expenditures to $0.1 millionfrom the date of the extended limited waiver. Lenders approving each of the March, April and May 2009 limited waivers were paid a fee of 0.10% of their revolver commitment and their portion of the outstanding principal amount of the term note.
For March 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. Additionally, as the limited waiver for these financial covenants is less than a year, it is probable we will not be in compliance with these financial covenants within the next year and given there is no amendment or other financing agreement currently in place, the revolver and term note are classified as a current liability in the consolidated balance sheet.
We are anticipating tax refunds of $56 million as a result of net operating losses for 2008. These refunds will be applied to reduce the amount outstanding under our term loan facility to approximately $275 million. The remaining portion of the tax refund will be available for working capital needs after payment of any borrowings under the revolver. We filed for our federal tax refund in April 2009 and our professional advisors have advised us that receipt of the refund is anticipated in mid- to late May 2009.
We are currently negotiating with our lenders to develop debt and capital structures to support our long-term strategic plan and business objectives. We expect that these negotiations may lead to a bankruptcy filing which we anticipate would reflect the agreement of our lenders and would provide for the payment in full of all amounts owing to key vendors and the uninterrupted supply of goods and services to our customers. Equity holders may be substantially diluted or be eliminated in a bankruptcy filing.
There can be no assurance these negotiations will result in debt and capital structures acceptable to us and the lenders or an agreement that would achieve our goals. If these negotiations fail, we would not be able to continue as a going concern and would be forced to seek relief through bankruptcy filing without an agreement of our lenders. We also continue to pursue alternative financing arrangements as well as evaluate other financing options.
We may not be able to meet near-term working capital and scheduled interest and debt payment requirements if cash flows are inadequate from our reduced operating activities or if our access to the revolver portion of our credit facility is restricted because we are unable to reach an agreement with our lenders. Absent any waiver, forbearance or modification to our current credit agreement, we believe our recurring losses from operations, interest and debt burden amid declining sales and potential inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern.
Additionally, our long-term future is dependent on more normal levels of single-family housing starts and our ability to implement and maintain cost structures, including reduced interest and debt that align with single-family housing trends. If this fails to transpire or if we cannot obtain a waiver, forbearance or modification to our current credit agreement or other financing options, we may not be able to continue as a going concern and may be forced to seek relief through a bankruptcy filing.
Performance Measurements
We measure our operating performance and financial condition based on several factors including:
| | | | | |
| | ● | Sales | ● | Cash flow |
| | ● | Income from operations | ● | Management of working capital |
| | | | ● | Return on investment |
The discussion of our results of operations and financial condition provides information to assist the reader in understanding our financial statements, changes in key items in those financial statements and the primary factors that accounted for those changes.
RESULTS OF OPERATIONS
FIRST QUARTER OF 2009 COMPARED TO FIRST QUARTER OF 2008
The following table sets forth the amounts and percentage relationship to sales of certain costs, expenses and income items (millions, except per share data):
| | | Three Months Ended March 31 | |
| | | 2009 | | | 2008 | |
Sales | | | | | | | | | | | | |
| Building products | | $ | 99 | | | | 59 | % | | $ | 180 | | | | 52 | % |
| Construction services | | | 68 | | | | 41 | % | | | 163 | | | | 48 | % |
Total sales | | | 167 | | | | 100 | % | | | 343 | | | | 100 | % |
| | | | | | | | | | | | | | | | | |
Costs and operating expenses | | | | | | | | | | | | | | | | |
| Cost of goods sold | | | | | | | | | | | | | | | | |
| Building products | | | 77 | | | | 78 | % | | | 131 | | | | 73 | % |
| Construction services | | | 67 | | | | 99 | % | | | 151 | | | | 93 | % |
| Impairment of assets | | | — | | | | — | | | | — | | | | — | |
| Selling, general and administrative expenses | | | 62 | | | | 37 | % | | | 84 | | | | 24 | % |
| Other income, net | | | (6 | ) | | | (4 | )% | | | (4 | ) | | | (1 | )% |
| Total costs and operating expenses | | | 200 | | | | 120 | % | | | 361 | | | | 105 | % |
| | | | | | | | | | | | | | | | | |
Loss from operations | | | (33 | ) | | | (20 | )% | | | (18 | ) | | | (5 | )% |
| | | | | | | | | | | | | | | | | |
| Interest expense | | | 12 | | | | 7 | % | | | 12 | | | | 3 | % |
| | | | | | | | | | | | | | | | | |
Loss from continuing operations before income taxes | | | (45 | ) | | | (27 | )% | | | (30 | ) | | | (9 | )% |
| | | | | | | | | | | | | | | | | |
| Income tax benefit (expense) | | | — | | | | — | | | | (4 | ) | | | (1 | )% |
Loss from continuing operations | | | (45 | ) | | | (27 | )% | | | (34 | ) | | | (10 | )% |
| | | | | | | | | | | | | | | | | |
| Loss from discontinued operations | | | — | | | | — | | | | (4 | ) | | | (1 | )% |
| Impairment of assets | | | — | | | | — | | | | — | | | | — | |
| Income tax expense | | | — | | | | — | | | | 4 | | | | 1 | % |
Loss from discontinued operations | | | — | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | |
Net loss | | | (45 | ) | | | (27 | )% | | | (34 | ) | | | (10 | )% |
| Noncontrolling interest loss | | | — | | | | — | | | | — | | | | — | |
Net loss attributable to common shareholders | | $ | (45 | ) | | | (27 | )% | | $ | (34 | ) | | | (10 | )% |
| | | | | | | | | | | | | | | | | |
Note: Certain amounts and percentages may not sum to totals due to rounding. | |
Consolidated Financial Results
Selected financial results were as follows (millions):
| | | 2009 | | | 2008 | | | % Change | |
Sales | | | | | | | | | |
| Building products | | $ | 99 | | | $ | 180 | | | | (45 | )% |
| Construction services | | | 68 | | | | 163 | | | | (58 | )% |
| | | $ | 167 | | | $ | 343 | | | | (51 | )% |
| | | | | | | | | | | | | |
Loss from operations | | $ | (33 | ) | | $ | (18 | ) | | | 83 | % |
Sales decreased 51% to $167 million from $343 million in the same quarter a year ago. Sales were lower in all our regions, particularly sales of construction services. National trends in single-family home construction continue to be at depressed levels as annualized single-family housing starts for the U.S. as a whole were 64% lower or 0.4 million starts as of February 2009 compared to an average of 1.1 million starts per year since 1990 excluding the boom years of 2006 through 2003. Increased home foreclosures, tightening lending standards and rising unemployment have driven housing starts to their lowest level in the 50 years of available housing data. Similarly, as of February 2009 annualized single-family permits in our markets fell 46% to 0.1 million from the prior year. The depth and duration of the current housing downturn remains uncertain.
Loss from operations was $33 million compared to a loss of $18 million in the same quarter a year ago and included the following:
| | · | Gross margins declined to 14% from 18% for the same quarter a year ago. Lower margins resulted from intensified competition for building products and construction services for fewer housing starts. |
| | · | We recognized $0.4 million for the impairments of certain property and equipment held for sale. |
| | · | Partially offsetting lower gross margins, selling and general administrative expenses decreased 27% or $22 million from the same quarter a year ago. These expenses were lower due to employee reductions resulting in a decrease of $16 million or 51% in our operations and 10% in our administrative operation as well as $4 million of reductions in occupancy and shipping and handling expenses and $4 million of reductions in other costs. These reductions were partially offset by $2 million increase in the allowance for doubtful accounts receivable as our customers struggle with fewer construction projects and financing. |
| | · | Nonrecurring expenses associated with closure and consolidation of underperforming business units classified in selling, general and administrative expenses included $5 million of payroll and related expenses and other administrative operating expenses. As a percent of sales, selling, general and administrative expenses increased to 37% from 24%. In addition to the nonrecurring expenses, the increase was the result of: |
| | § | a substantial decline in sales volume, particularly construction services and |
| | § | a shift in sales mix to building products from construction services. |
Interest Expense
Interest expense was 4% or $0.5 million more than the same quarter a year ago. Excluding $2.4 million of deferred loan cost write off in the first quarter of 2008, interest expense was 32% or $2.9 million more than the same quarter a year ago. The increase was due to:
| | · | $1.6 million for higher interest rates, |
| | · | $0.8 million for amortization of unrealized loss and notional reduction settlement payments as well as an unrealized loss for an increase in the fair value of the interest rate swap contracts no longer accounted for as a cash flow hedge and |
| | · | $0.4 million for fees associated with the limited waiver of our credit facility in March 2009. |
Income Taxes
Our effective income tax rate was zero and is lower than statutory federal and state tax rates due to uncertainty in our ability to realize deferred tax assets resulting from operating losses and impairments. To the extent taxable income is generated in future periods, these tax benefits may be realized and reduce our effective tax rate in future periods.
Discontinued Operations
In June 2008 and as a consequence of the significant and ongoing correction in single-family home construction, we discontinued our concrete block masonry and concrete services business as well as our truss manufacturing business in Florida. For 2008, we incurred a loss from these operations of $12 million and recognized impairments of $8 million for customer relationships and assets held for sale. These operations represented approximately 6% of sales.
In March 2008, we discontinued framing services in Virginia. These operations represented less than 1% of sales.
LIQUIDITY AND CAPITAL RESOURCES
Uncertainty of Liquidity
Beginning with the fourth quarter of 2007 and continuing through the first quarter of 2009, we have incurred losses from operations and, during 2008 and the first quarter of 2009, restructuring costs as we downsized our business to match the current environment. We have managed our liquidity during this time with closure and consolidation of underperforming business units and cost reduction initiatives as well as sales of assets. However, the downturn in the housing industry has been deepened by an increase in home foreclosures and reduced consumer confidence from tightened lending standards and rising unemployment, which have created a difficult business environment for homebuilders generally. Our operating performance and liquidity were negatively affected by these economic and industry conditions, which are beyond our control.
These business conditions have not improved during 2009. As of March 2009, single-family housing starts for the U.S. as a whole fell to an annualized rate below 0.4 million and single-family permits in our markets remained at a depressed annualized rate of 0.1 million. We do not believe these business conditions will improve significantly during 2009.
Our actions to align our cost structure with anticipated sales may not be sufficient to fund our operating costs, restructuring costs and debt service requirements. When funds from operations are insufficient, our primary source of funding has been the revolver component of our credit facility. Our amended credit facility provides a $200 million revolver and a $340 million term note maturing in November 2011. Our revolver is subject to borrowing base limitations based on certain accounts receivable, inventory, property and equipment and real estate and may not provide adequate liquidity. As of March 31, 2009, there were $2.3 million borrowings outstanding under the revolver and $313.8 million was outstanding under the term note.
Our credit agreement requires monthly compliance with financial covenants, including minimum liquidity and adjusted earnings before interest, taxes, depreciation and amortization (monthly Adjusted EBITDA). Operating results, particularly income from continuing operations, are a primary factor for these covenants, and our ability to comply with these covenants depends on our operating performance. Lack of compliance with these covenants would constitute an event of default under the credit agreement which, absent any waiver, forbearance or modification, would enable the lenders under our credit agreement to cause all amounts borrowed to become due and payable immediately and to prohibit further borrowings by us under the revolver.
Based on financial information for February 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. In March 2009, we obtained a limited waiver through April 15, 2009 for lack of compliance with the monthly Adjusted EBITDA requirement and we preserved access to limited liquidity permitting us to borrow up to $20 million under the revolver. Previously, we had obtained waivers for financial covenants due to lower than planned operating performance as of both June 2008 and December 2007.
Due to the difficulty of reliably projecting our operating results within the depressed business conditions of the homebuilding industry, we believe that it is likely that we will not be able to meet the financial covenants of our credit agreement during 2009. Also, our independent registered public accounting firm included a going concern explanatory paragraph in their report on our financial statements for 2008, citing among other things, the uncertainty that we would remain in compliance with these financial covenants. The going concern explanatory paragraph constitutes a default under our credit agreement. In April 2009, we obtained a waiver for the going concern explanatory paragraph.
In April 2009, our lenders also agreed to extend the limited waiver through June 1, 2009. In May 2009, the limited waiver was extended through June 29, 2009. This limited waiver continues to waive compliance with the monthly Adjusted EBITDA, forecast and projection requirements of our credit agreement. The limited waiver limits borrowings under the revolver to $20 million and limits capital expenditures to $0.1 millionfrom the date of the extended limited waiver. Lenders approving each of the March, April and May 2009 limited waivers were paid a fee of 0.10% of their revolver commitment and their portion of the outstanding principal amount of the term note.
For March 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. Additionally, as the limited waiver for these financial covenants is less than a year, it is probable we will not be in compliance with these financial covenants within the next year and given there is no amendment or other financing agreement currently in place, the revolver and term note are classified as a current liability in the consolidated balance sheet.
We are anticipating tax refunds of $56 million as a result of net operating losses for 2008. These refunds will be applied to reduce the amount outstanding under our term loan facility to approximately $275 million. The remaining portion of the tax refund will be available for working capital needs after payment of any borrowings under the revolver. We filed for our federal tax refund in April 2009 and our professional advisors have advised us that receipt of the refund is anticipated in mid- to late May 2009.
We are currently negotiating with our lenders to develop debt and capital structures to support our long-term strategic plan and business objectives. We expect that these negotiations may lead to a bankruptcy filing which we anticipate would reflect the agreement of our lenders and would provide for the payment in full of all amounts owing to key vendors and the uninterrupted supply of goods and services to our customers. Equity holders may be substantially diluted or be eliminated in a bankruptcy filing.
There can be no assurance these negotiations will result in debt and capital structures acceptable to us and the lenders or an agreement that would achieve our goals. If these negotiations fail, we would not be able to continue as a going concern and would be forced to seek relief through bankruptcy filing without an agreement of our lenders. We also continue to pursue alternative financing arrangements as well as evaluate other financing options.
We may not be able to meet near-term working capital and scheduled interest and debt payment requirements if cash flows are inadequate from our reduced operating activities or if our access to the revolver portion of our credit facility is restricted because we are unable to reach an agreement with our lenders. Absent any waiver, forbearance or modification to our current credit agreement, we believe our recurring losses from operations, interest and debt burden amid declining sales and potential inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern.
Additionally, our long-term future is dependent on more normal levels of single-family housing starts and our ability to implement and maintain cost structures, including reduced interest and debt that align with single-family housing trends. If this fails to transpire or if we cannot obtain a waiver, forbearance or modification to our current credit agreement or other financing options, we may not be able to continue as a going concern and may be forced to seek relief through a bankruptcy filing.
Cash Flows
Historically, our primary needs for capital resources were to fund working capital and acquisitions as well as finance capital expenditures. In the future we expect to fund working capital requirements and necessary capital expenditures with cash flow from operations and seasonal borrowings under our credit facility.
If we are unable to implement and maintain cost structures, including debt and interest, that align with single-family housing trends or if we cannot obtain a waiver, forbearance or similar amendment to our current credit agreement or other financing options, we may not be able to continue as a going concern and we may be forced to seek relief by altering our capital structure or through a bankruptcy filing.
Operations
Operating activities used $7 million of cash compared to $8 million provided in the same period a year ago. Net loss adjusted for non-cash items increased $34 million from the same period a year ago due to lower sales and reduced profitability as a result of the significant downturn in home construction. Our working capital requirements were $17 million less than the same period a year ago. Cash provided by working capital requirements was $40 million compared to cash provided of $23 million in the same period a year ago, as our working capital requirements decreased despite an increase in our cash conversion cycle as days payable outstanding decreased, inventory turns slowed and there was no significant change in days sales outstanding.
Capital Investment and Acquisitions
Cash provided by investing activities was $10 million compared to $11 million used in the same period a year ago. Cash of $11 million was provided principally from the sale of real property due to the consolidation of building distribution facilities in Nevada, Washington and Colorado. Cash used for investing activities also included capital expenditures of $0.6 million or $6.6 million less than the same period a year ago. Capital expenditures were principally for consolidation of building component operations with existing building product distribution facilities in Idaho, California and Colorado and lease buyout requirements for certain equipment.
Financing
Cash used by financing activities was $9 million compared to $17 million used in the same period a year ago. Borrowings under the revolver were $2 million compared to no borrowings in the same period a year ago. Cash for operating needs and payments on the term note were funded by reductions in working capital requirements, proceeds from dispositions and existing cash. In addition to the $0.9 million scheduled principal payment, $11 million was paid on the term note as a result of proceeds from dispositions.
Financing Arrangements
Our debt structure consists of a revolver, term note and other borrowings.
In September 2008, we entered into an amendment to our credit agreement with our lenders. The amended credit facility continues to provide a $200 million revolver subject to borrowing base limitations and a $340 million term note maturing in November 2011. However, the April 2009 limited waiver limits borrowings under the revolver to $20 million and may not provide adequate liquidity.
The $200 million revolver is subject to borrowing base limitations and matures in November 2011. The revolver may consist of both LIBOR and Prime based borrowings. In the September 2008 amendment, the variable interest rate for the revolver was increased to LIBOR plus 5.25% or Prime plus 3.25%. Minimum LIBOR interest is 3.0%. Additionally, a commitment fee for the unused portion is 0.50%. LIBOR interest is paid quarterly and Prime interest is paid monthly. As of March 31, 2009, $2.3 million was outstanding under the revolver.
The effective interest rate is based on interest rates for the period as well as the commitment fee for the unused portion of the revolver.
Letters of credit outstanding that guaranteed performance or payment to third parties were $109.0 million as of March 31, 2009. These letters of credit reduce the $200 million revolver commitment.
Total availability under the revolver is subject to a monthly borrowing base calculation that includes:
| | · | 70% of certain accounts receivable, |
| | · | 50% of certain inventory, |
| | · | 25% of certain other inventory, |
| | · | approximately 75% of the appraised value of certain property and equipment and |
| | · | 50% of the appraised value of real estate. |
As of March 31, 2009, the unused borrowing base under the revolver was $49.2 million, however the April 2009 limited waiver limits borrowings under the revolver to $20 million.
The term note matures in November 2011 and is payable in quarterly installments of $0.9 million with the remaining principal of $270.0 million payable in November 2011. In the September 2008 amendment, the variable interest rate for the term note was increased to LIBOR plus 5.25% or Prime plus 3.25%. Minimum LIBOR interest is 3.0%. LIBOR interest is paid quarterly and Prime interest is paid monthly. In addition to the LIBOR and Prime interest rates, the term note includes an additional annual payment-in-kind interest or fee of 2.75% that is payable on the earlier of payoff or maturity. As of March 31, 2009, $313.8 million was outstanding under this term note.
Other long-term debt consists of term notes, equipment notes and capital leases for equipment. Interest rates vary and dates of maturity are through March 2021. As of March 31, 2009, other long-term debt was $1.3 million.
Covenants and Maturities
Our credit agreement requires monthly compliance with financial covenants, including minimum liquidity and adjusted earnings before interest, taxes, depreciation and amortization (monthly Adjusted EBITDA). Operating results, particularly income from continuing operations, are a primary factor for these covenants, and our ability to comply with these covenants depends on our operating performance. Lack of compliance with these covenants would constitute an event of default under the credit agreement which, absent any waiver, forbearance or modification, would enable the lenders under our credit agreement to cause all amounts borrowed to become due and payable immediately and to prohibit further borrowings by us under the revolver.
Based on financial information for February 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. In March 2009, we obtained a limited waiver through April 15, 2009 for lack of compliance with the monthly Adjusted EBITDA requirement and we preserved access to limited liquidity permitting us to borrow up to $20 million under the revolver. Previously, we had obtained waivers for financial covenants due to lower than planned operating performance as of both June 2008 and December 2007.
Due to the difficulty of reliably projecting our operating results within the depressed business conditions of the homebuilding industry, we believe that it is likely that we will not be able to meet the financial covenants of our credit agreement during 2009. Also, our independent registered public accounting firm included a going concern explanatory paragraph in their report on our financial statements for 2008, citing among other things, the uncertainty that we would remain in compliance with these financial covenants. The going concern explanatory paragraph constitutes a default under our credit agreement. In April 2009, we obtained a waiver for the going concern explanatory paragraph.
In April 2009, our lenders also agreed to extend the limited waiver through June 1, 2009. In May 2009, the limited waiver was extended through June 29, 2009. This limited waiver continues to waive compliance with the monthly Adjusted EBITDA, forecast and projection requirements of our credit agreement. The limited waiver limits borrowings under the revolver to $20 million and limits capital expenditures to $0.1 millionfrom the date of the extended limited waiver. Lenders approving each of the March, April and May 2009 limited waivers were paid a fee of 0.10% of their revolver commitment and their portion of the outstanding principal amount of the term note.
For March 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. Additionally, as the limited waiver for these financial covenants is less than a year, it is probable we will not be in compliance with these financial covenants within the next year and given there is no amendment or other financing agreement currently in place, the revolver and term note are classified as a current liability in the consolidated balance sheet.
We are anticipating tax refunds of $56 million as a result of net operating losses for 2008. These refunds will be applied to reduce the amount outstanding under our term loan facility to approximately $275 million. The remaining portion of the tax refund will be available for working capital needs after payment of any borrowings under the revolver. We filed for our federal tax refund in April 2009 and our professional advisors have advised us that receipt of the refund is anticipated in mid- to late May 2009.
We are currently negotiating with our lenders to develop debt and capital structures to support our long-term strategic plan and business objectives. We expect that these negotiations may lead to a bankruptcy filing which we anticipate would reflect the agreement of our lenders and would provide for the payment in full of all amounts owing to key vendors and the uninterrupted supply of goods and services to our customers. Equity holders may be substantially diluted or be eliminated in a bankruptcy filing.
There can be no assurance these negotiations will result in debt and capital structures acceptable to us and the lenders or an agreement that would achieve our goals. If these negotiations fail, we would not be able to continue as a going concern and would be forced to seek relief through bankruptcy filing without an agreement of our lenders. We also continue to pursue alternative financing arrangements as well as evaluate other financing options.
If our leverage ratio is at or above a certain maximum as of September 30, 2010, the monthly Adjusted EBITDA may be replaced with quarterly compliance with a leverage ratio and interest coverage ratio. Operating results, particularly income from continuing operations, are a primary factor for these covenants and our ability to comply with these covenants depends on our operating performance. The significant downturn in single-family housing starts has negatively impacted and may continue to negatively impact our operating performance.
The credit agreement requires certain proceeds and cash flows be applied to the credit facility as follows:
| | § | cash in excess of $25 million. |
| | § | proceeds from certain dispositions, |
| | § | 75% of excess cash flow as defined beginning in 2010. |
Proceeds from tax refunds and certain dispositions are retained in a separate cash account. Cash in excess of $25 million in this separate cash account is to be applied to the revolver or term note. There was no amount in this separate cash account as of March 31, 2009. In the event of default, this cash is restricted and not available for our operating needs.
The amended credit facility continues to restrict our ability to incur additional indebtedness, pay dividends, repurchase shares, enter into mergers or acquisitions, use proceeds from equity offerings, make capital expenditures and sell assets. The amended credit facility is secured by all assets of our wholly-owned subsidiaries.
In connection with the September 2008 amendment, 100% or $2.8 million of unamortized deferred loan costs related to the term note were recognized as interest expense in the third quarter of 2008. We also incurred $3.8 million of costs in connection with the amendment and $2.0 million of these costs will be amortized over the remaining term of the credit facility whereas $1.8 million of these costs were recognized as interest expense in the third quarter of 2008.
In connection with the February 2008 amendment, 60% or $2.4 million of unamortized deferred loan costs related to the previous revolver were recognized as interest expense in the first quarter of 2008. We also incurred $4.9 million of fees in connection with the amendment and these costs were to be amortized over the remaining term of our credit facility. However, in connection with the September 2008 amendment, the remaining $2.6 million of these unamortized costs were recognized as interest expense in the third quarter of 2008.
Scheduled maturities of long-term debt are as follows (thousands):
| 2009 | | $ | 316,246 | |
| 2010 | | | 223 | |
| 2011 | | | 66 | |
| 2012 | | | 65 | |
| 2013 | | | 70 | |
| Thereafter | | | 678 | |
| | | $ | 317,348 | |
Warrants
In connection with the amendment of our credit facility in September 2008, we issued warrants that entitle the lenders to purchase approximately 8.75% or 2.8 million of our common shares at a purchase price of $0.47 per common share, the closing price on the NYSE on September 30, 2008. These warrants may be exercised through September 2015.
The fair value of the warrants of $0.8 million was recorded as a discount on the term note. Amortization of the discount will be recognized ratably through November 2011, the remaining term of our credit facility.
Hedging Activities
In addition to the amendment to our credit facility in September 2008, we amended our interest rate swap contracts to lower amounts and a maturity matching the credit facility. As of March 2009, the interest rate swap contracts effectively converted $123.0 million of variable rate borrowings to a fixed interest rate of 10.6% plus any difference between minimum LIBOR interest of 3.0% and LIBOR, thus reducing the impact of increases in interest rates on future interest expense. Additionally, the notional amount of the interest rate swap contracts will be ratably reduced to zero through the maturity of November 2011.
As of March 2009, approximately 39% of the outstanding variable rate borrowings have been hedged with these interest rate swap contracts. After giving effect to the interest rate swap contracts, total borrowings were 61% variable and 39% fixed. The fair value of the interest rate swap contracts was a liability of $6.4 million as of March 31, 2009. Management may choose not to swap variable rates to fixed rates or may terminate a previously executed swap if the variable rate positions are more beneficial.
Hedge accounting was discontinued in January 2009, as it is not probable future LIBOR interest rates for the remaining term of the interest rate swap contracts will be at or above the minimum LIBOR interest of 3.0% of the term note. In September 2008, we amended our interest rate swap contracts. Monthly settlements are made to ratably reduce the notional amount of the interest rate swap contracts through November 2011. As a result, the following amounts were recognized as Interest expense:
| | · | $0.1 million for the period ended March 31, 2009 for an increase in the fair value of the interest rate swap contracts rather than recorded in Accumulated other comprehensive loss, net, a component of equity. This increase in the fair value was after $1.2 million of notional reduction settlement payments for the period ended March 31, 2009. There were no notional reduction settlement payments for the period ended March 31, 2008. |
| | · | $0.4 million for the period ended March 31, 2009 for amortization of unrealized loss due to increases in fair value of interest rate swap contracts previously accounted for as a cash flow hedge and recorded in Accumulated other comprehensive loss, net. The remaining unrealized loss of $4.1 million in Accumulated other comprehensive loss, net as of March 31, 2009 will be subsequently amortized to Interest expense over the remaining term of our term note. |
| | · | $0.2 million for the period ended March 31, 2009 and $0.9 million for 2008 for amortization of the notional reduction settlement payments previously accounted for as a cash flow hedge and recorded in Accumulated other comprehensive loss, net. The remaining unrealized loss of $2.7 million for notional reduction settlement payments previously accounting for cash flow hedged for 2008 recorded in Accumulated other comprehensive loss, net as of March 31, 2009 will be subsequently amortized to Interest expense over the remaining term of our term note. |
In December 2008, we determined the interest rate swap contracts were not an effective hedge of variable interest due to the recent significant reductions in LIBOR interest rates. As a result of the estimated difference between the LIBOR interest of the interest rate swap contracts and the minimum LIBOR interest of 3.0% of the term note, we recognized $3.0 million of interest expense for the ineffective portion of these interest rate swap contracts for 2008. The effective portion of the interest rate swap contracts of $4.5 million was recorded as an unrealized loss and an unrealized tax benefit of $1.7 million in Accumulated other comprehensive loss, net, a component of equity. A corresponding deferred tax asset for the unrealized tax benefit was eliminated with a valuation allowance as there may be an inability to utilize this deferred tax asset. The remaining unrealized loss of $4.1 million in Accumulated other comprehensive loss, net as of March 31, 2009 will be subsequently amortized to Interest expense over the remaining term of our term note.
Equity
Equity Repurchases
Our credit facility amended in September 2008 prohibits the repurchase of our common shares. The determination of future share repurchases will depend on many factors, including credit facility restrictions, financial position, results of operations and cash flows.
Shelf Registration
In the third quarter of 1998, we filed a shelf registration with the Securities and Exchange Commission to register 4 million common shares. We may issue these shares in connection with future business acquisitions, combinations or mergers. Shares have been issued from this registration statement for a portion of the purchase price for acquisitions. There are approximately 3.7 million shares remaining and available under this shelf registration.
OFF-BALANCE SHEET ARRANGEMENTS
As part of our ongoing business, we do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships often referred to as structured finance or special purpose entities which might be established to facilitate off-balance sheet arrangements or other contractually narrow or limited purposes. As of March 31, 2009, we were not involved in any transactions with unconsolidated entities.
DISCLOSURES OF CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
Contractual obligations as of March 31, 2009 (millions):
| | | Payments Due by Period | |
| Contractual Obligations | | 2009 | | | | 2010 - 2012 | | | | 2013 - 2015 | | | Thereafter | | | Total | |
Long-term debt(1) | | $ | 316.2 | | | $ | 0.4 | | | $ | 0.2 | | | $ | 0.5 | | | $ | 317.3 | |
| Capital lease obligations | | | — | | | | — | | | | — | | | | — | | | | — | |
Interest on long-term debt and capital leases(2) | | | 6.9 | | | | 0.2 | | | | 0.1 | | | | 0.1 | | | | 7.3 | |
Operating lease obligations(3) | | | 18.3 | | | | 38.5 | | | | 7.2 | | | | 0.9 | | | | 64.9 | |
Unconditional purchase obligations | | | — | | | | — | | | | — | | | | — | | | | — | |
| Other long-term commitments | | | — | | | | — | | | | — | | | | — | | | | — | |
| | | $ | 341.4 | | | $ | 39.1 | | | $ | 7.5 | | | $ | 1.5 | | | $ | 389.5 | |
| | | | | | | | | | | | | | | | | | | | | |
| Interest rate swap contracts | | | | | | | | | | | | | | | | | | | | |
Notional principal amount of interest rate exchange agreements | | | | | | | | | | | | | | | | | | $ | 123.0 | |
| Variable to fixed | | | | | | | | | | | | | | | | | | | | |
| Average pay rate | | | | | | | | | | | | | | | | | | | 5.3 | % |
| Average receive rate | | | | | | | | | | | | | | | | | | | 2.7 | % |
| | | | | | | | | | | | | | | | | | | | | |
| (1) | Long-term debt obligations may differ due to potential changes in our debt and capital structures or future refinancing of debt. |
| (2) | Interest obligations may differ due to potential changes in our debt and capital structures or future refinancing of debt. Interest on our variable rate debt was calculated for all years using the rates in effect as of March 31, 2009. |
| (3) | Operating lease obligations may differ due to potential changes in our debt and capital structures or changes in operating plans and sublease arrangements. Operating lease obligations are net of sublease arrangements of $1.2 million for remainder of 2009, $1.3 million for 2010-2012 and $0.1 million for 2013-2015. |
Our credit facility consists of the revolver and term note. Accelerated repayment of our revolver and term note may occur if certain financial conditions or warranties and representations are not met. The credit facility is secured by all the assets of our wholly-owned subsidiaries.
Our amended credit facility requires monthly compliance with financial covenants including minimum liquidity and adjusted earnings before interest, taxes, depreciation and amortization (monthly Adjusted EBITDA) at least through 2010.
If our leverage ratio is at or above a certain maximum as of September 30, 2010, the monthly Adjusted EBITDA may be replaced with quarterly compliance with a leverage ratio and interest coverage ratio. Lack of compliance with these covenants may accelerate the related scheduled maturities.
We have $109.0 million in letters of credit outstanding principally for the deductible portion of automobile, general liability and workers’ compensation claims. These obligations are not required to be recorded as liabilities on our balance sheet and renew automatically on their various anniversary dates or until released by their respective beneficiaries.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Inventory Price Risk
Prices of commodity wood products, which are subject to significant volatility, may adversely impact operating income when prices rapidly rise or fall within a relatively short period of time. We do not use derivative financial instruments to hedge commodity wood product prices.
Interest Rate Risk
Changes in interest expense occur when market interest rates change. Changes in the amount of debt could also increase interest rate risks. We currently utilize interest rate swap contracts to hedge variable interest rates. As of March 2009, the interest rate swap contracts effectively converted $123.0 million of variable rate debt to a fixed interest rate of 10.6% plus any difference between minimum LIBOR interest of 3.0% and LIBOR. The notional amount of the interest rate swap contracts will be ratably reduced to zero through the maturity of November 2011.
Approximately 39% of the outstanding variable rate borrowings have been hedged with interest rate swap contracts. After giving effect to the interest rate swap contracts, total borrowings are 61% variable and 39% fixed. Based on debt outstanding as of March 31, 2009, a 0.25% increase in interest rates would result in approximately $0.5 million of additional interest expense annually.
Derivative financial instruments are not utilized to hedge other risks or for speculative or trading purposes.
CRITICAL ACCOUNTING ESTIMATES
Preparing financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. These estimates and assumptions include critical accounting estimates which are defined by the Securities and Exchange Commission as those that are the most important to the portrayal of our financial condition, results of operations or cash flows. These estimates require our subjective and complex judgments often as a result of the need to estimate matters that are inherently uncertain. We review the development, selection and disclosure of these estimates with our Audit Committee. We believe the estimates utilized are reasonable under the circumstances, however actual results could differ from these estimates and may require adjustment in future periods. Our critical accounting estimates are:
| | · | Revenue Recognition for Construction Services |
The percentage-of-completion method is used to recognize revenue for construction services. Periodic estimates of our progress towards completion are made based on a comparison of labor costs incurred to date with total estimated contract costs for labor. The percentage-of-completion method requires the use of various estimates, including among others, the extent of progress towards completion, contract revenues and contract completion costs. Contract revenues and contract costs to be recognized are dependent on the accuracy of estimates, including quantities of materials, labor productivity and other cost estimates. We have a history of making reasonable estimates of the extent of progress towards completion, contract revenues and contract completion costs. However, due to uncertainties inherent in the estimation process, it is possible that actual contract revenues and completion costs may vary from estimates. Revisions of contract revenues and cost estimates as well as provisions for estimated losses on uncompleted contracts are recognized in the period such revisions are known.
| | · | Estimated Losses on Uncompleted Contracts and Changes in Contract Estimates |
Estimated losses on uncompleted contracts and changes in contract estimates are established by assessing estimated costs to complete, change orders and claims for uncompleted contracts. Revisions of estimated losses are recognized in the period such revisions are known.
At March 31, 2009, the reserve for these estimated losses was $0.1 million. These reserves are established by assessing estimated costs to complete, change orders and claims. Assumptions for estimated costs to complete include material prices, labor costs, labor productivity and contract claims. Such estimates are inherently uncertain and therefore it is possible that actual completion costs may vary from these estimates. We have a history of making reasonable estimates of the extent of progress towards completion, contract revenue and contract completion costs. However, due to uncertainties inherent in the estimation process, it is possible that actual completion costs may vary from estimates.
| | · | Realizability of Net Deferred Tax Asset |
Deferred tax assets and liabilities are recognized for tax credits and for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A valuation allowance is recognized to reduce the carrying amount of deferred tax assets to the amount that is more likely than not to be realized. If it is later determined it is more likely than not that deferred tax assets will be realized, the valuation allowance will be adjusted. Revisions of the valuation allowance are recognized in the period such revisions are known.
At March 31, 2009, the valuation allowance was $177.7 million. The valuation allowance was recognized due to the potential inability to realize these deferred tax assets. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. The scheduled reversal of deferred tax liabilities, loss carryback and carryforward abilities, projected future taxable income, tax planning strategies, cumulative earnings and our industry are considered in making this assessment. Our ability to realize the deferred tax assets could change if estimates of future taxable income change. To the extent taxable income is generated in future periods, these tax benefits may be realized and reduce our effective tax rate in future periods.
Goodwill represents the excess of purchase price over the fair values of net tangible and identifiable intangible assets of acquired businesses. An annual assessment for impairment is completed in the fourth quarter and whenever events and circumstances indicate the carrying amount may not be recoverable. An impairment is recognized if the carrying amount is more than the estimated future operating cash flows as measured by fair value techniques.
At March 31, 2009, there was no goodwill remaining due to impairments in 2008 and 2007. The impairment assessment includes determining the estimated fair value of reporting units based on discounting the future operating cash flows using a discount rate reflecting our estimated average cost of funds. Future operating cash flows are derived from our annual plan and forecast information, which includes assumptions of future volumes, pricing of commodity products and labor costs. Prices for commodity products are inherently volatile. Due to the variables associated with prices of commodity products and the effects of changes in circumstances, both the precision and reliability of the estimates of future operating cash flows are subject to uncertainty. As additional information becomes known, we may change our estimates.
| | · | Insurance Deductible Reserves |
The estimated cost of automobile liability, general liability and workers’ compensation claims is determined by actuarial methods. Claims in excess of insurance deductibles are insured with third-party insurance carriers. Insurance deductible reserves for claims are recognized based on the estimated costs of these claims as limited by deductibles of the applicable insurance policies. Revisions to insurance deductible reserves for estimated claims are recognized in the period such revisions are known.
At March 31, 2009, the reserve for automobile, general liability and workers’ compensation claims was $42.3 million. The estimated cost of claims is determined by actuarial methods. Actual loss experience may differ substantially from the actuarial assumptions. Future estimates of the cost of claims are subject to the nature and frequency of claims, medical cost inflation and changes in the insurance deductibles of the applicable insurance policies.
The estimated cost of warranties for certain construction services is based on the nature and frequency of claims, anticipated claims and cost per claim. Claims in excess of insurance deductibles are insured with third-party insurance carriers. Estimated costs for warranties are recognized when the revenue associated with the service is recognized. Revisions of estimated warranties are recognized in the period such revisions are known.
At March 31, 2009, the reserve for warranties was $5.4 million. Specific terms and conditions for warranties vary from one year to ten years and are based on geographic market and state regulations. The reserve for these claims is susceptible to change based on the estimated cost of the claim. We have a history of making reasonable estimates of warranties. However, due to uncertainties inherent in the estimation process, it is possible that actual warranty costs may vary from estimates.
| | · | Share-based Compensation |
Our estimates of the fair values of our share-based payment transactions are based on the modified Black-Scholes-Merton model. To meet the fair value measurement objective, we are required to develop estimates regarding expected exercise patterns, share price volatility, forfeiture rates, risk-free interest rate and dividend yield. These assumptions are based principally on historical experience. When circumstances indicate changes in forfeiture rates, revisions to forfeiture rates are recognized in the periods such revisions are known. Due to uncertainties inherent in these assumptions, it is possible that actual share-based compensation may vary from these estimates.
RECENT ACCOUNTING PRINCIPLES
In May 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles. This accounting principle identifies a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with U.S. generally accepted accounting principles (GAAP) for nongovernmental entities. This accounting principle was adopted November 2008 and had no impact on our consolidated financial position, results of operations or cash flows.
In March 2008, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 161, Disclosures about Derivative Instruments and Hedging Activities. This accounting principle enhances disclosure for derivative instruments and hedging activities and their effects on consolidated financial position, results of operations and cash flows. Specifically, enhanced disclosures include objectives and strategies for using derivatives, including underlying risk and accounting designation, as well as fair values, gains and losses. This accounting principle was adopted June 2008 and had no impact on our consolidated financial position, results of operations or cash flows.
In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements. This accounting principle eliminates noncomparable accounting for noncontrolling interests. Specifically, noncontrolling interests are presented as a component of equity; consolidated net income includes amounts attributable to both the parent and noncontrolling interest and is disclosed on the face of the income statement; changes in the ownership interest are accounted for as equity transactions if ownership remains controlling; purchase accounting for acquisitions of noncontrolling interests and acquisitions of additional interests is eliminated; and deconsolidated controlling interests are recognized based on fair value consistent with Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations. The accounting requirements were adopted January 2009 and had no impact on our consolidated financial position, results of operations or cash flows.
In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations. This accounting principle requires acquisition accounting (purchase accounting) be applied to all business combinations in which control is obtained regardless of consideration and for an acquirer to be identified for each business combination. Additionally, this accounting principle requires acquisition-related costs and restructuring costs at the date of acquisition to be expensed rather than allocated to the assets acquired and the liabilities assumed; noncontrolling interests, including goodwill, to be recorded at fair value at the acquisition date; recognition of the fair value of assets and liabilities arising from contingent consideration (payments conditioned on the outcome of future events) at the acquisition date; recognition of bargain purchase (acquisition-date fair value exceeds consideration plus any noncontrolling interest) as a gain; and recognition of changes in deferred taxes. This accounting principle was adopted January 2009 and had no impact on our consolidated financial position, results of operations or cash flows.
BUSINESS RISKS AND FORWARD-LOOKING STATEMENTS
There are a number of business risks and uncertainties that affect our operations and therefore could cause future results to differ from past performance or expected results. Additional information regarding business risks and uncertainties is contained in Part II Item 1A of this Form 10-Q. These risks and uncertainties may include, however are not limited to:
| | · | substantial doubt about our ability to continue as a going concern; |
| | · | our existing common equity may have no value; |
| | · | demand for and supply of single-family homes which are influenced by changes in the overall condition of the U.S. economy, including interest rates, consumer confidence, job formation, availability of credit and other important factors; |
| | · | our ability to maintain adequate liquidity, reduce operating costs and increase market share in an industry that has experienced and continues to experience a significant reduction in average annual housing starts; |
| | § | our liquidity is dependent on operating performance, an efficient cash conversion cycle and compliance with financial covenants; |
| | § | our ability to implement and maintain cost structures that align with sales trends and |
| | § | loss of customers as well as changes in the business models of our customers may limit our ability to provide building products and construction services; |
| | · | additional impairment charges and costs to close or consolidate additional business units in underperforming markets; |
| | · | availability of and our ability to attract, train and retain qualified individuals; |
| | · | fluctuations in our costs and availability of sourcing channels for commodity wood products, concrete, steel and other building materials; |
| | · | weather conditions including natural catastrophic events; |
| | · | exposure to product liability and construction defect claims as well as other legal proceedings; |
| | · | disruptions in our information systems; |
| | · | actual and perceived vulnerabilities as a result of widespread credit and liquidity concerns, terrorist activities and armed conflict; |
| | · | costs and/or restrictions associated with federal, state and other regulations and |
| | · | numerous other matters of a local and regional scale, including those of a political, economic, business, competitive or regulatory nature. |
Risks related to our shares may include, however are not limited to:
| | · | price for our shares may fluctuate significantly; |
| | · | our shares may be less attractive as they are not traded on a large, more well-known exchange and |
| | · | anti-takeover defenses and certain provisions could prevent an acquisition of our company or limit share price. |
Certain statements in this Form 10-Q including those related to expectations about homebuilding activity in our markets, demographic trends supporting homebuilding, competition trends, anticipated sales and operating income and negotiations with our lenders are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Statements that are not historical or current facts, including statements about our expectations, anticipated financial results and future business prospects are forward-looking statements. While these statements represent our current judgment on what the future may hold and we believe these judgments are reasonable, these statements involve risks and uncertainties that are important factors that could cause our actual results to differ materially from those in forward-looking statements. These factors include, however are not limited to the risks and uncertainties cited in the above paragraph, as well as our ability to timely and successfully implement our restructuring program and achieve the benefits that the program is designed to provide, including preserving value, enhancing our liquidity, generating tax refunds, reducing expenses and generating cash proceeds. Undue reliance should not be placed on such forward-looking statements, as such statements speak only as of the date of the filing of this Form 10-Q. We undertake no obligation to update forward-looking statements.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Inventory Price Risk
Prices of commodity wood products, which are subject to significant volatility, may adversely impact operating income when prices rapidly rise or fall within a relatively short period of time. We do not use derivative financial instruments to hedge commodity wood product prices.
Interest Rate Risk
Changes in interest expense occur when market interest rates change. Changes in the amount of debt could also increase interest rate risks. We currently utilize interest rate swap contracts to hedge variable interest rates. As of March 2009, the interest rate swap contracts effectively converted $123.0 million of variable rate debt to a fixed interest rate of 10.6% plus any difference between minimum LIBOR interest of 3.0% and LIBOR. The notional amount of the interest rate swap contracts will be ratably reduced to zero through the maturity of November 2011.
Approximately 39% of the outstanding variable rate borrowings have been hedged with interest rate swap contracts. After giving effect to the interest rate swap contracts, total borrowings are 61% variable and 39% fixed. Based on debt outstanding as of March 31, 2009, a 0.25% increase in interest rates would result in approximately $0.5 million of additional interest expense annually.
Derivative financial instruments are not utilized to hedge other risks or for speculative or trading purposes.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
As of the end of the period covered by this report, management carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and Chief Financial Officer, of the design and operation of our disclosure controls and procedures. This evaluation was conducted to determine whether the disclosure controls and procedures are effective and timely in bringing material information to the attention of senior management and are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements in accordance with generally accepted accounting principles. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in ensuring information required to be disclosed in reports filed under the Securities and Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and is accumulated and communicated to our Chief Executive Officer and Chief Financial Officer to allow timely decisions regarding required disclosure.
Changes in Internal Controls Over Financial Reporting
Our disclosure controls and procedures and internal controls over financial reporting are routinely evaluated and tested for effectiveness. These evaluations are discussed with management and the Audit Committee of the Board of Directors. As a result of these evaluations, revisions and corrective actions are made to ensure the continuing effectiveness of our disclosure controls and procedures and internal controls over financial reporting.
During the period covered by this report, we identified deficiencies in the design or operation of our internal controls, however revisions and corrective actions are being made to ensure the effectiveness of our disclosure controls and procedures and internal controls over financial reporting. None of these deficiencies have been considered a material weakness and there were no changes in the design or operation of our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
PART II – OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in litigation and other legal matters arising in the normal course of business. In the opinion of management the recovery or liability, if any, under any of these matters will not have a material effect on our consolidated financial position, results of operations or cash flows.
Item 1A. Risk Factors
Risks Related to Our Business
We face a number of significant risks and uncertainties in connection with our operations. The factors described below may adversely affect our business, financial position, results of operations or cash flows and could cause future results to differ from past performance or expected results.
While we describe each risk separately, some of these risks are interrelated and certain risks could trigger other risks described below. Also, the risks and uncertainties described below are not the only risks and uncertainties we may face:
There is substantial doubt about our ability to continue as a going concern.
Our consolidated financial statements were prepared assuming we will continue as a going concern. We may not be able to meet near-term working capital and scheduled interest and debt payment requirements if cash flows are inadequate from our suppressed operating activities or if our access to the revolver portion of our credit facility is restricted due to lack of compliance with financial covenants or revolver borrowing base limitations. Absent any waiver, forbearance or modification to our current credit agreement or other financing options, we believe our recurring losses from operations, interest and debt burden amid declining sales and potential inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue near-term as a going concern.
Additionally, our long-term future is dependent on more normal levels of single-family housing starts and our ability to implement and maintain cost structures, including reduced interest and debt that align with single-family housing trends. If this fails to transpire or if we cannot obtain a waiver, forbearance or modification to our current credit agreement or other financing options, we may not be able to continue as a going concern and may be forced to seek relief through a bankruptcy filing. Such actions would have an adverse impact on the holders of our common shares.
Our existing common equity may have no value.
Given our current debt and capital structure, including our significant amount of debt and accumulated deficit, our existing common equity may have little or no value. Even if we successfully modify our credit agreement and restructure our debt and capital structure, the terms of the restructuring and any new financing that we may be able to raise could be expected to substantially dilute our current shareholders, including resulting in potential loss of the entire value of their investment. In addition, our long-term future is dependent on more normal levels of single-family housing starts and our ability to implement and maintain cost structures, including reduced interest and debt that align with single-family housing trends. If this fails to transpire or if we cannot obtain a waiver, forbearance or modification to our current credit agreement or other financing options, we may not be able to continue as a going concern and may be forced to seek relief through a bankruptcy filing. Such actions would have an adverse impact on the holders of our common shares.
Our business is dependent on demand for and supply of single-family homes that are influenced by changes in the overall condition of the U.S. economy, including interest rates, consumer confidence, job formation, availability of credit and other important factors.
The residential building products and construction services industry is highly dependent on demand for single-family homes, which is influenced by several factors. These factors include economic changes nationally and locally, mortgage and other interest rates, consumer confidence, job formation, demographic trends, tax incentives and availability of credit as well as other factors. The construction of new homes may experience decline due to excess unsold home inventory levels, lack of availability of credit for lenders, builders and homebuyers, lack of available and affordable land in attractive metropolitan areas, shortages of qualified tradespeople, shortages of materials and regulations that impose restrictive zoning and density requirements. Also, changes to housing patterns may occur, such as an increase in consumer demand for urban living rather than single-family suburban neighborhoods.
All of these factors could limit demand for home construction and may result in lower sales of our building products and construction services as well as lower operating results due to our inability to align our cost structure with these sales trends.
Our ability to maintain adequate liquidity, reduce operating costs and increase market share in an industry experiencing a 64% reduction in average annual housing starts may not be fully realized or may take longer to realize than expected.
Already under contraction, single-family housing starts declined further in the first quarter of 2009 as home foreclosures increased, lending standards tightened and rising unemployment sapped consumer confidence. According to the U.S. Census Bureau as of February 2009, single-family housing starts for the U.S. as a whole fell below an annualized rate of 0.4 million. Excluding the boom years of 2006 through 2003, single-family housing starts for the U.S. as a whole averaged 1.1 million starts per year since 1990.
Similarly, as of February 2009 annualized single-family permits in our markets fell 46% to 0.1 million from the prior year. The decline was widespread across all our markets for both building products and construction services. Lower sales from weakening buyer demand and increased competition for fewer contracts led to declines in our margins, particularly for construction services. As of March 2009, single-family housing starts for the U.S. as a whole fell to an annualized rate below 0.4 million and single-family permits in our markets remained at an annualized rate of 0.1 million. We expect market conditions to be challenging and may apply further pressure to our sales, margins and operating results.
| | · | Our liquidity is dependent on operating performance, an efficient cash conversion cycle and compliance with financial covenants. |
Liquidity is essential to our business. We fund working capital requirements and necessary capital expenditures with cash flow from operations and seasonal borrowings under our credit facility. A substantial deterioration in operating performance as well as inefficient conversion of business activities to cash may adversely affect our ability to obtain funding from operations or our credit facility.
We may not be able to meet near-term working capital and scheduled interest and debt payment requirements if cash flows are inadequate from our reduced operating activities or if our access to the revolver portion of our credit facility is restricted because we are unable to reach an agreement with our lenders. Absent any waiver, forbearance or modification to our current credit agreement, we believe our recurring losses from operations, interest and debt burden amid declining sales and potential inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern.
Additionally, our long-term future is dependent on more normal levels of single-family housing starts and our ability to implement and maintain cost structures, including reduced interest and debt that align with single-family housing trends. If this fails to transpire or if we cannot obtain a waiver, forbearance or modification to our current credit agreement or other financing options, we may not be able to continue as a going concern and may be forced to seek relief through a bankruptcy filing.
Based on financial information for February 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. In March 2009, we obtained a limited waiver through April 15, 2009 for lack of compliance with the monthly Adjusted EBITDA requirement and we preserved access to limited liquidity permitting us to borrow up to $20 million under the revolver. Previously, we had obtained waivers for financial covenants due to lower than planned operating performance as of both June 2008 and December 2007.
Due to the difficulty of reliably projecting our operating results within the depressed business conditions of the homebuilding industry, we believe that it is likely that we will not be able to meet the financial covenants of our credit agreement during 2009. Also, our independent registered public accounting firm included a going concern explanatory paragraph in their report on our financial statements for 2008, citing among other things, the uncertainty that we would remain in compliance with these financial covenants. The going concern explanatory paragraph constitutes a default under our credit agreement. In April 2009, we obtained a waiver for the going concern explanatory paragraph.
In April 2009, our lenders also agreed to extend the limited waiver through June 1, 2009. In May 2009, the limited waiver was extended through June 29, 2009. This limited waiver continues to waive compliance with the monthly Adjusted EBITDA, forecast and projection requirements of our credit agreement. The limited waiver limits borrowings under the revolver to $20 million and limits capital expenditures to $0.1 million from the date of the extended limited waiver. Lenders approving each of the March, April and May 2009 limited waivers were paid a fee of 0.10% of their revolver commitment and their portion of the outstanding principal amount of the term note.
For March 2009, we were not in compliance with the monthly Adjusted EBITDA requirement of our credit agreement. Additionally, as the limited waiver for these financial covenants is less than a year, it is probable we will not be in compliance with these financial covenants within the next year and given there is no amendment or other financing agreement currently in place, the revolver and term note are classified as a current liability in the consolidated balance sheet.
We are anticipating tax refunds of $56 million as a result of net operating losses for 2008. These refunds will be applied to reduce the amount outstanding under our term loan facility to approximately $275 million. The remaining portion of the tax refund will be available for working capital needs after payment of any borrowings under the revolver. We filed for our federal tax refund in April 2009 and our professional advisors have advised us that receipt of the refund is anticipated in mid- to late May 2009.
We are currently negotiating with our lenders to develop debt and capital structures to support our long-term strategic plan and business objectives. We expect that these negotiations may lead to a bankruptcy filing which we anticipate would reflect the agreement of our lenders and would provide for the payment in full of all amounts owing to key vendors and the uninterrupted supply of goods and services to our customers. Equity holders may be substantially diluted or be eliminated in a bankruptcy filing.
There can be no assurance these negotiations will result in debt and capital structures acceptable to us and the lenders or an agreement that would achieve our goals. If these negotiations fail, we would not be able to continue as a going concern and would be forced to seek relief through bankruptcy filing without an agreement of our lenders. We also continue to pursue alternative financing arrangements as well as evaluate other financing options.
If our operating performance, particularly cash flows from operations, is inadequate, we could suffer unfavorable consequences, such as payment delays to our suppliers or failure to honor contractual commitments including financial obligations.
Changes in or perceptions of our liquidity or the liquidity of our suppliers and customers may adversely affect our cash flows and compound other risks. Our suppliers of building products as well as customers of our building products and construction services may experience or perceive uncertain liquidity and cause changes in our liquidity. For example, vendors may disrupt supply with changes in terms such as credit and quantity limitations, pricing or payment. Similarly, customers may disrupt demand with changes in purchasing habits.
Increases in interest rates and the credit risk premium assigned to us as well as changes in the amount of debt will increase our interest expense. Higher interest expense may adversely impact our financial position, results of operations or cash flows for operating needs.
| | · | An inability to implement and maintain cost structures that align with sales trends may have an adverse impact on our operating results or the anticipated benefits of restructuring may not be fully realized or may take longer to realize than expected. |
When we experience slower periods of homebuilding activity, we may experience inefficiencies in our cost structures. In response to the current challenging economic and industry conditions, we have implemented restructuring plans that include closure or consolidation of underperforming business units, reductions in the number of employees and consolidation of certain administrative functions. These actions are designed to align our cost structures with anticipated sales. Our evaluation of and changes to expenses in response to declining sales may not be sufficient, timely or realized, leading to costs that are too high relative to sales and to lower returns on sales.
| | · | Loss of customers as well as changes in the business models of customers may have an adverse impact on our operating results. |
We are exposed to the risk of loss arising from the failure or financial distress of customers. Although amounts due from our customers are typically secured by liens on their construction projects, in the event a customer cannot meet its payment obligations to us, there is a risk that lender evaluations of customer creditworthiness may limit amounts paid to us or the value of their underlying project will not be sufficient to recover the amounts owed to us. Estimated credit losses are considered in the valuation of amounts due from our customers, however the entire carrying amount is generally at risk.
While market and regulatory changes seek to reduce excess unsold home inventory and stabilize housing affordability, we may experience losses of and changes in customers. Many homebuilders are experiencing business and financial challenges in the current housing environment. Our 5 largest customers represent 14% of consolidated sales. Additionally, diversification of our sales to more products and services for multi-family and commercial projects may result in changes in our customer mix. The loss of one or more of our significant customers or changes in customer mix may adversely affect our financial condition, results of operations or cash flows.
As the business models of our customers evolve, our existing building products and construction service offerings may not meet the needs of certain homebuilders. Homebuilders may decide to no longer outsource construction services or may purchase construction services and building products from separate suppliers. If we do not timely assess shifts in customer expectations, preferences and demands, our financial condition, results of operations or cash flows may be adversely affected.
Due to the continuing downturn in the housing industry, we may incur additional impairment charges and costs to close or consolidate additional business units in underperforming markets.
If weakness in the housing industry continues, all or a portion of remaining intangible assets for customer relationships as well as operating assets of underperforming business units may be impaired. Our ongoing evaluation of business operations places a priority on positive cash flow, efficient use of capital and higher returns. As a result of these evaluations, we may incur additional costs to close or consolidate additional underperforming business units. These impairment charges and costs may adversely affect our financial condition, results of operations or cash flows.
Our business is subject to intense competition.
Already under contraction, single-family housing starts declined further in the first quarter of 2009 as home foreclosures increased, lending standards tightened and rising unemployment sapped consumer confidence. According to the U.S. Census Bureau as of February 2009, single-family housing starts for the U.S. as a whole fell below an annualized rate of 0.4 million. Excluding the boom years of 2006 through 2003, single-family housing starts for the U.S. as a whole averaged 1.1 million starts per year since 1990.
Similarly, as of February 2009 annualized single-family permits in our markets fell 46% to 0.1 million from the prior year. The decline was widespread across all our markets for both building products and construction services. Lower sales from weakening buyer demand and increased competition for fewer contracts led to declines in our margins, particularly for construction services. As of March 2009, single-family housing starts for the U.S. as a whole fell to an annualized rate below 0.4 million and single-family permits in our markets remained at an annualized rate of 0.1 million.
There are numerous competitors providing building materials and construction services for these lower housing starts. These competitive factors have led to pricing pressures and caused reductions in sales or margins as well as increases in operating costs. Loss of significant market share due to competition could result in the closure of facilities. Additionally, the availability of our financial information as well as concerns about our financial viability may be utilized against us by our competitors. Intense competition may adversely affect our financial condition, results of operations or cash flows.
Our success is dependent upon the availability of and our ability to attract, train and retain qualified individuals.
Competition for employees is especially intense in both building products distribution and construction services. Weak operating results may limit our ability to offer competitive compensation and benefits and may result in shortages of qualified labor and key personnel and in turn, may limit our ability to complete contracts as well as obtain additional contracts with builders. Also, as a result of the downturn in the homebuilding industry, many qualified individuals have sought and may continue to seek employment in other industries. Additional employment and eligibility requirements as well as enhanced and perceived enforcement from state and federal authorities could also limit the availability of qualified labor. We cannot guarantee that we will be successful in recruiting and retaining qualified employees in the future.
Our success is also dependent on our ability to profitably implement evolving employment legislation. For example, potential legislation easing union organizing activities and limiting arbitration options may significantly increase costs and may reduce or eliminate our ability to provide building products or construction services in certain markets. Increases in health care and unemployment benefits, holidays and various job protections increase costs. Likewise, changes required to reasonably balance employment levels and profitability are difficult to obtain under binding arbitration provisions. There is no assurance we will be successful in balancing a changing sense of entitlement with shareholder value. Employment legislation may adversely affect our financial condition, results of operations or cash flows.
Our operating results are affected by fluctuations in our costs and the availability of sourcing channels for commodity wood products, concrete, steel and other building products.
Prices of commodity wood products, concrete, steel and other building products are historically volatile and are subject to fluctuations arising from changes in domestic and international supply and demand, labor costs, competition, market speculation, government regulations and periodic delays in delivery. Rapid and significant changes in product prices may affect sales as well as margins due to a limited ability to pass on short-term price changes. We do not use derivative financial instruments to hedge commodity price changes.
We may experience shortages of building products as a result of unexpected demand or production difficulties as well as transportation limitations. We have preferred suppliers for certain building products. We maintain an open dialogue with our suppliers to avoid supply disruptions. Suppliers may experience liquidity problems due to the decline in the homebuilding industry and tightened credit availability. Also, our suppliers may have concerns about our financial viability and address their own liquidity needs by requesting faster payment of invoices or other assurances. If this were to happen, our need for cash may intensify and we may be unable to make payments to our suppliers as they become due. Any disruption in our sources of supply for key building products could negatively impact our financial condition, results of operations or cash flows.
Weather conditions, including natural catastrophic events, may cause our operating results to fluctuate each quarter.
Our first and fourth quarters historically have been, and are expected to continue to be, adversely affected by weather conditions in some of our markets, causing decreases in operating results due to slower homebuilding activity. In addition, natural catastrophic events may cause our operating results to fluctuate.
The nature of our business exposes us to product liability and construction defect claims as well as other legal proceedings.
We are involved in product liability and construction defect claims relating to the products we distribute and manufacture and our various construction trades. We are also exposed to potential claims arising from the conduct of homebuilders and their subcontractors. We also operate a large fleet of trucks and other vehicles and therefore face some risk of accidents. Although we believe we maintain adequate insurance, we may not be able to maintain such insurance on acceptable terms or such insurance may not provide adequate protection against potential liabilities.
The nature of our business also exposes us to wage and hour claims. Accuracy of timekeeping methods may be difficult to defend and the extrapolation methods utilized may result in significant claims. Current or future claims may adversely affect our financial condition, results of operations or cash flows.
We may be adversely affected by disruptions in our information systems.
Our operations are dependent upon information for decision-making and the related information systems. A substantial disruption in our information systems for a prolonged period could delay the delivery of our products and services and adversely affect our ability to complete contracts and fulfill customer demands. Such delays, problems or costs may have an adverse effect on our financial condition, results of operations or cash flows.
Actual and perceived vulnerabilities as a result of widespread credit and liquidity concerns, terrorist activities and armed conflict may adversely impact consumer confidence and our business.
Instability in the economy and financial markets as a result of widespread credit and liquidity concerns, terrorism or war may impact consumer confidence and result in a decrease in homebuilding in our markets. Terrorist attacks may also directly impact our ability to maintain operations and services and may have an adverse effect on our business.
Federal, state and other regulations could impose substantial costs and/or restrictions on our business.
We are subject to various federal, state, local and other regulations, including among other things:
| | § | work safety regulations promulgated by the Department of Labor’s Occupational Safety and Health Administration, |
| | § | transportation regulations promulgated by the Department of Transportation, |
| | § | employment regulations promulgated by the Department of Homeland Security and the United States Equal Employment Opportunity Commission as well as |
| | § | state and local zoning restrictions and building codes. |
More burdensome regulatory requirements in these or other areas may increase our costs and have an adverse effect on our financial condition, results of operations or cash flows.
Numerous other matters of a local and regional scale, including those of a political, economic, business, competitive or regulatory nature may have an adverse impact on our business.
Many factors shape the homebuilding industry and our business. In addition to the factors previously cited, there are other matters of a local and regional scale, including those of a political, economic, business, competitive or regulatory nature that may have an adverse effect on our business.
Risks Related to Our Shares
Risks related to our shares may include, however are not limited to:
| | § | Our share price may fluctuate significantly, which may make it difficult for shareholders to trade our shares when desired or at attractive prices. |
The market price of our shares is subject to significant changes as a result of our operating performance and the other factors discussed above as well as perceptions and events that are beyond our control. Price and trading volume fluctuations for our shares may be unrelated or disproportionate to our operating performance. Additionally, our share price could fluctuate based on the expectations and performance of other publicly traded companies in the building products distribution and construction services industry.
| | § | Our shares may be less attractive as they are not traded on a large, well-known exchange. |
Our shares trade on the OTC Bulletin Board. Our shares were suspended from trading on the New York Stock Exchange (NYSE) in October 2008 as our market capitalization was less than $25 million for a 30 trading-day period. The OTC Bulletin Board may be perceived by investors as less desirable than the larger, more well-known exchanges. As a result, there may be a reduction in the number of investors willing to acquire or hold our shares which could impact our ability to raise equity financing as well as reduce the liquidity and market price of our shares.
| | § | Anti-takeover defenses in our governing documents and certain provisions under Delaware law could prevent an acquisition of our company or limit the price that investors might be willing to pay for our shares. |
Our governing documents and certain provisions of Delaware law that apply to us could make it difficult for another company to acquire control of our company. For example:
| | · | our certificate of incorporation allows our Board of Directors to issue, at any time and without shareholder approval, preferred shares with such terms as they may determine; |
| | · | our bylaws provide that during certain types of transactions that could affect control, including the acquisition of 15% or more of our common shares, affiliates of any party to the transaction and persons having a material financial interest in the transaction may not be elected to the Board of Directors; and |
| | · | certain provisions of Delaware law generally prohibit us from engaging in any business combination with a person owning 15% or more of our common shares, or who is affiliated with us and owned 15% or more of our common shares at any time within three years prior to the proposed business combination, for a period of three years from the date the person became a 15% owner, unless specified conditions are met. |
These provisions and others could delay, prevent or allow our Board of Directors to resist an acquisition of our company, even if a majority of our shareholders favored the proposed transaction.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Warrants
In connection with the amendment of our credit facility in September 2008, we issued warrants that entitle our lenders to purchase approximately 8.75% or 2.8 million shares of our common shares at a purchase price of $0.47 per common share, the closing price on the NYSE on September 30, 2008. These warrants may be exercised through September 2015.
The fair value of each common share for these warrants was estimated on the date of grant using the modified Black-Scholes-Merton model. The following table presents the assumptions used in the valuation and the resulting fair value as of the date of grant:
| Expected term (years) | | | 5.5 | |
| Expected volatility | | | 64.6% | |
| Expected dividend yield | | | 0.0% | |
| Risk-free interest rate | | | 3.0% | |
| Exercise price | | | $0.47 | |
| Weighted average fair value | | | $0.28 | |
These assumptions to determine fair value are based principally on historical experience. Due to uncertainties inherent in these assumptions, it is possible that actual value received by the warrant holders may vary from the estimate of the fair value of these common shares.
No warrants have been exercised and all 2.8 million warrants are outstanding and exercisable as of March 31, 2009. Warrants exercised are settled with newly issued common shares.
The warrants were issued without registration on the exemption provided by Section 4(2) of the Securities Act of 1933.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
| (a) | | Exhibits | | |
| | | | | |
| | | Number | | Description |
| | | | | |
| | | 10.10.2.3 | | Limited Waiver Agreement to Second Amended and Restated Credit Agreement Dated as of May 14, 2009 among Building Materials Holding Corporation and other Subsidiary Grantors, Wells Fargo Bank, National Association, as L/C Issuer, Swingline Lender and Administrative Agent for the Lenders |
| | | | | |
| | | 31.1 | | Section 302 Certification |
| | | | | |
| | | 31.2 | | Section 302 Certification |
| | | | | |
| | | 32.0 | | Section 906 Certifications |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | BUILDING MATERIALS HOLDING CORPORATION |
| Date: May 14, 2009 | /s/ Robert E. Mellor | |
| | Robert E. Mellor Chairman of the Board and Chief Executive Officer (Principal Executive Officer) |
| Date: May 14, 2009 | /s/ William M. Smartt | |
| | William M. Smartt Senior Vice President and Chief Financial Officer (Principal Financial Officer) |
