UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K

 

Commission File Number 0-22462

GIBRALTAR INDUSTRIES, INC.

(Exact name of Registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(716) 826-6500

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None

 

Indicate by checkmark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o     No þ.

 

Indicate by checkmark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o     No þ.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ     No o.

 

Indicate by checkmark 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes o     No o.

 

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

 

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o     No þ.

 

The aggregate market value of the Common Stock outstanding held by non-affiliates computed by reference to the price the Common Stock was last sold on the NASDAQ Stock Exchange Global Select Market^® on June 30, 2010, the last business day of the registrant’s most recently completed second quarter, was approximately $288.6 million.

 

As of February 21, 2011, the number of common shares outstanding was: 30,398,296.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

The information required to be furnished pursuant to Part III of this Annual Report on Form 10-K will be set forth in, and is incorporated by reference to, the registrant’s Definitive Proxy Statement for the Annual Meeting of Stockholders (2010 Proxy Statement), which will be filed no later than 120 days after the end of the registrant’s 2010 fiscal year.

 

Exhibit Index begins on Page 81

 

 

 

 

Safe Harbor Statement

 

Certain information set forth herein, other than historical statements, contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 that are based, in whole or in part, on current expectations, estimates, forecasts, and projections about the Company’s business, and management’s beliefs about future operations, results, and financial position. These statements are not guarantees of future performance and are subject to a number of risk factors, uncertainties, and assumptions. Risk factors that could affect these statements include, but are not limited to, the following: the availability of raw materials and the effects of changing raw material prices on the Company’s results of operations; energy prices and usage; changing demand for the Company’s products and services; changes in the liquidity of the capital and credit markets; risks associated with the integration of acquisitions; and changes in interest and tax rates. In addition, such forward-looking statements could also be affected by general industry and market conditions, as well as general economic and political conditions. The Company undertakes no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required by applicable law or regulation.

 

 

General

 

Gibraltar is a leading manufacturer and distributor of products for the building markets. Our products provide structural and architectural enhancements for residential homes, and to a lesser extent, to low-rise retail, professional buildings, and other commercial and industrial building structures. These products include bar grating and expanded metal products, ventilation products, mail storage solutions including mailboxes and package delivery products, roof edging, flashing, soffit, drywall corner bead, metal roofing and accessories, steel framing, rain-carrying systems, and structural connectors. We serve customers throughout North America and Europe. Our most significant customers consist of The Home Depot, Lowe’s Companies, Menard Cashway Lumber, and ABC Supply. We operate 43 facilities in 20 states, Canada, England, Germany, and Poland, giving us a broad platform for just-in-time delivery and support to our customers.

 

Our strategy is to position Gibraltar as the low-cost provider and market share leader in product areas that offer the opportunity for sales growth and margin enhancement over the long-term. We focus on operational excellence including lean initiatives throughout the Company to position Gibraltar as our customers’ low-cost provider of products. We continuously seek to improve our on-time delivery, quality, and service to position Gibraltar as a preferred supplier to our customers. We also strive to develop new products, enter new markets, expand market share in the residential markets, and further penetrate domestic and international building markets to strengthen our product leadership positions.

 

Recent Developments

 

On February 1, 2010, Gibraltar completed the sale of the majority of the assets of the Processed Metal Products business. The completion of this transaction finalized our exit from the steel processing business. This strategic initiative began in 2005 and included the 2006 sale of our steel strapping business, the 2007 sale of the Hubbell Steel business, and the 2008 sale of the SCM powdered metal business. This transaction was an ongoing part of our objective to build a company with optimal operating characteristics and improve shareholder value. We now are solely focused on the manufacture and distribution of building products where the Company has historically generated its highest operating margins.

 

The accelerated economic turmoil impacting the United States and the rest of the world in the second half of 2008 continued to negatively impact the key end markets we served during 2010 and 2009. As shown below, the residential construction market in the United States continued to experience significant declines in volume:

 

 

The decrease in residential housing starts affected by higher unemployment and tighter consumer credit had a significant impact on the operations of our business by contributing to decreased sales volumes. Although we experienced improved order levels in March and April 2010, the expiration of the federal tax credit for first-time homebuyers, coupled with the factors noted above negatively affecting the housing market, lowered 2010 order levels in total. Similar trends were noted in the other end markets we serve, including commercial construction and related repair and remodeling activity.

 

Additionally, commodity raw material prices for materials such as steel, aluminum, and resins, have fluctuated significantly during the past three years. These raw material prices impact the cost of raw materials we purchase and also impact the pricing we offer to customers on sales of our products. During the first three quarters of 2008, a period of comparatively stronger growth, we were able to successfully manage significant increases in raw material costs. However, commodity prices fell precipitously during the fourth quarter of 2008 and continued to fall during the first two quarters of 2009. The rapid decrease in commodity prices led to lower sales prices offered to customers and falling margins on our product sales during the fourth quarter of

2008 and the first half of 2009. Commodity prices stabilized over the last six months of 2009 and most of 2010 and were followed by a significant increase in commodity costs during the fourth quarter of 2010. Material margins were managed closely during 2010, however, the rising cost of raw materials led to compressed margins during the last six months of the year.

 

In an effort to respond to these market forces, we have taken a number of steps to position the Company as a low-cost provider of our products. Our focus has been on achieving operational excellence through lean initiatives and the consolidation of facilities. These efforts have resulted in the closing or consolidation of 30 facilities since January 2008, including six during 2010. We have also aggressively reduced operating costs to adjust to decreased sales volumes and maximize cash flows generated from operating activities. As a result, we believe our break-even point has reduced significantly from 2008.

 

During the year ended December 31, 2010, we reduced our net debt level and continuously increased the Company’s liquidity. We made net payments of $50.0 million on debt under our revolving credit facility provided by the Third Amended and Restated Credit Agreement dated July 24, 2009 (the Senior Credit Agreement). As a result of these repayments, we do not have any amounts outstanding under our revolving credit facility and the amount available under this facility increased by $16.1 million from December 31, 2009 to $85.8 million as of December 31, 2010. The positive cash flow generated from operations during the past two years and from the sale of the Processed Metal Products business allowed us to make significant repayments on our long-term debt since December 31, 2008. During this period, we have decreased our outstanding debt by $149.2 million from $356.4 million as of December 31, 2008 to $207.2 million as of December 31, 2010, a 41.9% decrease. Additionally, the Company has increased its cash on hand to $60.9 million as of December 31, 2010 from $23.6 million as of December 31, 2009.

 

Industry Overview

 

Our business occupies an intermediate market between the primary steel, aluminum, resin, and other basic material producers and the wholesale, retail building supply, and industrial manufacturing markets. The primary producers typically focus on producing high volumes of their product. We purchase raw materials from these producers and, through various production processes, convert these raw materials into specialized products for use in the construction or repair and remodel of residential and commercial buildings and industrial products. We distribute our products through wholesale distributors and retailers.

 

Products and Services

 

Gibraltar is primarily, but not exclusively, a manufacturer of metal products used in the residential and commercial building and industrial manufacturing markets. We operate 32 manufacturing facilities and 8 distribution centers throughout the United States, Canada, England, Germany, and Poland, giving us a base of operations to provide customer support, delivery, service, and quality to a number of regional and national customers, and providing us with manufacturing and distribution efficiencies in North America, as well as a presence in the European market.

 

We manufacture an extensive variety of products that are sold through a number of sales channels including lumber and building material wholesalers, buying groups, discount and major retail home centers, major home builders, heating, ventilation and air conditioning and roofing distributors, residential, industrial and commercial contractors, and industrial manufacturers.

 

Our product offerings include a full line of bar grating and safety plank grating used in walkways, platforms, safety barriers, drainage covers, and ventilation grates; expanded metal used in walkways, shelving, barriers, patio furniture, and other applications where both visibility and security are necessary; perforated metal and metal lath products; fiberglass grating used in areas where high strength, light weight, low maintenance, and corrosion resistance are required; ventilation products and accessories; storage solutions, including mailboxes and package delivery products; roof edging, underlayment, and flashing; soffit; drywall corner bead; coated coil stock; metal roofing and accessories; steel framing; rain-carrying systems, including gutters and accessories; builders’ hardware; shelving and closet rods; lawn and garden products; diffusers;

fasteners; and structural support products, each of which can be sold separately or as an integral part of a package or program sale.

 

We improve our offerings of building products by launching new products, enhancing existing products, adjusting product specifications to respond to building code and regulatory changes, and providing additional solutions to homeowners and contractors. During 2010, we developed mailbox and locker products with locking mechanisms which we believe will be in demand as consumers put greater emphasis on the protection of their security and privacy. Additionally, our Air Vent subsidiary introduced the Hip and Ridge Vent^®, a shingle-over vent providing exhaust along the roof’s hip allowing maximum airflow. Another subsidiary expanded its product offerings of stainless steel expanded metal products.

 

Many of our building products are used by home owners and builders to provide structural and architectural enhancements for residential and commercial building projects, including projects in geographic locations subject to severe weather or seismic activity, and facilitate compliance with increasingly stringent building codes and insurance requirements. Our building products are manufactured primarily from galvanized and painted steel, anodized and painted aluminum, copper, brass, zinc, and various resins. These metal purchases enhance our purchasing position due to the increased total volume and value-added component of these purchases.

 

Our production capabilities allow us to process the wide range of metals and plastics necessary for manufacturing building products. Our equipment includes automatic roll forming machines, stamping presses, shears, press brakes, paint lines, milling, welding, injection molding, and numerous automated assembly machines. We maintain our equipment with a thorough preventive maintenance program, including in-house tool and die shops, allowing us to meet the demanding service requirements of many of our customers.

 

Quality Assurance

 

We place great importance on providing our customers with high-quality products for use in critical applications. We carefully select our raw material vendors and use computerized inspection and analysis to maintain our quality standards so that our products will meet critical customer specifications. To meet customer specifications, we use documented procedures utilizing statistical process control systems linked directly to processing equipment to monitor all stages of production. Physical, chemical, and metallographic analyses are performed during the production process to verify that mechanical and dimensional properties, cleanliness, surface characteristics, and chemical content are within specification.

 

Technical Services

 

We employ a staff of engineers, metallurgists, and other technical personnel and maintain fully-equipped, modern laboratories to support our operations. These laboratories enable us to verify, analyze, and document the physical, chemical, metallurgical, and mechanical properties of our raw materials and products. In addition, our engineering staff employs a range of drafting software to design highly specialized and technically precise products. Technical service personnel also work in conjunction with our sales force to determine the types of products and services required for the particular needs of our customers.

 

Suppliers and Raw Materials

 

Our business is required to maintain substantial inventories of raw material in order to accommodate the short lead times and just-in-time delivery requirements of our customers. Accordingly, we plan our purchases to maintain an inventory of raw materials at sufficient levels to satisfy the anticipated needs of our customers. We manage our inventory levels through forecasts of customer orders, efficient supply chain management, and an ongoing assessment of market conditions.

 

The primary raw material we purchase is flat-rolled steel and we also procure aluminum and resins. We purchase flat-rolled steel at regular intervals on an as-needed basis, primarily from the major North American

suppliers, as well as a limited amount from foreign steel producers. Because of our strategy to develop longstanding relationships in our supply chain, we have been able to adjust our deliveries of raw materials to match our required inventory positions to support our on-time deliveries to customers.

 

In 2010, we purchased substantially all of our aluminum requirements from several domestic mills with a small amount sourced with off-shore mills. Our resin purchases are all domestic, primarily through distributors with a small amount direct from the manufacturer. Supply has been adequate from these sources to fulfill our needs.

 

We purchase natural gas and electricity from suppliers in proximity to our operations.

 

We have no long-term contractual commitments with our suppliers. Our Vice President of Supply Chain Management continually examines and improves our purchasing practices across our geographically dispersed facilities in order to streamline purchasing across like commodities.

 

Intellectual Property

 

We protect our intellectual property by trademark, copyright, and patent registrations and use our intellectual property in the business activities of each operating segment. While no individual item of our intellectual property is considered material, we do believe our trademarks, copyrights, and patents provide us with a competitive advantage when marketing our products to customers.

 

Sales and Marketing

 

Our products and services are sold primarily by channel partners who are called on by our sales personnel and outside sales representatives located throughout the United States, Canada, Mexico, and Europe. We have organized sales teams to focus on specific customers and national accounts to allow us to provide enhanced supply solutions, and enhance our ability to increase the number of products that we provide to those customers and accounts. Our sales staff works with certain retail customers to optimize shelf space for our products which is expected to increase sales at these locations.

 

Customers and Distribution

 

We have numerous customers located throughout the United States, Canada, Mexico, Europe, and Central America, principally in the home improvement; residential, commercial, and industrial construction; building materials; and architectural industries. Major customers include home improvement retailers, building product distributors, and commercial and residential contractors. The Home Depot represented 15%, 16%, and 10% of our consolidated net sales for 2010, 2009, and 2008, respectively. No other customer accounted for more than 10% of our net sales.

 

Although we negotiate annual sales orders with the majority of our customers, these orders are subject to customer confirmation as to product amounts and delivery dates. We do not have long-term contracts with any of our customers.

 

Backlog

 

Because of the nature of our products and the short lead time order cycle, backlog is not a significant factor in our business. We believe that substantially all of our firm orders existing on December 31, 2010 will be shipped prior to the end of the first quarter of 2011.

 

Competition

 

Gibraltar operates in the highly competitive building products market with several North American suppliers and, in the case of European operations, some foreign suppliers. A few of our competitors may be larger, have greater financial resources, or have less financial leverage than we do. As a result, these competitors may be better positioned to respond to any downward pricing pressure or other adverse economic or industry conditions or to identify and acquire companies or product lines compatible with their business.

We compete with numerous suppliers of building products based on the range of products offered, quality, price, and delivery. Although some of these competing suppliers are large companies, the majority are small to medium-sized and do not offer the range of building products we do.

 

The prices for the raw materials we use in our operations, primarily steel, aluminum, and resins, are volatile due to a number of factors beyond our control, including supply shortages, general industry and economic conditions, labor costs, import duties, tariffs, and currency exchange rates. Although we have strategies to deal with volatility in raw material costs, such as reducing inventory levels, our competitors who do not have to maintain inventories as large as ours may be better able to mitigate the effects of this volatility and thereby compete effectively against us on product price.

 

We believe our broad range of products, high product quality, and sustained ability to meet exacting customer delivery requirements gives us a competitive advantage over many competitors.

 

Employees

 

At December 31, 2010 and 2009, we employed approximately 2,054 and 2,450 employees, respectively. Approximately 19% of our workforce was represented by unions through various collective bargaining agreements (CBAs) as of December 31, 2010. One CBA, representing 5% of our workforce, will expire during 2011. Our other CBAs expire between February 19, 2012 and December 31, 2013. We historically have had good relationships with our unions. We expect the current and future negotiations with our unions to result in contracts that provide employee benefits that are consistent with those provided in our current agreements.

 

Seasonality

 

Our net sales are generally lower in the first and fourth quarters primarily due to reduced activity in the building and construction industry due to colder and more inclement weather.

 

Governmental Regulation

 

Our manufacturing facilities and distribution centers are subject to many federal, state, and local requirements relating to the protection of the environment and we use environmentally sensitive materials in our production processes. For example, we lubricate our machines with oil and use oil baths to treat some of our products. We believe that we operate our business in material compliance with all environmental laws and regulations, do not anticipate any material expenditures to meet environmental requirements and do not believe that future compliance with such laws and regulations will have a material adverse effect on our financial condition or results of operations. However, we could incur operating costs or capital expenditures in complying with new or more stringent environmental requirements in the future or with current requirements if they are applied to our facilities in a way we do not anticipate. In addition, new or more stringent regulation of our energy suppliers could cause them to increase the cost of energy they supply us.

 

Our operations are also governed by many other laws and regulations covering our labor relationships, the zoning of our facilities, our general business practices, and other matters. We believe that we are in material compliance with these laws and regulations and do not believe that future compliance with such laws and regulations will have a material adverse effect on our financial condition or results of operations.

 

Internet Information

 

Copies of the Company’s Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through the Company’s Web site (www.gibraltar1.com) as soon as reasonably practicable after the Company electronically files the material with, or furnishes it to, the Securities and Exchange Commission.

 

The United States and worldwide capital and credit markets have experienced significant price and credit availability volatility, dislocations, and disruptions.

 

These events have caused market prices of many stocks to fluctuate substantially, the spreads on prospective debt financings to widen considerably, and have materially impacted liquidity in the financial markets, making terms for certain financings less attractive, and in some cases have resulted in the unavailability of financing. Continued uncertainty in the capital and credit markets may negatively impact our business, including our ability to access additional financing at reasonable terms, which may negatively affect our ability to make future acquisitions. A prolonged downturn in the financial markets may cause us to seek alternative sources of potentially less attractive financing, and may require us to further adjust our business plan accordingly. These events may also make it more difficult or costly for us to raise capital through the issuance of our equity securities and could reduce our net income by increasing our interest expense and other costs of capital. The disruptions in the financial markets may have a material adverse effect on the market value of our common stock.

 

The diminished availability of credit and other capital is also affecting end users in the key markets we serve including the building markets. There is continued uncertainty as to sustainability of the recovery of the worldwide capital and credit markets and the impact this period of volatility will continue to have on our key end markets. The effects of existing and any new U.S. Government measures to aid economic recovery including economic stimulus legislation continue to be unknown. Further volatility in the worldwide capital and credit markets may continue to significantly impact the key end markets we serve and could result in further reductions in sales volumes, increased credit and collection risks, and may have other adverse effects on our business.

 

The residential building as well as the repair and remodel industries account for a significant portion of our sales, and any further reduction in demand from these industries is likely to adversely affect our profitability and cash flow further.

 

The residential building market in North America experienced a significant decline in volume beginning in 2008 and continuing throughout 2009 and 2010 as shown below:

 

 

Similar trends were noted in the other end markets we serve, including the repair and remodel industry. Our largest customers are retail home improvement centers and wholesale distributors who serve our key end markets. In 2010, 2009, and 2008, The Home Depot accounted for approximately 15%, 16%, and 10% of our net sales, respectively. A loss of sales to the residential building industry, or the repair and remodel industry, or to the specified customer, would adversely affect our profitability and cash flow as it did throughout the years ended December 31, 2010 and 2009. Our sales of building products decreased during the past two years due to a decline in demand in the new build residential building and repair and remodel industries. This reduction in volume caused a decrease in our operating margins compared to prior years. This industry is cyclical, with product demand based on numerous factors such as availability of credit, interest rates, general economic conditions, consumer confidence, unemployment levels, and other factors beyond our control. The current poor economic conditions have negatively affected all of these factors.

 

Further downturns in demand from the residential building and repair and remodel industries, or any of the other industries we serve, or a decrease in the prices that we can realize from sales of our products to customers in any of these markets could continue to adversely affect our profitability and cash flows.

Our level of indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes in the economy, or our industry and prevent us from meeting our obligations.

 

We have total indebtedness of $207.2 million as of December 31, 2010. The following chart shows our level of indebtedness and certain other information as of December 31, 2010 (dollars in millions):

 

 

 

 

We may not be able to generate sufficient cash flow from profitability and other sources to service all of our indebtedness and we could be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.

 

Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business, and other factors beyond our control. We cannot assure you that we will maintain a level of cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness.

 

If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital or restructure or refinance our indebtedness. We cannot assure you that we would be able to take any of these actions, that these actions would be successful and permit us to meet our scheduled debt service obligations or that these actions would be permitted under the terms of our existing or future debt agreements. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to dispose of material assets or operations to meet our debt service and other obligations. Our Third Amended and Restated Credit Agreement dated July 24, 2009 (the Senior Credit Agreement) and our indenture agreement for our Senior Subordinated 8% Notes restrict our ability to dispose of assets and the use of proceeds from the disposition. We may not be able to consummate those dispositions or to obtain the proceeds which we could realize from them and these proceeds may not be adequate to meet any debt service obligations then due.

 

If we cannot make scheduled payments on our debt, we will be in default and, as a result:

 

 

Relative to current indebtedness levels, we may still be able to incur substantially more debt. This could further exacerbate the risks described above.

 

The terms of the indenture for our Senior Subordinated 8% Notes do not fully prohibit us or our subsidiaries from incurring additional debt. Additionally, our Senior Credit Agreement provides us with a

revolving credit facility commitment of $200 million with borrowings limited to the lesser of (i) $200 million or (ii) a borrowing base determined by reference to the trade receivables, inventories, and property, plant, and equipment of our significant domestic subsidiaries. At December 31, 2010, we had $85.8 million of availability under our revolving credit facility. Under the terms of our Senior Credit Agreement, we are required to repay all amounts outstanding under the revolving credit facility by August 30, 2012. Our principal operating subsidiary, Gibraltar Steel Corporation of New York, is also a borrower under our Senior Credit Agreement and the full amount of our commitments under the revolving credit facility may be borrowed by that subsidiary.

 

In addition, our substantial degree of indebtedness could have other important consequences, including the following:

 

 

Restrictive covenants may adversely affect our operations.

 

Our Senior Credit Agreement and the indenture governing our Senior Subordinated 8% Notes contain various covenants that limit our ability to, among other things:

 

 

In addition, the restrictive covenants in the Senior Credit Agreement include a single financial covenant that requires the Company to maintain a minimum fixed charge coverage ratio of 1.25 to 1.00. Our ability to meet the restrictive covenants in the future can be affected by events beyond our control and we cannot assure you that we will meet the financial ratio. A breach of any of these covenants would result in a default under the Senior Credit Agreement. Upon the occurrence of an event of default under the Senior Credit Agreement, we would attempt to receive a waiver from our lenders, which could result in us incurring additional financing fees that would be costly and adversely affect our profitability and cash flows. If a waiver was not provided, the lenders could elect to declare all amounts outstanding under such facility to be immediately due and payable and terminate all commitments to extend further credit. If such event of default and election occurs,

the lenders under the Senior Credit Agreement would be entitled to be paid before current Senior Subordinated 8% Note holders receive any payment under our notes. In addition, if we were unable to repay those amounts, the lenders under the Senior Credit Agreement could proceed against the collateral granted to them to secure that indebtedness. We have pledged substantially all our assets as collateral under our Senior Credit Agreement. If the lenders under our Senior Credit Agreement accelerate the repayment of borrowings, we cannot assure you that we will have sufficient assets to repay debt outstanding under our Senior Credit Agreement and our other indebtedness, including our Senior Subordinated 8% Notes, or borrow sufficient funds to refinance such indebtedness. An acceleration of the amounts outstanding under the Senior Credit Agreement would result in an event of default under our Senior Subordinated 8% Notes which would then entitle the holders thereof to accelerate and demand repayment of the notes as well. Even if we are able to obtain new financing to pay the amounts due under the Senior Credit Agreement and Senior Subordinate 8% Notes, it may not be on commercially reasonable terms, or terms that are acceptable to us. A breach of any of our covenants would have an adverse effect on our business, results of operations, and cash flow.

 

Variable rate indebtedness subjects us to interest rate risk which could cause our debt service obligations to increase significantly.

 

Certain of our borrowings, primarily borrowings under our Senior Credit Agreement, are, and are expected to continue to be, at variable rates of interest and expose us to interest rate risk. If interest rates increase, our debt service obligations on the variable rate indebtedness would increase on any amounts outstanding under the Senior Credit Agreement, and our net income would decrease. Assuming all revolving loans were fully drawn or funded on December 31, 2010, as applicable, each 25 basis point change in interest rates would result in a $0.5 million change in annual interest expense on debt outstanding under our Senior Credit Agreement.

 

We rely on a few customers for a significant portion of our net sales, and the loss of those customers would adversely affect us.

 

Some of our customers are material to our business and results of operations. In 2010, 2009, and 2008, our ten largest customers accounted for approximately 37%, 37%, and 30% of our net sales, respectively. Our percentage of net sales to our major customers may increase if we are successful in pursuing our strategy of broadening the range of products we sell to existing customers. In such an event, or in the event of any consolidation in the markets we serve, including retailers selling building products, our net sales may be increasingly sensitive to deterioration in the financial condition of, or other adverse developments with, one or more of our largest customers. These customers are also able to exert pricing and other influences on us, requiring us to market, deliver, and promote our products in a manner that may be more costly to us. Moreover, we generally do not have long-term contracts with our customers. As a result, although our customers periodically provide indications of their product needs and purchases, they generally purchase our products on an order-by-order basis, and the relationship, as well as particular orders, can be terminated at any time. The loss, bankruptcy, or significant decrease in business from any of our major customers would have a material adverse effect on our business, results of operations, and cash flow.

 

Our business is highly competitive, and increased competition could reduce our gross profit, net income, and cash flow.

 

The principal markets that we serve are highly competitive. Competition is based primarily on quality, price, raw materials and inventory availability, and the ability to meet delivery schedules dictated by customers. We compete in building markets with companies of various sizes, some of which have greater financial and other resources than we do and some of which have better established brand names in the markets we serve. Increased competition could force us to lower our prices or to offer additional services or enhanced products at a higher cost to us, which could reduce our gross profit, net income, and cash flow and cause us to lose market share.

Our future operating results may be affected by fluctuations in raw material costs. We may not be able to pass on increases in raw material costs to our customers.

 

Our principal raw materials are steel, aluminum, and resins, which we purchase from multiple primary suppliers. The steel industry as a whole is cyclical, and at times availability and pricing can be volatile due to a number of factors beyond our control, including general economic conditions, domestic and worldwide demand, labor costs, competition, import duties, tariffs, and currency exchange rates. This volatility can significantly affect our steel costs. Our other significant raw materials, including aluminum and resins, are also subject to price volatility.

 

Global consolidation of the primary steel producers and increased demand from other nations such as China and India continue to put upward pressure on market prices for steel and other commodities. Additionally, we are required to maintain substantial inventories to accommodate the short lead times and just-in-time delivery requirements of our customers. Accordingly, we purchase raw materials on a regular basis in an effort to maintain our inventory at levels that we believe are sufficient to satisfy the anticipated needs of our customers based upon expected buying practices and market conditions. In an environment of increasing raw material prices, competitive conditions will impact how much of the steel price increases we can pass on to our customers. To the extent we are unable to pass on future price increases in our raw materials to our customers, the profitability of our business and resulting cash flows could be adversely affected. In the event of rapidly decreasing raw material prices, we may be left to absorb the cost of higher cost inventory as customers receive reduced pricing related to decreases in raw material costs. To the extent we are unable to match our costs to purchase raw materials to prices given to our customers, the profitability of our business and resulting cash flows could be adversely affected.

 

Lead time and the cost of our products could increase if we were to lose one of our primary suppliers.

 

If, for any reason, our primary suppliers of steel, aluminum, or other metals should curtail or discontinue deliveries to us in quantities we need and at prices that are competitive, our business could suffer. The number of available suppliers has been reduced in recent years due to industry consolidation and bankruptcies affecting steel and metal producers and this trend may continue. Our top ten suppliers accounted for 35% of our purchases during 2010. We could be significantly and adversely affected if delivery were disrupted from a major supplier or several suppliers. In addition, we do not have long-term contracts with any of our suppliers. If, in the future, we were unable to obtain sufficient amounts of the necessary metals at competitive prices and on a timely basis from our traditional suppliers, we may not be able to obtain such metals from alternative sources at competitive prices to meet our delivery schedules, which would have a material adverse effect on our results, profitability, and cash flow.

 

Increases in energy and freight prices would increase our operating costs, and we may be unable to pass all these increases on to our customers in the form of higher prices for our products.

 

We use energy to manufacture and transport our products. In particular, our plants use considerable electricity. Our operating costs increase if energy costs rise. Although we do not believe we have experienced materially higher energy costs as a result of new or more stringent environmental regulations of our energy suppliers, such regulations could increase the cost of generating energy that is passed on to us. During periods of higher freight and energy costs, we may not be able to recover our operating cost increases through price increases without reducing demand for our products. In addition, we do not hedge our exposure to higher prices via energy futures contracts. Increases in energy prices may reduce our profitability and cash flows if we are unable to pass all the increases on to our customers.

 

We may not be able to identify, manage, and integrate future acquisitions successfully, and if we are unable to do so, we are unlikely to sustain growth in net sales or profitability and our ability to repay our outstanding indebtedness may decline.

 

Historically, we have grown through a combination of internal growth plus external expansion through acquisitions. Although we intend to actively pursue our growth strategy in the future, we cannot provide any

assurance that we will be able to identify appropriate acquisition candidates or, if we do, that we will be able to negotiate successfully the terms of an acquisition, finance the acquisition, or integrate the acquired business profitably into our existing operations. Integration of an acquired business could disrupt our business by diverting management away from day-to-day operations and could result in liabilities that were not anticipated. Further, failure to integrate any acquisition successfully may cause significant operating inefficiencies and could adversely affect our profitability and our ability to repay our outstanding indebtedness. Consummating an acquisition could require us to raise additional funds through additional equity or debt financing. Additional debt financing would increase our interest expense and reduce our cash flow otherwise available to reinvest in our business and neither debt nor equity financing may be available on satisfactory terms when required.

 

We are subject to information system security risks and systems integration issues could disrupt our internal operations.

 

We are dependent upon information technology for the distribution of information internally and also to our customers and suppliers. This information technology is subject to theft, damage, or interruption from a variety of sources, including but not limited to malicious computer code, such as worms, viruses and Trojan horses, security breaches, and defects in design. The implementation of new information technology solutions could lead to interruptions of information flow internally and to our customers and suppliers while the implementation project is being completed. We implemented new systems in 2010 and 2009 at several business units. Various measures have been taken to manage our risks related to information system and network disruptions, but a security breach, system failure, or failure to implement new systems properly could negatively impact our operations and financial results.

 

Our principal stockholders have the ability to exert significant influence in matters requiring a stockholder vote and could delay, deter, or prevent a change in control of the Company.

 

Approximately 10% of our outstanding common stock, including shares of common stock issuable under options and similar compensatory instruments granted which are exercisable, or which are vested or will vest within 60 days, are owned by Brian J. Lipke, the Chairman of the Board and Chief Executive Officer of the Company, Eric R. Lipke, Neil E. Lipke, Meredith A. Lipke, and Curtis W. Lipke, all of whom are siblings, and certain trusts for the benefit of each of them. As a result, the Lipke family has influence over all actions requiring stockholder approval, including the election of our board of directors. Through their concentration of voting power, the Lipke family could delay, deter, or prevent a change in control of our Company or other business combinations that might otherwise be beneficial to our Company. In deciding how to vote on such matters, the Lipke family may be influenced by interests that conflict with the interests of other shareholders. In addition, the Lipke family may have an interest in pursuing transactions that, in their judgment, enhance the value of their equity investment in the Company, even though those transactions may involve risks to our other shareholders.

 

We depend on our senior management team, and the loss of any member could adversely affect our operations.

 

Our success is dependent on the management and leadership skills of our senior management team. The loss of any of these individuals or an inability to attract, retain, and maintain additional personnel could prevent us from successfully executing our business strategy. We cannot assure you that we will be able to retain our existing senior management personnel or to attract additional qualified personnel when needed. We have not entered into employment agreements with any of our senior management personnel other than Brian J. Lipke, our Chairman of the Board and Chief Executive Officer, and Henning N. Kornbrekke, our President and Chief Operating Officer.

 

We could incur substantial costs in order to comply with, or to address any violations of, environmental laws.

 

Our operations and facilities are subject to a variety of federal, state, local, and foreign laws and regulations relating to the protection of the environment and human health and safety. Failure to maintain or

achieve compliance with these laws and regulations or with the permits required for our operations could result in substantial operating costs and capital expenditures, in addition to fines and civil or criminal sanctions, third-party claims for property damage or personal injury, cleanup costs or temporary or permanent discontinuance of operations. Certain facilities of ours have been in operation for many years and, over time, we and other predecessor operators of these facilities have generated, used, handled, and disposed of hazardous and other regulated wastes. Environmental liabilities could exist, including cleanup obligations at these facilities or at off-site locations where materials from our operations were disposed of or at facilities we divested, which could result in future expenditures that cannot be currently quantified and which could reduce our profits and cash flow. We may be held strictly liable for the contamination of these sites, and the amount of that liability could be material. Under the “joint and several” liability principle of certain environmental laws, we may be held liable for all remediation costs at a particular site, even with respect to contamination for which we are not responsible. Changes in environmental laws, regulations or enforcement policies, including without limitation new or more stringent regulations affecting greenhouse gas emissions, could have a material adverse effect on our business, financial condition, or results of operations.

 

Labor disruptions at any of our major customers or at our own manufacturing facilities could adversely affect our results of operations and cash flow.

 

Many of our customers have unionized workforces and could experience labor disruptions such as work stoppages, slow-downs, and strikes. A labor disruption at one or more of our customers could interrupt production or sales by that customer and cause the customer to halt or limit orders for our products and services. Any such reduction in the demand for our products and services would adversely affect our net sales, results of operations, and cash flow.

 

In addition, approximately 19% of our own employees are represented by unions through various collective bargaining agreements that are scheduled to expire between March 31, 2011 and December 31, 2013. It is likely that our unionized employees will seek an increase in wages and benefits at the expiration of these agreements, and we may be unable to negotiate new agreements without labor disruption. In addition, labor organizing activities could occur at any of our facilities. If any labor disruption were to occur at our facilities, we could lose sales due to interruptions in production and could incur additional costs, which would adversely affect our net sales, results of operations, and cash flow.

 

Our operations are subject to seasonal fluctuations that may impact our cash flow.

 

Our net sales are generally lower in the first and fourth quarters primarily due to reduced activity in the building industry due to colder, more inclement weather. In addition, quarterly results may be affected by the timing of large customer orders. Therefore, our cash flow from operations may vary from quarter to quarter. If, as a result of any such fluctuation, our quarterly cash flows were significantly reduced, we may not be able to service our indebtedness or maintain covenant compliance. A default under any of our indebtedness could prevent us from borrowing additional funds and limit our ability to pay interest or principal, and allow our senior secured lenders to enforce their liens against our personal property.

 

Economic, political, and other risks associated with foreign operations could adversely affect our financial results.

 

Although the majority of our business activity takes place in the United States, we derive a portion of our revenues and earnings from operations in foreign countries, and are subject to risks associated with doing business internationally. Our sales originating outside the United States represented approximately 15% of our consolidated net sales during the year ended December 31, 2010. We have facilities in Canada, England, Germany, and Poland. We believe that our business activities outside of the United States involve a higher degree of risk than our domestic activities. The risks of doing business in foreign countries include the potential for adverse changes in the local political climate, in diplomatic relations between foreign countries and the United States or in governmental policies, laws or regulations, terrorist activity that may cause social disruption, logistical and communications challenges, costs of complying with a variety of laws and regulations, difficulty in staffing and managing geographically diverse operations, deterioration of foreign

economic conditions, currency rate fluctuations, foreign exchange restrictions, differing local business practices and cultural considerations, restrictions on imports and exports or sources of supply, and changes in duties or taxes. Adverse changes in any of these risks could adversely affect our net sales, results of operations, and cash flows.

 

Disruptions to our business or the business of our customers or suppliers, could adversely impact our operations and financial results.

 

Business disruptions, including increased costs for or interruptions in the supply of energy or raw materials, resulting from severe weather events such as hurricanes, floods, blizzards, from casualty events, such as fires or material equipment breakdown, from acts of terrorism, from pandemic disease, from labor disruptions, or from other events such as required maintenance shutdowns, could cause interruptions to our businesses as well as the operations of our customers and suppliers. Such interruptions could have an adverse effect on our operations and financial results.

 

 

None.

 

 

We maintain our corporate headquarters in Buffalo, New York and conduct business operations in facilities located throughout the United States and in Canada, England, Germany, and Poland.

 

We believe the facilities we operate, listed below, and their equipment are effectively utilized, well maintained, in good condition, and will be able to accommodate our capacity needs through 2011.

 

 

 

 

 

From time to time, the Company is named a defendant in legal actions arising out of the normal course of business. The Company is not a party to any pending legal proceedings the resolution of which the management of the Company believes will have a material adverse effect on the Company’s results of operations or financial condition or to any other pending legal proceedings other than ordinary, routine litigation incidental to its business. The Company maintains liability insurance against risks arising out of the normal course of business.

 

 

As of December 31, 2010 there were 146 shareholders of record of the Company’s common stock. However, the Company believes that it has a significantly higher number of shareholders because of the number of shares that are held by nominees.

 

The Company’s common stock is traded in the over-the-counter market and quoted on the NASDAQ Stock Exchange — Global Select Market (“NASDAQ”) under the symbol “ROCK.” The following table sets forth the high and low sale prices per share for the Company’s common stock for each quarter of 2010 and 2009 as reported on the NASDAQ Stock Exchange.

 

 

The Company did not declare cash dividends during the years ended December 31, 2010 and 2009. Cash dividends are declared at the discretion of the Company’s Board of Directors. The Board of Directors reviews the dividend quarterly and establishes the rate of any dividend it determines to pay based upon such factors as the Company’s earnings, financial condition, capital requirements, debt covenant requirements, and other relevant conditions. During the first quarter of 2009, the Board of Directors approved management’s suggestion to suspend quarterly dividends indefinitely as a result of the impact of economic conditions on the Company and the markets it serves. The Company expects to continue to declare and pay cash dividends on its common stock in the future when earnings are available and the Board of Directors believes other relevant factors and conditions are appropriate for the payment of such dividends. However, the Company cannot assure that either cash or stock dividends will be paid in the future or that, if paid, the dividends will be paid in the same amount or at the same frequency as paid in the past.

 

Equity Compensation Plan Information

 

The following table summarizes information concerning securities authorized for issuance under the Company’s stock option plans:

 

 

 

PERFORMANCE GRAPH

 

The following information in this Item of the Annual Report on Form 10-K is not deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934, as amended (the Exchange Act), or to the liabilities of Section 18 of the Exchange Act, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that we specifically incorporate such information into such a filing.

 

The performance graph shown below compares the cumulative total shareholder return on the Company’s common stock, based on the market price of the common stock, with the total return of the S&P SmallCap 600 Index and the S&P SmallCap 600 Industrials Index for the five-year period ended December 31, 2010. The comparison of total return assumes that a fixed investment of $100 was invested on December 31, 2005 in common stock and in each of the foregoing indices and further assumes the reinvestment of dividends. The stock price performance shown on the graph is not necessarily indicative of future price performance.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
Among Gibraltar Industries Inc., the S&P Smallcap 600 Index
S&P SmallCap 600 Industrials

 

 

 

 

The following selected historical consolidated financial data for each of the five years in the period ended December 31, 2010 have been derived from the Company’s audited financial statements. The selected historical consolidated financial data presented in Item 6 are qualified in their entirety by, and should be read in conjunction with, the Company’s audited consolidated financial statements and notes thereto contained in Item 8 and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in Item 7 of this Annual Report on Form 10-K.

 

 

 

 

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Company’s risk factors and its consolidated financial statements and notes thereto included in Item 1A and Item 8, respectively, of this Annual Report on Form 10-K. Certain information set forth herein Item 7 constitutes “forward-looking statements” as that term is used in the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based, in whole or in part, on management’s beliefs, estimates, assumptions, and currently available information. For a more detailed discussion of what constitutes a forward-looking statement and of some of the factors that could cause actual results to differ materially from such forward-looking statements, please refer to the “Safe Harbor Statement” on page 2 of this Annual Report on Form 10-K.

 

Overview

 

Gibraltar is a leading manufacturer and distributor of products for the building markets. Our products provide structural and architectural enhancements for residential homes, and to a lesser extent, to low-rise retail, professional buildings, and other commercial and industrial building structures. These products include bar grating and expanded metal products, ventilation products, mail storage solutions including mailboxes and package delivery products, roof edging, flashing, soffit, drywall corner bead, metal roofing and accessories, steel framing, rain-carrying systems, and structural connectors. We serve customers throughout North America and Europe. Our most significant customers consist of The Home Depot, Lowe’s Companies, Menard Cashway Lumber, and ABC Supply. We operate 43 facilities in 20 states, Canada, England, Germany, and Poland, giving us a broad platform for just-in-time delivery and support to our customers.

 

Our strategy is to position Gibraltar as the low-cost provider and market share leader in product areas that offer the opportunity for sales growth and margin enhancement over the long-term. We focus on operational excellence including lean initiatives throughout the Company to position Gibraltar as our customers’ low-cost provider of products. We continuously seek to improve our on-time delivery, quality, and service to position Gibraltar as a preferred supplier to our customers. We also strive to develop new products, enter new markets, expand market share in the residential markets, and further penetrate domestic and international building markets to strengthen our product leadership positions.

 

The accelerated economic turmoil impacting the United States and the rest of the world in the second half of 2008 continued to negatively impact the key end markets we served during 2010 and 2009. As shown below, the residential construction market in the United States continued to experience significant declines in volume:

 

 

The decrease in residential housing starts affected by higher unemployment and tighter consumer credit had a significant impact on the operations of our business by contributing to decreased sales volumes. Although we experienced improved order levels in March and April 2010, the expiration of the federal tax credit for first-time homebuyers, coupled with the factors noted above negatively affecting the housing market, lowered 2010 order levels in total. Similar trends were noted in the other end markets we serve, including commercial construction and related repair and remodeling activity.

 

Additionally, commodity raw material prices for materials such as steel, aluminum, and resins, have fluctuated significantly during the past three years. These raw material prices impact the cost of raw materials we purchase and also impact the pricing we offer to customers on sales of our products. During the first three quarters of 2008, a period of comparatively stronger growth, we were able to successfully manage significant increases in raw material costs. However, commodity prices fell precipitously during the fourth quarter of 2008 and continued to fall during the first two quarters of 2009. The rapid decrease in commodity prices led to lower sales prices offered to customers and falling margins on our product sales during the fourth quarter of 2008 and the first half of 2009. Commodity prices stabilized over the last six months of 2009 and most of

2010 and were followed by a significant increase in commodity costs during the fourth quarter of 2010. Material margins were managed closely during 2010, however, the rising cost of raw materials led to compressed margins during the last six months of the year.

 

In an effort to respond to these market forces, we have taken a number of steps to position the Company as a low-cost provider of our products. Our focus has been on achieving operational excellence through lean initiatives and the consolidation of facilities. These efforts have resulted in the closing or consolidation of 30 facilities since January 2008, including six during 2010. We have also aggressively reduced operating costs to adjust to decreased sales volumes and maximize cash flows generated from operating activities. As a result, we believe our break-even point has reduced significantly from 2008.

 

During the year ended December 31, 2010, we reduced our net debt level and continuously increased the Company’s liquidity. We made net payments of $50.0 million on debt under our revolving credit facility provided by the Third Amended and Restated Credit Agreement dated July 24, 2009 (the Senior Credit Agreement). As a result of these repayments, we do not have any amounts outstanding under our revolving credit facility and the amount available under this facility increased by $16.1 million from December 31, 2009 to $85.8 million as of December 31, 2010. The positive cash flow generated from operations during the past two years and from the sale of the Processed Metal Products business allowed us to make significant repayments on our long-term debt since December 31, 2008. During this period, we have decreased our outstanding debt by $149.2 million from $356.4 million as of December 31, 2008 to $207.2 million as of December 31, 2010, a 41.9% decrease. Additionally, the Company has increased its cash on hand to $60.9 million as of December 31, 2010 from $23.6 million as of December 31, 2009.

 

Divestitures

 

On February 1, 2010, Gibraltar completed the sale of the majority of the assets of the Processed Metal Products business. The completion of this transaction finalized our exit from the steel processing business. This strategic initiative began in 2005 and included the 2006 sale of our steel strapping business, the 2007 sale of the Hubbell Steel business, and the 2008 sale of the SCM powdered metal business. This transaction was an ongoing part of our objective to build a company with optimal operating characteristics and improve shareholder value. We now are solely focused on the manufacture and distribution of building products where the Company has historically generated its highest operating margins.

 

As noted above, we sold our powdered metal business, SCM Metal Products (SCM) in October 2008. We expect to continue evaluating our businesses to focus our resources and capital on those areas that we expect will provide the best long-term strategic fit.

 

The divestitures of the Processed Metal Products and powdered metal businesses as described above are properly classified as discontinued operations in the Company’s consolidated financial statements and notes thereto. See Note 14 of the Company’s consolidated financial statements for more information regarding the divestitures described above in Item 8 of this Annual Report on Form 10-K.

Results of Operations

 

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

 

The following table sets forth selected results of operations data (in thousands) and its percentages of net sales for the years ended December 31:

 

 

 

 

Net sales decreased by $6.7 million, or 1.0%, to $685.1 million during 2010 compared to $691.8 million for 2009. The decrease in net sales from the prior year was the net result of a 2.6% decrease in volume partially offset by a 1.6% increase in pricing offered to customers. The lower volume was primarily due to the slow recovery in the economy which did not generate an increase in the demand for our products used in the building markets. As previously noted, the economic downturn continues to have a negative impact on the residential and commercial construction markets and demand of our products remains low compared to historical levels. The higher selling prices were primarily a result of increased commodity costs for steel, aluminum, and resins.

 

Our gross margin also decreased to 17.3% during 2010 from 18.8% for 2009. The decrease in gross margin was attributable to a less favorable alignment of material costs to customer selling prices during the current year compared to the previous year. The low level of sales volume led to more pressure on pricing from competitors which in some cases limited our ability to pass along material cost increases. This factor, in combination with rising costs for our raw materials particularly late in the year, contributed to the decline in gross margins. Additionally, we incurred a $4.7 million increase in restructuring charges recognized in cost of sales during 2010 compared to the prior year. The impact of pricing pressures, raw material commodity cost fluctuations, and restructuring charges experienced during 2010 more than offset the cost reduction initiatives we implemented over the past two years to align our cost structure to a lower level of sales volume. We have also continued to implement lean manufacturing initiatives to further reduce our costs and improve efficiencies. We believe these cost cutting measures will lead to much improved gross margins in future periods when the economy recovers and our sales volume increases.

Selling, general, and administrative expenses increased by $1.5 million, or 1.4%, to $109.5 million during 2010 compared to $108.0 million for 2009. The $1.5 million increase was primarily the net result of a $5.1 million increase in variable incentive compensation driven by improved working capital management and the effect of the Company’s appreciating stock price on vested stock-based awards during 2010 compared to 2009. This was partially offset by a $1.0 million reduction in bad debt expense and a $3.4 million reduction in salary and other payroll costs. We implemented a number of cost reduction initiatives during the past two years that included restructuring the business and staff reductions leading to the cost reduction noted above.

 

During 2010 and 2009, due to changes in the estimated fair value of certain reporting units resulting from a significant decrease in sales projections, we recognized intangible asset impairment charges of $77.0 million and $60.1 million, respectively.

 

Interest expense decreased $1.9 million, or 8.2%, to $21.2 million during 2010 from $23.1 million for 2009. We repaid all of our variable-rate debt by May 2010 which decreased the amount of interest paid compared to the prior year. We have reduced debt outstanding by $50.1 million, or 19.5%, to $207.2 million as of December 31, 2010 from $257.3 million as of December 31, 2009 through debt repayments. Additionally, during the year ended December 31, 2009, we recognized $1.4 million of interest expense to write-off deferred financing costs as a result of amending our Senior Credit Agreement in July 2009.

 

The benefit of income taxes for 2010 was $15.8 million, an effective tax rate of 17.7%, compared to $19.4 million, an effective tax rate of 32.1%, for 2009. The effective tax rates for 2010 and 2009 were lower than the U.S. federal statutory tax rate of 35% due to the effect of non-deductible permanent differences, a large portion of which related to intangible asset impairment charges that were not deductible for tax purposes. In addition, we recognized a $2.4 million valuation allowance for certain state net operating losses during 2010 which further reduced the effective tax rate. State taxes partially offset the reduction in the effective tax rate during 2009.

 

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

 

The following table sets forth selected results of operations data (in thousands) and its percentages of net sales for the years ended December 31:

 

 

 

 

Net sales decreased by $295.0 million, or 29.9%, to $691.8 million during 2009 compared to $986.8 million for 2008. The severe economic downturn, which greatly accelerated in the fourth quarter of 2008, intensified during 2009. The economic conditions had negative effects on the key end markets we serve which led to the significant decline in net sales as demand for our products decreased and volume fell. Customer selling prices also decreased as a result of declines in volume and commodity costs which, in part, impact the prices agreed to with our customers. However, the prevailing factor in the significant decrease in net sales was due to a decline in volume due to macroeconomic factors that negatively impacted our key markets such as residential housing construction as noted above.

 

Our gross margin also decreased to 18.8% during 2009 from 20.1% for 2008. The decrease in gross margin was primarily the result of the significant decline in sales volume which more than offset the benefits from our cost cutting initiatives. The precipitous decline in raw material commodity costs also led to a decline in gross margin as higher cost inventory was sold at lowered customer selling prices. The effect of declining raw material costs was most significant during the first three quarters of 2009.

 

Selling, general, and administrative expenses decreased by $26.7 million, or 19.8%, to $108.0 million during 2009 compared to $134.7 million for 2008. The $26.7 million decrease was primarily a result of a $15.2 million decrease in payroll-related expenses resulting from staff reductions and lower incentive compensation costs, $5.7 million of cost reductions from lower travel, marketing, and outside professional fees, and the impact of our other cost reduction initiatives. Despite our effort to reduce costs, our selling, general, and administrative expenses as a percentage of net sales increased to 15.6% during 2009 from 13.6% for 2008 as a result of the 29.9% reduction in net sales during 2009 compared to the prior year.

 

During 2009, due to changes in the estimated fair value of certain reporting units resulting from a significant decrease in sales projections, we recognized intangible asset impairment charges of $60.1 million.

 

Interest expense decreased $2.6 million, or 10.1%, to $23.1 million during 2009 from $25.7 million for 2008. Interest expense decreased due to lower average borrowings during 2009 compared to the prior year. We reduced debt outstanding by $99.1 million, or 27.8%, to $257.3 million as of December 31, 2009 from $356.4 million as of December 31, 2008 through debt repayments. The decrease in interest expense was partially offset by $1.4 million of charges incurred to write-off a portion of deferred financing costs arising from the amendment to our Senior Credit Agreement in July 2009 and repayment of our term loan under the Senior Credit Agreement.

 

The benefit of income taxes for 2009 was $19.4 million, an effective tax rate of 32.1%, compared with a provision for income taxes of $14.5 million, an effective tax rate of 37.4%, for 2008. The effective tax rate for 2009 was lower than the U.S. federal statutory tax rate of 35% due to the effect of non-deductible permanent differences and intangible asset impairment charges, portions of which were not deductible for tax purposes. These items were offset by state taxes which partially offset the reduction in the effective tax rate during 2009. The effective tax rate of 37.4% for 2008 exceeded the statutory rate primarily due to the impact of state taxes partially offset by lower rates paid on foreign-sourced income.

 

Outlook

 

Looking ahead to 2011, we expect modest improvement in the building markets we serve including the repair and remodel, residential construction, and non-residential construction markets. However, the extent of any sustained economic recovery in these markets is uncertain. For the first quarter of 2011, which is historically a period of lower order levels for our business, we anticipate net sales to be modestly favorable to the first quarter of 2010. Over the long-term, we believe that the fundamentals of the building markets are positive and the aggressive actions taken to streamline and improve the efficiency of our business have reduced our break-even point and positioned the Company to generate marked improvements in profitability when economic and market conditions return toward historical levels.

Liquidity and Capital Resources

 

General

 

Our principal capital requirements are to fund our operations, including working capital, the purchase and funding of capital improvements to our business and facilities, and to fund acquisitions. During the next twelve months, with the uncertainty in the general economy and the related effects on the building markets, we will continue to focus on maintaining adequate liquidity to meet our principal capital requirements. As noted below in the “Cash Flows” section of Item 7 of this Annual Report on Form 10-K, we have been successful in generating positive cash flows from our operating activities to fund our capital requirements during the past two years. We generated positive operating cash flows during these periods despite the challenging economic conditions our business faced. In the future, we expect to continue our aggressive cost reduction initiatives and sustain strong working capital management to continue to generate positive operating cash flow.

 

On July 24, 2009, we entered into the Third Amended and Restated Credit Agreement (the Senior Credit Agreement) to convert our previous credit arrangement into a secured revolving credit facility that allowed us to remove many of the restrictive financial covenants contained in the Second Amended and Restated Credit Agreement before it was amended and restated. As of December 31, 2010, our liquidity of $146.7 million consisted of $60.9 million of cash and $85.8 million of availability under our revolving credit facility. We believe that availability of funds under our Senior Credit Agreement together with the cash generated from operations should be sufficient to provide the Company with the liquidity and capital resources necessary to support our principal capital requirements during the next twelve months.

 

Our Senior Credit Agreement provides the Company with liquidity and capital resources for use by our U.S. operations. Historically, our foreign operations have generated cash flow from operations sufficient to invest in working capital and to purchase and fund capital improvements to their businesses and facilities. As of December 31, 2010, our foreign subsidiaries held $14.5 million of cash. We believe cash held by our foreign subsidiaries provides our foreign operations with the necessary liquidity to meet future obligations and allows our foreign subsidiaries to reinvest in their operations and could eventually be used to fund acquisitions that would grow our business internationally.

 

Over the long-term, we expect that future obligations, including strategic business opportunities such as acquisitions, may be financed through a number of sources, including internally available cash resources, new debt financing, the issuance of equity securities, or any combination of the above. Any potential acquisitions are evaluated on the basis of our ability to enhance our existing products, operations, or capabilities, as well as provide access to new products, markets, and customers.

 

These expectations are forward-looking statements based upon currently available information and may change if conditions in the credit and equity markets further deteriorate or other circumstances change. To the extent that operating cash flows are lower than current levels or sources of financing are not available or available at acceptable terms, our future liquidity may be adversely affected.

 

Cash Flows

 

The following table sets forth selected cash flow data for the year ended December 31 (in millions):

 

 

During the year ended December 31, 2010, the Company’s cash flow from continuing operations totaled $55.7 million. The Company’s net loss from continuing operations of $73.4 million was impacted by non-cash

charges including depreciation, amortization, stock compensation, and intangible asset impairments of $119.1 million and $20.4 million of cash generated from a net decrease in assets and liabilities offset by a $10.6 million decrease in deferred tax liabilities. Net cash provided by operating activities for 2009 was $99.8 million. The Company’s net loss from continuing operations of $41.1 million was impacted by non-cash charges including depreciation, amortization, stock compensation, and intangible asset impairments of $97.8 million and $60.8 million of cash generated from a net decrease in assets and liabilities offset by a $17.7 million decrease in deferred tax liabilities.

 

During the year ended December 31, 2010, the Company decreased its working capital along with other long-term assets and liabilities from December 31, 2009 resulting in $20.4 million of cash flow. Cash flows generated from the decrease in working capital and other net assets were primarily a result of an increase in accounts payable and accrued liabilities of $21.2 million and a decrease in inventory of $1.9 million offset by an increase in accounts receivable of $4.1 million. The increases in accounts payable and accounts receivable were a result of increased manufacturing activity and sales volume during the last month of the year compared to the last month of the prior year. Inventory levels were reduced from the prior year as a result of our continued focus on lean initiatives and inventory management which have led to an increase in inventory turnover during 2010 compared to the prior year. The accrued liabilities account increased from the prior year due to greater accruals for incentive compensation and deferred compensation plans. In addition, the other asset balance has decreased from December 31, 2009 as a result of a decline in current deferred tax assets related to the timing of temporary tax differences.

 

Cash flow provided by investing activities of continuing operations during 2010 was $19.8 million consisting of $29.2 million of cash flow generated from the sale of our Processed Metal Products business offset by capital expenditures of $8.5 million and a $1.3 million investment in a software company. Net cash used in investing activities of continuing operations during 2009 of $14.4 million consisted of capital expenditures of $9.8 million and additional consideration for a previous acquisition of $4.9 million.

 

Net cash used in financing activities of continuing operations during 2010 was $51.4 million, consisting primarily of $50.4 million of net payments on long-term debt and $1.1 million in payments of tax withholdings for stock issued to employees from the vesting of restricted stock units. Net cash used in financing activities of continuing operations for 2009 was $103.8 million, consisting primarily of net payments of $99.4 million on long-term debt, payments of $2.4 million for deferred financing costs, and dividend payments of $1.5 million. Payments of long-term debt made during 2010 and 2009 were the result of cash flows generated from operations and the sale of the Processed Metal Products business offset by other investing activities. We have made net payments on long-term debt outstanding in the amount of $149.8 million since December 31, 2008.

 

Senior Credit Agreement and Senior Subordinated Notes

 

Borrowings under the Senior Credit Agreement are secured by the trade receivables, inventory, personal property and equipment, and certain real property of the Company’s significant domestic subsidiaries. The Senior Credit Agreement provides for a revolving credit facility and letters of credit in an aggregate amount that does not exceed the lesser of (i) $200 million or (ii) a borrowing base determined by reference to the trade receivables, inventories, and property, plant, and equipment of the Company’s significant domestic subsidiaries. The Senior Credit Agreement also provided a term loan originally aggregating $58.7 million which was subsequently repaid in full during 2009. The revolving credit facility is committed through August 30, 2012. Borrowings on the revolving credit facility bear interest at a variable interest rate based upon the London Interbank Offered Rate (LIBOR), with a LIBOR floor of 1.50% plus 3.25%, or at the Company’s option, an alternate base rate. The revolving credit facility also carries an annual facility fee of 0.50% on the entire facility, whether drawn or undrawn, and fees on outstanding letters of credit which are payable quarterly. As of December 31, 2010, we had $85.8 million of availability under the revolving credit facility.

During the year ended December 31, 2010, we made net payments of $50.0 million on the revolving credit facility and have not had any borrowings under the Senior Credit Agreement since May 3, 2010. We had outstanding letters of credit of $13.7 million as of December 31, 2010.

 

The Company’s $204.0 million of Senior Subordinated 8% Notes (8% Notes) were issued in December 2005 at a discount to yield 8.25%. Provisions of the 8% Notes include, without limitation, restrictions on indebtedness, liens, and distributions from restricted subsidiaries, asset sales, affiliate transactions, dividends, and other restricted payments. Dividend payments are subject to annual limits of $0.25 per share and $10 million. The 8% Notes are currently redeemable at the option of the Company, in whole or in part, at the redemption price (as defined in the Senior Subordinated 8% Notes Indenture), which declines annually from 104% to 100% on and after December 1, 2013. In the event of a Change in Control (as defined in the Senior Subordinated 8% Notes Indenture), each holder of the 8% Notes may require the Company to repurchase all or a portion of such holder’s 8% Notes at a purchase price equal to 101% of the principal amount thereof. At December 31, 2010, we had $202.0 million, net of discount, of our 8% Notes outstanding.

 

Each of our significant domestic subsidiaries has guaranteed the obligations under the Senior Credit Agreement. Debt outstanding under the Senior Credit Agreement and the related guarantees are secured by a first priority security interest (subject to permitted liens as defined in the Senior Credit Agreement) in substantially all the tangible and intangible assets of our Company and our material domestic subsidiaries, subject to certain exceptions, and a pledge of 100% of the stock of our significant domestic subsidiaries and a pledge of 65% of the voting stock of our foreign subsidiaries. The 8% Notes are guaranteed by each of our significant domestic subsidiaries.

 

On a trailing four-quarter basis, the Senior Credit Agreement includes a single financial covenant that requires the Company to maintain a minimum fixed charge coverage ratio (as defined in the Senior Credit Agreement) of 1.25 to 1.00 at the end of each quarter. As of December 31, 2010, the Company was in compliance with the minimum fixed charge coverage ratio covenant. Management expects to be in compliance with the fixed charge ratio throughout 2011. The Senior Credit Agreement contains other provisions and events of default that are customary for similar agreements and may limit the Company’s ability to take various actions. The Senior Subordinated 8% Notes Indenture also contains provisions that limit additional borrowings based on the Company’s consolidated interest coverage ratio.

 

Off Balance Sheet Arrangements

 

The Company does not have any off balance sheet arrangements.

 

Contractual Obligations

 

The following table summarizes by category our Company’s expected future cash outflows associated with contractual obligations in effect at December 31, 2010 (in thousands):

 

 

 

Critical Accounting Policies

 

The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make decisions based upon estimates, assumptions, and factors it considers relevant to the circumstances. Such decisions include the selection of applicable principles and the use of judgment in their application, the results of which could differ from those anticipated.

 

A summary of the Company’s significant accounting policies are described in Note 1 of the Company’s consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

 

Our most critical accounting policies include:

 

 

Management reviews the estimates, including the allowance for doubtful accounts and inventory reserves, on a regular basis and makes adjustments based on historical experience, current conditions, and future expectations. Management believes these estimates are reasonable, but actual results could differ from these estimates.

 

Valuation of Accounts Receivable.  Our accounts receivable represent those amounts that have been billed to our customers but not yet collected. As of December 31, 2010 and 2009, allowances for doubtful accounts of $3.7 million and $3.9 million were recorded, respectively, or 5% of gross accounts receivable for both periods. We record an allowance for doubtful accounts based on the portion of those accounts receivable that we believe are potentially uncollectible based on various factors, including experience, creditworthiness of customers, and current market and economic conditions. If the financial condition of customers were to deteriorate, resulting in impairment of their ability to make payments, additional allowances may be required. Changes in judgments on these factors could impact the timing of costs recognized.

 

Valuation of Inventories.  We state our inventories at the lower of cost or market. We determine the cost basis of our inventory on a first-in-first-out basis using a standard cost methodology that approximates actual cost. On a regular basis, we calculate an estimated market value of our inventory, considered to be the prevailing selling price for the inventory less the cost to complete and sell the product. We compare the current carrying value of our inventory to the estimated market value to determine whether a reserve to value inventory at the lower of cost or market is necessary. We recorded insignificant charges during the years ended December 31, 2010, 2009, and 2008 to value our inventory at the lower of cost or market.

We regularly review inventory on hand and record provisions for excess, obsolete, and slow-moving inventory based on historical and current sales trends. We recorded reserves for excess, obsolete, and slow-moving inventory of $4.0 million and $4.6 million as of December 31, 2010 and 2009, respectively, or 5% of gross inventories for both periods. Changes in product demand and our customer base may affect the value of inventory on hand, which may require higher provisions for obsolete inventory.

 

Impairment of Depreciable and Amortizable Long-lived Assets

 

We test long-lived assets for impairment when events or changes in circumstances indicate that the carrying amount of those assets may not be recoverable and exceed their fair market value. The following summarizes the value of long-lived assets subject to impairment testing when events or circumstances indicate potential impairment as of December 31, 2010 (in millions):

 

 

Impairment exists if the carrying amount of the asset in question exceeds the sum of the undiscounted cash flows expected to result from the use of the asset. The impairment loss would be measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value as determined by discounted cash flow method, an independent market appraisal of the asset, or another acceptable valuation technique. We recognized impairment charges for property, plant, and equipment as a result of restructuring activities during the years ended December 31, 2010 and 2008 and amortizable intangible assets as a result of our 2010 impairment testing. No depreciable or amortizable long-lived assets were impaired during the year ended December 31, 2009.

 

Goodwill and Other Indefinite-lived Intangible Asset Impairment Testing

 

Our goodwill and indefinite-lived intangible asset balances of $325.7 million and $35.4 million as of December 31, 2010, respectively, are subject to impairment testing. We test goodwill and indefinite-lived intangible assets for impairment on an annual basis as of October 31 and at interim dates when indicators of impairment are present. Indicators of impairment could include a significant long-term adverse change in business climate, poor indicators of operating performance, or a sale or disposition of significant portion of a reporting unit.

 

During 2010, we concluded that no new indicators of impairment existed at interim dates and did not perform any interim impairment tests related to goodwill and indefinite-lived intangible assets. We tested goodwill and other indefinite-lived intangible assets for impairment during the fourth quarter of 2010 at the annual test date. As a result of the October 31, 2010 impairment test, the Company recognized an intangible asset impairment charge of $77.0 million for the year ended December 31, 2010 compared to a $60.1 million intangible asset impairment charge for the year ended December 31, 2009. In addition the annual impairment test, goodwill and other indefinite-lived assets were tested for impairment at two interim dates during 2009: March 31 and June 30.

 

We test goodwill for impairment at the reporting unit level. We identify our reporting units by assessing whether the components of our operating segments constitute businesses for which discrete financial information is available and segment management regularly reviews the operating results of those components. As of the October 31, 2010 impairment test, we identified 10 reporting units with goodwill compared to 11 reporting units with goodwill in the 2009 goodwill impairment tests. The number of reporting units was decreased when we consolidated the manufacturing and management of one reporting unit into another reporting unit during 2010.

 

The goodwill impairment test consists of comparing the fair value of a reporting unit with its carrying amount including goodwill. If the carrying amount of the reporting unit exceeds the reporting unit’s fair value, the implied fair value of goodwill is compared to the carrying amount of goodwill. An impairment loss is recognized for the amount by which the carrying amount of goodwill exceeds the implied fair value of goodwill.

The following table sets forth the amount of goodwill allocated to each reporting unit tested for goodwill impairment prior to any impairment charges, the percentage by which the estimated fair value of each reporting unit exceeded its carrying value, any impairment losses recognized, and the remaining goodwill allocated to each reporting unit after any impairment charges as of the October 31, 2010 goodwill impairment test (in thousands):

 

 

The Company’s October 31, 2010 impairment analysis included significant assumptions in both steps one and two of the impairment test. To estimate the fair value of the reporting units as a part of step one of the impairment test, the Company used two valuation techniques: an income approach and a market approach. The income approach included a discounted cash flow model relying on significant assumptions consisting of revenue growth rates and profit margins based on internal forecasts, terminal value, and the weighted average cost of capital (WACC) used to discount future cash flows. The market approach consisted of applying an Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) multiple to the forecasted EBITDA to be generated in 2010 and 2011. The market approach also relied on significant assumptions consisting of revenue growth rates and profit margins based on internal forecasts and the EBITDA multiple selected from an analysis of peer companies.

 

The following table sets forth the compound annual revenue growth rate for the five-year period used to forecast cash flows and the average operating margin for the forecasted periods compared to actual operating margins generated over the long-term which we estimated to be the six-year and ten-month period ended October 31, 2010:

 

 

 

 

 

We analyzed third-party forecasts of housing starts and other macroeconomic indicators that impact the Company’s reporting units to provide a reasonable estimate of revenue growth in future periods. Our analysis of third-party forecasts noted that housing starts were projected to grow at a compound annual growth rate of 23% from 2010 to 2015. Therefore, we considered these forecasts in developing each reporting unit’s growth rates over the next five years depending on the level of correlation between housing starts and net sales for each reporting unit. The correlation between housing starts and net sales was based on an analysis of historical housing starts and our historical revenue. We concluded that this approach provided a reasonable estimate of long-term revenue growth and cash flows for our reporting units.

 

The operating margins we used to estimate future cash flows were consistent with long-term margins generated by the reporting units while they have been owned and operated by the Company as shown in the table above. The reporting units where forecasted operating margins exceed long-term operating margins generated by the reporting unit were for reporting units that were recently acquired and, therefore, the long-term operating margins were more significantly impacted by the economic turmoil that began in the fourth quarter of 2008. Additionally, the Company took strategic actions to consolidate facilities, reduce costs, and restructure these business units to become more profitable as the economy recovers. These actions led to increased costs and lower operating margins in the short term. Based on our understanding of these reporting units and the actions taken by management to restructure the businesses for improved growth and profitability, we concluded that the long-term cash flows forecasted for all of the Company’s reporting units were reasonable.

 

In addition to revenue growth and operating margin forecasts, the discounted cash flow model used to estimate the fair value of each reporting unit also uses assumptions for the amount of working capital needed to support each business unit. We forecasted modest improvement in working capital management for future periods at each reporting unit based on past performance. The Company experienced a significant reduction in days of working capital from 96 days for the year ended December 31, 2007 to 76 days for the year ended December 31, 2009 and has further reduced days of working capital to 61 days for the year ended December 31, 2010. We have been able to significantly improve our working capital management through lean initiatives, efficiency improvements, and facility consolidations. We believe continued improvement in our ability to manage working capital will allow us to increase the cash flow generated from each reporting unit.

 

The terminal value of each reporting unit was based on a projected terminal year of forecasted cash flows in our discounted cash flow model. We made an assumption that cash flows would grow 2.5% each year thereafter based on our approximation of gross domestic product growth in the North American and European markets served by the Company. This assumption was based on a third-party forecast of future economic growth over the long-term.

 

The discounted cash flow model uses the WACC to discount cash flows in the forecasted period and to discount the terminal value to present value. To determine the WACC, we used a standard valuation method, the capital asset pricing model, based on readily available and current market data of peer companies considered market participants. Acknowledging the risk inherent in the reporting units’ ability to achieve the long-term forecasted cash flows, in applying the income approach we increased the WACC of each reporting unit based upon each reporting unit’s past operating performance and their relative ability to achieve the

forecasted cash flows. As a result of these analyses, we assigned a WACC between 12.0% and 12.9% for each reporting unit.

 

The EBITDA multiple used in the market approach to determine the fair value of each reporting unit was applied to the forecasted EBITDA to be generated during 2010 and 2011. The market approach relies on significant assumptions consisting of revenue growth rates and profit margins based on internal forecasts and the EBITDA multiple selected from an analysis of peer companies considered market participants. The revenue growth rates and profit margins used in the market approach were the same projections used in the discounted cash flows model as described above. The EBITDA multiples were established by analyzing each peer companies’ total invested capital in proportion to EBITDA derived from each peer companies’ most recently reported earnings. Similar to the WACC analysis, we assessed the risk of each reporting unit achieving its forecasts with consideration given to how each reporting unit has performed historically compared to forecasts. As a result of these analyses, we assigned an EBITDA multiple between 8.8 and 9.8 for 2010 EBITDA forecasts and 6.2 and 7.2 for 2011 EBITDA forecasts.

 

As noted above, we used two valuation techniques that are commonly accepted in the valuation community to estimate a fair value for each reporting unit. The estimated fair value for each reporting unit was calculated using a weighted average between the calculated amounts determined under the income approach and the market approach. We weighted the income approach more heavily (67%) as the technique uses a long-term approach that considers the expected operating profit of each reporting unit during periods where housing starts and other macroeconomic indicators are nearer historical averages. The market approach (33%) values the reporting units using 2010 and 2011 EBITDA values which were forecasted using estimated housing starts of 604,000 and 796,000, respectively. Housing starts have historically approximated 1.5 million each year. We believe the income approach considers the expected recovery in the residential building market better than the market approach. Therefore, we concluded that the income approach more accurately estimated the fair value of the reporting units as it considers earnings potential during a longer term and does not use the short-term perspective used by the market approach. Accordingly, we concluded that the market participants who execute transactions to sell or buy a business in the current economic environment would place greater emphasis on the income approach.

 

The following table sets forth the Company’s estimated fair value and carrying value for each reporting unit as of October 31, 2010 (in thousands):

 

The “Corporate” category includes unallocated corporate cash out flows. Unallocated corporate cash out flows include executive compensation and other administrative costs. The Company has grown substantially through acquisitions and our strategy is to allow business unit management to operate the business units autonomous of corporate management. For example, each business unit has its own accounting, marketing, purchasing, information technology, and executive functions. As a result, we believe a market participant would not consider unallocated corporate cash flows when valuing each reporting unit and these cash flows have been properly excluded from the valuation of the reporting units.

 

Step two of the impairment analysis involved estimating the implied fair value of goodwill by allocating the fair value of each reporting unit to its assets and liabilities other than goodwill and comparing the implied fair value of goodwill to its carrying value. The step two analyses relied on a number of significant assumptions to determine the fair value of inventory; property, plant, and equipment; and intangible assets for each reporting unit. The significant assumptions used in the determination of the fair value of inventory included the determination of the market value of raw materials, the estimated costs to complete work-in-process inventory, and the estimated selling prices for finished goods inventories. The assumptions we employed in determining the fair values of these inventory components were based primarily on historical gross margins and selling costs generated by the reporting units and we believe this to be a reasonable basis for estimating the fair value of inventories as of the impairment test date. The fair value of property, plant, and equipment was determined using standard valuation methodologies including market and cost approaches. These valuations were based on market data gathered for similar assets sold in the markets in which the reporting units’ property, plant, and equipment are located and based on the highest and best use from a market participant perspective. Third-party appraisals were commissioned where appropriate to assist in estimating the fair value of the reporting units’ property, plant, and equipment. The overall condition and age of the assets, current replacement cost, current market demand for the assets, and other factors were considered in the determination of the fair value of the assets. The fair value of intangible assets was also determined using standard valuation methodologies including the “relief-from-royalty” method and “excess earnings” method. These methods primarily employed the use of future cash flows to determine the fair value of the applicable intangible assets. The future cash flows used to determine the fair vales of these intangible assets were derived from step one of the goodwill impairment analysis as described above. The discount rate used in the valuation of intangible assets was derived from the WACC used in step one of the goodwill impairment analysis. Based on the analysis described above, we concluded the assumptions underlying step two of our impairment analysis were reasonable and appropriate.

 

In addition to the analyses described above, we performed a reconciliation of the total estimated fair values of the reporting units to our market capitalization as of October 31, 2010 to support the reasonableness of the fair value estimates used in our October 31, 2010 impairment analysis. The following calculation provides this reconciliation and the resulting control premium determined as of our October 31, 2010 impairment analysis (in thousands):

 

 

Despite the difference between our net book value and the estimated fair value of equity, all reporting units with goodwill had fair values in excess of their carrying value. The difference between our net book value and the estimated fair value of equity is the result of the negative future cash flows associated with our unallocated corporate net assets net of reporting units without goodwill allocated to them described above.

Although the Company’s book value of equity exceeds its market capitalization, we deemed the control premium as of the October 31, 2010 impairment analysis to be reasonable based upon recent comparable transactions to acquire the control of similar businesses in our industry. Accordingly, we concluded the estimated fair value of each reporting unit was reasonably estimated.

 

We test our intangible assets for impairment by comparing the fair value of the indefinite-lived intangible asset, determined using a discounted cash flow model, with its carrying amount. An impairment loss would be recognized for the carrying amount in excess of its fair value. We recognized impairment charges for indefinite-lived intangible assets as a result of our October 31, 2010 and 2009 impairment tests. The assumptions used to determine the fair value of our indefinite-lived intangible assets are consistent with the assumptions employed in the determination of the fair values of our reporting units.

 

Accounting for Income Taxes and Deferred Tax Assets and Liabilities

 

Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities, and any valuation allowance. Our effective tax rates differ from the statutory rate due to the impact of permanent differences between income or loss reported for financial statement purposes and tax purposes, provisions for uncertain tax positions, state taxes, and income generated by international operations. Our effective tax rate was 17.7%, 32.1%, and 37.4%, for the years ended December 31, 2010, 2009, and 2008, respectively. Our future effective tax rates could be adversely affected by earnings being lower than anticipated in countries where we have lower statutory rates and vice versa. Changes in the valuation of our deferred tax assets or liabilities or changes in tax laws or interpretations thereof may also adversely affect our future effective tax rate. In addition, we are subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our provision for income taxes.

 

Deferred tax assets and liabilities are determined based upon the differences between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates that will be in effect when these differences reverse. Valuation allowances are provided if based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

 

During the year ended December 31, 2010, deferred income tax liabilities decreased primarily as a result of the tax effect of the $77.0 million intangible asset impairment charge along with a decrease in the difference between depreciation recognized on property, plant, and equipment for tax purposes. Deferred income tax assets increased primarily due to additional equity compensation recognized during 2010. Regarding deferred income tax assets, we maintained valuation allowances of $2.8 million and $1.8 million as of December 31, 2010 and 2009, respectively, due to uncertainties related to our ability to utilize these assets, primarily consisting of state net operating losses and other deferred tax assets. The valuation allowances are based on estimates of taxable income in each of the jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable. If market conditions improve and future results of operations exceed our current expectations, our existing tax valuation allowances may be adjusted, resulting in future tax benefits. Alternatively, if market conditions deteriorate further or future operating results do not meet expectations, future assessments may result in a determination that some or all of the deferred tax assets are not realizable. As a result, we may need to establish additional tax valuation allowances for all or a portion of the gross deferred tax assets, which may have a material adverse effect on our results of operations and financial condition.

 

It is the Company’s policy to record estimated interest and penalties to the tax authorities as income tax expense and tax credits as a reduction in income tax expense. During the years ended December 31, 2010, 2009, and 2008, we recognized $0.1 million, $0.2 million, and $0.1 million of interest (net of federal tax benefit) and penalties, respectively.

 

The Company recognizes the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate

resolution. As of December 31, 2010 and 2009, the liability for uncertain income tax positions was $2.2 million. Due to the high degree of uncertainty regarding the timing of potential future cash flows associated with these liabilities, we are unable to make a reasonably reliable estimate of the amount and period in which these liabilities might be paid.

 

Related Party Transactions

 

Two members of the Company’s Board of Directors, Gerald S. Lippes and Arthur A. Russ, Jr., were partners in law firms that provide legal services to the Company. During the years ended December 31, 2010, 2009, and 2008, the Company incurred costs of $1.1 million, $1.2 million, and $1.7 million for legal services from these firms, respectively. Of the amounts incurred, $0.2 million related to the sale of the Processed Metal Products business during 2010 and was recognized as a component of discontinued operations. Additionally, $0.1 million was capitalized as deferred debt issuance costs during 2009. All other amounts incurred during the years ended December 31, 2010, 2009, and 2008 were expensed as a component of selling, general, and administrative expenses. At December 31, 2010 and 2009, the Company had $0.3 million and $0.2 million recorded in accounts payable for these law firms, respectively.

 

A member of the Company’s Board of Directors, Robert E. Sadler, Jr., is a member of the Board of Directors of M&T Bank Corporation, one of the eleven participating lenders which have committed capital to our $200 million revolving credit facility in the Company’s Third Amended and Restated Credit Agreement dated July 24, 2009 (the Senior Credit Agreement). All amounts outstanding under the revolving credit facility were repaid in full as of December 31, 2010. At December 31, 2009, $50.0 million was outstanding on the revolving credit facility. During 2010, the largest aggregate amount of principal outstanding under the revolving credit facility was $50.0 million. The aggregate amount of principal and interest paid during the year ended December 31, 2010 was $58.6 million and $0.3 million, respectively, for amounts outstanding under the revolving credit facility.

 

Borrowings under the Senior Credit Agreement bear interest at a variable rate based upon the London Interbank Offered Rate (LIBOR), with a LIBOR floor of 1.50%, plus 3.25% for revolving credit facility borrowings or, at the Company’s option, an alternate base rate. The revolving credit facility also carries an annual facility fee of 0.50% on the entire facility, whether drawn or undrawn, and fees on outstanding letters of credit which are payable quarterly.

 

Recent Accounting Pronouncements

 

In July 2010, the FASB issued Update 2010-20, “Receivables (Topic 310) — Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” Update 2010-20 requires additional disclosure to assist financial statement users in assessing an entity’s credit risk exposures and evaluating the adequacy of its allowance for credit losses. Update 2010-20 affects all entities with financing receivables, excluding short-term trade accounts receivables or receivables measures at fair value or lower cost of fair value. The Company adopted all of the provisions of Update 2010-20 related to disclosures of financing receivables as of December 31, 2010. The financing receivables disclosures related to activity that occurs during a reporting period are required to be adopted by the Company during the three months ending March 31, 2011. The Company included additional disclosures related to notes receivable outstanding as of December 31, 2010 and 2009 in Note 1 of the consolidated financial statements to satisfy the provisions of this recent accounting pronouncement.

 

In December 2010, the FASB issued Update 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.” The amendments in Update 2010-29 specify that if a public entity presents comparative financial statements, the entity should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. Update 2010-29 also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributed to the business combination included in the pro forma financial data. The Company is required to adopt all the provisions of Update 2010-29 for any business combinations for which

the acquisition date is on or after January 1, 2011. The Company does not believe the provisions of this guidance will have a significant impact on the Company’s consolidated financial statements.

 

In the ordinary course of business, the Company is exposed to various market risk factors, including changes in general economic conditions, competition, and raw materials pricing and availability. In addition, the Company is exposed to market risk, primarily related to its long-term debt. To manage interest rate risk, the Company uses both fixed and variable interest rate debt. During 2010, the company repaid all amounts outstanding under the Third Amended and Restated Credit Agreement dated July 24, 2009 (the Senior Credit Agreement). As a result, fixed rate debt consisting of the Company’s Senior Subordinated 8% Notes is the only significant debt that remains outstanding at December 31, 2010. Prior to 2010, the Company entered into an interest rate swap agreement that converted a portion of its variable rate debt to fixed rate debt. The interest rate swap agreement expired during 2010 and all amounts due under the agreement were settled prior to December 31, 2010. The Company believes it has limited its exposure to interest rate risk as a result of repaying substantially all variable rate debt and the long-term nature of its fixed rate debt. However, the Company will continue to monitor changes in its debt levels and access to capital ensuring interest rate risk is appropriately managed.

 

The following table summarizes the principal cash flows and related interest rates of the Company’s long-term debt at December 31, 2010 by expected maturity dates. The weighted average interest rates are based on the actual rates that existed at December 31, 2010. The variable rate debt consists primarily of the revolving credit facility under the Senior Credit Agreement, of which no amounts are outstanding as of December 31, 2010, and other debt. A hypothetical 1% increase or decrease in interest rates would have changed the 2010 interest expense by approximately $0.1 million. Dollar amounts in the following are in thousands:

 

 

 

 

 

The Board of Directors and Shareholders of Gibraltar Industries, Inc.

 

We have audited the accompanying consolidated balance sheets of Gibraltar Industries, Inc. as of December 31, 2010 and 2009, and the related consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Gibraltar Industries, Inc. at December 31, 2010 and 2009 and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Gibraltar Industries, Inc.’s internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2011 expressed an unqualified opinion thereon.

 

 

Buffalo, New York

February 25, 2011

GIBRALTAR INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)

 

 

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

GIBRALTAR INDUSTRIES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except share and per share data)

 

 

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

GIBRALTAR INDUSTRIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)