**Exhibit 13.1**

** **

**BUILDING MATERIALSHOLDING CORPORATION**

 

**2003 ConsolidatedFinancial Statements**

 

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**FINANCIAL HIGHLIGHTS****,**

(Amounts in thousands, except per share data)

 
|                                |   | **2003****(1)** |          | **2002****(1)** |       | **2001 (1)** |       | **2000** |       | **1999** |       |
|-------------------------------------|--------|-----------------|---------------|-----------------|------------|--------------|------------|----------|------------|----------|------------|
|                                |   |            | ** **    |            | ** ** |         | ** ** |     | ** ** |     | ** ** |
| **FOR THE YEAR**                    |   |            | ** **    |            |       |         |       |     |       |     |       |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Sales                               |   | **$**           | **1,415,071** | ** **      | $          | 1,161,494    |       | $        | 1,092,867  |     | $          | 1,013,968 |   | $ | 1,007,108 |   |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Income from operations              |   | **40,429**      | ** **    | 39,121          | (2)        | 42,629       |       | 42,536   |       | 45,662   |       |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Net income                          |   | **19,929**      | ** **    | 7,015           | (2)        | 20,844       |       | 19,712   |       | 19,683   | (3)        |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Net income per diluted common share |   | **1.48**        | ** **    | 0.53            | (2)        | 1.60         |       | 1.54     |       | 1.54     | (3)        |
|                                |   |            | ** **    |            |       |         |       |     |       |     |       |
| **AT YEAR END**                     |   |            | ** **    |            |       |         |       |     |       |     |       |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Working capital                     |   | **$**           | **219,803**   | ** **      | $          | 170,492      |       | $        | 160,904    |     | $          | 142,075 |   | $ | 139,283 |   |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Total assets                        |   | **604,199**     | ** **    | 503,074         |       | 485,742      |       | 459,634  |       | 450,119  |       |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Long-term debt                      |   | **189,678**     | ** **    | 157,375         |       | 167,417      |       | 165,006  |       | 170,547  |       |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Shareholders’ equity           |   | **271,010**     | ** **    | 251,300         |       | 242,894      |       | 220,555  |       | 200,110  |       |
|                                |   |            | ** **    |            |       |         |       |     |       |     |       |
| **OTHER**                           |   |            | ** **    |            |       |         |       |     |       |     |       |
|                                |   |            |          |            |       |         |       |     |       |     |       |
| Cash dividends per share            |   | **$**           | **0.21**      | **(4)**         | $          | 0.05         |       | $        | 0.00       |     | $          | 0.00 |   | $ | 0.00 |   |
|                                |   |            | ** **    |            |       |         |       |     |       |     |       |
| Common stock prices:                |   |            | ** **    |            |       |         |       |     |       |     |       |
| High                                |   | **$**           | **15.750**    | ** **      | $          | 18.360       |       | $        | 16.960     |     | $          | 11.000 |   | $ | 13.313 |   |
| Low                                 |   | **11.750**      | ** **    | 10.000          |       | 8.250        |       | 7.563    |       | 7.500    |       |

 

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(1)          See Note 5 to the consolidated financialstatements for a description of the acquisitions that occurred in 2003, 2002and 2001.

 

(2)          After a charge for a change in accountingprinciple of $17,936 ($11,650 net of tax) or $0.88 per diluted share and a chargefor impairment of goodwill of $6,698 ($4,119 net of tax) or $0.31 per dilutedshare.

 

(3)          After a charge related to earlyretirement of debt of $5,451 ($3,352 net of tax) or $0.26 per diluted share.

 

(4)          Quarterly dividend was increased to $0.06in the fourth quarter of 2003.

 

1

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**CONSOLIDATED****STATEMENTS OF INCOME**

 
|                                                                                                                                |   | **For the  years ended December 31,** |        |
|-------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------|-------------|
| **(Amounts in thousands, except per  share data)**                                                                                  |   | **2003**                                   |        | **2002** |   | **2001** |   |
| **Sales**                                                                                                                           |   |                                       | ** **  |   |   |   |   |
| Building products                                                                                                                   |   | **$**                                      | **916,256** | ** ** | $ | 867,623 |   | $ | 945,504 |   |
| Construction services                                                                                                               |   | **498,815**                                | ** **  | 293,871 |   | 147,363 |   |
| Total sales                                                                                                                         |   | **1,415,071**                              | ** **  | 1,161,494 |   | 1,092,867 |   |
|                                                                                                                                |   |                                       | ** **  |   |   |   |   |
| **Costs and operating expenses**                                                                                                    |   |                                       | ** **  |   |   |   |   |
| Cost of goods sold                                                                                                                  |   |                                       | ** **  |   |   |   |   |
| Building products                                                                                                                   |   | **687,769**                                | ** **  | 639,713 |   | 700,168 |   |
| Construction services                                                                                                               |   | **437,493**                                | ** **  | 243,364 |   | 120,313 |   |
| Impairment of assets                                                                                                                |   | **829**                                    | ** **  | 6,698 |   | 1,750 |   |
| Selling, general and administrative expense                                                                                         |   | **250,319**                                | ** **  | 233,328 |   | 230,742 |   |
| Other income, net                                                                                                                   |   | **1,768**                                  | ** **  | 730 |   | 2,735 |   |
| Total costs and operating expenses                                                                                                  |   | **1,374,642**                              | ** **  | 1,122,373 |   | 1,050,238 |   |
|                                                                                                                                |   |                                       | ** **  |   |   |   |   |
| **Income from operations**                                                                                                          |   | **40,429**                                 | ** **  | 39,121 |   | 42,629 |   |
|                                                                                                                                |   |                                       | ** **  |   |   |   |   |
| Interest expense                                                                                                                    |   | **9,279**                                  | ** **  | 9,812 |   | 13,553 |   |
| Income before income taxes, minority  interest, equity in earnings of an unconsolidated company and change in  accounting principle |   | **31,150**                                 | ** **  | 29,309 |   | 29,076 |   |
| Income taxes                                                                                                                        |   | **11,402**                                 | ** **  | 10,871 |   | 11,194 |   |
| Minority interest (income) loss                                                                                                     |   | **(1,250**                                 | **)**       | 227 |   | — |   |
| Equity in earnings of an unconsolidated  company, net of tax of $918 and $1,855, respectively                                       |   | **1,431**                                  | ** **  | — |   | 2,962 |   |
| Income before change in accounting  principle                                                                                       |   | **19,929**                                 | ** **  | 18,665 |   | 20,844 |   |
| Change in accounting principle, net of tax  benefit of $6,286                                                                       |   | **—**                                 | ** **  | (11,650 | ) | — |   |
|                                                                                                                                |   |                                       | ** **  |   |   |   |   |
| **Net income**                                                                                                                      |   | **$**                                      | **19,929**  | ** ** | $ | 7,015 |   | $ | 20,844 |   |
|                                                                                                                                |   |                                       |        |   |   |   |   |
| Income before change in accounting  principle per share:                                                                            |   |                                       | ** **  |   |   |   |   |
| Basic                                                                                                                               |   | **$**                                      | **1.50**    | ** ** | $ | 1.43 |   | $ | 1.61 |   |
| Diluted                                                                                                                             |   | **$**                                      | **1.48**    | ** ** | $ | 1.41 |   | $ | 1.60 |   |
|                                                                                                                                |   |                                       | ** **  |   |   |   |   |
| Change in accounting principle, net of tax,  per share:                                                                             |   |                                       | ** **  |   |   |   |   |
| Basic                                                                                                                               |   | **$**                                      | **—**  | ** ** | $ | (0.89 | ) | $ | — |   |
| Diluted                                                                                                                             |   | **$**                                      | **—**  | ** ** | $ | (0.88 | ) | $ | — |   |
|                                                                                                                                |   |                                       | ** **  |   |   |   |   |
| **Net income per share:**                                                                                                           |   |                                       | ** **  |   |   |   |   |
| Basic                                                                                                                               |   | **$**                                      | **1.50**    | ** ** | $ | 0.54 |   | $ | 1.61 |   |
| Diluted                                                                                                                             |   | **$**                                      | **1.48**    | ** ** | $ | 0.53 |   | $ | 1.60 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

2

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**CONSOLIDATED BALANCE SHEETS**

 
|                                                                                                                                  |   | **At  December 31,** |        |
|---------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------|-------------|
| **(Amounts in thousands, except  share data)**                                                                                        |   | **2003**             |        | **2002** |   |
| **ASSETS**                                                                                                                            |   |                 |        |   |   |
| Cash                                                                                                                                  |   | **$**                | **19,506**  | ** ** | $ | 9,217 |   |
| Receivables, net                                                                                                                      |   | **187,790**          | ** **  | 132,757 |   |
| Unbilled receivables                                                                                                                  |   | **8,625**            | ** **  | 3,920 |   |
| Inventory                                                                                                                             |   | **111,146**          | ** **  | 89,828 |   |
| Deferred income taxes                                                                                                                 |   | **8,629**            | ** **  | 5,302 |   |
| Prepaid expenses and other current assets                                                                                             |   | **5,243**            | ** **  | 7,456 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Total current assets                                                                                                                  |   | **340,939**          | ** **  | 248,480 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Property and equipment, net                                                                                                           |   | **165,400**          | ** **  | 178,137 |   |
| Goodwill                                                                                                                              |   | **72,745**           | ** **  | 52,111 |   |
| Other intangibles, net                                                                                                                |   | **12,017**           | ** **  | 12,950 |   |
| Deferred income taxes                                                                                                                 |   | **—**           | ** **  | 529 |   |
| Deferred loan costs                                                                                                                   |   | **2,406**            | ** **  | 2,732 |   |
| Other long-term assets                                                                                                                |   | **10,692**           | ** **  | 8,135 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Total assets                                                                                                                          |   | **$**                | **604,199** | ** ** | $ | 503,074 |   |
|                                                                                                                                  |   |                 |        |   |   |   |   |
| **LIABILITIES, MINORITY  INTEREST AND SHAREHOLDERS’ EQUITY**                                                           |   |                 | ** **  |   |   |
| Billings in excess of costs and estimated  earnings                                                                                   |   | **$**                | **12,069**  | ** ** | $ | 3,927 |   |
| Accounts payable and accrued expenses                                                                                                 |   | **109,067**          | ** **  | 74,061 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Total current liabilities                                                                                                             |   | **121,136**          | ** **  | 77,988 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Long-term debt                                                                                                                        |   | **189,678**          | ** **  | 157,375 |   |
| Deferred income taxes                                                                                                                 |   | **5,354**            | ** **  | — |   |
| Other long-term liabilities                                                                                                           |   | **13,276**           | ** **  | 11,428 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Total liabilities                                                                                                                     |   | **329,444**          | ** **  | 246,791 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Minority interest                                                                                                                     |   | **3,745**            | ** **  | 4,983 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Commitments and contingencies  (Note 17)                                                                                         |   |                 | ** **  |   |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Shareholders’ equity                                                                                                             |   |                 | ** **  |   |   |
|                                                                                                                                  |   |                 |        |   |   |
| Common stock, $0.001 par value, 20,000,000  shares authorized; 13,333,711 and 13,135,562 shares issued and outstanding,  respectively |   | **13**               | ** **  | 13 |   |
| Additional paid-in capital                                                                                                            |   | **115,282**          | ** **  | 112,709 |   |
| Retained earnings                                                                                                                     |   | **155,715**          | ** **  | 138,578 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Total shareholders’ equity                                                                                                       |   | **271,010**          | ** **  | 251,300 |   |
|                                                                                                                                  |   |                 | ** **  |   |   |
| Total liabilities, minority interest and  shareholders’ equity                                                                   |   | **$**                | **604,199** | ** ** | $ | 503,074 |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

3

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**CONSOLIDATEDSTATEMENTS OF SHAREHOLDERS’ EQUITY**

(Amounts in thousands)

 
|                                   |   |              |       |       |       | **Additional  Paid-In  Capital** |       | **Retained  Earnings** |       | **Total**  |        |
|----------------------------------------|--------|-------------------|------------|------------|------------|----------------------------------|------------|------------------------|------------|------------|-------------|
|                                   |   | **Common  Stock** |       |       |       |                             |
|                                   |   | **Shares**        |       | **Amount** |       |                             |       |                   |
| Balance at  December 31, 2000     |   | 12,840            |       | $          | 13         |                             | $          | 109,166                |       | $          | 111,376     |   | $ | 220,555 |   |
|                                   |   |              |       |       |       |                             |       |                   |       |       |        |
| Net income                             |   | —            |       | —     |       | —                           |       | 20,844                 |       | 20,844     |        |
| Stock  options exercised and other     |   | 144               |       | —     |       | 1,495                            |       | —                 |       | 1,495      |        |
|                                   |   |              |       |       |       |                             |       |                   |       |       |        |
| Balance at  December 31, 2001     |   | 12,984            |       | 13         |       | 110,661                          |       | 132,220                |       | 242,894    |        |
|                                   |   |              |       |       |       |                             |       |                   |       |       |        |
| Net income                             |   | —            |       | —     |       | —                           |       | 7,015                  |       | 7,015      |        |
| Stock  options exercised and other     |   | 152               |       | —     |       | 2,048                            |       | —                 |       | 2,048      |        |
| Dividends  on common stock             |   | —            |       | —     |       | —                           |       | (657                   | )          | (657       | )           |
|                                   |   |              |       |       |       |                             |       |                   |       |       |        |
| Balance at  December 31, 2002     |   | 13,136            |       | 13         |       | 112,709                          |       | 138,578                |       | 251,300    |        |
|                                   |   |              | ** ** |       | ** ** |                             | ** ** |                   | ** ** |       | ** **  |
| **Net income**                         |   | **—**        | ** ** | **—** | ** ** | **—**                       | ** ** | **19,929**             | ** ** | **19,929** | ** **  |
| **Stock options exercised and other**  |   | **198**           | ** ** | **—** | ** ** | **2,573**                        | ** ** | **—**             | ** ** | **2,573**  | ** **  |
| **Dividends on common stock**          |   | **—**        | ** ** | **—** | ** ** | **—**                       | ** ** | **(2,792**             | **)**      | **(2,792** | **)**       |
|                                   |   |              | ** ** |       | ** ** |                             | ** ** |                   | ** ** |       | ** **  |
| **Balance at December 31,  2003** |   | **13,334**        | ** ** | **$**      | **13**     | ** **                       | **$**      | **115,282**            | ** ** | **$**      | **155,715** | ** ** | **$** | **271,010** | ** ** |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

4

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**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

(Amounts inthousands)

 
|                                                                                            |   | **For the  years ended December 31,** |       |
|-------------------------------------------------------------------------------------------------|--------|--------------------------------------------|------------|
|                                                                                            |   | **2003**                                   |       | **2002** |   | **2001** |   |
| **Cash Flows From Operating Activities**                                    |   |                                       |       |   |   |   |   |
| Net income                                                                                      |   | **$**                                      | **19,929** | ** ** | $ | 7,015 |   | $ | 20,844 |   |
| Adjustments to reconcile net income to cash  flows from operating activities:                   |   |                                       | ** ** |   |   |   |   |
| Depreciation and amortization                                                                   |   | **20,785**                                 | ** ** | 19,265 |   | 19,334 |   |
| Deferred income taxes                                                                           |   | **2,556**                                  | ** ** | (2,691 | ) | 1,218 |   |
| Net loss/(gain) on sale of assets                                                               |   | **(1,161**                                 | **)**      | 944 |   | (888 | ) |
| Asset impairment charge                                                                         |   | **829**                                    | ** ** | 6,698 |   | 1,750 |   |
| Deferred financing costs                                                                        |   | **660**                                    | ** ** | — |   | — |   |
| Equity in earnings of an unconsolidated  company, net of amortization and and before taxes      |   | **(2,349**                                 | **)**      | — |   | (4,817 | ) |
| Distributions received from unconsolidated  companies                                           |   | **—**                                 | ** ** | — |   | 5,325 |   |
| Change in accounting principle, net of tax  benefit of $6,286                                   |   | **—**                                 | ** ** | 11,650 |   | — |   |
| Minority interest                                                                               |   | **1,059**                                  | ** ** | (227 | ) | — |   |
| Changes in assets and liabilities, net of  effects of acquisitions and sales of business units: |   |                                       | ** ** |   |   |   |   |
| Receivables, net                                                                                |   | **(35,076**                                | **)**      | (20,324 | ) | 21,354 |   |
| Unbilled receivables                                                                            |   | **(473**                                   | **)**      | (3,920 | ) | — |   |
| Inventory                                                                                       |   | **(25,929**                                | **)**      | (3,989 | ) | 8,881 |   |
| Prepaid expenses and other current assets                                                       |   | **2,304**                                  | ** ** | 3,346 |   | (6,166 | ) |
| Billings in excess of costs and estimated  earnings                                             |   | **5,579**                                  | ** ** | 3,927 |   | — |   |
| Accounts payable and accrued expenses                                                           |   | **21,093**                                 | ** ** | 11,703 |   | (5,655 | ) |
| Other long-term assets and liabilities                                                          |   | **3,633**                                  | ** ** | 3,317 |   | 2,852 |   |
| Other, net                                                                                      |   | **(960**                                   | **)**      | (988 | ) | (345 | ) |
| Cash flows from operating activities                                                            |   | **12,479**                                 | ** ** | 35,726 |   | 63,687 |   |
|                                                                                            |   |                                       |       |   |   |   |   |
| **Cash Flows From Investing Activities**                                                        |   |                                       | ** ** |   |   |   |   |
| Purchases of property and equipment                                                             |   | **(15,887**                                | **)**      | (20,050 | ) | (23,825 | ) |
| Acquisitions of and investments in  businesses, net of cash acquired                            |   | **(30,269**                                | **)**      | (8,091 | ) | (34,374 | ) |
| Proceeds from dispositions of property and  equipment                                           |   | **10,065**                                 | ** ** | 1,155 |   | 4,770 |   |
| Proceeds from sales of business units, net  of cash sold                                        |   | **6,591**                                  | ** ** | 2,750 |   | 2,238 |   |
| Other, net                                                                                      |   | **(961**                                   | **)**      | (826 | ) | (683 | ) |
| Cash flows from investing activities                                                            |   | **(30,461**                                | **)**      | (25,062 | ) | (51,874 | ) |
|                                                                                            |   |                                       |       |   |   |   |   |
| **Cash Flows From Financing Activities**                                                        |   |                                       | ** ** |   |   |   |   |
| Borrowings under term note                                                                      |   | **31,500**                                 | ** ** | — |   | 7,232 |   |
| Principal payments of term note                                                                 |   | **(9,425**                                 | **)**      | (7,700 | ) | (5,555 | ) |
| Net payments under revolving credit  agreements                                                 |   | **9,200**                                  | ** ** | (1,900 | ) | (3,100 | ) |
| Principal payments of other notes payable                                                       |   | **—**                                 | ** ** | (156 | ) | (23 | ) |
| Increase (decrease) in book overdrafts                                                          |   | **554**                                    | ** ** | 2,024 |   | (9,198 | ) |
| Deferred financing costs                                                                        |   | **(1,394**                                 | **)**      | — |   | (1,696 | ) |
| Stock options exercised                                                                         |   | **895**                                    | ** ** | 1,043 |   | 1,025 |   |
| Dividend                                                                                        |   | **(2,649**                                 | **)**      | — |   | — |   |
| Other, net                                                                                      |   | **(410**                                   | **)**      | 60 |   | 114 |   |
| Cash flows from financing activities                                                            |   | **28,271**                                 | ** ** | (6,629 | ) | (11,201 | ) |
| Net change in cash                                                                              |   | **10,289**                                 | ** ** | 4,035 |   | 612 |   |
| Cash, beginning of year                                                                         |   | **9,217**                                  | ** ** | 5,182 |   | 4,570 |   |
| Cash, end of year                                                                               |   | **$**                                      | **19,506** | ** ** | $ | 9,217 |   | $ | 5,182 |   |
|                                                                                            |   |                                       |       |   |   |   |   |
| **Supplemental Disclosure of Cash Flow  Information**                                           |   |                                       | ** ** |   |   |   |   |
| Cash paid during the year for:                                                                  |   |                                       | ** ** |   |   |   |   |
| Interest, net of amounts capitalized                                                            |   | **$**                                      | **9,327**  | ** ** | $ | 10,349 |   | $ | 13,414 |   |
| Income taxes                                                                                    |   | **$**                                      | **7,795**  | ** ** | $ | 12,672 |   | $ | 16,346 |   |
| Accrued but unpaid dividends                                                                    |   | **$**                                      | **800**    | ** ** | $ | 657 |   | $ | — |   |

 

The accompanying notes are an integral partof these consolidated financial statements.

 

5

----

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

**1.****       ORGANIZATIONALSTRUCTURE, NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

***Nature of Operations***

 

Building Materials Holding Corporation (“BMHC”) provides buildingmaterials and construction services to professional homebuilders across theUnited States.  BMHC operates throughits two separately managed and reportable business segments -  BMC West and BMC Construction.  BMC West markets and sells buildingmaterials, manufactures building components (millwork, floor and roof trussesand wall panels) and provides construction services to homebuilders andcontractors at the local and regional level. BMC Construction provides construction services to high-volumeproduction homebuilders.

 

***Principles of Consolidation***

 

The consolidated financial statements include the accounts of BMHC andits subsidiaries (the “Company”).  Theequity method of accounting is used for investments in which the Company hassignificant influence.  All significantintercompany balances and transactions are eliminated.

 

***Revenue Recognition***

 

Revenuesfor building products are recognized when title to the goods and risk of losspasses to the buyer, which is at the time of delivery.  The percentage-of-completion method is usedto recognize revenue for certain construction and installation contracts.  We estimate revenue and related gross marginon construction and installation contracts on a percentage-of-completionmethod, utilizing labor dollars incurred to total forecasted labor dollars tomeasure progress toward completion.  Forcontracts based on a sequential production process where an entity producesunits of a basic product, we measure progress toward completion of a contractbased on the units of delivery method. Revisions of contractrevenues and cost estimates are reflected in the period such revisions aredetermined.

 

Contract costs include all direct material and labor, equipment costsand those indirect costs related to contract performance.  Provisions for estimated losses onuncompleted contracts are made in the period in which such losses aredetermined.

 

Unbilled receivables represent costs and estimated revenues recognizedin excess of amounts billed on uncompleted contracts.  Billings in excessof costs and estimated earnings represent billings in excess of estimated costsand revenues recognized.

 

***Use of Estimates***

 

The preparation of financial statements inconformity with gen­erally accepted accounting principles in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and contingent assets andliabilities at the date of the financial statements as well as the reportedamounts of sales and expenses during the reporting period.  Actual amounts could differ from thoseestimates.  Estimates are used whenaccounting for items such as revenue, allowance for returns, discounts anddoubtful accounts, employee compensation programs, depreciation andamortization periods, taxes, inventory values, insurance programs andvaluations of investments, goodwill, other intangible assets and long-livedassets.

 

***Cash and Cash Equivalents***

 

Cashrepresents amounts on deposit with financial institutions and such balancesmay, at times, exceed FDIC limits.  TheCompany considers all highly liquid investments that have an original orremaining maturity of three months or less at the date of purchase to be cashequivalents.  The Company had no cashequivalents at December 31, 2003 and 2002.

 

***Inventory***

 

Inventory consists principally of materialspurchased for resale and is stated at the lower of average cost or market.  Included in inventory are unbilledreceivables related to costs for construction services contracts of $5.9million and $4.3 million in 2003 and 2002, respectively.

 

6

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***Property and Equipment***

 

Property and equipment are recorded at cost anddepreciated using the straight-line method. The estimated useful lives are ten to thirty years for buildings andimprovements, seven to ten years for machinery and fixtures and three to tenyears for handling and delivery equipment.

 

Major additions and improvements are capitalized,while maintenance and repairs that do not extend the useful life of the propertyare expensed as incurred.  Gains andlosses from disposi­tions of property and equipment are included as a componentof “Other Income, Net”.

 

The Company capitalizes interest on borrowingsduring the active construction period on major capital projects.  Capitalized interest is added to the cost ofthe underlying asset and is amor­tized over the useful life of the asset.

 

The Company capitalizes certain costs of computersoftware developed or obtained for internal use, including interest, providedthat those costs are not research and development and certain other criteriaare met.  Software development costs forinternal use are $10,762,000 and $10,595,000 as of December 31, 2003 and 2002,respectively.  These costs are includedas a component of machinery and fixtures and are amortized on a straight-linebasis over a period of three to ten years.

 

***Long-lived Assets***

 

Long-lived assets such as property and equipmentand intangibles with finite lives are evaluated for impairment whenever eventsor changes in circumstances indicate the carrying amount may not berecoverable.   Intangible assets with finite lives represent valuesassigned to covenants not to compete and customer relationships and areamortized over their useful lives of two to seventeen years.  Animpairment is recognized if the carrying amount is less than the estimatedfuture operating cash flows on an undiscounted basis.

 

***Goodwill***

 

Goodwill represents the excess of purchase priceover the fair values of net tangible and identifiable intangible assets ofacquired businesses.  At December 31, 2003, other than goodwill, there areno intangibles with indefinite useful lives.  Goodwill is assessedannually for impairment and whenever events and circumstance indicate thecarrying amount may not be recoverable.  An impairment, based on fairvalue, is recognized if the carrying amount is less than the estimated futureoperating cash flows as measured by fair value techniques.

 

***Deferred Loan Costs***

 

Loan costs are capitalized upon the issuance oflong-term debt and amortized over the life of the related debt using theeffective interest rate method for the Company’sterm note and the straight-line method for the Company’s revolving creditfacility.  Interest expense includesamortization of deferred loan costs of $1,060,000, $1,536,000 and $1,290,000,in 2003, 2002 and 2001, respectively.

 

***Other Assets***

 

Other assets consist of cash surrender values oncompany-owned life insurance, executive deferred compensation investments,deposits and trade rebates receivable from cooperative supplier organ­izations.

 

***Warranty Expense***

 

The provision for warranty expense is calculated by applying ahistorical warranty cost factor to our gross sales.  The Company has warranty obligations with respect to mostmanufactured products, however the liability for warranty obligations is notsignificant as a result of third party inspection and acceptanceprocesses.  Warranty expense was$87,000, $152,000 and $118,000 in 2003, 2002 and 2001, respectively.

 

***Insurance Deductible Reserves***

 

The estimated cost of general liability andworkers’ compensation claims are determined by actuarial methods.  Claims in excess of insurance deductiblesare insured.  Reserves for these claimsare recognized based on the estimated costs of these claims as limited by theapplicable insurance deductibles.

 

***Advertising***

 

Advertising costs are expensed when incurred.  Advertising expense was $338,000, $118,000and $616,000 in 2003, 2002 and 2001, respectively.

 

7

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***Shipping and Handling***

 

Shipping and handling costs for manufactured building components andconstruction services are included as a component of cost of sales.  Shipping and handling costs for buildingproducts are included as a component of “Selling, General and AdministrativeExpense” and were $46,673,000 for 2003, $45,149,000 for 2002 and $48,699,000for 2001.

 

***Stock Compensation***

 

At December 31, 2003, BMHC had five stock-basedemployee compensation plans, which are more fully described in Note 13.  The Company accounts for these plans underthe recognition and measurement principles of Accounting Principles Board(“APB”) Opinion No. 25, “Accountingfor Stock Issued to Employees”, and related interpretations.  The following table illustrates the effecton net income and earnings per share if the Company had applied the fair valuerecognition provisions of Statement of Financial Accounting Standards (“SFAS”)Statement No. 123, “Accounting forStock-Based Compensation”, to stock-based employee compensation (amountsin thousands, except per share data).

 
|                                                                                                                                          |   | **Year Ended  December 31,** |       |
|-----------------------------------------------------------------------------------------------------------------------------------------------|--------|------------------------------|------------|
|                                                                                                                                          |   | **2003**                     |       | **2002** |   | **2001** |   |
| Net income, as reported                                                                                                                       |   | **$**                        | **19,929** | ** ** | $ | 7,015 |   | $ | 20,844 |   |
| Add:   Total stock-based employee compensation expense determined under APB  25, net of related tax effects                              |   | **446**                      | ** ** | 1,117 |   | 727 |   |
| Deduct:   Total stock-based employee compensation expense determined under fair  value method for all awards, net of related tax effects |   | **(1,664**                   | **)**      | (2,331 | ) | (1,842 | ) |
| Pro forma net income                                                                                                                          |   | **$**                        | **18,711** | ** ** | $ | 5,801 |   | $ | 19,729 |   |
|                                                                                                                                          |   |                         | ** ** |   |   |   |   |
| Earnings per share:                                                                                                                           |   |                         | ** ** |   |   |   |   |
| Basic – as reported                                                                                                                      |   | **$**                        | **1.50**   | ** ** | $ | 0.54 |   | $ | 1.61 |   |
| Basic – pro forma                                                                                                                        |   | **$**                        | **1.41**   | ** ** | $ | 0.44 |   | $ | 1.53 |   |
|                                                                                                                                          |   |                         | ** ** |   |   |   |   |
| Diluted – as reported                                                                                                                    |   | **$**                        | **1.48**   | ** ** | $ | 0.53 |   | $ | 1.60 |   |
| Diluted – pro forma                                                                                                                      |   | **$**                        | **1.39**   | ** ** | $ | 0.44 |   | $ | 1.52 |   |

 

***Reclassifications***

 

Certain reclassifications, none of which affectedthe Company’s previously reported results of operations, cash flows orshareholders’ equity, have been made to amounts reported in prior periods toconform to the current year presentation. In addition, our consolidated statement of income has been changed toshow sales and related cost of goods sold separately for “Building Products”and “Construction Services,” due to the increased significance of servicerevenues to total sales.  In connectionwith this change, we also reclassified certain other operating costs andexpenses from selling, general and administrative expense to cost of goodssold.

 

***New Accounting Standards***

 

In June 2001, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standards No. 143(“SFAS 143”), “Accounting for Asset Retirement Obligations.”  SFAS 143 established financial accountingand reporting standards associated with the retirement of tangible long-livedassets and the associated asset retirement costs.  This statement was effective for financial statements issued forfiscal years beginning after June 15, 2002. The adoption of SFAS 143 in the first quarter of 2003 did not have amaterial impact on the Company’s financial position, results of operations orcash flows.

 

In November 2002, the FASB issued FASBInterpretation No. 45 (“FIN 45”), “Guarantor’s Accounting and DisclosureRequirements for Guarantees, Including Indirect Guarantees of Indebtedness ofOthers”.  FIN 45 requires thatguarantors recognize, at the inception of the guarantee, a liability for thefair value of the guarantee.  Inaddition, FIN 45 clarifies the disclosures required of guarantors for certainguarantees that it has issued.  Therecognition and measurement criteria of this interpretation are to be appliedprospectively to guarantees issued or modified after December 31, 2002.  The adoption of FIN 45 had no impact on theCompany’s financial position, results of operations or cash flows.

 

In January 2003, the FASB issued FASBInterpretation No. 46 (“FIN 46”), “Consolidation of Variable InterestEntities”, an interpretation of ARB No. 51, which was further revised inDecember 2003. FIN 46 requires certain variable interest entities to beconsolidated by the primary 

 

8

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beneficiaryof the entity if the equity investors in the entity do not have thecharacteristics of a controlling financial interest or do not have sufficientequity at risk for the entity to finance its activities without additionalsubordinated financial support from other parties. FIN 46 also requiresdisclosure of significant variable interests in variable interest entities forwhich a company is not the primary beneficiary. We are required to apply therevised provisions of FIN 46 in the first quarter of 2004. The application ofthe revised Interpretation is not expected to have a material impact on theCompany’s financial position, results of operations or cash flows.

 

In March 2003, the consensus of Emerging IssuesTask Force (“EITF”) Issue No. 02-16, “Accounting by a Customer (including aReseller) for Certain Consideration Received from a Vendor,” waspublished.  EITF Issue No. 02-16addresses how a reseller of a vendor’s products should account for cashconsideration received from a vendor. The provisions of EITF Issue No. 02-16 were effective for newarrangements transacted after December 31, 2002.  The Company’s adoption of EITF 02-16 did not have a significantimpact on the Company’s financial position, results of operations or cashflows.

 

In March 2003, the consensus of EITF Issue No.00-21, “Accounting for Revenue Arrangements with Multiple Deliverables,” waspublished.  EITF Issue No. 00-21addresses certain aspects of the accounting by a vendor for arrangements underwhich it will perform multiple revenue-generating activities.  Specifically, EITF Issue No. 00-21 addresseshow to determine whether an arrangement involving multiple deliverables containsmore than one unit of accounting.  Theprovisions of EITF Issue No. 00-21 were effective in fiscal periods beginningafter June 15, 2003.  The Company’sadoption of EITF 00-21 did not have a significant impact on the Company’sfinancial position, results of operations or cash flows.

 

In May 2003, the FASB issued SFAS No. 150,“Accounting for Certain Financial Instruments with Characteristics of BothLiabilities and Equity.”  This statementestablishes standards for how an issuer classifies and measures certainfinancial arrangements with characteristics of both liabilities andequity.  It requires that an issuerclassify a financial arrangement that is within its scope as a liability (or anasset in some circumstances).  Theprovisions of this statement were effective for financial arrangements enteredinto or modified after May 31, 2003, and otherwise were effective at thebeginning of the first interim period beginning after June 15, 2003.  Certain provisions of this statement havebeen deferred for an indefinite period. The Company continues to monitor FASB deliberations on SFAS No. 150 todetermine the ultimate impact on the Company’s financial position, results ofoperations or cash flows.

 

**2.****              NET INCOME PERCOMMON SHARE**

 

Net income per common share was determined as follows (in thousands,except share data):

 
|                                                                                     |   | **2003**   |       | **2002**   |   | **2001** |   |
|------------------------------------------------------------------------------------------|--------|------------|------------|------------|--------|----------|--------|
| Net income available to common shareholders                                              |   | **$**      | **19,929** | ** ** | $      | 7,015    | (1)    | $ | 20,844 |   |
|                                                                                     |   |       | ** ** |       |   |     |   |
| Weighted average shares outstanding used to  determine basic net income per common share |   | **13,279** | ** ** | 13,086     |   | 12,910   |   |
|                                                                                     |   |       |       |       |   |     |   |
| Net effect of dilutive stock options (2)                                                 |   | **162**    | ** ** | 177        |   | 99       |   |
|                                                                                     |   |       |       |       |   |     |   |
| Average shares used to determine diluted  net income per common share                    |   | **13,441** | ** ** | 13,263     |   | 13,009   |   |
|                                                                                     |   |       | ** ** |       |   |     |   |
| Net income per common share:                                                             |   |       | ** ** |       |   |     |   |
| Basic                                                                                    |   | **$**      | **1.50**   | ** ** | $      | 0.54     | (1)    | $ | 1.61 |   |
| Diluted                                                                                  |   | **$**      | **1.48**   | ** ** | $      | 0.53     | (1)    | $ | 1.60 |   |

 

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(1)                                  Aftera loss from change in accounting principle of $11,650, net of tax, or $0.88 perdiluted share.

(2)                                  Stockoptions of 352,525, 416,529 and 558,938 were not included in the computation,because to do so would have been anti-dilutive for the years ended December 31,2003, 2002 and 2001, respectively.

 

9

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**3.****              CHANGEIN ACCOUNTING PRINCIPLE**

 

The Company adopted SFAS No. 142 “Goodwilland Other Intangible Assets” in the first quarter of 2002.  The provisions of SFAS 142 eliminated theamortization of goodwill and other indefinite lived intangible assets on aprospective basis beginning with acquisitions completed after June 30, 2001, orJanuary 1, 2002 for those completed prior to June 30, 2001.  This standard required the Company tocomplete a transitional impairment analysis of its recorded goodwill andindefinite lived intangible assets and to record any impairment charge as achange in accounting principle.  TheCompany completed the transitional impairment analysis in the first quarter of2002, which resulted in the following impaired amounts of goodwill as ofJanuary 1, 2002 (in thousands):

 
| **Reporting Unit**   |   | **Goodwill  Impairment** |   | **Goodwill  Impairment,  Net of Tax** |   |
|----------------------|--------|--------------------------|--------|---------------------------------------|--------|
| Northern  Nevada     |   | $                        | 2,257  |                                  | $      | 1,388 |   |
| Utah                 |   | 1,397                    |   | 859                                   |   |
| Spokane              |   | 41                       |   | 25                                    |   |
| San Antonio / Austin |   | 2,194                    |   | 1,969                                 |   |
| Royal Door           |   | 2,975                    |   | 1,830                                 |   |
| Dallas / Fort Worth  |   | 1,403                    |   | 863                                   |   |
| Puget Sound          |   | 6,253                    |   | 3,846                                 |   |
| Portland             |   | 1,416                    |   | 870                                   |   |
| Total                |   | $                        | 17,936 |                                  | $      | 11,650 |   |

 

In the case of each reporting unit, fairvalue was estimated using the present value of expected future cash flows.  Management’s estimate of future cash flowsused in the present value analysis resulted in estimated fair market value beingless than the carrying amount of tangible and intangible assets for thereporting units listed above.  Adivestiture of any individual business unit that comprises a reporting unitcould result in a loss.  Afterconsidering the estimated fair market value of tangible assets, including land,an impairment of recorded goodwill occurred. Reasons for the impairments included increased competition, a change inthe market mix of home building, a reduction in residential construction withinthe geographic markets serving these reporting units and management issues.

 

The Company is required to test acquiredgoodwill and other indefinite-lived intangible assets for impairment on anannual basis.  This annual test takesplace during the fourth quarter of each year. See Note 4.

 

**4.****             ****IMPAIRMENT OF ASSETS**

 

During thefourth quarter of 2003, the Company conducted its annual evaluation of its reporting units todetermine if it was necessary to record impairment charges in accordance withSFAS 142.  Based on the results of thisevaluation, it was determined that no impairment existed for goodwill.

 

Independent of the Company’s annualevaluation of reporting units in accordance with SFAS 142, an assessment ofintangible assets with indefinite lives identified the impairment of certaincustomer relationships within the BMC Construction business segment andresulted in a charge of $829,000 in the fourth quarter of 2003.  As a result of a change in businessconditions in the market in which the reporting unit operates, the Companydecided to discontinue business with certain customers and therefore impairedthe intangible assets associated with related customer relationships.  Further, as part of the evaluation theCompany assessed the continued propriety of the indefinite lives of theassets.  As a result of this assessmentthe Company determined the lives of customer relationships were no longerindefinite and should be amortized over the succeeding two to seventeen years.

 

During the first quarter of 2003, the Companydetermined that events and circumstances warranted that on a prospective basis,$2,600,000 of previously unamortized customer relationships within the BMCConstruction business segment should be amortized over the succeeding 21months.  Amortization expense recognizedin 2003 related to this change in life was $1,090,000.

 

During thefourth quarter of 2002, the Company conducted its annual evaluation of its reporting units todetermine if it was necessary to record impairment charges in accordance withSFAS 142.  Because of changes in themarket mix of home building from higher margin custom home building to lowermargin production homebuilding at the Dallas/Fort Worth and Marvin Windowsreporting units within the BMC West business segment, the operating results andcash flows of these reporting units were lower than expected. Based on thattrend, the earnings forecasts were revised and an impairment charge of$6,698,000 was recorded.  Subsequent toDecember 31, 2002, the Company completed a management restructuring which theCompany believes will lead to improved operating results.

 

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During the third quarter of 2001, the Company wroteoff its $1,000,000 investment in BuildNet, Inc. (“BuildNet”).  BuildNet filed under Chapter 11 of theBankruptcy Code and the Company was advised that BuildNet has conducted anorderly liquidation of its assets. Based on an analysis conducted by the Company of the bankruptcy filings,management determined that its investment will not be recovered.  During the second quarter of 2001, theCompany recognized a loss of $750,000 resulting from the anticipated sale ofreal property in Salem, Oregon.

 

**5.****              ACQUISITIONSOF AND INVESTMENTS IN BUSINESSES**

 

Businessesacquired are accounted for using the purchase method of accounting.  Under this accounting method, the pur­chaseprice is allocated to the assets acquired, including intangible assets, andliabilities assumed based on their estimated fair values at the date ofacquisition.  Any excess of the purchaseprice over the estimated fair value of the net assets acquired is recorded asgoodwill.  Operating results of theacquired businesses are included in the consolidated statements of income fromthe date of acquisition.

 

*WBC Mid-Atlantic*

InOctober of 2003, the Company purchased a 67.33% interest in a newly formedconstruction business, WBC Mid-Atlantic LLC, for approximately $5.1 million incash and the issuance of 15,059 shares of common stock.  The other 32.67% interest is owned by theprincipals of ANM Carpentry, Inc. (“ANM”), a privately held firm based inFredericksburg, Virginia, and is being recognized as minority interest.  The new business venture is providingframing services for high-volume production homebuilders in Virginia, Maryland,the District of Columbia and Delaware.

 

Underthe purchase agreement, the Company has the option to purchase the remaining32.67% of WBC Mid-Atlantic prior to October 1, 2010 subject to certainlimitations or prior to October 1, 2006 contingent on the written consent ofANM or if certain other conditions are met. The principals of ANM have the option to require the Company to purchasethe remaining 32.67% interest from October 1, 2008 through October 1, 2010.  The purchase price for the remaining interestwill generally be based on a multiple of historical earnings.

 

*WBC Construction*

InJanuary of 2003, the Company purchased a 60% interest in a newly formedconstruction business, WBC Construction, LLC (“WBC”), for approximately $22.9million in cash and the issuance of 70,053 shares of common stock.  The other 40% interest is owned by WillardBrothers Construction, Inc., a privately held firm based in Sunrise,Florida.  WBC contracts with high-volumeproduction homebuilders in Florida to construct the slab and structural shellof homes.

 

Underthe purchase agreement, the Company has the option to purchase the remaining40% interest in WBC from January 16, 2006 through January 16, 2009 and theprincipals of Willard Brothers Construction, Inc. have the option to requirethe Company to purchase the remaining 40% of WBC from January 16, 2007 throughJanuary 16, 2009.  The purchase pricefor the remaining 40% will generally be based on a multiple of historicalearnings.

 

Whenpurchased, the Company accounted for its investment in WBC using the equitymethod of accounting because the minority owners had certain approval and otherrights that precluded consolidation.  On August 11, 2003, WBC’s operatingagreement was amended to eliminate certain approval and other rights of theminority interest shareholder.  As a result, the equity method ofaccounting was ceased and the results of WBC’s operations have been included inthe consolidated financial statements effective August 12, 2003. The impact ofthe 40% ownership interest held by Willard Brothers Construction, Inc., isbeing recognized as minority interest.  The consolidation of WBC resultedin an increase in assets of $41.2 million, an increase in liabilities of $12.7million, an increase in minority interest of $2.3 million and a decrease inequity investments in an unconsolidated company of $26.2 million.  Theseamounts are considered non-cash items in the consolidated statement of cashflows.

 

In2003, the Company made five other acquisitions for aggregate consideration ofapproximately $2.3 million.

 

*KBI Norcal*

OnJuly 1, 2002, the Company purchased a 51% interest in a newly formedpartnership, KBI Norcal, for approximately $5.8 million in cash, $0.8 millionof assumed debt (equipment leases and a working capital loan) and the issuanceof 34,364 shares of common stock.  Theother 49% interest is owned by RJ Norcal, LLC, a privately held firm in Dixon,California.  KBI Norcal provides turnkeyframing services in Northern California.

 

Underthe purchase agreement, the Company has the option to purchase the remaining49% interest in KBI Norcal from July 1, 2004 through June 30, 2008 and theprincipals of RJ Norcal, LLC have the option to require the Company to purchasethe remaining 49% of KBI Norcal from July 1, 2006 through June 30, 2008.  The purchase price for the remaining 49%will generally be based on the higher of either a multiple of historicalearnings or the contractual minimum of $7.5 million.  On a quarterly basis, the Company evaluates the fair value of thenet assets to be acquired and if less than the amount payable under therequired purchase option, an impairment loss is recognized.  As of 

 

11

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December 31, 2003, thepurchase price would be approximately $7.5 million and no loss was required tobe recognized.  After the KBI Norcal transaction, BMCConstruction revised its acquisition guidelines and has not structured aminimum option price in any of its subsequent buyout agreements, nor does itintend to in future acquisition transactions.

 

KBINorcal’s operating results have been included in the consolidated financialstatements since July 1, 2002.  Theimpact of the 49% ownership interest of RJ Norcal, LLC is being recognized asminority interest.

 

In2002, the Company made four other acquisitions for aggregate consideration of approximately $2.3 million.

 

*KBI*

FromMay 1999 through July 3, 2001, the Company owned 49% of Knipp BrothersIndustries, LLC, KBI Distribution, LLC and KB Industries Limited Partnership(collectively, “KBI”), which primarily operate as framing contractors inArizona, Southern California and Nevada. On July 3, 2001, the Company purchased the remaining 51% of KBI (the“KBI Acquisition”).  The results ofKBI’s operations have been included in the consolidated financial statementssince that date.  The aggregateconsideration paid for the remaining 51% interest was $34.4 million in cash,net of cash acquired of $1.8 million.

 

The initial acquisition ofthe 49% interest in KBI was made in May 1999 for approximately $26.1 million incash and $2.2 million in various assets and was accounted for under the equitymethod until July 3, 2001.  Under theequity method of accounting the Company allocated the excess of its 1999investment over its proportionate ownership interest in the net assets of KBIto the assets and liabilities of KBI based on their estimated fair values atthe date of the investment.  The excessof this investment over the estimated fair value of the net assets represents goodwill.  The consolidation of KBI resulted in anincrease in assets of approximately $40.0 million, an increase in liabilitiesof approximately $7.0 million and a decrease in equity investments inunconsolidated companies of approximately $33.0 million.  These amounts are considered non-cash itemsin the consolidated statement of cash flows for the year ended December 31,2001.

 

The following is a summary of the assets acquiredand liabilities assumed in connection with the acquisition at July 3, 2001 (inthousands):

 

| Current assets            |   | $      | 22,113 |   |
|---------------------------|--------|--------|--------|--------|
| Property and equipment    |   | 3,597  |   |
| Intangible assets         |   | 5,576  |   |
| Goodwill                  |   | 12,650 |   |
| Other long-term assets    |   | 188    |   |
| Total assets acquired     |   | 44,124 |   |
|                      |   |   |   |
| Current liabilities       |   | (5,879 | )      |
| Long-term liabilities     |   | (2,040 | )      |
| Total liabilities assumed |   | (7,919 | )      |
| Net assets acquired       |   | $      | 36,205 |   |

 

Ofthe $5.6 million of acquired intangible assets, $4.9 million was assigned tocustomer relationships and $0.7 million was assigned to non-competeagreements.  Previously the customerrelationships were not subject to amortization, however, as previouslydiscussed in Note 4, these relationships are now being amortized over 2 to 17years.  The non-compete agreements arebeing amortized over three years.  Inaccordance with the transitional provisions of SFAS 142, the $12.6 million ofgoodwill, all of which is deductible for tax purposes, will not be amortizedand will be tested for impairment at least annually.

 

The following summarizesunaudited pro forma results of operations assuming the acquisition of KBIoccurred as of the beginning of 2001. The pro forma information only includes the effect of the KBIAcquisition because the effects of other acquisitions are not material.  The pro forma data has been prepared forcomparative purposes only.  It does notpurport to be indicative of the results of operations that would have resultedhad the KBI Acquisition been consummated at the beginning of the yearpresented, or that may occur in the future (in thousands, except per sharedata).

 

|                                |   | **Unaudited  2001** |      |
|-------------------------------------|--------|---------------------|-----------|
|                                |   |                |      |
| Net sales                           |   | $                   | 1,178,620 |   |
| Net income                          |   | 23,080              |      |
|                                |   |                |      |
| Net income per diluted common share |   | $                   | 1.78      |   |

 

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**6.****              RECEIVABLES**

 

Receivables consisted of the following at December 31, (in thousands):

 
|                                                    |   | **2003**   |        | **2002**   |   |
|---------------------------------------------------------|--------|------------|-------------|------------|--------|
|                                                    |   |       |        |       |   |
| Trade receivables                                       |   | **$**      | **182,736** | ** ** | $      | 128,923 |   |
| Other                                                   |   | **7,479**  | ** **  | 5,856      |   |
| Allowance for returns, discounts and  doubtful accounts |   | **(2,425** | **)**       | (2,022     | )      |
|                                                    |   |       | ** **  |       |   |
|                                                    |   | **$**      | **187,790** |       | $      | 132,757 |   |

 

Because customers are dispersed among the Company’s various markets,its credit risk to any one customer or state economy is not significant.  The Company performs ongoing creditevaluations of its customers and provides an allowance for doubtful accounts whenevents or circumstances indicate that collection is doubtful.

 

Pursuant to credit applications with customers, interest income isassessed and collected on accounts receivable.  The interest rate variesfrom 1% to 2% per month.  Interest income was recognized as a component of“Other Income, Net” and was $1.1 million in 2003, $1.2 million in 2002 and $1.3million in 2001.

 

Trade accounts receivable include balances billed but not paid bycustomers under retainage provisions and were not significant at December 31,2003 and 2002.  All receivables in theabove table are expected to be collected within one year and therefore areclassified as current assets.

 

**7.****              EQUITYINVESTMENTS**

 

Summarized financial information for theCompany’s equity investments in WBC and KBI are as follows (in thousands):

 
|                                                          |   | **Year to  date  ending August 11,  2003****(1)** |       | **2002**   |       | **2001****(2)** |       |
|---------------------------------------------------------------|--------|---------------------------------------------------|------------|------------|------------|-----------------|------------|
|                                                          |   |                                              | ** ** |       | ** ** |            | ** ** |
| Income statement:                                             |   |                                              |       |       |       |            |       |
| Sales                                                         |   | **$**                                             | **97,717** | ** ** | $          | —          |       | $ | 85,753 |   |
| Income from operations                                        |   | **10,418**                                        | ** ** | —     |       | 3,488           |       |
|                                                          |   |                                              | ** ** |       |       |            |       |
| Net income (loss)                                             |   | **4,511**                                         | ** ** | —     |       | (13,872         | )          |
| Less other members’ share of net (income)  loss          |   | **(1,805**                                        | **)**      | —     |       | 15,510          |       |
| Company share of net income                                   |   | **2,706**                                         | ** ** | —     |       | 1,638           |       |
|                                                          |   |                                              | ** ** |       |       |            |       |
| Other income allocations, net of  amortization of intangibles |   | **(357**                                          | **)**      | —     |       | 3,179           |       |
| Company’s equity in earnings                             |   | **$**                                             | **2,349**  | ** ** | —     |            | $          | 4,817 |   |
|                                                          |   |                                              | ** ** |       |       |            |       |
| Balance sheet:                                                |   |                                              | ** ** |       |       |            |       |
| Current assets                                                |   | **$**                                             | **—** | ** ** | $          | —          |       | $ | — |   |
| Non-current assets                                            |   | **—**                                        | ** ** | —     |       | —          |       |
| Current liabilities                                           |   | **—**                                        | ** ** | —     |       | —          |       |
| Non-current liabilities                                       |   | **$**                                             | **—** | ** ** | $          | —          |       | $ | — |   |

 

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(1)          InAugust 2003, the Company modified the WBC operating agreement and as a resultceased using the equity method of accounting. The 2003 income statement reflects equity method accounting throughAugust 11, 2003.

(2)          InJuly 2001, the Company purchased the remaining 51% of KBI.  As a result, the 2001 income statementreflects six months of equity method accounting.  The 2001 income statement includes a change in control bonus of$17.2 million paid for and specifically allocated to the previous 51% partner.

 

13

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**8.****             ****PROPERTY AND EQUIPMENT**

 

Property and equipment consisted of the followingat December 31 (in thousands):

 
|                            |   | **2003**    |        | **2002**   |   |
|---------------------------------|--------|-------------|-------------|------------|--------|
| Land                            |   | **$**       | **39,311**  | ** ** | $      | 43,791 |   |
| Buildings and improvements      |   | **99,135**  | ** **  | 100,351    |   |
| Machinery and fixtures          |   | **65,971**  | ** **  | 62,608     |   |
| Handling and delivery equipment |   | **46,519**  | ** **  | 43,541     |   |
| Construction in progress        |   | **4,632**   | ** **  | 8,217      |   |
|                            |   |        | ** **  |       |   |
|                            |   | **255,568** |        | 258,508    |   |
| Less accumulated depreciation   |   | **(90,168** | **)**       | (80,371    | )      |
|                            |   |        | ** **  |       |   |
|                            |   | **$**       | **165,400** |       | $      | 178,137 |   |

 

Interest capitalized as part of additions was$74,000, $379,000 and $541,000 in 2003, 2002 and 2001, respectively.  Depreciation expense was $17,996,000,$16,919,000 and $15,506,000 in 2003, 2002 and 2001, respectively.

 

The Company periodically evaluates the commercialand strategic operation of the land and related buildings and improvements ofits facilities.  In connection withthese evaluations, facilities may be consolidated, and others sold orleased.  During 2003, the Companyrecorded net gains on the sale of assets of $1,161,000 consisting primarily ofthe sale of real estate in Missoula, Montana; Houston, Texas; Spokane,Washington; Emmett, Idaho and Pocatello, Idaho.  During 2002, the Company recorded net losses from the sale ofassets of $944,000 consisting primarily of the sale of real estate in Tooele,Utah; Gardnerville, Nevada and Spokane, Washington.  During 2001, the Company recorded net gains from the sale ofassets of $888,000 consisting primarily of the gain on the sale of real estatein Boise and Lewiston, Idaho and Grand Junction, Colorado.  These facilities have not been reported asdiscontinued operations in the consolidated financial statements becausesubstantially all of the operations and cash flows will continue in the ongoingoperations of the Company or, if eliminated, the sales and operating income ofthe facilities are not material individually or in the aggregate.

 

**9.****              GOODWILLAND OTHER INTANGIBLE ASSETS**

 

Goodwill represents the purchase price over the fair values of nettangible and identifiable intangible assets of acquired businesses.

 

Changes in the carrying amount of goodwill by segment are as follows(in thousands):

 
|                                    |   | **BMC West** |   | **BMC  Construction** |   | **Total** |   |
|-----------------------------------------|--------|--------------|--------|-----------------------|--------|-----------|--------|
| Balance at January 1, 2002              |   | $            | 44,489 |                  | $      | 23,850    |   | $ | 68,339 |   |
| Goodwill acquired during the year       |   | —       |   | 9,558                 |   | 9,558     |   |
| Purchase price adjustments              |   | —       |   | (78                   | )      | (78       | )      |
| Change in accounting principle (1)      |   | (17,936      | )      | —                |   | (17,936   | )      |
| Impairment (2)                          |   | (6,698       | )      | —                |   | (6,698    | )      |
| Contingent consideration adjustment (3) |   | (1,074       | )      | —                |   | (1,074    | )      |
| Balance at December 31, 2002            |   | 18,781       |   | 33,330                |   | 52,111    |   |
|                                    |   |         |   |                  |   |      |   |
| Goodwill acquired during the year       |   | 1,558        |   | 19,979                |   | 21,537    |   |
| Purchase price adjustments              |   | 89           |   | 137                   |   | 226       |   |
| Impairment                              |   | —       |   | —                |   | —    |   |
| Contingent consideration adjustment (3) |   | (213         | )      | —                |   | (213      | )      |
| Goodwill divested during the year       |   | (916         | )      | —                |   | (916      | )      |
| Balance at December 31, 2003            |   | $            | 19,299 |                  | $      | 53,446    |   | $ | 72,745 |   |

 

(1)          See Note 3 related totransitional impairment.

(2)          See Note 4 related tothe fourth quarter impairment.

(3)          See Note 11 related tothe re-pricing of a non-interest bearing note payable.

 

14

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Intangible assets consist of the following (in thousands):

 
|                     |   | **As of  December 31, 2003** |   |
|--------------------------|--------|------------------------------|--------|
|                     |   | **Carrying  Amount**         |   | **Accumulated  Amortization** |   | **Net  Carrying  Amount** |   |
| Amortized intangibles    |   |                         |   |   |   |   |   |
| Covenants not to compete |   | $                            | 2,320  |   | $ | (1,121 | ) | $ | 1,199 |   |
| Customer relationships   |   | 12,600                       | (1)    | (1,793 | ) | 10,807 |   |
| Other                    |   | 500                          |   | (489 | ) | 11 |   |
|                     |   | $                            | 15,420 |   | $ | (3,403 | ) | $ | 12,017 |   |

 
|                     |   | **As of  December 31, 2002** |   |
|--------------------------|--------|------------------------------|--------|
|                     |   | **Carrying  Amount**         |   | **Accumulated  Amortization** |   | **Net  Carrying  Amount** |   |
| Amortized intangibles    |   |                         |   |   |   |   |   |
| Covenants not to compete |   | $                            | 2,004  |   | $ | (1,139 | ) | $ | 865 |   |
| Customer relationships   |   | 2,902                        |   | (145 | ) | 2,757 |   |
| Other                    |   | 500                          |   | (352 | ) | 148 |   |
| Unamortized intangibles  |   |                         |   |   |   |   |   |
| Customer relationships   |   | 9,180                        |   |   |   | 9,180 |   |
|                     |   | $                            | 14,586 |   | $ | (1,636 | ) | $ | 12,950 |   |

 

(1) An impairment charge for customer relationships of $829,000 wasincluded in the carrying amount (see Note 4).

 

As discussed in Note 4, the Company evaluated the propriety of notamortizing customer relationships to determine whether events and circumstanceswarrant amortization on a prospective basis. In April of 2003, the Company determined that $2.6 million of apreviously unamortized customer relationship should be amortized over thesucceeding twenty-one months. Additionally, in December of 2003, the Company determined thatpreviously unamortized customer relationships of $7.2 million should beamortized over two to seventeen years.

 

Intangible amortization expense was $1.7 million in 2003, $0.8 millionin 2002 and $2.5 million in 2001. Estimated amortization expense is $3.4 million for 2004, $1.7 millionfor 2005, $1.5 million for 2006, $1.0 million for 2007, $0.5 million for 2008and $3.9 million thereafter.

 

The following reflects adjustments that would be made to net income andearnings per share if the non-amortization provisions of SFAS 142 had beenadopted as of January 1, 2001 (in thousands, except per share data):

 
|                                                   |   | **2003**   |       | **2002** |   | **2001** |   |
|--------------------------------------------------------|--------|------------|------------|----------|--------|----------|--------|
| Reported net income                                    |   | **$**      | **19,929** |     | $      | 7,015    |   | $ | 20,844 |   |
| Goodwill amortization, net of income taxes             |   | **—** |       | —   |   | 1,344    |   |
| Customer relationship amortization, net of  income tax |   | **—** |       | —   |   | 97       |   |
| Adjusted net income                                    |   | **$**      | **19,929** |     | $      | 7,015    |   | $ | 22,285 |   |
|                                                   |   |       |       |     |   |     |   |
| Reported basic income per share                        |   | **$**      | **1.50**   |     | $      | 0.54     |   | $ | 1.61 |   |
| Goodwill amortization, net of income taxes             |   | **—** |       | —   |   | 0.11     |   |
| Customer relationship amortization, net of  income tax |   | **—** |       | —   |   | 0.01     |   |
| Adjusted basic net income per share                    |   | **$**      | **1.50**   |     | $      | 0.54     |   | $ | 1.73 |   |
|                                                   |   |       |       |     |   |     |   |
| Reported diluted income per share                      |   | **$**      | **1.48**   |     | $      | 0.53     |   | $ | 1.60 |   |
| Goodwill amortization, net of income taxes             |   | **—** |       | —   |   | 0.10     |   |
| Customer relationship amortization, net of  income tax |   | **—** |       | —   |   | 0.01     |   |
| Adjusted diluted net income per share                  |   | **$**      | **1.48**   |     | $      | 0.53     |   | $ | 1.71 |   |

 

15

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**10.****       ACCOUNTSPAYABLE AND ACCRUED EXPENSES**

 

Accounts payable and accrued expenses consisted of the following atDecember 31 (in thousands):

 
|                          |   | **2003**   |        | **2002** |   |
|-------------------------------|--------|------------|-------------|----------|--------|
| Trade accounts payable        |   | **$**      | **51,735**  |     | $      | 37,496 |   |
| Book overdrafts               |   | **5,312**  |        | 4,758    |   |
| Accrued compensation          |   | **18,241** |        | 19,164   |   |
| Sales tax payable             |   | **5,784**  |        | 3,800    |   |
| Insurance deductible reserves |   | **15,074** |        | 3,339    |   |
| Other                         |   | **12,921** |        | 5,504    |   |
|                          |   | **$**      | **109,067** |     | $      | 74,061 |   |

 

**11.****       DEBT**

 

Debt consisted of the following at December 31 (in thousands):

 
|                                                                                                                       |   | **2003**   |        | **2002** |   |
|----------------------------------------------------------------------------------------------------------------------------|--------|------------|-------------|----------|--------|
| Term note                                                                                                                  |   | **$**      | **124,375** |     | $      | 102,300 |   |
| Revolving credit facility                                                                                                  |   | **60,400** |        | 51,200   |   |
| Non-interest bearing term note, net of  related discount of $1,142 and $1,339 at December 31, 2003 and 2002,  respectively |   | **3,146**  |        | 2,949    |   |
| Capital leases                                                                                                             |   | **469**    |        | 926      |   |
| Other                                                                                                                      |   | **1,288**  |        | —   |   |
|                                                                                                                       |   | **$**      | **189,678** |     | $      | 157,375 |   |

 

During the third quarter of 2003, management entered into a new seniorsecured credit facility.  The new creditfacility replaces the old credit facility, which was scheduled to mature in2004.  It includes a term loan of $125million maturing in seven years, and a revolving line of credit of $175 millionmaturing in five years.  In connectionwith the new senior secured credit facility, certain previously deferredfinancing costs of $0.7 million associated with the former credit facility wereexpensed along with new costs of $0.3 million incurred to obtain the currentcredit facility and both are included in “Other Income, Net”.  All other remaining costs associated withthe former and current credit facilities are being amortized over the life ofthe new loan periods.

 

At December 31, 2003, the Company’s senior secured credit facilityprovided for borrowings of up to $299.4 million, including $124.4 millionoutstanding under the term loan and $175.0 million under the revolving creditfacility, $60.4 million of which was outstanding at December 31, 2003.  Revolver borrowings can be limited to aborrowing base equal to 60% of inventory plus 80% of trade accountsreceivable.  The borrowing base iscalculated monthly and was $179.5 million at December 31, 2003, but was limitedto the maximum of $175.0 million. Revolver availability was $88.1 million, net of $26.5 million inoutstanding letters of credit. Borrowings under the facility bear interest at a rate based on eitherPrime or LIBOR plus an additional spread based on performance.  Currently, the revolver rates are Prime plus1.25% and LIBOR plus 2.50%.  Theinterest rate on the term loan is based on either Prime or LIBOR plus 3.25%.

 

The terms of the credit agreement permit an increase in the facility ofup to $50 million, subject to certain conditions.  The term loan matures in 2010 and the revolving loan matures in2008.  The term loan is payable inquarterly installments over the initial six years in amounts equal to 1% of theinitial principal amount per year and equal quarterly installments of theremaining principal balance during year seven.

 

The term loan and revolving credit facility are both collateralized byall tangible and intangible property and interest in property and proceedsthereof now owned or hereafter acquired by the Company and any wholly-ownedsubsidiary, except BMC Insurance, Inc.

 

The agreements related to the above borrowings contain covenantsproviding for the maintenance of certain financial ratios and conditionsincluding:  consolidated net worth; acoverage ratio that includes earnings before interest, taxes, depreciation andamortization; a ratio of total funded debt to earnings before interest, taxes,depreciation and amortization; and limitations on capital expenditures, amongcertain other restrictions.  At December31, 2003, the Company was in compliance with these covenants and conditions.

 

The scheduled principal payments of debt are $2.9 million in 2004, $2.0million in 2005, $3.7 million in 2006, $1.3 million in 2007, $61.7 million in2008 and $118.1 million thereafter. Principal payments of $2.9 million due within the next twelve months areexpected to be refinanced through the unused portion of the revolving creditfacility.  As a result, this amount hasbeen classified as long-term.

 

16

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As of December 31, 2003, the Company had $26.5 million in letters ofcredit outstanding to guarantee performance or payments to third parties.  These letters of credit reduce borrowingavailability under the revolving credit facility.

 

In connection with a 1999 acquisition, the Company issued a $5,000,000non-interest bearing five-year term note to the previ­ous owner as partialconsideration for the purchase.  Underthe terms of the note, principal payments are due beginning 2004; however,accelerated payments may be due based on the operating results of the acquiredbusiness during each year prior to 2004. Due to the uncertain timing of the payout of this term note, the noterepresents a form of contingent consideration paid for the acquiredbusiness.  The Company recorded adiscount of $1,460,000 against the note in 1999 based on a 15% effectiveinterest rate and estimates of the operating results of the acquiredbusiness.  During the first quarters of2003 and 2002, the Company adjusted its estimates related to the timing of thepayout of the term note, which resulted in recording additional discounts of$213,000 and $1,074,000, respectively. The Company has made payments of $0 and $156,000 for the years endedDecember 31, 2003 and 2002 respectively, under the terms of the note.

 

**12.****      ****PREFERRED STOCK**

 

BMHC has 2,000,000 shares of preferred stockauthorized but not currently issued.

 

**13.****      ****STOCK PURCHASE AND INCENTIVE PLANS**

 

*Shareholders’ RightsPlan*

The Shareholders’ Rights Plan expires in 2007.  Under the plan, if a person acquires 15% ormore of the Company’s stock or makes a tender or other offer to do so withoutthe approval of the Board of Directors, shareholders would have the right topurchase stock of the Company or the acquiring company at a significantdiscount.  The Board of Directors hasthe right to redeem the rights for a nominal amount, to extend the periodbefore shareholders may exercise the rights or to take other actions permittedby the plan.  The rights trade with thestock but do not give shareholders any voting rights.  The rights plan is intended to encourage any person seeking toacquire the Company to negotiate with the Board of Directors.

 

*Cash Equity Plan*

On April 1, 1999, a Cash Equity Plan to provide incentives for keymanagement employees was adopted.  Theawards vest after three years from the date of grant and expire after fiveyears.  Each unit under an award allowsfor an exchange for cash in the amount of the fair market value of the commonstock at the date of exercise. The number of units available for grant,including those units outstanding and unexercised, cannot exceed two percent ofthe common shares outstanding at any given time.  This plan is accounted for as a variable plan.  As a result, compensation expense will varyat each reported period based on changes in the Company’s stock price.  During 2003 the Company did not award anyunits and recognized compensation expense of $346,000.  In 2002 and 2001, the Company awarded 15,250and 97,000 units, respectively, and recognized compensation expense of$1,487,000 and $1,004,000, respectively. At December 31, 2003, 104,240 units remained outstanding and unexercised.  Accelerated vesting may occur if there is achange of control of the Company, as defined in the Cash Equity Plan.

 

*Employee Stock Purchase Plan*

On October 1, 2000, a non-compensatory Employee Stock Purchase Plan(“ESPP”) was adopted.  Under the ESPP,eligible employees may elect each year to have up to 10% of their annualqualified compensation withheld to purchase the Company’s common stock.  The purchase price of the stock is 85% ofthe market price of the common stock on the last day of each month.  The purchase period is one month, commencingon the effective date of the ESPP, and continues consecutively after thetermination of the preceding purchase period. There were 200,000 shares of common stock authorized for purchase underthe ESPP.  As of December 31, 2003,there were 113,622 shares available for future purchase under the ESPP.

 

*Stock and Stock Option Plans*

The Company has five stock and stock option plans: the 1991 SeniorManagement and Field Management Plan, the 1992 Non-Qualified Stock Option Plan,the 1993 Employee Stock Option Plan, the 1993 Second Amended and RestatedNon-Employee Director Stock Plan and the 2000 Stock Incentive Plan (the “StockOption Plans”).  As of December 31,2003, there were 1,548,177 shares of common stock reserved for issuance underthe plans.

 

The 1991 Senior Management and Field Management Plan provided for thegranting of options to purchase shares of common stock at exercise prices belowfair market value.  At December 31,2003, there were no options remaining for future grants under the 1991 plan.  Options vest over four years from the dateof grant and expire at the end of ten years if unexercised.

 

The 1992 Non-Qualified Stock Option Plan and the 1993 Employee StockOption Plan provided for the granting of options, at the discretion of theBoard of Directors, to purchase shares of common stock.  At December 31, 2003, there were no optionsremaining for future 

 

17

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grants underthe 1992 and 1993 plans.  The exerciseprice is equal to the fair market value of common stock on the date the optionswere granted.  Options vest over fiveyears from the date of grant and expire at the end of ten years if unexercised.

 

On February 18, 2000, the 1993 Amended and Restated Non-EmployeeDirector Stock Option Plan was amended to the 1993 Second Amended and RestatedNon-Employee Director Stock Plan.  As aresult, the Company grants awards of common stock rather than stock optionawards under this plan.  This plan isavailable only to non-employee directors, and awards vest immediately upongrant.  During 2003, 2002 and 2001, theCompany granted 24,300, 19,200, and 18,200 shares, respectively, of stock underthis plan and recognized compensation expense of $316,400, $288,000 and$177,400, respectively. At December 31, 2003, 23,500 shares remain in the planfor future issuance.  The options thatremain outstanding from grants under the pre-amended plan are exercisable afterone year following the date of grant and expire at the end of ten years ifunexercised.

 

On February 18, 2000, the 2000 Stock Incentive Plan was adopted.  The plan provides for the granting of salesor bonuses of stock, restricted stock, stock options, stock purchase warrants,other rights to acquire stock, securities convertible into or redeemable forstock, stock appreciation rights and dividend equivalents.  The number of shares of common stock issuedand issuable pursuant to all awards granted under this plan shall not exceed600,000, with annual increases commencing in 2001 as defined in the plan.  During 2003 there were 185,750 non-statutoryoptions granted under the plan at a price equal to the fair market value of theCompany’s common stock on the date of grant. These grants vest at an annual rate of 25% commencing on December 31,2003.  At December 31, 2003 there were3,500 shares remaining in the plan for future issuance.  All options outstanding under the planexpire at the end of ten years if unexercised.

 

During 1997, as an additional incentive to attract a member of seniormanagement, the Board of Directors authorized and issued an award of 50,000options.  The exercise price was equalto the fair market value of common stock on the date the options weregranted.  These options vested inFebruary 2002 and expire 10 years from the date of grant, or 2007, and areincluded in the tables below.

 

A summary of the activity of the Stock Option Plans for the years endedDecember 31, 2003, 2002 and 2001 consisted of the following:

 
|                                                             |   | **2003**      |       | **2002**                           |       | **2001**   |       |
|------------------------------------------------------------------|--------|---------------|------------|------------------------------------|------------|------------|------------|
|                                                             |   | **Shares**    |       | **Weighted  Avg. Exercise  Price** |       | **Shares** |       | **Weighted  Avg. Exercise  Price** |   | **Shares** |   | **Weighted  Avg. Exercise  Price** |   |
|                                                             |   |          |       |                               |       |       |       |   |   |   |   |   |   |
| Balance at beginning of the year                                 |   | **1,515,183** | ** ** | **$**                              | **11.96**  | ** ** | 1,413,868  |   | $ | 11.58 |   | 1,406,673 |   | $ | 11.73 |   |
| Options granted                                                  |   | **185,750**   | ** ** |                               | **13.92**  | ** ** | 221,000    |   |   | 14.00 |   | 204,500 |   |   | 9.71 |   |
| Options exercised                                                |   | **(88,547**   | **)**      |                               | **10.10**  | ** ** | (97,694    | ) |   | 10.57 |   | (126,477 | ) |   | 8.11 |   |
| Options forfeited                                                |   | **(91,209**   | **)**      |                               | **13.79**  | ** ** | (21,991    | ) |   | 14.59 |   | (70,828 | ) |   | 15.12 |   |
|                                                             |   |          | ** ** |                               |       | ** ** |       |   |   |   |   |   |   |   |   |   |
| Balance at end of the year                                       |   | **1,521,177** | ** ** | **$**                              | **12.20**  | ** ** | 1,515,183  |   | $ | 11.96 |   | 1,413,868 |   | $ | 11.58 |   |
|                                                             |   |          | ** ** |                               | ** ** |       |       |   |   |   |   |   |   |
| Exercisable at end of the year                                   |   | **1,158,540** | ** ** | **$**                              | **12.22**  | ** ** | 1,017,683  |   | $ | 12.52 |   | 849,765 |   | $ | 12.83 |   |
| Weighted average fair value of options  granted at fair value    |   | **$**         | **8.87**   | ** **                         |       |       | ** ** | $ | 9.31 |   |   |   |   | $ | 6.52 |   |   |   |   |
| Weighted average fair value of options  granted below fair value |   | **$**         | **—** | ** **                         |       |       | ** ** | $ | — |   |   |   |   | $ | — |   |   |   |   |
|                                                                  |        |               |            |                                    |            |            |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

The following table summarizes informationabout stock options outstanding at December 31, 2003:

 
|                          |   | **Options  Outstanding**                      |          | **Options  Exercisable**                                   |       |
|-------------------------------|--------|-----------------------------------------------|---------------|------------------------------------------------------------|------------|
| **Range of  Exercise Prices** |   | **Number  Outstanding at  December 31, 2003** |          | **Weighted  Average  Remaining Contractual  Life (Years)** |       | **Weighted  Average  Exercise Price** |   | **Number  Exercisable at  December 31, 2003** |   | **Weighted  Average  Exercise Price** |   |
|                          |   |                                          | ** **    |                                                       | ** ** |   | ** ** |   | ** ** |   | ** ** |
| $1.21 to $6.85                |   |                                          | **73,000**    |                                                       | 6.6        |   | $ | 6.62 | ** ** | **23,000** |   | $ | 6.12 |   |
| $8.67 to $17.00               |   |                                          | **1,362,737** |                                                       | 6.2        |   |   | 11.84 | ** ** | **1,050,100** |   |   | 11.50 |   |
| $19.50 to $29.75              |   |                                          | **85,440**    |                                                       | 1.7        |   |   | 22.67 | ** ** | **85,440** |   |   | 22.67 |   |
|                          |   |                                          |          |                                                       |       |   |   |   |   |   |   |   |
| $1.21 to $29.75               |   |                                          | **1,521,177** |                                                       | 6.0        |   | $ | 12.20 |   | **1,158,540** |   | $ | 12.22 |   |

 

18

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The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option pricing model with the following weightedaverage assumptions used for grants in 2003, 2002 and 2001: risk-free interestrates of 3.9%, 5.0% and 5.1%, respectively; estimated lives of approximately 9years for all periods presented; and expected stock price volatility of 55.0%,55.1% and 55.0%, respectively.

 

The following table summarizes equity compensation plan information asof December 31, 2003:

 
| **Plan category**                                           |   | **Number of  Securities to be Issued  Upon Exercise of Outstanding  Options, Warrants and Rights** |   | **Weighted  Average Exercise  Price of Outstanding Options,****W****arrants and Rights** |   | **Number of  Securities Remaining  Available for Future Issuance****Under E****quity  Compensation Plans****(1)** |   |
|-------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------|--------|------------------------------------------------------------------------------------------|--------|-------------------------------------------------------------------------------------------------------------------|--------|
| Equity compensation plans approved by security  holders     |   | 1,471,177                                                                                          |   | $12.19                                                                                   |   | 27,000                                                                                                            | (2)    |
| Equity compensation plans not approved by security  holders |   | 50,000(3)                                                                                          |   | 12.50                                                                                    |   | —                                                                                                            |   |
| Total                                                       |   | 1,521,177                                                                                          |   | $12.20                                                                                   |   | 27,000                                                                                                            |   |

 

----

(1)          Excludes securities reflected in the secondcolumn.

(2)          Includes 23,500 from the 1993 Amended andRestated Non-Employee Director Stock Option Plan and 3,500 from the 2000 StockIncentive Plan.  The 2000 StockIncentive Plan allows for an increase of 100,000 shares each year not to exceed1,100,000 for the plan.

(3)          The exercise price was equal to the fairmarket value of common stock on the date the options were granted.  These options vested in February 2002 andexpire 10 years from the date of grant, or 2007.

 

**14.****       INCOMETAXES**

 

The asset and liabilitymethod is used in accounting for income taxes. Under this method, deferred tax assets and liabilities are recognizedfor tax credits and for the future tax consequences attributable to differencesbetween the financial statement carrying amounts of existing assets and theirtax bases.  Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled.  A valuationallowance is recorded to reduce the carrying amounts of deferred assets unlessit is more likely than not that such assets will be realized.

 

Income taxes for theyears ended December 31, 2003, 2002 and 2001 consisted of the following (inthousands):

 
|                  |   | **2003**  |       | **2002** |   | **2001** |   |
|-----------------------|--------|-----------|------------|----------|--------|----------|--------|
| Current income taxes  |   |      |       |     |   |     |   |
| Federal               |   | **$**     | **8,258**  |     | $      | 12,420   |   | $ | 9,066 |   |
| State                 |   | **588**   |       | 1,142    |   | 910      |   |
|                  |   | **8,846** |       | 13,562   |   | 9,976    |   |
|                  |   |      |       |     |   |     |   |
| Deferred income taxes |   |      |       |     |   |     |   |
| Federal               |   | **2,240** |       | (2,446   | )      | 1,107    |   |
| State                 |   | **316**   |       | (245     | )      | 111      |   |
|                  |   | **2,556** |       | (2,691   | )      | 1,218    |   |
|                  |   |      |       |     |   |     |   |
|                  |   | **$**     | **11,402** |     | $      | 10,871   |   | $ | 11,194 |   |

 

For the yearsended December 31, 2003 and 2001, income tax expense of $918,000 and$1,855,000, respectively, associated with equity in earnings of anunconsolidated company was not included in the table above.  For the year ended December 31, 2002, adeferred tax benefit of $6,286,000 was recognized and classified in the changein accounting principle (see Note 3).

 

The tax benefitassociated with non-statutory stock options exercised by employees under theCompany’s stock plans reduced taxes payable by approximately $141,000, $187,000and $257,000 for 2003, 2002 and 2001, respectively.  These benefits were credited to additional paid-in capital.

 

19

----

 

A reconciliation of the U.S. statutory federal income tax rate to therate as provided in the consolidated statements of income is as follows:

 
|                                       |   | **2003**      |       | **2002** |   | **2001** |   |
|--------------------------------------------|--------|---------------|------------|----------|--------|----------|--------|
|                                       |   |          |       |     |   |     |   |
| Statutory rate                             |   | **35.0**      | **%**      | 35.0     | %      | 35.0     | %      |
| State income taxes, net of federal benefit |   | **1.7**       | ** ** | 1.6      |   | 2.4      |   |
| Non-deductible items                       |   | **1.3**       | ** ** | 1.7      |   | —   |   |
| Minority interest income                   |   | **(1.4**      | **)**      | —   |   | —   |   |
| Other                                      |   | **—**    | ** ** | (1.2     | )      | 1.1      |   |
|                                       |   | **36.6****%** |       | 37.1     | %      | 38.5     | %      |

 

Deferred income taxes are provided using the liability method toreflect temporary differences between the financial and tax bases of assets andliabilities using presently enacted tax rates and laws.

 

The components of deferred income taxes included in the consolidatedbalance sheets were as follows at December 31 (in thousands):

 
|                                                   |   | **2003**   |       | **2002**   |   |
|--------------------------------------------------------|--------|------------|------------|------------|--------|
| Deferred tax assets                                    |   |       |       |       |   |
| Inventory, tax basis in excess of book  basis          |   | **$**      | **3,044**  | ** ** | $      | 2,446 |   |
| Reserves not yet deductible for tax                    |   | **6,516**  | ** ** | 5,723      |   |
| Intangible, tax basis in excess of book  basis         |   | **2,649**  | ** ** | 5,077      |   |
| Other                                                  |   | **5,558**  | ** ** | 2,544      |   |
| Total deferred tax assets                              |   | **17,767** | ** ** | 15,790     |   |
|                                                   |   |       | ** ** |       |   |
| Deferred tax liabilities                               |   |       | ** ** |       |   |
| Book basis in excess of tax basis of  acquired assets  |   | **262**    | ** ** | 493        |   |
| Tax in excess of book depreciation                     |   | **12,518** | ** ** | 8,302      |   |
| Deferred costs deducted for taxes                      |   | **1,712**  | ** ** | 1,164      |   |
| Total deferred tax liabilities                         |   | **14,492** | ** ** | 9,959      |   |
|                                                   |   |       | ** ** |       |   |
| Net deferred tax assets                                |   | **$**      | **3,275**  | ** ** | $      | 5,831 |   |
|                                                   |   |       | ** ** |       |   |
| Classified as:                                         |   |       | ** ** |       |   |
| Deferred income tax benefit (current  assets)          |   | **$**      | **8,629**  | ** ** | $      | 5,302 |   |
| Deferred income taxes (long-term asset  (liabilities)) |   | **(5,354** | **)**      | 529        |   |
|                                                   |   |       | ** ** |       |   |
|                                                   |   | **$**      | **3,275**  |       | $      | 5,831 |   |

 

Deferred tax assets are reduced by avaluation allowance when it is more likely than not that some portion of thedeferred tax asset will not be realized. Management believes deferred tax assets will be realized therefore novaluation allowance was recognized in any of the periods presented.

 

**15.****       RETIREMENTPLANS**

 

BMHC has a savings and retirement plan for its salaried and certain ofits hourly employees whereby the eligible employees may contribute a percentageof their earnings to a trust, i.e. a 401(k) plan.  The Company also makes contributions to the trust based on apercentage of the contributions made by the participating employees.  The Company’s contributions are chargedagainst operations and were $2,774,000, $2,711,000, and $3,005,000 in 2003,2002 and 2001, respectively.

 

BMHC has a supplemental retirement plan for selected key managementemployees and directors.  Thecontributions are based on the Company achieving certain operating earningslevels.  Pursuant to this plan, theCompany charged operations for $1,685,000 in 2003, $1,510,000 in 2002 and$1,503,000 in 2001.  BMHC has purchasedcompany-owned life insurance in order to have a funding mechanism for this plan.  Retirement payments will be paid to theparticipants or their beneficiaries over a 15 year period subsequent toretirement or death.

 

Effective with the 2002 year, directors were no longer covered by thesupplemental retirement plan and their existing benefits were 

 

20

----

 

transferred to a deferred account with a present value of an equivalentform of cash or stock compensation. Future compensation for directors will be limited to quarterly cashretainers and annual stock grants.

 

BMHC does notprovide any other post-retirement benefits for its employees.

 

**16.****       FINANCIALINSTRUMENTS**

 

The bookvalues compared with the fair values of financial instruments at December 31,were as follows (in thousands):

 
|               |   | **2003**        |        | **2002**        |   |
|--------------------|--------|-----------------|-------------|-----------------|--------|
|               |   | **Book  Value** |        | **Fair  Value** |   | **Book  Value** |   | **Fair  Value** |   |
|               |   |            |        |            |   |   |   |   |   |
| Long-term debt:    |   |            |        |            |   |   |   |   |   |
| Variable rate debt |   | **$**           | **185,760** | ** **      | **$**  | **185,760** |   | $ | 153,500 |   | $ | 153,500 |   |
| Fixed rate debt    |   | **3,918**       | ** **  | **3,853**       |   | 3,875 |   | 3,662 |   |
|               |   |            | ** **  |            |   |   |   |   |   |
|               |   | **$**           | **189,678** |            | **$**  | **189,613** |   | $ | 157,375 |   | $ | 157,162 |   |

 

The bookvalues of cash and cash equivalents, accounts receiv­able, accounts payable andvariable interest rate long-term debt approximated fair value due to either theshort-term maturities or current variable interest rates of these instruments.

 

The fair valueof fixed rate debt has been estimated based upon the discounted cash flowsusing the Company’s incremental rate of borrowing for similar debt.

 

**17.****       COMMITMENTSAND CONTINGENCIES**

 

***Operating Leases***

 

The Companyleases real property, vehicles and office equip­ment under operatingleases.  Rental expense was $9,919,000in 2003, $9,651,000 in 2002, and $8,317,000 in 2001.  Certain of the leases are non-cancelable and have minimum leasepayment requirements of  $11,287,000 in2004, $8,586,000 in 2005, $7,272,000 in 2006, $5,131,000 in 2007, $3,109,000 in2008 and $7,403,000 thereafter.

 

***Legal Proceedings***

 

The Company isinvolved in litigation and other legal matters arising in the normal course ofbusiness.  In the opinion of manage­ment,the Company’s recovery or liability, if any, under any of these matters willnot have a material adverse effect on the Company’s financial position,liquidity or results of operations.

 

**18.****       SEGMENTINFORMATION**

 

Building Materials Holding Corporation consists of two reportablesegments:  BMC West and BMCConstruction.  These segments representdistinct businesses that are managed separately due to the differing productsand services.  Each of these businessesrequires distinct operating and marketing strategies.  Management reviews the financial performance of the Company basedon these operating segments.

 

BMC West markets and sells building products, manufactures buildingcomponents and provides construction services. Products include structural lumber and building supplies purchased fromother manufacturers and manufactured building components for construction.  Construction services principally includeframing and installation of miscellaneous building materials.  Most products and construction services aresold to professional builders and contractors.

 

BMC Construction provides turnkey framing, shell construction and otherconstruction services to high-volume production homebuilders.

 

The financial performance for these reporting segments is based onoperating income before interest expense, income taxes, minority interest,equity earnings and the cumulative effect of change in accountingprinciple.  The segments follow theaccounting principles described in the Summary of Significant AccountingPolicies.  Sales between segments arerecorded primarily at market and no single customer accounts for more than 10%of sales.

 

21

----

 

Sales to external customers by product and service are as follows (inthousands):

 
|                        |   | **2003**      |          | **2002**   |   | **2001**  |   |
|-----------------------------|--------|---------------|---------------|------------|--------|-----------|--------|
| BMC West                    |   |          |          |       |   |      |   |
|  Building products     |   | **$**         | **917,487**   | ** ** | $      | 868,446   |   | $ | 945,504 |   |
|  Construction services |   | **89,886**    | ** **    | 73,399     |   | 46,851    |   |
|                        |   | **1,007,373** |          | 941,845    |   | 992,355   |   |
| BMC Construction            |   |          | ** **    |       |   |      |   |
|  Construction services |   | **408,929**   | ** **    | 220,472    |   | 100,512   |   |
|                        |   |          | ** **    |       |   |      |   |
| Corporate and other         |   | **(1,231**    | **)**         | (823       | )      | —    |   |
|                        |   | **$**         | **1,415,071** |       | $      | 1,161,494 |   | $ | 1,092,867 |   |

 

Financial information by segment is as follows (in thousands):

 
|                             |   |          |          |                |       |          |       | **Income (1)  (Loss)  Before  Taxes and  Minority  Interest** |          | **Equity in  Net  Income  (Loss) of  Affiliates** |       | **Depreciation  and  Amortization** |       | **Capital  (2)  Expenditures** |       | **Assets**  |       | **Invest-  ments  In Equity  Affiliates** |       |
|----------------------------------|--------|---------------|---------------|---------------------|------------|---------------|------------|---------------------------------------------------------------|---------------|---------------------------------------------------|------------|-------------------------------------|------------|--------------------------------|------------|-------------|------------|-------------------------------------------|------------|
|                             |   |          |          |                |       |          |       |                                                          |          |                                              |       |                                |       |
|                             |   |          |          |                |       |          |       |                                                          |          |                                              |       |                                |       |
|                             |   | **Sales**     |          |                |       |          |       |                                                          |          |
|                             |   | **Trade**     |          | **Inter-  Segment** |       | **Total**     |       |                                                          |          |                                              |       |                                |       |
|                             |   |          |          |                |       |          |       |
|                             |   |          |          |                |       |          |       |                                                          |          |                                              |       |                                |       |                           |       |        |       |                                      |       |
| **Year Ended December 31, 2003** |   |          |          |                |       |          |       |                                                          |          |                                              |       |                                |       |                           |       |        |       |                                      |       |
| BMC West                         |   | **$**         | **1,007,373** | ** **          | **$**      | —        | ** ** | **$**                                                         | **1,007,373** | ** **                                        | **$**      | **54,826**                          | ** ** | **$**                          | —     | ** **  | **$**      | **15,315**                                | ** ** | **$** | **12,121** | ** ** | **$** | **390,764** | ** ** | **$** | **—** | ** ** |
| BMC Construction                 |   | **408,929**   | ** **    | **—**          | ** ** | **408,929**   | ** ** | **18,954**                                                    | ** **    | **1,431**                                         | ** ** | **4,410**                           | ** ** | **5,555**                      | ** ** | **187,479** | ** ** | **—**                                | ** ** |
| Corporate and Other              |   | **—**    | ** **    | **(1,231**          | **)**      | **(1,231**    | **)**      | **(33,351**                                                   | **)**         | **—**                                        | ** ** | **1,060**                           | ** ** | **—**                     | ** ** | **25,956**  | ** ** | **—**                                | ** ** |
|                             |   | **1,416,302** |          | **(1,231**          | **)**      | **1,415,071** | ** ** | **40,429**                                                    | ** **    | **1,431**                                         | ** ** | **20,785**                          | ** ** | **17,676**                     | ** ** | **604,199** | ** ** | **—**                                | ** ** |
| Interest Expense                 |   | **—**    | ** **    | **—**          | ** ** | **—**    | ** ** | **(9,279**                                                    | **)**         | **—**                                        | ** ** | **—**                          | ** ** | **—**                     | ** ** | **—**  | ** ** | **—**                                | ** ** |
|                             |   | **$**         | **1,416,302** |                | **$**      | **(1,231**    | **)**      | **$**                                                         | **1,415,071** | ** **                                        | **$**      | **31,150**                          | ** ** | **$**                          | **1,431**  | ** **  | **$**      | **20,785**                                | ** ** | **$** | **17,676** | ** ** | **$** | **604,199** | ** ** | **$** | **—** | ** ** |
|                             |   |          |          |                |       |          |       |                                                          |          |                                              |       |                                |       |                           |       |        |       |                                      |       |
| **Year Ended December 31, 2002** |   |          | ** **    |                | ** ** |          | ** ** |                                                          | ** **    |                                              | ** ** |                                | ** ** |                           | ** ** |        | ** ** |                                      | ** ** |
| BMC West                         |   | $             | 941,845       |                | $          | —        |       | $                                                             | 941,845       |                                              | $          | 48,146                              |       | $                              | —     |        | $          | 15,184                                    |       | $ | 17,898 |   | $ | 371,717 |   | $ | — |   |
| BMC Construction                 |   | 220,472       |          | —              |       | 220,472       |       | 20,677                                                        |          | —                                            |       | 2,545                               |       | 4,303                          |       | 120,997     |       | —                                    |       |
| Corporate and Other              |   | —        |          | (823                | )          | (823          | )          | (29,702                                                       | )             | —                                            |       | 1,536                               |       | —                         |       | 10,360      |       | —                                    |       |
|                             |   | 1,162,317     |          | (823                | )          | 1,161,494     |       | 39,121                                                        |          | —                                            |       | 19,265                              |       | 22,201                         |       | 503,074     |       | —                                    | ** ** |
| Interest Expense                 |   | —        |          | —              |       | —        |       | (9,812                                                        | )             | —                                            |       | —                              |       | —                         |       | —      |       | —                                    |       |
|                             |   | **$**         | **1,162,317** |                | **$**      | **(823**      | **)**      | **$**                                                         | **1,161,494** | ** **                                        | **$**      | **29,309**                          | ** ** | **$**                          | —     | ** **  | **$**      | **19,265**                                | ** ** | **$** | **22,201** | ** ** | **$** | **503,074** | ** ** | **$** | — | ** ** |
|                             |   |          | ** **    |                | ** ** |          | ** ** |                                                          | ** **    |                                              | ** ** |                                | ** ** |                           | ** ** |        | ** ** |                                      | ** ** |
| **Year Ended December 31, 2001** |   |          | ** **    |                | ** ** |          | ** ** |                                                          | ** **    |                                              | ** ** |                                | ** ** |                           | ** ** |        | ** ** |                                      | ** ** |
| BMC West                         |   | $             | 992,355       |                | $          | —        |       | $                                                             | 992,355       |                                              | $          | 55,580                              |       | $                              | —     |        | $          | 16,785                                    |       | $ | 22,965 |   | $ | 395,229 |   | $ | — |   |
| BMC Construction                 |   | 100,512       |          | —              |       | 100,512       |       | 7,696                                                         |          | 2,962                                             |       | $                                   | 1,259      |                           | 7,434      |        | 82,126     |                                      | —     |   |
| Corporate and Other              |   | —        |          | —              |       | —        |       | (20,647                                                       | )             | —                                            |       | 1,290                               |       | —                         |       | 8,387       |       | —                                    |       |
|                             |   | 1,092,867     |          | —              |       | 1,092,867     |       | 42,629                                                        |          | 2,962                                             |       | 19,334                              |       | 30,399                         |       | 485,742     |       | —                                    | ** ** |
| Interest Expense                 |   | —        |          | —              |       | —        |       | (13,553                                                       | )             | —                                            |       | —                              |       | —                         |       | —      |       | —                                    |       |
|                             |   | **$**         | **1,092,867** |                | **$**      | —        | ** ** | **$**                                                         | **1,092,867** | ** **                                        | **$**      | **29,076**                          | ** ** | **$**                          | **2,962**  | ** **  | **$**      | **19,334**                                | ** ** | **$** | **30,399** | ** ** | **$** | **485,742** | ** ** | **$** | **—** | ** ** |

 

----

(1)  See Note 4 for an explanation of asset impairmentsaffecting our segments.

(2)  Property and equipment from acquisitions are included ascapital expenditures.

 

22

----

 

**19.****       RESULTSOF QUARTERLY OPERATIONS (UNAUDITED)**

 

Operating results by quarter for 2003 and 2002 were as follows (dollarsin thousands, except per share data):

 
|                                                                   |   | **First** |        | **Second** |       | **Third**   |       | **Fourth** |        |
|------------------------------------------------------------------------|--------|-----------|-------------|------------|------------|-------------|------------|------------|-------------|
| **2003**                                                               |   |      | ** **  |       | ** ** |        | ** ** |       | ** **  |
| **Sales**                                                              |   | **$**     | **276,392** | ** ** | **$**      | **322,266** | ** ** | **$**      | **396,325** | ** ** | **$** | **420,088** | ** ** |
| **Income from operations**                                             |   | **2,171** | ** **  | **10,319** | ** ** | **15,554**  | ** ** | **12,385** | **(1)**     |
| **Net income**                                                         |   | **586**   | ** **  | **5,649**  | ** ** | **7,916**   | ** ** | **5,778**  | ** **  |
|                                                                   |   |      | ** **  |       | ** ** |        | ** ** |       | ** **  |
| **Net income per diluted common share**                                |   | **$**     | **0.04**    | ** ** | **$**      | **0.42**    | ** ** | **$**      | **0.59**    | ** ** | **$** | **0.43** | ** ** |
| **Common stock prices:**                                               |   |      | ** **  |       | ** ** |        | ** ** |       | ** **  |
| **High**                                                               |   | **$**     | **15.750**  | ** ** | **$**      | **15.350**  | ** ** | **$**      | **15.710**  | ** ** | **$** | **15.530** | ** ** |
| **Low**                                                                |   | **$**     | **12.680**  | ** ** | **$**      | **12.160**  | ** ** | **$**      | **11.750**  | ** ** | **$** | **12.750** | ** ** |
|                                                                   |   |      |        |       |       |        |       |       |        |
| 2002                                                                   |   |      |        |       |       |        |       |       |        |
| Sales                                                                  |   | $         | 247,135     |       | $          | 300,528     |       | $          | 316,930     |   | $ | 296,901 |   |
| Income from operations                                                 |   | 3,539     | (2)         | 14,276     |       | 18,593      |       | 2,713      | (3)         |
| Income before change in accounting  principle                          |   | 618       |        | 7,291      |       | 9,710       |       | 1,046      |        |
| Net income (loss)                                                      |   | (11,032   | )           | 7,291      |       | 9,710       |       | 1,046      |        |
| Income per diluted common share before  change in accounting principle |   | $         | 0.05        |       | $          | 0.55        |       | $          | 0.73        |   | $ | 0.08 |   |
|                                                                   |   |      |        |       |       |        |       |       |        |
| Net income (loss) per diluted common share                             |   | $         | (0.84       | )          | $          | 0.55        |       | $          | 0.73        |   | $ | 0.08 |   |
| Common stock prices:                                                   |   |      |        |       |       |        |       |       |        |
| High                                                                   |   | $         | 18.360      |       | $          | 17.720      |       | $          | 15.358      |   | $ | 14.600 |   |
| Low                                                                    |   | $         | 10.850      |       | $          | 14.000      |       | $          | 10.410      |   | $ | 10.000 |   |

 

----

(1)          Includes $0.8 million charge forimpairment of intangibles.

(2)          Includes $11.6 million charge net of taxfor change in accounting principle.

(3)          Includes $6.7 million charge forimpairment of goodwill.

 

23

----

 

**Report of Independent Auditors**

 

To the Board of Directors and Shareholders

Building Materials Holding Corporation:

 

In our opinion, the accompanying consolidated balance sheets and therelated consolidated statements of income, shareholders’ equity and cash flowspresent fairly, in all material respects, the financial position of BuildingMaterials Holding Corporation and its subsidiaries (the “Company”) at December31, 2003 and 2002, and the results of their operations and their cash flows foreach of the three years in the period ended December 31, 2003, in conformitywith accounting principles generally accepted in the United States ofAmerica.  These financial statements arethe responsibility of the Company’s management; our responsibility is toexpress an opinion on these financial statements based on our audits.  We conducted our audits of these statementsin accordance with auditing standards generally accepted in the United Statesof America, which require that we plan and perform the audit to obtainreasonable assurance about whether the financial statements are free ofmaterial misstatement.  An auditincludes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements, assessing the accounting principlesused and significant estimates made by management, and evaluating the overallfinancial statement presentation.  Webelieve that our audits provide a reasonable basis for our opinion.

 

As explained in Note 3, effective January 1, 2002, the Company adoptedthe provisions of Statement of Financial Accounting Standards No. 142 “Goodwilland Other Intangible Assets.”

 

 
| /s/  PricewaterhouseCoopers LLP |   |
|---------------------------------|--------|
|                            |
| San Francisco, California       |
| March 12, 2004                  |

 

24

----

 

**FINANCIAL REVIEW**

**Building Materials Holding Corporation**

 

The following discussion and analysis providesinformation that management believes is relevant to an assessment andunderstanding of our consolidated results of operations for the years endedDecember 31, 2003, 2002 and 2001 and financial condition as of December 31,2003 and 2002.  The comparison of the2003 results with 2002 and the comparison of the 2002 results with 2001 wereaffected by the acquisitions that occurred during 2003 and 2002 as discussedmore fully in Note 5 to our consolidated financial statements.

 

**RESULTS OF OPERATIONS**

 

The following table sets forth, for the yearsended December 31, 2003, 2002 and 2001 amounts as well as the percentagerelationship to sales of certain costs, expenses and income items (amounts inmillions).

 
|                                                      |   | **2003**    |       | **2002**   |       | **2001**   |   |
|-----------------------------------------------------------|--------|-------------|------------|------------|------------|------------|--------|
| **Sales**                                                 |   |        |       |       |       |       |   |   |   |   |   |   |   |
| Building products                                         |   | **$**       | **916.3**  | ** ** | **64.8**   | **%**      | $      | 867.6 |   | 74.7 | % | $ | 945.5 |   | 86.5 | % |
| Construction services                                     |   | **498.8**   | ** ** | **35.2**   | ** ** | 293.9      |   | 25.3 |   | 147.4 |   | 13.5 |   |
| Total sales                                               |   | **1,415.1** | ** ** | **100.0**  | ** ** | 1,161.5    |   | 100.0 |   | 1,092.9 |   | 100.0 |   |
|                                                      |   |        | ** ** |       | ** ** |       |   |   |   |   |   |   |   |
| **Costs and operating  expenses**                         |   |        | ** ** |       | ** ** |       |   |   |   |   |   |   |   |
| Cost of goods sold                                        |   |        | ** ** |       | ** ** |       |   |   |   |   |   |   |   |
| Building products                                         |   | **687.8**   | ** ** | **75.1**   | ** ** | 639.7      |   | 73.7 |   | 700.2 |   | 74.1 |   |
| Construction services                                     |   | **437.5**   | ** ** | **87.7**   | ** ** | 243.4      |   | 82.8 |   | 120.3 |   | 81.6 |   |
| Total cost of goods sold                                  |   | **1,125.3** | ** ** | **79.5**   | ** ** | 883.1      |   | 76.0 |   | 820.5 |   | 75.0 |   |
| Impairment of assets                                      |   | **0.8**     | ** ** | **0.1**    | ** ** | 6.7        |   | 0.6 |   | 1.7 |   | 0.2 |   |
| Selling, general and administrative expense               |   | **250.3**   | ** ** | **17.6**   | ** ** | 233.3      |   | 20.1 |   | 230.8 |   | 21.1 |   |
| Other income, net                                         |   | **1.7**     | ** ** | **0.1**    | ** ** | 0.7        |   | 0.1 |   | 2.7 |   | 0.2 |   |
|                                                      |   |        | ** ** |       | ** ** |       |   |   |   |   |   |   |   |
| **Income from  operations**                               |   | **40.4**    | ** ** | **2.9**    | ** ** | 39.1       |   | 3.4 |   | 42.6 |   | 3.9 |   |
|                                                      |   |        | ** ** |       | ** ** |       |   |   |   |   |   |   |   |
| Interest expense                                          |   | **9.3**     | ** ** | **0.7**    | ** ** | 9.8        |   | 0.8 |   | 13.6 |   | 1.2 |   |
| Income taxes                                              |   | **11.4**    | ** ** | **0.8**    | ** ** | 10.9       |   | 1.0 |   | 11.2 |   | 1.0 |   |
| Minority interest (income) loss                           |   | **(1.2**    | **)**      | **0.1**    | ** ** | 0.2        |   | 0.0 |   | — |   | — |   |
| Equity earnings in an unconsolidated  company, net of tax |   | **1.4**     | ** ** | **0.1**    | ** ** | —     |   | — |   | 3.0 |   | 0.2 |   |
| Change in accounting principle, net of tax                |   | **—**  | ** ** | **—** | ** ** | (11.6      | )      | (1.0 | ) | — |   | — |   |
|                                                      |   |        | ** ** |       | ** ** |       |   |   |   |   |   |   |   |
| **Net income**                                            |   | **$**       | **19.9**   | ** ** | **1.4**    | ** ** | $      | 7.0 |   | 0.6 |   | $ | 20.8 |   | 1.9 |   |

 

**ACQUISITIONS**

 

***2003***

In October of  2003, the Companypurchased a 67.33% interest in a newly formed joint venture constructionbusiness, WBC Mid-Atlantic, LLC (“WBC Mid-Atlantic”), for approximately $5.1million consisting of cash and 15,059 shares of common stock.  The other 32.67% interest is owned by theprincipals of ANM Carpentry, Inc. (“ANM”), a privately held firm based inFredericksburg, Virginia, and is being recognized as minority interest.  The new business venture serves high-volumeproduction homebuilders in Virginia, Maryland, the District of Columbia andDelaware.

 

25

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Under the purchase agreement, BMHC will have the option to purchase theremaining 32.67% of WBC Mid-Atlantic prior to October 1, 2010 subject tocertain limitations or prior to October 1, 2006 contingent on the writtenconsent of ANM or if certain other conditions are met.  The principals of ANM have the option torequire the Company to purchase the remaining 32.67% interest from October 1,2008 through October 1, 2010.  Thepurchase price for the remaining interest will generally be based on a multipleof historical earnings.

 

In January of 2003, the Company purchased a 60% interest in a newlyformed limited liability company, WBC Construction, LLC (“WBC”), for approximately$22.9 million in cash and the issuance of 70,053 shares of  common stock.  The other 40% interest is owned by Willard Brothers Construction,Inc., a privately held firm based in Sunrise, Florida.  WBC contracts with high-volume productionhomebuilders in Florida to construct the slab and structural shell of homes.

 

Under the purchase agreement, the Company has the option to purchasethe remaining 40% interest in WBC from January 16, 2006 through January 16,2009 and the principals of Willard Brothers Construction, Inc. have the optionto require the Company to purchase the remaining 40% of WBC from January 16,2007 through January 16, 2009.  Thepurchase price for the remaining 40% will generally be based on a multiple ofhistorical earnings.

 

When purchased, the Company accounted for its investment in WBC usingthe equity method of accounting because the minority owners had certainapproval and other rights that precluded consolidation. On August 11, 2003,WBC’s operating agreement was amended to eliminate certain approval and otherrights of the minority interest shareholder.  As a result, the equitymethod of accounting was ceased and the results of WBC’s operations have beenincluded in the consolidated financial statements effective August 12, 2003.The impact of the 40% ownership interest by Willard Brothers Construction,Inc., is being recognized as minority interest.  The consolidation of WBCresulted in an increase in assets of $41.2 million, an increase in liabilitiesof $12.7 million, an increase in minority interest of $2.3 million and adecrease in equity investments in an unconsolidated company of $26.2 million. These amounts are considered non-cash items in the consolidated statementof cash flows.

 

In 2003, the Company made five other acquisitions for aggregateconsideration of approximately $2.3 million. These acquisitions did not have a material impact on sales.

 

***2002***

In July of2002, the Company purchased a 51% interest in a newly formed partnership, KBINorcal, for approximately $5.8 million in cash, $0.8 million of assumed debt(equipment leases and a working capital loan) and the issuance of 34,364 sharesof common stock.  The other 49% interestis owned by RJ Norcal, LLC, a privately held firm based in Dixon,California.  KBI Norcal provides turnkeyframing services for high-volume production homebuilders in NorthernCalifornia.

 

Under thepurchase agreement, the Company has the option to purchase the remaining 49%interest in KBI Norcal from July 1, 2004 through June 30, 2008 and theprincipals of RJ Norcal, LLC have the option to require the Company to purchasethe remaining 49% of KBI Norcal from July 1, 2006 through June 30, 2008.  The purchase price for the remaining 49%will generally be based on the higher of either a multiple of historicalearnings or the contractual minimum of $7.5 million.  On a quarterly basis, the Company evaluates the fair value of thenet assets to be acquired and if less than the amount payable under the requiredpurchase option, an impairment loss will be recognized.  As of December 31, 2003, the purchase pricewould be approximately $7.5 million and no loss was required to berecognized.  After the KBI Norcaltransaction, BMC Construction revised its acquisition guidelines and has notstructured a minimum option price in any of its subsequent buyout agreements,nor does it intend to do so in future acquisition transactions.

 

KBI Norcal’soperating results have been consolidated in our financial statements since July1, 2002.  The impact of the 49% ownershipinterest of RJ Norcal, LLC is being recognized as minority interest.

 

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In 2002, theCompany made four other acquisitions for aggregate consideration ofapproximately $2.3 million.  Theseacquisitions did not have a material impact on sales.

 

***2001***

From May 1999 through July 3, 2001, BMC Construction owned 49% ofKnipp Brothers Industries, LLC, KBI Distribution, LLC and KB Industries LimitedPartnership (collectively, “KBI”), which primarily operate as framingcontractors in Arizona, Southern California and Nevada.  On July 3, 2001, BMC Construction purchasedthe remaining 51% of KBI (the “KBI Acquisition”).  The results of KBI’s operations have been included in theconsolidated financial statements since that date.  The aggregate consideration paid for the remaining 51% interestwas $34.4 million in cash, net of cash acquired of $1.8 million.

 

Prior to July 3, 2001, the Company accounted for its 49% ownership inKBI using the equity method.  KBI operatingresults are included in the consolidated statements of income beginning July 3,2001.  Pro forma information whichassumes that the acquisition occurred at the beginning of 2001 is presented inNote 5 to the consolidated financial statements.  The pro forma information includes only the effect of the KBIAcquisition because the effect of other acquisitions are not significant.

 

**CRITICALACCOUNTING POLICIES AND ESTIMATES**

 

The following discussion andanalysis is based upon our consolidated financial statements, which have beenprepared in accordance with accounting principles generally accepted in theUnited States of America.  Thepreparation of our financial statements requires management to make estimatesand assumptions that affect the reported amounts of sales, expenses, assets andliabilities during the periods reported. Estimates are used when accounting for certain items such as sales,allowance for returns, discounts and doubtful accounts, employee compensationprograms, depreciation and amortization periods, taxes, inventory values,insurance programs, and valuations of investments, goodwill, other intangibleassets and long-lived assets.  We baseour estimates on historical experience, where applicable, and other assumptionsthat we believe are reasonable under the circumstances.  Actual results may differ from our estimatesunder different assumptions or conditions.

 

There are certain criticalestimates that we believe require more significant judgment in the preparationof our consolidated financial statements. We consider an accounting estimate to be critical if (i) it requires usto make assumptions because information was not available at the time or itincluded matters that were highly uncertain at the time we were making theestimate, and (ii) changes in the estimate or different estimates that we couldhave selected would have a material impact on our financial condition orresults of operations.

 

The table below presents information about the nature and rationale ofour critical accounting estimates:

 
| **Accounting  Area** |   | **Explanation  of Estimate**                                                                                          |   | **Accounting  Policy/Assumptions**                                                                                                                                                                                                                                                                                                                                                                                                                       |   | **Financial  Statement  Impact**                                                                                                                                |
|----------------------|--------|-----------------------------------------------------------------------------------------------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Sales                |   | We use the percentage-of-completion method  to recognize revenue for certain construction and installation contracts. |   | We estimate revenue and related gross  margin on construction and installation contracts on a  percentage-of-completion method, utilizing labor dollars incurred to total  forecasted labor dollars to measure progress toward completion.  For contracts based on a sequential production  process where an entity produces units of a basic product, we measure  progress toward completion of a contract based on the units of delivery  method. |   | Sales could increase or decrease with a  corresponding increase or decrease in gross margin if actual costs to  complete contracts differ from estimated costs. |

 

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| **Accounting  Area**                                             |   | **Explanation  of Estimate**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   | **Accounting  Policy/Assumptions**                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |   | **Financial  Statement  Impact**                                                                                                                                                                                   |
|------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Accounts receivable, net                                         |   | The allowance for doubtful accounts  reflects our estimated losses resulting from the inability of our customers  to make required payments.                                                                                                                                                                                                                                                                                                                                                                                            |   | We base our estimates on the aging of our  accounts receivable balances and our historical write-off experience, net of  recoveries.                                                                                                                                                                                                                                                                                                                                                                         |   | Changes in the financial condition of our  customers could impact the need to increase or decrease the allowance for  doubtful accounts.                                                                           |
| Property and equipment, net  Finite-lived intangible assets, net |   | We review our property. equipment and  finite-lived intangible assets for impairment whenever events or  circumstances indicate that the carrying amount may not be recoverable.  Impairment reviews require a comparison of  the estimated future undiscounted cash flows to the carrying amount of the  asset.  If the total of the  undiscounted cash flows is less than the carrying amount, an impairment  charge is recorded for the difference between the estimated fair value and  the carrying amount of the asset. |   | Significant assumptions required in  determining the undiscounted cash flows of our property, equipment and  finite-lived intangible assets include (i) growth rates to apply to expected  future cash flows, (ii) working capital requirements as a percent of sales  and (iii) capital expenditures as a percent of sales.                                                                                                                                                                                 |   | The use of different estimates within the  undiscounted cash flow model could result in under- or over-valuing property,  equipment, and finite-lived intangible assets as well as any related  impairment charge. |
| Goodwill and other indefinite- lived  intangibles, net           |   | We complete an impairment test of goodwill  and other intangible assets at least annually.  The impairment test for goodwill requires us to estimate the  fair value of our individual reporting units, which is done using a  discounted cash flow model.  The impairment test for indefinite-lived intangibles consists of a comparison  of the fair value of an intangible asset with its carrying amount.                                                                                                                      |   | Significant estimates required in our  discounted cash flow model include (i) expected future cash flows for individual  reporting units, (ii) our weighted average cost of capital, (iii) growth  rates to apply to expected future cash flows, (iv) working capital  requirements as a percent of sales and (v) capital expenditures as a percent  of sales.  The fair values of indefinite-lived intangible assets are determined using  the Income Approach which employs a discounted cash flow method. |   | The use of different estimates within the  discounted cash flow model could result in under- or over-valuing goodwill  and other indefinite-lived intangible assets, and any related impairment  charge.           |

 

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| **Accounting  Area**         |   | **Explanation  of Estimate**                                                                                                                                                                                                                                                                                                                       |   | **Accounting  Policy/Assumptions**                                                                                                                                                                                                                                                                                                                                                                                        |   | **Financial  Statement  Impact**                                                                                                                                                                                    |
|------------------------------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Inventory                    |   | We review our inventory for obsolescence  and marketability.                                                                                                                                                                                                                                                                                       |   | We write down inventory balances for  estimated obsolescence or unmarketable inventory equal to the difference  between the cost of the inventory and the estimated market value based upon  assumptions about future demand and market conditions.                                                                                                                                                                       |   | If actual market conditions are different  than those projected by management, inventory may be over or under valued.                                                                                               |
| Insurance deductible reserve |   | We have large deductibles for general  liability, auto liability and workers’ compensation insurance.  The deductible portion of the liability  for unpaid claims, including incurred but not reported losses, is determined  by a third-party actuary.  The  deductible is reflected on our balance sheet as an accrued liability. |   | Our accounting policy requires an internal  evaluation and adjustment of our reserve for all insurance-related  liabilities on a quarterly basis.  At  least on an annual basis, we require an external actuarial professional  (Mercer Oliver Wyman) to independently assess and estimate the total  liability outstanding, which is compared to the actual reserve balance at  that time and adjusted accordingly. |   | Changes in the key assumptions, or actual  loss experience that is substantially different from actuarial valuations,  may occur in the future, which would result in changes to related insurance  cost estimates. |

 

**Management’s Discussion and Analysis**

 

**OVERVIEW**

 

Building Materials Holding Corporation’s consolidated financialstatements include operations from two business segments: BMC West and BMCConstruction.  Sales and income arederived from providing building products and construction services tohomebuilders and contractors at the local and regional level.  BMC West markets building products andconstruction services primarily to custom and low-volume productionhomebuilders, while BMC Construction provides construction services tohigh-volume production homebuilders.

 

Financial condition and operating performance are measured by severalfactors considered key to the growth and success of the business.  Sales growth by acquisitions and expansionof existing operations, income from operations, and effective management ofworking capital and assets are the primary measures used to review financialresults.

 

In the context of a stable economy with historically low mortgageinterest rates, new home construction has benefited.  The Company has sought to take advantage of this opportunity bygrowing construction services which provides both building materials andconstruction service capabilities.

 

*Trends in theHomebuilding Industry*

New residential construction of entry level homes and first timemove-up homes has benefited from low mortgage interest rates.  Many people who, based on income, would berenters are able to buy houses as a result of low mortgage interest rates.  However, the slow-moving economy hasnegatively impacted the construction of custom and higher cost homes.

 

In the smaller markets served by the Company, BMC West has beensuccessful in supplying building materials to custom and low-volumehomebuilders.  In these markets,homebuilders rely on the expertise and on-time delivery service of BMC West.

 

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In the larger metropolitan markets, the high-volume productionhomebuilders have gained market share because they are focused on constructionof entry level and first time move-up homes. The high-volume production homebuilders’ capital resources havepermitted them in these markets to endure lengthy entitlement timelines and developland for large projects.  The custom andlow-volume homebuilder in these metropolitan markets has been adverselyimpacted by limited demand for custom homes and scarcity of lots for the entrylevel and first time move-up homes.

 

In general, high-volume production homebuilders also have differentservice needs than those of custom and low-volume homebuilders.  High-volume production homebuilders are moreprice sensitive than low-volume homebuilders because of their purchasing scaleand place relatively more importance on services that will decrease theirproduction cycle time, mitigate their risk of labor related and constructiondefect liabilities and ensure a steady source of trained, skilled andwell-managed laborers.  They place lessreliance on the product expertise and short term responsiveness offered by mostbuilding materials suppliers.  To meetthe needs of this growing segment of the homebuilding market, BMC West beganoffering construction services in the metropolitan markets it serves and BMHCformed a subsidiary company, BMC Construction, to sharply focus on serving theunique needs of high-volume production homebuilders.

 

BMC Construction’s growth strategy focuses on new market penetration,supply chain integration and construction service expansion.  We believe that high-volume productionhomebuilders are increasingly attracted to outsourcing of construction servicesfor the value that it brings in labor and materials management efficiencies andrisk mitigation.

 

Throughoutthe following discussion, the Company has used financial measures which are notin accordance with generally accepted accounting principles in the UnitedStates (“GAAP”).  These measures excludecharges for impairment of goodwill and intangible assets in both years as wellas the exclusion of acquisitions in certain financial comparisons.  We believe these measures provide meaningfulinformation regarding the Company’s operational performance and facilitatemanagement’s internal comparisons to the Company’s historical operatingresults.  The Company believes thatthese non-GAAP financial measures are useful to investors because they allowfor greater transparency.  Wherevernon-GAAP financial measures have been used, the Company has reconciled them inthe tables below to their GAAP counterparts. These non-GAAP financial measuresare not prepared in accordance with generally accepted accounting principlesand may be different from non-GAAP financial measures used by other companies.Non-GAAP financial measures should not be considered as a substitute for, orsuperior to, measures of financial performance prepared in accordance withGAAP. The below tables reconciles the non-GAAP financial measures used withGAAP.

 

**2003 COMPARED WITH 2002**

 

**Consolidated Sales**

** **

The following table shows consolidated and business segment salesadjusted for the impact of significant acquisitions for the periods endingDecember 31, 2003 and 2002 (amounts in millions):

** **
|              |   | **BMC West** |    | **BMC  Construction** |   | **Intersegment  Eliminations** |   | **BMHC** |   |
|-------------------|--------|--------------|---------|-----------------------|--------|--------------------------------|--------|----------|--------|
|              |   | **2003**     |    | **2002**              |   | **2003**                       |   | **2002** |   | **2003** |   | **2002** |   | **2003** |   | **2002** |   |
| Sales             |   | $            | 1,007.4 |                  | $      | 941.8                          |   | $        | 408.9  |   | $ | 220.5 |   | $ | (1.2 | ) | $ | (0.8 | ) | $ | 1,415.1 |   | $ | 1,161.5 |   |
| Less acquisitions |   | (11.0        | )       | (2.7                  | )      | (197.2                         | )      | (28.6    | )      | — |   | — |   | (208.2 | ) | (31.3 | ) |
|              |   |         |    |                  |   |                           |   |     |   |   |   |   |   |   |   |   |   |
| Adjusted sales    |   | $            | 996.4   |                  | $      | 939.1                          |   | $        | 211.7  |   | $ | 191.9 |   | $ | (1.2 | ) | $ | (0.8 | ) | $ | 1,206.9 |   | $ | 1,130.2 |   |

 

 

Consolidated sales for 2003 were $1,415.1 million, a 21.8% increaseover sales of $1,161.5 million in 2002. The impact of the rise in commodity wood prices and acquisitions affectcomparisons. At the BMC West business segment, the rise in commodity woodprices accounted for the increase in sales. At the BMC Construction business segment the acquisitions of  KBI Norcal in July of 2002 and WBC in thefirst quarter of 2003 (consolidated in August of 2003) were primarilyresponsible for the increase in sales.

 

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*BMC West*

Sales at BMC West were $1,007.4 million, an increase of 7.0% comparedto $941.8 million in 2002. Based on a year over year rise in commodity woodprices as measured by a lumber composite price index compiled from “RandomLengths Publications” and applied to the inventory mix at BMC West’s buildingmaterials facilities, the Company attributes the growth in 2003 sales comparedto prior year to be mainly due to inflation. To enhance sales growth, the Company is pursuing opportunities at itsexisting facilities to complement the sale of lumber and building products withmillwork operations, truss manufacturing and installation services.  Construction services currently represent8.9% of total BMC West sales.

 

*BMC Construction*

Sales at BMC Construction were $408.9 million in 2003, compared to$220.5 million in 2002.  Unit volume,including WBC during the period it was accounted for under the equity method,as measured by the number of housing units started, was up 85.8% to 18,276starts compared to 9,834 starts in 2002 due mainly to acquisition growth.  Sales per start, including WBC during theperiod it was accounted for under the equity method, were $27,640, up 24.0%compared to $22,284 per start in 2002. The increase in sales per start was due to a higher mix of starts inmarket areas with generally larger houses and higher costs of labor andmaterial.

 

Excluding the impact of acquisitions in both years, sales were $211.7million in 2003, up 10.3% compared to $191.9 million in 2002.  Excluding the impact of acquisitions in bothyears, unit volume was up 10.4% to 9,896 starts from 8,962 starts in 2002 andsales per start were up 4.2% to $22,223 from $21,330 in 2002.

 

**Income fromOperations**

 

The following table provides operating income by business segmentadjusted for the impact of goodwill and intangible asset impairments for theperiods ended December 31, 2003 and 2002 (amounts in millions):

 
|                                  |   | **BMC West** |   | **BMC  Construction** |   | **Corporate  and Other** |   | **BMHC** |   |
|---------------------------------------|--------|--------------|--------|-----------------------|--------|--------------------------|--------|----------|--------|
|                                  |   | **2003**     |   | **2002**              |   | **2003**                 |   | **2002** |   | **2003** |   | **2002** |   | **2003** |   | **2002** |   |
| Operating income                      |   | $54.8        |   | $48.1                 |   | $19.0                    |   | $20.7    |   | $(33.4 | ) | $(29.7 | ) | $40.4 |   | $39.1 |   |
| Goodwill and intangible asset addback |   | —       |   | 6.7                   |   | 0.8                      |   | —   |   | — |   | — |   | 0.8 |   | 6.7 |   |
|                                  |   |         |   |                  |   |                     |   |     |   |   |   |   |   |   |   |   |   |
| Adjusted operating income             |   | $54.8        |   | $54.8                 |   | $19.8                    |   | $20.7    |   | $(33.4 | ) | $(29.7 | ) | $41.2 |   | $45.8 |   |

 

Consolidated operating income for 2003 was $40.4 million compared to$39.1 million in the prior year.  Bothyears include impairment charges in accordance with Statement of FinancialAccounting Standards No. 142 “Goodwill and Other Intangible Assets” (“SFAS142”).  The current year charge of $0.8million relates to the impairment of intangible assets associated with customerrelationships at the BMC Construction business segment, while the 2002 chargeof $6.7 million relates to goodwill at the BMC West Dallas/Fort Worth andMarvin Windows operations.  Excluding impairmentcharges in both years, operating income of $41.2 million in 2003 compares to$45.8 million in 2002, a 10.0% decrease. Corporate and other costs were higher year over year due mainly toincreases in workers’ compensation expense and a loss on extinguishment ofdebt.  The following analysis of incomefrom operations at the business segment level provides further explanation forthe year over year comparisons.

 

*BMC West*

Income from operations at BMC West in 2003 was $54.8 million, a 13.9%increase compared to $48.1 million  inthe prior year.  Excluding the 2002fourth quarter charge for impairment of goodwill of $6.7 million, 2003operating income of $54.8 million matched the prior year.  However, gross profit margins as apercentage of sales decreased to 24.2% in 2003 from 25.8% in 2002.  The decrease is primarily due to the rapidrise in commodity wood prices in 2003. The Company’s ability to pass along increased prices was limited due toexisting customer sales commitments and the competitive environment.  The Company cannot control the volatility ofcommodity wood prices, but does attempt to control the timing of inventorypurchases so as to minimize the impact of rapid upward movement in prices whichcharacterized the latter

 

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half of 2003.  Reduced selling,general and administrative ("SG&A") expense as a percentage ofsales partially offset the decline in margins. In addition, BMC West experienced an operating loss at a newconstruction services acquisition in the latter half of 2003.

 

*BMC Construction*

Income from operations at BMC Construction declined 8.2% to $19.0million in 2003 from $20.7 million in 2002.  BMC Construction experiencedlower gross margins as a percentage of sales in 2003 compared to prior yearlargely due to competitive pressures, rapid growth of sales and the impact ofrising commodity wood costs. The amortization and write-off of intangibleassets related to customer relationships also had an adverse impact of $2.4million on operating results in 2003 compared to $0.3 million in 2002.  Additionally, improvements in operatingincome at KBI Norcal in 2003 compared to six months of activity in 2002, wereoffset by an operating loss due to rapid growth of new construction projects atlower operating margins at WBC Construction (acquired in January of 2003 andconsolidated in August of 2003).  BMCConstruction has been working on slowing the revenue growth and balancing theimpact of changes in commodity wood prices in order to increase earnings.

 

**2002 COMPARED WITH2001**

 

**Consolidated Sales**

 

Consolidated sales for 2002 were $1,161.5 million, a 6.3% increase oversales of $1,092.9 million in 2001. Affecting year over year comparisons was the impact of consolidating KBIas a result of purchasing the remaining 51% interest on July 3, 2001.  KBI was accounted for under the equitymethod of accounting prior to the buyout. Excluding sales from KBI in both years, sales for 2002 were $969.6million, a 2.3% decline from 2001 sales of $992.4 million.

 

*BMC West*

Sales at BMC West were $941.8 million in 2002, a 5.1% decline comparedto $992.4 million in prior year.  Thedecrease in 2002 sales was primarily attributable to deflation of commoditywood prices as well as construction of lower value houses which typically donot provide expanded sales opportunities due to the reduced cost ofmaterials.  Additionally, the relativelyflat sales year over year are indicative of a mature market of competitorswithin the geographic areas served by BMC West.

 

*BMC Construction*

Sales were $220.5 million in 2002 compared to $100.5 million in2001.  The year over year increase isdue to a full twelve months of consolidation from KBI in 2002 as opposed toonly six months in 2001.

 

**Income fromOperations**

 

The following table provides operating income by business segment,adjusted for the impact of goodwill and intangible asset impairments, for theperiods ended December 31, 2002 and 2001 (amounts in millions):

** **
|                      |   | **BMC West** |   | **BMC  Construction** |   | **Corporate  and Other** |   | **BMHC** |   |
|---------------------------|--------|--------------|--------|-----------------------|--------|--------------------------|--------|----------|--------|
|                      |   | **2002**     |   | **2001**              |   | **2002**                 |   | **2001** |   | **2002** |   | **2001** |   | **2002** |   | **2001** |   |
| Operating income          |   | $            | 48.1   |                  | $      | 55.5                     |   | $        | 20.7   |   | $ | 7.7 |   | $ | (29.7 | ) | $ | (20.6 | ) | $ | 39.1 |   | $ | 42.6 |   |
| Asset impairment addback  |   | 6.7          |   | 0.7                   |   | —                   |   | —   |   | — |   | 1.0 |   | 6.7 |   | 1.7 |   |
|                      |   |         |   |                  |   |                     |   |     |   |   |   |   |   |   |   |   |   |
| Adjusted operating income |   | $            | 54.8   |                  | $      | 56.2                     |   | $        | 20.7   |   | $ | 7.7 |   | $ | (29.7 | ) | $ | (19.6 | )(1) | $ | 45.8 |   | $ | 44.3 |   |
|                           |        |              |        |                       |        |                          |        |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

(1) “Corporate and Other” includes the benefit of a $3.6 millionmanagement fee allocated to KBI for services prior to the July 3, 2001 buyout(see Note 5).

 

Consolidated operating income for 2002 was $39.1 million, an 8.2%decrease compared to $42.6 million in prior year.  Excluding the 2002 impairment of goodwill charge of $6.7 millionat the BMC West Dallas/Fort Worth and Marvin Windows operations and the $1.7million asset impairment charge in 2001 ($1.0 million write-off of aninvestment in BuildNet Inc., and a loss of $0.7 million resulting from theanticipated sale of real estate in Salem, Oregon (see Note 4), operating incomeof $45.8 million compares to $44.3 million, an 3.4% increase.  This increase is due to the consolidation ofKBI for a full year in 2002

 

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compared to six months in 2001. Gross profit margins relative to sales declined to 24.0% in 2002 from25.0% in 2001, offset by improvements in SG&A expense of 20.1% in 2002compared to 21.1% in 2001.  SG&Aexpenses were higher due to the consolidation of KBI, the KBI Norcal investmentand general insurance expense.  Thesecosts were partially offset by savings in amortization resulting from theelimination of goodwill amortization in accordance with the adoption of FAS142.  The implementation and rollout ofimproved information systems at our BMC West facilities contributed to a risein corporate and other expenses relative to prior year.

 

*BMC West*

Income from operations at BMC West was $48.1 million, a 13.3% decreasecompared to $55.5 million in prior year. Excluding impairment of asset charges in both years of $6.7 million and$0.7 million respectively, 2002 operating income decreased 2.5% to $54.8million from $56.2 million in 2001. Gross profit margins as a percentage of sales increased to 26.3% in 2002from 25.9% in 2001.  However, this wasoffset by higher selling, general and administrative expenses.  The improvement in gross margins was due tothe increased mix of higher margin manufactured building components such asframing, pre-hung doors, millwork, roof and floor trusses and pre-assembledwindows.

 

*BMC Construction*

Income from operations at BMC Construction increased 168.8% to $20.7million in 2002 from $7.7 million in 2001. The consolidation of KBI in July of 2001 and therefore reporting onlysix months of operating income compared to a full year in 2002 accounts for thesignificant increase.  KBI equityearnings for the first half of 2001 were $4.8 million, or $3.0 million net oftax, as reported in the consolidated statements of income.  Full year consolidated KBI results in 2002and the July 1, 2002 acquisition of KBI Norcal, led to higher SG&A expensescompared to the prior year.

 

**LIQUIDITY AND CAPITAL RESOURCES**

 

The Company’sprimary need for capital resources is to fund capital expenditures andacquisitions, as well as to finance its working capital needs which have beenincreasing as the Company has grown in recent years.  Capital resources have prima­rily consisted of cash flows fromoperations and incurrence of debt.

 

***Operations***

 

Net cashprovided from operating activities was $12.5 mil­lion, compared to $35.7million generated in 2002, a decrease of $23.2 million. Cash flow fromoperations was impacted primarily by an increase in working capitalrequirements.

 

Uses of cashin operating activities were driven by increases of $35.1 million in accountsreceivable and $25.9 million in inventory, offset by a $21.1 million increasein accounts payable.  The cash outflowis due to a higher working capital investment required by our new acquisitionsand a strong sales performance in December of 2003.  In addition, the Company increased inventories to take advantageof falling commodity wood prices near the end of the year.

 

In 2002,operations provided $35.7 million in cash, compared with $63.7 million in 2001,a decrease of $28.0 million primarily due to increases in accounts receivableand inventory net of payables, partially offset by decreases in prepaidexpenses.  The increases in accountsreceivable, inventory, accounts payable and accrued expense were primarilyattributable to the operations of KBI Norcal.

 

***CapitalInvestment and Acquisitions***

 

Net cash usedin investing activities in 2003 was $30.5 million, which is $5.4 million higherthan the $25.1 million used in 2002. Outlays for business acquisitions and investments in businesses in 2003were $30.3 million, largely used to acquire WBC and WBC Mid-Atlantic, partiallyoffset by $6.6 million received in cash for the sale of the facility in GreatFalls, Montana.  Purchases of propertyand equipment were $15.9 million in 2003, offset by proceeds from dispositionsof $10.1 million.  The net usage of $5.8million for property and equipment was $13.1 million lower than the $18.9million net usage in 2002.  This was aresult of a company-wide effort to manage capital expenditures in 2003.

 

Net cash usedin investing activities was $25.1 million and $51.9 million for the years endedDecember 31, 2002 and 2001, respectively. During 2002, cash flows used in investing activities included $20.1

 

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million toacquire additional property and to expand and remodel existing facilities.  Cash flows used to purchase acquisitions andinvestments in businesses was $8.1 million, which included the investment inKBI Norcal of $5.8 million and $2.3 million related to other acquisitions.

 

***Financing***

 

Net cash provided by financing activities was $28.3 million in 2003,compared to $6.6 million used in 2002. The primary sources of cash from financing activities during the yearended December 31, 2003 were $22.1 million in net borrowings from the term noteand $9.2 million in borrowings from the revolving credit facility.  These sources were partially offset by $2.6million in dividend payments to shareholders and $1.4 million in deferredfinancing costs.

 

Net cash used in financing activities was $6.6 million in 2002,compared to $11.2 million in 2001. The primary use of cash for financingactivities during the year ended December 31, 2002 was $9.6 million of paymentson the term note and revolving credit facility.  This use was partially offset by a $2.0 million increase in bookoverdrafts and $1.0 million of proceeds from stock options exercised.

 

During the third quarter of 2003, the Companyentered into a new senior secured credit facility. The new credit facilityreplaces the old credit facility, which was scheduled to mature in 2004. Itincludes a term loan of $125 million maturing in seven years, and a revolvingline of credit of $175 million maturing in five years. In connection with thenew senior secured credit facility, certain previously deferred financing costsof $0.7 million associated with the former credit facility were expensed alongwith new costs of $0.3 million incurred to obtain the current credit facilityand both are included in “Other Income , Net”. All other remaining costs associated with the former and current creditfacility are being amortized over the life of the new loans.

 

At December 31, 2003, the Company’s seniorsecured credit facility provided for borrowings of up to $299.4 million,including $124.4 million outstanding under the term loan and $175.0 millionunder the revolving credit facility, $60.4 million of which was outstanding.Revolver borrowings can be limited by a borrowing base equal to 60% ofinventory plus 80% of trade accounts receivable. The borrowing base iscalculated monthly and was $179.5 million at December 31, 2003, but was limitedto the maximum of $175.0 million. Revolver availability was $88.1 million, netof $26.5 million in outstanding letters of credit. Borrowings under thefacility bear interest at a rate based on either Prime or LIBOR plus an additionalspread based on performance. Currently, the revolver rates are Prime plus 1.25%and LIBOR plus 2.50%.  The interest rateon the term loan is based on either Prime or LIBOR plus 3.25%.

 

The terms of the credit facility permit anincrease in the borrowings of up to $50 million, subject to certain conditions.The term loan matures in 2010 and the revolving loan matures in 2008. The termloan is payable in quarterly installments over the initial six years in amountsequal to 1% of the initial principal amount per year and equal quarterlyinstallments of the remaining principal balance during year seven.

 

The term loan and revolving credit facilityare both collateralized by all tangible and intangible property and interest inproperty and proceeds thereof now owned or hereafter acquired by the Companyand any wholly-owned subsidiary, except BMC Insurance Inc.

 

The agreements related to the aboveborrowings contain covenants providing for the maintenance of certain financialratios and conditions including: consolidated net worth; a coverage ratio that includes earnings beforeinterest, taxes and amortization; a ratio of total funded debt to earningsbefore interest, taxes, depreciation and amortization; and limitations oncapital expenditures, among certain other restrictions. At December 31, 2003,the Company was in compliance with these covenants and conditions.

 

The scheduled principal payments of debt are $2.9million in 2004, $2.0 million in 2005, $3.7 million in 2006, $1.3 million in2007, $61.7 million in 2008 and $118.1 million thereafter.  Principal payments of $2.9 million duewithin the next twelve months are expected to be refinanced through the unusedportion of the revolving credit facility. As a result, this amount has been classified as long-term.

 

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As of December 31, 2003, the Company had$26.5 million in letters of credit outstanding to guarantee performance orpayments to third parties. These letters of credit reduce borrowing availabilityunder the revolving credit facility.

 

Based on the Company’s ability to generate cash flows from operations,its borrowing capacity under the revolver and its access to equity markets, theCompany believes it will have sufficient capital to meet its anticipatedshort-term and long-term needs.

 

**DISCLOSURES OF CONTRACTUAL OBLIGATIONS ANDCOMMERCIAL COMMITMENTS**

 

The followingsummarizes the contractual obligations of the Company as of December 31, 2003(in thousands):

 
|                               |   | **Payments  Due by Period** |    |
|------------------------------------|--------|-----------------------------|---------|
| **Contractual Obligations**        |   | **Total**                   |    | **Less than  1 Year** |   | **1 – 3  Years** |   | **4  Years** |   | **5  Years** |   | **After 5  Years** |   |
| Long-Term Debt                     |   | $                           | 189,209 |   | $ | 2,512 |   | $ | 5,672 |   | $ | 1,250 |   | $ | 61,650 |   | $ | 118,125 |   |
| Capital Lease Obligations          |   | 469                         |    | 393 |   | 76 |   | — |   | — |   | — |   |
| Operating Leases                   |   | 42,788                      |    | 11,287 |   | 15,858 |   | 5,131 |   | 3,109 |   | 7,403 |   |
| Unconditional Purchase Obligations |   | —                      |    | — |   | — |   | — |   | — |   | — |   |
| Other Long-Term Commitments        |   | —                      |    | — |   | — |   | — |   | — |   | — |   |
| Total Contractual Cash Obligations |   | $                           | 232,466 |   | $ | 14,192 |   | $ | 21,606 |   | $ | 6,381 |   | $ | 64,759 |   | $ | 125,528 |   |
|                                    |        |                             |         |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See Note 5 tothe consolidated financial statements for a discussion of potential putobligations associated with recent acquisitions.

 

**DISCLOSURES OF CERTAIN MARKET RISKS**

 

The Companyexperiences changes in interest expense when market interest rates change.Changes in the Company’s debt could also increase these risks.  The Company has managed its exposure tomarket interest rate changes through periodic refi­nancing of its variable ratedebt with fixed rate term debt obliga­tions. Based on debt outstanding at December 31, 2003, a 25 basis pointincrease in interest rates would result in approximately $462,000 of additionalinterest costs annually.

 

The Companydoes not utilize any derivative financial instruments to hedge commodity pricemovements.  However, it does intend tobegin using interest rate swap contracts to fix long-term interest rates on upto $100 million of its floating rate debt.

 

Prices ofcommodity wood products, which are subject to significant volatility, adverselyimpact operating income when prices rapidly rise or fall within a relativelyshort period of time.

 

BMCConstruction purchases certain commodity materials, including wood, steel andconcrete, which are used as direct production inputs for construction of thecompleted house shell which it delivers. Short term changes in the cost of these raw materials, some of which aresubject to significant volatility, are sometimes, but not always, passed on toBMC Construction’s homebuilder customers. BMC Construction’s inability to pass on raw material price increases toits customers can adversely impact operating income.

 

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**QUARTERLY RESULTS AND SEASONALITY**

 

The Company’sfirst and fourth quarters historically have been, and are expected to continueto be, adversely affected by weather patterns in some of the Company’s markets,causing decreases in levels of residential construction activity.  In addition, quarterly results historicallyhave reflected, and are expected to continue to reflect, fluctuations fromperiod to period from various other factors, including general economicconditions, commodity wood prices, interest rates, building permit activity,single-family housing starts, employment levels, consumer confidence and the availabilityof credit to professional homebuilders and contractors.

 

Thecomposition and level of working capital typically changes during periods ofincreasing sales as the Company carries more inventory and receivables.  Working capital levels typically increase inthe second and third quarters of the year due to higher sales during the peakresidential construction season.  Theseincreases historically have resulted in negative operating cash flows duringthis peak season, which generally have been financed through the revolvingcredit facility.  Collection ofreceivables and reduction in inventory levels following the peak of thebuilding and construc­tion season have more than offset this negative cash flowin recent years.  The Company believesit will continue to generate positive annual cash flows from operatingactivities.

 

**NEW ACCOUNTING STANDARDS**

 

In June 2001,the Financial Accounting Standards Board (“FASB”) issued Statement No. 143(“SFAS 143”), “Accounting for Asset Retirement Obligations.”  SFAS 143 established financial accountingand reporting standards associated with the retirement of tangible long-livedassets and the associated asset retirement costs.  This statement was effective for financial statements issued forfiscal years beginning after June 15, 2002. The adoption of SFAS 143 in the first quarter of 2003 did not have amaterial impact on the Company’s financial position, results of operations orcash flows.

 

In November2002, the FASB issued FASB Interpretation No. 45 (“FIN 45”), “Guarantor’sAccounting and Disclosure Requirements for Guarantees, Including IndirectGuarantees of Indebtedness of Others”. FIN 45 requires that guarantors recognize, at the inception of theguarantee, a liability for the fair value of the guarantee.  In addition, FIN 45 clarifies thedisclosures required of guarantors for certain guarantees that it hasissued.  The recognition and measurementcriteria of this interpretation are to be applied prospectively to guaranteesissued or modified after December 31, 2002. The adoption of FIN 45 had no impact on the Company’s financialposition, results of operations or cash flows.

 

In January2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation ofVariable Interest Entities”, an interpretation of ARB No. 51, which was furtherrevised in December 2003. FIN 46 requires certain variable interest entities tobe consolidated by the primary beneficiary of the entity if the equityinvestors in the entity do not have the characteristics of a controllingfinancial interest or do not have sufficient equity at risk for the entity tofinance its activities without additional subordinated financial support fromother parties. FIN 46 also requires disclosure of significant variableinterests in variable interest entities for which a company is not the primarybeneficiary. We are required to apply the revised provisions of FIN 46 in thefirst quarter of 2004. The application of the revised Interpretation is notexpected to have a material impact on the Company’s financial position, resultsof operations or cash flows.

 

In March 2003,the consensus of Emerging Issues Task Force (“EITF”) Issue No. 02-16,“Accounting by a Customer (including a Reseller) for Certain ConsiderationReceived from a Vendor,” was published. EITF Issue No. 02-16 addresses how a reseller of a vendor’s productsshould account for cash consideration received from a vendor.  The provisions of EITF Issue No. 02-16 wereeffective for new arrangements transacted after December 31, 2002.  The Company’s adoption of EITF 02-16 did nothave a significant impact on the Company’s financial position, results ofoperations or cash flows.

 

In March 2003,the consensus of EITF Issue No. 00-21, “Accounting for Revenue Arrangementswith Multiple Deliverables,” was published. EITF Issue No. 00-21 addresses certain aspects of the accounting

 

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by a vendorfor arrangements under which it will perform multiple revenue-generatingactivities.  Specifically, EITF IssueNo. 00-21 addresses how to determine whether an arrangement involving multipledeliverables contains more than one unit of accounting.  The provisions of EITF Issue No. 00-21 wereeffective in fiscal periods beginning after June 15, 2003.  The Company’s adoption of EITF 00-21 did nothave a significant impact on the Company’s financial position, results ofoperations or cash flows.

 

In May 2003,the FASB issued SFAS No. 150, “Accounting for Certain Financial Instrumentswith Characteristics of Both Liabilities and Equity.”  This statement establishes standards for how an issuer classifiesand measures certain financial arrangements with characteristics of bothliabilities and equity.  It requiresthat an issuer classify a financial arrangement that is within its scope as aliability (or an asset in some circumstances). The provisions of this statement were effective for financialarrangements entered into or modified after May 31, 2003, and otherwise wereeffective at the beginning of the first interim period beginning after June 15,2003.  Certain provisions of thisstatement have been deferred for an indefinite period.  The Company continues to monitor FASBdeliberations on SFAS No. 150 to determine the ultimate impact on the Company’sfinancial position, results of operations or cash flows.

 

**OUTLOOK**

 

The Company’sfinancial performance will be impacted by economic changes nationally andlocally in the markets it serves.  Theresidential construction services and building materials industry has experiencedcyclicality in the past.  The Company’soperations are subject to fluctuations from period to period as a reflection ofchanges in general economic conditions and changes in local market conditions,commodity wood prices, building permit activity, interest rates, single-familyhousing starts, employment levels, availability and cost of labor, consumerconfidence, the impact on the economy of geopolitical events and theavailability of credit to professional homebuilders, contractors and homeowners. These factors may have a moresignificant impact on the Company, which derives a significant percentage ofits sales from professional homebuilders and contractors engaged in newresidential construction, than on those building supply companies that target abroad range of retail customers whose activities are generally more related tohome repair and remodeling.  The Companyexpects that fluctuations from period to period will continue in the future.

 

During 2003and 2002 the Company experienced softening demand from our low-volume andcustom homebuilder customers and a tightening of margins in some of the marketswe serve in our building materials distribution business.  If these trends continue into 2004 and futureyears, our operating income will be adversely affected.

 

The Companyhas a cash equity incentive plan that is accounted for as a variable rateplan.  As a result, compensation expensewill vary at each reported period based on changes in the Company’s stockprice.  An increase in the Company’s stockprice will cause the Company to report additional compensation expense underthe plan.

 

Additionally,the Company’s financial performance could be negatively impacted by inclementweather, which historically has affected residential construction activitylevels in the Company’s market areas in the first and fourth quarters.  Prices of commodity wood products, which aresubject to significant volatility, adversely impact operating income whenprices rapidly rise or fall within a relatively short period of time.  BMC Construction purchases certain commoditymaterials, including wood, steel and concrete, which are used as directproduction inputs for construction of the completed house shell which itdelivers.  Short term changes in thecost of these raw materials, some of which are subject to significantvolatility, are sometimes, but not always, passed onto BMC Construction’shomebuilder customers.  BMCConstruction’s inability to pass on raw material price increases to itscustomers can adversely impact operating income.

 

Certainstatements in the Financial Review and elsewhere in the Annual Report toShareholders may constitute forward-looking statements within the meaning ofthe Private Securities Litigation Reform Act of 1995.  Such forward-looking statements involve known and unknown risks,uncertainties and other

 

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factors thatmay cause the actual results, performance or achievements of the Company, orindustry results, to be materially different from any future results,performance or achievements expressed or implied by such forward-lookingstatements.  Such factors are discussedin detail above and in the Company’s Form 10-K for the fiscal year ended December31, 2003.  Given these uncertainties,prospective investors are cautioned not to place undue reliance on suchforward-looking statements.  The Companydisclaims any obligation to update any such factors or to announce publicly theresults of any revisions to any of the forward-looking statements contained inthe Annual Report on Form 10-K except as required by law.

 

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