Rebuilding from real estate rubble

Semper fidelis, the U.S. Marine Corps motto, means "always faithful" in Latin. As a young grunt serving at Camp Lejeune, N.C., Duane Draughon learned to remain loyal to the mission -- "whatever the cost," he says.

That mind-set has guided him since he left the Corps in 1997. "It's probably the only reason I've survived in business," says Draughon, who served as a police sergeant in the Marines and now owns a patio-paving company outside Columbus, Ohio. "I will never, ever give up."

He's been tested -- almost to the breaking point.

In 2005, after a stint selling cars, he started PaverStone Design Group. Launched during a national home-improvement boom, PaverStone was an instant success, designing and building lavish patios for affluent suburban homeowners in Columbus. To keep costs low, Draughon initially used prison inmates in a work-release program as laborers; later he hired and trained his own crews, mostly made up of immigrants from Mexico (all of them documented, he says).

Revenues topped $500,000 in 2006. Draughon had a new business, a new house and a new car, plus a new baby -- his third with his wife, Isabel.

Then came disaster.

Draughon's partner abruptly left the company in 2006, depriving PaverStone of a talented salesperson and a capable crew chief. Draughon admits that in trying to juggle a busy operation and manage the finances of his fast-growing business, he let costs spiral out of control. Soon he was broke -- and desperate. So the entrepreneur doubled down, betting everything he had on PaverStone.

Draughon began rebuilding the business one brick at a time. He worked out payment plans with creditors. In addition, he persuaded his wife to quit her $45,000-a-year job as a mortgage broker to take over PaverStone's marketing and bookkeeping so that he could spend more time closing deals and supervising his crews.

But in the summer of 2008, the Great Recession hit Columbus. To keep the business afloat, the Draughons pared expenses and laid off all five of their employees (the couple now hire subcontractors as needed). Orders trickled in during the summer and fall of 2009 -- enough to cover the utility bills and some other expenses -- but most projects have been much smaller than those the company handled before the economic downturn.

"Customers used to dip into home equity to build huge patios with fireplaces, kitchens and special lighting for $30,000 or $40,000," Draughon recalls, shaking his head in frustration. "Now all they want is a rectangle for $5,000."
Adapting to the downturn

Despite a rocky five years in business, the Draughons, both 33, are determined to make PaverStone work. Duane says the business taps all of his talents, which include selling, designing and supervising complex construction projects. Isabel takes great pride in the company's reputation as one of the top patio design firms in suburban Columbus. (PaverStone won a 2007 Consumers' Choice Award in a citywide contest.)

The Draughons foresee a rebound in the local home-improvement market -- perhaps in the spring of 2010 -- and they want to be prepared to grow the business rapidly when it comes.

But the Draughons know their company needs a stronger foundation. The couple seek a marketing strategy that maximizes their network of loyal customers and a more conservative financial plan to help them weather the vagaries of the real estate market. They also have questions about basic business practices. How can they find trustworthy lawyers and accountants? How should they negotiate better terms with suppliers?

To assist them in mapping out a plan, Fortune Small Business brought three Makeover experts to the company's spartan offices in an industrial park in Powell.

First up is Maureen Metcalf, 45, founder of management consultancy Metcalf & Associates in Columbus. Metcalf has found that thanks to aggressive search-engine optimization, PaverStone's slick Web site is usually one of the first to pop up in a Google search for "patio design in Columbus."

But it's almost too slick, Metcalf says. The site is loaded with stock photos, including an image found on countless Web sites of a young woman wearing a telephone headset who appears to be a national call-center representative.

The Draughons explain that they wanted to appear well established and businesslike. But they agree that they may have gone overboard with the corporate look.

"Many customers think we're part of a national franchise," says Isabel. "They don't understand that we're a family business. That really hurts. We've put our heart and soul into this company."

Metcalf's prescription: Use the site to share PaverStone's story. Tell potential customers about Duane's childhood just a few blocks away from the city's meanest streets, and how Duane's father put him and his two brothers to work mowing lawns to keep them out of trouble. Add that Duane turned an after-school job into a $120,000-a-year landscaping business before joining the Marines. Later he returned home, married and established a patio-building business.

"Finding reliable contractors is a nightmare for homeowners," Metcalf says. "You're a Marine veteran, a family man. You're trustworthy. You get the job done, on time. It's a compelling story."

Metcalf also advises the couple to update the Web site with photos of themselves. Get rid of the stock images. Add testimonials from satisfied customers who have been photographed lounging or dining on their patios. Create a section that offers before-and-after shots of backyards transformed by PaverStone.

"You're not just selling a paved patio," Metcalf says. "You're selling the idea of a beautiful place to relax with family and friends."
Untangling the books

FSB's next expert tackles the thorny topic of corporate finance. Michael Jokerst, 52, is a financial expert from CFO Leadership, a consultancy in Columbus.

The Draughons tell him they were unprepared to manage the finances of their fast-growing company. Marketing and labor costs soared. Duane suspects that he underestimated his costs as he raced from one job to another to oversee construction, damaging the company's bottom line. By the end of 2007, its busiest year to date, PaverStone owed $170,000 to suppliers. Bankruptcy loomed.

Although the Draughons have since worked out a repayment plan with the suppliers, they worry about their ability to withstand the boom-and-bust cycles of the real estate business.

"You've been using the 'big bucket' method of accounting," Jokerst says bluntly. "That's no way to run a business. You're pouring the money into a big bucket, taking out enough to cover your costs and hoping there's something left for you at the bottom of the bucket. That's dangerous."

Instead, the Draughons should determine their true cost of doing business, considering everything the company needs, from paper clips to paving stones. In the past, Duane calculated fixed costs of supplies for each job, then added a general fee for overhead -- 42% in boom times, but currently as little as 10% -- based on a formula that a consultant suggested last year.

"I suspect you aren't calculating the cost of your time," Jokerst says.

Duane nods in agreement. "Sometimes I'm up all night creating a design proposal for a homeowner -- because I want that job," Duane says. Jokerst explains that not all projects will be profitable, especially now, as competitors trim their margins.

"Calculate your costs to the penny," he tells the couple. "Or you could be working for nothing."

Jokerst offers more tips to boost the company's bottom line. Negotiate better terms with suppliers, he urges. PaverStone has been paying cash for construction materials since its financial troubles in 2007. "After two years, you've proved your creditworthiness to suppliers," Jokerst tells Duane. "You've earned the right to request better terms -- 30 days, at least."

Jokerst also recommends building a cash reserve during the busy spring and summer seasons to fund expenses during the slower winter months. Try to find a complementary business that would pull in needed revenue during the winter, he advises -- interior tiling, perhaps -- but be sure it's one that allows enough time to gear up for bidding on new projects in the spring.
Management trials

FSB's third expert, Nick Williams, 30, is a project manager with Definity Partners, a business consultancy in Columbus. Williams praises the Draughons' ability to survive a trial by fire during the past five years.

"One of the hardest things is having no guidance," Duane confesses. "Lots of times I don't know where to turn with business questions. Isabel and I have each other, but it gets lonely. We really need to find some mentors."

Duane says he's the one fielding calls from fledgling entrepreneurs within the African-American community in Columbus. Early on he sought help from a state-sponsored program for minority business owners, but "they treated me like a child," he recalls. "It was insulting."

Like most cities, Columbus offers dozens of networking groups for small business owners. "You've just got to make the rounds to find the right fit," Williams says. Local chambers of commerce provide opportunities to meet other business folk, though the quality of the programs varies widely from town to town. And Isabel should join groups that cater to women's business development and leadership. Don't judge an organization after just one event; try to attend several, and then meet with the group's leaders to discuss their mission and your goals.

Finding a mentor is a lot like dating, Williams says. "It could take a while to find that spark." But building a network of experienced advisers is essential. For example, mentors can provide valuable recommendations when you need a professional such as a lawyer or an accountant.

Immediately after the Makeover, the Draughons began to implement some of our experts' advice.

"The Makeover was a life-changing experience," Duane says. "We intend to come out of this downturn stronger than ever."

The Draughons are updating their Web site with bios and photos, including one of Duane as a Marine. Duane is assessing bids more carefully, trying to factor in the time he'll spend designing and overseeing each project. Every Friday, the couple review a financial report to monitor cash flow. This fall, they plan to attend several events sponsored by local business groups in the hope of building relationships with other entrepreneurs. To top of page
Could your business use a makeover? In general, successful Makeover candidates are profitable small companies with at least $1 million in annual gross revenues. To submit your firm for consideration, e-mail the FSB makeover editor here. Please describe your business briefly, provide your most recent and projected revenues, and explain why you think your company would benefit from a Makeover.

Stocks off to a sluggish start

Stocks opened lower Wednesday after a disappointing report on the housing market overshadowed higher oil and gold prices.

The Dow Jones industrial average (INDU) was down 26 points, or 0.2%, shortly after the opening bell. The S&P 500 (SPX) lost 0.2% and the Nasdaq composite (COMP) declined 0.4%.

Oil prices rose near $80 a barrel, while gold hit another all-time high. The dollar weakened against rival currencies.

Stocks closed at 13-month highs for the second day in a row Tuesday, as strength in commodity-linked shares offset weakness in the retail sector.
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Philip Isherwood, equities strategist at Evolution Securities in London, said the pre-market report on the housing market will be the prime influence on stock activity at the opening bell.

"Housing starts are obviously going to be important," he said prior to the report's release, when forecasts from Briefing.com consensus pointed to housing growth.

Economy: The U.S. Census Bureau and the Department of Housing and Urban Development reported that housing starts fell more than 10% to an annual rate of 529,000 in October, the lowest level in six months. An annual rate of 600,000 housing starts was expected, according to a forecast from Briefing.com consensus. The revised rate for September was 592,000.

The government reported that the annual rate of housing permits fell 4% to 552,000 in October, from the revised September rate of 575,000. This was lower than the 580,000 permits expected for October, according to Briefing.com consensus. .

The government also reported its Consumer Price Index, a key measure of inflation, rose 0.3%.

The CPI was expected to rise 0.2% in October, according to a consensus of economists surveyed by Briefing.com.

The core CPI, which excludes volatile food and energy prices, rose 0.2% in October. That was slightly more than the 0.1% increase expected for October, according to Briefing.com consensus.

Companies: Goldman Sachs (GS, Fortune 500) said Tuesday that it is launching a $500 million initiative aimed at propping up small businesses.

Obama administration officials, including Treasury Secretary Tim Geithner, are due to meet Wednesday to address the small business lending drought.

World markets: Japan's Nikkei index finished the session 0.6% lower. Major indexes in Europe were higher in midday trading.

Money, oil and gold: The dollar, which has suffered from recent weakness, was down versus all major currencies except the British pound.

The price of oil rose 76 cents to $79.91 per barrel.

For gold, it's been another day, another record. In electronic trading, the price of gold rose $8.40 to $1,147.20 per ounce.

Obama to hold jobs forum in December

President Obama, facing a 10.2% unemployment rate, said Thursday he would hold a jobs forum at the White House in December.

He noted the encouraging signs of economic growth and a slowing of the loss of jobs in recent months, but said employers are still reluctant to hire and millions are desperate to find work.

"Even though we've slowed the loss of jobs -- and today's report on the continued decline in unemployment claims is a hopeful sign -- the economic growth that we've seen has not yet led to the job growth that we desperately need," the President said in a statement delivered at the White House.

"We all know that there are limits to what government can and should do, even during such difficult times. But we have an obligation to consider every additional responsible step that we can to encourage and accelerate job creation in this country," he added.

Those invited to the forum will include CEOs, small business owners, economists, financial experts, and representatives from labor and non-profits.

The forum will be held against a background of highly mixed economic news.

On the bright side: the GDP grew 3.5% in the third quarter. But there are concerns that growth may not be sustainable, given that housing and jobs haven't showed signs of recovery.

Some economists have been arguing for another round of stimulus to ward off sliding into another recession.
0:00 /1:51Stimulus jobs cost taxpayers

Not everyone is convinced. And politically, the prospects for passing a single stimulus package with a big price tag are not high. Instead the administration and Congress are looking for smaller initiatives that can be taken both by the government and the private sector.

One idea that has been floated to spur job creation is a hiring credit, whereby employers would get a tax break for every new worker hired. But many economists and tax experts say it's a flawed concept since it would end up disproportionately rewarding employers that were planning to hire anyway.

So far lawmakers have extended and expanded some measures from the original $787 billion stimulus package passed in February -- specifically, federal unemployment benefits, the homebuyer credit, and big tax break for businesses looking to write off more of their losses.

Good news: Fewer underwater mortgages

Fewer people are underwater on their mortgages -- further evidence that the real estate free-fall may be slowing.

Just 21% of all single-family homeowners owe more on their mortgage balances than their homes are worth, according to a third quarter residential real estate report from Zillow.com. That is down from 23% at the end of the second quarter.

That is good news because it should help reduce the number of homeowners losing their homes to foreclosure. Being underwater is one of the two factors that lead to foreclosure, the other being, of course, not having enough income to make the monthly payments.

"The decline in the percentage of homeowners with negative equity is a positive sign and is directly attributable to the stabilization of home values from the second quarter to the third," said Zillow chief economist Stan Humphries.

But there's a second, less-positive factor that contributed to the reduction in underwater borrowers: foreclosures. So many people have already lost their homes that the ranks of those underwater is slowly dwindling.

And that highlights one of the most serious concerns that housing markets currently face. "Foreclosure rates," said Humphries, "are ramping up again."
Upswing

There are 1.2 million to 1.5 million seriously delinquent mortgages sitting out there like ticking time-bombs. These loans are at least 90 days late, and, historically, few borrowers who fall that far behind manage to start repaying.

Aggravating the foreclosure problem is the substantial numbers of option ARM loans that will reset over the next few months. These are loans with balances that have steadily increased because borrowers were permitted to make minimum monthly payments that did not even cover interest.

The resets will require borrowers to start paying down principal, and many will simply not be able to afford to do that.

Also resetting over the next several months will be many interest-only loans, which will also require borrowers to make much larger payments.

Another fear-factor for Humphries is that continued economic malaise will slow the housing market recovery. Recent macro-economic reports have been inconsistent. Good news came early in November, with the gross domestic product, growing at annualized rate of 3.5% during the third quarter.

A couple days later, however, the Labor Department reported the unemployment rate jumped to 10.2% in October. It's an understatement to say that losing a job can make it very difficult to pay off a mortgage.
Ghost hunting

Increased foreclosures also add to already long inventories. The National Association of Realtors reported there are 3.63 million homes on the market, a nearly eight-month supply at the current rates of sales. That's a two or three month oversupply, compared with a normal market.

But official inventory statistics may be undercounting; there is also the so-called "shadow inventory." For one, there are bank repossessions that have not been put back on the market. The banks have either fallen behind on processing these properties or they are reluctant to put REOs up for sale because the market is already overloaded.

The second element of the shadow inventory is that some individual owners would like to sell their homes but do not want to compete with foreclosures, which usually sell at a discount to market values. In many cities, foreclosures and short sales constitute the bulk of the market.

The housing market recovery will be affected by "how quickly these foreclosures transition back onto the marketplace," said Humphries.

Nationally, 21.4% of all sales were REOs, the industry term for bank-owned properties.

High as that rate is, that pales in comparison with some of the worst-hit metro areas. In Merced Calif., for example, 74.2% of all single-family home sales were of foreclosed properties; in nearby Stockton, the rate was 68.7%; and El Centro, down near the Mexican border, the rate was 68.1%.

The good news is that, in many areas at least, foreclosures are selling off quite quickly. The trouble is that, like Alice, who had to run to stay in place in "Through the Looking Glass," REO sales will have to increase at a blistering pace just to keep up with the new inventory coming onto the market.

That could put a damper on home prices for many months to come.

Dow tops 10,000

Stocks rallied Thursday, with the Dow industrials topping 10,000, after the government reported a bigger-than-expected drop in jobless claims, and a number of retailers reported improved October sales.

The Dow Jones industrial average (INDU) gained 200 points, or 2%, with 40 minutes left in the session. The S&P 500 (SPX) gained 19 points, or 1.8%, and the Nasdaq composite (COMP) climbed 47 points, or 2%.

"Today's big news was that we saw fewer claims for unemployment benefits," said Mike Stanfield, chief investment officer at VSR Financial Services. "That suggests that the underlying economics are continuing to improve."

He said that this was reassuring to investors following several weeks of concerns about the pace of the recovery. It was also encouraging for investors ahead of Friday's monthly employment report.

Stocks have been volatile over the past three weeks, with the S&P 500 losing 5% through Wednesday's close on worries that the rally has gotten ahead of the recovery. Between March 9 and the peak on Oct. 19, the S&P 500 gained 63%.

Stocks ended mixed on Wednesday after the Federal Reserve held interest rates steady at historic lows near zero -- and said it will keep them low for an extended period.

The issue for markets is whether there have been enough positive developments of late to give stocks another leg up, Stanfield said. He said he thinks that the next leg up could be delayed, and that stocks are likely to churn in a range for the next six months or so. After that point, investors will have a better sense of how the economy is doing without the benefit of trillions of dollars in government stimulus, which many credit for the 3.5% rise in GDP in the third quarter.

Gains were broad based, with all 30 Dow issues rising, led by Boeing (BA, Fortune 500), Caterpillar (CAT, Fortune 500), Chevron (CVX, Fortune 500), Exxon Mobil (XOM, Fortune 500), IBM (IBM, Fortune 500), JPMorgan Chase (JPM, Fortune 500), Procter & Gamble (PG, Fortune 500), 3M (MMM, Fortune 500), United Technologies (UTX, Fortune 500) and Wal-Mart Stores (WMT, Fortune 500).

Market breadth was positive. On the New York Stock Exchange, winners beat losers four to one on volume of 890 million shares. On the Nasdaq, advancers topped decliners by almost three to one on volume of 1.75 billion shares.

Jobs: The government's weekly jobless claims report and third-quarter productivity report showed that the pace of layoffs is slowing, but also that employers are still not creating jobs.

The number of Americans filing new claims for unemployment fell to 512,000 last week from 532,000 the previous week, the lowest level since January. Economists surveyed by Briefing.com expected 522,000 claims, on average.

Continuing claims, a measure of Americans who have been receiving benefits for a week or more, fell to 5.749 million from 5.817 million the week before. Economists thought it would fall to 5.750 million. It was the eighth decline in nine weeks. Although the decline could mean people are running out of benefits -- not that they are finding jobs.

Separately, the Senate and House both voted Wednesday to extend unemployment benefits by up to 20 weeks -- and extend the homebuyer tax credit. President Obama is expected to sign the bill into law Friday.
Unemployed ... without a lifeline

Another economic report showed that worker productivity is up, a good sign for corporate profits, but also further evidence that companies aren't hiring. Third-quarter productivity rose by 9.5% after rising 6.6% in the previous quarter. Economists thought it would fall to 6.5%.

"The productivity and jobless claims show a rapidly improving economy," said Ryan Detrick, senior technical strategist at Schaeffer's Investment Research.

But the key report this week is the October unemployment report from the Labor Department, due Friday, Detrick said.

Due before the start of trading, employers are expected to have cut 175,000 jobs from their payrolls after eliminating 263,000 in the prior month. The unemployment rate, generated by a separate survey, is expected to rise to 9.9% from 9.8% in September.

Retail: Shoppers remained cautious with their spending last month, with discounters and warehouse clubs seeing the best October retail sales.

On the upside, Costco (COST, Fortune 500) said sales at stores open a year or more rose 5% during the month, topping forecasts for a rise of 4.7%.

Gap (GPS, Fortune 500) reported sales rose a better-than-expected 4%, sending shares higher in morning trading.

On the downside, American Eagle Outfitters (AEO) said sales fell 5% versus forecasts for a rise of 1.7%. Shares fell over 11% in active New York Stock Exchange trading.

Company news: After the close Wednesday, Cisco Systems (CSCO, Fortune 500) reported weaker quarterly earnings and revenue that beat estimates.

The company's CEO, John Chambers, said current-quarter revenue would top estimates and that business conditions had bottomed at least six months ago. Cisco shares gained 2% Thursday.

Automaker Toyota (TM) reported a surprise quarterly profit Thursday and cut its annual loss forecast by over 50%

Shares of CVS Caremark (CVS, Fortune 500) slumped 21% in active trading after the company warned that 2010 profits at Caremark, its pharmacy benefits management division, are likely to slump by 10% to 12%. The company also said Caremark's CEO is stepping down. Drugstore CVS bought Caremark in March 2007

The news overshadowed the company's bigger-than-expected jump in quarterly profit.
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World markets: European markets rallied in late-afternoon trading. Asian markets tumbled.

Currency and commodities: The dollar fell versus the euro and gained against the yen.

U.S. light crude oil for December delivery fell 62 cents to settle at $79.78 a barrel on the New York Mercantile Exchange.

COMEX gold for December delivery climbed $2 to settle at $1,089.30 an ounce.

Bonds: Treasury prices fell, raising the yield on the 10-year note to 3.53% from 3.52% Wednesday. Treasury prices and yields move in opposite directions.

Manufacturing in 'recovery mode'

A key index of U.S. manufacturing activity jumped in October, reaching its highest level in three and a-half years, a purchasing managers' group said Monday.

The Tempe, Ariz.-based Institute for Supply Management's (ISM) manufacturing index rose to a reading of 55.7 in October from 52.6 the month before. It was the highest reading since April 2006 when the index registered 56.

Economists were expecting a reading of 53, according to consensus estimates gathered by Briefing.com.

"The jump in the index was driven by production and employment," said Norbert Ore, chair of the ISM's manufacturing business survey committee. "Overall, it appears that inventories are balanced and that manufacturing is in a sustainable recovery mode."

The monthly report is a national survey of ISM members, who are purchasing managers in the manufacturing field. Index readings above 50 indicate growth, while levels below 50 signal contraction. Readings below 41.2 are associated with a recession in the broader economy.

The index dipped slightly in September from the previous month. It first showed growth in August, after 18 months of contraction.

The ISM tracks new orders, production, employment, supplier deliveries, inventories, customers' inventories, the backlog of orders, prices, new export orders, imports and buying policies.

Of the 18 manufacturing sectors reporting, 13 posted growth -- including categories such as petroleum and coal products, apparel and transportation equipment. Sectors reporting contractions included metals, mineral products and wood products.