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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended February 28, 2007
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number: 333-129906
Ashton Woods USA L.L.C.
(Exact name of Registrant as specified in its charter)
Nevada | 75-2721881 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
1080 Holcomb Bridge Rd. Bldg 200 Suite 350 | 30076 | |
Roswell, Georgia | (Zip code) | |
(Address of principal executive offices) |
(770) 998-9663
(Registrant’s telephone number, including area code)
(Registrant’s telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year, if changed since last report)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
o Large accelerated filer o Accelerated filer þ Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).o Yesþ No
ASHTON WOODS USA L.L.C.
FORM 10-Q
For the Fiscal Quarter Ended February 28, 2007
For the Fiscal Quarter Ended February 28, 2007
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PART I: FINANCIAL INFORMATION
Item 1.Financial Statements
ASHTON WOODS USA L.L.C.
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
February 28, | May 31, | |||||||
2007 | 2006 | |||||||
(in thousands) | ||||||||
Assets | ||||||||
Cash and cash equivalents | $ | 84 | $ | 181 | ||||
Inventory | ||||||||
Construction in progress and finished homes | 173,062 | 173,824 | ||||||
Land and land under development | 246,919 | 220,115 | ||||||
Real estate not owned | 7,540 | 14,341 | ||||||
Property and equipment, net | 7,317 | 8,077 | ||||||
Accounts receivable | 4,481 | 16,073 | ||||||
Other assets | 15,896 | 16,765 | ||||||
Investments in unconsolidated entities | 5,913 | 6,809 | ||||||
$ | 461,212 | $ | 456,185 | |||||
Liabilities | ||||||||
Liabilities | ||||||||
Notes payable | $ | 214,581 | $ | 189,691 | ||||
Customer deposits | 9,563 | 10,043 | ||||||
Liabilities related to real estate not owned | 6,436 | 12,152 | ||||||
Accounts payable and accruals | 54,286 | 63,784 | ||||||
Total liabilities | 284,866 | 275,670 | ||||||
Minority interests in real estate not owned | 704 | 1,788 | ||||||
Members’ equity | 175,642 | 178,727 | ||||||
$ | 461,212 | $ | 456,185 | |||||
See accompanying notes to condensed consolidated financial statements
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ASHTON WOODS USA L.L.C.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
Three Months Ended | Nine months Ended | |||||||||||||||
February 28, | February 28, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
(in thousands) | (in thousands) | |||||||||||||||
Revenues | ||||||||||||||||
Home sales | $ | 129,037 | $ | 150,273 | $ | 407,445 | $ | 391,278 | ||||||||
Land sales | 170 | 7,021 | 7,382 | 30,699 | ||||||||||||
Other | 219 | 279 | 678 | 793 | ||||||||||||
129,426 | 157,573 | 415,505 | 422,770 | |||||||||||||
Cost of sales | ||||||||||||||||
Home sales | 105,358 | 114,486 | 334,747 | 304,739 | ||||||||||||
Land sales | 169 | 5,152 | 3,070 | 15,003 | ||||||||||||
105,527 | 119,638 | 337,817 | 319,742 | |||||||||||||
Gross profit | ||||||||||||||||
Home sales | 23,679 | 35,787 | 72,698 | 86,539 | ||||||||||||
Land sales | 1 | 1,869 | 4,312 | 15,696 | ||||||||||||
Other | 219 | 279 | 678 | 793 | ||||||||||||
23,899 | 37,935 | 77,688 | 103,028 | |||||||||||||
Expenses | ||||||||||||||||
Sales and marketing | 7,869 | 8,173 | 25,129 | 22,856 | ||||||||||||
General and administrative | 9,152 | 10,797 | 28,900 | 28,367 | ||||||||||||
Related party | 265 | 332 | 864 | 886 | ||||||||||||
Franchise taxes | — | 44 | 95 | 214 | ||||||||||||
Depreciation and amortization | 1,326 | 1,795 | 4,321 | 4,237 | ||||||||||||
18,612 | 21,141 | 59,309 | 56,560 | |||||||||||||
Earnings in unconsolidated entities | 887 | 600 | 2,327 | 1,788 | ||||||||||||
Net income | $ | 6,174 | $ | 17,394 | $ | 20,706 | $ | 48,256 | ||||||||
See accompanying notes to condensed consolidated financial statements
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ASHTON WOODS USA L.L.C.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Nine months Ended | ||||||||
February 28, | ||||||||
2007 | 2006 | |||||||
(in thousands) | ||||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 20,706 | $ | 48,256 | ||||
Adjustments to reconcile net income to net cash provide by (used in) operating activities: | ||||||||
Earnings in unconsolidated entities | (2,327 | ) | (1,788 | ) | ||||
Distributions from unconsolidated entities | 3,708 | 4,846 | ||||||
Depreciation and amortization | 4,321 | 4,237 | ||||||
Amortization of deferred debt issuance costs | 834 | 526 | ||||||
Impairment loss recognized on real estate inventory | 11,304 | — | ||||||
Changes in operating assets and liabilities: | ||||||||
Inventory | (36,873 | ) | (150,674 | ) | ||||
Accounts receivable | 11,592 | 1,088 | ||||||
Other assets | 393 | (4,864 | ) | |||||
Accounts payable and accruals | (10,268 | ) | 22,420 | |||||
Customer deposits | (480 | ) | 2,926 | |||||
Net cash provided by (used in) operating activities | 2,910 | (73,027 | ) | |||||
Cash flows from investing activities: | ||||||||
Investments in unconsolidated entities | (187 | ) | (2,498 | ) | ||||
Additions to property and equipment | (3,560 | ) | (7,133 | ) | ||||
Net cash used in investing activities | (3,747 | ) | (9,631 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from senior subordinated notes | — | 125,000 | ||||||
Proceeds from notes payable | 141,500 | 175,935 | ||||||
Repayments of notes payable | (116,610 | ) | (176,978 | ) | ||||
Proceeds of related party note | — | 833 | ||||||
Repayments of related party note | — | (11,445 | ) | |||||
Debt issuance costs | (359 | ) | (5,494 | ) | ||||
Members’ distributions | (23,791 | ) | (25,116 | ) | ||||
Net cash provided by financing activities | 740 | 82,735 | ||||||
(Decrease) increase in cash | (97 | ) | 77 | |||||
Cash and cash equivalents, beginning of period | 181 | 105 | ||||||
Cash and cash equivalents, end of period | $ | 84 | $ | 182 | ||||
Supplemental disclosures: | ||||||||
Non-cash operating activity: | ||||||||
Non-cash distribution of land from joint venture | $ | 472 | $ | — |
See accompanying notes to condensed consolidated financial statements
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Note 1 — Organization and Basis of Presentation
The accompanying unaudited condensed consolidated financial statements of Ashton Woods USA L.L.C. (“Ashton Woods” or the “Company”), a limited liability company operating as Ashton Woods Homes, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Such consolidated financial statements do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for a complete set of consolidated financial statements. In the Company’s opinion, all adjustments (consisting solely of normal recurring accruals) necessary for a fair presentation have been included in the accompanying consolidated financial statements. Certain items in prior period consolidated financial statements have been reclassified to conform to the current presentation. For further information, refer to the Company’s Annual Report on Form 10-K for the fiscal year ended May 31, 2006, filed with the Securities and Exchange Commission on August 10, 2006.
The Company has historically experienced, and expects to continue to experience, variability in quarterly results. The condensed consolidated statements of income for the three and nine months ended February 28, 2007, are not necessarily indicative of the results to be expected for the full year.
Note 2 — New Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004),Share-Based Payment(“SFAS No. 123(R)”), which is a revision of SFAS No. 123,Accounting for Stock-Based Compensation(“SFAS No. 123”). On June 1, 2006, the Company adopted SFAS No. 123(R). The Company has not made any new awards or modified any awards since the effective date. The adoption of SFAS No. 123(R) did not have a material impact on the consolidated financial statements of the Company.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”). SAB No. 108 addresses quantifying the financial statement effects of misstatements, specifically, how the effects of prior year uncorrected errors must be considered in quantifying misstatements in the current year financial statements. SAB No. 108 does not amend or change the SEC Staff’s previous positions in Staff Accounting Bulletin No. 99, “Materiality,” regarding qualitative considerations in assessing the materiality of misstatements. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The Company is evaluating the impact of SAB No. 108.
Note 3 — Inventory
Inventory consists of the following (in thousands):
February 28, 2007 | May 31, 2006 | |||||||
Homes under construction | $ | 173,062 | $ | 173,824 | ||||
Finished lots | 117,126 | 49,354 | ||||||
Land under development | 120,952 | 165,867 | ||||||
Land held for development | 8,841 | 4,894 | ||||||
$ | 419,981 | $ | 393,939 | |||||
Each quarter, the Company reviews all components of its inventory for the purpose of determining whether recorded costs and costs required to complete each home or project are recoverable. If this review indicates that an impairment loss is required under the SFAS No. 144 guidelines, the Company estimates and records such loss to cost of sales in that quarter. During the three and nine months ended February 28, 2007, the Company recorded a loss of approximately $1.8 million and $11.3 million, respectively.
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The Company capitalizes interest costs to inventory during development and construction. Capitalized interest is charged to cost of sales as the related inventory is delivered to the buyer. The following table summarizes the Company’s interest costs incurred, capitalized and charged to cost of sales during periods indicated (in thousands):
Three months ended | Nine months ended | |||||||||||||||
February 28, | February 28, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
Capitalized interest, beginning of period | $ | 13,883 | $ | 6,123 | $ | 9,483 | $ | 3,173 | ||||||||
Interest incurred | 5,057 | 4,542 | 14,727 | 9,938 | ||||||||||||
Interest amortized to cost of sales | (3,245 | ) | (2,151 | ) | (8,515 | ) | (4,597 | ) | ||||||||
Capitalized interest, end of period | $ | 15,695 | $ | 8,514 | $ | 15,695 | $ | 8,514 | ||||||||
Note 4 — Consolidated Land Inventory Not Owned
In the ordinary course of its business, the Company enters into land and lot option purchase contracts with unaffiliated entities in order to procure land or lots for the construction of homes. Under such option purchase contracts, the Company will fund a stated deposit in consideration for the right, but not the obligation, to purchase land or lots at a future point in time with predetermined terms. Under the terms of the option purchase contracts, many of the Company’s option deposits are non-refundable. Under FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” as amended by FIN 46-R issued in December 2003 (“FIN 46R”), certain non-refundable deposits are deemed to create a variable interest in a variable interest entity under the requirements of FIN 46R. As such, certain of the Company’s option purchase contracts result in the acquisition of a variable interest in the entity holding the land parcel under option.
In applying the provisions of FIN 46R, the Company evaluates those land and lot option purchase contracts with variable interest entities to determine whether the Company is the primary beneficiary based upon analysis of the variability of the expected gains and losses of the entity. Based on this evaluation, if the Company is the primary beneficiary of an entity with which the Company has entered into a land or lot option purchase contract, the variable interest entity is consolidated.
The consolidation of these variable interest entities added $7.5 million, $6.4 million and $0.7 million in real estate not owned, liabilities related to real estate not owned and minority interests in real estate not owned, respectively, to the Company’s balance sheet at February 28, 2007 and added $14.3 million, $12.2 million and $1.8 million in real estate not owned, liabilities related to real estate not owned and minority interests in real estate not owned, respectively, to the Company’s balance sheet at May 31, 2006.
Note 5 — Investments in Unconsolidated Entities
The Company participates in a number of land development entities in which it has equity investments of 50% or less and does not have a controlling interest. These land development entities are typically entered into with developers, other homebuilders and related parties to develop finished lots for sale to the members of the entities and other third parties. The Company accounts for its interest in these entities under the equity method. The Company’s share of the entity’s earnings is deferred until homes related to the lots purchased by the Company are delivered and title passes to a homebuyer. The land development entities with unrelated parties typically obtain secured acquisition and development financing. In some instances, the entity partners have provided varying levels of guarantees of debt of the unconsolidated entities. These repayment guarantees require the Company to repay its share of the debt of unconsolidated entities in the event the entity defaults on its obligations under the borrowings. The Company had repayment guarantees of $1.5 million and $3.6 million at February 28, 2007 and May 31, 2006, respectively.
The Company’s investments in Ashton Woods Mortgage and certain title services entities are also accounted for under the equity method, as the Company does not have a controlling interest. Under the equity method, the Company’s share of the unconsolidated entities’ earnings or loss is recognized as earned.
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Note 6 — Warranty Costs
The Company provides its homebuyers with limited warranties that generally provide for ten years of structural coverage, two years of coverage for plumbing, electrical and heating, ventilation and air conditioning systems and one year of coverage for workmanship and materials. Warranty liabilities are initially established on a per home basis by charging cost of sales and crediting a warranty liability for each home delivered to cover expected costs of materials and labor during the warranty period. The amounts accrued are based on management’s estimate of expected warranty-related costs under all unexpired warranty obligation periods. The Company’s warranty liability is based upon historical warranty cost experience in each market in which it operates and is adjusted as appropriate to reflect qualitative risks associated with the types of homes built and the geographic areas in which they are built. Warranty liabilities are included in accounts payable and accruals in the consolidated balance sheets, and totaled $5.9 million and $5.0 million, at February 28, 2007 and May 31, 2006, respectively. Warranty activity for the three and nine months ended February 28, 2007 and 2005 is shown below (in thousands):
Three months ended | Nine months ended | |||||||||||||||
February 28, | February 28, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
Balance at beginning of period | $ | 5,612 | $ | 3,054 | $ | 5,023 | $ | 3,075 | ||||||||
Provisions | 1,311 | 1,746 | 5,271 | 4,316 | ||||||||||||
Payments | (1,017 | ) | (1,259 | ) | (4,388 | ) | (3,850 | ) | ||||||||
Balance at end of period | $ | 5,906 | $ | 3,541 | $ | 5,906 | $ | 3,541 | ||||||||
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Note 7 — Notes Payable
The Company’s notes payable at February 28, 2007 and May 31, 2006, consist of the following (in thousands):
February 28, | May 31, | |||||||
2007 | 2006 | |||||||
9.5% Senior Subordinated Notes due 2015 | $ | 125,000 | $ | 125,000 | ||||
Unsecured revolving credit facility | 87,839 | 62,839 | ||||||
Secured Note | 1,742 | 1,852 | ||||||
$ | 214,581 | $ | 189,691 | |||||
In September 2005, the Company and Ashton Woods Finance Co., the Company’s 100% owned finance subsidiary, co-issued $125 million aggregate principal amount of 9.5% Senior Subordinated Notes due 2015 in a private placement pursuant to Rule 144A promulgated under the Securities Act of 1933, as amended. The net proceeds were used to repay amounts outstanding under the Company’s senior unsecured revolving credit facility and to repay certain related party debt. In April 2006, the Company completed an offer to exchange all of the notes issued in September 2005 for an equal amount of 9.5% Senior Subordinated Notes due 2015, which were registered under the Securities Act of 1933. Interest on the notes is payable semiannually. The Company may redeem the notes, in whole or part, at any time on or after October 1, 2010, at a redemption price equal to 100% of the principal amount, plus a premium declining ratably to par, plus accrued and unpaid interest. In addition, at any time prior to October 1, 2008, the Company may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of qualified equity offerings at a redemption price equal to 109.5% of the principal amount, plus accrued and unpaid interest. The notes are unsecured and subordinated in right of payment to all of the Company’s existing and future senior debt, including borrowings under the Company’s senior unsecured credit facility. All of the Company’s existing subsidiaries, other than the co-issuer, fully and unconditionally guaranteed, jointly and severally, the notes on a senior subordinated basis. Each of the subsidiary guarantors is 100% owned by the Company. Future direct and indirect U.S. subsidiaries, excluding subsidiaries that are designated unrestricted subsidiaries in accordance with the indenture governing the notes, will be required to guarantee the notes on a full and unconditional basis, jointly and severally with the other subsidiary guarantors. The guarantees are general unsecured obligations of the guarantors and are subordinated in right of payment to all existing and future senior debt of the guarantors, which includes their guarantees of the Company’s senior unsecured credit facility. The Company does not have any independent operations or assets apart from its investments in its subsidiaries. As of and for the nine months ended February 28, 2007, the Company was in compliance with the covenants under the senior subordinated notes. As of February 28, 2007, the outstanding notes with a face value of $125.0 million had a fair value of approximately $120.0 million, based on quoted market prices by independent dealers.
In December 2005, the Company entered into an amended senior unsecured credit facility. The amended senior unsecured credit facility provides for up to $300.0 million of unsecured borrowings, subject to a borrowing base, and includes an accordion feature by which the Company may request, subject to certain conditions, an increase of the amended senior unsecured credit facility up to a maximum of $400.0 million. The amended senior unsecured credit facility provides for the issuance of up to $50.0 million in letters of credit. The maturity date of the amended senior unsecured credit facility was initially January 19, 2010. However, once during each fiscal year (i.e., June 1-May 31) the Company may request that the lenders extend the maturity date by an additional year. On January 10, 2007, the Company amended the senior unsecured credit facility to amend the definition of “EBITDA” contained therein to exclude certain non-cash gains and include certain non-cash losses or charges and to extend the maturity date to January 19, 2011, for 88.3%, or $265.0 million of the facility. On February 21, 2007, the Company obtained consent from an additional lender representing 5.0%, or $15 million of the facility, to the extension of the senior unsecured credit facility to January 19, 2011. At February 28, 2007, the Company had available borrowing capacity under this facility of $189.6 million, net of letters of credit, as determined by borrowing base limitations defined in the facility. The Company’s obligations under the amended senior unsecured credit facility are guaranteed by all of its subsidiaries and all of the holders of its membership interests. The amended senior unsecured credit facility contains a number of customary financial and operating covenants, including covenants requiring the Company to maintain a minimum consolidated tangible net worth; requiring the Company to maintain a ratio of consolidated total liabilities to adjusted net worth not in excess of 2.25x; requiring the Company to maintain an interest coverage
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ratio of at least 2.5x; limiting the principal amount of the Company’s secured debt to $50 million at any given time; limiting the net book value of the Company’s unimproved entitled land, land under development and finished lots to 150.0% of the Company’s adjusted tangible net worth; limiting the aggregate distributions by the Company and its subsidiaries in any fiscal year; restricting the Company’s ability to incur additional indebtedness; and restricting the Company’s ability to engage in mergers and consolidations and its ability to sell all or substantially all of its assets. The borrowings under the facility bear daily interest at rates based upon the London Interbank Offered Rate (LIBOR) plus a spread based upon the Company’s ratio of debt to adjusted tangible net worth. In addition to the stated interest rates, the revolving credit facility requires the Company to pay certain fees. The effective interest rate of the unsecured bank debt at February 28, 2007, was approximately 6.6%. As of and for the nine months ended February 28, 2007, the Company was in compliance with the covenants under this facility.
Note 8 — Transactions With Related Parties
The Company has entered into a services agreement with a related party for the license, development and support of its computer systems and for the provision of certain administrative services. The Company pays $600 per home closing quarterly, in arrears, in payment for these services. The Company incurred fees of $0.3 million and $0.9 million related to these services during the three and nine month periods of fiscal 2007 and 2006.
The Company also has consolidated variable interest entities pursuant to FIN 46R where the Company has entered into lot purchase agreements with related parties. As of February 28, 2007, the Company has 211 finished lots to be purchased under contract with related parties, representing $8.4 million in purchase price.
Note 9 — Contingencies
The Company is involved in lawsuits and other contingencies in the ordinary course of business. Management believes that, while the ultimate outcome of the contingencies cannot be predicted with certainty, the ultimate liability, if any, will not have a material adverse effect on the Company’s financial statements.
Note 10 — Provision for income taxes
The Company operates as a limited liability company. Accordingly, the Company incurs no liability for federal or state income taxes, as these taxes are passed through to the members.
Note 11 — Information on business segments
SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information” (“SFAS 131”), defines operating segments as a component of an enterprise for which discrete financial information is available and is reviewed regularly by the chief operating decision-maker, or decision-making group, to evaluate performance and make operating decisions. The Company has identified its chief operating decision-makers (“CODMs”) as three key executives—the Chief Executive Officer, Senior Vice President and Chief Financial Officer.
The Company has identified each homebuilding market as an operating segment in accordance with SFAS 131. Operations of the Company’s homebuilding segments primarily include the sale and construction of single-family attached and detached homes, and to a lesser extent, condominiums, as well as the purchase, development and sale of residential land directly and through the Company’s unconsolidated entities. The Company’s operating segments have been aggregated into the reportable segments noted below because they have similar: (1) economic characteristics; (2) housing products; (3) class of homebuyer; (4) regulatory environments; and (5) methods used to construct and sell homes. The Company’s homebuilding reportable segments are as follows:
(1) East (Atlanta, Orlando and Tampa markets)
(2) West (Dallas, Houston, Phoenix and Denver markets)
Each reportable segment follows the same accounting policies described in Note 1 – “Summary of Significant Accounting Policies” to the consolidated financial statements in the Company’s 2006 Annual Report on Form 10-K.
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Operational results of each segment are not necessarily indicative of the results that would have occurred had the segment been an independent, stand-alone entity during the periods presented.
The following table summarizes revenue, gross profit and net income for each of the Company’s reportable segments (in thousands).
Three Months Ended | Nine months Ended | |||||||||||||||
February 28, | February 28, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
Revenues | ||||||||||||||||
Homebuilding | ||||||||||||||||
East | $ | 72,510 | $ | 72,590 | $ | 177,611 | $ | 193,002 | ||||||||
West | 56,875 | 84,931 | 237,744 | 229,611 | ||||||||||||
Total Homebuilding | 129,385 | 157,521 | 415,355 | 422,613 | ||||||||||||
Corporate | 41 | 52 | 150 | 157 | ||||||||||||
Consolidated | $ | 129,426 | $ | 157,573 | $ | 415,505 | $ | 422,770 | ||||||||
Gross Profit | ||||||||||||||||
Homebuilding | ||||||||||||||||
East | $ | 14,177 | $ | 20,045 | $ | 36,081 | $ | 58,185 | ||||||||
West | 9,681 | 17,839 | 41,457 | 44,686 | ||||||||||||
Total Homebuilding | 23,858 | 37,884 | 77,538 | 102,871 | ||||||||||||
Corporate | 41 | 51 | 150 | 157 | ||||||||||||
Consolidated gross profit | 23,899 | 37,935 | 77,688 | 103,028 | ||||||||||||
Net Income | ||||||||||||||||
Homebuilding | ||||||||||||||||
East | $ | 5,669 | $ | 11,616 | $ | 11,230 | $ | 36,052 | ||||||||
West | 505 | 5,778 | 9,476 | 12,216 | ||||||||||||
Total Homebuilding | 6,174 | 17,394 | 20,706 | 48,268 | ||||||||||||
Corporate | — | — | — | (12 | ) | |||||||||||
Consolidated net income | $ | 6,174 | $ | 17,394 | $ | 20,706 | $ | 48,256 | ||||||||
The following table summarizes assets for each of the Company’s reportable segments (in thousands).
February 28, 2007 | May 31, 2006 | |||||||
Homebuilding | ||||||||
East | $ | 221,926 | $ | 206,110 | ||||
West | 230,055 | 240,318 | ||||||
Total Homebuilding | 451,981 | 446,428 | ||||||
Corporate (1) | 9,231 | 9,757 | ||||||
Consolidated | $ | 461,212 | $ | 456,185 | ||||
(1) | Balance consists of cash, deferred debt issuance costs and other corporate assets not allocated to the segments. |
The following table sets forth information relating to home sales revenues by product for the three and nine months ending February 28, 2007, and 2006 (dollars in thousands).
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
February 28, | Change | February 28, | Change | |||||||||||||||||||||||||||||
2007 | 2006 | Amount | % | 2007 | 2006 | Amount | % | |||||||||||||||||||||||||
Revenue | ||||||||||||||||||||||||||||||||
Product: | ||||||||||||||||||||||||||||||||
Single-family | $ | 93,801 | $ | 111,843 | $ | (18,042 | ) | -16 | % | $ | 312,820 | $ | 295,509 | 17,311 | 6 | % | ||||||||||||||||
Townhome | 13,031 | 28,105 | (15,074 | ) | -54 | % | 36,340 | 81,034 | (44,694 | ) | -55 | % | ||||||||||||||||||||
Stacked flat condominiums | 22,205 | 10,325 | 11,880 | 115 | % | 58,285 | 14,735 | 43,550 | 296 | % | ||||||||||||||||||||||
Total Home Sales Revenue | $ | 129,037 | $ | 150,273 | $ | (21,236 | ) | -14 | % | $ | 407,445 | $ | 391,278 | 16,167 | 4 | % | ||||||||||||||||
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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Description of Business
Ashton Woods is one of the largest private homebuilders in the United States based on number of home closings and revenues. The Company designs, builds and markets high-quality single-family detached homes, townhomes and stacked-flat condominiums under the Ashton Woods Homes brand name. The Company currently operates in Atlanta, Dallas, Houston, Orlando, Phoenix and Tampa and is establishing homebuilding operations in Denver. These cities represent seven of the 20 largest new residential housing markets in the United States according to the U.S. Census Bureau. The Company has been in operation for over 15 years and serves a broad customer base including first-time buyers and first- and second-time move-up buyers. The Company focuses on achieving the highest standards in design, quality and customer satisfaction. The Company has received numerous awards, including the 2005 and 2004 J.D. Power Award for Highest in Customer Satisfaction with New Homebuilders in Atlanta, and is ranked in the top 13% of all homebuilders nationally in customer satisfaction in 2006 by a nationally recognized survey company not affiliated with the Company.
The Company’s revenues are primarily generated from designing, building and marketing single-family detached homes, townhomes, and stacked-flat condominiums in the five states and seven markets it currently serves. The Company also acquires and develops land for use in its homebuilding operations and for sale to others. From time to time, the Company elects to sell parcels of land or finished lots that do not fit with its home development program. Parcels of land or finished lots may be deemed not to fit within our home development program for a variety of reasons, including, when a specific parcel contains a greater supply of lots than deemed appropriate for the particular development or specific lots are designed for a housing product that is not within our business plan for that area, such as custom built homes or homes that are not within the size specifications for the particular development. These land sales are incidental to the Company’s business of selling and building homes and have fluctuated significantly in the past. The Company anticipates continuing to sell parcels of land and finished lots in the future when circumstances warrant; however, the Company does not anticipate future sales of land being as significant a part of its revenues as they have been in the past. The Company expects that the significance of land sales revenue will fluctuate from quarter to quarter.
The Company also conducts mortgage origination and title services for the benefit of its homebuilding operation. The Company does not record revenues from these ancillary services because they are carried out through separate jointly-owned entities, which are operated by the Company’s partners in these entities. The earnings from these jointly-owned entities are recorded using the equity method of accounting, and the earnings are a component of the line item “Earnings in unconsolidated entities” on the Company’s income statement. The Company has a 49.9% interest in an entity that offers mortgage financing to all of its buyers and in the past has offered refinancing services to others. The mortgage operation’s revenues consist primarily of origination and premium fee income, interest income and the gain on sale of the mortgages. The Company also offers title services to its homebuyers in Dallas and Houston through 49.0% ownership interests in two title companies and to its homebuyers in Orlando and Tampa through a 49.0% ownership interest in a title company. The title companies are managed by, and all underwriting risks associated with the title are transferred to, the majority owners.
Information regarding the J.D. Power and Associates 2005 New Home Builder Customer Satisfaction Studysm was based on responses from 73,353 buyers of newly constructed homes in 30 of the largest U.S. markets, who were surveyed between March and July 2005. With respect to the 2005 survey, the Atlanta market covers Barrow, Cherokee, Clayton, Cobb, Coweta, Dawson, Dekalb, Douglas, Fayette, Forsyth, Fulton, Gwinnett, Hall, Henry, Newton, Paulding, Rockdale, Spalding and Walton counties. Information regarding the J.D. Power 2004 New Home Builder Customer Satisfaction Studysm was based on responses from 64,502 buyers of newly constructed homes in 25 of the largest U.S. markets. With respect to the 2004 survey, the Atlanta market covers Barrow, Bartow, Carroll, Cherokee, Clayton, Cobb, Coweta, Dawson, DeKalb, Douglas, Fayette, Forsyth, Fulton, Gwinnett, Hall, Henry, Newton, Paulding, Rockdale, Spalding and Walton counties.
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Overview
For the three and nine months ended February 28, 2007, the Company closed 442 and 1,440 homes, respectively, compared with 552 and 1,476 homes closed, respectively, during the same periods of fiscal year 2006.
Net new home orders of 433 and 1,148, respectively, for the three and nine months ended February 28, 2007, represented a decrease of 26.6% and 37.2%, respectively, as compared to the same periods a year ago as a result of the general slowdown that the homebuilding industry has experienced and continues to experience. This slowdown, which first began to impact the Company during the third quarter of fiscal year 2006, has continued throughout the first nine months of fiscal year 2007 and into the fourth quarter of fiscal year 2007.
The Company’s cancellation rate for the three and nine months ended February 28, 2007, was 26% and 31%, respectively, compared to its historical cancellation rate in the 15% — 20% range. The continued high level of cancellations in the marketplace resulting from, among other things, the oversupply of homes available for sale, a general reduction in the demand for new homes and to a lesser extent the negative impact created by problems in the sub-prime lending market, has continued to negatively affect the number of units in backlog as of the end of the third quarter of fiscal year 2007. In addition, prospective homebuyers are taking more time making home buying decisions given concerns about the direction of home prices and, in many cases, are experiencing difficulty in selling their existing homes. The Company has increased the incentives offered to homebuyers and increased its marketing efforts to stimulate net new home orders and maintain homes in backlog. The Company offers sales incentives to our homebuyers in several forms, including sales price reductions, reductions in the prices of options for their homes, discounted upgrades, the payment of certain closing costs and other mortgage financing programs. These sales incentives are included in the contract price and do not require continuing involvement of the Company after the home is closed and title passes to the homebuyer. The decision to offer incentives and the types of incentives offered at any point in time are driven by market forces, including the marketing strategies of our competitors and will vary by market depending on the interests of target homebuyers, the features of the relevant communities and the competitive environment. The increase in sales incentives has and will continue to negatively affect gross margins on home sales. The Company has also actively pursued price concessions from its existing suppliers and subcontractors, redesigned its product offerings and reduced its general and administrative expenses in efforts to rebuild profitability.
The decline in the demand for new home orders combined with the increase in cancellations has resulted in a 43.3% decrease in the number of homes in backlog at February 28, 2007 as compared to February 28, 2006. At February 28, 2007, backlog consisted of 957 homes with a sales value of $270.4 million, compared to 1,687 homes at February 28, 2006, with a sales value of $520.5 million, which represents a 48.0% decrease in the sales value of backlog as compared to February 28, 2006.
Management has maintained its conservative balance sheet management practices through strict control of its speculative inventory and curtailment of its land acquisition activities throughout fiscal year 2007. The Company has focused its efforts on improving new order sales absorption through the use of increased sales incentives and advertising efforts throughout this downturn. At the end of February 28, 2007, the Company had 157 homes at various stages of completion (of which 65 homes were completed) for which we did not have a sales contract (“spec homes”), as compared to 148 total spec homes at the end of February 28, 2006 of which 32 homes were completed. As of February 28, 2007, our supply of land controlled for use in our homebuilding operations was 2.9 years, consisting of a 2.1-year supply of owned land and a 0.8-year supply of land controlled through option contracts. Our desire to maintain a conservative balance sheet through this downturn in the homebuilding industry has resulted in a land supply under our historical four-year supply target as we have increased our underwriting guidelines for new land acquisitions. Management continually evaluates its land supply in relation to the overall health of the homebuilding environment and anticipates increasing our land supply toward our historical target of approximately 4 years during the next 12 – 18 months, assuming demand in the homebuilding industry stabilizes and begins to improve.
Consistent with the Company’s inventory valuation policy, all components of inventory were evaluated to determine the recoverability of the carrying values on a community-by-community basis. Based on the procedures performed as of February 28, 2007, the Company determined that certain inventory costs were not recoverable and accordingly
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during the three and nine months ended February 28, 2007, the Company recorded a loss of approximately $1.8 million and $11.3 million, respectively.
The Company’s financial results for the remainder of fiscal year 2007 and fiscal year 2008 will depend largely on the Company’s ability to generate net new home orders, improve its ability to maintain its orders in backlog until the homes close and continue to control its costs of building and selling homes.
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Results of Operations
The following table sets forth key financial data for the three and nine months ended February 28, 2007 and 2006, (dollars in thousands):
Three Months Ended | Nine months Ended | |||||||||||||||
February 28, | February 28, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
Statement of Income Data: | ||||||||||||||||
Revenues | ||||||||||||||||
Home sales | $ | 129,037 | $ | 150,273 | $ | 407,445 | $ | 391,278 | ||||||||
Land sales | 170 | 7,021 | 7,382 | 30,699 | ||||||||||||
Other | 219 | 279 | 678 | 793 | ||||||||||||
129,426 | 157,573 | 415,505 | 422,770 | |||||||||||||
Cost of sales | ||||||||||||||||
Home sales | 105,358 | 114,486 | 334,747 | 304,739 | ||||||||||||
Land sales | 169 | 5,152 | 3,070 | 15,003 | ||||||||||||
105,527 | 119,638 | 337,817 | 319,742 | |||||||||||||
Gross profit | ||||||||||||||||
Home sales | 23,679 | 35,787 | 72,698 | 86,539 | ||||||||||||
Land sales | 1 | 1,869 | 4,312 | 15,696 | ||||||||||||
Other | 219 | 279 | 678 | 793 | ||||||||||||
23,899 | 37,935 | 77,688 | 103,028 | |||||||||||||
Expenses | ||||||||||||||||
Sales and marketing | 7,869 | 8,173 | 25,129 | 22,856 | ||||||||||||
General and administrative | 9,152 | 10,797 | 29,764 | 28,367 | ||||||||||||
Related party | 265 | 332 | 864 | 886 | ||||||||||||
Franchise taxes | — | 44 | 95 | 214 | ||||||||||||
Depreciation and amortization | 1,326 | 1,795 | 4,321 | 4,237 | ||||||||||||
18,612 | 21,141 | 59,309 | 56,560 | |||||||||||||
Earnings in unconsolidated entities | 887 | 600 | 2,327 | 1,788 | ||||||||||||
Net income | $ | 6,174 | $ | 17,394 | $ | 20,706 | $ | 48,256 | ||||||||
Other Data: | ||||||||||||||||
Homes closed | 442 | 552 | 1,440 | 1,476 | ||||||||||||
Average sales price per home closed | $ | 292 | $ | 272 | $ | 283 | $ | 265 | ||||||||
Home gross margin (1) | 18.4 | % | 23.8 | % | 17.8 | % | 22.1 | % | ||||||||
EBITDA (2) | $ | 10,745 | $ | 21,384 | $ | 33,637 | $ | 57,304 | ||||||||
Ratio of SG&A and related party expenses to revenues | 13.4 | % | 12.2 | % | 13.4 | % | 12.3 | % | ||||||||
Ratio of net income to revenues | 4.8 | % | 11.0 | % | 5.0 | % | 11.4 | % |
(1) | Home gross margins is defined as home sales revenues less cost of home sales, which includes land, house construction costs, indirect costs of construction, capitalized interest, warranty expense and closing costs, as a percent of home sales revenue. | |
(2) | EBITDA (earnings before interest, taxes, depreciation and amortization) is calculated by adding previously capitalized interest amortized to costs of sales, franchise taxes, depreciation and amortization to net income. EBITDA is not a financial measure under generally accepted accounting principles in the United States, or GAAP. EBITDA should not be considered an alternative to net income determined in accordance with GAAP as an indicator of operating performance, nor an alternative to cash flows from operating activities determined in accordance with GAAP as a measure of liquidity. Because some analysts and companies may not calculate EBITDA in the same manner as the Company, the EBITDA information in this report may not be comparable to similar presentations by others. |
EBITDA is a measure commonly used in the homebuilding industry and is presented as a useful adjunct to net income and other measurements under GAAP because it is a meaningful measure of a company’s performance, as interest, taxes, depreciation and amortization can vary significantly between companies due in part to differences in structure, accounting policies, tax strategies, levels of indebtedness, capital purchasing practices and interest rates. EBITDA also assists management in evaluating operating performance, and the Company believes that it is a useful measure for investors to compare the Company with its competitors. | |||
The following is a reconciliation of EBITDA to net income, the most directly comparable GAAP measure: |
Three Months Ended February 28, | Nine months Ended February 28, | |||||||||||||||
2007 | 2006 | 2007 | 2006 | |||||||||||||
(dollars in thousands) | ||||||||||||||||
Net income | $ | 6,174 | $ | 17,394 | $ | 20,706 | $ | 48,256 | ||||||||
Franchise taxes | — | 44 | 95 | 214 | ||||||||||||
Depreciation and amortization | 1,326 | 1,795 | 4,321 | 4,237 | ||||||||||||
Interest expense in cost of sales | 3,245 | 2,151 | 8,515 | 4,597 | ||||||||||||
EBITDA | $ | 10,745 | $ | 21,384 | $ | 33,637 | $ | 57,304 | ||||||||
EBITDA does have certain limitations as a tool for measuring Company performance from period to period, because that performance is affected by the use of cash to purchase capital assets and to pay interest and taxes. These amounts, as well as depreciation and amortization associated with capital assets, can fluctuate significantly over time due to the Company’s debt levels used to finance the Company’s inventory, purchases of capital assets and operations, income levels and other performance issues, which is not apparent if EBITDA is used as an evaluation tool. Because the Company borrows money to finance its inventory purchases and operations, interest expense is a necessary element of its costs and affects its ability to generate revenue. Further, because the Company uses capital assets, depreciation and amortization are necessary elements of its costs and also affect its ability to generate revenue. Any performance measure that excludes interest expense, depreciation and amortization has material limitations. To compensate for these limitations, the Company’s management uses both EBITDA and net income, the most directly comparable GAAP measure, to evaluate its performance. |
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Three and Nine Months Ended February 28, 2007 Compared to Three and Nine Months Ended February 28, 2006
Revenues.Revenues decreased by $28.1 million or 17.9% for the three months ended February 28, 2007, compared to the same period in the prior fiscal year as the Company experienced a decrease in home sales revenue from $150.3 million to $129.0 million and a decrease in land sales revenue from $7.0 million to $0.2 million. The Company closed 442 homes in the three months ended February 28, 2007, compared to 552 home closings in the same period in fiscal year 2006, a decrease of 19.9%. Home closings decreased in all markets as compared to the same period in the prior year, with the exception of Tampa. The average sales price of homes closed increased by 7.4% to $292,000 as compared to $272,000 for the prior year period due to the Company closing more homes in the higher priced single family product in Orlando and Atlanta. Since land sales are incidental to the Company’s business of building and selling homes, the Company generally sells only parcels of land and finished lots that do not fit with its home development program. The decrease in land sales revenue of 98%, or $6.9 million, was a result of the Company having identified a larger number of parcels of land and finished lots that did not fit with its home development program during the three months ended February 28, 2006 as compared to the three months ended February 28, 2007.
Revenues decreased by $7.3 million or 1.7% for the nine months ended February 28, 2007, as compared to the same period in the prior fiscal year. The Company closed 1,440 homes in the nine months ended February 28, 2007, compared to 1,476 home closings in the same period in fiscal year 2006, a decrease of 2.4%. Home closings decreased in all markets as compared to the same period in the prior year with the exception of Orlando, Phoenix and Tampa, which experienced increases in home closings of 2.9%, 25.7% and 100%, respectively as a result of closing the strong backlog levels remaining in these markets at the beginning of the fiscal year. The average sales price of homes closed increased by 6.8% to $283,000 as compared to $265,000 for the prior year due to the Company closing more homes in the single family product in Phoenix offset in part by an increase in homes closed in the condominium product in Orlando, which carries a lower average price point than the Company’s single-family product. This increase in home sales revenue was offset by a decline in land sales revenue in the nine months ended February 28, 2007, of $23.3 million or 76.0%. The decrease in land sales revenue was a result of the Company having identified fewer parcels of land and finished lots that did not fit with its home development program during the nine months ended February 28, 2007, as compared to the prior fiscal year.
Gross Margins.Home gross margins were 18.4% for the three months ended February 28, 2007, compared with 23.8% in the same period a year ago. The decline in home gross margins for the three months ended February 28, 2007 as compared to the same period a year ago resulted from the use of increased sales incentives on home closings during the quarter and the recognition of $1.8 million in impairment losses on land owned in Atlanta.
Home gross margins were 17.8% for the nine months ended February 28, 2007, compared with 22.1% in the same period a year ago. The decline in home gross margins for the nine months ended February 28, 2007 as compared to the same period a year ago resulted from the use of increased sales incentives on home closings during the period and the recognition of $11.3 million in impairment losses on land owned, primarily in Phoenix, Tampa and Atlanta.
Future home gross margins may be impacted by, among other things, continued high levels of sales incentives and cancellations, increases in the costs of material and labor used to develop our land and to build our homes to the extent that market conditions prevent the recovery of increased costs through higher selling prices, adverse weather, the impact of changes in the demand for new homes in our markets and other general risk factors.
Sales & Marketing Expenses.Sales and marketing expenses, which include sales commissions, advertising, model expenses and other costs, totaled $7.9 million during the three-month period ended February 28, 2007, compared to $8.2 million in the three-month period ended February 28, 2006. The decrease of 3.7%, or $0.3 million, was primarily due to decreased commissions related to lower home closings in many of the Company’s markets as compared to the same period in the prior fiscal year.
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Sales and marketing expenses totaled $25.1 million during the nine months ended February 28, 2007, compared to $22.9 million in the nine months ended February 28, 2006. The increase of 9.6%, or $2.2 million, was primarily due to increased advertising expenses in many of the Company’s markets due to increases in marketing efforts by the Company in response to recent industry conditions.
General & Administrative Expenses.General and administrative expenses, including related party expenses, totaled $9.4 million in the three months ended February 28, 2007, compared with $11.1 million in the three months ended February 28, 2006. The reduction is a result of the combination of overhead reductions in all of our markets and reduced bonus accruals on lower levels of income. General and administrative expenses, including related party expenses, totaled $30.6 million in the nine months ended February 28, 2007, compared with $29.3 million in nine months ended February 28, 2006. The increase of $1.3 million represents a 4.4% growth in these costs. These costs were driven primarily by the investment in start-up operations in Tampa and Denver offset in part by cost savings from recent staff reductions.
Net Income.As compared to the three month period ended February 28, 2006, net income in the three months ended February 28, 2007, decreased 64.5% or $11.2 million. The decrease resulted primarily from the reduction in homes closed and the income derived from those home closings, the decrease in land sale income as a result of the Company having identified fewer parcels of land and finished lots that did not fit with its home development program during the three months ended February 28, 2007 as compared to the same period in fiscal year 2006 and the recognition of $1.8 million in impairment losses on land owned. Total sales and marketing expenses decreased $0.3 million due primarily to decreased commissions related to lower home closings. General and administrative and related party expenses decreased $1.7 million during the period. Earnings from unconsolidated entities, which represent earnings primarily from the Company’s development joint ventures and the Company’s mortgage and title joint ventures in which the Company has 49% ownership interests, increased $0.3 million due primarily to increased earnings from the Company’s mortgage joint venture.
As compared to the nine month period ended February 28, 2006, net income in the nine months ended February 28, 2007, decreased 57.1% or $27.6 million. The decrease resulted primarily from the decrease in home closings this fiscal year as compared to fiscal year 2006, the decrease in land sale income and the recognition of $11.3 million in impairment losses on land owned. Total sales and marketing expenses increased $2.2 million due primarily to an increase in advertising expenses. General and administrative and related party expenses increased $1.3 million during the period as a result of the growth in operations in the Company’s newer divisions of Denver and Tampa. Earnings from unconsolidated entities, which represent earnings primarily from the Company’s development joint ventures and the Company’s mortgage and title joint ventures in which the Company has 49% ownership interests, increased $0.5 million due primarily to increased earnings from the Company’s mortgage joint venture.
The following table summarizes total revenue by reportable segment for the three months ended February 28, 2007 and 2006 (dollars in thousands).
Three Months Ended | ||||||||||||||||
February 28, | Change | |||||||||||||||
2007 | 2006 | Amount | % | |||||||||||||
Total Revenues | ||||||||||||||||
Homebuilding | ||||||||||||||||
East | $ | 72,510 | $ | 72,590 | $ | (80 | ) | — | ||||||||
West | 56,875 | 84,931 | (28,056 | ) | -33 | % | ||||||||||
Total Homebuilding | 129,385 | 157,521 | (28,136 | ) | -18 | % | ||||||||||
Corporate | 41 | 52 | (11 | ) | -21 | % | ||||||||||
Consolidated | $ | 129,426 | $ | 157,573 | $ | (28,147 | ) | -18 | % | |||||||
Gross Profit | ||||||||||||||||
Homebuilding | ||||||||||||||||
East | $ | 14,177 | $ | 20,045 | $ | (5,868 | ) | -29 | % | |||||||
West | 9,681 | 17,839 | (8,158 | ) | -46 | % | ||||||||||
Total Homebuilding | 23,858 | 37,884 | (14,026 | ) | -37 | % | ||||||||||
Corporate | 41 | 51 | (10 | ) | -20 | % | ||||||||||
Consolidated | $ | 23,899 | $ | 37,935 | $ | (14,036 | ) | -37 | % | |||||||
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Three Months Ended | ||||||||||||||||
February 28, | Change | |||||||||||||||
2007 | 2006 | Amount | % | |||||||||||||
Homes Closed | ||||||||||||||||
Homebuilding | ||||||||||||||||
Atlanta | 114 | 156 | (42 | ) | -27 | % | ||||||||||
Orlando | 90 | 95 | (5 | ) | -5 | % | ||||||||||
Tampa | 28 | — | 28 | 100 | % | |||||||||||
East | 232 | 251 | (19 | ) | -8 | % | ||||||||||
Dallas | 89 | 135 | (46 | ) | -34 | % | ||||||||||
Houston | 81 | 105 | (24 | ) | -23 | % | ||||||||||
Phoenix | 40 | 61 | (21 | ) | -34 | % | ||||||||||
Denver | — | — | — | — | ||||||||||||
West | 210 | 301 | (91 | ) | -30 | % | ||||||||||
Total Homebuilding | 442 | 552 | (110 | ) | -20 | % | ||||||||||
Average sales price per home closed | ||||||||||||||||
Homebuilding | ||||||||||||||||
Atlanta | $ | 268 | $ | 235 | $ | 33 | 14 | % | ||||||||
Orlando | $ | 334 | $ | 303 | $ | 31 | 10 | % | ||||||||
Tampa | $ | 425 | $ | 303 | $ | 122 | 40 | % | ||||||||
East | $ | 313 | $ | 261 | $ | 52 | 20 | % | ||||||||
Dallas | $ | 240 | $ | 212 | $ | 28 | 13 | % | ||||||||
Houston | $ | 239 | $ | 228 | $ | 11 | 5 | % | ||||||||
Phoenix | $ | 393 | $ | 526 | $ | (133 | ) | -25 | % | |||||||
Denver | $ | — | $ | — | $ | — | — | |||||||||
West | $ | 269 | $ | 281 | $ | (12 | ) | -4 | % | |||||||
Total Homebuilding | $ | 292 | $ | 272 | $ | 20 | 7 | % | ||||||||
Homebuilding East:Revenues decreased slightly for the three months ended February 28, 2007 to $72.5 million from $72.6 million in the same period in the prior year. The decrease in revenues was primarily due to a decrease in land sales revenue from $7.0 million to $0.0 million and an 8% decrease in the number of homes closed, which was partially offset by a 20% increase in the average sales price of homes closed. Homes closed in Atlanta decreased 27% due to continued weakening in the demand for new homes in the market. Homes closed in Orlando decreased 5% and homes closed in Tampa increased because the division had its first closings during the fourth quarter of fiscal year 2006. Since land sales are incidental to the Company’s business of building and selling homes, the Company generally sells only parcels of land and finished lots that do not fit with its home development program. The decrease in land sales revenue of $7.0 million was a result of the Company not having identified any parcels of land and finished lots that did not fit with its home development program during the three months ended February 28, 2007.
Gross profit decreased $5.9 million, or 29%, for the three months ended February 28, 2007, compared to the same period in the prior year. Gross profit decreased for the three months ended February 28, 2007 primarily as a result of increased sales incentives offered to homebuyers, $1.8 million of inventory valuation adjustments in Atlanta during the quarter and a decrease in gross profit from land sales of $2.1 million. Gross margins were 19.6% for the three months ended February 28, 2007, compared to 27.6% for the same period in the prior year.
Homebuilding West:Revenues decreased 33% for the three months ended February 28, 2007 to $56.9 million from $84.9 million in the same period in the prior year. The decrease in revenues was primarily due to the 34% decrease in the number of homes closed in Dallas, the 23% decrease in the number of homes closed in Houston, and the 34% decrease in homes closed in Arizona. The average sales price of homes delivered decreased 25% in Phoenix due to a decrease in the number of homes closed in higher priced communities.
Gross profit decreased $8.2 million, or 46%, for the three months ended February 28, 2007, compared to the same period in the prior year. Gross profit decreased for the three months ended February 28, 2007 primarily as a result of increased sales incentives offered to homebuyers and an increase in gross profit from land sales of $0.2 million. Gross margins were 17.0% for the three months ended February 28, 2007, compared to 21.0% for the same period in the prior year.
The following table summarizes total revenue by reportable segment for the nine months ended February 28, 2007 and 2006 (dollars in thousands).
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Nine Months Ended | ||||||||||||||||
February 28, | Change | |||||||||||||||
2007 | 2006 | Amount | % | |||||||||||||
Total Revenues | ||||||||||||||||
Homebuilding | ||||||||||||||||
East | $ | 177,611 | $ | 193,002 | $ | (15,391 | ) | -8 | % | |||||||
West | 237,744 | 229,611 | 8,133 | 4 | % | |||||||||||
Total Homebuilding | 415,355 | 422,613 | (7,258 | ) | -2 | % | ||||||||||
Corporate | 150 | 157 | (7 | ) | -4 | % | ||||||||||
Consolidated | $ | 415,505 | $ | 422,770 | $ | (7,265 | ) | -2 | % | |||||||
Gross Profit | ||||||||||||||||
Homebuilding | ||||||||||||||||
East | $ | 36,081 | $ | 58,185 | $ | (22,104 | ) | -38 | % | |||||||
West | 41,457 | 44,686 | (3,229 | ) | -7 | % | ||||||||||
Total Homebuilding | 77,538 | 102,871 | (25,333 | ) | -25 | % | ||||||||||
Corporate | 150 | 157 | (7 | ) | -4 | % | ||||||||||
Consolidated | $ | 77,688 | $ | 103,028 | $ | (25,340 | ) | -25 | % | |||||||
Homes Closed | ||||||||||||||||
Homebuilding | ||||||||||||||||
Atlanta | 321 | 371 | (50 | ) | -13 | % | ||||||||||
Orlando | 246 | 239 | 7 | 3 | % | |||||||||||
Tampa | 39 | — | 39 | 100 | % | |||||||||||
East | 606 | 610 | (4 | ) | -1 | % | ||||||||||
Dallas | 336 | 366 | (30 | ) | -8 | % | ||||||||||
Houston | 278 | 325 | (47 | ) | -14 | % | ||||||||||
Phoenix | 220 | 175 | 45 | 26 | % | |||||||||||
Denver | — | — | — | — | ||||||||||||
West | 834 | 866 | (32 | ) | -4 | % | ||||||||||
Total Homebuilding | 1,440 | 1,476 | (36 | ) | -2 | % | ||||||||||
Average sales price per home closed | ||||||||||||||||
Homebuilding | ||||||||||||||||
Atlanta | $ | 280 | $ | 256 | $ | 24 | 9 | % | ||||||||
Orlando | $ | 295 | $ | 283 | $ | 12 | 4 | % | ||||||||
Tampa | $ | 388 | $ | — | $ | 388 | 100 | % | ||||||||
East | $ | 293 | $ | 266 | $ | 27 | 10 | % | ||||||||
Dallas | $ | 231 | $ | 217 | $ | 14 | 6 | % | ||||||||
Houston | $ | 224 | $ | 226 | $ | (2 | ) | 1 | % | |||||||
Phoenix | $ | 409 | $ | 434 | $ | (25 | ) | -6 | % | |||||||
Denver | $ | — | $ | — | $ | — | — | |||||||||
West | $ | 276 | $ | 264 | $ | 12 | 5 | % | ||||||||
Total Homebuilding | $ | 283 | $ | 265 | $ | 18 | 7 | % | ||||||||
Homebuilding East:Revenues decreased for the nine months ended February 28, 2007 to $177.6 million from $193.0 million in the same period in the prior year. The decrease in revenues was primarily due to a decrease in land sales revenue of $30.5 million and an 1% decrease in the number of homes closed which was partially offset by a 10% increase in the average sales price of homes closed. Homes closed in Atlanta decreased 13% due to continued weakening in the market. Homes closed in Orlando increased 3% and homes closed in Tampa increased because the division had its first closings during the fourth quarter of fiscal year 2006. Since land sales are incidental to the Company’s business of building and selling homes, the Company generally sells only parcels of land and finished lots that do not fit with its home development program. The decrease in land sales revenue of $30.5 million was a result of the Company not having identified any parcels of land and finished lots that did not fit with its home development program during the nine months ended February 28, 2007.
Gross profit decreased $22.1 million, or 38%, for the nine months ended February 28, 2007, compared to the same period in the prior year. Gross profit decreased for the nine months ended February 28, 2007 primarily as a result of increased sales incentives offered to homebuyers, $4.0 million of inventory valuation adjustments, and a decrease in gross profit from land sales of $16.1 million. Gross margins were 20.3% for the nine months ended February 28, 2007, compared to 25.3% for the same period in the prior year.
Homebuilding West:Revenues increased 4% for the nine months ended February 28, 2007 to $237.7 million from $229.6 million in the same period in the prior year. The increase in revenues was primarily due to an increase in land
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sales revenue of $7.2 million and a 26% increase in the number of homes closed in Phoenix, which was partially offset by decreases in the number of homes closed in Dallas and Houston. The average sales price of homes closed increased 6% and 1% in Dallas and Houston, respectively. The average sales price decreased 6% in Phoenix due to a decrease in the number of homes closed in higher priced communities.
Gross profit decreased $3.2 million, or 7%, for the nine months ended February 28, 2007, compared to the same period in the prior year. Gross profit decreased for the nine months ended February 28, 2007 primarily as a result of a decrease in the number of homes closed and increased sales incentives offered to homebuyers and $7.3 million of inventory valuation adjustments, which was partially offset by an increase in land sales gross profit of $4.8 million. Gross margins were 17.4% for the nine months ended February 28, 2007, compared to 19.5% for the same period in the prior year.
The following table summarizes net new home orders by reportable segment for the three and nine months ended February 28, 2007 and 2006.
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
February 28, | Change | February 28, | Change | |||||||||||||||||||||||||||||
2007 | 2006 | Amount | % | 2007 | 2006 | Amount | % | |||||||||||||||||||||||||
Net new home orders | ||||||||||||||||||||||||||||||||
Homebuilding | ||||||||||||||||||||||||||||||||
Atlanta | 72 | 103 | (31 | ) | -30 | % | 259 | 385 | (126 | ) | -33 | % | ||||||||||||||||||||
Orlando | 67 | 119 | (52 | ) | -44 | % | 141 | 313 | (172 | ) | -55 | % | ||||||||||||||||||||
Tampa | 18 | 23 | (5 | ) | -22 | % | 43 | 31 | 12 | 39 | % | |||||||||||||||||||||
East | 157 | 245 | (88 | ) | -36 | % | 443 | 729 | (286 | ) | -39 | % | ||||||||||||||||||||
Dallas | 99 | 139 | (40 | ) | -29 | % | 247 | 498 | (251 | ) | -50 | % | ||||||||||||||||||||
Houston | 80 | 115 | (35 | ) | -30 | 282 | 310 | (28 | ) | -9 | % | |||||||||||||||||||||
Phoenix | 97 | 91 | 6 | 7 | % | 176 | 292 | (116 | ) | -40 | % | |||||||||||||||||||||
Denver | — | — | — | — | — | — | — | — | ||||||||||||||||||||||||
West | 276 | 345 | (69 | ) | -20 | % | 705 | 1,100 | (395 | ) | -36 | % | ||||||||||||||||||||
Total Homebuilding | 433 | 590 | (157 | ) | -27 | % | 1,148 | 1,829 | (681 | ) | -37 | % | ||||||||||||||||||||
Cancellation rate | 26 | % | 20 | % | 6 | % | 31 | % | 18 | % | 13 | % |
The following table below sets forth information relating to backlog by reportable segment.
February 28, | May 31, | February 28, | ||||||||||
2007 | 2006 | 2006 | ||||||||||
Backlog (units) at end of period: | ||||||||||||
Homebuilding | ||||||||||||
Atlanta | 141 | 203 | 274 | |||||||||
Orlando | 238 | 343 | 446 | |||||||||
Tampa | 39 | 35 | 31 | |||||||||
East | 418 | 581 | 751 | |||||||||
Dallas | 201 | 290 | 363 | |||||||||
Houston | 173 | 169 | 193 | |||||||||
Phoenix | 165 | 209 | 380 | |||||||||
Denver | — | — | — | |||||||||
West | 539 | 668 | 936 | |||||||||
Total Homebuilding | 957 | 1,249 | 1,687 | |||||||||
Sales value of backlog at end of period (dollars in thousands) | ||||||||||||
Homebuilding | ||||||||||||
Atlanta | $ | 41,065 | $ | 54,790 | $ | 71,050 | ||||||
Orlando | 79,588 | 109,705 | 136,911 | |||||||||
Tampa | 14,516 | 13,852 | 11,298 | |||||||||
East | 135,169 | 178,347 | 219,259 | |||||||||
Dallas | 43,373 | 67,052 | 79,251 | |||||||||
Houston | 38,418 | 37,433 | 40,677 | |||||||||
Phoenix | 53,412 | 97,074 | 181,318 | |||||||||
Denver | — | — | — | |||||||||
West | 135,203 | 201,559 | 301,246 | |||||||||
Total Homebuilding | $ | 270,372 | $ | 379,906 | $ | 520,505 | ||||||
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February 28, | May 31, | February 28, | ||||||||||
2007 | 2006 | 2006 | ||||||||||
Active communities at end of period: | ||||||||||||
Homebuilding | ||||||||||||
Atlanta | 10 | 9 | 11 | |||||||||
Orlando | 7 | 7 | 7 | |||||||||
Tampa | 3 | 2 | 2 | |||||||||
East | 20 | 18 | 20 | |||||||||
Dallas | 12 | 13 | 15 | |||||||||
Houston | 9 | 12 | 11 | |||||||||
Phoenix | 8 | 8 | 8 | |||||||||
Denver | — | — | — | |||||||||
West | 29 | 33 | 34 | |||||||||
Total Homebuilding | 49 | 51 | 54 | |||||||||
Net New Home Orders and Backlog. Net new home orders for the three and nine months ended February 28, 2007, were 433 and 1,148, respectively, representing decreases of 26.6% and 37.2%, respectively, as compared to the same periods a year ago. The decrease in net new home orders resulted from the general slowdown that the homebuilding industry has experienced and continues to experience. This slowdown, which first impacted the Company during the third quarter of fiscal year 2006, has continued throughout the first nine months of fiscal year 2007 and into the fourth quarter of fiscal year 2007.
In addition, prospective homebuyers are taking more time in making home buying decisions given concerns about the direction of home prices and, in many cases, have experienced difficulty in selling their existing homes. The Company has responded to the slowdown in demand through increased incentives offered to its homebuyers and increased its marketing efforts to stimulate net new home orders and maintain homes in backlog. The increase in sales incentives has and will continue to negatively affect gross margins on home sales.
Net new home orders declined in each of our markets during the three months ended February 28, 2007 as compared to the same period in the prior fiscal year, with the exception of Phoenix which experienced an increase in orders of six homes. The overall decline in net new home orders was due in part to increases in our cancellation rate, as well as increases in competition resulting from increased supply of new and used homes for sale on the market. The Company has increased sales incentives and reduced sales prices in an effort to maintain existing backlog and improve the net new home order results.
Backlog as of February 28, 2007, was 957 orders, a decrease of 43.3% as compared to February 28, 2006 and a decrease of 23.4% as compared to May 31, 2006. The Company’s backlog of 957 orders represents approximately $270.4 million in sales value and a decrease in the sales value of backlog of $250.1 million or 48.0% at the end of the current period as compared to February 28, 2006, and a decrease of approximately $109.5 million or 28.8% compared to May 31, 2006. This backlog provides the Company with visibility towards future homes sales revenues, gross margins and earnings and enables the Company’s management to better plan for community development and supply purchases. However, gross margins and earnings could be affected by changes in the costs of raw materials used in construction of the Company’s homes. For example, increases in the costs of raw materials for homes in backlog would decrease the expected earnings on these homes upon closing.
The Company experienced a cancellation rate of gross new home orders in the three and nine months ended February 28, 2007, of 26% and 31%, respectively, compared to our historical cancellation rates in the 15% — 20% range. In some instances, homebuyers are permitted to cancel sales contracts if they are unable to close on the sale of their existing home, fail to qualify for mortgage financing or under certain other circumstances. The continued high level of cancellations in the marketplace has resulted from, among other things, tightened mortgage lending standards and a general reduction in the demand for new homes coupled with the exit of speculators from the new home market which has created a high level of supply of new and used homes on the market. Revenue is not recognized on net new home orders under sales contracts until the sales are closed and title passes to the new homeowners. The increase in the cancellation rate of gross new home orders has created uncertainty regarding the number of units in the Company’s backlog that will close under existing sales contracts during fiscal year 2007. We
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expect, assuming no additional significant change in market conditions or mortgage interest rates, to close approximately 40% — 50% of our backlog during the fourth quarter of fiscal year 2007.
Liquidity and Capital Resources
The Company’s principal uses of cash are land purchases, lot development and home construction. The Company funds its operations with cash flows from operating activities and/or borrowings under its senior unsecured credit facility. As the Company utilizes its capital resources and liquidity to fund the growth of its operations, the Company focuses on maintaining conservative balance sheet leverage ratios. The Company believes that it will be able to continue to fund its operations and future cash needs (including debt maturities) through a combination of cash flows from operating activities and its existing senior unsecured credit facility.
As of February 28, 2007, the Company’s ratio of total debt to total capitalization was 55.0%, compared to 51.5% as of May 31, 2006. Total debt to total capitalization consists of notes payable divided by total capitalization (notes payable plus members’ equity). Total debt to capitalization increased as a result of increased inventory levels due primarily to the development of land in all of our markets and to a lesser extent an increase in work in process resulting in the incurrence of debt during the nine months ended February 28, 2007.
Operating Cash Flow. During the nine months ended February 28, 2007, the Company generated approximately $2.9 million in cash from operating activities as a result of net income of $20.7 million, adjustment for non-cash impairment losses recognized of $11.3 million and decreases in accounts receivable of $11.6 million which were partially offset by a $36.9 million increase in spending on inventory supply for future growth and decreases in accounts payable of $10.3 million.
During the nine months ended February 28, 2006, the Company used approximately $73.0 million in cash from operating activities as a result of a $150.7 million increase in spending on inventory supply for future growth, which was partially offset by net income of $48.3 million and decreases in accounts receivable and increases in customer deposits and accounts payable.
Investing Cash Flow. Cash used in investing activities totaled $3.7 million for the nine months ended February 28, 2007 as compared to $9.6 million for the nine months ended February 28, 2006, which was due to a decrease of $2.3 million in investments in unconsolidated entities, as compared to the same period in the prior fiscal year, and a $3.5 million decrease in investments in property and equipment, as compared to the same period in the prior fiscal year.
Financing Cash Flow. Net cash provided by financing activities totaled $0.7 million in the nine months ended February 28, 2007. The Company incurred borrowings under its senior unsecured credit facility of $141.5 million, made repayments of amounts outstanding under its senior unsecured credit facility of $116.6 million and made distributions of $23.8 million to its members for the payment of federal and state income taxes and as general distributions of income.
Net cash provided by financing activities totaled $82.7 million in the nine months ended February 28, 2006. In September 2005, the Company issued $125 million aggregate principal amount of 9.5% Senior Subordinated Notes due 2015 in a private placement pursuant to Rule 144A promulgated under the Securities Act of 1933, as amended. Interest on the 9.5% Senior Subordinated Notes due 2015 is payable semiannually. The net proceeds of $121.3 million were used to repay amounts outstanding under the Company’s senior unsecured credit facility and to repay certain related party debt. Additionally, the Company incurred borrowings under its senior unsecured credit facility of $175.9 million and made a distribution of $25.1 million to its members for the payment of federal and state income taxes and as general distributions of income.
Senior Unsecured Credit Facility.In December 2005, the Company entered into an amended senior unsecured credit facility. The amended senior unsecured credit facility provides for up to $300.0 million of unsecured borrowings, subject to a borrowing base, and includes an accordion feature by which the Company may request, subject to certain conditions, an increase of the amended senior unsecured credit facility up to a maximum of $400.0 million. The amended senior unsecured credit facility provides for the issuance of up to $50.0 million in
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letters of credit. The maturity date of the amended senior unsecured credit facility was initially January 19, 2010. However, once during each fiscal year (i.e., June 1-May 31) the Company may request that the lenders extend the maturity date by an additional year. On January 10, 2007, the Company amended the senior unsecured credit facility to amend the definition of “EBITDA” contained therein to exclude certain non-cash gains and include certain non-cash losses or charges and to extend the maturity date to January 19, 2011, for 88.3%, or $265.0 million of the facility. On February 21, 2007, the Company obtained consent from an additional lender representing 5.0% or $15 million of the facility, to the extension of the senior unsecured credit facility to January 19, 2011. At February 28, 2007, the Company had outstanding under this facility borrowings of $87.8 million and available borrowing capacity of $189.6 million, net of letters of credit, as determined by borrowing base limitations defined in the agreement. The Company’s obligations under the amended senior unsecured credit facility are guaranteed by all of its subsidiaries and all of the holders of its membership interests. The amended senior unsecured credit facility contains a number of customary financial and operating covenants, including covenants requiring the Company to maintain a minimum consolidated tangible net worth; requiring the Company to maintain a ratio of consolidated total liabilities to adjusted net worth not in excess of 2.25x; requiring the Company to maintain an interest coverage ratio of at least 2.5x; limiting the principal amount of the Company’s secured debt to $50 million at any given time; limiting the net book value of the Company’s unimproved entitled land, land under development and finished lots to 150.0% of the Company’s adjusted tangible net worth; limiting the aggregate distributions by the Company and its subsidiaries in any fiscal year; restricting the Company’s ability to incur additional indebtedness; and restricting the Company’s ability to engage in mergers and consolidations and its ability to sell all or substantially all of its assets. The borrowings under the facility bear daily interest at rates based upon the London Interbank Offered Rate (LIBOR) plus a spread based upon the Company’s ratio of debt to adjusted tangible net worth. In addition to the stated interest rates, the revolving credit facility requires the Company to pay certain fees. The effective interest rate of the unsecured bank debt at February 28, 2007, was approximately 6.6%. As of and for the nine months ended February 28, 2007, the Company was in compliance with the covenants under this facility.
Because the Company has been in compliance with the covenants in its senior unsecured credit facility, these covenants have not had a material impact on its operations, financial condition and results of operations. However, in the future the Company’s ability to secure financing for its operations or otherwise pursue its business plan could be limited by these covenants, and if the Company is unable to obtain financing for its operations or otherwise pursue its business plan, its growth may be impaired and the Company’s revenues may decline.
9.5% Senior Subordinated Notes.In September 2005, the Company issued $125 million aggregate principal amount of 9.5% Senior Subordinated Notes due 2015 in a private placement pursuant to Rule 144A promulgated under the Securities Act of 1933, as amended. The net proceeds were used to repay amounts outstanding under the Company’s senior unsecured credit facility and to repay certain related party debt. In April 2006, the Company completed an offer to exchange all of the notes issued in September 2005 for an equal amount of 9.5% Senior Subordinated Notes due 2015, which were registered under the Securities Act of 1933. Interest on the notes is payable semiannually.
The indenture governing the 9.5% Senior Subordinated Notes due 2015 contains covenants that limit the Company’s ability and the ability of its subsidiaries to, among other things, incur additional indebtedness; pay dividends or make other distributions; make investments; sell assets; incur liens; enter into agreements restricting our subsidiaries’ ability to pay dividends; enter into transactions with affiliates; and consolidate, merge or sell all or substantially all of its assets. Unlike the senior unsecured credit facility, the financial covenants in the indenture governing the 9.5% Senior Subordinated Notes due 2015 primarily limit the Company’s ability to incur additional debt, make distributions or engage in other actions rather than require the Company to maintain certain financial ratios or levels. Consequently, the covenants in the indenture have not had a significant impact on the Company’s operations, financial condition and results of operations. However, in the future the Company’s ability to secure financing for its operations could be limited by these covenants, and if the Company is limited in its ability to obtain financing, its operations, financial condition and results of operations could be adversely affected.
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CRITICAL ACCOUNTING POLICIES
Our accounting policies have been chosen based upon current authoritative literature that collectively comprises GAAP for companies operating in the United States of America. In instances where alternative methods of accounting are permissible under GAAP, we have chosen the method that most appropriately reflects the nature of our business, the results of our operations and our financial condition, and have consistently applied those methods over each of the period presented in the financial statements.
Some of our critical accounting policies require the use of judgment in their application or require estimates of inherently uncertain matters. Although our accounting policies are in compliance with GAAP, a change in the facts and circumstances of the underlying transactions could significantly change the application of the accounting policies and the resulting financial statement impact. Except as described below, our critical accounting policies have not changed from those disclosed in our Annual Report on Form 10-K for the fiscal year ended May 31, 2006. For a full discussion of our critical accounting policies, please see our Form 10-K filed with the Securities and Exchange Commission on August 10, 2006.
Inventories and Cost of Sales.Finished inventories and land held for sale are stated at the lower of accumulated cost or fair value less cost to sell. Homebuilding projects and land held for development and construction are stated at cost unless facts and circumstances indicate that such cost would not be recovered from the undiscounted cash flows generated by future dispositions, after considering estimated cash flows associated with all future expenditures to develop the assets, including interest payments that will be capitalized as part of the cost of the asset. In this instance, such inventories are written down to estimated fair value, which is determined based on management’s estimate of future revenues and costs that would be considered by an unrelated buyer in determining the fair value of the asset. Due to uncertainties in the estimation process, it is possible that actual results could differ.
In addition to the costs of direct land acquisition, land development and home construction, inventory costs include interest, real estate taxes and indirect overhead costs incurred during development and home construction. We use the specific identification method for the purpose of accumulating home construction costs. Cost of sales for homes closed includes the specific construction costs of each home and all applicable land acquisition, land development and related costs (both incurred and estimated to be incurred) based upon the total number of homes expected to be closed in each project. Any changes to the estimated total development costs subsequent to the initial home closings in a project are generally allocated on a pro-rata basis to the remaining homes in the project.
When a home is closed, we generally have not yet paid and recorded all incurred costs necessary to complete the home. Each month we record as a liability and a charge to cost of sales the amount we estimate will ultimately be paid related to completed homes that have been closed as of the end of that month.
We compare our home construction budgets to actual recorded costs to estimate the additional costs remaining to be paid on each closed home. We monitor the accuracy of each month’s accrual by comparing actual costs incurred on closed homes in subsequent months to the amount we accrued. Although actual costs to be paid on closed homes in the future could differ from our current estimate, our method has historically produced consistently accurate estimates of actual costs to complete closed homes.
Each reporting period, we review all components of inventory in accordance with SFAS No. 144, which requires that if the sum of the undiscounted future cash flows expected to result from a community is less than the carrying value of the community, an asset impairment must be recognized in the consolidated financial statements as a component of cost of sales. The amount of the impairment is calculated by subtracting the fair value of the community from the carrying value of the community.
In order for management to assess the fair value of a community, certain assumptions must be made which are highly subjective and susceptible to change. We evaluate, among other things, the actual gross margins for homes closed and the gross margins for homes sold in backlog. This evaluation also includes critical assumptions with respect to future home sales prices, cost of sales, including levels of sales incentives and the monthly rate of sale, which are critical in determining the fair value of a community. If events and circumstances indicate that the carrying value of a community may not be recoverable, then the community is written down to its estimated fair value. Given the historical cyclicality of the homebuilding industry, the valuation of homebuilding inventories are sensitive to changes in economic conditions, such as interest rates and unemployment levels. Changes in these economic conditions could materially affect the projected home sales price, the level of sales incentives, the costs to develop land and construct the homes and the monthly rate of sale. Because of these potential changes in economic and market conditions in conjunction with the assumptions and estimates required of
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management in valuing homebuilding inventory, actual results could differ materially from management’s assumptions and may require material inventory impairments to be recorded in the future.
In accordance with SFAS No. 144, valuation adjustments are recorded on finished homes and land held for sale when events or circumstances indicate that the fair value, less costs to sell, is less than the carrying value.
The Company has recorded $1.8 million of impairment losses on land owned in Atlanta during the quarter ended February 28, 2007 as compared to no impairment losses in the comparable quarter of fiscal year 2006. The Company recorded impairment losses of $1.9 million in Atlanta, $1.4 million in Dallas, $5.9 million in Phoenix and $2.1 million in Tampa for the nine months ended February 28, 2007 as compared to no impairment losses for the nine month period ended February 28, 2006. The Company does not currently anticipate additional impairment losses to be recorded in the fourth quarter of fiscal year 2007 under current market conditions; however, should the level of sales incentives utilized to maintain sales absorption increase or the monthly rate of sales decrease, as well as changes in other factors affecting fair value, such as decreases in sales prices or increases in construction costs, additional impairment losses could occur in any or all of the Company’s markets.
OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE
CONTRACTUAL COMMITMENTS
The Company’s primary contractual cash obligations for its operations are payments under its debt agreements, lease payments under operating leases and purchase obligations with specific performance requirements under lot option purchase agreements. These lot option purchase agreements may require the Company to purchase land contingent upon the land seller meeting certain obligations. The Company expects to fund its contractual obligations in the ordinary course of business through its operating cash flows and senior unsecured credit facility. As of February 28, 2007, the Company’s contractual obligations have not changed materially from those reported in the footnotes to the Company’s audited consolidated financial statements for the fiscal year ended May 31, 2006 and as reported in the Company’s Form 10-K for the fiscal year then ended with the Securities and Exchange Commission on August 10, 2006.
In the ordinary course of its business, the Company enters into land and lot option purchase contracts with unaffiliated entities in order to procure land or lots for the construction of homes. Certain of such land and lot option purchase contracts contain specific performance provisions, which require the Company to purchase the land or lots subject to the contract upon satisfaction of certain conditions by the Company and the sellers. Under option purchase contracts without specific performance provisions the Company will fund a stated deposit in consideration for the right, but not the obligation, to purchase land or lots at a future point in time with predetermined terms.
Under option contracts without specific performance provisions, the Company’s liability is generally limited to the forfeiture of deposits, any letters of credit posted and any other nonrefundable amounts specified in the contracts. Amounts subject to forfeiture under option contracts without specific performance obligations, at February 28, 2007, aggregated approximately $3.7 million. The amounts, net of cash deposits, committed under all option contracts without specific performance provision at February 28, 2007 were $51.7 million.
The Company expects to exercise, subject to market conditions, substantially all of its option contracts without specific performance provisions. Various factors, some which are beyond the Company’s control, such as market conditions, weather conditions and the timing of the completion of development activities, can have a significant impact on the timing of option exercises.
Under the terms of the option purchase contracts, many of the Company’s option deposits are non-refundable. Under FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” as amended by FIN 46-R issued in December 2003 (“FIN 46R”), certain non-refundable deposits are deemed to create a variable interest in a variable interest entity under the requirements of FIN 46R. As such, certain of the Company’s option purchase contracts result in the acquisition of a variable interest in the entity holding the land parcel under option.
In applying the provisions of FIN 46R, the Company evaluates those land and lot option purchase contracts with variable interest entities to determine whether the Company is the primary beneficiary based upon analysis of the
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variability of the expected gains and losses of the entity. Based on this evaluation, if the Company is the primary beneficiary of an entity with which the Company has entered into a land or lot option purchase contract, the variable interest entity is consolidated.
The consolidation of these variable interest entities added $7.5 million, $6.4 million and $0.7 million in real estate not owned, liabilities related to real estate not owned and minority interests in real estate not owned, respectively, to the Company’s balance sheet at February 28, 2007 and added $14.3 million, $12.2 million and $1.8 million in real estate not owned, liabilities related to real estate not owned and minority interests in real estate not owned, respectively, to the Company’s balance sheet at May 31, 2006.
The Company participates in a number of land development entities with equity investments of 50% or less and does not have a controlling interest. These land development entities are typically entered into with developers, other homebuilders and related parties to develop finished lots for sale to the members of the entities and other third parties. The Company accounts for its interest in these entities under the equity method. The Company’s share of profits from these entities are deferred and treated as a reduction of the cost basis of land purchased from the entity. The land development entities with unrelated parties typically obtain secured acquisition and development financing. In some instances, the entity partners have provided varying levels of guarantees of debt of the unconsolidated entities. These repayment guarantees require the Company to repay its share of the debt of unconsolidated entities in the event the entity defaults on its obligations under the borrowings. The Company had repayment guarantees of $1.5 million and $3.6 million at February 28, 2007 and May 31, 2006, respectively.
Cautionary Statements Regarding Forward-looking Information
This report contains forward-looking statements. These forward-looking statements represent the Company’s expectations or beliefs concerning future events, and no assurance can be given that the results described in this report will be achieved. These forward-looking statements can generally be identified by the use of statements that include words such as “estimate,” “project,” “believe,” “expect,” “anticipate,” “intend,” “plan,” “foresee,” “likely,” “will,” “goal,” “target” or other similar words or phrases. All forward-looking statements are based upon information available to the Company on the date of this report.
These forward-looking statements are subject to risks, uncertainties and other factors, many of which are outside of the Company’s control, that could cause actual results to differ materially from the results discussed in the forward-looking statements, including, among other things, the matters discussed in this report in the sections captioned Overview and Financial Condition and Liquidity. Other factors, risks and uncertainties that could cause actual results to differ materially from the results discussed in the forward-looking statements include but are not limited to:
Ø | economic changes nationally or in the Company’s local markets; | ||
Ø | volatility of mortgage interest rates and inflation; | ||
Ø | increased competition; | ||
Ø | shortages of skilled labor or raw materials used in the production of houses; | ||
Ø | increased prices for labor, land and raw materials used in the production of houses; | ||
Ø | increased land development costs on projects under development; | ||
Ø | decreased values for land underlying land option agreements or owned by the Company; | ||
Ø | the cost and availability of insurance, including the availability of insurance for the presence of mold; | ||
Ø | the impact of construction defect and home warranty claims; | ||
Ø | any delays in reacting to changing consumer preferences in home design; | ||
Ø | changes in consumer confidence; |
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Ø | delays in land development or home construction resulting from adverse weather conditions; | ||
Ø | potential delays or increased costs in obtaining necessary permits as a result of changes to, or complying with, laws, regulations or governmental policies, including environmental laws, regulations and policies; or | ||
Ø | terrorist acts and other acts of war. |
Any forward-looking statement speaks only as of the date on which such statement is made, and, except as required by law, the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time and it is not possible for the Company’s management to predict all such factors.
Item 3.Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Sensitivity
The Company is exposed to a number of market risks in the ordinary course of business. Our primary market risk exposure for financial instruments relates to fluctuations in interest rates. We do not believe our exposure in this area is material to cash flows or earnings. From time to time, the Company has entered into interest rate swap agreements to manage interest costs and hedge against risks associated with fluctuating interest rates with respect to floating rate debt, however, as of February 28, 2007, the Company has not entered into any interest rate swap agreements. The Company does not enter into or hold derivatives for trading or speculative purposes. As of February 28, 2007, the Company had a total of $87.8 million of floating rate debt outstanding under our senior unsecured credit facility, and borrowings under that facility generally bear interest based on an applicable margin plus LIBOR or an alternate base rate.
Exchange Rate Sensitivity
All of the Company’s revenue and expenses are denominated in U.S. dollars. As a result, the Company does not experience foreign exchange gains or losses.
Item 4.Controls and Procedures
The Company’s Chief Executive Officer and Chief Financial Officer, with the assistance of management, have evaluated the Company’s disclosure controls and procedures as of February 28, 2007, and based upon that evaluation have concluded that the Company’s disclosure controls and procedures were effective, as of February 28, 2007, to provide reasonable assurance that information the Company is required to disclose in reports that the Company files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported as and when required.
Further, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective for purposes of ensuring that information required to be disclosed in reports filed by us under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, in a manner to allow timely decisions regarding the required disclosure.
It should be noted, however, that a control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues within the Company have been detected. Furthermore, the design of any control system is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how unlikely. Because of these inherent limitations in a cost-effective control system, misstatements or omissions due to error or fraud may occur and not be detected.
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There has been no change in our internal control over financial reporting that occurred during the third fiscal quarter of 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
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PART II: OTHER INFORMATION
Item 1.Legal Proceedings
From time to time we are involved in various routine legal proceedings incidental to our business. We believe that none of these matters, some of which are covered by insurance, will have a material adverse impact upon our consolidated financial statements as a whole if decided against us.
Item 1A.Risk Factors
The information set forth below updates, and should be read in conjunction with, the risk factors previously disclosed in Item 1A of Part I of our Annual Report on Form 10-K for the fiscal year ended May 31, 2006.
The homebuilding industry historically has been cyclical and is now experiencing the first downturn in a number of years. Continuation of this downturn may result in continuing reduction in our operating revenues and lower net income.
The housing industry historically has been cyclical and has been affected significantly by adverse changes in consumer confidence levels and prevailing general and local economic conditions, including interest rate levels. These changes in economic conditions have in the past resulted in more caution on the part of potential purchasers of our homes and consequently resulted in a decline in our home sales. Beginning in 2006, the homebuilding industry began experiencing the first downturn in a number of years and it has continued into 2007 resulting in a significant decline in demand for newly built homes in many of our markets. Significant drivers of these economic conditions in this cycle have involved, among other things, a decline in demand in our markets due to changes in consumer confidence in the real estate market, increased inventory of new and used homes for sale and resulting increases in cancellation rates in most of our markets, pricing pressures resulting from the imbalance between supply and demand and the recent collapse of the sub-prime lending industry that financed a significant number of home sales over the last four years. These factors have had an impact on our operating performance, and have caused our operating revenues to decline. We have no basis for predicting how long demand and supply will remain out of balance in our markets and whether, once the market stabilizes, sales volumes or pricing will return to prior levels. While the factors discussed above may have an impact on the homebuilding industry generally, if they continue to put pressure on the homebuilding industry they may have a more significant impact on us compared to certain of our competitors because our operations are concentrated in fewer geographic markets.
Item 6.Exhibits
(A) Exhibits
Exhibit | ||||
Number | Document | |||
31.1 | — | Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31.2 | — | Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
32.1 | — | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
32.2 | — | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this amendment to be signed on its behalf by the undersigned thereunto duly authorized.
Ashton woods usa, l.l.c. (Registrant) | ||||||
By: | /s/Robert Salomon | |||||
Chief Financial Officer |
Date: April 16, 2007
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INDEX TO EXHIBITS
Exhibit | ||||
Number | Document | |||
31.1 | — | Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
31.2 | — | Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
32.1 | — | Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||
32.2 | — | Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
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