SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the Quarterly Period Ended June 30, 2005
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
0-23270
Commission File Number
Dominion Homes, Inc.
(Exact name of registrant as specified in its charter)
| Ohio | 31-1393233 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) |
5000 Tuttle Crossing Blvd, Dublin, Ohio
(Address of principal executive offices)
43016-5555
(Zip Code)
(614) 356-5000
(Registrant’s Telephone Number, Including Area Code)
Not Applicable
(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. Yes x No ¨
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act) Yes x No ¨
Number of common shares outstanding as of July 31, 2005: 8,254,115
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Dominion Homes, Inc.
Consolidated Balance Sheets
(In thousands, except share information)
June 30, 2005 | December 31, 2004 | |||||||
| (unaudited) | ||||||||
| Assets | ||||||||
Cash and cash equivalents | $ | 7,497 | $ | 6,710 | ||||
Accounts receivable: | ||||||||
Trade | 1,160 | 1,080 | ||||||
Due from financial institutions for residential closings | 4,259 | 3,441 | ||||||
Real estate inventories: | ||||||||
Land and land development costs | 304,086 | 307,682 | ||||||
Homes under construction | 101,555 | 102,224 | ||||||
Land held for sale | 17,129 | 3,726 | ||||||
Other | 3,669 | 2,887 | ||||||
Total real estate inventories | 426,439 | 416,519 | ||||||
Prepaid expenses and other | 8,062 | 6,503 | ||||||
Deferred income taxes | 1,534 | 2,685 | ||||||
Property and equipment, at cost | 14,785 | 19,357 | ||||||
Less accumulated depreciation | (8,334 | ) | (11,815 | ) | ||||
Net property and equipment | 6,451 | 7,542 | ||||||
Total assets | $ | 455,402 | $ | 444,480 | ||||
| �� | ||||||||
| Liabilities and Shareholders’ Equity | ||||||||
Liabilities: | ||||||||
Accounts payable | $ | 19,274 | $ | 9,317 | ||||
Deposits on homes under contract | 1,995 | 1,223 | ||||||
Accrued liabilities | 26,445 | 44,846 | ||||||
Note payable, banks | 206,389 | 194,378 | ||||||
Term debt | 8,709 | 5,819 | ||||||
Total liabilities | 262,812 | 255,583 | ||||||
Commitments and contingencies | ||||||||
Shareholders’ equity: | ||||||||
Common shares, without stated value, 12,000,000 shares authorized, 8,532,161 shares issued and 8,241,615 shares outstanding on June 30, 2005 and 8,517,061 shares issued and 8,226,515 shares outstanding on December 31, 2004 | 64,447 | 64,875 | ||||||
Deferred compensation | (1,391 | ) | (2,144 | ) | ||||
Retained earnings | 131,627 | 128,466 | ||||||
Accumulated other comprehensive income | 793 | 586 | ||||||
Treasury stock, at cost (290,546 shares at June 30, 2005 and 290,546 shares at December 31, 2004) | (2,886 | ) | (2,886 | ) | ||||
Total shareholders’ equity | 192,590 | 188,897 | ||||||
Total liabilities and shareholders’ equity | $ | 455,402 | $ | 444,480 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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Dominion Homes, Inc.
Consolidated Statements of Operations
(In thousands, except share and per share amounts)
(Unaudited)
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||
Revenues | $ | 105,207 | $ | 148,181 | $ | 197,850 | $ | 263,853 | ||||
Cost of real estate sold | 81,776 | 115,425 | 154,860 | 202,849 | ||||||||
Gross profit | 23,431 | 32,756 | 42,990 | 61,004 | ||||||||
Selling, general and administrative | 17,244 | 20,087 | 33,292 | 38,797 | ||||||||
Income from operations | 6,187 | 12,669 | 9,698 | 22,207 | ||||||||
Interest expense | 2,927 | 2,178 | 5,483 | 3,791 | ||||||||
Income before income taxes | 3,260 | 10,491 | 4,215 | 18,416 | ||||||||
Provision for income taxes | 741 | 3,852 | 1,054 | 6,739 | ||||||||
Net income | $ | 2,519 | $ | 6,639 | $ | 3,161 | $ | 11,677 | ||||
Earnings per share | ||||||||||||
Basic | $ | 0.31 | $ | 0.83 | $ | 0.39 | $ | 1.47 | ||||
Diluted | $ | 0.31 | $ | 0.81 | $ | 0.39 | $ | 1.43 | ||||
Weighted average shares outstanding | ||||||||||||
Basic | 8,054,648 | 7,973,456 | 8,049,844 | 7,967,334 | ||||||||
Diluted | 8,203,815 | 8,198,251 | 8,206,933 | 8,160,487 | ||||||||
The accompanying notes are an integral part of the consolidated financial statements.
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Dominion Homes, Inc.
Consolidated Statement of Changes in Shareholders’ Equity
(In thousands)
(Unaudited)
| Common Shares | Deferred Compensation | Retained Earnings | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Total | ||||||||||||||||||||
| Liability | Trust Shares | ||||||||||||||||||||||||
Balance, December 31, 2004 | $ | 64,875 | $ | (1,057 | ) | $ | (1,087 | ) | $ | 128,466 | $ | 586 | $ | (2,886 | ) | $ | 188,897 | ||||||||
Net income | 3,161 | 3,161 | |||||||||||||||||||||||
Unrealized hedging gain, net of deferred taxes of $(99) | 207 | 207 | |||||||||||||||||||||||
Comprehensive income | 3,368 | ||||||||||||||||||||||||
Shares awarded | 35 | 35 | |||||||||||||||||||||||
Exercise of stock options | 37 | 37 | |||||||||||||||||||||||
Issuance of restricted share award | 46 | (46 | ) | — | |||||||||||||||||||||
Change in value and vesting of restricted share awards | (546 | ) | 771 | 225 | |||||||||||||||||||||
Deferred compensation | (49 | ) | 77 | 28 | |||||||||||||||||||||
Balance, June 30, 2005 | $ | 64,447 | $ | (381 | ) | $ | (1,010 | ) | $ | 131,627 | $ | 793 | $ | (2,886 | ) | $ | 192,590 | ||||||||
The accompanying notes are an integral part of the consolidated financial statements.
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Dominion Homes, Inc.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Six Months Ended June 30, | ||||||||
| 2005 | 2004 | |||||||
Cash flows from operating activities: | ||||||||
Net income | $ | 3,161 | $ | 11,677 | ||||
Adjustments to reconcile net income to cash used in operating activities: | ||||||||
Depreciation and amortization | 1,954 | 1,995 | ||||||
Net loss on impaired real estate inventories | 2,398 | 231 | ||||||
Gain on sale of land | (824 | ) | — | |||||
Loss on disposal of fixed assets | 161 | 3 | ||||||
Issuance of common shares for compensation | 35 | 78 | ||||||
Deferred income taxes | 1,052 | 443 | ||||||
Changes in assets and liabilities: | ||||||||
Accounts receivable | (898 | ) | (3,114 | ) | ||||
Real estate inventories | (20,324 | ) | (97,715 | ) | ||||
Prepaid expenses and other | (1,412 | ) | 644 | |||||
Accounts payable | 9,957 | 1,969 | ||||||
Deposits on homes under contract | 772 | 1,429 | ||||||
Accrued liabilities | (5,918 | ) | 5,498 | |||||
Net cash used in operating activities | (9,886 | ) | (76,862 | ) | ||||
Cash flows from investing activities: | ||||||||
Purchase of property and equipment | (1,189 | ) | (725 | ) | ||||
Proceeds from sale of property | 840 | — | ||||||
Net cash used in investing activities | (349 | ) | (725 | ) | ||||
Cash flows from financing activities: | ||||||||
Payments on note payable banks | (45,839 | ) | (61,630 | ) | ||||
Proceeds from note payable banks | 57,850 | 145,035 | ||||||
Payments on term debt | (455 | ) | (1,609 | ) | ||||
Payments of financing fees | (100 | ) | (250 | ) | ||||
Payments on capital lease obligations | (471 | ) | (715 | ) | ||||
Proceeds from issuance of common shares | 37 | 210 | ||||||
Net cash provided by financing activities | 11,022 | 81,041 | ||||||
Net change in cash and cash equivalents | 787 | 3,454 | ||||||
Cash and cash equivalents, beginning of period | 6,710 | 5,025 | ||||||
Cash and cash equivalents, end of period | $ | 7,497 | $ | 8,479 | ||||
Supplemental disclosures of cash flow information: | ||||||||
Interest paid (net of amounts capitalized) | $ | 3,411 | $ | 2,062 | ||||
Income taxes paid | $ | 2,278 | $ | 10,249 | ||||
Land acquired by seller financing | $ | 3,619 | $ | 910 | ||||
The accompanying notes are an integral part of the consolidated financial statements.
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DOMINION HOMES, INC.
Notes to the Consolidated Financial Statements
(Unaudited)
1.Basis of Presentation
The accompanying unaudited consolidated financial statements of Dominion Homes, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The December 31, 2004 balance sheet data were derived from audited financial statements but do not include all disclosures required by accounting principles generally accepted in the United States of America. These consolidated financial statements should be read in conjunction with the December 31, 2004 audited consolidated financial statements contained in the Annual Report on Form 10-K for the year ended December 31, 2004.
The financial information included herein reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The results of operations for the three and six months ended June 30, 2005 are not necessarily indicative of the results of operations to be expected for the full year. Certain prior year amounts have been reclassified to conform to the 2005 presentation.
2.Stock-Based Compensation
The Company accounts for its stock option plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees (“APB 25”), and related interpretations. No stock-based employee compensation cost is reflected in net income since all stock option awards granted under the plans have an exercise price equal to the market value of the underlying common shares of Dominion Homes, Inc. on the grant date.
Compensation cost related to restricted share awards is determined at the date of grant and adjusted for changes in the fair value of the restricted shares until the performance criteria, if any, are met. The fair value of restricted share awards is initially recorded as unearned compensation expense and is amortized on a straight-line basis over the vesting period. The unearned compensation expense related to such awards was approximately $1,329,000 at June 30, 2005 and approximately $2,055,000 at December 31, 2004, and is reflected as a reduction of shareholders’ equity.
Pro forma information regarding net income and earnings per share is required under Financial Accounting Standards Board (the “FASB”) Statement No. 123,Accounting for Stock-Based Compensation (“FAS 123”), as amended by FASB Statement No. 148,Accounting for Stock-Based Compensation – Transition and Disclosure. This information is required to be determined as if the Company had accounted for its stock options granted after December 31,
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1994, under the fair value method prescribed by that statement. The following table illustrates the effects on net income and earnings per share if the Company had accounted for stock option awards using the fair value method, as required by FAS 123, for the periods indicated:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Net income, as reported | $ | 2,519,000 | $ | 6,639,000 | $ | 3,161,000 | $ | 11,677,000 | ||||||||
Add stock based compensation expense (benefit) included in reported net income, net of related tax effects | 172,000 | (106,000 | ) | 169,000 | 355,000 | |||||||||||
Deduct stock-based compensation expense determined using the fair value method, net of related tax effects | (421,000 | ) | (102,000 | ) | (492,000 | ) | (607,000 | ) | ||||||||
Pro forma net income | $ | 2,270,000 | $ | 6,431,000 | $ | 2,838,000 | $ | 11,425,000 | ||||||||
Earnings per share | ||||||||||||||||
Basic as reported | $ | 0.31 | $ | 0.83 | $ | 0.39 | $ | 1.47 | ||||||||
Basic pro forma | $ | 0.28 | $ | 0.81 | $ | 0.35 | $ | 1.43 | ||||||||
Diluted as reported | $ | 0.31 | $ | 0.81 | $ | 0.39 | $ | 1.43 | ||||||||
Diluted pro forma | $ | 0.28 | $ | 0.78 | $ | 0.35 | $ | 1.40 | ||||||||
The Company granted 15,000 stock options during the three months ended June 30, 2005 and 35,000 stock options during the three months ended June 30, 2004.
In December 2004, the FASB issued Statement No. 123R,Share-Based Payment(“FAS 123R”). FAS 123R is a revision of FAS 123 and it supercedes APB No. 25. FAS 123R requires all share-based payments, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure will not be an alternative. FAS 123R is effective for all annual periods beginning after June 15, 2005, and thus will become effective for the Company beginning January 1, 2006.
In March 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”). SAB 107 provides interpretations expressing the views of the SEC regarding the interaction between FAS 123R and certain SEC rules and regulations, and provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. SAB 107 does not modify any of FAS 123R’s conclusions or requirements. The Company has performed a preliminary assessment of the impact of adopting FAS 123R and the guidance provided by SAB 107. Based on this evaluation, the Company does not expect the adoption of FAS 123R to have a significant impact on its consolidated financial position or results of operations.
3.Capitalized Interest
The Company capitalizes interest costs during the land development and home construction periods. Capitalized interest is included in land and land development costs and homes under construction in the Consolidated Balance Sheets. Capitalized interest related to the
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costs of land development and home construction is included in interest expense in the period for which the home is closed. Capitalized interest related to land under development and construction in progress was approximately $4,775,000 and approximately $4,598,000 at June 30, 2005 and December 31, 2004, respectively.
The summary of the total interest is as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Interest incurred | $ | 2,959,000 | $ | 2,380,000 | $ | 5,686,000 | $ | 4,457,000 | ||||||||
Interest capitalized | (1,086,000 | ) | (1,318,000 | ) | (2,123,000 | ) | (2,630,000 | ) | ||||||||
Interest expensed directly | 1,873,000 | 1,062,000 | 3,563,000 | 1,827,000 | ||||||||||||
Previously capitalized interest charged to interest expense | 1,054,000 | 1,116,000 | 1,920,000 | 1,964,000 | ||||||||||||
Total interest expense | $ | 2,927,000 | $ | 2,178,000 | $ | 5,483,000 | $ | 3,791,000 | ||||||||
4.Note Payable, Banks
On December 3, 2003, the Company entered into a Second Amended and Restated $250,000,000 Senior Unsecured Revolving Credit Facility (the “Facility”). The Facility was amended on June 30, 2004 to increase the amount of the Facility to $300,000,000. The Facility terminates on May 31, 2007, unless extended by mutual agreement. For a more detailed description of the Facility, see Note 7, Note Payable, Banks, in the Notes to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
As of June 30, 2005, the Company was in compliance with the Facility covenants and had approximately $50,200,000 available to borrow under the Facility, after adjustment for borrowing base limitations. Borrowing availability under the Facility could increase or decrease, depending on the Company’s use of the proceeds of borrowings under the Facility.
Amounts outstanding under the Facility were approximately $206,389,000 and $194,378,000 as of June 30, 2005 and December 31, 2004, respectively.
5.Derivative Instruments and Hedging Activities
The Company has entered into various interest rate swap agreements, which effectively convert variable interest rates to fixed interest rates. As of June 30, 2005, the Company had interest rate swap agreements with a notional value of $130,000,000 and a weighted average fixed interest rate of 3.3% plus a variable margin of 1.75%. The Company has designated and accounted for the interest rate swap agreements as cash flow hedges as described in Note 10, Derivative Instruments and Hedging Activities, in the Notes to the Consolidated Financial Statements contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.
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At June 30, 2005 and December 31, 2004, the Company had assets related to the interest rate swap agreements of approximately $1,286,000 and $981,000, respectively. These assets are included in prepaid expenses and other in the Consolidated Balance Sheets. For the six months ended June 30, 2005, the Company recorded other comprehensive income of approximately $207,000, net of tax, related to the increase in the value of the interest rate swap agreements.
During the three and six month periods ended June 30, 2005 and 2004, all interest rate swap agreements were considered effective hedges and there were not any gains or losses recognized in earnings for hedge ineffectiveness.
6.Earnings per Share
A reconciliation of the weighted average common shares used in basic and diluted earnings per share calculations is as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||
| 2005 | 2004 | 2005 | 2004 | |||||
Weighted average shares - basic | 8,054,648 | 7,973,456 | 8,049,844 | 7,967,334 | ||||
Common share equivalents | 149,167 | 224,795 | 157,089 | 193,153 | ||||
Weighted average shares - diluted | 8,203,815 | 8,198,251 | 8,206,933 | 8,160,487 | ||||
Common share equivalents include stock options and restricted common shares. Restricted common shares are included in common share equivalents when performance contingencies are achieved. As of June 30, 2005 and 2004, there were 60,000 and 95,000 restricted shares, respectively, for which the performance contingencies had not been achieved and which were excluded from the diluted earnings per share calculations. There were 183,000 and 180,500 stock options which were antidilutive and which have been excluded from the three months end and six months end diluted earnings per share calculations, respectively, as of June 30, 2005. There were no antidilutive stock options at June 30, 2004.
7.Warranty Costs
The Company provides a two-year limited warranty on materials and workmanship and a thirty-year warranty against major structural defects. An estimated amount of warranty cost is provided for each home at the date of closing based on historical warranty experience. Warranty (income) expense was approximately ($103,000) and $59,000 for the three month period ending on June 30, 2005 and 2004, respectively. Accrued warranty cost was approximately $2,326,000 and $3,186,000 at June 30, 2005 and 2004, respectively.
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A reconciliation of the changes in the warranty liability for the three and six months ended June 30, is as follows:
Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Balance at the beginning of the period | $ | 2,864,000 | $ | 3,573,000 | $ | 3,175,000 | $ | 3,990,000 | ||||||||
Accruals for warranties issued during the period | 334,000 | 460,000 | 622,000 | 834,000 | ||||||||||||
Accruals related to pre-existing warranties (including changes in estimates) | (437,000 | ) | (401,000 | ) | (709,000 | ) | (701,000 | ) | ||||||||
Settlements made (in cash or in kind) during the period | (435,000 | ) | (446,000 | ) | (762,000 | ) | (937,000 | ) | ||||||||
Balance at the end of the period | $ | 2,326,000 | $ | 3,186,000 | $ | 2,326,000 | $ | 3,186,000 | ||||||||
8.Income Taxes
The Company provides for income taxes in interim periods based on its annual estimated effective tax rate. The effective tax rate for the second quarter of 2005 is 22.7% compared to 36.7% for the second quarter of 2004. The decrease in the effective tax rate for the second quarter of 2005 is due primarily to an approximately $820,000 reduction in estimated tax liabilities due to favorable tax audit settlements. This decline was partially offset by an increase in the state tax rate in the second quarter of 2005 as a result of new tax legislation enacted in Ohio and Kentucky.
On October 22, 2004, the President signed into law the American Jobs Creation Act of 2004 (the “Job Creation Act”). The Job Creation Act provides a tax deduction of up to 9% (when fully phased in - 3% for 2005) on the lesser of qualified production activities, as defined in the Job Creation Act, or taxable income. In December 2004, the FASB issued Staff Position No. 109-1, Application of FASB Statement No. 109,Accounting for Income Taxes,to the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004 (“FSP 109-1”). The Company has performed a preliminary assessment of FSP 109-1 and guidance provided by the Job Creation Act and does not expect it to have a significant impact on its consolidated financial position or results of operations. The Company’s effective tax rate for the second quarter of 2005 was not affected by the Job Creation Act or any related guidance.
9.Legal Proceedings
The Company is involved in various legal proceedings, most of which arise in the ordinary course of business, and some of which are covered by insurance. In the opinion of the Company’s management, none of the claims relating to such proceedings will have a material adverse effect on the Company’s financial condition or results of operations.
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10.Land Purchase Commitments
At June 30, 2005, the Company had non-cancelable contractual obligations to purchase residential lots and unimproved land at an aggregate cost of approximately $3,192,000. The Company intends to purchase this land within the next year.
At June 30, 2005, the Company also had cancelable contractual obligations to purchase residential lots and unimproved land. Cancelable contractual obligations consist of options under which the Company has the right, but not the obligation, to purchase land or developed lots and contingent purchase contracts under which its obligation to purchase land is subject to the satisfaction of zoning, utility, environmental, title or other contingencies. At June 30, 2005, the Company had approximately $39,468,000 of cancelable contractual obligations for which the Company determined it is reasonably likely that it will complete the land or lot purchase. Of this amount, approximately $1,778,000 relates to good faith deposits on these contracts that are recorded in land and land development costs in the Consolidated Balance Sheet at June 30, 2005. An additional approximately $2,027,000 of related pre-acquisition and due diligence costs are recorded in land and land development costs related to these contractual obligations. In addition, approximately $1,650,000 of performance bonds and irrevocable letters of credit were outstanding as collateral for these contingent land purchase commitments at June 30, 2005.
At June 30, 2005, the Company was in the process of evaluating approximately $58,001,000 of additional cancelable contractual obligations for which it had not yet determined whether it is reasonably likely that it will complete the land or lot purchase. Of this amount, approximately $1,687,000 relates to good faith deposits on these contracts that are recorded in land and land development costs in the Consolidated Balance Sheet at June 30, 2005. An additional approximately $1,233,000 of related pre-acquisition and due diligence costs are recorded in land and land development costs related to these contractual obligations. At such time as the Company determines that the purchase of any such land or lots will not be completed, the Company will charge to earnings the good faith deposits and related due diligence costs associated with such land or lots.
In addition, as a result of the application of FASB Interpretation No. 46R,Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51(“FIN 46R”), at June 30, 2005 the Company consolidated approximately $4,505,000 of land subject to option contracts for which the Company is the primary beneficiary. Of this amount, approximately $3,230,000 relates to cancelable contractual obligations for which the Company has determined that it is reasonably likely that it will complete the land or lot purchase. In addition to the amounts consolidated per FIN 46R, at June 30, 2005, good faith deposits and related due diligence costs on these contracts were approximately $330,000. The remaining approximately $1,275,000 relates to cancelable contractual obligations for which the Company has not yet determined whether it is reasonably likely that it will complete the land or lot purchase. In addition to the amounts consolidated per FIN 46R, at June 30, 2005, good faith deposits and related due diligence costs on these contracts were approximately $142,000.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
We are a leading builder of high-quality homes in Central Ohio (primarily the Columbus Metropolitan Statistical Area) and Louisville, Kentucky. During 2004, we entered the Lexington, Kentucky market. Our customer-driven focus targets entry-level and move-up homebuyers. We offer a variety of homes that are differentiated by price, size, standard features and available options. Our homes range in price from approximately $110,000 to more than $350,000 and in size from approximately 1,000 to 3,500 square feet.
Net income for the three months ended June 30, 2005 was $2.5 million, or $0.31 per diluted share, compared to $6.6 million, or $0.81 per diluted share, for the three months ended June 30, 2004. The lower net income for the second quarter of 2005 is principally due to the delivery of 29.6% fewer homes. The Company delivered fewer homes during the second quarter of 2005 because of a lower number of sales contracts in backlog at the beginning of this quarter compared to the second quarter of 2004.
Revenues for the second quarter of 2005 were $105.2 million from the delivery of 548 homes, compared to $148.2 million from the delivery of 778 homes during the same period the previous year. Second quarter 2005 revenues included fee revenues from its mortgage financing services subsidiary of $1.3 million compared to $2.1 million for the second quarter of 2004. Also included in second quarter 2005 revenues are 20 model home sales, with a sales value of $3.2 million. These homes were subsequently leased back by the Company for use as sales models. The average delivery price of homes during the second quarter of 2005 was approximately $189,600 compared to $187,700 for the second quarter of 2004. The decrease in the number of homes delivered also impacted our gross profit, which declined $9.3 million during the second quarter of 2005 compared to the second quarter of 2004. Our gross profit margin remained consistent at 22.3% during the second quarter of 2005 compared to 22.1% during the second quarter of 2004. Included in gross profit for the second quarter of 2005 and 2004 were $1.4 million and $349,000, respectively, of write-offs primarily related to deposits and due-diligence costs incurred for land that the Company decided not to purchase. In addition, $824,000 of gain was recorded in gross profit in the second quarter of 2005 from land the Company sold.
Selling, general and administrative expenses declined by approximately $2.8 million for the three months ended June 30, 2005 as compared to the three months ended June 30, 2004, principally as a result of delivering fewer homes. Interest expense increased $749,000, principally as a result of a higher average interest rate. Our effective tax rate decreased to 22.7% for the second quarter of 2005 compared to 36.7% for the second quarter of 2004 primarily due to favorable tax audit settlements that occurred during the second quarter of 2005.
During the three months ended June 30, 2005, we sold 655 homes, with a sales value of $123.1 million, compared to 510 homes, with a sales value $98.9 million, during the three months ended June 30, 2004. Our backlog at June 30, 2005 was 887 sales contracts, with a sales value of $177.1 million, compared to a backlog of 1,067 sales contracts, with a sales value of $216.4 million, at June 30, 2004. We increased our active sales communities at June 30, 2005 to 63 from 56 at June 30, 2004.
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We expect that 2005 will be a profitable year, but that net income will be lower than in recent years. In the short-term, we remain focused on increasing our sales, delivering well-built homes, and reducing our excess developed lot supply. As we move through the year, we continue to analyze our strategy with respect to geographic growth, product development, and asset management.
Safe Harbor Statement under the Private Securities Litigation Act of 1995
We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 (the “PSLRA”). This Quarterly Report on Form 10-Q contains various “forward–looking statements” within the meaning of the PSLRA and other applicable securities laws. Such statements can be identified by the use of the forward-looking words “anticipate,” “estimate,” “project,” “believe,” “intend,” “expect,” “hope” or similar words. These statements discuss future expectations, contain projections regarding future developments, operations or financial conditions, or state other forward-looking information. These forward-looking statements involve various important risks, uncertainties and other factors which could cause our actual results for 2005 and beyond to differ materially from those expressed in the forward-looking statements. Certain of these important factors are described in our Annual Report on Form 10-K for the year ended December 31, 2004, and include the following risks and uncertainties:
| • | short and long term interest rates; |
| • | changes in governmental regulations; |
| • | employment levels and job growth; |
| • | availability and affordability of mortgage financing for homebuyers; |
| • | availability and cost of building lots; |
| • | availability of materials (including lumber) and labor; |
| • | fluctuating costs of materials and labor; |
| • | adverse weather conditions and natural disasters; |
| • | consumer confidence and housing demand; |
| • | competitive overbuilding; |
| • | changing demographics; |
| • | cost overruns; |
| • | changes in tax laws; |
| • | changes in local government fees; |
| • | availability and cost of rental property and resale prices of existing homes; and |
| • | other risks described in our reports and filings with the Securities and Exchange Commission. |
In addition, domestic terrorist attacks and the threat or the escalation of the United States’ involvement in international armed conflict may also adversely affect general economic conditions, consumer confidence and the homebuilding markets.
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Seasonality and Variability in Quarterly Results
We experience significant seasonality and quarter-to-quarter variability in our homebuilding activity. Historically, closings and related revenues usually increase in the second half of the year. We believe this seasonality reflects the tendency of homebuyers to shop for a new home in the spring with the goal of closing in the fall or winter. Weather conditions can also accelerate or delay the scheduling of closings.
The following table sets forth certain data for each of our last eight quarters:
| Three Months Ended | Revenues | Sales Contracts* | Closings | Backlog At Period End | |||||
| (in thousands) | (in units) | (in units) | (in units) | ||||||
| Sept. 30, 2003 | $ | 153,188 | 718 | 844 | 1,326 | ||||
| Dec. 31, 2003 | $ | 166,317 | 586 | 893 | 1,019 | ||||
| Mar. 31, 2004 | $ | 115,672 | 950 | 634 | 1,335 | ||||
| June 30, 2004 | $ | 148,181 | 510 | 778 | 1,067 | ||||
| Sept. 30, 2004 | $ | 162,623 | 598 | 820 | 845 | ||||
| Dec. 31, 2004 | $ | 115,494 | 392 | 605 | 632 | ||||
| Mar. 31, 2005 | $ | 92,643 | 626 | 478 | 780 | ||||
| June 30, 2005 | $ | 105,207 | 655 | 548 | 887 | ||||
| * | Net of cancellations. |
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Results of Operations
The following table sets forth, for the periods indicated, certain items from our Consolidated Statements of Operations expressed as percentages of total revenues, as well as certain operating data:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||
| 2005 | 2004 | 2005 | 2004 | |||||||||||||
Consolidated Statements of Operations Data (unaudited) | ||||||||||||||||
Revenues | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of real estate sold | 77.7 | 77.9 | 78.3 | 76.9 | ||||||||||||
Gross profit | 22.3 | 22.1 | 21.7 | 23.1 | ||||||||||||
Selling, general and administrative | 16.4 | 13.6 | 16.8 | 14.7 | ||||||||||||
Income from operations | 5.9 | 8.5 | 4.9 | 8.4 | ||||||||||||
Interest expense | 2.8 | 1.4 | 2.8 | 1.4 | ||||||||||||
Income before income taxes | 3.1 | 7.1 | 2.1 | 7.0 | ||||||||||||
Provision for income taxes | 0.7 | 2.6 | 0.5 | 2.6 | ||||||||||||
Net income | 2.4 | % | 4.5 | % | 1.6 | % | 4.4 | % | ||||||||
Operating Data (unaudited) | ||||||||||||||||
Homes: | ||||||||||||||||
Sales contracts, net of cancellations | 655 | 510 | 1,281 | 1,460 | ||||||||||||
Closings | 548 | 778 | 1,026 | 1,412 | ||||||||||||
Backlog at period end | 887 | 1,067 | 887 | 1,067 | ||||||||||||
Average sales price of homes closed during the period (in thousands) | $ | 190 | $ | 188 | $ | 190 | $ | 184 | ||||||||
Average sales value of homes in backlog at period end (in thousands) | $ | 200 | $ | 203 | $ | 200 | $ | 203 | ||||||||
Aggregate sales value of homes in backlog at period end (in thousands) | $ | 177,121 | $ | 216,407 | $ | 177,121 | $ | 216,407 | ||||||||
We include a home in “sales contracts” when a homebuyer signs our standard sales contract which requires a deposit and generally has no contingencies other than for purchaser financing or for the sale of an existing home, or both. We recognize revenue and cost of real estate sold at the time of closing. “Closings” or “deliveries” occur when ownership has transferred to the homebuyer. We include a home in “backlog” when a homebuyer signs our standard sales contract, but the closing has not occurred as of the end of the period.
Homes included in “sales contracts” in the foregoing table are net of cancellations. Most cancellations occur when homebuyers cannot qualify for financing. While most cancellations occur prior to the start of construction, some cancellations occur during the construction process.
We annually incur a substantial amount of indirect construction costs which are essentially fixed in nature. For purposes of quarterly financial reporting, we capitalize these indirect construction costs in real estate inventories based on the ratio of estimated annual
14
indirect construction costs to direct construction costs to be incurred. Thus, variations in construction activity may result in changes in the amount of indirect construction costs capitalized in ending real estate inventories and cause fluctuations in interim and annual gross profits.
Second Quarter 2005 Compared to Second Quarter 2004
Revenues. Revenues for the second quarter of 2005 were $105.2 million from the delivery of 548 homes, compared to $148.2 million from the delivery of 778 homes during the same period the previous year. Second quarter 2005 revenues included fee revenues from the Company’s mortgage financing services subsidiary of $1.3 million compared to $2.1 million for the second quarter of 2004. This decrease in fee revenues is principally due to providing mortgage financing services to 415, or approximately 76%, of our homebuyers during the second quarter of 2005 compared to 628, or approximately 80%, of our homebuyers during the second quarter of 2004. Also included in second quarter 2005 revenues are 20 model home sales, with a sales value of $3.2 million. These homes were subsequently leased back by the Company for use as sales models. The average delivery price of homes during the second quarter of 2005 was approximately $189,600 compared to $187,700 for the second quarter of 2004.
Gross Profit. Gross profit margin for the second quarter of 2005 remained consistent at 22.3% compared to 22.1% for the second quarter of 2004. Included in gross profit for the second quarter of 2005 and 2004 were $1.4 million and $349,000, respectively, of write-offs primarily related to deposits and due-diligence costs incurred for land that the Company decided not to purchase. In addition, $824,000 of gain was recorded in gross profit in the second quarter of 2005 from land that the company sold.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased to $17.2 million for the three months ended June 30, 2005 compared to $20.1 million for the three months ended June 30, 2004, principally as a result of delivering fewer homes. As a percentage of revenues, selling general and administrative expenses were 16.4% and 13.6%, respectively.
Interest Expense. Interest expense was $2.9 million for the second quarter of 2005 compared to $2.2 million for the second quarter of 2004. The average borrowings under our bank credit facility (the “Facility”) decreased to $203.8 million for the second quarter of 2005 compared to $204.3 million for the second quarter of 2004. The weighted average rate of interest on total borrowings increased to 5.5% for the second quarter of 2005 compared to 4.8% for the second quarter of 2004.
Provision for Income Taxes. Income tax expense for the second quarter of 2005 was $741,000 compared to $3.9 million for the second quarter of 2004. The Company provides for income taxes in interim periods based on its annual estimated effective tax rate. The effective tax rate for the second quarter of 2005 was 22.7% and 36.7% for the second quarter of 2004. The decrease in the effective income tax rate for the second quarter of 2005 was primarily due to an approximately $820,000 reduction of our estimated tax liabilities due to favorable tax audit settlements. This decline was partially offset by an increase in our state tax rate in the second quarter of 2005 as a result of new tax legislation enacted in Ohio and Kentucky.
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First Six Months 2005 Compared to First Six Months 2004
Revenues.Revenues for the first six months of 2005 were $197.8 million from the delivery of 1,026 homes, compared to $263.9 million from the delivery of 1,412 homes during the same period the previous year. Revenues for the first six months of 2005 included fee revenues from the Company’s mortgage financing services subsidiary of $2.3 million compared to $4.1 million for the first six months of 2004. This decrease in fee revenues is principally due to providing mortgage financing services to 745, or approximately 73%, of our homebuyers during the first six months of 2005 compared to 1,131, or approximately 80%, of our homebuyers during the first six months of 2004. Also included in revenues for the first six months of 2005 are 20 model home sales, with a sales value of $3.2 million. These homes were subsequently leased back by the Company for use as sales models. The average delivery price of homes during the first six months of 2005 was approximately $190,500 compared to $183,900 for the first six months of 2004.
Gross Profit. Gross profit margin for the first six months of 2005 decreased to 21.7% from 23.1% for the first six months of 2004. This decrease was primarily due to an increase in the cost of constructing our homes and higher lot costs. Included in gross profit for the first six months of 2005 and 2004 were $2.4 million and $230,000, respectively, of write-offs related to deposits and due-diligence costs incurred for land that the Company decided not to purchase. In addition, $824,000 of gain was recorded in gross profit in the second quarter of 2005 from land that the company sold.
Selling, General and Administrative Expenses.Selling, general and administrative expenses decreased to $33.3 million for the first six months of 2005 from $38.8 million for the first six months of 2004, principally as a result of delivering fewer homes. As a percentage of revenues, selling general and administrative expenses were 16.8% and 14.7%, respectively.
Interest Expense.Interest expense for the first six months of 2005 increased to $5.5 million from $3.8 million for the first six months of 2004. The average borrowings under the Facility increased to $201.9 million for the first six months of 2005 from $177.5 million for the first six months of 2004. The weighted average rate of interest on total borrowings for the first six months of 2005 was 5.3% compared to 5.0% for the first six months of 2004. Interest expense for the first six months of 2005 was also higher due to capitalizing less interest compared to the first six months of 2004.
Provision for Income Taxes.Income tax expense for the first six months of 2005 was $1.1 million compared to $6.7 million for the first six months of 2004. The Company provides for income taxes in interim periods based on its annual estimated effective tax rate. The effective tax rate was 25.0% for the first six months of 2005 and 36.6% for the first six months of 2004. The decrease in the effective tax rate for the first six months of 2005 was primarily due to an approximately $820,000 reduction of our estimated tax liabilities due to favorable tax audit settlements. This decline was partially offset by an increase in our state tax rate in the second quarter of 2005 as a result of new tax legislation enacted in Ohio and Kentucky.
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Liquidity and Capital Resources
Historically, our capital needs have depended on sales volume, asset turnover, land acquisition and inventory levels. Our traditional sources of capital have been internally generated cash, bank borrowings and seller financing. At times, we also have sold our common shares in the public market. We have incurred indebtedness in the past and expect to incur indebtedness in the future to fund our operations and our investment in land. We expect the cash flow from our sales in backlog and funds from our Facility to allow us to meet our short-term cash obligations. The primary reasons that we could require additional capital are expansion in our existing markets, expansion into new markets, expansion of our mortgage financing services subsidiary, or purchase of a homebuilding company. We believe that our current borrowing capacity and anticipated cash flows from operations should be sufficient to meet our liquidity needs during 2005.
Sources and Uses of Cash for the First Six Months of 2005 Compared to the First Six Months of 2004
During the first six months of 2005, $9.9 million of cash was used in our operating activities, including a net additional $17.1 million investment in our real estate inventories. We also purchased $1.2 million of property and equipment which was offset by $840,000 of proceeds from the sale of property and equipment.
During the first six months of 2004, we generated $20.6 million of cash flow from operations before expenditures on real estate inventories of $97.5 million. The $97.5 million increase in real estate inventories consisted of a $72.4 million increase in land and land development and other costs and an increase of $25.1 million in homes under construction. We invested significantly in land and land development to expand our presence in Central Ohio and Louisville, Kentucky and to enter the Lexington, Kentucky market. We used cash from operations together with borrowings under our Facility to finance the increase in real estate inventories.
Real Estate Inventories
We generally attempt to maintain a land inventory that is sufficient to meet our anticipated lot needs for the next five to seven years. We are currently evaluating our land holdings and may sell some of our land to third parties in order to better match our land inventory to our expected land needs.
At June 30, 2005, we owned lots or land that we estimate could be developed into approximately 15,388 lots, including 2,270 lots in Kentucky. Included in the 15,388 lots are 1,168 lots that we have determined no longer fit into our sales plans and that we are offering for sale to other homebuilders or commercial developers.
At June 30, 2005, we controlled, through option agreements or contingent contracts expiring at various dates through 2014, land that we estimate could be developed into
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approximately 4,306 lots, including 208 lots in Kentucky. Based on our land review process, we have determined that we are reasonably likely to complete the purchase of these option agreements and contingent contracts. We hold other option agreements and contingent contracts that would allow us to develop additional lots that are not included in the totals above. For these contingent contracts, we have not yet determined if it is reasonably likely that we will complete the purchase. Consequently, we did not include these contingent agreements when estimating the total amount of land or number of lots that we control.
The following table sets forth an estimate of our land inventory as of June 30, 2005 and includes for land that we control under contingent contracts only that land we have determined that we are reasonably likely to complete the purchase. The table excludes the lots associated with cancelable contractual obligations for which we have not yet determined whether it is reasonably likely that we will complete the land or lot purchase. The estimated number of lots is based on our current development plans. As a result, the number of lots may change if our development plans change.
Land Inventory | Finished Lots | Lots Under Development | Unimproved Land Estimated Lots | Total Estimated Lots | ||||
Land we own: | ||||||||
Central Ohio | 1,602 | 1,513 | 9,039 | 12,154 | ||||
Kentucky | 463 | 514 | 1,089 | 2,066 | ||||
Land we control: | ||||||||
Central Ohio | 4,098 | 4,098 | ||||||
Kentucky | 208 | 208 | ||||||
Held for sale: | ||||||||
Central Ohio | 964 | 964 | ||||||
Kentucky | 204 | 204 | ||||||
Total Land Inventory | 2,065 | 2,027 | 15,602 | 19,694 | ||||
At June 30, 2005, we had 270 single-family inventory homes, including 63 in Kentucky, in various stages of construction, representing an aggregate investment of $21.9 million, compared to 290 single-family inventory homes, including 49 in Kentucky, in various stages of construction, representing an aggregate investment of $29.2 million, on June 30, 2004. We do not include inventory homes in sales or backlog.
Contractual Obligations
Note Payable, Banks. On December 3, 2003, we entered into a Second Amended and Restated $250.0 million Credit Agreement evidencing the Company’s Senior Unsecured Revolving Credit Facility (the “Facility”) that terminates on May 31, 2007. On June 30, 2004, the Facility was amended to increase the amount of the Facility to $300.0 million. For a more detailed description of the Facility, including restrictions it imposes on our business activities, see Note 7, Note Payable, Banks, in the Notes to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2004.
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The Facility provides for a variable rate of interest on our borrowings. The variable rate is the three month LIBOR rate plus a margin based on our interest coverage ratio that ranges from 1.75% to 2.50%, and is determined quarterly. The margin was 1.75% for the three months ended June 30, 2005. At June 30, 2005, we had fixed the interest rate on $130.0 million of our borrowings under the Facility by entering into interest rate swap contracts. Additional information regarding the interest rate swap contracts we have entered into is set forth under the heading “Quantitative and Qualitative Disclosures About Market Risk” in Item 3 below.
As of June 30, 2005, we were in compliance with the Facility covenants and had approximately $50.2 million of additional borrowings available under the Facility, after adjustment for borrowing base limitations. Borrowing availability under the Facility could increase or decrease, depending on our use of the proceeds of borrowings under the Facility. The borrowings outstanding under the Facility at June 30, 2005 were approximately $206.4 million.
Seller Financing. From time to time, we purchase land with seller financing. As of June 30, 2005, we held land for development that was partially financed with seller-provided term debt that had an outstanding balance of approximately $8.0 million.
Capital and Operating Leases.We believe the best use of our Facility is to finance real estate inventories and other investments in our homebuilding operations. Other assets that support our homebuilding operations are generally financed through capital and operating lease obligations. These assets include office facilities, model homes, vehicles and equipment. We analyze each lease and determine whether the lease is a capital lease, in which case the asset and related obligation is included on our Consolidated Balance Sheet, or an operating lease, in which case the asset and obligation is not included on our Consolidated Balance Sheet. We do not retain a residual financial interest in leased assets. Our capital lease obligations were approximately $706,000 at June 30, 2005. We believe our operating leases are properly classified as off balance sheet transactions. Our minimum rental commitment under such non-cancelable operating leases was approximately $14.1 million at June 30, 2005. For additional information on our leases, see Note 9, Operating Lease Commitments and Note 12, Related Party Transactions, in the Notes to the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the year ended December 31, 2004.
Land Purchase Commitments.On June 30, 2005, we had non-cancelable obligations to purchase residential lots and unimproved land at an aggregate cost of approximately $3.2 million. We intend to purchase this land within the next year.
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The following is a summary of our contractual obligations at June 30, 2005 (in thousands):
| Payments Due by Period | |||||||||||||||
Term obligations: | Total | Less than 1 year | 1 – 3 years | 3 – 5 years | After 5 years | ||||||||||
Note payable, banks | $ | 206,389 | $ | — | $ | 206,389 | $ | — | $ | — | |||||
Term debt | 8,003 | 3,533 | 850 | 3,620 | — | ||||||||||
Capital lease obligations | 706 | 662 | 44 | — | — | ||||||||||
Operating leases | 14,087 | 3,894 | 4,451 | 2,254 | 3,488 | ||||||||||
Land purchase commitments | 3,192 | 3,192 | — | — | — | ||||||||||
Total contractual cash obligations | $ | 232,377 | $ | 11,281 | $ | 211,734 | $ | 5,874 | $ | 3,488 | |||||
Off Balance Sheet Arrangements
Performance Bonds and Irrevocable Letters of Credit.We have caused to be issued performance bonds of approximately $48.1 million and irrevocable letters of credit of approximately $7.0 million at June 30, 2005. These instruments were issued to municipalities and other individuals to ensure performance and completion of certain land development activities and as collateral for contingent land purchase commitments. We do not anticipate incurring any liability with respect to these instruments.
Variable Interest Entities. From time to time, we selectively enter into joint ventures with other homebuilders to own and develop communities. Through the creation of joint venture partnerships and limited liability companies, these joint ventures engage in land development activities for the purpose of distributing developed lots to the partners in the joint venture. The partners in each joint venture acquire substantially all of the lots developed by the joint venture and fund the development costs in proportion to their equity interest. We receive our percentage interest in the lots developed in the form of capital distributions. At June 30, 2005, we had ownership interests in nine active joint ventures with ownership interests ranging from 33% to 50%.
Under certain circumstances, joint ventures may qualify as variable interest entities that are required to be consolidated within our financial statements. We have evaluated all of our existing joint venture arrangements and have determined that none of the joint ventures are variable interest entities that would require consolidation in our financial statements.
In managing our land inventories, we enter into land option and contingent purchase contracts with third parties to acquire unimproved land and developed lots that may qualify as variable interest entities. These contracts may be with individual land owners or entities that hold land for sale and generally require us to pay or issue one or a combination of the following: refundable deposits, non-refundable deposits and letters of credit. We have determined that certain of these contracts are with variable interest entities and that we are the primary beneficiary, as defined in FIN 46R, of approximately $4.5 million and $17.0 million of land subject to option contracts or contingent purchase contracts at June 30, 2005 and December 31,
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2004, respectively. These contracts were included in our Consolidated Balance Sheets at June 30, 2005 and December 31, 2004 even though we do not have legal title to the land subject to these contracts. Of the approximately $4.5 million at June 30, 2005, approximately $3.2 million relates to cancelable contracts for which we have determined that it is reasonably likely that we will complete the land or lot purchase. The remaining approximately $1.3 million relates to cancelable contractual obligations for which we have not yet determined whether it is reasonably likely that we will complete the land or lot purchase.
Cancelable contractual obligations consist of options under which we have the right, but not the obligation, to purchase land and contingent purchase contracts under which our obligation to purchase land is subject to the satisfaction of zoning, utility, environmental, title or other contingencies. We continually evaluate our cancelable contractual obligations to purchase unimproved land and developed lots. At June 30, 2005, we had approximately $39.5 million of cancelable contractual obligations for which we had determined it is reasonably likely that we will complete the land or lot purchase. Of this amount, approximately $1.8 million relates to good faith deposits on these contracts. An additional approximately $2.0 million of pre-acquisition and due diligence costs are also recorded at June 30, 2005, related to these contracts. In addition, approximately $1.7 million of performance bonds and irrevocable letters of credit were outstanding as collateral for these contingent land purchase commitments at June 30, 2005. Assuming that the contingencies are satisfied and that no other significant obstacles to development arise, we expect to purchase most of the residential lots and unimproved land that are subject to these cancelable contractual obligations within the next several years. We expect to fund our land acquisition and development obligations from internally generated cash and from the borrowing capacity under the Facility.
We are in the process of evaluating approximately $58.0 million of additional cancelable contractual obligations for which we have not yet determined whether it is reasonably likely that we will complete the land or lot purchase. Of this amount, approximately $1.7 million relates to good faith deposits on these contracts. An additional approximately $1.2 million of pre-acquisition and due diligence costs are also recorded at June 30, 2005, related to these contracts. Good faith deposits and related due diligence costs are charged to earnings when we determine the purchase of the land or lots will not be completed.
We own a 49.9% interest in a consolidated title insurance agency, Alliance Title Agency, Ltd., that provides closing services for our Central Ohio homes. At June 30, 2005, our investment in the title insurance agency was approximately $93,000. We determined that the title insurance agency is a variable interest entity and consolidated it with our other homebuilding operations.
In 1997, we entered into an agreement with an unaffiliated third party to sell and lease back certain model homes used as sales models, which agreement was amended on September 10, 2004. Under this agreement, at June 30, 2005, we had 20 model homes subject to a one-year lease which expires in June 2006, 20 model homes subject to a one-year lease which expires in September 2005 and four model homes subject to a month-to-month lease. The one-year leases may, at our option, be continued on a month-to-month basis. We have determined that these leases are not with a variable interest entity and rental obligations are properly classified as operating leases in our schedule of contractual obligations.
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BRC Properties Inc. (“BRC”), an entity controlled by members of the Borror Family, is the owner of two office buildings that we lease under long-term leases. We have no residual financial interest in these properties. We analyzed these leases with BRC and determined that BRC was not a variable interest entity requiring consolidation in our financial statements.
The following is a summary of our commercial commitments under off balance sheet arrangements at June 30, 2005 (in thousands):
| Amount of Commitment Expiration Per Period | |||||||||||||||
Other commercial commitments: | Total Amounts Committed | Less than 1 year | 1 – 3 years | 3 – 5 years | After 5 years | ||||||||||
Letters of credit | $ | 7,046 | $ | 2,286 | $ | 145 | $ | 4,615 | $ | — | |||||
Performance bonds | 48,096 | 41,899 | 5,723 | 474 | — | ||||||||||
Cancelable land contracts | 39,468 | 21,826 | 11,846 | 2,923 | 2,873 | ||||||||||
Total commercial commitments | $ | 94,610 | $ | 66,011 | $ | 17,714 | $ | 8,012 | $ | 2,873 | |||||
Inflation and Other Cost Increases
We are not always able to reflect all of our cost increases in the prices of our homes because competitive pressures and other factors sometimes require us to maintain or discount those prices. While we attempt to maintain material, labor and subcontractor costs from the date a sales contract with a customer is accepted until the date construction is completed, we may incur unanticipated costs which cannot be passed on to the customer. For example, delays in construction of a home can cause the mortgage commitment to expire and can require us, if mortgage interest rates have increased, to pay significant amounts to the mortgage lender to extend the original mortgage interest rate. In addition, during periods of high construction activities, we may incur additional costs to obtain subcontractors when certain trades are not readily available, which can result in lower gross profits. Periods of rapid price increases can result in lower gross profits.
Recently Issued Accounting Pronouncements
In December 2004, the FASB issued Statement No. 123R,Share-Based Payment(“FAS 123R”). FAS 123R is a revision of FAS 123 and it supercedes APB No. 25. FAS 123R requires all share-based payments, including grants of employee stock options, to be recognized in the statement of operations based on their fair values. Pro forma disclosure will not be an alternative. FAS 123R is effective for all annual periods beginning after June 15, 2005, and thus will become effective for the Company beginning January 1, 2006.
In March 2005, the Securities and Exchange Commission (the “SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”). SAB 107 provides interpretations expressing the views of the SEC regarding the interaction between FAS 123R and certain SEC rules and
22
regulations, and provides the staff’s views regarding the valuation of share-based payment arrangements for public companies. SAB 107 does not modify any of FAS 123R’s conclusions or requirements. We have performed a preliminary assessment of the impact of adopting FAS 123R and the guidance provided by SAB 107. Based on this evaluation, we do not expect the adoption of FAS 123R to have a significant impact on our consolidated financial position or results of operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
As of June 30, 2005, we were a party to twelve interest rate swap contracts with an aggregate notional amount of $130.0 million, as reflected in the table below. We enter into swap contracts to minimize earnings fluctuations caused by interest rate volatility associated with our variable rate debt. The swap contracts allow us to have variable rate borrowings and to select the level of fixed rate debt for the Company as a whole. Under the swap contracts, we agree with other parties to exchange, at specified intervals, the difference between fixed rate and floating rate amounts calculated by reference to an agreed notional amount. Our current intention is to maintain a range of approximately 40% to 60% of our debt at a fixed interest rate. However, market conditions and timing affect the Company’s ability to maintain this balance between fixed and variable interest rates. Therefore at any time, this percentage may be more or less depending on specific circumstances. At June 30, 2005, our level of fixed rate debt under the Facility, after considering the effect of the interest rate swaps, was approximately 63%. We do not enter into derivative financial instrument transactions for speculative purposes. The swap contracts are more fully described below:
| Notional Amount | Start Date | Maturity Date | Fixed Rate* | ||||
| $ | 10,000,000 | Oct. 23, 2002 | Oct. 4, 2005 | 3.16 % | |||
| 10,000,000 | Oct. 24, 2003 | Oct. 2, 2006 | 2.85% | ||||
| 10,000,000 | Oct. 24, 2003 | Jan. 2, 2007 | 2.87% | ||||
| 10,000,000 | Mar. 30, 2004 | Apr. 2, 2007 | 2.47% | ||||
| 10,000,000 | Mar. 30, 2004 | Apr. 2, 2007 | 2.51% | ||||
| 10,000,000 | May 7, 2004 | Apr. 2, 2007 | 3.30% | ||||
| 10,000,000 | May 7, 2004 | Apr. 2, 2007 | 3.30% | ||||
| 10,000,000 | May 9, 2003 | Apr. 3, 2008 | 3.01% | ||||
| 10,000,000 | May 9, 2003 | May 3, 2008 | 3.04% | ||||
| 10,000,000 | Sept. 8, 2004 | Aug. 31, 2008 | 3.74% | ||||
| 10,000,000 | Sept. 8, 2004 | Sept. 9, 2008 | 3.74% | ||||
| 20,000,000 | Apr. 15, 2005 | June 30, 2009 | 4.45% | ||||
| $ | 130,000,000 | ||||||
| * | Does not include a variable rate margin that ranges from 1.75% to 2.50% and was 1.75% at June 30, 2005. |
The following table presents descriptions of the financial instruments and derivative instruments that we held at June 30, 2005. For the liabilities, the table presents principal calendar year cash flows that exist by maturity date and the related average interest rate. For the interest rate derivatives, the table presents the notional amounts and expected interest rates that
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exist by contractual dates. Interest on our variable rate liabilities is LIBOR plus a variable margin ranging from 1.75% to 2.50%. Cash flows for interest on $130.0 million of variable rate liabilities that are subject to interest rate derivatives are the contractual average pay rate plus the variable margin (1.75% at June 30, 2005 and at December 31, 2004). The notional amount is used to calculate the contractual payments to be exchanged under the contract. The fair value of the variable rate liabilities eligible to be fixed with interest rate swaps was approximately $195.0 million and approximately $175.0 million at June 30, 2005 and December 31, 2004, respectively. The remaining variable rate liabilities at June 30, 2005 and December 31, 2004 of approximately $11.4 million and $19.4 million, respectively, are based on the prime rate. The fair value of the derivatives at June 30, 2005 and December 31, 2004 was an asset of $1.3 million and $981,000, respectively. We do not expect a gain to be realized from the $1.3 million asset because we expect to retain the swap contracts to maturity. All dollar amounts in the following table are in thousands.
| TOTAL | ||||||||||||||||||||||||||||
| 2005 | 2006 | 2007 | 2008 | 2009 | June 30, 2005 | Dec. 31, 2004 | ||||||||||||||||||||||
Liabilities | ||||||||||||||||||||||||||||
Variable rate | $ | 206,389 | $ | 206,389 | $ | 194,378 | ||||||||||||||||||||||
Average interest rate* | 4.97 | % | 4.73 | % | ||||||||||||||||||||||||
Interest Rate Derivatives | ||||||||||||||||||||||||||||
Notional amount | $ | 130,000 | $ | 120,000 | $ | 110,000 | $ | 60,000 | $ | 20,000 | $ | 130,000 | $ | 130,000 | ||||||||||||||
Average pay rate | 3.20 | % | 3.20 | % | 3.24 | % | 3.60 | % | 4.45 | % | 3.20 | % | 3.30 | % | ||||||||||||||
Average receive rate | 2.82 | % | 2.82 | % | 2.82 | % | 2.88 | % | 3.11 | % | 2.82 | % | 1.59 | % | ||||||||||||||
| * | Includes effect of interest rate swap agreements and excludes amortization of bank fees. |
Item 4. Controls and Procedures
Disclosure Controls and Procedures
With the participation of our management, including our principal executive officer and principal financial officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this Report (“Disclosure Controls”). Based on that evaluation, our principal executive officer and principal financial officer have concluded that as of the end of the period covered by this Report, the Company’s Disclosure Controls were effective for the purpose of ensuring that information required to be disclosed by the Company under the Exchange Act is (1) recorded, processed, summarized and reported within the time periods specified within the Securities and Exchange Commission’s rules and forms; and (2) accumulated and communicated to management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
No change has occurred in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the quarter ended June 30, 2005, 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.
We are involved in various legal proceedings most of which arise in the ordinary course of business and some of which are covered by insurance. In the opinion of our management none of the claims relating to such proceedings will have a material adverse effect on our financial condition or results of operations.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
| (a) | Not applicable. |
| (b) | Not applicable. |
| (c) | Purchases of Equity Securities. Neither the Company nor any “affiliated purchaser” of the Company purchased, during the second quarter of 2005, any of the Company’s equity securities registered under Section 12 of the Securities Exchange Act of 1934, as amended. |
Item 3. Defaults Upon Senior Securities. Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders.
| (a) | On May 11, 2005, the Company held its Annual Meeting of Shareholders. |
| (b) | See paragraph (c) below. |
| (c) | At the Annual Meeting, the Company’s shareholders elected four Class I Directors to the Board of Directors by the following vote: |
Director Nominees | Shares Voted For | Shares Withheld | ||
David P. Blom | 7,618,814 | 19,922 | ||
Douglas G. Borror | 7,617,969 | 20,767 | ||
Zuheir Sofia | 7,618,204 | 20,532 | ||
C. Ronald Tilley | 7,618,764 | 19,972 |
The term of office of the Company’s Class II Directors, Donald A. Borror, David S. Borror, R. Andrew Johnson, Gerald E. Mayo and Carl A. Nelson, Jr., continued after the Annual Meeting.
| (d) | Not applicable. |
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Item 5. Other Information.Not applicable.
| (a) | Not applicable. |
| (b) | Not applicable. |
Item 6. Exhibits.
Exhibits filed with this Quarterly Report on Form 10-Q are attached hereto or incorporated by reference herein. For a list of our exhibits, see “Index to Exhibits” (following the signature page).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
| DOMINION HOMES, INC. | ||||
(Registrant) | ||||
Date: August 8, 2005 | By: | /s/ Douglas G. Borror | ||
Douglas G. Borror | ||||
Chairman, Chief Executive Officer and President (Principal Executive Officer) | ||||
Date: August 8, 2005 | By: | /s/ Terrence R. Thomas | ||
Terrence R. Thomas | ||||
Senior Vice President of Finance and Chief Financial Officer (Principal Financial Officer) | ||||
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INDEX TO EXHIBITS
| Exhibit No. | Description | Location | ||
| 3.1 | Amended and Restated Articles of Incorporation of Dominion Homes, Inc., reflecting all amendments (for purposes of Commission reporting compliance only). | Incorporated by reference to Exhibit 4(a)(3) to the 1997 Form S-8. | ||
| 3.2 | Amended and Restated Code of Regulations of Dominion Homes, Inc. | Incorporated by reference to Exhibit 3.2 to the Company’s June 30, 2000 Form 10-Q (File No. 0-23270). | ||
| 4.1 | Specimen of Stock Certificate of Dominion Homes, Inc. | Incorporated by reference to Exhibit 2.2 to the Company’s Form 8-A/A filed April 30, 2003 (File No. 0-23270). | ||
| 10.1 | Stock Option Agreement dated May 12, 2005 between Dominion Homes, Inc. and Zuheir Sofia (which Agreement is substantially the same as Stock Option Agreements entered into between the Company and its other outside, independent directors, David P. Blom, R. Andrew Johnson, Gerald E. Mayo, Carl A. Nelson, Jr., and C. Ronald Tilley). | Filed herewith. | ||
| 31.1 | Certification of the Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | Filed herewith. | ||
| 31.2 | Certification of the Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | Filed herewith. | ||
| 32 | Certification pursuant to Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code. | Filed herewith. | ||