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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005
OR
[_] 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: 1-10153
HOMEFED CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware 33-0304982
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1903 Wright Place
Suite 220
Carlsbad, California 92008
(760) 918-8200
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer,
as defined in Rule 405 of the Securities Act. Yes [ ] No [x]
Indicate by check mark if the registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes [ ] No [x]
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].
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):
Large Accelerated Filer [ ] Accelerated Filer [x] Non-Accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company
(as defined in Rule 12-b of the Exchange Act). Yes [ ] No[x]
Based on the average bid and asked prices of the Registrant's Common Stock as
published by the OTC Bulletin Board Service as of June 30, 2005, the aggregate
market value of the Registrant's Common Stock held by non-affiliates was
approximately $261,084,000 on that date.
As of February 13, 2006, there were 8,265,334 outstanding shares of the
Registrant's Common Stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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PART I
Item 1. Business.
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THE COMPANY
Introduction
HomeFed Corporation ("HomeFed") was incorporated in Delaware
in 1988. As used herein, the term "Company" refers to HomeFed and its
subsidiaries, except as the context may otherwise require. The Company is
currently engaged, directly and through subsidiaries, in the investment in and
development of residential real estate projects in the State of California. The
Company also investigates the acquisition of new real estate projects, both
residential and commercial and within and outside the State of California,
although no assurance can be given that the Company will find new investments
providing a satisfactory return or, if found, that the Company will have access
to the capital necessary to make new real estate investments. The executive
office of the Company is located at 1903 Wright Place, Suite 220, Carlsbad,
California 92008.
The Company's current development projects consist of two
master-planned communities located in San Diego County, California: San Elijo
Hills, and a portion of the larger Otay Ranch planning area. As discussed below,
the Company acquired the San Elijo Hills project in October 2002. The Company
also owns the Rampage property, a 1,600 acre grape vineyard located in southern
Madera County, California, which is not currently entitled for commercial or
residential development.
As the owner of development projects, the Company is
responsible for the completion of a wide range of activities, including design
engineering, grading raw land, constructing public infrastructure such as
streets, utilities and public facilities, and finishing individual lots for home
sites or other facilities. Prior to commencement of development, the Company may
engage in incidental activities to maintain the value of the project; such
activities are not treated as a separate operating segment. The Company develops
and markets its communities in phases to allow itself the flexibility to sell
finished lots to suit market conditions and to enable it to create stable and
attractive neighborhoods. Consequently, at any particular time, the various
phases of a project will be in different stages of land development and
construction. In addition, from time to time the Company will receive
expressions of interest from buyers of multiple phases of a project, or the
remaining undeveloped land of an entire project. The Company evaluates these
proposals when it receives them, but no assurance can be given that the Company
will sell all or any portion of its development projects in such a manner.
For any master-planned community, plans must be prepared that
provide for infrastructure, neighborhoods, commercial and industrial areas,
educational and other institutional or public facilities, as well as open space.
Once preliminary plans have been prepared, numerous governmental approvals,
licenses, permits and agreements, referred to as "entitlements," must be
obtained before development and construction may commence. These often involve a
number of different governmental jurisdictions and agencies, challenges through
litigation, considerable risk and expense, and substantial delays. Unless and
until the requisite entitlements are received and substantial work has been
commenced in reliance upon such entitlements, a developer generally does not
have full "vested rights" to develop a project, and as a result, allocation of
acreage between developable and non-developable land may change. In addition, as
a precondition to receipt of building-related permits, master-planned
communities such as San Elijo Hills typically are required in California to pay
impact and capacity fees, or to otherwise satisfy mitigation requirements.
2
Current Development Projects
San Elijo Hills
In 2002, the Company purchased from Leucadia National
Corporation (together with its subsidiaries, "Leucadia") all of the issued and
outstanding shares of capital stock of CDS Holding Corporation ("CDS"), which
through its majority-owned subsidiaries is the owner of the San Elijo Hills
project. The San Elijo Hills project, a master-planned community located in the
City of San Marcos in San Diego County, California, at completion is expected to
be a community of approximately 3,500 homes and apartments, as well as
commercial properties and a towncenter; the San Elijo Hills project is expected
to be completed before the end of this decade. Since August 1998, the Company
has been the development manager for this project, with responsibility for the
overall management of the project, including, among other things, preserving
existing entitlements and obtaining any additional entitlements required for the
project, arranging financing for the project, coordinating marketing and sales
activity, and acting as the construction manager. The development management
agreement provided that the Company would participate in the net cash flow of
the project through the payment of a success fee, and that the Company receive
fees for the field overhead, management and marketing services it provides
("development management fees"), based on the revenues of the project. No
success fee had been paid prior to the Company's acquisition of CDS. Through its
majority owned subsidiaries, CDS has an effective 68% indirect equity interest
in the San Elijo Hills project, after considering minority interests held by
former owners of the project before CDS acquired its interest. However, CDS has
the right to the return of funds advanced to the project and to receive a
preferred return on its investment before any amounts are distributed to the
minority shareholders. In 2004, all amounts advanced to the project were repaid
and, except for amounts related to infrastructure improvement bond guarantees,
the preferred returns were fully satisfied. For more information on the minority
interests, see Note 6 of Notes to Consolidated Financial Statements.
Sales Activity: The table below summarizes sales activity at
the San Elijo Hills project during the last three years. At closing, a portion
of the sales proceeds is deferred and not immediately recognized as revenue in
the Company's consolidated statements of operations. The Company recognizes
deferred revenue upon completion of required improvements to the property sold,
including costs related to common areas, under the percentage of completion
method of accounting. Amounts shown below as development management fees earned
are intercompany payments, which are eliminated in consolidation and therefore
not reflected in the Company's consolidated statements of operations, but which
are a source of liquidity for the parent company.
For the Year Ended December 31,
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2005 2004 2003
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(Dollars in thousands)
Number of residential units sold (1) 406 139 739
Aggregate sales proceeds from sales of residential
units, net of closing costs (2) $ 127,100 $ 33,000 $ 133,400
Aggregate proceeds from the sales of school and
retail sites, net of closing costs (3) $ 700 $ 20,200 $ --
Development management fees earned $ 7,700 $ 3,300 $ 8,100
(1) Units are comprised of single family lots, multi-family units and very low
income apartment units.
(2) Excludes profit participation and consent fees described elsewhere in this
Report which are received subsequent to the closing of the land sales.
(3) Reflects the sale of one retail site in 2005 and the sale of one school
site in 2004.
As of December 31, 2005, the Company estimates that it will
spend approximately $20,600,000 to complete the required improvements to sold
properties, which results in a deferred revenue balance of $73,200,000. The
Company will recognize the deferred revenue in its consolidated statements of
operations as the required improvements are completed under the percentage of
completion method of accounting.
As of February 13, 2006, the Company has entered into
agreements with homebuilders that have not closed to sell 283 single family lots
for aggregate cash proceeds of $132,200,000 (of which $13,600,000 has been
received as non-refundable deposits). After considering this land under contract
for sale, the remaining land at the San Elijo Hills project to be developed and
sold or leased consists of the following:
Single family lots to be developed and sold 184
Multi-family units 40
Square footage of commercial space 132,000
3
The Company's current plans are to construct and sell or lease
the remaining mixed-use multi-family units in the towncenter rather than sell
the property to another developer. Assuming the Company's development is not
delayed, it expects to close the sales of the remaining residential units during
2006 and 2007; however, development activity on units sold is expected to
continue into 2007 and on common areas into 2008.
With respect to the towncenter commercial space, the Company
plans to construct and lease approximately 57,000 square feet of the commercial
space rather than sell it to a builder. The Company has begun discussions with
prospective users of the towncenter commercial space and expects it will begin
construction of the mixed-use towncenter during 2006. The Company intends to
sell the remainder of the towncenter commercial space, which includes the
supermarket site and daycare center site, to third party builders or owners.
The strength of the residential real estate market in San
Diego County over the past several years has been greatly responsible for the
successful sales activity at the San Elijo Hills project. Although the Company
plans to complete the construction and sale of the remaining residential sites
during the next two years, the continued resiliency of the residential real
estate market will be critical to these efforts. Should demand in the
residential real estate market decline, it may take longer for the Company to
complete residential sales activity, or result in lower prices for the
residential sites, or both. Including land under contract for sale discussed
above, the estimate of future taxable income discussed elsewhere in this Report
assumes that the Company will sell all of the remaining land at the San Elijo
Hills project for aggregate sales proceeds of approximately $250,000,000; after
deducting actual and projected development costs from this amount, projected
gross profit is estimated to be $150,000,000. These amounts are only estimates,
and actual sales and development costs could be materially different as a result
of changes in the real estate market or other factors that may or may not be
within the Company's control.
Although these development plans are based on the Company's
current intentions, these plans could change, including as a result of actions
of local regulatory authorities.
In order for the City of San Marcos to issue building permits
to the Company's prospective lot purchasers for lot sales above certain
thresholds, the Company is required to make improvements to two off-site roads.
Pursuant to the project development agreement with the City of San
Marcos/Redevelopment Agency of San Marcos (the "City"), the Company is required
to contribute $11,000,000 to fund a portion of the cost of building these roads;
the City is required to fund any costs in excess of this amount. The
improvements for one of these roads have been substantially completed, and
improvements for the second off-site road commenced in early 2005. The
commencement of construction of these roads removed the last significant
limitations to the issuance of building permits at the San Elijo Hills project.
By the end of February 2006, the Company expects that it will have substantially
fulfilled its entire $11,000,000 obligation and the City will need to fund the
balance of the construction costs before the road can be completed. Although the
absence of significant building permit limitations should enable the Company to
complete development of the project in accordance with its plans, unforeseen
developments or delays by the City in fulfilling its road improvement
obligations could adversely impact its development plans.
Since 1999, the San Elijo Hills project has carried
$50,000,000 of general liability and professional liability insurance under a
policy issued by the Kemper Insurance Companies ("Kemper"). The policy covered a
thirteen year term from the initial date of coverage, and the entire premium for
the life of the policy was paid in 1999. This policy is specific to the San
Elijo Hills project; the Company has general and professional liability
insurance for other matters with different insurance companies.
Kemper has ceased underwriting operations and has submitted a
voluntary run-off plan to its insurance regulators. Although Kemper is not in
receivership proceedings, it is operating under restrictive orders entered by
insurance regulators. It is uncertain whether Kemper will have sufficient assets
at such time, if ever, the Company makes a claim under the policy or, if they
are declared insolvent, whether state insurance guaranty funds would be
available to pay the claim. In May 2004, the Company purchased an excess policy
with another insurance carrier that provides up to $10,000,000 of coverage for
general liability claims, but not professional liability claims, relating to
homes sold through May 31, 2004. In September 2005, the excess policy was
extended to cover homes sold through May 31, 2005. The Company continues to
investigate whether insurance coverage for future home sales at the San Elijo
Hills project is available at acceptable prices.
4
Otay Ranch
In October 1998, the Company and Leucadia formed Otay Land
Company, LLC ("Otay Land Company") to purchase approximately 4,850 non-adjoining
acres of land located within the larger 22,900 acre Otay Ranch master-planned
community south of San Diego, California. Otay Land Company acquired this land
for $19,500,000. When Otay Land Company was formed, Leucadia contributed
$10,000,000 as a preferred capital interest, and the Company contributed all
other funds as non-preferred capital. In April 2003, Otay Land Company sold
1,445 acres to an unrelated third party and used a portion of the proceeds from
the sale to fully redeem Leucadia's preferred capital interest. As a result,
Otay Land Company became a wholly-owned subsidiary of the Company.
In 1993, the City of Chula Vista and the County of San Diego
approved a General Development Plan ("GDP") for the larger planning area.
Although there is no specified time within which implementation of the GDP must
be completed, it is expected that full development of the larger planning area
will take decades. The GDP establishes land use goals, objectives and policies
within the larger planning area. The GDP for the larger planning area
contemplates home sites, a golf-oriented resort and residential community,
commercial retail centers, a proposed university site and a network of
infrastructure, including roads and highways, a public transportation system,
park systems and schools. Any development within the larger Otay Ranch
master-planned community must be consistent with the GDP. While the GDP can be
amended, subject to approval by either or both of the City of Chula Vista and
the County of San Diego, Otay Land Company has certain vested and contractual
rights, pursuant to a development agreement, that protect its development
interests in Chula Vista, covering substantially all of its developable land.
However, actual land development will require that further entitlements and
approvals be obtained.
In April 2003, at the urging of the City of Chula Vista, the
developers within Otay Ranch (including Otay Land Company) entered into a three
year agreement to limit the number of annual building permits they would utilize
to an aggregate of 2,210 per year for all developers, with certain exceptions.
The City has requested that this agreement be extended for another three years
after it expires in April 2006. The terms of the proposed extension are
acceptable to the Company. If the developers do not agree to extend the
restriction, the City has the right to unilaterally impose a restriction on the
number of building permits that can be issued. However, there is no guaranty
that this agreement will be extended or, if it is, that the proposed permit
allocation will not change.
In August 2002, Otay Land Company reached an agreement with
the City of Chula Vista and another party whereby the City agreed to acquire 439
acres of mitigation land from Otay Land Company by eminent domain proceedings.
In January 2004, these proceedings were concluded and the mitigation land was
sold to the City for aggregate proceeds of approximately $5,800,000; a pre-tax
gain of approximately $4,800,000 was recognized in 2004.
After considering the above transactions, Otay Land Company
owns approximately 2,900 acres, of which the total developable area is
approximately 700 acres, including approximately 170 acres of land designated as
"Limited Development Area and Common Use Area." The remaining approximately
2,200 acres are designated as various qualities of non-developable open space
mitigation land. Under the GDP, 1.188 acres of open space mitigation land from
within the Otay Ranch project must be dedicated to the government for each 1.0
acre of land that is developed, excluding land designated Limited Development
Area and Common Use Area.
Some owners of development land have adequate or excess
mitigation land, while other owners lack sufficient acreage of mitigation land
to cover their inventory of development land. Otay Land Company currently has
substantially more mitigation land than it would need to develop its property at
this project. Based upon the GDP conditions, this land could have value to other
developers within the larger Otay Ranch development area as their development
progresses; however, this is partially dependent upon other parties with
developable land fully developing their land. Should other owners choose not to
develop their developable land, it is unlikely that Otay Land Company's
mitigation land can be sold to other owners within the larger Otay Ranch
planning area to meet their mitigation requirements. In addition, it is unclear
whether the Otay Ranch mitigation land is acceptable to meet mitigation
requirements for development outside of Otay Ranch in the greater San Diego
County region.
5
The Company continues to evaluate how to maximize the value of
this investment while pursuing land sales and processing further entitlements on
portions of its property. The Company has been working with the City of Chula
Vista and other developers on a GDP amendment for the overall Otay Ranch area.
In 2005, the Chula Vista City Council adopted an amendment to the GDP, which
modified land use designations in the Otay Ranch area, including land owned by
subsidiaries of the Company. The GDP amendment increased the development
potential for a parcel of approximately 300 contiguous acres owned by Otay Land
Company. The number of residential dwelling units was increased to 1,800 from
800, and approval of up to 300,000 square feet of retail neighborhood commercial
center was retained. The City Council deferred action with respect to a second
parcel of approximately 300 developable acres owned by Otay Land Company. The
pending GDP amendment for this parcel proposed an increase from 2,080 to 4,200
residential dwelling units, and an increase of commercial development from
approximately 1.2 million square feet to approximately 1.5 million square feet.
The Council deferred action on amending the GDP relating to this parcel until
April 2006. This deferral period is intended, among other things, to give the
City of Chula Vista staff, Otay Land Company and another land owner time to
reach agreement concerning land use surrounding a planned university, regional
technology park and adjacent parts of Otay Ranch. The Company is unable to
predict the impact the ultimate resolution of these matters will have, nor can
any assurance be given that the City Council will approve the currently pending
amendment to the GDP.
After considering the changes described above, the Company's
developable land is approved for 3,880 residential dwelling units, and
approximately 1.5 million square feet of commercial space. At the expiration of
the deferral period, if the City Council approves the proposed amendment for the
changes in the remaining parcel described above, then the Company's developable
land would be approved for an aggregate of 6,000 residential dwelling units, and
approximately 1.8 million square feet of commercial space.
San Diego Expressway Limited Partnership ("SDELP") is in the
process of constructing a toll road designated as SR 125 through south San Diego
County. Grading and bridge construction have begun, and the SDELP intends to
complete construction during the second quarter of 2007. This toll road runs
along the western border of one of Otay Land Company's land parcels and is a
quarter mile east of another. When complete the toll road will significantly
improve access to the southern portion of Otay Ranch, including the parcels
owned by the Company. Otay Land Company and other adjacent property owners will
need to negotiate with the City of Chula Vista and SDELP regarding the
construction timing and financing of interchanges that will provide access to SR
125.
Significant design and processing will be required to fully
entitle the Company's property in Otay Ranch before development and sale of the
finished neighborhoods to builders can begin, and there can be no assurance that
the Company will be successful in receiving the entitlements necessary for any
future development. Even if Otay Land Company receives its entitlements to
develop its property, it is uncertain whether it will fully develop or sell its
developable land. If or when development does occur, it will likely be phased
based on market conditions at the time of development and the progress of
infrastructure improvements. As a result, the Company is unable to predict when
revenues will be derived from this project. The ultimate development of projects
of this type is subject to significant governmental and environmental regulation
and approval and is likely to take many years. For additional information
concerning governmental and environmental matters, see "Government Regulation"
and "Environmental Compliance" below.
A map indicating the location of the Chula Vista General Plan
area in San Diego County and a more detailed map showing general information
about the Company's land within that General Plan area can be found on Otay Land
Company's website at www.otaylandcompany.com.
Other Projects
Rampage Property
In November 2003, the Company purchased a 2,159 acre grape
vineyard located in southern Madera County, California. The purchase price for
the property was $5,700,000, excluding expenses, of which $1,700,000 was paid in
cash and the balance was financed.
In July 2005, the Company sold approximately 600 acres of the
property to a neighboring land owner for approximately $5,000,000, which
resulted in the recognition of a pre-tax gain of $3,200,000. The buyer claimed
to own options to purchase this land, and had also filed a complaint against the
Company and the former owners of the property alleging that the property has
been devalued by approximately $3,000,000 due to poor farming practices since
2001. While the sale resolved any remaining dispute with respect to the purchase
options, the Company continues to have settlement discussions concerning the
farming practices complaint.
6
The Company had leased the farming rights to approximately
one-half of the property to one of the former owners for a fifteen-year period;
however, the lease was terminated in 2005 due to non-performance by the tenant
and the Company commenced eviction proceedings. On January 30, 2006, the tenant
filed a cross-complaint against the Company seeking a rescission of the purchase
agreement by which the Company acquired the Rampage property on the grounds that
they did not receive the consideration for which they bargained. The Company
does not expect that the ultimate resolution of this matter will be material to
its consolidated financial position; however, should the Company need to accrue
or pay damages, any such loss could be material to its consolidated results of
operations during the period recorded.
Although this property is not currently entitled for
residential development, it is located in a growing residential area northeast
of Fresno, California. The Company purchased this land with the intention of
obtaining the necessary entitlements to develop the property as a master-planned
community; however, approvals from various government agencies will be required,
including the acquisition of a water supply that meets regulatory requirements.
The Company expects the entitlement process will take several years and no
assurance can be given that such entitlements will be obtained. In the interim,
the Company is engaged in farming activities necessary to maintain the vineyard.
Competition
Real estate development is a highly competitive business.
There are numerous residential real estate developers and development projects
operating in the same geographic area in which the Company operates. Competition
among real estate developers and development projects is determined by the
location of the real estate, the market appeal of the development plan, and the
developer's ability to build, market and deliver project segments on a timely
basis. Many of the Company's competitors may have greater financial resources
and/or access to cheaper capital than the Company. Residential developers sell
to homebuilders, who compete based on location, price, market segmentation,
product design and reputation.
Government Regulation
The residential real estate development industry is subject to
substantial environmental, building, construction, zoning and real estate
regulations that are imposed by various federal, state and local authorities. In
developing a community, the Company must obtain the approval of numerous
government agencies regarding such matters as permitted land uses, housing
density, the installation of utility services (such as water, sewer, gas,
electric, telephone and cable television) and the dedication of acreage for open
space, parks, schools and other community purposes. Regulations affect
homebuilding by specifying, among other things, the type and quality of building
materials that must be used, certain aspects of land use and building design and
the manner in which homebuilders may conduct their sales, operations, and
overall relationships with potential home buyers. Furthermore, changes in
prevailing local circumstances or applicable laws may require additional
approvals, or modifications of approvals previously obtained.
Timing of the initiation and completion of development
projects depends upon receipt of necessary authorizations and approvals. Because
of the provisional nature of these approvals and the concerns of various
environmental and public interest groups, the approval process can be delayed by
withdrawals or modifications of preliminary approvals and by litigation and
appeals challenging development rights. The ability of the Company to develop
projects could be delayed or prevented due to litigation challenging previously
obtained governmental approvals. The Company may also be subject to periodic
delays or may be precluded entirely from developing in certain communities due
to building moratoriums or "slow-growth" or "no-growth" initiatives that could
be implemented in the future. Such delays could adversely affect the Company's
ability to complete its projects, significantly increase the costs of doing so
or drive potential customers to purchase competitors' products.
Environmental Compliance
Environmental laws may cause the Company to incur substantial
compliance, mitigation and other costs, may restrict or prohibit development in
certain areas and may delay completion of the Company's development projects.
Delays arising from compliance with environmental laws and regulations could
adversely affect the Company's ability to complete its projects, significantly
increase the costs of doing so or cause potential customers to purchase
competitors' products.
7
Under various federal, state and local environmental laws, an
owner or operator of real property may become liable for the costs of the
investigation, removal and remediation of hazardous or toxic substances at that
property. These laws often impose liability without regard to whether the owner
or operator knew of, or was responsible for, the presence of the hazardous or
toxic substances. The presence of hazardous or toxic substances, or the failure
to remediate these substances when present, may adversely affect the owner's
ability to sell or rent that property or to borrow funds using that property as
collateral. It may impose unanticipated costs and delays on projects. Persons
who arrange for the disposal or treatment of hazardous or toxic wastes may also
be liable for the costs of the investigation, removal and remediation of those
wastes at the disposal or treatment facility, regardless of whether that
facility is owned or operated by that person. In addition to remediation actions
brought by federal, state and local agencies, the presence of hazardous
substances on a property could result in personal injury, contribution or other
claims by private parties. These claims could result in costs or liabilities
that could exceed the value of that property. We are not aware of any
notification by any private party or governmental authority of any claim in
connection with environmental conditions at any of our properties that we
believe will involve any material expenditure other than as disclosed herein.
The Company obtained a preliminary remediation study
concerning approximately 30 acres of undeveloped land in the Otay Ranch
master-planned community that is owned by a subsidiary of Otay Land Company,
Flat Rock Land Company, LLC ("Flat Rock"). Flat Rock owns approximately 265
acres of the Company's total holdings in the Otay Ranch area, including 100
developable acres. The need for remediation results from activities conducted on
the land prior to Otay Land Company's ownership. Based upon the preliminary
findings of this study, in 2002 the Company estimated that the cost to implement
the most likely remediation alternative would be approximately $11,200,000, and
accrued that amount as an operating expense. The estimated liability is neither
discounted nor reduced for potential claims for recovery from previous owners
and users of the land who may be liable, and may increase or decrease based upon
the actual extent and nature of the remediation required, the type of remedial
process approved, the expenses of the regulatory process, inflation and other
items. The Company periodically adjusts its liability to reflect its current
best estimate; however, no assurance can be given that the actual amount of
environmental liability will not exceed the amount of reserves for this matter
or that it will not have a material adverse effect on the Company's financial
position, results of operations or cash flows. During 2004, the Company
increased its estimate of remediation costs by approximately $1,300,000,
primarily due to increases in site investigation and remediation costs, and
during 2003 by approximately $300,000, primarily for consulting costs.
During 2003, Otay Land Company developed an investigation
plan, which the San Diego Department of Environmental Health ("DEH") approved,
to further determine the nature and extent of contamination on the property. In
January 2004, the State Department of Toxic Substance Control ("DTSC") approved
DEH as the overseeing agency for the site investigation and the remediation.
Flat Rock selected an environmental consultant to implement the investigation
plan, which has been conducted under the San Diego County Voluntary Cleanup
Program and under the oversight of the DEH. In 2005, Flat Rock completed the
site investigation, and expects to submit the remediation plan for approval from
the DEH in 2006. Flat Rock anticipates starting the remediation process in 2006
with completion in 2007. However, the Company is unable to predict with
certainty when the remediation will commence and there is no current regulatory
requirement to commence remediation by a fixed date. Further, Otay Land Company
and Flat Rock have filed a lawsuit in Federal Court in the Southern District of
California seeking compensation from the parties who it believes are responsible
for the contamination. However, the Company can give no assurances that this
lawsuit will be successful or that it will be able to recover any of the costs
incurred in investigating and/or remediating the contamination.
Employees
At December 31, 2005, the Company and its consolidated
subsidiaries had 25 full-time employees.
Investor Information
The Company is subject to the informational requirements of
the Securities Exchange Act of 1934 (the "Exchange Act"). Accordingly, the
Company files periodic reports, proxy statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy statements
and other information may be obtained by visiting the Public Reference Room of
the SEC at 450 Fifth Street, NW, Washington, D.C. 20549 or by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding the Company and other issuers that file
electronically.
The Company does not maintain a website. The Company will
provide without charge upon written request copies of its annual report on Form
10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments
to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act. Requests for such copies should be directed to: HomeFed
Corporation, 1903 Wright Place, Suite 220, Carlsbad, CA 92008 (telephone number
(760) 918-8200), Attention: Corporate Secretary.
8
Item 1A. Risk Factors.
- ------- ------------
Our business is subject to a number of risks. You should
carefully consider the following risk factors, together with all of the other
information included or incorporated by reference in this Report, before you
decide whether to purchase our common stock. The risks set out below are not the
only risks we face. If any of the following risks occur, our business, financial
condition and results of operations could be materially adversely affected. In
such case, the trading price of our common stock could decline, and you may lose
all or part of your investment.
Our results of operations and financial condition are greatly
affected by the performance of the real estate industry. The real estate
development industry has historically been subject to up and down cycles driven
by numerous market and economic factors, both national and local, beyond the
control of the real estate developer. Real estate investments often cannot be
easily or quickly converted into cash. Market values may be adversely affected
by economic conditions, market fundamentals, competition and demographic
conditions. Because of the effect these factors have on real estate values, it
is difficult to predict with certainty when future sales will occur or what the
sales price will be.
Changes in mortage interest rate levels or changes in consumer
lending practices could reduce demand for housing. Our business is dependent
upon the availability and cost of mortgage financing for potential homebuyers.
Any significant increase in the prevailing low mortgage interest rate
environment or decrease in available credit could reduce consumer demand for
housing, which in turn could lead to fewer home sales or lower sale prices.
Our business is currently concentrated in Southern California.
As a result, our financial results are dependent on the economic strength of
that region. Our current operations are concentrated in Southern California,
specifically in the San Diego area. Because of our geographic concentration and
limited number of projects, our operations are more vulnerable to adverse
changes in the San Diego economy than those of larger, more diversified
companies. Any significant increase in the local cost of living, including
increases in residential property tax charges, may adversely affect consumer
demand for housing projects like ours. Should we experience softening in our
markets and not be able to offset the potential negative market influences on
price and volume, our financial results could be negatively impacted.
Changes in domestic laws and government regulations or in the
implementation and/or enforcement of government rules and regulations may delay
our projects or increase our costs. Our plans for development projects require
numerous government approvals, licenses, permits and agreements, which we must
obtain before we can begin development and construction. The approval process
can be delayed by withdrawals or modifications of preliminary approvals, by
litigation and appeals challenging development rights and by changes in
prevailing local circumstances or applicable laws that may require additional
approvals. Regulatory requirements may delay the start or completion of our
projects and/or increase our costs.
Demographic changes in the United States generally and
California in particular could reduce the demand for housing. Our operations are
sensitive to demographic changes. If the current trend of population increases
in California were not to continue, or in the event of any significant reduction
in job creation, demand for real estate in California may decline from current
levels.
Increases in real estate taxes and other local government fees
could adversely affect our results. Increases in real estate taxes and other
government fees may make it more expensive to own the properties that we are
currently developing, which would increase our carrying costs of owning the
properties.
Significant competition from other real estate developers and
homebuilders could adversely affect our results. There are numerous residential
real estate developers and development projects operating in the same geographic
area in which we operate. Many of our competitors may have advantages over us,
such as more favorable locations which may provide better schools and easier
access to roads and shopping, or amenities that we may not offer, as well as
greater financial resources and/or access to cheaper capital.
Delays in construction schedules and cost overruns could
adversely affect us. Any material delays could adversely affect our ability to
complete our projects, significantly increasing the costs of doing so, or drive
potential customers to purchase competitors' products. Cost overruns, if
material, could have a direct adverse impact on our results of operations.
9
Increased costs for land, materials and for labor could
adversely affect us. Our current and future development projects require us to
purchase significant amounts of land, materials and require significant amounts
of labor. If these costs increase, it will increase the costs of completing our
projects; if we are not able to recoup these increased costs, our results of
operations could be adversely affected.
Imposition of limitations on our ability to develop our
properties resulting from condemnations, environmental laws and regulations and
developments in or new applications thereof could increase our costs and delay
our projects. The real estate development industry is subject to the risk of
condemnation and to increasing environmental, building, construction, zoning and
real estate regulations that are imposed by various federal, state and local
authorities. Environmental laws may cause us to incur additional costs, and
adversely affect our ability to complete our projects in a timely and profitable
manner.
Property in California is at risk from earthquakes, fires and
other natural disasters. Damage to any of our properties, whether by natural
disasters, including earthquakes, and fires or otherwise, may either delay or
preclude our ability to develop and sell our properties, or affect the price at
which we may sell such properties. Although research on earthquake prediction
has increased in recent years, it cannot be predicted when and where an
earthquake will occur. We do not intend to obtain earthquake insurance for our
projects.
Under California law we could be liable for some construction
defects in structures we build or that are built on land that we develop.
California law imposes some liabilities on developers of land on which homes are
built as well as on builders. Future construction defect litigation could be
based on a strict liability theory based on our involvement in the project or it
could be related to infrastructure improvements or grading, even if we are not
building homes ourselves.
We may not be able to insure certain risks economically. We
may experience economic harm if any damage to our properties is not covered by
insurance. We cannot be certain that we will be able to insure all risks that we
desire to insure economically or that all of our insurers will be financially
viable if we make a claim. We may suffer losses that are not covered under our
insurance policies. If an uninsured loss or a loss in excess of insured limits
should occur, we could lose capital invested in a property, as well as any
future revenue from the property.
Shortages of adequate water resources and reliable energy
sources in the areas where we own real estate projects could adversely affect
the value of our properties or restrict us from commencing development. Any
shortage of reliable water and energy resources or a drop in consumer confidence
in the dependability of such resources in areas where we own land may adversely
affect the values of our properties and/or result in governmental restrictions
that curtail development projects.
Changes in the composition of our assets and liabilities
through acquisitions or divestitures may affect our results. We may make future
acquisitions or divestitures of assets. Any change in the composition of our
assets and liabilities could significantly affect our financial position and the
risks that we face.
The actual cost of environmental liabilities concerning land
owned in San Diego County, California could exceed the amount we reserved for
such matter. The actual cost of remediation of undeveloped land owned by one of
our subsidiaries could exceed the amount reserved for such matter, which would
adversely affect our results of operations and liquidity.
We may not be able to generate sufficient taxable income to
fully realize our deferred tax asset. We and certain of our subsidiaries have
net operating tax loss carryforwards ("NOLs") and other tax attributes. If we
are unable to generate sufficient taxable income, we will not be able to fully
realize the recorded amount of the deferred tax asset.
Significant influence over our affairs may be exercised by our
principal stockholders. As of February 13, 2006, the significant stockholders of
our Company are Leucadia National Corporation (approximately 29.9% beneficial
ownership), our Chairman, Joseph S. Steinberg (approximately 9.5% beneficial
ownership, including ownership by certain family members, but excluding Mr.
Steinberg's private charitable foundation) and one of our directors, Ian M.
Cumming (approximately 7.7% beneficial ownership, including ownership by certain
family members, but excluding Mr. Cumming's private charitable foundation). Mr.
Steinberg is also President, a director and a significant stockholder of
Leucadia. Mr. Cumming is also Chairman of the Board, a director and a
significant stockholder of Leucadia. Accordingly, Leucadia and Messrs. Steinberg
and Cumming could exert significant influence over all matters requiring
approval by our stockholders, including the election or removal of directors and
the approval of mergers or other business combination transactions.
Our common stock is subject to transfer restrictions. We and
certain of our subsidiaries have NOLs and other tax attributes, the amount and
availability of which are subject to certain qualifications, limitations and
uncertainties. In order to reduce the possibility that certain changes in
ownership could result in limitations on the use of the tax attributes, our
10
certificate of incorporation contains provisions that generally restrict the
ability of a person or entity from acquiring ownership (including through
attribution under the tax law) of 5% or more of our common stock and the ability
of persons or entities now owning 5% or more of our common stock from acquiring
additional common stock. The restriction will remain until the earliest of (a)
December 31, 2010, (b) the repeal of Section 382 of the Internal Revenue Code
(or any comparable successor provision) and (c) the beginning of our taxable
year to which these tax attributes may no longer be carried forward. The
restriction may be waived by our board of directors. Stockholders are advised to
carefully monitor their ownership of our common stock and consult their own
legal advisors and/or us to determine whether their ownership of our common
stock approaches the proscribed level.
Item 1B. Unresolved Staff Comments.
- ------- -------------------------
Not applicable.
Item 2. Properties.
- ------ ----------
The Company currently develops two real estate properties, the
San Elijo Hills project and the Otay Land Company project, and owns the Rampage
property, all of which are described under Item 1, Business. Real estate had an
aggregate book value of approximately $62,300,000 at December 31, 2005.
The Company leases 8,944 square feet for its corporate
headquarters which is located at 1903 Wright Place, Suite 220, Carlsbad,
California 92008. The Company rents office space at its corporate headquarters
to Leucadia. Effective March 1, 2005, the monthly rent is $1,000; in 2005, the
rent paid by Leucadia aggregated $21,000.
Item 3. Legal Proceedings.
- ------ -----------------
The Company is not a party to legal proceedings other than
ordinary, routine litigation, incidental to its business or not material to the
Company's consolidated financial position or liquidity.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------ ---------------------------------------------------
Not applicable.
PART II
Item 5. Market for the Registrant's Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities.
- ------ -----------------------------------------------------------------------
The Company's common stock is traded in the over-the-counter
market under the symbol "HOFD." The Company's common stock is not listed on any
stock exchange, and price information for the common stock is not regularly
quoted on any automated quotation system.
The following table sets forth, for the calendar periods
indicated, the high and low bid price of the Company's common stock, as
published by the National Association of Securities Dealers OTC Bulletin Board
Service.
High Low
---------- ---------
2004
First Quarter $ 34.60 $ 29.25
Second Quarter 35.00 32.00
Third Quarter 44.20 33.25
Fourth Quarter 52.50 42.00
2005
First Quarter $ 58.00 $ 49.75
Second Quarter 65.00 52.80
Third Quarter 70.50 56.00
Fourth Quarter 69.00 54.00
2006
First quarter (through February 13, 2006) $ 65.50 $ 60.50
The over-the-counter quotations reflect inter-dealer prices,
without retail mark up, markdown or commission, and may not represent actual
transactions. On February 13, 2006, the closing bid price for the Company's
common stock was $64.00 per share. As of that date, there were 998 stockholders
of record. On April 19, 2005, the Company's Board of Directors declared a cash
dividend equal to $0.50 per share of the Company's common stock, payable on May
9, 2005 to stockholders of record on April 29, 2005. The Company did not declare
dividends on its common stock during 2004 or 2003.
11
The Company does not currently meet certain requirements for
listing on a national securities exchange or inclusion on the Nasdaq Stock
Market.
The Company and certain of its subsidiaries have NOLs and
other tax attributes, the amount and availability of which are subject to
certain qualifications, limitations and uncertainties. In order to reduce the
possibility that certain changes in ownership could result in limitations on the
use of its tax attributes, the Company's certificate of incorporation contains
provisions which generally restrict the ability of a person or entity from
acquiring ownership (including through attribution under the tax law) of five
percent or more of the common stock and the ability of persons or entities now
owning five percent or more of the common stock from acquiring additional common
stock. The restrictions will remain in effect until the earliest of (a) December
31, 2010, (b) the repeal of Section 382 of the Internal Revenue Code (or any
comparable successor provision) and (c) the beginning of a taxable year of the
Company to which certain tax benefits may no longer be carried forward.
The transfer agent for the Company's common stock is American
Stock Transfer & Trust Company, 59 Maiden Lane, New York, New York 10038.
Item 6. Selected Financial Data.
- ------ -----------------------
The following selected financial data have been summarized
from the Company's consolidated financial statements and are qualified in their
entirety by reference to, and should be read in conjunction with, such
consolidated financial statements and Management's Discussion and Analysis of
Financial Condition and Results of Operations, contained in Item 7 of this
Report. The results of CDS are included in the Company's consolidated results of
operations from the date of acquisition (October 21, 2002), and is the primary
reason for the significant increase in revenues, expenses and profitability as
compared to the earlier period.
Year Ended December 31,
--------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ---------------- ------------ --------- ----------
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA:
Revenues (1) $107,932 $ 81,671 $ 148,285 $ 13,111 $ 6,523
Expenses (2) (3) 39,957 25,620 50,575 22,418 6,932
Income (loss) before minority interest 41,475 47,633 85,237 (9,375) (377)
Net income (loss) 31,792 36,792 74,076 (11,086) (1,377)
Basic income (loss) per share $3.85 $4.46 $9.08 $(1.80) $(0.24)
Diluted income (loss) per share $3.84 $4.45 $8.99 $(1.80) $(0.24)
At December 31,
--------------------------------------------------------------------------
2005 2004 2003 2002 2001
----------- ---------------- ------------ --------- ----------
SELECTED BALANCE SHEET DATA:
Cash and cash equivalents $131,688 $ 34,634 $ 43,503 $ 33,601 $ 1,454
Investments 65,190 82,249 88,519 -- --
Real estate 62,319 47,126 37,612 31,108 23,890
Total assets 294,261 211,487 217,010 117,043 25,804
Notes payable (4) 10,403 16,620 38,296 40,332 22,508
Stockholders' equity (deficit) 141,465 113,751 76,330 1,650 (11,623)
Shares outstanding 8,264 8,260 8,155 8,155 5,680
Book value per share $17.12 $13.77 $9.36 $ .20 $(2.05)
Cash dividend per share $ .50 $ -- $ -- $ -- $ --
(1) Prior to the acquisition of CDS, includes development management fee income
from San Elijo Hills of $1,600,000 for the period from January 1, 2002 to
October 21, 2002, and $4,800,000 for the year ended December 31, 2001.
After the acquisition, these payments are no longer reflected as revenues
since they are eliminated in consolidation.
(2) Includes provisions for environmental remediation of $1,300,000, $300,000
and $11,200,000 for the years ended December 31, 2004, 2003 and 2002,
respectively, which is more fully discussed in Results of Operations below.
(3) During 2005, the Company reclassified farming activities from general and
administrative expenses to other income (expense), net for all periods.
(4) At December 31, 2003, 2002 and 2001, includes a note payable to a
subsidiary of Leucadia for $24,716,000, $23,628,000 and $22,508,000,
respectively. In March 2004, the Company prepaid this borrowing in full.
12
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
- ------ -----------------------------------------------------------------------
The purpose of this section is to discuss and analyze the
Company's consolidated financial condition, liquidity and capital resources and
results of operations. This analysis should be read in conjunction with the
consolidated financial statements and related notes which appear elsewhere in
this Report.
Liquidity and Capital Resources
Net cash provided by operating activities, principally from
the proceeds from the sale of real estate, was $88,200,000, $22,500,000 and
$119,000,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
The large fluctuations in operating cash flows from year to year result from the
timing of real estate sales, principally at the San Elijo Hills project. The San
Elijo Hills project is being sold in phases, and the quantity of lot inventory
available for sale can vary greatly from period to period. During 2003 and 2005,
the Company closed on the sales of substantially more lot inventory than in
2004, the timing of which reflects both the planned phasing of the project and
the strong residential real estate market at San Elijo Hills. Information about
the remaining real estate to be sold at the San Elijo Hills project is provided
below. Operating cash flows in 2003 also reflect the sale of a relatively large
piece of land at the Otay Ranch project. Because of the nature of its real
estate projects, the Company does not expect operating cash flows will be
consistent from year to year.
The parent company's principal sources of funds are proceeds
from the sale of real estate, its $10,000,000 line of credit with Leucadia, fee
income from the San Elijo Hills project, dividends and tax sharing payments from
its subsidiaries and borrowings from or repayment of advances by its
subsidiaries. As of December 31, 2005, the Company had consolidated cash and
cash equivalents and marketable securities aggregating $196,900,000. Certain of
these amounts are held by subsidiaries that own the San Elijo Hills project, and
as such are fully available to satisfy the development needs of that project,
but are also subject to the interests of minority shareholders. Excluding those
amounts, at December 31, 2005 the parent company and its wholly owned
subsidiaries had approximately $72,100,000 of liquid assets to satisfy its
needs, the needs of its subsidiaries and for future investment opportunities.
13
The Company expects that its cash on hand, together with the
sources described above, will be sufficient for both its short and long term
liquidity needs. Residential sales at the San Elijo Hills project are expected
to be a continuing source of funds to the Company through 2007 if project
development continues as planned, and if economic conditions remain favorable
for the local housing market. Thereafter, cash flow from the San Elijo Hills
project will principally result from the sale or lease of the commercial space.
Until the Company is reasonably assured it will be able to sell or lease
developed property for an adequate return, the San Elijo Hills project will not
require significant funds for development. The Company is not relying on receipt
of funds from Otay Land Company for the foreseeable future, since the timing of
sales of undeveloped property, development activity and sales of developable and
undevelopable property cannot be predicted with any certainty. However, except
for the environmental remediation matter discussed below, Otay Land Company is
not expected to require material funds in the short term, and long term needs
will not be determined until a development plan is established. The Company does
not anticipate that the Rampage property will require any significant funding or
be the source of significant funds for the next few years. The Company is not
currently committed to acquire any new real estate projects, but it believes it
has sufficient liquidity to take advantage of appropriate acquisition
opportunities if they are presented.
The Company currently has an unsecured $10,000,000 line of
credit agreement with Leucadia, which has a maturity date of February 28, 2007.
Loans outstanding under this line of credit bear interest at 10% per year. As of
February 13, 2006, no amounts were outstanding under this facility.
In July 2005, the Company sold approximately 600 acres of land
at the Rampage property to a neighboring land owner for approximately
$5,000,000. The Company used $3,800,000 of the net proceeds received from the
sale to fully pay the principal, interest and pre-payment penalties due under
the Rampage mortgage note, as required under the mortgage note in connection
with the sale. The buyer claimed to own options to purchase this land, and had
also filed a complaint against the Company and the former owners of the Rampage
property alleging that the property has been devalued by approximately
$3,000,000 due to poor farming practices since 2001. While the sale resolved any
remaining dispute with respect to the purchase options, the Company continues to
have settlement discussions concerning the farming practices complaint. The
Company does not believe the ultimate resolution of this matter will be
material.
During 2005, the Company closed on the sales of 5
neighborhoods in the San Elijo Hills project consisting of 131 multi-family
units for aggregate sales proceeds of $36,000,000, net of closing costs, and 203
single family lots for aggregate sales proceeds of $91,100,000, net of closing
costs. The sales proceeds include $10,300,000 of non-refundable options payments
that had been received by the Company in 2004. At December 31, 2005, $57,100,000
of revenue related to these sales was deferred since the Company is required to
complete certain improvements under the purchase agreements.
As of December 31, 2005, the aggregate balance of deferred
revenue for all real estate sales (including the 2005 sales) was $73,200,000,
which the Company estimates will be substantially recognized as revenue by the
end of 2008. The Company estimates that it will spend approximately $20,600,000
to complete the required improvements, including costs related to common areas.
The Company will recognize revenues previously deferred and the related cost of
sales in its statements of operations as the improvements are completed under
the percentage of completion method of accounting.
As of December 31, 2005, the remaining land at the San Elijo
Hills project to be developed and sold or leased consisted of the following
(including real estate under contract for sale):
Single family lots to be developed and sold 467
Multi-family units 40
Square footage of commercial space 132,000
14
As of February 13, 2006, the Company has entered into
agreements with homebuilders that have not closed to sell 283 single family lots
for aggregate cash proceeds of $132,200,000, pursuant to which it had received
non-refundable option payments of $13,600,000 in 2005. These option payments are
non-refundable if the Company completes site improvement work and fulfills its
other obligations under the agreements, and will be applied to reduce the amount
due from the purchasers at closing. Although these agreements are binding on the
purchasers, should the Company fulfill its obligations under the agreements
within the specified timeframes and a purchaser decides not to close, the
Company's recourse will be primarily limited to retaining the option payment.
The Company is currently developing lots that are under
contract for sale or being marketed for sale. The Company believes it will sell
all of its remaining residential sites by the end of 2007, after which the
remaining activity at the San Elijo Hills project will be primarily concentrated
on commercial sites. These estimates of future property available for sale and
the timing of the sales are based upon current development plans for the project
and could change based on actions of regulatory agencies, the strength of the
housing market and other factors that are not within the control of the Company.
During 2005, the Company recorded $6,800,000 of revenues
related to revenue or profit sharing payments received from homebuilders who
purchased lots in the San Elijo Hills project. Certain of the Company's lot
purchase agreements with homebuilders include provisions that entitle the
Company to a share of the revenues or profits realized by the homebuilders upon
their sale of the homes, after certain thresholds are achieved. These amounts
are generally based on a formula and other specified criteria contained in the
lot purchase agreements, and are generally not payable and cannot be determined
with reasonable certainty until the builder has completed the sale of a
substantial portion of the homes covered by the lot purchase agreement. Since
the future plans and potential profits of the Company's homebuilders are
uncertain, the Company is unable to predict whether additional payments will be
received in the future.
Since 1999, the San Elijo Hills project has carried
$50,000,000 of general liability and professional liability insurance under a
policy issued by Kemper. The policy covered a thirteen year term from the
initial date of coverage, and the entire premium for the life of the policy was
paid in 1999. This policy is specific to the San Elijo Hills project; the
Company has general and professional liability insurance for other matters with
different insurance companies. To date, the Company has not made any material
claims under the policy.
Kemper has ceased underwriting operations and has submitted a
voluntary run-off plan to its insurance regulators. Although Kemper is not in
receivership proceedings, it is operating under orders entered by insurance
regulators. It is uncertain whether Kemper will have sufficient assets at such
time, if ever, the Company makes a claim under the policy or, if they are
declared insolvent, whether state insurance guaranty funds would be available to
pay the claim. In May 2004, the Company purchased an excess policy with another
insurance carrier that provides up to $10,000,000 of coverage for general
liability claims, but not professional liability claims, relating to homes sold
through May 31, 2004. In September 2005, the excess policy was extended to cover
homes sold through May 31, 2005. The Company continues to investigate whether
insurance coverage for future home sales at the San Elijo Hills project is
available at acceptable prices.
On April 19, 2005, the Company's Board of Directors declared a
cash dividend equal to $0.50 per share of the Company's common stock, payable on
May 9, 2005 to stockholders of record on April 29, 2005 (approximately
$4,100,000 in the aggregate). In July 2004, the Board of Directors approved the
repurchase of up to 500,000 shares of the Company's common stock, representing
approximately 6% of the Company's outstanding stock. Repurchased shares would be
available, among other things, for use in connection with the Company's stock
option plans. The shares may be purchased from time to time, subject to
prevailing market conditions, in the open market, in privately negotiated
transactions or otherwise. Any such purchases may be commenced or suspended at
any time without prior notice. No shares have been purchased to date.
As indicated in the table below, at December 31, 2005, the
Company's contractual cash obligations totaled $11,963,000. The notes payable to
trust deed holders are collateralized by the San Elijo Hills project. For
additional information, see Note 5 of Notes to Consolidated Financial
Statements.
15
Payments Due by Period (in thousands)
----------------------------------------------------------------------
Total Amounts Less Than 1 After 5
Contractual Obligations Committed Year 1-3 Years 4-5 Years Years
- ----------------------- ---------- ----------- --------- --------- ---------
Notes payable to trust deed holders $10,968 $ -- $ -- $10,968 $ --
Operating lease, net of sublease income 995 226 476 293 --
------- ------ ------- ------- ------
Total Contractual Cash Obligations $11,963 $ 226 $ 476 $11,261 $ --
======= ====== ======= ======= ======
Pursuant to an agreement with the City of San Marcos, the
Company is contractually obligated to contribute up to $11,000,000 towards the
cost of improving two off site roads to the San Elijo Hills project, which is
not reflected in the table above. The City of San Marcos is obligated to fund
the balance of the cost of the roads. As of December 31, 2005, the Company had
spent $7,500,000 towards the road improvements, and expects it will
substantially fulfill its road construction obligation in early 2006.
As of December 31, 2005, the Company had NOLs of $83,700,000
available to reduce its future federal income tax liabilities and $18,900,000 of
alternative minimum tax credit carryovers. The federal NOLs are not available to
reduce federal alternative minimum taxable income, which is currently taxed at
the rate of 20%. As a result, the Company expects to pay federal income tax at a
rate of 20% during future periods. For more information, see Note 10 of Notes to
Consolidated Financial Statements.
Off-Balance Sheet Arrangements
The Company is required to obtain infrastructure improvement
bonds primarily for the benefit of the City of San Marcos prior to the beginning
of lot construction work and warranty bonds upon completion of such improvements
at the San Elijo Hills project. These bonds provide funds primarily to the City
in the event the Company is unable or unwilling to complete certain
infrastructure improvements in the San Elijo Hills project. Leucadia is
contractually obligated to obtain these bonds on behalf of CDS and its
subsidiaries pursuant to the terms of agreements entered into when CDS was
acquired. CDS is responsible for paying all third party fees related to
obtaining the bonds. Should the City or others draw on the bonds for any reason,
certain of the Company's subsidiaries would be obligated to reimburse Leucadia
for the amount drawn. As of December 31, 2005, the amount of outstanding bonds
was approximately $29,500,000, none of which has been drawn upon.
Results of Operations
Critical Accounting Estimates
The Company's discussion and analysis of its financial
condition and results of operations are based upon its consolidated financial
statements, which have been prepared in accordance with accounting principles
generally accepted in the United States of America. The preparation of these
financial statements requires the Company to make estimates and assumptions that
affect the reported amounts in the financial statements and disclosures of
contingent assets and liabilities. On an on-going basis, the Company evaluates
all of these estimates and assumptions. Actual results could differ from those
estimates.
Profit Recognition on Sales of Real Estate - When the Company
has an obligation to complete improvements on property subsequent to the date of
sale, it utilizes the percentage of completion method of accounting to record
revenues and cost of sales. Under percentage of completion accounting, the
Company recognizes revenues and cost of sales based upon the ratio of
development costs completed as of the date of sale to an estimate of total
development costs which will ultimately be incurred, including an estimate for
common areas. Revenues which cannot be recognized as of the date of sale are
reported as deferred revenue on the consolidated balance sheets. As of December
31, 2005, the Company's deferred revenue balance aggregated $73,200,000.
16
The Company believes it can reasonably estimate its future
costs and profit allocation in order to determine how much revenue should be
deferred. However, such estimates are based on numerous assumptions and require
management's judgment. For example, the estimate of future development costs
includes an assumption about the cost of construction services for which the
Company has no current contractual arrangement. If the estimate of these future
costs proves to be too low, then the Company will have recognized too much
profit as of the date of sale resulting in less profit to be reported as the
improvements are completed. However, to date the Company's estimates of future
development costs that have been used to determine the amount of revenue to be
deferred at the date of sale have subsequently been proven to be reasonably
accurate estimates.
Income Taxes - The Company records a valuation allowance to
reduce its deferred tax asset to an amount that the Company expects is more
likely than not to be realized. If the Company's estimate of the realizability
of its deferred tax asset changes in the future, an adjustment to the valuation
allowance would be recorded which would either increase or decrease income tax
expense in such period. The valuation allowance is determined after considering
all relevant facts and circumstances and is based, in significant part, on the
Company's projection of taxable income in the future. The Company calculated the
allowance based on the assumption that it would be able to generate future
taxable income of approximately $167,000,000, which would be sufficient to fully
utilize the Company's NOLs, but not all of its alternative minimum tax credit
carryovers. The Company's estimate does not include any real estate development
profit at the Otay Ranch and Rampage properties, for the reasons discussed
below.
The calculation of the valuation allowance recognizes that the
Company's NOLs will not be available to offset alternative minimum taxable
income, which is currently taxed at a federal tax rate of 20%. When the Company
pays alternative minimum tax, it generates an alternative minimum tax credit
carryover, which generally can be used to reduce its future federal income tax
once it has used all of its NOLs and becomes subject to the regular tax (as
opposed to the alternative minimum tax). Assuming the Company realizes its
projected taxable income in the future and fully utilizes its NOLs, it will have
paid approximately $36,000,000 in federal alternative minimum taxes, generating
minimum tax credit carryovers of the same amount to reduce future federal income
taxes payable. Alternative minimum tax credit carryovers have no expiration
date. However, because the minimum tax credit carryovers do not offset
alternative minimum tax, effectively they are only able to reduce the Company's
federal income tax rate to 20% in any given year, which means the Company would
have to generate an additional $180,000,000 of taxable income above its current
estimate to fully use all of the credits. As a result, the Company has reserved
for a substantial portion of this benefit in its valuation allowance.
The projection of future taxable income is based upon numerous
assumptions about the future, including future market conditions where the
Company's projects are located, regulatory requirements, estimates of future
real estate revenues and development costs, the ability of the Company to
realize taxable profits prior to the expiration of its NOLs, future interest
expense, operating and overhead costs and other factors. To the extent the
Company's actual taxable income in the future exceeds its estimate, the Company
will recognize additional tax benefits and reduce its valuation allowance;
conversely, if the actual taxable income is less than the amounts projected, an
addition to the valuation allowance would be recorded that would increase tax
expense in the future.
During 2004 and 2003, the Company reduced its valuation
allowance and federal income tax expense as a result of increases in its
projected taxable income. During those periods, the Company had entered into lot
sale agreements at the San Elijo Hills project for prices that continued to
increase, at a rate greater than had been expected. The increase in projected
income resulted from the continued strong residential housing market in the San
Elijo Hills area. Since the Company's plans for development at the Otay Ranch
and Rampage properties are uncertain, the Company has not included estimates of
future development profit at these projects in its taxable income projections.
The Company believes that real estate markets and demand can change quickly, and
that projecting profits for these projects at this time is not appropriate.
Adjustments to the valuation allowance in the future should be expected.
17
Provision for Environmental Remediation - The Company records
environmental liabilities when it is probable that a liability has been incurred
and the amount or range of the liability is reasonably estimable. During 2002,
the Company recorded a charge of $11,200,000 representing its estimate of the
cost (including legal fees) to implement the most likely remediation alternative
with respect to approximately 30 acres of undeveloped land owned by the
Company's subsidiary, Flat Rock Land Company. The estimated liability was
neither discounted nor reduced for potential claims for recovery from previous
owners and users of the land who may be liable, and may increase or decrease
based upon the actual extent and nature of the remediation required, the type of
remedial process approved, the expenses of the regulatory process, inflation and
other items. During 2004, the Company increased its estimate of remediation
costs by approximately $1,300,000, primarily due to increases in site
investigation and remediation costs, and during 2003 by approximately $300,000,
primarily for consulting costs. The Company anticipates starting the remediation
process in 2006 with completion in 2007. However, the Company is unable to
predict with certainty when the remediation will commence and there is no
current regulatory requirement to commence remediation by a fixed date.
In 2005, Flat Rock completed the site investigation and
expects to submit the remediation plan for approval from the appropriate
regulatory authority in 2006. At any time prior to the completion of the
remediation, the Company may conclude that the current estimate of its liability
needs to be adjusted. A change to the current estimate could result from, among
other things, a conclusion that a different remediation alternative is more
appropriate (which could increase or decrease the estimate), that the cost to
implement any remediation alternative is different than the Company's current
estimate and/or requirements imposed by regulatory authorities that the Company
did not anticipate but is nevertheless required to implement. The Company
periodically adjusts its liability to reflect its current best estimate;
however, no assurance can be given that the actual amount of environmental
liability will not exceed the amount of reserves for this matter or that it will
not have a material adverse effect on the Company's financial position, results
of operations or cash flows.
Provision for Losses on Real Estate - The Company's real
estate is carried at cost. Whenever events or changes in circumstances suggest
that the carrying amount may not be recoverable, management assesses the
recoverability of its real estate by comparing the carrying amount with its fair
value. The process involved in the determination of fair value requires
estimates as to future events and market conditions. This estimation process may
assume that the Company has the ability to complete development and dispose of
its real estate properties in the ordinary course of business based on
management's present plans and intentions. If management determines that the
carrying value of a specific real estate investment is impaired, a write-down is
recorded as a charge to current period operations. The evaluation process is
based on estimates and assumptions and the ultimate outcome may be different.
The Company has not recorded any such provisions during the three year period
ended December 31, 2005.
Statement of Operations
The Company currently has two significant real estate
development projects, the San Elijo Hills project and the Otay Ranch project.
The San Elijo Hills project is a master-planned community that, when completed,
will contain approximately 2,364 single family lots, 826 multi-family units, 276
very low income apartment units, two school sites and commercial space which
will be sold or leased. As of February 13, 2006, the remaining land at the San
Elijo Hills project to be developed and sold or leased (including real estate
under contract for sale) consisted of 467 single family lots, 40 multi-family
units and 132,000 square feet of commercial space. The Company currently plans
to complete its development of residential sites during 2006 and 2007, after
which remaining activity at the San Elijo Hills project will be primarily
concentrated on the commercial sites. These estimates of future property
available for sale and the timing of the sales are derived from the current
plans for the project, and could change based upon the actions of the project's
homebuilders or regulatory agencies.
While the San Elijo Hills project is a development community
with significant sales activity, sales at the Otay Ranch project have been
limited to three individual transactions for relatively large amounts of land.
Individual lot development at the Otay Ranch project has not yet begun, as the
Company continues to evaluate how to maximize the value of this investment while
pursuing land sales and processing further entitlements on portions of the
property. If and when the Company determines to commence lot development at the
Otay Ranch project, it is expected to last several years. Similarly, the Rampage
property is not expected to have sales activity for several years. Any
residential development at the Rampage property can only commence after
approvals are obtained from several government agencies.
18
Real Estate Sales Activity
San Elijo Hills Project:
------------------------
The Company has closed on sales of real estate and recognized
revenues as follows:
Year Ended Year Ended Year Ended
December 31, 2005 December 31, 2004 December 31, 2003
----------------- ----------------- -----------------
(Dollars in thousands)
Single family units 203 94 535
Multi-family units 131 45 --
Very low income apartment units 72 -- 204
School and retail sites 1 1 --
Purchase price, net of closing costs $ 127,800 $ 53,200 $ 133,400
Revenues recognized on closing date $ 70,700 $ 28,800 $ 77,100
As discussed above, a portion of the revenue from these sales
was deferred, and is recognized as revenues upon the completion of the required
improvements to the property, including costs related to common areas, under the
percentage of completion method of accounting. In addition to revenues
recognized on the closing date reflected in the table above, revenues include
previously deferred amounts of $23,000,000, $38,800,000 and $35,500,000 for
2005, 2004 and 2003, respectively, which were recognized upon completion of
certain required improvements.
Revenues from sales of real estate also include amounts
received pursuant to profit sharing agreements with homebuilders of $6,800,000,
$4,500,000 and $5,500,000 for the years ended December 31, 2005, 2004 and 2003,
respectively. Additionally, revenues from sales of real estate in 2003 include
approximately $3,000,000 paid by one of San Elijo's homebuilders for the
Company's consent to allow the homebuilder to re-sell his lots to another
homebuilder.
During 2005, the very low income apartment units were sold for
a $1,500,000 note; however, no cash down payment was received, the note does not
bear interest and any payments the Company may receive are contingent upon the
buyer obtaining financing. The Company has not recognized any revenue or
receivable resulting from this transaction; revenues will be recognized if and
when cash is received under the note. Land cost for the parcel sold was
negligible.
During 2005, 2004 and 2003, cost of sales of real estate
aggregated $32,600,000, $16,000,000 and $29,100,000, respectively. Cost of sales
is recognized in the same proportion to the amount of revenue recognized under
the percentage of completion method of accounting.
Otay Ranch Project:
-------------------
During 2005, there were no real estate sales at the Otay Ranch
project except for the sale of a small parcel for proceeds of $40,000. During
2004, sales of real estate were $5,800,000 relating to an agreement with the
City of Chula and another party whereby the City acquired 439 acres of
mitigation land by eminent domain proceedings. Sales of real estate during 2003
consist of $22,500,000 from the sale of 1,445 acres.
During 2005, 2004 and 2003, cost of sales of real estate
aggregated $20,000, $1,000,000 and $4,800,000, respectively. Cost of sales is
based upon the allocation of project costs at acquisition to individual parcels,
based upon their relative fair values, in addition to parcel specific
development costs, closing costs and commissions, if any.
Rampage Property:
-----------------
As mentioned above, during 2005 the Company sold approximately
600 acres of land at the Rampage property to a neighboring land owner for
approximately $5,000,000, which resulted in the recognition of a pre-tax gain of
$3,200,000.
19
Paradise Valley Project:
------------------------
During 2003, the Company disposed of all of its remaining
interest in the Paradise Valley project and recognized pre-tax income of
$1,500,000, net of $300,000 that was allocated to the minority interest.
Other Results of Operations Activity
The Company recorded co-op marketing and advertising fees of
approximately $2,200,000, $3,700,000 and $1,300,000 for the years ended December
31, 2005, 2004 and 2003, respectively. The Company records these fees when the
San Elijo Hills project builders sell homes, and are generally based upon a
fixed percentage of the homes' selling price. These fees provide the Company
with funds to conduct its marketing activities for the San Elijo Hills project.
As more fully discussed above, in 2002, the Company recorded a
provision of approximately $11,200,000, representing the estimated cost of
environmental remediation. During 2004, the Company revised its estimate and
recorded approximately $1,300,000 of additional expense, primarily due to higher
site investigation and remediation costs. In 2003, the Company recorded
approximately $300,000 of additional expense, primarily for consulting costs.
Interest expense includes interest related to the Rampage
mortgage of $100,000 and $300,000 for the years ended December 31, 2005 and
2004, respectively; amounts were not material for 2003. As discussed above, the
Rampage mortgage note was repaid in July 2005. Interest expense reflects the
interest due on indebtedness to Leucadia of approximately $400,000 and
$1,600,000 for 2004 and 2003, respectively. Interest expense also includes
amortization of debt discount related to the indebtedness to Leucadia of
$300,000 and $1,100,000 for 2004 and 2003, respectively. The borrowing from
Leucadia was fully repaid in March 2004; as a result these interest costs ceased
at the date of repayment.
Interest expense excludes capitalized interest of $800,000,
$1,200,000 and $1,400,000 for the years ended December 31, 2005, 2004 and 2003,
respectively. Interest is capitalized for the notes payable to trust deed
holders on the San Elijo Hills project.
General and administrative expenses increased by $3,300,000
during 2005 as compared to 2004 primarily due to greater expenses related to
compensation, legal and marketing. Compensation expense increased by $1,900,000
principally due to an increase in general bonus expense, which includes a
$300,000 bonus awarded to the Company's President to pay taxes due on reimbursed
expenses relating to his temporary residence in California and the reimbursement
of certain relocation costs incurred by a newly hired executive officer. Legal
fees increased by $1,300,000 due to costs associated with pursuing claims
against the previous owners of undeveloped land that is undergoing environmental
remediation at the Otay Ranch project. Marketing expenses increased by $600,000
at the San Elijo Hills project, principally due to the addition of special
marketing events and increased advertising efforts to promote the project within
the surrounding community. Such increases were partially offset by lower
professional fees of $100,000 and charitable contributions of $100,000 during
2005. General and administrative expenses in 2004 also included $150,000 of
penalty fees and interest charges related to an underpayment of state taxes for
the 2002 year.
General and administrative expenses decreased by $2,400,000
during 2004 as compared to 2003 due to decreases in salaries expense of
$2,600,000 and stock compensation expense of $600,000. The decrease in salaries
expense related to reduced bonus expense and the resignation of two executive
officers in March 2004 who were not replaced. Stock compensation expense
declined because the performance stock options (granted in 2000) became fully
vested in 2003. Legal fees increased by $500,000 due to costs associated with
pursuing claims against previous owners of undeveloped land that is undergoing
environmental remediation at the Otay Ranch project.
20
The change in other income (expense), net for 2005 as compared
to 2004 primarily relates to the 2004 loss on prepayment of the Leucadia note
and related deferred costs of $1,600,000, which was fully repaid in March 2004.
In addition, interest income in 2005 increased by $1,600,000 as compared to the
same period in 2004 primarily due to greater interest income resulting from
higher interest rates. Other income (expense), net reflects sales of grapes from
the 2005 harvest of $800,000 and farming expenses of $1,100,000; during the
comparable period in 2004 the Company incurred farming expenses of $900,000 but
did not generate any farming income. Other income (expense), net also reflects
$200,000 of pre-payment penalties incurred upon extinguishing the Rampage
mortgage note during 2005.
The change in other income (expense), net for 2004 as compared
to 2003 primarily relates to the $1,600,000 loss on prepayment of the Leucadia
note in 2004 referred to above. Other income (expense), net in 2004 also
reflects an increase in farming and other expenses at the Rampage property,
which was acquired in November 2003. The increase in farming expenses at the
Rampage property of $900,000 primarily represents the cost of restoring
approximately 310 acres of vines for future production. Restoration involves the
application of farming practices including grafting to put the vineyard back
into production. Farming related activities at the Rampage property are expected
to continue while the Company seeks to have the land entitled as a
master-planned community, a process that will require numerous regulatory
approvals and is expected to take several years to complete. Other income
(expense), net in 2004 also reflects an increase in investment income of
$600,000 due to greater interest income resulting from a larger amount of
invested assets. Other income (expense), net in 2003 includes income of $200,000
from the reimbursement for improvement costs that were previously expensed at
the San Elijo Hills project, proceeds of $200,000 from an easement at the Otay
Ranch project and cash received of $300,000 to settle a dispute with one of the
Company's vendors.
The amount of minority expense recorded during each of the
last three years reflects the level of sales activity at the San Elijo Hills
project.
As a result of an increase in the Company's estimates of
future taxable income that exceeded its earlier estimates, the Company reduced
its income tax valuation allowance to recognize additional benefits from its
NOLs and minimum tax credit carryovers and recorded a credit to its income tax
provision of $15,000,000 and $26,065,000 for the years ended December 31, 2004
and 2003, respectively. For more information, see Note 10 of Notes to
Consolidated Financial Statements.
Recently Issued Accounting Standards
In April 2005, the Securities and Exchange Commission amended
the effective date of Statement of Financial Accounting Standards No. 123R,
"Share-Based Payment" ("SFAS 123R"), from the first interim or annual period
after June 15, 2005 to the beginning of the next fiscal year that begins after
June 15, 2005. SFAS 123R requires that the cost of all share-based payments to
employees, including grants of employee stock options, be recognized in the
financial statements based on their fair values. That cost will be recognized as
an expense over the vesting period of the award. Pro forma disclosures
previously permitted under SFAS 123 no longer will be an alternative to
financial statement recognition. In addition, the Company will be required to
determine fair value in accordance with SFAS 123R. The Company does not expect
that SFAS 123R will have a material impact on its consolidated financial
statements.
In May 2005, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 154, "Accounting Changes
and Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No.
3" ("SFAS 154"), which is effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. SFAS 154 applies
to all voluntary changes in accounting principles, and changes the accounting
and reporting requirements for a change in accounting principle. SFAS 154
requires retrospective application to prior periods' financial statements of a
voluntary change in accounting principle unless it is impracticable. APB 20
previously required that most voluntary changes in accounting principle be
recognized by including in net income of the period of the change the cumulative
effect of changing to the new accounting principle. SFAS 154 also requires that
a change in depreciation, amortization, or depletion method for long-lived,
nonfinancial assets be accounted for as a change in accounting estimate effected
by a change in accounting principle. SFAS 154 carries forward without change the
guidance in APB 20 for reporting the correction of an error in previously issued
financial statements, a change in accounting estimate and a change in reporting
entity, as well as the provisions of SFAS 3 that govern reporting accounting
changes in interim financial statements. The Company does not expect that SFAS
154 will have a material impact on its consolidated financial statements.
21
Inflation
The Company, as well as the real estate development and
homebuilding industry in general, may be adversely affected by inflation,
primarily because of either reduced rates of savings by consumers during periods
of low inflation or higher land and construction costs during periods of high
inflation. Low inflation could adversely affect consumer demand by limiting
growth of savings for down payments, ultimately adversely affecting demand for
real estate and the Company's revenues. High inflation increases the Company's
costs of labor and materials. The Company would attempt to pass through to its
customers any increases in its costs through increased selling prices. To date,
high or low rates of inflation have not had a material adverse effect on the
Company's results of operations. However, there is no assurance that high or low
rates of inflation will not have a material adverse impact on the Company's
future results of operation.
Interest Rates
The Company's operations are interest-rate sensitive. The
Company has indirectly benefited from the prevailing low mortgage interest rate
environment, since low rates made housing more affordable for the home buyer,
thereby increasing demand for homes. The Company can not predict whether
interest rates will remain low and what impact an increase in interest rates and
mortgage rates would have on the Company's operations, although any significant
increase in these rates could have a chilling effect on the housing market,
which could adversely affect the Company's results of operations.
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking
statements. Such statements may relate, but are not limited, to projections of
revenues, income or loss, development expenditures, plans for growth and future
operations, competition and regulation, as well as assumptions relating to the
foregoing. Such forward-looking statements are made pursuant to the safe-harbor
provisions of the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are inherently subject to risks and
uncertainties, many of which cannot be predicted or quantified. When used in
this Report, the words "estimates," "expects," "anticipates," "believes,"
"plans," "intends" and variations of such words and similar expressions are
intended to identify forward-looking statements that involve risks and
uncertainties. Future events and actual results could differ materially from
those set forth in, contemplated by or underlying the forward-looking
statements.
Factors that could cause actual results to differ materially
from any results projected, forecasted, estimated or budgeted or may materially
and adversely affect the Company's actual results include, but are not limited
to, those set forth in "Item 1A, Risk Factors" and elsewhere in this Report and
in the Company's other public filings with the Securities and Exchange
Commission.
Undue reliance should not be placed on these forward-looking
statements, which are applicable only as of the date hereof. The Company
undertakes no obligation to revise or update these forward-looking statements to
reflect events or circumstances that arise after the date of this Report or to
reflect the occurrence of unanticipated events.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
- ------- ---------------------------------------------------------
The Company's market risk arises principally from interest
rate risk related to its investment portfolio and borrowing activities.
At December 31, 2005, the Company had investments of
approximately $65,200,000 in securities issued by the U.S. government and U.S.
Government-Sponsored Enterprises. The Company's investment portfolio is
classified as available for sale, and is reflected in the balance sheet at fair
value with unrealized gains and losses reflected in stockholders' equity. The
securities in the portfolio are rated "AAA" and "Aaa" by Standard & Poor's and
Moody's, respectively. All of these fixed income securities mature in 2006; the
estimated weighted average remaining life of these fixed income securities was
approximately 0.2 years at December 31, 2005. At December 31, 2004, the
Company's investments consisted of fixed income securities with an estimated
weighted average remaining life of approximately 0.2 years and a weighted
average interest rate of 2.0%. The Company's fixed income securities, like all
fixed income instruments, are subject to interest rate risk and will fall in
value if market interest rates increase.
22
The Company is subject to interest rate risk on its long-term
fixed interest rate debt. Generally, the fair market value of debt securities
with a fixed interest rate will increase as interest rates fall, and the fair
market value will decrease as interest rates rise. For additional information
with respect to the Company's indebtedness, see Note 5 of Notes to Consolidated
Financial Statements.
Expected Maturity Date
-------------------------------------------------------------------------------------------------
2006 2007 2008 2009 2010 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities
U.S. Treasury Securities $ 52,604 $ - $ - $ - $ - $ - $ 52,604 $ 52,604
Weighted Average
Interest Rate 3.86%
U.S. Government-
Sponsored Enterprises $ 12,586 $ - $ - $ - $ - $ - $ 12,586 $ 12,586
Weighted Average
Interest Rate 4.33%
Rate Sensitive Liabilities:
Fixed Interest Rate
Borrowings $ 9,062 $ 1,341 $ - $ - $ - $ - $ 10,403 $ 10,403
Weighted Average
Interest Rate 6.12% 6.12%
Off-Balance Sheet Items:
Unused Lines of Credit $ - $ 10,000 $ - $ - $ - $ - $ 10,000 $ 10,000
Weighted Average
Interest Rate - 10.0%
Item 8. Financial Statements and Supplementary Data.
- ------ -------------------------------------------
Financial Statements and supplementary data required by this
Item 8 are set forth at the pages indicated in Item 15(a) below.
Item 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure.
- ------ ------------------------------------------------------------
None.
Item 9A. Controls and Procedures.
- ------- -----------------------
(a) The Company's management evaluated, with the participation of the
Company's principal executive and principal financial officers, the
effectiveness of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")), as of December 31, 2005. Based on their
evaluation, the Company's principal executive and principal financial officers
concluded that the Company's disclosure controls and procedures were effective
as of December 31, 2005.
(b) There has been no change in the Company's internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during the Company's fiscal quarter ended December
31, 2005, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
23
Management's Report on Internal Control Over Financial Reporting
Management of the Company is responsible for establishing and
maintaining adequate internal control over financial reporting as defined in
Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of
1934. Internal control over financial reporting is a process designed to provide
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles and includes those policies and
procedures that:
o Pertain to the maintenance of records that in reasonable detail accurately
and fairly reflect the transactions and disposition of the assets of the
Company;
o Provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of management
and directors of the Company; and
o Provide reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company's assets that
could have a material effect on the financial statements.
Because of its inherent limitations, internal control over
financial reporting may not prevent or detect misstatements. Also, projections
of any evaluation of effectiveness to future periods are subject to the risk
that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.
The Company's management assessed the effectiveness of the
Company's internal control over financial reporting as of December 31, 2005. In
making this assessment, the Company's management used the criteria established
in Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission ("COSO").
Based on our assessment and those criteria, management
concluded that, as of December 31, 2005, the Company's internal control over
financial reporting is effective.
The Company's independent registered public accounting firm
has audited management's assessment of the effectiveness of the Company's
internal control over financial reporting as of December 31, 2005 as stated in
the report which appears on page F-1 of this Report.
Item 9B. Other Information.
- ------- -----------------
Not applicable.
24
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ------- --------------------------------------------------
As of February 13, 2006, the directors and executive officers
of the Company, their ages, the positions held by them and the periods during
which they have served in such positions are as follows:
Name Age Position with the Company Office Held Since
- ---- --- ------------------------- -----------------
Paul J. Borden 57 Director and President May 1998
Curt R. Noland 49 Vice President October 1998
Erin N. Ruhe 40 Vice President, Treasurer and Vice President since April
Controller 2000; Treasurer since March
2004; Controller since January
1999
Patrick D. Bienvenue 51 Director August 1998
Timothy M. Considine 65 Director January 1992
Ian M. Cumming 65 Director May 1999
Michael A. Lobatz 57 Director February 1995
Joseph S. Steinberg 62 Chairman of the Board and Chairman of the Board since
Director December 1999; Director since
August 1998
The officers serve at the pleasure of the Board of Directors
of the Company.
The recent business experience of our executive officers and
directors is summarized as follows:
Paul J. Borden. Mr. Borden has served as a director and
President of the Company since May 1998. Mr. Borden had been a Vice President of
Leucadia National Corporation from August 1988 through October 2000, responsible
for overseeing many of Leucadia's real estate investments.
Curt R. Noland. Mr. Noland has served as Vice President of the
Company since October 1998. He spent the last 25 years in the land development
industry in San Diego County as a design consultant, merchant builder and a
master developer. From November 1997 until joining the Company, Mr. Noland was
employed by the prior development manager of San Elijo Hills and served as
Director of Development for San Elijo Hills. Prior to November 1997, Mr. Noland
was employed for eight years by Aviara Land Associates, LP, a 1,000 acre
master-planned resort community in Carlsbad, California. He is also a licensed
civil engineer and real estate broker.
Erin N. Ruhe. Ms. Ruhe has served as Vice President of the
Company since April 2000, Treasurer since March 2004 and has been employed by
the Company as Controller since January 1999. Previously, Ms. Ruhe was Vice
President since December 1995 and Controller since November 1994 of HSD Venture,
a real estate subsidiary of Leucadia.
Patrick D. Bienvenue. Mr. Bienvenue has served as a director
of the Company since August 1998. Since January 1996, Mr. Bienvenue has served
in a variety of executive capacities with real estate related subsidiaries of
Leucadia National Corporation and, from 1992 until December 1995, was President
and Chief Executive Officer of Torwest Inc., a privately held property
development and investment company.
25
Timothy M. Considine. Mr. Considine has served as a director
of the Company since January 1992, serving as Chairman of the Board from 1992 to
December 1999, and is employed by Considine and Considine, an accounting firm in
San Diego, California where he was a partner from 1969 to 2002.
Ian M. Cumming. Mr. Cumming has served as a director of the
Company since May 1999. He has been a director and Chairman of the Board of
Leucadia National Corporation since June 1978 and a director and Chairman of the
Board of The FINOVA Group Inc. ("FINOVA"), a middle market lender in which
Leucadia has an indirect 25% equity interest, since August 2001. Mr. Cumming has
also been a director of Skywest, Inc., a Utah-based regional air carrier, since
June 1986.
Michael A. Lobatz. Dr. Lobatz has served as a director of the
Company since February 1995 and has been a practicing physician in San Diego,
California since 1981.
Joseph S. Steinberg. Mr. Steinberg has served as a director of
the Company since August 1998 and as Chairman of the Board since December 1999.
Mr. Steinberg has been President of Leucadia National Corporation since January
1979 and a director of Leucadia National Corporation since December 1978. In
addition, he has served as a director of Jordan Industries Inc., a public
company that owns and manages manufacturing companies since June 1988, and
FINOVA since August 2001.
Audit Committee
The Board of Directors has a standing Audit Committee. The
Board of Directors has adopted a charter for the Audit Committee, which was
filed with the Company's proxy statement for its 2005 Annual Meeting of
Shareholders. The Audit Committee consists of Messrs. Considine (Chairman) and
Lobatz. Applying the Nasdaq criteria, the Board has determined that each of
Messrs. Considine and Lobatz is independent. In addition, the Board has
determined that Mr. Considine is qualified as an audit committee financial
expert within the meaning of regulations of the Securities and Exchange
Commission.
Code of Practice
The Company has a Code of Business Practice, which is
applicable to all directors, officers and employees of the Company, and includes
a Code of Practice applicable to the Company's principal executive officers and
senior financial officers. Both the Code of Business Practice and the Code of
Practice are available without charge upon request. Requests should be addressed
to Corporate Secretary, HomeFed Corporation, 1903 Wright Place, Suite 220,
Carlsbad, California 92008. The Company intends to file with the Securities and
Exchange Commission amendments to or waivers from our Code of Practice
applicable to our principal executive officers and senior financial officers.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires
the Company's executive officers and directors, and persons who beneficially own
more than 10% of a registered class of the Company's equity securities, to file
reports of ownership and changes in ownership with the Securities and Exchange
Commission. Based solely upon a review of the copies of such forms furnished to
the Company and written representations from the Company's executive officers,
directors and greater than 10% beneficial shareholders, the Company believes
that during the year ended December 31, 2005, all persons subject to the
reporting requirements of Section 16(a) filed the required reports on a timely
basis.
26
Item 11. Executive Compensation.
- ------- ----------------------
Summary Compensation Table
Set forth below is certain information with respect to the
cash compensation paid by the Company for services in all capacities to the
Company and its subsidiaries during the years ended 2005, 2004 and 2003 to (i)
the Company's President and Chief Executive Officer, Paul J. Borden, and (ii)
the other executive officers of the Company whose total annual salary and bonus
exceeded $100,000 during these periods.
Long-term
Annual Compensation (1) Compensation
-------------------------------------------------------------------------------------------------
Name and Principal Other Annual Options All Other
Position(s) Year Salary Bonus Compensation (# of shares) Compensation (5)
- ------------------- ------ ----------- ------------ ------------- ------------ ---------------
Paul J. Borden, 2005 $ 255,790(2) $ 606,954 $320,975 (3) 1,000 $ 8,400
President 2004 246,200(2) 356,751 84,662 (3) 1,000 8,200
2003 232,635(2) 1,006,619 89,780 (3) 100 8,000
Curt R. Noland, 2005 $ 149,995 $ 504,500 $ - - $ 8,400
Vice President 2004 115,995 303,477 - - 8,200
2003 113,620 603,409 - - 8,000
Erin N. Ruhe, 2005 $ 113,307 $ 303,399 $ - - $ 8,400
Vice President, 2004 95,472 253,300 - - 8,200
Treasurer & Controller 2003 78,805 302,364 - - 6,247
H. Pike Oliver, (6) 2005 $ 113,077 $ 103,375 $ 87,621(4) - $ 4,658
Vice President
- --------------------
(1) Effective January 2006, salaries were increased to the following
amounts: Mr. Borden, $238,744; Mr. Noland $154,500; and Ms. Ruhe
$125,000.
(2) Includes director fees of $24,000 for 2005, $21,000 for 2004 and
$12,000 for 2003 that Mr. Borden received from the Company.
(3) Mr. Borden maintains his primary residence in New Jersey. The
information reflected above includes the incremental cost to the
Company (valued in accordance with the disclosure rules of the
Securities and Exchange Commission) of reimbursing Mr. Borden for the
cost of a temporary residence in California ($29,045, $35,839 and
$36,830 in 2005, 2004 and 2003, respectively), airfare for travel to
and from his primary residence ($24,340, $38,715 and $42,515 in 2005,
2004 and 2003, respectively) and transportation costs including the
use of a company car while in California. Such reimbursements are
considered to be taxable compensation reportable by Mr. Borden under
federal income tax rules, which results in a net cash cost to him,
even though he does not gain any incremental financial benefit from
these reimbursements. As a result, beginning in 2005, the Company has
agreed to pay Mr. Borden additional compensation which, after taxes,
will provide him with sufficient funds to pay the taxes due on the
expense amounts reimbursed by the Company. In addition, in 2005 the
Company paid Mr. Borden for the 2004 additional taxable compensation
reported by Mr. Borden for reimbursements made with respect to prior
periods. These payments aggregated $260,415 during 2005 and is
reflected in the 2005 amount.
(4) The Company reimbursed Mr. Oliver for relocation expenses when he
joined the Company and personal use of a Company car.
(5) Represents the contribution made by the Company to a defined
contribution 401(k) plan on behalf of the named person.
(6) Mr. Oliver joined the Company as a Vice President on April 5, 2005 at
a salary of $150,000; the salary amount reflected in the table is for
the period he was with the Company. Mr. Oliver resigned from the
Company effective February 10, 2006.
27
Option Grants in 2005
The following table shows all grants of options to the named
executive officers of the Company in 2005.
Potential Realizable Value
At Assumed Annual Rates
of Stock Price Appreciation
Individual Grants for Option Term (2)
----------------------------------------------------------- ------------------------------
Securities % of Total
Underlying Options
Options Granted to Exercise
Granted Employees Price Expiration
(# of shares) in 2005 ($/share) Date 5%($) 10% ($)
------- --------- --------- ---- ----- -------
Name
- ----
Paul J. Borden 1,000 (1) 100.0% $65.19 7/12/10 $18,011 $39,799
- --------------
(1) The options were granted pursuant to the Company's 1999 Stock Incentive
Plan to all Directors of the Company at an exercise price equal to the fair
market value of the shares of Common Stock on the date of grant. The grant
date of the options is July 12, 2005. These options become exercisable at
the rate of 25% per year commencing one year after the date of grant.
(2) The potential realizable values represent future opportunity and have not
been reduced to reflect the time value of money. The amounts shown under
these columns are the result of calculations at the 5% and 10% rates
required by the Securities and Exchange Commission, and are not intended to
forecast future appreciation of the shares of Common Stock and are not
necessarily indicative of the values that may be realized by the named
executive officer.
Aggregate Option Exercises in 2005 and
Option Values at Year End 2005
The following table provides information as to options
exercised by each of the named executives in 2005 and the value of options held
by these executives at year end measured in terms of the last reported sale
price for the Common Stock as of December 31, 2005, $67.00.
Number of Value of
Unexercised Unexercised In-the-
Options at Money Options at
December 31, 2005 December 31, 2005
----------------- -----------------
Shares Acquired on Value Exercisable/ Exercisable/
Name Exercise Realized Unexercisable Unexercisable
- ---- -------- -------- ------------- -------------
Paul J. Borden 2,600 $ 144,350 2,975/1,825 $166,438/$22,103
Curt R. Noland 500 28,250 -- / -- $ -- /$ --
Erin N. Ruhe -- -- 2,500/ -- $148,750/$ --
Compensation of Directors
In 2005, each Director received a retainer of $24,000 for
serving on the Board of Directors. In addition, Mr. Considine was paid $26,000
for serving as Chairman of the Audit Committee, and Mr. Lobatz was paid $17,000
for serving on the Audit Committee. In addition, under the terms of the
Company's 1999 Stock Incentive Plan, each director is automatically granted
options to purchase 1,000 shares on the date on which the annual meeting of
stockholders of the Company is held each year. The purchase price of the shares
covered by such options is the fair market value of such shares on the date of
grant. These options become exercisable at the rate of 25% per year commencing
one year after the date of grant. As a result of this provision, options to
purchase 1,000 shares of Common Stock at an exercise price of $65.19 per share
were awarded to each of Messrs. Bienvenue, Borden, Considine, Cumming, Lobatz
and Steinberg on July 12, 2005. The Company reimburses directors for reasonable
travel expenses incurred in attending board and committee meetings.
28
2005 Board of Directors Compensation (1)
----------------------------------------
Director Total Fees Earned Stock Options (2)
-------- ----------------- -----------------
Patrick D. Bienvenue $24,000 1,000
Paul J. Borden $24,000 1,000
Timothy M. Considine $50,000 1,000
Ian M. Cumming $24,000 1,000
Michael A. Lobatz $41,000 1,000
Joseph S. Steinberg $24,000 1,000
(1) Table does not include reimbursement for reasonable travel expenses
incurred in attending board and committee meetings.
(2) Reflects options granted under the Company's 1999 Stock Incentive
Plan.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- ------- --------------------------------------------------------------
Set forth below is certain information as of February 13, 2006
with respect to the beneficial ownership determined in accordance with Rule
13d-3 under the Securities Exchange act of 1934, as amended, of Common Stock by
(i) each person who, to the knowledge of the Company, is the beneficial owner of
more than 5% of the outstanding Common Stock (the Company's only class of voting
securities), (ii) each Director, (iii) the executive officers named in the
Summary Compensation Table under "Executive Compensation," (iv) a trust for the
benefit of Mr. Steinberg's children and private charitable foundations
established by Mr. Cumming and Mr. Steinberg and (v) all executive officers and
Directors of the Company as a group.
Number of Shares
Name and Address and Nature of Percent
of Beneficial Owner Beneficial Ownership of Class
- ------------------- -------------------- --------
Leucadia National Corporation ...................................... 2,474,226 (a) 29.9%
Patrick D. Bienvenue................................................ 1,575 (b) *
Paul J. Borden...................................................... 7,153 (c) *
Timothy M. Considine................................................ 2,075 (d) *
Ian M. Cumming...................................................... 633,734 (e)(f) 7.7%
Michael A. Lobatz................................................... 1,575 (b) *
Curt R. Noland...................................................... 5,000 *
H. Pike Oliver...................................................... - (g) -
Erin N. Ruhe........................................................ 5,000 (h) *
Joseph S. Steinberg................................................. 782,195 (f)(i) 9.5%
The Steinberg Children Trust........................................ 27,532 (j) 0.3%
Cumming Foundation.................................................. 147,330 (k) 1.8%
The Joseph S. and Diane H. Steinberg 1992 Charitable Trust.......... 2,381 (l) *
All Directors and executive officers as a group (9 persons)......... 1,438,307 (m) 17.4%
- -------------------
* Less than .1%.
(a) The business address of this beneficial owner is 315 Park Avenue South, New
York, New York 10010.
(b) Includes 475 common shares that may be acquired upon the exercise of
currently exercisable stock options.
(c) Includes 2,975 common shares that may be acquired upon the exercise of
currently exercisable stock options.
29
(d) Includes (i) 500 shares held by the Seeseeanoh Inc. Retirement Plan. Mr.
Considine and his wife are the sole owners of Seeseeanoh, a real estate
company in San Diego, California, (ii) includes 1,325 shares held by The
Considine Family 1981 Trust, of which Mr. Considine and his wife are
trustees and (iii) includes 250 common shares that may be acquired upon the
exercise of currently exercisable stock options.
(e) Includes (i) 9,530 shares of Common Stock (.1%) beneficially owned by Mr.
Cumming's wife (directly and through trusts for the benefit of Mr.
Cumming's children of which Mr. Cumming's wife is trustee) as to which Mr.
Cumming may be deemed to be the beneficial owner and (ii) 475 shares that
may be acquired upon the exercise of currently exercisable stock options.
Does not include 2,474,226 shares held by Leucadia which Mr. Cumming may be
deemed to beneficially own as a result of his beneficial ownership of
Leucadia common shares. See Item 13, Certain Relationships and Related
Transactions.
(f) Messrs. Cumming and Steinberg have an oral agreement pursuant to which they
will consult with each other as to the election of a mutually acceptable
Board of Directors of the Company. The business address for Messrs. Cumming
and Steinberg is c/o Leucadia National Corporation, 315 Park Avenue South,
New York, New York 10010.
(g) Mr. Oliver resigned from the Company effective February 10, 2006.
(h) Includes 2,500 common shares that may be acquired upon the exercise of
currently exercisable stock options.
(i) Includes (i) 3,676 shares of Common Stock (less than .1%) beneficially
owned by Mr. Steinberg's wife and daughter as to which Mr. Steinberg may be
deemed to be the beneficial owner, (ii) 61,793 shares of Common Stock owned
by a trust for the benefit of Mr. Steinberg's children and (iii) 475 shares
that may be acquired upon the exercise of currently exercisable stock
options. Does not include 2,474,226 shares held by Leucadia which Mr.
Steinberg may be deemed to beneficially own as a result of his beneficial
ownership of Leucadia common shares. See Item 13, Certain Relationships
and Related Transactions.
(j) Mr. Steinberg disclaims beneficial ownership of the Common Stock held by
the Steinberg Children Trust.
(k) Mr. Cumming is a trustee and President of the foundation and disclaims
beneficial ownership of the Common Stock held by the foundation.
(l) Mr. Steinberg and his wife are trustees of the trust. Mr. Steinberg
disclaims beneficial ownership of the Common Stock held by the trust.
(m) Includes 7,625 shares of Common Stock that may be acquired upon the
exercise of currently exercisable stock options.
As of February 13, 2006, Cede & Co. held of record 4,861,688
shares of Common Stock (approximately 58.8% of the total Common Stock
outstanding). Cede & Co. held such shares as a nominee for broker-dealer members
of The Depository Trust Company, which conducts clearing and settlement
operations for securities transactions involving its members.
Equity Compensation Plan Information
The following table summarizes information regarding the
Company's equity compensation plans as of December 31, 2005. All outstanding
awards relate to the Company's Common Stock.
30
Number of securities
remaining available
for future issuance
Number of Securities Weighted-average under equity
to be issued upon exercise price of compensation plans
exercise of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
- ------------------------ --------------------------------- --------------------- -------------------------
Equity compensation
plans approved by
security holders 22,575 $33.24 487,900
Equity compensation
plans not approved
by security holders -- -- --
------- ------ -------
Total 22,575 $33.24 487,900
======= ====== =======
Item 13. Certain Relationships and Related Transactions.
- ------- ----------------------------------------------
Relationship with Leucadia and Various Agreements
In 1995, Leucadia funded the Company's bankruptcy plan by
purchasing common stock and a secured promissory note of the Company, which was
prepaid in full in March 2004. In 1999, Leucadia distributed all of the HomeFed
common stock that it owned to shareholders of Leucadia. In October 2002,
Leucadia again acquired an equity interest in the Company when it received
2,474,226 shares of the Company's common stock, representing approximately 30%
of the Company's outstanding shares, as partial consideration for its sale to
the Company of CDS. For additional information, see Note 2 of Notes to
Consolidated Financial Statements.
As a result of the distribution of HomeFed common stock to
Leucadia's shareholders in 1999, Joseph S. Steinberg, Chairman of the Board of
HomeFed, and Ian M. Cumming, a director of HomeFed, together with their
respective family members (excluding a trust for the benefit of Mr. Steinberg's
children) beneficially own, at February 13, 2006, approximately 9.5% and 7.7%,
respectively, of the Company's outstanding common stock, before consideration of
the common shares owned by Leucadia. In addition, the Joseph S. and Diane H.
Steinberg 1992 Charitable Trust owns 2,381 (less than 0.1%), and the Cumming
Foundation, a private charitable foundation independently established by Mr.
Cumming, beneficially owns 147,330 (1.8%) shares of the Company's outstanding
common stock, respectively. Mr. Steinberg and Mr. Cumming disclaim beneficial
ownership of the Company's common stock held by the Joseph S. and Diane H.
Steinberg 1992 Charitable Trust and the Cumming Foundation. Mr. Steinberg is
also President and a director of Leucadia and Mr. Cumming is Chairman of the
Board of Leucadia. At February 13, 2006, Mr. Steinberg and Mr. Cumming
beneficially owned (together with their respective family members but excluding
a trust for the benefit of Mr. Steinberg's children) approximately 12.6% and
11.5%, respectively, of Leucadia's outstanding common shares. The Joseph S. and
Diane H. Steinberg 1992 Charitable Trust owns 15,000 (less than 0.1%) and the
Cumming Foundation also beneficially owns 211,146 (0.2%) of Leucadia's
outstanding common shares, respectively. Mr. Steinberg and Mr. Cumming disclaim
beneficial ownership of Leucadia's common shares held by the Joseph S. and Diane
H. Steinberg Charitable Trust and the Cumming Foundation. In addition to their
ownership of HomeFed common stock (directly and through family members), as a
result of their beneficial ownership of Leucadia common shares, Messrs. Cumming
and Steinberg each may be deemed to be the beneficial owner of the shares of
HomeFed common stock owned by Leucadia.
In 2003, the Company paid Leucadia approximately $12,900,000
in redemption of Leucadia's preferred capital interest in Otay Land Company and
in full satisfaction of the preferred return related thereto.
31
The Company is required to obtain infrastructure improvement
bonds primarily for the benefit of the City of San Marcos prior to the beginning
of lot construction work and warranty bonds upon completion of such improvements
in the San Elijo Hills project. These bonds provide funds primarily to the City
in the event the Company is unable or unwilling to complete certain
infrastructure improvements in the San Elijo Hills project. Leucadia has
obtained these bonds on behalf of CDS and its subsidiaries both before and after
the acquisition of CDS by the Company. CDS is responsible for paying all third
party fees related to obtaining the bonds. Should the City or others draw on the
bonds for any reason, one of CDS's subsidiaries would be obligated to reimburse
Leucadia for the amount drawn. As of December 31, 2005, the amount of
outstanding bonds was approximately $29,500,000.
Since 1995, Leucadia has been providing administrative and
accounting services to the Company. Under the current administrative services
agreement, Leucadia provides services to the Company for a monthly fee of
$15,000 ($180,000 in the aggregate for all of 2005). Pursuant to this agreement,
Leucadia provides the services of Ms. Corinne A. Maki, the Company's Secretary,
in addition to various administrative functions. Ms. Maki is an officer of
subsidiaries of Leucadia.
The term of the administrative services agreement
automatically renews for successive annual periods unless terminated in
accordance with its terms. Leucadia has the right to terminate the agreement by
giving the Company not less than one year's prior notice, in which event the
then monthly fee will remain in effect until the end of the notice period. The
Company has the right to terminate the agreement, without restriction or
penalty, upon 30 days prior written notice to Leucadia. The agreement has not
been terminated by either party.
In March 2001, the Company entered into an unsecured
$3,000,000 line of credit agreement with Leucadia. Loans outstanding under this
line of credit bear interest at 10% per annum. Effective March 1, 2002, this
agreement was amended to extend the maturity to February 28, 2007, although
Leucadia had the right to terminate the line of credit on an annual basis. In
October 2002, the line of credit was increased to $10,000,000 and Leucadia's
ability to terminate the line of credit prior to maturity was removed, unless
the Company is in default. The Company paid $38,000 in commitment fees during
2005. No amounts have been borrowed under this facility since 2002.
The Company rents office space at its corporate headquarters
to Leucadia. Effective March 1, 2005, the monthly rent is $1,000; in 2005, the
rent paid by Leucadia aggregated $21,000.
Item 14. Principal Accounting Fees and Services.
- ------- --------------------------------------
The Audit Committee has adopted policies and procedures
effective May 2003 for pre-approving all audit and non-audit work performed by
the Company's independent registered public accounting firm,
PricewaterhouseCoopers LLP. Specifically, the Audit Committee has pre-approved
certain specific categories of work and an annual amount for each category. For
additional services or services in an amount above the annual amount that has
been pre-approved, additional authorization from the audit committee is
required. The Audit Committee has delegated to the Committee chair the ability
to pre-approve both general pre-approvals (where no specific, case-by-case
approval is necessary) and specific pre-approvals. Any pre-approval decisions
made by the Committee chair under this delegated authority will be reported to
the full Audit Committee. All requests for services to be provided by
PricewaterhouseCoopers LLP that do not require specific approval by the audit
committee must be submitted to the Controller of the Company, who determines
that such services are in fact within the scope of those services that have been
pre-approved by the Audit Committee. The Controller reports to the Audit
Committee periodically.
Audit fees of our independent registered public accounting
firm, PricewaterhouseCoopers LLP, incurred by us were $240,000 and $275,800 for
the fiscal years ended December 31, 2005 and 2004, respectively. These fees
include fees paid to PricewaterhouseCoopers LLP for professional services for
the audit of the Company's consolidated financial statements included in the
Company's Form 10-K, the review of financial statements included in the
Company's Form 10-Qs, services that are normally provided in connection with
statutory and regulatory filings or engagements, assurance and related services
that are reasonably related to the performance of the audit or review of our
financial statements including compliance with regulatory matters, the
Sarbanes-Oxley Act, and consulting with respect to technical accounting and
disclosure rules. All such services were approved by the Audit Committee.
32
PART IV
Item 15. Exhibits and Financial Statement Schedules.
- ------- ------------------------------------------
(a)(1) Financial Statements.
Report of Independent Registered Public Accounting Firm F-1
Consolidated Balance Sheets at December 31, 2005 and 2004 F-3
Consolidated Statements of Operations for the years ended December 31, 2005, 2004 and 2003 F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 2005, 2004 and 2003 F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2005, 2004 and 2003 F-6
Notes to Consolidated Financial Statements F-8
(a)(2) Financial Statement Schedules.
Schedules are omitted because they are not required or are not
applicable or the required information is shown in the financial
statements or notes thereto.
(a)(3) Executive Compensation Plans and Arrangements. See item 15(b)
below for a complete list of exhibits to this Report.
1999 Stock Incentive Plan (filed as Annex A to the Company's Proxy
Statement dated November 22, 1999).
Form of Grant Letter for 1999 Stock Incentive Plan.
See also Item 15(b) below.
(b) Exhibits.
We will furnish any exhibit upon request made to our Corporate
Secretary, 1903 Wright Place, Suite 220, Carlsbad, CA 92008. We charge
$.50 per page to cover expenses of copying and mailing.
3.1 Restated Certificate of Incorporation, as restated July 3, 1995 of the
Company (incorporated by reference to Exhibit 3.1 to the Company's
quarterly report on Form 10-Q for the quarter ended September 30,
1995).
3.2 By-laws of the Company as amended through December 14, 1999
(incorporated by reference to Exhibit 3.2 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 (the "1999
10-K")).
3.3 Amendment to Amended and Restated Bylaws of the Company, dated July 10,
2002 (incorporated by reference to Exhibit 3.3 to the Company's
quarterly report on Form 10-Q for the quarter ended September 30,
2002).
3.4 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2002 (incorporated by reference to Exhibit 3.4
to the Company's quarterly report on Form 10-Q for the quarter ended
September 30, 2002).
3.5 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2003 (incorporated by reference to Exhibit 3.5
to the Company's Annual Report on Form 10-K for the year ended December
31, 2003 (the "2003 10-K")).
33
3.6 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2003 (incorporated by reference to Exhibit 3.6
to the Company's 2003 10-K).
10.1 Development Management Agreement between the Company and Provence Hills
Development Company, LLC, dated as of August 14, 1998 (incorporated by
reference to Exhibit 10.3 to the Company's current report on Form 8-K
dated August 14, 1998).
10.2 Amended and Restated Limited Liability Company Agreement of Otay Land
Company, LLC, dated as of September 20, 1999, between the Company and
Leucadia National Corporation (incorporated by reference to Exhibit
10.16 to the Company's Registration Statement on Form S-2 (No.
333-79901)).
10.3 Administrative Services Agreement, dated as of March 1, 2000, between
Leucadia Financial Corporation ("LFC"), the Company, HomeFed Resources
Corporation and HomeFed Communities, Inc. (incorporated by reference to
Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the
quarter ended June 30, 2000).
10.4 Amendment No. 1 dated as of November 1, 2000 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000 (the "2000 10-K")).
10.5 Amendment No. 2 dated as of February 28, 2001 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.22 to the Company's 2000 10-K).
10.6 Amendment No. 3 dated as of December 31, 2001 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.26 to the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2001).
10.7 Registration Rights Agreement dated as of October 21, 2002, by and
between HomeFed Corporation and Leucadia National Corporation
(incorporated by reference to Exhibit 10.2 to the Company's current
report on Form 8-K dated October 22, 2002).
10.8 Amended and Restated Line Letter dated as of October 9, 2002, by and
between HomeFed Corporation and Leucadia Financial Corporation
(incorporated by reference to Exhibit 10.5 to the Company's current
report on Form 8-K dated October 22, 2002).
10.9 Amended and Restated Term Note dated as of October 9, 2002
(incorporated by reference to Exhibit 10.6 to the Company's current
report on Form 8-K dated October 22, 2002).
10.10 Amendment No. 4 dated as of May 28, 2002 to the Administrative Services
Agreement dated as of March 1, 2000 (incorporated by reference to
Exhibit 10.34 to the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2002 (the "2002 10-K/A")).
10.11 Amendment No. 5 dated as of November 15, 2002 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.35 of the 2002 10-K/A).
10.12 Amendment dated as of October 21, 2002 to the Development Management
Agreement dated as of August 14, 1998 (incorporated by reference to
Exhibit 10.36 of the 2002 10-K/A).
10.13 Contribution Agreement between the Company and San Elijo Hills
Development Company, LLC, dated as of October 21, 2002
(incorporated by reference to Exhibit 10.37 of the 2002 10-K/A).
10.14 Agreement and Guaranty, dated as of October 1, 2002, between Leucadia
National Corporation and CDS Holding Corporation (incorporated by
reference to Exhibit 10.38 of the 2002 10-K/A).
10.15 Obligation Agreement, dated as of October 1, 2002, between Leucadia
National Corporation and San Elijo Ranch, Inc. (incorporated by
reference to Exhibit 10.39 of the 2002 10-K/A).
10.16 Tax Allocation Agreement between the Company and its subsidiaries dated
as of November 1, 2002 (incorporated by reference to Exhibit 10.21 to
the Company's 2003 10-K).
10.17 Amendment No. 1 to the First Amended and Restated Development Agreement
and Owner Participation Agreement between the City of San Marcos, the
San Marcos Redevelopment Agency and the San Elijo Hills Development
Company, LLC dated as of February 11, 2004 (incorporated by reference
to Exhibit 10.22 to the Company's 2003 10-K).
34
10.18 Amendment No. 6 dated as of December 31, 2003 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.23 to the Company's 2003 10-K).
10.19 Amendment No. 7 dated as of December 31, 2004 to the Administrative
Services Agreement dated as of March 1, 2000.
10.20 1999 Stock Incentive Plan (incorporated by reference to Annex A to the
Company's Proxy Statement dated November 22, 1999).
10.21 Form of Grant Letter for the 1999 Stock Incentive Plan.
10.22 Director Compensation.
21 Subsidiaries of the Company.
23 Consent of PricewaterhouseCoopers LLP with respect to the incorporation
by reference into the Company's Registration Statement on Form S-8
(File No. 333-97079).
31.1 Certification of Principal Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.*
32.2 Certification of Principal Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.*
* Furnished herewith pursuant to Item 601(b) (32) of Regulation S-K.
35
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
HOMEFED CORPORATION
Date: February 27, 2006 By /s/ Erin N. Ruhe
---------------------------------
Erin N. Ruhe
Vice President, Treasurer and Controller
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the Registrant and in the capacities and on the dates indicated.
Date: February 27, 2006 By /s/ Joseph S. Steinberg
---------------------------------
Joseph S. Steinberg, Chairman
of the Board and Director
Date: February 27, 2006 By /s/ Paul J. Borden
---------------------------------
Paul J. Borden, President and Director
(Principal Executive Officer)
Date: February 27, 2006 By /s/ Erin N. Ruhe
---------------------------------------
Erin N. Ruhe, Vice President, Treasurer
and Controller
(Principal Financial and Accounting
Officer)
Date: February 27, 2006 By /s/ Patrick D. Bienvenue
---------------------------------
Patrick D. Bienvenue, Director
Date: February 27, 2006 By /s/ Timothy Considine
---------------------------------
Timothy Considine, Director
Date: February 27, 2006 By /s/ Ian M. Cumming
--------------------------------
Ian M. Cumming, Director
Date: February 27, 2006 By /s/ Michael A. Lobatz
------------------------
Michael A. Lobatz, Director
36
================================================================================
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
HomeFed Corporation
We have completed integrated audits of HomeFed Corporation's 2005 and 2004
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2005 and December 31, 2004, and an audit of its
2003 financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
Consolidated financial statements
- ---------------------------------
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, shareholders' equity and cash flows present
fairly, in all material respects, the financial position of HomeFed Corporation
and its subsidiaries at December 31, 2005 and December 31, 2004, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 2005 in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with the standards of the
Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit of
financial statements includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
Internal control over financial reporting
- -----------------------------------------
Also, in our opinion, management's assessment, included in Management's Report
on Internal Control Over Financial Reporting appearing in Part II, Item 9A that
the Company maintained effective internal control over financial reporting as of
December 31, 2005 based on criteria established in Internal Control - Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO), is fairly stated, in all material respects, based on those
criteria. Furthermore, in our opinion, the Company maintained, in all material
respects, effective internal control over financial reporting as of December 31,
2005, based on criteria established in Internal Control - Integrated Framework
issued by the COSO. The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management's assessment and on the
effectiveness of the Company's internal control over financial reporting based
on our audit. We conducted our audits of internal control over financial
reporting in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting,
evaluating management's assessment, testing and evaluating the design and
operating effectiveness of internal control, and performing such other
procedures as we consider necessary in the circumstances. We believe that our
audits provide a reasonable basis for our opinions.
F-1
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
San Diego, CA
February 22, 2006
F-2
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2005 and 2004
(Dollars in thousands, except par value)
2005 2004
---- ----
ASSETS
- ------
Real estate $ 62,319 $ 47,126
Cash and cash equivalents 131,688 34,634
Investments-available for sale (aggregate cost of $65,181 and $82,272) 65,190 82,249
Accounts receivable, deposits and other assets 2,988 3,321
Deferred income taxes 32,076 44,157
---------- ----------
TOTAL $ 294,261 $ 211,487
========== ==========
LIABILITIES
- -----------
Notes payable $ 10,403 $ 16,620
Deferred revenue 73,160 39,079
Accounts payable and accrued liabilities 12,601 7,752
Non-refundable option payments 13,583 11,669
Liability for environmental remediation 11,002 11,392
Income taxes payable 10,978 --
Other liabilities 3,612 3,464
---------- ----------
Total liabilities 135,339 89,976
---------- ----------
COMMITMENTS AND CONTINGENCIES
- -----------------------------
MINORITY INTEREST 17,457 7,760
- ----------------- ---------- ----------
STOCKHOLDERS' EQUITY
- --------------------
Common stock, $.01 par value; 25,000,000 shares authorized; 8,264,334 and
8,260,059 shares outstanding 83 83
Additional paid-in capital 381,224 381,192
Accumulated other comprehensive income (loss) 6 (14)
Accumulated deficit (239,848) (267,510)
---------- ----------
Total stockholders' equity 141,465 113,751
---------- ----------
TOTAL $ 294,261 $ 211,487
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the years ended December 31, 2005, 2004 and 2003
(In thousands, except per share amounts)
2005 2004 2003
---- ---- ----
REVENUES
- --------
Sales of real estate $ 105,732 $ 77,982 $ 147,028
Co-op marketing and advertising fees 2,200 3,689 1,257
--------- -------- ---------
107,932 81,671 148,285
--------- -------- ---------
EXPENSES
- --------
Cost of sales 26,719 13,626 35,508
Provision for environmental remediation -- 1,320 270
Interest expense 138 913 2,676
General and administrative expenses 12,920 9,641 12,001
Administrative services fees to Leucadia 180 120 120
--------- -------- ---------
39,957 25,620 50,575
--------- -------- ---------
Income from operations 67,975 56,051 97,710
--------- -------- ---------
Other income (expense), net 2,707 (768) 1,706
--------- -------- ---------
Income before income taxes and minority interest 70,682 55,283 99,416
Income tax provision (29,207) (7,650) (14,179)
--------- -------- ---------
Income before minority interest 41,475 47,633 85,237
Minority interest (9,683) (10,841) (11,161)
-------- -------- ---------
Net income $ 31,792 $ 36,792 $ 74,076
========= ======== =========
Basic income per common share $ 3.85 $ 4.46 $ 9.08
======== ======= =======
Diluted income per common share $ 3.84 $ 4.45 $ 8.99
======== ======= =======
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity
For the years ended December 31, 2005, 2004 and 2003
(In thousands, except par value and per share amounts)
Deferred
Common Compensation Accumulated
Stock Additional Pursuant to Other Total
$.01 Par Paid-in Stock Incentive Comprehensive Accumulated Stockholders'
Value Capital Plans Income (Loss) Deficit Equity
----- ------- ----- ------------- ------- ------
Balance, January 1, 2003 $ 82 $ 380,364 $ (418) $ -- $ (378,378) $ 1,650
--------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of tax provision
of $7 9 9
Net income 74,076 74,076
--------
Comprehensive income 74,085
--------
Amortization of restricted stock grants 11 11
Amortization related to stock options 583 583
Change in value of performance-based
stock options 180 (180) --
Exercise of options to purchase common
shares 1 1
------ --------- ------- ------- ---------- --------
Balance, December 31, 2003 82 380,545 (4) 9 (304,302) 76,330
--------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of tax benefit (23) (23)
of $16
Net income 36,792 36,792
--------
Comprehensive income 36,769
--------
Amortization related to stock options 4 4
Exercise of options to purchase common
shares 1 647 648
------ --------- ------- ------- ---------- --------
Balance, December 31, 2004 83 381,192 -- (14) (267,510) 113,751
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of tax provision
of $12 20
20
Net income 31,792 31,792
--------
Comprehensive income 31,812
--------
Exercise of options to purchase common
shares 32 32
Dividends ($.50 per common share) (4,130) (4,130)
------ --------- ------- ------- ---------- --------
Balance, December 31, 2005 $ 83 $ 381,224 $ -- $ 6 $ (239,848) $141,465
====== ========= ======= ======= ========== ========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the years ended December 31, 2005, 2004 and 2003
(In thousands)
2005 2004 2003
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 31,792 $ 36,792 $ 74,076
Adjustments to reconcile net income to net cash provided by
operating activities:
Minority interest 9,683 10,841 11,161
Provision (benefit) for deferred income taxes 12,069 (2,369) 2,963
Provision for environmental remediation -- 1,320 270
Net securities (gains) losses 3 (5) --
Amortization of deferred compensation pursuant to stock incentive plans -- 4 594
Loss on prepayment of Leucadia Financial Corporation note -- 1,606 --
Amortization of the debt discount on note payable to Leucadia
Financial Corporation -- 276 1,088
Other amortization related to investments (2,044) (939) (369)
Changes in operating assets and liabilities:
Real estate (14,388) (8,278) (542)
Deposits and other assets 333 (1,104) (242)
Note receivable -- -- 6,566
Notes payable (787) (683) (1,268)
Deferred revenue 34,081 (14,412) 20,870
Accounts payable and accrued liabilities 4,849 (3,233) 4,662
Non-refundable option payments 1,914 8,543 1,308
Liability for environmental remediation (390) (713) (301)
Income taxes receivable/payable 10,978 (1,861) (2,372)
Other liabilities 148 (3,269) 575
-------- -------- --------
Net cash provided by operating activities 88,241 22,516 119,039
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (other than short-term) (148,888) (184,146) (152,132)
Proceeds from maturities of investments-available for sale 152,795 144,385 60,600
Proceeds from sales of investments 15,225 46,936 3,398
Decrease (increase) in restricted cash -- 4,609 (4,336)
-------- -------- --------
Net cash provided by (used for) investing activities 19,132 11,784 (92,470)
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payment of Leucadia Financial Corporation note -- (26,462) --
Dividends paid (4,130) -- --
Contribution from minority interest 14 -- 43
Distributions to minority interest -- (16,192) (13,469)
Principal payments to notes payable holders (6,235) (1,163) (3,242)
Exercise of options to purchase common shares 32 648 1
-------- -------- --------
Net cash used for financing activities (10,319) (43,169) (16,667)
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 97,054 (8,869) 9,902
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 34,634 43,503 33,601
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $131,688 $ 34,634 $ 43,503
======== ======== ========
(continued)
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the years ended December 31, 2005, 2004 and 2003
(In thousands)
2005 2004 2003
---- ---- ----
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest (net of amount capitalized) $ 403 $ 410 $ 1,588
======= ======= =======
Cash paid for income taxes $ 4,801 $ 8,713 $10,976
======= ======= =======
NON-CASH FINANCING ACTIVITIES:
Liabilities assumed from acquisition of real estate $ -- $ -- $ 4,332
Contribution of real estate from minority interest -- -- 244
------- ------- -------
$ -- $ -- $ 4,576
======= ======= =======
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
HOMEFED CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying consolidated financial
statements include the accounts of HomeFed Corporation (the "Company"), Otay
Land Company, LLC and its wholly-owned subsidiaries ("Otay Land Company"),
HomeFed Communities, Inc., HomeFed Resources Corporation, CDS Holding
Corporation and its majority owned subsidiaries ("CDS") and Rampage Vineyard,
LLC ("Rampage"). The Company is currently engaged, directly and through its
subsidiaries, in the investment in and development of residential real estate
properties in the state of California. All significant intercompany balances and
transactions have been eliminated in consolidation.
The Company's business, real estate development, is highly competitive,
and there are numerous residential real estate developers and development
projects operating in the same geographic area in which the Company operates. In
addition, the residential real estate development industry is subject to
increasing environmental, building, zoning and real estate regulations that are
imposed by various federal, state and local authorities. Timing of the
initiation and completion of development projects depends upon receipt of
necessary authorizations and approvals. Furthermore, changes in prevailing local
circumstances or applicable laws may require additional approvals, or
modifications of approvals previously obtained. Delays could adversely affect
the Company's ability to complete its projects, significantly increase the costs
of doing so or drive potential customers to purchase competitors' products.
Environmental laws may cause the Company to incur substantial compliance,
mitigation and other costs, may restrict or prohibit development in certain
areas and may delay completion of the Company's development projects. Delays
arising from compliance with environmental laws and regulations could adversely
affect the Company's ability to complete its projects, significantly increase
the costs of doing so or cause potential customers to purchase competitors'
products. The Company's business may also be adversely affected by inflation and
is interest-rate sensitive.
Certain amounts for prior periods have been reclassified to be
consistent with the 2005 presentation.
Critical Accounting Estimates - The preparation of financial statements
in conformity with accounting principles generally accepted in the United States
of America requires the Company to make estimates and assumptions that affect
the reported amounts in the financial statements and disclosures of contingent
assets and liabilities. On an on-going basis, the Company evaluates all of these
estimates and assumptions. Actual results could differ from those estimates.
Profit Recognition on Sales of Real Estate - Profit from the sale of
real estate is recognized in full at the time title is conveyed to the buyer if
the profit is determinable, collectibility of the sales price is reasonably
assured (demonstrated by meeting minimum down payment and continuing investment
requirements), and the earnings process is virtually complete, such that the
seller is not obligated to perform significant activities after the sale and has
transferred to the buyer the usual risks and rewards of ownership. If it is
determined that all the conditions for full profit recognition have not been
met, revenue and profit is deferred using the deposit, installment, cost
recovery or percentage of completion method of accounting, as appropriate
depending upon the specific terms of the transaction.
When the Company has an obligation to complete improvements on property
subsequent to the date of sale, it utilizes the percentage of completion method
of accounting to record revenues and cost of sales. Under percentage of
completion accounting, the Company recognizes revenues and cost of sales based
upon the ratio of development costs completed as of the date of sale to an
estimate of total development costs which will ultimately be incurred, including
an estimate for common areas. Unearned revenues resulting from applying the
percentage of completion accounting are reported as deferred revenue in the
liabilities section of the consolidated balance sheets.
Income Taxes - The Company provides for income taxes using the
liability method. The Company records a valuation allowance to reduce its
deferred tax asset to an amount that the Company expects is more likely than not
to be realized. If the Company's estimate of the realizability of its deferred
tax asset changes in the future, an adjustment to the valuation allowance would
be recorded which would either increase or decrease income tax expense in such
period. The valuation allowance is determined after considering all relevant
facts and circumstances, and is based, in significant part, on the Company's
projection of taxable income in the future. Since any projection of future
profitability is inherently unreliable, changes in the valuation allowance
should be expected.
F-8
Provision for Environmental Remediation - The Company records
environmental liabilities when it is probable that a liability has been incurred
and the amount or range of the liability is reasonably estimable. During 2002,
the Company recorded a charge of $11,200,000 representing its estimate of the
cost (including legal fees) to implement the most likely remediation alternative
with respect to approximately 30 acres of undeveloped land owned by a subsidiary
of Otay Land Company. The estimated liability was neither discounted nor reduced
for potential claims for recovery from previous owners and users of the land who
may be liable, and may increase or decrease based upon the actual extent and
nature of the remediation required, the type of remedial process approved, the
expenses of the regulatory process, inflation and other items. During 2004, the
Company increased its estimate of remediation costs by approximately $1,300,000,
primarily due to increases in site investigation and remediation costs, and
during 2003 by approximately $300,000, primarily for consulting costs. The
Company anticipates starting the remediation process in 2006 with completion in
2007. However, the Company is unable to predict with certainty when the
remediation will commence and there is no current regulatory requirement to
commence remediation by a fixed date.
Provision for Losses on Real Estate - The Company's real estate is
carried at cost. Whenever events or changes in circumstances suggest that the
carrying amount may not be recoverable, management assesses the recoverability
of its real estate by comparing the carrying amount with its fair value. The
process involved in the determination of fair value requires estimates as to
future events and market conditions. This estimation process may assume that the
Company has the ability to complete development and dispose of its real estate
properties in the ordinary course of business based on management's present
plans and intentions. If management determines that the carrying value of a
specific real estate investment is impaired, a write-down is recorded as a
charge to current period operations. The evaluation process is based on
estimates and assumptions and the ultimate outcome may be different. The Company
has not recorded any such provisions during the three year period ended December
31, 2005.
Real Estate - Real estate, which consists of land held for development
and sale, includes all expenditures incurred in connection with the acquisition,
development and construction of the property, including interest and property
taxes. At acquisition, land costs are allocated to individual parcels or lots
based on relative fair values. Subsequent to acquisition, substantially all
development costs are specifically identifiable to individual parcels or lots,
or are considered allocated costs that are allocated principally based on
acreage (principally property taxes, legal fees and consulting fees).
Capitalized land costs are charged to cost of sales at the time that revenue is
recognized.
Cash and Cash Equivalents - Cash equivalents are money market accounts
and short-term, highly liquid investments that have maturities of less than
three months at the time of acquisition.
Investments - Securities with maturities equal to or greater than three
months at the time of acquisition are classified as investments available for
sale, and are carried at fair value with unrealized gains and losses reflected
as a separate component of shareholders' equity, net of taxes. The cost of
securities sold is based on specific identification.
Recognition of Fee Income - The Company receives co-op marketing and
advertising fees from the San Elijo Hills project that are paid at the time
builders sell homes, are generally based upon a fixed percentage of the homes'
selling price, and are recorded as revenue when the home is sold.
Revenue and Profit Sharing Arrangements - Certain of the Company's lot
purchase agreements with homebuilders include provisions that entitle the
Company to a share of the revenues or profits realized by the homebuilders upon
their sale of the homes, after certain thresholds are achieved. The actual
amount which could be received by the Company is generally based on a formula
and other specified criteria contained in the lot purchase agreements, and are
generally not payable and cannot be determined with reasonable certainty until
the builder has completed the sale of a substantial portion of the homes covered
by the lot purchase agreement. The Company's policy is to accrue revenue earned
pursuant to these agreements when amounts are payable pursuant to the lot
purchase agreements, which is classified as sales of real estate.
F-9
Option payments - Option payments received from prospective buyers are
recognized as liabilities until the title of the real estate is transferred, or
in the case of refundable deposits, the prospective buyer decides not to
purchase the real estate and the deposit is returned.
Capitalization of Interest and Real Estate Taxes - Interest and real
estate taxes attributable to land and property construction are capitalized and
added to the cost of those properties while the properties are being actively
developed.
Farming Activities - Income and expense from farming related activities
at the Rampage property are included with other income (expense), net in the
Company's consolidated statements of operations. See Note 9 for more
information.
Stock-Based Compensation - Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation", ("SFAS 123"), establishes a
fair value method for accounting for stock-based compensation plans, either
through recognition in the statements of operations or disclosure. As permitted,
the Company applies APB Opinion No. 25 and related Interpretations in accounting
for its plans. Accordingly, no compensation cost has been recognized in the
statements of operations related to employees and directors under its stock
compensation plans. Had compensation cost for the Company's fixed stock options
been recorded in the statements of operations consistent with the provisions of
SFAS 123, the Company's net income (loss) would not have been materially
different from the historical amounts.
Recently Issued Accounting Standards - In April 2005, the Securities
and Exchange Commission amended the effective date of Statement of Financial
Accounting Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), from the
first interim or annual period after June 15, 2005 to the beginning of the next
fiscal year that begins after June 15, 2005. SFAS 123R requires that the cost of
all share-based payments to employees, including grants of employee stock
options, be recognized in the financial statements based on their fair values.
That cost will be recognized as an expense over the vesting period of the award.
Pro forma disclosures previously permitted under SFAS 123 no longer will be an
alternative to financial statement recognition. In addition, the Company will be
required to determine fair value in accordance with SFAS 123R. The Company does
not expect that SFAS 123R will have a material impact on its consolidated
financial statements.
In May 2005, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 154, "Accounting Changes and
Error Corrections-a replacement of APB Opinion No. 20 and FASB Statement No. 3"
("SFAS 154"), which is effective for accounting changes and corrections of
errors made in fiscal years beginning after December 15, 2005. SFAS 154 applies
to all voluntary changes in accounting principles, and changes the accounting
and reporting requirements for a change in accounting principle. SFAS 154
requires retrospective application to prior periods' financial statements of a
voluntary change in accounting principle unless it is impracticable. APB 20
previously required that most voluntary changes in accounting principle be
recognized by including in net income of the period of the change the cumulative
effect of changing to the new accounting principle. SFAS 154 also requires that
a change in depreciation, amortization, or depletion method for long-lived,
nonfinancial assets be accounted for as a change in accounting estimate effected
by a change in accounting principle. SFAS 154 carries forward without change the
guidance in APB 20 for reporting the correction of an error in previously issued
financial statements, a change in accounting estimate and a change in reporting
entity, as well as the provisions of SFAS 3 that govern reporting accounting
changes in interim financial statements. The Company does not expect that SFAS
154 will have a material impact on its consolidated financial statements.
2. ACQUISITIONS
In October 2002, the Company purchased from Leucadia National
Corporation (together with its subsidiaries, "Leucadia") all of the issued and
outstanding shares of capital stock of CDS which, through its majority-owned
indirect subsidiary, San Elijo Hills Development Company, LLC ("San Elijo"), is
the owner of the San Elijo Hills project, a master-planned community located in
the City of San Marcos, in San Diego County, California. Since August 1998, the
Company has been the development manager for the San Elijo Hills project, for
which it was entitled to participate in the net cash flow of the project through
the payment of a success fee, and receive fees for the field overhead,
management and marketing services it provides, based on the revenues of the
project. No success fee had been paid prior to the Company's acquisition of CDS.
The purchase price of $25,000,000 consisted of $1,000,000 in cash and 2,474,226
shares of the Company's common stock, which represented approximately 30% of the
Company's outstanding common shares. Prior to the acquisition, Leucadia had also
committed to continue to provide to San Elijo project improvement bonds which
are required prior to the commencement of any project development (see Note 12).
The results of CDS have been included in the Company's consolidated results of
operations from the date of acquisition.
F-10
In November 2003, the Company purchased the Rampage property, a 2,159
acre grape vineyard located in southern Madera County, California, for
$6,000,000, excluding expenses, of which $1,700,000 was paid in cash and the
balance was financed by the seller. In addition, the Company furnished to the
seller a letter of credit (which was fully collateralized by cash) in the amount
of $4,300,000, which secured the Company's obligation to the seller. At the date
of acquisition, the Rampage property was encumbered by a mortgage lien of
$3,800,000 that was originally granted by the seller and which the Company was
not obligated to satisfy. Although the amount owed to the seller did not bear
interest, the Company was obligated to make interest payments due under the
mortgage during 2004, and any principal payments made by the Company to the
mortgagee would have reduced the balance owed by the Company to the seller. If
the seller had provided the mortgagee with replacement collateral and obtained a
release of the mortgage lien before the end of 2004, the Company would have been
obligated to pay the balance due to the seller. Since the seller did not obtain
the release of the mortgage lien, the Company became obligated to make all debt
service payments to the mortgagee, but was released from any further payment
obligation to the seller. The letter of credit that had collateralized the
Company's obligation to the seller expired in December 2004 and the cash
collateral was released. The excess of the liability due to the seller over the
remaining face amount of the mortgage, approximately $300,000, was applied to
reduce the purchase price of the land.
3. INVESTMENTS
At December 31, 2005 and 2004, the Company's investments consisted of
fixed income securities issued by the U.S. Government and U.S.
Government-Sponsored Enterprises, which were classified as available for sale.
All of the Company's investments mature in one year or less. The amortized cost,
gross unrealized gains and losses and estimated fair value of these investments
as of December 31, 2005 and 2004 are as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
---- ----- ------ ----------
2005
----
Bonds and notes:
U.S. Treasury securities $ 52,592 $ 13 $ 1 $ 52,604
U.S. Government-Sponsored Enterprises 12,589 1 4 12,586
---------- ----- ------ ----------
Total $ 65,181 $ 14 $ 5 $ 65,190
========== ===== ====== ==========
2004
----
Bonds and notes:
U.S. Treasury securities $ 66,939 $ 1 $ 17 $ 66,923
U.S. Government-Sponsored Enterprises 15,333 -- 7 15,326
---------- ----- ------ ----------
Total $ 82,272 $ 1 $ 24 $ 82,249
========== ===== ====== ==========
4. REAL ESTATE
A summary of real estate carrying values by project is as follows (in
thousands):
December 31,
----------------------------
2005 2004
---- ----
San Elijo Hills $ 34,611 $ 18,811
Otay Ranch 23,112 21,962
Rampage 4,596 6,353
-------- --------
Total $ 62,319 $ 47,126
======== ========
F-11
The San Elijo Hills and Otay Ranch projects are considered to be land
under development while the Rampage property is not currently being developed.
Interest totaling $805,000 and $1,236,000, related to the San Elijo Hills
project, was incurred and capitalized in real estate during 2005 and 2004,
respectively. All of the San Elijo Hills project land is pledged as collateral
for the notes payable to trust deed holders described in Note 5.
In 2005, the Company sold approximately 600 acres of land at the
Rampage property to a neighboring land owner for approximately $5,000,000, which
resulted in the recognition of a pre-tax gain of $3,200,000. The Company used
$3,800,000 of the net proceeds received from the sale to fully pay the
principal, interest and pre-payment penalties due under the Rampage mortgage
note, as required under the mortgage note in connection with the sale.
5. INDEBTEDNESS
In March 2004, the Company prepaid in full the $26,462,000 borrowing
from Leucadia Financial Corporation ("LFC"), a subsidiary of Leucadia, using its
available cash. As a result, the Company expensed the remaining unamortized
discount on the note and related deferred costs in the amount of $1,606,000,
which is included in other income (expense), net in the consolidated statements
of operations. Interest expense includes $649,000 and $2,676,000 for the years
ended December 31, 2004 and 2003, respectively, related to this note.
The Company currently has a $10,000,000 unsecured line of credit
agreement with LFC that matures February 28, 2007. Loans outstanding under this
line of credit bear interest at 10% per annum. No amounts have been borrowed
under this facility since 2002.
As of December 31, 2004, notes payable includes a 7 1/4% mortgage
payable in the amount of $3,650,000 that was collateralized by the Rampage
property. As discussed above, this note was fully repaid during 2005.
In addition, notes payable includes non-recourse promissory notes to
trust deed holders that mature on December 31, 2010, are non-interest bearing
and are collateralized by the San Elijo Hills project land. When a portion of
the San Elijo Hills project is sold, a specified amount is required to be paid
to the note holder in order to obtain a release of their security interest in
the land. Such amount is specified in the note agreements and takes into
consideration prior note payments. The sum of all payments made under these
notes, whether denominated as interest, principal or otherwise, cannot exceed
approximately $42,100,000. As of December 31, 2005, $31,100,000 had been paid.
The notes payable to trust deed holders were recorded at fair value at
the date of acquisition of CDS, based on the estimated future payments
discounted at 6.5%. The activity for the years ended December 31, 2005 and 2004
is as follows (in thousands):
2005 2004
---- ----
Beginning balance $ 12,970 $ 13,580
Principal payments (2,585) (1,163)
Interest added to principal 18 553
-------- --------
Ending balance $ 10,403 $ 12,970
======== ========
At the end of each quarterly reporting period, the carrying amounts of
the notes are compared to the most recent estimate of future payments. The
difference is amortized prospectively using the effective interest rate method.
The effective interest rate for the years ended December 31, 2005 and 2004 was
6.3% and 9.9%, respectively. Effective January 1, 2006, the effective interest
rate is 6.1%. Based on the Company's cash flow forecast, the expected payments
to the trust deed holders that will be allocated to principal are as follows (in
thousands): 2006 - $9,062 and 2007 - $1,341.
F-12
6. MINORITY INTEREST
Through its ownership of CDS, the Company owns 80% of the common stock
of CDS Devco, Inc. ("Devco"), which in turn owns 85% of the common stock of San
Elijo Ranch, Inc., ("SERI"). Pursuant to a stockholders' agreement with the
holder of the minority interest in Devco, the Company is entitled to a 15%
return on all funds advanced to Devco, compounded annually, plus the return of
its capital, prior to the payment of any amounts to the minority shareholder.
Once those amounts are paid, the minority shareholder is entitled to 20% of
future cash flows, if any, distributed to shareholders. Pursuant to a
stockholders' agreement with the holders of the minority interests in SERI,
Devco loans funds to SERI and charges a 12% annual rate. Once this loan is fully
repaid, the minority shareholders of SERI are entitled to 15% of future cash
flows, if any, distributed to shareholders. As of December 31, 2005,
approximately $17,500,000 has been accrued for the Devco and SERI minority
interests. Amounts accrued for minority interests have been reduced for income
taxes calculated pursuant to tax sharing agreements.
During 2004, all amounts advanced to the project were repaid and,
except for amounts related to infrastructure improvement bond guarantees, the
preferred returns were fully satisfied. Amounts paid to the minority interests
were applied to reduce the minority interest balance on the Company's
consolidated balance sheet.
7. STOCK INCENTIVE PLANS
Under the Company's 1999 Stock Incentive Plan (the "Plan"), the Company
may grant options, stock appreciation rights and restricted stock to
non-employee directors, certain non-employees and employees up to a maximum
grant of 30,000 shares to any individual in a given taxable year. Pursuant to
the Plan, each director of the Company is automatically granted options to
purchase 1,000 shares on the date on which the annual meeting of stockholders is
held. In August 2004, following shareholder approval, the Plan was amended to,
among other things, increase the number of shares of common stock available for
issuance by 300,000 shares. The Plan provides for the issuance of options and
rights at not less than 100% of the fair market value of the underlying stock at
the date of grant. Options generally become exercisable in five equal
instalments starting one year from the date of grant. No stock appreciation
rights have been granted.
During 2000, 25,000 shares of restricted common stock were issued to
eligible participants, subject to certain forfeiture provisions. In connection
with this issuance of restricted stock, the Company recorded deferred
compensation of $188,000 representing the value of stock on the date of issuance
based upon market price. This amount was amortized to expense over the three
year vesting period of the restricted stock. In addition, during 2000, options
to purchase an aggregate of 2,500 shares of Common Stock were granted to
non-employees at an exercise price of $7.50 per share (market price). In
connection with this issuance, the Company recorded deferred compensation of
$18,000 based upon the estimated fair value of these options at the time of
grant, using the modified Black-Scholes model. This amount was amortized to
expense over the five year vesting period of the options.
A summary of activity with respect to the Company's 1999 Stock
Incentive Plan for employees and directors for 2005, 2004 and 2003 is as
follows:
Common Weighted Available
Shares Average Options for Future
Subject to Exercise Exercisable Option
Option Price at Year-End Grants
------ -------- ----------- --------
Balance at January 1, 2003 17,225 $ 7.60 6,575 55,200
====== =======
Granted 600 $ 27.40
Exercised (75) $ 8.60
------
Balance at December 31, 2003 17,750 $ 8.28 10,050 199,400
====== =======
Granted 6,000 $ 44.50
Exercised (4,900) $ 7.62
Cancelled (500) $ 7.50
------
Balance at December 31, 2004 18,350 $ 20.32 8,850 493,900
====== =======
Granted 6,000 $ 65.19
Exercised (3,775) $ 7.59
------
Balance at December 31, 2005 20,575 $ 35.74 9,625 487,900
====== ====== =======
F-13
The weighted-average fair value of the options granted was $21.66 per
share for 2005, $15.10 per share for 2004 and $17.21 per share for 2003 as
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions: (1) expected volatility of 33.3% for 2005, 37.7% for
2004 and 86.1% for 2003; (2) risk-free interest rate of 3.9% for 2005, 3.2% for
2004 and 2.3% for 2003; (3) expected lives of 4.3 years for 2005 and 4.0 years
for 2004 and 2003; and (4) dividend yield of 0% for all years.
The following table summarizes information about fixed stock options
outstanding at December 31, 2005.
Options Outstanding Options Exercisable
---------------------------------------------------- --------------------------
Common Weighted Weighted Common Weighted
Shares Average Average Shares Average
Range of Subject to Remaining Exercise Subject to Exercise
Exercise Prices Option Contractual Life Price Option Price
- --------------- ------ ---------------- ----- ------ -----
$7.50 - $9.50 8,025 0.3 years $ 7.74 7,875 $ 7.71
$27.40 550 2.5 years $27.40 250 $ 27.40
$44.50 6,000 3.6 years $44.50 1,500 $ 44.50
$65.19 6,000 4.5 years $65.19 -- $ --
In July 2004, the Board of Directors approved the repurchase of up to
500,000 shares of the Company's common stock, representing approximately 6% of
the Company's outstanding stock. Repurchased shares would be available, among
other things, for use in connection with the Company's stock option plans. The
shares may be purchased from time to time, subject to prevailing market
conditions, in the open market, in privately negotiated transactions or
otherwise. Any such purchases may be commenced or suspended at any time without
prior notice. No shares have been purchased to date.
In 2000, under the Company's 2000 Stock Incentive Plan (the "2000
Plan"), the Company granted to two key employees options to purchase an
aggregate of 100,000 shares of common stock at an exercise price of $6.10 per
share, the then current market price per share. No additional options are
available to be granted under the 2000 Plan. These options were subject to
forfeiture provisions if performance criteria were not met by April 27, 2003.
Upon the closing of a sale at Otay Land Company in April 2003, the options were
no longer subject to forfeiture. As a result, the Company expensed the remaining
deferred compensation related to the performance options of approximately
$600,000 in 2003. These options were exercised during 2004.
8. SALES OF REAL ESTATE
Revenues from sales of real estate for each of the three years in the
period ended December 31, 2005 is comprised of the following (in thousands):
2005 2004 2003
---- ---- ----
Developed lots at San Elijo Hills project $ 100,723 $ 72,175 $ 121,062
Undeveloped land at the Otay Ranch project 43 5,807 22,500
Rampage 4,966 -- --
Other -- -- 3,466
--------- -------- ---------
Total $ 105,732 $ 77,982 $ 147,028
========= ======== =========
F-14
At the time the Company closes on sales of real estate at the San Elijo
Hills project, a portion of the revenue is initially deferred since the Company
is required to make significant improvements to the property. For each of the
three years in the period ended December 31, 2005, the activity in the deferred
revenue account is as follows (in thousands):
2005 2004 2003
---- ---- ----
Deferred revenue balance at January 1, $ 39,079 $ 53,491 $ 32,621
Revenue deferred on the date of sale 57,108 24,426 56,348
Deferred revenue recognized in operations (23,027) (38,838) (35,478)
--------- -------- ---------
Deferred revenue balance at December 31, $ 73,160 $ 39,079 $ 53,491
========= ======== =========
As of December 31, 2005, the Company estimates that it will spend
approximately $20,600,000 to complete the required improvements, including costs
related to common areas. The Company estimates these improvements will be
substantially complete by the end of 2007.
In 2005, the Company sold very low income apartment units for a
$1,500,000 note; however, no cash down payment was received, the note does not
bear interest and any payments the Company may receive are contingent upon the
buyer obtaining financing. The Company has not recognized any revenue or
receivable resulting from this transaction; revenues will be recognized if and
when cash is received under the note. Land cost for the parcel sold was
negligible.
9. OTHER RESULTS OF OPERATIONS
Other income (expense), net for each of the three years in the period
ended December 31, 2005, consists of the following (in thousands):
2005 2004 2003
---- ---- ----
Interest income $ 3,025 $1,451 $ 883
Farming activities, net (332) (870) --
Proceeds from settlements -- -- 346
Easement fees -- -- 172
Reimbursement for fees and improvements for
previously sold property -- -- 198
Gain (loss) on sale of fixed assets 8 (4) --
Rental income from Leucadia 21 68 72
Loss on prepayment of notes payable (169) (1,606) --
Cable trench fees 78 180 74
Other 76 13 (39)
------- ------ -------
Total $ 2,707 $ (768) $ 1,706
======= ====== =======
For the year ended December 31, 2005, farming activities, net includes
income from grape sales of $773,000 and farming expenses of $1,105,000. For the
year ended December 31, 2004, there was no income from grape sales.
Proceeds from sales of investments classified as available for sale
were $15,200,000, $46,900,000 and $3,400,000 during 2005, 2004 and 2003,
respectively. Realized gross gains (losses) were not material during the last
three years.
Advertising costs were $1,773,000, $1,172,000 and $966,000 for 2005,
2004 and 2003, respectively.
F-15
10. INCOME TAXES
The (provision) benefit for income taxes for each of the three years in
the period ended December 31, 2005 was as follows (in thousands):
2005 2004 2003
---- ---- ----
State income taxes - current $ (5,603) $ (3,820) $ (8,977)
State income taxes - deferred (742) (1,094) --
Federal income taxes - current (11,535) (6,199) (2,239)
Federal income taxes - deferred (11,327) 3,463 (2,963)
----------- ---------- ----------
$ (29,207) $ (7,650) $ (14,179)
========== ========== ==========
Current federal income taxes for all years principally relates to
federal alternative minimum tax.
The table below reconciles the expected statutory federal income tax to
the actual income tax provision (in thousands):
2005 2004 2003
---- ---- ----
Expected federal income tax $ (24,739) $ (19,349) $ (34,796)
State income taxes, net of federal income
tax benefit (4,384) (3,194) (5,835)
Otay Land Company taxable income
allocated to Leucadia -- -- 429
Decrease in valuation allowance -- 15,000 26,065
Other (84) (107) (42)
---------- ---------- ----------
Actual income tax provision $ (29,207) $ (7,650) $ (14,179)
========== ========== ==========
As a result of an increase in the Company's estimates of future taxable
income that exceeded its earlier estimates, the Company reduced its deferred tax
valuation allowance to recognize additional benefits from its net operating tax
loss carryforwards ("NOLs") and minimum tax credit carryovers and recorded a
credit to its income tax provision of $15,000,000 and $26,065,000 for the years
ended December 31, 2004 and 2003, respectively. There was no other material
activity in the deferred tax valuation allowance during the years ended December
31, 2005, 2004 and 2003.
The Company and its wholly-owned subsidiaries have NOLs available for
federal income tax purposes of $83,692,000 as of December 31, 2005. The NOLs
were generated during 1991 to 1999 and expire in 2006 to 2019 as follows (in
thousands):
Year of Expiration Loss Carryforwards
------------------ ------------------
2006 $ 19,701
2007 17,406
2008 2,347
2009 2,107
Thereafter 42,131
----------
$ 83,692
==========
F-16
At December 31, 2005 and 2004 the net deferred tax asset consisted of
the following (in thousands):
2005 2004
---- ----
NOL carryforwards $ 29,292 $ 50,053
Land basis 5,054 7,247
Minimum tax credit carryovers 18,885 7,350
Other, net 6,126 6,788
--------- ---------
59,357 71,438
Valuation allowance (27,281) (27,281)
--------- ---------
$ 32,076 $ 44,157
========= =========
The valuation allowance has been provided on the deferred tax asset due
to the uncertainty of future taxable income necessary for realization of the
deferred tax asset. The calculation of the valuation allowance recognizes that
the Company's NOLs will not be available to offset alternative minimum taxable
income, which is currently taxed at a federal tax rate of 20%. When the Company
pays alternative minimum tax, it generates an alternative minimum tax credit
carryover, which generally can be used to reduce its future federal income tax
once it has used all of its NOLs and becomes subject to the regular tax (as
opposed to the alternative minimum tax). Alternative minimum tax credit
carryovers have no expiration date. Assuming the Company realizes its projected
taxable income in the future and fully utilizes its NOLs, it will have paid
approximately $36,000,000 in federal alternative minimum taxes, generating
minimum tax credit carryovers of the same amount to reduce future federal income
taxes payable. However, because the minimum tax credit carryovers do not offset
alternative minimum tax, effectively they are only able to reduce the Company's
federal income tax rate to 20% in any given year, which means the Company would
have to generate an additional $180,000,000 of taxable income above its current
estimate to fully use all of the credits. As a result, the Company has reserved
for a substantial portion of this benefit in its valuation allowance.
11. EARNINGS PER SHARE
Income per share of common stock was calculated by dividing net income
by the sum of the weighted average number of common shares outstanding and, for
diluted earnings per share, the incremental weighted average number of shares
issuable upon exercise of outstanding options for the periods they were
outstanding. The treasury stock method is used for these calculations. The
number of shares used to calculate basic earnings per share amounts was
8,262,326, 8,248,203 and 8,155,111 for 2005, 2004 and 2003, respectively. The
number of shares used to calculate diluted earnings per share was 8,274,852,
8,271,670 and 8,238,164 for 2005, 2004 and 2003, respectively.
F-17
12. COMMITMENTS AND CONTINGENCIES
Prior to its acquisition by the Company, a subsidiary of CDS entered
into a non-cancelable operating lease for its office space, a portion of which
was sublet to the Company and a portion of which was sublet to Leucadia.
Effective October 2002, as a result of the acquisition of CDS, sublease payments
from Leucadia reflected in other income were $21,000, $68,000 and $72,000 in
2005, 2004 and 2003, respectively. Rental expense (net of sublease income) was
$204,000, $174,000 and $209,000 for 2005, 2004 and 2003, respectively. During
2004, the lease term was extended until February 2010 for a lower minimum rent;
however, the agreement includes rent escalation charges over its term.
On January 6, 2005, an owner of property adjacent to the Rampage
property filed a complaint against the Company and the former owners of the
Rampage property. The complaint alleges that the value of an option to purchase
a portion of the Rampage property was devalued by approximately $3,000,000 due
to poor farming practices since 2001. The Company does not believe the ultimate
resolution of this matter will be material.
The Company had leased the farming rights to approximately one-half of
the Rampage property to one of the former owners for a fifteen-year period;
however, the lease was terminated in 2005 due to non-performance by the tenant
and the Company commenced eviction proceedings. On January 30, 2006, the tenant
filed a cross-complaint against the Company seeking a rescission of the purchase
agreement by which the Company acquired the Rampage property on the grounds that
they did not receive the consideration for which they bargained. The Company
does not expect that the ultimate resolution of this matter will be material to
its consolidated financial position; however, should the Company need to accrue
or pay damages, any such loss could be material to its consolidated results of
operations during the period recorded.
The Company is required to obtain infrastructure improvement bonds
primarily for the benefit of the City of San Marcos (the "City") prior to the
beginning of lot construction work and warranty bonds upon completion of such
improvements in the San Elijo Hills project. These bonds provide funds primarily
to the City in the event the Company is unable or unwilling to complete certain
infrastructure improvements in the San Elijo Hills project. Leucadia is
contractually obligated to obtain these bonds on behalf of CDS and its
subsidiaries pursuant to the terms of agreements entered into when CDS was
acquired. CDS is responsible for paying all third party fees related to
obtaining the bonds. Should the City or others draw on the bonds for any reason,
one of CDS's subsidiaries would be obligated to reimburse Leucadia for the
amount drawn. As of December 31, 2005, the amount of outstanding bonds was
approximately $29,500,000, none of which has been drawn upon.
Pursuant to an agreement with the City of San Marcos, the Company is
contractually obligated to contribute up to $11,000,000 towards the cost of
improving two off site roads to the San Elijo Hills project. The City of San
Marcos is obligated to fund the balance of the cost of the roads. As of December
31, 2005, the Company had spent $7,500,000 towards the road improvements, and
expects it will substantially fulfill its road construction obligation in early
2006.
Since 1999, the San Elijo Hills project has carried $50,000,000 of
general liability and professional liability insurance under a policy issued by
the Kemper Insurance Companies ("Kemper"). The policy covered a thirteen year
term from the initial date of coverage, and the entire premium for the life of
the policy was paid in 1999. This policy is specific to the San Elijo Hills
project; the Company has general and professional liability insurance for other
matters with different insurance companies. Kemper has ceased underwriting
operations and has submitted a voluntary run-off plan to its insurance
regulators. Although Kemper is not in receivership proceedings, it is operating
under restrictive orders entered by insurance regulators. It is uncertain
whether Kemper will have sufficient assets at such time, if ever, the Company
makes a claim under the policy or, if they are declared insolvent, whether state
insurance guaranty funds would be available to pay the claim. In May 2004, the
Company purchased an excess policy with another insurance carrier that provides
up to $10,000,000 of coverage for general liability claims, but not professional
liability claims, relating to homes sold through May 31, 2004. In September
2005, the excess policy was extended to cover homes sold through May 31, 2005.
The Company continues to investigate whether insurance coverage for future home
sales at the San Elijo Hills project is available at acceptable prices.
The Company is subject to various litigation which arise in the course
of its business. Except as otherwise disclosed herein, based on discussions with
counsel, management is of the opinion that such litigation is not likely to have
any material adverse effect on the consolidated financial position of the
Company, its consolidated results of operations or liquidity.
F-18
13. OTHER RELATED PARTY TRANSACTIONS
The Company has entered into the following related party transactions
with Leucadia and its subsidiaries not otherwise described in these Notes to
Consolidated Financial Statements.
(a) Otay Land Company, LLC. In October 1998, the Company and Leucadia
formed Otay Land Company to purchase approximately 4,850 acres of land, which is
part of a 22,900 acre project located south of San Diego, California, known as
Otay Ranch. Otay Land Company acquired this land for $19,500,000. When Otay Land
Company was formed, Leucadia contributed $10,000,000 as a preferred capital
interest, and the Company contributed all other funds as non-preferred capital.
The Company is the managing member of Otay Land Company. In 2003, Otay Land
Company paid approximately $12,900,000 due to Leucadia to fully redeem the
preferred capital interest and preferred return. All future proceeds from this
project will be distributable solely to the Company.
(b) Administrative Services Agreement. Pursuant to administrative
services agreements, Leucadia provides administrative and accounting services to
the Company, including providing the services of the Company's Secretary.
Administrative fees paid to Leucadia were $180,000 in 2005 and $120,000 in 2004
and 2003. The administrative services agreement automatically renews for
successive annual periods unless terminated in accordance with its terms.
Leucadia has the right to terminate the agreement by giving the Company not less
than one year's prior notice, in which event the then monthly fee will remain in
effect until the end of the notice period. The Company has the right to
terminate the agreement, without restriction or penalty, upon 30 days prior
written notice to Leucadia. The agreement has not been terminated by either
party.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's material financial instruments include cash and cash
equivalents, certificate of deposits, investments available for sale, and notes
payable. In all cases, the carrying amounts of such financial instruments
approximate their fair values. In cases where quoted market prices are not
available, fair values are based on estimates using present value techniques.
15. SELECTED QUARTERLY FINANCIAL DATA (unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2005
- ----
Sales of real estate $ 4,087 $ 5,583 $ 9,708 $ 86,354
========== ========== ========== ========
Co-op marketing and advertising fees $ 428 $ 630 $ 464 $ 678
========== ========== ========== ========
Cost of sales $ 900 $ 269 $ 2,312 $ 23,238
========== ========== ========== ========
Income from operations (a) $ 720 $ 3,594 $ 5,112 $ 58,549
========== ========== ========== ========
Net income $ 642 $ 1,215 $ 3,142 $ 26,793
========== ========== ========== ========
Basic income per share $ 0.08 $ 0.15 $ 0.38 $ 3.24
========== ========== ========== ========
Diluted income per share (b) $ 0.08 $ 0.15 $ 0.38 $ 3.24
========== ========== ========== ========
2004
- ----
Sales of real estate $ 43,406 $ 12,396 $ 16,366 $ 5,814
========== ========== ========== ========
Co-op marketing and advertising fees $ 186 $ 964 $ 1,290 $ 1,249
========== ========== ========== ========
Cost of sales $ 9,654 $ 502 $ 2,886 $ 584
========== ========== ========== ========
Income from operations (a) (c) $ 30,725 $ 10,852 $ 11,929 $ 2,545
========== ========== ========== ========
Net income (c) (d) $ 13,801 $ 4,778 $ 2,399 $ 15,814
========== ========== ========== ========
Basic income per share (c) (d) $ 1.68 $ 0.58 $ 0.29 $ 1.91
========== ========== ========== ========
Diluted income per share (c) (d) $ 1.67 $ 0.58 $ 0.29 $ 1.91
========== ========== ========== ========
F-19
(a) During 2005, the Company reclassified farming activities from general and
administrative expenses to other income (expense), net. Prior periods were
reclassified to confirm with this presentation.
(b) In 2005, the quarterly diluted per share amount does not equal the annual
per share amount.
(c) During the fourth quarter of 2004, the Company recorded a provision
of $1,320,000 relating to environmental remediation.
(d) The fourth quarter of 2004 reflects a reduction to the income tax
provision of $15,000,000, resulting from a decrease to the valuation
allowance for deferred tax assets, in order to recognize additional tax
benefits for the expected use of NOLs and minimum tax credit carryovers.
F-20