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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, 2006
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 Incorporation (I.R.S. Employer
or Organization) Identification No.)
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, 2006, the aggregate
market value of the Registrant's Common Stock held by non-affiliates was
approximately $285,968,000 on that date.
As of February 16, 2007, there were 8,273,834 outstanding shares of the
Registrant's Common Stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's definitive proxy statement pursuant to
Regulation 14A of the Securities Exchange Act of 1934 in connection with the
2007 annual meeting of shareholders of the registrant are incorporated by
reference into Part III of this Report.
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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, within and outside the State of California. However,
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 in California are typically required 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, will be a community of
approximately 3,500 homes and apartments, as well as a commercial and
residential towncenter. 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 provides 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. Through its ownership interest in CDS, the Company 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. Before any amounts are distributed to the minority shareholders, the
Company has the right to the return of funds advanced to the project and to
receive a preferred return on any advances. 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.
Current Market Developments: Throughout most of the period
that the Company has been developing the San Elijo Hills project, the Company's
sales efforts have greatly benefited from a strong regional and national
residential housing market. As of December 31, 2006, the San Elijo Hills project
sold 1,923 of its 2,364 single family lots and 1,059 of its 1,099 multi family
units (including the very low income apartment units), at satisfactory prices
and generally in accordance with its development schedule. However, there has
been a slowdown in sales of residential properties in many U. S. markets,
including California and the greater San Diego region, which negatively affected
sales and profits during 2006. Sales of new homes and re-sales of existing homes
have not kept pace with the early years of the project's development; based on
information obtained from homebuilders and other public sources, the Company
estimates that total home sales (both new and re-sales) at the San Elijo Hills
project were approximately 300 in 2006 as compared to 470 in 2005 and 860 in
2004. Residential home prices and building starts have declined. The project's
builders have asked for concessions or modifications to their purchase
agreements, which the Company has generally rejected. During 2006, four
homebuilders that were under contract to purchase single family lots at the San
Elijo Hills project elected not to close on their purchase transactions, thereby
forfeiting option payments aggregating $12,600,000. In the aggregate, these four
homebuilders elected not to close on lot purchase transactions covering 257
single family lots with a total contract purchase price of $116,500,000.
Although it is not actively soliciting bids for its remaining
inventory of single family lots, the Company is currently completing development
of all of its remaining lots at the San Elijo Hills project, many of which are
"premium" lots which will command premium prices if, and when, the market
recovers. The Company is unable to predict when local residential real estate
market conditions might improve; however, the Company intends to wait for market
conditions to improve before marketing its remaining inventory for sale. The
Company believes that by exercising patience with the current market conditions
it can best maximize shareholder value with its remaining residential lot
inventory. The estimate of future taxable income discussed elsewhere in this
Report (see "Item 7, Management's Discussion and Analysis of Financial Condition
and Results of Operations - Critical Accounting Estimates") assumes that the
Company will sell all of the remaining land at the San Elijo Hills project for
aggregate sales proceeds of approximately $235,000,000; after adding previously
deferred revenue to and subtracting actual and projected development costs from
this amount, projected gross profit is estimated to be $130,000,000.
Estimates of future property available for sale, the timing of
the sales and future development costs are based upon current development plans
for the project and will change based on the strength of the real estate market
or other factors that are not within the control of the Company.
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. As of December 31, 2006, the Company estimates that it
will spend approximately $9,600,000 to complete the required improvements to
sold properties; as these improvements are completed the Company will recognize
in income $34,400,000 of revenue from closed sales which is reflected on the
December 31, 2006 balance sheet as deferred revenue.
3
For the Year Ended December 31,
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2006 2005 2004
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(Dollars in thousands)
Number of residential units sold (1) 26 406 139
Aggregate sales proceeds from sales of residential
units, net of closing costs (2) $ 15,600 $127,100 $ 33,000
Aggregate proceeds from the sales of school and
retail sites, net of closing costs (3) $ -- $ 700 $ 20,200
Development management fees earned (4) $ 900 $ 7,700 $ 3,300
(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 one school site in 2004.
(4) Development management fees 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.
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 441
Multi-family units 40
Square footage of commercial space 115,000
The Company intends to construct and sell or lease the
remaining multi-family units in the towncenter rather than sell the property to
another developer. With respect to the towncenter commercial space, the Company
intends to construct and lease approximately 57,000 square feet of the
commercial space and sell the remainder of the commercial space to third party
builders or owners, including the supermarket site and daycare center site.
Until the design plans are completed, regulatory approvals are received and
building permits are issued, it is uncertain as to when construction will begin
on the towncenter project or when it will be completed.
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 was 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 was 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
commencement of construction of these roads during 2005 removed the last
significant limitation to the issuance of building permits at the San Elijo
Hills project. During 2006, the Company fully funded its construction obligation
and continues to manage the remaining construction work on behalf of the City,
which is expected to be completed in mid-2007.
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 any claim (the Company has not made any claims to date). 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. This
excess policy has been subsequently extended to cover homes sold through August
1, 2007. 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 many years. 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 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. During the first quarter of
2006, the Company sold approximately 115 acres of non-developable land for
$1,500,000 and recognized a gain of $1,400,000 on the sale.
After considering the above transactions, Otay Land Company
owns approximately 2,800 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
2,100 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, there will be an excess of mitigation land in
Otay Ranch. In that event, Otay Land Company will have to find buyers for its
mitigation land outside the Otay Ranch General Plan Area, which the Company
believes it can do.
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, but deferred action with
regard to land owned by Otay Land Company. The City Council deferred action that
would have increased from 2,880 to 6,000 the number of residential dwelling
units that Otay Land Company's developable land is approved for, and would have
increased commercial development space that Otay Land Company's developable land
is approved for from approximately 1.5 million square feet to approximately 1.8
million square feet. This GDP amendment 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 City
Council has delayed consideration of any additional amendments to the GDP on
several occasions. The Company is unable to predict the impact that 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.
5
San Diego Expressway Limited Partnership ("SDELP") is in the
process of constructing a toll road designated as SR 125 through south San Diego
County; the SDELP intends to open most of the toll road during the third 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. The toll road is
being designed with one or more interchanges on or adjacent to land parcels
owned by the Company; when complete, it will significantly improve access to the
southern portion of Otay Ranch which could increase the value of the Company's
land. 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.
The San Diego Chargers NFL football team is considering
relocating their stadium facility, which is currently located in the City of San
Diego. The Company has been advised that members of the Chula Vista City Council
have met with the San Diego Chargers and have discussed several possible sites
for a new stadium facility in the City of Chula Vista, including land owned by
the Company. Although the Company has provided information to the San Diego
Chargers regarding sites it owns in Chula Vista, the San Diego Chargers have
many possible locations to consider. If the San Diego Chargers relocate their
stadium facility, it is unlikely that they will choose land owned by the
Company.
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. 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 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. The sale resolved any remaining dispute with respect to the purchase
options but the farming practices complaint remains outstanding.
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 Company terminated the lease in 2005 due to non-performance by the
tenant and the Company commenced eviction proceedings. In April 2006 a jury
issued a verdict in favor of the tenant, deciding that under the terms of the
lease no unpaid rent was due and that the lease was not terminated. The Company
is appealing the decision, including an award of court costs and attorneys fees;
in the interim the former owner continues to lease and farm the property. In a
separate matter, the same former owner is seeking to rescind the Company's
purchase of the Rampage property, as well as recover monetary damages based on
allegations of fraud, breach of contract, and various other claims. The Company
has denied all of the former owner's allegations and filed a cross-complaint
against him, which chiefly seeks indemnification against or compensation for the
damages claimed by the neighboring land owner discussed above. The Company does
not expect that the ultimate resolution of these matters 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 and cash flows 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.
In California, laws require that any large size residential community have
sufficient water supplies to meet the water demands of the project for a period
of 20 years. A preliminary site plan for development of the Rampage property
showed that the land would support a master planned community, but if entitled,
the build out and sale of homes will take many years.
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, which has resulted in a small loss.
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.
7
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 and
significantly increase development costs.
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. 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. We
have not received any claim or notification from any private party or
governmental authority concerning environmental conditions at any of our
properties other than as disclosed below.
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 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 examines, and when appropriate, 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, which was subsequently approved by the DEH. Flat Rock has
submitted a Remedial Investigation and Feasibility Study ("RIFS") to the DEH for
review and approval; DEH has requested DTSC assistance in its review of the
RIFS. Once the RIFS is approved, a remedial action plan will be prepared and
submitted to DEH for approval and subject to public comment prior to the
commencement of the remediation. The Company is unable to predict with certainty
when the remediation will commence and there is no regulatory requirement to
commence remediation at all.
Otay Land Company and Flat Rock commenced a lawsuit in the
United States District Court for the Southern District of California seeking
compensation from the parties who it believes are responsible for the
contamination. On July 20, 2006, the District Court dismissed the federal
environmental law claims and refused to retain jurisdiction on the related state
law claims. The Company has appealed the District Court's decision with respect
to the federal environmental law claims and is pursuing litigation in state
court. The Company has not reduced its estimated liability for environmental
remediation for any potential recoveries from these parties. 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.
8
Employees
At December 31, 2006 the Company and its consolidated
subsidiaries had 23 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.
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 mortgage 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 not be able to overcome the
negative market influences on price and volume resulting from the softening of
the real estate market, 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.
9
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.
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.
10
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.
Opposition from local community or political groups with
respect to construction or development at a particular site could increase
development costs. Before the Company can commence development on any of its
projects, numerous approvals from regulatory authorities are required. Before
these approvals are granted, other parties may oppose the Company's development
plans or require modifications to its plans, either of which can cause delays
and increase the development cost of a project.
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 16, 2007, the significant stockholders of
our Company are Leucadia National Corporation (approximately 29.9% beneficial
ownership), our Chairman, Joseph S. Steinberg (approximately 8.2% 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 7.3% 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
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.
Our common stock is not traded on NASDAQ or listed on any
securities exchange. Our common stock is not quoted on any market or listed on
any securities exchange. Prices for our common stock are quoted on the
Over-the-Counter (OTC) Bulletin Board. Securities whose prices are quoted on the
OTC Bulletin Board do not enjoy the same liquidity as securities that trade on a
recognized market or securities exchange. As a result, stockholders may find it
more difficult to dispose of or obtain accurate quotations as to the market
value of the securities.
11
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 $79,300,000 at December 31, 2006.
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 for an annual rent of $12,000, payable monthly.
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.
Item 10. Executive Officers of the Registrant.
- ------- ------------------------------------
All executive officers serve at the pleasure of the Board of
Directors of the Company. As of February 16, 2007, the 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 58 Director and President May 1998
Curt R. Noland 50 Vice President October 1998
Erin N. Ruhe 41 Vice President, Treasurer and Vice President since April
Controller 2000; Treasurer since March
2004; Controller since January
1999
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 has worked in the land development industry in
San Diego County as a design consultant, merchant builder and a master developer
since the 1980s. 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.
12
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
--------- ---------
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 $ 66.00 $ 60.50
Second Quarter 70.75 63.00
Third Quarter 68.50 59.00
Fourth Quarter 67.00 61.25
2007
First quarter (through February 16, 2007) $ 66.00 $ 60.00
The over-the-counter quotations reflect inter-dealer prices,
without retail mark up, markdown or commission, and may not represent actual
transactions. On February 16, 2007, the closing bid price for the Company's
common stock was $62.15 per share. As of that date, there were 888 stockholders
of record. On March 14, 2006, the Company's Board of Directors declared a cash
dividend equal to $0.50 per share of the Company's common stock, which was paid
on April 10, 2006 to stockholders of record on March 27, 2006. 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, which was paid on May 9, 2005 to
stockholders of record on April 29, 2005.
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.
13
Equity Compensation Table
The following table summarizes information regarding the
Company's equity compensation plans as of December 31, 2006. All outstanding
awards relate to the Company's Common Stock.
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 19,075 $56.16 481,900
Equity compensation
plans not approved
by security holders -- -- --
------ ------ -------
Total 19,075 $56.16 481,900
====== ====== =======
Stockholder Return Performance Chart
Set forth below is a chart comparing the cumulative total
stockholder return on common stock against cumulative total return of the
Standard & Poor's 500 Stock Index and the Standard & Poor's Homebuilding-500
Index for the period commencing December 31, 2001 to December 31, 2006. Index
data was furnished by Standard & Poor's Compustat Services, Inc. The chart
assumes that $100 was invested on December 31, 2001 in each of our common stock,
the S&P 500 Index and the S&P Homebuilding Index and that all dividends were
reinvested.
INDEXED RETURNS
Years Ending
Base
Period
Company / Index 2001 2002 2003 2004 2005 2006
- ---------------------- -------- ------- ------ ------- ------ ---------
HOMEFED CORP 100 152.63 305.26 526.42 711.12 705.97
S&P 500 100 77.90 100.25 111.15 116.61 135.03
S&P 500 HOMEBUILDING 100 99.43 196.69 262.86 332.74 266.19
14
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).
Year Ended December 31,
--------------------------------------------------------------------------
2006 2005 2004 2003 2002
---------- ---------- ---------- -------- --------
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA:
Revenues (1) $ 69,442 $ 107,932 $ 81,671 $ 148,285 $ 13,111
Expenses (2) 29,246 39,957 25,620 50,575 22,418
Income (loss) before minority interest 28,133 41,475 47,633 85,237 (9,375)
Net income (loss) 17,176 31,792 36,792 74,076 (11,086)
Basic income (loss) per share $ 2.08 $ 3.85 $ 4.46 $ 9.08 $(1.80)
Diluted income (loss) per share $ 2.08 $ 3.84 $ 4.45 $ 8.99 $(1.80)
At December 31,
--------------------------------------------------------------------------
2006 2005 2004 2003 2002
--------- --------- --------- --------- ---------
SELECTED BALANCE SHEET DATA:
Cash and cash equivalents $ 47,177 $ 131,688 $ 34,634 $ 43,503 $ 33,601
Investments 83,829 65,190 82,249 88,519 --
Real estate 79,341 62,319 47,126 37,612 31,108
Total assets 237,299 294,261 211,487 217,010 117,043
Notes payable (3) 9,898 10,403 16,620 38,296 40,332
Stockholders' equity 154,780 141,465 113,751 76,330 1,650
Shares outstanding 8,274 8,264 8,260 8,155 8,155
Book value per share $18.71 $17.12 $13.77 $9.36 $ .20
Cash dividend per share $ .50 $ .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. 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) At December 31, 2003 and 2002, includes a note payable to a subsidiary of
Leucadia for $24,716,000 and $23,628,000, respectively. In March 2004, the
Company prepaid this borrowing in full.
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.
15
Liquidity and Capital Resources
For the year ended December 31, 2006, net cash used for
operating activities was $50,000,000, principally for real estate improvement
expenditures at the San Elijo Hills project and for the payment of general and
administrative expenses and federal and state income tax payments. Net cash
provided by operating activities, principally from the proceeds from the sale of
real estate, was $88,200,000 and $22,500,000 for the years ended December 31,
2005 and 2004, 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. Sales at the San Elijo Hills project declined significantly
during 2006, principally due to the weak residential housing market. During
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. 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. Information about the
remaining real estate to be sold at the San Elijo Hills project is provided
below. Because of the nature of its real estate projects, the Company does not
expect operating cash flows will be consistent from year to year.
Throughout most of the period that the Company has been
developing the San Elijo Hills project, the Company's sales efforts have greatly
benefited from a strong regional and national residential housing market.
However, there has been a slowdown in sales of residential properties in many
U.S. markets, including California and the greater San Diego region, which
negatively affected sales and profits during 2006. Sales of new homes and
re-sales of existing homes have not kept pace with the early years of the
project's development; based on information obtained from homebuilders and other
public sources, the Company estimates that total home sales (both new and
re-sales) at the San Elijo Hills project were approximately 300 in 2006 as
compared to 470 in 2005 and 860 in 2004. Residential home prices and building
starts have declined. The project's builders have asked for concessions or
modifications to their purchase agreements, which the Company has generally
rejected. During 2006, four homebuilders that were under contract to purchase
single family lots at the San Elijo Hills project elected not to close on their
purchase transactions, thereby forfeiting option payments aggregating
$12,600,000. In total, these four homebuilders elected not to close on lot
purchase transactions covering 257 single family lots for a total contract
purchase price of $116,500,000.
Although it is not actively soliciting bids for its remaining
inventory of single family lots, the Company is currently completing development
of all of its remaining lots at the San Elijo Hills project, many of which are
"premium" lots which will command premium prices if, and when, the market
recovers. The Company is unable to predict when local residential real estate
market conditions might improve; however, the Company intends to wait for market
conditions to improve before marketing its remaining inventory for sale. The
Company believes that by exercising patience with the current market conditions
it can best maximize shareholder value with its remaining residential lot
inventory.
The parent company's principal sources of funds are proceeds
from the sale of real estate, 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, 2006, the Company
had consolidated cash and cash equivalents and marketable securities aggregating
$131,000,000. 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, 2006, the parent company
and its wholly owned subsidiaries had approximately $93,400,000 of liquid assets
to satisfy its needs, the needs of its subsidiaries and for future investment
opportunities.
The Company expects that its cash on hand and marketable
securities classified as available for sale, together with the other 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 in the future; however, the amount and
timing is uncertain due to current market conditions. 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, with the possible exception 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.
16
The Company currently has an unsecured $10,000,000 line of
credit agreement with Leucadia that matures on February 28, 2007. Loans
outstanding under this line of credit bear interest at 10% per year. As of
February 16, 2007, no amounts were outstanding under this facility, and the
Company will not pursue an extension of the facility.
During 2006, the Company closed on the sale of one
neighborhood in the San Elijo Hills project consisting of 26 single family lots
for aggregate sales proceeds of $15,600,000, net of closing costs. At the time
of closing, the Company deferred recognition of $4,600,000 of revenue from this
sale under the percentage of completion method of accounting.
As of December 31, 2006, the aggregate balance of deferred
revenue for all real estate sales was $34,400,000, which the Company estimates
will be substantially recognized as revenue during 2007. The Company estimates
that it will spend approximately $9,600,000 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, 2006, the remaining land at the San Elijo
Hills project to be developed and sold or leased consisted of the following:
Single family lots to be developed and sold 441
Multi-family units 40
Square footage of commercial space 115,000
The Company intends to construct and sell or lease the
remaining multi-family units in the towncenter rather than sell the property to
another developer. With respect to the towncenter commercial space, the Company
intends to construct and lease approximately 57,000 square feet of the
commercial space and sell the remainder of the commercial space to third party
builders or owners, including the supermarket site and daycare center site.
Until the design plans are completed, regulatory approvals are received and
building permits are issued, it is uncertain as to when construction will begin
on the towncenter project or when it will be completed.
Estimates of future property available for sale, the timing of
the sales and future development costs are based upon current development plans
for the project and will change based on the strength of the real estate market
or other factors that are not within the control of the Company.
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 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 any claim (the Company has not made any claims to date). 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. This excess
policy has been subsequently extended to cover homes sold through August 1,
2007. The Company continues to investigate whether insurance coverage for future
home sales at the San Elijo Hills project is available at acceptable prices.
On March 14, 2006, the Company's Board of Directors declared a
cash dividend equal to $0.50 per share of the Company's common stock, which was
paid on April 10, 2006 to stockholders of record on March 27, 2006
(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.
During 2006, dividends of $50,000,000 were paid by the
Company's subsidiary that owns the San Elijo Hills project, of which $15,300,000
was paid to the minority interests in the San Elijo Hills project, and the
balance was transferred to the parent company. The dividends retained by the
Company did not increase the amount of consolidated liquidity reflected on the
Company's consolidated balance sheet; however, they did increase the liquidity
of the parent company.
17
As indicated in the table below, at December 31, 2006, the
Company's contractual cash obligations totaled $10,838,000. 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.
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 $ 10,068 $ -- $ -- $10,068 $ --
Operating lease, net of sublease income 770 234 494 42 --
-------- ------ ----- ------- ------
Total Contractual Cash Obligations $ 10,838 $ 234 $ 494 $10,110 $ --
======== ====== ===== ======= ======
As of December 31, 2006, the Company had NOLs of $43,600,000
available to reduce its future federal income tax liabilities and $27,200,000 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 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, certain of the Company's subsidiaries would be obligated to
reimburse Leucadia for the amount drawn. As of December 31, 2006, the amount of
outstanding bonds was approximately $18,300,000, 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, 2006, the Company's deferred revenue balance aggregated $34,400,000.
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.
18
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 $126,000,000, 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, the Company reduced its valuation allowance and
federal income tax expense as a result of increases in its projected taxable
income. During that period, 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.
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 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 is unable to predict with certainty when the
remediation will commence and there is no regulatory requirement to commence
remediation at all.
19
In 2005, Flat Rock completed the site investigation and
expects to submit a remedial action plan for approval from the appropriate
regulatory authority in 2007. 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 examines, and when appropriate, 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, 2006.
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, 823 multi-family units, 276
very low income apartment units, two school sites and commercial space which
will be sold or leased. As of February 16, 2007, the remaining land at the San
Elijo Hills project to be developed and sold or leased consisted of 441 single
family lots, 40 multi-family units and 115,000 square feet of commercial space.
The Company's plan is to complete the development of its remaining single family
residential lots during 2007 and 2008, and to continue development of common
areas into 2008; however, the Company does not expect to market its lot
inventory for sale until current market conditions improve.
While the San Elijo Hills project is a development community
with significant sales activity, sales at the Otay Ranch project have been
limited to four 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 many 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.
20
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, 2006 December 31, 2005 December 31, 2004
----------------- ----------------- -----------------
(Dollars in thousands)
Single family units 26 203 94
Multi-family units -- 131 45
Very low income apartment units -- 72 --
School and retail sites -- 1 1
Purchase price, net of closing costs $ 15,600 $ 127,800 $ 53,200
Revenues recognized on closing date $ 11,000 $ 70,700 $ 28,800
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 $43,300,000, $23,000,000 and $38,800,000 for
2006, 2005 and 2004, 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 $0,
$6,800,000 and $4,500,000 for the years ended December 31, 2006, 2005 and 2004,
respectively. 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.
As discussed above, during 2006 four homebuilders that were
under contract to purchase single family lots elected not to close on their
purchase transactions, thereby forfeiting option payments of $12,600,000. Such
amount was recognized as revenue during 2006.
During 2005, 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 2006, 2005 and 2004, cost of sales of real estate
aggregated $13,900,000, $32,600,000 and $16,000,000, 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:
-------------------
In the first quarter of 2006, the Company sold approximately
115 acres of non-developable land at the Otay Ranch project for $1,500,000 and
recognized a gain of $1,400,000 on the sale. 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 Vista and another party whereby the City
acquired 439 acres of mitigation land by eminent domain proceedings.
During 2006, 2005 and 2004, cost of sales of real estate
aggregated $100,000, $20,000 and $1,000,000, 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.
21
Rampage Property:
-----------------
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.
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. The sale resolved any remaining dispute with
respect to the purchase options but the farming practices complaint remains
outstanding. The Company does not believe the ultimate resolution of this matter
will be material.
Other Results of Operations Activity
The Company recorded co-op marketing and advertising fees of
approximately $1,000,000, $2,200,000 and $3,700,000 for the years ended December
31, 2006, 2005 and 2004, 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.
Interest expense includes interest related to a Rampage
mortgage note of $100,000 and $300,000 for the years ended December 31, 2005 and
2004, respectively. The Rampage mortgage note was repaid in July 2005. Interest
expense reflects the interest due on indebtedness to Leucadia of approximately
$400,000 for 2004. Interest expense also includes amortization of debt discount
related to the indebtedness to Leucadia of $300,000 for 2004. 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 $400,000,
$800,000 and $1,200,000 for the years ended December 31, 2006, 2005 and 2004,
respectively. Interest is capitalized for the notes payable to trust deed
holders on the San Elijo Hills project.
General and administrative expenses increased by $2,200,000
during 2006 as compared to 2005, primarily due to greater expenses related to
legal and marketing. Legal fees increased by $1,700,000 in connection with the
litigation relating to a portion of the Rampage property and due to the costs
associated with pursuing the claims against the former owners of the
approximately 30 acres of undeveloped land at the Otay Ranch project that, as
previously disclosed, is undergoing environmental remediation. Marketing
expenses increased by $1,200,000 relating to increased efforts to promote the
release of new neighborhoods by homebuilders for sale at the San Elijo Hills
project. Compensation expense declined by $900,000 in 2006 principally due to a
decrease in general bonus expense. In addition, compensation expense in 2005
included a $300,000 bonus awarded to the President to pay taxes due on
reimbursed expenses relating to his temporary residence in California and the
reimbursement of certain costs incurred by a newly hired executive officer.
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 included 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.
The increase in other income (expense), net for 2006 as
compared to 2005 primarily relates to investment income. Investment income in
2006 increased by $3,600,000, primarily due to greater interest income resulting
from higher interest rates and greater assets invested. Other income, net also
reflects sales of grapes from the harvest at the Rampage property of $1,000,000
and farming expenses of $1,200,000 for 2006; in 2005 the Company recognized
$800,000 from the sales of grapes from the harvest and incurred farming expenses
of $1,100,000. In addition, real estate brokerage operations, which were
established in July 2005, closed on sales transactions resulting in commission
income of $300,000 in 2006 and $100,000 in 2005. Other income, net in 2005 also
reflects $200,000 of pre-payment penalties incurred upon extinguishing the
Rampage mortgage note.
22
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 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 for the year ended December 31, 2004. For more
information, see Note 10 of Notes to Consolidated Financial Statements.
Recently Issued Accounting Standards
In June 2006, the Financial Accounting Standards Board
("FASB") issued FASB Interpretation No. 48, "Accounting for Uncertainty in
Income Taxes - an Interpretation of FASB Statement No. 109" ("FIN 48"), which
prescribes the accounting for and disclosure of uncertainty in income tax
positions. FIN 48 defines the criteria that must be met before any part of the
benefit of a tax position can be recognized in the financial statements,
provides guidance for the measurement of tax benefits recognized and guidance
for classification and disclosure. FIN 48 is effective for fiscal years
beginning after December 15, 2006, with the cumulative effect of the change in
accounting principle recorded as an adjustment to opening retained earnings. The
Company continues to evaluate the impact of adopting FIN 48 on its consolidated
financial statements but does not expect it to be material; however, additional
footnote disclosures may be required.
In September 2006, the FASB issued Statement of Financial
Accounting Standards No. 157, "Fair Value Measurements" ("SFAS 157"), which
defines fair value, establishes a framework for measuring fair value and expands
disclosures about fair value measurements. SFAS 157 is effective for fiscal
years beginning after November 15, 2007. The Company is currently evaluating the
impact of adopting SFAS 157 on its consolidated financial statements.
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.
23
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, 2006, the Company had investments of
approximately $83,800,000 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 2007; the
estimated weighted average remaining life of these fixed income securities was
approximately 0.2 years at December 31, 2006. At December 31, 2005, 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 4.0%. 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.
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
2007 2008 2009 2010 2011 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities
U.S. Treasury Securities $ 66,581 $ - $ - $ - $ - $ - $ 66,581 $ 66,581
Weighted Average
Interest Rate 5.02%
U.S. Government-
Sponsored Enterprises $ 17,248 $ - $ - $ - $ - $ - $ 17,248 $ 17,248
Weighted Average
Interest Rate 5.29%
Rate Sensitive Liabilities:
Fixed Interest Rate
Borrowings $ 6,470 $ 3,428 $ - $ - $ - $ - $ 9,898 $ 9,898
Weighted Average
Interest Rate 1.57% 1.57%
Off-Balance Sheet Items:
Unused Lines of Credit $ 10,000 $ - $ - $ - $ - $ - $ 10,000 $ 10,000
Weighted Average
Interest Rate 10.0%
24
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, 2006. 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, 2006.
(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, 2006, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
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, 2006. 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, 2006, 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, 2006 as stated in
the report which appears on page F-1 of this Report.
Item 9B. Other Information.
- ------- -----------------
Not applicable.
25
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ------- --------------------------------------------------
The information to be included under the caption "Election of
Directors" and "Information Concerning the Board and Board Committees" in the
Company's definitive proxy statement to be filed with the Commission pursuant to
Regulation 14A of the Exchange Act in connection with the 2007 annual meeting of
shareholders of the Company (the "Proxy Statement") is incorporated herein by
reference. In addition, reference is made to Item 10 in Part I of this Report.
Item 11. Executive Compensation.
- ------- ----------------------
The information to be included under the caption "Executive
Compensation" in the Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- ------- --------------------------------------------------------------
The information to be included under the caption "Present
Beneficial Ownership of Common Shares" in the Proxy Statement is incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions.
- ------- ----------------------------------------------
The information to be included under the caption "Certain
Relationships and Related Transactions" in the Proxy Statement is incorporated
herein by reference.
Item 14. Principal Accounting Fees and Services.
- ------- --------------------------------------
The information to be included under the caption "Principal Accounting Fees and
Services" in the Proxy Statement is incorporated herein by reference.
26
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, 2006 and 2005 F-3
Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004 F-4
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 2006, 2005 and 2004 F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004 F-6
Notes to Consolidated Financial Statements F-7
(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 (filed as Exhibit
10.26 to the Company's Annual Report on Form 10-K for the year ended
December 31, 2005 (the "2005 10-K")).
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).
27
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")).
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 Form of Grant Letter for the 1999 Stock Incentive Plan (incorporated by
reference to Exhibit 10.26 to the Company's 2005 10-K).
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).
28
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).
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 (incorporated by reference
to Exhibit 10.24 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2004 (the "2004 10-K")).
10.20 1999 Stock Incentive Plan (incorporated by reference to Annex A to the
Company's Proxy Statement dated November 22, 1999).
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.
29
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 23, 2007 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 23, 2007 By /s/ Joseph S. Steinberg
---------------------------------
Joseph S. Steinberg, Chairman
of the Board and Director
Date: February 23, 2007 By /s/ Paul J. Borden
---------------------------------
Paul J. Borden, President and Director
(Principal Executive Officer)
Date: February 23, 2007 By /s/ Erin N. Ruhe
-----------------------------------------
Erin N. Ruhe, Vice President, Treasurer
and Controller
(Principal Financial and Accounting
Officer)
Date: February 23, 2007 By /s/ Patrick D. Bienvenue
---------------------------------
Patrick D. Bienvenue, Director
Date: February 23, 2007 By /s/ Timothy Considine
---------------------------------
Timothy Considine, Director
Date: February 23, 2007 By /s/ Ian M. Cumming
--------------------------------
Ian M. Cumming, Director
Date: February 23, 2007 By /s/ Michael A. Lobatz
------------------------
Michael A. Lobatz, Director
30
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 consolidated
financial statements and of its internal control over financial reporting as of
December 31, 2006, 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 operations, of stockholders' equity and of cash flows
present fairly, in all material respects, the financial position of HomeFed
Corporation and its subsidiaries at December 31, 2006 and December 31, 2005, and
the results of their operations and their cash flows for each of the three years
in the period ended December 31, 2006 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, 2006 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,
2006, 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 audit 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
audit provides a reasonable basis for our opinions.
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.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
San Diego, CA
February 20, 2007
F-2
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2006 and 2005
(Dollars in thousands, except par value)
2006 2005
---- ----
ASSETS
- ------
Real estate $ 79,341 $ 62,319
Cash and cash equivalents 47,177 131,688
Investments-available for sale (aggregate cost of $83,783 and $65,181) 83,829 65,190
Accounts receivable, deposits and other assets 1,798 2,988
Deferred income taxes 25,154 32,076
---------- ----------
TOTAL $ 237,299 $ 294,261
========== ==========
LIABILITIES
- -----------
Notes payable $ 9,898 $ 10,403
Deferred revenue 34,446 73,160
Accounts payable and accrued liabilities 8,734 12,601
Non-refundable option payments -- 13,583
Liability for environmental remediation 10,690 11,002
Income taxes payable 1,965 10,978
Other liabilities 3,719 3,612
---------- ----------
Total liabilities 69,452 135,339
---------- ----------
COMMITMENTS AND CONTINGENCIES
- -----------------------------
MINORITY INTEREST 13,067 17,457
- ----------------- ---------- ----------
STOCKHOLDERS' EQUITY
- --------------------
Common stock, $.01 par value; 25,000,000 shares authorized; 8,273,834 and
8,264,334 shares outstanding 83 83
Additional paid-in capital 381,478 381,224
Accumulated other comprehensive income 27 6
Accumulated deficit (226,808) (239,848)
---------- ----------
Total stockholders' equity 154,780 141,465
---------- ----------
TOTAL $ 237,299 $ 294,261
========== ==========
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, 2006, 2005 and 2004
(In thousands, except per share amounts)
2006 2005 2004
---- ---- ----
REVENUES
- --------
Sales of real estate $ 55,810 $105,732 $ 77,982
Income from options on real estate properties 12,583 -- --
Co-op marketing and advertising fees 1,049 2,200 3,689
-------- -------- --------
69,442 107,932 81,671
-------- -------- --------
EXPENSES
- --------
Cost of sales 13,988 26,719 13,626
Provision for environmental remediation -- -- 1,320
Interest expense -- 138 913
General and administrative expenses 15,078 12,920 9,641
Administrative services fees to Leucadia 180 180 120
-------- -------- --------
29,246 39,957 25,620
-------- -------- --------
Income from operations 40,196 67,975 56,051
-------- -------- --------
Other income (expense), net 6,870 2,707 (768)
-------- -------- --------
Income before income taxes and minority interest 47,066 70,682 55,283
Income tax provision (18,933) (29,207) (7,650)
-------- -------- --------
Income before minority interest 28,133 41,475 47,633
Minority interest (10,957) (9,683) (10,841)
-------- -------- --------
Net income $ 17,176 $ 31,792 $ 36,792
======== ======== ========
Basic income per common share $ 2.08 $ 3.85 $ 4.46
======== ======== ========
Diluted income per common share $ 2.08 $ 3.84 $ 4.45
======== ======== ========
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, 2006, 2005 and 2004
(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, 2004 $ 82 $ 380,545 $ (4) $ 9 $ (304,302) $ 76,330
---------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of tax benefit of $16 (23) (23)
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
---------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of tax
provision of $16 21 21
Net income 17,176 17,176
---------
Comprehensive income 17,197
---------
Share-based compensation expense 73 73
Exercise of options to purchase common
shares, including excess tax benefit 181 181
Dividends ($.50 per common share) (4,136) (4,136)
------ --------- --------- ------- ---------- ---------
Balance, December 31, 2006 $ 83 $ 381,478 $ -- $ 27 $ (226,808) $ 154,780
====== ========= ========= ======= ========== =========
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, 2006, 2005 and 2004
(In thousands)
2006 2005 2004
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 17,176 $ 31,792 $ 36,792
Adjustments to reconcile net income to net cash provided by (used for)
operating activities:
Minority interest 10,957 9,683 10,841
Provision (benefit) for deferred income taxes 6,906 12,069 (2,369)
Provision for environmental remediation -- -- 1,320
Share-based compensation expense 73 -- --
Excess tax benefit from exercise of stock options (109) -- --
Net securities (gains) losses -- 3 (5)
Amortization of deferred compensation pursuant to stock incentive plans -- -- 4
Loss on prepayment of Leucadia Financial Corporation note -- -- 1,606
Amortization of the debt discount on note payable to Leucadia
Financial Corporation -- -- 276
Other amortization related to investments (3,920) (2,044) (939)
Changes in operating assets and liabilities:
Real estate (16,627) (14,388) (8,278)
Deposits and other assets 1,190 333 (1,104)
Notes payable (383) (787) (683)
Deferred revenue (38,714) 34,081 (14,412)
Accounts payable and accrued liabilities (3,867) 4,849 (3,233)
Non-refundable option payments (13,583) 1,914 8,543
Liability for environmental remediation (312) (390) (713)
Income taxes receivable/payable (8,904) 10,978 (1,861)
Other liabilities 107 148 (3,269)
-------- -------- --------
Net cash provided by (used for) operating activities (50,010) 88,241 22,516
-------- -------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (other than short-term) (200,574) (148,888) (184,146)
Proceeds from maturities of investments-available for sale 178,893 152,795 144,385
Proceeds from sales of investments 6,999 15,225 46,936
Decrease in restricted cash -- -- 4,609
-------- -------- --------
Net cash provided by (used for) investing activities (14,682) 19,132 11,784
-------- -------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payment of Leucadia Financial Corporation note -- -- (26,462)
Dividends paid (4,136) (4,130) --
Contribution from minority interest -- 14 --
Distributions to minority interest (15,347) -- (16,192)
Principal payments to notes payable holders (517) (6,235) (1,163)
Exercise of options to purchase common shares 72 32 648
Excess tax benefit from exercise of stock options 109 -- --
-------- -------- --------
Net cash used for financing activities (19,819) (10,319) (43,169)
-------- -------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (84,511) 97,054 (8,869)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 131,688 34,634 43,503
-------- -------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 47,177 $131,688 $ 34,634
======== ======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest (net of amount capitalized) $ -- $ 403 $ 410
======= ====== ======
Cash paid for income taxes $20,930 $4,801 $8,713
======= ====== ======
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
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 and significantly increase
development costs. The Company's business may also be adversely affected by
inflation and is interest-rate sensitive.
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-7
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 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 is unable to predict with certainty when the remediation will commence.
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, 2006.
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.
Option payments - Option payments received from prospective buyers are
recognized as liabilities until the title of the real estate is transferred or
the option is forfeited, 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.
F-8
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.
Share-Based Compensation - Effective January 1, 2006, the Company
adopted Statement of Financial Accounting Standards No. 123R, "Share-Based
Payment" ("SFAS 123R"), using the modified prospective method. SFAS 123R
requires that the cost of all share-based payments to employees, including
grants of employee stock options and warrants, be recognized in the financial
statements based on their fair values. The cost is recognized as an expense over
the vesting period of the award. Prior to adoption of SFAS 123R, compensation
cost was not recognized in the statements of operations for all of the Company's
share-based compensation plans; the Company disclosed certain pro forma amounts
as required. The fair value of each award is estimated at the date of grant
using the Black-Scholes option pricing model.
Recently Issued Accounting Standards - In June 2006, the Financial
Accounting Standards Board ("FASB") issued FASB Interpretation No. 48,
"Accounting for Uncertainty in Income Taxes - an Interpretation of FASB
Statement No. 109" ("FIN 48"), which prescribes the accounting for and
disclosure of uncertainty in income tax positions. FIN 48 defines the criteria
that must be met before any part of the benefit of a tax position can be
recognized in the financial statements, provides guidance for the measurement of
tax benefits recognized and guidance for classification and disclosure. FIN 48
is effective for fiscal years beginning after December 15, 2006, with the
cumulative effect of the change in accounting principle recorded as an
adjustment to opening retained earnings. The Company continues to evaluate the
impact of adopting FIN 48 on its consolidated financial statements but does not
expect it to be material; however, additional footnote disclosure may be
required.
In September 2006, the FASB issued Statement of Financial Accounting
Standards No. 157, "Fair Value Measurements" ("SFAS 157"), which defines fair
value, establishes a framework for measuring fair value and expands disclosures
about fair value measurements. SFAS 157 is effective for fiscal years beginning
after November 15, 2007. The Company is currently evaluating the impact of
adopting SFAS 157 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. The Company has been
the development manager for the San Elijo Hills project since August 1998. 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.
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.
F-9
3. INVESTMENTS
At December 31, 2006 and 2005, 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, 2006 and 2005 are as follows (in thousands):
Gross Gross
Amortized Unrealized Unrealized Estimated
Cost Gains Losses Fair Value
--------- ---------- ---------- ----------
2006
----
Bonds and notes:
U.S. Treasury securities $ 66,543 $ 38 $ -- $ 66,581
U.S. Government-Sponsored Enterprises 17,240 8 -- 17,248
---------- ----- ------- ----------
Total $ 83,783 $ 46 $ -- $ 83,829
========== ===== ======= ==========
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
========== ===== ======= ==========
4. REAL ESTATE
A summary of real estate carrying values by project is as follows (in
thousands):
December 31,
----------------------------
2006 2005
---- ----
San Elijo Hills $ 51,005 $ 34,611
Otay Ranch 23,740 23,112
Rampage 4,596 4,596
-------- --------
Total $ 79,341 $ 62,319
========= =========
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 $400,000 and $800,000, related to the San Elijo Hills project,
was incurred and capitalized in real estate during 2006 and 2005, 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 prepayment penalties due under the Rampage mortgage
note, as required under the mortgage note in connection with the sale.
5. INDEBTEDNESS
Notes payable are 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, 2006, $32,000,000 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, 2006 and 2005
is as follows (in thousands):
F-10
2006 2005
---- ----
Beginning balance $ 10,403 $ 12,970
Principal payments (517) (2,585)
Interest added to principal 12 18
-------- --------
Ending balance $ 9,898 $ 10,403
======== ========
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, 2006 and 2005 was
3.6% and 6.3%, respectively. Effective January 1, 2007, the effective interest
rate is 1.6%. 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): 2007 - $6,500 and 2008 - $3,400.
The Company currently has a $10,000,000 unsecured line of credit
agreement with Leucadia Financial Corporation ("LFC"), a subsidiary of Leucadia,
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, and the Company will not pursue an extension of the facility.
In March 2004, the Company prepaid in full the $26,500,000 borrowing
from LFC 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 $1,600,000, which is included in other income (expense), net in the
consolidated statements of operations. Interest expense includes $600,000 for
the year ended December 31, 2004 related to this note.
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 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
distributed to shareholders. As of December 31, 2006, approximately $13,100,000
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. Dividends paid to the minority interests
of $15,300,000 and $16,200,000 for the years ended December 31, 2006 and 2004,
respectively, 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 granted to employees and certain non-employees
generally become exercisable in five equal instalments starting one year from
the date of grant and must be exercised within six years from the date of grant.
Options granted to directors generally become exercisable in four equal
instalments starting one year from the date of grant and must be exercised
within five years from the date of grant. No stock appreciation rights have been
granted. As of December 31, 2006, 481,900 shares were available for grant under
the plan.
F-11
A summary of activity with respect to the Company's 1999 Stock
Incentive Plan for employees and directors for 2006, 2005 and 2004 is as
follows:
Common Weighted- Weighted-Average
Shares Average Remaining Aggregate
Subject to Exercise Contractual Intrinsic
Option Price Term Value
-------- --------- ----------- ---------
Balance at January 1, 2004 17,750 $ 8.28
Granted 6,000 $44.50
Exercised (4,900) $ 7.62 $ 150,000
==========
Cancelled (500) $ 7.50
--------
Balance at December 31, 2004 18,350 $20.32
Granted 6,000 $65.19
Exercised (3,775) $ 7.59 $ 200,000
-------- ==========
Balance at December 31, 2005 20,575 $35.74
Granted 6,000 $65.50
Exercised (7,500) $ 7.62 $ 400,000
-------- ==========
Balance at December 31, 2006 19,075 $56.16 3.4 years $ 200,000
======== ========= ==========
Exercisable at December 31, 2006 5,425 $45.57 2.6 years $ 100,000
======== ========= ==========
During 2000, options to purchase an aggregate of 2,500 shares of Common
Stock at an exercise price of $7.50 per share (market price) were granted to
non-employees, and therefore are not reflected in the table above. These options
were exercised in 2005 (500 options) and 2006 (2,000 options); compensation cost
amounts were not material.
Effective January 1, 2006, the Company adopted SFAS 123R using the
modified prospective method. As a result of the adoption of SFAS 123R,
compensation cost increased by $70,000 for the year ended December 31, 2006 and
net income decreased by $40,000 for the year ended December 31, 2006. Had the
Company used the fair value based accounting method for 2005 and 2004,
compensation cost would have been higher by $50,000 and $30,000, respectively,
and primary and diluted earnings per share would not have changed materially. As
of December 31, 2006, total unrecognized compensation cost related to nonvested
share-based compensation plans was $250,000; this cost is expected to be
recognized over a weighted-average period of 1.6 years.
The following summary presents the assumptions used for the
Black-Scholes option pricing model to determine the fair value for each of the
stock option grants made during each of the three years for the period ended
December 31:
2006 2005 2004
---- ---- ----
Risk free interest rate 5.00% 3.91% 3.24%
Expected volatility 35.23% 33.26% 37.67%
Expected dividend yield 0.0% 0.0% 0.0%
Expected life 4.3 years 4.3 years 4.0 years
Fair value per grant $23.83 $21.66 $15.10
The expected life assumptions were based on historical behavior for the
awards identified. The expected volatility was based on the historical behavior
of the Company's stock price.
F-12
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.
8. SALES OF REAL ESTATE
Revenues from sales of real estate for each of the three years in the
period ended December 31, 2006 is comprised of the following (in thousands):
2006 2005 2004
---- ---- ----
Developed lots at San Elijo Hills project $ 54,314 $ 100,723 $ 72,175
Undeveloped land at the Otay Ranch project 1,496 43 5,807
Rampage -- 4,966 --
--------- -------- --------
Total $ 55,810 $ 105,732 $ 77,982
========= ========= ========
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, 2006, the activity in the deferred
revenue account is as follows (in thousands):
2006 2005 2004
---- ---- ----
Deferred revenue balance at January 1, $ 73,160 $ 39,079 $ 53,491
Revenue deferred on the date of sale 4,572 57,108 24,426
Deferred revenue recognized in operations (43,286) (23,027) (38,838)
--------- --------- --------
Deferred revenue balance at December 31, $ 34,446 $ 73,160 $ 39,079
========= ========= ========
As of December 31, 2006, the Company estimates that it will spend
approximately $9,600,000 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, 2006 consists of the following (in thousands):
2006 2005 2004
----- ---- ----
Interest income $ 6,668 $ 3,025 $ 1,451
Realty commissions 258 89 --
Farming activities, net (194) (332) (870)
Gain (loss) on sale of fixed assets 20 8 (4)
Rental income from Leucadia 12 21 68
Loss on prepayment of notes payable -- (169) (1,606)
Cable trench fees 124 78 180
Other (18) (13) 13
-------- --------- --------
Total $ 6,870 $ 2,707 $ (768)
======== ========= ========
F-13
For the year ended December 31, 2006 and 2005, farming activities, net
includes income from grape sales of $1,000,000 and $800,000, respectively, and
farming expenses of $1,200,000 and $1,100,000, respectively. 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 $7,000,000, $15,200,000 and $46,900,000 during 2006, 2005 and 2004,
respectively. Realized gross gains (losses) were not material during the last
three years.
Advertising costs were $3,000,000, $1,800,000 and $1,200,000 for 2006,
2005 and 2004, respectively.
10. INCOME TAXES
The (provision) benefit for income taxes for each of the three years in
the period ended December 31, 2006 was as follows (in thousands):
2006 2005 2004
---- ---- ----
State income taxes - current $ (3,886) $ (5,603) $ (3,820)
State income taxes - deferred (225) (742) (1,094)
Federal income taxes - current (8,141) (11,535) (6,199)
Federal income taxes - deferred (6,681) (11,327) 3,463
---------- ---------- --------
$ (18,933) $ (29,207) $ (7,650)
========== ========== ========
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):
2006 2005 2004
---- ---- ----
Expected federal income tax $ (16,473) $ (24,739) $ (19,349)
State income taxes, net of federal income
tax benefit (2,672) (4,384) (3,194)
Decrease in valuation allowance -- -- 15,000
Other 212 (84) (107)
--------- --------- ----------
Actual income tax provision $ (18,933) $ (29,207) $ (7,650)
========= ========= ==========
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 for the year ended December
31, 2004. There was no other material activity in the deferred tax valuation
allowance during the years ended December 31, 2006, 2005 and 2004.
The Company and its wholly-owned subsidiaries have NOLs available for
federal income tax purposes of $43,600,000 as of December 31, 2006. The NOLs
were generated during 1994 to 1999 and expire in 2009 to 2019 as follows (in
thousands):
Year of Expiration Loss Carryforwards
------------------ ------------------
2007 $ --
2008 --
2009 1,472
2010 5,169
Thereafter 36,962
----------
$ 43,603
==========
F-14
At December 31, 2006 and 2005 the net deferred tax asset consisted of
the following (in thousands):
2006 2005
---- ----
NOL carryforwards $ 15,261 $ 29,292
Land basis 4,619 5,054
Minimum tax credit carryovers 27,223 18,885
Other, net 5,332 6,126
--------- ---------
52,435 59,357
Valuation allowance (27,281) (27,281)
--------- ---------
$ 25,154 $ 32,076
========= =========
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
Basic and diluted 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 8,272,266, 8,262,326 and 8,248,203 for 2006, 2005 and 2004,
respectively. The number of shares used to calculate diluted earnings per share
was 8,274,833, 8,274,852 and 8,271,670 for 2006, 2005 and 2004, respectively.
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 $12,000, $20,000 and $70,000 in
2006, 2005 and 2004, respectively. Rental expense (net of sublease income) was
$200,000 for 2006 and 2005 and $150,000 for 2004. 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.
F-15
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
Company terminated the lease in 2005 due to non-performance by the tenant and
the Company commenced eviction proceedings. In April 2006 a jury issued a
verdict in favor of the tenant, deciding that under the terms of the lease no
unpaid rent was due and that the lease was not terminated. The Company is
appealing the decision, including an award of court costs and attorneys fees; in
the interim the former owner continues to lease and farm the property. In a
separate matter, the same former owner is seeking to rescind the Company's
purchase of the Rampage property, as well as recover monetary damages based on
allegations of fraud, breach of contract, and various other claims. The Company
has denied all of the former owner's allegations and filed a cross-complaint
against him, which chiefly seeks indemnification against or compensation for the
damages claimed by the neighboring land owner discussed above. The Company does
not expect that the ultimate resolution of these matters 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 and cash flows 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 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, 2006, the amount of outstanding bonds
was approximately $18,300,000, none of which has been drawn upon.
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 any claim (the Company has
not made any claims to date). 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. This excess policy has been
subsequently extended to cover homes sold through August 1, 2007. 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.
13. 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 2006 and 2005 and $120,000 in 2004. 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, investments classified as 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.
F-16
15. SELECTED QUARTERLY FINANCIAL DATA (unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2006:
Sales of real estate $ 16,985 $ 20,254 $ 10,108 $ 8,463
========== ========== ========== ========
Income from options on real estate
properties $ -- $ -- $ -- $ 12,583
========== ========== ========== ========
Co-op marketing and advertising fees $ 251 $ 252 $ 156 $ 390
========== ========== ========== ========
Cost of sales $ 4,424 $ 4,545 $ 2,616 $ 2,403
========== ========== ========== ========
Income from operations $ 7,665 $ 11,920 $ 4,551 $ 16,060
========== ========== ========== ========
Net income $ 4,427 $ 3,443 $ 2,535 $ 6,771
========== ========== ========== ========
Basic income per share (a) $ 0.54 $ 0.42 $ 0.31 $ 0.82
========== ========== ========== ========
Diluted income per share (a) $ 0.54 $ 0.42 $ 0.31 $ 0.82
========== ========== ========== ========
2005:
Sales of real estate $ 4,087 $ 5,583 $ 9,708 $ 86,354
========== ========== ========== ========
Income from options on real estate
properties $ -- $ -- $ -- $ --
========== ========== ========== ========
Co-op marketing and advertising fees $ 428 $ 630 $ 464 $ 678
========== ========== ========== ========
Cost of sales $ 900 $ 269 $ 2,312 $ 23,238
========== ========== ========== ========
Income from operations $ 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
========== =========== ========== ========
(a) In 2006 the quarterly basic and diluted per share amounts do not equal the
annual per share amount.
(b) In 2005, the quarterly diluted per share amount does not equal the annual
per share amount.
F-17