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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, 2004
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number: 1-10153
HOMEFED CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware 33-0304982
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1903 Wright Place
Suite 220
Carlsbad, California 92008
(760) 918-8200
(Address, Including Zip Code, and Telephone Number,Including Area Code,
of Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark 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 an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [x] No [ ]
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, 2004, the aggregate
market value of the Registrant's Common Stock held by non-affiliates was
approximately $140,134,000 on that date.
As of March 1, 2005, there were 8,260,059 outstanding shares of the
Registrant's Common Stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
None.
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PART I
Item 1. Business.
- ------ --------
THE COMPANY
Introduction
HomeFed Corporation ("HomeFed") was incorporated in Delaware
in 1988. As used herein, the term "Company" refers to HomeFed and its
subsidiaries, except as the context may otherwise require. The Company is
currently engaged, directly and through subsidiaries, in the investment in and
development of residential real estate projects in the State of California. The
Company also investigates the acquisition of new real estate projects, both
residential and commercial and within and outside the State of California,
although no assurance can be given that the Company will find new investments
providing a satisfactory return or, if found, that the Company will have access
to the capital necessary to make new real estate investments. The executive
office of the Company is located at 1903 Wright Place, Suite 220, Carlsbad,
California 92008.
The Company's current development projects consist of two
master-planned communities located in San Diego County, California: San Elijo
Hills, and a portion of the larger Otay Ranch planning area. As discussed below,
the Company acquired the San Elijo Hills project in October 2002 and as a
result, the San Elijo Hills project has been included in the Company's
consolidated financial statements since the date of acquisition. The Company
also owns the Rampage property, a 2,159 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 of a project,
the Company may engage in incidental activities to maintain the value of the
project. The Company develops and markets its communities in phases to allow
itself the flexibility to sell finished lots to suit market conditions and to
enable it to create stable and attractive neighborhoods. Consequently, at any
particular time, the various phases of a project will be in different stages of
land development and construction. In addition, from time to time the Company
will receive expressions of interest from buyers of multiple phases of a
project, or the remaining undeveloped land of an entire project. The Company
evaluates these proposals when it receives them, but no assurance can be given
that the Company will sell all or any portion of its development projects in
such a manner.
For any master-planned community, plans must be prepared that
provide for infrastructure, neighborhoods, commercial and industrial areas,
educational and other institutional or public facilities, as well as open space.
Once preliminary plans have been prepared, numerous governmental approvals,
licenses, permits and agreements, referred to as "entitlements," must be
obtained before development and construction may commence. These often involve a
number of different governmental jurisdictions and agencies, challenges through
litigation, considerable risk and expense, and substantial delays. Unless and
until the requisite entitlements are received and substantial work has been
commenced in reliance upon such entitlements, a developer generally does not
have full "vested rights" to develop a project, and as a result, allocation of
acreage between developable and non-developable land may change. In addition, as
a precondition to receipt of building-related permits, master-planned
communities such as San Elijo Hills typically are required in California to pay
impact and capacity fees, or to otherwise satisfy mitigation requirements.
Current Development Projects
San Elijo Hills
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 Holding Corporation ("CDS"), which
2
through its majority-owned subsidiaries is the owner of the San Elijo Hills
project. The $25,000,000 purchase price consisted of $1,000,000 in cash and
2,474,226 shares of the Company's common stock, representing approximately 30%
of the Company's outstanding shares. The San Elijo Hills project, a
master-planned community located in the City of San Marcos in San Diego County,
California, at completion is expected to be a community of approximately 3,500
homes and apartments, as well as commercial properties; the San Elijo Hills
project is expected to be completed before the end of this decade. Since August
1998, the Company has been the development manager for this project, with
responsibility for the overall management of the project, including, among other
things, preserving existing entitlements and obtaining any additional
entitlements required for the project, arranging financing for the project,
coordinating marketing and sales activity, and acting as the construction
manager. The development management agreement provided that the Company would
participate in the net cash flow of the project through the payment of a success
fee, and that the Company receive fees for the field overhead, management and
marketing services it provides ("development management fees"), based on the
revenues of the project. No success fee had been paid prior to the Company's
acquisition of CDS. Through its majority owned subsidiaries, CDS has an
effective 68% indirect equity interest in the San Elijo Hills project, after
considering minority interests held by former owners of the project before CDS
acquired its interest. However, CDS has the right to the return of funds
advanced to the project and to receive a preferred return on its investment
before any amounts are distributed to the minority shareholders. In 2004,
dividends of $71,000,000 were paid by the Company's subsidiary that owns the San
Elijo Hills project, of which $54,800,000 was ultimately received by the Company
and the balance was paid to the minority interests. As a result, all amounts
advanced to the project were repaid and the preferred return was fully
satisfied. For more information on the minority interests, see Note 6 of Notes
to Consolidated Financial Statements.
Sales Activity. The table below summarizes sales activity at
the San Elijo Hills project subsequent to the acquisition of CDS. At closing, a
portion of the sales proceeds is deferred and not immediately recognized as
revenue in the Company's consolidated statements of operations. The Company
recognizes deferred revenue upon completion of required improvements to the
property sold, including costs related to common areas, under the percentage of
completion method of accounting. Amounts shown below as development management
fees earned are intercompany payments, which are eliminated in consolidation and
therefore not reflected in the Company's consolidated statements of operations
after the acquisition of CDS, but which are a source of liquidity for the parent
company.
Year Ended Year Ended October 21, 2002 to
December 31, 2004 December 31, 2003 December 31, 2002
----------------- ----------------- -----------------
(Dollars in thousands)
Number of units sold (1) 139 739 92
School site 1 -- --
Aggregate sales proceeds from sales of residential
and school sites, net of closing costs (2) $ 53,200 $133,400 $ 24,700
Development management fees earned $ 3,300 $ 8,100 $ 1,400
(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.
Prior to the Company's acquisition of CDS, sales activity at
the San Elijo Hills project consisted of the sale of 1,584 residential and
non-residential units for aggregate sales proceeds of $182,700,000, net of
closing costs. Since the Company was not the owner of the project, it did not
reflect these sales in its consolidated statements of operations. However, the
Company did earn development management fees from these sales, which were
reflected in its consolidated statements of operations. Development management
fees earned were approximately $1,600,000 for the period from January 1, 2002 to
October 21, 2002, and $4,800,000 and $3,500,000 for the years ended December 31,
2001 and 2000, respectively.
As of December 31, 2004, the Company estimates that it will
spend approximately $8,900,000 to complete the required improvements to sold
properties, which results in a deferred revenue balance of $39,100,000. The
Company will recognize the deferred revenue in its consolidated statements of
operations as the required improvements are completed under the percentage of
completion method of accounting.
3
As of March 1, 2005, the Company has entered into agreements
to sell 241 single family lots for aggregate cash proceeds of $103,900,000 (of
which $8,000,000 has been received as a non-refundable deposit), and 131
multi-family units for aggregate cash proceeds of $36,000,000 (of which
$3,700,000 has been received as a non-refundable deposit). After considering
this land under contract for sale, the remaining land at the San Elijo Hills
project to be developed and sold or leased consists of the following:
Single family lots to be developed and sold 429
Multi-family units 40
Square footage of commercial space 135,000
The Company's current plans are to construct the multi-family
units rather than sell them to another developer, after which the units will be
sold or leased. Assuming the Company's development is not delayed, it expects to
close the sales of the remaining residential units during 2005 and 2006;
however, development activity on units sold is expected to continue into 2006
and on common areas into 2007.
With respect to the commercial space, the Company's current
plan is to construct some of the commercial space rather than sell it to a
builder. The commercial lots are substantially developed; however, with the
exception of the visitors' center, the Company has not yet constructed buildings
on the commercial lots. The Company's plan for the town center includes a
supermarket, gas station, office space and other stores, and discussions have
begun with prospective users of the commercial space. The Company expects it
will begin commercial space construction during 2005.
Although these development plans are based on the Company's
current intentions, these plans could change, including as a result of actions
of local regulatory authorities.
In order for the City of San Marcos to issue building permits
to the Company's prospective lot purchasers for lot sales above certain
thresholds, improvements to two off site roads need to be under construction.
Pursuant to the project development agreement with the City of San
Marcos/Redevelopment Agency of San Marcos (the "City"), the Company is required
to contribute $11,000,000 to fund a portion of the cost of building these roads,
including the acquisition of land, rights of way and/or environmental permits
prior to the commencement of construction. The City will fund any costs in
excess of this amount. During 2004, the Company commenced construction of one of
the roads which it expects to complete during 2005. The City has agreed to
impose a special tax which would be levied against future property owners of a
portion of the San Elijo Hills project that would give homebuilders the right to
receive funds from the City related to the cost of public infrastructure
improvements which were made at the Company's expense; a benefit which the
Company believes would enable it to recover all or a portion of these road
construction costs by charging homebuilders a price in excess of the market
price. However, there is no assurance that the Company will be successful in
recovering its expenses through higher prices to homebuilders.
In February 2005, the Company received the remaining
environmental permit and commenced construction of the second off site road
referred to above. The commencement of construction of this road removes the
last significant limitation to the issuance of building permits at the San Elijo
Hills project. Absent unforeseen developments, the removal of this restriction
should enable the Company to complete the development of this project in
accordance with its plans.
Since 1999, the San Elijo Hills project has carried
$50,000,000 of general liability and professional liability insurance under a
policy issued by the Kemper Insurance Companies ("Kemper"). The policy covered a
thirteen-year term from the initial date of coverage, and the entire premium for
the life of the policy was paid in 1999. This policy is specific to the San
Elijo Hills project; the Company has general and professional liability
insurance for other matters with different insurance companies.
4
Kemper has ceased underwriting operations and has submitted a
voluntary run-off plan to its insurance regulators. Although Kemper is not
formally in liquidation or under the supervision of insurance regulators, it is
uncertain whether they will have sufficient assets at such time, if ever, the
Company makes a claim under the policy or, if they are insolvent, whether state
insurance guaranty funds would be available to pay the claim. In May 2004, the
Company purchased an excess policy with another insurance carrier that provides
up to $10,000,000 of coverage for general liability claims, but not professional
liability claims, relating to homes sold through May 31, 2004. The Company
continues to investigate whether insurance coverage for future home sales at the
San Elijo Hills project is available at acceptable prices; however, the Company
has not yet found insurance coverage at an acceptable price.
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 for the larger planning area. Although there
is no specified time within which implementation of the General Development Plan
must be completed, it is expected that full development of the larger planning
area will take decades. This General Development Plan establishes land use
goals, objectives and policies within the larger planning area. The General
Development Plan 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 this General Development Plan. While the General Development
Plan can be amended, subject to approval by either or both of the City of Chula
Vista and the County of San Diego, Otay Land Company has certain vested and
contractual rights, pursuant to a development agreement, that protect its
development interests in Chula Vista, covering substantially all of its
developable land. However, actual land development will require that further
entitlements and approvals be obtained.
In April 2003, at the urging of the City of Chula Vista, the
developers within Otay Ranch (including Otay Land Company) entered into a three
year agreement to limit the number of annual building permits they would utilize
to an aggregate of 2,210 per year for all developers, with certain exceptions.
The City has requested that this agreement be extended for another three years
after it expires in April 2006. If the developers do not agree to extend the
restriction, the City has the right to unilaterally impose a restriction on the
number of building permits that can be issued. The current draft allocation for
Otay Land Company is acceptable to the Company. However, there is no guaranty
that this agreement will be extended or, if it is, that the proposed permit
allocation will not change.
In August 2002, Otay Land Company reached an agreement with
the City of Chula Vista and another party whereby the City agreed to acquire 439
acres of mitigation land from Otay Land Company by eminent domain proceedings.
On January 15, 2004, these proceedings were concluded and the mitigation land
was sold to the City for aggregate proceeds of approximately $5,800,000,
substantially all of which had been received as of December 31, 2003. A pre-tax
gain of approximately $4,800,000 was recognized in 2004.
After considering the above transactions, Otay Land Company
owns approximately 2,900 acres, of which the total developable area is
approximately 700 acres, including approximately 170 acres of land designated as
"Limited Development Area and Common Use Area." The remaining approximately
2,200 acres are designated as various qualities of non-developable open space
mitigation land. Under the General Development Plan, 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.
5
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 General Development Plan conditions, a market for
this land could develop within the larger Otay Ranch development area as
development progresses; however, such a market is partially dependent upon other
parties with developable land fully developing their land. Should other owners
choose not to develop their developable land, it is unlikely that Otay Land
Company's mitigation land can be sold to other owners within the larger Otay
Ranch planning area to meet their mitigation requirements. A sporadic market for
Otay Land Company's excess mitigation land may be developing among buyers of
such land in the San Diego County region. However, it is unclear whether the
County of San Diego would determine that Otay Ranch mitigation land is
acceptable for development unrelated to Otay Ranch.
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 General Development Plan Amendment for the
overall Otay Ranch area. The City has incorporated the Company's proposed
designs for Otay Land Company's holdings, and has stated it intends to consider
approval of the General Development Plan Amendment in March 2005. If adopted,
this amendment would increase Otay Land Company's approved residential units
from 2,880 to 5,500, and leave in place its existing approval for 1.8 million
square feet of commercial space. However, even if the General Development Plan
Amendment is approved, significant design and processing will be required in
order to fully entitle the property before development and sale of finished
neighborhoods to builders can begin.
Even if Otay Land Company receives its entitlements to develop
its property, it is uncertain whether it will fully develop or sell its
developable land. As a result, the Company is unable to predict when revenues
will be derived from this project. As indicated above, 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.
Other Projects
Rampage Property
In November 2003, the Company purchased a 2,159 acre grape
vineyard located in southern Madera County, California. The purchase price for
the property was $5,700,000, excluding expenses, of which $1,700,000 was paid in
cash and the balance was financed. The Company has leased the farming rights to
approximately one-half of the property to one of its former owners for a fifteen
year period; however, the lease can be cancelled by the Company, in whole or in
part, after five years (providing two years notice are given), or can be
cancelled earlier upon the occurrence of certain other specified events. The
lease provides that annual rent payments will be based upon the revenue received
by the tenant from selling the grapes produced, but the amount is not expected
to be material.
Although this property is not currently entitled for
residential development, it is located in a growing residential area northeast
of Fresno, California. The Company purchased this land with the intention of
obtaining the necessary entitlements to develop the property as a master-planned
community; however, approvals from various government agencies will be required,
including the acquisition of a water supply that meets regulatory requirements.
The Company expects the entitlement process will take several years and no
assurance can be given that such entitlements will be obtained. In the interim,
the Company is engaged in farming activities necessary to maintain the vineyard.
On January 6, 2005, an owner of adjacent property purported
to exercise options to purchase 600 acres of the Rampage property for
approximately $5,000,000. The party also filed a complaint against the Company
and the former owners of the Rampage property. The complaint alleges the
property has been devalued by approximately $3,000,000 due to poor farming
practices since approximately 2001. The Company is presently evaluating the
validity of the option, the notice of exercise, the claimed option price and the
allegations of the complaint.
6
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 master 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
governmental agencies regarding such matters as permitted land uses, housing
density, the installation of utility services (such as water, sewer, gas,
electric, telephone and cable television) and the dedication of acreage for open
space, parks, schools and other community purposes. Regulations affect
homebuilding by specifying, among other things, the type and quality of building
materials that must be used, certain aspects of land use and building design and
the manner in which homebuilders may conduct their sales, operations, and
overall relationships with potential home buyers. Furthermore, changes in
prevailing local circumstances or applicable laws may require additional
approvals, or modifications of approvals previously obtained.
Timing of the initiation and completion of development
projects depends upon receipt of necessary authorizations and approvals. Because
of the provisional nature of these approvals and the concerns of various
environmental and public interest groups, the approval process can be delayed by
withdrawals or modifications of preliminary approvals and by litigation and
appeals challenging development rights. The ability of the Company to develop
projects could be delayed or prevented due to litigation challenging previously
obtained governmental approvals. The Company may also be subject to periodic
delays or may be precluded entirely from developing in certain communities due
to building moratoriums or "slow-growth" or "no-growth" initiatives that could
be implemented in the future. Such delays could adversely affect the Company's
ability to complete its projects, significantly increase the costs of doing so
or drive potential customers to purchase competitors' products.
Environmental Compliance
Environmental laws may cause the Company to incur substantial
compliance, mitigation and other costs, may restrict or prohibit development in
certain areas and may delay completion of the Company's development projects.
Delays arising from compliance with environmental laws and regulations could
adversely affect the Company's ability to complete its projects, significantly
increase the costs of doing so or cause potential customers to purchase
competitors' products.
Under various federal, state and local environmental laws, an
owner or operator of real property may become liable for the costs of the
investigation, removal and remediation of hazardous or toxic substances at that
property. These laws often impose liability without regard to whether the owner
or operator knew of, or was responsible for, the presence of the hazardous or
toxic substances. The presence of hazardous or toxic substances, or the failure
to remediate these substances when present, may adversely affect the owner's
ability to sell or rent that real property or to borrow funds using that real
property as collateral. It may impose unanticipated costs and delays on
projects. Persons who arrange for the disposal or treatment of hazardous or
toxic wastes may also be liable for the costs of the investigation, removal and
remediation of those wastes at the disposal or treatment facility, regardless of
whether that facility is owned or operated by that person. In addition to
remediation actions brought by federal, state and local agencies, the presence
of hazardous substances on a property could result in personal injury,
contribution or other claims by private parties. These claims could result in
costs or liabilities that could exceed the value of that property. We are not
aware of any notification by any private party or governmental authority of any
claim in connection with environmental conditions at any of our properties that
we believe will involve any material expenditure other than as disclosed herein.
7
The Company obtained a preliminary remediation study
concerning approximately 30 acres of undeveloped land in the Otay Ranch
master-planned community that is owned by a subsidiary of Otay Land Company,
Flat Rock Land Company, LLC ("Flat Rock"). Flat Rock owns approximately 265
acres of the Company's total holdings in the Otay Ranch area, including 100
developable acres. The need for remediation results from activities conducted on
the land prior to Otay Land Company's ownership. Based upon the preliminary
findings of this study, in 2002 the Company estimated that the cost to implement
the most likely remediation alternative would be approximately $11,200,000, and
accrued that amount as an operating expense. The estimated liability is neither
discounted nor reduced for potential claims for recovery from previous owners
and users of the land who may be liable, and may increase or decrease based upon
the actual extent and nature of the remediation required, the type of remedial
process approved, the expenses of the regulatory process, inflation and other
items. The Company periodically adjusts its liability to reflect its current
best estimate; however, no assurance can be given that the actual amount of
environmental liability will not exceed the amount of reserves for this matter
or that it will not have a material adverse effect on the Company's financial
position, results of operations or cash flows. During 2004, the Company
increased its estimate of remediation costs by approximately $1,300,000,
primarily due to increases in site investigation and remediation costs, and
during 2003 by approximately $300,000, primarily for consulting costs.
During 2003, Otay Land Company developed an investigation
plan, which the San Diego Department of Environmental Health ("DEH") approved,
to further determine the nature and extent of contamination on the property. In
January 2004, the State Department of Toxic Substance Control ("DTSC") approved
DEH as the overseeing agency for the site investigation and the remediation.
Flat Rock selected an environmental consultant to implement the investigation
plan, which has been conducted under the San Diego County Voluntary Cleanup
Program and under the oversight of the DEH. Flat Rock expects to complete the
investigation during 2005, after which it will submit its remediation plan to
and seek approval from the DEH. However, the Company is unable to predict when
the remediation will commence and there is no current regulatory requirement to
commence remediation by a fixed date. Further, Otay Land Company and Flat Rock
have filed a lawsuit in Federal Court in the Southern District of California
seeking compensation from the parties which it believes are responsible for the
contamination. However, the Company can give no assurances that this lawsuit
will be successful or that it will be able to recover any of the costs incurred
in investigating and/or remediating the contamination.
Employees
At December 31, 2004, the Company and its consolidated
subsidiaries had 21 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 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 $47,100,000 at December 31, 2004.
The Company leases 8,944 square feet for its corporate
headquarters which is located at 1903 Wright Place, Suite 220, Carlsbad,
California 92008. A portion of this space was sub-leased to Leucadia for a
monthly base rental of $4,100 in 2004.
8
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 results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------ ---------------------------------------------------
Not applicable.
PART II
Item 5. Market for the Registrant's Common Stock, 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. All common share and per share amounts
in this Report have been restated to give retroactive effect to a
reverse/forward stock split of the Company's common stock, the net effect of
which was a reverse 1-for-10 stock split effected on July 14, 2003 following
shareholder approval.
The following table sets forth the high and low bid price of
the Company's common stock for each quarterly period within the two most recent
fiscal years. The prices below are based on the high and low bid price per
share, as published by the National Association of Securities Dealers OTC
Bulletin Board Service, as adjusted to give retroactive effect to the
reverse/forward stock split.
High Low
------- ------
Year ended December 31, 2003
First Quarter $ 15.30 $ 13.50
Second Quarter 29.00 13.70
Third Quarter 28.40 22.50
Fourth Quarter 30.00 24.30
Year ended December 31, 2004
First Quarter $ 34.60 $ 29.25
Second Quarter 35.00 32.00
Third Quarter 44.20 33.25
Fourth Quarter 52.50 42.00
Year ending December 31, 2005
First quarter (through March 1, 2005) $ 56.50 $ 49.75
The over-the-counter quotations reflect inter-dealer prices,
without retail mark up, markdown or commission, and may not represent actual
transactions. On March 1, 2005, the closing bid price for the Company's common
stock was $54.65 per share. As of that date, there were 1,109 stockholders of
record. The Company did not declare dividends on its common stock during 2003 or
2004.
The Company does not currently meet certain requirements for
listing on a national securities exchange or inclusion on the Nasdaq Stock
Market.
9
The Company and certain of its subsidiaries have net operating
loss carryforwards ("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 impose 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 accumulating five percent or
more of the common stock and the ability of persons or entities now owning five
percent or more of the common stock from acquiring additional common stock. The
restrictions will remain in effect until the earliest of (a) December 31, 2010,
(b) the repeal of Section 382 of the Internal Revenue Code (or any comparable
successor provision) and (c) the beginning of a taxable year of the Company to
which certain tax benefits may no longer be carried forward.
The transfer agent for the Company's common stock is American
Stock Transfer & Trust Company, 59 Maiden Lane, New York, New York 10038.
Item 6. Selected Financial Data.
- ------ -----------------------
The following selected financial data have been summarized
from the Company's consolidated financial statements and are qualified in their
entirety by reference to, and should be read in conjunction with, such
consolidated financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations," contained in Item 7 of this
Report. The results of CDS are included in the Company's consolidated results of
operations from the date of acquisition (October 21, 2002), and is the primary
reason for the significant increase in revenues, expenses and profitability as
compared to earlier periods. As indicated above, all common share and per share
amounts have been restated to give retroactive effect to the reverse/forward
stock split.
Year Ended December 31,
--------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ------------- ------------ --------- ----------
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA:
Revenues (1) $ 81,671 $ 148,285 $ 13,111 $ 6,523 $ 5,175
Expenses (2) 26,490 50,575 22,418 6,932 7,754
Income (loss) before minority interest 47,633 85,237 (9,375) (377) (2,409)
Net income (loss) 36,792 74,076 (11,086) (1,377) (3,409)
Basic income (loss) per share $ 4.46 $ 9.08 $ (1.80) $ (0.24) $ (0.60)
Diluted income (loss) per share $ 4.45 $ 8.99 $ (1.80) $ (0.24) $ (0.60)
Year Ended December 31,
--------------------------------------------------------------------------
2004 2003 2002 2001 2000
----------- ------------- ------------ --------- ----------
(In thousands, except per share amounts)
SELECTED BALANCE SHEET DATA:
Cash and cash equivalents $ 34,634 $ 43,503 $ 33,601 $ 1,454 $ 1,631
Investments 82,249 88,519 -- -- --
Real estate 47,126 37,612 31,108 23,890 22,979
Total assets 211,487 217,010 117,043 25,804 24,818
Note payable to Leucadia Financial Corporation -- 24,716 23,628 22,508 21,474
Other notes payable 16,620 13,580 16,704 -- --
Stockholders' equity (deficit) 113,751 76,330 1,650 (11,623) (10,421)
Shares outstanding 8,260 8,155 8,155 5,680 5,680
Book value per share $ 13.77 $ 9.36 $ .20 $ (2.05) $(1.83)
(1) Prior to the acquisition of CDS, includes development management fee income
from San Elijo Hills of $1,600,000 for the period from January 1, 2002 to
October 21, 2002, and $4,800,000 and $3,500,000 for the years ended
December 31, 2001 and 2000, respectively. 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.
10
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
- ------ -----------------------------------------------------------------------
The purpose of this section is to discuss and analyze the
Company's consolidated financial condition, liquidity and capital resources and
results of operations. This analysis should be read in conjunction with the
consolidated financial statements and related notes which appear elsewhere in
this Report.
Liquidity and Capital Resources
Net cash provided by operating activities, principally from
the proceeds from the sale of real estate, was $22,500,000, $119,000,000 and
$16,600,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
The large fluctuations in operating cash flows from year to year result from the
timing of real estate sales, principally at the San Elijo Hills project. The San
Elijo Hills project is being sold in phases, and the quantity of lot inventory
available for sale can vary greatly from period to period. During 2003, the
Company closed on the sales of substantially more lot inventory than any other
period, the timing of which reflects both the strong residential real estate
market at San Elijo Hills and the planned phasing of the project. Information
about the remaining real estate to be sold at the San Elijo Hills project is
provided below. Operating cash flows in 2003 also reflect the sale of a
relatively large piece of land at the Otay Ranch project. Because of the nature
of its real estate projects, the Company does not expect operating cash flows
will be consistent from year to year.
The parent company's principal sources of funds are proceeds
from the sale of real estate, its $10,000,000 line of credit with Leucadia, fee
income from the San Elijo Hills project, dividends and tax sharing payments from
its subsidiaries and borrowings from or repayment of advances by its
subsidiaries. As of December 31, 2004, the Company had consolidated cash and
cash equivalents and marketable securities aggregating $116,900,000. The
Company's investment portfolio and cash equivalents are comprised entirely of
highly rated investment grade securities issued by agencies of the U.S.
government that all mature within one year. During 2004, dividends of
$71,000,000 were paid by the Company's subsidiary that owns the San Elijo Hills
project, of which $16,200,000 was paid to the minority interests in the San
Elijo Hills project, and the Company retained the balance. 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. As of December 31, 2004, the
parent company has approximately $73,400,000 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, together with the
sources described above, will be sufficient for both its short and long term
liquidity needs. Residential sales at the San Elijo Hills project are expected
to be a continuing source of funds to the Company through 2006 if project
development continues as planned, and if economic conditions remain favorable
for the local housing market. Thereafter, cash flow from the San Elijo Hills
project will principally result from the sale or lease of the commercial space.
Until the Company is reasonably assured it will be able to sell or lease
developed property for an adequate return, the San Elijo Hills project will not
require significant funds for development. The Company is not relying on receipt
of funds from Otay Land Company for the foreseeable future, since the timing of
sales of undeveloped property, development activity and sales of developable and
undevelopable property cannot be predicted with any certainty. However, except
for the environmental remediation matter discussed below, Otay Land Company is
not expected to require material funds in the short term, and long term needs
will not be determined until a development plan is established. The Company does
not anticipate that the Rampage property will require any significant funding or
be the source of significant funds for the next few years. The Company is not
currently committed to acquire any new real estate projects, but it does have
sufficient liquidity to take advantage of appropriate acquisition opportunities
if they are presented.
In March 2004, the Company prepaid its $26,462,000 borrowing
from Leucadia in full, using its available cash. Although the Company has no
current plans or intentions to replace this debt, the Company believes that it
will have access to financing on acceptable terms should the need arise. Since
the note was reflected in the consolidated balance sheet net of a discount of
$1,606,000, the entire discount was reflected as an expense in the Company's
2004 consolidated statement of operations.
The Company currently has an unsecured $10,000,000 line of
credit agreement with Leucadia, which has a maturity date of February 28, 2007.
Loans outstanding under this line of credit bear interest at 10% per year. As of
March 1, 2005, no amounts were outstanding under this facility.
11
When the Company acquired the Rampage property in 2003,
$4,300,000 of the purchase price was to be paid to the seller by the end of 2004
and was reflected in the balance sheet as an other liability as of December 31,
2003. To secure its obligation to the seller, the Company gave the seller a
letter of credit that was fully collateralized by cash. The property was
encumbered by a mortgage lien granted by the seller and, although the Company
was not obligated to satisfy the mortgage, it did agree to make interest
payments due under the mortgage during 2004; in addition, any principal payments
made by the Company to the mortgagee 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. However, because
the seller did not obtain a release of the mortgage lien, the Company is no
longer obligated to pay any further amounts to the seller, but is now obligated
to make all debt service payments to the mortgagee. In addition, as of December
31, 2004, the letter of credit expired and the cash collateral was released. At
December 31, 2004, the principal amount of the mortgage is $3,700,000, it bears
interest at 7 1/4% and requires an annual payment of interest and principal of
$424,000 that fully amortizes the loan by its maturity in January 2018.
During 2004, two neighborhoods at the San Elijo Hills project
consisting of 94 single family lots and 45 multi-family units were sold for an
aggregate purchase price of $33,000,000, net of closing costs. Of this amount,
$3,100,000 related to non-refundable options payments that were received in
2003. In addition, the Company sold a school site for a purchase price of
$20,200,000, net of closing costs. At December 31, 2004, $18,500,000 of revenue
related to these sales was deferred since the Company is required to complete
certain improvements under the purchase agreements.
As of December 31, 2004, the aggregate balance of deferred
revenue for all real estate sales (including the 2004 sales) was $39,100,000,
which the Company estimates will be substantially recognized as revenue by the
end of 2006. The Company estimates that it will spend approximately $8,900,000
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, 2004, the remaining land at the San Elijo
Hills project to be developed and sold or leased consisted of the following
(including real estate under contract for sale):
Single family lots to be developed and sold 670
Multi-family units 171
Square footage of commercial space 135,000
In October 2004, the school district relinquished its option
to acquire a ten acre school site within the project. Once the Company received
notice from the school district, underlying zoning regulations permitted the
construction of 135 multi-family units on the site, 67 of which were previously
allocated to single family lots. These changes are reflected in the table above.
As of March 1, 2005, the Company has entered into agreements
with homebuilders to sell 241 single family lots for aggregate cash proceeds of
$103,900,000, pursuant to which it had received non-refundable option payments
of $8,000,000, which were received in 2004. In addition, the Company has entered
into an agreement with a builder to sell 131 multi-family units at a sales price
of $36,000,000, pursuant to which it received a non-refundable option payment of
$3,700,000 in 2004. These option payments are non-refundable if the Company
completes site improvement work and fulfills its other obligations under the
agreements, and will be applied to reduce the amount due from the purchasers at
closing. Although these agreements are binding on the purchasers, should the
Company fulfill its obligations under the agreements within the specified
timeframes and a purchaser decides not to close, the Company's recourse will be
primarily limited to retaining the option payment. The Company is also currently
marketing for sale 79 single family lots which are luxury estate lots which may,
by their nature, take more time to sell.
The Company is currently developing lots that are under
contract for sale or being marketed for sale. The Company believes it will sell
all of its remaining single family residential sites during 2005 and 2006, after
which the remaining activity at the San Elijo Hills project will be primarily
concentrated on multi-family and commercial sites. These estimates of future
property available for sale and the timing of the sales are based upon current
development plans for the project and could change based on actions of
regulatory agencies and other factors that are not within the control of the
Company.
12
During 2004, the Company recorded $4,500,000 of revenues
related to revenue or profit sharing payments received from homebuilders who
purchased lots in the San Elijo Hills project. Certain of the Company's lot
purchase agreements with homebuilders include provisions that entitle the
Company to a share of the revenues or profits realized by the homebuilders upon
their sale of the homes. Since the future plans and potential profits of the
Company's homebuilders are uncertain, the Company is unable to predict whether
additional payments will be received in the future.
Since 1999, the San Elijo Hills project has carried
$50,000,000 of general liability and professional liability insurance under a
policy issued by 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. To date, the
Company has not made any material claims under the policy.
Kemper has ceased underwriting operations and has submitted a
voluntary run-off plan to its insurance regulators. Although Kemper is not
formally in liquidation or under the supervision of insurance regulators, it is
uncertain whether they will have sufficient assets at such time, if ever, the
Company makes a claim under the policy or, if they are insolvent, whether state
insurance guaranty funds would be available to pay the claim. In May 2004, the
Company purchased an excess policy with another insurance carrier that provides
up to $10,000,000 of coverage for general liability claims, but not professional
liability claims, relating to homes sold through May 31, 2004. The Company
continues to investigate whether insurance coverage for future home sales at the
San Elijo Hills project is available at acceptable prices; however, the Company
has not yet found insurance coverage at an acceptable price.
In August 2002, Otay Land Company reached an agreement with
the City of Chula Vista and another party whereby the City agreed to acquire 439
acres of mitigation land from Otay Land Company by eminent domain proceedings.
In January 2004, these proceedings were concluded and the mitigation land was
sold to the City for aggregate proceeds of approximately $5,800,000,
substantially all of which had been received as of December 31, 2003. A pre-tax
gain of approximately $4,800,000 was recognized in 2004.
In July 2004, the Board of Directors approved the repurchase
of up to 500,000 shares of the Company's common stock, representing
approximately 6% of the Company's outstanding stock. Repurchased shares would be
available, among other things, for use in connection with the Company's stock
option plans. The shares may be purchased from time to time, subject to
prevailing market conditions, in the open market, in privately negotiated
transactions or otherwise. Any such purchases may be commenced or suspended at
any time without prior notice. No shares have been purchased to date.
As indicated in the table below, at December 31, 2004, the
Company's contractual cash obligations totaled $21,491,000. The notes payable to
trust deed holders are collateralized by the San Elijo Hills project. The
Rampage note payable is collateralized by the Rampage property. 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 $ 14,339 $ -- $ 161 $ 538 $13,640
Rampage note payable, including interest 5,941 424 849 849 3,819
Operating lease, net of sublease income 1,211 214 460 493 44
-------- ------ -------- ------- --------
Total Contractual Cash Obligations $ 21,491 $ 638 $ 1,470 $ 1,880 $ 17,503
======== ====== ======== ======= ========
13
Pursuant to an agreement with the City of San Marcos, the
Company is contractually obligated to contribute up to $11,000,000 towards the
cost of improving two off site roads to the San Elijo Hills project, which is
not reflected in the table above. The City of San Marcos is obligated to fund
the balance of the cost of the roads. The Company expects it will substantially
complete its road construction obligation by the end of 2005.
As of December 31, 2004, the Company had NOLs of $143,000,000
available to reduce its future federal income tax liabilities and $7,400,000 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 has
obtained these bonds on behalf of CDS and its subsidiaries both before and after
the acquisition of CDS by the Company. CDS is responsible for paying all third
party fees related to obtaining the bonds. Should the City or others draw on the
bonds for any reason, certain of the Company's subsidiaries would be obligated
to reimburse Leucadia for the amount drawn. As of December 31, 2004, the amount
of outstanding bonds was approximately $28,200,000, 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, 2004, the Company's deferred revenue balance aggregated $39,100,000.
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.
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, but is significantly influenced by 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 $205,000,000, which is sufficient to fully
utilize the Company's NOLs, but not all of its alternative minimum tax credit
carryovers.
14
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 can be used to reduce its future federal income tax rate once
it has used all of its NOLs. Assuming the Company realizes its projected taxable
income in the future and fully utilizes its NOLs, it will have approximately
$36,000,000 of minimum tax credit carryovers to reduce future federal income
taxes payable. However, the minimum tax credit carryovers 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 $175,000,000 of taxable
income above its current estimate to fully use them. 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; 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.
In each of the last two years, the Company has reduced its
valuation allowance and federal income tax expense as a result of increases in
its projected taxable income. During this period, the Company has entered into
lot sale agreements at the San Elijo Hills project for prices that continue to
increase, at a rate greater than had been expected. The increase in projected
income results from the continued strong residential housing market in the San
Elijo Hills area and the Company's management applying a conservative approach
to estimating future results. Further, since the Company's plans for development
at the Otay Ranch and Rampage properties are uncertain, the Company has not
included estimates of future revenues from 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 potential claims for recovery from previous
owners and users of the land who may be liable, and may increase or decrease
based upon the actual extent and nature of the remediation required, the type of
remedial process approved, the expenses of the regulatory process, inflation and
other items. During 2004, the Company increased its estimate of remediation
costs by approximately $1,300,000, primarily due to increases in site
investigation and remediation costs, and during 2003 by approximately $300,000,
primarily for consulting costs. The Company may begin remediation during 2005,
although it has no obligation to do so. The Company does not currently know when
the funds for remediation activities will be spent.
Flat Rock is currently performing an investigation and is
preparing the required documentation in order to obtain approval of a
remediation plan from the appropriate regulatory authority. Flat Rock expects
that it will be able to submit its remediation plan by the end of 2005. As it
continues its investigation and develops its remediation plan, the Company may
conclude that the current estimate of its liability needs to be adjusted. A
change to the current estimate could result from, among other things, a
conclusion that a different remediation alternative is more appropriate (which
could increase or decrease the estimate), that the cost to implement any
remediation alternative is different than the Company's current estimate and/or
requirements imposed by regulatory authorities that the Company did not
anticipate but is nevertheless required to implement. The Company periodically
adjusts its liability to reflect its current best estimate; however, no
assurance can be given that the actual amount of environmental liability will
not exceed the amount of reserves for this matter or that it will not have a
material adverse effect on the Company's financial position, results of
operations or cash flows.
15
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 du ring the three year period
ended December 31, 2004.
Statement of Operations
The Company currently has two significant real estate
development projects, the San Elijo Hills project and the Otay Ranch project.
The Company acquired the San Elijo Hills project in October 2002, and this
acquisition accounts for the significant increase in revenues, cost of sales and
profitability as compared to earlier periods. The San Elijo Hills project is a
master-planned community that, when completed, will contain approximately 2,364
single family lots, 830 multi-family units, 272 very low income apartment units,
two school sites and commercial space which will be sold or leased. As of March
1, 2005, the remaining land at the San Elijo Hills project to be developed and
sold or leased (including real estate under contract for sale) consisted of 670
single family lots, 171 multi-family units and 135,000 square feet of commercial
space. The Company currently plans to complete its development of residential
sites during 2005 and 2006, after which remaining activity at the San Elijo
Hills project will be primarily concentrated on the commercial sites. These
estimates of future property available for sale and the timing of the sales are
derived from the current plans for the project, and could change based upon the
actions of the project's homebuilders or regulatory agencies.
While the San Elijo Hills project is a development community
with significant sales activity, sales at the Otay Ranch project have been
limited to three individual transactions for relatively large amounts of land.
Individual lot development at the Otay Ranch project has not yet begun, as the
Company continues to evaluate how to maximize the value of this investment while
pursuing land sales and processing further entitlements on portions of the
property. If and when the Company determines to commence lot development at the
Otay Ranch project, it is expected to last several years. Similarly, the Rampage
property is not expected to have sales activity for several years. Approximately
one-half of the Rampage property has been leased to another party for a minimum
of five years (the net lease income is not expected to be significant), and any
residential development can only commence after approvals are obtained from
several government agencies.
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 October 21, 2002 to
December 31, 2004 December 31, 2003 December 31, 2002
----------------- ----------------- -----------------
(Dollars in thousands)
Single family units 94 535 92
Multi-family units 45 -- --
Very low income apartment units -- 204 --
School sites 1 -- --
Purchase price, net of closing costs $ 53,200 $ 133,400 $ 24,700
Revenues recognized on closing date $ 28,800 $ 77,100 $ 3,600
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 $38,800,000, $35,500,000 and $1,400,000 for 2004,
2003 and 2002, respectively, which were recognized upon completion of certain
required improvements.
16
Revenues from sales of real estate also include amounts
received pursuant to profit sharing agreements with homebuilders of $4,500,000,
and $5,500,000 during 2004 and 2003, respectively. Additionally, revenues from
sales of real estate in 2003 include approximately $3,000,000 paid by one of San
Elijo's homebuilders for the Company's consent to allow the homebuilder to
re-sell his lots to another homebuilder.
During 2004, 2003 and 2002, cost of sales of real estate
aggregated $16,000,000, $29,100,000 and $2,000,000, 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:
------------------
During 2004, sales of real estate were $5,800,000 relating to
an agreement with the City of Chula and another party whereby the City agreed to
acquire 439 acres of mitigation land by eminent domain proceedings. Sales of
real estate during 2003 consist of $22,500,000 from the sale of 1,445 acres. For
2002, sales of real estate consist of $4,300,000 from the sale of 85 acres of
developable land.
During 2004, 2003 and 2002, cost of sales of real estate
aggregated $1,000,000, $4,800,000 and $800,000, respectively. Cost of sales is
based upon the allocation of project costs to individual parcels, based upon
their relative fair values, in addition to closing costs and commissions, if
any.
Paradise Valley Project:
-----------------------
During 2003, the Company disposed of all of its remaining
interest in the Paradise Valley project and recognized pre-tax income of
$1,500,000, net of $300,000 that was allocated to the minority interest. There
were no sales relating to this project in 2002.
Other Results of Operations Activity
The Company recorded co-op marketing and advertising fees of
approximately $3,700,000, $1,300,000 and $1,900,000 for the years ended December
31, 2004, 2003 and 2002, 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.
Prior to the acquisition of CDS, the Company recognized
development management fee income in its consolidated statements of operations.
While development management fees have continued to be a source of liquidity to
the parent company since the acquisition of CDS, they are no longer reflected in
the consolidated statements of operations since they are intercompany payments
from a subsidiary and are eliminated in consolidation. Development management
fee income from the San Elijo Hills project was approximately $1,600,000 for the
period from January 1, 2002 to October 21, 2002.
Income from options on real estate properties reflects
non-refundable fees of approximately $300,000 in 2002. Payments received were to
extend the closing date on the sale of the 85 acres of developable land at the
Otay Ranch project, which closed in June 2002.
As more fully discussed above, in 2002, the Company recorded a
provision of approximately $11,200,000, representing its estimated cost of
environmental remediation. During 2004, the Company revised its estimate and
recorded approximately $1,300,000 of additional expense, primarily due to higher
site investigation and remediation costs. In 2003, the Company recorded
approximately $300,000 of additional expense, primarily for consulting costs.
Interest expense reflects the interest due on indebtedness to
Leucadia of approximately $400,000, $1,600,000 and $1,700,000 for 2004, 2003 and
2002, respectively. Interest expense also includes amortization of debt discount
related to the indebtedness to Leucadia of $300,000, $1,100,000, and $1,100,000
for 2004, 2003 and 2002, respectively. As described above, the borrowing from
Leucadia was fully repaid in March 2004; as a result these interest costs ceased
at the date of repayment. In addition, interest expense includes $300,000 for
2004 and was not material for 2003, with respect to the Rampage property.
17
Interest expense excludes capitalized interest of $1,200,000
and $1,400,000 for the years ended December 31, 2004 and 2003, respectively, and
$200,000 for the period from October 21, 2002 to December 31, 2002. Interest is
capitalized for the notes payable to trust deed holders on the San Elijo Hills
project.
General and administrative expenses decreased by $1,500,000
during 2004 as compared to 2003 due to decreases in salaries expense of
$2,600,000 and stock compensation expense of $600,000. The decrease in salaries
expense related to reduced bonus expense and the resignation of two executive
officers in March 2004 who have not been replaced. Stock compensation expense
declined because the performance stock options (granted in 2000) became fully
vested in 2003. General and administrative expenses also reflect an increase in
farming and other expenses at the Rampage property, which was acquired in
November 2003, and legal fees. The increase in expenses at the Rampage property
of $1,200,000 primarily represents the cost of restoring approximately 310 acres
of vines for future production. Restoration involves the application of farming
practices including grafting to put the vineyard back into production. Farming
related activities at the Rampage property are expected to continue while the
Company seeks to have the land entitled as a master-planned community. The
Company has just begun the process to obtain the necessary entitlements to
develop the Rampage property as a master-planned community; a process that will
require numerous regulatory approvals and is expected to take several years to
complete. Legal fees increased by $500,000 due to costs associated with pursuing
claims against previous owners of undeveloped land that is undergoing
environmental remediation at the Otay Ranch project.
General and administrative expenses increased by $6,500,000
during 2003 as compared to 2002 due to expenses of $1,500,000 related to CDS,
greater expenses related to employee compensation of $3,200,000 and legal and
professional fees. The increase in employee compensation is due to higher
bonuses attributable to better Company performance in 2003 compared to 2002. The
increase in legal and professional fees of $1,400,000 principally reflects costs
associated with the Otay Ranch project, including costs incurred in connection
with the eminent domain proceedings by the City of Chula Vista discussed above,
and expenses of $120,000 related to the Company's reverse/forward split. In
addition, general and administrative expenses increased by $300,000 in 2003 as
compared to 2002 for previously deferred stock compensation expense due to a
charge related to certain performance options that were no longer subject to
forfeiture and greater appreciation of the Company's stock price.
The decrease in other income, net for 2004 as compared to 2003
primarily relates to $1,600,000 for the remaining unamortized discount and
related deferred costs on the indebtedness to Leucadia, which was fully repaid
in March 2004. Other income in 2004 also reflects an increase in investment
income of $600,000 due to greater interest income resulting from a larger amount
of invested assets. Other income in 2003 includes income of $200,000 from the
reimbursement for improvement costs that were previously expensed at the San
Elijo Hills project, proceeds of $200,000 from an easement at the Otay Ranch
project and cash received of $300,000 to settle a dispute with one of the
Company's vendors.
The increase in other income, net for 2003 as compared to 2002
primarily relates to greater interest income of $800,000 resulting from a larger
amount of invested assets, and the aforementioned income from the reimbursement
for improvement costs that were previously expensed at the San Elijo Hills
project, proceeds from an easement at the Otay Ranch project and cash received
to settle a dispute with one of the Company's vendors. These increases were
partially offset by the gain on a sale of a foreclosed property in 2002 for
$100,000.
The decrease in minority expense in 2004 as compared to 2003
relates to lower sales at the San Elijo Hills project. The increase in minority
interest expense for 2003 as compared to 2002 is primarily due to the minority
interest related to CDS (which was acquired in October 2002) and increased
preferred capital interest related to Otay Ranch (prior to its redemption in
2003).
As a result of an increase in the Company's estimates of
future taxable income that exceeded its earlier estimates, the Company reduced
its income tax valuation allowance to recognize additional benefits from its
NOLs and minimum tax credit carryovers and recorded a credit to its income tax
provision of $15,000,000 and $26,065,000 for the years ended December 31, 2004
and 2003, respectively. Income taxes paid for 2002 principally relate to state
income taxes, reduced by a refund of prior year federal alternative minimum tax
payments. In 2002, the Company did not recognize income tax benefits for its
losses due to the uncertainty of sufficient future taxable income which is
required in order to recognize such tax benefits. For more information, see Note
10 of Notes to Consolidated Financial Statements.
18
Recently Issued Accounting Standards
In December 2004, the Financial Accounting Standards Board
("FASB") issued Statement of Financial Accounting Standards No. 123R,
"Share-Based Payment" ("SFAS 123R"), which replaces SFAS 123 and supersedes APB
Opinion No. 25, "Accounting for Stock Issued to Employees". SFAS 123R requires
that the cost of all share-based payments to employees, including grants of
employee stock options, be recognized in the financial statements based on their
fair values. That cost will be recognized as an expense over the vesting period
of the award. The pro forma disclosures previously permitted under SFAS 123 no
longer will be an alternative to financial statement recognition. In addition,
the Company will be required to determine fair value in accordance with SFAS
123R. SFAS 123R is effective for reporting periods beginning with the first
interim or annual period after June 15, 2005, with early adoption encouraged,
and requires the application of a transition methodology for stock options that
have not vested as of the date of adoption. The Company is currently evaluating
the impact of SFAS 123R on its consolidated financial statements.
In December 2004, the FASB issued Statement of Financial
Accounting Standards No. 153, "Exchanges of Nonmonetary Assets--An Amendment of
APB Opinion No. 29" ("SFAS 153"), which is effective for fiscal periods
beginning after June 15, 2005. SFAS 153 eliminates the exception from fair value
measurement for nonmonetary exchanges of similar productive assets in paragraph
21(b) of APB Opinion No. 29, "Accounting for Nonmonetary Transactions," and
replaces it with an exception for exchanges that do not have commercial
substance. SFAS 153 specifies that a nonmonetary exchange has commercial
substance if the future cash flows of the entity are expected to change
significantly as a result of the exchange. The adoption of SFAS 153 will not
have any material effect on the consolidated financial statements; however, SFAS
153 could impact the accounting for future transactions, if any, within its
scope.
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.
19
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, 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.
The factors that could cause actual results to differ
materially from those suggested by any of these statements or which may
materially and adversely affect the Company's actual results include, but are
not limited to, those discussed or identified from time to time in our public
filings, including:
o Changes in prevailing interest rate levels, including mortgage rates. Any
significant increase in the prevailing low mortgage interest rate
environment could reduce consumer demand for housing.
o Changes in domestic laws and government regulations or requirements and in
implementation and/or enforcement of governmental rules and regulations.
The Company's plans for its development projects require numerous
governmental approvals, licenses, permits and agreements, which must be
obtained before development and construction may commence. 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 or as a result of additional time required to
obtain government approvals.
o Changes in real estate pricing environments. Any significant decrease in
the prevailing price of real estate in the geographic areas in which the
Company owns, develops and sells real estate may adversely affect the
Company's results of operations.
o Regional or general increases in cost of living. Any significant increases
in the prevailing prices of goods and services that result in increased
costs of living, particularly in the regions in which the Company is
currently developing properties, may adversely affect consumer demand for
housing.
o Demographic and economic changes in the United States generally and
California in particular. The Company's operations are sensitive to
demographic and economic changes. Any economic downturn in the United
States in general, and California in particular, may adversely affect
consumer demand for housing by limiting the ability of people to save for
down payments and purchase homes. In addition, 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 not be as robust as current levels indicate.
o Increases in real estate taxes and other local government fees. Any such
increases may make it more expensive to own the properties that the Company
is currently developing, which would increase the carrying costs to the
Company of owning the properties and decrease consumer demand for them.
o Significant competition from other real estate developers and homebuilders.
There are numerous residential real estate developers and development
projects operating in the same geographic area in which the Company
operates. Many of the Company's competitors may have advantages over the
Company, such as more favorable locations which may provide better schools
and easier access to roads and shopping, or amenities that the Company may
not offer, as well as greater financial resources and/or access to cheaper
capital.
o Decreased consumer spending for housing. Any decrease in consumer spending
for housing may directly affect the Company's results of operations.
o Delays in construction schedules and cost overruns. Any material delays
could adversely affect the Company's ability to complete its projects,
significantly increasing the costs of doing so, including interests costs,
or drive potential customers to purchase competitors' products. Cost
overruns, if material, could have a direct adverse impact on the Company's
results of operations.
20
o Availability and cost of land, materials and labor and increased
development costs, many of which the Company would not be able to control.
The Company's current and future development projects require the Company
to purchase significant amounts of land, materials and labor. If the costs
of these items increase, it will increase the costs to the Company of
completing its projects; if the Company is not able to recoup these
increased costs, its results of operations could be adversely affected.
o Damage to or condemnation of properties and occurrence of significant
natural disasters and fires. Damage to or condemnation of any of the
Company's properties, whether by natural disasters and fires or otherwise,
may either delay or preclude the Company's ability to develop and sell its
properties, or affect the price at which it may sell such properties.
o Imposition of limitations on the Company's ability to develop its
properties resulting from environmental laws and regulations and
developments in or new applications thereof. The residential real estate
development industry is subject to increasing environmental, building,
construction, zoning and real estate regulations that are imposed by
various federal, state and local authorities. Environmental laws may cause
the Company to incur additional costs, and adversely affect its ability to
complete its projects in a timely and profitable manner.
o Property in California is at risk from earthquakes. 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. An earthquake could cause structural
damage or destroy our projects, which could have an adverse financial
impact on us.
o Under California law we could be liable for some construction defects in
homes 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.
o The inability to insure certain risks economically. The Company cannot be
certain that it will be able to insure all risks that it desires to insure,
that it can insure risks economically or that all of its insurers will be
financially viable if a claim is made by the Company.
o The availability of adequate water resources and reliable energy sources in
the areas where the Company owns real estate projects. Any shortage of
reliable water and energy resources or a drop in consumer confidence in the
dependability of such resources in areas where the Company owns land may
adversely affect the values of properties owned by the Company and curtail
development projects.
o Changes in the composition of the Company's assets and liabilities through
acquisitions or divestitures. The Company may make future acquisitions or
divestitures of assets. Any change in the composition of the Company's
assets and liabilities as a result thereof could significantly affect the
financial position of the Company and the risks that it faces.
o The actual cost of environmental liabilities concerning land owned in San
Diego County, California exceeding the amount reserved for such matter. The
actual cost of remediation of undeveloped land owned by a subsidiary could
exceed the amount reserved for such matter.
o The Company's ability to generate sufficient taxable income to fully
realize the deferred tax asset, net of the valuation allowance. The Company
and certain of its subsidiaries have NOLs and other tax attributes, but may
not be able to generate sufficient taxable income to fully realize the
deferred tax assets.
o The impact of 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.
21
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, 2004, the Company had investments of
approximately $82,200,000 in securities issued by the U.S. government and its
agencies. 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 shareholders' 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 2005; the estimated weighted average
remaining life of these fixed income securities was approximately 0.2 years at
December 31, 2004. At December 31, 2003, 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 1.1%. 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
----------------------
2005 2006 2007 2008 2009 Thereafter Total Fair Value
---- ---- ---- ---- ---- ---------- ----- ----------
(Dollars in thousands)
Rate Sensitive Assets:
Available for Sale Fixed
Income Securities
U.S. Government
Securities $ 82,249 $ -- $ -- $ -- $ -- $ -- $ 82,249 $ 82,249
Weighted Avg.
Interest Rate 1.99%
Rate Sensitive Liabilities:
Fixed Interest Rate
Borrowings $ 3,828 $ 7,039 $ 2,618 $ 197 $ 211 $ 2,727 $ 16,620 $ 16,620
Weighted Average
Interest Rate 6.81% 6.80% 6.82% 7.25% 7.25% 7.25%
Off-Balance Sheet Items:
Unused Lines of Credit $ -- $ -- $ 10,000 $ -- $ -- $ -- $ 10,000 $ 10,000
Weighted Average
Interest Rate -- 10.0%
Item 8. Financial Statements and Supplementary Data.
- ------ -------------------------------------------
Financial Statements and supplementary data required by this
Item 8 are set forth at the pages indicated in Item 15(a) below.
22
Item 9. Changes and Disagreements with Accountants on Accounting and
Financial Disclosure.
- ------ -------------------------------------------------------------
Not applicable.
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, 2004. 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, 2004.
(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, 2004, 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, 2004. 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, 2004, 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, 2004 as stated in
the report which appears on page F-1 of this Report.
Item 9B. Other Information.
- ------- -----------------
Not applicable.
23
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ------- --------------------------------------------------
As of March 1, 2005, the directors and executive officers of
the Company, their ages, the positions held by them and the periods during which
they have served in such positions are as follows:
Name Age Position with the Company Office Held Since
- ---- --- ------------------------- -----------------
Paul J. Borden 56 Director and President May 1998
Curt R. Noland 48 Vice President October 1998
Erin N. Ruhe 39 Vice President, Treasurer and Vice President since April 2000;
Controller Treasurer since March 2004;
Controller since January 1999
Patrick D. Bienvenue 50 Director August 1998
Timothy M. Considine 64 Director January 1992
Ian M. Cumming 64 Director May 1999
Michael A. Lobatz 56 Director February 1995
Joseph S. Steinberg 61 Chairman of the Board and Director Chairman of the Board since
December 1999; Director since
August 1998
The officers serve at the pleasure of the board of directors
of the Company.
The recent business experience of our executive officers and
directors is summarized as follows:
Paul J. Borden. Mr. Borden has served as a director and
President of the Company since May 1998. Mr. Borden had been a Vice President of
Leucadia National Corporation from August 1988 through October 2000, responsible
for overseeing many of Leucadia's real estate investments.
Curt R. Noland. Mr. Noland has served as Vice President of the
Company since October 1998. He spent the last 25 years in the land development
industry in San Diego County as a design consultant, merchant builder and a
master developer. From November 1997 until joining the Company, Mr. Noland was
employed by the prior development manager of San Elijo Hills and served as
Director of Development for San Elijo Hills. Prior to November 1997, Mr. Noland
was employed for eight years by Aviara Land Associates, LP, a 1,000 acre
master-planned resort community in Carlsbad, California. He is also a licensed
civil engineer and real estate broker.
Erin N. Ruhe. Ms. Ruhe has served as Vice President of the
Company since April 2000, Treasurer since March 2004 and has been employed by
the Company as Controller since January 1999. Previously, Ms. Ruhe was Vice
President since December 1995 and Controller since November 1994 of HSD Venture,
a real estate subsidiary of Leucadia.
24
Patrick D. Bienvenue. Mr. Bienvenue has served as a director
of the Company since August 1998. Since January 1996, Mr. Bienvenue has served
in a variety of executive capacities with real estate related subsidiaries of
Leucadia National Corporation and, from 1992 until December 1995, was President
and Chief Executive Officer of Torwest Inc., a privately held property
development and investment company.
Timothy M. Considine. Mr. Considine has served as a director
of the Company since January 1992, serving as Chairman of the Board from 1992 to
December 1999, and is employed by Considine and Considine, an accounting firm in
San Diego, California where he was a partner from 1969 to 2002.
Ian M. Cumming. Mr. Cumming has served as a director of the
Company since May 1999. He has been a director and Chairman of the Board of
Leucadia National Corporation since June 1978 and a director and Chairman of the
Board of The FINOVA Group Inc. ("FINOVA"), a middle market lender in which
Leucadia has an indirect 25% equity interest, since August 2001. Mr. Cumming has
also been a director of Skywest, Inc., a Utah-based regional air carrier, since
June 1986.
Michael A. Lobatz. Dr. Lobatz has served as a director of the
Company since February 1995 and has been a practicing physician in San Diego,
California since 1981.
Joseph S. Steinberg. Mr. Steinberg has served as a director
of the Company since August 1998 and as Chairman of the Board since December
1999. Mr. Steinberg has been President of Leucadia National Corporation since
January 1979 and a director of Leucadia National Corporation since December
1978. In addition, he has served as a director of Jordan Industries Inc., a
public company that owns and manages manufacturing companies, of which
approximately 10.1% of the common stock is beneficially owned by Leucadia, since
June 1988, FINOVA since August 2001 and White Mountains Insurance Group, Ltd., a
publicly traded insurance holding company in which Leucadia has a less than 5%
equity interest, since June 2001.
Audit Committee
The Board of Directors has a standing Audit Committee. The
Board of Directors has adopted a charter for the Audit Committee, which was
filed with the Company's proxy statement for its 2004 Annual Meeting of
Shareholders. The Audit Committee consists of Messrs. Considine (Chairman) and
Lobatz. Applying the Nasdaq criteria, the Board has determined that each of
Messrs. Considine and Lobatz is independent. In addition, the Board has
determined that Mr. Considine is qualified as an audit committee financial
expert within the meaning of regulations of the Securities and Exchange
Commission.
Code of Practice
The Company has a Code of Business Practice, which is
applicable to all directors, officers and employees of the Company, and includes
a Code of Practice applicable to the Company's principal executive officers and
senior financial officers. Both the Code of Business Practice and the Code of
Practice are available without charge upon request. Requests should be addressed
to Corporate Secretary, HomeFed Corporation, 1903 Wright Place, Suite 220,
Carlsbad, California 92008. The Company intends to file with the Securities and
Exchange Commission amendments to or waivers from our Code of Practice
applicable to our principal executive officers and senior financial officers.
Compliance with Section 16(a) of the Securities Exchange Act of 1934
Section 16(a) of the Securities Exchange Act of 1934 requires
the Company's executive officers and directors, and persons who beneficially own
more than 10% of a registered class of the Company's equity securities, to file
reports of ownership and changes in ownership with the Securities and Exchange
Commission. Based solely upon a review of the copies of such forms furnished to
the Company and written representations from the Company's executive officers,
directors and greater than 10% beneficial shareholders, the Company believes
that during the year ended December 31, 2004, all persons subject to the
reporting requirements of Section 16(a) filed the required reports on a timely
basis.
25
Item 11. Executive Compensation.
- ------- ----------------------
Summary Compensation Table
Set forth below is certain information with respect to the
cash compensation paid by the Company for services in all capacities to the
Company and its subsidiaries during the years ended 2004, 2003 and 2002 to (i)
the Company's President and chief executive officer, Paul J. Borden, and (ii)
the other executive officers of the Company whose total annual salary and bonus
exceeded $100,000 during these periods.
Long-term
Annual Compensation Compensation
-------------------------------------- -------------
Name and Principal Other Annual Options All Other
Position(s) Year Salary Bonus Compensation (2) (# of shares) Compensation (3)
----------- ---- ------ ----- ---------------- ------------- ---------------
Paul J. Borden, 2004 $ 246,200(1) $ 356,751 $ 84,662 $ 1,000 $ 8,200
President 2003 232,635(1) 1,006,619 89,780 100 8,000
2002 226,189(1) 231,426 117,397 100 8,000
Curt R. Noland, 2004 $ 115,995 $ 303,477 $ -- -- $ 8,200
Vice President 2003 113,620 603,409 -- -- 8,000
2002 110,318 153,309 -- -- 7,545
Erin N. Ruhe, 2004 $ 95,472 $ 253,300 $ -- -- $ 8,200
Vice President, 2003 78,805 302,364 -- -- 6,247
Treasurer 2002 76,493 77,295 -- -- 5,552
& Controller
- --------------------
(1) Included for 2004 is $21,000 and for 2003 and 2002 is $12,000 of director
fees Mr. Borden received from the Company.
(2) The executive maintains his primary residence in New Jersey. The
information reflected above includes the incremental cost to the Company
(valued in accordance with the disclosure rules of the Securities and
Exchange Commission) of providing the executive with a temporary residence
in California ($35,839, $36,830 and $35,343 in 2004, 2003 and 2002),
airfare for travel to and from his primary residence ($38,715, $42,515 and
$67,154 in 2004, 2003 and 2002) and transportation costs including the use
of a company car while in California.
(3) Represents the contribution made by the Company to a defined contribution
401(k) plan on behalf of the named person.
Option Grants in 2004
The following table shows all grants of options to the named
executive officers of the Company in 2004.
26
Potential Realizable Value
At Assumed Annual Rates
of Stock Price Appreciation
Individual Grants for Option Term (2)
------------------------------------------------------------- -----------------------------
Securities % of Total
Underlying Options
Options Granted to Exercise
Granted Employees Price Expiration
Name (# of shares) in 2004 ($/Share) Date 5%($) 10%($)
------------- ------------- -------- ---------- --------- --------
Paul J. Borden 1,000 (1) 100.0% $44.50 8/24/09 $12,295 $27,168
- --------------
(1) The options were granted pursuant to the Company's 1999 Stock Incentive
Plan to all Directors of the Company at an exercise price equal to the fair
market value of the shares of Common Stock on the date of grant. The grant
date of the options is August 24, 2004. These options become exercisable at
the rate of 25% per year commencing one year after the date of grant.
(2) The potential realizable values represent future opportunity and have not
been reduced to reflect the time value of money. The amounts shown under
these columns are the result of calculations at the 5% and 10% rates
required by the Securities and Exchange Commission, and are not intended to
forecast future appreciation of the shares of Common Stock and are not
necessarily indicative of the values that may be realized by the named
executive officer.
27
Aggregate Option Exercises in 2004 and
Option Values at Year End 2004
The following table provides information as to options
exercised by each of the named executives in 2004 and the value of options held
by these executives at year end measured in terms of the last reported sale
price for the Common Stock as of December 31, 2004, $50.01.
Number of Value of
Unexercised Unexercised In-the-
Options at Money Options at
December 31, 2004 December 31, 2004
----------------- ------------------
Number of shares
Underlying Value Exercisable/ Exercisable/
Name Options Exercised Realized Unexercisable Unexercisable
- ---- ----------------- -------- ------------- -------------
Paul J. Borden -- -- 4,250/2,150 $179,985/$52,759
Curt R. Noland 2,000 $85,500 --/ 500 $ -- /$21,255
Erin N. Ruhe -- -- 2,000/ 500 $ 85,020/$21,255
Compensation of Directors
In 2004, each Director received a retainer of $21,000 for
serving on the Board of Directors. In addition, Mr. Considine was paid $23,500
for serving as Chairman of the Audit Committee, and Mr. Lobatz was paid $15,750
for serving on the Audit Committee. In addition, under the terms of the
Company's 1999 Stock Incentive Plan, each director is automatically granted
options to purchase 1,000 shares on the date on which the annual meeting of
stockholders of the Company is held each year. The purchase price of the shares
covered by such options is the fair market value of such shares on the date of
grant.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- ------- --------------------------------------------------------------
Set forth below is certain information as of March 1, 2005
with respect to the beneficial ownership determined in accordance with Rule
13d-3 under the Securities Exchange act of 1934, as amended, of Common Stock by
(i) each person who, to the knowledge of the Company, is the beneficial owner of
more than 5% of the outstanding Common Stock (the Company's only class of voting
securities), (ii) each Director, (iii) the current executive officers named in
the Summary Compensation Table under "Executive Compensation," (iv) a trust for
the benefit of Mr. Steinberg's children and private charitable foundations
established by Mr. Cumming and Mr. Steinberg and (v) all executive officers and
Directors of the Company as a group.
Number of Shares
Name and Address and Nature of Percent
of Beneficial Owner Beneficial Ownership of Class
- ------------------- -------------------- --------
Leucadia National Corporation ...................................... 2,474,226 (a) 30.0%
Patrick D. Bienvenue................................................ 1,250 (b) *
Paul J. Borden...................................................... 6,828 (c) *
Timothy M. Considine................................................ 1,750 (d) *
Ian M. Cumming...................................................... 773,409 (e)(f) 9.4%
Michael A. Lobatz................................................... 1,250 (b) *
Curt R. Noland...................................................... 5,000 (g) *
Erin N. Ruhe........................................................ 5,000 (h) *
Joseph S. Steinberg................................................. 781,870 (f)(i) 9.5%
The Steinberg Children Trust........................................ 27,532 (j) 0.3%
Cumming Foundation.................................................. 7,329 (k) *
The Joseph S. and Diane H. Steinberg
1992 Charitable Trust.......................................... 2,381 (l) *
All Directors and executive officers as a group (8 persons)......... 1,576,357 (m) 19.1%
- -------------------
* Less than .1%.
28
(a) The business address of this beneficial owner is 315 Park Avenue South, New
York, New York 10010.
(b) Includes 250 common shares that may be acquired upon the exercise of
currently exercisable stock options.
(c) Includes 5,250 common shares that may be acquired upon the exercise of
currently exercisable stock options.
(d) Includes 500 shares held by the Seeseeanoh Inc. Retirement Plan. Mr.
Considine and his wife are the sole owners of Seeseeanoh, a real estate
company in San Diego, California. Also includes 1,250 shares held by The
Considine Family 1981 Trust, of which Mr. Considine and his wife are
trustees.
(e) Includes (i) 9,530 shares of Common Stock (.1%) beneficially owned by Mr.
Cumming's wife (directly and through trusts for the benefit of Mr.
Cumming's children of which Mr. Cumming's wife is trustee) as to which Mr.
Cumming may be deemed to be the beneficial owner and (ii) 250 shares that
may be acquired upon the exercise of currently exercisable stock options.
Does not include 2,474,226 shares held by Leucadia which Mr. Cumming may be
deemed to beneficially own as a result of his beneficial ownership of
Leucadia common shares. See Item 13, "Certain Relationships and Related
Transactions."
(f) Messrs. Cumming and Steinberg have an oral agreement pursuant to which they
will consult with each other as to the election of a mutually acceptable
Board of Directors of the Company. The business address for Messrs. Cumming
and Steinberg is c/o Leucadia National Corporation, 315 Park Avenue South,
New York, New York 10010.
(g) Includes 500 common shares that may be acquired upon the exercise of
currently exercisable stock options.
(h) Includes 2,500 common shares that may be acquired upon the exercise of
currently exercisable stock options.
(i) Includes (i) 3,676 shares of Common Stock (less than .1%) beneficially
owned by Mr. Steinberg's wife and daughter as to which Mr. Steinberg may be
deemed to be the beneficial owner, (ii) 61,793 shares of Common Stock owned
by a trust for the benefit of Mr. Steinberg's children and (iii) 250 shares
that may be acquired upon the exercise of currently exercisable stock
options. Does not include 2,474,226 shares held by Leucadia which Mr.
Steinberg may be deemed to beneficially own as a result of his beneficial
ownership of Leucadia common shares. See Item 13, "Certain Relationships
and Related Transactions."
(j) Mr. Steinberg disclaims beneficial ownership of the Common Stock held by
the Steinberg Children Trust.
(k) Mr. Cumming is a trustee and President of the foundation and disclaims
beneficial ownership of the Common Stock held by the foundation.
(l) Mr. Steinberg and his wife are trustees of the trust. Mr. Steinberg
disclaims beneficial ownership of the Common Stock held by the trust.
(m) Includes 9,250 shares of Common Stock that may be acquired upon the
exercise of currently exercisable stock options.
As of March 1, 2005, Cede & Co. held of record 4,755,776
shares of Common Stock (approximately 57.6% of the total Common Stock
outstanding). Cede & Co. held such shares as a nominee for broker-dealer members
of The Depository Trust Company, which conducts clearing and settlement
operations for securities transactions involving its members.
29
Equity Compensation Plan Information
The following table summarizes information regarding the
Company's equity compensation plans as of December 31, 2004. 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 20,850 $18.78 493,900
Equity compensation
plans not approved
by security holders -- -- --
----------- --------- ---------
Total 20,850 $ 18.78 493,900
=========== ========= =========
Item 13. Certain Relationships and Related Transactions.
- ------- ----------------------------------------------
Relationship with Leucadia and Various Agreements
In 1995, Leucadia funded the Company's bankruptcy plan by
purchasing common stock and a secured promissory note of the Company, which was
prepaid in full in March 2004. In 1999, Leucadia distributed all of the HomeFed
common stock that it owned to shareholders of Leucadia. In October 2002,
Leucadia again acquired an equity interest in the Company when it received
2,474,226 shares of the Company's common stock, representing approximately 30%
of the Company's outstanding shares, as partial consideration for its sale to
the Company of CDS. For additional information, see Note 2 of Notes to
Consolidated Financial Statements.
As a result of the distribution of HomeFed common stock to
Leucadia's shareholders in 1999, Joseph S. Steinberg, Chairman of the Board of
HomeFed, and Ian M. Cumming, a director of HomeFed, together with their
respective family members (excluding a trust for the benefit of Mr. Steinberg's
children) beneficially own, at March 1, 2005, approximately 9.5% and 9.4%,
respectively, of the Company's outstanding common stock, before consideration of
the common shares owned by Leucadia. In addition, the Cumming foundation, a
private charitable foundation independently established by Mr. Cumming,
beneficially owns 7,329 (less than 0.1%) shares of the Company's outstanding
common stock. Mr. Cumming disclaims beneficial ownership of the Company's common
stock held by the Cumming foundation. Mr. Steinberg is also President and a
director of Leucadia and Mr. Cumming is Chairman of the Board of Leucadia. At
March 1, 2005, Mr. Steinberg and Mr. Cumming beneficially owned (together with
their respective family members but excluding a trust for the benefit of Mr.
Steinberg's children) approximately 11.6% and 11.5%, respectively, of Leucadia's
outstanding common shares. The Cumming foundation also beneficially owns 211,146
(0.2%) of Leucadia outstanding common shares. Mr. Cumming disclaims beneficial
ownership of Leucadia's common shares held by the Cumming foundation. In
addition to their ownership of HomeFed common stock (directly and through family
members), as a result of their beneficial ownership of Leucadia common shares,
Messrs. Cumming and Steinberg each may be deemed to be the beneficial owner of
the shares of HomeFed common stock owned by Leucadia.
In 2003, the Company paid Leucadia approximately $12,900,000
in redemption of Leucadia's preferred capital interest in Otay Land Company and
in full satisfaction of the preferred return related thereto.
The Company is required to obtain infrastructure improvement
bonds primarily for the benefit of the City of San Marcos prior to the beginning
of lot construction work and warranty bonds upon completion of such improvements
in the San Elijo Hills project. These bonds provide funds primarily to the City
in the event the Company is unable or unwilling to complete certain
infrastructure improvements in the San Elijo Hills project. Leucadia has
obtained these bonds on behalf of CDS and its subsidiaries both before and after
the acquisition of CDS by the Company. CDS is responsible for paying all third
party fees related to obtaining the bonds. Should the City or others draw on the
bonds for any reason, one of CDS's subsidiaries would be obligated to reimburse
Leucadia for the amount drawn. As of December 31, 2004, the amount of
outstanding bonds was approximately $28,200,000.
30
Since 1995, Leucadia has been providing administrative and
accounting services to the Company. Under the current administrative services
agreement, Leucadia provides services to the Company for a monthly fee of
$15,000. The cost of services provided by Leucadia during 2004 aggregated
$120,000. Pursuant to this agreement, Leucadia provides the services of Ms.
Corinne A. Maki, the Company's Secretary, in addition to various administrative
functions. Ms. Maki is an officer of subsidiaries of Leucadia.
In December 2004, the term of the administrative services
agreement was extended to December 31, 2005, and thereafter 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.
In March 2001, the Company entered into an unsecured
$3,000,000 line of credit agreement with Leucadia. Loans outstanding under this
line of credit bear interest at 10% per year; in 2004, the Company paid $38,000
in commitment fees and incurred no interest expense. Effective March 1, 2002,
this agreement was amended to extend the maturity to February 28, 2007, although
Leucadia had the right to terminate the line of credit on an annual basis. In
October 2002, the line of credit was increased to $10,000,000 and Leucadia's
ability to terminate the line of credit prior to maturity was removed, unless
the Company is in default. As of March 1, 2005, no amounts were outstanding
under this facility.
The Company rents office space at its corporate headquarters
and furnishings to Leucadia for a monthly rental equal to Leucadia's pro rata
share of the Company's cost for such space and furnishings. In 2004, the rent
paid by Leucadia to the Company totaled $68,000.
Item 14. Principal Accounting Fees and Services.
- ------- --------------------------------------
The Audit Committee has adopted policies and procedures
effective May 2003 for pre-approving all audit and non-audit work performed by
the Company's independent registered public accounting firm,
PricewaterhouseCoopers LLP. Specifically, the Audit Committee has pre-approved
certain specific categories of work and an annual amount for each category. For
additional services or services in an amount above the annual amount that has
been pre-approved, additional authorization from the audit committee is
required. The Audit Committee has delegated to the Committee chair the ability
to pre-approve both general pre-approvals (where no specific, case-by-case
approval is necessary) and specific pre-approvals. Any pre-approval decisions
made by the Committee chair under this delegated authority will be reported to
the full Audit Committee. All requests for services to be provided by
PricewaterhouseCoopers LLP that do not require specific approval by the audit
committee must be submitted to the Controller of the Company, who determines
that such services are in fact within the scope of those services that have been
pre-approved by the Audit Committee. The Controller reports to the Audit
Committee periodically.
The following table sets forth the aggregate fees incurred by
us for the following periods relating to our independent registered public
accounting firm, PricewaterhouseCoopers LLP:
Fiscal Year Ended
December 31,
--------------
2004 2003
---- ----
Audit Fees $ 85,800 $ 87,500
Audit Related Fees 190,000 4,000
--------- --------
$ 275,800 $ 91,500
========= ========
In the table above, in accordance with the SEC's definitions
and rules, "audit fees" are fees paid to PricewaterhouseCoopers LLP for
professional services for the audit of the Company's consolidated financial
statements included in the Company's Form 10-K and review of financial
statements included in the Company's Form 10-Qs, and for services that are
normally provided by the accountants in connection with statutory and regulatory
filings or engagements; and "audit-related fees" are fees for assurance and
related services that are reasonably related to the performance of the audit or
review of our financial statements and in 2004 consist of compliance with
regulatory matters, including the Sarbanes-Oxley Act, and consulting with
respect to technical accounting and disclosure rules. All such services were
approved by the Audit Committee.
31
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, 2004 and 2003 F-3
Consolidated Statements of Operations for the years ended
December 31, 2004, 2003 and 2002 F-4
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
for the years ended December 31, 2004, 2003 and 2002 F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 2004, 2003 and 2002 F-6
Notes to Consolidated Financial Statements F-8
(a)(2) Financial Statement Schedules.
Schedules are omitted because they are not required or are not
applicable or the required information is shown in the financial
statements or notes thereto.
(a)(3) Executive Compensation Plans and Arrangements. See item 15(b) below
for a complete list of exhibits to this Report.
1999 Stock Incentive Plan (filed as Annex A to the Company's Proxy
Statement dated November 22, 1999).
Form of Grant Letter for 1999 Stock Incentive Plan.
See also Item 15(b) below.
(b) Exhibits.
We will furnish any exhibit upon request made to our Corporate
Secretary, 1903 Wright Place, Suite 220, Carlsbad, CA 92008. We charge
$.50 per page to cover expenses of copying and mailing.
3.1 Restated Certificate of Incorporation, as restated July 3, 1995 of the
Company (incorporated by reference to Exhibit 3.1 to the Company's
quarterly report on Form 10-Q for the quarter ended September 30,
1995).
3.2 By-laws of the Company as amended through December 14, 1999
(incorporated by reference to Exhibit 3.2 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 (the "1999
10-K")).
3.3 Amendment to Amended and Restated Bylaws of the Company, dated July 10,
2002 (incorporated by reference to Exhibit 3.3 to the Company's
quarterly report on Form 10-Q for the quarter ended September 30,
2002).
32
3.4 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2002 (incorporated by reference to Exhibit 3.4
to the Company's quarterly report on Form 10-Q for the quarter ended
September 30, 2002).
3.5 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2003 (incorporated by reference to Exhibit 3.5
to the Company's Annual Report on Form 10-K for the year ended December
31, 2003 (the "2003 10-K")).
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 Security Agreement and Stock Pledge by and between HomeFed Corporation
and Leucadia Financial Corporation dated as of July 3, 1995
(incorporated by reference to Exhibit 10.1 to the Company's 2003 10-K).
10.2 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).
10.3 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)).
10.4 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).
10.5 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")).
10.6 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).
10.7 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).
10.8 Third Amendment to Option and Purchase Agreement and Escrow
Instructions, dated as of June 21, 2002, by and between Otay Land
Company, LLC and Lakes Kean Argovitz Resorts - California, LLC
(incorporated by reference to Exhibit 10.27 to the Company's quarterly
report on Form 10-Q for the quarter ended June 30, 2002).
10.9 Stock Purchase Agreement dated as of October 21, 2002, by and between
HomeFed Corporation and Leucadia National Corporation (incorporated by
reference to Exhibit 10.1 to the Company's current report on Form 8-K
dated October 22, 2002).
10.10 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).
10.11 Second Amendment and Restated Loan Agreement dated as of October 9,
2002, by and between HomeFed Corporation and Leucadia Financial
Corporation (incorporated by reference to Exhibit 10.3 to the Company's
current report on Form 8-K dated October 22, 2002).
33
10.12 Second Amendment and Restated Variable Rate Secured Note dated as of
October 9, 2002 (incorporated by reference to Exhibit 10.4 to the
Company's current report on Form 8-K dated October 22, 2002).
10.13 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).
10.14 Amended and Restated Term Note dated as of October 9, 2002
(incorporated by reference to Exhibit 10.6 to the Company's current
report on Form 8-K dated October 22, 2002).
10.15 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")).
10.16 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).
10.17 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).
10.18 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).
10.19 Agreement and Guaranty, dated as of October 1, 2002, between Leucadia
National Corporation and CDS Holding Corporation (incorporated by
reference to Exhibit 10.38 of the 2002 10-K/A).
10.20 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).
10.21 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).
10.22 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).
10.23 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).
10.24 Amendment No. 7 dated as of December 31, 2004 to the Administrative
Services Agreement dated as of March 1, 2000.
10.25 1999 Stock Incentive Plan (incorporated by reference to Annex A to the
Company's Proxy Statement dated November 22, 1999).
10.26 Form of Grant Letter for the 1999 Stock Incentive Plan.
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.
34
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: March 8, 2005 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: March 8, 2005 By /s/ Joseph S. Steinberg
---------------------------------
Joseph S. Steinberg, Chairman
of the Board and Director
Date: March 8, 2005 By /s/ Paul J. Borden
---------------------------------
Paul J. Borden, President and Director
(Principal Executive Officer)
Date: March 8, 2005 By /s/ Erin N. Ruhe
-------------------------------
Erin N. Ruhe, Vice President, Treasurer
and Controller (Principal Financial and
Accounting Officer)
Date: March 8, 2005 By /s/ Patrick D. Bienvenue
---------------------------------
Patrick D. Bienvenue, Director
Date: March 8, 2005 By /s/ Timothy Considine
---------------------------------
Timothy Considine, Director
Date: March 8, 2005 By /s/ Ian M. Cumming
--------------------------------
Ian M. Cumming, Director
Date: March 8, 2005 By /s/ Michael A. Lobatz
------------------------
Michael A. Lobatz, Director
35
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
HomeFed Corporation
We have completed an integrated audit of HomeFed Corporation's 2004 consolidated
financial statements and of its internal control over financial reporting as of
December 31, 2004 and audits of its 2003 and 2002 consolidated financial
statements in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Our opinions, based on our audits, are
presented below.
Consolidated financial statements
- ---------------------------------
In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
HomeFed Corporation and its subsidiaries at December 31, 2004 and 2003, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2004 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, 2004 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,
2004, based on criteria established in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(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.
F-1
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
PricewaterhouseCoopers LLP
Irvine, CA
March 1, 2005
F-2
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2004 and 2003
(Dollars in thousands, except par value)
2004 2003
---- ----
ASSETS
Real estate $ 47,126 $ 37,612
Cash and cash equivalents 34,634 43,503
Restricted cash -- 4,609
Investments-available for sale (aggregate cost of $82,272 and $88,503) 82,249 88,519
Deposits and other assets 3,321 995
Deferred income taxes 44,157 41,772
--------- ---------
TOTAL $ 211,487 $ 217,010
========= =========
LIABILITIES
Note payable to Leucadia Financial Corporation $ -- $ 24,716
Other notes payable 16,620 13,580
Deferred revenue 39,079 53,491
Accounts payable and accrued liabilities 7,752 10,985
Non-refundable option payments 11,669 3,126
Liability for environmental remediation 11,392 10,785
Income taxes payable -- 503
Other liabilities 3,464 10,383
--------- ---------
Total liabilities 89,976 127,569
========= =========
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST 7,760 13,111
--------- ---------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; 25,000,000 shares authorized; 8,260,059 and
8,155,159 shares outstanding 83 82
Additional paid-in capital 381,192 380,545
Deferred compensation pursuant to stock incentive plans -- (4)
Accumulated other comprehensive income (loss) (14) 9
Accumulated deficit (267,510) (304,302)
--------- ---------
Total stockholders' equity 113,751 76,330
--------- ---------
TOTAL $ 211,487 $ 217,010
========= =========
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, 2004, 2003 and 2002
(In thousands, except per share amounts)
2004 2003 2002
---- ---- ----
REVENUES
Sales of real estate $ 77,982 $ 147,028 $ 9,259
Co-op marketing and advertising fees 3,689 1,257 1,942
Development management fee income from San Elijo Hills -- -- 1,610
Income from options on real estate properties -- -- 300
--------- --------- ---------
81,671 148,285 13,111
--------- --------- ---------
EXPENSES
Cost of sales 13,626 35,508 2,815
Provision for environmental remediation 1,320 270 11,160
Interest expense relating to Leucadia Financial Corporation 913 2,676 2,780
General and administrative expenses 10,511 12,001 5,543
Administrative services fees to Leucadia Financial Corporation 120 120 120
--------- --------- ---------
26,490 50,575 22,418
--------- --------- ---------
Income (loss) from operations 55,181 97,710 (9,307)
--------- --------- ---------
Other income, net 102 1,706 311
--------- --------- ---------
Income (loss) before income taxes and minority interest 55,283 99,416 (8,996)
Income tax provision (7,650) (14,179) (379)
--------- --------- ---------
Income (loss) before minority interest 47,633 85,237 (9,375)
Minority interest (10,841) (11,161) (1,711)
--------- --------- ---------
Net income (loss) $ 36,792 $ 74,076 $ (11,086)
========= ========= =========
Basic income (loss) per common share $ 4.46 $ 9.08 $ (1.80)
========= ========= =========
Diluted income (loss) per common share $ 4.45 $ 8.99 $ (1.80)
========= ========= =========
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 (Deficit)
For the years ended December 31, 2004, 2003 and 2002
(Dollars in thousands, except par value)
Deferred
Common Compensation Accumulated Total
Stock Additional Pursuant to Other Stockholders'
$.01 Par Paid-in Stock Incentive Comprehensive Accumulated Equity
Value Capital Plans Income (Loss) Deficit (Deficit)
----- ------- ----- ------------- ------- ---------
Balance, January 1, 2002 $ 57 $ 355,888 $ (276) $ -- $ (367,292) $(11,623)
--------
Comprehensive loss:
Net loss (11,086) (11,086)
--------
Issuance of 2,474,226 shares of
common stock 25 23,975 24,000
Amortization of restricted stock grants 63 63
Amortization related to stock options 295 295
Change in value of performance-based
stock options 500 (500) --
Exercise of options to purchase common
shares 1 1
------ --------- ------- ------ ---------- --------
Balance, December 31, 2002 82 380,364 (418) -- (378,378) 1,650
--------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of tax provision of $7 9 9
Net income 74,076 74,076
--------
Comprehensive income 74,085
--------
Amortization of restricted stock grants 11 11
Amortization related to stock options 583 583
Change in value of performance-based
stock options 180 (180) --
Exercise of options to purchase common
shares 1 1
------ --------- ------- ------ --------- --------
Balance, December 31, 2003 82 380,545 (4) 9 (304,302) 76,330
--------
Comprehensive income:
Net change in unrealized gain (loss)
on investments, net of tax benefit of $16 (23) (23)
Net income 36,792 36,792
--------
Comprehensive income 36,769
--------
Amortization of restricted stock grants 4 4
Exercise of options to purchase common
shares 1 647 648
------ ---------- ------- ------ --------- --------
Balance, December 31, 2004 $ 83 $ 381,192 $ -- $ (14) $(267,510) $113,751
====== ========== ======= ====== ========= ========
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, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 36,792 $ 74,076 $ (11,086)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Minority interest 10,841 11,161 1,711
Provision (benefit) for deferred income taxes (2,369) 2,963 363
Provision for environmental remediation 1,320 270 11,160
Net securities gains (5) -- --
Amortization of deferred compensation pursuant to stock incentive plans 4 594 358
Loss on prepayment of Leucadia Financial Corporation note 1,606 -- --
Amortization of the debt discount on note payable to Leucadia
Financial Corporation 276 1,088 1,120
Other amortization related to investments (939) (369) --
Changes in operating assets and liabilities:
Real estate (8,278) (542) (6,855)
Deposits and other assets (1,104) (242) 169
Note receivable -- 6,566 (6,566)
Other notes payable (683) (1,268) (185)
Deferred revenue (14,412) 20,870 19,792
Accounts payable and accrued liabilities (3,233) 4,662 183
Non-refundable option payments 8,543 1,308 1,818
Liability for environmental remediation (713) (301) (344)
Income taxes receivable/payable (1,861) (2,372) 286
Other liabilities (3,269) 575 4,662
------- --------- ---------
Net cash provided by operating activities 22,516 119,039 16,586
------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (other than short-term) (184,146) (152,132) --
Proceeds from maturities of investments-available for sale 144,385 60,600 --
Proceeds from sales of investments 46,936 3,398 --
Net cash received in acquisition of CDS -- -- 18,979
Decrease (increase) in restricted cash 4,609 (4,336) --
------- --------- ---------
Net cash provided by (used for) investing activities 11,784 (92,470) 18,979
------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payment of Leucadia Financial Corporation note (26,462) -- --
Borrowings under credit agreement with Leucadia Financial Corporation -- -- 2,150
Payments related to credit agreement with Leucadia Financial Corporation -- -- (2,150)
Contribution from minority interest -- 43 --
Distributions to minority interest (16,192) (13,469) (2,524)
Principal payments to trust deed note holders (1,163) (3,242) (895)
Exercise of options to purchase common shares 648 1 1
------- --------- ---------
Net cash used for financing activities (43,169) (16,667) (3,418)
------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (8,869) 9,902 32,147
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 43,503 33,601 1,454
------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $34,634 $ 43,503 $ 33,601
======= ========= =========
(continued)
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows, continued
For the years ended December 31, 2004, 2003 and 2002
(In thousands)
2004 2003 2002
---- ---- ----
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 410 $ 1,588 $ 1,660
======= ========= =========
Cash paid (refunded) for income taxes $ 8,713 $ 10,976 $ (279)
======= ========= =========
NON-CASH INVESTING ACTIVITIES:
Common stock issued for acquisition of CDS $ -- $ -- $ 24,000
======= ========= =========
NON-CASH FINANCING ACTIVITIES:
Liabilities assumed from acquisition of real estate $ -- $ 4,332 $ --
Contribution of real estate from minority interest -- 244 --
------- --------- ---------
$ -- $ 4,576 $ --
======= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-7
HOMEFED CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying consolidated financial
statements include the accounts of HomeFed Corporation (the "Company"), Otay
Land Company, LLC and its wholly-owned subsidiaries ("Otay Land Company"),
HomeFed Communities, Inc., HomeFed Resources Corporation, CDS Holding
Corporation and its majority owned subsidiaries ("CDS") and Rampage Vineyard,
LLC ("Rampage"). The Company is currently engaged, directly and through its
subsidiaries, in the investment in and development of residential real estate
properties in the state of California. All significant intercompany balances and
transactions have been eliminated in consolidation.
The Company's business, real estate development, is highly competitive,
and there are numerous residential real estate developers and development
projects operating in the same geographic area in which the Company operates. In
addition, the residential real estate development industry is subject to
increasing environmental, building, zoning and real estate regulations that are
imposed by various federal, state and local authorities. Timing of the
initiation and completion of development projects depends upon receipt of
necessary authorizations and approvals. Furthermore, changes in prevailing local
circumstances or applicable laws may require additional approvals, or
modifications of approvals previously obtained. Delays could adversely affect
the Company's ability to complete its projects, significantly increase the costs
of doing so or drive potential customers to purchase competitors' products.
Environmental laws may cause the Company to incur substantial compliance,
mitigation and other costs, may restrict or prohibit development in certain
areas and may delay completion of the Company's development projects. Delays
arising from compliance with environmental laws and regulations could adversely
affect the Company's ability to complete its projects, significantly increase
the costs of doing so or cause potential customers to purchase competitors'
products. The Company's business may also be adversely affected by inflation and
is interest-rate sensitive.
Certain amounts for prior periods have been reclassified to be consistent
with the 2004 presentation.
Critical Accounting Estimates - The preparation of financial statements
in conformity with accounting principles generally accepted in the United States
of America requires the Company to make estimates and assumptions that affect
the reported amounts in the financial statements and disclosures of contingent
assets and liabilities. On an on-going basis, the Company evaluates all of these
estimates and assumptions. Actual results could differ from those estimates.
Profit Recognition on Sales of Real Estate - Profit from the sale of real
estate is recognized in full at the time title is conveyed to the buyer if the
profit is determinable, collectibility of the sales price is reasonably assured
(demonstrated by meeting minimum down payment and continuing investment
requirements), and the earnings process is virtually complete, such that the
seller is not obligated to perform significant activities after the sale and has
transferred to the buyer the usual risks and rewards of ownership. If it is
determined that all the conditions for full profit recognition have not been
met, revenue and profit is deferred using the deposit, installment, cost
recovery or percentage of completion method of accounting, as appropriate
depending upon the specific terms of the transaction.
When the Company has an obligation to complete improvements on property
subsequent to the date of sale, it utilizes the percentage of completion method
of accounting to record revenues and cost of sales. Under percentage of
completion accounting, the Company recognizes revenues and cost of sales based
upon the ratio of development costs completed as of the date of sale to an
estimate of total development costs which will ultimately be incurred, including
an estimate for common areas. Unearned revenues resulting from applying the
percentage of completion accounting are reported as deferred revenue in the
liabilities section of the consolidated balance sheets.
Income Taxes - The Company provides for income taxes using the liability
method. The Company records a valuation allowance to reduce its deferred tax
asset to an amount that the Company expects is more likely than not to be
realized. If the Company's estimate of the realizability of its deferred tax
asset changes in the future, an adjustment to the valuation allowance would be
recorded which would either increase or decrease income tax expense in such
period. The valuation allowance is determined after considering all relevant
facts and circumstances, but is significantly influenced by the Company's
projection of taxable income in the future. Since any projection of future
profitability is inherently unreliable, changes in the valuation allowance
should be expected.
F-8
Provision for Environmental Remediation - The Company records
environmental liabilities when it is probable that a liability has been incurred
and the amount or range of the liability is reasonably estimable. During 2002,
the Company recorded a charge of $11,200,000 representing its estimate of the
cost (including legal fees) to implement the most likely remediation alternative
with respect to approximately 30 acres of undeveloped land owned by a subsidiary
of Otay Land Company. The estimated liability was neither discounted nor reduced
for potential claims for recovery from previous owners and users of the land who
may be liable, and may increase or decrease based upon the actual extent and
nature of the remediation required, the type of remedial process approved, the
expenses of the regulatory process, inflation and other items. During 2004, the
Company increased its estimate of remediation costs by approximately $1,300,000,
primarily due to increases in site investigation and remediation costs, and
during 2003 by approximately $300,000, primarily for consulting costs. The
Company may begin remediation during 2005, although it has no obligation to do
so. The Company does not currently know when the funds for remediation
activities will be spent.
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, 2004.
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. Land costs are allocated to lots based on relative fair values prior to
development and 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. Prior to its
acquisition of CDS, the Company recognized fee income for field overhead and
management services from the San Elijo Hills project in its consolidated
statements of operations when contractually earned. Subsequent to the
acquisition of CDS, such amounts are eliminated in consolidation.
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 is
generally not payable and cannot be determined with reasonable certainty until
the builder has completed the sale of a substantial portion of the homes covered
by the lot purchase agreement. The Company's policy is to accrue revenue earned
pursuant to these agreements when amounts are payable pursuant to the lot
purchase agreements, which is classified as sales of real estate.
F-9
Option payments - Option payments received from prospective buyers are
recognized as liabilities until the title of the real estate is transferred, or
in the case of refundable deposits, the prospective buyer decides not to
purchase the real estate and the deposit is returned.
Capitalization of Interest and Real Estate Taxes - Interest and real
estate taxes attributable to land and property construction are capitalized and
added to the cost of those properties while the properties are being actively
developed.
Stock-Based Compensation - Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation", ("SFAS 123"), establishes a
fair value method for accounting for stock-based compensation plans, either
through recognition in the statements of operations or disclosure. As permitted,
the Company applies APB Opinion No. 25 and related Interpretations in accounting
for its plans. Accordingly, no compensation cost has been recognized in the
statements of operations related to employees and directors under its stock
compensation plans. Had compensation cost for the Company's fixed stock options
been recorded in the statements of operations consistent with the provisions of
SFAS 123, the Company's net income (loss) would not have been materially
different from that reported in 2004, 2003 and 2002.
Recently Issued Accounting Standards - In December 2004, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 123R, "Share-Based Payment" ("SFAS 123R"), which replaces SFAS 123
and supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees".
SFAS 123R requires that the cost of all share-based payments to employees,
including grants of employee stock options, be recognized in the financial
statements based on their fair values. That cost will be recognized as an
expense over the vesting period of the award. The pro forma disclosures
previously permitted under SFAS 123 no longer will be an alternative to
financial statement recognition. In addition, the Company will be required to
determine fair value in accordance with SFAS 123R. SFAS 123R is effective for
reporting periods beginning with the first interim or annual period after June
15, 2005, with early adoption encouraged, and requires the application of a
transition methodology for stock options that have not vested as of the date of
adoption. The Company is currently evaluating the impact of SFAS 123R on its
consolidated financial statements.
In December 2004, the FASB issued Statement of Financial Accounting
Standards No. 153, "Exchanges of Nonmonetary Assets--An Amendment of APB Opinion
No. 29" ("SFAS 153"), which is effective for fiscal periods beginning after June
15, 2005. SFAS 153 eliminates the exception from fair value measurement for
nonmonetary exchanges of similar productive assets in paragraph 21(b) of APB
Opinion No. 29, "Accounting for Nonmonetary Transactions," and replaces it with
an exception for exchanges that do not have commercial substance. SFAS 153
specifies that a nonmonetary exchange has commercial substance if the future
cash flows of the entity are expected to change significantly as a result of the
exchange. The adoption of SFAS 153 will not have any material effect on the
consolidated financial statements; however, SFAS 153 could impact the accounting
for future transactions, if any, within its scope.
2. ACQUISITIONS
In October 2002, the Company purchased from Leucadia National Corporation
(together with its subsidiaries, "Leucadia") all of the issued and outstanding
shares of capital stock of CDS which, through its majority-owned indirect
subsidiary, San Elijo Hills Development Company, LLC ("San Elijo"), is the owner
of the San Elijo Hills project, a master-planned community located in the City
of San Marcos, in San Diego County, California. Since August 1998, the Company
has been the development manager for the San Elijo Hills project, for which it
was entitled to participate in the net cash flow of the project through the
payment of a success fee, and receive fees for the field overhead, management
and marketing services it provides, based on the revenues of the project. No
success fee had been paid prior to the Company's acquisition of CDS. The
purchase price of $25,000,000 consisted of $1,000,000 in cash and 2,474,226
shares of the Company's common stock, which represented approximately 30% of the
Company's outstanding common shares. Prior to the acquisition, Leucadia had also
committed to continue to provide to San Elijo project improvement bonds which
are required prior to the commencement of any project development (see Note 12,
below). The results of CDS have been included in the Company's consolidated
results of operations from the date of acquisition.
F-10
In November 2003, the Company purchased Rampage, 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. The amount due
to the seller was reflected in other liabilities in the Company's December 31,
2003 consolidated balance sheet. 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. However, because the seller did not obtain a release
of the mortgage lien, the Company is no longer obligated to pay any further
amounts to the seller, but is now obligated to make all debt service payments to
the mortgagee. The letter of credit that had collateralized the Company's
obligation to the seller expired in December 2004 and the cash collateral was
released. The excess of the liability due to the seller over the remaining face
amount of the mortgage, approximately $300,000, was applied to reduce the
purchase price of the land.
3. INVESTMENTS
At December 31, 2004 and 2003, the Company's investments consisted of
fixed income securities issued by the U.S. government and its agencies, which
were classified as available for sale and recorded at an aggregate fair value of
$82,249,000 and $88,519,000, respectively. At December 31, 2004 and 2003, these
investments had an aggregate amortized cost of $82,272,000 and $88,503,000,
respectively, and the Company had recognized gross unrealized gains (losses) of
$(23,000) and $16,000, respectively, for these securities. All of the Company's
investments mature in one year or less.
4. REAL ESTATE
A summary of real estate carrying values by project is as follows (in
thousands):
December 31,
-----------------------------
2004 2003
--------- ---------
Otay Ranch $ 21,962 $ 21,555
San Elijo Hills 18,811 9,664
Rampage 6,353 6,393
-------- --------
Total $ 47,126 $ 37,612
======== ========
The San Elijo Hills and Otay Ranch projects are considered to be land
under development while the Rampage project is not currently being developed.
Interest totaling $1,236,000 and $1,386,000, related to the San Elijo Hills
project, was incurred and capitalized in real estate during 2004 and 2003,
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, below.
5. INDEBTEDNESS
In March 2004, the Company prepaid in full the $26,462,000 borrowing from
Leucadia Financial Corporation ("LFC"), a subsidiary of Leucadia, using its
available cash. As a result, the Company expensed the remaining unamortized
discount on the note and related deferred costs in the amount of $1,606,000,
which is included in the caption "Other income, net" in the consolidated
statement of operations.
In March 2001, the Company entered into an unsecured $3,000,000 line of
credit agreement with LFC. Loans outstanding under this line of credit bear
interest at 10% per annum. Effective March 1, 2002, this agreement was amended
to extend the maturity to February 28, 2007, although LFC had the right to
terminate the line of credit on an annual basis. On October 9, 2002, the line of
credit was increased from $3,000,000 to $10,000,000 and LFC's ability to
terminate the line of credit prior to maturity was removed, unless the Company
is in default. At December 31, 2004 and 2003, no amounts were outstanding under
this facility. There was no interest expense for the line of credit during the
years ended December 31, 2004 and 2003. Interest expense includes approximately
$72,000 for the line of credit during the year ended December 31, 2002.
F-11
Other notes payable includes a mortgage payable in the amount of
$3,650,000 that is collateralized by the Rampage property. The mortgage bears
interest at 7 1/4%, and requires an annual payment of interest and principal of
$424,000 that fully amortizes the loan by its maturity in January 2018. If the
mortgage is prepaid prior to its maturity, the Company is obligated to pay a
pre-payment penalty that is calculated based on a formula that considers the
principal amount outstanding and the lender's cost of capital. The current
pre-payment penalty would amount to approximately $250,000.
In addition, other notes payable includes non-recourse promissory notes
to trust deed holders that mature on December 31, 2010, are non-interest bearing
and are collateralized by the San Elijo Hills project land. When a portion of
the San Elijo Hills project is sold, a specified amount is required to be paid
to the note holder in order to obtain a release of their security interest in
the land. Such amount is specified in the note agreements and takes into
consideration prior note payments. In addition, depending upon the amount of
payments made to release their security interest for prior sales, the notes may
require minimum annual payments. The minimum annual payments are currently
$269,000 for annual periods subsequent to 2004. 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, 2004, $27,800,000
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, 2004 and 2003
is as follows (in thousands):
2004 2003
---- ----
Beginning balance $ 13,580 $ 16,704
Principal payments (1,163) (3,242)
Interest added to principal 553 118
-------- --------
Ending balance $ 12,970 $ 13,580
======== ========
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, 2004 and 2003 was
9.9% and 9.3%, respectively. Effective January 1, 2005, the effective interest
rate was 6.8%. 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): 2005 - $3,668; 2006 - $6,868 and 2007 - $2,434.
6. MINORITY INTEREST
Through its ownership of CDS, the Company owns 80% of the common stock of
CDS Devco, Inc. ("Devco"), which in turns owns 85% of the common stock of San
Elijo Ranch, Inc., ("SERI"). Pursuant to a stockholders' agreement with the
holder of the minority interest in Devco, the Company is entitled to a 15%
return on all funds advanced to Devco, compounded annually, plus the return of
its capital, prior to the payment of any amounts to the minority shareholder.
Once those amounts are paid, the minority shareholder is entitled to 20% of
future cash flows, if any, distributed to shareholders. Pursuant to a
stockholders' agreement with the holders of the minority interests in SERI,
Devco loans funds to SERI and charges a 12% annual rate. Once this loan is fully
repaid, the minority shareholders of SERI are entitled to 15% of future cash
flows, if any, distributed to shareholders. As of December 31, 2004,
approximately $7,700,000 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, dividends of $71,000,000 were paid by the Company's
subsidiary that owns the San Elijo Hills project, of which $54,800,000 was
ultimately received by the Company and the balance was paid to the minority
interests. As a result, all amounts advanced to the project were repaid and the
preferred return was fully satisfied. Amounts paid to the minority interests
were applied to reduce the minority interest balance on the Company's
consolidated balance sheet.
F-12
7. STOCK INCENTIVE PLANS
Under the Company's 1999 Stock Incentive Plan (the "Plan"), the Company
may grant options, stock appreciation rights and restricted stock to
non-employee directors, certain non-employees and employees up to a maximum
grant of 30,000 shares to any individual in a given taxable year. Pursuant to
the Plan, each director of the Company is automatically granted options to
purchase 1,000 shares on the date on which the annual meeting of stockholders is
held. In August 2004, following shareholder approval, the Plan was amended to,
among other things, increase the number of shares of common stock available for
issuance by 300,000 shares. The Plan provides for the issuance of options and
rights at not less than 100% of the fair market value of the underlying stock at
the date of grant. Options generally become exercisable in five equal
instalments starting one year from the date of grant. No stock appreciation
rights have been granted. During 2000, 25,000 shares of restricted common stock
were issued to eligible participants, subject to certain forfeiture provisions.
In connection with this issuance of restricted stock, the Company recorded
deferred compensation of $188,000 representing the value of stock on the date of
issuance based upon market price. This amount was amortized over the three year
vesting period of the restricted stock. In addition, during 2000, options to
purchase an aggregate of 2,500 shares of Common Stock were granted to
non-employees at an exercise price of $7.50 per share (market price). In
connection with this issuance, the Company recorded deferred compensation of
$18,000 based upon the estimated fair value of these options at the time of
grant, using the modified Black-Scholes model. This amount is being amortized
over the five year vesting period of the options.
A summary of activity with respect to the Company's 1999 Stock Incentive
Plan for employees and directors for 2004, 2003 and 2002 is as follows:
Common Weighted Available
Shares Average Options for Future
Subject to Exercise Exercisable Option
Option Price at Year End Grants
------ ----- ----------- ------
Balance at January 1, 2002 16,675 $ 7.50 3,225 55,800
Granted 600 $ 9.50 ======= =======
Exercised (50) $ 8.15
------
Balance at December 31, 2002 17,225 $ 7.60 6,575 55,200
Granted 600 $ 27.40 ======= =======
Exercised (75) $ 8.60
------
Balance at December 31, 2003 17,750 $ 8.28 10,050 199,400
Granted 6,000 $ 44.50 ======= =======
Exercised (4,900) $ 7.62
Cancelled (500) $ 7.50
------
Balance at December 31, 2004 18,350 $20.32 8,850 493,900
====== ======= =======
The weighted-average fair value of the options granted was $15.10 per
share for 2004, $17.21 per share for 2003 and $6.50 per share for 2002 as
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions: (1) expected volatility of 37.7% for 2004, 86.1% for
2003 and 95.5% for 2002; (2) risk-free interest rate of 3.2% for 2004, 2.3% for
2003 and 3.5% for 2002; (3) expected lives of 4.0 years for all years; and (4)
dividend yield of 0% for all years.
F-13
The following table summarizes information about fixed stock options
outstanding at December 31, 2004.
Options Outstanding Options Exercisable
----------------------------------------------------- ---------------------------
Common Weighted Weighted Common Weighted
Shares Average Average Shares Average
Range of Subject to Remaining Exercise Subject Exercise
Exercise Prices Option Contractual Life Price to Option Price
- --------------- ------ ---------------- ----- --------- -----
$7.00 - $9.50 11,775 1.2 years $ 7.65 8,725 $ 7.61
$27.40 575 3.5 years $ 27.40 125 $ 27.40
$44.50 6,000 4.6 years $ 44.50 -- $ --
In July 2004, the Board of Directors approved the repurchase of up to
500,000 shares of the Company's common stock, representing approximately 6% of
the Company's outstanding stock. Repurchased shares would be available, among
other things, for use in connection with the Company's stock option plans. The
shares may be purchased from time to time, subject to prevailing market
conditions, in the open market, in privately negotiated transactions or
otherwise. Any such purchases may be commenced or suspended at any time without
prior notice. No shares have been purchased to date.
In 2000, under the Company's 2000 Stock Incentive Plan (the "2000 Plan"),
the Company granted to two key employees options to purchase an aggregate of
100,000 shares of common stock at an exercise price of $6.10 per share, the then
current market price per share. No additional options are available to be
granted under the 2000 Plan. These options were subject to forfeiture provisions
if performance criteria were not met by April 27, 2003. Upon the closing of a
sale at Otay Land Company in April 2003, the options were no longer subject to
forfeiture. As a result, the Company expensed the remaining deferred
compensation related to the performance options of approximately $600,000 in
2003. These options were exercised during 2004.
8. SALES OF REAL ESTATE
Revenues from sales of real estate for each of the three years in the
period ended December 31, 2004 is comprised of the following (in thousands):
2004 2003 2002
---- ---- ----
Developed lots at San Elijo Hills project $ 72,175 $ 121,062 $ 4,974
Undeveloped land at the Otay Ranch project 5,807 22,500 4,285
Other -- 3,466 --
-------- --------- -------
Total $ 77,982 $ 147,028 $ 9,259
======== ========= =======
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, 2004, the activity in the deferred
revenue account is as follows (in thousands):
2004 2003 2002
---- ---- ----
Deferred revenue balance at January 1, $ 53,491 $ 32,621 $ --
Amount recorded upon acquisition of CDS -- -- 12,830
Revenue deferred on the date of sale 24,426 56,348 21,179
Deferred revenue recognized in operations (38,838) (35,478) (1,388)
------- ------- ------
Deferred revenue balance at December 31, $ 39,079 $ 53,491 $ 32,621
======== ========= ========
F-14
As of December 31, 2004, the Company estimates that it will spend
approximately $8,900,000 to complete the required improvements, including costs
related to common areas. The Company estimates these improvements will be
substantially complete by the end of 2006.
9. OTHER RESULTS OF OPERATIONS
Other income, net for each of the three years in the period ended
December 31, 2004, consists of the following (in thousands):
2004 2003 2002
---- ---- ----
Interest income $ 1,451 $ 883 $ 96
Proceeds from settlements -- 346 --
Easement fees -- 172 --
Reimbursement for fees and improvements for
previously sold property -- 198 --
Gain (loss) on sale of fixed assets (4) -- 113
Rental income from Leucadia 68 72 21
Loss on prepayment of loan (1,606) -- --
Cable trench fees 180 74 23
Other 13 (39) 58
-------- ------- ------
Total $ 102 $ 1,706 $ 311
======== ======= ======
Proceeds from sales of investments classified as available for sale were
$46,900,000 and $3,400,000 during 2004 and 2003, respectively. Realized gross
gains were not material during 2004 and 2003. The Company did not have any
investments classified as available for sale during 2002.
Advertising costs were $1,172,000, $966,000 and $159,000 for 2004, 2003
and 2002, respectively.
10. INCOME TAXES
The (provision) benefit for income taxes for each of the three years in
the period ended December 31, 2004 was as follows (in thousands):
2004 2003 2002
---- ---- ----
State income taxes - current $ (3,820) $ (8,977) $ (471)
State income taxes - deferred (1,094) -- --
Federal income taxes - current (6,199) (2,239) 455
Federal income taxes - deferred 3,463 (2,963) (363)
--------- ---------- -------
$ (7,650) $ (14,179) $ (379)
========= ========== =======
Current income taxes for all years principally relate to federal
alternative minimum tax and state income tax.
The table below reconciles the expected statutory federal income tax to
the actual income tax (provision) (in thousands):
2004 2003 2002
---- ---- ----
Expected federal income tax $ (19,349) $ (34,796) $ 3,149
State income taxes, net of federal income
tax benefit (3,194) (5,835) (306)
Federal alternative minimum tax refund -- -- 455
Otay Land Company taxable income
allocated to Leucadia -- 429 1,024
(Increase) decrease in valuation allowance 15,000 26,065 (4,701)
Other (107) (42) --
--------- --------- ---------
Actual income tax (provision) $ (7,650) $ (14,179) $ (379)
========= ========= ========
F-15
As a result of an increase in the Company's estimates of future taxable
income that exceeded its earlier estimates, the Company reduced its income tax
valuation allowance to recognize additional benefits from its NOLs and minimum
tax credit carryovers and recorded a credit to its income tax provision of
$15,000,000 and $26,065,000 for the years ended December 31, 2004 and 2003,
respectively. There was no other material activity in the deferred tax valuation
allowance during the years ended December 31, 2004 and 2003.
The Company and its wholly-owned subsidiaries have net operating loss
carryforwards ("NOLs") available for federal income tax purposes of $143,000,000
as of December 31, 2004. The NOLs were generated during 1991 to 1999 and expire
in 2006 to 2019 as follows (in thousands):
Year of Expiration Loss Carryforwards
------------------ ------------------
2006 $ 79,017
2007 17,406
2008 2,347
2009 2,107
Thereafter 42,131
----------
$ 143,008
==========
These 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 will pay federal income tax at a rate of 20% during future periods
(resulting in additional minimum tax credit carryovers), until such time as all
of its NOLs are used or expire and all minimum tax credit carryovers are used.
Alternative minimum tax credit carryovers have no expiration date.
At December 31, 2004 and 2003 the net deferred tax asset consisted of the
following (in thousands):
2004 2003
---- ----
NOL carryforwards $ 50,053 $ 59,013
Land basis 7,247 9,153
Minimum tax credit carryovers 7,350 2,239
Other, net 6,788 13,452
--------- ---------
71,438 83,857
Valuation allowance (27,281) (42,085)
--------- ---------
$ 44,157 $ 41,772
========= =========
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 can be used to reduce its future federal income tax rate once
it has used all of its NOLs. Assuming the Company realizes its projected taxable
income in the future and fully utilizes its NOLs, it will have approximately
$36,000,000 of minimum tax credit carryovers to reduce future federal income
taxes payable. However, the minimum tax credit carryovers 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 $175,000,000 of taxable
income above its current estimate to fully use them. As a result, the Company
has reserved for a substantial portion of this benefit in its valuation
allowance.
F-16
11. EARNINGS PER SHARE
Income (loss) per share of common stock was calculated by dividing net
income (loss) by the sum of the weighted average number of common shares
outstanding and, for diluted earnings (loss) 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 (loss) per
share amounts was 8,248,203, 8,155,111 and 6,168,891 for 2004, 2003 and 2002,
respectively. The number of shares used to calculate diluted earnings (loss) per
share was 8,271,670, 8,238,164 and 6,168,891 for 2004, 2003 and 2002,
respectively. Options to purchase 42,135 weighted average shares for 2002 were
not included in the computation of diluted loss per share as those options were
antidilutive.
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, the Company has recorded
sublease income from Leucadia for a monthly amount equal to Leucadia's share of
the Company's cost for such space and furniture, and reflected such amounts in
other income. Such amount aggregated $68,000 in 2004, $72,000 in 2003 and
$21,000 for the period from October 21, 2002 to December 31, 2002. Rental
expense (net of sublease income) was $174,000, $209,000 and $227,000 for 2004,
2003 and 2002, respectively. During 2004, the lease term was extended until
February 2010 for a slightly lower minimum rent; however, the agreement includes
rent escalation charges over its term.
On January 6, 2005, an owner of adjacent property purported to exercise
options to purchase 600 acres of the Rampage property for approximately
$5,000,000. The party also filed a complaint against the Company and the former
owners of the Rampage property. The complaint alleges the property has been
devalued by approximately $3,000,000 due to poor farming practices since
approximately 2001. The Company is presently evaluating the validity of the
option, the notice of exercise, the claimed option price and the allegations of
the complaint.
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 has
obtained these bonds on behalf of CDS and its subsidiaries both before and after
the acquisition of CDS by the Company. CDS is responsible for paying all third
party fees related to obtaining the bonds. Should the City or others draw on the
bonds for any reason, one of CDS's subsidiaries would be obligated to reimburse
Leucadia for the amount drawn. As of December 31, 2004, the amount of
outstanding bonds was approximately $28,200,000, none of which has been drawn
upon.
Pursuant to an agreement with the City of San Marcos, the Company is
contractually obligated to contribute up to $11,000,000 towards the cost of
improving two off site roads to the San Elijo Hills project. The City of San
Marcos is obligated to fund the balance of the cost of the roads. The Company
expects it will substantially complete its road construction obligation by the
end of 2005.
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 formally in liquidation or under the
supervision of insurance regulators, it is uncertain whether they will have
sufficient assets at such time, if ever, the Company makes a claim under the
policy or, if they are insolvent, whether state insurance guaranty funds would
be available to pay the claim. In May 2004, the Company purchased an excess
policy with another insurance carrier that provides up to $10,000,000 of
coverage for general liability claims, but not professional liability claims,
relating to homes sold through May 31, 2004. The Company continues to
investigate whether insurance coverage for future home sales at the San Elijo
Hills project is available at acceptable prices; however, the Company has not
yet found insurance coverage at an acceptable price.
F-17
The Company is subject to various litigation which arise in the course of
its business. 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. OTHER RELATED PARTY TRANSACTIONS
The Company has entered into the following related party transactions
with Leucadia and LFC not otherwise described in these Notes to Consolidated
Financial Statements.
(a) Development Management Agreement. In August 1998, the Company entered
into a development management agreement with an indirect subsidiary of Leucadia
that owned the San Elijo Hills project. The development management agreement
provided that the Company would act as the development manager with
responsibility for the overall management of the project, including arranging
financing for the project, coordinating marketing and sales activity, and acting
as the construction manager. The development management agreement also provided
that the Company would participate in the net profits of the project through the
payment of a success fee and fee income for field overhead, management and
marketing services based on the revenues derived from the project. As a result
of the acquisition of CDS in October 2002, the Company acquired this indirect
subsidiary of Leucadia. Subsequently, the development management agreement was
amended to eliminate the success fee provisions. While development management
fees have continued to be a source of liquidity for the parent company since the
acquisition of CDS, they are no longer reflected in the consolidated statements
of operations since they are intercompany payments from a subsidiary and are
eliminated in consolidation.
(b) Otay Land Company, LLC. In October 1998, the Company and Leucadia
formed Otay Land Company to purchase approximately 4,850 acres of land, which is
part of a 22,900 acre project located south of San Diego, California, known as
Otay Ranch. Otay Land Company acquired this land for $19,500,000. When Otay Land
Company was formed, Leucadia contributed $10,000,000 as a preferred capital
interest, and the Company contributed all other funds as non-preferred capital.
The Company is the managing member of Otay Land Company. In 2003, Otay Land
Company paid approximately $12,900,000 due to Leucadia to fully redeem the
preferred capital interest and preferred return. All future proceeds from this
project will be distributable solely to the Company.
(c) 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 $120,000 in 2004, 2003 and 2002. In
December 2004, the administrative services agreement was amended to provide for
an annual fee of $180,000, and the term was extended to December 31, 2005, and
thereafter 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.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's material financial instruments include cash and cash
equivalents, certificate of deposits, investments available for sale, and notes
payable. In all cases, the carrying amounts of such financial instruments
approximate their fair values. In cases where quoted market prices are not
available, fair values are based on estimates using present value techniques.
F-18
15. SELECTED QUARTERLY FINANCIAL DATA (unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2004:
- ----
Sales of real estate $ 43,406 $ 12,396 $ 16,366 $ 5,814
========== ========== ========== ========
Co-op marketing and advertising fees $ 186 $ 964 $ 1,290 $ 1,249
========== ========== ========== ========
Cost of sales $ 9,654 $ 502 $ 2,886 $ 584
========== ========== ========== ========
Income from operations (a) $ 30,725 $ 10,251 $ 11,683 $ 2,522
========== ========== ========== ========
Net income (a) (b) $ 13,801 $ 4,778 $ 2,399 $ 15,814
========== ========== ========== ========
Basic income per share (a) (b) $ 1.68 $ 0.58 $ 0.29 $ 1.91
========== ========== ========== ========
Diluted income per share (a) (b) $ 1.67 $ 0.58 $ 0.29 $ 1.91
========== ========== ========== ========
2003:
- ----
Sales of real estate $ 7,016 $ 78,444 $ 29,667 $ 31,901
========== ========== ========== ========
Co-op marketing and advertising fees $ 380 $ 203 $ 249 $ 425
========== ========== ========== ========
Cost of sales $ 2,340 $ 14,792 $ 8,002 $ 10,374
========== ========== ========== ========
Income from operations $ 2,565 $ 60,524 $ 18,184 $ 16,437
========== ========== ========== ========
Net income (c) $ 1,245 $ 33,743 $ 8,325 $ 30,763
========== ========== ========== ========
Basic income per share (c) $ 0.15 $ 4.14 $ 1.02 $ 3.77
========== ========== ========== ========
Diluted income per share (c) $ 0.15 $ 4.10 $ 1.01 $ 3.73
========== ========== ========== ========
(a) During the fourth quarter of 2004, the Company recorded a provision
of $1,320,000 relating to environmental remediation.
(b) The fourth quarter of 2004 reflects a reduction to the income tax
provision of $15,000,000, resulting from a decrease to the valuation allowance
for deferred tax assets, in order to recognize additional tax benefits for the
expected use of NOLs and minimum tax credit carryovers.
(c) The fourth quarter of 2003 reflects a reduction to the income tax
provision of $26,065,000, resulting from a decrease to the valuation allowance
for deferred tax assets, in order to recognize additional tax benefits for the
expected use of NOLs.
F-19