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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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, 1997
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 1-9977
MONTEREY HOMES CORPORATION
(Exact Name of Registrant as specified in its charter)
Maryland
(State or other jurisdiction of incorporation or organization)
86-0611231
(I.R.S. Employer Identification No.)
6613 North Scottsdale Road, Suite 200
Scottsdale, Arizona
(Address of principal executive offices)
85250
(Zip Code)
(602) 998-8700
(Registrant's telephone number, including area code)
----------------------------------------------------
Securities registered pursuant to Section 12(b) of the Act
Common Stock, $.01 par value New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act NONE
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 statements incorporated by reference in Part III of this Form 10-K
or any amendment to this Form 10-K. [_]
At March 16, the aggregate market value of common stock held by
non-affiliates of the Registrant was $57,917,000.
The number of shares outstanding of the Registrant's common stock
on March 16, 1998 was 5,368,738.
DOCUMENTS INCORPORATED BY REFERENCE
Portions from the Registrant's Proxy Statement relating to the
1998 Annual Meeting of Stockholders to be held on June 11, 1998 have been
incorporated by reference into Part III, Items 10, 11, 12 and 13.
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TABLE OF CONTENTS
PAGE NO.
PART I ......................................................................................... 3
Item 1. Business............................................................. 3
Item 2. Properties........................................................... 14
Item 3. Legal Proceedings.................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders.................. 14
PART II ......................................................................................... 14
Item 5. Market for the Registrant's Common Stock
and Related Stockholder Matters...................................... 14
Item 6. Selected Financial Data.............................................. 16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................ 17
Item 8. Financial Statements and Supplementary Data.......................... 24
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure................................................. 41
PART III ........................................................................................ 41
Item 10. Directors and Executive Officers of the Registrant................... 41
Item 11. Executive Compensation............................................... 41
Item 12. Security Ownership of Certain Beneficial Owners and Management....... 41
Item 13. Certain Relationships and Related Transactions....................... 42
PART IV ......................................................................................... 43
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...... 43
SIGNATURES ..................................................................................... 47
2
PART I
Item 1. Business
History of the Company
Monterey Homes Corporation ("Monterey" or the "Company") designs, builds
and sells single family homes in two large markets, Arizona and Texas. The
Company builds move-up and semi-custom luxury homes in the Phoenix and Tucson,
Arizona metropolitan areas, and entry-level and move-up homes in the Dallas/Fort
Worth, Austin and Houston, Texas metropolitan areas. The Company has undergone
significant growth in recent periods and at December 31, 1997, was actively
selling homes in 33 communities in Arizona and Texas. The Company continues to
pursue a strategy of diversifying its product mix and the geographic scope of
its operations.
The Company was originally formed as a real estate investment trust
("REIT") under the name of Homeplex Mortgage Investment Corporation
("Homeplex"), investing in mortgage related assets and selected real estate
loans. On December 31, 1996, the Company acquired through merger the
homebuilding operations of various entities under the Monterey Homes name (the
"Merger"), and essentially discontinued its mortgage-related operations, changed
its name to Monterey Homes Corporation and instituted homebuilding as the
business focus. (All per share amounts herein have been adjusted for a
one-for-three stock split effected as part of the Merger.) As part of a
strategy to diversify its operations, on July 1, 1997, the Company combined with
the homebuilding operations (the "Legacy Combination") of several entities
operating under the name Legacy Homes ("Legacy"). Legacy has been operating in
Texas markets since 1988, and designs, builds and sells entry-level and move-up
homes.
As a result of losses from operations by the Company during its
operation as a REIT prior to December 31, 1996, the Company had net operating
loss carryforwards for federal income tax purposes of approximately $43 million
at December 31, 1997. Accordingly, the Company currently pays limited income
taxes.
This Annual Report on Form 10-K contains forward-looking statements.
Additional written or oral forward-looking statements may be made by the Company
from time to time in filings with the Securities and Exchange Commission or
otherwise. The words "believe", "expect," "anticipate," and "project," and
similar expressions identify forward-looking statements, which speak only as of
the date the statement was made. Such forward-looking statements are within the
meaning of that term in Section 27A of the Securities Act of 1933, as amended,
and Section 21E of the Securities Exchange Act of 1934, as amended. Such
statements may include, but not be limited to, projections of revenues, income
or loss, home sales, housing permits, backlog, inventory, capital expenditures,
plans for future operations, financing needs or plans, the impact of inflation
and plans relating to products or services of the Company, as well as
assumptions relating to the foregoing. The Company undertakes no obligation to
publicly update or revise any forward-looking statements, whether as a result of
new information, future events or otherwise.
Forward-looking statements are inherently subject to risks and
uncertainties, some of which cannot be predicted or quantified. Future events
and actual results could differ materially from those set forth in, contemplated
by, or underlying the forward-looking statements. Statements in this Annual
Report, including the Notes to Consolidated Financial Statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," describe factors, among others, that could contribute to or cause
such differences. Additional factors that could cause actual results to differ
materially from those expressed in such forward-looking statements are set forth
in "Business" and "Market for the Registrant's Common Stock and Related
Stockholder Matters" in this Annual Report.
3
Industry
The homebuilding industry is highly competitive and extremely
fragmented, and is greatly affected by a number of factors, on both a national
and regional level. Among the most vital factors on a national level are
interest rates and the influence of the Federal Reserve Board on interest rates.
The homebuilding industry's sensitivity to interest rate fluctuations is
two-pronged: an increase or decrease in interest rates affects (i) the
homebuilding company directly in connection with its cost of borrowed funds for
land and project development and working capital and (ii) the home buyers'
ability and desire to obtain long-term mortgages at rates favorable enough to
service a long-term mortgage obligation. The Company believes that the
availability of less expensive mortgage financing vehicles such as variable rate
mortgage loans have encouraged potential home buyers to be more willing to
purchase a new home now and refinance at a later date.
Business Strategy
The Company seeks to distinguish itself from other production
homebuilders through a business strategy focusing on the following elements:
Superior Design and Quality. The Company seeks to maximize customer
satisfaction by offering homes that, within their market segment, are built with
quality materials and craftsmanship, exhibit distinctive design features, and
are situated in premium locations. In Arizona, its competitive edge in the
selling process focuses on the home's features, design and available custom
options. In Texas, the competitive advantage is a focus on design and quality of
its entry-level and move-up homes which are offered at a price that reflects the
production efficiencies of a high volume tract builder. The Company believes
that its homes generally offer higher quality and more singular designs within
their defined price range or category than those built by its competitors.
Product Breadth. The Company offers new homes for a wide variety of
consumers. In Arizona, the Company addresses the luxury and move-up homebuyers'
markets. The luxury market segment is characterized by unique communities and
distinctive luxury homes. The Company's 1996 expansion into the move-up buyer
segment of the Arizona market reflects its desire to increase its share of the
overall housing market in the Phoenix and Tucson metropolitan areas. In Texas,
the Company focuses on entry-level and move-up homebuyers markets.
Highest Level of Service. The Company strives for the highest level of
customer satisfaction through the use of its customer care departments which
deal with any questions or warranty matters a buyer may have. In the
semi-custom, luxury market, along with customer care, the Company attempts to
involve the buyer in every phase of the building process through a series of
conferences with the sales staff, project managers, and construction
superintendents. This procedure is designed to give the high-end buyer an
opportunity to add custom design features and monitor the development of the
home, creating a sense of participation and control over the end product.
Conservative Land Acquisition Policy. The Company seeks to maximize its
return on capital employed by pursuing a conservative land acquisition policy.
Land is generally purchased subject to complete entitlement, including zoning
and utilities services, with a focus on development sites which the Company
expects will have less than a three-year lot inventory. Moreover, lots are often
controlled on a non-recourse, rolling option basis where the Company has the
right, but not the obligation, to buy lots at predetermined prices based on a
takedown schedule which reflects anticipated home closings. To date, the Company
has not speculated in raw land held for investment.
Penetration of New Markets. Depending on existing market conditions, the
Company may explore expansion opportunities in other parts of the country,
targeting its market niches in areas where it perceives an ability to exploit a
competitive advantage. Expansion may be effected through acquisitions of other
existing homebuilders or through internal growth.
4
Markets and Products
Overview. The Company's operations primarily serve the Phoenix and
Tucson, Arizona, and the Dallas/Fort Worth, Austin and Houston, Texas
metropolitan areas. The Company believes that these areas represent attractive
homebuilding markets with opportunities for long-term growth. The Company also
believes that its operations in certain markets, such as Phoenix and Dallas/Fort
Worth, are well established and that it has developed a reputation for building
quality homes with distinctive designs within the market segments served in
these communities.
Arizona Markets
In its Arizona markets, the Company's semi-custom, luxury homes are
single story, two to five bedroom homes, ranging in base price from
approximately $240,000 to over $500,000. The homes vary in size from
approximately 2,500 square feet to 4,500 square feet and are constructed on lots
ranging from 5,500 square feet to one acre. The Company also builds
single-family, move-up homes on subdivided lots. These are one and two story
detached homes, with two to five bedrooms, ranging in base price from
approximately $120,000 to over $200,000. The homes range from 1,400 square feet
to 3,500 square feet and are constructed on lots ranging from 6,500 square feet
to 10,000 square feet.
During 1997, the Company closed 284 homes in Arizona with an average
sales price of $344,800. At December 31, 1997, the Company had a total of 168
home purchase contracts in backlog totaling $56.9 million, with an average price
of $339,000. In 1996, the average sales price for all homes closed in Arizona
was $282,800, and the Company had a backlog of 120 home purchase contracts
totaling $42.7 million at December 31. The average price of homes in the 1996
backlog was $355,500.
Phoenix, Arizona. The Arizona Department of Economic Security estimates
that approximately 153,000 jobs will be created throughout Arizona in 1997 and
1998, resulting in gains of 4.6% and 3.3%, respectively. Nearly 80% of these new
jobs are expected to be in the Phoenix area.
From 1996 to 1997, permits for single-family residential units in the
Phoenix metropolitan area increased 7% from 29,609 to 31,715. Although
single-family housing permits in the Phoenix metropolitan area were at record
levels in 1997, real estate analysts are predicting that new home sales in this
area may be slightly lower in 1998. Any slowing in new home sales could have an
adverse affect on the Company's operating results. The Company is actively
selling homes in seven communities in the Phoenix area.
The Company derives substantial revenues from sales of homes in the
Scottsdale area. Scottsdale is a relatively affluent city within metropolitan
Phoenix, and has developed detailed master planning and zoning regulations.
Scottsdale has typically appealed to the type of higher-income buyer which the
Company generally targets in this market, and due to the strong market in this
area, the availability of land has decreased and the cost of such land has
increased. There can be no assurance that the Company will be able to continue
to acquire property in the Scottsdale area on terms that are favorable to the
Company. The inability to acquire land on favorable terms could have a material
adverse effect on the Company's business and operating results.
Tucson, Arizona. The Company began offering homes for sale in Tucson in
April 1996, and is actively selling in three communities in that area. Tucson
also has experienced growth over the last five years. Annual building permits
issued for single-family residential units in Tucson increased moderately from
approximately 5,200 in 1996 to approximately 5,400 in 1997, a 4% increase. Real
estate analysts are predicting that new home sales in the Tucson metropolitan
area will remain relatively flat in 1998.
The following table presents information relating to the current
communities in the Scottsdale and Tucson areas served by the Company for and as
of December 31, 1997:
5
Base Price
Number of Number of Number of Homes in Home Sites(1) Range(2)
Home Sites Homes Sold Homes Closed Backlog Remaining (in thousands)
--------------- --------------- --------------- --------------- ---------------
Phoenix Area
Semi-custom, luxury 871 392 284 108 479 $240-$525
Move-up 571 169 146 23 402 $166-$236
--------------- --------------- --------------- --------------- ---------------
Total 1,442 561 430 131 881
--------------- --------------- --------------- --------------- ---------------
Tucson Area
Semi-custom, luxury 148 63 40 23 85 $245-$385
Move-up 331 80 66 14 251 $124-$219
--------------- --------------- --------------- --------------- ---------------
Total 479 143 106 37 336
--------------- --------------- --------------- --------------- ---------------
Total Arizona 1,921 704 536 168 1,217
=============== =============== =============== =============== ===============
(1) "Home Sites Remaining" is the number of homes that could be built both
on the remaining lots available for sale and land to be developed into
lots as estimated by the Company.
(2) "Base Price Range" is the current average base sales price of homes
offered for sale.
Texas Markets
The Company operates in the Texas market under the Legacy Homes name and
is value focused, as it produces homes in volume that are efficient to build,
and offers buyers some degree of design discretion and a number of optional
features and upgrades. Typical of its Texas products are one and two story
homes, generally with attached garages, brick exteriors, three to five bedrooms,
and open kitchen/family rooms. In its Texas markets, the Company usually
purchases finished lots in newly-developing and growing areas, though
occasionally, the Company will acquire undeveloped land and develop homesites
for its own use.
From July 1, 1997, the date of the Legacy Combination, the Texas
division closed a total of 360 homes with an average sales price of $143,000. At
December 31, 1997, the Texas division had a total of 304 home purchase contracts
in backlog totaling $42.0 million, with an average sales price of $138,200,
while in Texas at December 31, 1996, there were 197 home purchase contracts in
backlog totaling $28.6 million, with an average sales price of $145,000.
Dallas/Fort Worth, Texas. With approximately 72,000 new jobs created in
Dallas in 1997, this market continues to enjoy significant job growth (4.14%).
Annual closings reached their highest level since the mid-1980's, with 16,740
new homes. Fort Worth's annual job growth at 25,600 represents a 3.6% rate,
higher than the average of the last four years. Housing activity in the Fort
Worth market reflected low inventory levels, with an increase in average starts
to almost 7,000, and a drop in closings to 6,760. Dallas/Fort Worth represents
the Company's greatest amount of activity in the Texas market. The Company is
actively selling in 16 different communities, targeted to both first time buyers
with homes starting at approximately 1,600 square feet and to move-up buyers
with homes up to 3,000 square feet. In this area, homes for first time buyers
are priced from $95,000 to $115,000 and those for the move-up market are priced
from $120,000 to $180,000.
Austin, Texas. According to the Texas Employment Commission, new jobs
created in Austin in 1997 were approximately 11,000, which is about the same as
the prior year, and is down from the 6% - 7% increases seen each year from 1992
to 1995. Annual 1997 starts of 7,270 represented a slight drop by 7.9% from
1996; a slight decrease (0.8%) in closings also occurred. Recognizing the
decrease in average sales price, the Company in 1997 re-positioned its product
to reflect the changing demand for lower priced homes by introducing a new
product line from approximately 1,400 to 2,500 square feet to take advantage of
opportunities in the $90,000 to $120,000 price range. The Company is actively
selling in five communities in the Austin area.
6
Houston, Texas. The Texas Workforce Commission statistics for calendar
1997 show a net gain of approximately 66,000 new jobs in Houston. This job
growth is estimated to have created approximately 36,000 new households
resulting in single family starts for 1997 at a 14 year high of 18,958. Closings
for the same period reached 16,553 homes. The Company entered the Houston market
by opening its first community late in 1997. A second community is in the
planning/pre-sell stages. The Company builds homes for affluent first-time and
move-up buyers in the desirable Northwest area, ranging from approximately 1,700
to 3,100 square feet and priced in the $110,000 to the $210,000 range. Houston's
job growth, low unemployment rate of 5% and growth in local population and
households may continue to fuel a strong demand for housing.
The following table presents information relating to the current
communities in the Texas markets served by the Company for and as of December
31, 1997:
Base Price
Number of Number of Number of Homes in Home Sites(1) Range(2)
Home Sites Homes Sold Homes Closed Backlog Remaining (in thousands)
---------- ---------- ------------ ------- --------- --------------
Dallas/Ft. Worth Area
Move-up 1,907 1,136 942 194 771 $120-$180
Entry-level 564 308 244 64 256 $ 95-$115
--------------- --------------- --------------- --------------- ---------------
Total 2,471 1,444 1,186 258 1,027
--------------- --------------- --------------- --------------- ---------------
Austin Area
Move-up 467 340 324 16 127 $130-$190
Entry-level 111 20 4 16 91 $100-$120
--------------- --------------- --------------- --------------- ---------------
Total 578 360 328 32 218
--------------- --------------- --------------- --------------- ---------------
Houston Area
Move-up 76 15 1 14 61 $115-$210
--------------- --------------- --------------- --------------- ---------------
Total Texas 3,125 1,819 1,515 304 1,306
=============== =============== =============== =============== ===============
(1) "Home Sites Remaining" is the number of homes that could be built both
on the remaining lots available for sale and land to be developed into
lots as estimated by the Company.
(2) "Base Price Range" is the current average base sales price of homes
offered for sale.
Land Acquisition and Development
Most of the land acquired by the Company is purchased only after
necessary entitlements have been obtained so that the Company has certain rights
to begin development or construction as market conditions dictate. The term
"entitlements" refers to development agreements, tentative maps or recorded
plats, depending on the jurisdiction within which the land is located.
Entitlements generally give the developer the right to obtain building permits
upon compliance with conditions that are usually within the developer's control.
After entitlements are obtained, the Company is still required to secure a
variety of other governmental approvals and permits during development. The
process of obtaining such approvals and permits can substantially delay the
development process so, in certain situations in the future, the Company may
consider purchasing unentitled property where it perceives an opportunity to
build in a manner consistent with its business strategy.
The Company selects land for development based upon a variety of
factors, including (i) internal and external demographic and marketing studies;
(ii) suitability of the projects, which generally are developments with fewer
than 150 lots; (iii) suitability for development within a one to three year time
period from the beginning of the development process to the delivery of the last
home; (iv) financial review as to the feasibility of the proposed project,
including projected profit margins, return on capital employed, and the capital
payback period; (v) the ability to secure governmental approvals and
entitlements; (vi) results of environmental and legal due diligence; (vii)
proximity to local traffic corridors and amenities; and (viii)
7
management's judgment as to the real estate market, economic trends, and
experience in a particular market. The Company may consider purchasing larger
properties consisting of 200 to 500 lots or more if it deems the situation to
have an attractive profit potential and acceptable risk limitations.
The Company acquires land through purchases and rolling option
contracts. Purchases are financed through traditional bank financing or through
working capital. The Company generally utilizes rolling option contracts that
are non-recourse and require non-refundable deposits. In Texas, the Company
acquires land almost exclusively through rolling option contracts.
Once land is acquired, the Company undertakes, where required,
development activities through contractual agreements with subcontractors that
include site planning and engineering, as well as constructing road, sewer,
water, utilities, drainage, recreation facilities and other refinements. The
Company often builds homes in master planned communities with home sites that
are along or in close proximity to a major amenity, such as a golf course.
The Company strives to develop a design and marketing concept for each
of its projects, which includes determination of size, style and price range of
the homes, street layout, size and layout of individual lots, and overall
community design. The product line offered in a particular project depends upon
many factors, including the housing generally available in the area, the need of
a particular market, and the Company's cost of lots in the project.
The Company has occasionally used partnerships or joint ventures to
purchase and develop land where such arrangements were necessary to acquire the
property or appeared to be otherwise economically advantageous.
The following table sets forth the Company's unclosed land inventory as of
December 31, 1997.
Land Under Contract
Land Owned or Option
---------- ---------
Lots Under Lots Under
Finished Development Finished Development
Projects Lots (estimate) Lots (estimate) Total
-------- ---- ---------- ---- ---------- -----
ARIZONA:
Phoenix Area
- ------------
Semi-custom, luxury 79 211 24 273 587
Move-up 41 -- 32 352 425
---------------- ---------------- ---------------- ---------------- ----------------
Total 120 211 56 625 1,012
---------------- ---------------- ---------------- ---------------- ----------------
Tucson Area
- -----------
Semi-custom, luxury 42 -- 32 34 108
Move-up 147 -- -- 118 265
---------------- ---------------- ---------------- ---------------- ----------------
Total 189 -- 32 152 373
---------------- ---------------- ---------------- ---------------- ----------------
Total Arizona 309 211 88 777 1,385
---------------- ---------------- ---------------- ---------------- ----------------
TEXAS:
Dallas/Ft. Worth Area
- ---------------------
Entry-level 91 91 167 30 379
Move-up 66 190 297 353 906
---------------- ---------------- ---------------- ---------------- ----------------
Total 157 281 464 383 1,285
---------------- ---------------- ---------------- ---------------- ----------------
Austin Area
- -----------
Entry-level 23 -- 152 -- 175
Move-up 11 -- 37 27 75
---------------- ---------------- ---------------- ---------------- ----------------
8
Total 34 -- 189 27 250
---------------- ---------------- ---------------- ---------------- ----------------
Houston Area
- ------------
Move-up -- -- 75 -- 75
---------------- ---------------- ---------------- ---------------- ----------------
Total Texas 191 281 728 410 1,610
---------------- ---------------- ---------------- ---------------- ----------------
TOTAL COMPANY 500 492 816 1,187 2,995
================ ================ ================ ================ ================
Construction
The Company acts as the general contractor for the construction of its
projects. Subcontractors typically are retained on a project-by-project basis in
Arizona and on a geographic area basis in Texas, to complete construction at a
fixed price. Agreements with subcontractors and materials suppliers are
generally entered into after competitive bidding on an individual basis. The
Company obtains information from prospective subcontractors and suppliers with
respect to their financial condition and ability to perform their agreements
prior to commencement of the formal bidding process. From time to time, the
Company enters into longer term contracts with subcontractors and suppliers if
management believes that more favorable terms can be secured. Subcontractors are
supervised by the Company's project managers and field superintendents, who
coordinate the activities of subcontractors and suppliers, subject the work to
quality and cost controls, and assure compliance with zoning and building codes.
The Company specifies that quality, durable materials be used in
constructing its homes. The Company does not maintain significant inventories of
construction materials, except for work in process materials for homes under
construction. When possible, the Company negotiates price and volume discounts
with manufacturers and suppliers on behalf of subcontractors to take advantage
of its volume of production. Generally, access to the Company's principal
subcontracting trades, materials and supplies continue to be readily available
in each of its markets; however, prices for these goods and services may
fluctuate due to various factors, including supply and demand shortages which
may be beyond the control of the Company or its vendors. The Company believes
that its relations with suppliers and subcontractors are good.
The Company generally clusters the homes sold within a project, which
management believes creates efficiencies in land development and construction,
and improves customer satisfaction by reducing the number of vacant lots
surrounding a completed home. Typically, a home in Arizona is completed by the
Company within four to eight months from commencement of construction, and
within three to four months of commencement of construction in Texas, although
schedules may vary depending on the availability of labor, materials and
supplies, product type, location and weather. The Company strives to design
homes which promote efficient use of space and materials, and to minimize
construction costs and time.
The Company generally provides a one-year limited warranty on
workmanship and building material with each of its homes. The Company's
subcontractors generally provide an indemnity and a certificate of insurance
prior to receiving payments for their work and, therefore, claims relating to
workmanship and materials are usually the primary responsibility of the
Company's subcontractors. The Company currently reserves $600 per home built in
Arizona and 1/2 of one percent of a home's sale price in Texas for warranty
expense. To date, these reserves have been sufficient to cover warranty repair.
Marketing and Sales
The Company believes that it has an established reputation for
developing high quality homes, which helps generate interest in each new
project. In addition, the Company uses advertising and other promotional
activities, including magazine and newspaper advertisements, brochures, direct
mail, and the placement of strategically located sign boards in the immediate
areas of its developments.
The Company uses furnished model homes as a tool in demonstrating the
competitive advantages of its home designs and features to prospective home
buyers. The Company generally employs or contracts
9
with interior designers who are responsible for creating an attractive model
home for each product line within a project designed to appeal to the
preferences of potential home buyers. The Company generally builds between one
and four model homes for each active community, depending upon the number of
homes to be built within the community and the product to be offered. At
December 31, 1997, the Company owned two model homes in Arizona, with 13 model
homes under construction. In Texas, the Company owned 22 model homes and had
three model homes under construction at December 31, 1997. The Company's Arizona
division attempts to sell its model homes and lease them back from purchasers
who own the models for investment purposes or who do not intend to live in the
home immediately. At December 31, 1997, Monterey had sold and was leasing back
15 model homes at a total monthly lease amount of $43,600.
In its Arizona markets, the Company tailors its product offerings,
including size, style, amenities and price, to attract higher income home
buyers. In these markets, the Company offers a broad array of options and
distinctive design features, and provides home buyers with the opportunity to
customize many aspects of their new home.
The Company's homes are generally sold by full-time, commissioned sales
employees who typically work from a sales office located in the model homes for
each project. The Company's goal is to ensure that its sales force has extensive
knowledge of the Company's operating policies and housing products. To achieve
this goal, all sales personnel are trained and attend periodic meetings to be
updated on sales techniques, competitive products in the area, the availability
of financing, construction schedules, marketing and advertising plans, and the
available product lines, pricing, options, and warranties offered by the
Company. The Company also requires its sales personnel to be licensed real
estate agents where required by law. Further, the Company utilizes independent
brokers to sell its homes and generally pays a sales commission on the base
price of the home.
From time to time, the Company offers various sales incentives, such as
landscaping and certain interior home improvements, in order to attract buyers.
The use and type of incentives depends largely on prevailing economic and
competitive market conditions.
Backlog
A significant majority of the homes sold by the Company are made
pursuant to standard sales contracts entered into prior to commencement of
construction. Such sales contracts require substantial cash deposits and are
usually subject to certain contingencies such as the buyer's ability to qualify
for financing. Homes covered by such sales contracts but not yet closed are
considered as "backlog". The Company does not recognize revenue on homes covered
by such contracts until sales are closed and ownership has been legally
transferred to the buyer. The Company generally constructs one or two homes per
project in advance of obtaining a sales contract, though such homes are not
included in backlog until they are subject to a sales contract. The Company
believes it will deliver significantly all homes in backlog at December 31, 1997
to customers during 1998.
The Company's backlog in number of units increased to 472 at December
31, 1997 from 120 at December 31, 1996. The dollar value of such backlog
increased to $99.0 million at December 31, 1997 from $42.7 million at December
31, 1996. These increases in backlog are due primarily to the addition of the
Texas operations, along with strong sales in 1997.
Customer Financing
The Company seeks to assist homebuyers who require financing in
obtaining loans from unaffiliated mortgage lenders offering qualified buyers a
variety of financing options. The Company provides mortgage banking services to
its customers in its Texas markets through a related mortgage lending company,
Texas Home Mortgage Corporation. The Company may pay a portion of the closing
costs and discount mortgage points to assist home buyers with financing. Since
many homebuyers utilize long-term mortgage financing
10
to purchase a home, adverse economic conditions, increases in unemployment, and
high mortgage interest rates may deter or reduce the number of potential
homebuyers.
Customer Relations and Quality Control
Management believes that strong customer relations and an adherence to
stringent quality control standards are fundamental to continued success. The
Company believes that its commitment to customer relations and quality control
have significantly contributed to its reputation as a high quality builder.
Generally, for each development, representatives of the Company, who may
be a project manager or project superintendent, and a customer relations
representative, oversee compliance with the Company's quality control standards.
These representatives allocate responsibility for (i) overseeing home
construction; (ii) overseeing performance by subcontractors and suppliers; (iii)
reviewing the progress of each home and conducting formal inspections as
specific stages of construction are completed; and (iv) regularly updating each
buyer on the progress of his or her home.
Competition and Market Factors
The development and sale of residential property is a highly competitive
and fragmented industry. The Company competes for residential sales in each of
its markets with national, regional, and local developers and homebuilders,
resales of existing homes, and to a lesser extent, condominiums and available
rental housing. Some homebuilders with whom the Company competes have
significantly greater financial resources and/or lower costs than the Company.
Competition among both small and large residential homebuilders is based on a
number of interrelated factors, including location, reputation, amenities,
design, quality and price. The Company believes that it compares favorably to
other homebuilders in the markets in which it operates due primarily to (i) its
experience within its specific geographic markets which allows it to develop and
offer new products to potential homebuyers which reflect and adapt to changing
market conditions; (ii) its ability, from a capital and resource perspective, to
respond to market conditions and to exploit opportunities to acquire land upon
favorable terms; and (iii) its reputation for outstanding service and quality
products.
The homebuilding industry is cyclical and affected by consumer
confidence levels, prevailing economic conditions in general and by job
availability and interest rates in particular. A variety of other factors affect
the homebuilding industry and demand for new homes, including changes in costs
associated with home ownership such as increases in property taxes and energy
costs, changes in consumer preferences, demographic trends, the availability of
and changes in mortgage financing programs, and the availability and cost of
land and building materials. Real estate analysts are predicting that new home
sales in the Phoenix metropolitan area may slow in 1998 and that sales in the
Tucson metropolitan area will remain relatively flat. In the Dallas/ Fort Worth,
Houston, and Austin metropolitan areas, predictions are that new home sales will
remain relatively flat or show a moderate increase. Any slowing in new home
sales would increase competition among homebuilders in these areas. There can be
no assurance that the Company will be able to compete successfully against other
homebuilders in its current markets in a more competitive business environment
that would result from such a slowdown in new home sales or that such increased
competition will not have a material adverse affect on the Company's business
and operating results.
Government Regulations and Environmental Matters
Most of the Company's land is purchased with entitlements, providing for
zoning and utility service to project sites and giving it the right to obtain
building permits and begin construction almost immediately upon compliance with
specified conditions, which generally are within the Company's control. The
length of time necessary to obtain such approvals and permits affects the
carrying costs of unimproved property acquired for the purpose of development
and construction. In addition, the continued effectiveness of permits already
granted is subject to factors such as changes in policies, rules and
regulations, and their interpretation and application. To date, the government
approval processes discussed above have not had a
11
material adverse effect on the development activities of the Company, though
there can be no assurance that these and other restrictions will not adversely
affect the Company in the future.
Because most of the Company's land is entitled, construction moratoriums
generally would only adversely affect the Company if they arose from health,
safety, and welfare issues, such as insufficient water or sewage facilities.
Local and state governments also have broad discretion regarding the imposition
of development fees for projects in their jurisdiction. These fees are normally
established when the Company receives recorded maps and building permits,
however as the Company expands, it may also become increasingly subject to
periodic delays or may be precluded entirely from developing communities due to
building moratoriums, "slow growth" initiatives, or building permit allocation
ordinances which could be implemented in the future in the states and markets in
which the Company may then operate.
The Company is also subject to a variety of local, state, and federal
statutes, ordinances, rules, and regulations concerning the protection of health
and the environment. In the Scottsdale market, the Company is subject to several
environmentally sensitive land ordinances which mandate open space areas with
public elements in housing developments. The Company must also comply with flood
plain restrictions. These and similar laws may result in delays, cause
substantial compliance and other costs, and prohibit or severely restrict
development in certain environmentally sensitive regions or areas. To date,
compliance with such ordinances has not materially affected the Company's
operations, though no assurance can be given that such a material adverse effect
will not occur in the future.
The Company generally will condition its obligation to purchase property
on, among other things, an environmental review of the land. However, there can
be no assurance that the Company will not incur material liabilities relating to
the removal of toxic wastes or other environmental matters affecting land
currently or previously owned by the Company. To date, the Company has not
incurred any liability relating to the removal of toxic wastes or other
environmental matters and to its knowledge has not acquired any land with
environmental problems.
Bonds and Other Obligations
The Company is generally not required, in connection with the
development of its projects, to obtain letters of credit and performance,
maintenance, and other bonds in support of its related obligations with respect
to such development. Such bonds are usually provided by subcontractors.
Mortgage Assets Acquired Prior to Merger
Prior to the Merger, the Company acquired a number of mortgage assets,
consisting of mortgage interests (commonly known as "residuals") and mortgage
instruments. As of December 31, 1997, the Company owned mortgage interests with
respect to six separate series of mortgage securities with a net amortized cost
balance of approximately $1,421,800. This cost represents the aggregate purchase
price paid for such mortgage interests less the amount of distributions on such
mortgage interests received by the Company representing a return of investment.
Subsequent to year-end, the Company entered into an agreement to sell
its remaining residual interests for $6.6 million during the first and second
quarters of 1998 for a gain of approximately $5.2 million.
Employees and Subcontractors
At December 31, 1997, the Company employed 180 persons, including 49 in
management and administration, 42 in sales and marketing, and 89 involved in
construction operations. The employees are not unionized, and the Company
believes that its employee relations are good. The Company acts solely as a
general contractor and all construction operations are conducted through project
managers and field superintendents who manage third party subcontractors. The
Company utilizes independent contractors for
12
construction, architectural and advertising services, and believes that its
relations with subcontractors and independent contractors are good.
NOL Carryforward
At December 31, 1997, the Company had a federal income tax net operating
loss carryforward (the "NOL Carryforward") of approximately $43 million, which
expires at various times beginning in 2007 and ending in 2009. It is anticipated
that future income taxes paid by the Company will be reduced during the period
the NOL Carryforward is available and will consist primarily of state income
taxes (since utilization of the Company's state net operating loss may be
significantly limited) and the federal alternative minimum tax.
The ability of the Company to use the NOL Carryforward to offset future
taxable income would be substantially limited under Section 382 of the Code if
an "ownership change", within the meaning of Section 382 of the Code, has
occurred or occurs with respect to the Company before expiration of the NOL
Carryforward. The Company believes that (i) there was not an "ownership change"
of the Company prior to the effective date of the Merger, (ii) the Merger did
not cause an "ownership change", and (iii) the Legacy Combination did not cause
an "ownership change".
In connection with the Merger, the Articles of Incorporation of the
Company were amended to, among other things, make more restrictive the
limitations on the transfer of Common Stock in an effort to preserve maximum
utility of the Company's NOL Carryforward. The Articles of Incorporation of the
Company generally prohibit concentrated ownership of the Company which might
jeopardize its NOL Carryforward. The transfer restrictions generally preclude,
for a period of up to five years following the effective date of the Merger, any
person from transferring shares of Common Stock (or any other subsequently
issued voting or participating stock), or rights to acquire Common Stock, if the
effect of the transfer would be to (a) make any person or group an owner of 4.9%
or more of the outstanding shares of such stock (by value), (b) increase the
ownership position of any person or group that already owns 4.9% or more of the
outstanding shares of such stock (by value), or (c) cause any person or group to
be treated like the owner of 4.9% or more of the outstanding shares of such
stock (by value) for tax purposes. Direct and indirect ownership of Common Stock
and rights to acquire Common Stock are taken into consideration for purposes of
the transfer restrictions. Pursuant to the Articles of Incorporation, the board
of directors of the Company has the authority to waive the transfer restrictions
under certain conditions, and may also accelerate or extend the period of time
during which such transfer restrictions are in effect or modify the applicable
ownership percentage that will trigger the transfer restrictions if there is a
change in law making such action necessary or desirable. The board of directors
also has the general power to make such other changes not in violation of law as
may be necessary or appropriate to preserve the Company's tax benefits. The
transfer restrictions described herein may impede an "ownership change"
involving the Company.
Pursuant to Section 384 of the Code, the Company may not be permitted to
use the NOL Carryforward to offset taxable income resulting from sales of assets
owned by the Monterey Entities at the time of the Merger (or to offset taxable
income resulting from sales of certain assets acquired in the Legacy
Combination) to the extent that the fair market value of such assets at the time
of the Merger (or at the time of the Legacy Combination) exceeded their tax
basis as of the relevant date.
There is no assurance that the Company will have sufficient earnings in
the future to fully utilize the NOL Carryforward.
Year 2000 Compliance
Many currently installed computer systems and software products,
including several used by the Company, are coded to accept only two digit
entries in the date code field. Beginning in the year 2000, these date code
fields will need to accept four digit entries to distinguish 21st century dates
from 20th century dates. Therefore, the Company's date critical functions
related to the Year 2000 and beyond may be
13
adversely affected unless these computer systems are or become Year 2000
compliant. In January 1997, the Company developed a plan to address this problem
and began converting its computer system to be Year 2000 compliant. The plan
provides for the conversion efforts to be completed by the end of 1999. The
Company is expensing all costs associated with these systems changes as the
costs are incurred. These costs are not expected to be material.
Item 2. Properties
The Company leases approximately 11,000 square feet of office space in
Scottsdale, Arizona from a limited liability company ("LLC") owned by the
Company's Chairman and President. The lease is for five years (ending September
1, 1999), net of taxes, insurance and utilities, at an annual rate which
management believes is competitive with lease rates for comparable space in the
Scottsdale area. Rents paid to the LLC totaled $192,487 and $173,160 during
fiscal years 1997 and 1996, respectively. The Company has an option to expand
its space in the building and to renew the lease for additional terms at rates
which are competitive with those in the market at such time. Management believes
that the terms of the lease are no less favorable than those which it could
obtain at an arm's length negotiated transaction. The Company also leases
approximately 1,500 square feet of office space in Tucson, Arizona. The lease
term is for 37 months commencing on October 1, 1995 at an initial annual rent of
approximately $20,600, increasing during the term of the lease to an ending rate
of approximately $23,600.
The Company leases approximately 13,000 square feet of office space in
Plano, Texas from a partnership owned by the Chief Operating Officer and his
spouse. The annual rent is $163,175 under the current lease which expires May
15, 2002. Management believes that the terms of the lease are no less favorable
than those which it could obtain in an arm's length negotiated transaction. The
Company also leases approximately 1,134 square feet of office space in Austin,
Texas at an annual rent of $20,412, with the lease expiring on March 31, 1998,
and approximately 934 square feet of office space in Houston, Texas at an annual
rent of $9,527 and with an expiration date of July 1, 1998.
The Company also leases, on a triple net basis, 15 model homes at a
total monthly lease amount of $43,600. Such leases are for terms ranging from
three months to 12 months, with renewal options ranging from 30 days to over one
year, on a month-to-month basis.
Item 3. Legal Proceedings
The Company is a party to various routine legal proceedings incidental
to its business. Management believes that none of these legal proceedings,
certain of which are covered by insurance, will have a material adverse impact
on the financial statements of the Company taken as a whole.
Item 4. Submission of Matters to a Vote of Security Holders
The Company did not submit any matters to a vote of security holders in
the fourth quarter of 1997.
PART II
Item 5. Market for the Registrant's Common Stock and Related Stockholder Matters
14
General
The Company's common stock (the "Common Stock") is publicly traded on
the New York Stock Exchange ("NYSE") under the symbol "MTH". The following table
sets forth the high and low closing sales prices of the Common Stock, as
reported by the NYSE, for the periods indicated below.
1997 1996
---- ----
High Low High Low
---- --- ---- ---
First Quarter ............... $ 7 1/4 $ 5 1/2 $ 6 $ 4 1/8
Second Quarter ............... 8 3/4 4 3/8 8 5/8 4 7/8
Third Quarter ............... 14 3/4 8 1/2 8 1/4 6
Fourth Quarter ............... 14 3/4 11 3/16 7 7/8 6 3/4
On March 16, 1998, the closing sales price of the Common Stock as
reported by the NYSE was $18 5/8 per share. At that date, there were
approximately 430 owners of record. The Company believes that there are
approximately 3,500 beneficial owners of Common Stock.
The transfer agent for the Company's common shares is ChaseMellon
Shareholder Services, L.L.C., Overpeck Centre, 85 Challanger Road, Ridgefield
Park, NJ 07760.
Cash dividends per share paid by the Company were $.06 in 1996 and $.09
in 1995, representing distributions of taxable income arising out of the
Company's prior status as a REIT. No cash dividends were paid in 1997. The
Company does not intend to pay any permitted cash dividends in the foreseeable
future, but will retain earnings to finance the growth of the Company's
business. The future payment of cash dividends, if any, will depend upon the
financial condition, results of operations and capital requirements of the
Company, as well as other factors deemed relevant by the board of directors.
In connection with the Merger, the Company issued 212,398 warrants( the
"Warrants") to purchase 256,343 shares of Common Stock. The Warrants are
exercisable at any time on or prior to October 15, 2001 or earlier upon the
dissolution, liquidation or winding up of the Company. Each Warrant is
exercisable for the purchase of 1.2069 shares of Common Stock at an exercise
price of $4.0634 per Warrant. The number of shares of Common Stock obtainable
upon exercise of the Warrants is subject to increase or decrease under certain
antidilution provisions. The Company will not receive any of the proceeds from
the sale of the Warrants or from the exercise of the Warrants. The Warrants are
not listed on any exchange or traded on any automated quotation system and there
is no market for the Warrants.
Factors That May Affect Future Stock Performance
The performance of the Company's Common Stock is dependent upon several
factors, including those set forth below and in "Management's Discussion and
Analysis of Financial Condition and Results of Operations - Factors that May
Affect Future Results and Financial Condition."
Restrictions or Transfer; Influence by Principal Stockholders. In order
to preserve certain net operating loss carryforwards, the Company's charter
precludes (i) any person from transferring such shares if the effect thereof
would be to make any person or group an owner of 4.9% or more of the outstanding
shares of Common Stock, or (ii) an increase in the ownership position of any
person or group that already owns 4.9% or more of such outstanding shares. As a
result of the foregoing factors, Messrs. Cleverly, Hilton and Landon should have
working control of the Company for the foreseeable future. One or more of the
foregoing factors could delay or prevent a future change of control of the
Company, which could depress the price of the Common Stock.
Possible Volatility of Stock Price. The market price of the Common Stock
could be subject to significant fluctuations in response to certain factors,
such as, among others, variations in anticipated or actual results of operations
of the Company or other companies in the homebuilding industry, changes in
conditions affecting the economy generally, general trends in the industry, and
analysts' reports, as well as other factors unrelated to the Company's operating
results.
15
Item 6. Selected Financial Data
The following table sets forth selected historical consolidated
financial data of the Company for each of the years in the five-year period
ended December 31, 1997. The selected annual historical consolidated financial
data for 1997 and 1996 are derived from the Company's Consolidated Financial
Statements audited by KPMG Peat Marwick LLP, independent auditors. The selected
annual historical consolidated financial data for 1995, 1994 and 1993 are
derived from the Company's Consolidated Financial Statements audited by Ernst &
Young LLP, independent auditors. For additional information, see the
Consolidated Financial Statements of the Company included elsewhere in this
Annual Report. The following table should be read in conjunction with
Management's Discussion and Analysis of Financial Condition and the Results of
Operations. Due to the Merger and the Legacy combination, the historical results
may not be indicative of future results. Pro forma financial information
reflecting the Merger is set forth in "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Pro Forma Results of
Operations".
Historical Consolidated Financial Data
Years Ended December 31,
(Dollars in thousands except per share data)
---------------------------------------------------------------
1997(4) 1996 1995 1994 1993
Income Statement Data:
Home and land sales revenue $ 149,630
Cost of home and land sales (124,594)
---------
Gross profit 25,036
Earnings (loss) from mortgage assets
and other income 5,435 $ 2,244 $ 3,564 $ (1,203) $ (21,814)
Interest expense 165 238 868 1,383 2,274
General, administrative and other expenses 15,107 1,684 1,599 1,938 1,822
--------- --------- --------- --------- ---------
Earnings (loss) before effect of
income taxes, accounting change and
extraordinary loss 15,199 322 1,097 (4,524) (25,910)
Income taxes(1) (962) (26) -- -- --
Cumulative effect of accounting change(2) -- -- -- -- (6,078)
Extraordinary loss(3) -- (149) -- -- --
--------- --------- --------- --------- ---------
Net income (loss) $ 14,237 $ 147 $ 1,097 $ (4,524) $ (31,988)
========= ========= ========= ========= =========
Income (loss) per share before effect of
accounting change/extraordinary loss $ 2.68 $ .09 $ .34 $ (1.40) $ (7.98)
Cumulative effect of accounting change per
diluted share -- -- -- -- (1.89)
Extraordinary loss per share -- (.05) -- -- --
--------- --------- --------- --------- ---------
Diluted earnings (loss) per share $ 2.68 $ .04 $ .34 $ (1.40) $ (9.87)
========= ========= ========= ========= =========
Cash dividends per share (1) $ N/A $ .06 $ .09 $ .06 $ .09
========= ========= ========= ========= =========
1997 1996(5) 1995 1994 1993
--------- --------- --------- --------- ---------
Balance Sheet Data:
Real estate under development $ 65,295 $ 35,991
Residual interests 1,422 3,909 $ 5,457 $ 7,654 $ 17,735
Total assets 96,633 72,821 27,816 31,150 43,882
Notes payable 22,892 30,542 7,819 11,783 19,926
Total liabilities 50,268 45,876 9,368 13,508 21,505
Stockholders' equity 46,365 26,945 18,448 17,642 22,377
16
(1) For any taxable year in which the Company qualified and elected to be
treated as a REIT under the Code, the Company was not subject to
federal income tax on that portion of its taxable income that was
distributed to stockholders in or with respect to that year. Regardless
of such distributions, however, the Company may be subject to tax on
certain types of income. Due to the Merger, the Company did not qualify
as a REIT in 1996 or 1997.
(2) Reflects the cumulative effect of adoption of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities."
(3) Reflects extraordinary loss from early extinguishment of long-term
debt.
(4) Includes the accounts of Legacy Homes, commencing on July 1, 1997.
(5) Reflects the Merger consummated on December 31, 1996.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Historical Results of Operations
Year Ended December 31, 1997 Compared to 1996
The Company had net earnings of $14,237,000 or $2.68 per share for the
twelve months ended December 31, 1997 compared to net earnings of $147,000, or
$.04 per share in 1996. The increase in the current year was caused by the
addition of the homebuilding operations during 1997. Home and land sales
revenue, cost of sales, commissions and other sales costs all increased in 1997,
reflecting the addition of homebuilding operations in 1997 along with the Legacy
Combination and the resulting expansion into the Texas markets in July 1997.
Results for the year ended December 31, 1996, include an extraordinary loss from
the early extinguishment of debt of $149,000, or $.05 per share.
Residual interest and real estate loan interest income was higher in the
twelve months ended December 31, 1997 than in the previous year mainly due to
the sale of two of the Company's mortgage securities, which resulted in gains of
approximately $3.1 million.
Selling, general and administrative expenses were $15.1 million and $1.7
million for the years ended December 31, 1997 and 1996 respectively. The
increase was caused by homebuilding administrative costs, including amortization
of goodwill, expenses related to the Legacy Combination and other home-selling
expenses, such as commissions, which the Company did not incur in 1996.
The increase in income taxes to $962,000 for the twelve months ended
December 31, 1997 from $26,000 in the prior year resulted from a significant
increase in pre-tax earnings in 1997. The favorable effective tax rates of 6%
and 8% in 1997 and 1996, respectively, result from the Company's net operating
loss carryforward.
Year Ended December 31, 1996 Compared to 1995
The Company had net earnings of $147,000 or $.04 per share in 1996
compared to earnings of $1,097,000 or $.34 per share in 1995. Results for the
year ended December 31, 1996 include an extraordinary loss from the early
extinguishment of debt of $149,000 or $.05 per share.
The Company's income from Mortgage Assets was $2,244,000 in 1996
compared to income of $3,564,000 in 1995.
The Company's interest expense declined from $868,000 in 1995 to
$238,000 in 1996 due to a reduction of the average aggregate long-term debt.
17
Liquidity and Capital Resources
The Company's principal uses of working capital are land purchases, lot
development and home construction. The Company uses a combination of borrowings
and funds generated by operations to meet is working capital requirements.
The cash flow for each of the Company's communities can differ
substantially from reported earnings, depending on the status of the development
cycle. The early stages of development or expansion require significant cash
outlays for, among other things, land acquisitions, obtaining plat and other
approvals, and construction of model homes, roads, certain utilities, general
landscaping and other amenities. Because these costs are capitalized, income
reported for financial statement purposes during those early stages may
significantly exceed cash flow. After the early stages of development and
expansion when these expenditures are made, cash flow can significantly exceed
earnings reported for financial statement purposes, as cost of sales includes
charges for substantial amounts of previously expended costs.
At December 31, 1997, the Company had available short-term secured
revolving construction loan facilities totaling $70 million and a $20 million
acquisition development facility, of which approximately $14.4 and $2.4 million
were outstanding, respectively. An additional $12.5 million of unborrowed funds
supported by approved collateral were available under its credit facilities at
such date. Borrowings under the credit facilities are subject to the inventory
collateral position of the Company and a number of other conditions, including
minimum net worth, debt to equity and debt coverage tests. The Company also has
outstanding $6 million in unsecured, senior subordinated notes due October 15,
2001 (the "Notes"), which were issued in October 1994. A provision of the senior
subordinated bond indenture provides bondholders with the option, at June 30,
1998, to require the Company to buy back the bonds at 101% of face value.
Management believes that the Company's current borrowing capacity, cash
on hand at December 31, 1997 and anticipated cash flows from operations are
sufficient to meet liquidity needs for the foreseeable future. There can be no
assurance, however, that amounts available in the future from the Company's
sources of liquidity will be sufficient to meet the Company's future capital
needs and the amount and types of indebtedness that the Company may incur may be
limited by the terms of the indenture governing its senior subordinated notes
and the credit agreements.
Comparison to Prior Year - Pro Forma Results of Operations
As a result of the Merger, the primary business of the Company has
shifted to homebuilding from the making of real estate loans and holding
residual interests. Due to this change, management believes that comparison of
operations in the current year with the prior year operations is not as
meaningful as a comparison to the prior year's pro forma results. Accordingly,
management has prepared pro forma condensed combined operating results for the
year ended December 31, 1996, which reflect the impact of combining the
pre-merger companies as though the Merger had taken place on January 1, 1996.
The following current year information only reflects the addition of Legacy
subsequent to July 1, 1997.
Results of Operations
For the Year Ended December 31,
-------------------------------
1997 1996 Pro Forma
---- --------------
(Dollars in thousands, except
per share data)
Home and land sales revenue............. $ 149,630 $ 87,754
Cost of home and land sales............. 124,594 75,099
------------- ----------
Gross profit.................... 25,036 12,655
Selling, general and administrative..... 15,106 7,777
Other income, net....................... 5,269 1,998
------------- ----------
18
Earnings before income taxes.... 15,199 6,876
Income tax expense...................... 962 756
------------- ----------
Net earnings.................... $ 14,237 $ 6,120
============= ==========
Diluted earnings per share.............. $ 2.68 $ 1.31
============= ==========
Key assumptions in the pro forma results of operations relate to the following:
(1) The Homeplex Merger was consummated on January 1, 1996.
(2) Compensation expense was adjusted to add the new employees' cost and
to deduct the terminated employees' cost.
(3) The net operating loss was utilized to reduce the maximum amount of
taxable income possible.
Results of Operations
The following discussion and analysis provides information regarding the
results of operations of the Company and its subsidiaries for the year ended
December 31, 1997 and pro forma operations for the year ended December 31, 1996.
All material balances and transactions between the Company and its subsidiaries
have been eliminated. Results include the operations of Legacy from July 1,
1997, the combination date, to December 31, 1997. This discussion should be read
in conjunction with the Company's Annual Report on Form 10-K for the year ended
December 31, 1996. In the opinion of management, the data reflects all
adjustments, consisting of only normal recurring adjustments, necessary to
fairly present the Company's financial position and results of operations for
the periods presented.
Home Sales Revenue
Home sales revenue is the product of the number of units closed during
the period and the average sales price per unit. The following table presents
comparative 1997 and 1996 housing revenues (dollars in thousands):
Year Ended Dollar/Unit Percentage
December 31, Increase Increase
1997 1996 (Decrease) (Decrease)
---- ---- ---------- ----------
Dollars...................... $ 149,385 $ 86,829 $ 62,556 72%
Units closed................. 644 307 337 110%
Average sales price.......... $ 232.0 $ 282.8 $ (50.8) (18%)
The increase in revenues and number of units closed in 1997 compared to
1996 resulted mainly from the addition of the Texas operations. The lower
average sales price in 1997 is also due to sales in the Texas market, where the
Company's focus is on entry-level and move-up homes.
Gross Profit
Gross profit equals home and land sales revenue, net of housing cost of
sales, which include developed lot costs, unit construction costs, amortization
of common community costs (such as the cost of model complex and architectural,
legal and zoning costs), interest, sales tax, warranty, construction overhead
and closing costs. The following table presents comparative 1997 and 1996
housing gross profit (dollars in thousands):
Year Ended
December 31, Dollar/Unit Percentage
1997 1996 Increase Increase
---- ---- ---------- ----------
Dollars......................... $ 25,036 $ 12,655 $ 12,381 98%
Percent of housing revenues..... 16.8% 14.6% 2.2% 15%
19
The dollar increase in gross profit for the twelve months ended December
31, 1997, is attributable to the increase in number of units closed due to the
Legacy Combination, along with increased closings in highly profitable Arizona
communities. The gross profit margin increased in 1997 due to generally higher
margins in Texas, and an increase in the purchase by customers of more
profitable custom options and upgrades with respect to Arizona closings.
Residual Interest and Real Estate Interest Income
The increase in residual interest and real estate loan interest income
is primarily due to the 1997 sale of two of the Company's mortgage securities,
which resulted in a gain of approximately $3.1 million.
Selling, General And Administrative Expenses
Selling, general and administrative expenses, which include advertising,
model and sales office, sales administration, commissions and corporate overhead
costs, were approximately $15.1 million in 1997, as compared to approximately
$7.8 million in 1996, an increase of 94%. These changes were caused mainly by
higher administrative, corporate and public company costs and the inclusion of
Legacy operating costs in the second half of 1997.
Net Orders
Net orders for any period represent the number of units ordered by
customers (net of units canceled) multiplied by the average sales price per
units ordered. The following table presents comparative 1997 and 1996 net orders
(dollars in thousands):
Year Ended Dollar/Unit Percentage
December 31, Increase Increase
1997 1996 (Decrease) (Decrease)
---- ---- ---------- ----------
Dollars.................. $ 157,479 $ 90,182 $ 67,297 75%
Units ordered 693 283 410 145%
Average sales price...... $ 227.2 $ 318.6 $ (91.4) (29%)
The Company does not include sales which are contingent on the sale of
the customer's existing home as orders until the contingency is removed.
Historically, the Company has experienced a cancellation rate of less than 16%
of gross sales. Total net orders increased in 1997 compared to 1996 due to the
expansion into Texas and the economic strength of both the Arizona and Texas
markets.
Net Sales Backlog
Backlog represents net orders which have not closed. The following table
presents comparative 1997 and 1996 net sales backlog for the total Company, and
the Arizona and Texas divisions individually. (dollars in thousands):
December 31, Dollar/Unit Percentage
Total 1997 1996(1) Increase (Decrease) Increase (Decrease)
- ----- ---- ------- ------------------- -------------------
Dollars................. $ 98,963 $ 42,661 $ 56,302 132%
Units in backlog........ 472 120 352 293%
Average sales price..... $ 209.7 $ 355.5 $ (145.8) (41%)
Arizona
Dollars............. $ 56,945 $ 42,661 $ 14,284 33%
Units in backlog.... 168 120 48 40%
Average sales price. $ 339.0 $ 355.5 $ (16.5) (5%)
Texas
Dollars............. $ 42,018 $ 28,570 $ 13,448 47%
Units in backlog.... 304 197 107 54%
Average sales price. $ 138.2 $ 145.0 $ (6.8) (5%)
(1) Prior year's Texas information is included for comparative purposes only.
20
Total dollar backlog increased 132% over the prior year due to a
substantial increase in units in backlog partially offset by a decrease in
average sales price. Average sales price as a whole has decreased due to the
Legacy Combination, where the focus is on entry-level and move-up homes. Units
in backlog have increased 293% over the prior year due to the increase in net
orders caused by the Texas expansion.
Arizona dollar backlog increased 33% over the prior year due to the
increased number of units in backlog offset by a decrease in average sales price
due to a change in the product mix of units ordered.
Texas dollar and unit backlog is up over the prior year due to increased
orders in 1997. The average sales price is slightly lower due to the increase in
the product mix of entry level home sales.
Seasonality
The Company has historically closed more units in the second half of the
fiscal year than in the first half, due in part to the slightly seasonal nature
of the market for their semi-custom, luxury product homes. Management expects
that this seasonal trend will continue in the future, but may change slightly as
operations continue to expand within the move-up and starter home segments of
the market.
Factors That May Affect Future Results and Financial Condition of the
Company
The Company's future operating results and financial condition are
dependent on the Company's ability to successfully design, develop, construct
and sell homes that satisfy dynamic customer demand patterns. Inherent in this
process are a number of factors that the Company must successfully manage in
order to achieve favorable future operating results and financial condition. In
addition, the price of the Company's Common Stock and Warrants could be affected
not only by such operating and financial conditions, but also by many other
factors. Potential risks and uncertainties that could affect the Company's
future operating results and financial condition could include, without
limitation, the factors discussed below.
Homebuilding Industry Factors. The homebuilding industry is cyclical and
is significantly affected by changes in national and local economic and other
conditions, such as employment levels, availability of financing, interest
rates, consumer confidence and housing demand. Although the Company believes
that certain of its customers (particularly purchasers of luxury homes) are
somewhat less price sensitive than generally is the case for other homebuilders,
such uncertainties could adversely affect the Company's performance. In
addition, homebuilders are subject to various risks, many of which are outside
the control of the homebuilders, including delays in construction schedules,
cost overruns, changes in government regulations, increases in real estate taxes
and other local government fees, and availability and cost of land, materials,
and labor. Although the principal raw materials used in the homebuilding
industry generally are available from a variety of sources, such materials are
subject to periodic price fluctuations. There can be no assurance that the
occurrence of any of the foregoing will not have a material adverse effect on
the Company.
Customer demand for new housing also impacts the homebuilding industry.
Real estate analysts predict that in 1998 new home sales in the Phoenix
metropolitan area may slow and that sales in the Tucson metropolitan area may
remain relatively flat. Any such slowing in new home sales would have a material
adverse effect on the Company's business and operating results. In general, home
sales in the Texas market are expected to show moderate growth or remain
relatively flat.
The homebuilding industry is subject to the potential for significant
variability and fluctuations in real estate values, as evidenced by the changes
in real estate values in recent years in Arizona and Texas. Although the Company
believes that its projects are currently reflected on its balance sheet at
appropriate values, no assurance can be given that write-downs of some or all of
the Company's projects will not occur if market conditions deteriorate, or that
such write-downs will not be material in amount.
21
Fluctuations in Operating Results. Monterey historically has
experienced, and in the future, the Company expects to continue to experience,
variability in home sales and net earnings on a quarterly basis. Factors
expected to contribute to this variability include, among others, (i) the timing
of home closings and land sales, (ii) the Company's ability to continue to
acquire additional land or options to acquire additional land on acceptable
terms, (iii) the condition of the real estate market and the general economy in
Arizona and Texas, and in other areas into which the Company may expand its
operations, (iv) the cyclical nature of the homebuilding industry and changes in
prevailing interest rates and the availability of mortgage financing, (v) costs
or shortages of materials and labor, and (vi) delays in construction schedules
due to strikes, adverse weather conditions, acts of God, the availability of
subcontractors or governmental restrictions. As a result of such variability,
the Company's historical performance may not be a meaningful indicator of future
results.
Interest Rates and Mortgage Financing. The Company believes that certain
of its move-up and luxury home customers have been somewhat less sensitive to
interest rate fluctuation than many homebuyers. However, many purchasers of the
Company's homes finance their acquisition through third-party lenders providing
mortgage financing. In general, housing demand is adversely affected by
increases in interest rates and housing costs, and the unavailability of
mortgage financing. If mortgage interest rates increase and the ability of
prospective buyers to finance home purchases is consequently adversely affected,
the Company's home sales, gross margins and net income may be adversely impacted
and such adverse impact may be material. In any event, the Company's
homebuilding activities are dependent upon the availability and costs of
mortgage financing for buyers of homes owned by potential customers so those
customers ("move-up buyers") can sell their homes and purchase a home from the
Company. Any limitations or restrictions on the availability of such financing
could adversely affect the Company's home sales. Furthermore, changes in federal
income tax laws may affect demand for new homes. From time to time, proposals
have been publicly discussed to limit mortgage interest deductions and to
eliminate or limit tax-free rollover treatment provided under current law where
the proceeds of the sale of a principal residence are reinvested in a new
principal residence. Enactment of such proposals may have an adverse effect on
the homebuilding industry in general, and on demand for the Company's products
in particular. No prediction can be made whether any such proposals will be
enacted and, if enacted, the particular form such laws would take.
Competition. The single-family residential housing industry is highly
competitive and fragmented. Homebuilders compete for desirable properties,
financing, raw materials, and skilled labor. The Company competes for
residential home sales with other developers and individual resales of existing
homes. Competitors include large homebuilding companies, some of which have
greater financial resources than the Company, and smaller homebuilders, who may
have lower costs than the Company. Competition is expected to continue and
become more intense, and there may be new entrants in the markets in which the
Company currently operates and in markets it may enter in the future.
Lack of Geographic Diversification. The Company's operations are
presently localized in the Phoenix and Tucson, Arizona and Dallas/Ft. Worth,
Austin and Houston, Texas metropolitan areas. In addition, the Company currently
operates in two primary market segments in Arizona: the semi-custom, luxury
market and move-up buyer market; and in two primary market segments in Texas:
the move-up buyer market and the entry-level home market. Failure to be more
geographically or economically diversified by product line could have a material
adverse impact on the Company if the homebuilding market in Arizona or Texas
should decline, because there may not be a balancing opportunity in a healthier
market in other geographic regions.
Additional Financing; Limitations. The homebuilding industry is capital
intensive and requires significant up-front expenditures to acquire land and
begin development. Accordingly, the Company incurs substantial indebtedness to
finance its homebuilding activities. At December 31, 1997, the Company's debt
totaled approximately $22.9 million. The Company may be required to seek
additional capital in the form of equity or debt financing from a variety of
potential sources, including bank financing and securities offerings. In
addition, lenders are increasingly requiring developers to invest significant
amounts of equity
22
in a project both in connection with origination of new loans as well as the
extension of existing loans. If the Company is not successful in obtaining
sufficient capital to fund its planned capital or other expenditures, new
projects planned or begun may be delayed or abandoned. Any such delay or
abandonment could result in a reduction in home sales and may adversely affect
the Company's operating results. There can be no assurance that additional debt
or equity financing will be available in the future or on terms acceptable to
the Company.
In addition, the amount and types of indebtedness that the Company can
incur is limited by the terms and conditions of its current indebtedness. The
Company must comply with numerous operating and financial maintenance covenants
and there can be no assurance that the Company will be able to maintain
compliance with such financial and other covenants. Failure to comply with such
covenants would result in a default and resulting cross defaults under the
Company's other indebtedness, and could result in acceleration of all such
indebtedness. Any such acceleration would have a material adverse affect on the
Company.
Government Regulations; Environmental Conditions. The Company is subject
to local, state, and federal statutes and rules regulating certain developmental
matters, as well as building and site design. In addition, the Company is
subject to various fees and charges of governmental authorities designed to
defray the cost of providing certain governmental services and improvements. The
Company may be subject to additional costs and delays or may be precluded
entirely from building projects because of "no growth" or "slow growth"
initiatives, building permit ordinances, building moratoriums, or similar
government regulations that could be imposed in the future due to health,
safety, welfare, or environmental concerns. The Company must also obtain
licenses, permits, and approvals from government agencies to engage in certain
of its activities, the granting or receipt of which are beyond the Company's
control.
The Company and its competitors are also subject to a variety of local,
state, and federal statutes, ordinances, rules and regulations concerning the
protection of health and the environment. Environmental laws or permit
restrictions may result in project delays, may cause substantial compliance and
other costs, and may prohibit or severely restrict development in certain
environmentally sensitive regions or areas. Environmental regulations can also
have an adverse impact on the availability and price of certain raw materials
such as lumber.
Recent Expansion and Future Expansion. The Company recently concluded a
significant expansion into the Texas market and the Company may continue to
consider growth in other areas of the country. The magnitude, timing and nature
of any future acquisitions will depend on a number of factors, including
suitable acquisition candidates, the negotiation of acceptable terms, the
Company's financial capabilities, and general economic and business conditions.
Acquisitions by the Company may result in the incurrence of additional debt
and/or amortization of expenses related to goodwill and intangible assets that
could adversely affect the Company's profitability. Acquisitions could also
result in potentially dilutive issuances of the Company's equity securities. In
addition, acquisitions involve numerous risks, including difficulties in the
assimilation of operations of the acquired company, the diversion of
management's attention from other business concerns, risks of entering markets
in which the Company has had no or only limited direct experience and the
potential loss of key employees of the acquired company. There can be no
assurance that the Company will be able to expand into new markets on a
profitable basis or that it can successfully manage its expansion into Texas or
any additional markets.
Dependence on Key Personnel. The Company's success is largely dependent
on the continuing services of certain key persons, including William W.
Cleverly, Steven J. Hilton and John R. Landon, and the ability of the Company to
attract new personnel required to continue the development of the Company. The
Company has entered into employment agreements with each of Messrs. Cleverly,
Hilton and Landon. A loss by the Company of the services of Messrs. Cleverly,
Hilton or Landon, or certain other key personnel, could have a material adverse
affect on the Company.
23
Dependence on Subcontractors. The Company conducts its business only as
a general contractor in connection with the design, development and construction
of its communities. Virtually all architectural and construction work is
performed by subcontractors of the Company. As a consequence, the Company is
dependent upon the continued availability and satisfactory performance by
unaffiliated third-party subcontractors in designing and building its homes.
There is no assurance that there will be sufficient availability and
satisfactory performance by unaffiliated third-party subcontractors in designing
and building its homes, and such a lack could have a material adverse affect on
the Company.
NOL Carryforward. The ability of the Company to use the NOL Carryforward
to offset future taxable income would be substantially limited under Section 382
of the Code if an "ownership change", within the meaning of Section 382 of the
Code, has occurred or occurs with respect to the Company before expiration of
the NOL Carryforward. The Company belives that (i) there was not an "ownership
change" of the Company prior to the effective date of the Merger, (ii) the
Merger did not cause an "ownership change", and (iii) the Legacy Combination did
not cause an "ownership change".
Pursuant to Section 384 of the Code, the Company may not be permitted to
use the NOL Carryforward to offset taxable income resulting from sales of assets
owned by the Monterey Entities at the time of the Merger (or to offset taxable
income resulting from sales of certain assets acquired in the Legacy
Combination) to the extent that the fair market value of such assets at the time
of the Merger (or at the time of the Lagacy Combination) exceeded their tax
basis as of the relevant date.
There is no assurance that the Company will have sufficiant earnings in
the future to fully utilize the NOL Carryforward.
Item 8. Financial Statements and Supplementary Data
Financial Statements of the Company as of December 31, 1997 and 1996,
and for the years then ended, together with related notes and the Report of KPMG
Peat Marwick LLP, independent auditors, and financial statements of the Company
for the year ended December 31, 1995, together with related notes and the Report
of Ernst & Young LLP, independent auditors, are set forth on the following
pages. Other required financial information set forth herein is more fully
described in Item 14 hereof.
24
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Monterey Homes Corporation
We have audited the accompanying consolidated balance sheets of Monterey
Homes Corporation and subsidiaries (previously known as Homeplex Mortgage
Investments Corporation and subsidiaries) as of December 31, 1997 and 1996 and
the related consolidated statements of earnings, stockholders' equity, and cash
flows the for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. 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 includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above,
present fairly in all material respects, the financial position of Monterey
Homes Corporation and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Phoenix, Arizona
February 11, 1998
25
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Monterey Homes Corporation
We have audited the consolidated balance sheet of Monterey Homes
Corporation and subsidiaries (previously known as Homeplex Mortgage Investments
Corporation and subsidiaries) as of December 31, 1995 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. 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 includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position of
Monterey Homes Corporation and subsidiaries as of December 31, 1995 and the
results of their operations and their cash flows for the year then ended, in
conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Phoenix, Arizona
February 13, 1996
26
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31,
1997 1996
---- ----
Assets
Cash and cash equivalents $ 8,245,392 $ 15,567,918
Short-term investments -- 4,696,495
Real estate under development 65,294,654 35,991,142
Option deposits 3,070,420 546,000
Real estate loans and other receivables 985,708 2,623,502
Residual interests 1,421,754 3,909,090
Deferred tax asset 10,404,000 6,783,000
Goodwill 5,970,773 1,763,488
Property and equipment, net 706,702 266,101
Other assets 534,101 673,994
---------------- ----------------
Total Assets $ 96,633,504 $ 72,820,730
================ ================
Liabilities
Accounts payable and accrued liabilities $ 21,171,301 $ 10,569,872
Home sale deposits 6,204,773 4,763,518
Notes payable 22,892,250 30,542,276
---------------- ----------------
Total Liabilities 50,268,324 45,875,666
---------------- ----------------
Stockholders' Equity
Common stock, par value $.01 per share; 50,000,000
shares authorized; issued and outstanding - 5,255,440
shares at December 31, 1997, and 4,580,611 shares at
December 31, 1996 52,554 45,806
Additional paid-in capital 97,819,584 92,643,658
Accumulated deficit (51,096,675) (65,334,117)
Treasury stock - 53,046 shares (410,283) (410,283)
----------------- ----------------
Total Stockholders' Equity 46,365,180 26,945,064
---------------- ----------------
Total Liabilities and Stockholders' Equity $ 96,633,504 $ 72,820,730
================ ================
See accompanying notes to consolidated financial statements
27
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
CONSOLDIATED STATEMENTS OF EARNINGS
Years Ended December 31,
1997 1996 1995
---- ---- ----
Home sales revenue $ 149,384,548
Land sales revenue 245,000
Cost of home sales (124,368,782)
Cost of land sales (225,000)
----------------
Gross profit 25,035,766
Residual interest and real estate loan interest income 5,088,693 $ 1,610,386 $ 2,901,353
Mortgage company income, net 207,784 -- --
Selling, general and administrative expense (15,106,199) (1,683,407) (1,599,157)
Interest expense (165,173) (237,945) (868,414)
Other income, net 138,487 633,449 663,343
---------------- -------------- ---------------
Earnings before income taxes and extraordinary loss 15,199,358 322,483 1,097,125
Income taxes (961,916) (26,562) --
----------------- --------------- ---------------
Earnings before extraordinary loss 14,237,442 295,921 1,097,125
Extraordinary loss from early extinguishment of debt -- (148,433) --
---------------- --------------- ---------------
Net earnings $ 14,237,442 $ 147,488 $ 1,097,125
================ ============== ===============
Basic earnings per share $ 2.93 $ .05 $ .34
================ ============== ===============
Diluted earnings per share $ 2.68 $ .04 $ .34
================ ============== ===============
See accompanying notes to consolidated financial statements
28
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended December 31, 1997, 1996 and 1995
Additional
Number of Common Paid-In Accumulated Treasury
Shares Stock Capital Deficit Stock Total
------ ----- ------- ------- ----- -----
Balance at December 31, 1994 3,291,885 $ 32,919 $ 84,112,289 $(66,092,904) $ (410,283) $ 17,642,021
Net earnings --- --- --- 1,097,125 --- 1,097,125
Cash dividends ................ --- --- --- (291,496) --- (291,496)
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1995 3,291,885 32,919 84,112,289 (65,287,275) (410,283) 18,447,650
Net earnings ..................... --- --- --- 147,488 --- 147,488
Cash dividends ................ --- --- --- (194,330) --- (194,330)
Shares issued in connection with
Merger ....................... 1,288,726 12,887 8,531,369 --- --- 8,544,256
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1996 4,580,611 45,806 92,643,658 (65,334,117) (410,283) 26,945,064
Net earnings -- -- -- 14,237,442 -- 14,237,442
Exercise of employee stock options.... 8,162 81 118,510 -- -- 118,591
Shares issued in connection with the
Legacy Combination ............ 666,667 6,667 3,393,335 -- -- 3,400,002
Stock option and contingent stock
compensation expense............... -- -- 1,664,081 -- -- 1,664,081
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1997 5,255,440 $ 52,554 97,819,584 $(51,096,675) $ (410,283) $ 46,365,180
============ ============ ============ ============= ============= ============
See accompanying notes to consolidated financial statements
29
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
1997 1996 1995
---- ---- ----
Cash flows from operating activities:
Net earnings ......................................... $ 14,237,442 $ 147,488 $ 1,097,125
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Extraordinary loss from early extinguishment of
debt .............................................. -- 148,433 --
Depreciation and amortization ........................ 376,916 38,300 122,970
Stock option compensation expense .................... 1,664,081 -- --
Gain on sales of residual interest ................... (3,067,829) -- --
Increase in real estate under development ............ (10,575,738) -- --
Increase in option deposits .......................... (1,712,139) -- --
Decrease in other receivables and other assets ....... 2,237,295 153,350 370,454
Amortization of residual interests ................... 55,165 1,548,076 2,196,394
Increase (decrease) in accounts payable and
accrued liabilities and home sale deposits ........ 3,461,023 317,094 (272,828)
------------ ------------ ------------
Net cash provided by operating activities ......... 6,676,216 2,352,741 3,514,115
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment .................. (174,257) -- --
Cash acquired in Combination/Merger .................. 1,306,998 6,495,255 --
Cash paid for acquisition, net of cash acquired ...... (1,952,857) (779,097) --
Principal payments received on real estate loans ..... 2,124,544 3,710,000 9,114,000
Real estate loans funded ............................. (428,272) (1,358,457) (3,902,000)
(Increase) decrease in short term investments ........ 4,696,495 4,272,605 (8,969,100)
Proceeds from sales of residual interest ............. 5,500,000 -- --
Decrease in funds held by Trustee .................... -- 5,637,948 1,082,549
------------ ------------ ------------
Net cash provided by (used in) investing activities 11,072,651 17,978,254 (2,674,551)
------------ ------------ ------------
Cash flows from financing activities:
Borrowings ........................................... 67,900,899 -- --
Repayment of borrowings .............................. (92,896,553) (7,818,824) (3,964,000)
Stock options exercised .............................. 118,591 -- --
Dividends paid ....................................... (194,330) (291,496) (194,330)
------------ ------------ ------------
Net cash used in financing activities ............. (25,071,393) (8,110,320) (4,158,330)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents ......... (7,322,526) 12,220,675 (3,318,766)
Cash and cash equivalents at beginning of year ............... 15,567,918 3,347,243 6,666,009
------------ ------------ ------------
Cash and cash equivalents at end of year ..................... $ 8,245,392 $ 15,567,918 $ 3,347,243
============ ============ ============
Supplemental information:
Cash paid for interest ............................... $ 3,801,764 $ 286,276 $ 804,113
Cash paid for income taxes ........................... $ 49,871 $ -- $ --
See accompanying notes to consolidated financial statements
30
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
Business. Monterey Homes Corporation (the "Company") is engaged in the
development, construction, marketing and sale of new high quality, single family
homes in the semi-custom luxury, move-up and entry level markets.
The Company was originally formed as a real estate investment trust
("REIT"), investing in mortgage-related assets, and selected real estate loans.
On December 31, 1996, the Company acquired by merger (the "Merger") the
homebuilding operations of various entities operating under the Monterey Homes
name (the "Monterey Entities"), and is phasing out the Company's
mortgage-related operations. The Monterey Entities have been building homes in
Arizona for over 12 years, specializing in semi-custom, luxury homes and move-up
homes. In connection with the merger, the management of the Monterey Entities
assumed effective control of the Company.
As part of a strategy to diversify its operations, on July 1, 1997, the
Company combined with (the "Legacy Combination") the homebuilding operations of
several entities operating under the name Legacy Homes ("Legacy"). Legacy has
been operating in the Texas market since 1988, and designs, builds and sells
entry-level and move-up homes. In connection with the transaction, John R.
Landon, the founder and President of Legacy, joined senior management and became
a Co-CEO and the Chief Operating Officer of the Company and joined the Board of
Directors as a significant stockholder (See Note 9).
Basis of Presentation. The consolidated financial statements include the
accounts of Monterey Homes Corporation and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation. Results include the operations of Legacy from July 1, 1997.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents. Short-term investments with an initial maturity of
three months or less are considered to be cash equivalents.
Real Estate Under Development. Real estate under development is valued in
accordance with Statement of Financial Accounting Standards (FAS) No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of". Accordingly, amounts are carried at cost unless expected future
net cash flows (undiscounted and without interest) are less than cost and then
amounts are carried at estimated fair value less cost to sell. Costs capitalized
include direct construction costs for homes, development period interest and
certain common costs which benefit the entire community. Common costs are
allocated on a community by community basis to residential lots based on the
number of lots to be built in the community, which approximates the relative
sales value method.
Deposits paid related to options and contracts to purchase land are
capitalized and included in option deposits until the related land is purchased.
Upon purchase of the land, the related option deposits are transferred to real
estate under development.
Cost of sales include land acquisition and development costs, direct
construction costs of the home, development period interest and closing costs,
and an allocation of common costs.
Income Recognition. Income from home sales is recognized when the homes are
delivered and title passes to the buyer.
31
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Residual Interests. Interests relating to mortgage participation certificates
and residual interest certificates are accounted for as described in Note 3.
Property and Equipment. Property and equipment are recorded at cost.
Depreciation is calculated on a straight-line method over the estimated useful
lives of the assets, which range from three to five years. Accumulated
depreciation was approximately $375,700 and $156,600 at December 31, 1997 and
1996, respectively. Maintenance and repair costs are expensed as incurred.
Goodwill. The excess of purchase price over fair value of net assets acquired
(goodwill) is amortized on a straight-line basis over a 20 year period.
Accumulated amortization was approximately $162,500 at December 31, 1997. There
was no amortization of goodwill prior to the Merger at December 31, 1996. The
Company assesses the recoverability of this intangible asset by determining
whether the amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the acquired
operation. The amount of goodwill impairment, if any, is measured based on
projected discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of the
recoverability of goodwill will be impacted if estimated future operating cash
flows are not achieved.
Income Taxes. The Company accounts for income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes". Under the asset and liability method of SFAS
No. 109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
basis. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in future years in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in the consolidated statement of earnings as an adjustment to the
effective income tax rate in the period that includes the enactment date.
Earnings Per Share. The Company adopted SFAS No. 128, "Earnings Per Share" in
1997 and restated all prior periods in accordance with its provisions. Basic
earnings per share is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if securities or contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company.
Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions relating to the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the period.
Actual results could differ from these estimates.
Fair Value of Financial Instruments. The carrying amounts of receivables, cash
and cash equivalents, option deposits, accounts payable and accrued liabilities
and home sale deposits approximate fair value due to the short term maturity of
these assets and liabilities. The short-term investments in 1996 are recorded at
fair value. The fair value of the Company's residual interests is discussed in
Note 3. The carrying amount of the Company's notes payable approximates fair
value because the notes are at interest rates comparable to market rates based
on the nature of the loans, their terms and remaining maturity. Considerable
judgment is required in interpreting market data to develop the estimates of
fair value. Accordingly, these fair value estimates are subjective and not
necessarily indicative of the amounts the Company would pay or receive in actual
market transactions.
32
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Disclosure of the fair value of financial instruments is made in
accordance with the requirements of SFAS No. 107, "Disclosure About Fair Value
of Financial Instruments."
Stock Option Plans. Prior to January 1, 1996, the Company accounted for its
stock option plan in accordance with the provisions of Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and
related interpretations. As such, compensation expense would be recorded on the
date of grant only if the current market price of the underlying stock exceeded
the exercise price. On January 1, 1996, the Company adopted SFAS No. 123,
"Accounting for Stock-Based Compensation", which allows entities to continue to
apply the measurement provisions of APB Opinion No. 25 and provide pro forma net
income and pro forma earnings per share disclosures for employee stock option
grants made in 1995 and subsequent years as if the fair-value based method
defined in SFAS No. 123 had been applied. The Company has elected to continue to
apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure
provisions of SFAS No. 123.
Year 2000. In January 1997, the Company developed a plan to address the Year
2000 problem and began converting its computer systems to be Year 2000
compliant. The plan provides for the conversion efforts to be completed by the
end of 1999. The Year 2000 problem is a result of computer programs being
written using two digits rather than four to define the applicable year. The
Company is expensing all costs associated with these system changes as the costs
are incurred.
Reclassifications. Certain prior period amounts have been reclassified in the
consolidated financial statements to conform with the current period
presentation.
NOTE 3 - RESIDUAL INTERESTS
The Company owns residual interests in collateralized mortgage
obligations (CMOs) and in mortgage participation certificates (MPCs)
(collectively residual interests). The residual interests are accounted for
using the prospective net level yield method, in which the interest is recorded
at cost and amortized over the life of the related CMO or MPC issuance.
Based on prevailing market interest rates and discussions with brokers
and investors who trade residual interests, Management believes that the
estimated fair value of the Company's residual interests, in the aggregate, was
approximately $6,600,000 at December 31, 1997, and $7,000,000 at December 31,
1996.
NOTE 4 - REAL ESTATE UNDER DEVELOPMENT AND CAPITALIZED INTEREST
The components of real estate under development at December 31 are as follows
(in thousands):
1997 1996
---- ----
Homes under contract, in production $ 30,523 $ 13,782
Finished lots and lots under development 28,471 18,364
Model homes and homes held for resale 6,301 3,845
--------- --------
$ 65,295 $ 35,991
========= ========
The Company capitalizes certain interest costs incurred on homes in
production and lots under development. Such capitalized interest is allocated to
inventory and included in cost of home sales when the units are delivered. The
following tables summarize interest capitalized and interest expensed (dollars
in thousands):
33
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Year Ended December 31,
1997 1996
---- ----
Beginning unamortized capitalized interest.... $ - $ N/A
Interest capitalized.......................... 3,679 N/A
Amortized cost of home sales.................. 1,789 N/A
--------- ---------
Ending unamortized capitalized interest....... $ 1,890 $ N/A
========= =========
Interest incurred............................. $ 3,844 $ 238
Interest capitalized.......................... 3,679 N/A
--------- ---------
Interest expense.............................. $ 165 $ 238
========= =========
Had capitalized interest maintained its character in purchase accounting
after the Merger and Legacy Combination, interest amortized by the Company (See
Note 9) through cost of home sales would have been approximately $4.2 million in
1997.
NOTE 5 - NOTES PAYABLE
Notes payable consist of the following at December 31:
1997 1996
---- ----
$30 million bank construction line of credit, interest
payable monthly approximating prime (8.5% at December
31, 1997), plus .25% payable at the earlier of close of
escrow, maturity date of individual homes within the line
or June 19, 2000, secured by first deeds of trust on land......... $ 4,663,973 $ 7,299,159
$40 million bank construction line of credit, interest payable
monthly approximating prime, payable at the earlier of close of
escrow, maturity date of individual homes within the line or
August 1, 1998, secured by first deeds of trust on land........... 9,769,567 --
$20 million bank acquisition and development credit facility,
interest payable monthly approximating prime plus 5%,
payable at the earlier of funding of construction financing,
the maturity date of individual projects within the line or
June 19, 2000, secured by first deeds of trust on land............ 2,393,935 9,628,993
Short-term bank credit facility, paid in full, June 1997.............. -- 5,552,500
Senior subordinated unsecured notes payable, maturing October
15, 2001, annual interest of 13%, payable semi-annually,
principal payable at maturity date with a put to the
Company at June 30, 1998, at 101% of face value.................... 6,000,000 8,000,000
Other .............................................................. 64,775 61,624
------------ ------------
Total .................................................... $ 22,892,250 $ 30,542,276
============ ============
34
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Scheduled maturities of the notes payable as of December 31, 1997 are as
follows:
Year ending
December 31,
------------
1998............ $ 16,892,250
1999............ ---
2000............ ---
2001............ 6,000,000
Thereafter...... ---
---------------
$ 22,892,250
===============
In August, 1997, $2,000,000 of the senior subordinated bonds were
repurchased by the Company. Approximately $3,000,000 of the bonds were held by
the Co-Chief Executive Officers of the Company at December 31, 1997.
NOTE 6 - EARNINGS PER SHARE
A summary of the reconciliation from basic earnings per share to diluted
earnings per share for the years ended December 31, 1997, 1996 and 1995 follows
(in thousands, except for per share amounts):
1997 1996 1995
---- ---- ----
Net earnings $ 14,237 $ 147 $ 1,097
Basic EPS - Weighted average shares outstanding 4,864 3,242 3,246
--------- -------- ---------
Basic earnings per share $ 2.93 $ .05 $ .34
========= ======== =========
Basic EPS - Weighted average shares outstanding 4,864 3,242 3,246
Effect of dilutive securities
Contingent shares and warrants 114 -- --
Stock options 330 93 --
--------- -------- ---------
Dilutive EPS - Weighted average shares outstanding 5,308 3,335 3,246
--------- -------- ---------
Diluted earnings per share $ 2.68 $ .04 $ .34
========= ======== =========
Antidilutive stock options not included in diluted EPS 4 4 92
========= ======== =========
Basic and diluted earnings per share for the extraordinary loss in 1996
were $.05 and $.04, respectively.
NOTE 7 - STOCK OPTIONS AND CONTINGENT STOCK
At December 31, 1997, the Company had two stock based compensation plans
which are described below. The per share weighted average fair values of stock
options granted during 1997 and 1996 were $4.58 and $1.63, respectively, on the
dates of grant using the Black Scholes pricing model with the following weighted
average assumptions for 1997 and 1996, respectively; expected dividend yield
1.2% and 1.4%, risk-free interest rate of 6.0% and 5.85%, expected volatility of
43% and 36% and an expected life
35
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
of five years. The Company applies APB Opinion No. 25 and related
interpretations in accounting for its plans. No compensation cost has been
recognized for its stock based compensation plan (which is a fixed stock option
plan). Had compensation cost for the Company's stock based compensation plan
been determined consistent with FASB Statement No. 123, the Company's net
earnings and earnings per share would have been reduced to the pro forma amounts
indicated below:
1997 1996
---- ----
Net earnings (loss) .............. As reported $ 14,237,442 $ 147,488
Pro forma 13,892,442 (151,345)
Diluted earnings (loss) per share. As reported $ 2.68 $.04
Pro forma $ 2.62 ($.05)
The Company's Stock Option Plans are administered by the Compensation
Committee of the Board of Directors. The plans provide for qualified stock
options which may be granted to the Company's key personnel, and non-qualified
stock options which may be granted the Company's Directors and key personnel.
The purpose of the plans are to provide a means of performance-based
compensation in order to attract and retain qualified personnel whose job
performance affects the Company.
The Homeplex Plan
The 1998 Homeplex Mortgage Investments Corporation Stock Option Plan
(the "Homeplex Plan") was in effect at the time of the Merger. No new grants
will be issued under this plan, and the options will expire on December 31,
1998.
Option holders received, at no additional cost, DER's which entitled
them to receive, upon exercise of the options, additional shares calculated
based on the dividends declared during the period from the grant date to the
exercise date. At December 31, 1997 and 1996, accounts payable and accrued
liabilities in the accompanying balance sheets include approximately $778,600
and $850,000, respectively, related to the Company's granting of DER's. This
liability will remain in the consolidated balance sheets until the options to
which the DER's relate are exercised, canceled or expire.
Under the Homeplex Plan, an exercising optionholder also has the rights
to require the Company to purchase some or all of the optionholder's shares of
the Company's common stock. That redemption right is exercisable by the
optionholder only with respect to shares (including the related dividend
equivalent rights) that the optionholder has acquired by exercise of an option
under the Plan. Furthermore, the optionholder can only exercise redemption
rights within six months from the last to expire of (i) the two year period
commencing with the grant date of an option, (ii) the one year period commencing
with the exercise date of an option, or (iii) any restriction period on the
optionholder's transfer of shares of common stock acquired through exercise of
options. The price for any shares repurchased as a result of an optionholder's
exercise of his redemption rights is the lesser of the book value of those
shares at the time of redemption or the fair market value of the shares on the
original date the options were exercised.
The Monterey Plan
At the 1997 Annual Meeting of Stockholders held on September 25, 1997, a
new stock option plan was approved by stockholders. The plan authorizes grants
of incentive stock options and non-qualified stock options to executives,
directors and consultants of the Company. A total of 225,000 shares of the
Company's common stock were reserved for issuance upon exercise of stock options
granted under the new plan, of which 150,000 were granted in 1997. The options
expire ten years after the date of grant.
36
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In addition to the above referenced options, in December 1995, in
connection with the renegotiation of the prior Chief Executive Officer's
Employment Agreement, the Company replaced his annual salary of $250,000 plus
bonus with 250,000 non-qualified stock options which became fully vested upon
the Merger at December 31, 1996. The exercise price of the options is $4.50 per
share which was equal to the closing market price of the common stock on grant
date. The options will expire in December 2000.
In connection with the Merger and Legacy Combination, Mssrs. Cleverly,
Hilton and Landon each received 166,667 non-qualified stock options which vest
equally over three years. The exercise price of the options is $5.25 per share
which was negotiated at the time of the Merger. Mr. Cleverly's and Mr. Hilton's
options will expire in December, 2002 and Mr.
Landon's will expire in June, 2001.
The following summarizes stock option activity under the Stock Option
Plans:
1997 1996 1995
---- ---- ----
Options outstanding at beginning of year 732,975 398,392 132,240
Employment options granted -- -- 250,000
Options granted 150,000 1,249 27,576
Merger/Legacy Combination options
granted 166,667 333,334 --
Options exercised (8,162) -- --
Options canceled -- -- (11,424)
--------------- --------------- -------------
Options outstanding at of year 1,041,480 732,975 398,392
=============== =============== =============
Options exercisable at end of year 515,090 399,941 120,634
Price range of options exercised $4.37 - $6.38
Price range of options outstanding $3.62 - $13.32 $3.62 - $13.32 $3.62 - $13.32
Total shares reserved 1,383,146 666,307 398,392
On December 31, 1996, in connection with the Merger, 266,666 shares of
contingent stock were reserved to be issued equally to Mr. Cleverly and Mr.
Hilton on the first, second and third anniversaries of the Merger, provided that
stock trading prices meet certain thresholds and that the Officer is an employee
of the Company at the time of issuance. Of these shares, 43,947 shares were
reserved to be issued to warrantholders upon exercise of the warrants. Upon
expiration, if the warrants are unexercised, the reserved shares will be issued
equally to Mr. Cleverly and Mr. Hilton. As of December 31, 1997, all price
thresholds had been exceeded, and Mr. Cleverly and Mr. Hilton were each due a
total of 44,444 shares of common stock, which were issued to them subsequent to
year end.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
The Company leases office facilities, model homes and equipment under
various operating lease agreements. Approximate future minimum lease payments
for noncancellable operating leases as of December 31, 1997 are as follows:
37
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Year Ending
December 31,
------------
1998............. $ 825,487
1999............. 425,869
2000............. 216,000
Thereafter....... 0
----------
$1,467,356
==========
Rental expense was $1,185,372 and $21,780 for the years ended December
31, 1997 and 1996, respectively.
The Company is subject to legal proceedings and claims which arise in
the ordinary course of business. In the opinion of management, the amount of
ultimate liability with respect to these actions will not materially affect the
Company's financial statements taken as a whole.
NOTE 9 - HOMEPLEX / MONTEREY MERGER AND LEGACY HOMES COMBINATION
On December 23, 1996, the stockholders of Homeplex Mortgage Investments
Corporation, now known as Monterey Homes Corporation (the "Company"), approved
the Merger (the "Merger") of Monterey Homes Construction II, Inc. and Monterey
Homes Arizona II, Inc., both Arizona corporations (collectively, the "Monterey
Entities"), with and into the Company. The Merger was effective on December 31,
1996, and the Company's focus is now on homebuilding as its primary business.
Ongoing operations of the Company are managed by the two previous stockholders
of the Monterey Entities, who at the time of the Merger became Co-Chief
Executive Officers, with one serving as Chairman and the other as President. At
consummation of the Merger, 1,288,726 new shares of common stock, $.01 par value
per share, were issued equally to the Chairman and President.
The total consideration paid by the Company for the net assets of the
Monterey Entities was $9,323,353. This amount included 1,288,726 shares of the
Company's common stock valued at $8,544,256 and $779,097 of transaction costs.
The purchase method of accounting was used by the Company, and the purchase
price was allocated among the Monterey net assets based on their estimated fair
market value at the date of acquisition, resulting in goodwill of $1,763,488,
which will be amortized over 20 years.
On May 29, 1997, the Company signed a definitive agreement with Legacy
Homes, Ltd., Legacy Enterprises, Inc. and John and Eleanor Landon (together,
"Legacy Homes"), to acquire the homebuilding and related mortgage service
business of Legacy Homes, Ltd. and its affiliates. This transaction was
effective on July 1, 1997. Legacy Homes is a builder of entry-level and move-up
homes headquartered in the Dallas/Fort Worth metropolitan area and was founded
in 1988 by its current President, John Landon.
Consideration for the Legacy Combination consisted of approximately $1.5
million in cash, 666,667 shares of the Company's common stock valued at $3.4
million and $370,000 in transaction costs. The purchase method of accounting was
used by the Company, and the purchase price was allocated among the Company's
net assets based on their estimated fair market value at the date of the
transaction, resulting in goodwill of approximately $1.5 million, which is to be
amortized over 20 years. In addition, deferred contingent payments not to exceed
$15 million will be made by the Company through the year 2001. The 1997
contingent payment was approximately $2.8 million which was recorded as goodwill
and will be amortized over 20 years.
38
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Also in connection with the Legacy transaction, John Landon entered into
a four-year employment agreement with the Company and was appointed Chief
Operating Officer and Co-Chief Executive Officer of the Company and President
and Chief Executive Officer of the Company's Texas division. Mr. Landon was also
granted an option to purchase 166,667 shares of the Company's common stock and
was elected to the Company's Board of Directors.
The following unaudited pro forma information presents a summary of
consolidated results of operations of the Company as if the Merger and the
Legacy Combination had occurred at January 1, 1996, with pro forma adjustments
together with related income tax effects. The pro forma results have been
prepared for comparative purposes only and do not purport to be indicative of
the results of operations that would actually have resulted had the combination
been in effect on the date indicated (in thousands except per share data).
Years Ended December 31,
(Unaudited)
1997 1996
---- ----
Home and land revenue............. $ 189,358 $ 172,868
Net earnings...................... $ 17,764 $ 12,525
Diluted net earnings per share ... $ 3.15 $ 2.34
NOTE 10 - INCOME TAXES
The components of income tax expense are:
1997 1996
---- ----
Current:
Federal $ 221,468 $ 18,700
State 740,448 7,862
------------- ------------
$ 961,916 $ 26,562
============= ============
Deferred income tax expense was -0- in 1997, 1996 and 1995 and current
income tax expense was -0- in 1995 due to the Company's status as a REIT in
1995.
Deferred tax assets and liabilities have been recognized in the
consolidated balance sheets due to temporary differences and carryforwards as
follows:
12/31/97 1997 12/31/96
-------- ---- --------
Net operating loss carryforward.............. $ 16,270,000 $ (4,930,000) $ 21,200,000
Residual interest basis differences.......... 970,000 (1,130,000) 2,100,000
Real estate basis differences................ 590,000 190,000 400,000
Debt issuance costs.......................... 310,000 44,000 266,000
Deductible merger/acquisition costs.......... 260,000 260,000 --
AMT credit................................... 220,000 220,000 --
Other 80,000 (5,000) 85,000
---------------- --------------- -----------------
18,700,000 (5,351,000) 24,051,000
Valuation allowance.......................... (8,266,000) 8,972,000 (17,238,000)
----------------- -------------- ------------------
10,434,000 3,621,000 6,813,000
Deferred tax liabilities..................... (30,000) -- (30,000)
----------------- -------------- ------------------
Net deferred tax asset............... $ 10,404,000 $ 3,621,000 $ 6,783,000
================ ============== =================
39
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Management of the Company believes it is more likely than not that the
results of future operations will generate sufficient taxable income to realize
the net deferred tax asset.
Reconciliation of Effective Income Tax Expense:
Income taxes differ for the years ended December 31, 1997 and 1996 from
the amounts computed using the federal statutory income tax rate as a result of
the following:
1997 1996
---- ----
Expected taxes at current federal statutory income tax rate $ 5,320,000 $ 60,000
State income taxes 740,448 7,862
Utilization of NOL (5,320,000) (60,000)
Alternative minimum tax 221,468 18,700
-------------- -----------
Income tax expense $ 961,916 $ 26,562
============== ===========
Carryforwards.
At December 31, 1997, the Company had federal and state net operating
loss carryforwards of $43 million and $27 million, respectively. The federal and
state carryforwards expire beginning in 2007 and 1998, respectively.
NOTE 11 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Unaudited quarterly consolidated financial information for the years
ended December 31, 1997 and 1996 is summarized as follows (in thousands except
per share amounts):
Net Earnings Net Earnings
Revenue (Loss) (Loss) Per Share
------- ------ ----------------
1997 - Three months ended:
March 31 $ 12,573 $ 288 $ .06
June 30 24,544 1,958 .42
September 30 42,685 5,079 .87
December 31 69,828 6,912 1.17
1996 - Three months ended:
March 31 $ 635 $ 84 $ .03
June 30 (1) 636 148 .04
September 30 530 314 .09
December 31 443 (399) (.12)
- ------------
(1) Net earnings in the second quarter of 1996 includes an extraordinary
charge of $148,000, or $.05 per share, to record the result of early
extinguishment of debt.
40
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 12 - SUBSEQUENT EVENTS
Sale of Residual Interests
On February 2, 1998, the Company sold five of the six remaining
residual interests in mortgage securities for approximately $4.6 million,
resulting in pre-tax earnings of approximately $3.2 million. The Company has
also entered into an agreement to sell the final residual interest in the second
quarter of 1998 for $2.0 million, which will result in pre-tax earnings of
approximately $2.0 million.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
On January 14, 1997, the Company's Board of Directors elected to dismiss
its independent accountants, Ernst & Young LLP, and to replace them with KPMG
Peat Marwick LLP. KPMG Peat Marwick LLP served as the independent accountants
for the Monterey Entities prior to the Merger.
Ernst & Young LLP rendered an unqualified report with respect to the
financial statements of the Company for the year ended December 31, 1995. In
addition, during the year ended December 31, 1995, there were no disagreements
between the Company and Ernst & Young LLP with respect to any matter of
accounting principles or practices, financial statement disclosure or auditing
scope or procedure.
PART III
Item 10. Directors and Executive Officers of the Registrant
Information regarding continuing directors and nominees of the Company
is set forth under the captions "Election of Directors," "Information Concerning
Directors, Nominees and Officers," and "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Registrant's Notice and Proxy Statement relating to
its 1998 Annual Meeting of Stockholders (the "1998 Proxy Statement")
incorporated by reference into this Form 10-K Report. With the exception of the
foregoing information and other information specifically incorporated by
reference into this Form 10-K Report, the Registrant's 1998 Proxy Statement is
not being filed as a part hereof.
Item 11. Executive Compensation
Information regarding executive compensation is set forth under the
captions "Executive Compensation," "Compensation Committee Interlocks and
Insider Participation," "Director Compensation" and "Employment Agreements" in
the 1998 Proxy Statement and is incorporated herein by reference into this Form
10-K report; provided, however, that the information set forth under the
captions "Compensation Committee Report on Executive Compensation" and "Stock
Price Performance Graph" contained in the 1998 Proxy Statement are not
incorporated by reference herein.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information respecting security ownership of certain beneficial owners
and management is included under the caption "Security Ownership of Principal
Stockholders and Management" in the 1998 Proxy Statement and is incorporated
herein by reference.
41
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Item 13. Certain Relationships and Related Transactions
Information respecting certain relationships and transactions of
management is set forth under the caption "Certain Transactions and
Relationships" and "Compensation Committee Interlocks and Insider Participation"
in the 1998 Proxy Statement and is incorporated herein by reference.
42
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
Page or
Method of Filing
(a) Financial Statements and Schedules
(i) Financial Statements
(1) Report of KPMG Peat Marwick LLP Page 25
(2) Consolidated Financial Statements and Notes to Consolidated Page 27
Financial Statements of the Company, including Consolidated
Balance Sheets as of December 31, 1997 and 1996 and related
Consolidated Statements of Earnings, Stockholder's Equity
and Cash Flows for each of the years in the three-year
period ended December 31, 1997
(ii) Financial Statement Schedules
Schedules have been omitted because of the absence of
conditions under which they are required or because the
required material information is included in the
Consolidated Financial Statements or Notes to the
Consolidated Financial Statements included herein.
(b) Reports on Form 8-K
No reports on Form 8-K were filed during the fourth quarter of 1997.
(c) Exhibits
Exhibit Description Page or Method of Filing
Number
2 Agreement and Plan of Reorganization, dated Incorporated by reference to Exhibit 2 of the
as of September 13, 1996, by an among Form S-4 Registration Statement No. 333-
Homeplex, the Monterey Merging Companies 15937 ("S-4 #333-15937").
and the Monterey Stockholders
2.1 Agreement of Purchase and Sale of Assets, Incorporated by reference to Exhibit 2 of the
dated as of May 29, 1997, by and among Form 8-K/A dated June 18, 1997.
Monterey, Legacy Homes, Ltd., Legacy
Enterprises, Inc., and John and Eleanor
Landon
3.1 Restated Articles of Incorporation of the Incorporated by reference to Exhibit 3.1 of the
Company Post-Effective Amendment No. 1 to the Form
S-1 Statement No. 333-29737 ("S-1 #333-
29737 Amendment No. 1).
3.2 Articles of Merger Incorporated by reference to Exhibit 3.2 to the
Form 10-K for the year ended December 31,
1996.
3.3 Amended and Restated Bylaws of the Company Incorporated by reference to Exhibit 3.3 of S-1
#333-29737 Amendment No. 1.
43
4.1 Specimen of Common Stock Certificate Incorporated by reference to Exhibit 4 to the
Form 10-K for the year ended December 31,
1996.
4.2 Warrant Agreement dated as of October 17, Previously filed.
1994 among Monterey and the Warrant Agent
4.3 Assumption Agreement dated as of December Previously filed.
31, 1996 modifying the Warrant Agreement in
certain respects, and relating to the assumption
of the Warrant Agreement by the Company
and certain other matters
4.4 Specimen Warrant Certificate Previously filed.
10.1 Subcontract Agreement between Homeplex and Incorporated by reference to Exhibit 10(b) of
American Southwest Financial Services, Inc. S-11 #33-22092.
10.2 Form of Master Servicing Agreement Incorporated by reference to Exhibit 10(c) of
S-11 #33-22092.
10.3 Form of Servicing Agreement Incorporated by reference to Exhibit 10(d) of
S-11 #33-22092.
10.4 Indenture dated October 17, 1994, as Incorporated by reference to Exhibit 10(j) of
amended, relating to 13% Senior Subordinated the S-4 #333-15937
Notes Due 2001
10.5 Master Revolving Line of Credit by and Incorporated by reference to Exhibit 10.5
between Norwest Bank Arizona, N.A. and the to the Form 10-K for the year ended December
Company 31, 1996.
10.6 Revolving Model Home Lease Back Incorporated by reference to Exhibit 10.6 to
Agreement between AMHM-1, L.P. and the the Form 10-K for the year ended December
Company 31, 1996.
10.7 Stock Option Plan* Incorporated by reference to Exhibit 10(d) of
Form 10-K for the fiscal year ended December
31, 1995 ("1995 Form 10-K").
10.8 Amendment to Stock Option Plan * Incorporated by reference to Exhibit 10(e) of
the 1995 Form 10-K.
10.9 Amendment to Stock Option Plan dated as of Previously Filed.
December 31, 1996*
10.10 Monterey Homes Corporation Stock Option Incorporated by reference to Exhibit 10.9 to
Plan the Form 10-K for the year ended December
31, 1996.
10.11 Monterey Homes Corporation 1997 Stock Previously filed.
Option Plan*
- --------------------------------------------------------------------------------
*Indicates a management contract or compensation plan.
44
10.12 Employment Agreement between the Company Incorporated by reference to Exhibit 10.10 to
and William W. Cleverly* the Form 10-K for the year ended December
31, 1996.
10.13 Employment Agreement between the Company Incorporated by reference to Exhibit 10.11 to
and Steven J. Hilton* the Form 10-K for the year ended December
31, 1996.
10.14 Employment Agreement between the Company Incorporated by reference to Exhibit C of the
and John R. Landon* Form 8-K filed on June 18, 1997.
10.15 Stock Option Agreement between the Company Incorporated by reference to Exhibit 10.12 of
and William W. Cleverly* the Form 10-K for the year ended December
31, 1996.
10.16 Stock Option Agreement between the Company Incorporated by reference to Exhibit 10.13 to
and Steven J. Hilton* the Form 10-K for the year ended December
31, 1996.
10.17 Stock Option Agreement between the Company Incorporated by reference to Exhibit C of the
and John R. Landon* Form 8-K filed on June 18, 1997.
10.18 Registration Rights Agreement between the Incorporated by reference to Exhibit 10.14 to
Company and William W. Cleverly* the Form 10-K for the year ended December
31, 1996.
10.19 Registration Rights Agreement between the Incorporated by reference to Exhibit 10.15 to
Company and Steven J. Hilton* the Form 10-K for the year ended December
31, 1996.
10.20 Registration Rights Agreement between the Incorporated by reference to Exhibit C of the
Company and John R. Landon* Form 8-K filed on June 18, 1997.
10.21 Escrow and Contingent Stock Agreement Incorporated by reference to Exhibit 10.16 of
the Form 10-K for the year ended December
31, 1996.
10.22 Amended and Restated Employment Incorporated by reference to Exhibit 10(g) of
Agreement and Addendum between the the 1995 Form 10-K.
Company and Alan D. Hamberlin*
10.23 Stock Option Agreement between the Company Incorporated by reference to Exhibit 10(h) of
and Alan D. Hamberlin* the 1995 Form 10-K.
10.24 Agreement regarding sale of residual interests Filed herewith.
between the Company and PaineWebber
45
23.1 Consent of KPMG Peat Marwick LLP Filed herewith.
23.2 Consent of Ernst and Young LLP Filed herewith.
24 Powers of Attorney See signature page.
27 Financial Data Schedules Filed herewith.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly cause this report on Form 10-K to
be signed on its behalf by the undersigned, thereunto duly authorized, this 24
day of March, 1998.
MONTEREY HOMES CORPORATION,
a Maryland Corporation
By /s/ WILLIAM W. CLEVERLY
--------------------------------------
William W. Cleverly
Chairman of the Board and
Co-Chief Executive Officer
POWER OF ATTORNEY
KNOW ALL MEN BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints William W. Cleverly, Steven J. Hilton, John R.
Landon and Larry W. Seay, and each of them, his true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for him and in his name, place and stead, in any and all
capacities, to sign any and all amendments to this Form 10-K Annual Report, and
to file the same, with all exhibits thereto and other documents in connection
therewith the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act of things requisite and necessary to be done in
and about the premises, as fully and to all intents and purposes as he might or
could do in person hereby ratifying and confirming all that said
attorneys-in-fact and agents, or his substitute or substitutes, may lawfully do
or cause to be done by virtue hereof.
Pursuant to these requirements of the Securities Exchange Act of 1934,
this report on Form 10-K has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ WILLIAM W. CLEVERLY Chairman of the Board and Co-Chief March 24, 1998
- ----------------------------- Executive Officer (Co-Principal
William W. Cleverly Executive Officer)
/s/ STEVEN J. HILTON President and Co-Chief Executive March 24, 1998
- ----------------------------- Officer (Co-Principal Executive
Steven J. Hilton Officer)
/s/ JOHN R. LANDON Chief Operating Officer and Co-Chief March 24, 1998
- ----------------------------- Executive Officer (Co-Principal
John R. Landon Executive Officer)
/s/ LARRY W. SEAY Vice President - Finance and Chief March 24, 1998
- ----------------------------- Financial Officer, Secretary and
Larry W. Seay Treasurer (Principal Financial and
Accounting Officer)
/s/ ALAN D. HAMBERLIN Director March 24, 1998
- -----------------------------
Alan D. Hamberlin
47
Signature Title Date
/s/ RAYMOND OPPEL Director March 24, 1998
- -----------------------------
Raymond Oppel
/s/ ROBERT G. SARVER Director March 24, 1998
- -----------------------------
Robert G. Sarver
/s/ C. TIMOTHY WHITE Director March 24, 1998
- -----------------------------
C. Timothy White
48