Back to GetFilings.com

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934

For the quarterly period ended September 30, 2003

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: 1-8029

THE RYLAND GROUP, INC.

24025 Park Sorrento, Suite 400
Calabasas, California 91302
818.223.7500
(Address and telephone number of principal executive offices)

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. [X] Yes   [   ] No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). [X] Yes   [   ] No

The number of shares of common stock of The Ryland Group, Inc. outstanding on November 10, 2003, was 24,723,797.

Table of Contents

THE RYLAND GROUP, INC.
FORM 10-Q
INDEX

2

Table of Contents

PART I. FINANCIAL INFORMATION
Item I. FINANCIAL STATEMENTS

CONSOLIDATED STATEMENTS OF EARNINGS (unaudited)
The Ryland Group, Inc. and subsidiaries
(in thousands, except share data)

See Notes to Consolidated Financial Statements.

3

Table of Contents

CONSOLIDATED BALANCE SHEETS
The Ryland Group, Inc. and subsidiaries
(in thousands, except share data)

See Notes to Consolidated Financial Statements.

4

Table of Contents

CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
The Ryland Group, Inc. and subsidiaries
(in thousands)

See Notes to Consolidated Financial Statements.

5

Table of Contents

THE RYLAND GROUP, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 1. Consolidated Financial Statements

The consolidated financial statements include the accounts of The Ryland Group, Inc., its wholly owned subsidiaries (“the Company”) and other entities in which the Company is the primary beneficiary (see Note 12). Intercompany transactions have been eliminated in consolidation. Certain prior year amounts have been reclassified to conform to the 2003 presentation.

The consolidated balance sheet at September 30, 2003, the consolidated statements of earnings for the three and nine months ended September 30, 2003 and 2002, and the consolidated statements of cash flows for the nine months ended September 30, 2003 and 2002, have been prepared by the Company without audit. In the opinion of management, all adjustments, which include normally recurring adjustments necessary to present fairly the Company’s financial position, results of operations and cash flows at September 30, 2003, and for all periods presented, have been made. Certain information and footnote disclosures normally included in the financial statements have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and related notes included in the Company’s 2002 annual report to its shareholders.

Assets presented in the financial statements are net of any valuation allowances.

The results of operations for the three and nine months ended September 30, 2003, are not necessarily indicative of the operating results expected for the year ended December 31, 2003.

Note 2. Segment Information

The Company is a leading national homebuilder and mortgage-related financial services firm. As one of the largest single-family on-site homebuilders in the United States, it builds homes in 27 markets. The Company’s homebuilding segment specializes in the sale and construction of single-family attached and detached housing. The Company’s financial services segment provides loan origination; title, escrow and insurance brokerage services; and maintains a portfolio of mortgage-backed securities and notes receivable. “Corporate” is a nonoperating business segment whose sole purpose is to support operations. Certain corporate expenses are allocated to the homebuilding and financial services segments. The Company evaluates performance and allocates resources based on a number of factors, including segment pretax earnings. The accounting policies of the segments are the same as those described in Note A of the Company’s 2002 annual report.

6

Table of Contents

THE RYLAND GROUP, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 3. Earnings Per Share Reconciliation

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except share data):

Note 4. Comprehensive Income

Comprehensive income consists of net income and the increase or decrease in unrealized gains or losses on the Company’s available-for-sale securities. Comprehensive income totaled $63.1 million and $47.5 million for the three months ended September 30, 2003 and 2002, respectively. Comprehensive income for the nine months ended September 30, 2003 and 2002, was $155.4 million and $118.0 million, respectively.

Note 5. Inventories

Inventories consist principally of homes under construction, land under development and improved lots. Inventories are stated at the lower of cost or fair value.

The following table is a summary of capitalized interest (in thousands):

7

Table of Contents

THE RYLAND GROUP, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Note 6. Investments in Joint Ventures

The Company routinely enters into joint ventures for the purpose of developing land in such locations as Atlanta, Dallas, Denver, Orlando, Phoenix and Washington, D.C. In most instances, the Company has less than a controlling interest in the joint venture; however, in certain instances, according to Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities,” the Company’s investment in certain joint ventures may create a variable interest in a variable interest entity (VIE), depending on the contractual terms of the arrangement, and require consolidation. FIN 46 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities and/or entitled to receive a majority of the VIE’s residual returns.

At September 30, 2003 and December 31, 2002, the Company’s investment in its unconsolidated joint ventures amounted to $12.4 million and $14.9 million, respectively. The Company’s equity in earnings of its unconsolidated joint ventures totaled $232,000 and $73,000 for the three- and nine-month periods ended September 30, 2003, compared to equity in (losses) earnings of ($72,000) and $2.7 million for the same periods ended September 30, 2002, respectively. The aggregate assets of the unconsolidated joint ventures in which the Company participated were $51.9 million and $61.0 million at September 30, 2003 and December 31, 2002, respectively. At September 30, 2003 and December 31, 2002, the aggregate debt of the unconsolidated joint ventures in which the Company participated was $24.5 million and $31.9 million, respectively. The Company does not guarantee the debt of its unconsolidated joint ventures.

Note 7. Financial Services Short-term Notes Payable

In March 2003, the Company’s financial services segment renewed and extended a revolving credit facility used to finance mortgage investment portfolio securities. The facility, previously $35.0 million, was renewed for $25.0 million. The agreement matures in March 2004, bears interest at market rates and is collateralized by collateralized mortgage obligations previously issued by one of the Company’s limited-purpose subsidiaries. Borrowings outstanding under this facility were $16.8 million and $22.8 million at September 30, 2003 and December 31, 2002, respectively.

Note 8. Long-term Debt

In June 2003, the Company issued $150.0 million of 5.38 percent senior notes, which pay interest semiannually and will mature on June 1, 2008. In July 2003, the net proceeds from this offering were used to fully redeem the $100.0 million aggregate principal from the Company’s 8.25 percent senior subordinated notes due April 1, 2008. The remaining proceeds were used for general corporate purposes. As a result of this redemption, the Company recorded a $5.1 million pretax loss associated with the early extinguishment of debt, which was recorded as interest expense in the third quarter of 2003.

Note 9. Postretirement Benefits

The Company has supplemental, nonqualified retirement plans which vest over five-year periods beginning January 1, 2003 and July 1, 2003, pursuant to which the Company will pay supplemental pension benefits to key employees upon retirement. In connection with these plans, the Company has purchased cost-recovery life insurance on the lives of certain employees. Insurance contracts associated with the plans are held by trusts, established as part of the plans to implement and carry out their provisions and finance their related benefits. The trusts are owners and beneficiaries of such contracts. The amount of coverage is designed to provide sufficient revenue to cover all costs of the plans if assumptions made as to employment term, mortality experience, policy earnings and other factors are realized. At September 30, 2003, the cash surrender value of these contracts was $3.8 million. The net periodic benefit cost for these plans for the three months ended September 30, 2003, was $954,000, which

8

Table of Contents

THE RYLAND GROUP, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

included service costs of $1.0 million, interest costs of $70,000 and investment income of $137,000. For the nine months ended September 30, 2003, the net periodic benefit cost was $2.1 million and included service costs of $2.3 million, interest costs of $171,000 and investment income of $368,000. The $2.5 million projected benefit obligation at September 30, 2003, was equal to the net liability recognized in the balance sheet at that date. For the nine-month period ended September 30, 2003, the weighted-average discount rate used for the plans was 7.9 percent.

Note 10. Stock-based Compensation

The Company has elected to follow the intrinsic value method to account for compensation expense related to the award of stock options and to furnish the pro forma disclosures required under Statement of Financial Accounting Standards No. 123 (SFAS 123), “Accounting for Stock-based Compensation,” as amended by Statement of Financial Accounting Standards No. 148. Since stock option awards are granted at prices no less than the fair market value of the shares at the date of grant, no compensation expense is recognized. Had compensation expense been determined based on fair value at the grant date for awards, consistent with the provisions of SFAS 123, the Company’s net earnings and earnings per share in the third quarter and first nine months of 2003 and 2002 would have been reduced to the pro forma amounts indicated in the following table (in thousands, except share data):

The fair value of each option grant is estimated on the grant date by using the Black-Scholes option-pricing model. The following weighted-average assumptions were used for grants during the first nine months of 2003 and 2002, respectively: a risk-free interest rate of 2.0 percent and 4.2 percent; an expected volatility factor for the market price of the Company’s common stock of 37.4 percent and 36.7 percent; a dividend yield of 0.2 percent; and an expected life of three years. The weighted-average fair values at the grant date for options granted during the nine months ended September 30, 2003 and 2002, were $11.85 and $13.66, respectively.

Note 11. Commitments and Contingencies

In the normal course of business, the Company acquires rights under option agreements to purchase land for use in future homebuilding operations. At September 30, 2003, the Company had related deposits

9

Table of Contents

THE RYLAND GROUP, INC. & SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

and letters of credit outstanding of $79.6 million for land options and land purchase contracts having a total purchase price of $1,299.7 million. At September 30, 2003, the Company had commitments with respect to option contracts containing specific performance provisions of approximately $64.8 million, compared to $68.0 million at December 31, 2002.

As an on-site housing producer, the Company is often required to obtain bonds and letters of credit in support of its contractual obligations. Some municipalities require the Company to obtain development bonds or letters of credit to assure completion of public facilities within a project. At September 30, 2003, total development bonds were $282.8 million and total related deposits and letters of credit were $46.0 million. In the event that any such bonds or letters of credit are called, the Company would be required to reimburse the issuer; however, the Company does not expect that any currently outstanding bonds or letters of credit will be called.

In November 2002, the Financial Accounting Standards Board (FASB) issued Interpretation No. 45 (FIN 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” In accordance with the provisions of FIN 45, the Company adopted its disclosure provisions on December 31, 2002. The adoption of FIN 45 did not have a material effect on the Company’s financial position or results of operations.

The Company provides its customers with product warranties covering workmanship and materials for one year, certain mechanical systems for two years and structural systems for ten years. The Company estimates and records warranty liabilities based on historical experience and known risks at the time a home closes. In the case of unexpected claims, these liabilities are based upon identification and quantification of the obligations. The Company periodically assesses the adequacy of its recorded warranty liabilities and adjusts the accruals as necessary.

Changes in the Company’s warranty reserve during the period are as follows (in thousands):

Please refer to “Part II, Other Information, Item 1. Legal Proceedings” of this document for additional information regarding the Company’s commitments and contingencies.

Note 12. New Accounting Pronouncements

In January 2003, the FASB issued Interpretation No. 46 (FIN 46), “Consolidation of Variable Interest Entities.” FIN 46 requires a variable interest entity (VIE) to be consolidated by a company if that company is subject to a majority of the risk of loss from the VIE’s activities and/or entitled to receive a majority of the VIE’s residual returns. FIN 46 also requires disclosures about VIEs that the Company is not required to consolidate but in which it has a significant variable interest and is not the primary beneficiary.

The consolidation requirements of FIN 46 applied immediately to VIEs created after January 31, 2003. For VIEs created before January 31, 2003, the consolidation requirements apply in the first fiscal year or interim period ending after December 15, 2003 (the Company’s fiscal year ending December 31, 2003).

10

Table of Contents

THE RYLAND GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Certain of the disclosure requirements apply in all financial statements issued after January 31, 2003, regardless of when the VIE was established.

As mentioned in Note 6, the Company routinely enters into joint ventures for the purpose of developing land. The Company’s investment in these joint ventures may create a variable interest in a VIE, depending on the contractual terms of the arrangement. Additionally, in the ordinary course of business, the Company enters into lot option purchase contracts in order to procure land for the construction of homes. Under such lot option purchase contracts, the Company will fund stated deposits in consideration for the right to purchase lots at a future point in time, usually at predetermined prices. In accordance with the requirements of FIN 46, certain of the Company’s lot option purchase contracts result in the creation of a variable interest with a VIE holding the land parcel under option.

Using the framework outlined in FIN 46, the Company evaluated its option contracts and the joint venture agreement it entered into after January 31, 2003. Based on its evaluation, the Company determined that, in some cases, it had the primary variable interest in certain VIEs subject to lot option contracts. While the Company may not have had legal title to the optioned land or guaranteed the seller’s debt associated with that property, under FIN 46 it had the primary variable interest and was required to consolidate the particular VIE’s assets under option at fair value. As a result, the Company consolidated $36.3 million of inventory not owned as of September 30, 2003. This represents the fair value of the optioned property because the Company was unable to obtain financial information for any of the selling entities. Additionally, to reflect the fair value of the inventory consolidated under FIN 46, the Company eliminated $2.1 million of its related cash deposits for lot option contracts, which are included in consolidated inventory not owned. Minority interest totaling $34.2 million was recorded with respect to the consolidation of these contracts, representing the selling entities’ ownership interests in these VIEs. At September 30, 2003, the Company had cash deposits and letters of credit totaling $4.9 million, representing the Company’s current maximum exposure to loss, relating to lot option contracts that were consolidated. Creditors of these VIEs, if any, have no recourse against the Company.

At September 30, 2003, the Company had cash deposits and/or letters of credit totaling $22.9 million, which were associated with lot option purchase contracts having an aggregate purchase price of $365.5 million and which were related to VIEs in which it did not have a primary variable interest.

In April 2003, the FASB issued Statement of Financial Accounting Standards No. 149 (SFAS 149), “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities under SFAS 133. This statement is effective for contracts entered into or modified after June 30, 2003. Management does not believe that the implementation of SFAS 149 will have a material impact on the Company’s financial condition or results of operations.

In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 (SFAS 150), “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” This statement establishes standards for the classification and measurement of certain financial instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the start of the first interim period beginning after June 15, 2003. Application of SFAS 150 to non-controlling interests in limited-life subsidiaries has been deferred indefinitely. Management does not believe that the implementation of SFAS 150 will have a material impact on the Company’s financial condition or results of operations.

11

Table of Contents

Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Note: Certain statements in Management’s Discussion and Analysis of Financial Condition and Results of Operations may be regarded as “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on various factors and assumptions that include such risks and uncertainties as the completion and profitability of sales reported; the market for homes generally and in areas where the Company operates; the availability and cost of land; changes in economic conditions and interest rates; the availability and increases in raw material and labor costs; consumer confidence; government regulations; and general competitive factors, all or each of which may cause actual results to differ materially.

RESULTS OF OPERATIONS

Three months ended September 30, 2003, compared to three months ended September 30, 2002

The Company reported consolidated net earnings of $63.3 million, or $2.40 per diluted share, for the third quarter of 2003, compared to consolidated net earnings of $47.4 million, or $1.70 per diluted share, for the third quarter of 2002. This net earnings increase resulted from higher volume and increased profitability for the homebuilding and financial services operations.

The Company’s revenues reached $872.2 million for the third quarter of 2003, up 19.0 percent from $732.7 million for the third quarter of 2002. Both housing and mortgage-banking revenues rose during the third quarter of 2003.

Nine months ended September 30, 2003, compared to nine months ended September 30, 2002

The Company reported consolidated net earnings of $155.5 million, or $5.85 per diluted share, for the first nine months of 2003, compared to consolidated net earnings of $118.1 million, or $4.18 per diluted share, for the nine months ended September 30, 2002. This net earnings increase resulted from higher volume and increased profitability for the homebuilding and financial services operations.

The Company’s revenues reached $2,371.9 million for the nine months ended September 30, 2003, up 21.8 percent from $1,947.5 million for the same period in 2002. Both housing and mortgage-banking revenues rose during the first nine months of 2003.

Cash and unused borrowing capacity for the Company’s homebuilding segment totaled $502.1 million at September 30, 2003, versus $480.1 million at December 31, 2002, primarily as a result of the issuance of $150.0 million of 5.38 percent senior notes in June 2003 and the increase in the borrowing capacity of the unsecured revolving credit facility from $300.0 million to $400.0 million, partially offset by the redemption of the 8.25 percent senior subordinated notes in July 2003. Consolidated inventories owned by the Company, which includes homes under construction, land under development and improved lots, grew 23.9 percent to $1,363.0 million. Stockholders’ equity increased 13.8 percent, or $94.1 million, during the first nine months of 2003.

12

Table of Contents

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

HOMEBUILDING

New orders rose 5.3 percent and 13.5 percent during the third quarter and first nine months of 2003, respectively, compared to the same periods in the prior year. The number of active communities at September 30, 2003, was 325, an increase of 8.0 percent from September 30, 2002. New orders for the three months ended September 30, 2003 increased 9.8 percent in the North, 10.2 percent in the Southeast and 6.2 percent in the West. New orders decreased 6.8 percent in Texas.