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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______________________
FORM 10-Q

SQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
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 1-36001

UCP, Inc.

(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation)
90-0978085
(IRS Employer Identification No.)
99 Almaden Blvd., Suite 400, San Jose, CA 95113
(Address of principal executive offices, including Zip Code)

(408) 207-9499
(Registrant’s telephone number, including area code)

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 S  No £
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes S  No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
£
 
Accelerated filer
£
 
Non-accelerated filer
S
 
Smaller reporting company
£
 
(Do not check if a smaller reporting company)
 
 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes £ No S
On August 7, 2014, the registrant had 7,922,216 shares of Class A common stock, par value $0.01 per share outstanding and 100 shares of Class B common stock, par value $0.01 per share outstanding.





UCP, Inc.

FORM 10-Q
For the Three and Six Months Ended June 30, 2014

TABLE OF CONTENTS
Page No.
Part I - Financial Information
 
 
 
 
 
 
 
Item 1.
Financial Statements (Unaudited)
 
 
 
 
Condensed Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013
 
 
 
 
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2014 and 2013
 
 
 
 
Condensed Consolidated Statements of Equity for the Six Months Ended June 30, 2014 and 2013
 
 
 
 
Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013
 
 
 
 
Notes to Condensed Consolidated Financial Statements
 
 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
 
 
Item 3.
Quantitative and Qualitative Disclosure About Market Risk
 
 
 
Item 4.
Controls and Procedures
 
 
 
Part II - Other Information
 
 
 
Item 1.
Legal Proceedings
 
 
 
Item 1A.
Risk Factors
 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

2


 
 
 
Item 3.
Defaults Upon Senior Securities
 
 
 
Item 4.
Mine Safety Disclosures
 
 
 
Item 5.
Other Information
 
 
 
Item 6.
Exhibits
 
 
 
Signatures
 

3





UCP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except shares and per share data)
 
 
June 30,
2014
 
December 31,
2013
Assets:
 
 
 
Cash and cash equivalents
$
39,171

 
$
87,503

Restricted cash
250

 

Real estate inventories
238,795

 
176,848

Fixed assets, net
1,383

 
1,028

Intangible assets, net
708

 

Goodwill
4,993

 

Receivables
692

 
785

Other assets
3,953

 
1,156

Total assets
$
289,945

 
$
267,320

 
 
 
 
Liabilities and equity:
 
 
 
Accounts payable and accrued liabilities
$
26,820

 
$
18,654

Debt
46,858

 
30,950

Total liabilities
73,678

 
49,604

 
 
 
 
Commitments and contingencies (Note 10)


 


 
 
 
 
  Stockholders’ Equity
 
 
 
Preferred stock, $0.01 par value; 50,000,000 authorized, no shares issued and outstanding at June 30, 2014 and December 31, 2013

 

Class A common stock, $0.01 par value; 500,000,000 authorized, 7,835,562 issued and outstanding at June 30, 2014 and 7,750,000 issued and outstanding at December 31, 2013
78

 
78

Class B common stock, $0.01 par value; 1,000,000 authorized, 100 issued and outstanding at June 30, 2014 and December 31, 2013

 

Additional paid-in capital
93,816

 
93,117

Accumulated deficit
(4,258
)
 
(1,941
)
Total UCP, Inc. stockholders’ equity
89,636

 
91,254

Noncontrolling interest
126,631

 
126,462

Total stockholders’ equity
216,267

 
217,716

Total liabilities and equity
$
289,945

 
$
267,320

 
See accompanying notes to condensed consolidated financial statements.


4


UCP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands, except shares and per share data)
 
 
Three Months Ended
 
Three Months Ended
 
Six Months Ended
 
Six Months Ended
 
June 30,
2014
 
June 30,
2013
 
June 30,
2014
 
June 30,
2013
REVENUE:
 
 
 
 
 
 
 
Homebuilding
$
50,010

 
$
20,907

 
$
75,456

 
$
25,240

Land development
12,075

 
6,815

 
12,249

 
14,285

Other revenue
1,518

 

 
1,518

 

Total revenue
63,603

 
27,722

 
89,223

 
39,525

 
 
 
 
 
 
 
 
COSTS AND EXPENSES:
 
 
 
 
 
 
 
Cost of sales - homebuilding
41,076

 
16,482

 
61,876

 
19,942

Cost of sales - land development
9,241

 
5,136

 
9,387

 
9,716

Cost of sales - other revenue
1,329

 

 
1,329

 

Sales and marketing
3,765

 
2,099

 
6,321

 
3,231

General and administrative
6,909

 
5,326

 
13,180

 
8,806

Total costs and expenses
62,320

 
29,043

 
92,093

 
41,695

Income (loss) from operations
1,283

 
(1,321
)
 
(2,870
)
 
(2,170
)
Other income, net
13

 
224

 
86

 
263

Net income (loss) before income taxes
1,296

 
(1,097
)
 
(2,784
)
 
(1,907
)
Provision for income taxes

 

 

 

Net income (loss)
$
1,296

 
$
(1,097
)
 
$
(2,784
)
 
$
(1,907
)
Net income (loss) attributable to noncontrolling interest
$
1,117

 
$
(1,097
)
 
$
(467
)
 
$
(1,907
)
Net income (loss) attributable to stockholders of UCP, Inc.
179

 

 
(2,317
)
 

Other comprehensive income (loss), net of tax

 

 

 

Comprehensive income (loss)
$
1,296

 
$
(1,097
)
 
$
(2,784
)
 
$
(1,907
)
Comprehensive income (loss) attributable to noncontrolling interest
$
1,117

 
$
(1,097
)
 
$
(467
)
 
$
(1,907
)
Comprehensive income (loss) attributable to stockholders of UCP, Inc.
$
179

 
$

 
$
(2,317
)
 
$

 
 
 


 
 
 
 
Earnings (loss) per share:
 
 
 
 
 
 
 
    Basic
$
0.02

 
$

 
$
(0.30
)
 
$

    Diluted
$
0.02

 
$

 
$
(0.30
)
 
$

 
 
 
 
 
 
 
 
Number of shares used in per share calculations:
 
 
 
 
 
 
 
    Basic
7,835,562

 

 
7,827,999

 

    Diluted
7,922,644

 

 
7,827,999

 

 
 
 
 
 
 
 
 

 See accompanying notes to condensed consolidated financial statements.


5


UCP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF EQUITY
(Unaudited)
(In thousands, except shares and per share data)

 
Members'
equity
Shares of common stock outstanding
Common stock
Additional
paid-in
capital
Accumulated
deficit
Noncontrolling
interest
Total
stockholders’
equity
 
 
Class A
Class B
Class A
Class B
 
 
 
 
Balance at December 31, 2013
$

7,750,000

100
$
78

$

$
93,117

$
(1,941
)
$
126,462

$
217,716

Class A - issuance of common stock
 
85,562

 

 
(460
)
 
(354
)
(814
)
Stock-based compensation expense
 
 
 
 
 
1,159

 
990

2,149

Net loss
 
 
 
 
 
 
(2,317
)
(467
)
(2,784
)
Balance at June 30, 2014
$

7,835,562

100

$
78

$

$
93,816

$
(4,258
)
$
126,631

$
216,267

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2012
$
102,315

 
 
 
 
 
 
 
$
102,315

Member contribution
33,956

 
 
 
 
 
 
 
33,956

Repayments of member contributions
(25,598
)
 
 
 
 
 
 
 
(25,598
)
Net loss, pre IPO
(1,907
)
 
 
 
 
 
 
 
(1,907
)
Balance at June 30, 2013
$
108,766

$

$

$

$

$

$

$

$
108,766

 
 
 
 
 
 
 
 
 
 

See accompanying notes to condensed consolidated financial statements.


6


UCP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
 
Six Months Ended June 30,
 
2014
 
2013
Operating activities:
 
 
 
Net loss
$
(2,784
)
 
$
(1,907
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Stock-based compensation
2,149

 

Abandonment of real estate inventories
173

 
12

Depreciation and amortization
268

 
113

Changes in operating assets and liabilities:
 
 
 
Real estate inventories
(48,147
)
 
(17,790
)
Receivables
155

 

Other assets
(2,362
)
 
(2,040
)
Accounts payable and accrued liabilities
1,915

 
5,555

Net cash used in operating activities
(48,633
)
 
(16,057
)
Investing activities:
 
 
 
Purchases of fixed assets
(536
)
 
(293
)
   Citizens acquisition
(14,006
)
 

   Restricted cash
(250
)
 

Net cash used in investing activities
(14,792
)
 
(293
)
Financing activities:
 
 
 
Cash contributions from member

 
33,956

Repayments of member contributions

 
(25,598
)
Proceeds from debt
37,017

 
10,011

Repayment of debt
(21,110
)
 
(10,555
)
Repurchase of Class A common stock for settlement of employee withholding taxes
(814
)
 

Net cash provided by financing activities
15,093

 
7,814

Net decrease in cash and cash equivalents
(48,332
)
 
(8,536
)
Cash and cash equivalents – beginning of period
87,503

 
10,324

Cash and cash equivalents – end of period
$
39,171

 
$
1,788


 
 
 
Supplemental disclosure of cash flow information:
 
 
 
  Debt incurred to acquire real estate inventories
$

 
$
4,691

      Accrued offering costs
$

 
$
1,678

Non-cash investing and financing activity
 
 
 
    Exercise of land purchase options acquired with acquisition of business
$
141

 
$

      Fair value of assets acquired from the acquisition of business
$
20,258

 
 
    Cash paid for the acquisition of business
$
(14,006
)
 
$

    Contingent consideration and liabilities assumed from the acquisition of business
$
6,252

 
$

 
 
 
 
    Issuance of Class A common stock for vested restricted stock units
$
2,074

 
$


See accompanying notes to condensed consolidated financial statements.


7



UCP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)
 
1.    Organization, Basis of Presentation and Summary of Significant Accounting Policies

As used in this report, unless the context otherwise requires or indicates, references to “the Company”, “we”, “our” and “UCP” refer (1) prior to the July 23, 2013 completion of the initial public offering of Class A common stock, par value $0.01 per share ( “Class A common stock”) of UCP, Inc. (the “IPO”) and related transactions, to UCP, LLC and its consolidated subsidiaries and (2) after the IPO and related transactions, to UCP, Inc. and its consolidated subsidiaries including UCP, LLC. UCP, Inc. had nominal assets and no liabilities, and conducted no operations prior to the completion of the Company’s IPO. Presentation of the historical results of UCP, Inc. alone would not be meaningful and accordingly the historical financial information prior to the IPO represents those of UCP, LLC.
 
Business Description and Organizational Structure of the Company:

Company’s Business
The Company is a homebuilder and land developer with land acquisition and entitlement expertise in California, Washington State, North Carolina, South Carolina, and Tennessee.

Company’s History

The Company’s operations began in 2004, and principally focused on acquiring land, entitling and developing it for residential construction, and selling residential lots to third-party homebuilders. In January 2008, the Company’s business was acquired by PICO Holdings, Inc. (“PICO”), a NASDAQ -listed, diversified holding company, which allowed the Company to accelerate the development of its business with a capital partner capable of funding its growth. In 2010, the Company formed Benchmark Communities, LLC, its wholly owned homebuilding subsidiary, to design, construct and sell high quality single-family homes. On April 10, 2014, the Company completed the acquisition of the assets of Citizens Homes, Inc.’s (the “Citizens Acquisition”), in order to position the Company to expand its operations into markets located in North Carolina, South Carolina and Tennessee.

Company’s Reorganization and the IPO

Historically, we operated our business through UCP, LLC and its subsidiaries, which, prior to our IPO, were indirect wholly owned subsidiaries of PICO. In anticipation of our IPO, UCP, Inc. was incorporated in the State of Delaware on May 7, 2013, as a wholly- owned subsidiary of PICO. UCP, Inc. is a holding company, whose principal asset is its interest in UCP, LLC. As of June 30, 2014, UCP, Inc. held a 42.5% economic interest in UCP, LLC and PICO held the remaining 57.5% economic interest in UCP, LLC.
Basis of Presentation

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All intercompany accounts have been eliminated upon consolidation.
The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X and should be read in conjunction with the Company's audited financial statements for the year ended December 31, 2013, which are included in our annual report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 17, 2014. The accompanying unaudited condensed consolidated financial statements include all adjustments (consisting of normal recurring entries) necessary for the fair presentation of the Company’s results for the interim periods presented. These consolidated and segment results are not necessarily indicative of the Company’s future performance.

The consolidated financial statements for the period prior to the completion of the Company’s IPO, which was completed on July 23, 2013, have been prepared on a stand-alone basis and have been derived from PICO’s consolidated financial statements and accounting records. These stand-alone financial statements have been prepared using the historical results of operations and assets and liabilities attributed to the Company’s operations.

8



As an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012, the Company has taken advantage of certain temporary exemptions from various reporting requirements, including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act and reduced disclosure obligations regarding executive compensation in its periodic reports and proxy statements. These exemptions will apply until the last day of the fiscal year following the fifth anniversary of the completion of our IPO, although we may lose our status as an emerging growth company and the related exemptions earlier upon the occurrence of certain events.
       
Use of Estimates in Preparation of Financial Statements:
 
The preparation of condensed consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses for each reporting period. The significant estimates made in the preparation of the Company’s condensed consolidated financial statements relate to the assessment of real estate impairments, valuation of assets and liabilities acquired, warranty reserves, income taxes and contingent liabilities. While management believes that the carrying value of such assets and liabilities are appropriate as of June 30, 2014 and December 31, 2013, it is reasonably possible that actual results could differ from the estimates upon which the carrying values were based.
 
Related Party Transactions:

Prior to the IPO, we were a wholly owned subsidiary of PICO. In addition, as of June 30, 2014, PICO holds an economic and voting interest in our Company equal to approximately 57.5%. In connection with the IPO, the Company entered into the Exchange Agreement, Investor Rights Agreement, Tax Receivable Agreement, (“TRA”) and Transition Services Agreement, (“TSA”) with PICO. The Company also entered into a Registration Rights Agreement with PICO, with respect to the shares of its Class A common stock that it may receive in exchanges made pursuant to the Exchange Agreement. In connection with the IPO, the amendment and restatement of UCP, LLC's Amended and Restated Limited Liability Company Operating Agreement was approved by PICO, the sole member of UCP, LLC prior to completion of the IPO.


Segment Reporting:

The Company determined that its operations are organized into two reportable segments: homebuilding and land development. In accordance with the aggregation criteria defined in the applicable accounting guidance, the Company considered similar economic and other characteristics, including product types, average selling prices, gross margins, production processes, suppliers, subcontractors, regulatory environments, land acquisition results and underlying supply and demand in determining its reportable segments.

Cash and Cash Equivalents and Restricted Cash:

Cash and cash equivalents include highly liquid instruments purchased with original maturities of three months or less.

Our cash items that are restricted as to withdrawal or usage include deposits of $250,000 and $0 as of June 30, 2014 and December 31, 2013, respectively. The balance as of June 30, 2014 was related to funds deposited with financial institutions as collateral for credit card agreements.


Capitalization of Interest:

The Company capitalizes interest to real estate inventories during the period of development. Interest capitalized as a cost of real estate inventories is included in cost of sales-homebuilding or cost of sales-land development as related homes or real estate are sold. To the extent the Company’s debt exceeds the cost of the related asset under development, the Company expenses that portion of the interest incurred. Qualifying assets include projects that are actively selling or under development.
 
Real Estate Inventories and Cost of Sales:
 
The Company capitalizes pre-acquisition costs, the purchase price of real estate, development costs and other allocated costs, including interest, during development and home construction. Pre-acquisition costs, including non-refundable land deposits, are expensed to cost of sales when the Company determines continuation of the related project is not probable.
 

9



Land, development and other common costs are typically allocated to real estate inventories using the relative-sales-value method. Direct home construction costs are recorded using the specific identification method. Cost of sales-homebuilding includes the allocation of construction costs of each home and all applicable land acquisition, real estate development, capitalized interest, and related common costs based upon the relative-sales-value of the home. Changes to estimated total development costs subsequent to initial home closings in a community are generally allocated on a relative-sales-value method to remaining homes in the community. Cost of sales-land development includes land acquisition and development costs, capitalized interest, impairment charges, abandonment charges for projects that are no longer economically viable, and real estate taxes. Abandonment charges during the three months ended June 30, 2014 and 2013 were $140,000 and $3,000, respectively, and were $173,000 and $12,000 during the six months ended June 30, 2014 and 2013, respectively. Abandonment charges are included in cost of sales in the accompanying condensed consolidated statement of operations and comprehensive income (loss) for the respective period. These charges were related to the Company electing not to proceed with one or more land acquisitions after due diligence. Real estate inventories are stated at cost, unless the carrying amount is determined not to be recoverable, in which case real estate inventories are written down to fair value.

All real estate inventories are classified as held until the Company commits to a plan to sell the real estate, the real estate can be sold in its present condition, is being actively marketed for sale, and it is probable that the real estate will be sold within the next twelve months. At June 30, 2014 and December 31, 2013, the Company had real estate inventories of $23.7 million and $8.6 million, respectively, classified as held for sale.

Impairment of Real Estate Inventories:

The Company evaluates for an impairment loss when conditions exist where the carrying amount of real estate may not be fully recoverable. Indicators of impairment include, but are not limited to, significant decreases in local housing market values and selling prices of comparable homes, significant decreases in gross margins and sales absorption rates, costs in excess of budget, and actual or projected cash flow losses. If indicators of impairment are present, the Company prepares and analyzes undiscounted cash flows at the lowest level for which there is identifiable cash flows that are independent of the cash flows of other groups of assets.

When estimating undiscounted future cash flows of its real estate assets, the Company makes various assumptions, including: (i) expected sales prices and sales incentives to be offered, including the number of homes available on the market, pricing and incentives being offered by us or other builders in other communities, and future sales price adjustments based on market and economic trends; (ii) expected sales pace and cancellation rates based on local housing market conditions, competition and historical trends; (iii) costs incurred to date and expected to be incurred, including, but not limited to, land and land development costs, home construction costs, interest costs, indirect construction costs, and selling and marketing costs; (iv) alternative product offerings that may be offered that could have an impact on sales pace, sales price and/or building costs; and (v) alternative uses for the property. The Company did not have any real estate assets for which the estimated undiscounted future cash flows were not in excess of their carrying values.

If events or circumstances indicate that the carrying amount is impaired, such impairment will be measured based upon the difference between the carrying amount and the fair value of such assets determined using the estimated future discounted cash flows, excluding interest charges, generated from the use and ultimate disposition of the respective real estate inventories. Such losses, if any, are reported within cost of sales. No such losses were recorded during the three and six months ended June 30, 2014 and 2013.

















10



Purchase Accounting
When acquiring a business, we allocate the purchase price of real estate to the tangible and intangible assets and liabilities acquired based on their estimated fair values. In making estimates of fair values for this purpose, we use a number of sources, including independent appraisals and information obtained about each property as a result our pre-acquisition due diligence and its marketing and housing activities.


Goodwill and Other Intangible Assets:
 

The purchase price of an acquired company is allocated between intangible assets and the net tangible assets of the acquired business with the residual purchase price recorded as goodwill. The determination of the value of the assets acquired and liabilities assumed involves certain judgments and estimates. These judgments can include, but are not limited to, the cash flows that an asset is expected to generate in the future and the appropriate weighted average cost of capital.

 
Acquired intangible assets with determinable useful lives are amortized on a straight-line basis over the estimated remaining useful lives, ranging from six months to five years, or added to the value of the land when an option intangible is used to purchase the related land, or expensed in the period when the option is cancelled. Acquired intangible assets with contractual terms are generally amortized over their respective contractual lives. When certain events or changes in operating conditions occur, an impairment assessment is performed for the intangible assets. Goodwill is not amortized, but is evaluated annually for impairment, or when indicators of a potential impairment are present. The annual evaluation for impairment of goodwill is based on valuation models that incorporate assumptions and internal projections of expected future cash flows and operating plans. As of June 30, 2014, acquired intangibles, including goodwill, relate to the Citizens Acquisition, which was completed on April 10, 2014. See Note 5 “Acquisitionfor further discussion of intangible assets.




Fixed Assets, Net:

Fixed assets are carried at cost, net of accumulated depreciation.  Depreciation is computed using the straight-line method over the estimated useful lives of the assets.  Computer software and hardware are depreciated over three years, office furniture and fixtures are depreciated over seven years, vehicles are depreciated over five years and leasehold improvements are depreciated over the shorter of their useful life or lease term and range from one to three years.  Maintenance and repairs are charged to expense as incurred, while significant improvements are capitalized.  Depreciation expense is included in general and administrative expenses, and gains or losses on the sale of fixed assets are included in other income in the accompanying condensed consolidated statement of operations and comprehensive income (loss).

         

Receivables:

Receivables include amounts due from buyers for homes sold on the last day of the month and from utility companies for reimbursement of costs. At June 30, 2014 and December 31, 2013, the Company had no allowance for doubtful accounts recorded.


Other Assets:

The detail of other assets is set forth below (in thousands):
 
 
June 30, 2014
 
December 31, 2013
Customer deposits in escrow
$
621

 
$
350

Prepaid expenses
2,707

 
441

Other deposits
625

 
365

 
$
3,953

 
$
1,156

 


11



Homebuilding, Land Development Sales and other revenues and Profit Recognition:
 
In accordance with Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”) Topic 360 - Property, Plant, and Equipment, revenue from home sales and other real estate sales are recorded and any profit is recognized when the respective sales are closed. Sales are closed when all conditions of escrow are met, title passes to the buyer, appropriate consideration is received and collection of associated receivables, if any, is reasonably assured and the Company has no continuing involvement with the sold asset. The Company does not offer financing to buyers. Sales price incentives are accounted for as a reduction of revenues when the sale is recorded. If the earnings process is not complete, the sale and any related profits are deferred for recognition in future periods. Any profit recorded is based on the calculation of cost of sales at the closing date, which is dependent on an allocation of costs.

In addition to homebuilding and land development, with the completion of the Citizens Acquisition, the Company now enters into construction management agreements to provide construction services which is included in other revenues, whereby the Company builds homes on behalf of property owners. The property owners fund all project costs incurred by the Company to build the homes. The Company primarily enters into “cost plus fee” contracts where it charges property owners for all direct and indirect costs plus a negotiated management fee. The management fee is typically a fixed fee based on a percentage of the cost or home sales revenue of the project, depending on the terms of the agreement with the property owners. In accordance with ASC Topic 605, Revenue Recognition, revenues from construction management services are recognized over a cost-to-cost approach in applying the percentage-of-completion method. Under this approach, revenue is earned in proportion to total costs incurred, divided by total costs expected to be incurred. The total estimated cost plus the management fee represents the total contract value. The Company recognizes revenue based on the actual costs incurred, plus the portion of the management fee it has earned to date. In the course of providing its services, the Company routinely subcontracts for services and incurs other direct costs on behalf of the property owners. These costs are included in the Company’s cost of revenue.



12




Stock-Based Compensation:

Stock-based compensation expense is measured at the grant date based on the fair value of the award adjusted for estimated forfeitures and is recognized as expense over the period in which the stock based compensation vests.

Warranty Reserves:
 
Estimated future direct warranty costs are accrued and charged to cost of sales-homebuilding in the period in which the related homebuilding revenue is recognized. Amounts accrued are based upon estimates of the amount the Company expects to pay for warranty work. The Company assesses the adequacy of its warranty reserves on a quarterly basis and adjusts the amounts recorded, if necessary. Warranty reserves are included in accounts payable and accrued liabilities in the accompanying condensed consolidated balance sheets.

A summary of changes in warranty reserves are detailed in the table set forth below (in thousands):
 
Three Months Ended June 30,
Six Months Ended June 30,
 
2014
 
2013
2014
 
2013
Warranty reserves, beginning of period
$
694

 
$
162

$
608

 
$
141

Warranty reserves accrued
361

 
147

491

 
170

Warranty expenditures
(31
)
 
(4
)
(75
)
 
(6
)
Warranty reserves, end of period
$
1,024

 
$
305

$
1,024

 
$
305


Consolidation of Variable Interest Entities:

The Company enters into purchase and option agreements for the purchase of real estate as part of the normal course of business. These purchase and option agreements enable the Company to acquire real estate at one or more future dates at pre-determined prices. The Company believes these acquisition structures reduce its financial risk associated with real estate acquisitions and holdings and allow the Company to better manage its cash position.

Based on the relevant accounting guidance, the Company concluded that when it enters into a purchase agreement to acquire real estate from an entity, a variable interest entity (“VIE”), may be created. The Company evaluates all option and purchase agreements for real estate to determine whether they are a VIE. The applicable accounting guidance requires that for each VIE, the Company assess whether it is the primary beneficiary and, if it is, consolidate the VIE in its condensed consolidated financial statements in accordance with ASC Topic 810 - Consolidations, and reflect such assets and liabilities as “Real estate inventories not owned.”

In order to determine if the Company is the primary beneficiary, it must first assess whether it has the ability to control the activities of the VIE that most significantly impact its economic performance. Such activities include, but are not limited to, the ability to determine the budget and scope of land development work, if any; the ability to control financing decisions for the VIE; the ability to acquire additional land into the VIE or dispose of land in the VIE not under contract with us; and the ability to change or amend the existing option contract with the VIE. If the Company is not determined to control such activities, the Company is not considered the primary beneficiary of the VIE. If the Company does have the ability to control such activities, the Company will continue its analysis by determining if it is also expected to absorb a potentially significant amount of the VIE’s losses or, if no party absorbs the majority of such losses, if the Company will benefit from a potentially significant amount of the VIE’s expected gains.

In substantially all cases, creditors of the entities with which the Company has option agreements have no recourse against the Company and the maximum exposure to loss on the applicable option or purchase agreements is limited to non-refundable option deposits and any capitalized pre-acquisition costs. Some of the Company’s option or purchase deposits may be refundable to the Company if certain contractual conditions are not performed by the party selling the lots. The Company did not consolidate any land under option irrespective of whether a VIE was or was not present at June 30, 2014 or December 31, 2013.

Price Participation Interests:
 
Certain land purchase contracts and other agreements include provisions for additional payments to the sellers. These additional payments are contingent on certain future outcomes, such as, selling homes above a certain preset price or achieving an

13



internal rate of return above a certain preset level. These additional payments, if triggered, are accounted for as cost of sales when they become due, however, they are neither fully determinable, nor due, until the transfer of title to the buyer is complete. Accordingly, no liability is recorded until the sale is complete.

Income Taxes:
 
The Company’s provision for income tax expense includes federal and state income taxes currently payable and those deferred because of temporary differences between the income tax and financial reporting bases of the assets and liabilities.  The liability method of accounting for income taxes also requires the Company to reflect the effect of a tax rate change on accumulated deferred income taxes in income in the period in which the change is enacted.

In assessing the realization of deferred income tax assets, the Company considered whether it is more likely than not that any deferred income tax assets will be realized.  The ultimate realization of deferred income tax assets is dependent upon the generation of future taxable income during the period in which temporary differences become deductible.  If it is more likely than not that some or all of the deferred income tax assets will not be realized a valuation allowance is recorded. The Company considered many factors when assessing the likelihood of future realization of its deferred tax assets, including recent cumulative earnings experience by taxing jurisdiction, expectations of future transactions, the carryforward periods available to the Company for tax reporting purposes, historical use of tax attributes, and availability of tax planning strategies. These assumptions require significant judgment about future events however, they are consistent with the plans and estimates the Company uses to manage the underlying businesses.  In evaluating the objective evidence that historical results provide, the Company considered three years of cumulative operating income or loss.

As a result of the analysis of all available evidence as of June 30, 2014 and December 31, 2013, the Company recorded a full valuation allowance on its net deferred tax assets.  Consequently, the Company reported no income tax benefit for the three or six month period ended June 30, 2014 or for the comparable periods in the prior year. If the Company’s assumptions change and the Company believes it will be able to realize these attributes, the tax benefits relating to any reversal of the valuation allowance on deferred tax assets will be recognized as a reduction of income tax expense.  If the assumptions do not change, each period the Company could record an additional valuation allowance on any increases in the deferred tax assets.

The Company recognizes any uncertain income tax positions on income tax returns at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority.  An uncertain income tax position will not be recognized unless it has a greater than 50% likelihood of being sustained. The Company recognizes any interest and penalties related to uncertain tax positions in income tax expense.

Noncontrolling Interest:

The Company reports the share of the results of operations that are attributable to other owners of its consolidated subsidiaries that are less than wholly-owned, as noncontrolling interest in the accompanying condensed consolidated financial statements.  In the condensed consolidated statements of operations and comprehensive income (loss), the income or loss attributable to the noncontrolling interest is reported separately, and the accumulated income or loss attributable to the noncontrolling interest, along with any changes in ownership of the subsidiary, is reported as a component of total equity.  For the three and six months ended June 30, 2014, the noncontrolling interest reported in the condensed consolidated statement of operations and comprehensive income (loss) includes PICO’s share of approximately 57.5% of the income (loss) related to UCP, LLC adjusted for $647,000 and $2.0 million of general and administrative expenses not allocable to the noncontrolling interest. The noncontrolling interest reported in the condensed consolidated statement of operations and comprehensive income (loss) was  100% prior to the completion of the IPO for the three and six months periods ended June 30, 2013 - see Note 12 - “Noncontrolling Interest”.


14



       
Recently Issued Accounting Standards:

 
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which provides guidance for revenue recognition. ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets and supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition,” and most industry-specific guidance. This ASU also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition-Construction-Type and Production-Type Contracts.” The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 is effective for the Company beginning November 1, 2017 and, at that time the Company may adopt the new standard under the full retrospective approach or the modified retrospective approach. Early adoption is not permitted. We are currently evaluating the method and impact the adoption of ASU 2014-09 will have on the Company’s condensed consolidated financial statements and disclosures.




2.    Income (Loss) per share

Basic earnings (loss) per share of Class A common stock is computed by dividing net income/ (loss) attributable to UCP, Inc. by the weighted average number of shares of Class A common stock outstanding during the period. Diluted earnings or loss per share of Class A common stock is computed similarly to basic earnings or loss per share except the weighted average shares outstanding are increased to include additional shares from the assumed exercise of any Class A common stock equivalents using the treasury method, if dilutive. The Company’s restricted stock units (“RSUs”) and stock options (“Options”) are considered common stock equivalents for this purpose. The number of additional shares of Class A common stock related to these common stock equivalents is calculated using the treasury stock method. 87,082 incremental common stock equivalents were included in calculating diluted earnings per share for the three months ended June 30, 2014. No incremental common stock equivalents were included in calculating diluted earnings per share for the six months ended June 30, 2014 because such amounts were anti-dilutive given the net loss attributable to UCP, Inc.’s stockholders for the six months ended June 30, 2014.

All losses prior to and up to the IPO were entirely allocable to noncontrolling interest. Consequently, only the loss allocable to UCP, Inc. is included in the net loss attributable to the holders of Class A common stock for the three and six months ended June 30, 2014. Basic and diluted net loss per share of Class A common stock for the three and six months ended June 30, 2014 have been computed as follows (in thousands, except share and per share amounts):
 

15



 
For the three month period ended June 30, 2014
For the six month period ended June 30, 2014
 

Numerator
 
 
 
Net income (loss) attributable to stockholders of UCP, Inc.
 
$
179

$
(2,317
)
 
 
 
 
Denominator
 
 
 
Weighted average shares of Class A common stock outstanding - basic
 
7,835,562

7,827,999

 
 
 
 
Effect of dilutive securities:
 
 
 
    Restricted stock units
 
87,082


    Stock options
 


Total shares for purpose of calculating diluted net income (loss) per share
 
7,922,644

7,827,999

 
 
 
 
Earnings (loss) per share:
 
 
 
    Net income (loss) per share of Class A common stock - basic
 
$
0.02

$
(0.30
)
    Net income (loss) per share of Class A common stock - diluted
 
$
0.02

$
(0.30
)
 
 
 
 
The following potential common shares were excluded from the computation of diluted net income (loss) per share because their effect would have been anti-dilutive:
 
 
 
 
 
For the three month period ended June 30, 2014
For the six month period ended June 30, 2014
    Restricted stock units
 
267,683

332,976

    Stock options
 
166,081

113,779




3.    Real Estate Inventories
 
Real estate inventories consisted of the following (in thousands):
  
June 30, 2014
 
December 31, 2013
Deposits and pre-acquisition costs
$
4,923

 
$
4,517

Land held and land under development
150,394

 
117,808

Homes completed or under construction
73,172

 
46,639

Model homes
10,306

 
7,884

 
$
238,795

 
$
176,848

 
Homes completed or under construction and model homes include all costs associated with home construction, including land, development, indirect costs, permits and fees, and vertical construction. Land under development includes costs incurred during site development, such as land, development, indirect costs and permits. As of June 30, 2014, the Company had $4.2 million of deposits pertaining to land purchase contracts for 1,056 lots with an aggregate purchase price of approximately $98.6 million.

Interest Capitalization
 
Interest is capitalized on real estate inventories during development. Interest capitalized is included in cost of sales as related sales are recognized. For the three months ended June 30, 2014 and 2013 interest incurred was $467,000 and $624,000, respectively, and for the six months ended June 30, 2014 and 2013 interest incurred was $877,000 and $1.3 million, respectively. Interest was fully capitalized in each respective period. Amounts of interest expense capitalized to home inventory and land inventory were as follows (in thousands): 

16



 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Interest expense capitalized as cost of home inventory
$
412

 
$
490

 
$
760

 
$
887

Interest expense capitalized as cost of land inventory
55

 
134

 
117

 
403

Total interest expense capitalized
467

 
624

 
877

 
1,290

Previously capitalized interest expense included in cost of sales - homebuilding
(1,035
)
 
(296
)
 
(1,473
)
 
(358
)
Previously capitalized interest expense included in cost of sales - land development
(3
)
 
(5
)
 
(3
)
 
(7
)
Net activity of capitalized interest
(571
)
 
323

 
(599
)
 
925

Capitalized interest expense in beginning inventory
6,310

 
5,222

 
6,338

 
4,620

Capitalized interest expense in ending inventory
$
5,739

 
$
5,545

 
$
5,739

 
$
5,545


4.    Fixed Assets, Net
 
Fixed assets consisted of the following (in thousands): 
  
June 30, 2014
 
December 31, 2013
Computer hardware and software
$
1,069

 
$
1,118

Office furniture, equipment and leasehold improvements
926

 
337

Vehicles
78

 
79

 
2,073

 
1,534

Accumulated depreciation
(690
)
 
(506
)
Fixed assets, net
$
1,383

 
$
1,028

 
Depreciation expense for the three months ended June 30, 2014 and 2013 was $97,000 and $62,000, respectively, and for the six months ended June 30, 2014 and 2013 was $184,000 and $113,000, respectively, and is recorded in general and administrative expenses in the accompanying condensed consolidated statements of operations and comprehensive income (loss).


5. Acquisition

On April 10, 2014, the Company completed the acquisition of the assets and liabilities of Citizens Homes, Inc (“Citizens”) used in the purchase of real estate and the construction and marketing of residential homes in North Carolina, South Carolina and Tennessee, pursuant to a Purchase and Sale Agreement, dated March 25, 2014 between UCP, LLC and Citizens. Accordingly, the results of Citizens are included in the Company’s condensed consolidated financial statements from the date of the acquisition. For the period from April 10, 2014 to June 30, 2014, the revenues and net income attributable to Citizens were $10.2 million and $85,000, respectively. This net income does not include any allocation of corporate costs. The Citizens Acquisition provides increased scale and presence in established markets with immediate revenue opportunities through an established backlog. Additional synergies are expected in the areas of purchasing leverage and integrating the best practices in operational effectiveness.

The Citizens Acquisition was accounted for as an acquisition of an ongoing business in accordance with ASC Topic 805 - Business Combinations (“ASC 805”), where the Company was treated as the acquirer and the acquired assets and assumed liabilities were recorded by the Company at their preliminary estimated fair values. The total purchase price of the assets acquired and assumed liabilities included; real estate inventory, architectural plans, deposits, trade name and land option intangibles, fixed assets, and accounts payable. The acquisition date estimated fair value of the consideration transferred totaled $18.7 million, which consisted of the following (in thousands):

Cash
$
14,006

Contingent consideration
4,644

  Total
$
18,650



17




The contingent consideration arrangement requires the Company to pay up to a maximum of $6.0 million of additional consideration based upon the newly acquired Citizens’ business achievement of various pre-tax net income performance milestones (“performance milestones”) over a five year period commencing on April 1, 2014. Payout calculations are made based on calendar year performance except for the 6th payout calculation which will be calculated based on the achievement of performance milestones from January 1, 2019 through March 25, 2019. Payouts are to be made on an annual basis. The potential undiscounted amount of all future payments that the Company could be required to make under the contingent consideration arrangement is between $0 and $6.0 million. The estimated fair value of the contingent consideration of $4.6 million was estimated based on applying the income approach and a weighted probability of achievement of the performance milestones. The estimated fair value of the contingent consideration was calculated by using a Monte Carlo simulation. The fair value of the contingent consideration was then estimated to be the arithmetic average of all simulation paths. The model was based on forecast adjusted net income over the contingent consideration period. The measurement is based on significant inputs that are not observable in the market, which ASC Topic 820 - Fair Value Measurements, refers to as Level 3 inputs. Key assumptions include: (1) forecasted adjusted net income over the contingent consideration period, (2) risk-adjusted discount rate reflecting the risk inherent in the forecasted adjusted net income, (3) risk-free interest rates, (4) volatility of adjusted net income, and (5) the Company’s credit spread. The risk adjusted discount rate for adjusted net income was 15.7% plus the applicable risk-free rate resulting in a combined discount rate ranging from 15.8% to 17% over the contingent consideration period. The Company’s volatility rate of 28.2% and a credit spread of 3.11% were applied to forecast adjusted net income over the contingent consideration period.

The following table summarizes the calculation of the preliminary estimated fair value of the assets and liabilities assumed at the acquisition date (in thousands):

Assets acquired

Accounts receivable
$
62

Prepaids and other current assets
409

Real estate inventories
13,832

Deposits
26

Fixed assets
3

Architectural plans
170

Trademark/Trade name
180

Land options
583

Total assets acquired
$
15,265

Liabilities assumed
 
Customer deposits
$
(27
)
Deferred revenue
(111
)
Accounts payable
(1,470
)
Total liabilities assumed
(1,608
)
 
 
Total net identifiable assets acquired
13,657

Goodwill
4,993

Total estimated fair value
$
18,650


The acquired assets and assumed liabilities were recorded by the Company at their initial estimated fair values. The Company estimated fair values with the assistance of preliminary appraisals or valuations performed by independent third party specialists, discounted cash flow analysis, and other estimates made by management. To the extent the consideration transferred exceeded the fair value of net assets acquired, such excess was assigned to goodwill.
Accounts receivables, other assets, fixed assets and accounts payable, and accrued and other liabilities were generally stated at historical carrying values given the short-term nature of these assets and liabilities in accordance with ASC 805.


18



The Company determined the fair value of real estate inventory on a lot-by-lot basis primarily using a combination of market comparable land transactions, where available, and discounted cash flow models. These estimated cash flows are significantly impacted by estimates related to expected average home selling prices and sales incentives, expected sales pace and cancellation rates, expected land development and construction timelines, and anticipated land development, construction, and overhead costs.
The following table outlines the key assumptions used to determine the fair value of real estate inventory.
Real Estate Inventories - Methodology and Significant Input Assumptions
 
 
Method
Home comparable sales and discounted cash flow models
Home comparable range of base price per square foot
$ 77- $118 per square foot
Average discount rate applied
15%
Range of builder profit margin
18-24%
Builder profit margin applied
20%

The fair values for acquired intangible assets were estimated based on preliminary valuations performed by independent valuation specialists. The $170,000 of intangible architectural plan assets will generally be amortized over five years and $180,000 of trademark and trade name intangibles will be amortized over a six month period. The $583,000 of land option intangibles will be added to the value of the land when the option is used to purchase the related land. A land option intangible if cancelled will be expensed in the period in which such option is cancelled.
As of the acquisition date, goodwill largely consisted of the expected economic value attributable to the assembled workforce relating to Citizens Acquisition as well as estimated economic value attributable to expected synergies resulting from the acquisition.
The Company has presented its preliminary estimates of the fair values of the assets acquired and liabilities assumed in the Citizens Acquisition as of June 30, 2014. The Company is in the process of finalizing its review and evaluation of the appraisal and related valuation assumptions supporting its fair value estimates for all of the assets acquired and liabilities assumed in the Citizens Acquisition and, therefore, the estimates used herein are subject to change. This may result in adjustments to the values presented above for assets and liabilities and a corresponding adjustment to goodwill. As such, the Company has not completed the assignment of goodwill to reporting units or its determination of the amount of goodwill that is expected to be deductible for tax purposes at this time.

Acquisition related costs directly related to the Citizens Acquisition, totaled approximately $180,000 and $640,000 for the three and six months ended June 30, 2014, respectively, are included in the condensed consolidated statements of operations and comprehensive income (loss) within general and administrative expenses. Such costs were expensed in the period incurred.
Three of the former employees of Citizens who have joined the Company have minority interests in land and general contracting operations that are either under option or contract with Citizens which were disclosed, and approved by the Company as part of the Citizens acquisition.

Pro Forma Financial Information
The pro forma financial information in the table below summarizes the results of operations for UCP as though the Citizens Acquisition was completed as of January 1, 2013. The pro forma financial information for all periods presented includes additional amortization charges from acquired intangible assets (certain of which are preliminary). The pro forma results do not reflect any cost savings, operating synergies or revenue enhancements that the Company may achieve as a result of the acquisition, the costs to integrate the operations of the assets acquired in the Citizens Acquisition, or the costs necessary to achieve these cost savings, operating synergies and revenue enhancements. Certain other adjustments, including those related to conforming accounting policies and adjusting acquired real estate inventory to fair value, have not been reflected in the supplemental pro forma operating results due to the impracticability of estimating such impacts.
The pro forma financial information as presented below is for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisitions had taken place at the beginning of fiscal 2013, or indicative of the results that will be attained in the future.


19



(In thousands, except shares and per share data)
Three Months Ended
Six Months Ended
 
June 30, 2014
June 30, 2013
June 30, 2014
June 30, 2013
 
 
Total revenues
$
64,328

$
36,038

$
99,825

$
55,117

Comprehensive income (loss)
$
1,186

$
(1,401
)
$
(2,465
)
$
(2,964
)
Comprehensive income (loss) attributable to stockholders of UCP, Inc.
$
169


$
(2,146
)

Net income (loss) per share - basic
$
0.02

 
$
(0.27
)
 
Net income (loss) per share - diluted
$
0.02

 
$
(0.27
)
 

Pro forma earnings for the three and six month periods ended June 30, 2014, were adjusted to exclude approximately $180,000 and $640,000 of acquisition-related costs incurred in the three and six month period ended June 30, 2014, respectively.


Intangible Assets

Other purchased intangible assets consisted of the following (in thousands): 
 
June 30, 2014
 
December 31, 2013
 
Gross Carrying Amount
Accumulated Amortization(Use)
Net Carrying Value
 
Gross Carrying Amount
Accumulated Amortization (Use)
Net Carrying Value
Architectural plans
$
170

$
(8
)
$
162

 
$

$

$

Land option
583

(141
)
442

 



Trademarks and trade names
180

(76
)
104

 



 
$
933

$
(225
)
$
708

 
$

$

$

 

Amortization expense for the three months ended June 30, 2014 and 2013 related to the architectural and trademarks and trade name intangibles was $84,000 and $0, respectively, and for the six months ended June 30, 2014 and 2013 was $84,000 and $0, respectively. The weighted average amortization period related to the architectural and trademarks and trade name intangibles is approximately 2.7 years. Amortization expense is recorded in general and administrative expenses in the accompanying condensed consolidated statements of operations and comprehensive income (loss). Additionally, $141,000 and $0 land options were used to purchase land and were capitalized during the three and six months ended June 30, 2014 and 2013, respectively. Future estimated amortization expense on the intangible assets over the next five years is as follows (in thousands):

 
December 31,

Remainder 2014
$
122

2015
34

2016
34

2017
34

2018
34

2019
8

Total
$
266










20



6.    Accounts Payable and Accrued Liabilities
 
Accounts payable and accrued liabilities consisted of the following (in thousands): 
  
June 30, 2014
 
December 31, 2013
Accrued expenses
$
19,220

 
$
14,162

Contingent consideration for acquisition
4,644

 

Accounts payable
922

 
2,118

Accrued payroll liabilities
1,010

 
1,766

Warranty reserves (Note 1)
1,024

 
608

 
$
26,820

 
$
18,654




7.    Debt
 
The Company enters into acquisition, construction and development loans to purchase and develop real estate inventories and for the construction of homes, which are secured by the underlying real estate. Certain of the loans are funded in full at the initial loan closing and others are revolving facilities under which the Company may borrow, repay and redraw up to a specified amount during the term of the loan. Acquisition indebtedness matures at various dates, but is generally repaid when lots are released from the loans based upon a specific release price, as defined in each loan agreement, or the loans are refinanced at current prevailing rates. The construction and development debt is required to be repaid with proceeds from home closings based upon a specific release price, as defined in each loan agreement. Certain of the construction and development loans include provisions that require minimum loan-to-value ratios. During the term of the loan, the lender may require the Company to obtain a third-party written appraisal of the underlying real estate collateral. If the appraised fair value of the collateral securing the loan is below the specified minimum, the Company may be required to make principal payments in order to maintain the required loan-to-value ratios. As of June 30, 2014 and December 31, 2013, the lenders have not requested, and the Company has not obtained, any such appraisals. As of June 30, 2014 and December 31, 2013, the Company had approximately $80.5 million and $56.4 million of aggregate loan commitments and approximately $33.6 million and $25.4 million of unused loan commitments respectively. At June 30, 2014 and December 31, 2013, the weighted average interest rate on the Company’s outstanding debt was 4.3% and 4.7%, respectively. Interest rates charged under variable rate debt are based on either a prime rate index plus 1.75% or LIBOR plus 3.75% to 4.0%.

Debt consisted of the following (in thousands):
  
June 30, 2014
 
December 31, 2013
Acquisition Debt:
 
 
 
Variable Interest Rate:
 
 
 
Interest rates of 3.94% to 4.19%, payments due through 2014
$
1,348

 
$
1,830

Interest rate of 3.94%, payments due through 2015
559

 
1,591

Interest rate of 3.94%, payments due through 2016
5,427

 

Fixed Interest Rate:


 


Interest rate of 5%, payments due through 2014

 
425

Interest rate of 5%, payments due through 2015
1,962

 
5,048

Interest rate of 6.5%, payments due through 2036

 
548

Interest rate of 10%, payments due through 2017
1,604

 
1,604

  Total acquisition debt
10,900

 
11,046

Construction and Development Debt:
 
 
 
Variable Interest Rate:
 
 
 
Interest rate of 3.94%, payments due through 2014
1,237

 
1,705

Interest rate of 3.94%, payments due through 2015
22,324

 
12,181

Interest rate of 3.94%, payments due through 2016
6,747

 

Interest rate of 5%, payments due through 2015
4,578

 
6,018

Interest rate of 5.5%, payments due from 2016
1,072

 

  Total construction and development debt
35,958

 
19,904

Total debt
$
46,858

 
$
30,950

 

21



       

At June 30, 2014, principal maturities of loans payable for the years ending December 31 are as follows (in thousands):

2014
$
2,586

2015
29,422

2016
13,246

2017
1,604

2018

Thereafter

Total
$
46,858



8.    Fair Value Disclosures
 
The accounting guidance regarding fair value disclosures defines fair value as the price that would be received for selling an asset or the price paid to transfer a liability in an orderly transaction between market participants at the measurement date.

The Company determines the fair values of its financial instruments based on the fair value hierarchy established in accordance with ASC Topic 820 - Fair Value Measurements, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The classification of a financial asset or liability within the hierarchy is based upon the lowest level input that is significant to the fair value measurement. The fair value hierarchy prioritizes the inputs into three levels that may be used to measure fair value:

Level 1—Quoted prices for identical instruments in active markets
Level 2—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are inactive; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets at measurement date
Level 3—Valuations derived from techniques where one or more significant inputs or significant value drivers are unobservable in active markets at measurement date
 
Estimated Fair Value of Financial Instruments Not Carried at Fair Value:

As of June 30, 2014 and December 31, 2013, the fair values of cash and cash equivalents, accounts payable and receivable approximated their carrying values because of the short-term nature of these assets or liabilities. The estimated fair value of the Company’s debt is based on cash flow models discounted at current market interest rates for similar instruments, which are based on Level 3 inputs. There were no transfers between fair value hierarchy levels during the six months ended June 30, 2014 and for the year ended December 31, 2013.

The following presents the carrying value and fair value of the Company’s financial instruments which are not carried at fair value (in thousands):
 
June 30, 2014
 
December 31, 2013
 
Carrying
Amount
 
Estimated Fair
 Value
 
Carrying
Amount
 
Estimated Fair
 Value
Financial liabilities:
 
 
 
 
 
 
 
Debt
$
46,858

 
$
47,821

 
$
30,950

 
$
32,044


Estimated Fair Value of Contingent Consideration

The contingent consideration arrangement for Citizens requires the Company to pay up to a maximum of $6.0 million of additional consideration based achievement of performance milestones over a five year period. The estimated fair value of the

22



contingent consideration of $4.6 million was estimated based on applying the income approach and a weighted probability of achievement of the performance milestones.

Non-Financial Fair Value Measurements:

Non-financial assets and liabilities include items such as real estate inventories and long lived assets that are measured at fair value when acquired and resulting from impairment, if deemed necessary. Other than the acquisition related fair-value measurements, there were no non-financial fair value measurements during the six months ended June 30, 2014 and for the year ended December 31, 2013, and no transfers between fair value hierarchy levels.



9.    Stock Based Compensation

The Company’s long-term incentive plan (“LTIP”) was adopted in July 2013 and provides for the grant of equity-based awards, including options to purchase shares of Class A common stock, Class A stock appreciation rights, Class A restricted stock, Class A restricted stock units and performance awards. The LTIP automatically expires on the tenth anniversary of its effective date. The Company’s board of directors may terminate or amend the LTIP at any time, subject to any stockholder approval required by applicable law, rule or regulation.

The number of shares of the Company’s Class A common stock authorized under the LTIP was 1,834,300 shares. To the extent that shares of the Company’s Class A common stock subject to an outstanding option, stock appreciation right, stock award or performance award granted under the LTIP are not issued or delivered by reason of the expiration, termination, cancellation or forfeiture of such award or the settlement of such award in cash, then such shares of the Company’s Class A common stock generally shall again be available under the LTIP, subject to certain exceptions. As of June 30, 2014, 1,171,325 shares were available for issuance under the LTIP.

On February 26, 2014, the Company granted an aggregate of 58,334 restricted stock units (“RSUs”) and 166,081 stock options (“Options”) under the LTIP to certain of its executive employees. The RSUs and Options granted were subject to the following vesting schedule: a) 10% vest on the first anniversary of the grant date, b) 20% vest on second anniversary of the grant date, c) 30% vest on the third anniversary of the grant date, and d) 40% vest on the fourth anniversary of the grant date. In April 2014, 8,227 RSUs were issued to certain directors of the Company and will vest on the first anniversary of the grant date. No RSUs or Options vested or were forfeited during the three or six months ended June 30, 2014.

During the three and six months ended June 30, 2014, the Company recognized $1.1 million and $2.1 million of stock based compensation expense respectively, which was included in general and administrative expenses in the accompanying condensed consolidated statement of operations and other comprehensive income (loss). No stock based compensation awards were outstanding as of June 30, 2013, accordingly, no stock based compensation expense was recognized during the three and six months ended June 30, 2013.

The following table summarizes the Options activity for the six months ended June 30, 2014:

 
Options Outstanding
 
Shares
Weighted Average Exercise Price
Weighted Average Remaining Contractual Term (in years)
Aggregate Intrinsic Value (in thousands)(1)
Outstanding at December 31, 2013


Options granted
166,081

$
16.20

9.7
Options exercised


Options forfeited


Outstanding at June 30, 2014
166,081

$
16.20

9.7

(1) The aggregate intrinsic value is calculated as the amount by which the fair value of the underlying stock exceeds the exercise price of the Option. The fair value of the Company’s Class A common stock as of June 30, 2014 was $13.67 per share.

23




The Company used the Black-Scholes option pricing model to determine the fair value of stock options. The assumptions used to estimate the fair value of Options granted during the first quarter ended March 31, 2014 were as follows:
Expected term
6.5 years

Expected volatility %
53.46
%
Risk free interest rate %
1.81
%
Dividend yield %
%
    
No Options were granted during the three month period ended June 30, 2014. Options vested and exercisable as of June 30, 2014 were zero.

The following table summarizes the non-vested RSU activity for the six months ended June 30, 2014:
 
Shares
Weighted Average Grant Date Fair Value (per share)
Non-vested RSUs at December 31, 2013
289,555

$
15.00

Granted
66,561

$
16.00

Vested


Forfeited


Non-vested RSUs at June 30, 2014
356,116

$
15.19

    
       

Unrecognized compensation cost for RSUs and Options issued under the LTIP was $4.4 million (net of estimated forfeitures) as of June 30, 2014; approximately $3.2 million of the unrecognized compensation costs related to RSUs and $1.2 million related to stock options. The expense is expected to be recognized over 1.7 years for the RSUs and 3.7 years for the Options.



10.    Commitments and Contingencies
 
Lawsuits, claims and proceedings have been or may be instituted or asserted against the Company in the normal course of business, including actions brought on behalf of various classes of claimants. The Company is also subject to local, state and federal laws and regulations related to land development activities, house construction standards, sales practices, employment practices and environmental protection. As a result, the Company is subject to periodic examinations or inquiries by agencies administering these laws and regulations.
 
The Company records a reserve for potential legal claims and regulatory matters when they are probable of occurring and a potential loss is reasonably estimable. The accrual for these matters is based on facts and circumstances specific to each matter and the Company revises these estimates when necessary.
 
In view of the inherent difficulty of predicting outcomes of legal claims and related contingencies, the Company generally cannot predict their ultimate resolution, related timing or any eventual loss. If the evaluations indicate loss contingencies that could be material are not probable, but are reasonably possible, disclosure of the nature with an estimate of possible range of losses or a statement that such loss is not reasonably estimable is made. The Company is not involved in any material litigation nor, to the Company's knowledge, is any material litigation threatened against it. At June 30, 2014 and December 31, 2013, the Company did not have any accruals for asserted or unasserted matters.

The Company is evaluating the impact of recent regulatory action under the federal Endangered Species Act on a project that we are developing in Washington State. Recent regulatory action involving the listing of a certain species of gopher as “threatened” under the federal Endangered Species Act may adversely affect this project, for example by imposing new restrictions and requirements on our activities there and possibly delaying, halting or limiting, our development activities. However, an estimate of the amount of impact cannot be made as there is not enough information to do so due to the lack of clarity regarding any restrictions that may be imposed on our development activities or other remedial measures that we may be required to make. Accordingly, no liability has

24



been recorded at June 30, 2014. The Company will continue to assess the impact of this regulatory action and will record any future liability as additional information becomes available.
 
The Company obtains surety bonds from third parties in the normal course of business to ensure completion of certain infrastructure improvements at its projects. The beneficiaries of the bonds are various municipalities. As of June 30, 2014 and December 31, 2013, the Company had outstanding surety bonds totaling $18.5 million and $10.3 million, respectively. In the event that any such surety bond issued by a third party is called because the required improvements are not completed, the Company could be obligated to reimburse the issuer of the bond.

The Company leases some of its offices under non-cancellable operating leases that expire at various dates through 2019. Future minimum payments under all operating leases for the years ending December 31 are as follows (in thousands):
2014
$
550

2015
1,013

2016
754

2017
737

2018
645

Thereafter
174

Total
$
3,873


 
11.    Segment Information
 
The Company’s operations are organized into two reportable segments: homebuilding and land development. The Company’s homebuilding operations construct and sell single-family homes, in California, Washington State, North Carolina, South Carolina and Tennessee. The homebuilding reportable segment includes real estate with similar economic characteristics, including similar historical and expected future long-term gross margin percentages, similar product types, production processes and methods of distribution. The land development reportable segment develops and sells lots, primarily in California, and includes real estate with similar economic characteristics, including similar historical and expected future long-term gross margin percentages, similar product types, production processes and methods of distribution. The reportable segments follow the same accounting policies as the condensed consolidated financial statements described in Note 1. Operating results of each reportable segment are not necessarily indicative of the results that would have been achieved had the reportable segment been an independent, stand-alone entity during the periods presented.
 
Financial information relating to reportable segments was as follows (in thousands): 
 
June 30, 2014
 
December 31, 2013
Assets
 
 
 
Homebuilding
$
172,317

 
$
108,594

Land development
66,478

 
68,254

Corporate and other assets
51,150

 
90,472

Total
$
289,945

 
$
267,320


Corporate and other assets primarily include cash and cash equivalents which are maintained centrally and used according to the cash flow requirements of each of the two segments.

25



 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
  
2014
 
2013
 
2014
 
2013
Revenue
 
 
 
 
 
 
 
Homebuilding
$
50,010

 
$
20,907

 
$
75,456

 
$
25,240

Land development
12,075

 
6,815

 
12,249

 
14,285

Non segment
1,518

 

 
1,518

 

Total
63,603

 
27,722

 
89,223

 
39,525

Gross margin
 
 
 
 
 
 
 
Homebuilding
8,934

 
4,425

 
13,580

 
5,298

Land development
2,834

 
1,679

 
2,862

 
4,569

Non segment
189

 

 
189

 

Total
11,957

 
6,104

 
16,631

 
9,867

 
 
 
 
 
 
 
 
Sales and marketing
3,765

 
2,099

 
6,321

 
3,231

General and administrative
6,909

 
5,326

 
13,180

 
8,806

Other income
13

 
224

 
86

 
263

Net income (loss) before income taxes
$
1,296

 
$
(1,097
)
 
$
(2,784
)
 
$
(1,907
)
    
 Non segment revenue and gross margin is related to construction management services provided by the Company and is not attributable to the operations of homebuilding and land development segments.

The Company evaluates the performance of the operating segments based upon gross margin. “Gross margin” is defined as operating revenues (homebuilding and land development) less cost of sales (cost of construction and acquisition, interest, abandonment, impairment and other cost of sales related expenses). Corporate sales, general and administrative expense and other non-recurring gains or losses are reflected within overall corporate expenses as this constitutes the Company’s primary business objective supporting both segments; corporate expenses are not particularly identifiable to any one segment. There is no intersegment activity.



26



12.    Noncontrolling interest

Prior to the completion of the IPO and related transactions on July 23, 2013, UCP, LLC was a wholly owned subsidiary of PICO. Subsequent to the IPO and related transaction, as of the June 30, 2014, the Company holds a 42.5% economic interest in UCP, LLC and is its sole managing member; UCP, LLC is fully consolidated. In accordance with applicable accounting guidance, these transactions are accounted for at historical cost. As of June 30, 2014, the noncontrolling interest balance is $126.6 million as compared to $126.5 million as of December 31, 2013.
 
The carrying value and ending balance at June 30, 2014 of the noncontrolling interest was calculated as follows (in thousands):

Carrying value of noncontrolling interest at December 31, 2013
$
126,462

Loss attributable to noncontrolling interest
(467
)
Stock-based compensation related to noncontrolling interest
990

Stock issuance related to noncontrolling interest
(354
)
Ending balance of noncontrolling interest at June 30, 2014
$
126,631




Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations



SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

We have made statements in Management's Discussion and Analysis of Financial Condition and Results of Operations below, and in other sections of this report that are forward-looking statements. All statements other than statements of historical fact included in this report are forward-looking statements. You can identify forward-looking statements by the fact that they do not relate strictly to historical facts. These statements may include words such as “may,” “might,” “will,” “should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential” or “continue,” the negative of these terms and other comparable terminology. These forward-looking statements, which are subject to risks, uncertainties and assumptions about us, may include projections of our future financial or operating performance, our anticipated growth strategies, anticipated trends in our business and other future events or circumstances. These statements are only predictions based on our current expectations and projections about future events.

Forward-looking statements involve numerous risks and uncertainties and you should not rely on them as predictions of future events. Forward-looking statements depend on assumptions, data or methods which may be incorrect or imprecise and we may not be able to realize them. We do not guarantee that the transactions and events described will happen as described (or that they will happen at all). The following factors, among others, could cause actual results and future events to differ materially from those set forth or contemplated in the forward-looking statements:


economic changes either nationally or in the markets in which we operate, including declines in employment, volatility of mortgage interest rates and inflation;
 
downturns in the homebuilding industry, either nationally or in the markets in which we operate;
 
continued volatility and uncertainty in the credit markets and broader financial markets;
 
our future operating results and financial condition;
 
our business operations;
 
changes in our business and investment strategy;
 
availability of land to acquire and our ability to acquire such land on favorable terms or at all;

27



 
availability, terms and deployment of capital;
 
disruptions in the availability of mortgage financing or increases in the number of foreclosures in our markets;
 
shortages of or increased prices for labor, land or raw materials used in housing construction;
 
delays in land development or home construction or reduced consumer demand resulting from adverse weather and geological conditions or other events outside our control;
 
the cost and availability of insurance and surety bonds;
 
changes in, or the failure or inability to comply with, governmental laws and regulations;
 
the timing of receipt of regulatory approvals and the opening of communities;
 
the degree and nature of our competition;
 
our leverage and debt service obligations;

our future operating expenses which may increase disproportionately to our revenue;

our ability to achieve operational efficiencies with future revenue growth;

our relationship, and actual and potential conflicts of interest, with PICO; and
 
availability of qualified personnel and our ability to retain our key personnel.

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date of this report. While forward-looking statements reflect our good faith beliefs, they are not guarantees of future performance, and our actual results could differ materially from those expressed in any forward-looking statement. We disclaim any obligation to publicly update or revise any forward-looking statement to reflect changes in underlying assumptions or factors, new information, data or methods, future events or other changes, except as required by law. For a further discussion of these and other factors, see the “Risk Factors” disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013and in this Quarterly Report on Form 10-Q. In light of these risks and uncertainties, the forward-looking events discussed in this report might not occur.


Overview

We are a homebuilder and land developer with land acquisition and entitlement expertise in California, Washington State, North Carolina, South Carolina, and Tennessee. As of June 30, 2014, we owned or controlled (through executed purchase contracts) a total of approximately 4,233 residential lots in California, approximately 825 lots in the Puget Sound area of Washington State, 319 lots in North Carolina, 141 lots in South Carolina and 177 lots in Tennessee. As of June 30, 2014, our property portfolio consisted of 87 communities in 34 cities in California, Washington State, North Carolina, South Carolina, and Tennessee. Our operations are organized into two reportable segments: homebuilding and land development.

During the three and six months ended June 30, 2014, in spite of interest rate volatility, the overall U.S. housing market continued to show signs of improvement, driven by factors such as decreasing home inventories, high home affordability and improving employment. We believe that during the prior year, the broader housing market was adversely affected by interest rate volatility and the partial federal government shutdown and the events leading up to it. Additionally, we believe that seasonal factors affected the broader housing market as well as our markets (see “Seasonality” below). Individual markets continue to experience varying results, as local home inventories, home affordability, and employment factors strongly influence each local market.
 
Numerous factors can affect the performance of an individual market, however, we believe that trends in employment, housing inventory, home affordability, interest rates and home prices have a particularly significant impact. We expect that these factors will have an impact on our operating performance and community count. Trends in housing inventory, home affordability, employment, interest rates and home prices are the principal factors that affect our revenues and many of our costs and expenses.

28



For example, when these trends are favorable, we expect our revenues from homebuilding and land development, as well as our related costs and expenses, to generally increase; conversely, when these trends are negative, we expect our revenue and costs and expenses to generally decline, although in each case the impact may not be immediate. When trends are favorable, we would expect to increase our community count by opening additional communities and expanding existing communities; conversely, when these trends are negative, we would expect to maintain our community count or decrease the pace at which we open additional communities and expand existing communities.
 
Our operations for the three months ended June 30, 2014 reflect our continued emphasis on our homebuilding segment and the results from our newly acquired operations in the South East encompassing North Carolina , South Carolina, and Tennessee stemming from the Citizens Acquisition, which was completed on April 10, 2014. As a result of these factors, the number of average selling communities during the three month period increased from seven to twenty seven, driving a $29.1 million, or 139%, increase in our homebuilding revenue when compared to the three month period ended June 30, 2013. Our homebuilding backlog at June 30, 2014 of $39.7 million was $13.1 million higher than the $26.7 million backlog at June 30, 2013. We delivered 138 homes during the second quarter of 2014, as compared to 57 homes during the same period in 2013, and our average selling price of homes increased to approximately $362,000 during the second quarter of 2014 as compared to approximately $367,000 during the second quarter of 2013. This increase in average sales price was mainly caused by the change in regional mix. Revenue from land development for the three months ended June 30, 2014 increased to $12.1 million as compared to $6.8 million during the three months ended June 30, 2013.

Our net income was $1.3 million for the three months ended June 30, 2014 as compared to a net loss of $1.1 million for the three months ended June 30, 2013. Stock based compensation expense of approximately $1.1 million and transaction expenses related to the Citizens Acquisition of $180,000 were included in our results for the three month period ended June 30, 2014. There were no stock based compensation or transaction expenses related to an acquisition for the comparable period in the prior year.

Similar to our three month results, our operations for the six months ended June 30, 2014 were primarily driven by deliberate efforts to grow our homebuilding platform and secondarily by the Citizens Acquisition. The number of average selling communities increased during the six month period from six to nineteen, resulting in a $50.2 million, or 199%, increase in our homebuilding revenue when compared to the six months ended June 30, 2013. We delivered 190 homes on a year to date basis through the second quarter of 2014 as compared to 69 homes during the same period in 2013. Revenue from land development for the six months ended June 30, 2014 decreased to $12.2 million as compared to $14.3 million for the comparable period in the prior year, mainly due to the mix of properties sold.

Our net loss was $2.8 million for the six months ended June 30, 2014 as compared to a net loss of $1.9 million for the six months ended June 30, 2013. Stock based compensation expense of approximately $2.1 million and transaction expenses related to the Citizens Acquisition of $640,000 were included in our results for the six month period ended June 30, 2014. There were no stock based compensation or transaction expenses related to an acquisition for the comparable period in the prior year.

Revenue and gross margin in our land development segment tend to be dynamic, as land development revenue tends to be driven by discrete transactions, which are motivated by numerous considerations, while revenue and gross margin in our homebuilding segment tend to be more predictable.

In addition to 113 lots acquired through the Citizens Acquisition during the three months ended June 30, 2014, we identified land investment opportunities that met our underwriting criteria and we increased our total lots owned by 496 lots. During the second quarter of 2014, we completed the Citizens Acquisition and continued to develop our business particularly in the Puget Sound area of Washington State and in our Los Angeles, Ventura, and Kern county locations in Southern California.

During the remainder of 2014, we expect to seek revenue growth from our homebuilding operations, buy and sell land, and seek operational efficiencies across all our regional operations. For our South East operations, we expect to reduce our community count, with a near term objective of increasing sales in a fewer number of communities. Our South East operations, which resulted from our April 10, 2014 Citizens Acquisition, have historically had a high community count relative to revenue, as compared to our other operations. Over the next several quarters, we expect to bring the relationship of community count and revenue at our South East operations more in line with that of the rest of our operations, which may result in reduction of our total community count for our South East operations. Additionally, we expect to continue to integrate our operations and seek to grow our presence in the South East.

  
Results of Operations - Three Months Ended June 30, 2014 and 2013


29



Consolidated Financial Data
 
 
 
 
 
 
 
Three Months Ended June 30,
 
2014
 
2013
 
Change
 
(in thousands)
Revenue:
 
 
 
 

  Homebuilding
$
50,010

 
$
20,907

 
$
29,103

  Land development
12,075

 
6,815

 
5,260

  Other revenue
1,518

 

 
1,518

Total revenue
63,603

 
27,722

 
35,881

Cost of sales:
 
 
 
 

  Homebuilding
41,076

 
16,482

 
24,594

  Land development
9,241

 
5,136

 
4,105

  Other cost of revenue
1,329

 

 
1,329

Gross margin
11,957

 
6,104

 
5,853

Expenses:
 
 
 
 

  Sales and marketing
3,765

 
2,099

 
1,666

  General and administrative
6,909

 
5,326

 
1,583

Total expenses
10,674

 
7,425

 
3,249

Income (loss) from operations
1,283

 
(1,321
)
 
2,604

Other income
13

 
224

 
(211
)
Net income (loss)
$
1,296

 
$
(1,097
)
 
$
2,393


Select Operating Metrics

 
Three Months Ended June 30,
 
2014

 
2013

 
Change

Net new home orders (1)
133

 
59
 
74

Cancellation rate (2)
8.9
%
 
4.8
%
 
4.1
%
Average selling communities during period (3)
27

 
7
 
20




 
June 30,
 
2014
 
2013
 
Change
Selling communities at end of period
26

 
9

 
17

Backlog (4) (in thousands)
39,734

 
$
26,674

 
$
13,060

Backlog (4) (units)
124

 
78

 
46

Average sales price of backlog (in thousands)
$
320

 
$
342

 
$
(22
)

(1) 
“Net new home orders” refers to new home sales contracts reduced by the number of sales contracts canceled during the relevant period.

(2) 
“Cancellation rate” refers to sales contracts canceled divided by sales contracts executed during the relevant period.

(3) 
“Average selling communities during the period” refers to the average number of open selling communities at the end of each month during the period.


30



(4) 
“Backlog” refers to homes under sales contracts that have not yet closed at the end of the relevant period. Sales contracts relating to homes in backlog may be canceled by the purchaser for a number of reasons, such as the prospective purchaser's inability to obtain suitable mortgage financing. Upon a cancellation, the escrow deposit is returned to the prospective purchaser (other than with respect to certain design-related deposits, which we retain). Accordingly, backlog may not be indicative of our future revenue.
 
The increase in net new home orders was primarily due to having an average of twenty-seven selling communities during the three month period ended June 30, 2014 as compared to an average of seven communities during the comparable period in 2013. The Citizens Acquisition which was completed on April 10, 2014, accounted for fifteen of these communities and was the main cause for the increase in number of average selling communities as well as for the increase in backlog to 124 units as of June 30, 2014.

We had twenty-six selling communities at June 30, 2014 as compared to nine selling communities at the end of the comparable period in 2013. Our homebuilding backlog value increased by $13.1 million, or approximately 49% to $39.7 million at June 30, 2014 as compared to $26.7 million at June 30, 2013. The net increase in backlog was largely the result of the increase in number of selling communities, which was mainly the result of Citizens Acquisition which was completed on April 10, 2014. Further, five of the active selling communities that came from the Citizens Acquisition in run off and each has fewer than ten units to sell. Consequently, the average number of selling communities in the South East may decrease throughout the year. Our cancellation rate for the three months ended June 30, 2014 was 8.9% as compared to 4.8% for the three months ended June 30, 2013. The increase was due to loan qualification difficulties of potential homebuyers.

The number of homes we sell during any quarter depends upon numerous factors and, as such, the number of home sales in any quarter is unpredictable. The number of homes we have sold on a quarterly basis has fluctuated from quarter to quarter. Accordingly, it should not be assumed that our historical sales or growth will be maintained in future periods.


31



Owned and Controlled Lots

As of June 30, 2014 and December 31, 2013, we owned or controlled, pursuant to purchase or option contracts, an aggregate of 5,695 and 5,380 lots, respectively, as set forth in the tables below:
 
As of June 30, 2014
 
Owned
 
Controlled(1)
 
Total
Central Valley Area-California
1,796

 

 
1,796

Monterey Bay Area-California
1,477

 

 
1,477

South San Francisco Bay Area-California
107

 
462

 
569

Southern California
234

 
157

 
391

Puget Sound Area-Washington
825

 

 
825

North Carolina
154

 
165

 
319

South Carolina
1

 
140

 
141

Tennessee
45

 
132

 
177

Total
4,639

 
1,056

 
5,695


 
As of December 31, 2013
 
Owned
 
Controlled(1)
 
Total
Central Valley Area-California
1,658

 
322

 
1,980

Monterey Bay Area-California
1,517

 
154

 
1,671

South San Francisco Bay Area-California
19

 
465

 
484

Southern California

 
251

 
251

Puget Sound Area-Washington
836

 
158

 
994

Total
4,030

 
1,350

 
5,380


(1) 
Controlled lots are those subject to a purchase or option contract.

Revenue
 
 
Three months ended June 30,
 
2014
 
2013
 
Change
 
(Dollars in thousands)
Homebuilding
 
 
 
 
 
 
 
Revenue
$
50,010

 
$
20,907

 
$
29,103

 
139.2
 %
Homes delivered (units)
138

 
57

 
81

 
142.1
 %
Average selling price
$
362

 
$
367

 
$
(5
)
 
(1.4
)%
Average cost of sales
$
298

 
$
289

 
$
9

 
3.1
 %
 
 
 
 
 
 
 
 
Land development
 
 
 
 
 
 
 
Revenue
$
12,075

 
$
6,815

 
$
5,260

 
77.2
 %
Lots sold (units)
149

 
54

 
95

 
175.9
 %
Average selling price
$
81

 
$
126

 
$
(45
)
 
(36
)%
Average cost of sales
$
62

 
$
95

 
$
(33
)
 
(35
)%
 
 
 
 
 
 
 
 
Other revenue
1,518

 
$

 
$
1,518

 
 %
 
 
 
 
 
 
 
 
Total revenue
$
63,603

 
$
27,722

 
$
35,881

 
129.4
 %

Total revenue for the three months ended June 30, 2014 increased by $35.9 million, or 129.4%, to $63.6 million as compared to $27.7 million for the three months ended June 30, 2013. The increase in revenue was primarily the result of increased home deliveries

32



during the 2014 period attributable to several factors, including an increased number of selling communities mainly due to the Citizens Acquisition and a more favorable sales pace.

Homebuilding Revenue

Revenue from homebuilding for the three months ended June 30, 2014 increased by $29.1 million, or 139.2%, to $50.0 million as compared to $20.9 million for the three months ended June 30, 2013. The increase was primarily the result of an increase in the number of homes delivered to 138 during the 2014 period, as compared to 57 homes during the 2013 period. The increase in number of homes delivered during the three months ended June 30, 2014, as compared to June 30, 2013, was partially attributable to the Citizens Acquisition, which was completed on April 10, 2014, and added 15 new selling communities to our total number of selling communities. In aggregate, the average selling price per home (ASP) during the second quarter of 2014 decreased slightly over the comparable prior year quarter offsetting some of the revenue increase. Our West Coast ASP increased to approximately $408,000 from $367,000 from the same period last year due to the regional mix of homes delivered. The ASP of our South East operations, which began with our April 10, 2014 Citizens Acquisition, was approximately $235,000 for the three months ended June 30, 2014.
 

 

Land Development Revenue

Revenue from land development for the three months ended June 30, 2014 was $12.1 million as compared to $6.8 million for the three months ended June 30 2013. We sold 69 finished lots and 50 entitled lots in California, and 30 finished lots in Washington State during the three month period ended June 30, 2014 and 54 lots during the comparable period in 2013. The increase in revenue was largely due to a greater number of lots sold during the second quarter of 2014, as compared to 2013, but was partially offset by a lower average selling price during the second quarter of 2014 as compared to the comparable period in 2013. The lower average selling price for the lots sold during the second quarter of 2014 was due to a mix of improved and unimproved parcels sold in the South San Francisco Bay Area last year; these parcels yielded relatively high revenue per lot due to the higher value of land in that market.

Other revenue

Other revenue related to construction management services provided to third parties primarily under “cost plus fee” contracts. The construction management services commenced as a result of the Citizens Acquisition, which was completed on April 10, 2014. Other revenue for the three months ended June 31, 2014 and 2013 was $1.5 million and zero, respectively.

Gross Margin and Adjusted Gross Margin

33



 
 
Three Months Ended June 30,
 
 
2014
 
%
 
2013
 
%
 
 
(Dollars in thousands)
Consolidated Adjusted Gross Margin
 
 
 
 
 
 
 
 
Revenue
 
$
63,603

 
100.0
%
 
$
27,722

 
100.0
%
Cost of sales
 
51,646

 
81.2
%
 
21,618

 
78.0
%
Gross margin
 
11,957

 
18.8
%
 
6,104

 
22.0
%
Add: interest in cost of sales
 
1,038

 
1.6
%
 
301

 
1.1
%
Add: impairment and abandonment charges
 
140

 
0.2
%
 
3

 
%
Adjusted gross margin(1)
 
$
13,135

 
20.7
%
 
$
6,408

 
23.1
%
Consolidated gross margin percentage
 
18.8
%
 
 
 
22.0
%
 
 
Consolidated adjusted gross margin percentage(1)
 
20.7
%
 
 
 
23.1
%
 
 
 
 
 
 
 
 
 
 
 
Homebuilding Adjusted Gross Margin
 
 
 
 
 
 
 
 
Homebuilding revenue
 
$
50,010

 
100.0
%
 
$
20,907

 
100.0
%
Cost of home sales
 
41,076

 
82.1
%
 
16,482

 
78.8
%
Homebuilding gross margin
 
8,934

 
17.9
%
 
4,425

 
21.2
%
Add: interest in cost of home sales
 
1,035

 
2.0
%
 
296

 
1.4
%
Add: impairment and abandonment charges
 

 
%
 

 
%
Adjusted homebuilding gross margin(1)
 
$
9,969

 
19.9
%
 
$
4,721

 
22.6
%
Homebuilding gross margin percentage
 
17.9
%
 
 
 
21.2
%
 
 
Adjusted homebuilding gross margin percentage(1)
 
19.9
%
 
 
 
22.6
%
 
 
 
 
 
 
 
 
 
 
 
Land Development Adjusted Gross Margin
 
 
 
 
 
 
 
 
Land development revenue
 
$
12,075

 
100.0
%
 
$
6,815

 
100.0%
Cost of land development
 
9,241

 
76.5
%
 
5,136

 
75.4%
Land development gross margin
 
2,834

 
23.5
%
 
1,679

 
24.6%
Add: interest in cost of land development