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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: September 30, 1998
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: 0-28024
THE FORTRESS GROUP, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 54-1774997
--------------------------------- ----------------------------------
(State or other jurisdiction (IRS Employer Identification No.)
of incorporation or organization)
1650 Tysons Boulevard, Suite 600, McLean, Virginia 22102
--------------------------------------------------------
(Address of principal executive offices and zip code)
Registrant's telephone number, including area code: (703) 442-4545
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No __
As of November 13, 1998, there were outstanding 11,916,178 shares of
common stock, par value $.01, of the registrant.
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<PAGE>
THE FORTRESS GROUP, INC.
QUARTER ENDED SEPTEMBER 30, 1998
INDEX
PAGE
-----
PART I - FINANCIAL INFORMATION
Item 1.
The Fortress Group, Inc.
Consolidated Balance Sheets 3
Consolidated Statements of Operations
(unaudited) 4
Consolidated Statements of Cash Flows
(unaudited) 6
Notes to Consolidated Financial Statements
(unaudited) 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 14
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K. 23
(a) Exhibits.
(b) Reports on Form 8-K.
SIGNATURES 24
EXHIBIT INDEX 25
2
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
------ ------
(unaudited)
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 17,568 $ 12,406
Accounts and notes receivable 12,908 21,944
Due from related parties 2,353 4,416
Real estate inventories 315,267 217,342
Land held for resale 7,664 6,934
Mortgage loans held for sale 15,820 11,128
Investments in land partnerships 10,180 6,763
Property and equipment, net 13,572 10,246
Prepaid expenses and other assets 24,437 22,655
Goodwill, net 37,356 23,470
--------- ---------
Total assets $457,125 $337,304
--------- ---------
--------- ---------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities $ 33,231 $ 23,172
Notes and mortgages payable 292,714 228,420
Due to related parties 3,846 783
Accrued expenses 18,252 14,464
Customer deposits 15,133 7,300
-------- ---------
Total liabilities 363,176 274,139
--------- ---------
Minority interest 49 268
--------- ---------
Shareholders' equity
Preferred stock, all classes and series, $.01 par value, 1 million
authorized (See Note 8 for designations and respective amounts
outstanding) 1 1
Common stock, $.01 par value, 99 million authorized,
12,170,032 and 11,748,694 issued, respectively 122 117
Additional paid-in capital 73,295 47,371
Preferred subscription receivable (500)
Retained earnings 22,203 15,936
Treasury stock, at cost, 265,100 and 120,100 shares, respectively (1,221) (528)
--------- ----------
Total shareholders' equity 93,900 62,897
--------- ---------
Total liabilities and shareholders' equity $457,125 $337,304
--------- ----------
--------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Three For the Three
Months Ended Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
TOTAL REVENUES $175,668 $118,627
-------- -------
HOMEBUILDING:
Residential sales $170,001 $116,781
Lot sales and other 4,544 982
--------- --------
Homebuilding revenues 174,545 117,763
Cost of sales
Construction and land costs 145,442 98,305
Amortization of purchase accounting adjustments 333 946
--------- --------
Gross profit 28,770 18,512
Selling 10,887 7,074
General and administrative 8,926 5,872
Severance expense 737
Goodwill amortization 596 210
--------- -------
Net operating income 7,624 5,356
--------- -------
Other expense (income):
Interest expense 1,073 1,551
Interest income (104) (48)
Minority interest (10) 4
Other, net (571) (202)
--------- --------
Homebuilding income before taxes 7,236 4,051
MORTGAGE:
Operating revenues 1,123 864
General, administrative and other expenses 1,181 691
--------- --------
Mortgage (loss) income before taxes (58) 173
Total income before taxes 7,178 4,224
Provision for income taxes 2,872 1,634
--------- ---------
Net income $ 4,306 $ 2,590
========== =========
NET INCOME PER SHARE DATA (See Note 9):
Basic net income per share $ .31 $ .22
=========== ==========
Diluted net income per share $ .16 $ .20
=========== ==========
Basic weighted average shares outstanding 11,979,840 11,754,405
=========== ==========
Diluted weighted average shares outstanding 26,724,353 12,927,397
=========== ==========
The accompanying notes are an integral part of these financial statements.
</TABLE>
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C>
TOTAL REVENUES $462,679 $294,958
------- -------
HOMEBUILDING:
Residential sales $452,139 $289,394
Lot sales and other 7,706 4,015
--------- ---------
Homebuilding revenues 459,845 293,409
Cost of sales
Construction and land costs 387,289 247,814
Amortization of purchase accounting adjustments 1,404 1,359
--------- ---------
Gross profit 71,152 44,236
Selling 29,855 18,581
General and administrative 23,735 15,915
Severance expense 737
Goodwill amortization 1,739 444
--------- ---------
Net operating income 15,086 9,296
------- --------
Other expense (income):
Interest expense 3,174 2,422
Interest income (471) (188)
Minority interest (53) 6
Other, net (1,081) (648)
--------- ----------
Homebuilding income before taxes 13,517 7,704
MORTGAGE:
Operating revenues 2,834 1,549
General, administrative and other expenses 2,881 1,397
--------- ----------
Mortgage (loss) income before taxes (47) 152
Total income before taxes 13,470 7,856
Provision for income taxes 5,391 3,016
--------- ----------
Net income $ 8,079 $ 4,840
========== ==========
NET INCOME PER SHARE DATA (See Note 9):
Basic net income per share $ .54 $ .40
========== ==========
Diluted net income per share $ .37 $ .38
========== ==========
Basic weighted average shares outstanding 11,798,929 11,778,975
========== ==========
Diluted weighted average shares outstanding 21,524,512 12,670,210
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
September 30, 1998 September 30, 1997
------------------- ------------------
<S> <C> <C>
Cash flows from operating activities
Net income $ 8,079 $ 4,840
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization 6,377 3,058
Minority interest (53) 6
(Gain) loss on sale of property and equipment (158) 34
Changes in operating assets and liabilities
Accounts receivable 9,724 2,791
Due from related parties 1,626 147
Real estate inventories (34,793) (13,205)
Land held for resale (730)
Mortgage loans held for sale (4,692) (11,497)
Prepaid expenses and other assets (1,082) (326)
Accounts payable and accrued construction liabilities 5,590 (777)
Accrued expenses 3,902 3,208
Customer deposits 6,417 550
-------- ---------
Net cash provided by (used in) operating activities 207 (11,171)
--------- -------
Cash flows from investing activities
Acquisition of homebuilders, net of acquired cash (26,972) (13,170)
Payment of contingent consideration (2,034)
Conversion of preferred stock (305)
Redemption of preferred stock (684)
Purchase of property and equipment (4,624) (3,791)
Proceeds from sale of property and equipment 402 155
Investment in limited partnerships (3,417) (8,523)
-------- --------
Net cash used in investing activities (37,634) (25,329)
------- --------
Cash flows from financing activities
Borrowings under notes and mortgages payable 450,038 220,653
Repayment of notes and mortgages payable (431,761) (193,921)
Related party borrowings 88 45
Repayment of related party borrowings (368) (341)
Proceeds from issuance of Class AA Preferred Stock, net 26,765
Proceeds from Employee Stock Purchase Plan 59
Deferred financing costs (1,882)
Preferred dividends (1,450) (82)
Common dividends (89) (59)
Purchase of treasury stock (693) (642)
--------- ----------
Net cash provided by financing activities 42,589 23,771
--------- --------
Net increase (decrease) in cash and cash equivalents 5,162 (12,729)
Cash and cash equivalents, beginning of period 12,406 16,212
-------- --------
Cash and cash equivalents, end of period $ 17,568 $ 3,483
======== =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1 - BUSINESS AND ORGANIZATION
The Fortress Group, Inc. ("Fortress" or the "Company") was formed in June 1995
to create a national homebuilding company for the acquisition and development of
land or improved lots and the construction of residential for-sale housing.
Four homebuilding companies were acquired by Fortress simultaneous with the
closing of its initial public offering on May 21, 1996 (the "Offering")
including Buffington Homes, Inc. ("Buffington"), doing business in Austin and
San Antonio, Texas; Christopher Homes and Affiliates ("Christopher"), doing
business in Las Vegas, Nevada; The Genesee Company ("Genesee"), doing business
in Denver and Fort Collins, Colorado and Tucson, Arizona; and Solaris
Development Corporation ("Sunstar"), doing business in Raleigh-Durham, North
Carolina. These companies as a group are referred to as the Predecessor
Companies. Prior to the Offering, Fortress was a nonoperating entity and
principally incurred costs associated with the consummation of the Offering.
Fortress has made additional acquisitions of Landmark Homes, Inc. ("Landmark"),
a Wilmington, North Carolina and Myrtle Beach, South Carolina homebuilder, on
August 31, 1996; Brookstone Homes, Inc. ("Brookstone"), a Janesville, Madison
and Milwaukee, Wisconsin homebuilder, on December 31, 1996; D.W. Hutson
Construction Company ("Hutson"), a Jacksonville, Florida homebuilder, on
February 28, 1997; Wilshire Homes ("Wilshire"), an Austin, Texas homebuilder,
effective April 1, 1997; Don Galloway Homes, Inc. ("Galloway"), a Charlotte,
North Carolina and Charleston, South Carolina homebuilder, effective August 1,
1997; The Iacobucci Organization ("Iacobucci"), a Philadelphia, Pennsylvania
homebuilder, effective October 1, 1997; WestBrook Homes ("WestBrook"), a Loudoun
County, Virginia homebuilder effective January 1, 1998; Whittaker Homes
("Whittaker"), a St. Louis, Missouri homebuilder, effective March 1, 1998; and
Quail Construction, Inc. ("Quail"), a Portland, Oregon homebuilder, effective
April 1, 1998.
In January 1997, Fortress formed Fortress Mortgage, Inc. ("Fortress Mortgage"),
a wholly-owned subsidiary, to provide a mortgage lending source to the Company's
builder subsidiaries as an ancillary benefit. Fortress Mortgage currently
provides mortgage services in the Company's markets in Texas, Colorado, North
Carolina, Nevada, Pennsylvania, Wisconsin, Florida, Oregon, and Missouri.
The accompanying consolidated financial statements of Fortress have been
prepared by the Company. Certain information and footnote disclosures normally
included in financial statements presented in accordance with generally accepted
accounting principles have been condensed or omitted. The Company believes the
disclosures made are adequate to make the information presented not misleading.
However, the financial statements should be read in conjunction with the
financial statements of the Company and notes thereto included in the 1997
Annual Report on Form 10-K.
Interim results are not necessarily indicative of fiscal year performance
because of the impact of seasonal and short-term variations.
NOTE 2 - BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of
Fortress, a Delaware corporation, and its majority-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Due to the substantial continuing interests in the Company of the former
stockholders of the Predecessor Companies, the acquisition in May 1996 of the
Predecessor Companies has been accounted for on a historical cost basis. Each
<PAGE>
subsequent acquisition has been accounted for under the purchase method of
accounting. The purchase price of each of the acquired companies was allocated
first to record the assets and liabilities acquired at estimated fair value on
the acquisition date with any remaining balances recorded as goodwill.
The consolidated statements of operations, shareholders' equity and cash flows
include the results of Fortress, inclusive of the Predecessor Companies and all
of the companies acquired since their respective dates of acquisition.
Certain amounts in the prior period financial statements have been reclassified
to conform to the current presentation.
Included in the Consolidated Statements of Operations for the three and nine
months ended September 30, 1998 is $737,000 of severance related expenses
resulting from the resignation of the Company's Chief Executive Officer and
Chief Financial Officer.
NOTE 3 - PRO FORMA SUMMARY CONSOLIDATED RESULTS OF OPERATIONS
The Company's unaudited pro forma summary consolidated results of operations for
the nine months ended September 30, 1998 and 1997, as if the significant 1997
and 1998 acquisitions had occurred at January 1, 1997 and excluding the
amortization of the purchase accounting adjustments for the step-up of
inventory, are presented below. The issuance of 40,000 shares of Class AA
convertible preferred stock, which provided financing for the Galloway and
Whittaker acquisitions, has been factored into the earnings per share
calculations for both periods. In preparing the unaudited pro forma information,
various assumptions were made, and the Company does not purport this information
to be indicative of what would have occurred had these transactions been made as
of January 1, 1997.
Nine Months Ended
September 30,
1998 1997
---- ----
(unaudited, in thousands,
except per share amounts)
Revenue $472,074 $411,048
Net income 9,376 10,700
Net income per share .63 .74
Net income per share, assuming dilution* .42 .50
*Without the additional dilution as discussed in Note 9, the pro forma diluted
earnings per share would be $.47 and $.53 for the nine months ended September
30, 1998 and 1997.
NOTE 4 - SIGNIFICANT ACQUISITIONS
On March 6, 1998, the Company acquired the stock of Whittaker for initial
consideration of approximately $62.1 million ($26.4 million in cash and
approximately $35.7 million in assumed debt).
Effective August 1, 1997, the Company acquired the stock of Galloway for initial
consideration of approximately $34.6 million ($5.0 million in cash, $5.0 million
in a short-term note, 60,000 shares of Series D Convertible preferred stock with
a $6.0 million liquidation value, and approximately $18.6 million in assumed
debt). Additional consideration not to exceed $5.0 million is expected to be
paid over a period not to exceed four years based upon the future performance of
Galloway.
In February 1997, the Company acquired the assets of Hutson for initial
consideration of approximately $24.7 million ($9.0 million in cash, $1.2 million
<PAGE>
in Class B preferred stock, and approximately $8.5 million in assumed debt).
Approximately $1 million in cash and $315,000 of the preferred stock was
returned to the Company based on the final accounting of the acquisition.
Additional consideration of $6.0 million is expected to be paid over a period
not to exceed six years based upon the future performance of Hutson (See Note
8).
In each of these acquisitions, the earnout consideration will be accounted for
as additional purchase price and, accordingly, increase the goodwill related to
the acquisitions when earned and be amortized over the corresponding remaining
amortization periods.
NOTE 5 - REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
September 30, December 31,
1998 1997
----- -----
(unaudited)
<S> <C> <C>
Work-in-progress
Sold homes $134,504 $ 81,225
Speculative 57,966 45,058
------- -------
Total work-in-progress 192,470 126,283
Land
Finished lots 65,203 43,585
Land under development 41,234 39,666
Unimproved land held for development 2,814 1,084
--------- ---------
Total land 109,251 84,335
Lumber yard inventory 1,896
Model homes 11,650 6,724
-------- ---------
$315,267 $217,342
======= =======
</TABLE>
NOTE 6 - INTEREST
Information regarding interest is as follows (in thousands):
<TABLE>
<CAPTION>
For the Nine Months Ended September 30,
1998 1997
----- ----
(unaudited) (unaudited)
<S> <C> <C>
During the periods:
Interest incurred $ 24,667 $ 18,045
Interest capitalized (20,968) (15,623)
Interest amortized to cost of sales 15,662 11,959
------ ------
Total interest expensed in statement of operations $ 19,361 $ 14,381
====== ======
At the end of the periods:
Capitalized interest in ending inventory $ 26,426 $ 17,100
====== ======
</TABLE>
Included in general, administrative and other expenses for Fortress Mortgage is
approximately $525,000 of interest expense for the nine months ended September
30, 1998.
<PAGE>
NOTE 7 - NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable consist of the following (in thousands):
September 30, December 31,
1998 1997
----- ----
(unaudited)
13.75% Senior Notes due 2003 $100,000 $100,000
Project specific land, land development and
construction loans 174,208 111,318
Mortgage warehouse lines of credit 15,027 15,546
Other 3,479 1,556
--------- ---------
$292,714 $228,420
--------- ---------
--------- ---------
The Company pays interest on the Senior Notes in arrears on May 15 and November
15 of each year at the rate of 13.75% per annum. The Senior Notes may not be
redeemed at any time prior to maturity. The Senior Notes are unsecured and rank
pari passu with, or senior in right of payment to, all other existing and future
unsecured indebtedness of the Company. The Senior Notes, however, are
effectively subordinated to secured debt of the Company to the extent of any
collateral, as well as to the Company's subsidiaries indebtedness. The Company
is required to maintain a consolidated tangible net worth of at least $15
million and other financial covenants, as defined in the Senior Note Indenture.
The loan agreements for project specific land, land development and construction
loans are secured by a lien on the applicable residential development project or
a specific unit under construction. Repayment of the loans are generally due
upon sale of the collateral property. The loans bear interest at annual variable
rates ranging from two percentage points over London Interbank Offer Rate
("LIBOR") to two percentage points over prime rate and fixed rates generally
from 6.15% to 12.75%.
The Company's mortgage subsidiary has a warehouse line of credit outstanding for
the purpose of originating loans. The warehouse line is secured by the mortgage
loans held for sale and is repaid upon sale of the mortgage loans. The line
bears interest at variable rates ranging from 2.0% to 3.0% over the 30-day
Federal Funds Rate. The line of credit matures March 30, 1999 but can be renewed
at the Company's option. The aggregate commitment available at September 30,
1998 was $20 million.
One of the Company's subsidiaries has a line of credit for the purpose of
purchasing lumber yard inventory. The line of credit matures June 30, 1999. At
September 30, 1998 the total commitment available is $2 million with $1.65
million currently outstanding. The outstanding portion of this line is included
in "other" above. The remainder of other notes and mortgages payable consists
primarily of debt financed corporate insurance policies which bear interest at
varying rates between 6.8%and 7.8%.
NOTE 8 - CONVERTIBLE PREFERRED STOCK
The following are the Company's classes and series of preferred stock, amounts
designated, and amounts outstanding at September 30, 1998 and December 31, 1997:
Class AA cumulative convertible (rate of 12% per annum decreased to 6% on
March 6, 1998), 53,333 designated, 40,000 and 11,700, respectively,
issued and outstanding ($40 million initial liquidation preference)
Series A 11% cumulative convertible, designated, 0 and 10,000,
respectively, issued and outstanding
Series B convertible, 40,000 designated, 276 and 8,854, respectively, issued
and outstanding ($27,600 aggregate liquidation preference)
Series C convertible, 70,000 designated, 39,656 and 60,000, respectively,
issuable (See below)
Series D convertible, 67,500 designated, 45,000 and 60,000, respectively, issued
and outstanding ($4,500,000 aggregate liquidation preference)
10
<PAGE>
Series E convertible, 50,000 designated, 19,381 and 0, respectively, issued
and outstanding ($1,938,100 aggregate liquidation preference)
Series F convertible, 5,000 designated, 5,000 and 0, respectively, issued and
outstanding ($500,000 aggregate liquidation preference)
In connection with the Whittaker acquisition, the Company loaned $500,000 and
then sold 5,000 shares of Series F 6% Cumulative Convertible Preferred Stock
("Series F") with a liquidation value of $100 per share to a key member of
management at Whittaker. The loan bears interest at 6% which is offset by the 6%
dividend rate on the Series F. The Series F is convertible, based on the future
earnings of the acquired business, for a period of 60 days commencing on
February 15, 1999, 2000, and 2001 at the closing price of the Common Stock on
the Closing Date and the first and second anniversaries of the Closing Date,
respectively. The loan has been accounted for as a subscription receivable in
the equity section of the Company's balance sheet and will be reduced based on
the future earnings of the acquired business.
In connection with the WestBrook and Quail acquisitions, the Company issued
19,881 shares of Series E 6% Cumulative Convertible Preferred Stock ("Series
E"). The purchase price was subsequently adjusted and 500 Series E shares were
returned to the Company. Each Series E share is convertible into ten shares of
Common Stock at any time at the option of the holder. After the Common Stock has
traded for $10.00 per share or more for ten consecutive business days, the
Company may require the conversion of the Series E at the same 10-for-1
conversion rate. At the option of the holder, the Company may be required to
redeem up to 20% of the total number of shares initially issued each year
beginning with the first anniversary of the date of issuance in cash or Common
Stock at the Company's option. The holder's redemption right is cumulative.
The Company executed the second closing related to its agreement with Prometheus
Homebuilders LLC (Prometheus) on March 6, 1998. The Company sold an additional
28,300 shares of Class AA Preferred Stock for $28.3 million.
In March 1998, the Company amended the Hutson purchase agreement to pay the 1997
earnout in cash rather than Series C Convertible Preferred Stock ("Series C").
The total cash payment was approximately $2.0 million. The remaining Series C
stock (39,656 shares) has been treated as outstanding for the purpose of
calculating earnings per share; however, it will only be legally outstanding
upon issuance.
NOTE 9 - EARNINGS PER SHARE
The following table reconciles the numerators (income) and the denominators
(shares) of the basic and diluted per-share computations (in thousands):
<TABLE>
<CAPTION>
For the Three Months For the Three Months
Ended September 30, 1998 Ended September 30, 1997
------------------------ ------------------------
Per-Share Per-Share
Income Shares Amount Income Shares Amount
------ ------ -------- ------ ------ ---------
<S> <C> <C> <C> <C> <C> <C>
Net income $4,306 $2,590
Less: Preferred stock dividends (629) (28)
Less: Imputed preferred stock dividend (17)
------- -------
Basic EPS
Income available to common
shareholders $3,660 11,979,840 $.31 $2,562 11,754,405 $.22
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C> <C> <C> <C>
Effect of Dilutive Securities
Preferred stock $ 646 14,482,185 $ 28 1,159,225
Options 3,967 2,354
Restricted stock 20,000 11,413
Warrants 238,361
-------- --------- ------- ----------
Diluted EPS
Income available to common
shareholders plus assumed
conversions $4,306 26,724,353 $.16 $2,590 12,927,397 $.20
</TABLE>
<TABLE>
<CAPTION>
For the Nine Months For the Nine Months
Ended September 30, 1998 Ended September 30, 1997
------------------------ ------------------------
Per-Share Per-Share
Income Shares Amount Income Shares Amount
<S> <C> <C> <C> <C> <C> <C>
Net income $8,079 $4,840
Less: Preferred stock dividends (1,701) (83)
Less: Imputed preferred stock dividend (51)
------- ------
Basic EPS
Income available to common
shareholders $6,327 11,798,929 $.54 $4,757 11,778,975 $.40
Effect of Dilutive Securities
Preferred stock $1,691 9,435,622 $ 83 879,037
Options 5,577 785
Restricted stock 21,502 11,413
Warrants 262,882
------ ---------- ------- ---------
Diluted EPS
Income available to common
shareholders plus assumed
conversions $8,018 21,524,512 $.37 $4,840 12,670,210 $.38
</TABLE>
The Company's Class AA Convertible Preferred Stock is convertible, in whole or
in part, at the option of the holder, into Common Stock, at an initial
conversion price of $6.00 per share, subject to certain adjustments. At any
time, the Company can force conversion at $6.00 per share if the market price of
the Common Stock equals or exceeds $12.00 per share. Alternatively, the
conversion price is subject to decrease, at the option of the holder between
September 30, 2001 and September 30, 2003, if the average prior 60-day closing
price of the Company's Common Stock is $12.00 per share or less according to the
following schedule:
Adjustment Conversion
Price(s) Price(s)
---------- ---------
$10.01 - 12.00 $5.50
5.00 - 10.00 5.25
4.01 - 4.99 3.00
2.01 - 4.00 2.00
0.00 - 2.00 1.00
<PAGE>
Additionally, the Company's outstanding warrants are exercisable between
September 30, 1999 and September 30, 2004 at an exercise price of $7.00 per
share of Common Stock, subject to adjustment between September 30, 2001 and
September 30, 2003 based on the average prior 60-day closing price of the
Company's Common Stock as follows:
Additional Shares
Adjustment Price(s) Exercise Price(s) per Warrant
-------------------- ----------------- -----------------
$20.01 or greater $7.00 0.00
17.51 - 20.00 7.00 0.33
15.01 - 17.50 7.00 0.667
12.01 - 15.00 7.00 1.00
10.01 - 12.00 6.50 1.25
8.01 - 10.00 6.00 1.50
6.01 - 8.00 5.00 1.75
4.01 - 6.00 4.00 2.00
2.01 - 4.00 3.00 2.25
0.00 - 2.00 2.00 2.50
Pursuant to the current relevant accounting guidance related to the earnings per
share calculation, the Class AA preferred stock and the Warrants have been
included based on the conversion tables using the current price of the Common
Stock even though the holder of the Class AA preferred stock cannot elect to
convert under the reset tables until September 30, 2001. The total theoretical
shares included in the diluted calculation as reported are 6.9 million shares
and 3.0 million shares for the three and nine months ended September 30, 1998.
If the diluted earnings per share had been calculated based on the current
conversion prices of $6.00 and $7.00, respectively, diluted earnings per share
and total diluted shares would have been $.43 and 19.0 million shares for the
nine months ended September 30, 1998 and $.22 and 19.8 million shares for the
quarter then ended.
The Company's intention upon conversion or redemption (as the case may be) of
Series B, C and D preferred stock is to issue Common Stock on the basis of
10-for-1 conversion ratio contemplated in the respective agreements and to pay
cash for the difference between the $100 liquidation value per share and the
market value of the Common Stock converted at 10-for-1. Accordingly, the Company
has included, in its calculation of earnings per share, additional Common Stock
to be issued under the "if converted" method at the 10-for-1 conversion ratio.
At September 30, 1998, 19,381 shares of Series E convertible preferred stock
were outstanding and convertible into 193,810 shares of Common Stock; for EPS
purposes, the conversion features of these shares resulted in Common Stock
equivalents totaling 140,173 shares for the nine months ended September 30,
1998. None of these shares were included in the computation of diluted EPS for
the nine months ended September 30, 1998 as the effect of adding back the
related dividends and the weighted average common shares is antidilutive.
Additional options to purchase approximately 482,000 shares of Common Stock at
various prices between $5.375 and $6.25 per share were outstanding at September
30, 1998, and additional options to purchase 416,000 shares of Common Stock at
various prices between $5.9375 and $6.25 per share were outstanding at September
30, 1997. These options were not included in the computations of diluted EPS
because the options' exercise prices were greater than the average market price
of the common shares.
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
The Fortress Group, Inc. (the "Company" or "Fortress") was formed in
June 1995 and completed its initial public equity and senior note offerings on
May 16, 1996 (the "Offerings"). Simultaneous with the closing of the Offerings
on May 21, 1996, the Company acquired, in a series of transactions, four
homebuilding companies (collectively, the "Founding Builders" or "Combined
Predecessor Companies") which have operations in seven separate markets. During
the period prior to May 16, 1996, the Combined Predecessor Companies were not
under common control or management. The Offerings provided the capital required
to acquire the Founding Builders.
Fortress was founded on the belief that homebuilding is localized and
is most successful when managed by experienced local managers who have developed
in depth market knowledge and strong local relationships and that that success
can be even greater when combined with operating economies of scale and
significant sharing of operational best practices within the industry.
The Company acquired Landmark Homes, Inc. ("Landmark"), with operations
in Wilmington, North Carolina and Myrtle Beach, South Carolina and Brookstone
Homes, Inc. ("Brookstone"), with operations in the Milwaukee-Madison, Wisconsin
corridor in 1996 and the following builders in 1997: D.W. Hutson Construction
Company ("Hutson"), with operations in the Jacksonville, Florida area; Wilshire
Homes, Inc. ("Wilshire"), with operations in San Antonio and Austin, Texas; Don
Galloway Homes, Inc. ("Galloway"), with operations primarily in Charlotte, North
Carolina and Charleston, South Carolina; and The Iacobucci Organization
("Iacobucci"), with operations in the Philadelphia, Pennsylvania area. In 1998
the Company has acquired WestBrook Homes ("WestBrook"), with operations in the
Loudoun County, Virginia; Whittaker Homes ("Whittaker"), with operations in St.
Louis, Missouri; and Quail Construction ("Quail"),with operations in Portland,
Oregon and Vancouver, Washington. All acquired companies are referred to as the
Acquired Builders. In addition, the Company formed Fortress Mortgage, Inc.
("Fortress Mortgage") in January of 1997 as a wholly-owned subsidiary of the
Company.
The Company's revenues are derived primarily from the sale of the
residential homes. Revenue is generally recognized when construction of the home
is complete and title transfers from the Company to the buyer. Cost of sales
includes all direct and indirect construction costs including construction
supervision; land costs, including the purchase price of land and land
development costs; relief of interest previously capitalized against qualified
inventory; real estate taxes; and an accrual for anticipated warranty and
service costs. All of these costs incurred prior to title transfer are
capitalized into inventory and relieved from inventory at time of title transfer
concurrent with revenue recognition. Sales and marketing costs, such as
advertising and promotion expenses, as well as general and administrative costs
are recognized as expense when incurred.
The following table sets forth for the periods indicated certain items of the
Company's unaudited consolidated financial statements in dollars (expressed in
thousands) and as a percentage of the Company's total and segment revenues:
<TABLE>
<CAPTION>
For the Nine For the Nine
Months Ended Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C> <C> <C> <C> <C>
Total revenues $462,679 100.0% $294,958 100.0%
Homebuilding revenues 459,845 99.4% 100.0% 293,409 99.5% 100.0%
Homebuilding gross profit including step-up 71,152 15.4% 15.5% 44,236 15.0% 15.1%
Homebuilding gross profit excluding step-up 72,556 15.7% 15.8% 45,595 15.5% 15.5%
Homebuilding income before taxes 13,517 2.9% 2.9% 7,704 2.6% 2.6%
Mortgage revenues 2,834 .6% 100.0% 1,549 .5% 100.0%
Mortgage expenses 2,881 .6% 101.7% 1,397 .5% 90.2%
Mortgage (loss) income before taxes (47) - (1.6)% 152 - 9.8%
Net income 8,079 1.7% 4,840 1.6%
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
For the Three For the Three
Months Ended Months Ended
September 30, 1998 September 30, 1997
------------------ ------------------
<S> <C> <C> <C> <C> <C> <C>
Total revenues $175,668 100.0% $118,627 100.0%
Homebuilding revenues 174,545 99.4% 100.0% 117,763 99.3% 100.0%
Homebuilding gross profit including step-up 28,770 16.4% 16.5% 18,512 15.6% 15.7%
Homebuilding gross profit excluding step-up 29,103 16.6% 16.7% 19,458 16.4% 16.5%
Homebuilding income before taxes 7,236 4.1% 4.1% 4,051 3.4% 3.4%
Mortgage revenues 1,123 .6% 100.0% 864 .7% 100.0%
Mortgage expenses 1,181 .7% 105.2% 691 .6% 80.0%
Mortgage (loss) income before taxes (58) - (5.2)% 173 .1% 20.0%
Net income 4,306 2.5% 2,590 2.2%
</TABLE>
Acquisitions
The Company's actual results of operations reflect the operating
activity of the acquisitions from their respective effective dates of
acquisition.
Acquisition of WestBrook Homes
Effective January 1, 1998, the Company acquired WestBrook, a
homebuilder in Loudoun County, Virginia. Located west of the District of
Columbia, Loudoun County, Virginia is part of the Washington PMSA. WestBrook
builds first and second time move-up single-family homes and townhomes.
Acquisition of Whittaker Homes
Effective March 1, 1998, the Company acquired Whittaker, a homebuilder
in St. Charles County, Missouri. The largest single-family homebuilder in the
St. Louis MSA, Whittaker builds single-family detached and attached homes
targeting entry level and first and second move-up buyers.
Acquisition of Quail Construction
Effective April 1, 1998, the Company acquired Quail, a homebuilder
based in Vancouver, Washington with operations in the greater Portland, Oregon
market area, marking the Company's expansion into the Pacific Northwest. Quail
is a single-family homebuilder whose product targets the entry level, first
move-up and empty-nester market segments.
<PAGE>
Consolidated Results of Operations
Comparison of the Company's Results of Operations for the Nine and Three Months
Ended September 30, 1998 and 1997.
Homebuilding Operations
General
<TABLE>
<CAPTION>
New Orders, Net Closings Backlog/1 at September 30,
----------------- ---------- ------------------------
Nine Months Three Months Nine Months Three Months
1998 1997 1998 1997 1998 1997 1998 1997 1998 1997
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
State
Arizona 62 29 28 12 34 25 19 12 37 12
Colorado 304 290 72 91 250 239 79 76 237 189
Florida 675 428 175 163 497 442 168 191 329 206
Missouri 338 N/A 133 N/A 295 N/A 137 N/A 207 N/A
Nevada 134 110 51 40 70 64 21 25 127 67
North Carolina 585 356 175 137 495 394 180 182 342 292
Oregon 36 N/A 27 N/A 30 N/A 26 N/A 16 N/A
Pennsylvania 171 N/A 48 N/A 159 N/A 58 N/A 61 N/A
South Carolina 144 18 41 15 143 16 52 16 79 73
Texas 755 692 211 225 603 567 209 234 401 373
Virginia 40 N/A 11 N/A 26 N/A 12 N/A 26 N/A
Washington 47 N/A 25 N/A 50 N/A 33 N/A 11 N/A
Wisconsin 187 120 48 35 112 89 48 34 97 49
------ ------ ------------- ------ ----- ------ ---- ----- -----
Total 3,478 2,043 1,045 718 2,764 1,836 1,042 770 1,970 1,261
</TABLE>
As seen in the above chart, the Company achieved new orders of 3,478
homes for the nine months ended September 30, 1998 compared to 2,043 homes for
the same period in 1997, an increase of 70.2%. New orders for the quarter ended
September 30, 1998 and 1997 were 1,045 and 718, an increase of 45.5%. These
increases are attributable to the acquisitions in 1998 and late 1997 and
significant new order increases in the Company's Jacksonville, Las Vegas, and
Janesville-Milwaukee operations as well as significant increases for the nine
months year over year in the Austin operations.
The Company has a combined backlog of 1,970 units with a dollar value
of $376.4 million as of September 30, 1998 as compared to 1,261 homes with a
dollar value of $226.8 million as of September 30, 1997. The increase in homes
in backlog, 56.2%, is consistent with the increase in new orders as previously
discussed. The per home value of backlog at September 30, 1998 is approximately
$191,100 compared to $179,900 at September 30, 1997. This is primarily due to an
89.6% increase in the number of luxury homes in backlog at the Company's Las
Vegas operations, where the average backlog value per home at September 30, 1998
was approximately $524,900. The increases in this high value backlog were
somewhat offset by 98.0% and 59.7% increases in backlog at the Company's
Janesville-Madison and Jacksonville operations, where the September 30, 1998 per
home backlog values averaged $121,900 and $115,700, respectively.
Revenues
Homebuilder revenues for the Company totalled $459.8 million for the
nine months ended September 30, 1998 compared to $293.4 million for the same
period in 1997. The 56.7% increase in revenue is consistent with the number of
homes closed, 2,764 homes as compared to 1,836 homes for the nine months ended
September 30, 1998 and 1997, respectively. For the quarter, homebuilding
revenues increased 48.1%, up $56.7 million to $174.5 million for the quarter
ended September 30, 1998 compared to $117.8 million for the quarter ended
- - -----------------
/1 Backlog represents homes sold but not yet closed.
<PAGE>
September 30, 1997. These increases are attributable to moderate growth in the
founding builders and early-1997 acquisitions and significant increases due to
the Company's late-1997 and 1998 acquisitions. The Company has shifted its focus
from acquisitions to integration of its businesses. Consequently, the Company
anticipates that revenue increases resulting from the significant historical
pace of acquisitions will not continue.
Gross Profit
Gross profit for the nine months ended September 30, 1998 was $71.2
million compared to $44.2 million for the same period in 1997, representing an
increase of 61.1%. The Company's gross profit as a percentage of homebuilding
revenue, or gross margin, increased to 15.5% from 15.1% for the same periods.
For the quarter, gross profit increased to $28.8 million in 1998 from $18.5
million in 1997 and the corresponding margins increased to 16.5% from 15.7%. The
Company has been able to achieve these increases in gross profits and gross
margins through its continued focus on builder integration as well as market
acceptance of moderate price increases and a strong national housing market.
Gross profits of acquired companies Landmark, Hutson, Galloway,
WestBrook, Whittaker, and Quail were lower than they ordinarily would be due to
amortization of inventory written up to fair value at their respective
acquisitions. Without this step-up amortization, Fortress's gross profit as a
percentage of revenue would increase to 15.8% for the nine months ended
September 30, 1998 and 16.7% for the quarter then ended as compared to 15.5% and
16.6% for the same periods of 1997, respectively. As anticipated, the costs
associated with purchase accounting have been and will continue to decrease as
the acquisition inventory is closed.
The slightly lower margins for the nine months as compared to the
quarter were due to the continued effect of a successful concerted effort by the
Company to liquidate older, lower profit speculative housing inventory,
particularly in its Texas markets, during the first quarter of 1998.
Operating Expenses
Total operating expenses increased as a percentage of revenue to 12.2%
($56.1 million) from 11.9% ($34.9 million) for the nine months ended September
30, 1998 and 1997, respectively. For the quarter ended September 30, 1998, total
operating expenses increased as a percentage of revenue to 12.1% ($21.1 million)
from 11.2% ($13.2 million). During the third quarter, the Company recorded
payments and accruals for non-recurring severance costs totalling $737,000
resulting from the resignation of the Company's Chief Executive Officer and
Chief Financial Officer. Without these non-recurring costs, operating expenses
as a percentage of revenue would have been 12.0% and 11.7% for the nine and
three months ended September 30, 1998, respectively.
Selling expenses as a percentage of revenue increased to 6.5% ($29.9
million) from 6.3% (18.6 million) between 1998 and 1997 for the first nine
months. For the quarters ended September 30, 1998 and 1997, selling expenses
increased to 6.2% ($10.9. million) from 6.0% ($7.1 million). As discussed during
the first and second quarter reviews, the Company's Las Vegas subsidiary opened
five new luxury model homes in late December of 1997 which required extensive
upgrades that are being amortized as additional selling expenses. While sales
activity has been strong in this new community, few of these homes have closed
yet due to longer build times consistent with luxury homes and some minor start
delays related to permitting. Therefore, the added selling expenses have been
recognized without corresponding increases in revenues. Going forward, this
situation will reverse as closings in this community accelerate. Without these
additional costs from this new community, selling expenses as a percentage of
revenue would have been consistent with 1997.
General and administrative expenses as a percentage of revenue
decreased for the nine months ended September 30, 1998 to 5.2% ($23.7 million)
from 5.4% ($15.9 million) for the same period in 1997 and increased slightly for
the three months then ended to 5.1% ($8.9 million) from 5.0% ($5.9 million) for
1998 and 1997, respectively. The decrease for the nine months is due to the
effects of certain economies of scale gained from the Company's dramatic growth.
A partial offset to these savings is the increase in information technology
<PAGE>
related expenses as the Company continues its plan to convert all of its builder
subsidiaries to an integrated computer information system. In addition, the
Company has increased bonus accruals in anticipation of higher bonus payments in
1998 as compared to 1997.
Amortization of goodwill for the nine months increased $1.3 million to
$1.7 million in 1998 from $444,000 in 1997 and for the quarter increased
$386,000 to $596,000 in 1998 from $210,000 in 1997. The increase in goodwill
amortization is a function of the increase in goodwill resulting from the
acquisitions of Galloway, Iacobucci, Whittaker, and Quail.
Homebuilding Income before Taxes
Homebuilding pre-tax income increased $5.8 million to $13.5 million for
the first nine months of 1998 from $7.7 million for the same period in 1997,
representing an increase of 75.3%. For the quarter, homebuilding pre-tax income
increased 75.6% to $7.2 million in 1998 from $4.1 million in 1997. As previously
discussed, these increases are due to income from acquisitions made during
late-1997 and 1998 and higher gross profits in the third quarter slightly offset
by the non-recurring severance expenses.
Fortress Mortgage Operations
Fortress Mortgage, which was formed in January of 1997, continues to
open new branch operations primarily in our builder markets. At the end of the
third quarter of 1997, Fortress Mortgage had five operating branches and, by the
end of the third quarter of 1998 has opened an additional nine branches for a
current total of fourteen branches.
Fortress Mortgage showed pre-tax losses of $47,000 and $58,000 for the
first nine and three months of 1998 down from pre-tax income during the same
periods of 1997 of $152,000 and $173,000, respectively. Fortress Mortgage's
earnings have been negatively impacted by the start-up costs incurred in
conjunction with the aforementioned office openings. For the nine months ended
September 30, 1998, Fortress Mortgage provided mortgages to 23.5% of the
Company's closings in those markets which it serves. In those markets which
Fortress Mortgage has served for one year or more, the capture rate, the
percentage of closings for which Fortress Mortgage provided mortgages, for the
first nine months of the year has increased to 54.1% in 1998 from 50.5% in 1997.
The Company anticipates increased capture rates as more recently opened branches
continue to grow and stabilize.
Net Income
Due to the previously described factors and the income tax effect
thereof, net income for the nine months ended September 30, 1998 increased 68.8%
to $8.1 million from $4.8 million in 1997. Net income for the third quarter of
1998 increased 65.4% to $4.3 million from $2.6 million for the same quarter of
1997.
Diluted earnings per share for the nine and three months ended
September 30, 1998 was impacted by the dilutive effect of the $40 million of
Class AA preferred stock and 375,000 Warrants issued to Prometheus at the end of
the third quarter of 1997 ($11.7 million) and on March 6, 1998 ($28.3 million).
The proceeds from this issuance were used for the acquisitions of Galloway,
Iacobucci, Whittaker, and Quail. The Class AA preferred stock is currently
convertible at $6.00 per share. However, Class AA preferred stock and the
Warrants carry future reset tables that are in effect between September 30, 2001
and September 30, 2003 whereby the conversion rate changes based on the then
current market price of the Common Stock (See Note 9). The dilution of earnings
per share was significantly increased from the second quarter of 1998 due to the
lower average stock value during the quarter ended September 30, 1998. Pursuant
to the current relevant accounting literature, the Company must report currently
the potential future conversion based on the contractual reset tables and the
current market price even though the holder of the Class AA preferred stock and
warrants cannot effect a conversion under these reset tables until September 30,
2001. Because diluted earnings per share is based in part on the market price
of the Common Stock, a decline in the market price would generally lead to
further dilution.
18
<PAGE>
If the earnings per share had been calculated using the current
conversion prices of the Class AA preferred stock ($6.00 per share) and the
Warrants ($7.00 per share), the diluted earnings per share for the nine and
three months ended September 30, 1998 would be $.43 and $.22, respectively,
increases of $.05 and $.02 for the nine months and three months, respectively,
in 1998 over 1997.
Earnings before interest, taxes, depreciation and amortization (EBITDA)
increased 51.8% to $38.1 million for the nine months ended September 30, 1998
compared to $25.1 million in for the same period in 1997. For the third quarter,
EBITDA increased 37.9% to $16.0 million in 1998 from $11.6 million in 1997.
EBITDA is provided as a supplemental measurement of the Company's operating
performance. EBITDA does not represent cash flows from operations as defined by
GAAP and should not be considered as an alternative to net income as an
indicator of the Company's operating performance or to cash flows as a measure
of liquidity. In addition, EBITA measures presented by the Company may not be
comparable to other similarly titled measures of other companies.
Liquidity and Capital Resources
The Company's operating activities involve several components,
principally home construction, land development, and mortgage loan origination
for home purchasers. During the nine months ended September 1998, the Company's
operating activities, taken in the aggregate, provided approximately $207,000 of
cash. This cash flow was primarily generated by home sales offset in part by the
Company's increasing inventories due to additional build up consistent with the
Company's growth in its backlog due to the seasonal nature of the homebuilding
industry.
The majority of the Company's investing activities during the nine
months--net cash use of $37.6 million--related to (a) the purchases of
Whittaker, WestBrook, and Quail ($27.0 million), (b) additional consideration
under the earnout provision of prior period acquisitions ($2.0 million), (c)
property and equipment expenditures partially resulting from the continued
implementation of the corporate-wide management information system ($4.6
million), and (d) investments in limited land partnerships ($3.4 million).
The Company's financing activities generated cash of $42.6 million.
These activities included net proceeds from the issuance of 28,300 shares of
Class AA preferred stock to Prometheus and net borrowings under notes and
mortgages payable $18.2 million. Preferred dividend payments of $1.5 million
offset these cash inflows.
The Company has entered into a stock purchase agreement (the
"Agreement") with Prometheus Homebuilders LLC ("Prometheus"), a subsidiary of
Lazard Freres Strategic Realty Investors II L.P., which commits Prometheus to
purchase $75 million of Fortress preferred stock and/or debt. The second closing
under the Agreement took place on March 6, 1998 with Prometheus's purchase of
28,300 shares ($28.3 million initial liquidation value) of Class AA preferred
stock. The proceeds were used to purchase Whittaker in March and Quail in April.
The Company is required to sell the remaining $35 million preferred stock and/or
debt to Prometheus by December 31, 1998.
Management believes that funds available through the existing credit
facilities coupled with the cash on hand and cash generated through operations
will be adequate for the anticipated cash need of its current operations for the
foreseeable future. As of September 30, 1998, the Company had cash and cash
equivalents on hand of $17.6 million.
At September 30, 1998, the Company had 3,687 lots in inventory, which
represents an estimated ten month supply of land based on sales absorption rates
for the first nine months of 1998. It is one of the Company's operating
strategies to keep a relatively low supply of finished lots and lots under
development in order to manage and minimize risk associated with land ownership.
The Company utilizes land options and investments in limited land partnerships
as methods of controlling and subsequently acquiring land. The Company plans to
continue these practices and expects to exercise, subject to market conditions,
<PAGE>
substantially all of its option contracts. At September 30, 1998, the Company
had an additional 6,980 lots under option representing just under a
one-and-a-half-year supply of land based on the same absorption rates as above.
Year 2000
As many computer systems and other business equipment are embedded with
chips or processors that use only two digits to represent the year or are
programmed with software that uses such a two digit system, they may be unable
to accurately process certain data before, during or after January 1, 2000. If
not addressed and corrected, such programs and chips may cause computer systems
to fail or to miscalculate data. This issue is commonly referred to as the "Y2K"
issue.
In conjunction with its ongoing process of converting all of its
builder subsidiaries to an integrated computer information system ("ICIS"),
Fortress has begun the project of addressing the Y2K issue during 1998. The
Company's project is directed at modifying or replacing portions of its existing
computer systems to ensure that they will function properly with respect to
dates in the year 2000 and thereafter. The Company's plan encompasses both
information technology systems and non-information technology systems, such as
chips embedded in its security systems, office equipment, and facilities.
The general phases of the Company's plan include the following: (1)
plan and ensure company-wide awareness of the Y2K issue, (2) inventory all
possible Y2K risks, (3) assess inventory (including identification of non-Y2K
compliant items, prioritize inventory into mission-critical and
non-mission-critical categories, and plan for repair and replacement of
non-compliant items), (4) repair or replace non-Y2K compliant items, (5) plan
and execute Y2K testing, and (6) design and implement contingency plans for
non-compliant items. Due to the Company's structure and its ongoing computer
information system rollout, the Company is in different phases of implementation
of its plan at its different subsidiaries.
The Company has assessed the information systems of the subsidiaries as
its greatest area of business risk and, accordingly, has given this area highest
priority. At September 30, 1998, the Company has completed the first phase and
is well underway with phases two and three at all subsidiaries. The plan is to
be through phase five at all subsidiaries early in the third quarter of 1999 and
to have completed all phases throughout the Company by the end of the third
quarter of 1999.
The Company's information technology ("IT") group is currently involved
with its ICIS vendor performing Y2K testing on the ICIS. The Company plans to
upgrade the three subsidiaries currently on the ICIS to the Y2K compliant
version of the software during the first quarter of 1999. Additionally, the five
builder subsidiaries with non-compliant systems will begin conversion to the
compliant version of the ICIS during the first and second quarters of 1999 with
all conversions being completed early in the third quarter of 1999. (The IT
group has identified Y2K compliant upgrades for these varying non-compliant
systems, which are available at a cost that would be immaterial to the Company.)
The main information systems at four of the Company's builder subsidiaries are
currently Y2K compliant. Due to the IT group's current focus on bringing the
Company into Y2K compliance, these subsidiaries will not implement ICIS until
2000. Management does not consider this delay in implementation to have a
material adverse impact on the Company.
While the Company is giving greatest priority to its operating systems
and those of its subsidiaries, the Company is also addressing the Y2K issues
associated with the Company's telephone and voice mail systems, fax machines,
copiers and other office systems integrated into the office facilities, and
other equipment including embedded chips or processors. These items are
scheduled to be assessed, repaired or replaced, and tested by the end of June
1999.
The Company is currently assessing whether third parties with which the
Company and its operating subsidiaries have a material relationship are Y2K
compliant. The Company is currently in various stages of assessment with respect
to these third party verification projects. These assessments are currently
expected to be substantively completed by the end of 1998. As part of this
assessment, the Company is examining its relationships with suppliers,
subcontractors, financial institutions and other third parties to determine the
status of their Y2K efforts as related to the Company. As a general matter, the
Company is vulnerable to significant suppliers' inability to remedy their own
Y2K issues. Furthermore, the Company relies on financial institutions,
government agencies (particularly for zoning, building permits and related
<PAGE>
matter), utility companies, telecommunication service companies and other
service providers outside of its control. While certain third parties
significant to the Company's business have provided certain assurances regarding
their intentions to be Y2K compliant, there is no assurance that such third
parties will not suffer a Y2K business disruption. It is conceivable that such
failures could, in turn, have a material adverse effect on the Company's results
of operations, financial condition, and liquidity.
Costs
As the Company's Y2K project has been combined with the ICIS project,
many areas of the project would have been undertaken regardless of the Y2K
issue. Management estimates that the total cost of the projects associated with
the Y2K compliance work will approximate just over $4.0 million; however, it is
not possible to determine the portion of that amount which is specifically
attributable only to the Y2K compliance work. The total amount expended on this
work was approximately $2.6 million as of September 30, 1998. The Company
believes that the costs to specifically address the Y2K issue will not have a
material impact on the Company's results of operations, financial condition, or
liquidity for any year in the reasonably foreseeable future. The plan for the
successful completion of the Company's Y2K project and the estimated total costs
are based upon certain assumptions by management regarding future events,
including the continued availability of qualified resources to implement the
program and the cost of such resources.
Risks
The Company acknowledges that its failure to resolve a material Y2K
issue could result in the interruption in, or a failure of, certain normal
business activities or operations. Possible risks of Y2K failure include among
other risks, delays or errors with respect to payments, third-party delivery of
materials, and government approvals. Such failures could materially adversely
affect the Company's results of operations. Although the Company generally
considers its exposure to the Y2K issue risks from third party suppliers as
generally low, due to the uncertainty of the Y2K readiness of third-party
suppliers, the Company is unable to determine at this time whether the
consequences of Y2K failures will have a material impact on the Company's
results of operations, financial condition, or liquidity. In addition, the
Company could be materially adversely affected by Y2K system failures at
government agencies on which the Company is dependent for zoning, building
permits, and related matters. Further, the Company could be materially adversely
affected if Y2K system failures result in widespread economic or financial
market disruption. The Company's Y2K project is expected to significantly reduce
the Company's level of uncertainty and exposure to the Y2K issue. To date, the
Company has not identified any operating systems, either of its own or of a
material third-party supplier, that present a material risk of not being Y2K
compliant or for which a suitable alternative cannot be implemented.
Contingency Plan
The Company's Y2K plan calls for a Y2K-specific contingency plan to be
developed. This plan is currently in progress and is expected to be completed by
the end of the Company's 1999 first quarter.
While management expects that the company will not experience material
adverse consequences in connection with the Y2K issue as it relates to its
internal operating system, no assurance can be given that the system will
operate as expected in the Year 2000.
Statement on Forward-Looking Information
Certain information included within this report is forward-looking
within the meaning of the Private Litigation Reform Act of 1995, including but
not limited to, statements concerning growth, anticipated operating results,
<PAGE>
financial position, and liquidity and financial resources. Such forward-looking
information involves important risks and uncertainties that could significantly
affect actual results and cause them to differ materially from the expectations
expressed herein. These risks and uncertainties include the competitive
environment in which the Company operates, fluctuations in interest rates,
local, regional and national economic conditions, the effect of government
regulation, the availability and costs of land, the availability of capital, the
availability and cost of labor and materials, changes in home prices, and
weather conditions.
<PAGE>
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Number Description
------ -----------
27 Financial Data Schedule
(b) Reports on Form 8-K.
None
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
THE FORTRESS GROUP, INC.
Date: 11/16/98 By: /s/ George C. Yeonas
------------------- -----------------------------------------
George C. Yeonas
President and Chief Operating Officer
Date: 11/16/98 By: /s/ Jeffrey W. Shirley
------------------- -----------------------------------------
Jeffrey W. Shirley
Vice President of Finance
(Principal Financial Officer)
24
<PAGE>
EXHIBIT INDEX
Number Description
------ -----------
27 Financial Data Schedule
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORTRESS
GROUP, INC. CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1998 AND FROM THE
FORTRESS GROUP, INC. CONSOLIDATED STATEMENT OF OPERATIONS FOR THE NINE MONTHS
ENDED SEPTEMBER 30, 1998.
</LEGEND>
<CIK> 0001010607
<NAME> The Fortress Group, Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-1-1998
<PERIOD-END> SEP-30-1998
<EXCHANGE-RATE> 1.000
<CASH> 17,568
<SECURITIES> 0
<RECEIVABLES> 15,261
<ALLOWANCES> 0
<INVENTORY> 315,267
<CURRENT-ASSETS> 0
<PP&E> 13,572
<DEPRECIATION> 0
<TOTAL-ASSETS> 457,125
<CURRENT-LIABILITIES> 0
<BONDS> 100,000
0
1
<COMMON> 122
<OTHER-SE> 93,777
<TOTAL-LIABILITY-AND-EQUITY> 457,125
<SALES> 459,845
<TOTAL-REVENUES> 462,679
<CGS> 388,693
<TOTAL-COSTS> 444,759
<OTHER-EXPENSES> 1,329
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,174
<INCOME-PRETAX> 13,470
<INCOME-TAX> 5,391
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,079
<EPS-PRIMARY> 0.54
<EPS-DILUTED> 0.37
</TABLE>
