================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997 Commission file number 0-28024
THE FORTRESS GROUP, INC.
-----------------------------------------------------
(Exact name of registrant as specified in its charter)
-----------
Delaware 54-1774977
------------------------------ ------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1650 Tysons Boulevard, Suite 600, McLean, Virginia 22102
-------------------------------------------------- ---------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (703) 442-4545
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01
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 such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: YES X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statement incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
Aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 27, 1998 was $17,503,298.
As of March 27, 1997, 11,601,498 shares of the Registrant's Common
Stock, $.01 par value per share, were outstanding.
================================================================================
<PAGE>
Documents Incorporated By Reference
Certain information required by Items 10, 11, 12 and 13 of Form 10-K is
incorporated by reference into Part III hereof, from the registrant's proxy
statement, which will be filed with the Securities and Exchange Commission
within 120 days after the close of the fiscal year covered by this Form 10-K,
and certain documents are incorporated by reference into Part IV hereof.
2
<PAGE>
PART I
Item 1. Business
Introduction
The Fortress Group, Inc. (the "Company" or "Fortress") is a national
homebuilding company engaged in designing, building and selling single family
homes in the metropolitan areas surrounding a diversified group of cities in the
United States. The Company offers high-quality, innovative homes, targeting a
diverse range of market segments including the first-time, entry-level buyer,
move-up buyer and executive/luxury home buyer. The Company markets a wide range
of single family detached and attached homes ranging in size from 1,000 to 6,000
square feet at prices ranging generally from $70,000 to $800,000.
The Company was formed in June 1995 to create a national homebuilding company
through the simultaneous acquisition of four homebuilding companies and an
initial public offering of the Company's equity and debt securities (the
"Offerings"). The acquisitions and the Offerings were completed in May 1996. The
acquired companies became wholly-owned subsidiaries of Fortress and as a group
are referred to as the Combined Predecessor Companies or the Founding Builders.
Substantially all of the former owners of the Founding Builders remain as senior
managers of the Company. Each of the Founding Builders continues to be operated
locally under its original name. In 1996, subsequent to closing on the
acquisitions and the Offerings, the Company acquired two additional homebuilding
companies; in 1997, an additional four companies were acquired; and in 1998 to
date an additional two companies have been acquired.
The Company's homebuilding operations are currently conducted in the following
market areas:
STATES MARKET AREAS
------ ------------
Arizona Tucson
Colorado Denver, Fort Collins
Florida Jacksonville
Missouri St. Louis
Nevada Las Vegas
North Carolina Raleigh-Durham, Wilmington, Charlotte
Pennsylvania Philadelphia
South Carolina Myrtle Beach, Charleston
Texas Austin, San Antonio
Virginia Loudoun County
Wisconsin Janesville-Madison-Milwaukee
Operating Strategy
The Company believes it is positioned for continued success in the homebuilding
industry because of (i) its established operations in attractive housing
markets; (ii) its ability to enhance profitability through an improved capital
structure and certain operating synergies; (iii) its management expertise both
in homebuilding generally and its specific target and geographic markets; (iv)
diversification of its geographic markets and products; (v) its conservative
land acquisition policies; and (vii) its ability to
3
<PAGE>
expand both within its existing markets and through acquiring other local
homebuilding companies located in other strong housing markets.
Strong Market Positions in Attractive Housing Markets. The Company believes that
it operates in some of the most attractive housing markets in the nation.
Generally, the metropolitan areas where the Company conducts operations have
experienced unemployment rates below the national average and population growth
rates in excess of the national average for the past five years. Additionally,
the Company believes that population and employment growth, as well as housing
starts, will continue at levels above the national average through the year
1999. The Company believes that each of its local operations has developed a
reputation within its respective market as a quality homebuilder with desirable
products. Each local operation has targeted one or more specific niches within
its market and has developed products which specifically target its customers.
As a result, the Company believes that each of its local operations has
established strong positions within its market.
Reducing the Risk of Cyclicality Through Geographic and Product Diversification.
In addition to focusing on growth markets, the Company's overall strategy also
relies on the geographic diversification of its existing markets. Since local
housing markets are cyclical and cycles depend, in part, on local and regional
conditions, the Company believes that by operating in 16 distinct geographic
markets it is less subject to the effects of local and regional economic cycles
than homebuilders that operate in a single geographic market. Additionally, the
Company believes that its product diversification (which generally range in
sales price from $70,000 to $800,000) and diversity of niche markets (which
range from young families to "empty-nesters") reduce risk in the event that
existing national factors, such as interest rates, inflation, the general state
of the economy or tax legislation, detrimentally affect particular income levels
or demographic groups.
Enhancing Profitability Through Improved Capital Structure and Operating
Synergies. The Company believes that the financial strength of its local
operations, coupled with the application of the proceeds from the Offerings and
future financing, has enhanced the Company's competitive position, substantially
reduced its overall costs associated with land acquisition and project
construction, and provided the necessary capital to employ its strategies for
expansion. Additionally, the Company's subsidiaries have generally been able to
obtain financing on more favorable terms than previously available.
Although the Company's most significant services and commodities are obtained on
a local level, the Company's overall size and strength of operations has enabled
it to secure favorable terms from certain suppliers by purchasing in volume. The
Company also has been able to integrate certain administrative functions of the
local operations and realize both cost savings and enhanced efficiency through
the centralized management of insurance policies, employee benefits and certain
other administrative functions. Additionally, the Company believes that each of
its local operations can significantly benefit by understanding and employing
those practices, policies and strategies, such as a market analysis, costing
procedures and quality control, that have contributed to the success of the
Company's other local operations.
Combining Decentralized Operations with Experienced Management. The Company was
founded on the belief that the homebuilding industry is localized and therefore
homebuilders are most successful when managed by experienced and cycle-tested
local managers who have developed in-depth market knowledge and strong local
relationships. The Company believes that the senior management of each of its
local operations has in-depth knowledge of the local markets where operations
are conducted, thereby enabling the Company to better serve its customers and
maximize each local operation's profitability.
4
<PAGE>
The Company's top five senior managers overseeing the centralized corporate
operations have nearly 100 years of combined experience in the national
homebuilding industry and are responsible for formulating and implementing the
Company's policies and procedures intended to make the operating subsidiaries
achieve profitability and growth goals. The Company has implemented centralized
financial controls and cash management policies as well as comprehensive
planning and reporting systems that require approval by the corporate senior
management team of, among other items, all projects and material capital
commitments.
Limiting the Company's Exposure to Real Estate-Related Risks. Management
attempts to minimize risks associated with land ownership and to maximize
return on invested capital by deferring, to the extent practical, substantial
investment in land until the later phases of the land development and
construction process. The Company attempts to control a two- to four-year
supply of lots based on its expected absorption rates. In some markets, the
Company generally acquires fully developed lots pursuant to options or purchase
contracts in quantities sufficient to satisfy near-term demands. In other
markets, the Company strives to control undeveloped land (through options or
contingent purchase contracts) through most of the zoning and land development
process, closing on such land as close as possible to the start of home
construction. These acquisitions are generally limited to smaller tracts of
entitled land that will yield 25 to 100 lots when developed. By limiting its
land acquisitions and development activities generally to smaller parcels of
land, the Company reduces the financial and market risks associated with owning
land during the development period.
Increase Market Share in Existing Markets. One of the Company's goals, subject
to existing market conditions, such as the availability and cost of developable
land, is to accelerate growth in the Company's current markets through the
improved access to capital provided by the financial strength of the Company.
The Company believes that each of its current markets has a strong economy and
will provide certain opportunities for expansion. Most of the Company's existing
markets encompass broad metropolitan areas surrounding major cities which have
an extremely fragmented homebuilding industry. The Company believes that its
improved access to capital will directly enable each local operation to pursue
additional land acquisitions, have more communities under development and
increase its backlog for future home sales. The Company believes that such
internal expansion can be done conservatively while improving the Company's
financial performance.
Growth by New Markets and Acquisitions. Depending on existing market conditions,
the Company intends to enter into one or more new markets each year. Recognizing
the highly fragmented nature of the homebuilding industry, the Company intends
to utilize an acquisition program whereby it will acquire established, local
homebuilding companies that operate in new markets. The Company believes that it
will be an attractive acquirer of other local homebuilding companies due to (i)
the benefits afforded by being a part of a national, public homebuilding
company, including an enhanced ability to compete in the local market through
the Company's financial strength and improved access to capital; (ii) the
Company's decentralized management strategy, which will enable existing local
management to continue to oversee their local operations; and (iii) a team of
senior executives with over 100 years of combined experience in the homebuilding
industry who are responsible for all centralized Company operations and will be
available to provide operational support and advice on an as-needed basis. In
most instances, the Company expects to retain the management, employees and name
of the acquired company while seeking to improve the acquired company's
profitability by implementing the Company's business strategies and providing
improved access to capital.
In the event such new markets are in close proximity to one or more of the
Company's existing markets, the expanded operations may be conducted under the
management of the Company's existing operations
5
<PAGE>
currently operating in that area. Management believes that such expansion will
provide the Company with valuable synergies and economies of scale which will
increase the profitability of the local operation overseeing operations within
the new market. The Company intends to reduce its risk when entering such new
markets by thoroughly developing a marketing and overall strategy prior to
commencing operations, acquiring land in a conservative manner and upon
favorable terms and hiring local management who has developed an expertise in
the marketplace.
While the Company intends to make acquisitions which are accretive to earnings,
there can be no assurance that any companies acquired in the future will be
beneficial to the successful implementation of the Company's overall business
strategy, or that such companies will ultimately produce returns that justify
the investment therein. In addition, there can be no assurance that the Company
will be able to profitably manage additional companies or successfully integrate
such additional companies into the Company.
The Company currently intends to finance future acquisitions by using available
cash resources and shares of the Company's stock. In keeping with this plan, the
Company entered into an agreement to sell certain preferred stock to Prometheus
Homebuilders LLC (Prometheus) with the intention of utilizing at least a portion
of the proceeds to finance future acquisitions. (See Management's Discussion and
Analysis of Financial Condition and Results of Operation of the Company on
Liquidity and Capital Resources.) The potential target companies' willingness to
accept the Company's stock as part of the purchase price, as well as the
availability of cash resources, will impact the Company's ability to continue
its acquisition program. The Company's growth through acquisitions could be
limited unless it can obtain the necessary funds through additional equity or
debt financing.
Markets and Products
Overview
The Company's operations serve the metropolitan areas surrounding the following
cities: Raleigh-Durham, Wilmington, and Charlotte, North Carolina; Myrtle Beach
and Charleston, South Carolina; Austin and San Antonio, Texas; Las Vegas,
Nevada; Denver and Fort Collins, Colorado; Tucson, Arizona; Janesville, Madison
and Milwaukee, Wisconsin; Jacksonville, Florida; Philadelphia, Pennsylvania;
Loudoun County, Virginia (Washington, DC MSA); and St. Louis, Missouri. The
Company believes that each of these areas represents an attractive homebuilding
market with significant opportunity for growth. The Company also believes that
each of its local operations is well established in its market and has developed
a reputation for building quality homes at competitive prices. The Company
maintains the flexibility to tailor its product mix within a given market
depending upon market conditions including demographic trends, demand for a
particular type of product, margins, timing and the economic strength of the
market.
Raleigh-Durham, North Carolina
Raleigh is the state capital of North Carolina. The state government and the
three major universities located in the area provide stable employment
throughout the region. Employment growth in the region has been fueled by the
high technology industry operating in and around the area's "Research Triangle"
(Raleigh-Durham-Chapel Hill). The long-term projection in this area is for
continued job growth and expansion, both from net immigration of business as
well as from home-grown, high-tech, and biotechnology firms conceived,
incubated, and launched in the Research Triangle.
6
<PAGE>
The Company believes that it is well positioned in the Raleigh-Durham market
with its Raleigh-Durham operation building high-quality, innovative,
single-family detached and attached homes that range in sales prices from
approximately $115,000 to approximately $350,000 and targets entry-level and
first- and second-time move-up buyers and retirees. Depending on the opportunity
available within each community, the Company will either develop land which it
controls under option or contract or purchase developed lots from developers or
other homebuilders. As of December 31, 1997, the Company controlled
approximately 983 optioned lots (including land anticipated to be subdivided
into lots) in the Raleigh-Durham area for new home construction. The Company's
North Carolina operation has received numerous marketing awards and has been
selected as the Triangle Sales and Marketing Council's and the Raleigh-Wake
County Homebuilders' Association's "Builder of the Year" awards multiple times,
most recently in 1994 and 1995, respectively.
Wilmington, North Carolina
The Wilmington economy is driven by a wide range of industry including
manufacturing, tourism, retirement living, and the University of North Carolina
at Wilmington. In the Wilmington area, residential building permits averaged
2,828 units annually during the 1994-1996 time period. This represents an
increase of 33.6% compared to the permits recorded annually during the 1983-1989
period and an increase of 69.1% compared to the average recorded during the
1990-1993 period. The Company entered the Wilmington market in August 1996
through its acquisition of one of the largest homebuilding companies in
southeastern North Carolina. This operating subsidiary, founded in 1988, builds
single family and attached homes and targets entry, move-up, and luxury home
buyers. Sales prices range from approximately $98,000 to $200,000. As of
December 31, 1997, the Company controlled approximately 359 optioned lots in the
Wilmington area for new home construction.
Charlotte, North Carolina
During the last decade, the city of Charlotte has become the second largest
financial center in the nation surpassed in banking resources by New York only.
Wholesale trade, transportation and manufacturing have added significantly to
form a strong economic base in the Charlotte area. The growth primarily in these
industries period has created a market averaging annual employment increases of
just under 20,000 new workers in the period from 1983 to 1996. This growth has
supported single family housing permits of approximately 8,400 homes per year
for the same period. Charlotte continues to be one of the more affordable
metropolitan areas in the nation in terms of the cost of living and one of the
more attractive metropolitan areas in the country for company relocations.
The Company's Charlotte division focuses on delivering innovative single family
homes to entry level and first and second move-up buyers with homes with average
prices ranging from $110,000 to $197,000 for average square footage of 1,350 to
2,650 square feet. The Charlotte subsidiary hosts an annual golf tournament for
charity which is supported by donations from subcontractors and benefits The
Make-A-Wish Foundation. As of December 31, 1997, the Company controlled
approximately 1,535 optioned lots in the Charlotte market for new home
construction and lot sales.
Myrtle Beach, South Carolina
The two-county Myrtle Beach area receives an estimated 12 million visitors each
year with an ever-increasing number of entertainment attractions, live music
theatres, shopping centers, beach-front activities, and golf courses. This
activity within the tourism industry has sparked plans for three more
7
<PAGE>
signature golf courses, eight new hotels, and renovation of the downtown area
over the next few years. Additionally, the activities that have traditionally
made Myrtle Beach a tourism destination (including golf, tennis, and boating)
are also making Myrtle Beach a desirable retirement destination. In the Myrtle
Beach area, residential building permits averaged 3,414 units annually during
the 1983-1996 time period. Most recently, between 1994 and 1996, total permit
authorizations averaged 3,799 units, representing a 108.5% jump over the average
recorded during the previous five years. The Company's Wilmington-based
subsidiary is increasing its presence in the Myrtle Beach market.
Charleston, South Carolina
The Company's Charlotte subsidiary also has operations in the Charleston, South
Carolina market. Charleston has a broad economic base with the largest
containerized cargo port on the South Atlantic and Gulf coasts, a $2.3 billion
tourism industry, an impressive medical hub, a well-established manufacturing
industry and a large military presence. This diverse base has assisted in
Charleston's apparent recovery from the closing of a shipyard and a number of
military bases. Housing permits in the area have been steady in the 2,200 to
2,400 range from 1994 to 1996. While the Company's subsidiary builds homes from
the low $100,000s to $300,000s in the Charleston market, it focuses building in
the $100,000 to $174,000 range. As of December 31, 1997, the Company controlled
approximately 126 optioned lots in the Charleston market for new home
construction and lot sales.
Austin, Texas
Austin is the state capital of Texas. The state government and the University of
Texas provide stability to the region's employment base. Many of the trends in
employment growth in the region have been fueled by the significant growth in
the high technology industry operating in the Austin area. From 1988-1996, the
Austin Metropolitan Statistical Area (MSA) averaged 21,450 new jobs annually. In
1997, the Austin MSA saw a decrease in building permits of approximately 30%.
This decrease is largely the result of slowed job growth as the Austin job
market is beginning to level off from the 1988-1996 boom.
The Company has offices located in Austin and San Antonio, Texas and conducts
operations in both of these metropolitan areas. This local operation offers
primarily single family detached homes to entry-level and first-time move-up
homebuyers that generally range in sales price from $75,000 to approximately
$250,000 under the Buffington Homes name. The subsidiary's second-time move-up
and higher-end products are sold under the Wilshire Homes name. In 1997, the
Austin subsidiary was able to hold new order activity steady with 1996 activity,
thus capturing a larger share of the market. This operation generally controls a
significant number of lots, which it purchases after the lots are developed and
available for the commencement of home construction. As of December 31, 1997,
the Company controlled, through options, a supply of optioned lots for the
construction of 1,266 homes in the Austin area.
San Antonio, Texas
The Company's Texas Founding Builder entered the San Antonio market in September
1993 after extensive market and demographic research and offers primarily the
same type of product as is sold in Austin. The San Antonio MSA owes a great deal
of its strength to the medical industry, especially as it relates to medical
research and biotechnology, and to the tourism industry. The area experienced
strong net job formations in the early to mid-1990s and appears to be reaching
more moderate levels of job
8
<PAGE>
growth currently. Single housing permits peaked at approximately 6,900
single-family housing permits in 1996.
The Company's office in Austin handles the administrative functions for its San
Antonio operation. The Company believes that it is well positioned to take
advantage of the growth in the San Antonio area housing market in the near and
long term. As of December 31, 1997, the Company controlled, through options, a
supply of optioned lots for the construction of 475 homes in the San Antonio
area.
Las Vegas, Nevada
Las Vegas has experienced strong growth in employment and in-migration due to
the growth in the tourism and entertainment industries fueled by the gaming
industry. It is estimated that every hotel room constructed in Las Vegas creates
approximately 2.5 direct and indirect jobs. Relocation and expansion of major
new businesses, primarily in manufacturing, finance, insurance, and real estate
sectors, have bolstered the economic activity in the area. Additionally, the Las
Vegas economy benefits by the growth in retirement living due to the lower cost
of living, including lower housing costs and state taxes. The Las Vegas MSA has
consistently outpaced the nation as a whole with a population growth rate of
over 6%.
The Company's Las Vegas operation specializes in the construction of homes in
masterplanned communities which are self-contained, pre-planned communities
consisting of governmental, commercial and residential areas, schools, parks and
various other amenities such as swimming pools and golf courses. The Company
believes that such masterplanned communities will continue to gain market share.
Specifically, the Company's Las Vegas operation constructs single family
detached and attached homes (with many of its communities located on golf
courses) that range in sales price from approximately $180,000 to approximately
$800,000, and targets luxury second- and third-time (or higher) move-up and
second home buyers. The Company generally controls partially developed land
which, as part of the masterplanned community, is fully entitled, and develops
the land into finished lots ready for home construction. In 1996, the Company's
Las Vegas subsidiary was named Homebuilder of the Year by the Greater Las Vegas
Association of Realtors and received several awards for home designs.
Denver, Colorado
The economy of the Denver MSA is diversified and fueled by a wide range of
industries including financial services, telecommunications and technology
services. Economic growth during 1996 and the first six months of 1997 offer a
prelude to the area's future - that of moderated expansion from the strong
growth evident during the previous two years. Employment growth in the Denver
area is likely to continue through 1998 at a more modest level as the national
economy cools down and the local telecommunications industry, which was largely
responsible for Denver's explosive growth over the last four years, has begun to
mature.
The Company's Colorado operation offers a wide range of affordably priced,
single family detached custom and semi-custom homes and single-family attached
homes that range in sales price from approximately $130,000 to $350,000 and
targets all move-up and "custom" home buyers. The Company's Colorado operation
has successfully established its reputation as a "custom builder," offering
move-up buyers an opportunity to acquire homes with features that meet their
lifestyle expectations by selecting from a wide variety of upgrades and options.
The Company's Colorado operation currently conducts homebuilding operations in
the Denver area, Fort Collins, Colorado and Tucson, Arizona and
9
<PAGE>
has a land development project in Oakland County, Michigan. Although the Company
generally develops land in the Denver area, it has, from time to time, acquired
developed lots in Tucson if a favorable price was obtained. As of December 31,
1997, the Company controlled approximately optioned 164 lots in the Denver area
for new home construction and lot sales. In 1995, the Colorado operation was
selected as the winner of the "Gold Medal" by Builder magazine as the country's
"Best Builder," constructing 100 to 500 homes. In 1996, Bob Short, President of
the Company's Colorado operation, was awarded "Builder of the Year" by the
Metropolitan Denver Homebuilders' Association.
Fort Collins, Colorado
Fort Collins is the home of Colorado State University. The University and the
related service business provides the local economy significant stability in
employment. This division offers products comparable to those offered in the
Denver area, selling single-family detached homes targeting move-up and custom
home buyers that range in sales price from approximately $130,000 to
approximately $350,000. This subsidiary had one of its best years in 1997 and,
in 1998, expects to introduce a condominium project in the area. As of December
31, 1997, the Company controlled approximately 100 optioned lots in the Fort
Collins area for new home construction and lot sales.
Tucson, Arizona
With a 13% increase in the Tucson metro population over the past five years, the
housing market is more diversified than a few years ago. This division is
shifting focus in this market from a semi-custom builder with a $170,000 to
$350,000 to a production builder with homes under $120,000 in keeping with the
area's market trends. As the new program proves its success, the Company intends
to expand its operations in this market range. As of December 31, 1997, the
Company controlled approximately 70 optioned lots in the Tucson area for new
home construction and lot sales.
Janesville/Madison/Milwaukee, Wisconsin
With the acquisition of Brookstone Homes on December 31, 1996, the Company
entered the Janesville/ Madison/Milwaukee, Wisconsin area. The Madison area
experienced a marked slow down in single-family construction during 1997 while
maintaining approximately 2.5% job growth during the first three quarters of the
year. The Company's Wisconsin operations are seeking to achieve additional
growth through expansion of their operations in the Milwaukee area. Employing
just over twenty percent of the area's workers, manufacturing is the cornerstone
of the Milwaukee MSA's economy. This dependence on manufacturing has not
fostered high levels of labor force in-migration; however, housing permit levels
are expected to be stable. The Company's subsidiary has a continuum of base
floorplans ranging from 1,040 to 2,400 square feet, in ranch, two story and
split level layouts. Base prices range from approximately $95,000 to $150,000.
As of December 31, 1997, the Company had options on approximately 636 lots in
the Janesville/Madison/ Milwaukee area for new home construction and lot sales.
Jacksonville, Florida
The Jacksonville MSA is the dominant economy within the northeast
Florida/southeast Georgia region. Though not heavily dependent on any one major
employer or economic sector, the area has exhibited recent strength in
information and employment services, warehousing and distribution, medical and
health care products and services, sports and recreation activities and the
military. In general, the Jacksonville MSA maintains a diversified economic base
that is not dependent upon the tourist or retiree
10
<PAGE>
markets. At the end of February 1997, the Company acquired D.W. Hutson
Construction Company, thereby entering the Jacksonville, Florida market. As of
December 31, 1997, the Company controlled approximately 1,515 optioned lots in
the Jacksonville area for new home construction and lot sales. The Company's
Jacksonville builder was recently ranked the second busiest builder in the
Jacksonville area by Builder magazine.
Philadelphia, Pennsylvania
The Company's Philadelphia subsidiary has focused building in Delaware, Chester,
and Montgomery counties. These counties are considered the Philadelphia growth
areas with higher population and job growth and lower unemployment rates when
compared to the Philadelphia MSA, which includes Philadelphia County/City. The
Philadelphia area boasts the nation's second largest concentration of health
care resources in the nation with approximately 10% of the workforce employed in
this industry. Research and development companies, particularly in the areas of
engineering and scientific instruments and computers and data processing, and
the "Medical Mile," with pharmaceutical companies, biomedical research
companies, and medical surgical and dental instrument manufacturers, as well as
government employment and have formed a strong economic base for the area.
During the 1985 to 1995 period, the largest growth as a percentage of the
economy was seen in the services and the finance, insurance and real estate
sectors. Additionally, Philadelphia has a strong tourism trade with
approximately 10.5 million visitors in 1994.
The Company entered the Philadelphia market in October of 1997 with the
acquisition of an established builder with over forty years experience in the
area. The Company's Philadelphia subsidiary targets a large market audience with
a wide array of products building townhomes, condominiums, duplex units,
carriage homes, and detached homes. The product line varies from 900 to 2,700
square feet and ranges in price from approximately $90,000 to $265,000. The
Philadelphia division offers award-winning floorplans that incorporate enhanced
exterior elevations and numerous interior design elements as well as pre-priced
options. As of December 31, 1997, the Company controlled approximately 371
optioned lots in the Philadelphia market for new home construction and sales.
Loudoun County, Virginia
Located west of the District of Columbia, Loudoun County, Virginia is part of
the Washington PMSA. The Washington PMSA ranked fifth as a Building Permit
Volume Leader in 1996, fourth in 1996's Busiest Single-Family Markets, and
seventh in 1996's Busiest Multifamily Markets according to U.S. Housing Markets.
For 1997, the Washington PMSA ranked sixth for total projected 1997 permits. The
projections for Loudoun County, Virginia in employment and job growth are the
highest in the Northern Virginia area. The management of the Company's Northern
Virginia subsidiary feels that they have identified a market niche in a
high-growth area of the competitive Washington DC metropolitan area.
St. Louis, Missouri
The Company entered the St. Louis market with the acquisition of the dominant
St. Charles County homebuilder in early 1998. The St. Louis area is among top
locations for corporate headquarters including TWA, Boeing-McDonnell Douglas,
Anheuser-Busch, Ralston-Purina, Consolidated Aluminum, May Department Stores,
Emerson electric, Peabody Coal, General American Life Insurance, Graybar
Electric, and Monsanto. St. Louis is a regional center in the health care
industry and also has a strong gaming and amusement sector. While the St. Louis
MSA is not a high-
11
<PAGE>
growth market, it has historically been a very stable market outside of the
recession (1991-1993) and flood (1994) periods. The level of permits for the
period from 1984 to 1996 averaged 12,852 units.
The Company's St. Louis subsidiary builds single family detached homes targeting
first and second move-up buyers with homes ranging from 1,355 to 3,700 square
feet with base prices ranging from $108,000 for a ranch style home up to
$167,400 for an atrium home and up to $382,000 in their high-end product line.
The company also offers a custom home option.
Land Acquisition and Development
The Company's policies and strategies regarding land acquisition and development
vary and are dictated by the specific market conditions where the Company
conducts its operations. Overall, the Company's land acquisition and development
practices include (i) acquiring and exercising options to purchase finished
lots; (ii) purchasing finished lots; (iii) controlling (by option or conditional
sales contract) fully entitled land; (iv) securing options to purchase land,
which options are subject to the seller obtaining required entitlements; and (v)
in some instances, controlling raw land and assuming the cost of obtaining the
necessary entitlements. Generally, the Company seeks to minimize its overall
land costs and the risks associated with developing unentitled land by, whenever
possible, using options and other financing arrangements that allow the Company
to control land through the entitlement process but defer the payment for such
land until the entitlement process has been completed and the Company is
prepared to commence construction. In these situations, the Company strives to
negotiate land purchase contracts that allow the Company to purchase portions of
a parcel as close as possible to the commencement of construction.
Typically, the Company purchases land only after necessary entitlements have
been obtained so that the Company has certain rights to begin development or
construction as market conditions dictate. In some instances, however, the
Company controls unentitled land where the Company perceives an opportunity to
build on such property in a manner consistent with the Company's overall
strategy. The term "entitlements" refers to development agreements, preliminary
maps or recorded plats, depending upon the jurisdiction within which the land is
located. Entitlements generally give the developer the right to obtain building
permits upon compliance with conditions that are usually within the developer's
control. Even after entitlements are obtained, the Company is still required to
obtain a variety of other governmental approvals and permits during the
development process.
The Company selects land for development based upon a variety of factors,
including (i) internal and external demographic and marketing studies; (ii)
financial review as to the feasibility of the proposed project, including
projected profit margins, return on capital employed and the capital payback
period; (iii) competition for the proposed project; (iv) the ability to secure
governmental approvals and entitlements; (v) results of environmental and legal
due diligence; (vi) proximity to concentrated job markets, quality school
districts and local traffic corridors; (vii) infrastructure requirements for
grading, drainage, utilities and streets; and (viii) management's judgment as to
the real estate market, economic trends and the Company's experience in a
particular market.
To control its investment in land and land acquisition costs, the Company
utilizes option arrangements or conditional purchase contracts as often as
possible. These arrangements generally provide the Company with either the right
to pursue the entitlement process directly or the right to direct the seller in
its pursuit of entitlement and obligate the Company to take title to the land
only when specified conditions relating to entitlements (such as a minimum
density) have been obtained. Once the entitled land is purchased (or
entitlements are obtained on previously unentitled land), the Company
undertakes, where required, the
12
<PAGE>
development activities that include site planning and engineering, as well as
constructing road, sewer, water, utilities, drainage and recreational facilities
and other amenities.
Due to the ready supply of finished lots in the Austin, San Antonio, Wilmington,
Charlotte, Myrtle Beach, Tucson, and Jacksonville markets, the Company's
homebuilding operation purchases finished lots from land developers using
rolling options which typically require that a specified number of lots are
purchased each quarter. Failure to purchase the specified number of lots can
result in the loss of the options scheduled for subsequent quarters. Although
the Company's operations in Denver, Raleigh-Durham,
Janesville-Milwaukee-Madison, Philadelphia, and St. Louis also utilize rolling
options on finished land where appropriate, each of these markets also provide
the Company with significant opportunities to purchase undeveloped land and
invest the time and resources into obtaining all necessary entitlements and
developing the land itself. In these situations, the Company (i) realizes
greater returns on its investment in land due to the significant value that is
added once entitlements are obtained and the land is fully developed; (ii) is
provided with a greater degree of involvement and control over the design and
development process; and (iii) continues to minimize risk and capital investment
since the purchase is not consummated until all necessary entitlements are
obtained.
Unlike the markets that exist in the previously discussed areas, the Company's
strategy in Las Vegas and Loudoun County is to build in masterplanned
communities with homesites that are along, or close in proximity to, the major
amenity which is generally a golf course. These masterplanned communities are
designed and developed by a major land developer who develops groups of lots,
commonly referred to as "super pads," which are sold to a single homebuilder. In
Las Vegas, the Company typically purchases super pads containing between 60 and
100 fully entitled lots which are roughly graded and have all utilities and
paving brought up to the boundaries of the super pad. The Company completes the
development of each super pad by completing paving, final grading and installing
all utilities. Similar to when the Company purchases raw land, the Company
achieves enhanced profitability while minimizing the risk of holding excess land
inventory.
The Company (through its local operations) has occasionally used partnerships or
joint ventures to purchase and develop land where such arrangements were
necessary to acquire the land or appeared to be otherwise economically
advantageous to the Company. The Company will continue to consider such
partnership, joint venture and other financing arrangements with landowners
where management perceives an opportunity to acquire land upon favorable terms,
minimize risk and exploit opportunities presented through seller financing.
The Company strives to develop a design and marketing concept for each of its
communities based on the specific geographic and target market, which includes
determination of size, style, price range of homes, layout of streets, size and
layout of individual lots and overall community design. The development and
construction of each project are managed by the Company's local operations. At
the development stage, a project manager (who may be assigned to several ongoing
projects) supervises the development of buildable lots. In addition, project
superintendents are often utilized depending on the size of the development, and
each local operation has one or more customer service and marketing
representatives assigned to its communities.
At December 31, 1997, the Company owned 1,428 finished lots and 843 lots held
for or under development. As of December 31, 1997, the Company also had under
contract or option, subject to the satisfaction of the Company's purchase
contingencies, 7,600 finished, undeveloped or partially developed lots.
13
<PAGE>
Construction
The Company's subsidiaries act as the general contractor for the construction of
its homes and development of finished lots. The Company's project development
operations are also controlled by its local operations, whose employees oversee
the construction of each community, including coordinating activities of
subcontractors and suppliers and insuring that all work is subject to quality
and cost controls and complies with zoning and building codes. Subcontractors
typically are retained on a subdivision-by-subdivision basis to complete
construction at a fixed price. Agreements with the Company's subcontractors and
materials suppliers are generally entered into after competitive bidding on an
individual basis.
Fortress management specifies that quality, durable materials be used in
constructing the Company's homes. The Company does not maintain significant
inventory of construction materials. Each of the Company's local operations
maintains close contact with its respective subcontractors and suppliers and the
Company believes that its relationship with its suppliers and subcontractors are
good. When possible, the Company negotiates price and volume discounts with
manufacturers and suppliers on behalf of subcontractors to take advantage of its
volume of production. Although the Company generally has made no long-term
purchase commitments to materials suppliers in the past and although certain key
materials and supplies are, and will continue to be, purchased at local/regional
levels, the Company negotiates contractual terms with certain of its vendors to
provide additional cost savings on a national basis. Generally, access to the
Company's principal subcontracting trades, materials and supplies continue to be
readily available in each of its markets; however, prices for these goods and
services may fluctuate due to various factors, including supply and demand
shortages which may be beyond the control of the Company or its vendors.
The Company generally provides a one-year limited warranty of workmanship and
materials with each of its homes although warranty policies may differ within
each local operation and by project. The Company's subcontractors generally
provide the Company with an indemnity and a certificate of insurance prior to
receiving payments for their work; therefore, claims relating to workmanship and
materials are usually the primary responsibility of the Company's
subcontractors. Historically, the Company's divisions have not incurred any
material costs relating to any warranty claims or defects in construction.
Sales and Marketing
Each of the Company's subsidiaries are directly responsible for the sales and
marketing activities relating to each of their completed and planned
communities. The Company makes extensive use of advertising and other
promotional activities, including newspaper advertisements, brochures, direct
mail and the placement of strategically located sign boards in the immediate
areas of its developments. The Company believes that each of its local
operations has an established reputation for developing high quality homes in
the markets they serve, which helps generate interest in each new project.
The Company believes that the effective use of model homes plays an integral
part in demonstrating the competitive advantages of its home designs and
features to prospective homebuyers. The Company generally builds between one and
six model homes for each active community, depending upon the number of homes to
be built within each community and the products to be offered. Each of the
Company's local operations generally employs, or contracts with, interior
designers who are responsible for creating an attractive model home for each
product line within a project designed to appeal to the preferences of potential
home buyers.
14
<PAGE>
The Company's objective is to enter into sales contracts for all of its homes in
advance of construction, thereby reducing the risk of unsold inventory upon
completion of a project. Depending on market conditions and the specific
project, the Company builds speculative homes in each of its entry-level and
move-up subdivisions. Speculative homes are homes which are under construction
or completed but for which the Company does not yet have sales contracts. These
homes are often sold while under construction or soon after completion. The
Company carefully reviews local market factors, such as new employment
opportunities, significant job relocations and growing housing demand in
determining how many speculative homes to build and keep in inventory. The
construction of such homes is often necessary to supply homes to individuals who
are relocating or to satisfy the requirements of independent brokers, who often
represent customers who require a completed home within a short time period. The
Company's sales contract for its homes generally provide for mortgage approval
within a specified period. The Company attempts to minimize cancellations by
requiring a nonrefundable cash deposit of on average 5% to 10% of the purchase
price for buyers using conventional financing and by training its sales force to
assess the qualification of potential home buyers.
Backlog
The Company's homes are generally offered for sale in advance of their
construction. The majority of the Company's homes sold in 1997 were sold
pursuant to standard sales contracts entered into prior to commencement of
construction. Such sales contracts are usually subject to certain contingencies
such as the buyer's ability to qualify for financing. Homes covered by such
sales contracts are considered by the Company as its "backlog." As of December
31, 1997, the Company had backlog of $198.2 million (1,056 homes); and as of
December 31, 1996, the Company had backlog of $96 million (512 homes). The
Company does not recognize revenue on homes covered by such contracts until the
sales are closed and the risk of ownership has been legally transferred to the
buyer.
Customer Financing
In January 1997, the Company created a wholly-owned subsidiary, Fortress
Mortgage, Inc., for the purpose of providing decentralized mortgage origination
and centralized underwriting to the buyers of homes sold by the Company's
subsidiaries. Fortress Mortgage, Inc. is approved by the Federal Housing
Administration (FHA) and Veterans Administration (VA) as a qualified mortgage
lender and is licensed in Texas, Colorado, North Carolina, Pennsylvania,
Wisconsin, and Nevada. Licenses are pending in Florida, Missouri, and South
Carolina. The Company facilitates the sale of the Company's homes through the
origination of first mortgage loans utilizing programs established by FHA, VA,
GNMA (Government National Mortgage Association) and FHLMC (Federal Home Loan
Mortgage Corporation). As a mortgage banker, this operation will complete the
processing of loan applications, perform credit checks, process applications to
underwrite loans and originate and subsequently sell the mortgage loans.
Due to the sales prices of homes, the Colorado, Arizona and Las Vegas operations
do not rely on homebuyers who seek FHA and VA mortgage financing. However, the
majority of the homes sold by the Company's Texas and Wisconsin operations and a
significant number of the homes sold by the Company's North Carolina operation
met the dollar limits published in FHA and VA guidelines. FHA and VA financing
generally enables home buyers to purchase homes with lower down payments than
the down payments required by conventional mortgage lenders, allowing a
purchaser to borrow up to 90% to 95% of the value of the home. The Company
believes that, when conventional lending rates are higher, the availability of
FHA and VA financing broadens the group of potential purchasers for the
Company's homes. Substantially all home buyers utilize long-term mortgage
financing to purchase a home, and
15
<PAGE>
lenders generally make loans only to borrowers who earn three to four times the
total amount of the monthly mortgage payment plus insurance and property taxes.
As a result, economic conditions, increases in unemployment and high mortgage
interest rates can eliminate a number of potential homebuyers from the market.
Prior to 1997, the Company did not provide customer financing to its homebuyers.
Rather, at each on-site office, sales employees provided prospective homebuyers
with information as to the qualifying criteria for mortgage financing. Either a
mortgage lender was typically made available at the sales offices to assist
prospective buyers in applying for mortgage financing or the Company acted as a
mortgage broker and received a brokerage fee once the loan was originated.
Corporate Operations
The Company's centralized corporate operations generally oversee all of the
Company's local operations. The holding company's top five senior managers have
nearly 100 years of combined national homebuilding experience. This senior
management group is primarily responsible for formulating and implementing the
Company's policies and procedures to ensure the cohesiveness and direction of
its local operations.
Specifically, the Company's senior management (i) reviews and approves
subsidiary capital requirements and requests, short and long range plans,
project acquisition activity, and monitors all operational and financial
performance as it relates to established objectives; (ii) evaluates and selects
geographic markets; (iii) maintains relationships with various institutional
lenders; (iv) performs accounting functions, establishes financial policies and
regularly completes financial analyses both on a consolidated and
subsidiary-by-subsidiary basis; (v) reviews and approves subsidiary capital
requirements, short- and long-range plans, and land acquisition activity and
monitors performance in regard to these activities; and (vi) secures and obtains
capital resources. The corporate operations also provide for and encourage the
flow of technical information and ideas among the senior management of its local
operations.
In fulfilling the duties set forth above, the senior management developed a
Comprehensive Planning System whereby each local operation is required, among
other things, to prepare an annual plan for the upcoming fiscal year, a
three-year plan which is updated and revised each year and a project feasibility
analysis for all land acquisitions. The annual plan includes a thorough review
and analysis of the previous fiscal year, monthly detailed projections of all
revenue and expenses, financial ratio projections such as return on assets and
inventory turnover and operational changes to be instituted in the coming year.
The three-year plan insures that the local managers continue to (i) plan for
potential changes in their respective geographic and target markets; (ii)
evaluate the present and future competition; and (iii) seek opportunities to
further improve their operations. The project feasibility analysis, which is
prepared by the local managers, is reviewed and approved before any land or lot
acquisition is consummated. This pre-designed analysis requires the local
managers to provide senior management with a myriad of information and
projections such as a subdivision plan, product type, projected absorption
rates, completion time, market analysis and rate of return ratios. The senior
management ensures that the information presented in the project feasibility
analysis satisfies the Company's established minimum criteria before a capital
investment is approved.
The Company allocates the necessary capital resources for new communities
consistent with its overall strategy and utilizes anticipated return on capital,
return of capital and profit margins as criteria for allocating capital. In
addition to establishing certain pre-determined targets, the Company establishes
its capital allocation policies based on the existing market, results of
operations and other factors. All
16
<PAGE>
capital commitments are determined by the Finance Committee and the Project and
Feasibility Review Committee of the Board of Directors.
Structurally, the Company operates through separate subsidiaries, which are
located within the areas in which they operate. Each subsidiary is managed by
executives with substantial experience in the subsidiary's markets. Although
formal approval of new communities are determined by committees of the Board,
each subsidiary is fully equipped with the skills and resources to oversee all
local operations including land acquisition, map processing, land development,
construction, marketing, sales and product service.
The Company's corporate office handles cash management functions for both
corporate and subsidiary funds. Each operating subsidiary provides the corporate
office with a three month cash flow projection by week updated monthly which
allows the Company to efficiently manage its cash position. The Company utilizes
a Comprehensive Reporting System (CRS) in order to ensure the timely and
accurate flow of critical information between each operating subsidiary and the
corporate office. The CRS requires preparation of periodic reports by each
operating subsidiary including weekly sales, closing, traffic and backlog
reports by subdivision. Each operating subsidiary also prepares detailed
financial statements which include a narrative discussing trends, monthly
performance and budgets.
Customer Relations and Quality Control
Management believes that strong customer relations and an adherence to tough
quality control standards are fundamental to the Company's continued success.
The Company believes that its commitment to customer relations and quality
control has significantly contributed to its reputation as a quality builder in
each of its local markets.
Generally, for each development, Company representatives, a project manager or
project superintendent and a customer relations representative, oversee
compliance with the Company's quality control standards. These representatives
allocate responsibility for (i) overseeing the entire project from land
development through construction; (ii) overseeing performance by the Company's
subcontractors and suppliers; (iii) reviewing the progress of each home and
conducting formal inspections as specific stages of construction are completed;
and (iv) regularly updating each buyer on the progress of their home.
Competition and Market Factors
The development and sale of residential property is highly competitive and
fragmented. The Company competes for residential sales with national, regional
and local developers and homebuilders, resales of existing homes and, to a
lesser extent, condominiums and available rental housing. The Company's
competitors include a number of large national and regional homebuilding
companies and small local homebuilding companies, some of which may have greater
financial resources, easier access to capital markets and/or lower costs than
the Company. Competition among both small and large residential homebuilders is
based on a number of interrelated factors, including location, reputation,
amenities, design, quality and price. The Company believes it compares favorably
to other homebuilders in the markets in which it operates due primarily to (i)
its experience within its specific geographic markets which allows it to develop
and offer new products to potential home buyers which reflect, and adapt to,
changing market conditions; (ii) its ability, from a capital and resource
perspective, to respond to market conditions and to exploit opportunities to
acquire land upon favorable terms; and (iii) its respective subsidiaries'
reputation for outstanding service and quality products.
17
<PAGE>
The homebuilding industry is cyclical and affected by consumer confidence
levels, prevailing economic conditions in general and by job availability and
interest rate levels in particular. A variety of other factors affect the
homebuilding industry and demand for new homes, including changes in costs
associated with home ownership such as increases in property taxes and energy
costs, changes in consumer preferences, demographic trends and the availability
of and changes in mortgage financing programs. In addition, homebuilders are
subject to various risks often outside of their control, including weather
conditions and natural disasters, construction delays, cost overruns, changes in
governmental regulations, as well as availability and price fluctuations of
land, labor and raw materials.
The homebuilding industry is also subject to the potential for significant
variability and fluctuations in real estate values. Although the Company
believes the real estate assets currently reflected on the Company balance sheet
are reasonable in amount given the size of the Company's business and are
reflected at or below their fair value, no assurances can be given that
write-downs to the net realizable value of some or all of the Company's assets
will not occur if market conditions deteriorate, or that such write-downs,
should they occur, will not be material in amount.
Government Regulations and Environmental Controls
The Company is also subject to a variety of Federal, state and local statutes,
ordinances, rules and regulations concerning protection of health and the
environment. These laws may result in delays, cause the Company to incur
substantial compliance costs and prohibit or severely restrict development in
certain environmentally sensitive regions or areas. Prior to purchasing a parcel
of land, the Company's local management evaluates such land for the presence of
hazardous or toxic materials, wastes or substances. The Company generally
engages independent environmental engineers to complete such an evaluation. The
Company has not been materially adversely affected to date by the presence or
potential presence of such materials. However, no assurance can be given that
such a material adverse affect will not occur in the future.
Whether Fortress controls entitled or unentitled land, certain building and
other permits, as well as approvals, are required to complete all residential
developments. The ability of the Company to obtain necessary approvals and
permits for its planned communities is often beyond the Company's control and
could restrict or prevent the development of otherwise desirable property. The
length of time necessary to obtain permits and approvals increases the carrying
costs of unimproved land acquired for the purpose of development and
construction. In addition, the continued effectiveness of permits already
granted is subject to factors such as changes in policies, rules and regulations
and their interpretation and application.
Interest Rates; Mortgage Financing
In general, housing demand is adversely affected by increases in interest rates,
unavailability of mortgage financing, increasing housing costs and unemployment
levels. If mortgage interest rates increase and the ability of prospective
buyers to finance home purchases is adversely affected, the Company's sales,
gross margins and net income and the market price of the common stock may be
adversely impacted. The Company's homebuilding activities are also dependent
upon the availability and cost of mortgage financing for buyers of homes owned
by potential customers so those customers ("move-up buyers") can sell their
homes and purchase a home from the Company. In addition, the Company believes
that the availability of FHA and VA mortgage financing is an important factor in
marketing a number of its homes. Any limitation or restriction on the
availability of such financing could adversely affect the Company's sales.
Furthermore, changes in Federal income tax laws may affect
18
<PAGE>
demand for new homes. Enactment of proposals to limit deductibility of mortgage
interest may have an adverse effect on the homebuilding industry in general, and
demand for the Company's products in particular. No prediction can be made as to
whether any such proposals will be enacted and, if enacted, the particular form
such laws would take.
Employees and Subcontractors
As of December 31, 1997, the Company employed 571 (538 full-time and 33
part-time) persons, including corporate staff and other personnel involved in
sales, construction management and customer service. Although none of the
Company's employees are covered by collective bargaining agreements, many of the
subcontractors and suppliers which the Company engages in various markets are
represented by labor unions or are subject to collective bargaining agreements.
The Company believes that its relations with its employees, subcontractors and
suppliers are good.
The Company's operations are dependent on the continued efforts of its executive
officers and on senior management of the Company. In addition, the operations of
each subsidiary are dependent upon the senior management of the acquired
builders. If any of these people become unable to continue in their present
roles, or if the Company is unable to attract and retain other skilled
employees, the Company's business could be adversely affected.
Acquisitions
Founding Builders
Simultaneous with the closing of the Offerings, Fortress acquired each of the
Founding Builders through the merger of each Founding Builder with and into a
newly formed wholly-owned subsidiary of Fortress. The aggregate consideration
paid by Fortress in these transactions was as follows:
(a) An aggregate of approximately $6.0 million in cash;
(b) An aggregate of 6,233,875 shares of common stock of the Company,
representing approximately 53% of the total shares of common stock
outstanding after giving effect to the Offerings; and
(c) An aggregate of 20,000 shares of Series A 11% Cumulative
Convertible Preferred Stock of the Company.
The consideration paid for the Founding Builders was determined through arm's
length negotiations among the Company and representatives of the Founding
Builders.
The agreements governing each of the acquisitions (the Acquisition Agreements)
provide piggyback registration rights to the Founding Builders' owners which
allows them to register their shares of common stock under the Federal
securities laws, on a pro rata basis, to the extent allowable by the managing
underwriter of such offering, in the event the Company consummates a "follow-on"
offering of the Company's common stock for cash. Additionally, for a one-year
period beginning November 1997, (i) the holders of at least one-third of the
common stock then held by the Founding Builders' owners or (ii) all of the
Founding Builders' owners of a particular Founding Builder who hold shares of
common stock, have a one-time right to require the Company to effectuate a
registration under the Federal
19
<PAGE>
securities laws of the shares of common stock held by the Founding Builders'
owners which are then available for sale. On March 26, 1998, a registration
statement filed under the Securities Act became effective, registering for
resale up to 6,431,192 shares owned by certain of the Founding Builders'
owners and other persons.
Pursuant to each Acquisition Agreement, the Founding Builders' owners have
agreed not to compete with the Company for two years following the closing of
the acquisitions, within 100 miles of where Fortress, the particular Founding
Builder or any of the other Founding Builders conduct business. The Founding
Builders' owners who are also parties to employment agreements with the Company
have agreed to non-compete provisions which extend for a two-year period after
termination of each respective employment period. The Acquisition Agreement
provides that in the event a Founding Builder owner enters into an employment
agreement with the Company, the terms of the non-compete provisions set forth in
the applicable employment agreement shall control over the noncompetition
provisions set forth in the Acquisition Agreement.
The acquisition transactions included the following:
Buffington. Under an acquisition agreement with Thomas Buffington, who
became a director of the Company upon closing of the Offerings, Edward
Kirkpatrick and James Giddens, Fortress acquired by merger all of the
issued and outstanding stock of Buffington Homes. The consideration
paid by Fortress for Buffington was approximately $1.13 million in cash
and 1,897,897 shares of Common Stock of the Company.
Christopher. Under an acquisition agreement with J. Christopher
Stuhmer, who became a director of the Company upon closing of the
Offerings, Fortress acquired by merger all of the issued and
outstanding stock of Christopher Homes. The consideration paid by
Fortress for Christopher was approximately $179,000 in cash and
1,691,227 shares of common stock of the Company.
Genesee. Under an acquisition agreement with Robert Short, who became a
director of the Company upon closing of the Offerings, Fortress
acquired by merger all of the issued and outstanding stock of The
Genesee Company. The consideration paid by Fortress for Genesee was
approximately $695,000 in cash, 1,729,495 shares of common stock of the
Company and 20,000 shares of the Company's Series A 11% Cumulative
Convertible Preferred Stock.
Sunstar. Under an acquisition agreement with Lawrence Witek, who became
a director of the Company upon closing of the Offerings, Lanold
Caldwell and David Schmidt, Fortress acquired by merger all of the
issued and outstanding stock of Solaris Development Corporation and
Sunstar Mortgage Company. The consideration paid by Fortress for
Sunstar was approximately $3,876,000 in cash and 915,256 shares of
common stock of the Company.
Subsequent Acquisitions
During 1996, the Company acquired certain assets and assumed related
indebtedness of Landmark Homes, Inc. (Landmark) and Brookstone Homes, Inc.
(Brookstone) on August 31, 1996 and December 31, 1996, respectively. Landmark
operates in both Wilmington, North Carolina and Myrtle Beach, South Carolina,
and Brookstone operates in the Janesville-Milwaukee-Madison corridor of
Wisconsin. The purchase price for the assets of Landmark and Brookstone totaled
$6.6 million in cash and 60,000 shares of common stock. The Company agreed that
all or any of the shares may be put to the Company at a price of $10.00 per
share for a period of 30 days commencing six months from the date of closing.
The excess purchase price was allocated first to
20
<PAGE>
record inventory at fair value on the acquisition date; the remaining excess
purchase price was recorded as goodwill. Cost of goods sold for the period May
21, 1996 through December 31, 1996 included $210,000 related to the allocation
of the purchase price to inventory.
In February 1997, the Company acquired the assets of D.W. Hutson Construction
Company (Hutson), a Jacksonville, Florida homebuilder, for approximately $24.7
million to be paid $8.0 million in cash, $.9 million in Class B preferred stock
and approximately $8.5 million in assumed debt. Additional consideration of $6.0
million in Class C preferred stock is expected to be paid over a period not to
exceed six years based upon the future performance of Hutson.
Effective August 1, 1997, the Company acquired the stock of Don Galloway Homes,
Inc. and related interests (Galloway), a Charlotte, North Carolina and
Charleston, South Carolina builder, 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.
Effective October 1, 1997, the Company acquired The Iacobucci Organization
(Iacobucci), a homebuilder in the Philadelphia, Pennsylvania. The acquisition
price, the cash portion of which was funded by the proceeds from the First
Closing, was not material to the Company.
Effective January 1, 1998, the Company acquired WestBrook Homes (WestBrook), a
homebuilder in the Loudoun County, Virginia area of the Washington, DC MSA. The
acquisition price was not material to the Company.
Effective March 1, 1998, the Company acquired Whittaker Homes, a St. Louis,
Missouri homebuilder. The acquisition cost including cash paid and assumption of
debt was $62.1 million. The cash portion of the transaction was funded by the
sale of preferred stock to Prometheus.
Cost of goods sold for the year ended December 31, 1997 included approximately
$1,928,000 related to the allocation of purchase price to inventory.
Executive Officers of the Company
The Executive Officers of the Company are as follows:
Name Age Position
------- ---- ---------
J. Marshall Coleman 56 Chairman of the Board and Director
James J. Martell, Jr. 47 President, Chief Executive Officer and Director
George C. Yeonas 43 Chief Operating Officer and Director
Jamie M. Pirrello 39 Vice President and Chief Financial Officer
J. Marshall Coleman has been a director of the Company since June 1995 and
Chairman of the Board since May 1996. From August 1992 through April 1996, Mr.
Coleman was an attorney with Katten Muchin & Zavis, a national law firm, and was
the Managing Partner of its Washington office from 1994
21
<PAGE>
until April 1996. From 1985 until 1992, Mr. Coleman was an attorney at the
Washington, D.C. firm of Arent, Fox, Kintner, Plotkin and Kahn. Mr. Coleman was
Attorney General of Virginia from 1978 to 1982. In 1975, Mr. Coleman was elected
to the Virginia State Senate and also served as a United States Magistrate from
1970 to 1972. In 1972, Mr. Coleman was elected to the Virginia House of
Delegates. From 1986 to 1993, Mr. Coleman was a director of NVR, a publicly
traded homebuilding company.
James J. Martell, Jr. is a founder of the Company and has been its President,
Chief Executive Officer and a director since June 1995 and has more than 13
years in the homebuilding industry. Since 1992, Mr. Martell has been an advisor
and consultant to various companies in the homebuilding and technology
industries, including Canuso Homes, Joe Miller Homes and n-Vision. From 1991 to
1992, Mr. Martell served as Managing Director of Investment Banking at Credit
International Bank as well as a member of its Board of Directors. From 1987 to
1991, Mr. Martell was a member of the board of directors of NVR and the Chief
Executive Officer of its subsidiary, NVR Development, responsible for
identifying new sources of capital and new business opportunities for NVR. From
1985 to 1986, Mr. Martell was the Chief Financial Officer of NVHomes which
became a public company in 1986 and merged with Ryan Homes in 1987 to become
NVR, a publicly traded national homebuilding company.
George C. Yeonas joined the Company as Chief Operating Officer in September of
1997 and has over 20 years in the homebuilding industry. Prior to joining
Fortress, Mr. Yeonas served for seven years as Vice President and General
Manager of the Arvida Company's South Florida division. His responsibilities
there included the management of the city of Weston, Florida's number one
selling community. Prior to joining Arvida Mr. Yeonas served as Vice President
of Development for NVR in Washington, DC, and as Divisional Partner for Trammell
Crow in Tampa, Florida.
Jamie M. Pirrello is a founder of the Company and has been the Vice President of
Finance and Chief Financial Officer of the Company since June 1995 and has over
17 years of experience in the homebuilding industry. From November 1993 to
January 1995, Mr. Pirrello was Executive Vice President of Miles Homes, Inc., a
publicly traded company, and was in charge of the operations of two of its
subsidiaries, Patwil Homes, Inc. and Miles Homes Services, Inc. From 1988 to
1993, Mr. Pirrello was Chief Executive Officer of H.R. Remington Properties,
Inc. and Vice President of Finance of H.R. Remington Properties, L.P., a
subsidiary of NVR, a publicly traded company that is one of the largest
homebuilding companies in the United States. From 1985 to 1989, Mr. Pirrello was
the Corporate Controller of NVHomes (predecessor to NVR) and Controller in the
Northern Virginia Division of Pulte Home Corporation.
Item 2. PROPERTIES
The Company's principal executive offices are located at 1650 Tysons Boulevard,
Suite 600, McLean, Virginia 22102. The Company leases approximately 7,400 square
feet of office space for its corporate office in Virginia and leases an
aggregate of approximately 75,000 square feet of space in 15 locations for its
homebuilding and mortgage subsidiaries.
22
<PAGE>
Item 3. LEGAL PROCEEDINGS
The Company is, from time to time, a party to litigation arising in the normal
course of its business. Management believes that none of these actions will have
a material adverse effect on the financial condition, results of operations or
cash flows of the Company.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the Company's stockholders for consideration during
the quarter ended December 31, 1997.
23
<PAGE>
PART II
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
(a) Price Range of Common Stock. The Company's common stock has traded on
the Nasdaq National Market since May 16, 1996. On March 26, 1998, the
closing price of the common stock was $4.94 per share. The following
table sets forth the range of high and low sale prices for the common
stock, as reported on the Nasdaq National Market, for the period from
May 16, 1996, the date of the Company's initial public offering,
through the end of the fiscal year 1997.
High Low
Fiscal Year 1996
Second fiscal quarter(1) $9.25 $8.75
Third fiscal quarter $9.00 $7.75
Fourth fiscal quarter $8.00 $4.56
Fiscal Year 1997
First fiscal quarter $6.88 $5.25
Second fiscal quarter $6.63 $4.88
Third fiscal quarter $6.50 $4.50
Fourth fiscal quarter $5.25 $4.00
(1) The Company's common stock commenced trading on May 16, 1996 at
$9.00 per share.
(b) Approximate Number of Equity Security Holders. The number of record
holders of the Company's common stock as of March 27, 1998 was 90,
which does not include beneficial owners who hold the Company's stock
in street name.
(c) Dividends. In March 1997, the Company established a new dividend
policy including the initiation of a cash dividend. The initial
dividend policy is to pay a dividend of one cent per year paid
quarterly. Pursuant to this policy, the Board of Directors
subsequently declared a quarterly cash dividend of one-quarter cent
per share on the Company's common stock for each of the fiscal
quarters in 1997. The Company intends to increase the dividend in the
future as the Company grows. The payment of dividends will be at the
discretion of the Company's Board of Directors and will depend upon,
among other things, future earnings, the success of the Company's
business activities, capital requirements, the general financial
condition of the Company and general business conditions. In
addition, the Indenture and outstanding preferred stock will restrict
the amount of dividends payable by the Company.
Under the terms of its agreement with Prometheus Homebuilders LLC (Prometheus),
the Company issued 11,700 shares of Class AA preferred stock and 375,000
Warrants to Prometheus on September 30, 1997. See Note 9 - Shareholders' Equity
in the Company's consolidated financial statements included in Item 8 hereof.
In relying on the exemption provided by Section 4(2) of the Securities Act in
connection with the private placement described above, the Company relied upon
written representations of Prometheus that it was acquiring the shares and
Warrants for investment purposes and that it had received adequate opportunity
to obtain information, and had reviewed such information regarding the Company.
Certificates representing the shares issued to these persons contain a legend
restricting transfer thereof absent registration under the Securities Act or the
availability of an exemption therefrom.
24
<PAGE>
Item 6. SELECTED FINANCIAL DATA OF THE COMPANY
The selected combined financial data provided should be read in conjunction
with the Combined Predecessor Companies Financial Statements, The Fortress
Group, Inc. Consolidated Financial Statements, the related notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations of the Company."
THE FORTRESS GROUP, INC. AND COMBINED PREDECESSOR COMPANIES(1)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS AND OPERATING DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, COMBINED THE FORTRESS YEAR THE FORTRESS
---------------------------------- PREDECESSOR GROUP, INC. ENDED GROUP, INC.
COMBINED PREDECESSOR COMPANIES COMPANIES MAY 21- DECEMBER 31, YEAR ENDED
JANUARY 1- DECEMBER 31, 1996 DECEMBER 31,
1993 1994 1995 MAY 20, 1996 1996 TOTAL 1997
-------- -------- -------- ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue............................ $148,269 $174,715 $199,029 $66,119 $ 210,354 $276,473 $ 445,311
Gross profit....................... 22,124 28,431 31,595 9,694 32,967 42,661 67,704
Operating income................... 4,169 5,411 6,750 1,113 12,787 13,900 16,170
Income before provision/ benefit
for income taxes................. 4,898 4,828 6,076 1,274 13,221 14,495 13,923
Net income(2).................... $ 3,973 $ 4,745 $ 6,055 $ 1,274 $ 8,208 $ 9,482 $ 8,460
======== ======== ======== ======= =========== ======== ===========
Basic earnings per share............. $ .69 $ .68
Diluted earnings per share........... $ .68 $ .63
=========== ===========
Cash dividends per common share...... $ .01
Weighted average shares outstanding,
basic................. 11,701,587 11,759,712
Weighted average shares outstanding,
diluted............................ 12,138,302 12,925,544
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------- THE FORTRESS
COMBINED PREDECESSOR COMPANIES THE FORTRESS GROUP, INC.
---------------------------------- GROUP, INC. DECEMBER 31,
1993 1994 1995 1996 1997
------- -------- -------- ------------ -------------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash.......................................... $ 2,904 $ 4,866 $ 2,710 $ 16,212 $ 12,406
Inventory..................................... 65,507 101,214 109,016 144,106 217,342
Total assets.................................. 72,855 111,403 121,666 193,733 337,304
13.75% Senior Notes due 2003.................. 100,000 100,000
Notes and mortgages payable................... 52,912 83,161 87,604 40,136 228,420
Minority interests............................ 806 1,346 1,295 274 268
Stockholders' equity.......................... 4,374 6,018 9,836 31,986 62,897
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------
. THE FORTRESS
GROUP, INC.
COMBINED PREDECESSOR COMPANIES COMBINED(1) YEAR ENDED
--------------------------------- ----------- DECEMBER 31,
1993 1994 1995 1996 1997
-------- -------- -------- ------------ -------------
<S> <C> <C> <C> <C> <C>
OPERATING DATA:
Units:
New contracts, net of cancellations......... 870 1,015 1,100 1,410 2,706
Closings.................................... 838 966 998 1,402 2,762
Backlog(3).................................. 308 357 459 512 1,056
Aggregate sales value of backlog (in
thousands)(3)............................... $ 57,914 $ 78,760 $ 97,242 $ 95,992 $198,247
Average sales price per home closed........... $171,300 $176,400 $190,700 $189,500 $159,300
</TABLE>
- ------------------
(1) As a result of the substantial continuing interests in the Company of the
former stockholders of the Founding Builders and Fortress (the Combined
Predecessor Companies'), the historical financial and operational
information of the
(Footnotes continued on next page)
25
<PAGE>
(Footnotes continued from previous page)
Combined Predecessor Companies has been combined on a historical cost basis
for all periods presented prior to the Acquisitions as if these companies
had always been members of the same operating group. However, during the
periods presented prior to the Acquisitions, the Founding Builders were not
under common control or management.
(2) All of the Founding Builders were S corporations through May 20, 1996
with the exception of Buffington which converted to an S corporation
effective January 1, 1994. As S corporations, the Founding Builders were not
subject to federal income tax. Accordingly, the data presented should not be
viewed as comparable to or indicative of the post-combination results to be
achieved by the Company. Subsequent to the Acquisitions, the information
presented is on a consolidated basis of The Fortress Group, Inc.
(3) At end of period and represents homes sold but not closed.
26
<PAGE>
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Fortress Group, Inc. 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.
Consistent with the Company's stated strategy of growing through
acquisitions, the Company acquired Landmark Homes, Inc. (Landmark), with
operations in Wilmington, North Carolina and Myrtle Beach, South Carolina, on
August 31, 1996; Brookstone Homes, Inc. (Brookstone), with operations in the
Milwaukee-Madison, Wisconsin corridor on December 31, 1996; D.W. Hutson
Construction Company (Hutson), with operations in the Jacksonville, Florida area
on February 28, 1997; Wilshire Homes, Inc. (Wilshire), with operations in San
Antonio and Austin, Texas, effective April 1, 1997; Don Galloway Homes, Inc.
(Galloway), with operations primarily in Charlotte, North Carolina and
Charleston, South Carolina effective August 1, 1997; and The Iacobucci
Organization (Iacobucci), with operations primarily in Philadelphia,
Pennsylvania effective October 1, 1997 (collectively, the "Acquired Builders").
The Company's revenues are derived primarily from the sale of the
residential homes. Revenue is 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, interest expense on related land acquisitions and land
development and construction loans; 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.
27
<PAGE>
The following table sets forth for the periods indicated certain items
of the Company's consolidated results of operations including, for the periods
prior to the Offerings, the results of operations for the Combined Predecessor
Companies (dollars expressed in millions) and as a percentage of the Company's
total revenue:
<TABLE>
<CAPTION>
For the Year For the Period For the Period For the Year For the Year
Ended May 21 - Jan. 1 - Ended Ended
Dec. 31, 1997 Dec. 31, 1996 May 20, 1996 Dec. 31, 1996 Dec. 31, 1995
------------- ------------- ------------ ------------- -------------
<S> <C> <C> <C> <C> <C>
Revenue $445.3 $210.4 $66.1 $276.5 $199.0
Gross profit without step-up(1) 69.6 15.6% 33.2 15.8% N/A 42.9 15.5% N/A
Gross profit with step-up 67.7 15.2% 33.0 15.7% 9.7 14.7% 42.7 15.4% 31.6 15.9%
SG&A 51.5 11.6% 20.2 9.6% 8.6 13.0% 28.8 10.4% 24.8 12.5%
Pre-tax net income 13.9 3.1% 13.2 6.3% 1.3 2.0% 14.5 5.2% 6.1 3.1%
</TABLE>
- ----------------
(1) Excluding the effect of the purchase accounting adjustments to the
inventory of the acquired companies.
Acquisitions
Acquisition of D.W. Hutson Construction Company
On February 28, 1997, the Company acquired substantially all of the
assets of Hutson. Hutson is one of the largest homebuilders in the Jacksonville,
Florida market and is engaged in the construction and sale of homes targeted for
the entry level and first-time move-up markets.
Acquisition of Wilshire Homes, Inc.
Effective April 1, 1997, the Company acquired the stock of Wilshire and
related interests. Wilshire has operations in the San Antonio and Austin, Texas
markets and is engaged in the construction and sale of homes targeted for the
first and second-time move-up markets.
Acquisition of Don Galloway Homes, Inc.
Effective August 1, 1997, the Company acquired the stock of Galloway
and related interests. Galloway is a premier homebuilding company operating
primarily in the Charlotte, North Carolina and Charleston, South Carolina
marketing homes to entry-level and first and second move-up buyers.
Acquisition of The Iacobucci Organization
The Company acquired certain assets of Iacobucci effective October 1,
1997. Iacobucci has homebuilding operations primarily in the Philadelphia,
Pennsylvania area and targets a wide range of buyers from the entry-level to the
high-end empty-nesters markets.
The Company's actual results of operations reflect the operating
activity of Hutson, Wilshire, Galloway and Iacobucci from the effective dates of
their acquisitions.
Consolidated Results of Operations
No comparison has been made to 1996 actual results (the period May 21
through December 31, 1996) due to the incomparability of periods resulting from
the Company's Offerings.
28
<PAGE>
Results of Operations for the Year Ended December 31, 1997 Compared to the
Combined Results of Operations of the Company from May 21 through December 31,
1996 and the Combined Predecessors from January 1 through May 20, 1996
General
<TABLE>
<CAPTION>
New Orders Closings Backlog at December 31,
---------- -------- -----------------------
1997 1996 1997 1996 1997 1996
---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C>
State
-----
Arizona 38 24 37 21 9 8
Colorado 377 306 332 267 183 138
Florida 567 N/A 636 N/A 151 N/A
Nevada 134 80 92 121 63 21
North Carolina 522 346 612 318 250 164
Pennsylvania 34 N/A 43 N/A 49 N/A
South Carolina 72 N/A 53 N/A 80 N/A
Texas 812 654 811 675 249 163
Wisconsin 150 N/A 146 N/A 22 18
----- ----- ----- ----- ----- ---
Total 2,706 1,410 2,762 1,402 1,056 512
</TABLE>
As seen in the chart above, the Company achieved net new orders of
2,706 units and 1,410 units in the years ended December 31, 1997 and 1996, an
increase of 91.9%. This increase is attributable to the Company's acquisitions
and an increase in net new orders in the Company's Colorado (increase of 71
units or 23.2%) and Nevada (increase of 54 units or 67.5%) operations. As a
group, the Founding Builders showed a 9.6% increase in net new orders in 1997
from 1996. At December 31, 1997, the Company has a combined backlog of 1,056
units with a dollar value of $198.2 million as compared to 512 units with a
dollar value of $96.0 million as of December 31, 1996, which is consistent with
the strong increase in new orders as stated above. The backlog of the Founding
Builders at December 31st increased 18.7% in 1997 from 1996.
Revenue
Revenue for the Company was $445.3 million for the year ended December
31, 1997 as compared to $276.5 million for the year ended December 31, 1996, an
increase of 61.0%. The increase in revenue is consistent with the increase in
the number of homes closed during the respective years. In 1997, 2,762 homes
were closed as compared to 1,402 closings in 1996. This 97.0% increase is
attributable to the Company's recent acquisitions as well as a 28.1% increase in
closings in the Company's Denver and Fort Collins operations.
Offsetting the effect on the revenue of the increase in units closed
was a decline in the average price of units closed, to $159,300 from $189,500
for 1997 and 1996, respectively. This decrease reflects the effects of fewer
closings in the higher-end homes available in the Las Vegas market (due to a
shortage of land on which to build these homes at the beginning of the year) and
the Hutson and Brookstone acquisitions whose average price of units closed is
approximately $109,000 and $125,000 per unit, respectively. Despite the Las
Vegas slowdown in closings, the Founding Builders' unit closings were up 2.8% in
1997 compared to 1996.
Also offsetting the effect of the increase in closings was a decrease
in lot sales and other revenue to $5.3 million in 1997 from $10.8 million in
1995. Lot sales and other revenue represented 1.2% of revenue in 1997 compared
to 3.9% of revenue in 1996. The decrease in this area was expected and will
continue as it is not the Company's policy to invest resources in land strictly
for resale. One of the Founding Builders joined The Fortress Group with a
significant land development project in Michigan. The project is now in its
final stages and is expected to close out in early 1998. The
29
<PAGE>
Company is currently carrying another land parcel of significant size that was
under a Founding Builder's control at the time of the Offerings. This North
Carolina subsidiary has generally not developed long-term land projects on its
own and is, therefore, actively marketing the parcel. The Company expects this
parcel to be sold during 1998.
Gross Profit
The Company's gross profit as a percentage of revenue increased to
15.6% for the year ended December 31, 1997 from 15.5% in 1996 excluding the
effect of the purchase accounting adjustments to the inventory of the acquired
companies. The Company has begun implementing national purchasing programs, a
key task of the added regional corporate structure, to enable improvement in
gross margins through cost reductions. However, the Company's generally-improved
margins in 1997 were depressed by acquisition accounting adjustments. Generally
accepted accounting principles require that, in a purchase transaction, the
acquirer write-up inventory to an estimated fair value upon acquisition.
This results in increased cost of sales as the written-up inventory is closed
and, therefore, decreased gross margins. Accordingly, gross margins of acquired
companies Landmark, Hutson, Galloway, and Iacobucci were lower than they
otherwise would have been. At December 31, 1997, the amount of unamortized
inventory write-up is approximately $219,000.
The amortization of the inventory write-up in 1997 totaled $1.9 million
and in 1996 totaled $210 thousand. This amortization had the effect of
decreasing the 1997 gross profit margin to an actual gross profit margin of
15.2%.
Additionally, the Company has experienced higher gross margins in its
Denver and Las Vegas markets that have been offset by decreased margins in
Austin and Raleigh. The reduction of margins in the Texas and North Carolina
markets reflects the effect of increasing competitive pressure. The Company's
subsidiaries have responded by implementing aggressive marketing strategies and
modest price decreases to maintain volume, which have slightly impacted the
Company's margins. However, the Company has seen some positive signs in these
slowed markets. In Austin, the Company's subsidiary has been able to increase
its market share by maintaining its 1996 sales level in this market, which has
shown a 30% decrease in 1997 from 1996 in building permits (due in part to the
shrinking increase in job growth after a boom in the early 1990s).
Operating Expenses
In June 1997, Fortress chose not to go forward with a potential
acquisition of significant size. This resulted in the expensing of approximately
$335,000 of acquisition costs that had previously been capitalized.
Without this non-recurring item, overall SG&A increased as a percentage
of revenue to 11.5% ($51.2 million) from 10.4% ($28.7 million) for the years
ended December 31, 1997 and 1996, respectively. Selling expenses increased to
6.3% ($28.0 million) from 5.9% ($16.2 million) while general and administrative
expenses rose to 5.2% ($23.2 million) from 4.5% ($12.5 million) in 1997 and
1996, respectively. The increase in selling expenses as a percentage of revenue
is a result of the Company's successful efforts earlier during the year to
enlist outside broker services. Additionally, as previously discussed, the
Company has attacked tightening markets in Austin and Raleigh with new marketing
strategies in order to counteract increasing competition.
Amortization of goodwill increased $865,125 to $947,883 in 1997 from
$82,758 in 1996. Without goodwill amortization, general and administrative
expenses as a percentage of revenue would have been 5.1% in 1997. Additionally,
general and administrative expenses for 1996 are not truly comparable to those
of 1997 as they do not include any adjustment for corporate expenses which would
have been incurred if the Company had existed as a single public entity for the
entire year. In 1997, the increase in general and administrative expenses as a
percentage of revenue reflects the Company's commitment to building a corporate
structure to properly integrate and oversee its growing operations. As the
Company has grown from ten markets at the end of 1996 to fourteen markets at the
end of the same
30
<PAGE>
period in 1997, operational and financial management has been increased in order
to enhance subsidiary management through strategic planning, refined budgeting
processes, and identification and implementation of operational best practices
and efficiencies and a standardized computer system.
Net Income
Pre-tax net income decreased $.6 million to $13.9 million in 1997 from
$14.5 million in 1996, representing a decrease of 4.1%. Net income for the year
ended December 31, 1997 ($8.5 million) decreased from net income for the year
ended December 31, 1996 ($9.5 million). However, the net income for these
periods is not comparable as the 1996 net income does not include (1) a
provision for income taxes as if the Predecessor Companies were combined and
subject to the effective Federal statutory income tax rate throughout the period
(including such a provision, pro forma net income would have been $9.0 million)
or (2) any adjustment for corporate expenses which would have been incurred had
the Company existed as a single public entity for the entire 12 months.
In addition, Fortress incurred significantly higher interest expense
during 1997. This is consistent with the Company's investment in "non-qualified"
assets, those assets for which interest must be immediately expensed. In 1997
and 1996, Fortress acquired several reputable homebuilders with solid
operational histories. In most cases, these acquisitions required payments in
excess of the acquired companies' book value for the goodwill that the owners'
have established, an intangible asset that has long-term value. Management
considers this a key investment in the growth of the Company; however, this
growth does come with the added cost of the goodwill. The Company has also
significantly increased its investments as a limited partner in partnerships
with land developing entities and, as previously mentioned, has invested in a
company-wide standardized information system. These investments in the future of
the Company have increased the overall leverage of the Company which has
resulted in increased interest expense.
Earnings before interest, taxes, depreciation and amortization (EBITDA)
increased 35.0% to $39.7 million in 1997 compared to $29.4 million in 1996.
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, EBITDA measures presented by the Company may not be
comparable to other similarly titled measures of other companies.
Combined Actual Results of the Company from May 21 through December 31, 1996 and
the Combined Predecessors from January 1 through May 20, 1996 Compared to the
Combined Predecessor Results for the Year Ended December 31, 1995
Revenue
The Company's total 1996 revenues increased by $77.4 million to $276.5
million compared to the 1995 revenues of $199.0 million. The increase in revenue
is the result of the greater number of homes delivered in 1996 over 1995
reflecting growth in the combined companies and the acquisition of Landmark. In
1996, the Company delivered 405 more homes than it delivered in 1995. The
average sales price of a home delivered in 1996 fell to $189,500 from $190,700
in 1995. The decrease in average sales price reflects the strong growth in the
Texas operations, which target the entry level and first time move-up markets
and the acquisition of Landmark Homes, which predominately builds for the same
target markets. In addition, the Colorado and Nevada subsidiaries introduced
more affordable product lines in 1996 which contributed to the Company's lower
average sales price during the year compared to 1995. Lot sales and other
revenue increased by $2.1 million in 1996 to $10.8 million compared to the
Combined Predecessor Companies total lot sales and other revenue of $8.7 million
in 1995. As a percentage of total revenue, lot sales and other revenue accounted
for 3.9% of revenue in 1996 compared to 4.4% in 1995.
31
<PAGE>
Gross Profit
The Company's total gross profit increased by $11.1 million to $42.7
million in 1996 compared to $31.6 million in 1995 resulting from the 39%
increase in revenue in 1996 over 1995 partially offset by lower margins. As a
percentage of revenue, the Company's gross profit was 15.4% in 1996 compared to
15.9% in 1995. This decline was due to the Company's decision to liquidate a
significant portion of its speculative housing inventory during the fourth
quarter of 1996, accepting lower margins in order to do so, and increased
competitive pressures in the Raleigh-Durham, North Carolina market.
Operating Expenses
The Company's total operating expenses increased by $4.0 million to
$28.8 million compared to $24.8 million in 1995. The Company incurred an
additional $3.1 million in selling expenses in 1996 compared to 1995, due to the
larger number of communities in which the Company was actively selling homes in
1996 compared to 1995. General and administrative expenses increased by $0.9
million due to the growth of the operating companies in 1996 compared to 1995
and an increase in expenses due to the creation of the Company. Even so, as a
percentage of revenue, operating expenses were significantly reduced to 10.4% of
revenue in 1996 compared to 12.5% of revenue in 1995. This decline is due to the
39% increase in revenue in 1996 over 1995 resulting in additional operating
efficiencies due to the mostly fixed nature of operating expenses.
Net Income
The Company's total pre-tax income increased by $8.4 million to $14.5
million compared to 1995 pre-tax income of $6.1 million, an increase of 139%.
Provision for income taxes increased to $5.0 million from $0 in 1995. Net income
increased $3.4 million to $9.5 million compared to $6.1 million in 1995. This
increase reflects the Company's C corporation status compared to the Combined
Predecessor Companies' status as S corporations; as previously mentioned, net
income for 1996 includes a tax provision from the time of the Offerings. Since
the Predecessor Companies were largely S corporations and did not have tax
provisions, the 1996 and 1995 net income amounts are not comparable.
EBITDA increased 46.3% to $29.4 million in 1996 compared to $20.1
million in 1995. 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, EBITDA 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 1997, the Company's operating activities, taken in
the aggregate, used approximately $1.5 million of cash. This cash outflow,
however, was largely due to the mortgage loan operations which were commenced in
1997. The funding of mortgage loans held for sale and the related mortgage
receivables are reflected as cash outflows in the operations section of the
statement of cash flows but the borrowings to fund these loans are reflected in
the financing section of the statement of cash flows. Excluding the cash outflow
to fund mortgage loans, the Company's operating activities provided net cash.
This cash flow was primarily generated by home sales which was offset in part by
the Company's increasing inventories due to (a) the increased number of
homebuilding subsidiaries and (b) some additional build up consistent with the
Company's growth and risk management strategies.
The majority of the Company's investing activities during 1997 related
to the purchases of Hutson, Wilshire, Galloway, and Iacobucci as well as
investments in land limited partnerships and significant property and equipment
purchases, largely resulting from the Company's rollout of a management
information system. The Company's
32
<PAGE>
financing activities generated cash of $31.1 million, consisting of net
borrowings under notes and mortgages payable of $24.5 million (which includes
the borrowings to fund the mortgage loans held for resale) and the net proceeds
of $10.0 million from the sale of Class AA preferred stock to Prometheus offset
by miscellaneous financing activities requiring cash.
From May 21 through December 31, 1996, operating activities used $6.1
million. The majority of the use of funds included an increase in receivables of
$7.6 million reflecting the proceeds of home sale closings on December 31, 1996
which were not received until early January 1997. The Company built up
inventories in anticipation of the higher end-of-year closings which in turn
resulted in increased receivables at December 31st. These very short-term
receivables were collected within the first weeks of 1997. Additionally, while
the level of inventories appears lower due to the period presented (May 21st to
December 31st), the Company increased its inventories at December 31, 1996
compared to December 31, 1995 as part of its key growth and risk management
strategies as previously discussed. The other significant use of cash during
this period was for the $5.2 million reduction in the operating subsidiaries
accounts payable. The Company, through its subsidiaries, has been able to
renegotiate many supplier and subcontractor contracts based on quicker payment
of outstanding invoices. Even with the decrease in accounts payable, excluding
the cyclical build up of accounts receivable and the increased inventories, the
Company's operating activities provided net cash during the period.
The majority of the Company's investing activities during 1996 related
to the acquisition of Landmark and Brookstone. The Company's financing
activities generated cash of $27.0 million. The Company generated $21.8 million
from its equity offering, $172.5 million from borrowings under notes and
mortgages payable and used $152.8 million for the repayment of notes and
mortgages payable. Cash and cash equivalents at December 31, 1996 were $16.2
million.
Since the culmination of the initial public offering through December
31, 1997, the Company has refinanced existing loan agreements, executed new loan
agreements or assumed loans resulting from the acquisitions totaling
approximately $280.4 million of available secured financing at the subsidiary
level. Under these credit facilities, the Company has borrowed approximately
$126.4 million at December 31, 1997.
In May 1997, the Company received the written consent of registered
holders of its 13.75% Senior Notes due 2003 to proposed amendments to the
Indenture under which the Senior Notes were issued. The amendments allow the
Company the opportunity to continue to increase its secured borrowing capacity
at the subsidiary level. It has been the Company's experience that this
financing strategy provides lower cost borrowings and flexible terms as compared
to unsecured borrowings at the parent company level.
In August 1997, Fortress executed a definitive agreement and, on
September 30, 1997 and February 19, 1998, amended and restated agreements (the
Agreement) with Prometheus Builders LLC (Prometheus), an affiliate of Lazard
Freres Real Estate Investors, LLC, which commits Prometheus to purchase $75
million of Fortress preferred stock and/or debt. The first closing under the
Agreement was effective as of September 30, 1997 with Prometheus's purchase of
11,700 shares ($11.7 million initial liquidation value) of Class AA preferred
stock and 375,000 warrants. The proceeds from the first closing were used in the
Galloway and Iacobucci acquisitions.
Shareholder approval of the Agreement was obtained at a special meeting
of the shareholders on March 6, 1998. Concurrent with shareholder approval,
Prometheus purchased the remaining $28.3 million of Class AA preferred stock to
be sold under the Agreement. Prometheus will purchase an additional $35.0
million of Class AB preferred stock and/or debt, in increments of not less than
$10 million, 625,000 warrants, and certain contingent warrants no later than
December 31, 1998. The warrants will be included in the first purchase of Class
AB preferred stock. The Agreement also provides that Fortress and Prometheus may
mutually agree to the purchase by Prometheus of an additional combination of
Class AA and Class AB preferred stock and/or debt totaling up to $25 million.
33
<PAGE>
The Company 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 needs of its current operations for
the foreseeable future. As of December 31, 1997, the Company had cash and cash
equivalents on hand of $12.4 million.
In evaluating its capital resources needs to cover planned
expenditures, management has reviewed the Year 2000 impact on its information
technology systems. With the exception of one software system, the Company's
systems are currently capable and ready to handle Year 2000 processing. This
software system will be modified to handle Year 2000 processing through routine
upgrades and testing scheduled for mid-1998. Management anticipates the
implementation to have no more than a minor effect as no additional costs in
excess of routine software maintenance are expected to be incurred.
At December 31, 1997, the Company had 2,271 lots in inventory, which
represent approximately eleven months supply of land based on sales absorption
rates during 1997. 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, substantially
all of its option contracts. At December 31, 1997, the Company had 7,600 lots
under option representing a nearly 2 1/2 -year supply of land based on the same
absorption rates as above.
The Company has and will continue to pursue its strategy to increase
operations through strategic acquisitions as it did with Hutson, Wilshire,
Galloway, and Iacobucci during 1997. Such acquisitions may be funded through a
combination of cash, stock (common and preferred) and notes issued by the
Company. Any cash portion will be funded by cash from operations, availability
under credit facilities (existing or newly-negotiated), the agreement with
Prometheus or a combination thereof.
Seasonality and Variability of Results
The Company experiences significant seasonality and quarterly
variability in homebuilding activity levels. The annual operating cycle
generally reflects greater home sales in the spring and autumn months and slower
sales in the winter and summer months. Closings are slowest during the first
quarter and activity increases during the second and third quarter with the
greatest level of closing activity taking place during the fourth quarter. The
Company believes that this seasonality is a reflection of the impact of winter
weather on construction activity and the preference of homebuyers to close on
their new home either prior to the start of a new school year in the fall or
prior to the holiday season.
Outlook
Early 1998 brought two new additions to The Fortress Group. During the
first quarter, the Company has closed the acquisitions of WestBrook Homes, a
homebuilder in Loudoun County, Virginia (Washington, DC MSA), and Whittaker
Homes, a homebuilder in St. Charles County, Missouri, one of the eleven counties
in the St. Louis MSA.
The Company has experienced a significant increase in new order
activity during 1997 compared to 1996 particularly in the Denver and Las Vegas
markets. This increase has been augmented by the strong new order activity of
the 1997 acquisitions and is continuing in 1998. At March 15, 1998, the Company
already had 915 new orders including those of the most recent additions to
the Company from their respective dates of acquisition. In just two and a
half months, the Company has reached home sales equal to 33.8% of total home
sales for all of 1997.
As of March 15, 1998, the Company has outstanding sales contracts of
1,758 homes in backlog, including backlog amount for both Whittaker and
WestBrook. These contracts represent approximately $325.0 million in anticipated
1998 revenue.
34
<PAGE>
The Company has addressed and continues to address key business
strategies through (i) the implementation of the Fortress Mortgage business
plan, (ii) the growth of operational and financial management groups providing
assistance in the company-wide program to reduce direct construction costs as a
percentage of revenue, the controlled management of speculative inventory
including homes and land, and identification and implementation of processes to
improve return on assets at the subsidiary level, and (iii) the continued
acquisitions of well managed and successful homebuilding companies that will be
accretive to the Company's earnings.
While management maintains a conservative outlook for 1998, it believes
the Company is well positioned for growth in 1998. This belief assumes continued
stability in market conditions, interest rates, job growth and consumer
confidence in its homebuilding markets. The Company believes the anticipated
increase in home deliveries, coupled with the continued successful
implementation of the Company's key strategies, should result in improved
operating income and earnings per share in 1998.
Please refer to the Statement on Forward-Looking Information.
Interest Rates and Inflation
The Company's business performance and the homebuilding industry in
general can be negatively affected by the impact of inflation and the adverse
effect inflation has on interest rates and the overall economic climate both
nationally and in the Company's markets.
Inflation affects the Company in a number of ways including increasing
the Company's cost of construction. Costs including land acquisition and
development, materials and subcontractor labor, overhead and interest rates on
floating rate credit facilities can all be adversely affected by inflation. In
additional, inflation may reduce consumers' ability to purchase a new home,
thereby adversely affecting the Company's new order flow. During 1997 and 1996,
inflation has not significantly affected the performance of the Company.
While inflation has not been a significant factor in 1997 or 1996,
rising inflation in the future would likely have an adverse long-term impact on
the Company's business performance.
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, acquisitions, anticipated
operating results, 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 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 cost of land, the availability of capital, the availability and
cost of labor and materials, changes in home prices and weather conditions.
35
<PAGE>
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements are listed under Item 14(a)(1) and filed as part of
this report on the pages indicated and are incorporated herein by reference.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
36
<PAGE>
PART III
The information required by Part III is omitted from this Annual Report
on Form 10-K and is incorporated by reference from the definitive proxy
statement with respect to the 1998 Annual Meeting of Stockholders (the Proxy
Statement) which the Company will file with the Securities and Exchange
Commission (the Commission) not later than 120 days after the end of the fiscal
year covered by this Report.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Identification of Directors. Information required by this Item will
be set forth under the caption "Proposal 1, Election of Directors -
Nominees for Election at this Annual Meeting" in the Proxy Statement,
which information is incorporated herein by reference.
(b) Identification of Executive Officers. Information required by this
Item is set forth under the caption "Executive Officers of the
Company" under Part I, Item 1 of this Report, which information is
incorporated herein by reference.
Item 11. EXECUTIVE COMPENSATION
Information required by this Item will be set forth under the captions
"Executive Compensation" and "Proposal 1, Election of Directors - Directors'
Remuneration" in the Proxy Statement, which information is incorporated herein
by reference.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information required by this Item will be set forth under the caption
"Stock Ownership" in the Proxy Statement, which information is incorporated
herein by reference.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information required by this Item will be set forth under the caption
"Certain Transactions" in the Proxy Statement, which information is incorporated
herein by reference.
37
<PAGE>
PART IV
Item 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements, Schedules and Exhibits.
1. Financial Statements (See Item 8 hereof.)
THE FORTRESS GROUP, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
THE FORTRESS GROUP, INC.
Report of Price Waterhouse LLP, Independent Accountants F-7
Consolidated Balance Sheets as of December 31, 1997 and 1996 F-8
Consolidated Statement of Operations for the year ended December 31, 1997 and the
period May 21, 1996 through December 31, 1996 F-9
Consolidated Statement of Shareholders' Equity for the year ended December 31, 1997
and the period ended December 31, 1996 F-10
Consolidated Statement of Cash Flows for the year ended December 31, 1997 and the
period May 21, 1996 through December 31, 1996 F-11
Notes to Consolidated Financial Statements F-12
COMBINED PREDECESSOR COMPANIES
Report of Price Waterhouse LLP, Independent Accountants F-22
Combined Balance Sheets as of December 31, 1995 and May 20, 1996 F-23
Combined Statements of Operations for the year ended December 31, 1995
and the period January 1, 1996 through May 20, 1996 F-24
Combined Statements of Shareholders' Equity for the year ended December 31, 1995
and for the period January 1, 1996 through May 20, 1996 F-25
Combined Statement of Cash Flows for the year ended December 31, 1995
and the period January 1, 1996 through May 20,1996 F-26
Notes to Combined Financial Statements F-27
</TABLE>
38
<PAGE>
2. Financial Statement Schedules
None.
3. Exhibits
Number Description
2.1 Agreement and Plan of Reorganization dated as of March 11, 1996 by
and among the Company, Buffington Acquisition, Inc., Buffington
Holdings, Inc. and the Stockholders named therein ("Buffington
Merger Agreement"). (Exhibit 2.1 of the Registration Statement on
Form S-1 (File No. 333-2332) effective May 16, 1996, is hereby
incorporated by reference)
2.1(a) First Amended to Buffington Merger Agreement, dated May 15, 1996.
(Exhibit 2.1(a) of the Registration Statement on Form S-1 (File No.
333-2332) effective May 16, 1996, is hereby incorporated by
reference)
2.2 Amended and Restated Agreement and Plan of Reorganization dated as
of March 11, 1996 by and among the Company, Christopher
Acquisition, Inc., Christopher Homes, Custom Homes Division, Inc.
and the Stockholders named therein ("Christopher Merger
Agreement"). (Exhibit 2.2 of the Registration Statement on Form S-1
(File No. 333-2332) effective May 16, 1996, is hereby incorporated
by reference)
2.2(a) First Amendment to Christopher Merger Agreement, dated May 15,
1996. (Exhibit 2.2(a) of the Registration Statement on Form S-1
(File No. 333-2332) effective May 16, 1996, is hereby incorporated
by reference)
2.3 Amended and Restated Agreement and Plan of Reorganization dated as
of March 11, 1996 by and among the Company, Genesee Acquisition,
Inc., The Genesee Company, The Genesee Company/Castle Pines, Ltd.,
The Genesee Company of Michigan, Ltd., Genesee Development Company
and the Stockholders named therein ("Genesee Merger Agreement").
(Exhibit 2.3 of the Registration Statement on Form S-1 (File No.
333-2332) effective May 16, 1996, is hereby
incorporated by reference)
<PAGE>
2.3(a) First Amendment to Genesee Merger Agreement, dated May 15, 1996.
(Exhibit 2.3(a) of the Registration Statement on Form S-1 (File No.
333-2332) effective May 16, 1996, is hereby incorporated by
reference)
2.4 Amended and Restated Agreement and Plan of Reorganization dated as
of March 11, 1996 by and among the Company, Sunstar Acquisition,
Inc., Solaris Development Corporation and the Stockholders named
therein ("Sunstar Merger Agreement"). (Exhibit 2.4 of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
2.4(a) First Amendment to Sunstar Merger Agreement, dated May 15, 1996.
(Exhibit 2.4(a) of the Registration Statement on Form S-1 (File No.
333-2332) effective May 16, 1996, is hereby incorporated by
reference)
2.5 Asset Purchase Agreement, dated August 31, 1996 by and among The
Fortress Group, Inc., Fortress Acquisition, Inc., Landmark Homes,
Inc., B. Rex Stephens, and Bobby W. Harrelson. (Exhibit 2.1 of the
Current Report on Form 8-K dated September 16, 1996 (File No.
0-28024) is hereby incorporated by reference)
2.6 Asset Purchase Agreement, dated February 28, 1997 by and among The
Fortress Group, Inc., Fortress-Florida, Inc., DW Hutson
Construction, Inc., and David Hutson. (Exhibit 10.1 of the Current
Report on Form 8-K dated March 17, 1997 (File No. 0-28024) is
hereby incorporated by reference)
2.7 Purchase Agreement dated August 18, 1997 among The Fortress Group,
Inc.; Fortress Galloway, Inc.; Don Galloway Homes, Inc.; Don
Galloway Land, LLC; Galloway Limited Partnership; Thornblade, LLC,
and the Persons named herein. (Exhibit 1 of the Current Report on
Form 8-K dated August 27, 1997 (File No. 000-28024) is hereby
incorporated by reference.)
2.8 Amended and Restated Purchase Agreement among the Company;
Whittaker Construction, Incorporated; RRKTG Lumber, Inc.; Lewis and
Clark Title Company and person named therein (incorporated herein
by reference to Exhibit 2.1 to the Company's Form 8-K dated March
16, 1998).
3.1 Amended and Restated Certificate of Incorporation of the
Registrant. (Exhibit 3.1 of the Registration Statement on Form S-1
(File No. 333-2332) effective May 16, 1996, is hereby incorporated
by reference)
3.2 Certificate of Amendment of Certificate of Incorporation of the
Company (incorporated herein by reference to Exhibit 3.1(a) to
Amendment No. 3 to the Company's Registration Statement on Form S-1
File No. 333-2332).
3.3 Certificate of Amendment of Certificate of Incorporation of the
Company, effective March 6, 1998 (incorporated herein by reference
to Exhibit 3.1 to the Company's Form 8-K dated March 16, 1998).
3.4 Amended and Restated Bylaws of the Registrant. (Exhibit 3.2 of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
3.5 Amendments to the Company's By-laws, effective March 6, 1998
(incorporated herein by reference to Exhibit 3.2 to the Company's
Form 8-K dated March 16, 1998).
4.2 Form of Indenture for Senior Notes. (Exhibit 4.2 of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
4.3 Form of Certificate for Senior Notes. (Exhibit 4.3 of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
The Company is a party to a number of other instruments
defining the rights of holders of long-term debt. No such
instrument authorizes an amount of securities in excess of 10% of
the total assets of the Company and its subsidiaries on a
consolidated basis. On request, the Company agrees to furnish a
copy of each such instrument to the Commission.
4.4 Stockholders' Agreement, dated as of April 15, 1996, by and among
the Company and certain shareholders (incorporated herein by
reference to Exhibit 10.7 to Amendment No. 1 to the Company's
Registration Statement on Form S-1 File No. 333-2332).
<PAGE>
4.5 Certificate of Amendement of Certificate of Designations,
Preferences and Relative, Participating, Optional and Other Special
Rights of Preferred Stock and Qualifications, Limitations and
Restrictions thereof of Class AA Convertible Preferred Stock of the
Company (incorporated herein by reference to Exhibit 4.5 to the
Company's Form 8-K dated March 16, 1998).
4.6 Amended and Restated Warrant Agreement by and between the Company
and Prometheus Homebuilders LLC (incorporated herein by reference
to Exhibit 4.6 to the Company's Form 8-K dated March 16, 1998).
4.7 Amended and Restated Stockholders Agreement by and among the
Company, Prometheus Homebuilders, LLC and the Stockholders named
therein (incorporated herein by reference to Exhibit 4.7 to the
Company's Form 8-K dated March 16, 1998).
4.8 Amended and Restated Registration Rights Agreement by and between
the Company and Prometheus Homebuilders, LLC (incorporated herein
by reference to Exhibit 4.8 to the Company's Form 8-K dated March
16, 1998).
10.1 Stock Incentive Plan. (Exhibit 10.1 of the Registration Statement
on Form S-1 (File No. 333-2332) effective May 16, 1996, is hereby
incorporated by reference)
10.3 Incentive Compensation Plan. (Exhibit 10.3 of the Registration
Statement on Form S-1 (File No. 333-2332) effective May 16, 1996,
is hereby incorporated by reference)
10.4(a) Employment Agreement between Buffington Holdings, Inc. and Thomas
Buffington. (Exhibit 10.4(a) of the Registration Statement on Form
S-1 (File No. 333-2332) effective May 16, 1996, is hereby
incorporated by reference)
10.4(b) Employment Agreement between Buffington Holdings, Inc. and Edward
Kirkpatrick. (Exhibit 10.4(b) of the Registration Statement on Form
S-1 (File No. 333-2332) effective May 16, 1996, is hereby
incorporated by reference)
10.4(c) Employment Agreement between Buffington Holdings, Inc. and James
Giddens. (Exhibit 10.4(c) of the Registration Statement on Form S-1
(File No. 333-2332) effective May 16, 1996, is hereby incorporated
by reference)
10.4(d) Employment Agreement between Christopher Homes, Custom Home
Division, Inc. and J. Christopher Stuhmer. (Exhibit 10.4(d) of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
10.4(e) Employment Agreement between The Genesee Company and Robert Short.
(Exhibit 10.4(e) of the Registration Statement on Form S-1 (File
No. 333-2332) effective May 16, 1996, is hereby incorporated by
reference)
10.4(f) Employment Agreement between Solaris Development Company and Lanold
W. Caldwell. (Exhibit 10.4(f) of the Registration Statement on Form
S-1 (File No. 333-2332) effective May 16, 1996, is hereby
incorporated by reference)
<PAGE>
10.4(g) Employment Agreement between Solaris Development Company and
Lawrence J. Witek. (Exhibit 10.4(g) of the Registration Statement
on Form S-1 (File No. 333-2 332) effective May 16, 1996, is hereby
incorporated by reference)
10.4(h) Employment Agreement between The Fortress Group, Inc. and James J.
Martell, Jr. (Exhibit 10.4(h) of the Registration Statement on Form
S-1 (File No. 333-2332) effective May 16, 1996, is hereby
incorporated by reference)
10.4(j) Employment Agreement between The Fortress Group, Inc. and James M.
Pirrello. (Exhibit 10.4(j) of the Registration Statement on Form
S-1 (File No. 333-2332) effective May 16, 1996, is hereby
incorporated by reference)
10.5 Directors Indemnification Agreement between The Fortress Group,
Inc. and Thomas B. Buffington, J. Marshall Coleman, Charles F.
Smith, Mark L. Fine, Steve D. Rivers, James F. McEneaney, James J.
Martell, Jr., J. Christopher Stuhmer, Lawrence J. Witek and Robert
Short. (Exhibit 10.5 of the Registration Statement on Form S-1
(File No. 333-2332) effective May 16, 1996, is hereby incorporated
by reference)
10.6(a) Promissory Note payable to Thomas Buffington. (Exhibit 10.6(a) of
the Registration Statement on Form S-1 (File No. 333-2332)
effective May 16, 1996, is hereby incorporated by reference)
10.6(b) Promissory Note payable to Edward Kirkpatrick. (Exhibit 10.6(b) of
the Registration Statement on Form S-1 (File No. 333-2332)
effective May 16, 1996, is hereby incorporated by reference)
10.6(c) Promissory Note payable to James Giddens. (Exhibit 10.6(c) of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
10.6(d) Promissory Note payable to Lanold Caldwell. (Exhibit 10.6(d) of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
10.6(e) Promissory Note payable to Lawrence Witek. (Exhibit 10.6(e) of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
10.6(f) Promissory Note payable to J. Christopher Stuhmer. (Exhibit 10.6(f)
of the Registration Statement on Form S-1 (File No. 333-2332)
effective May 16, 1996, is hereby incorporated by reference)
10.6(g) Promissory Note payable to Robert Short. (Exhibit 10.6(g) of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
10.7 Stockholders' Agreement between Charles F. Smith, Jr., James J.
Martell, Jr., Patricia Donnelly, Michael P. Kahn and Pepi A. Kahn,
Co-Trustees of Kahn Grantor Trust of 1993, James F. McEneaney, Jr.,
James M. Pirrello, Brian McGregor, Brian Buchanan, Thomas B.
Buffington, Edward A. Kirkpartrick, James M. Giddens, J.
Christopher Stuhmer, Robert Short, Lanold W. Caldwell, and Lawrence
J. Witek. (Exhibit 10.7 of the Registration Statement on Form S-1
(File No. 333-2332) effective May 16, 1996, is hereby incorporated
by reference)
10.8(a) Promissory Notes payable to Charles F. Smith. (Exhibit 10.8(a) of
the Registration Statement on Form S-1 (File No. 333-2332)
effective May 16, 1996, is hereby incorporated by reference)
10.8(b) Promissory Note payable to Patricia Donnelly. (Exhibit 10.8(b) of
the Registration Statement on Form S-1 (File No. 333-2332)
effective May 16, 1996, is hereby incorporated by reference)
10.8(c) Promissory Note payable to James J. Martell, Jr. (Exhibit 10.8(c)
of the Registration Statement on Form S-1 (File No. 333-2332)
effective May 16, 1996, is hereby incorporated by reference)
10.8(d) Promissory Note payable to Brian McGregor. (Exhibit 10.8(d) of the
Registration Statement on Form S-1 (File No. 333-2332) effective
May 16, 1996, is hereby incorporated by reference)
10.9 Consulting Agreement between The Fortress Group, Inc., and
Commonwealth Homes, Inc. (Exhibit 10.9 of the 1996 Annual Report on
Form 10-K (File No. 000-28024) is hereby incorporated by reference)
<PAGE>
10.10 Lease Agreement between Christopher Homes Custom Home Division,
Inc., and Towne Center Limited Partnership. (Exhibit 10.10 of the
1996 Annual Report on Form 10-K (File No. 000-28024) is hereby
incorporated by reference)
10.11 Lease Agreement between The Genesee Company and Genesee Holdings
Corporation. (Exhibit 10.11 of the 1996 Annual Report on Form 10-K
(File No. 000-28024) is hereby incorporated by reference)
10.12 Asset Purchase Agreement, dated July 1, 1996 by and among The
Genesee Company and Genesee Custom Homes, Inc. (Exhibit 2.1 of the
Quarterly Report on Form 10-Q for the quarter ended June 30, 1996
(File No. 0-28024) is hereby incorporated by reference)
10.13 Second Amended and Restated Stock Purchase Agreement dated as of
February 19, 1998 by and between the Company and Prometheus
Homebuilders LLC (incorporated by reference to Exhibit 10 to the
Company's Form 8-K dated March 16, 1998).
10.14 Employment agreement between The Fortress Group, Inc. and George C.
Yeonas (filed herewith)
21.1 List of Subsidiaries
23.1 Consent of Price Waterhouse LLP (filed herewith)
27.1 Financial Data Schedule
27.2 Financial Data Schedule
27.3 Financial Data Schedule
(b) Reports on Form 8-K.
Form 8-K filed September 10, 1997 reporting pursuant to Item 2 the
acquisition of Don Galloway Homes, Inc. and related interests.
Form 8-K/A filed November 10, 1997 to amend the Form 8-K filed September 10,
1997 providing financial statements required by Item 7.
Form 8-K filed August 18, 1997 and amended by Form 8-K/A filed October 6,
1997 reporting purusant to Item 5 the investment of Prometheus in the
Company.
<PAGE>
SIGNATURES
Pursuant to the requirements Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized March 31, 1998.
THE FORTRESS GROUP, INC.
By: /s/ James J. Martell, Jr.
-------------------------
Name: James J. Martell, Jr.
Title: President, Chief Executive
Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Capacity In Which Signed Date
--------- ------------------------ ----
<S> <C> <C>
/s/ James J. Martell, Jr.
- ------------------------
James J. Martell, Jr. President, Chief Executive Officer
and Director (Principal Executive Officer)
/s/ Jamie M. Pirrello
- ------------------------
Jamie M. Pirrello Vice President of Finance and Chief Financial
Officer Principal Financial Officer and
(Principal Accounting Officer)
/s/ George C. Yeonas
- ------------------------
George C. Yeonas Chief Operating Officer and Director
/s/ J. Marshall Coleman
- ------------------------
J. Marshall Coleman Chairman of the Board and Director
/s/ J. Christopher Stuhmer
- --------------------------
J. Christopher Stuhmer Director
/s/ Lawrence J. Witek
- ------------------------
Lawrence J. Witek Director
- ------------------------
Robert Short Director
/s/ Thomas B. Buffington
- ------------------------
Thomas B. Buffington Director
- ------------------------
Mark L. Fine Director
- ------------------------
Robert P. Freeman Director
- ------------------------
Murry N. Gunty Director
- ------------------------
James D. Klingbeil Director
<PAGE>
/s/ Edward J. Mathias
- ------------------------
Edward J. Mathias Director
/s/ Steven D. Rivers
- ------------------------
Steven D. Rivers Director
/s/ William A. Shutzer
- ------------------------
William A. Shutzer Director
/s/ Charles F. Smith
- ------------------------
Charles F. Smith Director
</TABLE>
<PAGE>
Report of Independent Accountants
To the Board of Directors and
Shareholders of The Fortress Group, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations, of shareholders equity, and of
cash flows present fairly, in all material respects, the financial position of
The Fortress Group, Inc. and its subsidiaries at December 31, 1997 and 1996, and
the results of their operations and their cash flows for the year ended December
31, 1997, for the period May 21, 1996 through December 31, 1996, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibiliity is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. As audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Washington, DC
March 12, 1998
F-1
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1996
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
1997 1996
---- ----
ASSETS
<S> <C> <C>
Cash and cash equivalents .............................................. $12,406 $ 16,212
Accounts and notes receivable .......................................... 21,944 10,700
Due from related parties ............................................... 4,416 5,176
Real estate inventories ................................................ 217,342 144,106
Land held for resale ................................................... 6,934
Mortgage loans held for sale ........................................... 11,128
Investments in land partnerships ....................................... 6,763
Property and equipment, net ............................................ 10,246 3,543
Prepaid expenses and other assets ...................................... 22,655 10,355
Goodwill, net .......................................................... 23,470 3,641
-------- --------
Total assets ...................................................... $337,304 $193,733
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities .................. $ 23,172 $ 8,526
Notes and mortgages payable ............................................ 228,420 140,136
Due to related parties ................................................. 783 27
Accrued expenses ....................................................... 14,464 8,525
Customer deposits ...................................................... 7,300 4,259
-------- --------
Total liabilities ................................................. 274,139 161,473
-------- --------
Commitments and contingencies (Note 16)
Minority interest ...................................................... 268 274
-------- --------
Shareholders' equity
Preferred stock, all classes and series, $.01 par value, 1 million
authorized...................................................... 1
Class AA cumulative convertible (rate of 12% per annum decreasing
to 6%), 53,333 designated, 11,700 and 0, respectively, issued
and outstanding ($11.7 million initial liquidation preference)
Series A 11% cumulative convertible, 20,000 designated, 10,000
issued and outstanding ($1 million aggregate liquidation
preference)
Series B convertible, 40,000 designated, 8,854 and 0, respectively,
issued and outstanding ($885,400 aggregate liquidation
preference)
Series C convertible, 70,000 designated, 60,000 and 0,
respectively, issuable (Note 9)
Series D convertible, 67,500 designated, 60,000 and 0, respectively,
issued and outstanding ($6,000,000 aggregate liquidation preference)
Common stock, $.01 par value, 49 million authorized, 11,748,694 and
11,764,375 issued, respectively ................................ 117 118
Additional paid-in capital .......................................... 47,371 23,808
Retained earnings ................................................... 15,936 8,072
Treasury stock, at cost, 120,100 and 1,700 shares, respectively ..... (528) (12)
-------- --------
Total shareholders' equity......................................... 62,897 31,986
-------- --------
Total liabilities and shareholders' equity......................... $337,304 $193,733
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Year For the Period
Ended May 21 -
Dec. 31, 1997 Dec. 31, 1996
------------- -------------
<S> <C> <C>
Revenue:
Residential sales ..................................................... $440,006 $200,721
Lot sales and other revenue ........................................... 5,305 9,633
-------- --------
Total revenue ........................................................ 445,311 210,354
Cost of sales ............................................................. 377,607 177,387
-------- --------
Gross profit .............................................................. 67,704 32,967
Operating expenses:
Selling ............................................................... 27,952 11,527
General and administrative ............................................ 23,582 8,653
-------- --------
Net operating income ................................................. 16,170 12,787
-------- --------
Other expense (income):
Interest .............................................................. 3,396 429
Minority interest ..................................................... (6) 92
Other, net ............................................................ (1,143) (955)
-------- --------
Income before provision for income taxes .................................. 13,923 13,221
Provision for income taxes ................................................ 5,463 5,013
-------- --------
Net income ................................................................ $ 8,460 $ 8,208
======== ========
Net income available for common shareholders .............................. $ 7,982 $ 8,072
======== ========
Basic earnings per share .................................................. $ .68 $ .69
======== ========
Diluted earnings per share................................................. $ .63 $ .69
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Shares Amount Additional Total
--------------------- ------------------ Paid-in Retained Treasury Shareholders'
Preferred Common Preferred Common Capital Earnings Stock Equity
--------- ------ --------- ------ ------- -------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at May 20, 1996 2,231 $ 22 $ (22)
Issuance of preferred stock ....... 20
Issuance of common stock, net of
related costs .................... 9,534 96 21,747 $21,843
Acquisition of Founding Builders'
equity ........................... 8,927 8,927
Distributions to Founding Builders (6,063) (6,063)
Sale of Genesee Custom Division ... 258 258
Redemption of preferred stock ..... (10) (1,000) (1,000)
Preferred stock dividends ......... $ (136) (136)
Purchase of treasury stock ........ (62) $ (429) (429)
Reissuance of treasury stock ...... 60 (39) 417 378
Net income ........................ 8,208 8,208
--- ------ -- ---- ------- ------- ------- -------
Balance at December 31, 1996 ........ 10 11,763 $118 $23,808 $ 8,072 $ (12) $31,986
Issuance of preferred stock ....... 144 $1 23,828 23,829
Amortization of discount on
preferred stock .................. 263 263
Cancellation of preferred stock ... (3) (315) (315)
Preferred stock dividends ......... (461) (461)
Imputed preferred stock dividend .. 17 (17)
Issuance of common stock .......... 69 336 336
Adjustment of stock guarantee ..... (57) (57)
Common stock dividends declared ... (118) (118)
Purchase of treasury stock ........ (227) (1,170) (1,170)
Retirement of treasury stock ...... (1) (511) 512
Reissuance of treasury stock ...... 24 2 142 144
Net income ........................ 8,460 8,460
--- ------ -- ---- ------- ------- ------- -------
Balance at December 31, 1997 151 11,629 $1 $117 $47,371 $15,936 $ (528) $62,897
=== ====== == ==== ======= ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
For the Year For the Period
Ended May 21-
Dec. 31, 1997 Dec. 31, 1996
------------- -------------
<S> <C> <C>
Cash flows from operating activities
Net income ......................................................... $ 8,460 $ 8,208
Adjustments to reconcile net income to net cash used in
operating activities:
Depreciation and amortization ................................. 5,304 741
Minority interest ............................................. (6) 93
Loss on sale of property and equipment ........................ 45 19
Changes in operating assets and liabilities
Accounts receivable ........................................... (10,277) (7,586)
Due from related parties ...................................... 2,761 (403)
Real estate inventories ....................................... 1,116 829
Land held for resale .......................................... (6,934)
Mortgage loans held for sale .................................. (11,128)
Prepaid expenses and other assets ............................. 837 (2,164)
Accounts payable and accrued construction liabilities ......... 3,471 (5,205)
Accrued expenses .............................................. 4,309 1,539
Customer deposits ............................................. 545 (2,123)
--------- ---------
Net cash used in operating activities ...................... (1,497) (6,052)
--------- ---------
Cash flows from investing activities
Acquisition of homebuilders, net of acquired cash .................. (19,976) (3,036)
Sale of Genesee Custom Homes division .............................. 253
Purchase of property and equipment ................................. (6,933) (1,979)
Proceeds from sale of property and equipment ....................... 267 31
Investment in limited partnerships ................................. (6,763)
--------- ---------
Net cash used in investing activities ...................... (33,405) (4,731)
--------- ---------
Cash flows from financing activities
Borrowings under notes and mortgages payable ....................... 357,304 172,461
Repayment of notes and mortgages payable ........................... (332,759) (152,824)
Related party borrowings ........................................... 193
Repayments of related party borrowings ............................. (363) (2,941)
Proceeds from issuance of Class AA Preferred Stock, net ............ 9,958
Proceeds from Employee Stock Purchase Plan ......................... 14
Deferred financing costs ........................................... (1,882) (2,694)
Capital distributions to predecessor shareholders .................. (6,063)
Common stock dividends paid ........................................ (89)
Distributions to minority interest ................................. (1,274)
Preferred stock redemption ......................................... (1,000)
Preferred dividends ................................................ (110) (109)
Purchase of treasury stock ......................................... (1,170) (429)
Net proceeds from issuance of common stock ......................... 21,843
--------- ---------
Net cash provided by financing activities .................. 31,096 26,970
--------- ---------
Net (decrease) increase in cash and cash equivalents .................. (3,806) 16,187
Cash and cash equivalents, beginning of period ........................ 16,212 25
--------- ---------
Cash and cash equivalents, end of period .............................. $ 12,406 $ 16,212
========= =========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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; and The
Iacobucci Organization (Iacobucci), a Philadelphia, Pennsylvania homebuilder,
effective October 1, 1997.
In August 1996, the Company sold the Custom Home Division of Genesee (Genesee
Custom) to a director. No gain or loss was recognized in conjunction with this
sale. (See Note 11 - Related Party Transactions.).
In January 1997, Fortress formed Fortress Mortgage Company (Fortress Mortgage),
a wholly-owned subsidiary, to provide a mortgage lending source to the Company's
builder subsidiaries as an ancillary benefit. Fortress Mortgage is licensed in
Texas, Colorado, Nevada, North Carolina, Pennsylvania, and Wisconsin. Licenses
are pending in Florida, Missouri, and South Carolina.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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
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.
F-5
<PAGE>
Revenue recognition
Residential homes and lot sales are recognized when all conditions precedent to
closing have been fulfilled and title has passed to the buyer. The Company's
homes are generally sold in advance of their construction. The Company's
standard sales contract generally requires the customer to make an earnest money
deposit which is recognized as a liability until the unit closes.
Mortgage income
Statement of Financial Accounting Standards (SFAS) No. 91, Accounting for
nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and
Initial Direct Costs of Leases, requires the deferral of loan origination fees
and direct loan origination costs and certain origination expenses over the
estimated life of the loans for loans originated and not sold as of December 31,
1997. The Company has deferred the income and expenses attributable to these
loans and will recognize them at the time of sale of the loans.
Gains and losses from sales of mortgage loans are recognized at the time of sale
and are determined by the difference between net sale proceeds and the carrying
value of the mortgage loans sold.
Recognition of gains and losses is based on SFAS No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,
which was effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996. SFAS No. 125 is
based upon consistent application of a financial components approach that
focuses on control. Under that approach, after a transfer of financial assets,
an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished.
Cash and cash equivalents
For purposes of reporting cash flows, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
Real estate inventories and cost of sales
Real estate inventories are held for sale and are carried at cost which is less
than fair value as measured in accordance with SFAS No. 121, Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of.
Costs incurred which are included in inventory consist of land, land
development, direct and certain indirect construction costs, interest,
real estate taxes, direct model construction costs, and related improvements.
At the time of revenue recognition, cost of sales is charged with the actual
construction costs incurred and any specifically identified estimate to
complete, plus an allocation of the total estimated cost of land and land
development, interest, real estate taxes and any other capitalizable common
costs based on the relative sales value method of accounting.
The Company generally provides a one-year limited warranty of workmanship and
materials with each of its homes. Accordingly, a warranty reserve, based on the
Company's historical experience, is provided as residential sales are closed.
Interest capitalization
Interest and related debt issuance costs are capitalized to qualifying real
estate inventories as incurred, in accordance with SFAS No. 34, Capitalization
of Interest Cost, and charged to cost of sales as revenue from residential sales
is recognized.
Mortgage loans held for sale
Mortgage loans held for sale to nonaffiliated investors are recorded in the
aggregate at the lower of cost or market. Fair value is based upon contractually
established prices at which mortgage loans will be sold or, if loans are not
committed for sale, at current market prices. No valuation allowance was
required at December 31, 1997.
F-6
<PAGE>
Investments in land partnerships
The Company records its investments in land partnerships in which it holds less
than a majority interest under the equity method of accounting.
Property and equipment
Property and equipment are carried at cost less accumulated depreciation and are
depreciated using the straight-line method over the estimated useful lives of
the assets which range from two to ten years. Costs incurred for common area
model improvements and certain furnishings are amortized on a per unit basis as
home sales in the related development are closed. Significant additions and
improvements are capitalized while expenditures for repairs and maintenance are
charged to operations as incurred.
Deferred financing costs
Costs associated with the issuance of the Senior Notes have been capitalized and
are being amortized using the straight-line method over the seven-year term of
the related notes.
Option deposits
The Company enters into option agreements that allow the takedown of land under
the specified terms. When a deposit is required, the Company records the deposit
amount in "other assets." When the land is taken down, the deposit becomes part
of the cost basis of the land and is reclassified as land inventory. If the
decision is made not to take down the land, the deposit is expensed. Option
deposits totaling approximately $8.7 million are included in "other assets" at
December 31, 1997.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of
assets acquired and is being amortized over periods ranging from five to twenty
years. Accumulated amortization at December 31, 1997 and amortization expense
for the year then ended was $1,030,641 and $947,883, respectively. Accumulated
amortization at December 31, 1996 and amortization expense for the period May 21
through December 31, 1996 was $82,758. The Company routinely evaluates the
recoverability of goodwill based on the estimated future undiscounted cash flows
associated with the assets. In the event that facts and circumstances indicate
that the carrying value of goodwill is impaired, it would be written down to its
estimated fair value.
Income taxes
The Company accounts for income taxes in accordance with SFAS No. 109,
Accounting for Income Taxes. The asset and liability approach used in SFAS No.
109 requires the recognition of deferred tax assets and liabilities for the tax
consequences of temporary differences by applying enacted statutory tax rates
applicable to future years to differences between the financial statement
carrying amounts and the tax bases of existing assets and liabilities.
Minority interest
Certain of the Company's subsidiaries are participants in real estate joint
ventures in which parties unrelated to the Company own a minority interest.
Joint venture profits are allocated to the Company and the other partners
according to their respective ownership.
F-7
<PAGE>
Beneficial conversion feature
In accordance with the Securities and Exchange Commission's Topic D-60,
Accounting for the Issuance of Convertible Preferred Stock and Debt Securities
with a Nondetachable Conversion Feature, the Company recorded a $274,000
"discount" for the 11,700 shares of Class AA convertible preferred stock issued
during 1997. (See description of preferred stock in Note 9 - Shareholders'
Equity.) As required by Topic D-60, the Company is amortizing this discount
using the effective interest method from the date of issuance, September 30,
1997, through the date at which the Class AA conversion features are subject to
adjustment, September 30, 2001. This amortization is recognized as an additional
return to the preferred shareholders (see Note 10 - Earnings per Share) and is
included in the Statement of Shareholders' Equity for the year ended December
31, 1997 as an "imputed preferred stock dividend."
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
New accounting pronouncements
SFAS No. 128, Earnings per Share, was issued by the Financial Accounting
Standards Board (FASB) in February 1997. This statement requires that the
previous calculations of primary and fully diluted earnings per share be
replaced by basic and diluted earnings per share calculations. The adoption of
SFAS No. 128 resulted in a restatement of earnings per share for all periods
presented in the accompanying financial statements. (See Note 10 Earnings per
Share.)
Also in February 1997, the FASB issued SFAS No. 129, Disclosure of Information
about Capital Structure. SFAS No. 129, which applies to all entities that have
issued securities, requires in summary form, the pertinent rights and privileges
of the various securities outstanding. The Company has disclosed this
information in Note 9 - Shareholders' Equity.
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, which supersedes SFAS No. 14, Financial Reporting for Segments of a
Business Enterprise, establishes disclosure standards for disclosure of
operating segments in annual and interim financial statements of public
entities. It includes standards for disclosures regarding products and services,
geographic areas and major customers. SFAS No. 131 is effective for financial
statements for periods beginning after December 15, 1997 and requires
information for earlier years to be restated. The Company will adopt SFAS No.
131 in its fiscal year 1998. Adoption of this standard is not expected to have a
material impact on the Company.
NOTE 3 - ACQUISITIONS
The Company acquired certain assets and assumed certain related indebtedness of
Hutson and Iacobucci effective February 28, 1997 and October 1, 1997,
respectively. Additionally, the Company acquired the stock of Wilshire and
Galloway effective April 1, 1997 and August 1, 1997, respectively. The initial
purchase price for these acquisitions totaled $110.6 million including $17.7
million in cash, $5.7 million in short-term notes payable, 65,000 shares of
common stock with a stated value of $10 per share, 128,854 shares of preferred
stock (liquidation value of approximately $12.9 million), and assumed
liabilities of approximately $73.8 million. In addition, the Company loaned
approximately $3.0 million in cash to the previous owners of Galloway and
Iacobucci which is to be repaid through their respective earnouts or to be
personally repaid by the borrowers at the end of the earnout period.
The Company acquired certain assets and assumed related indebtedness of Landmark
and Brookstone on August 31, 1996 and December 31, 1996, respectively. The
purchase price for the assets of the 1996 acquisitions totaled $20.4
F-8
<PAGE>
million including $6.6 million in cash, 60,000 shares of Common Stock with a
stated value of $10 per share, and assumed liabilities of $13.2 million.
In each of these acquisitions, the excess purchase price was allocated first to
record assets and liabilities at fair value on the acquisition date; the
remaining excess purchase price was recorded as goodwill. Cost of goods sold for
the year ended December 31, 1997 and the period May 21 through December 31, 1996
included $1,928,000 and $210,000 related to the allocation of the purchase price
to inventory. Without this amortization, earnings per share for the year ended
December 31, 1997 would have been $.78 (basic) and $.72 (diluted) and for the
period May 21, 1996 through December 31, 1996 would have been $.70 (basic and
diluted).
Most of the Company's acquisition agreements include earnout provisions, by
which the seller(s) may receive future consideration based upon the operational
results of the purchased business. These provisions generally extend two to four
years past the purchase date and are calculated as a set percentage of
operational results in excess of operational goal "hurdles." In each of the
acquisitions including earnout provisions, the earnout consideration will be
accounted for as additional purchase price and, accordingly, increase the
goodwill related to the acquisitions and be amortized over the corresponding
remaining goodwill amortization periods. Under these provisions, the Company is
committed to earnout payments of a minimum of $1.0 million per year in the form
of Series C preferred stock through the year 2001. (See Note 9 - Shareholders'
Equity.)
The Company's unaudited pro forma summary consolidated results of operations for
the year, as if the significant acquisitions had occurred at January 1, 1996 and
excluding the amortization of the purchase accounting adjustments for the step
up of inventory, are presented below. These results include the unaudited pro
forma results of Combined Predecessor Companies. The unaudited pro forma results
also include certain administrative costs of the Fortress corporate organization
that would have been incurred had the Company existed in its current structure
for the entire period; the results of operations of Genesee as if the sale of
Genesee Custom had occurred on January 1, 1996; and the increased provision for
income taxes as if the Combined Predecessor Companies and the subsequent
acquisitions were C corporations throughout the periods presented. Additionally,
the issuance of 11,700 shares of Class AA convertible preferred stock, which
provided financing for Galloway, 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, 1996.
Year Ended
December 31,
1997 1996
---- ----
(unaudited, in thousands,
except per share amounts)
Revenue ........................................ $ 494,810 $ 426,409
Net income ..................................... 12,676 17,033
Net income per share ........................... .94 1.31
Net income per share - assuming dilution ....... .81 1.09
NOTE 4 - SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures of cash flow information are as follows (in thousands):
For the Year For the Period
Ended from May 21 -
December 31, 1997 December 31, 1996
----------------- -----------------
Cash paid for the following:
Interest ................. $23,964 $11,214
Income taxes ............. $ 3,721 $ 4,958
F-9
<PAGE>
NOTE 5 - REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
December 31,
1997 1996
---- ----
Work-in-progress
Sold homes ........................... $ 81,225 $ 38,547
Speculative .......................... 45,058 44,669
-------- --------
Total work-in-progress .............. 126,283 83,216
Land
Finished lots ........................ 43,585 34,671
Land under development ............... 39,666 13,930
Unimproved land held for development.. 1,084 1,009
-------- --------
Total land .......................... 84,335 49,610
Model homes ............................ 6,724 11,280
-------- --------
$217,342 $144,106
======== ========
Model homes are constructed to assist in the marketing effort of a development.
Speculative homes, included above in work-in-progress, represent both completed
and under-construction, non-model homes which are not subject to a sales
contract. Both work-in-progress and model homes include the allocation of land,
land development, and other allocable costs.
NOTE 6 - INTEREST
Information regarding interest is as follows (in thousands):
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
During the year ended December 31, 1997 and the
period May 21 through December 31, 1996:
Interest incurred ....................................... $ 23,569 $ 12,930
Interest capitalized .................................... (19,877) (12,314)
Interest amortized to cost of sales ..................... 17,288 9,704
-------- --------
Total interest expensed in statement of operations .... $ 20,980 $ 10,320
======== ========
At December 31, 1997 and 1996:
Capitalized interest in ending inventory ................ $ 16,559 $ 12,159
======== ========
</TABLE>
F-10
<PAGE>
NOTE 7 - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
1997 1996
---- ----
<S> <C> <C>
Model home upgrades and furnishings ..................... $ 7,957 $ 1,845
Equipment and furniture ................................. 4,749 2,564
Vehicles ................................................ 509 468
Leasehold improvements .................................. 1,524 725
------- -------
14,739 5,602
Less: Accumulated depreciation and amortization ........ (4,493) (2,059)
------- -------
$10,246 $ 3,543
======= =======
</TABLE>
NOTE 8 - NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable consist of the following (in thousands):
December 31,
1997 1996
---- ----
13.75% Senior Notes due 2003 ..................... $100,000 $100,000
Project specific land, land development and
construction loans ........................... 111,318 38,613
Mortgage warehouse lines of credit ............... 15,546
Other loans ...................................... 1,556 1,523
-------- --------
$228,420 $140,136
======== ========
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 Company was in compliance with all financial covenants at December 31, 1997.
In May 1997, the Company received the written consent of registered holders of
its 13.75% Senior Notes due 2003 to proposed amendments to the Indenture under
which the Senior Notes were issued. The amendments allow the Company the
opportunity to continue to increase its secured borrowing capacity at the
subsidiary level.
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 2.5% over the London InterBank Offered Rate (LIBOR) to 2%
over prime rate and fixed rates generally from 8.5% to 12.75%.
The Company's mortgage subsidiary has two warehouse lines of credit outstanding
for the purpose of originating loans. The warehouse lines are secured by the
mortgage loans held for sale and are repaid upon sale of the mortgage loans. The
lines bear interest at variable rates ranging from 1.5% to 2.75% over the 30-day
LIBOR based on the type of loan and lending requirements. At December 31, 1997,
LIBOR was 5.94%. The lines of credit mature April 30, 1998 and August 31, 1998.
The aggregate commitment available at December 31, 1997 was $17,000,000.
F-11
<PAGE>
Other loans consist primarily of debt financed corporate insurance policies
which bear interest at rates ranging from 7.0% to 7.8%.
Principal maturities of the above indebtedness at December 31, 1997 are as
follows (in thousands):
Year Ended December 31,
- -----------------------
1998 ........................... $114,770
1999 ........................... 13,310
2000 ........................... 340
2001 ...........................
2002 ...........................
Thereafter ..................... 100,000
--------
$228,420
========
NOTE 9 - SHAREHOLDERS' EQUITY
Preferred stock
The Company has authorized 1 million shares of $.01 par value preferred stock,
of which 300,833 has been designated for the following specific series or
classes of preferred stock:
Effective September 30, 1997, the Company executed the first closing related to
its agreement with Prometheus Homebuilders LLC (Prometheus). In connection with
this agreement to sell Prometheus $75 million in preferred stock, the Company
designated 53,333 shares of Class AA Convertible Preferred Stock. These
preferred shares carry a cumulative 12% return per annum, until the second
closing at which time the rate is reduced to 6% per annum, calculated on the
liquidation value of $1,000 per share. (The second closing occurred on March 6,
1998. See Note 17 - Subsequent Events.) The Class AA 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. 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 (the Adjustment Price) is
$12.00 per share or less. The amount of adjustment will vary based on the
average closing price of the Common Stock. Prometheus will have the right during
this period to elect to adjust up to five times per year the conversion price
for the Class AA preferred stock, by reference to the then prevailing Adjustment
Price as follows:
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
After the second closing, the Company will have the option to require conversion
of all, but not less than all, of the Class AA preferred stock into Common Stock
if the average closing price of the Common Stock for the 90 days preceding such
conversion is $12.00 per share or more. In either case, the conversion price is
subject to certain antidilution adjustments. The Company does not have the right
to redeem the Class AA preferred stock. The holders of Class AA preferred stock
having voting rights on an as-converted basis equal to the holders of Common
Stock. At December 31, 1997, 11,700 shares of Class AA preferred stock were
outstanding with dividends of approximately $350,000 accrued. In the first
quarter of 1998, 28,300 additional shares of Class AA preferred stock were sold.
(See Note 17 - Subsequent Events.)
F-12
<PAGE>
As part of the acquisition of the Combined Predecessors, 20,000 shares were
issued in 1996 as Series A 11% cumulative convertible non-voting preferred
stock. The preferred stock is restricted from converting into Common Stock for
the first two years that the shares are issued and outstanding. The conversion
rate of the shares is the lesser of $9.00, the price of the Common Stock
Offering, or 75% of the lowest closing price during the thirty days immediately
preceding the date of conversion. The Company has the right to redeem all of the
preferred stock prior to conversion at a redemption price equal to the
liquidation value plus any accumulated but unpaid dividends. Accrued dividends
on the 10,000 outstanding shares at December 31, 1997 totaled $27,000.
In connection with the Hutson acquisition, Fortress issued 12,000 shares of
Series B convertible preferred stock with a liquidation value of $100 per share.
As a result of post-closing audit adjustments to the purchase price, 3,146 of
these shares were subsequently cancelled resulting in a total of 8,854
outstanding shares at December 31, 1997. These preferred shares are convertible
into ten shares of Common Stock for each preferred share until February 1998.
Thereafter, the Series B preferred stock is convertible into $100 value per
share, payable in Common Stock at ten shares of Common Stock for one share of
preferred stock, and additional Common Stock or cash, at the option of Fortress,
to equal $100 value. Series B preferred stock is paid dividends on an
as-converted basis. Unpaid dividends of approximately $700 were accrued at
December 31, 1997.
Also in connection with the Hutson acquisition, Fortress has agreed to issue
60,000 shares (70,000 authorized) of Series C convertible preferred stock on an
annual basis over a period not to exceed six years ($6 million liquidation
preference). The amount of each annual issuance will be based upon future
earnings of Hutson. The stock has been treated as outstanding for the purpose of
calculating earnings per share; however, it will only be legally outstanding
upon issuance. The Series C preferred stock is convertible into Common Stock
based on $100 liquidation value per Series C share, payable in Common Stock,
cash, or a combination of both, at the option of Fortress.
In connection with the Galloway acquisition, Fortress has issued 60,000 shares
of Series D convertible preferred stock with a liquidation value of $100 per
share ($6 million aggregate liquidation preference). Each Series D share is
convertible into ten shares of Common Stock. Series D shares are redeemable at
the option of the holder up to 25% each year, cumulative, over a four-year
period. However, the shares can be redeemed in cash, Common Stock or a
combination of both equal to the $100 per share liquidation value. The
allocation between Common Stock and cash is at the sole option of Fortress.
Although no shares have been issued, the Company has designated 50,000 shares as
Series E 6% convertible preferred stock with a liquidation value of $100 per
share. Each of the Series E preferred shares converts into ten shares of the
Company's Common Stock at the option of the holder. The Company may require
conversion into ten shares of the Company's Common Stock when the Common Stock
has traded at $10 per share or more for ten consecutive business days. The
holder will have the right to require the Company to redeem up to 20% of the
total number of Series E shares initially issued for cash equal to $100 per
share plus all unpaid dividends thereon, including accrued dividends, whether or
not declared. The redemption amount is cumulative in nature in that shares a
holder had a right to but did not redeem on a redemption date may be added to
the total that may be redeemed on the next redemption date. The Company has the
option to redeem the shares at any time.
Common Stock
In May 1996, the Company completed an offering of 3,000,000 shares of Common
Stock (300,000 additional shares were issued in June 1996 pursuant to the
underwriter's overallotment option) for total net proceeds of approximately
$21.8 million. The proceeds were used together with proceeds from the issuance
of the Senior Notes (see Note 8 Notes and Mortgages Payable) to retire
borrowings of the subsidiaries as well as for general corporate purposes.
In November 1996, the Company's Board of Directors approved a stock repurchase
plan authorizing the purchase of up to 350,000 shares of the Company's currently
outstanding common stock. Such repurchases are effected at various prices from
time to time in the open market. During the years ended December 31, 1997 and
1996, the Company has repurchased 226,534 and 61,700 shares, respectively,
84,100 of which were subsequently canceled and 84,034 of which were reissued.
In March 1997, the Company established a dividend policy including the
initiation of a cash dividend of $.01 per share annually, payable quarterly, as
permitted under the Indenture. During 1997, the Board of Directors declared
quarterly dividends in accordance with this policy. At December 31, 1997,
approximately $30,000 was accrued for unpaid Common Stock dividends.
In 1997, 30,000 shares of restricted stock were granted to an officer of the
Company as part of a compensation package approved by the Board of Directors.
F-13
<PAGE>
The resulting compensation expense is being amortized over the vesting period of
thirty months.
Warrants
Under the agreement with Prometheus, the Company issued warrants to purchase a
minimum of 375,000 shares of Common Stock to Prometheus. The 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 Adjustment Price. The
following table show the changes in the exercise price and the number of shares
of Common Stock into which each Warrant will convert upon exercise of the
Warrants during this period:
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
The exercise price and the number of shares of Common Stock into which each
warrant will convert are also subject to certain antidilution adjustments.
F-14
<PAGE>
NOTE 10 - EARNINGS PER SHARE
The Company has adopted SFAS No. 128, Earnings per Share, and has presented
basic and diluted earnings per share (EPS) for the year ended December 31, 1997
and the period May 21 through December 31, 1996. 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 Year Ended For the Period
December 31, 1997 May 21 - December 31, 1996
----------------- --------------------------
Per-Share Per-Share
Income Shares Amount Income Shares Amount
------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Net income $8,460 $8,208
Less: Preferred stock dividends (461) (136)
Less: Imputed preferred stock dividend (17)
Basic EPS
Income available to common
shareholders $7,982 11,759,712 $.68 $8,072 11,701,587 $.69
Effect of Dilutive Securities
Series A convertible preferred stock $ 110 222,222 $ 136 218,357
Series B convertible preferred stock 1 82,917
Series C convertible preferred stock 504,658
Series D convertible preferred stock 208,767
Restricted stock 11,753
Warrants 72,142
------ ---------- ------ ----------
Diluted EPS
Income available to common
shareholders plus assumed
conversions $8,093 12,862,171 $.63 $8,208 11,919,944 $.69
</TABLE>
The Company's intention upon conversion or redemption (as the case may be) of
Series B, C and D preferred stock (See Note 9 - Shareholders' Equity) 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.
During the fourth quarter of 1997, 11,700 shares of Class AA convertible
preferred stock were outstanding and convertible into 1,950,000 shares of Common
Stock; for EPS purposes, the conversion features of these shares resulted in
Common Stock equivalents totaling 555,616 shares. These shares were not included
in the computation of diluted EPS as the effect of adding back the related
dividends and the weighted average common shares is antidilutive.
Additionally, options to purchase 550,071 shares of Common Stock at various
prices between $4.25 and $6.25 per share were outstanding at December 31, 1997,
and options to purchase 342,800 shares of Common Stock at $9.00 per share
(subsequently repriced at $6.00 per share) were outstanding at December 31,
1996. These options were not included in the computations of diluted EPS because
the options' exercise price was greater than the average market price of the
common shares. Note 13 - Employee Benefit and Incentive Plans contains more
detailed disclosure regarding the Company's outstanding options.
F-15
<PAGE>
NOTE 11 - RELATED PARTY TRANSACTIONS
Due from related parties
Due from related parties consists of the following (in thousands):
December 31,
------------
1997 1996
---- ----
Note receivable from sale of Genesee Custom ....... $3,309
Accounts receivable from sale of Genesee Custom ... $ 490 977
Note receivable from director ..................... 698 487
Loans on acquisition earnouts ..................... 1,878
Other ............................................. 1,350 403
------ ------
$4,416 $5,176
====== ======
In connection with the sale of Genesee Custom to a director of the Company, the
Company had a note receivable bearing interest at 12% from the director for
approximately $3.3 million at December 31, 1996. The note was paid in full in
December 1997. The related accounts receivable are non-interest bearing and are
due on demand.
The Company has a note receivable bearing interest at 13.75% from another
director for approximately $600,000 and $460,000, net of accrued interest, at
December 31, 1997 and 1996, respectively. The note is secured by a portion of
that director's shares in the Company, which have a market value at December 31,
1997 of $802,995.
In conjunction with certain acquisitions, the Company loaned amounts to certain
sellers. These loans bear interest at 6% per annum and are primarily repayable
either through the future earnout due to the borrower or by the borrower
personally. Based on actual performance, these loans are expected to be repaid
through earnout amounts due as a result of future earnings over the next two to
four years.
Due to related parties
Due to related parties at December 31, 1997 totals $783,000. Approximately,
$350,000 represents the accrued Class AA dividend payable to Prometheus. The
balance consists of individually immaterial amounts due to various related
parties.
Other transactions
A limited liability corporation (LLC) owned by two of the Company's directors
and one of the Company's officers has provided consulting services related to
the Company's formation and subsequent acquisitions. Total capitalized costs
associated with this LLC during the year ended December 31, 1997 and the period
May 21 through December 31, 1996 were approximately $540,000 and $219,000,
respectively.
During 1997, the Company sold and leasedback 22 models to related parties. Total
revenue recognized in connection with these sales was approximately $5,880,000;
F-16
<PAGE>
and total gross profit recognized on these sales was $870,000. (See Note 12 -
Leases.)
Landmark purchases landscaping and lot improvement services from a company
affiliated with its president. Expense related to these services was $569,552
for the year ended December 31, 1997 and $198,740 from acquisition through
December 31, 1996. Additionally, Landmark purchases developed land from an
affiliated company. For the year ended December 31, 1997 and the period from
acquisition through December 31, 1996, Landmark acquired land from this
affiliate of approximately $2,771,100 and $1,119,600, respectively.
During 1997, Hutson purchased a majority of its finished lots under written
agreements with an entity whose principal is a significant holder of the
Company's Series B and C preferred stock. During the period since acquisition,
Hutson purchased approximately $14,000,000 of such lots. The Company had
deposits of approximately $4.5 million at December 31, 1997 with this related
party for future acquisitions of finished lots with an aggregate purchase price
of approximately $38.9 million. Hutson intends to fulfill its obligation under
this agreement by acquiring these remaining lots. (See Note 16 - Commitments and
Contingencies.)
During 1997, Hutson contracted cabinetry, interior finish services and other
items from a party affiliated with its president for the majority of 1997.
During the post-acquisition period, Hutson purchased approximately $4,068,000
from this party.
Pursuant to an option agreement executed simultaneously with the acquisition of
Iacobucci, the Company has an option to acquire from certain parties related to
Iacobucci's president approximately 385 fully improved lots over a period of
five years. Fourteen of these lots were acquired prior to December 31, 1997 at a
total cost of approximately $384,000. The total purchase price of the remaining
optioned lots will be a minimum of approximately $12.0 million. (See Note 16 -
Commitments and Contingencies.)
NOTE 12 - LEASES
The Company is obligated under various noncancelable operating leases for office
facilities and equipment expiring at various times through 2006. Rental expense
under these agreements amounted to approximately $3,603,000 and $757,000 for the
year ended December 31, 1997 and the period May 21 through December 31, 1996,
respectively. Included in this amount is rent paid to affiliated companies,
under office, model home, and warehouse leases, totaling $1,030,000 and $290,000
for the respective periods.
As of December 31, 1997, future minimum lease payments under noncancelable
operating lease agreements are as follows (in thousands):
Year Ended
December 31,
1998 .............................. $ 3,414
1999 .............................. 2,530
2000 .............................. 2,243
2001 .............................. 1,566
2002 .............................. 1,151
Thereafter ........................ 2,804
-------
$13,708
=======
NOTE 13 - EMPLOYEE BENEFIT AND INCENTIVE PLANS
Bonus award plan
The Company has a bonus award plan under which directors, officers, employees
and key consultants of the Company may be awarded cash or common stock based
upon the satisfaction of specific performance criteria. The plan provides for
the grant of up to 575,000 shares of common stock. No awards have been made
under the plan as of December 31, 1997.
F-17
<PAGE>
Profit sharing plan
The Company's profit sharing plan is a defined contribution plan qualified under
the Internal Revenue Code. All employees who have completed one year of service
with the Company may participate in the plan on the next January 1. A
participant's interest in Company contributions vests 20% per year in each of
the first five years of employment and is 100% vested thereafter. Contributions
to the plan are entirely within the discretion of the Company's Board of
Directors and are determined annually. No contributions have been made to the
plan as of December 31, 1997.
Stock purchase plan
The Board of Directors of the Company has approved a stock purchase plan under
which 500,000 shares of the Company's common stock are reserved for issuance and
sale to substantially all of the employees of the Company at 85% of market price
of the stock on specified offering dates. The number of shares issued and the
average price per share under this plan during the year ended December 31, 1997
was 3,419 and $3.97. At December 31, 1997, a total of 496,581 shares were
available for issuance. Subsequent to December 31, 1997, 3,904 shares were
issued at a price of approximately $4.27 under this plan.
Stock incentive plan
The Company has a stock incentive plan under which non-employee directors,
officers, key employees and consultants of the Company may be granted options to
purchase up to 1,125,000 shares of the Company's common stock. The stock
incentive plan also allows for the award of stock appreciation rights,
restricted stock and deferred stock. As of December 31, 1997, no stock
appreciation rights, restricted stock or deferred stock had been granted under
this plan. On March 6, 1998, the Company's shareholders approved an increase in
the total shares subject to the plan to 1,550,000.
The stock options granted may be either nonqualified or incentive stock options
although only employees of the Company may be granted incentive stock options.
The option price shall not be less than the fair market value of the common
stock on the date of grant; options will expire five to ten years from the grant
date. Options granted in 1997 and 1996 vested over various periods from
immediately to over three years.
The Company accounts for its stock option plans under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, as
the option price equals the market price at the date of issuance, no
compensation expense is recognized. The Company provides disclosure in
accordance with SFAS No. 123, Accounting for Stock-Based Compensation.
The fair value of each stock option grant is estimated on the date of the grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for stock options granted in 1997: expected volatility of 35%,
risk-free interest rate of 6.0%, and an expected life of 7.68 years. The
following weighted average assumptions were used for those options granted in
1996: expected volatility of 30%, risk-free interest rate of 6.44%, and an
expected life of 7.93 years. Expected dividends were estimated at one cent per
share in accordance with the Company's dividend policy. The weighted-average
fair value of the stock options granted in 1997 and 1996 was approximately $2.78
per share and $2.62 per share, respectively.
Under the model, the total value of stock options granted in 1997 and 1996 was
approximately $769,000 (including additional value for the repricing of 1996
grants) and $989,000, respectively. Had the Company determined the compensation
cost for these plans in accordance with SFAS No. 123, the Company's resulting
unaudited pro forma net income would have been approximately $7,915,000 and the
resulting unaudited pro forma earnings per share would have been $.63 and,
assuming dilution, $.59 for the year ended December 31, 1997. The resulting
unaudited pro forma net income and earnings per share for the period May 21,
1996 through December 31, 1996 would have been $8,039,000 for net income, $.68
for basic earnings per share and $.67 for diluted earnings per share.
F-18
<PAGE>
Option activity is summarized as follows:
<TABLE>
<CAPTION>
Weighted
Shares average
available Number option
for options of shares price
----------- --------- -----
<S> <C> <C> <C>
Balance available at May 21, 1996 ............. 575,000
Grants* ........................................... (377,800) 377,800 $6.00
Exercises
Cancellations* .................................... 35,000 (35,000) 6.00
-------- ------- -----
December 31, 1996 ............................. 232,200 342,800 6.00
Increase in shares available under the plan ....... 550,000
Grants ............................................ (230,895) 230,895 5.52
Exercises
Cancellations ..................................... 23,624 (23,624) 5.89
-------- ------- -----
December 31, 1997 ............................. 574,929 550,071 $5.75
======== ======= =====
</TABLE>
- ----------
* In May 1997 the Board re-priced the 1996 grants from the Offering price of
$9.00 to $6.00, the then-current market price of the Common Stock.
The following tables summarize information about options outstanding at December
31, 1997:
<TABLE>
<CAPTION>
Outstanding Options Exercisable Options
------------------- -------------------
Number Remaining Weighted
Range of Outstanding at Contractual Life Average
Exercise Prices December 31, 1997 (in years) Exercisable Exercise Price
--------------- ----------------- ---------- ----------- --------------
<S> <C> <C> <C> <C>
$4.25 - $5.00 24,000 9.9 6,000 $4.2500
$5.00 - $5.50 112,671 5.2 108,921 $5.3939
$5.50 - $6.00 373,500 8.7 178,750 $5.9956
$6.00 - $6.25 39,900 9.2 5,000 $6.2500
------- --- ------- -------
550,071 8.1 298,671 $5.7454
======= === ======= =======
</TABLE>
NOTE 14 - INCOME TAXES
The provision for income taxes consists of the following (in thousands):
December 31,
1997 1996
---- ----
Current:
Federal ................. $4,862 $4,840
State ................... 935 847
------ ------
5,797 5,687
Deferred:
Federal ................. (325) (619)
State ................... (9) (55)
------ ------
(334) (674)
Total ...................... $5,463 $5,013
====== ======
F-19
<PAGE>
The provision for income taxes differs from the amount computed by applying the
Federal income tax statutory rate as follows (in thousands):
December 31,
1997 1996
---- ----
Income tax computed at statutory rate ........ $4,768 $4,495
State income taxes, net of Federal benefit ... 609 523
Other, net ................................... 86 (5)
------ ------
Total ............................... $5,463 $5,013
====== ======
Deferred tax assets (liabilities) arise due to the recognition of income and
expense items for tax purposes in periods which differ from those used for
financial statement purposes. At December 31, 1997 and 1996, the net deferred
tax asset was comprised of the following:
1997 1996
---- ----
Warranty and general reserves ................ $ 660 $ 674
Amortization ................................. 136
Capitalized inventory ........................ 128
------ -----
Total deferred tax assets ........... 1,020 674
Prepaid expenses ............................. (12)
------ -----
Total deferred tax liabilities ...... (12) 0
Net deferred tax asset ....................... $1,008 $ 674
====== =====
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The financial instruments of the Company consist of accounts receivable, loans
held for sale, due to and from related parties, accounts payable and
construction liabilities and notes and mortgages payable. Mortgage loans held
for sale to nonaffiliated investors of $11.1 million at December 31, 1997 are
recorded in the aggregate at the lower of cost or market. The estimated fair
value of $11.2 million at December 31, 1997 is based upon contractually
established prices at which mortgage loans will be sold or, if loans are not
committed for sale, at current market prices. The fair value of the Company's
Senior Notes at December 31, 1997 and 1996, which are recorded at their carrying
value of $100 million, was approximately $121 million and $115 million,
respectively, based on quoted market prices. The fair value of the remainder of
the financial instruments is equal to the recorded amounts due to the short-term
nature of the instruments.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
In the ordinary course of business, the Company enters into option agreements to
purchase land. As of December 31, 1997, the Company had approximately $8.7
million in deposits outstanding to acquire land with an aggregate purchase price
of approximately $186.0 million.
The Company is involved in various routine legal proceedings incidental to the
conduct of its normal business operations. The Company's management believes
that none of these legal proceedings will have a material adverse impact on the
financial condition or results of operations of the Company.
F-20
<PAGE>
NOTE 17 - SUBSEQUENT EVENTS
Issuance of Preferred Stock
On March 6, 1998, the shareholders of the Company approved the transactions
described in the Amended and Restated Stock Purchase Agreement dated as of
September 30, 1997 between the Company and Prometheus Homebuilders LLC
(Prometheus), an affiliate of Lazard Freres Real Estate Investors LLC (Lazard),
and the Company simultaneously issued an additional 28,300 shares of Class AA
preferred stock ($28,300,000 initial liquidation value). The Company will issue
$35,000,000 initial liquidation value (35,000 shares) of Class AB preferred
stock, an additional 625,000 Warrants (See Note 9 - Shareholders' Equity), and
Contingent Warrants which potentially provide for the issuance of between
380,952 and 5,714,286 shares of Common Stock. The Class AB preferred stock,
additional Warrants, and Contingent Warrants are required to be issued by
December 31, 1998. The proceeds are intended to be used primarily for the
selective acquisition of established homebuilding companies.
Subsequent to the March 6, 1998 closing, the holders of Class AA preferred stock
and Class AB preferred stock are entitled elect additional directors sufficient
to constitute a majority of the Board and all committees of the Board in the
event that on any date that is 60 days after the end of a fiscal quarter both
(a) the average trading price of the Common Stock is less than $4.375 per share
(as adjusted) and (b) the percentage change in the Company's earnings before
interest expense, income taxes and extraordinary or non-recurring items (EBIT)
per share for the most recent two fiscal quarters as measured against the same
two fiscal quarters of the prior year is less than the percentage change in the
EBIT per share for a specified comparable group of companies for the two most
recent fiscal quarters as measured against the same two fiscal quarters of the
prior year. This right will continue until such time as neither of the
conditions exists for two consecutive fiscal quarters.
The Class AB preferred stock carries a 12% dividend, cumulative and compounded
quarterly, on the liquidation value of $1,000 per share and is convertible, in
whole or in part, at the option of the holder, into Common Stock at the
Conversion Price, on or after September 30, 2001, the fourth anniversary of the
date of the First Closing. The Company, at its option, will have the right at
any time on or after September 30, 2002, but before the redemption date, to
convert all, but not less than all, of the Class AB preferred stock into Common
Stock at the Conversion Price. The Conversion Price is defined as 95% of the
average closing price for the 30 consecutive trading days commencing 45 trading
days before the conversion date. In addition, the Company will have the right,
on or after September 30, 2002, to redeem in whole the Class AB preferred stock
at a price per share equal to the liquidation value plus an amount equal to
accumulated and unpaid dividends. Whether conversion is at the election of the
holders of Class AB preferred stock or the Company, the conversion price will be
equal to 95% of the average of the closing prices of the Common Stock for the 30
trading days commencing 45 trading days before the applicable conversion date.
The Class AB preferred stock will be apportioned between Class ABI preferred
stock and Class ABII preferred stock so that as a result of such issuances,
along with the Class AA preferred stock, Prometheus has no more than 45% of the
total voting power of the Company on the date of issuance of such Class AB
preferred stock with respect to the election of directors to the Board generally
(other than the three directors elected exclusively by holders of Class AA and
Class AB preferred stock). Holders of Class AA and Class ABI preferred stock
will vote on an as-converted basis with the holders of the Common Stock as a
single class on all matters on which the Common Stock is entitled to vote,
including the election of directors. Holders of Class ABII preferred stock will
vote on an as-converted basis with the holders of Common Stock as a single class
on all matters on which the Common Stock is entitled to vote, except for the
election of directors generally. Holders of the Class ABII preferred stock will
not vote on the election of directors generally unless the average of the
closing prices of the Common Stock for the 30 trading days commencing 45 trading
days before the applicable date is less than $3.00 per share and such holders
provide notice to the Company of their intention to vote on the election of
directors generally.
The Contingent Warrants would be exercisable at an exercise price of $.01 per
share of Common Stock if, between September 30, 2001 and September 30, 2003, the
Adjustment Price (the average closing price of the Common Stock for the 60 days
preceding an election by the Holder of the Class AA preferred stock to adjust
the optional conversion price of such stock) is between $5.00 and $10.00 per
share. The number of shares of Common Stock into which the Contingent Warrants
will convert upon exercise is based on the following chart:
Adjustment Price(s) Conversion Shares
------------------- -----------------
$8.01 - 10.00 380,952
6.01 - 8.00 2,380,952
5.00 - 6.00 5,714,286
F-21
<PAGE>
If during the exercise period the Adjustment Price is less than $5.00 per share
and the holder makes an election to adjust the optional conversion price of the
Class AA preferred stock, then the Contingent Warrants will terminate. The
Contingent Warrants will also terminate upon (a) voluntary conversion by the
holder of the Class AA preferred stock before September 30, 2001 or (b)
mandatory conversion by the Company of the Class AA preferred stock.
The Contingent Warrants expire on March 30, 2004.
Subsequent Acquisition
The Company acquired the stock of Whittaker Homes, a St. Louis, Missouri
homebuilder on March 6, 1998. The acquisition cost including cash paid and
assumption of debt was approximately $62.1 million. The cash portion of the
transaction was funded by the sales of preferred stock to Prometheus as
described above.
F-22
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Combined Predecessor Companies
In our opinion, based upon our audits and the reports of other
auditors, the accompanying combined balance sheets and the related combined
statements of operations, of shareholders equity, and of cash flows present
fairly, in all material respects, the financial position of Combined Predecessor
Companies (the Company) at May 20, 1996 and at December 31, 1995, and the
results of their operations and their cash flows for the period January 1, 1996
through May 20, 1996 and for the year ended December 31, 1995 in conformity with
generally accepted accounting principles. These financial statements are the
responsibility of company's management; our responsibility is to express an
opinion on these financial statements based on our audits. We did not audit the
combined financial statements of Solaris Development Corporation as of and for
the year ended December 31, 1995 which statements reflect total assets of $16.4
million and total revenues of $42.6 million. Those statements were audited by
other auditors whose report thereon has been furnished to us, and our opinion
expressed herein on the Combined Predecessor Companies financial statements,
insofar as it relates to the amounts included for the Solaris Development
Corporation is based solely on the report of the other auditor. We conducted our
audits of these statements in accordance with generally accepted auditing
standards which require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We belive that our
audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Minneapolis, Minnesota
February 20, 1997
F-23
<PAGE>
COMBINED PREDECESSOR COMPANIES
BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
December 31, 1995 May 20, 1996
----------------- ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents ................................................. $ 2,710 $ 3,028
Related party and other receivables ....................................... 2,106 2,797
Real estate inventories ................................................... 109,016 133,820
Property and equipment, net ............................................... 2,099 1,713
Deferred transaction costs ................................................ 2,121 4,282
Prepaid expenses and other assets ......................................... 3,614 4,298
-------- --------
Total assets .................................................... $121,666 $149,938
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction
liabilities ............................................................ $ 10,726 $ 14,645
Notes and mortgages payable ............................................... 87,604 112,004
Due to related parties .................................................... 2,495 3,062
Accrued expenses .......................................................... 4,588 3,585
Customer deposits ......................................................... 5,122 6,332
Commitments and contingencies (Note 11) ...................................
-------- --------
Total liabilities ............................................... 110,535 139,628
-------- --------
Minority interests ........................................................ 1,295 1,383
-------- --------
Shareholders' equity:
Preferred Stock ......................................................
Common Stock ......................................................... 599 600
Additional paid-in capital ........................................... 2,606 3,070
Retained earnings .................................................... 6,631 5,257
-------- --------
Total shareholders' equity ...................................... 9,836 8,927
-------- --------
Total liabilities and shareholders' equity ...................... $121,666 $149,938
======== ========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-24
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENTS OF OPERATIONS
(In thousands)
For the Period
January 1, 1996
Year Ended through
December 31, 1995 May 20, 1996
----------------- ------------
Revenue:
Residential sales ................... $190,312 $ 64,984
Lot sales ........................... 8,098 1,036
Other revenue ....................... 619 99
-------- --------
Total revenue .................. 199,029 66,119
Cost of sales ............................ 167,434 56,425
-------- --------
Gross profit ............................. 31,595 9,694
Operating expenses:
Selling expenses .................... 13,152 4,689
General and administrative
expenses ......................... 11,693 3,892
-------- --------
Net operating income ................ 6,750 1,113
Other expense (income):
Interest ............................ 120 63
Minority interests .................. 745 89
Other, net .......................... (191) (313)
-------- --------
Income before provision for income
taxes ................................. 6,076 1,274
Provision for income taxes ............... 21
-------- --------
Net income ............................... $ 6,055 $ 1,274
======== ========
Unaudited pro forma net income (Note 13).. $ 764
========
The accompanying notes are an integral part of these
financial statements.
F-25
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
Additional
Common Paid-in Retained
Stock Capital Earnings Total
------- ------- -------- -------
Balance at December 31, 1994 ....... 575 1,861 3,582 6,018
Capital contributions ......... 24 767 357 1,148
Distributions to shareholders . -- (22) (3,363) (3,385)
Net income .................... -- -- 6,055 6,055
------- ------- ------- -------
Balance at December 31, 1995 ....... 599 2,606 6,631 9,836
Capital contributions ......... 1 464 82 547
Distributions to shareholders . (2,730) (2,730)
Net income .................... -- -- 1,274 1,274
------- ------- ------- -------
Balance at May 20, 1996 ............ $ 600 $ 3,070 $ 5,257 $ 8,927
======= ======= ======= =======
The accompanying notes are an integral part of these
financial statements.
F-26
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Year For the Period
Ended January 1,
December 31, 1996 through
1995 May 20, 1996
--------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income ............................................................ $ 6,055 $ 1,274
Adjustments to reconcile net income to net cash
(used in) provided by operating activities
Equity in income from investment partnership .....................
Depreciation and amortization .................................... 621 277
Minority interest ................................................ 745 89
Changes in operating assets and liabilities:
Real estate inventories ....................................... (8,155) (24,803)
Related party and other receivables ........................... (1,118) (690)
Prepaid expenses and other assets ............................. (1,299) (256)
Accounts payable and accrued construction
liabilities ................................................. (35) 2,754
Accrued expenses .............................................. 919 (578)
Customer deposits ............................................. 513 981
--------- --------
Net cash used in operating activities ....................... (1,754) (20,952)
--------- --------
Cash flows from investing activities:
Purchase of property and equipment .................................... (962) (330)
Proceeds from sale of property and equipment .......................... 26 8
--------- --------
Net cash used in investing activities ....................... (936) (322)
--------- --------
Cash flows from financing activities:
Borrowings under notes and mortgages payable .......................... 115,740 52,839
Repayments of notes and mortgages payable ............................. (111,298) (33,689)
Borrowings on line of credit ....................................... 7,477
Repayments on line of credit ....................................... (2,225)
Repayment of bonds ................................................. (236)
Related party borrowings .............................................. 2,248 1,076
Repayment of related party borrowings ................................. (2,073) (510)
Distributions to minority interest .................................... (791)
Transaction costs ..................................................... (1,114) (957)
Capital contributions ................................................. 1,123 547
Capital distributions ................................................. (3,301) (2,730)
--------- --------
Net cash provided by financing activities ................... 534 21,592
--------- --------
Net increase (decrease) in cash and cash equivalents ....................... (2,156) 318
Cash and cash equivalents, beginning of period ............................. 4,866 2,710
--------- --------
Cash and cash equivalents, end of period ................................... $ 2,710 $ 3,028
========= ========
</TABLE>
The accompanying notes are an integral part of these
financial statements.
F-27
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS
NOTE 1 - BUSINESS ORGANIZATION
The Fortress Group, Inc. ("Fortress" or the "Company") was founded in 1995 to
create a national homebuilding company to be engaged in the acquisition and
development of land or improved lots and the construction of residential
for-sale housing.
Fortress has entered into definitive agreements to acquire, simultaneously with
the closing of an initial public offering (the Offering), four homebuilding
companies, Buffington Homes, Inc. (Buffington), Christopher Homes and Affiliates
(Christopher), The Genesee Company (Genesee), and Solaris Development
Corporation (Solaris), and one mortgage company, Sunstar Mortgage Limited
Liability Company (Sunstar) in exchange for common and preferred stock and cash.
The four homebuilders and the mortgage company to be acquired by Fortress
combined with the Fortress holding company are referred to herein as the
"Predecessor Companies."
The aggregate consideration to be paid by Fortress in these transactions is as
follows:
(a) An aggregate of $5,995,000 in cash;
(b) An aggregate of 6,233,875 shares of common stock of the Company;
and
(c) An aggregate of 20,000 shares of Series A 11% Cumulative
Convertible Preferred Stock of the Company, see Note 12.
The allocation of the above to each of the Predecessor Companies is as follows:
Common Preferred
Predecessor Company Shares Shares
------------------- Cash Allocation Allocation
---------- ---------- ----------
Buffington .................. $1,129,000 1,897,897 --
Christopher ................. 179,000 1,691,227 --
Genesee ..................... 811,000 1,729,495 20,000
Solaris/Sunstar ............. 3,876,000 915,256 --
---------- ---------- ----------
$5,995,000 6,233,875 20,000
========== ========== ==========
The consideration to be paid for the Predecessor Companies was determined
through arm's length negotiations among the Company and representatives of the
Predecessor Companies.
Fortress completed the Offering and the acquisitions on May 20, 1996.
NOTE 2 - BASIS OF PRESENTATION
Simultaneously with the closing of the Offering, Fortress will acquire by merger
each of the five operating businesses, Buffington, Christopher, Genesee, Solaris
and Sunstar (the Mergers). The accompanying combined financial statements and
related notes to the combined financial statements are presented on a combined
basis without giving effect to the Mergers or the Offering. The assets and
liabilities of the Predecessor Companies are reflected at their historical
amounts and include accounts of joint ventures where the Company controls the
management activities and holds a significant economic interest. All
inter-company transactions have been eliminated.
F-28
<PAGE>
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Estimates by management
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue recognition
Residential and lot sales are recognized when all conditions precedent to
closing have been fulfilled and title has passed to the buyer. The Company
generally enters into contracts of sale for its houses in advance of their
construction. The Company's standard residential sales contract generally
requires the customer to make an earnest money deposit which is recognized as a
liability until the sale closes.
Real estate inventories and cost of sales
All real estate inventories which are held for sale are carried at cost which is
less than fair value as measured in accordance with Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." Fair value is
measured based on the application of discounting expected future cash flows of
each of the Company's real estate developments. Costs incurred which are
included in inventory consist of land, land development, direct and certain
indirect construction costs, interest and real estate taxes, and direct model
construction costs and related improvements.
At the time of revenue recognition, cost of sales is charged with the actual
construction costs incurred and any estimate to complete (specific
identification), plus an allocation of the total estimated cost of land and land
development, interest, real estate taxes and any other capitalizable common
costs based on the relative sales value method of accounting.
The Company generally provides a one year limited warranty of workmanship and
materials with each of its homes. Accordingly, a warranty reserve, based on the
Company's historical experience, is provided as residential sales are closed;
this reserve is reduced by the cost of subsequent work performed.
Interest capitalization
Interest and related debt issuance costs are capitalized to qualifying real
estate inventories as incurred, in accordance with SFAS No. 34, "Capitalization
of Interest Cost," and charged to cost of sales as revenue from residential
sales is recognized. The interest and related debt issuance costs capitalized
are determined by applying a weighted average capitalization rate to the
accumulated qualified real estate expenditures. The capitalization rate is based
on the Company's outstanding borrowings associated with the acquisition,
development and construction of the qualified real estate inventory. The amount
of financing costs capitalized does not exceed those costs incurred for any year
presented in the accompanying combined financial statements.
Deferred transaction costs
Transaction costs, which consist of costs incurred in conjunction with the
Mergers and Offering, have been deferred and will be recorded as a reduction of
equity when the Offering is completed.
F-29
<PAGE>
Property and equipment
Property and equipment are carried at cost less accumulated depreciation and are
depreciated using either straight line or accelerated depreciation methods over
the estimated useful lives of the assets which range in years from 5 to 10.
Costs incurred for common area model improvements and certain furnishings are
amortized on a per unit basis as home sales in the related development are
closed. Significant additions and improvements are capitalized, while
expenditures for repairs and maintenance are charged to operations, as incurred.
Income taxes
Each of the Predecessor Companies was either a subchapter S corporation or
partnership for income tax purposes for all periods presented and, accordingly,
any income tax liabilities are the responsibility of the Predecessor Companies'
respective shareholders or partners. The combined financial statements of
Christopher are comprised of one subchapter S corporation, one limited
partnership and two C corporations. Each of the Predecessor Companies subchapter
S corporation or partnership status will terminate on consummation of the
Merger, as disclosed in Notes 1 and 2. See Note 13 for information regarding the
pro forma income tax disclosure.
For 1995 and 1996, no income tax provision was recognized because the taxable
income generated by the combined Christopher entities was primarily incurred by
the S corporation. The tax provision for the year ended December 31, 1995
represents the greater of income or equity component of Texas state franchise
taxes.
At December 31, 1995 and May 20, 1996, no deferred taxes have been
provided for the net operating losses and other temporary differences between
the financial reporting basis and the income tax basis because the realization
of the net deferred tax asset is unlikely. Net operating loss carry forwards
available in 1995 aggregate approximately $325,000. The fiscal tax year ends for
Christopher's C corporations are April 30 and June 30, respectively.
Historical net income per share
Historical net income per share has not been presented as it is not deemed to be
a meaningful presentation as a result of the Mergers.
Cash and cash equivalents
For purposes of reporting cash flows, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents. Supplemental disclosures of cash flow information are as follows
(in thousands):
Period
January 1, 1996
Year Ended through
December 31, 1995 May 20, 1996
----------------- ------------
Cash paid for:
Interest ..................... $8,612 $2,826
====== ======
Income taxes ................. $ 83 $ 6
====== ======
F-30
<PAGE>
Supplemental disclosure of non-cash activities are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
Period
January 1, 1996
Year Ended through
December 31, 1995 May 20, 1996
----------------- ------------
<S> <C> <C>
Net assumption and assignment of Special Improvement District
Bonds ....................................................................... $ 623 $ (83)
Distribution of property to owners of Predecessor Companies .................... 58
Redemption of common stock for notes payable ...................................
Other .......................................................................... 35
------ ------
Total ................................................................ $ 716 $ (83)
====== ======
</TABLE>
NOTE 4 - REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
December 31, 1995 May 20, 1996
----------------- ------------
Work-in-progress:
Sold homes ...................... $ 34,460 $ 53,355
Speculative homes ............... 24,208 34,423
-------- --------
58,668 87,778
-------- --------
Land:
Finished lots ................... 28,219 34,029
Land under development .......... 12,819 984
Land and other costs ............ 456 1,887
-------- --------
41,494 36,900
-------- --------
Models ............................... 8,854 9,142
-------- --------
Total ...................... $109,016 $133,820
======== ========
Models are constructed to assist in the marketing effort of a development and
speculative construction represents non-model homes either under construction or
substantially completed which are not subject to a sales contract.
F-31
<PAGE>
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
December 31, 1995 May 20, 1996
----------------- ------------
Model home upgrades and furnishings ..... $ 1,997 $ 1,435
Equipment and furniture ................. 1,197 1,363
Vehicles ................................ 266 250
Leasehold improvements .................. 44 36
Other ................................... 108
------- -------
3,612 3,084
Less: Accumulated depreciation
and amortization (1,513) (1,371)
------- -------
$ 2,099 $ 1,713
======= =======
NOTE 6 - NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
December 31, 1995 May 20, 1996
----------------- ------------
<S> <C> <C>
Project specific land, land development and construction loans $ 66,629 $ 85,775
Demands for deed on sales-leasebacks ......................... 230
Other loans .................................................. 1,149 3,254
Subordinated investor notes and equity participation loans ... 19,596 22,975
-------- --------
$ 87,604 $112,004
======== ========
</TABLE>
The loan agreements for project specific land, land development and construction
loans are collateralized by a lien on the applicable residential development
project or a specific unit under construction. Repayment of these loans are
normally payable upon the closing of the encumbered unit. The method to
determine the repayment amount varies depending on the specific loan agreement
but is generally based on a specified per unit amount or as a percentage of the
sale price of the sold unit. In addition, the loan agreements typically include
a limitation on the total amount that can be borrowed or the amount that can be
outstanding at any time. These loans bear interest at annual variable rates
ranging from .5% to 2.0% over prime (8.75% to 10.25% at May 20, 1996) or a fixed
rate of 9.0%. The shareholders of Genesee, Christopher and Sunstar have
personally guaranteed the repayment of a significant amount of the outstanding
project specific land, land development and construction loans.
Demands for deed on sales-leaseback represent financing arrangements on certain
finished model homes which are leased by Christopher for one to two years for
marketing purposes. The demand for deed yields approximately 12% annually with a
3% commission paid upon the resale of the model home.
Other loans consist of non-recourse notes payable secured by assets of the
Company not related to its normal business operations of homebuilding. These
loans bear interest at an annual rate of 2.0% over prime (10.25% at May 20,
1996) or a fixed rate of 6.0%. Repayment of these loans varies based on the
terms of the respective loan agreements.
Subordinated investor notes and equity participation loans generally consist of
loans from third party investors which were used to facilitate the initial
purchase of residential real estate to be held for development for certain
Genesee and Christopher projects.
F-32
<PAGE>
The investor loans outstanding for Christopher are secured by a deed of trust,
subordinated to the land acquisition and development loan. These notes are
payable in monthly distributions equal to a 15% annualized return and a 10% fee
due at the closing of each lot collateralized. The sole shareholder of
Christopher has personally guaranteed the repayment of these obligations which
at December 31, 1995 and at May 20, 1996 was approximately $9.2 million and
$10.6 million, respectively.
Genesee's subordinated seller notes are either unsecured or collateralized by a
lien on its real estate inventories and are guaranteed by Genesee's sole
stockholder. Genesee's outstanding obligation for these loans at December 31,
1995 and May 20, 1996 was approximately $5.9 million and $7.9 million,
respectively. Generally, these loans bear interest at a fixed annual rate of
12%, paid monthly. The unsecured notes entitle the holder to receive an
additional 6% interest per annum payable at maturity of the note. These notes
generally have maturities of six months, at which time the principal and all
unpaid interest are due.
Genesee has entered into a series of equity participation agreements and related
notes payable with one private investor. Under these agreements, Genesee has
received advances from this equity participant totaling $4.6 million and $4.5
million as of December 31, 1995 and May 20, 1996, respectively, in the form of
equity participation notes payable. The proceeds from these notes are used to
acquire and develop various predetermined real estate properties and to
construct homes in certain developments.
In general, no interest is accrued on the principal balance of these notes, but
rather, the note holder is entitled to a portion of the net profits of the
development which collateralizes the note. However, at May 20, 1996, Genesee had
two equity participation notes payable which require that the private investor
receive the greater of some minimal rate of return or a portion of the net
profits of the development. At May 20, 1996, Genesee has accrued approximately
$289,000 in interest costs, all of which has been capitalized, related to these
two notes since the developments which collateralize these notes are in the
start-up stages and net profits earned as of May 20, 1996 have been less than
the minimum rate of return guaranteed the investor. With respect to the other
equity participation agreements, in the event of default, interest would be
accrued at the rate of the greater of 3% over prime or 18%, retroactive to the
origination date of the note. As of May 20, 1996, there have been no events of a
default. Genesee periodically reviews the expected profits and cash flows of
developments with equity participation notes payable and would accrue interest
on the notes if it determined that an event of default was probable. In general,
equity participation notes payable have maturities within two years of
origination.
Based upon the equity participation agreements, net profits of the individual
developments are distributed, at Genesee's discretion, as follows: first,
distributions are to repay the principal balance and interest, if applicable, of
the equity participation note payable related to that development; and second,
once the principal balance of the equity participation note payable for a
development is repaid, net profits are distributed between the equity
participant and Genesee.
Maturities of notes and mortgages payable in future periods are as follows (in
thousands):
<TABLE>
<CAPTION>
Year Ended
December 31,
- ------------
<S> <C>
1996 ................................................ $ 87,561
1997 ................................................ 20,808
1998 ................................................ 3,578
1999 ................................................ 56
2000 ................................................ 1
--------
$112,004
========
</TABLE>
The timing of repayments on these notes and mortgages payable may differ from
the above schedule due to the actual closing pace of the units sold.
F-33
<PAGE>
Interest and related debt issuance costs incurred and capitalized aggregated
approximately $16.1 million and $5.2 million for the year ended December 31,
1995 and the period January 1, 1996 through to May 20, 1996, respectively.
NOTE 7 - ACCRUED EXPENSES
Included in accrued expenses are Special Improvement District assessments which
consist of special assessments issued by the city of Las Vegas to fund the
acquisition and construction of certain public improvements specially benefiting
property located in the City's Special Improvement District No. 404, the
Summerlin area. The city-issued bonds are secured by the unpaid assessments on
property within the district and are payable by the property owners. The
assessments are due on April 1 and October 1 of each year until October 1, 2009.
As property is sold, the balance of the assessment is assigned to, and the
liability assumed by, the buyer of the property. For the years ended December
31, 1994 and 1995 and the period from January 1, 1996 through May 20, 1996,
management believes that maturities of these obligations prior to buyer
assumptions will not be material to these combined financial statements of the
Predecessor Companies. The outstanding obligation for these assessments at
December 31, 1995 and May 20, 1996 is $1.5 million and $1.3 million,
respectively.
NOTE 8 - MINORITY INTERESTS
The minority interests at December 31, 1995 and May 20, 1996 include
Solaris' Village Lakes and Park Village ventures in which these partners hold a
50% non-controlling ownership interest and 34% ownership interest, respectively.
The minority interest expense included in the accompanying combined financial
statements includes the minority partners' interest in the profits generated by
the real estate ventures based on the respective ownership interest.
NOTE 9 - RELATED PARTY TRANSACTIONS
Immediate family members of certain shareholders of Buffington have an interest
in a title insurance company which provides title services to Buffington's home
buyers. It has been the business practice to normally pay closing costs and
title insurance premiums to this title company on behalf of its customers as an
inducement to purchase the Buffington product. Title insurance premiums are
state regulated and the fees charged to Buffington are consistent to those fees
paid to unrelated customers. Fees in the approximate amount of $674,000 and
$315,000 were paid by Buffington for the year ended December 31, 1995, and the
period from January 1, 1996 through May 20, 1996, respectively.
The owners of Buffington held an ownership interest in a residential mortgage
origination company. Buffington paid origination fees to this affiliated company
on behalf of its customers in the amount of $584,000 for the year ended December
31, 1995. No origination fees were paid by Buffington to this related party in
the period from January 1, 1996 through May 20, 1996.
Genesee has entered into an agreement with a company (from which the sole
shareholder receives compensation for management services) to perform certain
marketing and management activities on behalf of Genesee. For the year ended
December 31, 1995, approximately $98,000 has been recorded under this agreement,
respectively. This agreement was terminated as of January 1, 1996.
Genesee is involved in a limited partnership in which its sole shareholder
receives compensation for management services. The purpose of this partnership
is to acquire and develop land for sale. Genesee receives management fees from
the partners of this partnership for services performed which was approximately
$6,000 for the year ended December 31, 1995. No management fees were received in
the period from January 1, 1996 through May 20, 1996. In addition, Genesee is
entitled to a marketing fee, but it has allowed a company, from which the sole
shareholder receives management compensation, to receive this fee directly from
the partnership with no financial impact on these combined statements.
F-34
<PAGE>
Christopher provides certain accounting services for related parties and in
return receives a management fee, which was approximately $39,000 for the year
ended December 31, 1995. No fees were received in the period January 1, 1996
through May 20, 1996. Sales commissions paid by related parties to Christopher
amounted to approximately $62,000 for the year ended December 31, 1995. No sales
commissions were paid to related parties in the period January 1, 1996 through
May 20, 1996. In addition, Christopher paid rent during the year ended December
31, 1995 and the period from January 1, 1996 through May 20, 1996 of
approximately $34,000 and $14,000, respectively, for office and warehouse space
under a month-to-month lease to a related party.
Solaris entered into an office lease with an affiliated company on November 1,
1995. Rent expense related to this lease was approximately $32,500 for the
period January 1, 1996 through to May 20, 1996.
NOTE 10 - EMPLOYEE BENEFIT PLANS
Each of the Predecessor Companies excluding Christopher maintains a contributory
profit sharing plan established pursuant to the provisions of Section 401(k) of
the Internal Revenue Code which provides retirement benefits for their eligible
employees. The Predecessor Companies may make annual discretionary or matching
contributions to the respective plans. Contributions were approximately
$156,000 and $38,000 for the year ended December 31, 1995 and the period from
January 1, 1996 through May 20, 1996, respectively.
NOTE 11 - COMMITMENTS AND CONTINGENCIES
Leases
The Predecessor Companies lease various office space, models and equipment under
noncancellable operating lease agreements which expire at various dates and on
month-to-month lease arrangements. Rent expense under such leases aggregated
approximately $825,000 and $442,000 during the year ended December 31, 1995 and
the period January 1, 1996 through May 20, 1996, respectively. Future minimum
rental payments under fixed expiration term operating leases are as follows (in
thousands):
F-35
<PAGE>
<TABLE>
<CAPTION>
Year Ended
December 31,
- ------------
<S> <C>
1996 ................................................... $ 284
1997 ................................................... 220
1998 ................................................... 137
1999 ................................................... 124
2000 ................................................... 98
---------
$ 863
=========
</TABLE>
Genesee leases certain office equipment classified as capital leases. These
leases have a cost of $206,000 and $207,000 and accumulated depreciation of
approximately $81,000 and $97,000 as of December 31, 1995 and the period January
1, 1996 through May 20, 1996, respectively. The scheduled future minimum lease
payments are $84,000.
Other commitments
On January 1, 1994 Solaris entered into a consulting contract with a former
shareholder which requires Solaris to pay a fee for services rendered in the
amount of $5,000 per month over a sixty month period.
The Company is involved in various routine legal proceedings incidental to the
conduct of its normal business operations. In the opinion of the Predecessor
Companies' management, these matters are not anticipated to have a material
adverse effect on the financial position or results of operations or cash flows
of the Company.
Christopher has signed a letter of intent to purchase a parcel of land for
approximately $7.7 million in a master planned development in Las Vegas, Nevada.
NOTE 12 - SHAREHOLDERS' EQUITY
The Company has authorized 1 million shares (par value of $.01) of which 20,000
shares have been authorized as Series A 11% Cumulative Convertible Non-Voting
Preferred Stock of which no shares were issued and outstanding as of May 20,
1996. The preferred stock is restricted from converting into common stock of
Fortress for the first two years that such shares are issued and outstanding.
The preferred stock has a liquidation preference of $100 per share ($2 million
in the aggregate) and other terms, as defined in the Certificate of Designation.
The conversion ratio of such shares is the lesser of the price of the common
stock Offering or 75% of the lowest closing price during the thirty days
immediately preceding the date of conversion.
In 1995, Genesee adopted an incentive stock option plan for certain employees.
The plan allows the grant of options to purchase up to 10,000 shares of
Genesee's common stock. The exercise price is equal to the estimated fair value
of the common stock at the date of grant. The options generally vest nine years
after the date of grant, but the vesting period is accelerated upon a change of
control or the occurrence of certain other events as specified in the plan
agreement. The options are exercisable over periods of up to 10 years. During
1995, options to purchase 10,000 shares of Genesee's common stock were granted
at an exercise price of $50.15 per share. All outstanding options were exercised
on May 20, 1996.
F-36
<PAGE>
NOTE 13 - UNAUDITED PRO FORMA NET INCOME
The following unaudited pro forma income tax information is presented in
accordance with SFAS No. 109,"Accounting for Income Taxes", as if the Company
had been a C Corporation subject to Federal and state income taxes for period
from January 1, 1996 through May 20, 1996.
For the
Period January 1, 1996
through May 20, 1996
--------------------
Net income before pro forma adjustments,
per statement of operations $1,274
Pro forma adjustment:
Provision for income taxes at estimated
effective rate of 40% 510
------
Pro forma net income $ 764
======
F-37
Exhibit 10.14
EMPLOYMENT AGREEMENT
EMPLOYMENT AGREEMENT (the "Agreement"), dated as of July 21, 1997, by
and between The Fortress Group, Inc., a Delaware corporation and George Yeonas
("Employee").
PRELIMINARY RECITALS
A. The Company is engaged in the construction and sale of detached and
unattached single family residential homes (the "Business");
B. Employee has extensive knowledge and a unique understanding of the
Business
C. The Company desires to employ Employee as its Chief Operating
Officer, and Employee desires to be employed by the Company as such, all under
the terms and conditions set forth herein.
NOW, THEREFORE, in consideration of the premises, the mutual covenants
of the parties hereinafter set forth and other good and valuable consideration,
the receipt and sufficiency of which are hereby acknowledged, the parties hereto
hereby agree as follows:
1. Employment.
1.1 Engagement of Employee. The Company agrees to employ Employee as
Vice President and Chief Operating Officer of the Company, and Employee agrees
to accept such employment, all in accordance with the terms and conditions of
this Agreement, effective August 11, 1997.
1.2 Duties and Powers. At all times during the Employment Period (as
defined herein), the Company agrees that Employee will serve as Vice President
and Chief Operating Officer of the Company. He shall have such other
responsibilities, duties and authorities, and will render such services for the
Company and its affiliates as the Board of Directors of the Company (the
"Board") shall from time to time reasonably direct; provided, however, such
duties and responsibilities shall be commensurate with his position in the
Company. The Employee agrees primarily to devote his time to the affairs of the
Company and to carry out his duties and responsibilities faithfully. Fortress
covenants that it will use its best efforts through its President and Chairman
of the Board to recommend the appointment of Employee to the Company's Board of
Directors as soon as practicable following the effective date of the Employee's
employment.
1.3 Employment Period. Employee's employment under this Agreement shall
be for a period of three years commencing __________ (the "Initial Employment
Period"). This Agreement shall automatically renew for successive one-year
periods (each one-year period shall be referred to herein as a "Renewal Period")
unless either the Company or Employee, as the case may be, provides written
notice within ninety (90) days prior to the termination of any such period,
stating its/his desire to terminate this Agreement. The Initial Employment
Period and each successive Renewal Period shall be referred to herein together
as the "Employment Period". Notwithstanding anything to the contrary contained
herein, the Employment Period is subject to termination pursuant to Section 1.4
below.
<PAGE>
1.4 Termination of Employment
(a) Termination by the Company For Cause. The Company has the
right to terminate Employee's employment under this Agreement, by notice
to Employee in writing at any time, (i) for "Cause" or (ii) due to the
death or the Disability of Employee. Any such termination shall be
effective upon the date of service of such notice pursuant to Section
6.6 hereof, except in the case of the death, in which such termination
shall become effective immediately upon the death of Employee.
"Cause," as used herein, means the occurrence of any of the
following events:
(i) final non-appealable conviction of (A) a felony or
(B) any crime involving moral turpitude;
(ii) the failure of Employee to comply with the
instructions of the Chief Executive Officer of The Fortress
Group, Inc., a Delaware corporation, otherwise consistent with
this Agreement after (A) written notice delivered to Employee
describing the breach and (B) Employee has failed to cure after a
period of 30 days as set forth in Section 1.4(c), below;
(iii) the good faith determination by the Board in the
exercise of its reasonable judgment that Employee has committed
an act or acts in the course of his employment constituting
fraud, provided Employee is given an opportunity, with at least
10 days notice, to disprove the allegation;
(iv) a material breach by Employee of any of the terms,
conditions or covenants set forth in Section 3 of this Agreement;
and
Employee shall be deemed to have a "Disability" for
purposes of this Agreement if he is unable to perform, by reason
of physical or mental incapacity, his material duties or
obligations under this Agreement, for a total period of 180 days
in any 360-day period. The Board shall determine, according to
the facts then available, whether and when the Disability of the
Employee has occurred. Such determination shall not be arbitrary
or unreasonable and the Board will take into consideration the
expert medical opinion of a physician chosen by the Company,
after such physician has completed an examination of Employee.
Employee agrees to make himself available for such examination
upon the reasonable request of the Company.
(b) Termination for Good Reason. Employee shall have the right at
any time to terminate his employment with the Company for any reason.
For purposes of this Agreement and subject to the Company's opportunity
to cure as provided in Section 1.4(c) below, the Employee shall have
"Good Reason" to terminate his employment hereunder if such termination
shall be the result of:
2
<PAGE>
(i) a material breach by the Company of the compensation
and benefits provisions of Section 2 hereof;
(ii) a material breach by the Company of any other term
of this Agreement.
(c) Notice and Opportunity to Cure. Notwithstanding the
foregoing, it shall be a condition precedent to the Company's right to
terminate the Employee's employment for "cause" and the Employee's right
to terminate for "good reason" that (1) the party seeking the
termination shall first have given the other party written notice
stating with specificity the reason for the termination ("breach") and
(2) if such breach is susceptible of cure or remedy, a period of 30 days
from and after the giving of such notice shall have elapsed without the
breaching party having effectively cured or remedied such breach during
such 30 day period, unless such breach cannot be cured or remedied
within 30 days, in which case the period for remedy or cure shall be
extended for a reasonable time (not to exceed an additional 30 days),
provided the breaching party as made and continues to make a diligent
effort to effect such remedy or cure.
2. Compensation and Benefits.
2.1 Salary. In consideration of Employee performing his duties under
this Agreement during the Employment Period, the Company will pay Employee a
base salary at a rate of $250,000 per annum (the "Base Salary"), payable in
accordance with the Company's regular payroll policy for salaried employees. The
Base Salary may be increased (but not decreased), from time to time during the
Employment Period, as determined by the Board, in its sole discretion. If the
Employment Period is terminated pursuant to Section 1.4 above, then the Base
Salary for any partial year will be prorated based on the number of days elapsed
in such year prior to the termination.
2.2 Incentive Compensation. Employee shall participate in Fortress'
Executive Compensation Program (the "Incentive Compensation Program"), as
amended, under which Employee shall be entitled to incentive compensation based
on the financial performance of the Company. Employee will participate at a .75
point share basis. For 1997 Employee's share will be a percentage of this based
upon that percentage of the calendar year he has been an employee of the
Company. For 1997, if the preceding calculation results in an incentive
compensation payment of less than $150,000, Fortress agrees to pay to Employee
an additional sum equal to the difference between $150,000 and the amount earned
under the Incentive Compensation Program. Incentive compensation earned by
Employee hereunder shall be payable in accordance with Company policy. Exhibit A
hereto provides a summary of the Plan as approved by Compensation Committee of
the Board on March 5, 1997.
2.3 Restricted Stock. Employee shall be granted a total of 30,000 shares
of Fortress Common Stock on the following dates, provided he is an employee of
the Company on the date in question: 10,000 shares on the first day of the month
following his sixth month of employment by the Company; 10,000 shares on the
eighteenth month of employment by the Company; and 10,000 shares on the
thirtieth month of employment by the Company.
3
<PAGE>
2.4 Stock Options. As of the effective date of this Agreement and for
each year of the Initial Employment Period of this Agreement, Employee shall be
entitled to receive options to purchase 12,500 shares of the common stock of The
Fortress Group, Inc. (the "Stock"), for a total of 50,000 shares, at the closing
price per share of the Stock reported on a consolidated basis for the Stock on
the principal stock exchange or market on which the Stock is traded on the date
of this Agreement as follows: (i) 12,500 shares on the date of this Agreement;
(ii) 12,500 shares on the first anniversary of this Agreement, (iii) 12,500
shares on the second anniversary of this Agreement, ) 12,500 shares on the third
anniversary of this Agreement. The options will be granted pursuant to the terms
and conditions of The Fortress Group, Inc. 1996 Stock Incentive Plan which is
hereby incorporated by reference.
2.5 Moving and Relocation Expenses. Fortress will reimburse Employee for
all normal and customary Moving Expenses from his Boca Raton, Florida residence
to a new residence in the Washington, D.C. metropolitan area ("Washington,
D.C."). For purposes of this Agreement "Moving Expenses" shall include --
(a) expenses of professional packers and movers to pack and move
Employee's household goods and personal effects from Boca Raton to the
new residence;
(b) expenses for a reasonable number of trips (including meals,
lodging, transportation expense, and car rental) to the Washington, D.C.
for the principal purpose of searching for a new residence; and
(c) expenses of traveling (including meals, lodging and other
related customary expenses) from Boca Raton to the new place of
residence in Washington, D.C.
2.6 Sale of Current Home. Fortress will reimburse Employee for the seven
(7%) percent brokerage commission he incurs upon the sale of his current place
of residence, not to exceed $25,000.
2.7 Temporary Commuting Expenses. Fortress will reimburse Employee for
reasonable expenses in connection with commuting from Boca Raton to Washington,
D.C. for a period of one year or until Employee moves his family to Washington,
D.C., whichever occurs first. The reimbursable expenses will include
transportation, lodging, and car rental.
2.8 Benefits, Expenses and Pension Plan. During the Employment Period,
the Company agrees to provide to Employee such vacation and other health and
insurance benefits as are generally provided, from time to time, to executive
officers of Fortress.
2.9 Compensation After Termination During Employment Period.
a) If the Company terminates Employee's employment during the
Employment Period for any reason (other than for "Cause" pursuant to
Section 1.4(a) of this Agreement) or Employee shall terminate his
employment for Good Reason, Employee shall be entitled to receive his
accrued benefits and as severance the lesser of (x) his Base Salary for
the period of time which would have been remaining in the Initial
Employment Period or any Renewal Period but not less than a sum of money
equal to one times this Base Salary at that time and (y) a sum of money
equal to two times this Base Salary at the time.
4
<PAGE>
(b) If the Company shall terminate Employee's employment during
the Employment Period pursuant to Sections 1.4(a), the Company shall
have no further obligations hereunder or otherwise with respect to
Employee's employment from and after the termination or expiration date
(except payment of Employee's Base Salary accrued through the date of
termination or expiration), and the Company shall continue to have all
other rights available hereunder (including, without limitation, all
rights under Section 3 hereof at law or in equity).
3. Covenants.
3.1 Employee's Acknowledgment. Employee acknowledges that:
(a) the Company is and will be engaged in the Business
during the Employment Period and thereafter;
(b) Employee will occupy a position of trust and
confidence with the Company after the date of this Agreement, and during
such period and Employee's employment under this Agreement, Employee
will become familiar with the Company's proprietary and confidential
information concerning the Company and the Business;
(d) the agreements and covenants contained in this
Section 3 are essential to protect the Company and the goodwill of the
Business and are a condition precedent to the Company entering into this
Agreement;
(e) Employee's employment with the Company has special,
unique and extraordinary value to the Company and the Company would be
irreparably damaged if Employee were to provide services to any person
or entity in violation of the provisions of this Agreement.
(f) Employee has means to support himself and his
dependents other than by engaging in the Business, or a business similar
to the Business, and the provisions of this Section 3 will not impair
such ability.
3.2 Non-Compete.
(a) Employee hereby agrees that during the Employment
Period and hereafter through the period ending with the second
anniversary of the last day of the Initial Employment Period and any
Renewal Period during which the termination date occurred, as the case
may be, (collectively, the "Restrictive Period"), he shall not, for any
reason whatsoever, directly or indirectly, for himself or on behalf of
or in conjunction with any other person, persons, company, partnership,
corporation or business of whatever nature:
(i) engage, as an officer, director, shareholder, owner,
partner, joint venturer, or in a managerial capacity, whether as
an employee, independent contractor, consultant or advisor, or as
a sales representative, in any business which constructs or sells
single-family residential homes in any community in which
Fortress or its subsidiaries are doing business or commence doing
business during the term of this Agreement ("Territory").
5
<PAGE>
(ii) call upon any person who is, at that time, within
the Territory, an employee of the Company in a managerial
capacity for the purpose or with the intent of enticing such
employee away from or out of the employ of the Company; provided,
that the Employee shall be permitted to call upon and hire any
member of his or her immediate family.
Employee may personally supervise and have built, or have the
Company build, one home designed and intended for use as his personal
residence and one home designed and intended for use as his secondary
residence. If built by the Company, Employee will be sold the home[s] at
a sales price to the Employee equal to the Company's cost of goods sold
for the construction of the home in question. In the event Employee
personally supervises and has built a home, the Company acknowledges
that the Employee may personally be given discounts from suppliers and
vendors for materials and services provided in the construction of the
home, and the Company covenants that it will do nothing to prevent or
discourage this benefit. Moreover, notwithstanding the above, the
foregoing covenant shall not be deemed to prohibit the Employee from
acquiring as an investment not more than one (1%) percent of the capital
stock of a competing business whose stock is traded on a national
securities exchange or over the counter so long as the Employee does not
consult with or is not employed by such competitor.
(b) The provisions of subsection 3.2(a) notwithstanding, neither
this Agreement nor any of the provisions and recitals contained therein
shall prohibit Employee or his Affiliates from engaging, as an officer,
director, shareholder, owner, partner, joint venturer, or in a
managerial capacity, whether as an employee, independent contractor,
consultant or advisor, or as a sales representative, in any business
which develops real estate for commercial, industrial, multi-family or
attached single family uses, provided Employee and his Affiliates give
to the Company a right of first refusal on all detached single family
real estate so developed.
3.3 Interference with Relationships. Other than in the performance of
his duties hereunder, during the Restrictive Period, Employee shall not,
directly or indirectly, as employee, agent, consultant, stockholder, director,
co-partner or in any other individual or representative capacity solicit or
encourage any present or future customer, supplier or other third party to
terminate or otherwise alter his, her or its relationship with the Company with
respect to the Business engaged in by the Company.
6
<PAGE>
3.4 Confidential Information. Other than in the performance of his
duties hereunder, during the Restrictive Period and thereafter, Employee shall
keep secret and retain in strictest confidence, and shall not, without the prior
written consent of the Company, furnish, make available or disclose to any third
party or use for the benefit of himself or any third party, any Confidential
Information. As used in this Agreement, "Confidential Information" shall mean
any information relating to the business or affairs of the Company or the
Business, including, but not limited to, information relating to financial
statements, employees, suppliers, construction, manufacturing and servicing
methods, equipment, programs, strategies and information, analyses, profit
margins, or other proprietary information used by Fortress, the Company or any
other subsidiary of Fortress in connection with the Business; provided, however,
that Confidential Information shall not include any information which is in the
public domain or becomes known in the industry through no wrongful act on the
part of Employee. Employee acknowledges that the Confidential Information is
vital, sensitive, confidential and proprietary to the Company and Fortress.
3.5 Blue-Pencil. If any court of competent jurisdiction shall at any
time deem the term of this Agreement or any particular Restrictive Covenant (as
defined) too lengthy or the territory too extensive, the other provisions of
this Section 3 shall nevertheless stand, the Restrictive Period herein shall be
deemed to be the longest period permissible by law under the circumstances and
the territory herein shall be deemed to comprise the largest territory
permissible by law under the circumstances. The court in each case shall reduce
the time period and/or territory to permissible duration or size.
3.6 Remedies. Employee acknowledges and agrees that the covenants set
forth in this Section 3 (collectively, the "Restrictive Covenants") are
reasonable and necessary for the protection of the Company's business interests,
that irreparable injury will result to the Company if Employee breaches any of
the terms of said Restrictive Covenants, and that in the event Employee breaches
or threatens to breach any such Restrictive Covenants, the Company will have no
adequate remedy at law. Employee accordingly agrees that in the event Employee
breaches or threatens to breach any of the Restrictive Covenants, the Company
shall be entitled to immediate temporary injunctive and other equitable relief,
without bond and without the necessity of showing actual monetary damages,
subject to hearing as soon thereafter as possible. Nothing contained herein
shall be construed as prohibiting the Company from pursuing any other remedies
available to it for such breach or the threat of such a breach by Employee,
including the recovery of any damages which it is able to prove.
4. Effect of Termination.
4.1 For Cause or Voluntary Quitting. If the Employee terminates
employee's employment during the Employment Period other than for Good Reason as
defined in Section 1.4(b) or the Company terminates Employee's employment for
Cause pursuant to Sections 1.4(a) then, notwithstanding such termination, the
provisions contained in Sections 3 hereof shall remain in full force and effect.
4.2 Other Reasons. If the Company terminates Employee's employment
during the term of this Agreement or Renewal of it other than for Cause as
defined in Sections 1.4(a) or Employee terminates his employment for Good Reason
during the term of this Agreement or Renewal of it, then --
7
<PAGE>
(a) the provisions and covenants of Section 3.2 and 3.3 shall
have no effect and shall be unenforceable, and
(b) Employee shall receive severance pay as follows: Employee
shall be entitled to receive his accrued benefits and as Severance Pay
the lesser of (x) his Base Salary for the period of time which would
have been remaining in the Initial Employment Period or any Renewal
Period but not less than a sum of money equal to one times his Base
Salary at the time and (y) a sum of money equal to two times this Base
Salary at the time.
Furthermore, if Employee's employment is terminated pursuant to this Section
4.2, the right to receive Severance Pay as defined above shall be the exclusive
remedy in any action arising out of Employee's employment seeking damages or any
other form of monetary relief brought by Employee.
5. Income Tax Treatment. Employee and the Company acknowledge that it is
the intention of the Company to deduct all amounts paid under Section 2 hereof
as ordinary and necessary business expenses for income tax purposes. Employee
agrees and represents that he will treat all such amounts as required pursuant
to all applicable tax laws and regulations, and should he fail to report such
amounts as required, he will indemnify and hold the Company harmless from and
against any and all taxes, penalties, interest, costs and expenses, including
reasonable attorneys' and accounting fees and costs, which are incurred by
Company directly or indirectly as a result thereof.
6. Miscellaneous.
6.1 Assignment. No party hereto may assign or delegate any of its rights
or obligations hereunder without the prior written consent of the other party
hereto; provided, however, that the Company shall have the right to assign all
or any part of its rights and obligations under this Agreement (i) to any
affiliate of the Company to which the Business of the Company is assigned at any
time, any subsidiary or affiliate of the Company or any surviving entity
following any merger or consolidation of any of those entities with any entity
other than the Company or (ii) in connection with the sale of the Business by
the Company. Except as otherwise expressly provided herein, all covenants and
agreements contained in this Agreement by or on behalf of any of the parties
hereto shall bind and inure to the benefit of the respective legal
representatives, heirs, successors and assigns of the parties hereto whether so
expressed or not.
6.2 Entire Agreement. Except as otherwise expressly set forth herein,
this Agreement and all other agreements entered into by the parties hereto on
the date hereof set forth the entire understanding of the parties, and supersede
and preempt all prior oral or written understandings and agreements, with
respect to the subject matter hereof.
6.3 Severability. Whenever possible, each provision of this Agreement
shall be interpreted in such manner as to be effective and valid under
applicable law, but if any provision of this Agreement is held to be prohibited
by or invalid under applicable law, such provision shall be ineffective only to
the extent of such prohibition or invalidity, without invalidating the remainder
of this Agreement.
8
<PAGE>
6.4 Amendment; Modification. No amendment or modification of this
Agreement and no waiver by any party of the breach of any covenant contained
herein shall be binding unless executed in writing by the party against whom
enforcement of such amendment, modification or waiver is sought. No waiver shall
be deemed a continuing waiver or a waiver in respect of any subsequent breach or
default, either of a similar or different nature, unless expressly so stated in
writing.
6.5 Governing Law. This Agreement shall be construed and enforced in
accordance with, and all questions concerning the construction, validity,
interpretation and performance of this Agreement shall be governed by, the laws
of the State of Virginia, without giving effect to provisions thereof regarding
conflict of laws. To the extent that any provision of this Agreement is
inconsistent with the laws of the State of Wisconsin, the parties agree to be
governed and abide by the law of the State of Virginia.
6.6 Notices. All notices, demands or other communications to be given or
delivered hereunder or by reason of the provisions of this Agreement shall be in
writing and shall be deemed to have been properly served if (a) delivered
personally, (b) delivered by a recognized overnight courier service, (c) sent by
certified or registered mail, return receipt requested and first class postage
prepaid, or (d) sent by facsimile transmission followed by a confirmation copy
delivered by a recognized overnight courier service the next day. Such notices,
demands and other communications shall be sent to the addresses indicated below:
(a) If to Employee:
George Yeonas
(b) If to the Company:
The Fortress Group, Inc.
1921 Gallows Road, Suite 730
Vienna, VA 22182
Attention: James J. Martell, Jr.
or to such other address or to the attention of such other person as the
recipient party has specified by prior written notice to the sending
party. Date of service of such notice shall be (i) the date such notice
is personally delivered or sent by facsimile transmission (with issuance
by the transmitting machine of a confirmation of successful
transmission, (ii) three days after the date of mailing if sent by
certified or registered mail or (iii) one day after date of delivery to
the overnight courier if sent by overnight courier.
6.7 Counterparts. This Agreement may be executed in multiple
counterparts, each of which shall be deemed an original, but all of which taken
together shall constitute one and the same Agreement and shall become effective
when one or more counterparts have been executed by each of the parties hereto
and delivered to the other.
9
<PAGE>
6.8 Descriptive Headings; Interpretation. The descriptive headings in
this Agreement are inserted for convenience of reference only and are not
intended to be part of or to affect the meaning or interpretation of this
Agreement. The use of the word "including" in this Agreement shall be by way of
example rather than by limitation. The Preliminary Recitals set forth above are
incorporated by reference into this Agreement.
6.9 No Strict Construction. The language used in this Agreement will be
deemed to be the language chosen by the parties hereto to express their mutual
interest, and no rule of strict construction will be applied against any party
hereto.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year first above written.
COMPANY:
THE FORTRESS GROUP, INC..
By: /s/ James J. Martell, Jr.
--------------------------
Its: President
--------------------------
EMPLOYEE:
/s/ George Yeonas
--------------------------
George Yeonas
10
<PAGE>
Exhibit A
THE FORTRESS GROUP, INC.
INCENTIVE COMPENSATION PLAN
A cash bonus pool will be set aside for the key executive officers of
the Company equal to 50% of the Company's pre-tax profit in excess of $1.35 per
share up to a maximum of 4% of pre-tax income. The pool will be divided between
the participants based upon unit values assigned to each participant expressed
as a fraction of a whole unit.
11
<TABLE>
<CAPTION>
Exhibit 21.1
Subsidiaries
Jurisdiction of Jurisdiction of Foreign
Company Incorporation Qualification, if any
- ------- ------------- ---------------------
<S> <C> <C>
Brookstone Homes, Inc. Delaware Wisconsin
Buffington Holdings, Inc. Delaware None
Christopher Homes Custom Nevada None
Home Division, Inc.
Fortress-Florida, Inc. Delaware Florida
d/b/a Fortress-Jax, Inc.
Fortress Galloway, Inc. Delaware None
Fortress Mortgage, Inc. Delaware Arizona
Florida
Nevada
North Carolina
South Carolina
Texas
Virginia
Wisconsin
Fortress Missouri-Construction, LLC Delaware None
Fortress Missouri-Lumber, LLC Delaware None
Fortress Missouri-Title, LLC Delaware None
Fortress Pennsylvania, LLC Delaware Pennsylvania
Fortress Tysons, LLC Delaware Virginia
The Genesee Company Colorado Arizona, Michigan
Landmark Homes, Inc. North Carolina South Carolina
Legacy Homes, Inc. North Carolina None
Solaris Development Corporation North Carolina None
Wilshire Homes, Inc. Texas None
</TABLE>
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-3 and Form S-8 of our
reports as of the dates and relating to the financial statements of the
companies listed below, which appear on the following pages of this Form 10-K.
<TABLE>
<CAPTION>
Page
Company Date of Report Ref. Document
------- -------------- ---- --------
<S> <C> <C> <C>
The Fortress Group, Inc. March 12, 1998 F-1 Annual Report of Form 10-K for the year
ended December 31, 1997
Combined Predecessor February 20, 1997 F-23 Annual Report on Form 10-K for the year
Companies ended December 31, 1997
</TABLE>
Price Waterhouse LLP
Washington, DC
March 31, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORTRESS
GROUP, INC. CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1997 AND FROM THE
FORTRESS GROUP, INC. CONSOLIDATED STATEMENT OF OEPRATIONS FOR THE YEAR EDNED
DECEMBER 31, 1997.
</LEGEND>
<CIK> 0001010607
<NAME> The Fortress Group, Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S.
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-1-1997
<PERIOD-END> DEC-31-1997
<EXCHANGE-RATE> 1
<CASH> 12,406
<SECURITIES> 0
<RECEIVABLES> 26,260
<ALLOWANCES> 0
<INVENTORY> 217,342
<CURRENT-ASSETS> 0
<PP&E> 10,246
<DEPRECIATION> 0
<TOTAL-ASSETS> 337,304
<CURRENT-LIABILITIES> 0
<BONDS> 100,000
0
1
<COMMON> 117
<OTHER-SE> 62,779
<TOTAL-LIABILITY-AND-EQUITY> 337,304
<SALES> 445,311
<TOTAL-REVENUES> 445,311
<CGS> 377,607
<TOTAL-COSTS> 429,141
<OTHER-EXPENSES> (1,143)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,396
<INCOME-PRETAX> 13,923
<INCOME-TAX> 5,463
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,460
<EPS-PRIMARY> 0.68
<EPS-DILUTED> 0.63
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORTRESS
GROUP, INC. CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1996, JUNE 30, 1996,
AND SEPTEMBER 30, 1996 AND FROM THE FORTRESS GROUP, INC. CONSOLIDATED STATEMENT
OF OEPRATIONS FOR THE YEAR EDNED DECEMBER 31, 1996 AND THE PERIOD ENDED JUNE 30,
1996 AND THE QUARTER ENDED SEPTEMBER 30, 1996.
</LEGEND>
<CIK> 0001010607
<NAME> The Fortress Group, Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S.
<S> <C> <C> <C>
<PERIOD-TYPE> 12-MOS 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1996 DEC-31-1996 DEC-31-1996
<PERIOD-START> MAY-21-1996 MAY-21-1996 JUL-1-1996
<PERIOD-END> DEC-31-1996 JUN-30-1996 SEP-30-1996
<EXCHANGE-RATE> 1.00 1.00 1.00
<CASH> 16,212 30,688 14,380
<SECURITIES> 0 0 0
<RECEIVABLES> 15,878 4,347 12,580
<ALLOWANCES> 0 0 0
<INVENTORY> 144,106 133,489 150,645
<CURRENT-ASSETS> 0 0 0
<PP&E> 34,543 1,829 2,507
<DEPRECIATION> 0 0 0
<TOTAL-ASSETS> 193,733 179,647 193,261
<CURRENT-LIABILITIES> 0 0 0
<BONDS> 0 0 0
0 0 0
0 0 0
<COMMON> 118 118 118
<OTHER-SE> 31,868 26,623 24,973
<TOTAL-LIABILITY-AND-EQUITY> 193,733 179,647 193,261
<SALES> 209,848 42,388 76,051
<TOTAL-REVENUES> 210,354 42,388 76,557
<CGS> 177,387 35,718 64,214
<TOTAL-COSTS> 197,567 39,412 72,166
<OTHER-EXPENSES> 0 (58) (329)
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 429 36 95
<INCOME-PRETAX> 13,221 2,983 4,623
<INCOME-TAX> 5,013 1,125 1,776
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 8,208 1,858 2,847
<EPS-PRIMARY> 0.69 0.16 0.24
<EPS-DILUTED> 0.69 0.16 0.24
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORTRESS
GROUP, INC. CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 1997, JUNE 30, 1997,
AND SEPTEMBER 30, 1997 AND FROM THE FORTRESS GROUP, INC. CONSOLIDATED STATEMENTS
OF OPERATIONS FOR THE QUARTERS ENDED MARCH 31, 1997, JUNE 30, 1997, AND
SEPTEMBER 30, 1997.
</LEGEND>
<CIK> 0001010607
<NAME> The Fortress Group, Inc.
<MULTIPLIER> 1,000
<CURRENCY> U.S.
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 3-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1997 DEC-31-1997 DEC-31-1997
<PERIOD-START> JAN-1-1997 APR-1-1997 JUL-1-1997
<PERIOD-END> MAR-31-1997 JUN-30-1997 SEP-30-1997
<EXCHANGE-RATE> 1.00 1.00 1.00
<CASH> 12,212 8,820 3,483
<SECURITIES> 0 0 0
<RECEIVABLES> 11,523 10,511 9,618
<ALLOWANCES> 0 0 0
<INVENTORY> 164,057 192,938 215,872
<CURRENT-ASSETS> 0 0 0
<PP&E> 4,593 6,584 7,735
<DEPRECIATION> 0 0 0
<TOTAL-ASSETS> 226,800 257,101 314,149
<CURRENT-LIABILITIES> 0 0 0
<BONDS> 0 0 0
0 0 0
1 1 1
<COMMON> 118 118 118
<OTHER-SE> 39,219 38,478 54,515
<TOTAL-LIABILITY-AND-EQUITY> 226,800 257,101 314,149
<SALES> 68,399 105,581 117,763
<TOTAL-REVENUES> 70,065 105,581 117,763
<CGS> 59,598 90,324 99,251
<TOTAL-COSTS> 68,452 103,304 112,407
<OTHER-EXPENSES> (173) (392) (423)
<LOSS-PROVISION> 0 0 0
<INTEREST-EXPENSE> 206 665 1,551
<INCOME-PRETAX> 1,613 2,019 4,224
<INCOME-TAX> 618 764 1,634
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 0 0
<CHANGES> 0 0 0
<NET-INCOME> 995 1,255 2,590
<EPS-PRIMARY> 0.08 0.10 0.22
<EPS-DILUTED> 0.08 0.10 0.20
</TABLE>
