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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(A) OF THE SECURITIES EXCHANGE ACT OF 1934
(AMENDMENT NO. 4)
Filed by the Registrant /x/
Filed by a Party other than the Registrant / /
Check the appropriate box:
/ / Preliminary Proxy Statement
/x/ Definitive Proxy Statement
/ / Definitive Additional Materials
/ / Soliciting Material Pursuant to Rule 14a-11(c) or Rule 14a-12
THE FORTRESS GROUP, INC.
(NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
(NAME OF PERSON(S) FILING PROXY STATEMENT)
Payment of Filing Fee (Check the appropriate box):
/ / No fee required.
/x/ Fee computed on table below per Exchange Act Rule 14a-6(i)(1) and 0-11.
1) Title of each class of securities to which transaction applies:
_____________________________________________________________________________
2) Aggregate number of securities to which transaction applies:
_____________________________________________________________________________
3) Per unit price or other underlying value of transaction computed pursuant to
Exchange Act Rule 0-11 (set forth the amount on which the filing fee is
calculated and state how it was determined):
_____________________________________________________________________________
4) Proposed maximum aggregate value of transaction: $25,750,000
5) Total fee paid: $5,150
/x/ Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the form or schedule and the date of its filing.
1) Amount previously paid: $5,150
2) Form, Schedule or Registration No. 14A, Amendment #1
3) Filing party: The Fortress Group, Inc.
4) Date filed: January 23, 1998
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THE FORTRESS GROUP, INC.
1650 TYSONS BOULEVARD, SUITE 600
MCLEAN, VIRGINIA 22102
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NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD ON MARCH 6, 1998
------------------------
A SPECIAL MEETING of stockholders of The Fortress Group, Inc. (the
'Company') will be held on March 6, 1998 at the offices of The Fortress Group,
Inc., 1650 Tysons Boulevard, Suite 600, McLean, Virginia 22102 at 8:00 a.m.,
local time, to consider and act upon:
1. A proposal to approve certain investment transactions involving the
purchase by an affiliate of Lazard Freres Real Estate Investors, LLC of
up to $100,000,000 of the Company's newly issued convertible preferred
stock and amendments to the Company's certificate of incorporation
which, among other things, would increase the Company's authorized
common stock and would require the affirmative vote of more than 81% of
the Company's board of directors or executive committee for the Company
to engage in certain significant actions or transactions;
2. A proposal to authorize an increase in the common stock subject to the
Company's 1996 Stock Incentive Plan; and
3. Any other matter that may properly come before the Special Meeting.
Stockholders of record at the close of business on January 14, 1998 will be
entitled to notice of and to vote at the Special Meeting or any adjournment
thereof.
All stockholders are cordially invited to attend the Special Meeting.
BY ORDER OF THE BOARD OF DIRECTORS
James J. Martell, Jr.
President and Chief Executive Officer
McLean, Virginia
February 19, 1998
WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE FOLLOW THE INSTRUCTIONS
ON THE ENCLOSED PROXY IN ORDER TO ENSURE REPRESENTATION OF YOUR SHARES AT THE
MEETING.
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[THIS PAGE INTENTIONALLY LEFT BLANK]
<PAGE>
TABLE OF CONTENTS
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<S> <C>
GENERAL INFORMATION........................................................................................ 1
SUMMARY.................................................................................................... 2
Introduction............................................................................................. 2
Stockholders Approval.................................................................................... 2
Certain Considerations................................................................................... 2
Recommendation of Board.................................................................................. 2
Closings................................................................................................. 2
Use of Proceeds.......................................................................................... 3
Other Purchases.......................................................................................... 3
Class AA Preferred Stock................................................................................. 3
Apportionment of Class AB Preferred Stock................................................................ 4
Class AB Preferred Stock................................................................................. 4
Voting Rights and Board Representation................................................................... 4
Supermajority Approval................................................................................... 5
Consent Rights........................................................................................... 5
Warrants................................................................................................. 5
Contingent Warrants...................................................................................... 5
Covenants and Actions Prior to Closing; No Solicitation.................................................. 6
Conditions............................................................................................... 6
Fees and Expenses........................................................................................ 6
Termination.............................................................................................. 6
Registration Rights...................................................................................... 6
Participation Rights and Tag-Along Rights................................................................ 6
Proposed Increase in Authorized Common Stock............................................................. 7
Whittaker Acquisition.................................................................................... 7
Proposal to Amend 1996 Stock Incentive Plan.............................................................. 7
Interests of Certain Persons in the Transactions and the Stock Option Proposal........................... 7
Intention of Directors and Officers...................................................................... 7
Market Price of Common Stock............................................................................. 7
CERTAIN CONSIDERATIONS..................................................................................... 8
Uncertainties Regarding Acquisitions..................................................................... 8
Dilution................................................................................................. 8
Change of Control........................................................................................ 9
Anti-takeover Effects.................................................................................... 10
FORWARD-LOOKING STATEMENTS................................................................................. 10
THE TRANSACTIONS........................................................................................... 10
Background............................................................................................... 10
Certain Effects of the Transactions...................................................................... 12
Use of Proceeds.......................................................................................... 14
Recommendation of the Board; Reasons for the Transactions................................................ 15
Consequences if the Transactions Are Not Consummated..................................................... 17
Absence of Appraisal Rights.............................................................................. 17
Interests of Certain Persons in the Transactions......................................................... 17
Expenses of the Transactions............................................................................. 18
Stock Purchase Agreement................................................................................. 18
Purchase and Sale of Securities....................................................................... 18
First Closing......................................................................................... 18
Second Closing........................................................................................ 18
Subsequent Closings................................................................................... 18
Further Purchases..................................................................................... 19
Right of First Refusal................................................................................ 19
</TABLE>
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Class AA Preferred Stock.............................................................................. 19
<S> <C>
Number of Shares.................................................................................... 19
Rank................................................................................................ 19
Dividends........................................................................................... 20
Liquidation Preference.............................................................................. 20
Conversion.......................................................................................... 21
No Redemption....................................................................................... 22
Voting Rights....................................................................................... 22
Preferred Stock Director Designees.................................................................. 23
Consent Rights...................................................................................... 24
Financial Statements................................................................................ 24
Modification and Waiver............................................................................. 24
Debt Alternative.................................................................................... 24
Apportionment of Class AB Preferred Stock............................................................. 25
Class AB Preferred Stock.............................................................................. 25
Number of Shares.................................................................................... 25
Rank................................................................................................ 25
Dividends........................................................................................... 25
Liquidation Preference.............................................................................. 26
Conversion.......................................................................................... 26
Redemption.......................................................................................... 27
Voting Rights....................................................................................... 27
Consent Rights...................................................................................... 28
Financial Statements................................................................................ 28
Modification and Waiver............................................................................. 28
Warrants.............................................................................................. 28
Initial Exercise Price and Payment.................................................................. 28
Exercise Period..................................................................................... 29
Adjustments Based on Common Stock Market Price...................................................... 29
Listing and Registration............................................................................ 30
Contingent Warrants................................................................................... 30
Initial Exercise Price.............................................................................. 30
Adjustment Based on Common Stock Market Price....................................................... 30
Exercise Period..................................................................................... 31
Listing and Registration............................................................................ 32
HSR Act............................................................................................... 32
Certain Covenants and Actions Prior to Second Closing................................................. 32
No Solicitation....................................................................................... 33
Conditions to Closings................................................................................ 33
Representations and Warranties........................................................................ 35
Indemnification....................................................................................... 37
Fees and Expenses..................................................................................... 37
Termination........................................................................................... 38
Registration Rights Agreement............................................................................ 38
Stockholders Agreement................................................................................... 40
Members of the Board.................................................................................. 41
Conduct of Business................................................................................... 41
Participation Rights.................................................................................. 42
Tag-Along Rights...................................................................................... 42
Certificate of Incorporation and Bylaws Amendments....................................................... 43
Amendments to the Certificate of Incorporation........................................................ 43
Conduct of Business................................................................................... 43
Adoption or Amendment of Bylaws....................................................................... 44
</TABLE>
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PAGE
<S> <C>
Termination........................................................................................... 44
Increase in Authorized Common Stock................................................................... 44
Amendments to the Class AA Certificate of Designations................................................ 45
Amendments to the Bylaws.............................................................................. 45
Number of Directors................................................................................... 45
Quorum................................................................................................ 45
Removal of Directors.................................................................................. 45
Election of Directors Following Adverse Event......................................................... 46
Committees............................................................................................ 46
Executive Committee................................................................................... 46
Conduct of Business................................................................................... 46
Termination........................................................................................... 48
Stockholders Voting Agreement............................................................................ 48
Stockholders Approval.................................................................................... 48
ACQUISITION OF WHITTAKER COMPANIES......................................................................... 49
SELECTED PRO FORMA FINANCIAL DATA.......................................................................... 52
SELECTED FINANCIAL DATA OF WHITTAKER COMPANIES............................................................. 53
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF WHITTAKER
COMPANIES................................................................................................ 54
SELECTED FINANCIAL DATA OF THE COMPANY..................................................................... 58
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY....... 60
MARKET PRICES OF AND DIVIDENDS ON THE COMPANY'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS............... 67
DESCRIPTION OF THE COMPANY................................................................................. 68
PROPERTIES................................................................................................. 82
PROPOSAL TO AUTHORIZE AN INCREASE IN THE COMMON STOCK SUBJECT TO THE COMPANY'S 1996 STOCK INCENTIVE PLAN... 83
BENEFICIAL OWNERSHIP OF SECURITIES......................................................................... 86
COMPENSATION............................................................................................... 88
CERTAIN TRANSACTIONS....................................................................................... 90
INDEPENDENT PUBLIC ACCOUNTANTS............................................................................. 91
Other Proposals....................................................................................... 91
INDEX TO FINANCIAL STATEMENTS.............................................................................. F-1
</TABLE>
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<PAGE>
THE FORTRESS GROUP, INC.
1650 TYSONS BOULEVARD, SUITE 600
MCLEAN, VIRGINIA 22102
PROXY STATEMENT FOR A SPECIAL MEETING OF STOCKHOLDERS
To Be Held On March 6, 1998
GENERAL INFORMATION
A Special Meeting of stockholders of The Fortress Group, Inc. (the
'Company') will be held at the offices of The Fortress Group, Inc., 1650 Tysons
Boulevard, Suite 600, McLean, Virginia 22102 on March 6, 1998 at 8:00 a.m.,
local time, for the purposes set forth in the accompanying Notice of Special
Meeting of Stockholders (the 'Special Meeting'). The approximate mailing date
for this proxy statement and proxy is February 20, 1998.
Holders of record of shares of the Company's common stock, $.01 par value
(the 'Common Stock'), at the close of business on January 14, 1998 (the 'Record
Date') are entitled to notice of, and to vote at, the Special Meeting or at any
adjournment of the Special Meeting. Each share of Common Stock has one vote. On
the Record Date, there were issued and outstanding 11,612,594 shares of Common
Stock.
In addition, holders of record of shares of the Company's Class AA
Convertible Preferred Stock, $.01 par value, at the close of business on the
Record Date are entitled to vote at the Special Meeting or at any adjournment of
the Special Meeting. On the Record Date, there were issued and outstanding
11,700 shares of Class AA Convertible Preferred Stock, entitling the holder
thereof to cast 1,950,000 votes at the Special Meeting. Prometheus Homebuilders
LLC, which is the holder of the Class AA Convertible Preferred Stock, has agreed
not to vote on certain of the proposals to be considered at the Special Meeting.
It is important that your shares be represented at the Special Meeting. If
it is impossible for you to attend the Special Meeting, please sign and date the
enclosed proxy and return it in the envelope provided. The proxy is solicited by
the board of directors of the Company (the 'Board'). Shares represented by valid
proxies in the enclosed form will be voted if received in time for the Special
Meeting. Expenses in connection with the solicitation of proxies will be borne
by the Company and may include requests by mail, telephone and personal contact
by its directors, officers and employees. The Company will reimburse brokers or
other nominees for their out-of-pocket expenses in forwarding proxy materials to
principals. If you return the enclosed proxy, you still have the right to vote
in person at the Special Meeting. If you give a proxy, you have the power to
revoke it any time before it is voted. You may revoke a proxy at any time prior
to its exercise by sending a notice of revocation in writing to the Secretary of
the Company, by presenting to the Company a later-dated proxy card executed by
the person executing the prior proxy card or by attending the Special Meeting
and voting in person.
Shares of Common Stock represented by properly executed proxy cards
received by the Company in time for the Special Meeting will be voted in
accordance with the choices specified in the proxies. Abstentions and broker
non-votes (proxies that do not indicate that brokers or nominees have received
instructions from the beneficial owner of shares) will be counted for purposes
of determining the presence or absence of a quorum for the transaction of
business. Abstentions are counted in tabulating the total number of votes cast
on proposals presented to stockholders, whereas broker non-votes are not counted
for purposes of determining the total number of votes cast.
<PAGE>
SUMMARY
The following summary provides selected information regarding a proposal to
approve certain investment transactions, including the amendment of the
Company's certificate of incorporation, and a proposal to amend the 1996 Stock
Incentive Plan. This summary is not intended to be complete and is qualified in
all respects by reference to the detailed information contained elsewhere in
this Proxy Statement including the financial statements and pro forma financial
statements, which appear at pages F-1 through F-149, of this Proxy Statement.
You are urged to review carefully the entire Proxy Statement.
Introduction. The Company and Prometheus Homebuilders LLC ('Prometheus')
entered into a Stock Purchase Agreement dated as of August 14, 1997, and an
Amended and Restated Stock Purchase Agreement dated as of September 30, 1997, as
amended (the 'Stock Purchase Agreement'). Prometheus is owned by Lazard Freres
Strategic Realty Investors II L.P., which is an affiliate of Lazard Freres Real
Estate Investors, LLC ('Lazard'). The activities of Lazard consist principally
of acting as general partner of several real estate investment partnerships that
are affiliated with Lazard Freres & Co. LLC, an investment banking firm.
Prometheus is a special purpose investment vehicle formed by Lazard to acquire
the Company's securities as contemplated by the Stock Purchase Agreement.
Subject to the terms and conditions of the Stock Purchase Agreement,
Prometheus will purchase for an aggregate purchase price of $75,000,000 (a) an
aggregate of $40,000,000 initial liquidation value (40,000 shares) of the
Company's Class AA Convertible Preferred Stock, $0.01 par value per share (the
'Class AA Preferred Stock'), (b) an aggregate of $35,000,000 initial liquidation
value (35,000 shares) of the Company's Class AB Preferred Stock, apportioned
between Class ABI Convertible Preferred Stock, $0.01 par value per share (the
'Class ABI Preferred Stock') and Class ABII Convertible Preferred Stock, $0.01
par value per share (the 'Class ABII Preferred Stock') (the Class ABI Preferred
Stock and the Class ABII Preferred Stock together are referred to as the 'Class
AB Preferred Stock'), (c) warrants to purchase 1,000,000 shares of Common Stock
(the 'Warrants') and (d) warrants to purchase between 380,952 and 5,714,286
shares of Common Stock in certain circumstances (the 'Contingent Warrants'). See
'The Transactions--Stock Purchase Agreement--Purchase and Sale of Securities.'
Stockholders Approval. The approval at the Special Meeting by the holders
of a majority of the outstanding voting stock (the 'Stockholders Approval') is
required to effect the transactions contemplated by the Stock Purchase Agreement
(the 'Transactions'), except for certain of the Transactions effected at the
First Closing (as defined below). Stockholders Approval is assured because
certain principal stockholders who are parties to an Amended and Restated
Stockholders Voting Agreement dated September 30, 1997 and who own in the
aggregate a majority of the outstanding voting stock have agreed to vote in
favor of the Transactions. See 'The Transactions--Stockholders Voting Agreement'
and '--Stockholders Approval.' As of the Record Date, Prometheus owns 11,700
shares of Class AA Preferred Stock, which shares entitle Prometheus to 1,950,000
votes (calculated on an as-converted basis) at the Special Meeting. The Stock
Purchase Agreement provides that Prometheus will not vote on the proposal to
approve the Transactions.
Certain Considerations. Certain factors and information should be
considered in evaluating the Transactions. Such factors and information involve
acquisitions uncertainties, dilution, change of control matters, antitakeover
effects and other information. See 'Certain Considerations' and 'Certain Effects
of the Transactions.'
Recommendation of Board. The Board believes that the Transactions are
advisable and in the best interests of the Company and its stockholders and
unanimously recommends that the stockholders vote for the proposal to approve
the Transactions. In arriving at its recommendation, the Board considered the
expected benefits and advantages of the Transactions, the likelihood of
realizing such benefits and advantages, and the risks, costs and disadvantages
of the Transactions. See 'The Transactions--Background;' '--Certain Effects of
the Transactions;' and '--Recommendation of the Board; Reasons for the
Transactions.'
Closings. Effective September 30, 1997, Prometheus purchased $11,700,000
initial liquidation value (11,700 shares) of Class AA Preferred Stock and
Warrants for 375,000 shares of Common Stock, for a purchase price of $11,700,000
(the 'First Closing'). Subject to the terms and conditions of the Stock Purchase
Agreement, at a second closing Prometheus will purchase $28,300,000 initial
liquidation value (28,300 shares) of Class AA Preferred Stock, for a purchase
price of $28,300,000 (the 'Second Closing'). The Stock Purchase Agreement
provides that the Second Closing will occur no later than March 6, 1998.
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Upon consummation of the Second Closing, Prometheus will have invested
$40,000,000 in the Company, and Prometheus will have acquired $40,000,000
initial liquidation value (40,000 shares) of Class AA Preferred Stock and
Warrants for 375,000 shares of Common Stock. Subject to the terms and conditions
of the Stock Purchase Agreement, at subsequent closings, to occur by December
31, 1998, Prometheus will purchase an aggregate of $35,000,000 initial
liquidation value (35,000 shares) of Class AB Preferred Stock, Warrants for
625,000 shares of Common Stock and Contingent Warrants, for an aggregate
purchase price of $35,000,000 ('Subsequent Purchases'). Upon consummation of all
of the Subsequent Purchases, Prometheus will have invested $75,000,000 in the
Company and will have acquired $40,000,000 initial liquidation value (40,000
shares) of Class AA Preferred Stock, $35,000,000 initial liquidation value
(35,000 shares) of Class AB Preferred Stock, Warrants for 1,000,000 shares of
Common Stock and the Contingent Warrants. See 'The Transactions--Stock Purchase
Agreement--First Closing;' '--Second Closing;' and '--Subsequent Closings.'
Use of Proceeds. The aggregate net proceeds from the sale of the
$75,000,000 in newly issued securities are expected to be approximately
$72,000,000, after payment of related fees and expenses. Under the Stock
Purchase Agreement, the Company has the right to use such net proceeds for any
business purpose. The Company currently expects to use such net proceeds
primarily for the acquisition of established homebuilding companies. Proceeds
from the First Closing were used to pay in part for the Company's acquisitions
of Don Galloway Homes, Inc. and the Iacobucci Organization. Proceeds from the
Second Closing are intended to be used to pay for the Company's acquisition of
Whittaker Construction, Incorporated. See 'The Transactions--Use of Proceeds'
and 'Acquisition of Whittaker Companies.'
Other Purchases. Prometheus has agreed to purchase in connection with the
Second Closing approximately 900,000 shares of Common Stock from certain
stockholders who are among the Company's founders, for a purchase price of
approximately $4,944,000. See 'The Transactions--Interests of Certain Persons in
the Transactions.' After the Subsequent Purchases, the Company and Prometheus
may, in their discretion, agree upon the sale to Prometheus of up to an
additional $13,333,000 initial liquidation value (13,333 shares) of Class AA
Preferred Stock, up to an additional $11,667,000 initial liquidation value
(11,667 shares) of Class AB Preferred Stock and Warrants for up to an additional
333,250 shares of Common Stock, for an aggregate purchase price of up to
$25,000,000. In addition, Prometheus will have a right of first refusal with
respect to any bona fide offer to purchase up to $25,000,000 of equity capital
of the Company. See 'The Transactions--Stock Purchase Agreement--Further
Purchases' and '--Right of First Refusal.'
Class AA Preferred Stock. The Class AA Preferred Stock will rank senior to
the Common Stock with respect to dividends and distributions. Dividends will be
payable in cash at the annual rate of 12% until the Second Closing, and
thereafter at the annual rate of 6%, in each case cumulative and compounded
quarterly, on the liquidation value of $1,000 per share. The Company will be
required to declare and pay such dividends to the extent that funds are legally
available therefor. See 'The Transactions--Stock Purchase Agreement--Class AA
Preferred Stock--Rank;' '--Dividends;' and '--Liquidation Preference.'
The Class AA Preferred Stock will be convertible, in whole or in part, at
the option of the holder, into Common Stock, at any time after issuance, 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, up to five
times per year, between September 30, 2001 and September 30, 2003, if the
average closing price of Common Stock for the 60 days prior to such adjustment
(the 'Adjustment Price') is $12.00 or less, as follows:
<TABLE>
<CAPTION>
ADJUSTMENT PRICE(S) OPTIONAL CONVERSION PRICE(S)
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<S> <C>
$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
</TABLE>
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
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certain antidilution adjustments. The Company will not have the right to redeem
the Class AA Preferred Stock. See 'The Transactions--Stock Purchase
Agreement--Class AA Preferred Stock--Conversion' and '--No Redemption.'
Apportionment of Class AB Preferred Stock. 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 issuances of 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
directors elected exclusively by holders of Class AA and Class AB Preferred
Stock) and so that the Company will issue the maximum amount of Class ABI
Preferred Stock before issuing any Class ABII Preferred Stock. See 'The
Transactions--Stock Purchase Agreement--Class AB Preferred Stock--Issuances and
Apportionment.'
Class AB Preferred Stock. The Class AB Preferred Stock will rank senior to
the Common Stock with respect to dividends and distributions. Dividends will be
payable in cash at the annual rate of 12%, cumulative and compounded quarterly,
on the liquidation value of $1,000 per share. The Company will be required to
declare and pay such dividends to the extent that funds are legally available
therefor. See 'The Transactions--Stock Purchase Agreement--Class AB Preferred
Stock--Rank;' '--Dividends;' and '--Liquidation Preference.'
Class AB Preferred Stock will be convertible, in whole or in part, at the
option of the holder, into Common Stock, on or after September 30, 2001, the
fourth anniversary of the date of the First Closing. The Company will have the
option to require conversion of all, but not less than all, of the Class AB
Preferred Stock into Common Stock, on or after September 30, 2002, the fifth
anniversary of the date of the First Closing. 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. 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 accrued
and unpaid dividends. See 'The Transactions--Stock Purchase Agreement--Class AB
Preferred Stock--Conversion' and '--Redemption.'
Voting Rights and Board Representation. Holders of Class AA Preferred
Stock and Class ABI 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, including the election of directors. Holders of Class
ABII Preferred Stock will vote on an as-converted basis with the holders of
Common Stock (along with the holders of Class AA Preferred Stock and Class ABI
Preferred 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. See 'The Transactions--Stock
Purchase Agreement--Class AA Preferred Stock--Voting Rights' and '--Class AB
Preferred Stock--Voting Rights.'
Until a Termination Event (defined below), holders of Class AA Preferred
Stock and Class AB Preferred Stock, voting together as a single class
(separately from other stockholders), will have the exclusive right to elect
three directors (each, a 'Preferred Stock Director') of a 15-member Board. Two
of such Preferred Stock Directors will be designated to a five-member executive
committee of the Board (the 'Executive Committee'), which will have substantial
operational authority with respect to the management of the Company. Prometheus
has not, as of the date of this Proxy Statement, exercised its right to elect
Preferred Stock Directors. Prometheus has indicated that it does not intend to
exercise such rights until Stockholders Approval, although it reserves the right
to do so at any time.
After the Second Closing, holders of Class AA Preferred Stock and Class AB
Preferred Stock will be entitled to elect additional Preferred Stock Directors
sufficient to cause the Preferred Stock Directors to constitute a majority of
the Board and all committees of the Board (the 'Additional Preferred Stock
Directors') in the event (an 'Adverse 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 ('EBT') per share for the most recent two
fiscal quarters as measured against the same two fiscal quarters of the
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prior year is less than the percentage change in the EBT 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. The right to
elect Additional Preferred Stock Directors will continue until such time as
neither of the conditions constituting an Adverse Event exists for two
consecutive fiscal quarters. A 'Termination Event' will occur when, after all
closings under the Stock Purchase Agreement have occurred, (a) the aggregate
amount of Class AA Preferred Stock and Class AB Preferred stock is less than 20%
of the maximum amount of such stock issued as of such date or (b) the aggregate
remaining investment or commitment to invest by Prometheus and any of its
affiliates (or any single or related group of transferees) is less than the
greater of $10,000,000 or 10% of the market value of the Company's outstanding
Common Stock as measured by the 30 preceding trading days. See 'The
Transactions--Stock Purchase Agreement--Class AA Preferred Stock--Voting
Rights'; '--Class AB Preferred Stock--Voting Rights.'
Supermajority Approval. Under a Stockholders Agreement entered into at the
First Closing, among the Company, Prometheus and certain stockholders, who
beneficially own in the aggregate a majority of the voting stock, and pursuant
to amendments to the Company's certificate of incorporation and bylaws effective
upon Stockholders Approval, the Company will not, and will not permit any of its
subsidiaries to, engage in or agree to engage in certain significant actions or
transactions, without the affirmative vote of over 81% of the directors or over
81% of the members of the Executive Committee. Accordingly, the Company will
need the approval of at least one of the three Preferred Stock Directors on the
Board (together with 12 non-Preferred Stock Directors) or the unanimous approval
of the Executive Committee, which will include two Preferred Stock Directors, to
engage in certain significant actions or transactions. Upon the occurrence of a
Termination Event, the provisions of the Company's certificate of incorporation
and bylaws regarding matters subject to approval of over 81% of the directors or
members of the Executive Committee will be of no further force and effect. See
'The Transactions--Stockholders Agreement--Conduct of Business'and
'--Certificate of Incorporation and Bylaws Amendments.'
Consent Rights. Holders of the Class AA Preferred Stock and the Class AB
Preferred Stock will have certain consent rights. The consent of the holders of
at least 66 2/3% of the outstanding shares of each of the Class AA Preferred
Stock, Class ABI Preferred Stock and Class AB II Preferred Stock will be
necessary to effect certain actions or transactions, including, for example, any
amendment of the certificate of incorporation or bylaws which adversely affects
the rights of such class; any authorization or increase in the amount of any
shares of any class ranking senior to or on a parity with such class; any
increase or decrease in the number of authorized shares of such class; any sale
or transfer of substantially all of the assets of the Company or any of its
material subsidiaries; any consolidation or merger involving the Company or any
of such subsidiaries; any reclassification of any stock or any dissolution,
liquidation or winding up of the Company; any purchase or redemption of any
Common Stock or other capital stock of the Company; or any declaration or
payment of any dividends or other distributions on the Common Stock unless all
accrued and unpaid dividends on such class have been paid in cash. See 'The
Transactions--Stock Purchase Agreement--Class AA Preferred Stock--Consent
Rights' and '--Class AB Preferred Stock--Consent Rights.'
Warrants. Under the Stock Purchase Agreement, Prometheus will acquire
Warrants to purchase 1,000,000 shares of Common Stock. The Warrants will be
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, the exercise price of the Warrants
is subject to decrease, at the option of the holder, if the average closing
price of the Common Stock is $12 per share or less for the 60 preceding days,
and the number of shares of Common Stock into which each Warrant will convert
upon exercise of the Warrants is subject to increase if the average closing
price of the Common Stock is $20 per share or less for the 60 preceding days.
The exercise price and the number of shares of Common Stock into which each
Warrant will convert are also subject to certain antidilution adjustments. If
the Stock Purchase Agreement is terminated under certain circumstances prior to
the Second Closing, the exercise price of each outstanding Warrant will be
decreased to $0.01 per share. See 'The Transactions--Stock Purchase
Agreement--Warrants.'
Contingent Warrants. Under the Stock Purchase Agreement, Prometheus will
acquire Contingent Warrants to purchase between 380,952 and 5,714,286 shares of
Common Stock in certain circumstances. 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
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into which the Contingent Warrants will convert upon exercise will be based on
the Adjustment Price. 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 will expire on March 31, 2004. The number of shares of
Common Stock into which the Contingent Warrants would convert is also subject to
certain antidilution adjustments. See 'The Transactions--Stock Purchase
Agreement--Contingent Warrants.'
Covenants and Actions Prior to Closing; No Solicitation. The Stock
Purchase Agreement contains certain covenants to be performed by the Company and
other provisions regarding actions to be taken with respect to the consummation
of the Transactions and the conduct of business. The Stock Purchase Agreement
contains certain provisions that preclude the Company, its directors, officers
and other representatives from soliciting or initiating proposals or offers
regarding transactions alternative to the Transactions. The Board is not
prohibited from taking certain actions to comply with its fiduciary duties in
response to an unsolicited proposal to enter into an alternative transaction.
See 'The Transactions--Stock Purchase Agreement--Certain Covenants and Actions
Prior to Closing' and '--No Solicitation.'
Conditions. Under the Stock Purchase Agreement, consummation of the
Transactions is subject to a number of conditions including Stockholders
Approval with respect to all closings other than the First Closing, which has
occurred. See 'The Transactions--Stock Purchase Agreement--Conditions to
Closings.'
Fees and Expenses. The Company expects to incur fees and expenses incident
to the Transactions of approximately $3,000,000. The Company has agreed to
reimburse Prometheus for its reasonable fees and expenses, including fees and
expenses of legal counsel, accountants and consultants in connection with the
preparation of the Stock Purchase Agreement and its due diligence examination
relating to the Transactions. Such fees and expenses are estimated to total
approximately $1,750,000. In addition, the costs and expenses of the Company in
connection with the Transactions are estimated to total approximately
$1,250,000. If the Stock Purchase Agreement is terminated under certain
conditions prior to the Second Closing (other than as a result of a material
breach by Prometheus of its representations, warranties or obligations
thereunder), the Company will be obligated to pay Prometheus a termination fee
in the amount of $4,000,000, in addition to the fees and expenses incurred by
Prometheus. See 'The Transactions--Stock Purchase Agreement--Fees and Expenses.'
Termination. The Stock Purchase Agreement may be terminated prior to the
Second Closing (a) by the Company or Prometheus if Stockholders Approval has not
been obtained by March 6, 1998, (b) by Prometheus if the Second Closing has not
occurred by March 6, 1998, (c) by Prometheus if the Company breaches any
representation, warranty, covenant or agreement except for any breach which
would not have a material adverse effect on the Company or Prometheus, and (d)
by the Company if Prometheus materially breaches any representation, warranty,
covenant or agreement except for any breach which would not have a material
adverse effect on the Company. See 'The Transactions--Stock Purchase
Agreement--Termination.'
Registration Rights. Pursuant to a Registration Rights Agreement between
the Company and Prometheus, holders of the Class AA Preferred Stock, the Class
AB Preferred Stock, shares of Common Stock issued upon conversion of such
Preferred Stock, shares of Common Stock issued upon exercise of any Warrants or
Contingent Warrants, and shares of Common Stock purchased from certain
stockholders will have certain 'demand' registration rights and 'piggyback'
registration rights with respect to the registration of such securities under
the Securities Act of 1933, as amended. See 'The Transactions--Registration
Rights Agreement.'
Participation Rights and Tag-Along Rights. Under the Stockholders
Agreement, Prometheus will have certain participation rights to purchase or
subscribe for additional shares of capital stock that the Company sells or
issues such that Prometheus will be able to maintain its relative percentage
ownership of the Company's capital stock. Prometheus will also have certain
'tag-along' rights to sell certain amounts of the Class AA Preferred Stock,
Class AB Preferred Stock and Common Stock held by Prometheus, if stockholders
who are parties to the Stockholders Agreement propose to sell their Common Stock
to third parties. The participation rights and tag-along rights will terminate
upon a Termination Event (defined above). See 'The Transactions--Stockholders
Agreement--Participation Rights' and '--Tag-Along Rights.'
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Proposed Increase in Authorized Common Stock. The Company's certificate of
incorporation will be amended, upon Stockholders Approval, to increase the
number of authorized shares of Common Stock from 49,000,000 to 99,000,000. An
increase in the number of authorized shares of Common Stock is needed to permit,
under certain circumstances, the conversion of the Class AA Preferred Stock and
the Class AB Preferred Stock, and the exercise of the Warrants and the
Contingent Warrants to be issued in the Transactions. Additional authorized
Common Stock also would provide the Board with flexibility in the management of
the Company's capitalization. See 'Certificate of Incorporation and Bylaws
Amendments.'
Whittaker Acquisition. On January 5, 1998, the Company entered into an
agreement to acquire Whittaker Construction, Incorporated and related entities
('Whittaker Companies'), a homebuilding company in St. Charles County, Missouri,
a suburb of St. Louis. The purchase price is approximately $25,750,000 in cash
and approximately $36,000,000 of assumed debt. The Company intends to use the
proceeds from the Second Closing with Prometheus to fund the purchase price.
Closing under the agreement is subject to a number of conditions, including the
requirement that the closing occur no later than February 27, 1998. Because
Stockholders Approval and the Second Closing cannot occur before March 6, 1998,
the Company intends to seek an extension from the sellers of the February 27,
1998 closing date to at least March 6, 1998 and/or bridge financing to
consummate the acquisition of the Whittaker Companies prior to the Second
Closing. The Company has not made arrangements for any bridge financing, and
there can be no assurance that the Company can obtain such an extension or
bridge financing. If the Company does not obtain an extension or bridge
financing, the agreement to acquire the Whittaker Companies will terminate, and
the Company will forfeit the $500,000 deposit paid with respect to the
acquisition and immediately recognize previously capitalized acquisition
expenses of approximately $185,000. See 'Acquisition of Whittaker Companies;'
'Selected Pro Forma Financial Data;' 'Selected Financial Data of Whittaker
Companies;' 'Management's Discussion and Analysis of Financial Condition and
Results of Operations of Whittaker Companies;' 'Selected Financial Data of the
Company;' and 'Management's Discussion and Analysis of Financial Condition and
Results of Operations of the Company.'
Proposal to Amend the 1996 Stock Incentive Plan. At the Special Meeting,
the stockholders will vote on a proposal to authorize a 425,000 share increase
in the Common Stock subject to the Company's 1996 Stock Incentive Plan (the
'Stock Option Proposal'). The Board proposes to increase the shares of Common
Stock available for grant under the Plan from 1,125,000 shares to 1,550,000. The
Board recommends that stockholders vote for the proposal. As required by the
Stockholders Agreement, Prometheus will vote in favor of the proposal the 11,700
shares of Class AA Preferred Stock it acquired at the First Closing, which
shares entitle Prometheus to 1,950,000 votes (calculated on an as-converted
basis), equal to approximately 14% of the total votes entitled to be cast at the
Special Meeting. See 'Proposal to Authorize an Increase in the Common Stock
Subject to the Company's 1996 Stock Incentive Plan.'
Interests of Certain Persons in the Transactions and the Stock Option
Proposal. As described above, the Company is proposing to authorize a share
increase in the Common Stock subject to the 1996 Stock Incentive Plan. In
addition, Prometheus will purchase from certain stockholders, who are among the
parties to the Stockholders Agreement and Stockholders Voting Agreement,
approximately 900,000 shares of Common Stock owned by such stockholders for
approximately $4,944,000. Accordingly, in considering the Board's
recommendation, stockholders should consider that certain directors and officers
have certain interests in the Transactions. See 'The Transactions--Interests of
Certain Persons in the Transactions.'
Intention of Directors and Officers. Under the Stockholders Voting
Agreement, certain stockholders, six of whom are directors and officers of the
Company, have agreed to vote in favor of the Transactions. Such stockholders own
in the aggregate a majority of the outstanding voting stock. The Company's other
directors and executive officers, who own in the aggregate approximately 5% of
the outstanding voting stock, have indicated that they intend to vote in favor
of the Transactions. The Company's directors and executive officers, who own in
the aggregate approximately 49% of the outstanding voting stock, and Prometheus,
which owns approximately 14% of the outstanding voting stock, intend to vote in
favor of the Stock Option Proposal. Therefore, approval of the Transactions and
the Stock Option Proposal is assured. See 'The Transactions--Stockholders Voting
Agreement.'
Market Price of Common Stock. The closing sales price of the Common Stock,
as quoted on the Nasdaq National Market System, on August 14, 1997, the last
trading day prior to the public announcement of the Company's execution of the
August 14 Agreement, was $6.00 per share. On February 17, 1998, the closing
sales price of the Common Stock was $5.00 per share. See 'Market Price of and
Dividends on the Company's Common Stock and Related Stockholder Matters.'
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CERTAIN CONSIDERATIONS
The following considerations and related information, as well as the other
information described in the Proxy Statement, should be considered in evaluating
the transactions (the 'Transactions') contemplated by the Amended and Restated
Stock Purchase Agreement dated as of September 30, 1997, as amended (the 'Stock
Purchase Agreement') between the Company and Prometheus Homebuilders LLC
('Prometheus'), an affiliate of Lazard Freres Real Estate Investors, LLC
('Lazard').
UNCERTAINTIES REGARDING ACQUISITIONS
The Company expects to use the net proceeds from the Transactions primarily
for the selective acquisition of established homebuilding companies, including
the Whittaker Companies. In evaluating potential acquisitions of homebuilders,
the Company seeks transactions in which the financial results of the acquired
company are expected to be accretive to the Company's earnings per share and
financial ratios, on an historical pro forma basis and on a prospective basis.
There can be no assurance that the Company will be able to make additional
acquisitions of homebuilders which meet the Company's acquisition criteria or
that additional acquisitions, including the Whittaker Companies, or other uses
of the net proceeds, will have a positive impact on the Company's earnings.
Also, there can be no assurance that income from the acquisitions of additional
homebuilders will exceed the cost to the Company of the securities issued by the
Company under the Transactions. Thus, it is possible that the potential benefits
to the Company and the stockholders from the Transactions may not be realized
and that the Company's financial condition and results may not improve by using
the net proceeds.
DILUTION
Under the Transactions, the Company will issue $40,000,000 initial
liquidation value (40,000 shares) of Class AA Preferred Stock, $35,000,000
initial liquidation value (35,000 shares) of Class AB Preferred Stock, Warrants
for 1,000,000 shares of Common Stock and Contingent Warrants which potentially
provide for the issuance of between 380,952 and 5,714,286 shares of Common
Stock. The Class AA Preferred Stock will be convertible at the option of the
holder into Common Stock at any time after issuance. The initial conversion
price of $6.00 per share for the Class AA Preferred Stock is subject to
decrease, at the option of the holder, between September 30, 2001 and September
30, 2003 if the average closing price of the Common Stock for the 60 days prior
to such adjustment is $12.00 or less and the amount of adjustment will vary
based on the average closing price of the Common Stock. The Class AB Preferred
Stock will be convertible at the option of the holder into Common Stock on or
after September 30, 2001. 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 Warrants
will be 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, the exercise price of the
Warrants is subject to decrease, at the option of the holder, if the average
closing price of the Common Stock is $12 per share or less for the 60 preceding
days, and the number of shares of Common Stock into which the Warrants will
convert upon exercise of the Warrants, is subject to increase if the average
closing price of the Common Stock is $20 per share or less for the 60 preceding
days. The Contingent Warrants would be exercisable at an exercise price of $.01
per share 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 Class AA Preferred Stock and the Class AB Preferred Stock will be
accounted for as equity when issued, net of the pro rata share of allocable
issuance costs. Additionally, the five percent discount conversion feature of
the Class AB Preferred Stock must be recognized for accounting purposes upon
issuance of the Class AB Preferred Stock. This discount will be based on the
market price of the Common Stock when the Class AB Preferred Stock is issued and
will be amortized over the period from the issuance to the date that the
security is first convertible, September 30, 2001. Based upon the current market
price of the Common Stock and the current weighted average shares outstanding,
if all of the Class AB Common Stock were issued at the Second Closing, the
impact would be an annual decrease in earnings per share of approximately $.04
per share through the year 2001. The issuance and conversion of the Class AA
Preferred Stock and the Class AB Preferred Stock, the issuance and exercise of
the Warrants, including the potential adjustments to increase the number of
shares issuable upon exercise and to decrease the exercise price, and the
issuance and exercise of the Contingent Warrants, which potentially provide for
the issuance of between 380,952 and 5,714,286 shares of Common Stock at an
exercise price of $.01 per share, could
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have the effect of further materially reducing the Company's earnings per share
and diluting the economic interests of the Company's existing stockholders.
The holders of Class AA Preferred Stock and Class AB Preferred Stock,
voting as a single class, will have the exclusive right to elect three Preferred
Stock Directors of a 15-member Board. A proportionate number of the Preferred
Stock Directors will serve on each committee of the Board, except for the
Executive Committee. The Executive Committee, which will have substantial
operational authority, will consist of five members of which two will be
Preferred Stock Directors. After the Second Closing, upon the occurrence of an
Adverse Event (as defined), the holders of Class AA Preferred Stock and Class AB
Preferred Stock, voting as a single class, will be entitled to elect additional
Preferred Stock Directors sufficient to constitute a majority of the Board and
all committees of the Board. In addition, holders of Class AA Preferred Stock
and Class AB Preferred Stock will be entitled to vote on all matters voted on by
holders of Common Stock, voting together with the Common Stock as a single class
at all meetings of the stockholders, except that holders of Class ABII Preferred
Stock (if any) will not be entitled to vote in the election of directors
generally unless the market price of the Common Stock is less than $3.00 per
share. Each share of Class AA Preferred Stock will entitle its holder to cast
the number of votes equal to the number of votes which could be cast in such
vote by a holder of the number of shares of Common Stock into which such shares
of Class AA Preferred Stock is convertible based on a price of $6.00 per share.
Each share of Class AB Preferred Stock will entitle its holder to cast the
number of votes equal to the number of votes which could be cast in such vote by
a holder of the number of shares of Common Stock into which such share of Class
AB Preferred Stock is convertible based on a price of $5.25 per share. Upon its
purchase of $40,000,000 initial liquidation value (40,000 shares) of Class AA
Preferred Stock and $35,000,000 initial liquidation value (35,000 shares) of
Class AB Preferred Stock and 898,845 shares of Common Stock (from certain
stockholders), Prometheus will have acquired an aggregate of up to approximately
57% of the total voting power of the Company except with respect to the election
of directors generally. Such securities will have an aggregate of up to
approximately 48.6% of the total voting power of the Company with respect to the
election of directors generally (other than directors elected exclusively by
holders of Class AA and Class AB Preferred Stock), subject to increase to up to
approximately 57% if the market price of the Common Stock is less than $3.00 per
share (based on the same assumptions as above). Prometheus may acquire
additional voting power under certain circumstances including the conversion of
Class AA Preferred Stock following an adjustment of the conversion price, the
exercise of the 1,000,000 Warrants, subject to increase if the exercise price
and the number of shares of Common Stock into which each Warrant will convert
upon exercise are adjusted, and the exercise of the Contingent Warrants. Thus,
the Transactions will have the effect of diluting the voting power of the
existing stockholders.
CHANGE OF CONTROL
As described above, Prometheus will have substantial voting power from its
acquisition of securities in the Transactions, including the right to elect
under certain circumstances a majority of the Board, its Executive Committee and
other committees. The holders of Class AA Preferred Stock and Class AB Preferred
Stock will also have certain consent rights. To effect certain actions or
transactions the consent of the holders of at least 66 2/3% of each of the Class
AA Preferred Stock, the Class ABI Preferred Stock and the Class ABII Preferred
Stock will be required. Further, under the Company's amended certificate of
incorporation and bylaws, and the amended bylaws of the Company's subsidiaries,
the Company will not, and will not permit any of its subsidiaries to, engage in
or agree to engage in certain significant actions or transactions, without the
affirmative vote of over 81% of the Board ('Supermajority Director Approval') or
the affirmative vote of over 81% of the members of the Executive Committee
('Supermajority Executive Committee Approval'). Therefore, the Company will need
the approval of at least one of the three Preferred Stock Directors (together
with 12 non-Preferred Stock Directors) or the unanimous approval of the
Executive Committee, including two Preferred Stock Directors, to engage in
significant actions or transactions. As a result, Prometheus will have
substantial influence over, and could under certain circumstances exercise
effective control of, the direction and management of the Company and the
conduct of its business. There can be no assurance that the influence and
participation of Prometheus and the Preferred Stock Directors in the direction
and management of the Company will have a positive effect on the Company's
financial performance and condition.
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ANTI-TAKEOVER EFFECTS
Prometheus's representation on the Board and the Executive Committee, its
voting rights, its consent rights, the requirements of Supermajority Director
Approval and Supermajority Executive Committee Approval for certain significant
actions and transactions, the amendments to the certificate of incorporation
increasing the amount of authorized Common Stock and other aspects of the
Transactions could have anti-takeover effects. Such effects could include
deterring, delaying or preventing tender offers or other takeover proposals or
attempts that might result in benefits to stockholders including the payment to
stockholders of a premium over the market price of the Common Stock.
FORWARD-LOOKING STATEMENTS
This Proxy Statement includes 'forward-looking' statements that are subject
to risks and uncertainties. Such 'forward-looking' statements include (a) the
Company's ability to realize the business advantages and benefits expected to
result from the Company's use of the net proceeds from the Transactions
contemplated by the Stock Purchase Agreement, including (i) the expectation that
the Company will be able to use the net proceeds to improve its financial
condition and performance, (ii) the expectation that the availability of such
funds will enable the Company to make additional acquisitions of homebuilders,
and achieve additional market diversification and increased economies of scale
in purchasing power and spreading of overhead expenses in connection with such
additional acquisitions and (iii) the expectation that such additional
acquisitions or other uses of the net proceeds could have a positive impact on
the Company's earnings; (b) the possibility that Lazard's significant investment
in the Company could increase investors' awareness and interest in the Company;
(c) the possibility that, as a result of the expected benefits of the
Transactions, the market price of the Common Stock could increase, both directly
benefitting the Company's stockholders and enabling the Company to raise capital
in the future by additional public offerings of Common Stock; and (d) other
statements preceded by, followed by or that include the words 'believes,'
'expects,' 'intends,' 'anticipates,' 'potential' or other similar expressions.
For these statements, the Company claims the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995. The following important factors, in addition to those discussed
elsewhere in this Proxy Statement, could affect the Company's future results and
could cause those results to differ materially from those expressed in the
forward-looking statements: (a) the inability of the Company to identify or
acquire homebuilders meeting the Company's acquisition criteria; (b) the failure
of acquired homebuilders, the Whittaker Companies, which are subject to an
acquisition agreement, or the Company's existing operations, to perform at
anticipated levels; (c) the incurrence of unanticipated liabilities or other
adverse contingencies associated with the Company's acquired homebuilders, the
Whittaker Companies, or the Company's existing operations; (d) the competitive
environment in markets in which the acquired homebuilders, the Whittaker
Companies, or the Company's existing businesses operate; (e) fluctuations in
interest rates, which may effect the availability of financing to home
purchasers and also may affect the Company's cost of capital; (f) the
availability of capital; (g) changes in local, regional or national economic
conditions; (h) the availability and cost of labor and materials; (i) the effect
of government regulations; (j) the availability and cost of land; (k) changes in
home prices; and (l) adverse weather conditions.
THE TRANSACTIONS
BACKGROUND
The Company was founded on the belief that homebuilding is localized and is
most successfully managed by experienced and cycle-tested local managers who
have developed the in-depth market knowledge and strong local relationships
necessary to succeed in their local markets. Homebuilding, however, is a capital
intensive industry due to the need to fund land acquisition and development and
home construction, and local builders' capital structure and limited access to
capital is a perceived weakness in their operations. The Company's objective is
to combine experienced local homebuilders and to provide more capital, on better
terms, than would be available to the local homebuilders individually.
The Company intends to implement its objective of combining local
homebuilders through a long-term strategy of the selective acquisition of
established homebuilding companies. Management believes that, because
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of the fragmented nature of the homebuilding industry, there are significant
opportunities to acquire a number of existing homebuilding companies that
satisfy the Company's profitability, investment return and other criteria. The
Company intends to acquire homebuilding companies that the Company believes
should have a positive impact on the Company's earnings.
Since the Company's initial public offering in May 1996, the Company has
acquired a number of additional homebuilders. These acquisitions have been
financed by a combination of cash on hand, the issuance of preferred stock and
Common Stock and, to a limited extent, the incurrence of additional debt. The
acquisitions in 1997 included the following: On February 28, 1997, the Company
acquired the homebuilding assets of D.W. Hutson Construction Company, a
homebuilder in the Jacksonville, Florida area, for $9,000,000 in cash,
$1,200,000 liquidation value of the Company's Series B Preferred Stock and
approximately $8,500,000 in assumed debt. In addition, the Company agreed to
issue up to $6,000,000 liquidation value of the Company's Series C Preferred
Stock to be issued over a period of up to six years based upon the future
financial performance of the acquired business. Effective April 1, 1997, the
Company acquired the stock of Wilshire Homes, Inc. (and other related
interests), a homebuilding company operating in the areas of Austin and San
Antonio, Texas, for $2,900,000 in cash and Common Stock and approximately
$13,800,000 of assumed debt. On August 27, 1997, the Company acquired the stock
of Don Galloway Homes, Inc. (and other related interests), a homebuilding
company operating primarily in Charlotte, North Carolina and in Charleston,
South Carolina, for $5,000,000 in cash, a $5,000,000 note, $6,000,000
liquidation value of the Company's Series D Preferred Stock and an earn-out of
up to $5,000,000 which will be paid through the year 2000. In addition, the
Company assumed debt of approximately $18,600,000. Effective October 1, 1997,
the Company acquired the homebuilding assets of The Iacobucci Organization, a
homebuilder in the Philadelphia, Pennsylvania area, for $2,850,000 in cash,
approximately $13,900,000 of assumed debt, and an earn-out to be paid through
the year 2001.
Based upon the Company's long-term growth strategy and its rapid pace of
acquisition of homebuilders, the Company's management determined that it was
necessary to increase the Company's capital. After discussions with several
investment bankers and an evaluation of the market for the Common Stock,
management concluded that a private sale of equity or debt securities would more
likely be completed than a public offering. Management met with several
investment bankers and potential investors, and several of them expressed
interest in some level of investment in the Company. After evaluation of several
preliminary proposals and discussions with certain of the Company's directors,
management determined to pursue further its discussions with Lazard. This
determination was based particularly upon Lazard's expressed willingness to
invest $75,000,000 to $100,000,000 in the form of an equity investment.
In May 1997, representatives of Lazard and the Company discussed a
potential equity investment in the Company by Lazard or a controlled affiliate.
On May 21, 1997, management made an initial presentation to the Board describing
Lazard's preliminary proposal.
Following a series of meetings in late May and early June 1997, the
Company's management and Lazard developed a preliminary term sheet for a
proposed investment by Lazard in the Company. On June 4, 1997, Lazard made a
presentation to the Board with respect to the terms of the preliminary term
sheet. Following the presentation, the Board discussed the terms of the
preliminary term sheet. The Board unanimously approved the Company entering into
the preliminary term sheet with Lazard and authorized management to negotiate
definitive transaction documents with Lazard. The Board also authorized the
Company to reimburse up to $825,000 of Lazard's expenses in engaging counsel and
accountants to assist in the conduct of a thorough due diligence review of the
Company and engaging counsel to prepare drafts of the transaction documents.
During late June, July and August, Lazard and its representatives engaged
in an extensive due diligence review of the Company's operations and financial
condition. Lazard's counsel prepared drafts of proposed transaction documents,
and representatives of the Company and its counsel and representatives of Lazard
and its counsel engaged in numerous discussions and negotiations with respect to
the terms of the proposed transactions.
On August 13, 1997, management made a presentation to the Board with
respect to the proposed transactions, including the terms of the proposed
transactions and the variations of the transaction documents from the
preliminary term sheet. The Board unanimously approved the proposed transactions
and documents and authorized the Company's management to finalize and execute
the documents.
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The Company and Prometheus, an affiliate of Lazard, entered into a stock
purchase agreement dated as of August 14, 1997 (the 'August 14 Agreement').
Certain principal stockholders of the Company and Prometheus entered into a
stockholders voting agreement dated as of August 14, 1997. On August 15, 1997,
the Company announced the principal terms of the transactions under the August
14 Agreement.
Prior to entering into the August 14 Agreement, the Company requested the
advice of the staff of the Nasdaq Stock Market with respect to the compliance of
certain voting rights and other provisions included in the transactions with
applicable Nasdaq rules. On September 16, 1997, after discussions with the
Company's representatives, the Nasdaq staff advised the Company that the
transactions as described to the staff complied with the applicable rules,
provided that certain changes were made to the terms, including that (i) the
market price of the Common Stock included in the test for an Adverse Event (as
defined in the certificates of designations for the Class AA Preferred Stock and
Class AB Preferred Stock) must represent a significant decrease from the market
price at the time of the First Closing, (ii) an Adverse Event must not occur
prior to the Second Closing, (iii) in fixing the voting power of the Class AB
Preferred Stock on an 'as converted' basis, the number of votes must be
determined as if the conversion price were 100 percent of the market price of
the Common Stock immediately prior to the First Closing and (iv) the vote of the
preferred stock issued at the First Closing must not be counted in determining
the receipt of Stockholders Approval.
In addition, the Company and Prometheus, as contemplated by the August 14
Agreement, continued discussions as to the possibility of the issuance of the
interests of a limited liability company to be formed by the Company in lieu of
a portion of the Class ABI Preferred Stock.
The Company and Prometheus agreed to amend the August 14 Agreement to (a)
provide that Class AA Preferred Stock, rather than Class AB Preferred Stock,
would be issued at the First Closing, (b) provide for the possible issuance of
debt instruments through a limited liability company subsidiary formed by the
Company in lieu of all or a portion of the Class AB Preferred Stock, subject to
further negotiation between the Company and Prometheus, (c) revise certain
provisions in accordance with the comments of the Nasdaq staff and (d) revise
certain terms of the August 14 Agreement in other respects. The Company's
directors reviewed and approved the proposed amendments.
On September 30, 1997, the Company and Prometheus entered into an amended
and restated stock purchase agreement (the 'September 30 Agreement'). At the
First Closing effective September 30, 1997, Prometheus purchased 11,700 shares
of Class AA Preferred Stock and 375,000 Warrants for a purchase price of
$11,700,000. See 'Stock Purchase Agreement--First Closing.'
On January 5, 1998, the Company entered into an agreement to acquire
Whittaker Construction, Incorporated (and other related interests), a
homebuilding company operating in the area of St. Louis, Missouri, for
approximately $25,750,000 in cash and approximately $36,000,000 of assumed debt.
On February 19, 1998, the Company and Prometheus entered into an amendment
to the September 30 Agreement which revised the terms of the September 30
Agreement in certain respects.
CERTAIN EFFECTS OF THE TRANSACTIONS
The holders of Class AA Preferred Stock and Class AB Preferred Stock,
voting as a single class, will have the exclusive right to elect three directors
(each, a 'Preferred Stock Director') of a 15-member Board and a proportionate
number will serve on each committee of the Board, except for the Executive
Committee. The Executive Committee, which will have substantial operational
authority, will consist of five members of which two will be Preferred Stock
Directors. As the holder of 11,700 shares of Class AA Preferred Stock, which
were issued at the First Closing, Prometheus currently has the right to elect
three Preferred Stock Directors. Prometheus has not exercised such right as of
the date of this Proxy Statement and has informed the Company that Prometheus
does not intend to exercise such right until Stockholders Approval, although it
reserves the right to do so at any time.
After the Second Closing, upon the occurrence of an Adverse Event (as
defined), the holders of Class AA Preferred Stock and Class AB Preferred Stock,
voting as a single class, will be entitled to elect additional Preferred Stock
Directors sufficient to cause the Preferred Stock Directors to constitute a
majority of the Board
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and all committees of the Board, including the Executive Committee. See 'Stock
Purchase Agreement--Class AA Preferred Stock--Voting Rights' and '--Class AB
Preferred Stock--Voting Rights.'
In addition, holders of Class AA Preferred Stock and holders of Class AB
Preferred Stock will be entitled to vote on all matters voted on by holders of
Common Stock, voting together with the Common Stock as a single class at all
meetings of the stockholders, except that holders of Class ABII Preferred Stock
(if any) will not be entitled to vote in the election of directors generally
unless the market price of the Common Stock is less than $3.00 per share. Each
share of Class AA Preferred Stock will entitle its holder to cast the number of
votes equal to the number of votes which could be cast in such vote by a holder
of the number of shares of Common Stock into which such share of Class AA
Preferred Stock is convertible based on the Mandatory Conversion Price (as
defined) of $6.00 per share. Each share of Class AB Preferred Stock will entitle
its holder to cast the number of votes equal to the number of votes which could
be cast in such vote by a holder of the number of shares of Common Stock into
which such share of Class AB Preferred Stock is convertible based on the closing
trading price of the Common Stock on the day immediately preceding the First
Closing, which price was $5.25 per share.
Upon consummation of the Second Closing (as defined), Prometheus will have
purchased an aggregate of $40,000,000 initial liquidation value (40,000 shares)
of Class AA Preferred Stock. In addition, Prometheus will have purchased an
aggregate of 898,845 shares of Common Stock from certain stockholders. The
securities acquired by Prometheus will have an aggregate of up to approximately
41% of the total voting power of the Company (based on the Mandatory Conversion
Price (as defined) of $6.00 per share for the Class AA Preferred Stock and
assuming no other issuances of Common Stock or securities convertible into
Common Stock are effected and no Warrants, Contingent Warrants or options have
been exercised). Upon consummation of all of the Subsequent Purchases by
December 31, 1998, Prometheus will have purchased an aggregate of $40,000,000
initial liquidation value (40,000 shares) of Class AA Preferred Stock and
$35,000,000 initial liquidation value (35,000 shares) of Class AB Preferred
Stock, plus 898,845 shares of Common Stock. Such securities will have an
aggregate of up to approximately 57% of the total voting power of the Company
except with respect to the election of directors generally. Such securities will
have an aggregate of up to approximately 48.6% of the total voting power of the
Company with respect to the election of directors generally (other than
directors elected exclusively by holders of Class AA and Class AB Preferred
Stock), subject to increase to up to approximately 57% if the market price of
the Common Stock is less than $3.00 per share (based on the same assumptions as
above). If the conversion price of the Class AA Preferred Stock is adjusted at
the option of the holders between September 30, 2001 and September 30, 2003,
then the voting power of the holders would increase. See 'Stock Purchase
Agreement--Class AA Preferred Stock--Voting Rights;' '--Class AB Preferred
Stock--Voting Rights;' '--Second Closing;' '--Subsequent Closings;' and
'--Apportionment of Class AB Preferred Stock.'
Upon consummation of the first Subsequent Purchase, Prometheus will have
acquired Warrants to purchase 1,000,000 shares of Common Stock (subject to
adjustment) at an initial exercise price of $7.00 per share (subject to
adjustment). The Warrants will be exercisable between September 30, 1999, and
September 30, 2004. If Prometheus exercises the Warrants, its total voting power
would increase. If the exercise price and the number of shares of Common Stock
into which the Warrants will convert upon exercise are adjusted between
September 30, 2001 and September 30, 2003, and Prometheus thereafter exercises
the Warrants, then its voting power would further increase. See 'Stock Purchase
Agreement--Warrants.'
Also upon consummation of the first Subsequent Purchase, Prometheus will
have acquired Contingent Warrants to purchase between 380,952 and 5,714,286
shares of Common Stock in certain circumstances at an exercise price of $.01 per
share. The Contingent Warrants will be exercisable if between September 30,
2001, and September 30, 2003 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. If Prometheus exercises the Contingent Warrants, its total
voting power would increase. See 'Stock Purchase Agreement--Contingent
Warrants.'
The holders of the Class AA Preferred Stock and the holders of Class AB
Preferred Stock will also have certain consent rights. The consent of the
holders of at least 66 2/3% of each of the Class AA Preferred Stock, the Class
ABI Preferred Stock and the Class ABII Preferred Stock will be necessary to
effect or validate certain
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actions or transactions. See 'Stock Purchase Agreement--Preferred Stock--Consent
Rights' and '--Class AB Preferred Stock--Consent Rights.'
Further, under the Company's amended certificate of incorporation and
bylaws, and the amended bylaws of the Company's subsidiaries, the Company will
not, and will not permit any of its subsidiaries to, engage in or agree to
engage in certain significant actions or transactions, without either the
affirmative vote of over 81% of the directors ('Supermajority Director
Approval') or the affirmative vote of over 81% of the members of the Executive
Committee ('Supermajority Executive Committee Approval'). Therefore, the Company
will need the approval of at least one of the three Preferred Stock Directors on
the Board (together with 12 non-Preferred Stock Directors) or the unanimous
approval of the Executive Committee, which will include two Preferred Stock
Directors, to undertake such significant actions or transactions, which may
include the use of proceeds from the Transactions for acquisitions or other
purposes. See 'Stockholders Agreement--Conduct of Business' and '--Certificate
of Incorporation and Bylaws Amendments.'
As a result of the foregoing, upon consummation of the Second Closing
Prometheus or its transferees will have substantial influence over, and could
under certain circumstances exercise effective control of, the direction and
management of the Company and the conduct of its business.
Prometheus's representation on the Board and the Executive Committee, its
voting rights, its consent rights and the requirements of Supermajority Director
Approval and Supermajority Executive Committee Approval for certain significant
actions and transactions and other aspects of the Transactions, including the
amendments to the certificate of incorporation increasing the number of
authorized shares of Common Stock, could have certain anti-takeover effects,
including deterring, delaying or preventing tender offers or other takeover
proposals or attempts that might result in the payment to stockholders of a
premium over the market price of the Common Stock. The Company, however, did not
enter into, and does not view, the Stock Purchase Agreement, the Stockholders
Voting Agreement, the Stockholders Agreement, the other Ancillary Agreements,
and the Transactions as an anti-takeover measure. The Board is not aware of any
current effort by any person or group to obtain control of the Company.
The Board expects the Transactions to result in substantial benefits for
the Company and its stockholders. The Transactions, however, could have the
effect of diluting the economic interests and will have the effect of diluting
the voting rights, of the existing stockholders. The Company expects to benefit
from the participation of Prometheus's designees on the Board and the Executive
Committee and other committees; however, there can be no assurances regarding
the effect that the influence and participation of Prometheus and the Preferred
Stock Directors in the direction and management of the Company will have on the
Company's financial performance and condition.
USE OF PROCEEDS
The Company expects the aggregate net proceeds from the sale of the
$40,000,000 initial liquidation value (40,000 shares) of Class AA Preferred
Stock, the $35,000,000 initial liquidation value (35,000 shares) of Class AB
Preferred Stock, the Warrants and the Contingent Warrants to be approximately
$72,000,000, after payment of related fees and expenses. The Stock Purchase
Agreement does not restrict the Company's use of proceeds from the Transactions
and, accordingly, the Company may use the net proceeds for any business purpose
consistent with the fiduciary duties of the Company's directors and officers.
The Company currently expects to use such net proceeds primarily for the
selective acquisition of established homebuilding companies. However, the
Company may decide to use proceeds from the Transactions for other purposes
although the Company currently has no specific plan to do so. The Company does
not intend to use the proceeds from the Transactions to pay or refinance its
operating lines of credit which are used to finance the acquisition and
development of land and construction of homes. Pending such uses, net proceeds
may be invested in short-term income producing investments.
In evaluating potential acquisitions of homebuilders, the Company seeks
transactions in which the financial results of the acquired company are expected
to be accretive to the Company's earnings per share and financial ratios, both
on an historical pro forma basis and on a prospective basis. In addition, the
Company seeks homebuilders that are expected to provide strong local management
committed to working with the Company and are intended to add geographic and/or
product diversification.
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On August 27, 1997, the Company completed the acquisition of Don Galloway
Homes, Inc. and related interests ('Galloway'), a homebuilding company operating
primarily in Charlotte, North Carolina and in Charleston, South Carolina, for a
total transaction price of up to $21,000,000, consisting of $5,000,000 in cash,
a $5,000,000 note bearing interest at one percent per annum over the prime rate
and initially due on September 30, 1997, $6,000,000 in newly-issued zero
dividend convertible and redeemable Series D preferred stock, and an earn-out of
up to $5,000,000 which will be paid through the year 2000. In addition, the
Company assumed debt of approximately $18,600,000. For the fiscal year ended
June 30, 1997, Galloway delivered approximately 470 homes, generating gross
revenues of $66,000,000 and pre-tax profit of approximately $7,800,000. As of
June 30, 1997, Galloway had a backlog of 235 homes under contract with an
aggregate value of approximately $33,000,000. Proceeds from the First Closing
were used to pay the above-referenced note and to repay advances made for the
purchase of Galloway under working capital lines maintained by several of the
Company's subsidiaries. Advances under these lines bear interest at floating
rates between one-half and two points above the lenders' prime rates, and
borrowings under the lines mature annually.
On November 26, 1997, the Company completed the acquisition of The
Iacobucci Organization, a homebuilder in the Philadelphia, Pennsylvania, area
for $2,850,000 in cash, approximately $13,900,000 of assumed debt, and an
earn-out to be paid through the year 2001. For 1997, the Iacobucci business is
expected to deliver approximately 175 homes, and to generate gross revenues of
approximately $26,700,000 and pre-tax profit of approximately $1,600,000. As of
September 30, 1997, Iacobucci had a backlog of 59 homes under contract with an
aggregate value of approximately $9,700,000. A portion of the proceeds from the
First Closing were used to pay part of the purchase price of Iacobucci.
On January 5, 1998, the Company entered into an agreement to acquire
Whittaker Construction, Incorporated and related entities (the 'Whittaker
Companies'), a homebuilding company in St. Charles County, Missouri, a suburb of
St. Louis. The purchase price is approximately $25,750,000 in cash. In addition,
the Company will assume approximately $36,000,000 of debt. For the nine months
ended September 30, 1997, the Whittaker Companies delivered 435 homes and
generated gross revenues of approximately $66,600,000 and pre-tax profit of
approximately $3,800,000. As of December 31, 1997, the Whittaker Companies had a
backlog of 218 homes under contract with an aggregate value of approximately
$38,000,000. The Company intends to use the proceeds from the Second Closing to
fund the purchase price of the Whittaker Companies. The Company, however, is not
required to use the proceeds to acquire the Whittaker Companies, and the closing
of the acquisition of the Whittaker Companies is not a condition to the Second
Closing. See 'Acquisition of Whittaker Companies.'
The Company continues to evaluate potential acquisitions of homebuilding
companies. Other than as described above, the Company has not made any
determination to use net proceeds.
RECOMMENDATION OF THE BOARD; REASONS FOR THE TRANSACTIONS
The Board believes that the Transactions are advisable and in the best
interests of the Company and its stockholders, and accordingly, the Board
unanimously recommends to the stockholders that they vote their Common Stock in
favor of the Transactions. Certain principal stockholders who are members of the
Board and who own in the aggregate Common Stock having a majority of the votes
entitled to be cast at the Special Meeting have agreed to vote in favor of the
Transactions and, accordingly, the Transactions can be approved without the vote
of any other stockholders. See 'Stockholders Voting Agreement.' As of the Record
Date, Prometheus was the owner of 11,700 shares of Class AA Preferred Stock,
which entitles Prometheus to cast 1,950,000 votes at the Special Meeting. Under
the Stock Purchase Agreement, Prometheus will not vote on the proposal to
approve the Transactions.
As part of its review in respect of the Transactions, the Board considered
(a) information concerning the Company's financial performance, condition,
business operations and prospects; (b) the proposed terms and conditions of the
Transactions documents and the Transactions; (c) the negotiations that led to
the terms and conditions of the Transactions documents; (d) management's
assessment of the other preliminary proposals for financing received by the
Company; (e) the likelihood of completion of the Transactions; (f) the dilutive
effect on the outstanding Common Stock, including the potential downward
adjustment of the conversion price of the Class AA Preferred Stock, the issuance
of the Warrants and the exercise thereof for Common Stock, including the
potential adjustments to increase the number of shares issuable upon exercise
and to decrease the exercise
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price, and the issuance of the Contingent Warrants and the possible exercise
thereof for Common Stock; (g) the business advantages and benefits expected to
result from the Company's use of the net proceeds from the Transactions,
including the expectation that the Company's financial condition and performance
will be improved by the use of the net proceeds and that the availability of
such funds will enable the Company to make additional acquisitions, including
the Whittaker Companies, which the Company believes could have a positive impact
on the Company's earnings; (h) the potential effect of the Transactions on the
Company's earnings and earnings per share; (i) the possibility that Lazard's
significant investment in the Company could increase investors' awareness and
interest in the Company; and (j) the possibility that, as a result of the
expected benefits of the Transactions, the market price of the Common Stock
could increase, both directly benefitting the Company's stockholders and
enabling the Company to raise capital in the future by additional public
offerings of Common Stock. The Board also noted Lazard's agreement to purchase
Common Stock from certain of the Company's principal stockholders, providing
these stockholders with liquidity for a portion of their shares, which benefit
had been anticipated in connection with the Company's initial public offering
but had not been realized to date.
The Board believes that the Transactions are in the best interest of the
Company and its stockholders for the following reasons:
The Board believes that a key to the Company's long-term success is
continuing growth through acquisitions. Growth will allow additional market
diversification and increased economies of scale in purchasing power and
spreading of overhead expenses. The availability of the funds from the
Transactions will enable the Company to make additional acquisitions, including
the Whittaker Companies, which the Board believes should have a positive impact
on the Company's earnings.
The Board believes that the Transactions should increase investors'
awareness and interest in the Company. This may increase the trading market for
the Common Stock and may facilitate additional public offerings of the Common
Stock in the future.
The Board believes that the Company's cost of funds from the Transactions
is favorable as compared to the other options available to and considered by the
Company. Lazard's willingness to permit the Transactions to be completed in a
series of closings should permit funding to be coordinated with acquisition
closings and help avoid underutilization of the invested funds. Also, the
Transactions, as private transactions, permit completion on a rapid schedule.
The Board considered that the 'exclusivity' provisions of the Stock
Purchase Agreement preclude the Company during a specified period of time from
soliciting alternative transactions. See 'Stock Purchase Agreement--No
Solicitation.' The Stock Purchase Agreement provides, however, that the Company
may furnish information to, and enter into discussions or negotiations with, any
party that makes an unsolicited bona fide proposal to consummate an alternative
transaction, if the Company receives written advice of outside legal counsel
that such action is advisable to enable the Board to comply with its fiduciary
duties, the Company provides written notice to Lazard and the third party enters
into a customary confidentiality agreement with such third person. The Board
also noted that the Stock Purchase Agreement provides for the payment by the
Company on the closing dates of Lazard's fees and expenses in connection with
the Transactions. The Board further noted that the Stock Purchase Agreement
provides for the payment of a $4,000,000 termination fee to Lazard as liquidated
damages if the Stock Purchase Agreement is terminated under certain
circumstances prior to the Second Closing. See 'Stock Purchase Agreement--Fees
and Expenses.' The Board concluded that Lazard would not enter into the Stock
Purchase Agreement without those provisions. The Board concluded that, while the
existence of the termination fee and transaction expense provisions might reduce
the likelihood that a third party would propose an alternative transaction, the
Company had determined that it was unlikely that the Company would receive any
further third party proposals or that any such proposal would be more favorable
to the Company than the Transactions.
In considering the Transactions, the Board acknowledged that there are
certain risks and costs associated with the Transactions, including (a) the
possibility that the potential benefits to the Company and the stockholders may
not be realized,and that the Company's financial condition and performance may
not improve by using the net proceeds including that the Company may not succeed
in making timely acquisitions of additional homebuilders or that the
acquisitions may not have a positive impact on the Company's earnings;
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(b) the dilutive effect on the outstanding Common Stock, including the potential
downward adjustment of the conversion price of the Class AA Preferred Stock, the
issuance of the Warrants and the exercise thereof for Common Stock, including
the potential adjustments to increase the number of shares issuable upon
exercise and to decrease the exercise price, and the issuance of the Contingent
Warrants and the possible exercise thereof for Common Stock; (c) the possibility
that the cost to the Company of the securities may exceed the income from the
acquisitions of additional homebuilders; and (d) the possibility that the Second
Closing may not occur, resulting in the payment of a termination fee to Lazard,
the reduction of the exercise price of the Warrants and a potential adverse
effect on the market price of the Common Stock.
The Board concluded that the expected benefits and advantages described
above, and the likelihood of realizing such benefits, outweighed the risks,
costs and disadvantages. In view of the wide variety of factors considered in
connection with its evaluation of the Transactions, the Board did not find it
practical to, and did not, quantify or otherwise attempt to assign relative
weights to the specific factors considered in reaching its determination.
The Board unanimously recommends that stockholders vote 'FOR' the
Transactions.
CONSEQUENCES IF THE TRANSACTIONS ARE NOT CONSUMMATED
If the Stock Purchase Agreement is terminated under certain conditions
prior to the Second Closing (other than as a result of a material breach by
Prometheus of its representations, warranties or obligations thereunder), then,
in addition to any other rights of Prometheus thereunder, the Company will be
obligated to pay Prometheus a termination fee in the amount of $4,000,000 plus
the reasonable fees and expenses incurred by Prometheus estimated in the
approximate amount of $1,750,000. See 'Stock Purchase Agreement--Fees and
Expenses.' In addition, if the Stock Purchase Agreement is terminated prior to
the Second Closing, other than as a result of a material breach by Prometheus of
its representations, warranties or obligations thereunder, the exercise price of
each outstanding Warrant will immediately be reduced to $0.01 per share.
Further, if the Second Closing does not occur, the dividend rate on the Class AA
Preferred Stock will remain 12% per annum and the Company will not have the
right to require conversion of the Class AA Preferred Stock into Common Stock.
See 'Stock Purchase Agreement--Warrants--Adjustment of Exercise Price and Number
of Warrant Shares' and '--Class AA Preferred Stock--Dividends.'
If the Company does not obtain an extension of the closing date for the
Whittaker acquisition until at least March 6, 1998 or obtain bridge financing
for the acquisition, the Company will forfeit the $500,000 deposit paid with
respect to the acquisition and immediately recognize previously capitalized
acquisition expenses of approximately $185,000. The Company would also forfeit
the deposit and recognize such expenses if the Second Closing were not to occur
on or before any extended closing date for the Whittaker acquisition.
ABSENCE OF APPRAISAL RIGHTS
Under Delaware law, objecting stockholders will have no appraisal,
dissenters' or similar rights (i.e., the right to seek a judicial determination
of the 'fair value' of the Common Stock and to compel the Company to purchase
their Common Stock for cash in that amount) with respect to matters presented at
the Special Meeting or otherwise with respect to the Transactions, nor will the
Company voluntarily accord such rights to stockholders.
Therefore, approval by the requisite number of shares of the matters
presented at the Special Meeting will bind all stockholders and objecting
stockholders will be able to liquidate their Common Stock only by selling it in
the market.
INTERESTS OF CERTAIN PERSONS IN THE TRANSACTIONS
In considering the Board's recommendation to vote in favor of the
Transactions, stockholders should consider that the Company's directors and
officers have certain interests in the Transactions that are different from, or
in addition to, the interests of stockholders generally. The Company is
submitting for approval of the stockholders and, pursuant to the Stockholders
Agreement, Prometheus will vote in favor of, a proposal to increase the number
of shares of Common Stock available for grant under the 1996 Stock Incentive
Plan. See 'Proposal to Authorize an Increase in the Common Stock Subject to the
Company's 1996 Stock Incentive Plan.' In addition, Prometheus has entered into
agreements dated as of February 18, 1998 to purchase from certain
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stockholders (the 'Selling Stockholders'), an aggregate of 898,845 shares of
Common Stock owned by such stockholders for a purchase price of $5.50 per share,
an aggregate purchase price of $4,943,648. The Selling Stockholders, the number
of shares to be sold, and the sales price are: Thomas Buffington, 284,685
shares, $1,565,768; J. Christopher Stuhmer, 181,818 shares, $999,999; James M.
Giddens, 142,342 shares, $782,881; Theodore Kirkpatrick, 125,000 shares,
$687,500; Lawrence J. Witek, 90,000 shares, $495,000; and Lanold W. Caldwell,
75,000 shares, $412,500. Messrs. Buffington, Stuhmer and Witek are directors of
the Company. Messrs. Buffington, Stuhmer, Giddens, Witek and Caldwell are
parties to the Stockholders Agreement (see 'Stockholders Agreement') and the
Stockholders Voting Agreement (see 'Stockholders Voting'). The purchase by
Prometheus of such shares will be concurrent with the Second Closing. Further,
one of the Company's directors is a director of Furman Selz LLC ('Furman Selz'),
which will be paid an investment banking fee in connection with the
Transactions.
EXPENSES OF THE TRANSACTIONS
The Company expects to incur fees and expenses incident to the Transactions
of approximately $3,000,000, including (a) reimbursement of fees and expenses
incurred by Lazard of approximately $1,750,000, of which approximately
$1,031,000 has been paid to date, and (b) legal fees, an investment banking fee
to be paid to Furman Selz, and other expenses. See 'Stock Purchase
Agreement--Fees and Expenses.'
STOCK PURCHASE AGREEMENT
Purchase and Sale of Securities. Subject to the terms and conditions of
the Stock Purchase Agreement, Prometheus will purchase from the Company, and the
Company will issue and sell to Prometheus, for an aggregate purchase price of
$75,000,000 (a) an aggregate of 40,000 shares, having an initial liquidation
value of $40,000,000, of Class AA Preferred Stock; (b) an aggregate of 35,000
shares, having an initial liquidation value of $35,000,000, of Class AB
Preferred Stock, (c) Warrants to purchase up to an aggregate of 1,000,000 shares
of Common Stock, subject to adjustment in certain circumstances, and (d) the
Contingent Warrants to purchase between 380,952 and 5,714,286 shares of Common
Stock in certain circumstances. 'Class AB Preferred Stock' means the Class ABI
Preferred Stock and the Class ABII Preferred Stock.
First Closing. Effective September 30, 1997, Prometheus purchased from the
Company 11,700 shares, having an initial liquidation value of $11,700,000 of
Class AA Preferred Stock and 375,000 Warrants (the 'First Closing') for an
aggregate purchase price of $11,700,000. The First Closing was not conditioned
on Stockholders Approval (defined below).
Pursuant to the September 30 Agreement, at the First Closing the Company
and Prometheus entered into the Warrant Agreement, the Stockholders Agreement
and the Registration Rights Agreement (the 'Ancillary Agreements'), all of which
are described below. See 'Warrants;' 'Stockholders Agreement;' and 'Registration
Rights Agreement.' In addition, certain principal stockholders of the Company
and Prometheus entered into an Amended and Restated Stockholders Voting
Agreement.
Second Closing. Subject to the terms and conditions of the Stock Purchase
Agreement, including Stockholders Approval, at a second closing, Prometheus will
purchase from the Company 28,300 shares, having an initial liquidation value of
$28,300,000, of Class AA Preferred Stock, for an aggregate purchase price of
$28,300,000 (the 'Second Closing'). 'Stockholders Approval' means approval by
the record holders of the requisite number of shares of outstanding Common Stock
of all items necessary to effectuate the transactions contemplated by the Stock
Purchase Agreement and the Ancillary Agreements. Stockholders Approval is
assured because certain principal stockholders who hold in the aggregate Common
Stock having a majority of the votes entitled to be cast at the Special Meeting
have agreed to vote in favor of the Transactions. See 'Stockholders Voting
Agreement' and 'Stockholders Approval.' Under the Stock Purchase Agreement, the
Second Closing is to occur no later than March 6, 1998.
Upon the consummation of the Second Closing, Prometheus for a price of
$40,000,000 will have purchased 40,000 shares, having an initial liquidation
value of $40,000,000, of Class AA Preferred Stock and Warrants for 375,000
shares of Common Stock.
Subsequent Closings. Subject to the terms and conditions of the Stock
Purchase Agreement, following the Second Closing, the Company will sell to
Prometheus, from time to time at one or more subsequent closings, an
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aggregate of 35,000 shares, having an initial liquidation value of $35,000,000,
of Class AB Preferred Stock, and apportioned between the Class ABI Preferred
Stock and the Class ABII Preferred Stock as described below, Warrants for
625,000 shares of Common Stock and the Contingent Warrants, for an aggregate
purchase price of $35,000,000 (the 'Subsequent Purchases'). At least 20 business
days prior to any Subsequent Purchase, the Company is obligated to notify
Prometheus of the anticipated date of the subsequent closing and the number of
shares of Class AB Preferred Stock the Company is requiring Prometheus to
purchase, which will not be fewer than $10,000,000 aggregate purchase price of
the securities unless such purchase is of the balance of the securities. The
Company will be obligated to require Prometheus to make all of the Subsequent
Purchases on or before December 31, 1998. Warrants for 625,000 shares and the
Contingent Warrants will be issued to Prometheus at the first Subsequent
Purchase to occur after the Second Closing. Thereafter, if Prometheus defaults
in any of its obligations to fund Subsequent Purchases (other than because of a
default of the Company), Prometheus is required to redeliver to the Company for
cancellation all Warrants (but not the Contingent Warrants) received in excess
of one Warrant for every $75 of the amount of Liquidation Preference (defined
below) of preferred stock issued under the Stock Purchase Agreement.
The Stock Purchase Agreement provides that no Subsequent Purchase shall
occur within six months following the date of the Second Closing without the
consent of Prometheus. Further, the Stock Purchase Agreement provides that if
Prometheus consents to a merger of the Company with a bona fide third party in
an arm's length transaction such that following the merger more than 51 percent
of the Common Stock is owned by such third party, the Company would have the
right to be released from its obligations to sell to Prometheus the
then-unissued balance of the Class AB Preferred Stock. The Company is not
engaged in any negotiations with a third party with respect to the sale of a
majority of the Common Stock nor is the Company aware of any effort by a third
party to acquire a majority of the Common Stock.
Upon the consummation of all of the Subsequent Purchases, Prometheus will
have purchased 40,000 shares, having an initial liquidation value of
$40,000,000, of Class AA Preferred Stock, 35,000 shares, having an initial
liquidation value of $35,000,000, of Class AB Preferred Stock, Warrants for
1,000,000 shares of Common Stock and the Contingent Warrants, for an aggregate
price of $75,000,000.
Further Purchases. Provided that all Subsequent Purchases have been sold
to Prometheus, the Company may, at its option, request, on not less than 30
business days notice, that Prometheus purchase in the aggregate from the
Company, in proportionate amounts and on terms otherwise identical to the terms
of the securities referred to above, up to an additional 13,333 shares, having
an initial liquidation value of $13,333,000, of Class AA Preferred Stock, up to
an additional 11,667 shares, having an initial liquidation value of $11,667,000,
of Class AB Preferred Stock and up to an additional 333,250 Warrants (a 'Further
Purchase'), for an aggregate purchase price of up to $25,000,000. Prometheus
may, in its sole discretion, agree to or refuse any such request for a Further
Purchase.
Right of First Refusal. Prometheus will have a right of first refusal with
respect to any bona fide offer to purchase up to $25,000,000 of equity capital
of the Company. Prometheus must respond to such offer within 30 days and if it
does not accept such offer, the Company may proceed with such issuance but is
prohibited from raising such capital on terms materially less favorable to the
Company without first offering the securities again to Prometheus.
CLASS AA PREFERRED STOCK. The following is a summary of the preferences,
powers and rights of the Class AA Preferred Stock set forth in a proposed
amended Certificate of Designations, Preferences and Relative Participating,
Optional and Other Special Rights of Preferred Stock and Qualifications,
Limitations and Restrictions Thereof ('Class AA Certificate of Designations').
The original Class AA Certificate of Designations was filed with the Delaware
Secretary of State in connection with the First Closing. See 'Certificate of
Incorporation and Bylaws Amendments--Amendment of Class AA Certificate of
Designations.'
Number of Shares. The number of authorized shares of Class AA Preferred
Stock will be 53,333 shares.
Rank. With respect to dividends and distributions upon liquidation,
dissolution or winding up of the Company, the Class AA Preferred Stock will rank
equally with any Parity Stock and senior to the Common Stock and any other
equity or other securities into which any convertible indebtedness is
convertible which are issued by the Company. 'Parity Stock' means (a) the Series
A Cumulative Convertible Preferred Stock, (b) the Series B Convertible Preferred
Stock, (c) the Series C Convertible Preferred Stock, (d) the Series D
Convertible
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Redeemable Preferred Stock, (e) the Class ABI Preferred Stock, (f) the Class
ABII Preferred Stock, and (g) any class or series of stock of the Company
authorized after the date that the Company first issues (the 'Initial Issue
Date') the Class AA Preferred Stock which is entitled to receive payment of
dividends, or assets upon liquidation, dissolution or winding up of the Company,
on a parity with the Class AA Preferred Stock. See 'Certificate of Incorporation
and Bylaws Amendments' with respect to the shares of Series A, Series B, Series
C, Series D and Series E Preferred Stock authorized, issued and outstanding.
Dividends. The record holders of Class AA Preferred Stock will be entitled
to receive dividends, when and as declared by the Board, out of funds legally
available for payment of dividends. Such dividends will be payable
in cash at the annual rate of 12% of the Liquidation Preference until such time,
if any, as the Second Closing occurs. If the Second Closing occurs, such
dividends will be payable in cash from and after the Second Closing at the
annual rate of 6% of the Liquidation Preference. 'Liquidation Preference' means
$1,000 per share. Dividends on shares of Class AA Preferred Stock will accrue
and be cumulative from the date of issuance of such shares. Dividends will be
payable quarterly in arrears when and as declared by the Board on March 31, June
30, September 30 and December 31 of each year (a 'Dividend Payment Date'),
commencing on December 31, 1997. For any Dividend Period in which dividends are
not paid in full on the Dividend Payment Date first succeeding the end of such
Dividend Period, then such accrued and unpaid dividends will be added (solely
for the purpose of calculating dividends payable on the Class AA Preferred
Stock) to the Liquidation Preference of the Class AA Preferred Stock effective
at the beginning of the Dividend Period succeeding the Dividend Period as to
which such dividends were not paid and will thereafter accrue additional
dividends at the applicable dividend rate until such accrued and unpaid
dividends have been paid in full. 'Dividend Period' means the period from, and
including, the Initial Issue Date to, but not including, the first Dividend
Payment Date and thereafter, each quarterly period from, and including, the
Dividend Payment Date to, but not including, the next Dividend Payment Date.
The Company will be required to declare and pay dividends at the applicable
dividend rate on each Dividend Payment Date to the extent that funds are legally
available for declaration of such dividends. If full dividends are not paid to
the holders of Class AA Preferred Stock and of any Parity Stock with respect to
any Dividend Period and funds available for payment of dividends are
insufficient to permit payment in full to holders of all such stock, then the
entire amount legally available for payment of dividends will be distributed
ratably among all such holders of Class AA Preferred Stock and of any Parity
Stock. The dividends payable in respect of the Class AA Preferred Stock will be
a mandatory obligation to the Company, subject only to the limitations set forth
in the Delaware General Corporation Law with respect to funds legally permitted
to be used for the payment of dividends.
While any Class AA Preferred Stock is outstanding, (a) the Company will not
declare, pay or set apart for payment on any Junior Stock any dividends (other
than dividends payable in shares of the class or series upon which such
dividends are declared or paid, or payable in shares of Common Stock with
respect to Junior Stock other than Common Stock, together with cash in lieu of
fractional shares), (b) the Company will not make any distribution on any Junior
Stock, (c) the Company or any of its majority-owned subsidiaries will not
purchase, redeem or otherwise acquire any Junior Stock, and (d) no money will be
paid or made available for a sinking fund for the purchase or redemption of any
Junior Stock, unless all dividends to which the holders of Class AA Preferred
Stock will have been entitled for all previous Dividend Periods have been paid
or declared and a sum of money sufficient for such payment has been set apart.
'Junior Stock' means the Common Stock, other Common Equity and any class or
series of stock of the Company authorized after the Initial Issue Date which is
not entitled to receive any dividends in any Dividend Period unless all
dividends required to have been paid or declared and set apart for payment on
the Class AA Preferred Stock and on any Parity Stock have been so paid or
declared and set apart for payment or which is not entitled to receive any
assets upon liquidation, dissolution or winding up of the Company until the
Class AA Preferred Stock and any Parity Stock have received the entire amount to
which such stock is entitled upon such liquidation, dissolution or winding up.
'Common Equity' means all shares of any class of common stock of the Company,
including the Common Stock, and any other stock of the Company authorized after
the Initial Issue Date, which has the right to participate in the distribution
of the assets and earnings of the Company without limit as to per share amount.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or other winding up of the Company, before any payment
or distribution will be made to the holders of Junior Stock, the
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holders of Class AA Preferred Stock will be entitled to be paid out of the
Company's assets in cash or property at its fair market value as determined by
the Board, the Liquidation Preference per share plus an amount equal to all
dividends accrued and unpaid thereon to the date of such liquidation,
dissolution or such other winding up. If, upon any such liquidation, dissolution
or other winding up of the Company the Company's assets are insufficient to
permit the payment in full of the Liquidation Preference per share plus an
amount equal to all dividends accrued and unpaid on the Class AA Preferred Stock
and the full liquidating payments on all Parity Stock, then the Company's assets
will be ratably distributed among the holders of Class AA Preferred Stock and
any Parity Stock in proportion to the full amounts to which they would otherwise
be respectively entitled if all amounts thereon were paid in full. For the
purposes of the foregoing, neither the consolidation or merger of the Company
into or with another entity or entities, nor the sale, lease, transfer or
conveyance of all or substantially all of the Company's assets to another
entity, will be deemed a liquidation, dissolution or winding up of the Company.
Conversion. Holders of shares of Class AA Preferred Stock will have the
right at any time after the Initial Issue Date to convert such shares into
Common Stock at the then prevailing Optional Conversion Price. 'Optional
Conversion Price' means initially $6.00 per share subject thereafter to
adjustment at the option of the holder during the period between September 30,
2001 and September 30, 2003 (the 'Adjustment Period'). A holder of Class AA
Preferred Stock will have the right during the Adjustment Period to elect to
adjust up to five times per year the Optional Conversion Price for the Class AA
Preferred Stock held by such holder (an 'Election'), by reference to the then
prevailing Adjustment Price as follows:
<TABLE>
<CAPTION>
ADJUSTMENT PRICE(S)
OPTIONAL CONVERSION PRICE(S)
- -------------------------- ----------------------------
<S> <C>
$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
</TABLE>
'Adjustment Price' means, on any date of determination, the average of the
closing prices of the Common Stock over the 60 day period prior to such date. If
and when the Company makes any adjustment to the Conversion Prices as referred
to below (the 'Antidilution Adjustments'), the Company will make a like
adjustment to the Adjustment Prices set forth above.
After the date of the Second Closing (if any), at any time during a period
when the Average Trading Price is equal to or exceeds $12.00, subject to the
Antidilution Adjustments referred to below, the Company will have the right to
convert all, but not less than all, of the Class AA Preferred Stock outstanding
at such time into Common Stock at the then prevailing Mandatory Conversion
Price, provided that on the mandatory conversion date, the Company will have
paid all accrued dividends on all shares of Class AA Preferred Stock then
outstanding (a 'Mandatory Conversion'). 'Average Trading Price' means, on any
date of determination, the average of the closing prices of the Common Stock
over the 90 day period prior to such date. 'Mandatory Conversion Price' means
initially $6.00 per share subject thereafter to the Antidilution Adjustments
referred to below. For the purposes of conversion, each share of Class AA
Preferred Stock will be valued at the Liquidation Preference plus all accrued
but unpaid dividends thereon through the relevant conversion date, which value
will be divided by the Optional Conversion Price or Mandatory Conversion Price,
as applicable, in effect on the conversion date to determine the number of
shares issuable upon conversion.
Certain Antidilution Adjustments will be made to the Optional Conversion
Price and the Mandatory Conversion Price (the 'Conversion Prices') from time to
time upon the following events, subject to certain exceptions and limitations:
(a) if the Company (i) pays a dividend or makes a distribution on its Common
Stock in shares of its Common Stock, (ii) subdivides its outstanding shares of
Common Stock into a greater number of shares, (iii) combines its outstanding
shares of Common Stock into a smaller number of shares, (iv) issues by
reclassification of its Common Stock any shares of its capital stock; (b) if the
Company distributes any rights or warrants to all holders of its Common Stock
entitling them to purchase shares of Common Stock at a price per share less than
the current market price per share on the applicable record date; (c) if the
Company distributes to all holders of its Common Stock (i) any class of capital
stock of the Company other than its Common Stock, (ii) any evidence of
indebtedness or other securities of the Company or any subsidiary of the
Company, (iii) any other assets of the Company or any subsidiary of the Company
(other than cash), (iv) distributions in cash in
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<PAGE>
excess of 3% of the net earnings before extraordinary items of the Company for
the previous fiscal year, or (v) any rights, options or warrants to acquire any
of the foregoing; (d) if the Company issues Common Stock for a consideration per
share less than the Current Market Price per share on the date the Company fixes
the offering price of such additional shares; (e) if the Company issues any
options, warrants or other securities convertible into or exchangeable or
exercisable for Common Stock (other than certain preferred stock or securities
described in (b) or (c) above) and for a consideration per share of Common Stock
initially deliverable upon conversion, exchange or exercise of such securities
less than the Current Market Price per share on the date of issuance of such
options, warrants or other securities. 'Current Market Price' means, for a share
of Common Stock on any date, the average of Quoted Prices for the 30 consecutive
trading days commencing 45 trading days before the date in question. 'Quoted
Price' means the last reported sales price for Common Stock as reported by the
National Association of Securities Dealers, Inc. Automated Quotations System,
National Market System, or, if the Common Stock is listed or admitted for
trading on a securities exchange, the last reported sales price of the Common
Stock on the principal exchange on which the Common Stock is listed or admitted
for trading, or if not so reported or listed or admitted for trading, the last
reported bid price of the applicable security in the over-the-counter market.
The formulas for calculating the Antidilution Adjustments upon the events
described above are set forth in the Class AA Certificate of Designations.
The Company from time to time may reduce the Conversion Prices by any
amount for any period of time if the period is at least 20 business days and if
the reduction is irrevocable during the period, but in no event may the
Conversion Prices be less than the par value of a share of Common Stock.
If the Company is party to a merger which reclassifies or changes its
Common Stock, upon consummation of such transaction Class AA Preferred Stock
will automatically become convertible into the kind and amount of securities,
cash or other assets which the holder of Class AA Preferred Stock would have
owned immediately after the consolidation or merger, if such holder had
converted Class AA Preferred Stock immediately before the effective date of the
transaction.
The Company has reserved and will continue to reserve out of its authorized
but unissued Common Stock or its Common Stock held in treasury enough shares of
Common Stock to permit the conversion of the Class AA Preferred Stock in full.
No Redemption. The Company will not have the right to redeem the Class AA
Preferred Stock.
Voting Rights. The record holders of Class AA Preferred Stock will be
entitled to vote on all matters voted on by holders of Common Stock, voting
together with the Common Stock as a single class (together with all other
classes and series of stock of the Company that are entitled to vote as a single
class with the Common Stock) at all meetings of the stockholders of the Company.
In any such vote, each share of Class AA Preferred Stock will entitle the holder
thereof to cast the number of votes equal to the number of votes which could be
cast in such vote by a holder of the number of shares of Common Stock into which
such share of Class AA Preferred Stock is convertible based on the Mandatory
Conversion Price of the Class AA Preferred Stock.
On any matter on which the holders of Class AA Preferred Stock are entitled
by law or under the Certificate of Incorporation to vote separately as a class,
each such holder will be entitled to one vote for each share held, and such
matter will be determined by a majority of the votes cast unless Delaware law or
the Class AA Certificate of Designations requires approval by a higher
percentage.
From the earlier of the Stockholders Approval or the request by Prometheus,
until a Termination Event (defined below), the number of directors comprising
the Board will be equal to 15 and the holders of Class AA Preferred Stock and
Class AB Preferred Stock, voting as a single class (separately from other
stockholders), will have the exclusive right to elect 3 directors (each such
director, a 'Preferred Stock Director'). Any increases in the size of the Board
will require a proportional increase in the number of Preferred Stock Directors
(rounded up to the next whole number) such that the Preferred Stock Directors
represent not less than 20% of the votes of the Board. A proportionate number of
Preferred Stock Directors will serve on each committee of the Board, provided
that the Executive Committee will consist of five members of which two members
will be Preferred Stock Directors. The 'Executive Committee' means the
five-member executive committee of the Board to which substantial operational
matters regarding the Company will be delegated. At least one Preferred Stock
Director may serve on the board or other governing body of each of the Company's
subsidiaries and affiliates, other than operational home building companies. See
'Stockholders Agreement--Members of the Board.'
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<PAGE>
A 'Termination Event' means the date on which (a) the aggregate amount of
Class AA and Class AB Preferred Stock outstanding is less than 20% of the
maximum amount of the Class AA and Class AB Preferred Stock issued or (b) the
aggregate remaining investment or commitment to invest in the Company by
Prometheus and any of its affiliates (or any single transferee or related group
of transferees) is less than the greater of $10,000,000 or 10% of the Company's
Market Capitalization, provided that a Termination Event will not occur prior to
all closings being consummated under the Stock Purchase Agreement. With respect
to (b) above, the value of such investment will be based on the sum of: (i) the
greater of the Liquidation Preference of the Preferred Stock and the value of
the Common Stock underlying such Preferred Stock (as measured by the Conversion
Price) then held by it; (ii) the value of the Common Stock then held by it; and
(iii) the value of the Warrants then held by it. 'Market Capitalization' means
the market value of the outstanding Common Stock as measured by the 30 trading
days preceding any measurement date.
As a result of the acquisition by Prometheus of 11,700 shares of Class AA
Preferred Stock at the First Closing, Prometheus currently, upon request, has
the right, among other things, to require the Company to take all necessary
action to permit Prometheus to elect three Preferred Stock Directors to the
Board, to have two of such Preferred Stock Directors appointed to the Executive
Committee and to have a proportionate number of Preferred Stock Directors serve
on each other committee of the Board. Prometheus has indicated that it does not
intend to exercise such rights until Stockholders Approval, although it reserves
the right to do so at any time.
The holders of Class AA Preferred Stock and Class AB Preferred Stock,
voting as a single class (separately from other stockholders), will be entitled
to elect additional Preferred Stock Directors sufficient to cause the Preferred
Stock Directors to constitute a majority of the Board and all committees of the
Board, including the Executive Committee (the 'Additional Preferred Stock
Directors') in the following event (an 'Adverse Event'): that on any date
following the Second Closing that is 60 days after the end of a fiscal quarter
of the Company (a 'Test Date') both (a) the Average Trading Price of the Common
Stock is below $4.375 per share (adjusted in the same manner as the Mandatory
Conversion Price to take account of any of the occurrences that would require an
Antidilution Adjustment) and (b)(i) the percentage change in the EBT per share
of the issued and outstanding Common Stock for the most recent two fiscal
quarters as measured against the same two fiscal quarters from the prior fiscal
year is less than (ii) the percentage change in the EBT per share of the issued
and outstanding common stock of the Comparable Group for the same period as
compared against the EBT per share (calculated on the same basis) of the
Comparable Group during the same period in the prior fiscal year. 'EBT' means
earnings before interest expense, income taxes and extraordinary or
non-recurring items, all calculated in accordance with generally accepted
accounting principles. 'Comparable Group' means the following entities: Pulte
Corporation; The Ryland Group, Inc.; U.S. Home Corporation; NVR Inc.; Hovnanian
Enterprises, Inc.; Toll Brothers, Inc.; Washington Homes, Inc.; Zaring National
Corporation; M/I Schottenstein Homes, Inc.; Continental Homes Holding Corp.;
Engle Homes, Inc.; Crossman Communities; Beazer Homes USA, Inc.; and D.R.
Horton, Inc. The size of the Board and all committees will be automatically
increased in order to effect any Additional Preferred Stock Directors. The right
of the holders of Preferred Stock to elect Additional Preferred Stock Directors
will continue until such time as neither (a) nor (b) above is true for two
consecutive Test Dates. See 'Stockholders Agreement--Members of the Board.'
The Preferred Stock Directors elected will serve until the next annual
meeting or until their respective successors are elected and qualify. Upon the
termination of the right to elect Additional Preferred Stock Directors, any
Additional Preferred Stock Directors will resign. Any Preferred Stock Director
may be removed with or without cause by the vote of the holders of a majority of
the outstanding shares of Preferred Stock, voting separately as a single class.
Preferred Stock Director Designees. Prometheus, which holds 11,700 shares
of Class AA Preferred Stock, has informed the Company that of the three
Preferred Stock Directors it is entitled to elect, it currently expects to elect
Robert P. Freeman, James D. Klingbeil and Murry N. Gunty.
Robert P. Freeman, age 52, is a principal of Lazard. In that capacity, Mr.
Freeman is responsible for Lazard's investments, portfolio management, asset
management and administrative functions. Mr. Freeman joined Lazard at the end of
1992 from Perini Investment Properties, Inc., an American Stock Exchange listed
real estate investment and management company, where he had been president and
chief executive officer since 1991 and a director since 1985. Mr. Freeman serves
on the board of directors of ARV Assisted Living, American Apartment
Communities, Atlantic American Properties Trust and Commonwealth Atlantic
Properties.
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<PAGE>
James D. Klingbeil, age 61, is the Chairman, President and Chief Executive
Officer of American Apartment Communities, which owns, manages or has a
controlling interest in a portfolio of apartment communities. Mr. Klingbeil also
serves as Chairman of The Klingbeil Company, which since its formation in 1961
has engaged in real estate investment, development, construction and management.
Murry N. Gunty, age 30, is a principal of Lazard. In that capacity, Mr.
Gunty is responsible for Lazard's investments. Prior to joining Lazard in 1995,
Mr. Gunty was employed by J.E. Robert Company, where he worked on investment
activities involving real estate investment trusts, commercial mortgage-backed
securities, and other corporate real estate opportunities. Prior to that, he
worked at Trammell Crow Ventures. Mr. Gunty serves on the Board of Directors of
ARV Assisted Living and Atlantic American Properties Trust.
Consent Rights. In addition to any vote or consent of shareholders
required by law or the Certificate of Incorporation, the consent of the holders
of at least 66 2/3% of the shares of Class AA Preferred Stock at the time
outstanding will be necessary to effect or validate the following actions or
transactions: (a) any amendment, alteration or repeal of any provision of the
Certificate of Incorporation or of the by-laws of the Company, which affects
adversely the voting powers, preferences and rights of the holders of Class AA
Preferred Stock; (b) any authorization or creation of or increase in the amount
of any shares of any class or any security convertible into shares of any class
ranking senior to or on parity with shares of Class AA Preferred Stock (other
than the Class AB Preferred Stock) in the distribution of assets on any
liquidation, dissolution or winding up of the Company or in the payment of
dividends or otherwise; (c) any increase or decrease (other than by conversion)
in the total number of authorized shares of Class AA Preferred Stock; (d) any
sale, lease, assignment, transfer or other conveyance of all or substantially
all of the assets of the Company or any of its material subsidiaries of which it
owns 50% or more of the voting power, or any consolidation or merger involving
the Company or any of such subsidiaries (except mergers between the Company's
subsidiaries), or any reclassification or other change of any stock, or any
liquidation, dissolution, or winding up of the Company or, unless the Company's
obligations under an agreement are expressly conditioned upon the requisite
approval of the holders of 66 2/3% of the Class AA Preferred Stock then
outstanding, make any agreement or become obligated to do so; (e) any purchase,
redemption or other acquisition for value (or payment into or setting aside as a
sinking fund for such purpose) of any shares of Common Stock or other capital
stock of the Company; or (f) any declaration or payment of any dividends on or
declaration or making of any other distribution on account of the Common Stock
or setting apart any sum for any such purpose unless all accrued unpaid
dividends on Class AA Preferred Stock have been paid in cash.
Financial Statements. Until the occurrence of a Termination Event, the
Company will furnish to the holders of Class AA Preferred Stock all quarterly
and annual financial information required to be filed with the Securities and
Exchange Commission ('SEC') on Forms 10-Q and 10-K and, with respect to the
annual information, a report thereon by the Company's certified independent
accountants, and all current reports required to be filed with the SEC on Form
8-K.
Modification and Waiver. The Class AA Certificate of Designations may be
amended and the rights of the holders of the Class AA Preferred Stock waived
with the consent of holders of at least 66 2/3% of the shares of the Class AA
Preferred Stock then outstanding.
Debt Alternative. The Company and Prometheus are continuing to discuss the
possibility of the Company issuing a debt instrument in lieu of the issuance of
a portion of the Class AB Preferred Stock. Such a debt instrument, if issued,
will bear interest at an annual rate of 12% payable quarterly, will mature on
December 31, 2004 and will have terms and conditions substantially the same as
the Class AB Preferred Stock, except that such debt will not carry any voting
rights. The Company may seek to issue debt in lieu of the issuance of a portion
of the Class AB Preferred Stock depending upon the Company's evaluation of (i)
the relative cost of the issuance of debt versus the cost of issuance of the
Class AB Preferred Stock, (ii) the benefits to the Company, including the
financial and accounting impact, and the financial market's evaluation, of the
issuance of additional debt as opposed to the issuance of the Class AB Preferred
Stock and (iii) the federal income tax and other consequences of the issuance of
debt versus the Class AB Preferred Stock.
The Company has not made any determination as to the amount of debt, if
any, it might seek to issue in lieu of the issuance of the Class AB Preferred
Stock. The Company's ability to effect the debt alternative in lieu of the Class
AB Preferred Stock is subject to compliance with the Indenture, which governs
the Company's Senior Notes.
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<PAGE>
APPORTIONMENT OF CLASS AB PREFERRED STOCK. Under the Stock Purchase
Agreement, the parties will apportion the Class AB Preferred Stock to be issued
between the Class ABI Preferred Stock and the Class ABII Preferred Stock to
ensure that 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 directors elected
exclusively by holders of Class AA Preferred Stock and Class AB Preferred
Stock), and so that the Company will issue the maximum amount of Class ABI
Preferred Stock that it is permitted to issue before issuing any Class ABII
Preferred Stock. Such apportionment will not be required until a Subsequent
Purchase.
CLASS AB PREFERRED STOCK. The following is a summary of the preferences,
powers and rights of the Class ABI Preferred Stock set forth in a Certificate of
Designations, Preferences and Relative, Participating, Optional and Other
Special Rights of Preferred Stock and Qualifications, Limitations and
Restrictions Thereof ('Class ABI Certificate of Designations') and the Class
ABII Preferred Stock set forth in a Certificate of Designations, Preferences and
Relative, Participating, Optional and Other Special Rights of Preferred Stock
and Qualifications, Limitations and Restrictions Thereof ('Class ABII
Certificate of Designations').
Number of Shares. The number of authorized shares of Class AB Preferred
Stock will be 46,670 shares, which will be apportioned between Class ABI
Preferred Stock and Class ABII Preferred Stock.
Rank. With respect to dividends and distributions upon liquidation,
dissolution or winding up of the Company, the Class ABI Preferred Stock and the
Class ABII Preferred Stock will rank equally with the Class AA Preferred Stock
and any other Parity Stock and senior to the Common Stock and any other equity
or other securities into which any convertible indebtedness is convertible which
are issued by the Company. With respect to Class ABI Preferred Stock and Class
ABII Preferred Stock, 'Parity Stock' means (a) the Series A Preferred Stock, (b)
the Series B Preferred Stock, (c) the Series C Preferred Stock, (d) the Series D
Preferred Stock, (e) the Class AA Preferred Stock, (f) the Class ABII Preferred
Stock (with respect to the Class ABI Preferred Stock) and the Class ABI
Preferred Stock (with respect to the Class ABII Preferred Stock), and (g) any
class or series of stock of the Company authorized after the Initial Issue Date
which is entitled to receive payment of dividends, or assets upon liquidation,
dissolution or winding up of the Company, on a parity with the Class ABI
Preferred Stock and the Class ABII Preferred Stock.
Dividends. The record holders of Class ABI Preferred Stock and Class ABII
Preferred Stock will be entitled to receive dividends, when and as declared by
the Board, out of funds legally available for payment of dividends. Such
dividends will be payable in cash at the annual rate of 12% of the Liquidation
Preference. As with the Class AA Preferred Stock, 'Liquidation Preference' with
respect to the Class ABI Preferred Stock and Class ABII Preferred Stock means
$1,000 per share. Dividends on shares of Class ABI Preferred Stock and Class
ABII Preferred Stock will accrue and be cumulative from the date of issuance of
such shares. Dividends will be payable quarterly in arrears when and as declared
by the Board on March 31, June 30, September 30 and December 31 of each year (a
'Dividend Payment Date'), commencing on the Dividend Payment Date following the
issuance of any such Class AB Preferred Stock. For any Dividend Period in which
dividends are not paid in full on the Dividend Payment Date first succeeding the
end of such Dividend Period, then such accrued and unpaid dividends will be
added (solely for the purpose of calculating dividends payable on the Class ABI
Preferred Stock or the Class ABII Preferred Stock, as applicable) to the
Liquidation Preference of the Class ABI Preferred Stock or the Class ABII
Preferred Stock, as applicable, effective at the beginning of the Dividend
Period succeeding the Dividend Period as to which such dividends were not paid
and will thereafter accrue additional dividends at the annual rate of 12% until
such accrued and unpaid dividends have been paid in full.
The Company will be required to declare and pay dividends at the rate of
12% per annum of the Liquidation Preference on each Dividend Payment Date to the
extent that funds are legally available for declaration of such dividends. If
full dividends are not paid to the holders of Class ABI Preferred Stock, Class
ABII Preferred Stock and of any Parity Stock with respect to any Dividend Period
and funds available for payment of dividends are insufficient to permit payment
in full to holders of all such stock, then the entire amount legally available
for payment of dividends will be distributed ratably among all such holders of
Class ABI Preferred Stock, Class ABII Preferred Stock and any Parity Stock. The
dividends payable in respect of the Class ABI Preferred Stock and the Class ABII
Preferred Stock will be a mandatory obligation of the Company, subject only to
the limitations set forth in the Delaware General Corporation Law with respect
to funds legally permitted to be used for the payment of dividends.
While any Class ABI Preferred Stock or Class ABII Preferred Stock is
outstanding, (a) the Company will not declare, pay or set apart for payment on
any Junior Stock any dividends (other than dividends payable in
25
<PAGE>
shares of the class or series upon which such dividends are declared or paid, or
payable in shares of Common Stock with respect to Junior Stock other than Common
Stock, together with cash in lieu of fractional shares), (b) the Company will
not make any distribution on any Junior Stock, (c) the Company or any of its
majority-owned subsidiaries will not purchase, redeem or otherwise acquire any
Junior Stock, and (d) no money will be paid or made available for a sinking fund
for the purchase or redemption of any Junior Stock, unless all dividends to
which the holders of Class ABI Preferred Stock and Class ABII Preferred Stock
will have been entitled for all previous Dividend Periods have been paid or
declared and a sum of money sufficient for such payment has been set apart. With
respect to Class ABI Preferred Stock as well as Class ABII Preferred Stock,
'Junior Stock' means the Common Stock, other Common Equity and any class or
series of stock of the Company authorized after the Initial Issue Date which is
not entitled to receive any dividends in any Dividend Period unless all
dividends required to have been paid or declared and set apart for payment on
the Class AB Preferred Stock and on any Parity Stock have been so paid or
declared and set apart for payment or which is not entitled to receive any
assets upon liquidation, dissolution or winding up of the Company until the
Class ABI Preferred Stock, the Class ABII Preferred Stock and any Parity Stock
have received the entire amount to which such stock is entitled upon such
liquidation, dissolution or winding up.
Liquidation Preference. In the event of any voluntary or involuntary
liquidation, dissolution or other winding up of the Company, before any payment
or distribution will be made to the holders of Junior Stock, the holders of
Class ABI Preferred Stock and Class ABII Preferred Stock will be entitled to be
paid out of the Company's assets in cash or property at its fair market value as
determined by the Board, the Liquidation Preference per share plus an amount
equal to all dividends accrued and unpaid thereon to the date of such
liquidation, dissolution or such other winding up. If, upon any such
liquidation, dissolution or other winding up of the Company the Company's assets
are insufficient to permit the payment in full of the Liquidation Preference per
share plus an amount equal to all dividends accrued and unpaid on the Class ABI
Preferred Stock and the Class ABII Preferred Stock and the full liquidating
payments on all Parity Stock, then the Company's assets will be ratably
distributed among the holders of Class ABI Preferred Stock, Class ABII Preferred
Stock and any Parity Stock in proportion to the full amounts to which they would
otherwise be respectively entitled if all amounts thereon were paid in full. For
the purposes of the foregoing, neither the consolidation or merger of the
Company into or with another entity or entities, nor the sale, lease, transfer
or conveyance of all or substantially all of the Company's assets to another
entity will be deemed a liquidation, dissolution or winding up of the Company.
Conversion. Holders of shares of Class ABI Preferred Stock and holders of
shares of Class ABII Preferred Stock will have the right at any time on or after
September 30, 2001, the fourth anniversary of the date of the First Closing, but
before the redemption date, to convert such shares into Common Stock at the
Conversion Price described below.
The Company, at its option, will have the right at any time on or after
September 30, 2002, the fifth anniversary of the date of the First Closing, but
before the redemption date, to convert all, but not less than all, of the Class
ABI Preferred Stock and the Class ABII Preferred Stock outstanding at such time
into Common Stock at the Conversion Price described below, provided that on the
conversion date the Company will have paid all accrued dividends on all Class
ABI Preferred Stock and Class ABII Preferred Stock then outstanding.
For the purposes of conversion, whether at the election of either the
holders of shares of Class ABI Preferred Stock or Class ABII Preferred Stock or
the Company as described above, the Conversion Price will be equal to 95% of the
Current Market Price (defined above) on the applicable conversion date. Each
share of Class ABI Preferred Stock and Class ABII Preferred Stock will be valued
at the Liquidation Preference plus all accrued but unpaid dividends thereon
through the relevant conversion date, which value will be divided by the
Conversion Price in effect on the conversion date to determine the number of
shares issuable upon conversion.
The Company from time to time may reduce the Conversion Price by any amount
for any period of time if the period is at least 20 business days and if the
reduction is irrevocable during the period, but in no event may the Conversion
Price be less than the par value of a share of Common Stock.
If the Company consolidates or merges with or into, transfers or leases all
or substantially all its assets to any person, upon consummation of such
transaction Class ABI Preferred Stock and Class ABII Preferred Stock will
automatically become convertible into the kind and amount of securities, cash or
other assets which the holders thereof would have owned immediately after the
consolidation, merger, transfer or lease if such holders had converted such
Preferred Stock immediately before the effective date of the transaction.
26
<PAGE>
The Company has reserved and will continue to reserve out of its authorized
but unissued Common Stock or its Common Stock held in treasury enough shares of
Common Stock to permit the conversion of the Class ABI Preferred Stock and Class
ABII Preferred Stock in full.
Redemption. The Company will have the right at its option at any time on
or after September 30, 2002, the fifth anniversary of the First Closing, to
redeem in whole the Class ABI Preferred Stock and the Class ABII Preferred Stock
together at the Redemption Price. The 'Redemption Price' means a price per share
equal to the Liquidation Preference, plus an amount equal to all cumulative
dividends accrued and unpaid on such share to the redemption date.
Voting Rights. The record holders of Class ABI Preferred Stock will be
entitled to vote on all matters voted on by holders of Common Stock, voting
together with the Common Stock as a single class (together with all other
classes and series of stock of the Company that are entitled to vote as a single
class with the Common Stock) at all meetings of the stockholders of the Company.
In any such vote, each share of Class ABI Preferred Stock will entitle the
holder thereof to cast the number of votes equal to the number of votes which
could be cast in such vote by a holder of the number of shares of Common Stock
into which such share of Class ABI Preferred Stock would be convertible if the
conversion price were $5.25 per share (the closing trading price of the Common
Stock on the date immediately preceding the First Closing).
The record holders of Class ABII Preferred Stock will be entitled to vote
on all matters voted on by holders of Common Stock, voting together with the
Common Stock as a single class (together with all other classes and series of
stock of the Company that are entitled to vote as a single class with the Common
Stock) at all meetings of the stockholders of the Company other than in respect
of the election of directors, except that the Class ABII Preferred Stock will
vote in the election of directors if (a) the price of the Common Stock (as
measured by the Current Market Price) is less than $3.00 per share (such amount
to be adjusted for stock splits and recombinations as appropriate) and (b) the
holder provides notice to the Company that it elects to obtain such voting
right. In any vote with respect to which the holders of Class ABII Preferred
Stock are entitled to vote with the holders of Common Stock as a single class,
each share of Class ABII Preferred Stock will entitle the holder thereof to cast
the number of votes equal to the number of votes which could be cast in such
vote by a holder of the number of shares of Common Stock into which such share
of Class ABII Preferred Stock would be convertible if the conversion price were
$5.25 per share (the closing trading price of the Common Stock on the date
immediately preceding the First Closing).
On any matter on which the holders of Class ABI Preferred Stock or Class
ABII Preferred Stock are entitled by law or under the Certificate of
Incorporation to vote separately as a class, each such holder will be entitled
to one vote for each share held, and such matter will be determined by a
majority of the votes cast unless Delaware law or the Certificate of
Designations requires approval by a higher percentage.
As discussed above with respect to the Class AA Preferred Stock, from the
earlier of the Stockholders Approval or the request by Prometheus, until a
Termination Event (as defined above) the number of directors comprising the
Board will be equal to 15 and the holders of Class AA Preferred Stock and Class
AB Preferred Stock, voting as a single class (separately from other
stockholders), will have the exclusive right to elect 3 Preferred Stock
Directors. Any increases in the size of the Board will require a proportional
increase in the number of Preferred Stock Directors (rounded up to the next
whole number) such that the Preferred Stock Directors represent not less than
20% of the votes of the Board. A proportionate number of Preferred Stock
Directors will serve on each committee of the Board, provided that the Executive
Committee will consist of five members of which two members will be Preferred
Stock Directors. At least one Preferred Stock Director may serve on the board or
other governing body of each of the Company's subsidiaries and affiliates, other
than operational home building companies. See 'The Transactions--Stock Purchase
Agreement--Class AA Preferred Stock--Voting Rights' and '--Stockholders
Agreement--Members of the Board.'
As discussed above with respect to the Class AA Preferred Stock, upon the
occurrence of an Adverse Event (as defined above) which follows the Second
Closing, the holders of Class AA Preferred Stock and Class AB Preferred Stock,
voting as a single class (separately from other stockholders), will be entitled
to elect Additional Preferred Stock Directors sufficient to cause the Preferred
Stock Directors to constitute a majority of the Board and all committees of the
Board, including the Executive Committee. The size of the Board and all
committees will be automatically increased in order to effect any Additional
Preferred Stock Directors. The right to elect Additional Preferred Stock
Directors will continue until such time as certain conditions are met, as
discussed above. See 'Class AA Preferred Stock--Voting Rights' and 'Stockholders
Agreement--Members of the Board.'
27
<PAGE>
Consent Rights. In addition to any vote or consent of stockholders
required by law or the Certificate of Incorporation, the consent of the holders
of at least 66 2/3% of the shares of Class ABI Preferred Stock or Class ABII
Preferred Stock, as applicable, at the time outstanding, will be necessary to
effect or validate the following actions or transactions: (a) any amendment,
alteration or repeal of any provision of the Certificate of Incorporation or of
the by-laws of the Company, which affects adversely the voting powers,
preferences and rights of the holders of Class ABI Preferred Stock or Class ABII
Preferred Stock; (b) any authorization or creation of or increase in the amount
of any shares of any class or any security convertible into shares of any class
ranking senior to or on parity with shares of Class ABI Preferred Stock or Class
ABII Preferred Stock (other than the Class AA Preferred Stock) in the
distribution of assets on any liquidation, dissolution or winding up of the
Company or in the payment of dividends or otherwise; (c) any increase or
decrease (other than by conversion) in the total number of authorized shares of
Class ABI Preferred Stock or Class ABII Preferred Stock; (d) any sale, lease,
assignment, transfer or other conveyance of all or substantially all of the
assets of the Company or any of its material subsidiaries of which it owns 50%
or more of the voting power, or any consolidation or merger involving the
Company or any of such subsidiaries (except mergers between the Company's
subsidiaries), or any reclassification or other change of any stock, or any
dissolution, liquidation, or winding up of the Company or, unless the Company's
obligations under an agreement are expressly conditioned upon the requisite
approval of the holders of 66 2/3% of the Class ABI Preferred Stock and the
Class ABII Preferred Stock then outstanding, make any agreement or become
obligated to do so; (e) any purchase, redemption or other acquisition for value
(or payment into or setting aside as a sinking fund for such purpose) of any
shares of Common Stock or other capital stock of the Company; or (f) any
declaration or payment of any dividends on or declaration or making of any other
distribution on account of the Common Stock or setting apart any sum for any
such purpose unless all accrued unpaid dividends on Class ABI Preferred Stock
and Class ABII Preferred Stock have been paid in cash.
Financial Statements. Until a Termination Event occurs, the Company will
furnish to the holders of Class ABI Preferred Stock and Class ABII Preferred
stock all quarterly and annual financial information required to be filed with
the SEC on Forms 10-Q and 10-K and, with respect to the annual information, a
report thereon by the Company's certified independent accountants and all
current reports required to be filed with the SEC on Form 8-K.
Modification and Waiver. The Class ABI Certificate of Designations or the
Class ABII Certificate of Designations may be amended and the rights of holders
of the Class ABI Preferred Stock or the Class ABII Preferred Stock waived with
the consent of holders of at least 66 2/3% of the shares of the Class ABI
Preferred Stock or the Class ABII Preferred Stock, respectively, then
outstanding.
WARRANTS. Under the Stock Purchase Agreement, Prometheus will receive
Warrants to purchase an aggregate of 1,000,000 shares of Common Stock. In
accordance with the Stock Purchase Agreement, the Company and Prometheus entered
into a Warrant Agreement at the First Closing. Prometheus acquired Warrants for
375,000 shares of Common Stock at the First Closing. See 'First Closing.'
Prometheus will receive Warrants for 625,000 shares of Common Stock in
connection with the first Subsequent Purchase. See 'Subsequent Closings.'
The following is a summary of certain terms and conditions of the Warrants
as set forth in the Stock Purchase Agreement and the Warrant Agreement.
Initial Exercise Price and Payment. Pursuant to the Stock Purchase
Agreement, the Warrants entitle the holder to purchase shares of Common Stock at
an initial exercise price of $7.00 per share, subject to certain adjustments
(the 'Exercise Price') set forth in the Warrant Agreement. The Common Stock
issuable on exercise of the Warrants is referred to as the 'Warrant Shares.'
Payment of the Exercise Price may be made at the Warrant holder's option in
cash or through the surrender of debt or preferred equity securities of the
Company having a principal amount or liquidation preference, as the case may be,
equal to the aggregate Exercise Price to be paid. As an alternative to the
payment of the Exercise Price, each Warrant holder may exercise his right to
receive Warrant Shares on a net basis, such that, without the payment of any
funds, the Warrant holder receives that number of Warrant Shares otherwise
issuable upon exercise of his Warrants less that number of Warrant Shares having
an aggregate fair market value at the time of exercise equal to the aggregate
Exercise Price that would otherwise have been paid by the holder of the Warrant
Shares. Fair market value of the Warrant Shares will be determined in good faith
by a majority of the Non-Preferred Stock Directors of the Company, as of the
date of any such exercise, subject to the right of the holders of a majority of
the Warrants to challenge such determination. Any such dispute will be resolved
by an investment banking firm selected by the Company and acceptable to such
Warrant holders. 'Non-Preferred
28
<PAGE>
Stock Directors' means directors of the Company excluding any director elected
by the holders of the Preferred Stock voting as a separate class.
Exercise Period. The Warrants are exercisable during the period commencing
on September 30, 1999, until September 30, 2004.
Adjustments Based on Common Stock Market Price. Between September 30, 2001
and September 30, 2003, a holder of Warrants will have the right to elect to
adjust up to five times per year (a) the Exercise Price of each Warrant and (b)
the number of shares of Common Stock into which each Warrant held by such holder
will convert upon exercise of the Warrants, by reference to the Adjustment
Price, as follows:
<TABLE>
<CAPTION>
ADDITIONAL SHARES
ADJUSTMENT PRICE($) EXERCISE PRICE($) PER WARRANT
- ------------------- ----------------- -----------------
<C> <C> <S>
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
</TABLE>
The 'Adjustment Price'with respect to the Warrants means the average of the
Quoted Price (as defined above) of the Common Stock for the 60 days preceding
such adjustment. For purposes of illustration, assuming the holder makes an
election during the adjustment period, if the average of the closing prices of
the Common Stock for the 60 days preceding is $9.00 per share, the total number
of Warrant Shares will be 2,500,000 and the Exercise Price will be $6.00 per
share.
If the Company makes any adjustment to the Exercise Price as referred to
below, the Adjustment Prices set forth above will be adjusted in like manner.
Adjustment of Exercise Price and Number of Warrant Shares. The Exercise
Price and the number of Warrant Shares issuable upon the exercise of each
Warrant are subject to adjustment from time to time upon the following events,
subject to certain exceptions and limitations: (a) if the Company (i) pays a
dividend or makes a distribution on its Common Stock in shares of its Common
Stock, (ii) subdivides its outstanding shares of Common Stock into a greater
number of shares, (iii) combines its outstanding shares of Common Stock into a
smaller number of shares, (iv) issues by reclassification of its Common Stock
any shares of its capital stock; (b) if the Company distributes any rights or
warrants to all holders of its Common Stock entitling them to purchase shares of
Common Stock at a price per share less than the Current Market Price (as defined
above) per share on the applicable record date; (c) if the Company distributes
to all holders of its Common Stock (i) any class of capital stock of the Company
other than its Common Stock, (ii) any evidence of indebtedness or other
securities of the Company or any subsidiary of the Company, (iii) any other
assets of the Company or any subsidiary of the Company (other than cash), (iv)
distributions in cash in excess of 3% of the net earnings before extraordinary
items of the Company for the previous fiscal year, or (v) any rights, options or
warrants to acquire any of the foregoing; (d) if the Company issues Common Stock
for a consideration per share less than the Current Market Price per share on
the date the Company fixes the offering price of such additional shares; (e) if
the Company issues any options, warrants or other securities convertible into or
exchangeable or exercisable for Common Stock (other than certain preferred stock
or securities described in (b) or (c) above) and for a consideration per share
of Common Stock initially deliverable upon conversion, exchange or exercise of
such securities less than the Current Market Price per share on the date of
issuance of such options, warrants or other securities. The formulas for
calculating the adjustments upon the events described above, which are set forth
in the Warrant Agreement, are substantially similar to the comparable formulas
in the Class AA Certificate of Designations.
The Company from time to time may reduce the Exercise Price by any amount
for any period of time if the period is at least 20 business days and if the
reduction is irrevocable during the period, but in no event may the Conversion
Prices be less than the par value of a share of Common Stock.
29
<PAGE>
If the Company consolidates or merges with or into, or transfers or leases
all or substantially all of its assets to any person, upon consummation of such
transaction the Warrants will automatically become exercisable for the kind and
amount of securities, cash or other assets which the holder of a Warrant would
have owned immediately after the consolidation, merger, transfer or lease if
such holder had exercised the Warrant immediately before the effective date of
the transaction. Upon each adjustment of the Exercise Price as described above,
each Warrant outstanding prior to the making of the adjustment in the Exercise
Price will be adjusted with respect to the number of shares of Common Stock that
each Warrant entitles the holder to purchase. The formula for calculating such
adjustment to the number of Warrant Shares is set forth in the Warrant
Agreement.
Notwithstanding the foregoing, if the Stock Purchase Agreement is
terminated prior to the Second Closing (other than as a result of a default by
Prometheus of its obligations thereunder), the Exercise Price of each Warrant
then outstanding will immediately be reduced to $0.01.
The Company will reserve and keep available, free from preemptive rights,
out of the aggregate of its authorized but unissued Common Stock or its
authorized and issued Common Stock held in treasury, to enable it to satisfy its
obligation to issue Warrant Shares upon exercise of the Warrants, the maximum
number of shares of Common Stock which may be deliverable upon the exercise of
all outstanding Warrants as determined in good faith by the Board from time to
time based on the Exercise Price in effect at such time.
Listing and Registration. The Company will from time to time, at its
expense, (a) take all action necessary so that the Warrant Shares, immediately
upon their issuance and upon the exercise of Warrants, will be listed and
maintained on the principal securities exchanges and markets on which other
shares of Common Stock are then listed and (b) register under the Securities
Exchange Act of 1934, as amended (the 'Exchange Act'), all shares of Common
Stock issuable upon exercise if and at the time that any existing shares of the
Company's capital stock are so registered.
CONTINGENT WARRANTS. Under the Stock Purchase Agreement, Prometheus will
receive Contingent Warrants to purchase between 380,952 and 5,714,286 shares of
Common Stock in certain circumstances. See 'Subsequent Closings.'
The following is a summary of certain terms and conditions of the
Contingent Warrants as set forth in the Stock Purchase Agreement and the
Contingent Warrant Agreement.
Exercise Price and Payment. Pursuant to the Stock Purchase Agreement, the
Contingent Warrants entitle the holder to purchase shares of Common Stock at an
exercise price of $.01 per share, (the 'Exercise Price') set forth in the
Contingent Warrant Agreement. The Common Stock issuable on exercise of the
Contingent Warrants is referred to as the 'Contingent Warrant Shares.'
Payment of the Exercise Price may be made at the Contingent Warrant
holder's option in cash or through the surrender of debt or preferred equity
securities of the Company having a principal amount or liquidation preference,
as the case may be, equal to the aggregate Exercise Price to be paid. As an
alternative to the payment of the Exercise Price, each Contingent Warrant holder
may exercise his right to receive Contingent Warrant Shares on a net basis, such
that, without the payment of any funds, the Contingent Warrant holder receives
that number of Contingent Warrant Shares otherwise issuable upon exercise of his
Contingent Warrants less that number of Contingent Warrant Shares having an
aggregate fair market value at the time of exercise equal to the aggregate
Exercise Price that would otherwise have been paid by the holder of the
Contingent Warrant Shares. Fair market value of the Contingent Warrant Shares
will be determined in good faith by a majority of the Non-Preferred Stock
Directors of the Company, as of the date of any such exercise, subject to the
right of the holders of a majority of the Contingent Warrants to challenge such
determination. Any such dispute will be resolved by an investment banking firm
selected by the Company and acceptable to such Contingent Warrant holders. 'Non-
Preferred Stock Directors' means directors of the Company excluding any director
elected by the holders of the Preferred Stock voting as a separate class.
Adjustment Based on Common Stock Market Price. Between September 30, 2001
and September 30, 2003, upon each and every Election pursuant to the Class AA
Preferred Stock, the number of shares of Common Stock
30
<PAGE>
into which the Contingent Warrants will convert upon exercise of the Contingent
Warrants, if any, will be adjusted by reference to the Adjustment Price, as
follows:
<TABLE>
<CAPTION>
CONTINGENT
ADJUSTMENT PRICE(S) WARRANT SHARES
- ------------------- --------------
<S> <C>
$8.01--10.00 380,952
6.01-- 8.00 2,380,952
5.00-- 6.00 5,714,286
</TABLE>
The 'Adjustment Price'with respect to the Contingent Warrants means the
average of the Quoted Price (as defined above) of the Common Stock for the 60
days preceding such adjustment. For purposes of illustration, assuming an
Election is made during the adjustment period, if the average of the closing
prices of the Common Stock for the 60 days preceding such adjustment is $9.00
per share, the total number of Contingent Warrant Shares will be 380,952.
Exercise Period. The Contingent Warrants will become exercisable if at any
time between September 30, 2001 and September 30, 2003 the Adjustment Price of
the Common Stock is between $5.00 and $10.00 per share. If, during such period,
the Adjustment Price of the Common Stock is less than $5.00 per share and the
holder of the Class AA Preferred Stock makes an Election to adjust the Optional
Conversion Price of the Class AA Preferred Stock then the Contingent Warrants
shall terminate. See 'Class AA Preferred Stock--Conversion.' Further, the
Contingent Warrants shall 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. Otherwise, the
Contingent Warrants will expire on March 31, 2004.
Adjustment of Number of Contingent Warrant Shares. The number of
Contingent Warrant Shares issuable upon the exercise of the Contingent Warrants
is subject to adjustment from time to time upon the following events, subject to
certain exceptions and limitations: (a) if the Company (i) pays a dividend or
makes a distribution on its Common Stock in shares of its Common Stock, (ii)
subdivides its outstanding shares of Common Stock into a greater number of
shares, (iii) combines its outstanding shares of Common Stock into a smaller
number of shares, (iv) issues by reclassification of its Common Stock any shares
of its capital stock; (b) if the Company distributes any rights or warrants to
all holders of its Common Stock entitling them to purchase shares of Common
Stock at a price per share less than the Current Market Price (as defined above)
per share on the applicable record date; (c) if the Company distributes to all
holders of its Common Stock (i) any class of capital stock of the Company other
than its Common Stock, (ii) any evidence of indebtedness or other securities of
the Company or any subsidiary of the Company, (iii) any other assets of the
Company or any subsidiary of the Company (other than cash), (iv) distributions
in cash in excess of 3% of the net earnings before extraordinary items of the
Company for the previous fiscal year, or (v) any rights, options or warrants to
acquire any of the foregoing; (d) if the Company issues Common Stock for a
consideration per share less than the Current Market Price per share on the date
the Company fixes the offering price of such additional shares; (e) if the
Company issues any options, warrants or other securities convertible into or
exchangeable or exercisable for Common Stock (other than certain preferred stock
or securities described in (b) or (c) above) and for a consideration per share
of Common Stock initially deliverable upon conversion, exchange or exercise of
such securities less than the Current Market Price per share on the date of
issuance of such options, warrants or other securities. The formulas for
calculating the adjustments upon the events described above, which are set forth
in the Contingent Warrant Agreement, are substantially similar to the comparable
formulas in the Class AA Certificate of Designations.
If the Company consolidates or merges with or into, or transfers or leases
all or substantially all of its assets to any person, upon consummation of such
transaction the Contingent Warrants will automatically become exercisable for
the kind and amount of securities, cash or other assets which the holder of a
Contingent Warrant would have owned immediately after the consolidation, merger,
transfer or lease if such holder had exercised the Contingent Warrant
immediately before the effective date of the transaction.
The Company will reserve and keep available, free from preemptive rights,
out of the aggregate of its authorized but unissued Common Stock or its
authorized and issued Common Stock held in treasury, to enable it to satisfy its
obligation to issue Contingent Warrant Shares upon exercise of the Contingent
Warrants, the
31
<PAGE>
maximum number of shares of Common Stock which may be deliverable upon the
exercise of all outstanding Contingent Warrants as determined in good faith by
the Board from time to time based on the Exercise Price in effect at such time.
Listing and Registration. The Company will from time to time, at its
expense, (a) take all action necessary so that the Contingent Warrant Shares,
immediately upon their issuance and upon the exercise of Contingent Warrants,
will be listed and maintained on the principal securities exchanges and markets
on which other shares of Common Stock are then listed and (b) register under the
Exchange Act all shares of Common Stock issuable upon exercise if and at the
time that any existing shares of the Company's capital stock are so registered.
HSR Act. Promptly after receipt of notice from any Warrant holder or
Contingent Warrant holder of its intention to exercise any Warrants or
Contingent Warrants, the Company will make any filings required to be made under
the Hart-Scott-Rodino Improvements Act of 1976 (the 'HSR Act') in connection
with such exercise. The applicable waiting period, including any extension
thereof, under the HSR Act must expire or terminate prior to the issuance of any
Warrant Shares upon exercise of Warrants or Contingent Warrant Shares upon
exercise of Contingent Warrants.
Certain Covenants and Actions Prior to Second Closing. The Stock Purchase
Agreement provides that upon the terms and conditions contained therein, the
Company, both before and after each closing, will use all reasonable efforts to
consummate the Transactions. In addition, the Company has agreed that from the
date of the Stock Purchase Agreement to the earlier of the Second Closing or
termination of the Stock Purchase Agreement in accordance with its terms, the
Company and its subsidiaries will conduct their business in the ordinary and
usual course, and neither the Company nor any of its subsidiaries will engage in
certain significant actions or transactions without the prior consent of
Prometheus. See 'Stockholders Agreement.'
The Company and Prometheus have also agreed that from the date of the Stock
Purchase Agreement through the Second Closing: (a) the Company will take all
actions necessary to hold a meeting of stockholders to consider and vote upon
the adoption and approval of the Transactions, and, except to the extent
otherwise determined in good faith by the Board in the exercise of its fiduciary
duties (taking into account the advice of outside counsel), the Board will (i)
recommend to the Company's stockholders that they vote in favor of the adoption
and approval of all matters necessary to effectuate the Transactions, (ii) use
its reasonable best efforts to solicit from the Company's stockholders proxies
in favor of such adoption and approval, and (iii) take all actions reasonably
necessary to secure a vote of the stockholders in favor of such adoption and
approval; (b) the Company will use its reasonable best efforts and take all
action reasonably necessary to obtain the confirmation of the Nasdaq Stock
Market, Inc. ('Nasdaq') that the Transactions will not violate certain rules set
forth in the National Association of Securities Dealers, Inc. ('NASD') Manual
applicable to issuers listed on the Nasdaq National Market System; (c) neither
the Company nor Prometheus will issue any press release with respect to the
Stock Purchase Agreement or the Transactions without the other's reasonable
consent, except as required by applicable laws; (d) the Company will provide
Prometheus with access to the Company's premises, books and records; (e) the
Company and Prometheus will each give prompt notice to the other of any event
likely to cause a representation or warranty in the Stock Purchase Agreement to
be materially untrue or inaccurate, or any material failure to comply with or
satisfy any covenant or condition contained therein, and will use all reasonable
efforts to remedy such failure, and the Company will promptly notify Prometheus
of any material development involving the operations or activities of the
Company or its subsidiaries; (f) the Company, its affiliates and their
respective directors, officers, employees, representative or agents will not
solicit certain proposals or transactions alternative to the Transactions (see
'The Transactions--Stock Purchase Agreement--No Solicitation'); (g) to the
extent that the HSR Act is determined to be applicable to the Transactions, the
Company and Prometheus will file all documents and items required under the HSR
Act; (h) the Company will take all actions reasonably necessary to ensure that
the Transactions will not result in the acceleration or creation of any rights
of any persons under any employee plan of the Company; (i) on the date of the
Stockholders Approval, the Board will take or cause to be taken all actions
necessary or desirable (x) to cause the Board to consist of 15 directors, three
of whom will be elected by Prometheus, and (y) to effect certain bylaws
amendments; (j) prior to the Second Closing, the Board will take or cause to be
taken all actions necessary or desirable to file certain amendments to the
Certificate of Incorporation with the Secretary of State of the State of
Delaware; (k) on or prior to the appointment of the Preferred Stock Directors to
the Board, the Company will ensure that each director of the Company on and
after the date of such appointment will receive certain liability insurance
coverage, in no event
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less than $25,000,000; and (l) the Company and Prometheus will keep confidential
all information provided to each pursuant to the Stock Purchase Agreement,
subject to certain exceptions.
Immediately after Stockholders Approval, (a) the Board and the board of
directors of each subsidiary of the Company will adopt certain bylaws
amendments, (b) certain amendments to the certificates of incorporation of the
Company and its subsidiaries will be filed with the Secretary of State of the
State of Delaware, and (c) the Preferred Stock Directors will be appointed to
the Board. Upon the request of Prometheus, however, the Company will take the
actions set forth in clauses (a) and (c) above prior to Stockholders Approval.
No Solicitation. Under the Stock Purchase Agreement, until the Second
Closing has occurred, neither the Company nor any of its affiliates nor any of
their respective directors, officers, employees, representatives or agents will
solicit or initiate any discussions, submissions of proposals or offers or
negotiations with, participate in any negotiations or discussions with, provide
any information or data of any nature whatsoever to, or otherwise cooperate in
any way with, or assist or participate in, facilitate or encourage any effort or
attempt by, any third party concerning any Alternative Transaction. 'Alternative
Transaction' means any merger, consolidation (other than insofar as such merger
or consolidation relates exclusively to the acquisition by the Company or one of
its subsidiaries of companies or businesses engaged primarily in the same
business as the Company), sale of substantial assets not in the ordinary course,
sale of shares of existing or future capital stock or other equity securities or
securities convertible into equity securities or derivatives thereof (other than
pursuant to employee stock options), recapitalization, capital infusion,
incurrence of material additional indebtedness except pursuant to existing lines
of credit or refinancings thereof, debt restructuring or similar transaction
involving the Company or any of its subsidiaries, or any division of the Company
or any of its subsidiaries.
Notwithstanding the foregoing, nothing contained in the Stock Purchase
Agreement will prohibit the Board from (a) furnishing information or affording
access to properties, books or records to, or entering into discussions or
negotiations with, any person or entity in connection with any unsolicited bona
fide proposal by such person orentity to enter into any Alternative Transaction
or entering into an Alternative Transaction if, and only to the extent that, (i)
the Company receives the written advice of outside legal counsel that such
action is advisable to enable the Board to comply with its fiduciary duties
imposed by applicable law and (ii) prior to furnishing such information to, or
entering into discussions or negotiations with, such person or entity, the
Company (X) provides written notice to Prometheus to the effect that it is
furnishing information or affording access to properties, books or records to,
or entering into discussions or negotiations with, such person or entity and (Y)
receives from such person or entity an executed confidentiality agreement on
terms and in form customary for similar transactions or (b) with regard to an
Alternative Transaction, complying with Rule 14e-2 promulgated under the
Exchange Act, which requires, following the publication or announcement of a
tender offer for a company, the publication or other dissemination to the
subject company's security holders of such company's recommendations with
respect to the tender offer and its reasons therefor. As part of the written
notice to be provided to Prometheus as described above, the Company will
indicate the identity of the offeror and the terms and conditions of any
proposals or offers or the nature of any inquiries or contacts, and thereafter
will use reasonable efforts to keep Prometheus informed, on a current basis, of
the status and terms of any such proposals or offers and the status of any such
discussions or negotiations. The Company will not release any third party from,
or waive any provision of, any confidentiality or standstill agreement to which
the Company is a party.
Conditions to Closings. The respective obligations of the Company and
Prometheus to consummate the Transactions in respect of each purchase of Class
AA Preferred Stock, Class AB Preferred Stock, Warrants or Contingent Warrants by
Prometheus (each a 'Closing') are subject to the satisfaction or waiver, on or
prior to the relevant Closing Date (defined below) of each of the following
conditions: (a) there will be no injunction or court order restraining
consummation of the Transactions and no pending or threatened action or
proceeding by or before a court or governmental body brought by or on behalf of
any governmental entity seeking to restrain or invalidate all or any portion of
the Transactions, and no law or regulation will have been adopted making all or
any portion of the Transactions illegal; (b) any waiting period applicable to
the Transactions under the HSR Act will have expired or been terminated; (c)
Nasdaq will have informed the Company that the Transactions will not violate
certain rules set forth in the NASD Manual applicable to issuers listed on the
Nasdaq National Market System; and (d) Nasdaq will not have indicated any
intention to delist the Common Stock. 'Closing Date' means, with respect to any
Closing, the date of such Closing, which will be the third business day
following the date on which the conditions set forth in the Stock Purchase
Agreement with respect to such Closing are satisfied
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or duly waived, or if the Company and Prometheus mutually agree on a different
date, the date upon which they have mutually agreed.
The obligation of the Company to consummate the Transactions on the
applicable Closing Date with respect to each Closing is subject to the
satisfaction or waiver, on or prior to the relevant Closing Date, of each of the
following conditions: (a) all representations and warranties of Prometheus in
the Stock Purchase Agreement will be true and correct in all material respects
and Prometheus will have performed in all material respects all agreements and
covenants required to be performed by it under the Stock Purchase Agreement
prior to or at the applicable Closing Date, and will deliver a certificate to
such effect; (b) all consents, approvals, permits and waivers from governmental
entities necessary to consummate the Transactions will have been obtained,
unless the failure to obtain any such consent, approval, permit or waiver would
not have a Material Adverse Effect (defined below) on the Company; (c)
Prometheus will have delivered to the Company an opinion of its counsel in form
and substance reasonably acceptable to the Company; and (d) Prometheus will have
furnished to the Company such certificates to evidence compliance with the
conditions set forth in the Stock Purchase Agreement as may reasonably be
requested by the Company. 'Material Adverse Effect' means, with respect to any
person or entity, an event, occurrence or condition that has had or reasonably
would be expected to have a material adverse effect on the business, condition
(financial or otherwise), assets, liabilities, working capital, operations or
prospects of such person or entity and its subsidiaries (if any), taken as a
whole.
The obligation of Prometheus to consummate the Transactions on the
applicable Closing Date with respect to each Closing is subject to the
satisfaction or waiver, on or prior to the relevant Closing Date, of each of the
following conditions: (a) all representations and warranties of the Company in
the Stock Purchase Agreement will be true and correct in all material respects
and the Company will have performed in all material respects all agreements and
covenants required to be performed by it under the Stock Purchase Agreement
prior to or at the applicable Closing Date, and will deliver a certificate to
such effect; (b) all consents, approvals, permits and waivers from governmental
entities necessary to consummate the Transactions will have been obtained,
unless the failure to obtain any such consent, approval, permit or waiver would
not have a Material Adverse Effect on the Company or Prometheus; (c) the Company
will have delivered to Prometheus an opinion of its counsel in form and
substance reasonably acceptable to Prometheus; (d) the Company will have
furnished to Prometheus such certificates to evidence compliance with the
conditions set forth in the Stock Purchase Agreement as may reasonably be
requested by Prometheus; (e) since the date of the Stock Purchase Agreement,
there will not have been any Material Adverse Effect on the Company; (f) the
Company, its stockholders, and the Board will have taken all necessary action so
that immediately upon Stockholders Approval (i) the Board will consist of 15
directors, (ii) Prometheus may elect three members of the Board effective as of
Stockholders Approval, (iii) as of the date of Stockholders Approval, a
five-member Executive Committee of the Board of Directors will have been
established, and (iv) two members nominated by Prometheus will have been
appointed to the Executive Committee; (g) the Company will have entered into and
delivered to Prometheus the Ancillary Agreements; and (h) the Existing
Stockholders Agreement (defined below) will be, or will have been amended, if
necessary, to be, consistent with the Stock Purchase Agreement and the Ancillary
Agreements. The 'Existing Stockholders Agreement' means that certain
Stockholders Agreement, dated as of April 15, 1996, by and among certain
stockholders of the Company.
In addition to the foregoing, the respective obligations of the Company and
Prometheus to consummate the Transactions on the Second Closing and Subsequent
Closings are subject to the satisfaction or waiver, on or prior to the Second
Closing or the date of any Subsequent Closing (as the case may be), of the
condition that the Stockholders Approval will have been obtained. Further, the
obligation of Prometheus to consummate the Transactions on the Second Closing or
on Subsequent Closings are subject to the satisfaction or waiver, on or prior to
the Second Closing or the date of any Subsequent Closing (as the case may be),
of the following conditions: (a) the certificate of incorporation amendments and
the bylaws amendments in a form satisfactory to Prometheus will have become
effective; (b) the Company will have provided evidence of compliance with
certain insurance provisions under the Stock Purchase Agreement; and (c) the
Company will have amended the employment agreement of James J. Martell, Jr. in
form and substance satisfactory to Prometheus to require that he devote at least
95% of his working time to conducting the Company's business affairs and to
include customary non-compete provisions and, if Prometheus in its sole
discretion requires, the Company will have
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entered into an employment agreement on similar terms with J. Marshall Coleman.
See 'Compensation--Employment Agreements' and 'Certain Transactions.'
Representations and Warranties. The Stock Purchase Agreement contains
representations and warranties by the Company concerning, among other things:
(a) due organization, existence and good standing of the Company and its
subsidiaries and similar corporate matters; (b) capitalization of the Company on
the date of the Stock Purchase Agreement and the absence of preemptive rights or
obligations to issue or sell, repurchase, redeem or register shares of the
Company's or any subsidiary's capital stock; (c) authorization and validity of
the Class AA Preferred Stock, the Class AB Preferred Stock, Common Stock
issuable upon conversion of the Class AA Preferred stock or Class AB Preferred
Stock ('Conversion Shares'), Warrant Shares and Contingent Warrant Shares; (d)
the Company's authority to enter into and, subject to obtaining Stockholders
Approval, perform, and the execution, delivery, validity and enforceability of,
the Stock Purchase Agreement and the Ancillary Agreements; (e) the absence of
(i) conflict with or violation of the certificate of incorporation or bylaws of
the Company or any of its subsidiaries, (ii) conflict with or violation of or
default, right of termination, cancellation or acceleration under any Material
Agreement (defined below), (iii) loss of a benefit which would have a Material
Adverse Effect, (iv) the creation of any encumbrance upon the properties of the
Company or any of its subsidiaries or (v) the violation of any applicable law,
as a result of the Company entering into and performing the transactions
contemplated by the Stock Purchase Agreement and the Ancillary Agreements; (f)
governmental approvals required to enter into the Stock Purchase Agreement and
the Ancillary Agreements and to consummate the Transactions; (g) ownership and
valid issuance of the outstanding capital stock or other equity interests of
each subsidiary of the Company; (h) employee benefit plans and similar
agreements; (i) filing of required documents with the SEC, absence of untrue or
misleading statements of material facts or omissions of material facts in such
documents and compliance with applicable requirements of the federal securities
laws and generally accepted accounting principles; (j) the absence of (i)
undisclosed liabilities of the Company or any of its subsidiaries expected to
have a Material Adverse Effect on the Company or (ii) undisclosed Material
Agreements (defined below); (k) the absence of certain undisclosed material
events, occurrences, liabilities, transactions, agreements, commitments or
changes in the Company since November 30, 1997; (l) compliance with all
applicable laws; (m) the absence of any undisclosed litigation, investigation or
proceeding pending or threatened with respect to the Company, any of its
subsidiaries, the Stock Purchase Agreement or any of the Ancillary Agreements,
and the absence of knowledge of facts likely to give rise to any such proceeding
having a Material Adverse Effect on the Company; (n) the truth and accuracy of
the Company's representations and warranties in the Stock Purchase Agreement,
the schedules thereto and the certificates delivered thereunder, and the good
faith preparation of and reasonableness of assumptions underlying the financial
projections of the Company; (o) taxes; (p) real properties owned by the Company
or any of its subsidiaries; (r) environmental matters; (s) insurance policies;
(t) sufficiency of the tangible assets of the Company and its subsidiaries for
the conduct of their businesses, and the conformity thereof with applicable
laws; (u) the absence of undisclosed Material Agreements of the Company and each
of its Subsidiaries and the absence of any undisclosed breach or default
thereunder having a Material Adverse Effect on the Company; (v) accuracy and
fairness of books and records; (w) labor matters; (x) the absence of illegal
finder's fees or commissions; (y) the absence of false or misleading statements
or omissions in this Proxy Statement, other than with respect to information
provided by Prometheus, as to which the Company makes no representations, and
the compliance of this Proxy Statement with the Exchange Act and the rules and
regulations thereunder; (z) resolutions of the Board relating to the approval of
the Transactions; (aa) intellectual property; (bb) the absence of any
undisclosed sale by the Company of unregistered securities since the date of the
Company's initial public offering and the compliance of the Transactions with
federal and state securities laws; (cc) the absence of agreements to sell the
capital stock, material assets or business of the Company or any of its
subsidiaries, other than with respect to the Stock Purchase Agreement or to
effect any merger, liquidation, dissolution, recapitalization or other
reorganization of the Company; (dd) the absence of broker's fees, finder's fees
or other fees or commissions in connection with the Transactions; and (ee) the
absence of undisclosed related party transactions.
In addition, the Stock Purchase Agreement contains representations and
warranties by Prometheus concerning, among other things: (a) due organization,
existence and good standing of Prometheus and similar corporate matters; (b)
authority to enter into and perform, and the execution and delivery, validity
and enforceability of, the Stock Purchase Agreement and the Ancillary
Agreements; (c) the absence of conflict with, violation of, or default under, or
the creation of any encumbrance under, any applicable legal requirement,
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governing instrument or contractual obligation, except as would not materially
adversely effect Prometheus's ability to consummate the Transactions; (d)
governmental approvals required to enter into the Stock Purchase Agreement and
the Ancillary Agreements and to consummate the Transactions; (e) purchase of the
Class AA Preferred Stock, Class AB Preferred Stock, Warrants and Contingent
Warrants by and for Prometheus's own account and for investment purposes only,
acknowledgment of the restrictions on resale of the Class AA Preferred Stock,
Class AB Preferred Stock, Warrants, Contingent Warrants, Conversion Shares,
Warrant Shares and Contingent Warrant Shares, and other matters under federal
securities laws; (f) the absence of false or misleading statements or omissions
in the information supplied by Prometheus or any of its affiliates for inclusion
in this Proxy Statement; and (g) the absence of any broker, finder or other
intermediary employed by Prometheus or asserting a valid claim against
Prometheus for fees or commissions in connection with the Transactions.
Certain of the representations and warranties of the Company and Prometheus
are subject to exceptions and limitations. The Stock Purchase Agreement provides
that all representations and warranties contained therein will survive all of
the Closings and remain in full force and effect until December 31, 2000, except
that (i) certain representations and warranties will survive until a specified
later date, indefinitely or until the applicable statute of limitations has
expired and (ii) there will be no termination of any representation or warranty
as to which (a) a bona fide claim has been asserted prior to such Closing Date
or (b) Prometheus had actual knowledge of any breach thereof prior to such
Closing Date.
'Material Agreements' means all of the following Contracts (defined below)
to which the Company or any of its Subsidiaries is a party: (a) all Contracts
which (i) involve payments by or to any Person, of more than $50,000 in cash or
other property or services, (ii) extend for a term of more than 30 days from the
date of the Stock Purchase Agreement (unless the same is (y) cancelable on not
more than 30 days' notice without fee, premium or penalty or (z) motor vehicle
or equipment leases not involving payments in excess of $50,000), (b) all loan
agreements and commitments, credit agreements, indentures, promissory notes,
mortgages, deeds of trust, pledge or security agreements, factoring agreements,
conditional sales Contracts, letters of credit or other agreements or
instruments evidencing, securing or issued in connection with any liability of
the Company or any of its subsidiaries, (c) all operating leases or capital
leases for equipment to which the Company is a party involving annual payments
in excess of $50,000 per lease, (d) all union, labor or collective bargaining
Contracts, (e) all consulting, management, development, leasing brokerage or
similar agreements with total obligations in excess of $50,000, (f) any
guarantee of any liability or other obligations of any person other than
guarantees by the Company of the obligations of its wholly owned subsidiaries,
(g) each joint venture, partnership, operating or similar agreement, (h) each
agreement relating to any outstanding commitment for capital expenditures
involving future payments which, together with future payments under all other
agreements, Contracts or commitments relating to the same capital project,
exceed $50,000, (i) any agreement, Contract or commitment relating to a
disposition or an acquisition of the assets (except in respect of the
disposition or acquisition of assets with a fair market value of less than
$50,000) or securities of, or any interest in, any person or other business
enterprise, (j) any agreement, Contract or commitment in respect of any
liability of whatever nature (including, without limitation, open account
indebtedness) to any affiliate of the Company, (k) any agreement, Contract or
commitment containing any covenant limiting the freedom of the Company to
undertake, conduct or engage in any business or activity or to compete with any
person in any geographic area, (l) any Financial Product Agreement (defined
below), (m) any construction, development, service, supply and maintenance
agreement (unless the same is (y) cancelable on not more than 30 days' notice
without fee, premium or penalty or (z) does not involve payments in excess of
$50,000), (n) all leases of real property and (o) all agreements not entered
into in the ordinary course of business. 'Contract' means any written or oral
agreement, contract, lease, commitment, understanding, instrument or obligation
to which the Company or any of its Subsidiaries is a party or by which the
Company or any of its subsidiaries or any of their respective properties may be
bound. 'Financial Product Agreement' means any (a) interest rate, currency,
commodity or other swap, cap, floor, collar, insurance or similar agreement or
arrangement, (b) put, call, futures or forward contract, straddle, commodities
contract, option or warrant other than outstanding options or warrants for
Common Stock, (c) repurchase or reverse repurchase or similar agreement or
arrangement, or (d) any other financial, derivative, hedge, or speculative
product, service or agreement, contract or arrangement.
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Indemnification. The Company has agreed to indemnify and hold harmless
Prometheus and its members, affiliates, directors, officers, advisors, agents
and employees (collectively, the 'Prometheus Indemnified Parties') to the
fullest extent lawful, from and against any and all demands, damages, penalties,
claims, liabilities, obligations, actions, causes of action, and reasonable
expenses (including without limitation, costs of investigating, preparing or
defending any such claim or action and reasonable legal fees and expenses)
(collectively, 'Losses'), (i) arising out of or in connection with the Stock
Purchase Agreement, the Transactions, and/or the delivery, enforcement and
performance of the Stock Purchase Agreement or the Ancillary Agreements except
to the extent that Losses with respect thereto are the result of Prometheus's
actions or omissions, or (ii) arising by reason of or resulting from any breach
of any warranty, representation, covenant or agreement of the Company contained
in the Stock Purchase Agreement, the Ancillary Agreements or in any certificate
delivered pursuant thereto. Prometheus has agreed to indemnify and hold harmless
the Company and its affiliates, directors, officers, advisors, agents and
employees (collectively, the 'Company Indemnified Parties,' and together with
the Prometheus Indemnified Parties, the 'Indemnified Parties') to the fullest
extent lawful, from and against any and all Losses (i) arising from the Stock
Purchase Agreement or the Ancillary Agreements to the extent of Losses from
Prometheus's actions or omissions or (ii) arising by reason of or resulting from
any breach of any warranty, representation, covenant or agreement of Prometheus
contained in the Stock Purchase Agreement or in any certificate delivered
pursuant thereto. The foregoing indemnification provisions will remain in full
force and effect indefinitely.
The parties have agreed that any indemnification payments made pursuant to
the Stock Purchase Agreement will be treated for tax purposes as an adjustment
to the consideration for the purchase of the Class AA Preferred Stock, the Class
AB Preferred Stock, the Warrants and the Contingent Warrants issued under the
Stock Purchase Agreement, unless otherwise required by applicable law, in which
event indemnification payments will be made in an amount sufficient to indemnify
the party on a net after-tax basis. After the First Closing, all decisions on
behalf of the Company as to payment of indemnification pursuant to the Stock
Purchase Agreement and otherwise regarding the Company's rights and obligations
pursuant to the Stock Purchase Agreement and the Ancillary Agreements will be
made by a committee of the Board consisting of all directors not elected by the
holders of the Class AA Preferred Stock and the Class AB Preferred Stock, voting
together as a separate class, and a decision of a majority of such directors
will be a decision of the committee. Nothing contained in the Stock Purchase
Agreement will prevent any Indemnified Party from receiving indemnification
pursuant to some other source (such as, by way of example, the bylaws of the
Company in the event that such Indemnified Party is a director of the Company
and such director seeks indemnification due to circumstances that do not pertain
to an alleged breach of the Stock Purchase Agreement), and the determination as
to whether indemnification pursuant to such other source is available will be
made in accordance with the procedures applicable thereto.
Fees and Expenses. The Company will be responsible for the payment of all
costs and expenses incurred by the Company in connection with the Transactions,
regardless of whether the Transactions close, including, without limitation, all
fees and expenses incurred in connection with the preparation and distribution
of this Proxy Statement and the fees and expenses of the Company's legal counsel
and all third party consultants engaged by the Company to assist in the
Transactions. Such fees and expenses incurred or to be incurred by the Company
are estimated to total approximately $1,250,000, including legal fees, an
investment banking fee to be paid to Furman Selz and other expenses. On the
closing dates, the Company will reimburse Prometheus for the Transaction
Expenses. 'Transaction Expenses' means the reasonable fees and expenses incurred
by Prometheus, including, but not limited to, fees and expenses of legal
counsel, accountants and consultants and travel expenses in connection with the
preparation of the Stock Purchase Agreement and Prometheus's due diligence
examination relating to the Stock Purchase Agreement and the Transactions,
including, without limitation, any fees for filings under the HSR Act. The
Transaction Expenses for which the Company has reimbursed or will reimburse
Prometheus are estimated to total approximately $1,750,000, of which
approximately $1,031,000 has been reimbursed to date. See 'Expenses of the
Transactions.'
In the event that the Stock Purchase Agreement is terminated prior to the
Second Closing (i) by the Company or Prometheus if the Stockholders Approval is
not obtained on or before March 6, 1998, (ii) by Prometheus, if the Second
Closing has not occurred by March 6, 1998 or (iii) by Prometheus, if there is a
breach of any representation or warranty set forth in the Stock Purchase
Agreement or any covenant or agreement to be complied with or performed by the
Company pursuant to the terms of the Stock Purchase Agreement except for
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any breach which would not have a Material Adverse Effect (defined above) on the
Company or Prometheus, in addition to any other rights of Prometheus under the
Stock Purchase Agreement, the Company will be obligated promptly to pay
Prometheus, by way of liquidated damages, a termination fee of $4,000,000 plus
the Transaction Expenses (to the extent not already paid or reimbursed by the
Company). The foregoing provision does not apply in the event that the Stock
Purchase Agreement is terminated by the Company prior to the Second Closing if
there is a material breach by Prometheus of any representation or warranty in
the Stock Purchase Agreement or of any covenant or agreement to be complied with
or performed by Prometheus pursuant to the terms of the Stock Purchase Agreement
except for any breach which would not have a Material Adverse Effect on the
Company.
Termination. The Stock Purchase Agreement (other than certain portions
thereof) may be terminated prior to the Second Closing (i) by the Company or
Prometheus if Stockholders Approval has not been obtained on or before March 6,
1998, provided that the Company will not have the right to elect this
termination if the Company has not complied with all of its obligations under
the Stock Purchase Agreement; (ii) by Prometheus, if the Second Closing has not
occurred by March 6, 1998; (iii) by Prometheus, if there is a breach of any
representation or warranty set forth in the Stock Purchase Agreement or any
covenant or agreement to be complied with or performed by the Company pursuant
to the terms of the Stock Purchase Agreement except for any breach which would
not have Material Adverse Effect on the Company or Prometheus; and (iv) by the
Company, if there is a material breach of any representation or warranty set
forth in the Stock Purchase Agreement or any covenant or agreement to be
complied with or performed by Prometheus pursuant to the terms of the Stock
Purchase Agreement except for any breach which would not have Material Adverse
Effect on the Company.
If the Stock Purchase Agreement is terminated pursuant to the foregoing,
then, except for the provisions relating to indemnification and fees and
expenses, neither the Company nor Prometheus will have any liability or further
obligation to each other relating to the transactions contemplated by the Stock
Purchase Agreement, provided that no such termination will relieve the Company
or Prometheus from liability or a prior breach of the Stock Purchase Agreement.
REGISTRATION RIGHTS AGREEMENT
In accordance with the Stock Purchase Agreement, the Company and Prometheus
entered into a Registration Rights Agreement dated as of September 30, 1997 (the
'Registration Rights Agreement') at the First Closing. The Registration Rights
Agreement provides that holders of Registrable Securities (defined below)
constituting at least twenty percent (20%) of the Registrable Securities then
outstanding may request at any time that the Company file a registration
statement and use its best efforts to register (a 'Demand Registration') under
the Securities Act such number of Registrable Securities that are the subject of
such request. 'Registrable Securities' means (a) the shares of Class AA
Preferred Stock and Class AB Preferred Stock, whether or not owned by
Prometheus, (b) any debt instrument issued in lieu of all or a portion of the
Class AB Preferred Stock pursuant to the Stock Purchase Agreement, whether or
not owned by Prometheus, (c) the shares of Common Stock issued or issuable upon
conversion of Class AA Preferred Stock and Class AB Preferred Stock or debt
instrument, whether or not owned by Prometheus, (d) the shares of Common Stock
issued or issuable upon exercise of any Warrants or Contingent Warrants, whether
or not owned by Prometheus and (e) any securities issued or issuable with
respect to such Common Stock by way of a stock dividend or stock split or in
connection with a combination of shares, recapitalization, merger, consolidation
or reorganization whether or not owned by Prometheus; provided that any such
share or other security shall be deemed to be Registrable Securities only if and
so long as it is a Transfer Restricted Security. The Registration Rights
Agreement will be amended to include as Registrable Securities the 898,845
shares of Common Stock that Prometheus has agreed to purchase from the Selling
Stockholders. 'Transfer Restricted Security' means a security that has not been
sold to or through a broker, dealer or underwriter in a public distribution or
other public securities transaction or sold in a transaction exempt from the
registration and prospectus delivery requirements of the Securities Act under
Rule 144 promulgated thereunder (or any successor rule). The foregoing
notwithstanding, a security will remain a Transfer Restricted Security until (i)
all stop transfer instructions or notations and restrictive legends with respect
to such security have been lifted or removed and (ii) the holder of such
security has received at the Company's expense an opinion of counsel to the
Company (which counsel and opinion are reasonably satisfactory to such holder),
to the effect that such shares in such holder's hands are freely transferable in
any public or private transaction without registration under the Securities Act
(or such holder has waived receipt of such opinion).
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The Company will be obligated to cause to become effective no more than (a)
two Demand Registrations in any two-year period and (b) three Demand
Registrations in total; provided, however, that a registration statement filed
as part of a Demand Registration shall not be counted as one of the three Demand
Registrations unless it becomes effective and is maintained effective until all
Registrable Securities covered by such registration statement have been sold.
The Company will not be obligated to effect a Demand Registration on Form S-1
unless (a) the proposed aggregate public offering price of the securities to be
included in such Demand Registration is at least $5,000,000 and (b) if the
demand is made by less than fifty percent (50%) of the holders of Registrable
Securities then outstanding, such demand is made not less than 90 days after the
effective date of the Company's most recent registration statement for shares of
Common Stock (other than a registration statement on Form S-4 or Form S-8 or any
successor forms thereto). The Company will give written notice to all holders of
Registrable Securities upon receipt of a request for a Demand Registration and
will include in such Demand Registration such shares of Registrable Securities
for which it has received written requests to register within 30 days after such
written notice has been given. The holders of a majority of shares of
Registrable Securities to be included in a Demand Registration will have the
right to select the underwriters for such Demand Registration. The Company may,
once per Demand Registration, require Prometheus not to sell under a Demand
Registration or to suspend the effectiveness thereof if the Company determines,
in its good faith judgment, that such offering or continued effectiveness would
interfere with any material financing, acquisition, disposition, corporate
reorganization or other material transaction involving the Company or any of its
subsidiaries or when the Company is in possession of material information that
it deems advisable not to disclose in a registration statement.
If the Company proposes to register any of its securities under the
Securities Act (other than registrations on Form S-4 or Form S-8 or any
successor forms thereto, and other than a Demand Registration) for sale for
money, the Company is obligated to notify all holders of Registrable Securities
and will include under the registration statement proposed to be filed by the
Company such shares of Registrable Securities for which it has received written
requests to register, and the Company will use its best efforts to register
under the Securities Act the sale of such Registrable Securities (a 'Piggyback
Registration'). Following notice to holders of Registrable Securities of a
Piggyback Registration, the Company may decline to file a registration statement
or may withdraw a registration statement prior to effectiveness provided that
the Company notifies each holder of Registrable Securities of such action.
Under certain circumstances, the number of Registrable Securities that the
holders thereof will be entitled to include in either a Demand Registration or a
Piggyback Registration will be limited. If the public offering of Registrable
Securities pursuant to a Demand Registration is to be underwritten and, in the
good faith judgment of the managing underwriter, the inclusion of all the
Registrable Securities requested to be registered thereunder would interfere
with the successful marketing of a smaller number of such shares of Registrable
Securities, the number of shares of Registrable Securities to be included will
be reduced to such smaller number with the participation in such offering to be
pro rata among the holders of Registrable Securities requesting such
registration, based upon the number of shares of Registrable Securities owned by
such holders. If in the good faith judgment of the managing underwriter of a
Piggyback Registration, the inclusion of all of the shares of Registrable
Securities and any other Common Stock requested to be registered would interfere
with the successful marketing of a smaller number of such shares, then the
number of shares of Registrable Securities and other Common Stock to be included
in the offering (except for shares of Registrable Securities to be included in a
Demand Registration) will be reduced to such smaller number with the
participation in such offering to be in the following order of priority: (a)
first, the shares of Registrable Securities requested to be included, and (b)
second, any other shares of Common stock requested to be included. Any necessary
allocation among the holders of shares within each of the foregoing groups will
be pro rata among such holders requesting such registration based upon the
number of shares of Common Stock and Registrable Securities owned by such
holders. All shares so excluded from the underwritten public offering pursuant
to a Demand Registration or a Piggyback Registration must be withheld from the
market by the holders thereof for a period (not to exceed 30 days prior to the
effective date and 75 days thereafter) that the managing underwriter reasonably
determines is necessary in order to effect the underwritten public offering.
Upon the written request of the managing underwriter of any underwritten
offering of the Company's securities, a holder of Registrable Securities will
not be permitted to sell, make any short sale of, loan, grant any
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option for the purchase of, or otherwise dispose of any Registrable Securities
(other than those included in such registration) without the prior written
consent of such managing underwriter for a period (not to exceed 30 days before
the effective date and 75 days thereafter) that such managing underwriter
reasonably determines is necessary in order to effect the underwritten public
offering; provided that each of the officers and directors of the Company have
entered into substantially similar holdback agreements with such managing
underwriter covering at least the same period.
The Company has agreed (i) not to effect any public or private sale or
distribution of its Equity Securities (defined above) during the 30-day period
prior to, and during the 75-day period after, the effective date of each
underwritten offering made pursuant to a Demand Registration or a Piggyback
Registration, if so requested in writing by the managing underwriter (except as
part of such underwritten offering or pursuant to registrations on Forms S-4 or
S-8 or any successor forms thereto), and (ii) not to issue any Equity Securities
other than for sale in a registered public offering unless each of the persons
to which such securities are issued has entered a written agreement binding on
its transferees not to effect any public sale or distribution of such securities
during such period, including, without limitation, a sale pursuant to Rule 144
under the Securities Act (except as part of such underwritten registration, if
and to the extent permitted hereunder).
The Company will bear all Registration Expenses, as defined below, incurred
in connection with all Piggyback Registrations and the first two of the three
Demand Registrations. The Registration Expenses of the third Demand Registration
will be shared proportionately between the Company and the holders of
Registrable Securities to be included in such Demand Registration. 'Registration
Expenses' means all out-of-pocket expenses, including: registration, filing and
NASD fees; all fees and expenses of complying with securities or blue sky laws;
fees and disbursements of counsel for the Company and not more than one firm of
attorneys for the sellers of Registrable Securities; fees and disbursements of
the Company's independent public accountants; printing costs; premiums and other
costs of securities acts liability insurance; and fees and disbursements of
underwriters, excluding fees or expenses relating to the distribution of
Registrable Securities.
The Registration Rights Agreement contains certain indemnification and
contribution provisions in the event of a registration of any Registrable
Securities under the Securities Act. The Company will (whether or not it shall
then be required to do so) timely file such information, documents and reports
as the SEC may require or prescribe under Section 13 or 15(d) (whichever is
applicable) of the Exchange Act. In addition, the Company will take such other
measures and file such other information, documents and reports, as are
hereafter required by the SEC as a condition to the availability of Rule 144
under the Securities Act (or any successor provision) and the use of Form S-3.
The Company has agreed not to enter into any agreement to register any
equity securities of the Company after the date of the Registration Rights
Agreement, except for an agreement between the Company and one or more
professional underwriters of securities, unless such agreement specifically
provides: (i) the holder of such equity securities may not participate in any
Demand Registration without the consent of the holders of a majority of
Registrable Securities, except under certain conditions; (ii) the holder of such
equity securities may not participate in any Piggyback Registration if the sale
of Registrable Securities is to be underwritten, except under certain
conditions; and (iii) all equity securities excluded from any Demand
Registration or Piggyback Registration as a result of the foregoing limitations
may not be publicly offered or sold for a period (not to exceed 30 days prior to
the effective date and 75 days thereafter) that the managing underwriter
reasonably determines is necessary in order to effect the underwritten public
offering of Registrable Securities registered pursuant to the Registration
Rights Agreement.
STOCKHOLDERS AGREEMENT
In accordance with the Stock Purchase Agreement, the Company, Prometheus
and certain stockholders entered into a Stockholders Agreement dated as of
September 30, 1997, at the First Closing. The stockholders who are parties to
the Stockholders Agreement (the 'Stockholder Parties') are: Messrs. J. Marshall
Coleman, James J. Martell, Jr., Robert R. Short, J. Christopher Stuhmer, Thomas
B. Buffington, Lawrence J. Witek, Lanold W. Caldwell, James M. Giddens, Ms.
Patricia A. Donnelly (Mr. Coleman's spouse) and Ms. Mary Ann Martell (Mr.
Martell's spouse). Messrs. Coleman, Martell, Short, Stuhmer, Buffington and
Witek are directors of the Company and constitute a majority, six of 11
directors, of the Board. The Stockholder Parties own in the
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aggregate Common Stock representing approximately 50.7% of the votes entitled to
be cast at the Special Meeting. 'See Beneficial Ownership of Securities.'
Members of the Board. Under the Stockholders Agreement, from the earlier
of the Stockholders Approval or the request by Prometheus, until a Termination
Event (defined above), the Company and the Stockholder Parties will take all
action necessary to cause (a) the number of directors comprising the Board to be
equal to 15, (b) the holders of Class AA Preferred Stock and Class AB Preferred
Stock, voting as a single class, as set forth in the Certificates of
Designations, to have the exclusive right to elect a minimum of three Preferred
Stock Directors, (c) any increases in the size of the Board to result in an
increase in the number of Preferred Stock Directors (rounded up to the next
whole number) such that Preferred Stock Directors represent at least 20% of the
votes exercisable by the Board, (d) at least a proportionate number (rounded up
to the next whole number) of Preferred Stock Directors to serve on each
committee of the Board, provided that with respect to the Executive Committee,
it will consist of five members, of which two will be Preferred Stock Directors,
and (e) at least one Preferred Stock Director to have the right to serve on the
board or other governing body of each of the Company's subsidiaries and
affiliates other than operational home building companies. See 'Stock Purchase
Agreement--Class AA Preferred stock--Voting Rights' and '--Class AB Preferred
Stock--Voting Rights.'
Upon the occurrence of an Adverse Event (defined above), which follows the
Second Closing, the Company and the Stockholder Parties will take all action
necessary to cause: (a) the holders of Class AA Preferred Stock and Class AB
Preferred Stock, voting as a single class, to elect Additional Preferred Stock
Directors sufficient to cause the Preferred Stock Directors to constitute a
majority of the Board and all committees of the Board, including the Executive
Committee and (b) the size of the Board and all committees to be automatically
increased in order to effect any such additional Directors. With respect to the
occurrence of an Adverse Event, the right of the holders of Class AA Preferred
Stock and Class AB Preferred Stock to elect Additional Preferred Stock Directors
will continue until such time as neither of the two components constituting an
Adverse Event is true for two consecutive Test Dates (defined above). See 'Stock
Purchase Agreement--Class AA Preferred Stock--Voting Rights' and '--Class AB
Preferred Stock--Voting Rights.'
In the event that all of the Class AA Preferred Stock and Class AB
Preferred Stock will have been converted into Common Stock prior to the
occurrence of a Termination Event, the Company will support the nomination and
election of designees to the Board by Prometheus (or its assignees) ('Prometheus
Nominees') and each Stockholder Party will vote all of his shares to elect such
Prometheus Nominees, such that Prometheus will have the same right to elect
directors as set forth above as if Prometheus still owned all of the Class AA
Preferred Stock and Class AB Preferred Stock, and the Company and the
Stockholder Parties will exercise all authority under applicable law to cause
such Prometheus Nominees to be elected to the Board. If a director has been
designated by Prometheus and Prometheus requests that such director be removed
(with or without cause), then such director will be removed with or without
cause, and each Stockholder Party has agreed to vote all shares of Common Stock
owned to effect such removal. Nothing in the Stockholder Agreement will prevent
Prometheus or any of its transferees or assignees from voting securities owned
by them in their sole and absolute discretion, including voting securities to
elect additional directors to the Board in excess of the directors which
Prometheus is entitled to elect pursuant to the Stockholders Agreement.
Conduct of Business. After the bylaws amendments have become effective,
notwithstanding the fact that a vote of the Board or the Executive Committee may
not be required under applicable law, the Company will not, and will not permit
any of its subsidiaries, without either Supermajority Director Approval (the
affirmative vote of over 81% of the entire Board) or Supermajority Executive
Committee Approval (the affirmative vote of over 81% of the members of the
entire Executive Committee), to engage in certain significant actions and
transactions. See 'Certificate of Incorporation and Bylaw Amendments.'
After the bylaws amendments have become effective, the Board will promptly
establish an Executive Committee, which will be delegated the authority to the
maximum extent permitted by law to approve any matter permissible under law for
authorization by an Executive Committee, including the matters that are subject
to Supermajority Director Approval or Supermajority Executive Committee
Approval.
The bylaws of the Company will provide that the number of directors
required to constitute a Supermajority Director Approval and a Supermajority
Executive Committee Approval will constitute a quorum for the Board and
Executive Committee, respectively, and the Company and the Stockholder Parties
will take all action
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necessary to amend the Company's certificate of incorporation and bylaws (and
the bylaws and certificates of incorporation of its subsidiaries) to give effect
to terms and conditions of the Stockholders Agreement, the forms of such
amendments to be reasonably satisfactory to Prometheus. Prior to a Termination
Event, Prometheus may elect to terminate all or a portion of the voting
provisions of the Stockholders Agreement, such that except as otherwise required
by law, actions requiring Supermajority Director Approval or Supermajority
Executive Committee Approval will require only majority approval, and the
Company and each of the Stockholder Parties agree to take all such action as may
be necessary to give effect to such termination, including amending the
Stockholders Agreement and the bylaws and certificates of incorporation of the
Company and its subsidiaries. Upon the occurrence of a Termination Event,
Prometheus is required to deliver a notice to the Company electing to terminate
certain provisions of the certificate of incorporation regarding (a) matters
subject to Supermajority Director Approval or Supermajority Executive Committee
Approval and (b) the vote of Class AA Preferred Stock and Class AB Preferred
Stock required to adopt or amend the bylaws. See 'Certificate of Incorporation
and Bylaws Amendments.'
Prometheus has agreed to vote the 11,700 shares of Class AA Preferred Stock
it acquired at the First Closing in favor of the proposal to increase to
1,550,000 shares the Common Stock subject to the Company's 1996 Stock Incentive
Plan. See 'Interests of Certain Persons in the Transactions.'
Each of the Stockholder Parties has agreed to take all such action as may
be necessary to effect an amendment to the Company's certificate of
incorporation to increase the number of authorized shares of Common Stock if
required to satisfy the conversion/exercise rights of the securities purchased
by Prometheus under the Stock Purchase Agreement.
Participation Rights. Until a Termination Event, if any, Prometheus will
be entitled to a participation right to purchase or subscribe for up to that
number of additional shares of capital stock to be issued or sold by the Company
which represents the same proportion of the total number of shares of capital
stock to be issued or sold by the Company as is represented by the number of
shares of Common Stock owned by Prometheus or into which Prometheus has the
right to convert prior to such sale or issuance at the conversion price in
effect at the relevant time relative to the number of shares of Common Stock
outstanding prior to such sale or issuance. The foregoing participation rights
will not apply to (a) the conversion of the Existing Preferred Stock, the Class
AA Preferred Stock, the Class AB Preferred Stock or the exercise of Warrants, or
the conversion, exchange or exercise of other securities convertible into or
exchangeable or exercisable for Common Stock whose issuance was subject to an
adjustment pursuant to the Certificates of Designations and (b) Common Stock
issued to the Company's employees under the Executive Equity Plan and other
employee benefit plans adopted by the Board and approved by the holders of
Common Stock when required by law. The purchase or subscription by Prometheus or
an affiliate of Prometheus, as the case may be, will be on the same price and
other terms and conditions, including the date of sale or issuance, as are
applicable to the purchasers or subscribers of the additional shares of capital
stock of the Company whose purchases or subscriptions give rise to the
participation rights (except that the price to Prometheus or its assignees to
make such purchase or subscription will be net of payment of any underwriting,
placement agent or similar fee), which price and other terms and conditions will
be substantially as stated in the relevant notice to be sent by the Company to
Prometheus. Prometheus will have 20 days after its receipt of the notice to
exercise its participation rights.
Tag-Along Rights. Each of Messrs. Coleman and Martell (the 'Executive
Shareholders') has agreed that (a) from the date of the Stockholders Agreement
through the third anniversary thereof, he will not sell, transfer, assign,
pledge or hypothecate ('Transfer'), whether in a single transaction or in a
series of linked transactions, more than 10% per year, when aggregated with all
such other Transfers made by such shareholder in such year, of the Common Stock
beneficially owned by him on the date of the Stockholders Agreement, and (b)
from the third anniversary of the date of the Stockholders Agreement through the
fourth anniversary thereof, he will not Transfer, whether in a single
transaction or in a series of linked transactions, more than 5%, when aggregated
with all such other Transfers made by such shareholder during such period, of
the Common Stock beneficially owned by him on the date of the Stockholders
Agreement, unless the terms and conditions of such Transfer will include an
offer to Prometheus to include in the transfer to the proposed transferee (the
'Third Party'), at Prometheus's option and on the same price and on the same
terms and conditions as apply to the Executive Shareholder, an amount of Class
AA Preferred Stock and Class AB Preferred Stock and Common Stock held by
Prometheus, determined as described below.
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Each of the Stockholder Parties other than the Executive Shareholders (the
'Homebuilder Shareholders') has agreed that after the date of the Stockholders
Agreement, he will not Transfer, whether in a single transaction or in a series
of linked transactions, more than 50% when aggregated with all such other
Transfers made by such shareholder, of the Common Stock then beneficially owned
by him, unless the terms and conditions of such Transfer will include an offer
to Prometheus to include in the transfer to the third party at the option of
Prometheus and on the same price and on the same terms and conditions as apply
to the Homebuilder Shareholder, an amount of Class AA Preferred Stock and Class
AB Preferred determined as described below.
The third party will be required to purchase from Prometheus, if Prometheus
desires to participate in such transaction, the number of shares of Common Stock
beneficially owned by Prometheus equaling the lesser of (a) the number derived
by multiplying (i) the total number of shares of Common Stock which the third
party proposes to purchase by (ii) a fraction, the numerator of which will be
the number of shares of Common Stock beneficially owned by Prometheus and the
denominator of which will be the number of shares of Common Stock beneficially
owned by Prometheus and the applicable shareholder or (b) such lesser number of
shares as Prometheus may designate in a notice. Prometheus will have 30 days
after its receipt of the selling shareholder's notice of a proposed Transfer to
exercise its tag-along rights.
For purposes of the above-described provisions regarding tag-along rights,
Prometheus will be deemed to own that number of shares of Common Stock that it
beneficially owns at any given date plus the number of shares of Common Stock
into which the Class AA Preferred Stock and the Class AB Preferred Stock is
convertible, based on the applicable conversion price of such stock in effect on
the relevant date. The parties intend that only Common Stock will be transferred
to the third party pursuant to the tag-along rights provisions and if the
tag-along rights result in Prometheus including more shares of Common Stock
beneficially owned by him in any tag-along notice than will, on the date of
transfer by Prometheus to the third party, have been converted into Common
Stock, Prometheus and the Company will take such steps as are reasonably
required to convert to Common Stock any Class AA Preferred Stock or Class AB
Preferred Stock to be purchased by the third party which Prometheus desires to
transfer immediately prior to such transfer and contingent upon such transfer
occurring.
The tag-along rights will terminate upon a Termination Event (defined
above).
CERTIFICATE OF INCORPORATION AND BYLAWS AMENDMENTS
AMENDMENTS TO THE CERTIFICATE OF INCORPORATION. The Stock Purchase
Agreement provides that, upon Stockholders Approval, the Board will file with
the Delaware Secretary of State certain amendments to the Company's certificate
of incorporation. Such amendments, which are summarized below, are set forth in
a Certificate of Amendment of Certificate of Incorporation of the Company.
Conduct of Business. Under the proposed amendments to the certificate of
incorporation, which are subject to the Stockholders Approval, the Company and
its subsidiaries will not be permitted to engage in certain significant actions
or transactions without Supermajority Director Approval (the affirmative vote of
over 81% of the members of the entire Board) or Supermajority Executive
Committee Approval (the affirmative vote of over 81% of the members of the
entire Executive Committee). Specifically, in addition to any other vote
required by applicable law and notwithstanding the fact that a lesser or no vote
of the Board or the Executive Committee is required under applicable law, the
Company will not, and will not permit any of its subsidiaries to, do any of the
following without Supermajority Director Approval or Supermajority Executive
Committee Approval:
(a) purchase, sell, license, assign, transfer, convey or otherwise
acquire or dispose of any assets, securities, or businesses, unless such
transaction is provided for in the annual budget or is in the ordinary
course of business and does not involve the acquisition or disposition of
homebuilding operations or any homebuilding company or entity;
(b) split (including any reverse split), combine, or reclassify any
shares of its capital stock; adopt resolutions authorizing a liquidation,
dissolution, merger, consolidation, restructuring, recapitalization, or
other reorganization of the capital structure of the Company or any of its
subsidiaries; or make any other material changes in its capital structure;
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(c) enter into any new line of business other than the business
engaged in by the Company and its subsidiaries on the date of the
amendments to the certificate of incorporation, cease to be engaged in any
material line of business engaged in by the Company and its subsidiaries on
such date or materially change the nature of the business engaged in by any
of them on such date;
(d) file any petition seeking relief, or consent to the institution of
any proceeding against itself seeking to adjudicate it a bankrupt or
insolvent, under any law relating to bankruptcy, insolvency or
reorganization or relief of debtors;
(e) amend or otherwise alter the Company's or any subsidiary's
certificate of incorporation or adopt, alter, amend or repeal any bylaw of
the Company (other than the adoption, alteration, amendment or repeal of
any bylaw of the Company by the stockholders of the Company) or any
subsidiary of the Company;
(f) declare or pay any dividend or make any other distribution with
respect to its capital stock, other than dividends paid by any subsidiary
to the Company or another subsidiary in the ordinary and usual course of
business or to the holders of the Class AA Preferred Stock, Class AB
Preferred Stock or the other preferred stock outstanding on such date;
(g) issue or sell (whether through the issuance or granting of
options, warrants, commitments, subscriptions, rights to purchase, or
otherwise) any of its capital stock (other than upon conversion of the
Class AA Preferred Stock and Class AB Preferred Stock or other outstanding
convertible securities of the Company, or upon exercise of outstanding
warrants or stock options) or deliver other securities other than as
contemplated in the Stockholders Agreement, or purchase or otherwise
acquire any of its capital stock, employee or director stock options or
debt securities; or
(h) agree to do any of the foregoing.
Adoption or Amendment of Bylaws. The proposed amendments to the
certificate of incorporation also provide that the affirmative vote of the
holders of at least a majority in voting power of the then outstanding shares of
Class AA Preferred Stock and Class AB Preferred Stock, voting together as a
single class, will be required in order for the Company's stockholders to adopt,
alter, amend or repeal any bylaw of the Company. The foregoing provision applies
notwithstanding any provision of law which might otherwise permit a lesser vote
or no vote, but in addition to any affirmative vote of the holders of any
particular class or series of stock required by law or the Company's certificate
of incorporation.
Termination. The provisions of the amendments to the certificate of
incorporation described in the preceding paragraphs will be in effect until such
time as Prometheus provides written notice to the Company's Secretary that
Prometheus elects to have such provisions to be of no further force and effect.
The Stockholders Agreement requires Prometheus to deliver such notice upon the
occurrence of a Termination Event (as defined above).
Increase in Authorized Common Stock. Under the Company's certificate of
incorporation as currently in effect, the Company's authorized capital stock
consists of 49,000,000 shares of Common Stock and 1,000,000 shares of preferred
stock. Of the 49,000,000 shares of authorized Common Stock, as of the Record
Date (a) 11,612,594 shares were issued and outstanding and (b) 136,100 shares
were held in the Company's treasury. Of the 1,000,000 shares of authorized
preferred stock, as of the Record Date there were: (a) 20,000 shares of Series A
Cumulative Convertible Preferred Stock authorized, of which 10,000 shares
(having an aggregate liquidation value of $1,000,000) were issued and
outstanding; (b) 40,000 shares of Series B Convertible Preferred Stock
authorized of which 8,854 shares (having an aggregate liquidation value of
$885,400) were issued and outstanding; (c) 70,000 shares of Series C Convertible
Preferred Stock authorized of which no shares were issued and outstanding; (d)
67,500 shares of Series D Convertible Redeemable Preferred Stock authorized of
which 60,000 shares (having an aggregate liquidation value of $6,000,000) were
issued and outstanding; (e) 50,000 shares of Series E Cumulative Convertible
Preferred Stock authorized of which 2,500 shares (having an aggregate
liquidation value of $250,000) were issued and outstanding; and (f) 46,670
shares of Class AA Preferred Stock authorized, of which 11,700 shares (having an
aggregate liquidation value of $11,700,000) were issued and outstanding.
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Under the proposed amendments to the Company's certificate of
incorporation, the number of authorized shares of Common Stock would be
increased from 49,000,000 to 99,000,000. An increase in the number of authorized
shares of Common Stock is needed to permit, under certain circumstances, the
conversion of the Class AA Preferred Stock, the Class AB Preferred Stock, the
Warrants and the Contingent Warrants to be issued in the Transactions. The
circumstances under which an increase in the number of authorized shares of
Common Stock may be needed include: (a) the conversion of the Class AA Preferred
Stock and the Class AB Preferred Stock by the holder(s) after decrease(s) in the
Optional Conversion Price (as defined above), which is subject to adjustment at
the option of the holder during the period between September 30, 2001 and
September 30, 2003, based on the closing prices of the Common Stock; (b) the
exercise of the Warrants after decrease(s) in the Exercise Price and increase(s)
in the number of Warrant Shares between September 30, 2001 and September 30,
2003, based on the closing prices of the Common Stock; and (c) the exercise of
the Contingent Warrants if the Adjustment Price is less than $8.01 per share.
See 'Stock Purchase Agreement--Class AA Preferred Stock--Conversion;'
'Warrants--Adjustments Based on Common Stock Market Price;' and 'Contingent
Warrants.'
The additional 50,000,000 shares of authorized Common Stock would also
provide the Board with flexibility for future capital requirements including the
issuance of Common Stock in connection with possible business acquisitions. The
Company has no specific plans to issue Common Stock other than Common Stock
issuable: (a) upon conversion of the Class AA Preferred Stock and the Class AB
Preferred Stock, and upon exercise of the Warrants and the Contingent Warrants;
(b) upon conversion of the Company's other preferred stock issued or issuable;
(c) upon exercise of options issued or issuable under the Company's 1996 Stock
Incentive Plan; (d) under the Company's Employee Stock Purchase Plan; and (e)
under the Company's 1996 Bonus Award Plan. Further, other than as described in
this Proxy Statement, there are no agreements, understanding or arrangements for
the issuance of the additional Common Stock under the amendments to the
certificate of incorporation.
Amendments to the Class AA Certificate of Designations. In accordance with
the September 30 Agreement, the Class AA Certificate of Designations was filed
with the Delaware Secretary of State in connection with the First Closing. Under
the Stock Purchase Agreement, the Class AA Certificate of Designations will be
amended, subject to Stockholders Approval, (a) to increase the number of
authorized shares of Class AA Preferred Stock from 46,670 to 53,333; (b) to add
the words 'as amended' to the references to the 'Stock Purchase Agreement' to
reflect that the September 30 Agreement has been amended; (c) to modify the
Adjustment Prices and Optional Conversion Prices for the Class AA Preferred
Stock as described herein; and (d) to exclude the exercise of the Warrants and
the Contingent Warrants from certain antidilution provisions. See 'Class AA
Preferred Stock--Conversion.' Under the Class AA Certificate of Designations as
originally filed, the optional conversion price is subject to decrease according
to the following schedule: if the Adjustment Price were (a) $10.01 to $12.00,
the optional conversion price ('OCP') would be $5.50; (b) $8.01 to $10.00, the
OCP would be $5.00; (c) $6.01 to $8.00, the OCP would be $4.00; (d) $4.01 to
$6.00, the OCP would be $3.00; (e) $2.01 to $4.00, the OCP would be $2.00; and
(f) $0 to $2.00, the OCP would be $1.00. Prometheus has indicated its consent,
as holder of the Class AA Preferred Stock, to the amendment to the Class AA
Certificate of Designations.
AMENDMENTS TO THE BYLAWS. The Stock Purchase Agreement provides that, upon
Stockholders Approval, the Board will adopt certain amendments to the Company's
bylaws and that the Company's subsidiaries will adopt certain amendments to
their bylaws. Upon the request of Prometheus, however, the Board will adopt such
amendments prior to Stockholders Approval. The amendments to the Company's
bylaws are described below.
Number of Directors. The number of directors will be 15 unless otherwise
fixed by a majority of the whole Board, subject to the provision governing the
election of directors following an Adverse Event (as defined). Any increase in
the size of the Board over 15 directors will result in an increase in the number
of Preferred Stock Directors (rounded up to the next whole number) such that
Preferred Stock Directors represent at least 20% of the votes exercisable by the
whole Board.
Quorum. A quorum for the transaction of business will require 81% of the
whole Board.
Removal of Directors. Any Preferred Stock Director or Additional Preferred
Stock Director may be removed with or without cause upon the affirmative vote of
the holders of a majority in voting power of the outstanding shares of Class AA
Preferred Stock and Class AB Preferred Stock then entitled to vote at an
election of directors.
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<PAGE>
Election of Directors Following Adverse Event. In the event of an Adverse
Event (as defined), the number of directors on the Board will immediately and
automatically be increased to such number as will enable the appointment or
election of Additional Preferred Stock Directors such that the Preferred stock
Directors together with the Additional Preferred Stock Directors will constitute
a majority of the Board. The Additional Preferred Stock Directors will be
elected exclusively by the holders of Class AA Preferred Stock and Class AB
Preferred Stock then entitled to vote. The Additional Preferred Stock Directors
will be entitled to serve on the Board until the second consecutive Test Date
(as defined) at which neither component of an Adverse Event exists.
Committees. Each committee of the Board will consist of at least 3
directors. The number of Preferred Stock Directors to serve on each committee
(other than the Executive Committee) will be proportionate to the number of
Preferred Stock Directors on the Board.
Executive Committee. The Board will have an Executive Committee composed
of five directors, two of which will be Preferred Stock Directors. A quorum for
the transaction of business will require 81% of the total number of directors
constituting the Executive Committee. The Executive Committee will have all the
powers and authority of the Board in the management of the Company's business
and affairs, including the power to declare dividends and authorize the issuance
of stock, except that the Executive Committee will not have the power or
authority to take action with respect to any matter on which it is prohibited
from taking action under the certificate of incorporation, the bylaws or certain
provisions of the Delaware General Corporation Law ('DGCL'). The bylaws
amendments provide that the Executive Committee will not have the power or
authority to:
(a) amend the certificate of incorporation (except that the Executive
Committee may, to the extent authorized in a resolution of the Board
providing for the issuance of the Company's stock, fix the designations and
any of the preferences or rights of such shares relating to dividends,
redemption, dissolution, any distribution of the Company's assets or the
conversion into, or the exchange of such shares for, shares of any other
class or series of stock or authorize the increase or decrease of the
shares of any series;
(b) adopt an agreement of merger or consolidation (other than a
certificate of ownership and merger with respect to a merger of the Company
and one or more of its subsidiaries pursuant to the DGCL);
(c) recommend to the stockholders the sale, lease or exchange of all
or substantially all of the Company's property and assets;
(d) recommend to the stockholders a dissolution of the Company or a
revocation of a dissolution; or
(e) amend the Company's bylaws.
Conduct of Business. Under the bylaws amendments of the Company and its
subsidiaries, the Company and its subsidiaries will not be permitted to engage
in certain significant actions or transactions, described below, without
Supermajority Director Approval or Supermajority Executive Committee Approval.
Specifically, in addition to any other vote required by applicable law and
notwithstanding the fact that a vote of the Board or the Executive Committee may
not be required under applicable law, the Company will not, and will not permit
any of its subsidiaries to, do any of the following without Supermajority
Director Approval or Supermajority Executive Committee Approval:
(a) purchase, sell, license, assign, transfer, convey or otherwise
acquire or dispose of any assets, securities, or businesses, unless such
transaction is provided for in the annual budget or is in the ordinary
course of business and does not involve (i) the acquisition or disposition
of homebuilding operations or any homebuilding company or entity or (ii)
land acquisitions with a value in excess of $100,000 for any transaction or
group of related transactions or with an aggregate value in excess of
$5,000,000 in any 12 month period;
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<PAGE>
(b) directly or indirectly incur, refinance, repay, prepay, create,
assume, guarantee or otherwise become liable with respect to any
liabilities with an aggregate face amount in excess of $1,000,000 in the
aggregate, other than in accordance with existing credit facilities and
renewals thereof on substantially the same terms;
(c) enter into any transaction or materially amend any transaction in
effect, with any affiliate of the Company (other than between the Company
and its subsidiaries or between its subsidiaries);
(d) split (including any reverse split), combine, or reclassify any
shares of its capital stock; adopt resolutions authorizing a liquidation,
dissolution, merger, consolidation, restructuring, recapitalization, or
other reorganization of the capital structure of the Company or any of its
subsidiaries; or make any other material changes in its capital structure;
(e) engage in any new development or redevelopment of any real
property for an amount in excess of $100,000, whether in a single
transaction or a series of related transactions (provided that it is
contemplated that such authority will be delegated to a committee of the
Board on guidelines approved by the Executive Committee);
(f) incur any capital expenditure for an amount, outside of the
approved annual budget, in excess of $50,000 per occurrence or $500,000 in
the aggregate, whether in a single transaction or a series of related
transactions, or waive, release, grant or transfer any rights of value in
respect thereof or enter into any agreement or arrangement that could
adversely affect the marketability of any real estate of the Company or any
of its subsidiaries;
(g) enter into any employment agreement with any employee involving
payments in excess of $100,000 per annum or with any director or executive
officer of the Company or any of its subsidiaries or enter into or
materially change any benefit arrangement between the Company and its
employees or consultants;
(h) enter into any new line of business other than the business
engaged in by the Company and its subsidiaries on the date of the bylaws
amendments, cease to be engaged in any material line of business engaged in
by the Company and its subsidiaries on such date or materially change the
nature of the business engaged in by any of them on such date;
(i) approve the annual operating budget of the Company for any year
after 1997;
(j) amend or take actions materially inconsistent with the approved
annual operating budget for 1997 or any subsequent year;
(k) make any general assignment for the benefit of creditors;
(l) file any petition seeking relief, or consent to the institution of
any proceeding against itself seeking to adjudicate it a bankrupt or
insolvent, under any law relating to bankruptcy, insolvency or
reorganization or relief of debtors;
(m) institute, voluntarily dismiss, terminate or settle any litigation
or arbitration against any person involving payments for damages and
penalties in excess of $50,000 or otherwise material to the Company and its
subsidiaries taken as a whole;
(n) engage, retain, pay or agree to pay the fees or expenses of any
third party consultants or advisors (other than advisors retained in the
ordinary course of business), to the extent that such fees and expenses
exceed $100,000 in the aggregate;
(o) appoint, ratify or replace the independent accountants, change any
accounting policy or practice other than as mandated by generally accepted
accounting principles then in effect; or change any significant tax
methods, practices, procedures or policies;
(p) enter into or amend any joint venture, partnership or profit
sharing agreement or arrangement;
(q) amend the Company's or any subsidiary's certificate of
incorporation or bylaws;
(r) declare or pay any dividend or make any other distribution with
respect to its capital stock, other than dividends paid by any subsidiary
to the Company or another subsidiary in the ordinary and usual course
47
<PAGE>
of business or to the holders of the Class AA Preferred Stock, Class AB
Preferred Stock or the other existing preferred stock of the Company;
(s) issue or sell (whether through the issuance or granting of
options, warrants, commitments, subscriptions, rights to purchase, or
otherwise) any of its capital stock (other than upon conversion of the
Class AA Preferred Stock and Class AB Preferred Stock or other outstanding
convertible securities of the Company, or upon exercise of outstanding
warrants or stock options) or deliver other securities other than as
contemplated in the Stockholders Agreement, or purchase or otherwise
acquire any of its capital stock, employee or director stock options or
debt securities; or
(t) agree to do any of the foregoing.
Termination. The above-described provisions regarding matters subject to
Supermajority Director Approval or Supermajority Executive Committee Approval
will be effective from the date of adoption of the bylaw amendments until such
time, if any, as Prometheus elects to terminate such provisions. The
Stockholders Agreement requires Prometheus to make such election upon the
occurrence of a Termination Event.
STOCKHOLDERS VOTING AGREEMENT
Concurrently with the execution of the Stock Purchase Agreement at the
First Closing, certain holders of the Common Stock and Prometheus entered into
an Amended and Restated Stockholders Voting Agreement dated as of September 30,
1997 (the 'Stockholders Voting Agreement'). The stockholders who are parties to
the Stockholders Voting Agreement are the same stockholders who are parties to
the Stockholders Agreement: Messrs. Coleman, Martell, Short, Stuhmer,
Buffington, Witek, Caldwell, and Giddens, Ms. Donnelly and Ms. Martell. Messrs.
Coleman, Martell, Short, Stuhmer, Buffington and Witek are directors and/or
officers of the Company. The stockholders who are parties to the Stockholders
Voting Agreement own in the aggregate Common Stock representing approximately
50.7% of the votes entitled to be cast at the Special Meeting. See 'Beneficial
Ownership of Securities.'
Each of such stockholders has agreed to vote his shares of Common Stock in
favor of the Transactions. See 'Stockholders Approval.' In addition, each of
such stockholders has agreed not to sell, transfer or otherwise dispose of any
of his Common Stock until the Second Closing under the Stock Purchase Agreement.
The Stockholders Voting Agreement will terminate at the Second Closing.
STOCKHOLDERS APPROVAL
Stockholders Approval will constitute approval of the Transactions
including: (a) the sale and issuance to Prometheus of an aggregate of 40,000
shares, having an initial liquidation value of $40,000,000, of Class AA
Preferred Stock, 35,000 shares, having an initial liquidation value of
$35,000,000, of Class AB Preferred Stock, the Warrants and the Contingent
Warrants, for an aggregate purchase price of $75,000,000 (except that the sale
and issuance of 11,700 shares of Class AA Preferred Stock and 375,000 Warrants
at the First Closing was not subject to Stockholders Approval); (b) the sale and
issuance to Prometheus of up to an additional 13,333 shares, having an initial
liquidation value of $13,333,000, of Class AA Preferred Stock and up to an
additional 11,667 shares, having an initial liquidation value of $11,667,000, of
Class AB Preferred Stock and 333,250 Warrants, for an aggregate purchase price
of $25,000,000; and (c) the amendments to the certificate of incorporation.
Under the DGCL, approval of the amendments to the certificate of
incorporation requires the affirmative vote of holders of a majority of the
outstanding Common Stock. Subject to certain exceptions, Nasdaq National Market
System rules require that a Nasdaq National Market System-quoted company obtain
the affirmative vote of holders of a majority of the outstanding voting stock
voting at a meeting at which a quorum is present to issue, other than in a
public offering, common stock or securities convertible into or exchangeable for
common stock representing 20% or more of the common stock or voting power
outstanding prior to the issuance, at a price less than the greater of book or
market value, or issue securities that will result in a change in control of the
listed company. If the consummation of the Transactions would result in such an
issuance, such requirement would be satisfied by obtaining Stockholders
Approval. Stockholder approval was not required with respect to the sale and
issuance of 11,700 shares of Class AA Preferred Stock at the First Closing which
resulted in Prometheus having
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<PAGE>
less than 20% of the outstanding voting power of the Company's capital stock and
did not result in a change in control pursuant to the applicable rules. See
'Stock Purchase Agreement--First Closing.'
Stockholders Approval is assured by reason of the fact that the
stockholders who are parties to the Stockholders Voting Agreement have agreed to
vote in favor of the Transactions and such stockholders own in the aggregate
Common Stock representing approximately 50.7% of the votes entitled to be cast
at the Special Meeting. See 'Beneficial Ownership of Securities.'
The Board unanimously recommends that stockholders vote FOR the
Transactions.
ACQUISITION OF WHITTAKER COMPANIES
On January 5, 1998, the Company entered into an agreement dated as of
December 31, 1997 (the 'Whittaker Purchase Agreement') to acquire Whittaker
Construction, Incorporated ('Whittaker Homes'), a homebuilder, and two related
companies, RRKTG Lumber, Inc. ('RKG Lumber'), and Lewis and Clark Title Company
('L&C Title') (Whittaker Homes, RKG Lumber and L&C Title collectively referred
to as the 'Whittaker Companies'). Whittaker Homes acquires and develops land and
constructs for sale single family attached and detached homes in St. Charles
County, Missouri, a submarket of the St. Louis Metropolitan Statistical Area.
Whittaker Homes builds single family detached homes targeting first and second
move-up buyers and builds custom homes. RKG Lumber supplies lumber products to
Whittaker Homes. L&C Title provides title insurance primarily for Whittaker
Homes customers. For the nine months ended September 30, 1997, Whittaker Homes
delivered 435 homes and the Whittaker Companies generated gross revenues of
approximately $66,600,000 and pre-tax profit of approximately $3,800,000. For
the year ended December 31, 1996, Whittaker Homes delivered 566 homes and the
Whittaker Companies generated gross revenues of approximately $85,500,000 and
pre-tax profit of approximately $5,100,000. Whittaker Homes' backlog at December
31, 1997 was 218 homes under contract with an aggregate value of approximately
$38,000,000.
On the terms and subject to the conditions of the Whittaker Purchase
Agreement, the Company will buy all the outstanding stock of the Whittaker
Companies from Robert N. Whittaker, Sr. and members of his family. The purchase
price is approximately $25,750,000 in cash, subject to adjustments. In addition,
the Company will assume approximately $36,000,000 of debt subject to
adjustments. To fund the purchase price, the Company intends to utilize the
proceeds from the Second Closing with Prometheus. Closing under the agreement is
subject to a number of conditions, including the requirement that the closing
occur no later than February 27, 1998. Because Stockholders Approval and the
Second Closing cannot occur before March 6, 1998, the Company intends to seek an
extension from the sellers of the February 27, 1998 closing date to at least
March 6, 1998 and/or bridge financing to consummate the acquisition of the
Whittaker Companies prior to the Second Closing. The Company has not made
arrangements for any bridge financing, and there can be no assurance that the
Company can obtain such an extension or bridge financing. If the Company does
not obtain an extension or bridge financing, the agreement to acquire the
Whittaker Companies will terminate, and the Company will forfeit the $500,000
deposit paid with respect to the acquisition and immediately recognize
previously capitalized acquisition expenses of approximately $185,000.
The purchase price is payable as follows. The Company made a deposit in
the amount of $500,000 upon execution of the Whittaker Purchase Agreement on
January 5, 1998. This deposit is nonrefundable if the Company fails to close for
any reason other than a material breach by the sellers. Subject to a
post-closing adjustment, the Company will pay $12,250,000 in cash at the closing
in addition to the $500,000 paid upon execution. Of the $12,250,000 to be paid
at closing, $1,000,000 will be paid into escrow to secure certain
indemnification obligations. Prior to the closing, the sellers will receive in
the aggregate approximately $13,000,000 from the Whittaker Companies consisting
of (a) cash dividends or other distributions in an amount approximately equal to
the combined net worth of the Whittaker Companies as of December 31, 1997; (b)
the Whittaker Companies' payment of personal loans, including accrued interest,
that the sellers made to the Whittaker Companies; and (c) a dividend just prior
to closing in the amount of the estimated increase in the net worth of Whittaker
Homes as a result of income realized for the period from December 31, 1997 to
the closing date. The Company will loan to Whittaker Homes at least two days
prior to the closing any Cash Short-Fall defined as the difference between 'X'
and 'Y' where 'X' is the sum of items (a) and (b) above and 'Y' is the Whittaker
Companies' Available Cash.
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'Available Cash' is defined as the Whittaker Companies' total cash on hand
less a reasonable amount reserved for working capital, which will not be less
than $2,000,000.
As of or immediately following the closing, the Company is obligated to
invest sufficient equity capital in the Whittaker Companies to enable them to
meet minimum net worth requirements and leverage ratios with respect to their
indebtedness as well as additional funds for working capital on an as needed
basis. The Company expects that no additional investment will be needed. After
closing, the purchase price is subject to adjustment based on a determination of
the net worth of the Whittaker Companies as reflected in an audited combined
balance sheet as of the date of the closing. To the extent that the amount of
the net worth plus the pre-closing distributions is less than $13,000,000, the
Company will pay the difference to the sellers.
The Company and the sellers have agreed to make an election under Section
338(h)(10) of the Code, so that the transaction will be treated for federal
income tax purposes as if the Company purchased all of the assets of the
Whittaker Companies. As a result of the election, the Company will recognize
taxable gain or loss on future sales of acquired assets (as well as any tax
depreciation) based on the price paid to the sellers rather than on the price
originally paid by the Whittaker Companies. An adjustment will be made to the
purchase price based on the determination of the amount of increase in state and
federal taxes payable by the sellers on the transaction as a result of the
Section 338 election. If the Section 338 tax increase is less than $750,000, the
sellers will pay the difference to the Company. If the Section 338 tax increase
is more than $750,000, the Company will pay such additional amount to the
sellers.
The transaction will be accounted for as a 'purchase.' The acquired assets
will be recorded at their fair value. The remaining excess of the purchase price
over the fair value of the assets received less the liabilities assumed will be
recorded as goodwill and amortized accordingly.
The Whittaker Purchase Agreement contains customary representations and
warranties by the Whittaker Companies, the sellers and the Company. The purchase
agreement also contains customary covenants prior to closing and customary
conditions precedent to closing. The conditions precedent to the Company's
obligations and the sellers' obligations include the execution of certain
employment agreements and a consulting agreement between Whittaker Homes and
certain of its senior officers and the execution of certain rights of first
refusal. The president and the chairman of Whittaker Homes, who are two of the
sellers, and their affiliates will grant to Whittaker Homes rights of first
refusal on all real property currently owned (with the exception of property
adjacent to their personal residences) or acquired by such persons and their
affiliates prior to the tenth anniversary of the date of grant of the rights,
which properties are developable or developed by or on behalf of such persons
and their affiliates for residential use or as golf course lots designed to be
associated with housing units.
The obligations of the Company under the Whittaker Purchase Agreement are
also subject to the conditions, among other things, that a certain lease is
executed with respect to the offices of Whittaker Homes and that the consents
required for the Company to conduct the business of the Whittaker Companies will
have been obtained. The obligations of the sellers are subject to the
conditions, among other things, that the Company will have secured releases of
certain personal guarantees of the sellers. Consents to the acquisition of the
Whittaker Companies must be obtained from certain financial institutions in
connection with various credit facilities to which the Whittaker Companies are
party. The Whittaker Purchase Agreement contains certain restrictive covenants
by the sellers including certain covenants not to compete through December 31,
2001.
A certain senior officer of Whittaker Homes will acquire 5,000 shares,
having a liquidation value of $500,000, of the Company's newly issued Series F
Convertible Preferred Stock (the 'Series F Preferred Stock'). To fund the
acquisition of the Series F Preferred Stock, such officer will receive a
$500,000 loan at an annual interest rate of 6% from the Company. Principal and
accrued interest on the loan will be due on March 1, 2001 (subject to the
completion of the annual audit of the Whittaker Companies' financial statements
for the prior year) except to the extent principal is forgiven based on
specified financial performance of the Whittaker Companies for the years 1998,
1999 and 2000. The Series F Preferred Stock will rank senior to the Common Stock
with respect to dividends and distributions. Dividends will be payable in cash
at the annual rate of 6% and will accrue for three years. No dividends will be
payable thereafter. The Series F Preferred Stock will have no voting rights
except as required by Delaware law. The holder may convert the Series F
Preferred Stock into Common Stock to the extent of the amount of any forgiven
debt. The conversion dates will be February 15, 1999,
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<PAGE>
2000 and 2001, subject to the completion of the annual audit of the Whittaker
Companies' financial statements for the prior year. The conversion prices will
be based on the closing price of the Common Stock on the closing date and on the
first and second anniversary thereof. Within 30 days after conversion, the
underlying Common Stock will be registered under the Securities Act or otherwise
freely transferrable. After March 1, 2002, the Company will have the right to
redeem the Series F Preferred Stock at its liquidation value for cash or Common
Stock. If Common Stock is issued on redemption, the number of shares of Common
Stock to be issued will be based on the average closing price of Common Stock
for the 10 days prior to the most recent conversion date. After completion of
the audit of the financial results of the Whittaker Companies for the year 2000,
the holder of the Series F Preferred Stock will have the right to require the
Company to buy for cash the Series F Preferred Stock to the extent of the amount
of unforgiven debt.
The Whittaker Purchase Agreement contains customary indemnification
provisions concerning misrepresentations, breaches of representations or
warranties and breaches of agreements. In addition, the sellers will indemnify
the Company and Whittaker Homes from and against any loss arising from a certain
lawsuit, Allen et al. v. Whittaker Construction, Incorporated, et al., pending
in Circuit Court of St. Louis County, Missouri (the 'Allen Litigation'), which
was filed in November 1997 as a class action. The complaint by 78 plaintiff home
buyers alleges that Whittaker Homes installed defective flat work concrete which
resulted in the cracking, flaking and chipping of concrete driveways, walkways,
patios, porches and other elements. The complaint seeks damages of more than
$25,000 for each plaintiff and exemplary and punitive damages. The sellers also
have agreed to pay the litigation costs associated with the defense of the Allen
Litigation. In addition, the sellers will indemnify the Company and Whittaker
Homes in an amount equal to the greater of (a) one-half of the fee of Michael
Kahn & Associates ('Kahn's Fee'), a broker retained by the sellers, or (b)
Kahn's Fee minus $175,000; the Company will indemnify the sellers and Whittaker
Homes in an amount equal to the lesser of one-half of Kahn's Fee or $175,000.
Except for the indemnification obligations with respect to the Allen Litigation,
the indemnification obligations of a party will not arise until the total of all
losses sustained by an indemnified party exceed $50,000 and then only for such
excess. The total losses for which sellers in the aggregate will provide
indemnification will be limited to $2,700,000. In addition to the Allen
Litigation, Whittaker Homes is a party to other lawsuits involving principally
construction related claims arising in the ordinary course of Whittaker Homes'
business.
The Company or the sellers may terminate the Whittaker Purchase Agreement
if the closing has not occurred on or before February 27, 1998, or by mutual
consent at any time prior to the closing. The Company or the sellers may
terminate the Whittaker Purchase Agreement if the other party or parties fail to
perform in any material respect obligations prior to the closing or materially
breaches any representations, warranties or covenants.
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SELECTED PRO FORMA FINANCIAL DATA
The selected pro forma combined financial data provided should be read in
conjunction with the Pro Forma Consolidated Financial Statements and the related
notes thereto.
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, 1996 SEPTEMBER 30, 1997
----------------- ------------------
<S> <C> <C>
Statement of Operations Data:
Revenue.................................................................. $ 511,915 $ 409,500
Gross profit............................................................. 85,318 65,816
Other expenses net....................................................... 53,645 49,638
----------- ------------
Income before provision for income taxes................................. 31,673 16,178
Provision for income taxes............................................... 12,029 6,182
----------- ------------
Net income............................................................... $ 19,644 $ 9,996
----------- ------------
----------- ------------
Net income per share..................................................... $ 1.40 $ .58
----------- ------------
----------- ------------
Weighted average shares outstanding...................................... 11,743,040 13,067,515
Balance Sheet Data:
Cash and cash equivalents................................................ $ 8,799
Inventory................................................................ 269,949
Other assets............................................................. 108,371
------------
Total assets.......................................................... $ 387,119
------------
------------
Accounts payable and accrued liabilities................................. $ 37,715
Notes payable............................................................ 248,299
Other.................................................................... 13,866
Equity................................................................... 86,959
------------
Total liabilities and equity.......................................... $ 387,119
------------
------------
</TABLE>
The selected pro forma combined financial data reflect adjustments as
follows: (i) incremental selling, general and administrative expenses associated
with the Company's corporate activities of $644,000 for 1996; (ii) incremental
income taxes of $7,016,000 for the year ended December 31, 1996 and $3,166,000
for the nine months ended September 30, 1997, which would have resulted if the
entities had been combined and subject to the effective Federal and state
statutory income tax rates; (iii) reductions in minority interest expense of
$98,000 for 1996 resulting from the repurchase of a minority interest at the
time of the acquisitions of the Predecessor Companies (defined below); (iv)
adjustments to reflect the results of operations of Landmark Homes, Inc., DW
Hutson Construction Company, and Don Galloway Homes, Inc. for the periods prior
to acquisition, as well as the amortization of goodwill for each of those
periods; (v) adjustments to reflect the proposed acquisition of the Whittaker
Companies and to include the results of operations of the Whittaker Companies
for both periods presented, as well as the amortization of goodwill for each of
those periods; (vi) adjustments to remove the results of operations of the
Company's Genesee Custom Home Division due to the sale of the division effective
July 1, 1996; (vii) reductions of $110,000 for the year ended December 31, 1996
and $82,500 for the nine months ended September 30, 1997 to reflect the 11%
cumulative preferred dividend based on the net liquidation value of the Series A
11% cumulative, convertible preferred stock issued at $100 per share ($.01 par
value); the net liquidation value of $1 million reflects the Company's approval
effective July 1, 1996, to redeem 10,000 shares of the originally issued and
authorized 20,000 shares in connection with the sale of the Genesee Custom Home
Division; (viii) reductions of $1,404,000 for the year ended December 31, 1996
and $1,049,000 for the nine months ended September 30, 1997 to reflect the 12%
cumulative preferred dividend based on the net liquidation value of the Class AA
preferred stock issued at $1,000 per share ($.01 par value) (The net liquidation
value of $11,700,000 million reflects the Company's sale of 11,700 shares of
Class AA preferred stock to Prometheus to provide a portion of the funding for
the Galloway transaction.); (ix) reduction to reflect the 6% cumulative
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<PAGE>
preferred dividend based on the net liquidation value of the additional shares
of Class AA Preferred Stock, issued at $1,000 per share ($.01 par value), to
partially fund the Whittaker Companies acquisition.
The pro forma weighted average shares outstanding of 11,743,004 for the
year ended December 31, 1996 consist of the following: (i) 2,230,500 shares
issued by the Company prior to the Offerings (defined below); (ii) 6,233,875
shares issued to the stockholders of the Founding Builders (defined below) in
connection with the Acquisitions (defined below); (iii) 1,990,089 weighted
averages outstanding share issued to the public in the Offerings; and (iv)
1,288,540 shares representing the common stock equivalent of preferred shares
issued as part of the Hutson and Galloway acquisitions. The 13,067,515 weighted
average shares outstanding for the nine months ended September 30, 1997 consist
of the 11,743,004 shares described above plus (i) an increase of 1,297,428
shares in the weighted average of the shares issued to the public in the
Offerings and (ii) 27,083 weighted average restricted shares issued by the
Company subsequent to the Offerings.
SELECTED FINANCIAL DATA OF WHITTAKER COMPANIES
The selected combined financial data provided should be read in conjunction
with the Whittaker Construction, Inc. and affiliates financial statements, the
related notes thereto and Management's Discussion and Analysis of Financial
Condition and the Results of Operations of Whittaker Companies.
WHITTAKER CONSTRUCTION, INC. AND AFFILIATES
(DOLLARS IN THOUSANDS, EXCEPT OPERATING DATA)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------- NINE MONTHS ENDED
1992 1993 1994 1995 1996 SEPTEMBER 30, 1997
-------- -------- -------- -------- -------- ------------------
<S> <C> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenue.............................. $ 47,734 $ 61,031 $ 94,370 $ 89,628 $ 85,506 $ 66,592
Gross profit......................... 9,598 10,136 16,406 15,680 15,027 11,458
Other expenses net................... 5,969 7,415 8,161 8,748 10,118 7,686
-------- -------- -------- -------- -------- --------
Net income before the pro forma
provision for income taxes........ $ 3,629 $ 2,721 $ 8,245 $ 6,932 $ 4,909 $ 3,772
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
Balance Sheet Data:
Cash and cash equivalents............ $ 297 $ 1,918 $ 2,470 $ 2,493 $ 1,396 $ 3,176
Inventory............................ 12,758 24,818 26,112 35,738 51,189 51,077
Other assets......................... 1,338 1,801 3,523 2,900 2,849 3,208
-------- -------- -------- -------- -------- --------
Total assets...................... $ 14,393 $ 28,536 $ 32,105 $ 41,131 $ 55,434 $ 57,461
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
Accounts payable and accrued
liabilities....................... $ 3,023 $ 6,489 $ 5,594 $ 4,655 $ 5,120 $ 5,712
Notes payable........................ 8,648 17,328 15,123 24,968 38,180 36,674
Shareholder advances................. 940 1,148 2,564 2,814 2,873 3,546
Other................................ 916 1,785 1,729 1,411 1,174 1,665
Equity............................... 866 1,786 7,095 7,283 8,087 9,864
-------- -------- -------- -------- -------- --------
Total liabilities and equity...... $ 14,393 $ 28,536 $ 32,105 $ 41,131 $ 55,434 $ 57,461
-------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- --------
Operating Data:
Units:
New contracts, net of
cancellations................... 516 684 650 526 578 359
Closings.......................... 413 500 704 600 566 435
Backlog........................... 275 459 405 331 343 267
Aggregate sales value of backlog..... $ 33,110 $ 59,670 $ 56,700 $ 49,650 $ 53,165 $ 42,720
Average price per home closed........ $ 116 $ 122 $ 134 $ 149 $ 151 $ 153
</TABLE>
53
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF WHITTAKER COMPANIES
BACKGROUND
Whittaker Construction, Inc. ('WCI') was founded in 1977 by Robert N.
Whittaker, Sr. Building homes exclusively in St. Charles County, Missouri, WCI
has a significant presence in the St. Louis, Missouri area. In 1994 the
shareholders formed a sister company RRKTG Lumber, Inc. ('RKG') to acquire and
sell building products to WCI. RKG sells lumber, millwork, windows, siding and
many other products exclusively to WCI. Also in 1994, Mr. Whittaker formed Lewis
and Clark Title Company, Inc. ('LCT') to provide title insurance services to
home buyers. The financial statements of WCI, RKG, and LCT (collectively,
'Whittaker') are presented on a combined basis.
Whittaker's revenues are derived primarily from the sale of residential
homes. Revenue is recognized when construction of the home is complete and title
transfers to the buyer. Revenue from RKG is recognized at the time of closing,
and intercompany profit is eliminated from ending inventory. Cost of sales
includes all direct and indirect construction costs including construction
supervision, land costs, lot development costs, interest on land, development
and construction costs, and an accrual for warranty and service costs. All of
these costs incurred prior to closing are capitalized into inventory and
relieved from inventory at closing concurrent with the revenue recognition.
RESULTS OF OPERATIONS
Basis of Presentation
Whittaker's actual results from operations reflect operating activity of
WCI for the entire period and for RKG and LCT from the start of operations,
April 1994 and October 1994, respectively.
ACTUAL RESULTS FOR THE NINE AND THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED
TO THE ACTUAL RESULTS FOR THE NINE AND THREE MONTHS ENDED SEPTEMBER 30, 1996.
Overview
Whittaker achieved new orders of 478 units and 615 units in the nine months
ended September 30, 1997 and 1996, a decrease of 22.3%. New orders for the
quarter ended September 30, 1997 and 1996, were 108 and 156, a decrease of
30.8%. The decrease reflects a softening in demand in the St. Louis housing
market for the period and the impact of price increases by the company in late
1996 and early 1997. The company has backlog of 267 units with a dollar value of
$42.7 million at September 30, 1997, compared to 402 units with a dollar value
of $60.3 million at September 30, 1996, which is consistent with the new orders
as stated above.
Revenue
Revenue for Whittaker was $66.6 million for the nine months ended September
30, 1997 as compared to $60.6 million for the nine months ended September 30,
1996, an increase of 9.9%. For the quarters ended September 30, 1997 and 1996,
revenue increased 14.8%, up $3.4 million from $23 million to $26.4 million. The
increase in revenue is due primarily to an increase in the average selling price
based upon implemented price increases combined with an increase in units
closed. Unit closings for the nine months ended September 30, 1997 and September
30, 1996 were 435 and 397, respectively. Closings for the quarter also increased
with 165 in 1997 and 156 in 1996. The increase of 9.6% and 5.8% is attributable
to an overall reduction in backlog of sold homes.
Gross Profit
Whittaker's gross profit was $11.5 million for the nine months ended
September 30, 1997, as compared to $10.7 million for the nine months ended
September 30, 1996, an increase of 7.5%. For the quarters ended September 30,
1997 and 1996, gross profit increased 41.0%, up $1.6 million from $3.9 million
to $5.5 million. The quarter increase of 41.0% is due to the impact of price
increases on closings in the third quarter. First and second quarter profits
were below expectation due to higher land development costs without the
aforementioned offsetting effect of price increases. Management considers third
quarter results to demonstrate the effectiveness of the newly implemented
pricing program.
54
<PAGE>
Operating Expenses
Whittaker's management implemented steps to control operating expenses in
1997. Overall SG&A decreased as a percentage of revenue to 10.7% ($7.1 million)
from 11.1% ($6.7 million) for the nine months ended September 30, 1997 and 1996,
respectively. During the nine months, general and administrative expenses
decreased as a percentage of revenue to 6.3% ($4.2 million) from 7.1% ($4.3
million) while selling expenses rose to 4.4% ($2.9 million) from 4.1% ($2.5
million). For the quarters ended September 30, 1997 and 1996, general and
administrative expenses decreased as a percentage of revenue to 4.2% ($1.1
million) from 5.7% ($1.3 million) while selling expenses rose to 4.5% ($1.2
million) from 3.9% ($.9 million). The increase in selling expenses as a
percentage of revenue in the third quarter is due primarily to higher
commissions paid at Camelot, a custom home development, and an increase in
outside agent commissions. The decrease in general and administrative costs as a
percentage of revenue is the result of ongoing cost control measures as well as
higher revenue over which to spread the general and administrative expenses.
Net Income
Net income for the nine months ended September 30, 1997 ($3.8 million)
increased marginally from net income for the nine months ended September 30,
1996, ($3.5 million). The small increase in net income is due to lower than
expected profits on first and second quarter closings due to a combination of
less than anticipated closings and lower than anticipated profits on two
subdivisions because of a failure to increase prices to reflect higher capital
costs associated with land development. Price increases implemented to correct
the increased costs positively impacted net income for the quarter ended
September 30, 1997 ($2.6 million) raising it over the September 30, 1996 net
income ($1.3 million) by 100.0%.
ACTUAL RESULTS FOR THE YEAR ENDED DECEMBER 31, 1996 COMPARED TO THE ACTUAL
RESULTS FOR THE YEAR ENDED DECEMBER 31, 1995
Overview
Whittaker achieved new orders of 758 units and 690 units in the years ended
December 31, 1996 and 1995, an increase of 9.9%. The increase is the result of
new subdivisions opened in 1996 with very desirable locations. Whittaker had a
backlog of 343 units with a dollar value of $52.7 million at December 31, 1996
compared to 331 units with a dollar value of $49.6 million at December 31, 1995
which is consistent with the new orders as stated above. Whittaker's backlog
increased in the year ended December 31, 1996 due to an increase in overall
sales volume in the latter half of 1996.
Revenue
Revenue for Whittaker was $85.5 million for the year ended December 31,
1996 as compared to $89.6 million for the year ended December 31, 1995, a
decrease of 4.6%. The decrease in revenue is due to a decrease in units closed
offset by an increase in the average selling price for the period. Unit closings
for the years ended December 31, 1996 and 1995 were 566 and 601, respectively.
Gross Profit
Gross profit for Whittaker was $15.0 million for the year ended December
31, 1996 as compared to $15.7 million for the year ended December 31, 1995, a
decrease of 4.5%. The decrease is consistent with the lower number of closings.
Operating Expenses
Overall SG&A increased as a percentage of revenue to 11.1% ($9.5 million)
from 9.6% ($8.6 million) for the years ended December 31, 1996 and 1995,
respectively. During the year, general and administrative expenses increased as
a percentage of revenue to 7.0% ($6.0 million) from 5.7% ($5.1 million) while
selling expenses rose to 4.1% ($3.5 million) from 3.9% ($3.5 million). The
increases in general and administrative costs are due in part to additional
staffing at the lumberyard and in the office personnel at the construction
company, increased costs associated with rent and measures taken to control
material losses. Selling expense increases are due to increased marketing
efforts during 1996 to offset soft market conditions in the first half of 1996.
55
<PAGE>
Net Income
Net income for the year ended December 31, 1996, ($4.9 million) decreased
by 29.0% from net income for the year ended December 31, 1995, ($6.9 million).
The decrease in net income is due to the lower number of closings in 1996 and
lower margins in some subdivisions due to increases in the lot costs that were
not fully absorbed by necessary price increases.
ACTUAL RESULTS FOR THE YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE ACTUAL
RESULTS FOR THE YEAR ENDED DECEMBER 31, 1994
Overview
Whittaker achieved new orders of 690 units and 844 units in the years ended
December 31, 1995 and 1994, a decrease of 18.2%. The decrease is the result of
management's decision to target 600 closings for 1995. Whittaker had backlog of
331 units with a dollar value of $49.6 million at December 31, 1995, compared to
405 units with a dollar value of $56.7 million at December 31, 1994, which is
consistent with the new orders as stated above.
Revenue
Revenue for Whittaker was $89.6 million for the year ended December 31,
1995 as compared to $94.4 million for the year ended December 31, 1994, a
decrease of 5.1%. The decrease in revenue is due to a decrease in units closed
offset by an increase in the average selling price for the period. Unit closings
for the year ended December 31, 1996 and 1995, were 601 and 704, respectively.
Gross Profit
Gross profit for Whittaker was $15.7 million for the year ended December
31, 1995 as compared to $16.4 million for the year ended December 31, 1994, a
decrease of 4.3%. The decrease is consistent with the lower number of closings.
Operating Expenses
Overall SG&A increased as a percentage of revenue to 9.6% ($8.6 million)
from 8.4% ($7.9 million) for the years ended December 31, 1995 and 1994,
respectively. During the year, general and administrative expenses increased as
a percentage of revenue to 5.7% ($5.1 million) from 4.8% ($4.5 million) while
selling expenses rose to 3.9% ($3.5 million) from 3.6% ($3.4 million). The
increases in general and administrative costs and selling expense are due to
increased operational costs from the addition of the lumberyard location and
staffing increases in the marketing, safety, and accounting departments in late
1994 and early 1995.
Net Income
Net income for the year ended December 31, 1995 ($6.9 million) decreased by
15.9% from net income for the year ended December 31, 1994, ($8.2 million). The
decrease in net income is due to the lower number of closings in 1996 and the
expense changes noted above.
Capital Resources and Liquidity
Whittaker's activities involve several components, principally home
construction, land development, title services and the sale of building
products. During the first nine months of 1997, Whittaker's operating activities
provided $4.9 million in cash which was primarily generated by home sales.
Whittaker investing activities during the first nine months of 1997
consisted of fixed asset purchases of $.3 million. Whittaker financing
activities provided $10,334,188 in borrowings on notes payable and net
borrowings on lines of credit. This was offset by principal payments on notes
payable of $11,839,959, net reductions in advances from shareholders in the
amount of $.7 million, and distributions to shareholders of $2.0 million made to
pay income tax on Whittaker's profits.
During the year ended December 31, 1996, Whittaker's operating activities
used approximately $9.5 million. This cash outflow, however, was largely due to
acquisitions of land and the development costs associated with the lots
developed during the year. Two significant land parcels and the related
development
56
<PAGE>
costs incurred account for most of the increase. The owners of both of the land
parcels required that the entire parcel be acquired at one time. Management
determined that both parcels could be developed efficiently and both would
generate sufficient income to support the carrying costs.
Whittaker investing activities during the 1996 consisted of fixed asset
purchases of $.8 million. Whittaker financing activities provided $29,658,002 in
borrowings on notes payable. This was offset by payments of principal on notes
payable and net payments on lines of credit of $16,445,418, net increase
advances from shareholders in the amount of $.6 million, and distributions to
shareholders of $4.1 million made substantially to pay income tax on Whittaker's
profits. The net cash provided by increased borrowings was used to fund land and
development activity. Excluding the build up of land inventory and the related
increase in accounts payable for development activities, the operating
activities of Whittaker provided net cash.
Seasonality and Variability of Results
Whittaker experiences seasonality and quarterly variability in
home-building levels. The annual operating cycle generally reflects greater home
sales in the spring and autumn. The number of closings is lowest in the first
quarter and increases in the second and third quarters with the greatest number
of closings occurring in the fourth quarter. Management believes this
seasonality reflects the impact of winter weather on construction activity and
the preference of home buyers to close prior to year end.
Outlook
As of December 31, 1997, Whittaker had outstanding sale contracts of 218
units in backlog, representing approximately $38 million of value. Whittaker has
recently introduced a new product line of attached housing units marketed to
attract empty-nest couples and a tuck-under garage, single-family home designed
to attract single-family buyers motivated to purchase based upon greater square
footage at a lower per-square-foot cost. Whittaker will continue to introduce
new product lines to meet market demand. In addition, new lot developments
located near a new public golf facility are expected to generate significant
sales in 1998.
Whittaker will continue to address direct costs as a percentage of revenue
through implementation of cost control measures and additional product lines to
be acquired directly from manufacturers through the lumberyard operation. In
addition, through the acquisition of Whittaker stock by the Company, Whittaker
expects to attain additional direct cost savings through group purchase
discounts.
Whittaker will host a Home-a-rama, Showcase of Dreams, event sponsored by
the St. Louis Home Builders Association in June 1998. The Home-a-rama will have
eleven custom homes open to the public. The Home-a-rama will be held at
Whittaker's Camelot subdivision, an upscale, custom home development. Whittaker
expects lot and home sales at Camelot and other subdivisions to be significantly
enhanced by the Home-a-rama event.
See 'Forward-Looking Statements.'
Interest Rates and Inflation
Whittaker's business performance can be negatively affected by the impact
of inflation and the adverse effect inflation has on interest rates and the
overall economic climate nationally and in Whittaker's market.
Inflation affects Whittaker in a number of ways including Whittaker's cost
of conducting business. Costs including land acquisition and development,
materials, labor, overhead and interest rates on floating credit facilities can
all be adversely affected by inflation. In addition, inflation may reduce
consumers' ability to purchase a new home, thereby adversely affecting
Whittaker's new order flow. During 1996 and 1997, inflation has not
significantly affected the performance of Whittaker. Only fluctuations in lumber
costs, mitigated by the ownership of the lumberyard, and increases in labor
costs have had an inflationary impact on Whittaker's performance.
While inflation has not been a significant factor in 1996 or 1997, rising
inflation in the future would likely have an adverse long-term impact on
Whittaker's business performance.
57
<PAGE>
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 individual
Founding Builders 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>
THE
FORTRESS
YEAR ENDED DECEMBER 31, COMBINED THE FORTRESS YEAR GROUP, INC.
------------------------------------- PREDECESSOR GROUP, INC. ENDED NINE MONTHS
COMPANIES MAY 21- DECEMBER 31, ENDED
COMBINED PREDECESSOR COMPANIES JANUARY 1- DECEMBER 31, 1996 SEPTEMBER 30,
1992 1993 1994 1995 MAY 20, 1996 1996 TOTAL 1997
------- -------- -------- -------- ------------ ------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenue............................ $82,543 $148,269 $174,715 $199,029 $ 66,119 $ 210,354 $276,473 $ 293,409
Gross profit....................... 11,060 22,124 28,431 31,595 9,694 32,967 42,661 44,236
Operating income................... 2,232 4,169 5,411 6,750 1,113 12,787 13,900 9,296
Income before provision/ benefit
for income taxes................. 2,678 4,898 4,828 6,076 1,274 13,221 14,495 7,856
Net income(2).................... $ 2,349 $ 3,973 $ 4,745 $ 6,055 $ 1,274 $ 8,208 $ 9,482 $ 4,840
------- -------- -------- -------- ---------- ----------- -------- ------------
------- -------- -------- -------- ---------- ----------- -------- ------------
Net income per share............... $ .69 $ .38
----------- ------------
----------- ------------
Cash dividends per common share...... $ .0075
Weighted average shares
outstanding........................ 11,701,587 12,466,591
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------
THE FORTRESS
COMBINED PREDECESSOR COMPANIES THE FORTRESS GROUP, INC.
------------------------------------------ GROUP, INC. SEPTEMBER 30,
1992 1993 1994 1995 1996 1997
------- ------- -------- -------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash.......................................... $ 2,803 $ 2,904 $ 4,866 $ 2,710 $ 16,212 $ 3,483
Inventory..................................... 42,212 65,507 101,214 109,016 144,106 215,872
Total assets.................................. 46,495 72,855 111,403 121,666 193,733 314,149
13.75% Senior Notes due 2003.................. 100,000 100,000
Notes and mortgages payable................... 43,120 52,912 83,161 87,604 40,136 111,625
Minority interests............................ 633 806 1,346 1,295 274 280
Stockholders' equity.......................... 5,640 4,374 6,018 9,836 31,986 60,115
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------
THE FORTRESS THE FORTRESS
GROUP, INC. GROUP, INC.
PRO FORMA NINE MONTHS
COMBINED PREDECESSOR COMPANIES AS ADJUSTED ENDED
-------------------------------------------- ------------ SEPTEMBER 30,
1992 1993 1994 1995 1996 1997
-------- -------- -------- -------- ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
OPERATING DATA:
Units:
New contracts, net of cancellations......... 660 870 1,015 1,100 1,502 2,043
Closings.................................... 541 838 966 998 1,525 1,836
Backlog(3).................................. 276 308 357 459 512 1,261
Aggregate sales value of backlog (in
thousands)(3)............................... $ 61,378 $ 57,914 $ 78,760 $ 97,242 $ 95,992 $ 226,792
Average sales price per home closed........... $152,600 $171,300 $176,400 $190,700 $182,800 $ 157,600
</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 information of the
Combined Predecessor Companies has been combined on a historical cost basis
for all periods presented
(Footnotes continued on next page)
58
<PAGE>
(Footnotes continued from previous page)
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. Additionally, all of the Founding Builders were S corporations
through December 31, 1995 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.
(2) Each of the Founding Builders with the exception of Buffington Homes, Inc.
('Buffington') was an S corporation or partnership through May 20, 1996 and,
accordingly, was not subject to federal income taxes. Buffington converted
from a C corporation to an S corporation effective January 1, 1994. Except
for the 'Pro Forma' columns, net income does not give effect to the
conversion from S corporation to C corporation status and the resulting
imposition of federal income tax.
(3) At end of period and represents homes sold but not closed.
59
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS OF THE COMPANY
BACKGROUND
The Company 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.
The Company 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 in the Philadelphia, Pennsylvania
area effective November 1, 1997 (collectively, the 'Acquired Builders'). The pro
forma results of operations for 1996 include the operations of Landmark as if
the acquisition occurred on January 1, 1996.
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.
ACQUISITIONS
Acquisition of Landmark Homes, Inc. On August 31, 1996, the Company
consummated the acquisition of substantially all of the assets of Landmark.
Landmark is the largest production homebuilder in the Wilmington, North Carolina
market and also has operations in Myrtle Beach, South Carolina.
Acquisition of Brookstone Homes, Inc. On December 31, 1996, the Company
acquired substantially all of the assets of Brookstone. Brookstone operates in
the Milwaukee--Madison, Wisconsin area and has developed strong internal systems
of control, which allow it to offer its customers the opportunity to customize
their homes in the entry level and first and second time move-up market
segments.
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 entry-level and 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
60
<PAGE>
Charlotte, North Carolina and Charleston, South Carolina markets and targeting
entry-level and first and second move-up buyers.
Acquisition of The Iacobucci Organization. Effective November 1, 1997, the
Company acquired the homebuilding assets of Iacobucci. Iacobucci targets
first-time buyers, upscale entry, move-up and move-down buyers in the high
growth areas surrounding the city of Philadelphia, Pennsylvania. Since its
inception in 1953, Iacobucci has grown to consistently rank as one of the ten
largest homebuilders in the Philadelphia area.
Acquisition of WestBrook Homes, LLC. On December 29, 1997, the Company
executed an agreement to acquire the assets of WestBrook, a small Loudoun
County, Virginia homebuilder.
RESULTS OF OPERATIONS
Basis of Presentation. The Company's actual results of operations reflect
the operating activity of Landmark, Brookstone, Hutson, Wilshire and Galloway
from the effective dates of their acquisitions. The results of Iacobucci and
WestBrook are not included in any results of operations due to the periods being
presented.
ACTUAL FOR THE NINE AND THREE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO THE
COMBINED ACTUAL RESULTS OF THE COMPANY FROM MAY 21 THROUGH SEPTEMBER 30, 1996
AND THE COMBINED PREDECESSORS FROM JANUARY 1 THROUGH MAY 20, 1996 FOR THE NINE
MONTHS AND ACTUAL COMPANY RESULTS FOR THE THREE MONTHS ENDED SEPTEMBER 30, 1996.
Overview. The Company achieved new orders of 2,043 units and 1,138 units
in the nine months ended September 30, 1997 and 1996, an increase of 79.5%. New
orders for the quarter ended September 30, 1997 and 1996 were 718 and 253, an
increase of 183.8%. This increase is attributable to the Company's acquisitions
and an increase in new orders in the Company's Denver, Fort Collins and Las
Vegas operations. The Company has a combined backlog of 1,261 units with a
dollar value of $226.8 million as of September 30, 1997 as compared to 671 units
with a dollar value of $125.9 million as of September 30, 1996 which is
consistent with the increase in new orders as stated above.
Revenue. Revenue for the Company was $293.4 million for the nine months
ended September 30, 1997 as compared to $185.3 million for the nine months ended
September 30, 1996, an increase of 58.5%. For the quarter ended September 30,
1997 and 1996, revenue increased 53.8% in 1997, up $41.2 million to $117.8
million from $76.6 million in 1996. The increase in revenue is consistent with
the increase in the number of units closed during the nine and three month
periods. During the nine months ended September 30, 1997, 1,836 homes were
closed as compared to the same period in 1996 in which 953 homes were closed.
Closings for the quarter also increased with 770 closings in 1997 from 399
closings in 1996. This increase which represents 92.7% and 93.0%, respectively,
is attributable to the Company's recent acquisitions, as well as growth in
revenue of 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 $157,600 from $189,600 for the
nine months ended September 30, 1997 and 1996, respectively. The average price
of units closed for the quarter ended September 30, 1997 and 1996, is
approximately $151,700 and $187,500. This 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
$105,000 and $125,000 per unit, respectively.
Gross Profit. Gross profit for the nine months ended September 30, 1997
was $44.2 million compared to $28.7 million for the same period in 1996,
representing an increase of 54.0%. As a percentage of revenue, gross profit was
15.1% for the nine months ended September 30, 1997 as compared to 15.5% for the
nine months ended September 30, 1996.
For the quarter ended September 30, 1997, gross profit was $18.5 million
compared to $12.3 million for the same period of 1996, an increase of 50.4%. As
a percentage of revenue for the same periods, gross profit was 15.7% and 16.1%,
respectively.
Gross margins of acquired companies Landmark, Hutson, and Galloway were
lower than they ordinarily would be due to amortization of inventory written up
to fair value at their respective acquisitions. Without this purchase accounting
adjustment, the Company's gross profit as a percentage of revenue would increase
to 15.4%
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for the nine months ended September 30, 1997 and 16.2% for the three months then
ended. It is anticipated that this amortization of inventory which was written
up to fair value will be fully amortized by the end of 1997.
Additionally, the Company has experienced higher gross margins in its Las
Vegas, Denver, and Wisconsin markets that have been offset by decreased margins
in Austin and Raleigh. These Texas and North Carolina markets have shown
tightening during the first nine months due to increasing competitive pressure
in these areas. The Company's subsidiaries have had success in addressing these
pressures with moderate price decreases, which have affected the Company's
margins, and with aggressive marketing strategies.
Operating Expenses. In June 1997, the Company chose not to go forward with
a potential acquisition. This resulted in the expensing of approximately
$335,000 of acquisition costs that had previously been capitalized.
Additionally, the Company established a second quarter reserve of $410,000
relating to a 1997 sales-leaseback transaction in its Denver operations.
Subsequent to the closing of the sale, the Company discovered that the buyer's
collateral to secure the Company's seller financing was not in place though the
title had been delivered to the buyer and all other matters to effect a closing
occurred. The Company has filed a claim against the title company and buyer to
recover all monies owed in connection with this transaction. During the third
quarter five of the related homes were sold and the corresponding reserve was
reversed.
Without these non-recurring items, overall SG&A increased as a percentage
of revenue to 11.7% ($34.3 million) from 10.9% ($20.2 million) for the nine
months ended September 30, 1997 and 1996, respectively. During the nine months,
selling expenses increased to 6.3% ($18.6 million) from 5.9% ($11.0 million)
while general and administrative expenses rose to 5.4% ($15.7 million) from 5.0%
($9.2 million) in 1997 and 1996, respectively. For the quarter ended September
30, 1997 and 1996, selling expenses increased to 6.0% ($7.1 million) from 5.9%
($4.5 million) while general and administrative expenses increased to 5.3% ($6.2
million) from 4.6% ($3.5 million). 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 with new marketing
strategies in order to counteract increasing competition.
General and administrative expenses for 1996 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 nine months. Additionally, general and
administrative expenses increased as a percentage of revenue which reflects the
Company's commitment to build a corporate structure to properly integrate and
oversee its growing operations. As the Company has grown from five builders at
the end of the third quarter in 1996 to nine builders at the end of the same
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.
Net Income. Net income for the nine months ended September 30, 1997 ($4.8
million) decreased significantly from net income for the nine months ended
September 30, 1996 ($6.0 million). However, the net income for these periods is
not comparable as the 1996 nine-month net income does not include (i) 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
or (ii) any adjustment for corporate expenses which would have been incurred had
the Company existed as a single public entity for the entire nine months.
For the three months ended September 1997 and 1996, the net income
decreased 7.1% to $2.6 million in 1997 from $2.8 million in 1996. In addition to
the previously discussed operating income factors and non-recurring expenses,
Fortress incurred significantly higher interest expense in the first nine months
of 1997. Consistent with the Company's philosophy of limiting its land risk, the
Company has continued its use of lot option deposits and has significantly
increased its investments in partnerships with land developing entities in a
limited partner capacity. While these strategies provide a highly effective
means of controlling land, the Company has incurred additional,
non-capitalizable carrying costs associated with these investments.
Earnings before interest, taxes, depreciation and amortization (EBITDA) for
the nine months ended September 30th increased 36.4% to $25.1 million in 1997
compared to $18.4 million in 1996. For the quarter ended September 30th, EBITDA
increased 39.8% to $11.6 million in 1997 from $8.3 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
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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
Buffington's operations, which targets 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, Genesee and Christopher introduced more
affordable product lines in 1996 which contributed to the Company's lower
average sales price during the year compared to 1995. Land sales increased by
$2.2 million in 1996 to $10.3 million compared to the Combined Predecessor
Companies total land sales of $8.1 million in 1995. As a percentage of total
revenue, land sales accounted for 3.7% of revenue in 1996 compared to 4.1% in
1995.
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
$3.9 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. This
increase reflects the Company's C Corporation status in 1996 compared to the
Combined Predecessor Companies status as S Corporations. Net income increased
$3.4 million to $9.5 million compared to $6.1 million in 1995.
Earnings before interest, taxes, depreciation and amortization (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.
COMBINED PREDECESSORS FOR THE YEAR ENDED DECEMBER 31, 1995 COMPARED TO THE YEAR
ENDED DECEMBER 31, 1994
Revenue. Revenue increased 13.9% to $199.0 million in 1995 from $174.7
million in 1994. The number of homes closed by the Combined Predecessor
Companies increased by 3.3% to 998 units in 1995 from 966 units in 1994. The
increases were the result of earlier investments in new communities which
produced closings in 1995. The Company's 1995 increase in revenues was also due
in part to a 8.2% increase in the average selling price of homes closed to
$190,700 in 1995 from $176,400 in 1994. The increase was primarily to changes in
the product mix of homes closed within the Combined Predecessor Companies.
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Gross Profit. Cost of sales increased by 14.5%, to $167.4 million in 1995
from $146.3 million in 1994. As a percentage of revenue, cost of sales increased
by 0.4%, to 84.1% in 1995 from 83.7% in 1994. The increase was due primarily to
an increase in cost of sales, as a percentage of revenue at Genesee. This
increase was the result of a decision, during the first half of 1995, to
discount home sale prices in response to the prevailing higher mortgage interest
rates during this period.
Operating Expenses. Selling, general and administrative expenses increased
7.9% to $24.8 million in 1995 from $23.0 million in 1994. As a percentage of
revenue, however, SG&A expenses in 1995 were 12.5% compared to 13.2% in 1994.
The decrease in SG&A as a percentage of revenue was due to increased
efficiencies as revenue grew between 1994 and 1995. The increase in SG&A
expenses was due to the increase in sales and construction activity required to
sustain the higher levels of revenues in 1995 as well as the increase in land
acquisitions, market analysis and marketing activity needed to add new
communities in 1995 for which sales and closings are expected in 1996 and
beyond. The Combined Predecessor Companies opened 18 new communities in 1995.
Net Income. Other non-operating expenses (income) increased 15.6% to
$674,000 in 1995 from $583,000 in 1994. The increase of $91,000 was due to a
decrease in other income at Christopher due to a decrease in management fee
income between 1994 and 1995 of $240,000. This decrease in other income was
partially offset by a decrease in minority interest expense at Sunstar between
1994 and 1995.
Capital Resources and Liquidity. The Company's operating activities
involve several components, principally home construction, land development and
mortgage loan origination for home purchasers. During the first nine months of
1997, the Company's operating activities, taken in the aggregate, used
approximately $11.1 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 resale is reflected as a cash outflow 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
cyclical nature of homebuilding and anticipation of higher fourth quarter
closings 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 the nine months
related to the purchases of Hutson, Wilshire, and Galloway as well as
investments in land limited partnerships. The Company's financing activities
generated cash of $23.8 million, consisting of net borrowings under notes and
mortgages payable of $26.7 million (which includes the borrowings to fund the
mortgage loans held for resale) offset by miscellaneous financing activities
requiring cash.
From May 21, 1996 (the time of the Offerings) 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. The majority of these very short-term receivables were collected within
the next month. Additionally, while the level of inventories appears lower due
to the period presented (May 21st to December 31st), the company has 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 the period
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.
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Since the culmination of the initial public offering through September 30,
1997, the Company has refinanced existing loan agreements, executed new loan
agreements or assumed loans resulting from the acquisitions totaling
approximately $261 million of available secured financing at the subsidiary
level. Under these credit facilities, the Company has borrowed approximately
$100 million at September 30, 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.
The Company has entered into the Stock Purchase Agreement with Prometheus,
an affiliate of Lazard which commits Prometheus to invest $75 million as
described in this Proxy Statement. The First Closing 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.
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 September 30, 1997, the Company had cash and cash
equivalents on hand of $3.5 million.
At September 30, 1997, the Company had 1,887 finished or under-development
lots, which represent approximately nine months supply of land based on sales
absorption rates for the first nine months of 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 September 30,
1997, the Company had 6,793 lots under option representing slightly more than a
two-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, and
Galloway during the first three quarters of 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
investment from Prometheus or a combination thereof.
During November, the Company closed on the acquisition of certain assets of
Iacobucci, a homebuilding company with operations in the Philadelphia,
Pennsylvania area for an initial purchase price of cash of $2.9 million plus
debt assumption of approximately $13.9 million. The acquisition terms include
earnout provisions based on the future operations of the acquired business.
Seasonality and Variablity 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 home buyers 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. As of September 30, 1997, the Company had outstanding sales
contracts of 1,261 units in backlog, representing $227 million of value. The
Company has experienced a significant increase in new order activity during the
first three quarters of 1997 compared to 1996 particularly in the Denver, Las
Vegas, and Milwaukee markets. This increase has been augmented by the strong new
order activity of the 1997 acquisitions.
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
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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 are expected to 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 stable or
improving 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.
See 'Forward-Looking Statements.'
Interest Rates and Inflation. The Company's business performance can be
negatively affected by the impact of inflation and the adverse effect inflation
has on interest rates and the overall economic climate nationally and in the
Company's markets.
Inflation affects the Company in a number of ways including increasing the
Company's cost of conduction business. 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 1996 and 1997,
inflation has not significantly affected the performance of the Company. Only
rising lumber costs and, to a lesser degree, increases in subcontractor costs in
a number of the Company's markets due to tight labor markets has had an
inflationary impact on the Company's performance.
While inflation has not been a significant factor in 1996 or 1997, rising
inflation in the future would likely have an adverse long-term impact on the
Company's business performance.
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MARKET PRICES OF AND DIVIDENDS ON THE COMPANY'S
COMMON STOCK AND RELATED STOCKHOLDER MATTERS
Price Range of Common Stock. The Common Stock has traded on the Nasdaq
National Market since May 16, 1996. On February 17, 1998, the closing sale price
of the Common Stock was $5.00 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.
<TABLE>
<CAPTION>
FISCAL YEAR 1996, HIGH LOW
- ----------------- ----- -----
<S> <C> <C>
Second fiscal quarter(1)............................................................... $9.25 $8.75
Third fiscal quarter................................................................... $9.00 $7.75
Fourth fiscal quarter.................................................................. $8.00 $4.56
<CAPTION>
FISCAL YEAR 1997,
- -----------------
<S> <C> <C>
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
</TABLE>
- ------------------
(1) The Company's common stock commenced trading on May 16, 1996 at $9.00 per
share.
Approximate Number of Equity Security Holders. The number of record holders
of the Common Stock as of January 14, 1998 was 87, which does not include
beneficial owners who hold the Common Stock in street name.
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 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 Board and will depend
upon, among other things, future earnings, the success of the Company's business
activities, capital requirements, the dividend requirements of the Preferred
Stock, the general financial condition of the Company and general business
conditions. In addition, the Indenture restrict the amount of dividends payable
by the Company.
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DESCRIPTION OF THE COMPANY
INTRODUCTION
The Company 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
the Offerings. The acquisitions and the Offerings were completed in May 1996.
The acquired companies became wholly-owned subsidiaries of the Company 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.
The Company's homebuilding operations are currently conducted in the
following market areas:
<TABLE>
<CAPTION>
STATES MARKET AREAS
- ------ ------------
<S> <C>
Arizona Tucson
Colorado Denver, Fort Collins
Florida Jacksonville
Nevada Las Vegas
North Carolina Raleigh-Durham, Wilmington, Charlotte
Pennsylvania Philadelphia
South Carolina Myrtle Beach, Charleston
Texas Austin, San Antonio
Wisconsin Janesville, Madison, Milwaukee
</TABLE>
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 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 11
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
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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. Management expects that the reduced cost of capital provided by the
Offerings and future financing will directly contribute to the Company's
profitability by reducing its subsidiaries' average financing cost. 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.
Although the Company's most significant services and commodities are
obtained on a local level, management believes that the Company's overall size
and strength of operations will enable it to secure favorable terms from certain
suppliers by purchasing in volume such items as appliances, plumbing fixtures
and floor coverings. The Company also believes by integrating the administrative
functions of each local operation, the Company will 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. The senior
management overseeing the Company's centralized corporate operations has over
100 years of combined experience in the national homebuilding industry and is
responsible for formulating and implementing the Company's policies and
procedures designed 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
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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 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. 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; Philadelphia, Pennsylvania; Denver and Fort
Collins, Colorado; Tucson, Arizona; Janesville, Madison and Milwaukee,
Wisconsin; and Jacksonville, Florida. 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 ear 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 at the Research Triangle Park.
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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 September 30, 1997, the Company controlled
approximately 1,246 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.
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 1998-1996, the Austin Metropolitan Statistical Area (MSA) averaged 21,450
new jobs annually.
The Company has offices located in Austin and San Antonio, Texas and
conducts operations in both of these metropolitan areas. Since its inception,
the Company's Texas operation has closed the sale of over 2,500 homes in the
Austin area. This local operation offers primarily single family detached homes
to entry-level and first- and second-time move-up home buyers that generally
range in sales price from $75,000 to approximately $250,000. 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 September 30, 1997, the Company controlled, through options, a supply of
optioned lots for the construction of 862 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-90s and appears to be reaching more moderate levels of job 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 dynamic growth in the San Antonio area housing market in the
near and long term. As of September 30, 1997, the Company controlled, through
options, a supply of optioned lots for the construction of 341 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. As of September 30,
1997, the Company controlled approximately 18 optioned lots in the Las Vegas
area for new home construction and lot sales. 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.
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Denver, Colorado. The economy of the Denver CMSA 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. The rate of employment
growth in the Denver area for all of 1997 is likely to continue through 1998 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 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 September 30, 1997, the
Company controlled approximately optioned 61 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, is introducing a condominium project in the
area. As of September 30, 1997, the Company controlled approximately 80 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. The Company's subsidiary is approaching
this new focus with a conservative enthusiasm. As the new program proves its
success, the Company will expand its operations in this market range. As of
September 30, 1997, the Company controlled approximately 141 optioned lots in
the Tucson area for new home construction and lot sales.
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. Employment gains during 1998 are
expected to approximate 3,500 with increases during the period from 1999 to 2002
to average 4,425 annually. Housing permits are anticipated to total
approximately 3,400 units in 1998 slowing slightly to about 3,000 units in 1999.
The Company entered the Wilmington market in August 1996 by virtue of its
acquisition 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 September 30, 1997, the
Company controlled approximately 396 optioned lots in the Wilmington area for
new home construction.
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 signature golf courses, eight new hotels, and
renovation of the downtown area over the next few years. This is translating
into expected nonfarm job additions of 4,000 annually over the 1999-2002 period,
a level almost 16 percent ahead of the approximately 3,400 new jobs averaged
since 1983. 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. Housing demand for both
single family and
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multifamily projects are anticipated to be 3,500 in 1998 with a slow to 3,200 in
1999 before moving upward to an annual average of 4,200 homes through the 2000
to 2002 forecast period. The Company's Wilmington-based subsidiary is increasing
its presence in the Myrtle Beach market.
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
Primary Metropolitan Statistical Area's (PMSA) 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 September 30, 1997, the Company had options on approximately
662 lots in the Janesville/Madison/Milwaukee area for new home construction and
lot sales.
Jacksonville, Florida. The Jacksonville Metropolitan Statistical Area
(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 markets. At the end of February 1997, the Company
acquired D.W. Hutson Construction Company, thereby entering the Jacksonville,
Florida market. As of September 30, 1997, the Company controlled approximately
1,610 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.
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 September 30, 1997, the Company
controlled approximately 1,378 optioned lots in the Charlotte market for new
home construction and lot sales.
Charleston, South Carolina. The Company's Charlotte subsidiary also has
operations in the Charleston, South Carolina market. Charleston's 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 appears
to have 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's to $300's in the Charleston market,
it focuses building in the $100,000 to $174,000 range. As of September 30, 1997,
the Company controlled approximately 139 optioned lots in the Charleston market
for new home construction and lot sales.
Philadelphia, Pennsylvania. The Company's Philadelphia subsidiary has
focused building in the 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
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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.
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
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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, and Charlotte 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, Milwaukee-Madison, and Philadelphia 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 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. 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 September 30, 1997, the Company owned 1,494 finished lots and 393 lots
under development. As of September 30, 1997, the Company also had under contract
or option, subject to the satisfaction of the Company's purchase contingencies,
6,793 finished, undeveloped or partially developed lots.
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.
The Company's 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
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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.
Although policies may differ within each local operation and by project,
the Company generally provides a one-year limited warranty of workmanship and
materials with each of its homes. The Company's subcontractors generally provide
the Company with an indemnity and a certificate of insurance prior to receiving
payments for their work and therefore, claims relating to workmanship and
materials are usually the primary responsibility of the Company's
subcontractors. 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 home buyers. 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.
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. From time to time, depending on market conditions
and the specific project, the Company may build 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 subsequent to the
Offerings 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 September 30, 1997, the Company had backlog of $227 million
(1,261 homes); and as of December 31, 1996, the Company had backlog of $96
million (512 homes). The Company
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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. 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 thereafter sell the mortgage loans.
Due to the sales prices of homes, the Colorado, Arizona and Las Vegas
operations do not rely on home buyers 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 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 home buyers from the market.
Prior to 1997, the Company did not provide customer financing to its home
buyers. Rather, at each on-site office, sales employees provided prospective
home buyers 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 senior management has over 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
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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 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
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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.
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 the Company 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
Virtually all purchasers of the Company's homes finance their acquisitions
through third-party lenders providing 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 demand for new homes.
Recently, proposals have been publicly discussed to eliminate or limit the
deductibility of mortgage interest for Federal income tax purposes and to
eliminate or limit tax-free rollover treatment provided under current law where
proceeds of the sale of a principal residence are reinvested in a new principal
residence. Enactment of such proposals may have an adverse effect on the
homebuilding industry in general, and 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.
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EMPLOYEES AND SUBCONTRACTORS
As of September 30, 1997, the Company employed 568 (538 full-time and 30
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, the
Company acquired each of the Founding Builders through the merger of each
Founding Builder with and into a newly formed wholly-owned subsidiary of the
Company. The aggregate consideration paid by the Company 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, 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 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 securities laws of the shares of Common Stock
held by the Founding Builders' owners which are then available for sale.
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 the Company, 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, the Company acquired by merger all of the
issued and outstanding stock of Buffington. The consideration paid by the
Company for Buffington was approximately $1.13 million in cash and
1,897,897 shares of Common Stock.
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Christopher. Under an acquisition agreement with J. Christopher
Stuhmer, who became a director of the Company upon closing of the
Offerings, the Company acquired by merger all of the issued and outstanding
stock of Christopher. The consideration paid by Fortress for Christopher
was approximately $179,000 in cash and 1,691,227 shares of Common Stock.
Genesee. Under an acquisition agreement with Robert Short, who became
a director of the Company upon closing of the Offerings, the Company
acquired by merger all of the issued and outstanding stock of Genesee. The
consideration paid by Fortress for Genesee was approximately $695,000 in
cash, 1,729,495 shares of Common Stock 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, the Company acquired by merger all of the
issued and outstanding stock of Sunstar. The consideration paid by Fortress
for Sunstar was approximately $3,876,000 in cash and 915,256 shares of
Common Stock.
SUBSEQUENT ACQUISITIONS
During 1996, 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 Landmark and Brookstone
totaled $6 million in cash and 60,000 shares of Common Stock with a stated value
of $10 per share. The excess purchase price was allocated first to 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 Hutson, a
Jacksonville, Florida homebuilder, for approximately $24.7 million to be paid
$9.0 million in cash, $1.2 million in Series B preferred stock and approximately
$8.5 million in assumed debt. Approximately $1 million in cash and $315,000 in
preferred stock was returned to the Company based on the final accounting of the
acquisition. Additional consideration of $6.0 million in Series 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 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.
On November 26, 1997, the Company completed the acquisition of Iacobucci, a
homebuilder in the Philadelphia, Pennsylvania, area for $2,850,000 in cash,
approximately $13,900,000 of assumed debt, and an earn-out to be paid through
the year 2001. A portion of the proceeds from the First Closing was used to pay
part of the purchase price of Iacobucci.
On December 29, 1997, the Company executed an agreement to acquire the
assets of WestBrook, a small Loudoun County, Virginia homebuilder, for
approximately $325,000 in cash, $250,000 in Series E Convertible preferred
stock, $3.0 million in assumed debt, and an earn-out to be paid through the year
2000.
EXECUTIVE OFFICERS OF THE COMPANY
The Executive Officers of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
J. Marshall Coleman............................. 55 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
</TABLE>
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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 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., both
subsidiaries 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.
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.
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PROPOSAL TO AUTHORIZE AN INCREASE IN THE COMMON STOCK
SUBJECT TO THE COMPANY'S 1996 STOCK INCENTIVE PLAN
The 1996 Stock Incentive Plan as amended (the '1996 Plan') currently
authorizes the grant of stock options, stock appreciation rights, deferred stock
and restricted stock with respect to a maximum of 1,125,000 shares of Common
Stock, subject to certain antidilution adjustments.
The purpose of the 1996 Plan is to promote the overall financial objectives
of the Company and its stockholders by motivating those persons selected to
participate in the Plan to achieve long-term growth in stockholder equity in the
Company and by retaining the association of those individuals who are
instrumental in achieving such growth. The persons eligible to participate are
and will be directors, officers, employees, independent contractors and
consultants of the Company or any of its subsidiaries who will be in a position
to make contributions to the growth, management, protection and success of the
Company and its subsidiaries. The Company believes that equity participation by
its key employees is an important element in its overall compensation program.
The 1996 Plan originally authorized the grant of stock options, stock
appreciation rights, deferred stock and restricted stock with respect to a
maximum of 575,000 shares of Common Stock. In order to continue its policy of
providing equity participation to the Company's employees and to provide
availability for the issuance of stock options in connection with the Company's
acquisitions, the Board proposed that the 1996 Plan be amended to increase the
shares of Common Stock available for grant under the 1996 Plan from 575,000
shares to 1,125,000 shares. Such proposal was approved at the annual meeting of
stockholders on May 21, 1997. In light of the Transactions which will enable the
Company to effect additional acquisitions of homebuilding companies (see 'The
Transactions'), and in furtherance of the purposes of the Plan, the Board
proposes that the 1996 Plan be further amended to increase the shares of Common
Stock available for grant under the 1996 Plan from 1,125,000 shares to 1,550,000
shares.
In May 1997 the Company, pursuant to the decision of the Board, reduced the
exercise price of the stock options issued under the 1996 Plan to $6.00, from a
weighted average exercise price of $8.92 per share, in order to increase the
value of the options as an incentive to the option holders in furtherance of the
purposes of the 1996 Plan. At that time, stock options to purchase 349,200
shares of Common Stock were outstanding of which stock options to purchase
149,200 shares of Common Stock were repriced.
As of December 31, 1997, options for the purchase of a total of 518,189
shares of Common Stock at a weighted average of $5.92 per share were
outstanding, 30,000 shares of restricted stock were awarded to be delivered by
the Company in certain amounts and at certain dates, and approximately 320
persons were participating in the Plan. On February 17, 1998, the closing price
of the Common Stock on the Nasdaq National Market was $5.00 per share.
The 1996 Plan is administered by the Compensation Committee (the
'Committee'). The 1996 Plan authorizes the issuance of up to 1,125,000 shares of
Common Stock pursuant to the grant or exercise of stock options, stock
appreciation rights, restricted stock or deferred stock. Options granted to
certain senior executives, management and other employees vest over varied
periods which have been and will be determined at the time such options are
granted. Directors who are not employees of the Company or any affiliate
('Non-Employee Directors') are automatically granted options to purchase 3,000
shares on the date of each annual stockholder's meeting, beginning in 1996.
Stock Options may be either 'incentive stock options' (within the meaning
of Section 422 of the Internal Revenue Code) or nonqualified stock options. The
exercise price per share purchasable under a stock option is determined by the
Committee except that the price with respect to Non-Employee Directors is the
fair market value on the date of grant and except that options were repriced in
May 1997 in accordance with the decision of the Board as described above.
Generally, participants are given ten years in which to exercise a stock option,
or a shorter period upon termination of employment. Payment may be made in cash,
or, if approved by the Committee, in the form of unrestricted Common Stock the
participant already owns, or by certain other forms of payment. At the Company's
option it may provide a participant with a loan or guarantee of a loan for the
exercise price of an option. The right to exercise an option may be conditioned
upon the completion of a period of service or other conditions. Stock options
are subject to certain restrictions as to transferability.
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Stock appreciation rights ('SAR's') entitle a participant, upon exercise,
to receive an amount in cash, shares of Common Stock or both, equal in value to
(i) the excess of the fair market value per share of Common Stock over the
exercise price per share specified in the related agreement multiplied by (ii)
the number of shares to which the SAR relates. The right to exercise a SAR may
be conditioned upon the completion of a period of service or other conditions.
SAR's may be granted in conjunction with stock options or on a stand alone
basis. Generally, participants will be given ten years in which to exercise a
SAR, or a shorter period upon a termination of employment. SAR's are subject to
certain restrictions as to transferability.
Shares of restricted stock may also be awarded under the 1996 Plan, based
on service or the attainment of specified performance goals by the participant
or the Company or an affiliate (including a division or department of the
Company or an affiliate) or such other criteria as the Committee may determine.
Upon a participant's termination of employment, the restricted stock to the
extent then subject to restriction generally will be forfeited by the
participant. The Committee may waive these restrictions.
Deferred stock is stock that can be awarded to a participant for receipt in
the future, at a specified time and under specified conditions. The Committee
will determine the participants to whom, and the time or times at which, any
deferred stock will be awarded, the number of shares of deferred stock to be
awarded to any participant, the duration of the period during which and the
conditions under which receipt of the shares will be deferred and any other
terms and conditions of the award. At the expiration of the deferral period, the
Committee may elect to deliver Common Stock, cash equal to the fair market value
of such Common stock, or a combination thereof, to the participant for the
shares covered by such award. Upon a participant's termination of employment,
the deferred stock to the extent then subject to restrictions generally will be
forfeited by the participant. The Committee may waive the remaining deferral
limitations.
The 1,125,000 shares of Common Stock issuable under the 1996 Plan have been
registered under the Securities Act pursuant to a Form S-8 Registration
Statement filed with the SEC on September 5, 1997. If the proposal to authorize
an increase in the Common Stock subject to the 1996 Plan is approved by the
stockholders, the Company intends to file a Form S-8 Registration Statement to
register the additional 425,000 shares of Common Stock which would be issuable
under the Plan.
The 1996 Plan is not limited as to its duration. The Board may amend,
alter, or discontinue the 1996 Plan, subject to certain limitations. In the
event of a Change in Control of the Company (as defined in the Plan):
(a) any SARs and stock options outstanding as of the date of such
Change in Control which are not then exercisable and vested will become
fully exercisable and vested to the full extent of the original grant;
(b) the restrictions and deferral limitations applicable to any shares
of restricted stock and deferred stock will lapse, and such shares of
restricted stock and deferred stock will become free of all restrictions
and become fully vested and transferable to the full extent of the original
grant;
(c) the performance goals and other conditions with respect to any
outstanding award will be deemed to have been satisfied in full and such
award will be fully distributable, if and to the extent provided by the
Committee; and
(d) the Committee will have discretion to (i) cause any award to be
canceled on notice, (ii) provide that the securities of another entity be
substituted under the 1996 Plan for the Common Stock and to make equitable
adjustment with respect thereto, (iii) grant the participant the right to
receive a specified amount of cash upon surrender of a stock-based award,
(iv) require the assumption of the obligation of the Company under the Plan
subject to appropriate adjustment; and (v) take any other action.
A Change in Control includes, subject to certain exceptions: any
transaction which would result in any person owning, directly or indirectly, 50%
or more of the outstanding Common Stock or the voting power of the Company;
certain changes in the members of the Board of Directors; certain
reorganizations, mergers, consolidations or sales of substantially all of the
Company's assets; and stockholders' approval of a complete liquidation or
dissolution of the Company. The 1996 Plan was amended on September 30, 1997, to
provide that Change in Control does not include any event resulting from or
contemplated by, directly or indirectly, the Stock Purchase Agreement. The
Company is in the process of requesting that the participants consent to such
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amendment with respect to the stock options that have been issued. As of the
date of this Proxy Statement, the Company has received consents from more than
75% of the participants.
Tax Consequences. A participant will not recognize taxable income upon the
grant of a stock option or at any time prior to the exercise of the option or a
portion thereof. At the time the participant exercises a nonqualified stock
option or portion thereof, he will recognize compensation taxable as ordinary
income in an amount equal to the excess of the fair market value of the Common
Stock, and the Company will then be entitled to a corresponding deduction.
A participant who exercises an incentive stock option will not be taxed at
the time he exercises his option or a portion thereof. Instead, he will be taxed
at the time he sells the Common Stock acquired pursuant to the option. The
participant will be taxed on the difference between the sales price and the
amount he paid for the stock. If the participant does not sell the stock prior
to two years from the date of grant of the option and one year from the date he
acquired the stock, the gain will be capital gain and the Company will not be
entitled to a corresponding deduction. If the participant sells the stock at a
gain prior to that time, the difference between the amount the participant paid
for the stock and the lesser of the fair market value on the date of exercise or
the sales price will be taxed as ordinary income and the Company will be
entitled to a corresponding deduction. If the participant sells the stock for an
amount in excess of the fair market value on the date of exercise, the excess
amount is taxed as capital gain. If the participant sells the stock for less
than the amount he paid for the stock prior to the one or two year periods
indicated, no amount will be taxed as ordinary income and the loss will be taxed
as a capital loss. Exercise of an incentive stock option may subject a
participant to, or increase a participant's liability for, the alternative
maximum tax.
A participant generally will not recognize income upon the grant of a SAR.
At the time a participant receives a SAR, he generally will recognize
compensation taxable as ordinary income in an amount equal to the cash or the
fair market value of the Common Stock received, and the Company will be entitled
to a corresponding deduction.
A participant will not be taxed upon the grant of restricted stock or
deferred stock if such stock is not transferable by the participant or is
subject to a 'substantial risk of forfeiture,' as defined in the Internal
Revenue Code. When the shares of Common Stock that are subject to the stock
award are transferable by the participant and are no longer subject to a
substantial risk of forfeiture, the participant will recognize compensation
taxable as ordinary income in an amount equal to the fair market value of the
stock subject to the stock award, less any amount paid for such stock, and the
Company then will be entitled to a corresponding deduction. However, if a
participant so elects at the time of receipt of a restricted stock or deferred
stock award, he may include the fair market value of the stock subject to the
stock award, less any amount paid for such stock, in income at that time and the
Company also will be entitled to a corresponding deduction at that time.
As of December 31, 1997, there were 576,811 shares available for issuance
under the 1996 Plan. The Board has determined that the 1996 Plan should be
amended to authorize the issuance of an additional 425,000 shares.
In accordance with the Stockholders Agreement, Prometheus will vote the
11,700 shares of Class AA Preferred Stock it acquired at the First Closing (see
'The Transactions--Stock Purchase Agreement--First Closing'), which entitles it
to cast 1,950,000 votes, in favor of the adoption of the proposal.
The Board of Directors recommends that stockholders vote FOR the adoption
of the proposal.
85
<PAGE>
BENEFICIAL OWNERSHIP OF SECURITIES
OWNERSHIP BY PERSONS OWNING MORE THAN FIVE PERCENT
The following table sets forth information with respect to persons known to
the Company to be the beneficial owners of more than five percent of the
outstanding Common Stock or preferred stock with voting rights. Other than the
Class AA Preferred Stock held by Prometheus, all the stock set forth in the
table is Common Stock.
<TABLE>
<CAPTION>
AMOUNT AND PERCENT OF OUTSTANDING
NATURE OF SHARES OF COMMON PERCENT OF VOTING
NAME AND ADDRESS OF BENEFICIAL STOCK AS OF STOCK AS
BENEFICIAL OWNER OWNERSHIP RECORD DATE OF RECORD DATE
- ------------------- ---------- ---------------------- -----------------
<S> <C> <C> <C>
Prometheus Homebuilders LLC................................ 11,700 (a) -- 14.4%
c/o Lazard Freres Real Estate
Investors, LLC
Thirty Rockefeller Plaza
63rd Floor
New York, New York 10020
J. Christopher Stuhmer..................................... 1,691,727 14.6% 12.5%
9500 Hillwood Drive
Suite 200
Las Vegas, NV 89134
Robert Short............................................... 1,573,517 (b) 13.6% 11.6%
534 Commons Drive
Golden, CO 80401
Thomas Buffington.......................................... 948,949 8.2% 7.0%
8716 Mopac Expressway
Suite 100
Austin, TX 78759
Heartland Advisors, Inc.................................... 752,500 (c) 6.5% 5.5%
790 North Milwaukee Street
Milwaukee, WI 53202
Charles F. Smith........................................... 686,748 (d) 5.9% 5.1%
P.O. Box 9672
McLean, VA 22102
J. Marshall Coleman........................................ 651,585 (e) 5.6% 4.8%
1650 Tysons Boulevard
Suite 600
McLean, VA 22102
James J. Martell, Jr....................................... 624,423 (f) 5.4% 4.6%
1650 Tysons Boulevard
Suite 600
McLean, VA 22102
</TABLE>
- ------------------
(a) 11,700 shares, having an initial liquidation value of $11,700,000, of Class
AA Preferred Stock are issued and outstanding. Prometheus holds all such
shares, which were issued at the First Closing. Such shares entitle
Prometheus to cast 1,950,000 votes at the Special Meeting. Subject to the
terms and conditions of the Stock Purchase Agreement, Prometheus has the
right to acquire an aggregate of 40,000 shares, having an initial
(Footnotes continued on next page)
86
<PAGE>
(Footnotes continued from previous page)
liquidation value of $40,000,000, of Class AA Preferred Stock (which
includes the 11,700 shares acquired at the First Closing), 35,000 shares,
having an initial liquidation value of $35,000,000, of Class AB Preferred
Stock, Warrants for 1,000,000 shares of Common Stock and Contingent Warrants
which potentially provide for the issuance of between 380,952 and 5,714,286
shares of Common Stock. In addition, Prometheus has the right to acquire
approximately 900,000 shares of Common Stock from certain stockholders.
Prometheus, which may be deemed to be the beneficial owner of the foregoing
securities, disclaims beneficial ownership of all but the 11,700 shares of
Class AA Preferred Stock it acquired at the First Closing.
(b) Of the 1,573,517 shares, Mr. Short's children own 4,000 shares.
(c) This information is based on a Schedule 13G dated February 12, 1997 which
was filed by Heartland Advisors, Inc. According to such Schedule 13G,
Heartland Advisors, Inc. has sole voting power over 747,000 shares of Common
Stock.
(d) Of the 686,748, Mr. Smith's children own 39,805 shares.
(e) Of the 651,585 shares, Mr. Coleman owns 325,792.5 shares and Patricia A.
Donnelly, his wife, owns 325,792.5 shares.
(f) Of the 624,423 shares, Mr. Martell owns 494,423 shares, Mary Ann Martell,
his wife, owns 125,000 shares, and his children own 5,000 shares.
OWNERSHIP BY DIRECTORS AND EXECUTIVE OFFICERS
The following stock ownership information is furnished with respect to each
director and each executive officer of the Company holding Common Stock.
<TABLE>
<CAPTION>
SHARES OF
COMMON
STOCK OF THE
COMPANY PERCENTAGE OF
BENEFICIALLY OUTSTANDING SHARES
OWNED AS OF COMMON VOTING
POSITIONS AND NAME OFFICES WITH THE COMPANY THE RECORD DATE STOCK STOCK
- ------------------------------ -------------------------------------- --------------- ------------- ------
<S> <C> <C> <C> <C>
J. Marshall Coleman Chairman of the Board of the Company 651,585(a) 5.5% 4.8%
James J. Martell, Jr. President, Chief Executive Officer and 624,423(b) 5.3% 4.6%
Director
George Yeonas Chief Operating Officer and Director 12,500 * *
Thomas B. Buffington Director 948,949 8.1% 6.9%
Robert Short Director 1,573,517 13.4% 11.5%
J. Christopher Stuhmer Director 1,691,727 14.4% 12.3%
Lawrence J. Witek Director 457,628 3.9% 3.3%
Mark L. Fine Director 7,000(c) * *
Edward J. Mathias Director 16,000(c) * *
Steven D. Rivers Director 6,000(c) * *
William A. Shutzer Director 11,000(c) * *
Charles F. Smith Director 686,748 5.8% 5.0%
Jamie M. Pirrello Chief Financial Officer 18,632 * *
All Directors and Executive
Officers as a group (13
persons) 6,705,209 56.8% 48.8%
</TABLE>
(Footnotes on next page)
87
<PAGE>
(Footnotes from previous page)
- ------------------
* Less than 1%
(a) Of the 651,585 shares, Mr. Coleman owns 325,792.5 shares and Patricia A.
Donnelly, his wife, owns 325,792.5 shares.
(b) Of the 624,423 shares, Mr. Martell owns 490,423 shares, Mary Ann Martell,
his wife, owns 120,150 shares, and his children own 13,850 shares.
(c) Includes 6,000 shares that Messrs. Fine, Shutzer and Rivers have the right
to acquire and 3,000 shares that Mr. Mathias has the right to acquire
pursuant to the Company's Stock Option Plan.
COMPENSATION
COMPENSATION OF EXECUTIVE OFFICERS AND DIRECTORS
SUMMARY COMPENSATION TABLE
The following table sets forth information for the fiscal year ended
December 31, 1996 concerning the compensation of the Company's Chief Executive
Officer and each of the Company's other executive officers whose total annual
salary and bonus exceeded $100,000.
SUMMARY COMPENSATION
<TABLE>
<CAPTION>
LONG TERM COMPENSATION
--------------------------
AWARDS
----------- PAYOUTS
ANNUAL COMPENSATION SHARES ----------- ALL OTHER
NAME AND ----------------------- UNDERLYING LTIP COMPENSATION
PRINCIPAL POSITION SALARY ($) BONUS ($) OPTIONS (#) PAYOUTS ($) ($)
- --------------------------------------------------- ---------- --------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C>
James J. Martell, Jr............................... 166,667 225,490(1) -0- -0- 75,078(3)
President and Chief
Executive Officer
Thomas B. Buffington............................... 306,250 161,350 100,000 -0- -0-
President of Buffington
Homes, Inc., a subsidiary
of the Company(2)
Jamie M. Pirrello, Chief........................... 106,667 112,745(1) -0- -0- 36,000(3)
Financial Officer
Brian J. McGregor.................................. 121,875 -0- -0- -0- 75,000(3)
Former Chief Operating Officer
</TABLE>
- ------------------
(1) Of the bonus paid to Mr. Martell and Mr. Pirrello, 20% was paid in the form
of Common Stock, valued at $6.00 per share.
(2) Mr. Buffington served as the Company's Chief Operating Officer from January
through August 1997.
(3) Except for Mr. Martell, the entire amount of other compensation represents
payment for consulting services prior to the Company's initial public
offering. Mr. Martell's total includes the above and an auto allowance in
the amount of $3,078.
88
<PAGE>
STOCK OPTIONS
The Company's Employee Stock Option Plan provides for the grant of options
with respect to the Common Stock. The table below sets forth information on
option grants in fiscal 1996 to the named executive officers.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
PERCENT OF
TOTAL OPTIONS GRANT
GRANTED TO DATE
OPTIONS EMPLOYEES IN EXERCISE EXPIRATION PRESENT
NAME GRANTED(1) FISCAL YEAR PRICE DATE VALUE(2)
- ----------------------------------------------------- ---------- ------------- -------- ---------- --------
<S> <C> <C> <C> <C> <C>
James J. Martell, Jr................................. 0 0 0 0 0
Thomas B. Buffington................................. 100,000 28.4% $ 6.00 12/23/06 $229,000
Jamie M. Pirrello.................................... 0 0 0 0 0
Brian J. McGregor.................................... 0 0 0 0 0
</TABLE>
- ------------------
(1) All options vest 50% one year from the date of grant and the remainder on
the second anniversary of the date of grant.
(2) The grant date present values are calculated based on the Black-Scholes
model. The assumptions used in the calculations include an expected
volatility of .30, a risk free rate of return of 6.138%, a dividend yield of
.017% and a time to exercise of five years.
AGGREGATED OPTION EXERCISES AND FISCAL YEAR-END OPTION VALUE TABLE
The following table sets forth information concerning each exercise of
stock options during the fiscal year ended December 31, 1996 by each of the
executive officers named in the Summary Compensation Table above and the value
of unexercised options held by such persons as of December 31, 1996.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FY-END OPTION VALUES
<TABLE>
<CAPTION>
VALUE OF
UNEXERCISED
IN-THE-MONEY
SHARES UNDERLYING OPTIONS
SHARES UNEXERCISED OPTIONS AT FY-END
ACQUIRED ON AT FY-END (#) ($)
EXERCISE VALUE ---------------------------- -----------
NAME (#) REALIZED ($) EXERCISABLE UNEXERCISABLE EXERCISABLE
- ---- ----------- ------------ ----------- ------------- -----------
<S> <C> <C> <C> <C> <C>
James J. Martell, Jr.................... -0- -0- -0- -0- -0-
Thomas B. Buffington.................... -0- -0- -0- 100,000 -0-
Jamie M. Pirrello....................... -0- -0- -0- -0- -0-
Brian J. McGregor....................... -0- -0- -0- -0- -0-
<CAPTION>
NAME UNEXERCISABLE
- ---- -------------
<S> <C>
James J. Martell, Jr.................... -0-
Thomas B. Buffington.................... -0-
Jamie M. Pirrello....................... -0-
Brian J. McGregor....................... -0-
</TABLE>
EMPLOYMENT AGREEMENTS
Messrs. Martell and Pirrello have employment agreements with the Company,
effective April 15, 1996, and expiring in the year 2000. The agreements
automatically renew for successive one-year periods, following the initial term,
unless either the Company or employee provides written notice of its intent to
terminate. As amended effective January 1, 1997, the agreements provide for
various benefits including a base salary of $350,000 and $180,000, respectively.
The agreements also provide for additional bonus compensation under the Company
bonus program, which is tied to operational results.
Under an agreement with Mr. Buffington, which was effective April 15, 1996
for a period of three years, Mr. Buffington was to be paid a salary of $250,000
annually as President of Buffington Homes, Inc., a subsidiary of the Company. In
his capacity as Chief Operating Officer from January through August 1997, Mr.
Buffington was paid an annual salary of $350,000. Mr. Buffington is eligible for
additional bonus compensation under the Company bonus plan.
Messrs. Martell, Buffington and Pirrello may be terminated for 'cause' as
defined in the agreements, or without cause. If terminated for cause, the
termination will be effective upon receipt of proper notice by the
89
<PAGE>
employee. If Messrs. Martell, Buffington or Pirrello are terminated for other
than cause, the employee shall be entitled to his base salary for the remainder
of the agreement term as well as a pro-rata share of his bonus, as determined by
the Board of Directors.
COMPENSATION OF DIRECTORS
Under the Company's standard arrangements, each non-employee director of
the Company receives an annual director's fee of $20,000, payable $5,000 each
quarter, and $1,000 for attendance at Board meetings. All directors are
reimbursed for out-of-pocket expenses incurred to attend meetings. Employee
directors of the Company do not receive any additional compensation for services
as a director.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The current members of the Compensation Committee are William A. Shutzer,
Mark L. Fine and Edward Mathias. Prior to May 21, 1997 Steven D. Rivers was a
member of the Compensation Committee and Mr. Mathias was not a member. Since May
21, 1997, Messrs. Shutzer and Fine have been members of the Executive Committee.
None of the Compensation Committee members are or were officers or employees of
the Company or any of its subsidiaries.
CERTAIN TRANSACTIONS
The Company's Genesee subsidiary leases its administrative office space
from Genesee Holdings Corporation, of which Mr. Short is the president. In 1996,
the Company made lease payments of $108,960 to Genesee Holdings Corporation. The
Company's Christopher Homes subsidiary leases its administrative office space
from Towne Center L.P. Mr. Stuhmer is the president and sole shareholder of the
general partner of this partnership. In 1996, the Company made lease payments of
$149,728 to Towne Center L.P. The Company's Solaris subsidiary leased its
administrative office space from Square LD, LLC, of which Mr. Witek is a
partner. On September 5, 1996, Square LD, LLC sold the building to an unrelated
party. Until that time, Sunstar made lease payments of $57,833 in 1996. The
Company believes that the above referenced leases are at market rates.
In July of 1996, the Company sold its Genesee Custom Homes division to an
entity owned by Mr. Short, a director of the Company. The sale price was $4.9
million, and the Company took back a one-year note at 12% in the amount of $4.1
million. The note, which was initially due in July 1997 and was extended for six
months at the borrower's option, carried a balance of $3.3 million at December
31, 1996. The sale price of the division was at a small premium over the book
value as of June 30, 1996, of the assets sold.
The Company also has a note receivable bearing interest at 13.75% from
another director, Mr. Stuhmer, for approximately $460,000, net of accrued
interest, which is secured by that director's shares in the Company.
The Company has entered into a Consulting Agreement dated as of May 1, 1996
with Commonwealth Homes, Inc. ('Commonwealth'), a company owned by Mr. Coleman
(the 'Consulting Agreement'). Pursuant to the Consulting Agreement, Commonwealth
is engaged to provide mergers and acquisitions, financial advisory and strategic
planning services. The Consulting Agreement has a term of three years and
automatically renews for successive one-year periods unless either party
provides notice within 90 days of termination stating that the agreement will be
terminated. The Consulting Agreement provides for the payment of consulting
fees, in amounts to be agreed upon, on a transaction-by-transaction basis in
connection with acquisitions, joint ventures and similar arrangements and
capital raising transactions. Such fees generally will be based upon a
percentage of the value of the transaction and are required to be (i) approved
as to fairness by a committee of disinterested directors, (ii) reasonable and
customary in relation to the size and complexity of the transaction and (iii)
contingent upon the completion of the subject transaction. The agreement also
provides for reimbursement for reasonable and necessary out-of-pocket expenses
and an annual fee of $350,000, which amount is to be taken into account in
determining the transaction based fees. The Company paid $311,311 pursuant to
the Consulting Agreement in 1996. In connection with the Second Closing,
Prometheus may require, in its sole discretion, that the Consulting Agreement be
replaced by an employment agreement with Mr. Coleman. Such employment agreement,
if entered into, would have terms substantially similar to the Consulting
Agreement and would also include customary non-competition provisions.
90
<PAGE>
Also during 1996, the Company paid fees for legal services to Katten Muchin
& Zavis. Mr. Coleman was the former managing partner of Katten Muchin & Zavis'
Washington D.C. office.
During 1996, the Company paid fees to Furman Selz related to underwriting
the Company's initial public offering. Mr. Shutzer, who was not a director of
the Company at the time of the offering, is a director of Furman Selz. The
Company will pay Furman Selz an investment banking fee in connection with the
Transactions.
The Company has and will continue to engage in transactions with
affiliates. The terms of such transactions will be determined on a case by case
basis. Under the bylaws amendments to be adopted by the Company and its
subsidiaries, the Company and its subsidiaries will not be permitted to engage
in certain actions or transactions without Supermajority Director Approval (81%
of the Board) or Supermajority Executive Committee Approval (81% of the
Executive Committee). The actions or transactions that are subject to
Supermajority Director Approval or Supermajority Executive Committee Approval
include entering into any transaction or materially amending any transaction in
effect with any affiliate of the Company (other than between the Company and its
subsidiaries or between its subsidiaries). The bylaws amendments will be adopted
upon Stockholders Approval or prior thereto upon the request of Prometheus. See
'The Transactions--Certificate of Incorporation and Bylaws
Amendments--Amendments to the Bylaws--Conduct of Business.'
INDEPENDENT PUBLIC ACCOUNTANTS
The firm of Price Waterhouse LLP served as the Company's independent public
accountants for 1996 and was reappointed for 1997. A representative of Price
Waterhouse LLP is expected to be present at the Special Meeting and will have
the opportunity to make a statement if he desires to do so. The representative
will be available to respond to appropriate questions.
OTHER PROPOSALS
Neither the Company nor the members of the Board intend to bring before the
Special Meeting any matters other than those set forth in the Notice of Special
Meeting, and they have no present knowledge that any other matters will be
presented for action at the meeting. If, however, any other matters are properly
presented at the Special Meeting, it is the intention of the persons named in
the enclosed form of proxy to vote in accordance with their best judgment.
By Order of the Board of Directors
JAMES J. MARTELL, JR.
President and Chief Executive Officer
February 19, 1998
91
<PAGE>
THE FORTRESS GROUP, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
INDEX TO FINANCIAL STATEMENTS............................................................................. F-1
PRO FORMA FINANCIAL INFORMATION
Introduction............................................................................................ F-4
Pro Forma Consolidated Balance Sheet as of September 30, 1997........................................... F-5
Pro Forma Consolidated Statement of Operations for the year ended December 31, 1996 (unaudited)......... F-6
Pro Forma Consolidated Statement of Operations for the nine months ended September 30, 1997
(unaudited).......................................................................................... F-7
Notes to Pro Forma Consolidated Financial Statements.................................................... F-8
THE FORTRESS GROUP, INC.
Report of Price Waterhouse LLP, Independent Accountants................................................. F-11
Consolidated Balance Sheets as of December 31, 1996 and 1995............................................ F-12
Consolidated Statement of Operations for the period May 21, 1996 through December 31, 1996.............. F-13
Consolidated Statement of Shareholders' Equity for the period ended December 31, 1996................... F-14
Consolidated Statement of Cash Flows for the period May 21, 1996 through December 31, 1996.............. F-15
Notes to Consolidated Financial Statements (fiscal year)................................................ F-16
Consolidated Balance Sheets as of September 30, 1997 (unaudited) and December 31, 1996.................. F-27
Consolidated Statements of Operations for the three months ended September 30, 1997 and 1996
(unaudited).......................................................................................... F-28
Consolidated Statements of Operations for the nine months ended September 30, 1997 (unaudited), for the
period May 21 through September 30, 1996 (unaudited), for the period January 1 through May 20, 1996
(Combined Predecessor Companies) (unaudited), and for the nine months ended September 30, 1996
(Combined) (unaudited)............................................................................... F-29
Consolidated Statements of Shareholders' Equity for the nine months ended September 30, 1997 (unaudited
except for December 31, 1996 balances)............................................................... F-30
Consolidated Statements of Cash Flows for the nine months ended September 30, 1997 (unaudited) and for
the period May 21 through September 30, 1996 (unaudited)............................................. F-31
Notes to Consolidated Financial Statements (interim periods)............................................ F-32
WHITTAKER CONSTRUCTION, INCORPORATED AND AFFILIATES
Report of Price Waterhouse LLP, Independent Accountants................................................. F-38
Combined Balance Sheets as of December 31, 1996 and 1995 (unaudited) and September 30, 1997
(unaudited).......................................................................................... F-39
Combined Statements of Operations for the years ended December 31, 1996, 1995 (unaudited), and 1994
(unaudited).......................................................................................... F-40
Combined Statements of Operations for the nine and three months ended September 30, 1997 (unaudited) and
1996 (unaudited)..................................................................................... F-41
Combined Statements of Changes in Stockholders' Equity for the periods ended September 30, 1997
(unaudited) and December 31, 1996 and 1995 (unaudited)............................................... F-42
Combined Statements of Cash Flows for the years ended December 31, 1996, 1995 (unaudited), and 1994
(unaudited).......................................................................................... F-43
Combined Statements of Cash Flows for the nine months ended September 30, 1997 (unaudited) and 1996
(unaudited).......................................................................................... F-44
Notes to Combined Financial Statements.................................................................. F-45
</TABLE>
F-1
<PAGE>
<TABLE>
<CAPTION>
PAGE
-----
DON GALLOWAY HOMES, INC. AND AFFILIATES
<S> <C>
Report of Price Waterhouse LLP, Independent Accountants................................................. F-51
Combined Balance Sheets as of December 31, 1996, June 30, 1997 (unaudited) and June 30, 1996
(unaudited).......................................................................................... F-52
Combined Statements of Operations for the year ended December 31, 1996, for the six months ended June
30, 1997 (unaudited) and 1996 (unaudited)............................................................ F-53
Combined Statements of Changes in Stockholder's and Members' Equity as of December 31, 1996 and June 30,
1997 (unaudited)..................................................................................... F-54
Combined Statements of Cash Flows for the year ended December 31, 1996, for the six months ended June
30, 1997 (unaudited) and 1996 (unaudited)............................................................ F-55
Notes to Combined Financial Statements.................................................................. F-56
D.W. HUTSON CONSTRUCTION, INC.
Report of Price Waterhouse LLP, Independent Accountants................................................. F-61
Balance Sheets as of December 31, 1996 and 1995......................................................... F-62
Statements of Income for the years ended December 31, 1996 and 1995..................................... F-63
Statements of Changes in Shareholders' Equity as of December 31, 1996................................... F-64
Statements of Cash Flows for the years ended December 31, 1996 and 1995................................. F-65
Notes to Financial Statements........................................................................... F-66
LANDMARK HOMES, INC.
Report of Price Waterhouse LLP, Independent Accountants................................................. F-72
Balance Sheet as of December 31, 1995, June 30, 1995 (unaudited) and 1996 (unaudited)................... F-73
Statement of Operations for the year ended December 31, 1995, for the six months ended June 30, 1995
(unaudited) and 1996 (unaudited)..................................................................... F-74
Statement of Shareholders' Equity as of December 31, 1995 and June 30, 1996 (unaudited)................. F-75
Statement of Cash Flows for the year ended December 31, 1995 and for the six months ended June 30, 1995
(unaudited) and 1996 (unaudited)..................................................................... F-76
Notes to Financial Statements........................................................................... F-77
COMBINED PREDECESSOR COMPANIES
Report of Price Waterhouse LLP, Independent Accountants................................................. F-82
Combined Balance Sheets as of December 31, 1994 and 1995 and May 20, 1996............................... F-83
Combined Statements of Operations for the years ended December 31, 1994 and 1995 and the period January
1, 1996 through May 20, 1996......................................................................... F-84
Combined Statements of Shareholders' Equity for the years ended December 31, 1994 and 1995 and for the
period January 1, 1996 through May 20, 1996.......................................................... F-85
Combined Statement of Cash Flows for the years ended December 31, 1994 and 1995 and the period January
1, 1996 through May 20, 1996......................................................................... F-86
Notes to Combined Financial Statements.................................................................. F-87
BUFFINGTON HOMES, INC.
Report of Price Waterhouse LLP, Independent Accountants................................................. F-96
Combined Balance Sheets as of December 31, 1994 and 1995 and May 20, 1996............................... F-97
Combined Statements of Operations for the years ended December 31, 1994 and 1995 and the period of
January 1, 1996 through May 20, 1996................................................................. F-98
Combined Statements of Shareholders' Equity for the years ended December 31, 1994 and 1995 and the
period of January 1, 1996 through May 20, 1996....................................................... F-99
Combined Statements of Cash Flows for the years ended December 31, 1994 and 1995 and the period January
1, 1996 through May 20, 1996......................................................................... F-100
Notes to Combined Financial Statements.................................................................. F-101
</TABLE>
F-2
<PAGE>
<TABLE>
<CAPTION>
PAGE
-----
CHRISTOPHER HOMES, INC.
<S> <C>
Report of Price Waterhouse LLP, Independent Accountants Combined........................................ F-106
Balance Sheets as of December 31, 1994 and 1995 and May 20, 1996........................................ F-107
Combined Statements of Operations for the years ended December 31, 1994 and 1995 and the period January
1, 1996 through May 20, 1996......................................................................... F-108
Combined Statements of Shareholder's (Deficit) Equity for the years ended December 31, 1994 and 1995 and
the period January 1, 1996 through May 20, 1996...................................................... F-109
Combined Statements of Cash Flows for the years ended December 31, 1994 and 1995 and the period January
1, 1996 through May 20, 1996......................................................................... F-110
Notes to Combined Financial Statements.................................................................. F-111
THE GENESEE COMPANY
Report of Price Waterhouse LLP, Independent Accountants................................................. F-117
Report of Hein & Associates LLP, Independent Auditors................................................... F-118
Combined Balance Sheets as of December 31, 1994 and 1995 and May 20, 1996............................... F-119
Combined Statements of Operations for the years ended December 31, 1994 and 1995 and the period of
January 1, 1996 through May 20, 1996................................................................. F-120
Combined Statements of Shareholder's Equity for the years ended December 31, 1994 and 1995 and the
period January 1, 1996 through May 20, 1996.......................................................... F-121
Combined Statements of Cash Flows for the years ended December 31, 1994 and 1995 and the period January
1, 1996 through May 20, 1996......................................................................... F-122
Notes to Combined Financial Statements.................................................................. F-123
SOLARIS DEVELOPMENT CORPORATION
Report of Price Waterhouse LLP, Independent Accountants................................................. F-130
Consolidated Balance Sheet as of May 20, 1996........................................................... F-131
Consolidated Statement of Income for the period January 1, 1996 through May 20, 1996.................... F-132
Consolidated Statement of Shareholders' Equity for the period January 1, 1996 through May 20, 1996...... F-133
Consolidated Statement of Cash Flows for the period January 1, 1996 through May 20, 1996................ F-134
Notes to Consolidated Financial Statements.............................................................. F-135
Report of Ernst & Young LLP, Independent Auditors....................................................... F-140
Consolidated Balance Sheets as of December 31, 1994 and 1995............................................ F-141
Consolidated Statements of Income for the years ended December 31, 1994 and 1995........................ F-142
Consolidated Statements of Shareholders Equity for the years ended December 31, 1994 and 1995........... F-143
Consolidated Statements of Cash Flows for the years ended December 31, 1994 and 1995.................... F-144
Notes to Consolidated Financial Statements.............................................................. F-145
</TABLE>
F-3
<PAGE>
THE FORTRESS GROUP, INC.
PRO FORMA CONSOLIDATED FINANCIAL DATA
The Fortress Group, Inc. ('Fortress' or the 'Company') was formed in June
1995 to create a national homebuilding company through the May 1996 initial
public offering (Offering) and the simultaneous merger of four separate
homebuilding companies ('Combined Predecessor Companies' or 'Founding
Builders'). The unaudited pro forma financial statements included herein reflect
the merger of the Combined Predecessor Companies, the sale effective July 1,
1996 of the Genesee Custom Homes Division (Genesee Custom), the purchase on
August 31, 1996 of Landmark Homes, Inc. (Landmark), the purchase on February 28,
1997 of D.W. Hutson Construction Company (Hutson), and the purchase effective
August 1, 1997 of Don Galloway Homes, Inc. and related interests (collectively,
'Galloway'), and the proposed purchase of Whittaker Construction, Inc. and
affiliates (collectively, 'Whittaker'). Additionally, a balance sheet has been
included to reflect the proposed acquisition of Whittaker as of September 30,
1997. (The other mergers, sale, and purchases were already reflected in
Fortress's actual balance sheet as of September 30, 1997.)
The unaudited pro forma statements of operations present pro forma results
from operations for the year ended December 31, 1996 and for the nine months
ended September 30, 1997 as if the merger, the sale of Genesee Custom and the
purchases of Landmark, Hutson, Galloway, and Whittaker had occurred on January
1, 1996. The pro forma adjustments reflect certain administrative costs of the
Fortress corporate organization, the sale of Genesee Custom, amortization of
goodwill and the increased provision for income taxes as if the Combined
Predecessor Companies, Landmark, Hutson, Galloway, and Whittaker were combined
and subject to the effective Federal statutory income tax rate throughout the
period.
The pro forma financial statements of The Fortress Group, Inc. are
unaudited and are based upon historical information, preliminary estimates and
certain assumptions management deems appropriate. The unaudited pro forma
financial data presented herein are not necessarily indicative of the results of
Fortress would have attained had such events occurred at the beginning of the
period, nor are they indicative of the future results of Fortress. The unaudited
pro forma financial data and notes thereto should be read in conjunction with
the Company's 1996 consolidated financial statements and notes thereto.
F-4
<PAGE>
THE FORTRESS GROUP, INC.
PRO FORMA CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1997
(UNAUDITED, IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
HISTORICAL
----------------------------------
WHITTAKER
THE FORTRESS CONSTRUCTION, INC. PRO FORMA PRO FORMA
GROUP, INC. AND AFFILIATES ADJUSTMENTS BALANCE SHEET
------------ ------------------ ----------- -------------
<S> <C> <C> <C> <C>
ASSETS
Cash and cash equivalents............................ $ 3,483 $ 3,176 $ 2,140(a) $ 8,799
Accounts receivable.................................. 9,618 564 10,182
Due from related parties............................. 16,730 16,730
Real estate inventories.............................. 215,872 51,077 3,000(c) 269,949
Loans held for resale................................ 11,497 11,497
Property and equipment, net.......................... 7,735 2,509 10,244
Prepaid expenses and other assets.................... 29,700 135 (1,456)(a) 30,454
2,075(f)
Goodwill, net........................................ 19,514 9,750(d) 29,264
---------- ---------- --------- -----------
Total assets....................................... $314,149 $ 57,461 $15,509 $ 387,119
---------- ---------- --------- -----------
---------- ---------- --------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued expenses................ $ 29,928 $ 5,712 $ 2,075(f) $ 37,715
Notes and mortgages payable.......................... 211,625 36,674 248,299
Shareholder advances................................. 3,546 (3,546)(e)
Due to related parties............................... 5,306 105 5,411
Customer deposits.................................... 6,895 1,560 8,455
---------- ---------- --------- -----------
Total liabilities.................................. 253,754 47,597 (1,471) 299,880
---------- ---------- --------- -----------
Minority interest.................................... 280 280
Shareholders' equity
Preferred stock of Fortress........................ 1 1
Common stock of Fortress........................... 118 118
Common stock of Whittaker.......................... 41 (41)(b)
Additional paid-in capital......................... 47,772 490 26,844(a) 75,116
(490)(b)
500(g)
Retained earnings.................................. 12,736 9,333 (9,333)(b) 12,736
Treasury stock, at cost, 84,100 shares............. (512) (512)
Subscription receivable............................ (500)(g) (500)
---------- ---------- --------- -----------
Total shareholders' equity...................... 60,115 9,864 16,980 86,959
---------- ---------- --------- -----------
Total liabilities and shareholders' equity...... $314,149 $ 57,461 $15,509 $ 387,119
---------- ---------- --------- -----------
---------- ---------- --------- -----------
</TABLE>
See Notes to Pro Forma Consolidated Financial Statements.
F-5
<PAGE>
THE FORTRESS GROUP, INC.
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1996
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
COMBINED LANDMARK
PREDECESSORS/ HOMES, INC. D.W. HUTSON DON
THE FORTRESS JAN. 1, 1996- CONSTRUCTION GALLOWAY PRO FORMA
GROUP, INC. AUG. 31, 1996 COMPANY HOMES, INC. ADJUSTMENTS
------------- ------------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
Revenue:
Residential sales........................... $ 265,705 $18,062 $ 79,471 $57,123 $(4,964)(a)
Lot sales and other revenue................. 10,768 244
------------- ------------- ------------ ----------- -----------
Total revenue............................. 276,473 18,062 79,715 57,123 (4,964)
Cost of sales................................. 233,812 15,308 65,721 46,205 (4,928)(a)
------------- ------------- ------------ ----------- -----------
Gross profit.................................. 42,661 2,754 13,994 10,918 (36)
Operating expenses:
Selling..................................... 16,216 168 4,421 2,059 (163)(a)
General and administrative.................. 12,545 1,028 1,695 3,461 (121)(a)
157(b)
644(c)
396(d)
568(e)
------------- ------------- ------------ ----------- -----------
Net operating income...................... 13,900 1,558 7,878 5,398 (1,517)
------------- ------------- ------------ ----------- -----------
Other expense (income):
Interest.................................... 492 42 224 553
Minority interest........................... 181 (98)(f)
Other, net.................................. (1,268) (7) (154)
------------- ------------- ------------ ----------- -----------
Income before provision for income taxes...... 14,495 1,523 7,654 4,999 (1,419)
Provision for income taxes.................... 5,013 879(g)
2,773(h)
1,684(i)
------------- ------------- ------------ ----------- -----------
Net income.................................... $ 9,482 $ 1,523 $ 7,654 $ 4,999 $(6,755)
------------- ------------- ------------ ----------- -----------
------------- ------------- ------------ ----------- -----------
Less cumulative preferred dividends...........
Net income available to common shareholders...
Net income per share..........................
Weighted average shares outstanding...........
<PAGE>
<CAPTION>
WHITTAKER
CONSTRUCTION,
INC. AND PRO FORMA
PRO FORMA AFFILIATES ADJUSTMENTS PRO FORMA
---------- ------------- ----------- ----------
<S> <C> <C> <C> <C>
Revenue:
Residential sales........................... $ 415,397 $85,506 $ 500,903
Lot sales and other revenue................. 11,012 11,012
---------- ------------- ----------- ----------
Total revenue............................. 426,409 85,506 511,915
Cost of sales................................. 356,118 70,479 426,597
---------- ------------- ----------- ----------
Gross profit.................................. 70,291 15,027 85,318
Operating expenses:
Selling..................................... 22,701 3,466 26,167
General and administrative.................. 20,373 6,038 $ 488(m) 26,899
---------- ------------- ----------- ----------
Net operating income...................... 27,217 5,523 (488) 32,252
---------- ------------- ----------- ----------
Other expense (income):
Interest.................................... 1,311 891 2,202
Minority interest........................... 83 83
Other, net.................................. (1,429) (277) (1,706)
---------- ------------- ----------- ----------
Income before provision for income taxes...... 27,252 4,909 (488) 31,673
Provision for income taxes.................... 10,349 1,680(n) 12,029
---------- ------------- ----------- ----------
Net income.................................... $ 16,903 $ 4,909 $(2,168) $ 19,644
---------- ------------- ----------- ----------
---------- ------------- ----------- ----------
Less cumulative preferred dividends........... 1,514(j) 1,698(o) 3,212
---------- ----------
Net income available to common shareholders... $ 15,389 $ 16,432
---------- ----------
---------- ----------
Net income per share.......................... $ 1.31 $ 1.40
---------- ----------
---------- ----------
Weighted average shares outstanding........... 11,743,004(k) 11,743,004
---------- ----------
---------- ----------
</TABLE>
See Notes to Pro Forma Financial Statements.
F-6
<PAGE>
THE FORTRESS GROUP, INC.
PRO FORMA CONSOLIDATED STATEMENT OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
(UNAUDITED, IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
D.W. HUTSON DON
CONSTRUCTION GALLOWAY
COMPANY HOMES, INC.
THE FORTRESS JANUARY 1- JANUARY 1- PRO FORMA
GROUP, INC. FEBRUARY 28, 1997 JULY 31, 1997 ADJUSTMENTS
------------ ----------------- ------------- -----------
<S> <C> <C> <C> <C>
Revenue:
Residential sales.................................... $ 289,394 $ 9,992 $39,507
Lot sales and other revenue.......................... 4,015
------------ ------- ------------- -----------
Total revenue...................................... 293,409 9,992 39,507
Cost of sales.......................................... 249,173 8,486 30,891
------------ ------- ------------- -----------
Gross profit........................................... 44,236 1,506 8,616
Operating expenses:
Selling.............................................. 18,581 491 2,180
General and administrative........................... 15,740 237 1,776 $ 66(d)
331(e)
Non-recurring acquisition abandonment................ 335
Model home reserve................................... 284
------------ ------- ------------- -----------
Net operating income............................... 9,296 778 4,660 (397)
------------ ------- ------------- -----------
Other expense (income):
Interest............................................. 2,422 4 261
Minority interest.................................... 6
Other, net........................................... (988) (38) (102)
------------ ------- ------------- -----------
Income before provision for income taxes............... 7,856 812 4,501 (397)
Provision for income taxes............................. 3,016 288(h)
1,584(i)
------------ ------- ------------- -----------
Net income............................................. $ 4,840 $ 812 $ 4,501 $(2,269)
------------ ------- ------------- -----------
------------ ------- ------------- -----------
Less cumulative preferred dividends.................... 86
------------
Net income available to common shareholders............ $ 4,754
------------
------------
Net income per share................................... $ .38
------------
------------
Weighted average shares outstanding.................... 12,466,591
------------
------------
<PAGE>
<CAPTION>
WHITTAKER
CONSTRUCTION,
INC. AND PRO FORMA
PRO FORMA AFFILIATES ADJUSTMENTS PRO FORMA
---------- ------------- ----------- ----------
<S> <C> <C> <C> <C>
Revenue:
Residential sales.................................... $ 338,893 $66,592 $ 405,485
Lot sales and other revenue.......................... 4,015 4,015
---------- ------------- ----------- ----------
Total revenue...................................... 342,908 66,592 409,500
Cost of sales.......................................... 288,550 55,134 343,684
---------- ------------- ----------- ----------
Gross profit........................................... 54,358 11,458 65,816
Operating expenses:
Selling.............................................. 21,252 2,874 24,126
General and administrative........................... 18,150 4,191 $ 366(m) 22,707
Non-recurring acquisition abandonment................ 335 335
Model home reserve................................... 284 284
---------- ------------- ----------- ----------
Net operating income............................... 14,337 4,393 (366) 18,364
---------- ------------- ----------- ----------
Other expense (income):
Interest............................................. 2,687 804 3,491
Minority interest.................................... 6 6
Other, net........................................... (1,128) (183) (1,311)
---------- ------------- ----------- ----------
Income before provision for income taxes............... 12,772 3,772 (366) 16,178
Provision for income taxes............................. 4,888 1,294(n) 6,182
---------- ------------- ----------- ----------
Net income............................................. $ 7,884 $ 3,772 $(1,660) $ 9,996
---------- ------------- ----------- ----------
---------- ------------- ----------- ----------
Less cumulative preferred dividends.................... 1,136(j) 1,274(o) 2,410
---------- ----------
Net income available to common shareholders............ $ 6,748 $ 7,586
---------- ----------
---------- ----------
Net income per share................................... $ .52 $ .58
---------- ----------
---------- ----------
Weighted average shares outstanding.................... 13,067,515(l) 13,067,515
---------- ----------
---------- ----------
</TABLE>
See Notes to Pro Forma Financial Statements.
F-7
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--PRO FORMA BALANCE SHEET ADJUSTMENTS
The pro forma balance sheet adjustments have been prepared to reflect the
acquisition of Whittaker.
(a) Adjustment to reflect the second closing under the Stock Purchase Agreement
with Prometheus under which the remaining Class AA convertible preferred
stock (28,300 shares) was issued to Prometheus as required by the agreement.
Proceeds from the second closing are to be used in part to fund the
Whittaker acquisition. The gross equity is reduced by allocated issuance
costs as follows:
<TABLE>
<CAPTION>
PREFERRED
STOCK
---------------
<S> <C>
Gross amount issued................................................................ $28,300
Allocable issuance costs........................................................... (1,456)
---------------
Net equity......................................................................... $26,844
---------------
---------------
</TABLE>
(b) Adjustment to eliminate the shareholders' equity accounts of Whittaker.
(c) Adjustment to increase inventory of Whittaker to estimated fair value.
(d) Adjustment to reflect the excess purchase price over the fair value:
<TABLE>
<S> <C>
Whittaker historical book value as of September 30, 1997........................... $ 9,864
Adjusted by the repayment of loans from shareholders............................. 3,546
-------
Adjusted Whittaker historical book value........................................... 13,410
Adjusted by the step-up of real estate inventory to fair value................... 3,000
-------
Fair value of Whittaker assets acquired............................................ 16,410
Remaining negotiated premium over book value....................................... 9,750
-------
Purchase price based on September 30, 1997 adjusted book value..................... $26,160
-------
-------
</TABLE>
The variance between the pro forma purchase price of $26.16 million and the
anticipated purchased price of $25.75 million, as discussed in the
'Acquisition of Whittaker Companies' section included in this proxy
statement, is a function of a negotiated premium ($12.75 million) over the
adjusted net book value of Whittaker, determined on a GAAP basis, at the date
of purchase. Based on the Whittaker Companies' anticipated earnings offset by
shareholder distributions during the period from October 1, 1997 through the
actual purchase date, the Company's management anticipates the adjusted net
book value (before purchase accounting) to be $13 million at the time of
closing.
(e) Adjustment to repay the current balance of loans from Whittaker's
shareholders.
(f) Adjustment to accrue costs anticipated to be incurred in connection with the
Prometheus agreement. These costs are expected to be incurred by the time of
the Whittaker closing and will be allocated to subsequent issuances.
(g) Adjustment to record 5,000 shares of Series F Convertible Preferred Stock
(Series F) to be issued to a certain senior officer of Whittaker at $100 per
share with certain redemption provisions at the option of the Company (total
liquidation value of $500,000) and a corresponding recourse loan to be made
to the same officer in the same amount. Dividends on the Series F and
interest on the loan will accrue at 6% per year.
NOTE 2--PRO FORMA STATEMENTS OF OPERATIONS ADJUSTMENTS
The pro forma statements of operations adjustments have been prepared to
reflect the merger of the Combined Predecessor companies, operating expenses of
the Fortress corporate organization, the sale of Genesee
F-8
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--PRO FORMA STATEMENTS OF OPERATIONS ADJUSTMENTS--(CONTINUED)
Custom, the acquisition of Landmark, the acquisition of Hutson, the acquisition
of Galloway, and the acquisition of Whittaker.
(a) Adjustment to remove the results of operations of Genesee Custom due to the
sale of the division with an effective date of July 1, 1996.
(b) Adjustment to record amortization of goodwill for the period January 1, 1996
through August 31, 1996 associated with the purchase of Landmark on a
straight-line basis over fifteen years.
(c) Adjustment of $644,000 for the year ended December 31, 1996, to reflect
increased expenses for corporate operating activities related to the newly
formed public entity.
(d) Amortization of goodwill associated with the purchase of Hutson on a
straight-line basis over fifteen years.
(e) Amortization of goodwill associated with the purchase of Galloway on a
straight-line basis over twenty years.
(f) Adjustments to reduce minority interest expense by approximately $98,000 for
the year ended December 31, 1996, as a result of the Company's buyout in May
1996 of the minority interest holding in one of its consolidated joint
venture partnerships.
(g) Adjustments to calculate the provision for income taxes on the combined pro
forma results at the effective statutory tax rates applicable for each of
the Founding Builders and Landmark as if they had been subject to the
effective Federal statutory income tax rate throughout the period.
(h) Adjustment to reflect the calculation of a provision for income taxes for
Hutson resulting from pre-tax income net of pro forma adjustments at the
effective statutory tax rates applicable for each adjustment.
(i) Adjustment to reflect the calculation of a provision for income taxes for
Galloway resulting from pre-tax income net of pro forma adjustments at the
effective statutory tax rates applicable for each adjustment.
(j) Adjustments to reduce net income to determine earnings per share as follows:
(1) Reductions of $110,000 for the year ended December 31, 1996 and $82,500
for the nine months ended September 30, 1997 to reflect the 11%
cumulative preferred dividend based on the net liquidation value of the
11% cumulative, convertible preferred stock issued at $100 per share
($.01 par value). The net liquidation value of $1 million reflects the
Company's approval effective July 1, 1996, to redeem 10,000 shares of the
originally issued and authorized 20,000 shares in connection with the
sale of Genesee Custom. [See Note 1(a).]
(2) Reductions of $1,404,000 for the year ended December 31, 1996 and
$1,053,000 for the nine months ended September 30, 1997 to reflect the
12% cumulative preferred dividend based on the net liquidation value of
the Class AA preferred stock issued at $1,000 per share ($.01 par value).
The net liquidation value of $11,700,000 million reflects the Company's
sale of 11,700 shares of Class AA preferred stock to Prometheus Builders
to finance the Galloway transaction.
F-9
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO PRO FORMA CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--PRO FORMA STATEMENTS OF OPERATIONS ADJUSTMENTS--(CONTINUED)
(k) The weighted average number of common shares outstanding used to calculate
pro forma net income per share based on the estimated average number of
shares of common stock and common stock equivalents of the pro forma
consolidated company outstanding during the periods presented is as follows:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
----------------
<S> <C>
Shares issued by Fortress prior to the Common Stock Offering..................... 2,230,500
Shares issued to the stockholders of the Founding Builders....................... 6,233,875
Weighted average outstanding shares issued to the public in the offerings........ 1,990,089
Common stock equivalent of preferred shares issued in the Hutson and Galloway
acquisitions................................................................... 1,288,540
---------
11,743,004
----------
----------
</TABLE>
(l) The weighted average number of common shares outstanding used to calculate
pro forma net income per share based on the estimated average number of
shares of common stock and common stock equivalents of the pro forma
consolidated Company outstanding during the periods presented is as follows:
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1997
------------------
<S> <C>
Shares issued by Fortress prior to the Common Stock Offering................... 2,230,500
Shares issued to the stockholders of the Founding Builders..................... 6,233,875
Weighted average outstanding shares issued to the public in the offerings...... 3,287,517
Weighted average restricted shares issued by the Company subsequent to the
offerings.................................................................... 27,083
Common stock equivalent of preferred shares issued in the Hutson and Galloway
acquisitions................................................................. 1,288,540
----------
13,067,515
----------
----------
</TABLE>
(m) Amortization of goodwill associated with the purchase of Whittaker on a
straight-line basis over twenty years.
(n) Adjustment to reflect the calculation of a provision for income taxes for
Whittaker resulting from pre-tax income net of pro forma adjustments at the
effective statutory tax rates applicable for each adjustment.
(o) Reductions to reflect the 6% cumulative preferred dividend based on the net
liquidation value of the additional shares of Class AA preferred stock,
issued at $1,000 per share ($.01 par value), to partially fund the Whittaker
acquisition.
F-10
<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, 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, 1996 and 1995, and the
results of their operations and their cash flows 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 responsibility 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. 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 believe that our audits provide a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Minneapolis, Minnesota
February 18, 1997
F-11
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1995
-------- ------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................................................... $ 16,212 $ 25
Accounts receivable......................................................................... 10,700
Due from related parties.................................................................... 5,176
Real estate inventories..................................................................... 144,106
Property and equipment, net................................................................. 3,543
Prepaid expenses and other assets........................................................... 10,355 2,121
Goodwill, net............................................................................... 3,641
-------- ------
Total assets........................................................................... $193,733 $2,146
-------- ------
-------- ------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and construction liabilities............................................... $ 8,526 $1,007
Notes and mortgages payable................................................................. 140,136
Due to related parties...................................................................... 27 1,139
Accrued expenses............................................................................ 8,525
Customer deposits........................................................................... 4,259
-------- ------
Total liabilities...................................................................... 161,473 2,146
-------- ------
Commitments and contingencies (Note 15)
Minority interest........................................................................... 274
-------- ------
Shareholders' equity
Preferred stock, $.01 par value, 1 million shares authorized, 10,000 issued and
outstanding ($1 million aggregate liquidation preference)
Common stock, $.01 par value, 49 million and 25 million authorized, 11,762,675 and
2,230,500 issued and outstanding....................................................... 118 22
Additional paid-in capital................................................................ 23,808 (22)
Retained earnings......................................................................... 8,072
Treasury stock, at cost, 1,700 shares..................................................... (12)
-------- ------
Total shareholders' equity............................................................. 31,986
-------- ------
Total liabilities and shareholders' equity............................................. $193,733 $2,146
-------- ------
-------- ------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-12
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENT OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD
MAY 21, 1996
THROUGH
DECEMBER 31, 1996
-----------------
<S> <C>
Revenue:
Residential sales............................................................................ $ 200,721
Lot sales.................................................................................... 9,239
Other revenue................................................................................ 394
-----------
Total revenue............................................................................. 210,354
Cost of sales.................................................................................. 177,387
-----------
Gross profit................................................................................... 32,967
Operating expenses:
Selling expenses............................................................................. 11,527
General and administrative expenses.......................................................... 8,653
-----------
Net operating income...................................................................... 12,787
Other expense (income):
Interest..................................................................................... 429
Minority interest............................................................................ 92
Other, net................................................................................... (955)
-----------
Income before provision for income taxes....................................................... 13,221
Provision for income taxes..................................................................... 5,013
-----------
Net income................................................................................ $ 8,208
-----------
-----------
Net income per share........................................................................... $ .69
-----------
-----------
Weighted average shares outstanding............................................................ 11,701,587
-----------
-----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-13
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENT 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 December 31, 1995 and
May 20, 1996 (See Note 1)....... 2,231 $ 22 $ (22) --
Issuance of preferred stock..... 20 --
Issuance of common stock, net of
related cost.................. 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
---- ------ --------- ------ ---------- -------- -------- ----------
---- ------ --------- ------ ---------- -------- -------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-14
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD
MAY 21, 1996
THROUGH
DECEMBER 31, 1996
-----------------
<S> <C>
Cash flows from operating activities
Net income................................................................................... $ 8,208
Adjustments to reconcile net income to net cash used in operating activities
Depreciation and amortization............................................................. 741
Minority interest......................................................................... 93
Loss on sale of property and equipment.................................................... 19
Changes in operating assets and liabilities, net of effects from purchased companies
Accounts receivable..................................................................... (7,586)
Due from related parties................................................................ (403)
Real estate inventories................................................................. 829
Prepaid expenses and other assets....................................................... (2,164)
Accounts payable and accrued construction liabilities................................... (5,205)
Accrued expenses........................................................................ 1,539
Customer deposits....................................................................... (2,123)
--------
Net cash used in operating activities................................................ (6,052)
--------
Cash flows from investing activities
Acquisitions, net of cash acquired........................................................... (6,049)
Cash balances of Predecessor Companies at acquisition date................................... 3,013
Sale of Genesee Custom Division.............................................................. 253
Purchase of property and equipment........................................................... (1,979)
Proceeds from sale of property and equipment................................................. 31
--------
Net cash used in investing activities................................................ (4,731)
--------
Cash flows from financing activities
Net proceeds from issuance of common stock................................................... 21,843
Capital distributions to Predecessor Companies' stockholders................................. (6,063)
Deferred financing costs..................................................................... (2,694)
Borrowings under notes and mortgages payable................................................. 172,461
Repayment of notes and mortgages payable..................................................... (152,824)
Repayment of related party borrowings........................................................ (2,941)
Distributions to minority interest........................................................... (1,274)
Preferred stock redemption................................................................... (1,000)
Preferred stock dividend..................................................................... (109)
Purchase of treasury stock................................................................... (429)
--------
Net cash provided by financing activities............................................ 26,970
--------
Net increase in cash and cash equivalents...................................................... 16,187
Cash and cash equivalents, beginning of period................................................. 25
---------
Cash and cash equivalents, end of period....................................................... $ 16,212
---------
---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-15
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1995
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 the Solaris Development Corporation
(Sunstar), doing business in Raleigh-Durham, North Carolina. The acquired
companies as a group are referred to as the Founding Builders or, when combined
with Fortress, as the Combined Predecessor Companies. When the Company was
founded in June 1995, the Company issued 2,231,000 shares (par value of $.01 per
share) of its founding common stock to its shareholders in exchange for the
value of the intangible assets and activities of the stockholders. For financial
reporting purposes, these founder shares have been recorded at par with an
offsetting reduction to additional paid in capital.
Prior to the Offering, Fortress was a nonoperating entity and principally
incurred costs associated with the consummation of the Offering. Simultaneous
with the closing of the Offering, Fortress acquired by merger each of the
Predecessor Companies. The accompanying consolidated financial statements
reflect the results of Fortress and its Predecessor Companies, now referred to
as its wholly-owned subsidiaries, from May 21, 1996 through December 31, 1996.
As a result of the substantial continuing interests in the Company of the former
stockholders of the Predecessor Companies, the acquisitions have been accounted
for on a historical cost basis. The assets and liabilities of the Predecessor
Companies are reflected at their historical amounts and include joint ventures
where the Company controls the management activities and holds a significant
economic interest. In connection with the acquisition, Sunstar purchased the
minority interest position related to one of its joint ventures for
approximately $1.3 million in cash.
In August 1996, the Company sold the Custom Home Division of Genesee
(Genesee Custom) and purchased Landmark Homes, Inc., a Wilmington, North
Carolina and Myrtle Beach, South Carolina homebuilder. On December 31, 1996, the
Company purchased Brookstone Homes, Inc., a Janesville, Madison and Milwaukee,
Wisconsin homebuilder.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying consolidated financial statements include the accounts of
Fortress and its subsidiaries. All intercompany transactions have been
eliminated in consolidation.
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'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.
Other revenue is primarily mortgage revenue. Other non-operating income
includes interest income, a legal settlement, and outsourced design services
provided by a Company subsidiary to parties unrelated to the Company and its
customers.
F-16
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
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
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 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 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 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; 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 Statement of Financial
Accounting Standards 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.
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 are capitalized and
being amortized using the straight-line method over the seven-year term of the
related notes.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of
assets acquired and is being amortized over a 15-year period. Accumulated
amortization at December 31, 1996 and amortization expense for the period May
21, 1996 through December 31, 1996 was $82,758. In the event that facts and
circumstances indicate that the carrying value of goodwill may be impaired, an
evaluation of recoverability would be
F-17
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
performed. If an adjustment is required, the estimated future undiscounted cash
flows associated with the asset would be compared to the asset's carrying amount
to determine if a write-down to fair value is required.
Income taxes
The Company accounts for income taxes in accordance with Statement of
Financial Accounting Standards No. 109 (SFAS 109), 'Accounting for Income
Taxes.' The asset and liability approach used in SFAS 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. In estimating future tax
consequences,
SFAS 109 generally considers all expected future events other than
enactments of changes in the tax law or rates.
Fair value of financial instruments
The financial instruments of the Company consist of accounts receivable,
due to and from related parties, accounts payable and construction liabilities
and notes and mortgages payable. The fair value of the Company's Senior Notes at
December 31, 1996, which are recorded at their carrying value of $100 million,
is approximately $115 million 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.
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.
NOTE 3--ACQUISITIONS
During 1996, the Company acquired certain assets and assumed related
indebtedness of Landmark Homes, Inc. and Brookstone Homes, Inc. (Acquired
Companies) on August 31, 1996 and December 31, 1996, respectively. The purchase
price for the assets of the Acquired Companies totaled $6 million in cash and
60,000 shares of common stock with a stated value of $10 per share. The excess
purchase price was allocated first to record assets and liabilities at fair
value on the acquisition date; the 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.
The Acquired Companies are involved in homebuilding and land development.
The Company has accounted for these acquisitions under the purchase method. The
operations of the Acquired Companies are included in the Company's accompanying
consolidated statement of operations since the acquisition date.
The Company's unaudited pro forma summary consolidated results of
operations, as if the acquisitions had occurred at January 1, 1995, are
presented below. These results include the pro forma results of Combined
Predecessor Companies. The pro forma results also include the application of the
net proceeds from the Offering to refinance debt outstanding during the period,
certain administrative costs of the Fortress corporate organization, the sale of
Genesee Custom and the increased provision for income taxes as if the Combined
Predecessor Companies, the Acquired Companies were C corporations. In preparing
the pro forma information,
F-18
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 3--ACQUISITIONS--(CONTINUED)
various assumptions were made, and the Company does not purport this information
to be indicative of what would have occurred had the acquisitions been made as
of January 1, 1995.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------------
1996 1995
-------- --------
(UNAUDITED, IN
THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C>
Revenue............................................................... $306,974 $228,271
Net income............................................................ $ 11,759 $ 7,709
Net income per share.................................................. $ 1.08 $ .81
</TABLE>
NOTE 4--SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures of cash flow information are as follows (in
thousands):
<TABLE>
<CAPTION>
MAY 21, 1996
THROUGH
DECEMBER 31, 1996
--------------------
<S> <C>
Cash paid for the following:
Interest.......................................... $ 11,214
Income taxes...................................... $ 4,958
</TABLE>
Significant non-cash transactions:
In connection with the acquisitions of the Founding Builders and
Brookstone, the Company paid the following non-cash consideration in the form of
shares of the Company's common stock (dollar amounts in thousands):
<TABLE>
<CAPTION>
SHARES AMOUNT
---------- -------
<S> <C> <C>
Brookstone........................................................... 60,000 $ 379
Buffington........................................................... 1,897,897 17,081
Christopher.......................................................... 1,691,227 15,221
Genesee.............................................................. 1,729,495 15,654
Sunstar.............................................................. 915,256 8,237
</TABLE>
Additionally, in connection with the acquisition of Genesee, the Company
issued 20,000 shares of Series A 11% Cumulative Convertible Preferred Stock.
As part of the sale of the Genesee Custom, the Company received a $4.1
million note receivable from the buyer.
F-19
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 5--REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Work-in-progress............................................ 83,216
Model homes................................................. 11,280
Finished lots............................................... 34,671
Land under development...................................... 13,930
Unimproved land held for development........................ 1,009
--------
Total....................................................... $144,106
--------
--------
</TABLE>
Model homes are constructed to assist in the marketing effort of a
development. Work-in-progress includes sold homes and speculative homes, which
represent non-model, completed or substantially completed homes which are not
subject to a sales contract. In addition, model homes and work-in-progress
include the allocation of land and development and other allocable costs.
NOTE 6--INTEREST
Information regarding interest is as follows (in thousands):
<TABLE>
<CAPTION>
MAY 21, 1996
THROUGH
DECEMBER 31, 1996
--------------------
<S> <C>
During the period:
Interest incurred................................. $ 12,930
Interest capitalized.............................. (12,314)
Interest amortized to cost of sales............... 9,704
--------
Total interest expensed in statement of
operations..................................... $ 10,320
--------
--------
At the end of the period:
Capitalized interest in ending inventory.......... $ 12,159
--------
--------
</TABLE>
NOTE 7--PROPERTY AND EQUIPMENT
Property and equipment consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Model home upgrades and furnishings......................... $1,845
Equipment and furniture..................................... 2,564
Vehicles.................................................... 468
Leasehold improvements...................................... 725
------
5,602
Less: Accumulated depreciation and amortization............. (2,059)
------
$3,543
------
------
</TABLE>
F-20
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 8--NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable consist of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
13.75% Senior Notes due 2003................................ $100,000
Project specific land, land development and construction
loans..................................................... 38,613
Other loans................................................. 1,523
--------
$140,136
--------
--------
</TABLE>
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 indebtedness of any guaranties by the Company's
subsidiaries. The Company is required to maintain a consolidated tangible net
worth of at least $15 million.
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 .5% to 2% over prime rate (8.75%
to 10.25% at December 31, 1996) or at fixed rates ranging from 9.00% to 9.75%.
Other loans consist primarily of debt financed corporate insurance policies
which bear interest at 6.9%.
Principal maturities of the above indebtedness at December 31, 1996 are as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1997.......................................................... $ 31,825
1998.......................................................... 5,925
1999.......................................................... 2,386
Thereafter.................................................... 100,000
----------
$ 140,136
----------
----------
</TABLE>
NOTE 9--MINORITY INTEREST
The Company's Sunstar subsidiary is a participant in a real estate joint
venture in which a party unrelated to the Company owns a minority interest.
Joint venture profits are allocated to the Company and the other partners
according to their respective ownership.
F-21
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 10--RELATED PARTY TRANSACTIONS
Due from related parties consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Note receivable from sale of Genesee Custom................. $3,309
Accounts receivable from sale of Genesee Custom............. 977
Note receivable from director............................... 487
Other....................................................... 403
------
$5,176
------
------
</TABLE>
In connection with the sale of Genesee Custom to a director of the Company,
the Company has a note receivable bearing interest at 12% from the director for
approximately $3.3 million at December 31, 1996. The note is due in July of 1997
and is extendable for six months at the borrower's option. The related accounts
receivable are non-interest bearing and are due on demand.
The Company also has a note receivable bearing interest at 13.75% from
another director for approximately $460,000, net of accrued interest, which is
secured by that director's shares in the Company.
Due to related parties at December 31, 1996 consists of preferred dividends
of $27,000 payable to a director of the Company.
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 period May 21, 1996
through December 31, 1996 are approximately $219,000.
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 by unrelated customers. Fees in the approximate
amount of $659,500 were paid by Buffington for the period May 21, 1996 through
December 31, 1996.
Landmark purchases landscaping and lot improvement services from an
affiliated company. Expense related to these services was $198,740 from
acquisition through December 31, 1996. Additionally, Landmark purchases
developed land from an affiliated company at its estimated fair value. For the
period from acquisition through December 31, 1996, Landmark acquired
approximately $1,119,600.
NOTE 11--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 $757,000 for the period
May 21, 1996 through December 31, 1996. Included in this amount is rent paid to
affiliated companies, under office and warehouse leases, totalling $290,000 for
the same period.
F-22
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 11--LEASES--(CONTINUED)
As of December 31, 1996, future minimum lease payments under noncancelable
operating lease agreements are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1997............................................................. $1,065
1998............................................................. 790
1999............................................................. 715
2000............................................................. 596
2001............................................................. 404
Thereafter....................................................... 1,285
------
$4,855
------
------
</TABLE>
NOTE 12--SHAREHOLDER'S EQUITY
Preferred stock
The Company has authorized 2 million shares of $.01 par value preferred
stock of which 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 accrued but unpaid
dividends. Accrued dividends on the 10,000 outstanding shares at December 31,
1996 totaled $27,000.
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 in the
underwriter's overallotment) for total proceeds of approximately $21.8 million.
The proceeds were used together with proceeds from the issuance of the Senior
Notes (see Note 8) 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, if completed,
would be effected at various prices from time to time in the open market.
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, 1996.
F-23
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 13--EMPLOYEE BENEFIT AND INCENTIVE PLANS--(CONTINUED)
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, 1996.
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 employees of the Company at 85% of market value. The plan
will be effective January 1, 1997, subject to approval of the stockholders.
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 575,000 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, 1996, no stock appreciation rights,
restricted stock or deferred stock were granted.
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 ten years from the grant
date. Options granted in 1996 become 50% vested on the first grant date
anniversary and 100% vested on the second grant date anniversary.
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 Statement of Financial Accounting Standards No. 123 (SFAS 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 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 1996 was approximately $548,000.
Under the model, the total value of stock options granted in 1996 was
approximately $989,000 which would be amortized ratably on a pro forma basis
over the two-year vesting period. Had the Company determined the compensation
cost for these plans in accordance with SFAS 123, the Company's pro forma net
income would have been approximately $8,039,000 for the period May 21, 1996
through December 31, 1996 and the effect on earnings per share would be
immaterial.
F-24
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 13--EMPLOYEE BENEFIT AND INCENTIVE PLANS--(CONTINUED)
Option activity is summarized as follows:
<TABLE>
<CAPTION>
SHARES AVAILABLE NUMBER WEIGHTED AVERAGE
FOR OPTIONS OF SHARES OPTION PRICE
---------------- --------- ----------------
<S> <C> <C> <C>
Balance available at May 21, 1996........................ 575,000
Grants................................................... (351,500) 351,500 $ 8.94
Exercises
Cancellations............................................ 34,700 (34,700) 9.00
------- ------- ------
Balance at December 31, 1996 258,200 316,800 $ 8.92
------- ------- ------
------- ------- ------
Options exercisable at:
December 31, 1996........................................ 0
December 31, 1997........................................ 155,050
December 31, 1998........................................ 316,800
</TABLE>
The following table summarizes information about options outstanding at
December 31, 1996:
<TABLE>
<CAPTION>
OPTIONS
OUTSTANDING
-----------------
NUMBER REMAINING
OUTSTANDING AT CONTRACTUAL LIFE
EXERCISE PRICE DECEMBER 31, 1996 (IN YEARS)
- -------------- ----------------- ----------------
<S> <C> <C>
$6.00.................................................... 200,000 9.98
$9.00.................................................... 116,800 9.39
-------
316,800
-------
-------
</TABLE>
NOTE 14--INCOME TAXES
The provision for income taxes consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Current:
Federal................................................... $4,840
State..................................................... 847
------
5,687
Deferred:
Federal................................................... (619)
State..................................................... (55)
------
(674)
------
Total....................................................... $5,013
------
------
</TABLE>
F-25
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1996 AND 1995
NOTE 14--INCOME TAXES--(CONTINUED)
The provision for income taxes differs from the amount computed by applying
the Federal income tax statutory rate as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Income tax computed at statutory rate....................... $4,495
State income taxes, net of federal benefit.................. 523
Other, net.................................................. (5)
------
Total....................................................... $5,013
------
------
</TABLE>
Deferred tax assets relate principally to warranty reserves and differences
in capitalization of inventory.
NOTE 15--COMMITMENTS AND CONTINGENCIES
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.
NOTE 16--SUBSEQUENT EVENTS (UNAUDITED)
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
subsidiary homebuilders. The Company made a capital contribution of $750,000 in
exchange for 100 shares of $.01 par value common stock in Fortress Mortgage,
Inc. In February 1997, the Company authorized 40,000 and 70,000 shares of $.01
par value, voting, noncumulative convertible Class B and Class C preferred
stock. Class B preferred stock has liquidation value of $100 per share.
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 $9.0 million in cash, $1.2 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. This consideration will be accounted for as additional
purchase price and, accordingly, increase the goodwill related to the
acquisition and be amortized over the remaining amortization period.
F-26
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Cash and cash equivalents........................................................... $ 3,483 $ 16,212
Accounts receivable................................................................. 9,618 10,700
Due from related parties............................................................ 16,730 5,176
Real estate inventories............................................................. 215,872 144,106
Loans held for resale............................................................... 11,497
Property and equipment, net......................................................... 7,735 3,543
Prepaid expenses and other assets................................................... 29,700 10,355
Goodwill, net....................................................................... 19,514 3,641
--------- --------
Total assets................................................................... $ 314,149 $193,733
--------- --------
--------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities............................... $ 16,872 $ 8,526
Notes and mortgages payable......................................................... 211,625 140,136
Due to related parties.............................................................. 5,306 27
Accrued expenses.................................................................... 13,056 8,525
Customer deposits................................................................... 6,895 4,259
--------- --------
Total liabilities.............................................................. 253,754 161,473
--------- --------
Minority interest................................................................... 280 274
--------- --------
Shareholders' equity
Preferred stock, $.01 par value, 1 million authorized............................. 1
Class AA cumulative convertible (rate of 12% per annum decreases to 6% upon the
second closing with Prometheus), 46,670 designated, 11,700 issued and
outstanding ($11.7 million initial liquidation preference)
Series A 11% cumulative convertible, 20,000 authorized, 10,000 issued and
outstanding ($1 million aggregate liquidation preference)
Series B convertible, 40,000 authorized, 8,854 issued and outstanding ($885,400
aggregate liquidation preference)
Series C convertible, 70,000 authorized, 60,000 issuable (Note 8)
Series D convertible, 67,500 authorized, 60,000 issued and outstanding
($6,000,000 aggregate liquidation preference)
Common stock, $.01 par value, 49 million authorized, 11,745,275 and 11,762,675
issued and outstanding......................................................... 118 118
Additional paid-in capital.......................................................... 47,772 23,808
Retained earnings................................................................... 12,736 8,072
Treasury stock, at cost, 84,100 and 1,700 shares.................................... (512) (12)
--------- --------
Total shareholders' equity..................................................... 60,115 31,986
--------- --------
Total liabilities and shareholders' equity..................................... $ 314,149 $193,733
--------- --------
--------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
FOR THE FOR THE
THREE THREE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1996
------------ ------------
<S> <C> <C>
Revenue:
Residential sales................................................................ $ 116,781 $ 74,827
Lot sales and other.............................................................. 982 1,730
---------- ----------
Total revenue................................................................. 117,763 76,557
Cost of sales...................................................................... 99,251 64,214
----------- ----------
Gross profit....................................................................... 18,512 12,343
Operating expenses:
Selling.......................................................................... 7,074 4,463
General and administrative....................................................... 6,208 3,489
Model home reserve............................................................... (126)
----------- ----------
Net operating income.......................................................... 5,356 4,391
----------- ----------
Other expense (income):
Interest......................................................................... 1,551 95
Minority interest................................................................ 4 2
Other, net....................................................................... (423) (329)
----------- ----------
Income before provision for income taxes........................................... 4,224 4,623
Provision for income taxes......................................................... 1,634 1,776
----------- ----------
Net income......................................................................... $ 2,590 $ 2,847
----------- ----------
----------- ----------
Net income per share............................................................... $ .20 $ .24
----------- ----------
----------- ----------
Weighted average shares outstanding................................................ 12,840,772 11,764,375
----------- ----------
----------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED, DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
COMBINED
PREDECESSOR
THE COMPANY COMPANIES COMBINED
------------------------------- -------------- --------------
FOR THE NINE FOR THE PERIOD FOR THE PERIOD FOR THE NINE
MONTHS ENDED MAY 21- JANUARY 1- MONTHS ENDED
SEPT. 30, 1997 SEPT. 30, 1996 MAY 20, 1996 SEPT. 30, 1996
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenue:
Residential sales................................. $ 289,394 $ 115,723 $ 64,984 $180,707
Lot sales and other revenue....................... 4,015 3,222 1,135 4,357
---------- ---------- -------- --------
Total revenue.................................. 293,409 118,945 66,119 185,064
Cost of sales....................................... 249,173 99,932 56,425 156,357
---------- ---------- -------- --------
Gross profit........................................ 44,236 19,013 9,694 28,707
Operating expenses:
Selling........................................... 18,581 6,326 4,689 11,015
General and administrative........................ 15,740 5,320 3,892 9,212
Non-recurring acquisition abandonment............. 335
Model home reserve................................ 284
---------- ------------ -------- ------
Net operating income........................... 9,296 7,367 1,113 8,480
---------- ------------ -------- ------
Other expense (income):
Interest.......................................... 2,422 131 63 194
Minority interest................................. 6 17 89 106
Other, net........................................ (988) (387) (313) (700)
---------- ----------- -------- ------
Income before provision for income taxes............ 7,856 7,606 $ 1,274 $8,880
-------- ------
-------- ------
Provision for income taxes (Note 2)................. 3,016 2,901
---------- ----------
Net income.......................................... $ 4,840 $ 4,705
---------- ----------
---------- ----------
Net income per share................................ $ .38 $ .40
---------- ----------
---------- ----------
Weighted average shares outstanding................. 12,466,591 11,680,916
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-29
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(UNAUDITED, EXCEPT FOR DECEMBER 31, 1996 BALANCES, 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 December 31, 1996..... 10 11,763 $118 $ 23,808 $ 8,072 $ (12) $31,986
Issuance of preferred stock.... 144 $ 1 23,955 23,956
Redemption of preferred
stock........................ (3) (315) (315)
Preferred stock dividends...... (86) (86)
Issuance of common stock....... 65 322 322
Dividends declared............. (90) (90)
Purchase of treasury stock..... (107) (642) (642)
Reissuance of treasury stock... 24 2 142 144
Net income..................... 4,840 4,840
--- ------ --------- ------ ---------- -------- -------- -------------
Balance at September 30, 1997.... 151 11,745 $ 1 $118 $ 47,772 $12,736 $ (512) $60,115
--- ------ --------- ------ ---------- -------- -------- -------------
--- ------ --------- ------ ---------- -------- -------- -------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-30
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED, IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE NINE FOR THE PERIOD
MONTHS ENDED MAY 21-
SEPT. 30, 1997 SEPT. 30, 1996
-------------- --------------
<S> <C> <C>
Cash flows from operating activities
Net income....................................................................... $ 4,840 $ 4,705
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization................................................. 3,058 287
Minority interest............................................................. 6 17
Loss on sale of property and equipment........................................ 34 21
Changes in operating assets and liabilities
Accounts receivable......................................................... 2,791 (10,571)
Due from related parties.................................................... 147
Real estate inventories..................................................... (13,205) (6,522)
Loans held for resale....................................................... (11,497)
Prepaid expenses and other assets........................................... (326) (627)
Accounts payable and accrued construction liabilities....................... (777) (3,687)
Accrued expenses............................................................ 3,208 5,566
Customer deposits........................................................... 550 (1,570)
-------- ----------
Net cash used in operating activities.................................... (11,171) (12,381)
-------- ----------
Cash flows from investing activities
Acquisition of homebuilders, net of acquired cash................................ (13,170) (4,650)
Sale of Genesee Custom Homes division............................................ 253
Purchase of property and equipment............................................... (3,791) (813)
Proceeds from sale of property and equipment..................................... 155 12
Investment in limited partnerships............................................... (8,523)
-------- ----------
Net cash used in investing activities.................................... (25,329) (5,198)
-------- ----------
Cash flows from financing activities
Borrowings under notes and mortgages payable..................................... 220,653 132,974
Repayment of notes and mortgages payable......................................... (193,921) (112,342)
Related party borrowings......................................................... 45
Repayments of related party borrowings........................................... (341) (4,470)
Deferred financing costs......................................................... (1,882) (1,737)
Capital distributions............................................................ (59) (6,063)
Distributions to minority interest............................................... (1,274)
Preferred dividends.............................................................. (82)
Purchase of treasury stock....................................................... (642)
Net proceeds from issuance of stock.............................................. 21,843
-------- ----------
Net cash provided by financing activities................................ 23,771 28,931
-------- ----------
Net (decrease) increase in cash and cash equivalents............................... (12,729) 11,352
Cash and cash equivalents, beginning of period..................................... 16,212 3,028
-------- ----------
Cash and cash equivalents, end of period........................................... $ 3,483 $ 14,380
-------- ----------
-------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-31
<PAGE>
FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1--BUSINESS AND ORGANIZATION
The Fortress Group, Inc. ('Fortress' or the 'Company') was formed in June
1995 to create a national homebuilding company for the acquisition and
development of land or improved lots and the construction of residential
for-sale housing.
Four homebuilding companies were acquired by Fortress simultaneous with the
closing of its initial public offering on May 21, 1996 (the Offering) including
Buffington Homes, Inc. (Buffington), Christopher Homes and Affiliates
(Christopher), The Genesee Company (Genesee), and Solaris Development
Corporation (Sunstar). These companies as a group are referred to as the
Predecessor Companies.
Fortress has made additional acquisitions of Landmark Homes, Inc.
(Landmark) on August 31, 1996; Brookstone Homes, Inc. (Brookstone) on December
31, 1996; D.W. Hutson Construction Company (Hutson) on February 28, 1997;
Wilshire Homes (Wilshire) effective April 1, 1997; and Don Galloway Homes, Inc.
(Galloway) effective August 1, 1997. On January 1, 1997, Fortress formed
Fortress Mortgage Company, a fully-owned subsidiary providing mortgage services
at several of the Company's builder subsidiaries.
The accompanying consolidated financial statements of Fortress have been
prepared by the Company. Certain information and footnote disclosures normally
included in financial statements presented in accordance with generally accepted
accounting principles have been condensed or omitted. The Company believes the
disclosures made are adequate to make the information presented not misleading.
However, the financial statements should be read in conjunction with the audited
financial statements of the Company and notes thereto included herein.
In the opinion of the Company, the accompanying consolidated financial
statements reflect all adjustments (which include only normal recurring
adjustments) necessary to present fairly the financial position of The Fortress
Group, Inc. at September 30, 1997 and the results of operations for the three
and nine months ended September 30, 1997, the three months ended September 30,
1996, and the period from May 21 through September 30, 1996 (actual) and cash
flows for the nine months ended September 30, 1997 and the period from May 21
through September 30, 1996. Interim results are not necessarily indicative of
fiscal year performance because of the impact of seasonal and short-term
variations.
NOTE 2--BASIS OF PRESENTATION
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. The
acquisitions have been accounted for under the purchase method of accounting.
The purchase price in excess of book value of each of the acquired companies
were allocated first to record the assets and liabilities at fair value on
acquisition date with any remaining balances recorded as goodwill.
The consolidated balance sheet of the Company at December 31, 1996 consists
of Fortress and its subsidiaries (the Predecessor Companies and the 1996
acquired companies, Landmark and Brookstone). The consolidated balance sheet at
September 30, 1997 and the consolidated statements of operations, of
shareholders' equity and of cash flows are unaudited and include the results of
Fortress, inclusive of the Predecessor Companies and all of the acquisition
companies subsequent to the initial public offering.
The unaudited consolidated statements of operations for the three and nine
months ended September 30, 1997 include the actual results of Fortress and its
subsidiaries from the respective dates of their acquisitions.
In the fourth quarter of 1996 and in 1997, the Company acquired limited
partnership interests in certain land limited partnerships. These investments
are accounted for under the equity method and are included in the balance sheet
in 'other assets' in the 'Prepaid expenses and other assets' line item.
F-32
<PAGE>
FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--BASIS OF PRESENTATION--(CONTINUED)
The Company's unaudited pro forma net income and net income per share for
1996 as if the Predecessor Companies were combined and subject to the effective
Federal statutory income tax rate throughout the period is presented below. This
amount does not include any adjustment for additional corporate operating
activities that the newly formed public entity would have incurred if it had
existed as such for the entire period.
<TABLE>
<CAPTION>
COMBINED
------------
FOR THE NINE
MONTHS ENDED
SEPT. 30,
1996
------------
<S> <C>
Unaudited pro forma data:
Income before provision income taxes............................... $ 8,880
Provision for income taxes......................................... 3,374
------------
Net income......................................................... $ 5,506
------------
Net income per share............................................... $ .54
------------
------------
Weighted average shares outstanding used in pro forma net income
per share calculation........................................... 10,025,689
------------
------------
</TABLE>
As discussed, the unaudited pro forma net income for the nine months ended
September 30, 1996 includes the actual results of the Company and the
Predecessor Companies plus a pro forma adjustment to reflect the calculation of
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.
The unaudited statement of cash flows for the period from May 21 through
September 30, 1996 includes the actual results of The Fortress Group, Inc.
subsequent to the initial public offering.
During the second quarter, the Company terminated discussions with a
potential acquisition of significant size and, accordingly, wrote off the
related accumulated acquisition costs.
NOTE 3--PRO FORMA SUMMARY CONSOLIDATED RESULTS OF OPERATIONS
The Company's unaudited pro forma summary consolidated results of
operations, as if the acquisitions of Hutson and Galloway had occurred at
January 1, 1997 are presented below. In preparing the 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 acquisitions been made as
of January 1, 1997.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, 1997
-------------------------
(UNAUDITED, IN THOUSANDS,
EXCEPT PER SHARE AMOUNTS)
<S> <C>
Revenue................................................... $ 342,908
Net income................................................ 7,884
Net income per share...................................... .52
</TABLE>
NOTE 4--SIGNIFICANT ACQUISITIONS
In February 1997, the Company acquired the assets of Hutson for initial
consideration of approximately $24.7 million ($9.0 million in cash, $1.2 million
in Class B preferred stock, and approximately $8.5 million in assumed debt).
Approximately, $1 million in cash and $315,000 of the preferred stock was
returned to the Company based on the final accounting of the acquisition.
Additional consideration of $6.0 million is expected to be paid over a period
not to exceed six years based upon the future performance of Hutson.
F-33
<PAGE>
FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4--SIGNIFICANT ACQUISITIONS--(CONTINUED)
Effective August 1, 1997, the Company acquired the stock of Galloway for
initial consideration of approximately $34.6 million ($5.0 million in cash, $5.0
million in a short-term note, 60,000 shares of Series D convertible preferred
stock with a $6.0 million liquidation value, and approximately $18.6 million in
assumed debt). Additional consideration not to exceed $5.0 million is expected
to be paid over a period not to exceed four years based upon the future
performance of Galloway.
In both acquisitions, 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 amortization
periods.
NOTE 5--REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
<S> <C> <C>
Work-in-progress
Sold homes........................................................................ $ 81,933 $ 38,547
Speculative....................................................................... 43,538 44,669
--------- --------
Total work-in-progress......................................................... 125,471 83,216
Land
Finished lots..................................................................... 50,342 34,671
Land under development............................................................ 23,078 13,930
Land held for development......................................................... 7,498 1,009
--------- --------
Total land..................................................................... 80,918 49,610
Model homes........................................................................ 9,483 11,280
--------- --------
$ 215,872 $144,106
--------- --------
--------- --------
</TABLE>
NOTE 6--INTEREST
Information regarding interest is as follows (in thousands):
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
-----------------------------
1997 1996 COMBINED
----------- --------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
During the periods:
Interest incurred................................................................. $ 18,045 $ 12,625
Interest capitalized.............................................................. (15,623) (12,431)
Interest amortized to cost of sales............................................... 11,959 8,599
--------- --------
Total interest expensed in statement of operations............................. $ 14,381 $ 8,793
--------- --------
--------- --------
At the end of the periods:
Capitalized interest in ending inventory.......................................... $ 17,100 $ 11,363
--------- --------
--------- --------
</TABLE>
NOTE 7--SIGNIFICANT NON-CASH TRANSACTIONS
Effective September 30, 1997, the Company executed the first closing
related to its agreement with Prometheus Homebuilders LLC (Prometheus), a
subsidiary of Lazard Freres Strategic Realty Investors II L.P. In connection
with this transaction, Prometheus purchased 11,700 shares having an initial
liquidation value of
F-34
<PAGE>
FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7--SIGNIFICANT NON-CASH TRANSACTIONS--(CONTINUED)
$11,700,000 of Class AA Preferred Stock and 375,000 warrants for a puchase price
of $11,700,000. The funding for this transaction occurred on October 2, 1997;
accordingly, the receivable is included in 'Due from related parties' at
September 30, 1997.
In connection with the acquisition of Galloway, the Company paid (in
addition to cash consideration) non-cash consideration of $5 million in the form
of a note payable bearing interest at prime rate plus 1% and $6 million
liquidation value of Series D preferred stock (60,000 shares) to Galloway's sole
shareholder and assumed $18.6 million in debt. The note, included in 'Due to
related parties' at September 30, 1997, was paid in full on October 2, 1997.
NOTE 8--NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable consist of the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
1997 1996
------------- ------------
(UNAUDITED)
<S> <C> <C>
13.75% Senior Notes due 2003.............................................. $ 100,000 $100,000
Project specific land, land development and construction loans............ 99,616 38,613
Mortgage lines of credit.................................................. 9,399
Other loans............................................................... 2,610 1,523
--------- --------
$ 211,625 $140,136
--------- --------
--------- --------
</TABLE>
The Company pays interest on the Senior Notes in arrears on May 15 and
November 15 of each year at the rate of 13.75% per annum. The Senior Notes may
not be redeemed, at any time prior to maturity. The Senior Notes are unsecured
and rank pari passu with, or senior in right of payment to, all other existing
and future unsecured indebtedness of the Company. The Senior Notes, however, are
effectively subordinated to secured debt of the Company to the extent of any
collateral, as well as to the Company's subsidiaries' indebtedness. The Company
is required to maintain a consolidated tangible net worth of at least $15
million and other financial covenants, as defined, in the Senior Note Indenture.
The loan agreements for project specific land, land development and
construction loans are secured by a lien on the applicable residential
development project or a specific unit under construction. Repayment of the
loans are generally due upon sale of the collateral property. The loans bear
interest at annual variable rates ranging from 2.5% over the London InterBank
Offered Rate (LIBOR) to 2% over prime rate and fixed rates from 7.8% to 18%.
The Company's mortgage subsidiary has two warehouse lines of credit
outstanding for the purpose of originating loans. The warehouse lines, totaling
$10 million, are secured by the mortgage loans held for sale and are repaid upon
sale of the mortgage loans. The line bears interest at variable rates ranging
from 1.5% to 2.75% over the 30-day LIBOR. The lines of credit mature April 30,
1998 and August 31, 1998 but can be renewed at the Company's option.
Other loans consist primarily of debt financed corporate insurance policies
which bear interest at varying rates between 7.0% and 7.8%.
NOTE 9--CONVERTIBLE PREFERRED STOCK
In connection with the Hutson acquisition, Fortress issued 12,000 shares
(8,854 outstanding at September 30, 1997) of Series B convertible preferred
stock with a liquidation value of $100 per share. These preferred shares are
convertible into 10 shares of common stock for each preferred share until
February 1998. Thereafter,
F-35
<PAGE>
FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 9--CONVERTIBLE PREFERRED STOCK--(CONTINUED)
the Series B preferred stock is convertible into $100 value per share, payable
in stock at 10 for 1 and additional shares or cash, at the option of Fortress,
to equal $100 value.
In addition, Fortress has also 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 shares, 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 10 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 shares or a
combination of both equal to the $100 per share liquidation value. The
allocation between common shares and cash is at the sole option of Fortress.
NOTE 10--EARNINGS PER SHARE
Earnings per share is calculated by dividing net income available to common
shareholders by the weighted average number of common shares outstanding plus
the weighted average number of common stock equivalents. Common stock
equivalents consist of convertible preferred stock (under the if-converted
method). The Company's intention upon conversion or redemption (as the case may
be) of Series B, C and D preferred stock (see Note 9) 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.
NOTE 11--MODEL HOME RESERVE
On March 31, 1997, Genesee, a subsidiary of the Company, closed on a
transaction pursuant to which it sold to a certain purchaser 11 model homes and
concurrently leased back the model homes. Pursuant to the terms of the sale,
Genesee was to receive cash and a note secured by a second mortgage on the model
homes and by a lien on certain other collateral. Genesee recorded revenue of
approximately $3 million and a gain of approximately $410,000 in the quarter
ended March 31, 1997.
During April, Genesee discovered that the title company handling the
closing had recorded deeds conveying the model homes to the purchaser and
recorded first mortgages securing indebtedness incurred by the purchaser in
connection with the purchase of the model homes notwithstanding the fact that
the purchaser had failed to deliver to the title company certain collateral
required by the terms of the transaction to secure the purchaser's note issued
to Genesee.
A suit has been filed in the District Court for the City and County of
Denver seeking a judicial determination of who is entitled to the proceeds of
the transaction, and Genesee has also asserted claims in the suit against the
purchaser, the title company, the brokers and a number of other participants in
the transaction seeking damages. Pending a decision in such litigation, the
remainder of the sale proceeds is being held by the court and in escrow by the
title company. Also pending the outcome of the litigation, the purchaser, based
upon Genesee's agreement to make the required payments on the first mortgage
loan, has conveyed the title to the model homes to an affiliate of Genesee,
subject to the first mortgage liens and the lease was canceled.
F-36
<PAGE>
FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 11--MODEL HOME RESERVE--(CONTINUED)
Given the events subsequent to the initial recording of the transaction,
Genesee recorded a reserve in the second quarter equal to the full amount of
profit recognized. During the third quarter, Genesee sold five of the 11 model
homes and reversed a portion of the related reserve.
NOTE 12--SUBSEQUENT EVENTS
Effective October 1, 1997, the Company acquired certain assets of The
Iacobucci Organization, a homebuilding company with operations in the
Philadelphia, Pennsylvania area, subject to certain requirements, for an initial
purchase price of cash of $2.9 million plus debt assumption of approximately
$13.9 million. The acquisition terms include earnout provisions based on the
future operations of the acquired business. The earnout consideration will be
accounted for as additional purchase price in the form of goodwill.
F-37
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders of Whittaker
Construction, Incorporated and Affiliates
In our opinion, the accompanying combined balance sheet and the related
combined statements of operations, of changes in stockholders' equity and of
cash flows present fairly, in all material respects, the financial position of
Whittaker Construction, Incorporated and Affiliates at December 31, 1996, and
the results of their operations and their cash flows for the year in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audit. We conducted our
audit 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 believe that our
audit provides a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Washington, DC
January 14, 1998
F-38
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED AND AFFILIATES
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, --------------------------
1997 1996 1995
------------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents........................................... $ 3,176,002 $ 1,395,669 $ 2,493,446
Accounts receivable, net............................................ 563,714 29,030 376,562
Due from related parties, net....................................... 41,066
Building products inventories....................................... 2,273,311 2,081,938 2,149,936
Real estate inventories............................................. 48,803,578 49,107,187 33,588,490
Prepaid and other assets............................................ 135,794 132,064 162,064
Property and equipment, net of accumulated depreciation of
$2,554,362, $2,123,706 and $1,639,195, respectively............... 2,508,714 2,646,639 2,360,553
------------ ----------- -----------
Total assets.............................................. $ 57,461,113 $55,433,593 $41,131,051
------------ ----------- -----------
------------ ----------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued expenses............................... $ 5,711,983 $ 5,120,275 $ 4,654,744
Due to related parties, net......................................... 105,266 33,914
Notes payable....................................................... 36,674,356 38,180,127 24,967,543
Advances from stockholders.......................................... 3,546,174 2,872,901 2,813,893
Customer deposits................................................... 1,559,534 1,173,237 1,377,770
------------ ----------- -----------
Total liabilities......................................... 47,597,313 47,346,540 33,847,864
------------ ----------- -----------
Commitments and contingencies (Note 10)
Stockholders' equity:
Common stock (Note 7).......................................... 41,000 41,000 41,000
Additional paid-in capital..................................... 490,000 490,000 490,000
Retained earnings.............................................. 9,332,800 7,556,053 6,752,187
------------ ----------- -----------
Total stockholders' equity................................ 9,863,800 8,087,053 7,283,187
------------ ----------- -----------
Total liabilities and stockholders' equity........... $ 57,461,113 $55,433,593 $41,131,051
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-39
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED AND AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994
----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Sales............................................................... $85,506,353 $89,627,635 $94,369,567
Cost of sales....................................................... 70,479,295 73,947,570 77,963,743
----------- ----------- -----------
Gross profit........................................................ 15,027,058 15,680,065 16,405,824
Operating expenses:
General and administrative..................................... 6,037,724 5,126,367 4,547,098
Marketing and selling.......................................... 3,466,275 3,472,079 3,401,521
----------- ----------- -----------
Net operating income...................................... 5,523,059 7,081,619 8,457,205
Other (income) expense:
Interest income................................................ (129,671) (106,794) (80,461)
Interest expense............................................... 891,210 511,506 448,555
Other.......................................................... (147,346) (254,700) (155,539)
----------- ----------- -----------
Total other (income) expense.............................. 614,193 150,012 212,555
----------- ----------- -----------
Net income.......................................................... $ 4,908,866 $ 6,931,607 $ 8,244,650
----------- ----------- -----------
----------- ----------- -----------
Unaudited pro forma provision for income taxes (Note 2)............. (1,865,369) (2,634,010) (3,132,967)
----------- ----------- -----------
Unaudited pro forma net income...................................... $ 3,043,497 $ 4,297,597 $ 5,111,683
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-40
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED AND AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED THREE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
1997 1996 1997 1996
----------- ----------- ------------ -----------
(UNAUDITED) (UNAUDITED) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C>
Sales............................................... $66,591,820 $60,568,105 $ 26,463,806 $23,016,926
Cost of sales....................................... 55,133,422 49,907,950 21,001,602 19,118,589
----------- ----------- ------------ -----------
Gross profit........................................ 11,458,398 10,660,155 5,462,204 3,898,337
Operating expenses:
General and administrative..................... 4,191,553 4,283,429 1,137,032 1,314,161
Marketing and selling.......................... 2,873,965 2,459,412 1,201,827 934,272
----------- ----------- ------------ -----------
Net operating income...................... 4,392,880 3,917,314 3,123,345 1,649,904
Other (income) expense:
Interest income................................ (86,457) (93,000) (27,138) (18,832)
Interest expense............................... 804,068 652,372 259,688 353,252
Other.......................................... (96,478) (157,995) 336,494 38,610
----------- ----------- ------------ -----------
Total other (income) expense.............. 621,133 401,377 569,044 373,030
----------- ----------- ------------ -----------
Net income.......................................... $ 3,771,747 $ 3,515,937 $ 2,554,301 $ 1,276,874
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
Unaudited pro forma provision for income taxes (Note
2)................................................ (1,433,264) (1,336,056) (970,634) (485,212)
----------- ----------- ------------ -----------
Unaudited pro forma net income...................... $ 2,338,483 $ 2,179,881 $ 1,583,667 $ 791,662
----------- ----------- ------------ -----------
----------- ----------- ------------ -----------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-41
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED AND AFFILIATES
COMBINED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
TOTAL
COMMON ADDITIONAL RETAINED STOCKHOLDERS'
SHARES AMOUNT PAID-IN CAPITAL EARNINGS EQUITY
------ ------- --------------- ---------- -------------
<S> <C> <C> <C> <C> <C>
Balance, December 31, 1994 (unaudited)......... 300 $41,000 $ 490,000 $6,564,463 $ 7,095,463
Distributions to stockholders (unaudited).... (6,743,883) (6,743,883)
Net income (unaudited)....................... 6,931,607 6,931,607
------ ------- --------------- ---------- -------------
Balance, December 31, 1995 (unaudited)......... 300 41,000 490,000 6,752,187 7,283,187
Distributions to stockholders................ (4,105,000) (4,105,000)
Net income................................... 4,908,866 4,908,866
------ ------- --------------- ---------- -------------
Balance at December 31, 1996................... 300 41,000 490,000 7,556,053 8,087,053
Distributions to stockholders (unaudited).... (1,995,000) (1,995,000)
Net income (unaudited)....................... 3,771,747 3,771,747
------ ------- --------------- ---------- -------------
Balance, September 30, 1997 (unaudited)........ 300 $41,000 $ 490,000 $9,332,800 $ 9,863,800
------ ------- --------------- ---------- -------------
------ ------- --------------- ---------- -------------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-42
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1995 1994
----------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Cash flows from operating activities:
Net income...................................................... $ 4,908,866 $ 6,931,607 $ 8,244,650
Adjustments to reconcile net income to net cash (used in)
provided by operating activities:
Depreciation and amortization expense........................... 516,378 355,376 347,989
Changes in operating assets and liabilities:
Decrease (increase) in:
Accounts receivable........................................ 347,532 709,598 (720,684)
Real estate inventories............................... (15,450,699) (9,626,556) (1,294,219)
Prepaid and other assets.............................. 30,000 (7,808) (74,366)
Increase (decrease) in:
Accounts payable and accrued expenses................. 465,531 (879,924) (1,027,666)
Due to related parties................................ (74,980) (116,402) (110,114)
Customer deposits..................................... (204,532) (259,641) 186,100
----------- ----------- -----------
Net cash (used in) provided by operating
activities.......................................... (9,461,904) (2,893,750) 5,551,690
----------- ----------- -----------
Cash flows from investing activities:
Purchases of equipment and furniture............................ (802,465) (432,759) (1,275,864)
----------- ----------- -----------
Net cash used in investing activities...................... (802,465) (432,759) (1,275,864)
----------- ----------- -----------
Cash flows from financing activities:
Borrowings on notes payable..................................... 29,658,002 20,189,164 4,127,554
Repayments of notes payable..................................... (13,519,295) (12,812,333) (9,373,600)
Line of credit activity, net.................................... (2,926,123) 2,467,830 3,041,208
Advances from stockholders, net................................. 59,008 249,643 1,415,847
Distributions to stockholders................................... (4,105,000) (6,743,882) (3,465,000)
Contributions from stockholders................................. -- -- 530,000
----------- ----------- -----------
Net cash provided by (used in) financing activities........ 9,166,592 3,350,422 (3,723,991)
----------- ----------- -----------
Net (decrease) increase in cash and cash equivalents................. (1,097,777) 23,913 551,835
Cash and cash equivalents, beginning of period....................... 2,493,446 2,469,533 1,917,698
----------- ----------- -----------
Cash and cash equivalents, end of period............................. $ 1,395,669 $ 2,493,446 $ 2,469,533
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-43
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------
1997 1996
----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net income.................................................................... $ 3,771,747 $ 3,515,937
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization expense.................................... 430,656 337,840
Changes in operating assets and liabilities:
(Increase) decrease in:
Accounts receivable............................................ (534,684) 110,421
Real estate inventories........................................ 112,236 (17,899,352)
Prepaid and other assets....................................... (3,730) (91,305)
Increase in:
Accounts payable and accrued expenses.......................... 591,707 2,427,608
Due to related party........................................... 146,332 103,493
Customer deposits.............................................. 386,297 167,986
----------- -----------
Net cash provided by (used in) operating activities....... 4,900,561 (11,327,372)
----------- -----------
Cash flows from investing activities:
Purchases of equipment and furniture.......................................... (292,730) (530,703)
----------- -----------
Net cash used in investing activities..................... (292,730) (530,703)
----------- -----------
Cash flows from financing activities:
Borrowings on notes payable................................................... 10,186,709 23,885,410
Repayments of notes payable................................................... (11,839,959) (10,171,660)
Line of credit activity, net.................................................. 147,479 (1,884,027)
Advances from stockholders, net............................................... 673,273 2,194,282
Distributions to stockholders................................................. (1,995,000) (3,605,000)
----------- -----------
Net cash (used in) provided by financing activities....... (2,827,498) 10,419,005
----------- -----------
Net increase (decrease) in cash and cash equivalents............................... 1,780,333 (1,439,070)
Cash and cash equivalents, beginning of period..................................... 1,395,669 2,493,446
----------- -----------
Cash and cash equivalents, beginning of period..................................... $ 3,176,002 $ 1,054,376
----------- -----------
----------- -----------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-44
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
1. BUSINESS AND ORGANIZATION
The accompanying combined financial statements consist of the accounts of
Whittaker Construction, Inc. (WCI), combined with its affiliates, RRKTG Lumber,
Inc. (RKG), and Lewis and Clark Title Company (Lewis and Clark) (collectively,
referred to as 'Whittaker'). These entities are related through common ownership
and management; see Note 7 for additional discussion.
WCI is engaged primarily in the construction and sale of single and
multi-family residential property in St. Charles County, one of 11 counties
included in the St. Louis, Missouri metropolitan area. WCI develops land and
designs, builds, and sells single and multi-family houses on developed lots. RKG
supplies WCI with various building products including lumber, windows and
siding. Lewis and Clark facilitates the closing of WCI sales transactions,
including the sale of title insurance to home buyers.
On January 5, 1998, Whittaker's stockholders entered into a definitive
agreement with The Fortress Group, Inc. (Fortress) pursuant to which the Company
is intended to be acquired by Fortress on or about February 27, 1998. All
outstanding shares of Whittaker will be exchanged for cash.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of combination
The combined financial statements include the accounts of the entities
described in Note 1. All significant intercompany accounts and transactions have
been eliminated in combination.
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.
Fair value of financial instruments
The carrying amounts of cash, accounts receivable, accounts payable and
accrued expenses approximate fair value because of the short maturity of these
items. The carrying amount of the debt issued pursuant to the Whittaker's bank
credit agreements and stockholder advances approximates fair value because the
interest rates change with market interest rates. These fair value estimates are
subjective in nature and involve uncertainties and matters of significant
judgment and therefore, cannot be determined with precision. Changes in
assumptions could significantly affect these estimates.
Revenue recognition
Revenues from residential sales are recognized when all conditions
precedent to closing have been fulfilled and title has passed to the buyer. A
contract for sale of a home is generally entered into in advance of construction
of the home. Whittaker's standard sales contract generally requires the customer
to make an earnest money deposit which is recognized as a liability until
closing.
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 discounting of expected future cash flows of each of
Whittaker's real estate developments. Costs incurred
F-45
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
which are included in inventory consist of land, land development, direct and
certain indirect construction costs, interest and real estate taxes, and 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, plus an allocation of the total estimated cost of land and
land development, interest, real estate taxes and any other capitalizable common
costs. Work-in-progress includes the direct home construction costs and an
allocation of certain indirect costs.
Building products inventories
Lumber, siding, windows and other building products are maintained in
inventory at cost and on a first-in first-out (FIFO) basis. Cost has been
adjusted for slow-moving and obsolete inventories.
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 based on Whittaker's outstanding borrowings associated with the acquisition,
development and construction of the qualified real estate inventory
Property and equipment
Property and equipment is carried at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets which range from three to thirty-nine years.
Significant additions and improvements are capitalized while expenditures for
repairs and maintenance are charged to operations as incurred.
Income taxes
WCI, RKG, and Lewis and Clark have elected to be treated as Subchapter S
corporations under the Internal Revenue Code. Accordingly, any income tax
liabilities are the responsibility of the stockholders of each of the affiliated
companies.
The unaudited pro forma income tax information is presented in accordance
with Statement of Financial Accounting Standards No. 109, 'Accounting for Income
Taxes,' as if Whittaker had been comprised of Subchapter C corporations subject
to Federal and state income taxes for the periods presented.
Cash and equivalents
For purposes of reporting cash flows, Whittaker considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents. Included in cash equivalents are restricted amounts relating to
development projects and self-insured workers compensation. At September 30,
1997, December 31, 1996, 1995 and 1994, restricted balances amounted to
$587,145, $726,622, $821,791 and $196,403, respectively.
F-46
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Supplemental disclosure of cash flow information for the nine months ended
September 30, 1997 and 1996 and the years ended December 31, 1996, 1995 and 1994
is as follows:
<TABLE>
<CAPTION>
CASH PAID
FOR INTEREST
------------
<S> <C>
Nine months ended September 30, 1997 (unaudited)...................... $ 2,676,963
Nine months ended September 30, 1996 (unaudited)...................... 2,164,853
Year ended December 31, 1996.......................................... 3,057,384
Year ended December 31, 1995 (unaudited).............................. 2,187,641
Year ended December 31, 1994 (unaudited).............................. 1,578,514
</TABLE>
3. REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, --------------------------
1997 1996 1995
------------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Work-in-progress:
Homes under construction and models....................... $ 13,898,594 $14,824,644 $11,698,560
Land:
Finished lots........................................... 25,937,919 25,598,696 16,122,613
Land under development.................................. 4,742,519 2,358,172 4,822,295
Land held for development............................... 4,229,546 6,325,675 945,022
------------ ----------- -----------
Total..................................................... $ 48,808,578 $49,107,187 $33,588,490
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
4. INTEREST
Interest incurred and capitalized is summarized below:
<TABLE>
<CAPTION>
INCURRED CAPITALIZED
---------- -----------
<S> <C> <C>
Nine months ended September 30, 1997 (unaudited)............................ $2,656,843 $ 1,852,775
Nine months ended September 30, 1996 (unaudited)............................ 2,223,292 1,570,920
Year ended December 31, 1996................................................ 3,117,917 2,226,707
Year ended December 31, 1995 (unaudited).................................... 2,241,608 1,730,102
Year ended December 31, 1994 (unaudited).................................... 1,587,649 1,139,094
</TABLE>
F-47
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
5. PROPERTY AND EQUIPMENT
Property and equipment consisted of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, --------------------------
1997 1996 1995
------------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Land....................................................... $ 29,500 $ 29,500 $ 29,500
Equipment and furniture.................................... 3,061,718 2,938,024 2,314,311
Motor vehicles............................................. 1,369,324 1,200,287 1,057,387
Buildings.................................................. 602,534 602,534 598,550
------------ ----------- -----------
5,063,076 4,770,345 3,999,748
Less: Accumulated depreciation............................. (2,554,362) (2,123,706) (1,639,195)
------------ ----------- -----------
Total...................................................... $ 2,508,714 $ 2,646,639 $ 2,360,553
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
6. NOTES PAYABLE
Notes payable are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, ----------------------------
1997 1996 1995
------------- ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Project-specific construction loans..................... $ 5,553,738 $ 6,168,802 $ 6,344,888
Land acquisition and development loans.................. 29,319,656 30,730,884 16,527,073
Equipment loans......................................... 289,167 385,793 385,535
Lumber inventory and receivables........................ 1,511,795 894,648 1,710,047
------------- ------------ ------------
Total................................................... $ 36,674,356 $ 38,180,127 $ 24,967,543
------------- ------------ ------------
------------- ------------ ------------
</TABLE>
These loans are primarily from financial institutions and bear interest at
annual rates ranging from prime to prime plus 25 basis points(the prime rate was
8.5% at September 30, 1997 and December 31, 1996) and at fixed rates ranging
from 8 to 8.25%. Principal payments are normally made at the time of the sales
of the related real estate properties and interest is paid monthly. The loan
agreements include customary representations and restrictive covenants,
including limitations on the maximum principal amount that can be outstanding at
any time. Substantially all inventories are pledged as collateral for these
loans, and substantially all of these loans are personally guaranteed by the
stockholders.
At September 30, 1997 (unaudited) and December 31, 1996, Whittaker has
combined lines of credit available for borrowings up to approximately $8,500,000
and $7,000,000, respectively, with four financial institutions. Approximately
$2,893,133 and $2,734,955 was outstanding at September 30, 1997 (unaudited) and
December 31, 1996, respectively. These lines expire at various dates through
1998 and, in most cases, must be renewed annually.
At December 31, 1996, future maturities of notes payable were as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1997....................................................... $ 4,784,191
1998....................................................... 30,251,063
1999....................................................... 14,000
2000....................................................... 3,014,000
2001 and after............................................. 116,873
-----------
$38,180,127
-----------
-----------
</TABLE>
F-48
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
6. NOTES PAYABLE--(CONTINUED)
See Note 8 for additional information on borrowings from Whittaker's
stockholders.
7. STOCKHOLDERS' EQUITY
Authorized and outstanding common shares of the companies making up
Whittaker is as follows at each of the three years ended December 31, 1996 and
at September 30, 1997 (unaudited):
<TABLE>
<CAPTION>
SHARES SHARES PAR
COMPANY AUTHORIZED OUTSTANDING VALUE
- ------- ---------- ----------- -------
<S> <C> <C> <C>
Whittaker Construction, Inc........................................ 30,000 100 $ 1,000
RRKTG Lumber, Inc.................................................. 30,000 100 10,000
Lewis and Clark Title Company, Inc................................. 30,000 100 30,000
---------- --- -------
90,000 300 $41,000
---------- --- -------
---------- --- -------
</TABLE>
While shares outstanding are owned by six stockholders, voting rights have
been assigned to a voting trust for which one stockholder is trustee.
8. RELATED PARTY TRANSACTIONS
Whittaker is a group of affiliated companies and has transactions and
relationships with its stockholders and affiliates. Because of these
relationships, it is possible that the terms of those transactions are not the
same as those that would result from transactions with wholly unrelated parties.
Advances from stockholders represent borrowings to fund home construction
costs. These advances bear interest at 9%. Interest and principal payments are
made at the time of sale of the related real estate properties. A commitment fee
of 1% of the loan availability ($56,000 for 1996) is paid to the stockholders
annually. Total interest incurred and paid on these advances is as follows:
<TABLE>
<CAPTION>
INTEREST INTEREST
INCURRED PAID
-------- --------
<S> <C> <C>
Nine months ended September 30, 1997 (unaudited)................................ $231,000 $240,602
Year ended December 31, 1996.................................................... 410,545 401,185
Year ended December 31, 1995 (unaudited)........................................ 283,878 269,879
Year ended December 31, 1994 (unaudited)........................................ 173,549 159,585
</TABLE>
WCI leases office space from a stockholder of Whittaker on a month-to-month
basis. Total lease costs are as follows:
<TABLE>
<CAPTION>
LEASE COSTS
-----------
<S> <C>
Nine months ended September 30, 1997................................... $58,950
Year ended December 31, 1996........................................... 64,650
Year ended December 31, 1995........................................... 60,000
Year ended December 31, 1994........................................... 53,280
</TABLE>
Whittaker provided construction services to stockholders which were repaid
at 100% of cost. The cost of such services provided were reimbursed throughout
the construction period and repaid in total and, accordingly, are not included
in the accompanying statements of operations. Such services amounted to
$289,317, $1,779,915, $993,144 and $412,230 for the nine months ended September
30, 1997 and the years ended December 31, 1996, 1995 and 1994, respectively.
Whittaker provides construction services to certain entities owned by
stockholders of Whittaker. Whittaker is reimbursed for direct costs plus 10
percent for indirect costs. Gross profit recognized in the statements of
F-49
<PAGE>
WHITTAKER CONSTRUCTION, INCORPORATED
AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
8. RELATED PARTY TRANSACTIONS--(CONTINUED)
operations as of September 30, 1997, December 31, 1996 and 1995 for these
services was $2,766, $6,372 and $280,284, respectively.
During May 1997, Whittaker sold 70.2 acres of land to a related entity at a
selling price of $256,000. A gain on this transaction of $192,000 has been
recorded in the accompanying statement of operations for the nine months ended
September 30, 1997.
Whittaker has included a country club membership to Whitmoor Country Club
(WMCC), an affiliated entity, in certain home sale contracts. Whittaker pays
WMCC a fee per membership. The membership is transferred to the homeowner, and
the homeowner assumes responsibility for all club charges and dues. Payments to
WMCC for memberships totaled $20,300, $85,000, $180,000 and $99,250 for the nine
months ended September 30, 1997 and the years ended December 31, 1996, 1995 and
1994, respectively.
9. EMPLOYEE BENEFIT PLANS
Whittaker maintains a profit sharing plan (the 'Plan') for all eligible
employees. Non-union employees become eligible to participate after one year of
service and enter the plan June 1 or January 1 following the first full year of
service. Participants become 20% vested after one year as a plan participant and
are fully vested after five years as a plan participant. Annual contributions
are made at the discretion of Whittaker's stockholders and directors but cannot
exceed 15% of qualifying salaries; employees are not allowed to contribute to
the plan. Whittaker's contribution to the profit sharing plan amounted to
$122,188, $191,451 and $181,981 for the years ended December 31, 1996, 1995 and
1994, respectively.
Whittaker formed a qualified, defined-contribution, money purchase pension
plan in 1995. Each year Whittaker funds a required contribution of 5% of
qualifying salaries for eligible employees. Qualification for the money purchase
plan is the same as for the profit sharing plan. All plan contributions are made
by Whittaker. Whittaker contributed $97,045 and $98,658 for the years ended
December 31, 1996 and 1995, respectively.
The income statement for the nine months ended September 30, 1997 includes
an accrual of $157,782 for the combined profit sharing plan and money purchase
plan 1997 contributions.
10. COMMITMENTS AND CONTINGENCIES
Whittaker operates within an area that represents a geographic
concentration of risk within St. Charles County, Missouri. Whittaker's ability
to make future sales and recover its costs included in real estate (primarily
land) inventories is dependent upon the economic conditions within these areas.
In management's opinion, this concentration represents a normal business risk.
Whittaker is involved in various legal proceedings incidental to the
conduct of its normal business operations. Whittaker's management believes that
none of these legal proceedings will have a material adverse impact on the
financial condition or results of operations of Whittaker.
As of December 31, 1996, Whittaker had entered into a contingent contract
to purchase undeveloped land from an unrelated party for $695,000. The purchase
was completed in April 1997.
F-50
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholder and Members of
Don Galloway Homes, Inc. and Affiliates
In our opinion, the accompanying combined balance sheet and the related
combined statements of operations, of changes in stockholder's and members'
equity and of cash flows present fairly, in all material respects, the financial
position of Don Galloway Homes, Inc. and Affiliates at December 31, 1996, and
the results of their operations and their cash flows for the year, in conformity
with generally accepted accounting principles. These financial statements are
the responsibility of the Company's management; our responsibility is to express
an opinion on these financial statements based on our audit. We conducted our
audit 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 believe that our
audit provides a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Charlotte, North Carolina
October 10, 1997
F-51
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30, JUNE 30,
1996 1997 1996
------------ ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents........................................... $ 1,897,431 $ 1,503,946 $ 1,011,122
Accounts receivable................................................. 457,669 1,497,698 34,452
Due from related party.............................................. 112,812 -- 206,818
Real estate inventories............................................. 20,345,162 22,504,722 20,101,301
Prepaid assets...................................................... 27,149 21,012 38,659
Equipment and furniture, net of accumulated depreciation of
$225,801, $198,011 and $223,252, respectively..................... 108,940 222,533 75,770
Other assets........................................................ 457,996 745,578 436,475
------------ ----------- -----------
$ 23,407,159 $26,495,489 $21,904,597
------------ ----------- -----------
LIABILITIES AND STOCKHOLDER'S AND MEMBERS' EQUITY
Accounts payable and accrued construction liabilities............... $ 3,449,074 $ 3,326,940 $ 2,557,434
Notes payable....................................................... 13,406,064 16,908,904 15,117,705
Customer deposits................................................... 607,735 631,813 548,309
Other accrued expenses.............................................. 474,773 351,037 377,036
------------ ----------- -----------
Total liabilities......................................... 17,937,646 21,218,694 18,600,484
------------ ----------- -----------
Commitments and contingencies (Note 9)
Stockholder's and members' equity:
Common stock................................................... 21,807 23,807 21,807
Paid-in capital................................................ 4,500 2,500 4,500
Retained earnings.............................................. 5,443,206 5,250,488 3,277,806
------------ ----------- -----------
Total stockholder's and members' equity................... 5,469,513 5,276,795 3,304,113
------------ ----------- -----------
$ 23,407,159 $26,495,489 $21,904,597
------------ ----------- -----------
------------ ----------- -----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-52
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED FOR THE SIX FOR THE SIX
DECEMBER 31, MONTHS ENDED MONTHS ENDED
1996 JUNE 30, 1997 JUNE 30, 1996
------------ ------------- ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Sales.............................................................. $ 57,123,396 $33,917,201 $25,804,154
Cost of sales...................................................... 46,205,095 26,322,598 21,029,441
------------ ------------ ------------
Gross profit....................................................... 10,918,301 7,594,603 4,774,713
Operating expense:
General and administrative expenses.............................. 2,059,347 1,269,767 1,034,344
Marketing and selling expenses................................... 3,460,950 1,876,673 1,587,924
------------ ------------ ------------
Total operating expense....................................... 5,520,297 3,146,440 2,622,268
Other income/(expense):
Interest income/(expense)........................................ (553,213) (221,555) (293,497)
Other income/(expense)........................................... 153,752 105,674 24,318
------------ ------------ ------------
Total other income/(expense).................................. (399,461) (115,881) (269,179)
------------ ------------ ------------
------------ ------------ ------------
Net income......................................................... $ 4,998,543 $ 4,332,282 $ 1,883,266
------------ ------------ ------------
------------ ------------ ------------
Unaudited pro forma provision for income taxes (Note 2)............ (1,899,446) (1,646,267) (715,641)
------------ ------------ ------------
Unaudited pro forma net income..................................... $ 3,099,097 $ 2,686,015 $ 1,167,625
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-53
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
COMBINED STATEMENTS OF CHANGES IN STOCKHOLDER'S AND MEMBERS' EQUITY
<TABLE>
<CAPTION>
COMMON PAID-IN RETAINED
STOCK CAPITAL EARNINGS TOTAL
------- ------- ----------- ----------
<S> <C> <C> <C> <C>
Balance, December 31, 1995...................................... $21,807 $ 3,500 $ 2,945,411 $2,970,718
Contributions of capital........................................ 1,000 -- 1,000
Distributions to stockholder/members............................ -- -- (2,500,748) (2,500,748)
Net income...................................................... -- -- 4,998,543 4,998,543
------- ------- ----------- ----------
Balance, December 31, 1996...................................... 21,807 4,500 5,443,206 5,469,513
(Unaudited)
Distributions to stockholder/members............................ -- -- (4,525,000) (4,525,000)
Transfer of paid-in capital of Don Galloway Homes of North
Carolina, LLC and Don Galloway Homes of South Carolina, LLC to
members....................................................... -- (2,000) -- (2,000)
Issuance of 1,000 shares of Common Stock, $1.00 par and value,
of Don Galloway Homes of North Carolina, Inc. and Don Galloway
Homes of South Carolina, Inc., respectively................... 2,000 -- -- 2,000
Net income...................................................... -- -- 4,332,282 4,332,282
------- ------- ----------- ----------
Balance, June 30, 1997.......................................... $23,807 $ 2,500 $ 5,250,488 $5,276,795
------- ------- ----------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-54
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED FOR THE SIX FOR THE SIX
DECEMBER 31, MONTHS ENDED MONTHS ENDED
1996 JUNE 30, 1997 JUNE 30, 1996
------------ ------------- -------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Cash flows from operating activities
Net income...................................................... $ 4,998,543 $ 4,332,282 $ 1,883,265
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization expense........................ 33,215 24,938 16,180
Gain on sale of equipment and furniture...................... (9,133) (5,877) (9,240)
Changes in operating assets and liabilities:
Decrease (increase) in:
Due from related party.................................. 38,376 112,812 (55,630)
Accounts receivable..................................... (452,746) (1,040,029) (29,529)
Real estate inventories................................. (825,543) (2,159,559) (581,682)
Prepaid and other assets................................ (126,769) (281,445) (116,757)
Increase (decrease) in:
Accounts payable and accrued construction
liabilities........................................... 1,585,024 (122,134) 693,384
Other accrued expenses.................................. 98,254 (123,736) 517
Customer deposits....................................... 237,719 24,078 178,293
------------ ------------ ------------
Net cash provided by operating activities............... 5,576,940 761,330 1,978,801
------------ ------------ ------------
Cash flows from investing activities
Proceeds from sale of equipment and furniture................... 11,585 10,500 11,585
Purchases of equipment and furniture............................ (63,779) (143,155) (6,156)
------------ ------------ ------------
Net cash used in investing activities................... (52,194) (132,655) 5,429
------------ ------------ ------------
Cash flows from financing activities
Borrowings under notes payable.................................. 37,902,393 25,957,030 17,184,385
Repayments of notes payable..................................... (39,540,292) (22,454,190) (17,268,077)
Distributions to shareholder/members............................ (2,400,000) (4,525,000) (1,300,000)
------------ ------------ ------------
Net cash used in financing activities................... (4,037,899) (1,022,160) (1,383,692)
------------ ------------ ------------
Increase (decrease) in cash and cash equivalents................ 1,486,847 (393,485) 600,538
Cash and cash equivalents, beginning of year.................... 410,584 1,897,431 410,584
------------ ------------ ------------
Cash and cash equivalents, end of year.......................... $ 1,897,431 $ 1,503,946 $ 1,011,122
------------ ------------ ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-55
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
1. BUSINESS AND ORGANIZATION
General
The accompanying combined financial statements consist of the accounts of
Don Galloway Homes, Inc. combined with those of Don Galloway Homes of North
Carolina, Inc. (formerly Don Galloway Homes of North Carolina, LLC), Don
Galloway Homes of South Carolina, Inc. (formerly Don Galloway Homes of South
Carolina, LLC), Don Galloway Land, LLC and Thornblade, LLC (collectively
referred to as the 'Company'). These entities are related through common
ownership and management. See Note 2 for additional discussion.
The Company is engaged primarily in the construction and sale of
single-family residential property in North Carolina and South Carolina. The
Company designs, builds, and sells single-family houses on finished lots, which
it purchases ready for home construction or which it develops. The Company also
purchases undeveloped land to develop finished lots for future construction of
single-family houses.
Effective August 1, 1997, the Company and its stockholder entered into a
definitive agreement with The Fortress Group, Inc. ('Fortress') pursuant to
which the Company was acquired by Fortress (the 'Acquisition'). All outstanding
shares of the Company were exchanged for cash and shares of Fortress' Preferred
stock.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Combination
The combined financial statements include the accounts of the entities
described in Note 1. Don Galloway Homes, Inc. is owned by a sole stockholder
(the 'Stockholder'). Don Galloway Homes of North Carolina, Inc., Don Galloway
Homes of South Carolina, Inc. are 100% owned by Don Galloway Homes, Inc.
Thornblade, LLC is 99% owned by the Stockholder. Don Galloway Land, LLC is 99%
owned by Galloway Limited Partnership, which is owned by outside parties,
including the Stockholder. All significant intercompany accounts and
transactions have been eliminated in combination.
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
Revenues from residential 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 closing.
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 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
F-56
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
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.
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 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. Interest incurred and capitalized during the year was $1,526 and
$879, respectively (in thousands).
Equipment and Furniture
Equipment and furniture are carried at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets which range from five to eight years. Significant
additions and improvements are capitalized, while expenditures for repairs and
maintenance are charged to operations as incurred.
Other Assets
Other assets include deposits paid on options to purchase developed lots of
approximately $453,000 as discussed in Note 9.
Income Taxes
As of December 31, 1996, Don Galloway Homes, Inc. was a Subchapter S
corporation and the remaining affiliates, as discussed in Note 1, were limited
liability corporations ('LLC') for income tax purposes. Accordingly, any income
tax liabilities are the responsibility of the Company's Stockholder and members.
In connection with a change in tax laws, Don Galloway Homes of North Carolina,
LLC and Don Galloway Homes of South Carolina, LLC were liquidated effective
January 1, 1997. All of the assets and liabilities of the entities were
transferred to their members, who concurrently contributed the assets into two
new Subchapter S Corporations, wholly-owned by Don Galloway Homes, Inc. The
entities' Subchapter S corporation and LLC status terminated on consummation of
the Merger as disclosed in Note 1.
The unaudited pro forma income tax information is presented in accordance
with Statement of Financial Accounting Standards No. 109, 'Accounting for Income
Taxes,' as if the companies had been Subchapter C corporations subject to
Federal and state income taxes for the periods presented.
Cash and 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):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
-----------------
<S> <C>
Cash paid for interest........................................... $ 1,542
</TABLE>
F-57
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
3. REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------
<S> <C>
Work-in-progress:
Speculative homes.............................................. $ 5,493
Sold homes under construction.................................. 8,632
-------
14,125
Land:
Finished lots.................................................. 2,499
Land under development......................................... 2,006
-------
4,505
Models........................................................... 1,715
-------
$20,345
-------
-------
</TABLE>
Speculative homes and models include completed homes and homes under
construction. Speculative construction represents homes which are not subject to
a sales contract. Completed homes and work-in-progress include the allocation of
land and development and other allocable costs.
4. EQUIPMENT AND FURNITURE
During March 1996, the Company transferred its office building, in the form
of non-cash distribution with a net book value of $400,748, to an affiliated
entity controlled by the Stockholder.
At December 31, 1996, furniture and equipment consisted of the following
(in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------
<S> <C>
Motor vehicles................................................... $ 110
Equipment and furniture.......................................... 225
-----
335
Less: Accumulated depreciation................................... (226)
-----
$ 109
-----
-----
</TABLE>
5. NOTES PAYABLE
Notes payable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------
<S> <C>
Project specific construction loans.............................. $12,083
Conventional land acquisition and development loans.............. 1,323
-------
$13,406
-------
-------
</TABLE>
Project specific construction loans consist of land and construction loans
primarily from financial institutions. These loans bear interest at annual rates
ranging from 1/2% to 1% over prime (the prime rate was 8.5% at December 31,
1996). Principal payments are normally made at the time the sales of the related
real estate properties are closed, whereas interest is paid monthly. The loan
agreements include customary representations and covenants, including
limitations on the maximum principal amount that can be outstanding at any time.
Substantially all inventories are pledged as collateral for these loans, and
substantially all of these loans are personally guaranteed by the Stockholder.
F-58
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
5. NOTES PAYABLE--(CONTINUED)
At December 31, 1996, the Company has combined lines of credit available
for borrowings up to approximately $30,750,000 with five financial institutions,
of which approximately $7,879,000 was outstanding. The Company also has a
facility with another lender for pre-approved borrowings of approximately
$19,000,000, of which approximately $4,204,000 was outstanding at December 31,
1996. These lines expire at various dates through December 1997 and, in most
cases, must be renewed annually.
At December 31, 1996, the Company also has combined land acquisition and
development loans for borrowings of up to approximately $2,968,000 with two
financial institutions and two individuals, of which approximately $1,323,000
was outstanding. These loans expire at various dates through June 1999.
Maturities of notes payable at December 31, 1996 in future periods are as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1997........................................................... $13,147
1998........................................................... 161
1999........................................................... 98
-------
$13,406
-------
-------
</TABLE>
6. STOCKHOLDER'S EQUITY
At December 31, 1996, Don Galloway Homes, Inc. had 100,000 shares of common
stock authorized at $1.00 par value, of which 21,807 were issued and
outstanding. Also at December 31, 1996, Don Galloway Homes of North Carolina,
LLC and Don Galloway Homes of South Carolina, LLC, each had contributed capital
of $1,000, while Don Galloway Homes, Inc. had paid-in capital of $500. Effective
January 1, 1997, all of the assets of Don Galloway Homes of North Carolina, LLC
and Don Galloway Homes of South Carolina, LLC were transferred to their members,
who concurrently contributed the assets into two new Subchapter S Corporations
wholly-owned by Don Galloway, Homes, Inc. At June 30, 1997, Don Galloway Homes
of North Carolina, Inc. and Don Galloway Homes of South Carolina, Inc. each had
1,000 shares of $1.00 par value common stock authorized, issued and outstanding.
At December 31, 1996 and at June 30, 1997, Don Galloway Land, LLC and
Thornblade, LLC each had contributed capital of $1,000.
7. RELATED PARTY TRANSACTIONS
As discussed in Note 4, the Company transferred its office building to the
Stockholder in March 1996 and began making monthly lease payments in April 1996
of $9,900 in accordance with a lease agreement entered between the parties,
which expires March 31, 2001. Estimated future minimum lease payments under this
lease are as follows for fiscal years ending December 31:
<TABLE>
<S> <C>
1997.......................................................... $ 118,800
1998.......................................................... 118,800
1999.......................................................... 118,800
2000.......................................................... 118,800
2001.......................................................... 29,700
---------
$ 504,900
---------
---------
</TABLE>
The accompanying financial statements include certain amounts due from
Galloway Land, Inc., an entity affiliated through common ownership. Amounts
outstanding at December 31, 1996 were approximately $112,800, which primarily
represents amounts paid on behalf of Galloway Land, Inc. by the Company. These
amounts were repaid in early 1997.
F-59
<PAGE>
DON GALLOWAY HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
8. EMPLOYEE BENEFIT PLANS
The Company maintains a profit sharing plan (the 'Plan') for all eligible
employees. Employees become eligible to participate after one year of service.
Participants become 20% vested in the Plan after two years of service and are
fully vested after six years. Annual contributions are made at the discretion of
the Board of Directors. The Company made no contributions to the Plan in 1996.
The Company also has a 401(k) plan which became effective in July 1993. The
Company matches a percentage of participant contributions based on years of
service of each participant. The Company contributed approximately $15,000 to
the 401(k) plan in 1996.
9. COMMITMENTS AND CONTINGENCIES
As of December 31, 1996, the Company had various options and commitments to
purchase approximately 1,000 developed lots for approximately $23,275,000 during
1997 and beyond. Failure to meet these commitments and option dates could result
in forfeitures of deposits and option fees of up to approximately $453,000 and
possible voiding of the contracts with the sellers for future purchases at the
specified contract prices. Under certain agreements, sellers may force the
purchase of all lots under contract.
The Company operates within an area that represents a geographic
concentration of risk within the states of North Carolina and South Carolina.
The Company's ability to make future sales and recover its costs included in
development inventories is dependent upon the economic conditions within these
areas. In management's opinion, this concentration represents a normal business
risk.
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-60
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders
of D.W. Hutson Construction, Inc.
In our opinion, the accompanying balance sheets and the related statements
of income, of changes in shareholders' equity and of cash flows present fairly,
in all material respects, the financial position of D.W. Hutson Construction,
Inc. at December 31, 1996 and 1995, and the results of its operations and its
cash flows for the years then ended in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our 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. 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 believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Fort Lauderdale, Florida
April 24, 1997
F-61
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
BALANCE SHEETS
(IN THOUSANDS EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1995
------- -------
<S> <C> <C>
ASSETS
Cash and cash equivalents................................................................... $ 1,251 $ 688
Restricted cash............................................................................. 546 761
Related party receivables................................................................... 6,055 3,797
Other receivables........................................................................... 10 83
Real estate inventories..................................................................... 14,652 13,997
Equipment and furniture, net of accumulated depreciation of $562 and $467, respectively..... 571 573
Deposits on land with related parties....................................................... 1,612 2,456
Prepaid expenses and other assets........................................................... 186 209
------- -------
Total assets...................................................................... $24,883 $22,564
------- -------
------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities....................................... $ 2,422 $ 2,509
Notes payable............................................................................... 8,486 10,389
Accrued expenses............................................................................ 287 169
Customer deposits........................................................................... 628 620
------- -------
Total liabilities................................................................. 11,823 13,687
Commitments and contingencies (Note 6)...................................................... -- --
Shareholders' equity:
Common stock, $1 par value, 25,000 shares authorized, issued and outstanding........... 25 25
Retained earnings...................................................................... 13,035 8,852
------- -------
Total shareholders' equity........................................................ 13,060 8,877
------- -------
Total liabilities and shareholders' equity........................................ $24,883 $22,564
------- -------
------- -------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-62
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
STATEMENTS OF INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1996 1995
------- -------
<S> <C> <C>
Revenue:
Residential sales...................................................................... $79,471 $60,531
Lot sales.............................................................................. 100 --
------- -------
Total revenue..................................................................... 79,571 60,531
Cost of sales............................................................................... 65,721 51,407
------- -------
Gross profit................................................................................ 13,850 9,124
Operating expenses
Selling expenses....................................................................... 4,644 3,160
General and administrative expenses.................................................... 1,431 2,213
------- -------
Total operating expenses.......................................................... 6,075 5,373
------- -------
Net operating income................................................................... 7,775 3,751
Other expense (income)
Interest............................................................................... 225 274
Other.................................................................................. (104) (127)
------- -------
Total other expense............................................................... 121 147
------- -------
Net income.................................................................................. $ 7,654 $ 3,604
------- -------
------- -------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-63
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON TOTAL
AMOUNT RETAINED SHAREHOLDERS'
STOCK EARNINGS EQUITY
------ -------- -------------
<S> <C> <C> <C>
Balance, December 31, 1994................................................... $ 25 $ 9,444 $ 9,469
Distributions.............................................................. -- (4,196) (4,196)
Net income................................................................. -- 3,604 3,604
----- -------- -------
Balance, December 31, 1995................................................... 25 8,852 8,877
Distributions.............................................................. -- (3,471) (3,471)
Net income................................................................. -- 7,654 7,654
----- -------- -------
Balance, December 31, 1996................................................... $ 25 $ 13,035 $13,060
----- -------- -------
----- -------- -------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-64
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------------
1996 1995
------- -------
<S> <C> <C>
Cash flows from operating activities
Net income............................................................................. $ 7,654 $ 3,604
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense................................................................. 113 107
Changes in operating assets and liabilities:
Loss on sale of equipment and furniture.............................................. 47 --
Decrease (increase) in:
Restricted cash................................................................. 215 (402)
Related party receivables....................................................... (2,258) 4,627
Other receivables............................................................... 73 (62)
Real estate inventories:
Additions to real estate inventories......................................... (65,445) (54,294)
Capitalized interest......................................................... (931) (954)
Cost of sales................................................................ 65,721 51,407
Deposit on land with related parties............................................ 844 (2,456)
Prepaid expenses and other assets............................................... 23 37
Increase (decrease) in:
Accounts payable and accrued construction liabilities........................... (87) 232
Accrued expenses................................................................ 118 (282)
Customer deposits............................................................... 8 220
------- -------
Net cash provided by operating activities......................................... 6,095 1,784
------- -------
Cash flows from investing activities
Purchases of equipment and furniture................................................... (277) (128)
Proceeds from sale of equipment and furniture.......................................... 119 18
------- -------
Net cash used in investing activities............................................. (158) (110)
------- -------
Cash flows from financing activities (Repayments) borrowings under notes payable,
net....................................................................................... (1,903) 2,141
Distributions to shareholders.......................................................... (3,471) (4,196)
------- -------
Net cash used in financing activities............................................. (5,374) (2,055)
------- -------
Increase (decrease) in cash and cash equivalents............................................ 563 (381)
Cash and cash equivalents, beginning of year................................................ 688 1,069
------- -------
Cash and cash equivalents, end of year...................................................... $ 1,251 $ 688
------- -------
------- -------
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
F-65
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
NOTES TO FINANCIAL STATEMENTS
1. BUSINESS AND ORGANIZATION
General
D.W. Hutson Construction, Inc. (the 'Company') is engaged primarily in the
construction and sale of single-family residential housing units in northeastern
Florida. The Company designs, builds and sells single-family houses on finished
lots, which it purchases ready for home construction or which it develops.
During 1996, the Company and its shareholders entered into negotiations
with Fortress--Florida, Inc. (qualified to do business in Florida as
Fortress--Jax Florida, Inc.) a wholly owned subsidiary of The Fortress Group,
Inc. ('Fortress') pursuant to which certain assets of the Company were purchased
and related liabilities were assumed by Fortress subsequent to December 31,
1996. (See Note 7)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Estimates by Management
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. The Company is a member of a
group of commonly owned Companies and, as disclosed in Note 5, has significant
transactions and relationships with members of the group. Management believes
values of these transactions approximates fair value.
Cash and Cash Equivalents
For purposes of reporting cash flows, the Company considers all highly
liquid investments with an original purchased maturity of three months or less
to be cash equivalents.
Supplemental disclosures of cash flow information are as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
------------
1996 1995
---- ----
<S> <C> <C>
Cash paid for interest, excluding amounts capitalized:
Lines of credit with third parties...................... $205 $217
Related parties......................................... 20 57
</TABLE>
Restricted Cash
Restricted cash consists principally of escrow accounts representing
customer deposits restricted as to use.
Revenue Recognition
Revenues from residential 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 contracted for 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 customer deposit liability until
the unit 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
F-66
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
the 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 model construction costs and related improvements.
Cost of sales includes construction, land and land development costs
incurred, interest, real estate taxes and other capitalizable common costs.
Interest charged to cost of sales totaled $999,642 and $806,991 in 1996 and
1995, respectively, resulting primarily from loans from financial institutions.
General and administrative expenses of $150,241 and $157,000 were capitalized to
real estate inventories respectively, as of December 31, 1995 and 1996.
Interest Capitalization
Interest and related amortization of debt issuance costs are capitalized to
qualifying real estate inventories, and are relieved from inventory to cost of
sales as revenue from residential sales is recognized. Interest and related
amortization of debt issuance costs are capitalized under the specific
identification method to individual qualifying real estate inventory. The
capitalization rate is based on the Company's outstanding borrowings for
acquisition, development and construction of the qualified real estate
inventory.
Equipment and Furniture
Equipment and furniture are carried at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets which range from 5 to 39 years. Significant additions
and improvements are capitalized, while expenditures for repairs and maintenance
are charged to operations as incurred.
Prepaid Expenses and Other Assets
Prepaid expenses and other assets include debt issue costs, other deposits
and prepaid expenses.
Deposits on Land
Deposits on land include deposits held by a related party for future
acquisitions of finished lots ready for home construction.
Concentrations of Credit Risk
The Company's operations are concentrated in the construction and sale of
single-family residential property in northeastern Florida. Furthermore, the
Company from time to time maintains cash balances at certain financial
institutions in excess of Federally insured limits.
Income Taxes
The Company is a Subchapter S corporation for income tax purposes and,
accordingly, any income tax liabilities are the responsibility of the Company's
shareholders. The Company's Subchapter S corporation status will terminate on
the acquisition by Fortress as disclosed in Note 1. See Note 8 for information
regarding the pro forma income tax disclosures.
F-67
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
3. REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1996 1995
------- -------
<S> <C> <C>
Work-in-progress:
Sold homes under construction............................................................. $ 8,063 $ 9,628
Speculative homes......................................................................... 2,325 2,109
------- -------
10,388 11,737
------- -------
Land:
Finished lots............................................................................. 2,359 1,805
Land under development.................................................................... 1,076 --
------- -------
3,435 1,805
Models: 829 455
------- -------
$14,652 $13,997
------- -------
------- -------
</TABLE>
Speculative homes and models include completed homes and homes under
construction. Speculative construction represents homes built without an advance
sales contract in order to accelerate closing. Completed homes include land,
development, and other allocable costs.
4. NOTES PAYABLE
Notes payable at December 31 are summarized as follows (in thousands):
<TABLE>
<CAPTION>
1996 1995
------ -------
<S> <C> <C>
Construction notes payable
$11,000 Line of Credit....................................... $3,785 $ 4,000
$6,000 Line of Credit........................................ 2,013 2,869
$4,000 Line of Credit........................................ 2,406 3,172
$3,000 Line of Credit........................................ 101 215
Other notes payable to related parties......................... 181 133
------ -------
$8,486 $10,389
------ -------
------ -------
</TABLE>
Construction loans consist of four lines of credit with commercial banks
for the purpose of financing acquisition of lot inventory and related single
family home construction. The loans bear interest at annual rates ranging from
.5% to 1% over the individual lender's prime rate, payable monthly. Fundings
under the loans, together with unpaid accrued related interest, are due
primarily upon sale of each completed home or upon demand.
The lines of credit are secured by individual lots and related construction
and certain lines of credit are secured by mortgages on property held by the
Company's related parties. The lines of credit are individually guaranteed by a
majority shareholder of the Company. The loan agreements include restrictive
covenants, including financial ratio compliance, limitations on construction
advances and the maximum outstanding principal balance.
Other loans payable consist of three loans from current and former
stockholders, all of which are unsecured, bear interest at annual rates ranging
from 6.25% to 9.25%, and mature before December 31, 2006.
F-68
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
4. NOTES PAYABLE--(CONTINUED)
Maturities of loans payable at December 31, 1996 are as follows (in
thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1997............................................................. $ 8,414
1998............................................................. 9
1999............................................................. 9
2000............................................................. 9
2001............................................................. 9
thereafter....................................................... 36
-------
$ 8,486
-------
-------
</TABLE>
Interest incurred and capitalized, excluding amortization of deferred loan
costs during the years ended December 31, 1996 and 1995 aggregated approximately
$931,000 and $954,000, respectively.
5. RELATED PARTY TRANSACTIONS
The Company purchases substantially all of its finished lots under verbal
agreements at fair value from related parties, Hutson Land Company, Inc., Hutson
Land Group, Inc., Land Planners Development, Inc., and Heritage Land Group,
Inc., which share common majority shareholders and are under common management.
The Company also purchases land from its majority shareholders. During 1995 and
1996, the Company purchased approximately $14,763,000 and $15,238,000,
respectively. The Company had deposits of $2,456,500 and $1,612,500,
respectively at December 31, 1995 and 1996 with Hutson Land Group, Inc. for
future acquisitions of finished lots ready for home construction.
The Company pays a fee to shareholders based on the number of homes closed
in a particular development as compensation. In 1995 and 1996, the Company paid
approximately $459,000 and $570,000, respectively, in compensation to the
shareholders.
Hutson Land Company, Inc. develops certain land for future construction by
the Company and is reimbursed for development costs incurred. During 1996, the
Company reimbursed Hutson Land Company, Inc. approximately $134,000 for land
development costs and capitalized these amounts to real estate inventories. The
Company did not incur charges from Hutson Land Company, Inc. in conjunction with
land development during 1995. Charges by Hutson Land Company, Inc. for land
development services may not be necessarily indicative of that which would be
negotiated with an independent third party.
The Company contracted cabinetry and interior finish services from a
related party, Southeastern Supply Company, Inc., an entity wholly owned by the
Company's majority shareholder. During 1995 and 1996, the Company incurred fees
of approximately $3,500,000 and $4,500,000, respectively, for these related
party services. Charges by Southeastern Supply Company, Inc. for these services
may not be necessarily indicative of that which would be negotiated with an
independent third party.
During 1995 and 1996, the Company sold models to shareholders at cost and
recognized revenues and cost of sales of approximately $157,500 and $500,000,
respectively. These sales are not the same as those which would result from
transactions with an independent third party.
The Company leased models from a related party, Hutson Rental Partnership
which shares common ownership and is under common management, under varying
cancelable verbal agreements and incurred rental expense of $121,060 and
$176,231, respectively, for years ended December 31, 1995 and 1996,
respectively. The Company also leases office space from the majority shareholder
under a verbal agreement and incurred rental expense of $139,539, for years
ended December 31, 1995 and 1996, respectively. Rental charges by Hutson Rental
Partnership may not be necessarily indicative of that which would be negotiated
with an independent third party.
F-69
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
5. RELATED PARTY TRANSACTIONS--(CONTINUED)
The Company provides financial and administrative services and is the
employer of certain workers for five entities which share common majority
shareholders. The Company is reimbursed by these related entities for costs
incurred based upon time spent performing services on their behalf. For the
years ended December 31, 1995 and 1996, the Company recognized management fee
revenues of approximately $42,840 and $39,522, respectively, for services
provided.
The Company made home sales to several affiliates of the shareholders and
to an employee during 1996, at cost and accordingly recognized revenues and cost
of sales of approximately $655,888. Construction in progress includes $535,000
for a custom home being built for the majority shareholder at December 31, 1996.
No home sales were made to affiliates of shareholders and/or employees during
1995.
Receivables from related parties represent non-interest bearing advances
and notes to the shareholders and related entities. Such amounts are generally
due on demand or within one year.
6. COMMITMENTS AND CONTINGENCIES
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.
The Company may be responsible for funding certain homeowners associations
activities in the ordinary course of business. The Company does not currently
believe these obligations will have any material adverse effect on its financial
position or results of operations.
7. SUBSEQUENT EVENTS
On February 28, 1997, Fortress acquired certain assets of the Company and
assumed certain related liabilities for $7,653,753 in cash, $1,200,000 of
Fortress Class B convertible preferred stock, and future payments in the form of
Class C convertible preferred stock totaling $6,000,000 at a minimum of
$1,000,000 annually until 2002. The Fortress Class B and Class C convertible
preferred stock issues have a par value of $.01 per share with a liquidation
value of $100 and each share of preferred stock is convertible into 10 shares of
Fortress Common Stock.
In conjunction with the acquisition, Fortress entered into a purchase and
sale agreement with Hutson Land Company, Inc. for $7,000,000 to acquire certain
finished lots at estimated fair market value over a period expiring March 31,
2000. Fortress also entered into an agreement under which Hutson Land Company,
Inc. will manage the development of a certain subdivision. The related fee will
be based on the number of lots serviced. Fortress entered into an exclusive
purchasing agreement for a period of five years to contract cabinetry and
interior finish services with Southeastern Supply Company, Inc. at an initial
price equal to the amount that the contractor charged the Company on the last
date prior to the acquisition by Fortress. Fortress entered into an agreement
with the majority shareholder of the Company, for a period of five years
commencing March 1, 1997 under which Fortress is the exclusive builder and
purchaser of lots developed by the shareholder and its affiliates.
F-70
<PAGE>
D.W. HUTSON CONSTRUCTION, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
8. UNAUDITED PRO FORMA INCOME TAX INFORMATION
The following unaudited pro forma income tax information is as if the
Company had been a Subchapter C corporation subject to Federal and state income
taxes for the year ended December 31, 1996 (in thousands).
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1996
-----------------
<S> <C>
Earnings (loss) before pro forma adjustment, per
statement of income.................................. $ 7,654
Provision for income taxes............................. (3,062)
--------
Pro forma net income................................... $ 4,592
--------
--------
</TABLE>
F-71
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
of Landmark Homes, Inc.
In our opinion, the accompanying balance sheet and the related statements
of operations, of shareholders' equity and of cash flows present fairly, in all
material respects, the financial position of Landmark Homes, Inc. (the
'Company') at December 31, 1995, and the results of its operations and its cash
flows for the year then ended, in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our audit. We conducted our audit 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 believe that our audit provides a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Minneapolis, Minnesota
October 11, 1996
F-72
<PAGE>
LANDMARK HOMES, INC.
BALANCE SHEET
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, -----------------
1995 1995 1996
------------ ------ -------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents........................................................ $ 25 $ 113 $ 106
Accounts receivable.............................................................. 293 247 446
Accounts receivable--related parties............................................. 787 747 701
Real estate inventories.......................................................... 7,173 4,205 9,704
Property and equipment, net...................................................... 204 182 182
Prepaid expenses and other assets................................................ 16 10 --
------------ ------ -------
Total assets........................................................... $8,498 $5,504 $11,139
------------ ------ -------
------------ ------ -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities............................ $1,361 $ 488 $ 1,367
Customer deposits................................................................ 144 90 136
Notes payable.................................................................... 5,182 3,269 7,217
------------ ------ -------
Total liabilities...................................................... 6,687 3,847 8,720
------------ ------ -------
Shareholders' equity:
Common stock, $1 par value; 100,000 shares authorized, 1,000 shares issued
and outstanding........................................................... 1 1 1
Additional paid-in capital.................................................. 275 275 275
Retained earnings........................................................... 1,535 1,381 2,143
------------ ------ -------
Total shareholders' equity............................................. 1,811 1,657 2,419
------------ ------ -------
Total liabilities and shareholders' equity............................. $8,498 $5,504 $11,139
------------ ------ -------
------------ ------ -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-73
<PAGE>
LANDMARK HOMES, INC.
STATEMENT OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR ENDED ENDED JUNE 30,
DECEMBER 31, ----------------------------
1995 1995 1996
------------------ ----------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Revenue:
Residential sales............................................. $ 19,640 $10,043 $ 12,624
Cost of sales...................................................... 16,950 8,624 10,718
---------- ----------- ----------
Gross profit....................................................... 2,690 1,419 1,906
Operating expenses:
General and administrative expenses........................... 1,821 736 816
Selling expenses.............................................. 122 79 57
---------- ----------- ----------
Net operating income.......................................... 747 604 1,033
Other (income) expense:
Interest, net................................................. (10) -- 26
Other......................................................... (43) -- (19)
---------- ----------- ----------
Net income......................................................... $ 800 $ 604 $ 1,026
---------- ----------- ----------
---------- ----------- ----------
Unaudited pro forma net income..................................... $ 496 $ 637
---------- ----------
---------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-74
<PAGE>
LANDMARK HOMES, INC.
STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
COMMON PAID-IN RETAINED SHAREHOLDERS'
STOCK CAPITAL EARNINGS EQUITY
------ ---------- -------- -------------
<S> <C> <C> <C> <C>
Balance at January 1, 1995....................................... $1 $275 $1,820 $ 2,096
Net Income....................................................... 800 800
Distributions to shareholders.................................... (1,085) (1,085)
--
---- ------ -------
Balance at December 31, 1995..................................... 1 275 1,535 1,811
Net income (unaudited)........................................... 1,535 1,026
Distributions to shareholders (unaudited)........................ (418) (418)
--
---- ------ -------
Balance at June 30, 1996 (unaudited)............................. $1 $275 $2,143 $ 2,419
--- ---- ------ -------
--- ---- ------ -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-75
<PAGE>
LANDMARK HOMES, INC.
STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE SIX MONTHS
FOR THE YEAR ENDED ENDED JUNE 30,
DECEMBER 31, -----------------------
1995 1995 1996
------------------ ------- ----------
(UNAUDITED)
<S> <C> <C> <C>
Cash flows from operating activities
Net income..................................................... $ 800 $ 604 $1,026
Adjustments to reconcile net income to net cash used for
operating activities:
Depreciation.............................................. 68 27 21
Changes in operating assets and liabilities:
Accounts receivable.................................. (651) (564) (65)
Real estate inventories.............................. (2,886) (1,203) (2,531)
Prepaid expenses and other assets.................... 2 (4) 17
Accounts payable and accrued construction
liabilities........................................ 491 (372) 6
Customer deposits.................................... (1,027) 43 (8)
---------- ------- ----------
Net cash used by operating activities............................... (3,203) (1,469) (1,534)
---------- ------- ----------
Cash flows from investing activities
Purchase of property and equipment............................. (108) (45) (2)
---------- ------- ----------
Net cash used by investing activities................ (108) (45) (2)
---------- ------- ----------
Cash flows from financing activities
Proceeds from notes payable.................................... 13,133 5,277 8,734
Principal payments on notes payable............................ (8,868) (2,925) (6,699)
Distributions to shareholders.................................. (1,085) (881) (418)
---------- ------- ----------
Net cash provided by financing activities............ 3,180 1,471 1,617
---------- ------- ----------
Net increase (decrease) in cash and cash equivalents................ (131) (43) 81
Cash and cash equivalents, beginning of period...................... 156 156 25
---------- ------- ----------
Cash and cash equivalents, end of period............................ $ 25 $ 113 $ 106
---------- ------- ----------
---------- ------- ----------
Supplemental disclosures of cash flows information
Cash payments for interest..................................... $ 268 $ 140 $ 277
---------- ------- ----------
---------- ------- ----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-76
<PAGE>
LANDMARK HOMES, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1--BUSINESS ORGANIZATION
Landmark Homes, Inc. (Landmark, the Company) was organized on January 1,
1989 as an S-Corporation and is engaged primarily in the construction and sale
of single and multi-family residential property in North Carolina and South
Carolina. The Company designs, builds and sells single and multi-family houses
on finished lots, which it purchases ready for home construction. The Company
has also purchased undeveloped land in South Carolina to develop finished lots
for sale and future construction of single family.
The Company's business, and the housing industry in general, are cyclical.
The Company's operations are concentrated in North Carolina and South Carolina
and are affected by local and regional factors such as local economies,
demographic demand for housing, population growth, property taxes and energy
costs. National factors such as short and long-term interest rates, federal
mortgage financing programs, federal income tax policies and general economic
trends also can impact the Company's operations. In addition, the Company is
subject to various risks including availability and cost of land, conditions of
supply and demand in local markets, weather conditions, delays in construction
schedules and the entitlement process.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying balance sheet at June 30, 1996 and the statements of
operations and cash flows for the six months ended June 30, 1996 and 1995 and
the statement of shareholders' equity for the six months ended June 30, 1996,
are unaudited. In the opinion of management, these statements have been prepared
on the same basis as the audited financial statements and include all
adjustments, consisting primarily of normal recurring accruals, necessary for a
fair presentation of the financial condition of the Company as of June 30, 1996
and the results of operations and cash flows for the six month period ended June
30, 1996 and 1995.
Revenue recognition
Revenue from the sale of homes is recognized when all conditions precedent
to closing have been filled and title has passed to the buyer. The Company
considers accounts receivable to be fully collectible; accordingly, no allowance
for doubtful accounts has been established. If accounts become uncollectible,
the balances are charged to operations when that determination is made. The
Company's standard sales contract generally requires the customer to make a
deposit which is recognized as a liability until the home sale closes.
Cash and cash equivalents
The Company considers all highly liquid debt instruments purchased with a
maturity of three months or less to be cash equivalents.
Real estate inventories and cost of sales
Real estate inventories are carried at cost which is less than fair value
as measured in accordance with Statement of Financial Accounting Standards 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
projects. Costs incurred which are included in inventory consist of land, land
development, direct and certain indirect construction costs, interest, real
estate taxes, and direct model construction costs and related improvements.
Costs incurred for common area model improvements are amortized on a per unit
basis as home sales in the related development are closed.
At the time of revenue recognition, cost of sales is charged with the
actual construction costs incurred and any estimate to complete using the
specific identification method.
F-77
<PAGE>
LANDMARK HOMES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Property and equipment
Property and equipment is carried at cost less accumulated depreciation and
is depreciated using either accelerated or straight-line methods over the
estimated useful lives of the respective assets which range from five to seven
years. Significant additions and improvements are capitalized while expenditure
for repairs and maintenance are charged to operations as incurred.
Income taxes
The Company, with the consent of its shareholders, has elected, under the
Internal Revenue Code and the laws of the State of North Carolina, to be an S
corporation. In lieu of corporation income taxes, the shareholders of an
S-Corporation are taxed on their proportionate share of the Company's taxable
income. Therefore, no provision for federal or state income taxes has been
included in these financial statements.
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 revenue and expenses during the reporting
period. Actual results could differ from those estimates.
NOTE 3--REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, ------------------
1995 1995 1996
------------ ------ ------
(UNAUDITED)
<S> <C> <C> <C>
Work-in-progress:
Sold homes................................................................. $3,028 $1,984 $4,337
Speculative homes.......................................................... 3,174 1,323 4,054
Land:
Finished lots.............................................................. 97 423 97
Land under development..................................................... 469 353 604
Model homes.................................................................. 405 122 612
------ ------ ------
$7,173 $4,205 $9,704
------ ------ ------
------ ------ ------
</TABLE>
Speculative homes and model homes include completed homes and homes under
construction. Speculative construction represents homes built without an advance
sales contract in order to accelerate closing.
F-78
<PAGE>
LANDMARK HOMES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4--PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, ---------------
1995 1995 1996
------------ ----- ----
(UNAUDITED)
<S> <C> <C> <C>
Model home upgrades and furnishings.............................................. $ 10 $ 44 $ 86
Equipment and furniture.......................................................... 389 293 315
---- ----- ----
399 337 401
Less: accumulated depreciation................................................... (195) (155) (219)
---- ----- ----
$204 $ 182 $182
---- ----- ----
---- ----- ----
</TABLE>
NOTE 5--NOTES PAYABLE
Notes payable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, ------------------
1995 1995 1996
------------ ------ ------
(UNAUDITED)
<S> <C> <C> <C>
Project specific construction loans.......................................... $4,790 $2,904 $6,839
Shareholders' notes payable.................................................. 285 280 293
Equipment loans.............................................................. 107 85 85
------ ------ ------
$5,182 $3,269 $7,217
------ ------ ------
------ ------ ------
</TABLE>
Project specific construction loans are collateralized by homes under
construction, are payable in monthly interest only installments and are due upon
demand. These loans bear interest at the prime rate plus 0.25% to 0.50%, which
ranged from 9.00% to 9.25% at December 31, 1995.
Shareholders' notes payable are loans from the principals of the Company
and are payable upon demand. These loans bear interest at 18%.
Equipment loans are collateralized by the equipment, are payable in monthly
interest only installments and are due upon demand. These loans bear interest at
the prime rate plus .25% which was 9.00% at December 31, 1995.
At December 31, 1995, the Company has approximately $5,100,000 in unused
lines of credit available.
The Company's management believes that recorded cost approximates fair
value for notes payable at December 31, 1995.
Maturities of notes payable are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1996........................................................ $5,108
1997........................................................ --
1998........................................................ 74
------
$5,182
------
------
</TABLE>
F-79
<PAGE>
LANDMARK HOMES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 6--RELATED PARTY TRANSACTIONS
Accounts receivable--related parties are summarized as follows (in
thousands):
<TABLE>
<CAPTION>
JUNE 30,
DECEMBER 31, ---------------
1995 1995 1996
------------ ----- ----
(UNAUDITED)
<S> <C> <C> <C>
Note receivable--Landmark Real Estate............................................ $416 $ 380 $478
Account receivable--Landmark Organization, Inc................................... 285 338 192
Shareholder receivable........................................................... 86 29 31
---- ----- ----
$787 $ 747 $701
---- ----- ----
---- ----- ----
</TABLE>
Note receivable--Landmark Real Estate is receivable from a corporation
owned by the principal shareholders of the Company. The unsecured note
receivable bears interest at 8% annually and payment is due upon demand.
Management of the Company has represented that this note is collectible and that
the Company will receive payment as provided for in the note.
Account receivable--Landmark Organization, Inc. is due from a corporation
owned principally by the shareholders of the Company. Management has represented
that this receivable is collectible.
Shareholder receivable is an amount due from corporations owned principally
by the shareholders of the Company and from shareholders of the Company, arising
from transactions occurring in the normal course of business.
Other miscellaneous related party transactions (in thousands) during the
year ended December 31, 1995 include the following:
Rental expense of $53 in 1995 was paid to a corporation owned principally
by the shareholders of the Company for office space and rental of pagers.
Management fee income and expense of $38 and $13, respectively, in 1995 was
derived from transactions with various corporations owned principally by the
shareholders of the Company.
Salaries expense was reduced by $198 in 1995 for reimbursements for
services rendered by employees of the Company to various corporations owned
principally by the shareholders of the Company.
Accounts payable and accrued construction liabilities at December 31, 1995
include $48 due to a partnership comprised of shareholders of the Company and a
corporation owned principally by the shareholders of the Company.
Real estate purchases of $3,733 were made in 1995 from corporations owned
principally by the shareholders of the Company.
Commissions of $596 were paid on sales of real estate in 1995 to a
corporation owned principally by the shareholders of the Company.
Development costs of $580 were paid in 1995 to a corporation owned
principally by the shareholders of the Company.
Interest income in the amount of $56 was collected on intercompany
receivables in 1995 from corporations owned principally by the shareholders of
the Company.
Inventory at December 31, 1995 includes $60 for homes being built for an
officer of the Company and an employee of a corporation owned principally by the
shareholders of the Company.
F-80
<PAGE>
LANDMARK HOMES, INC.
NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7--COMMITMENTS AND CONTINGENCIES
The Company is involved in certain legal disputes arising in the normal
course of business, generally relating to claims by customers for repairs on
purchased homes. In the opinion of management, resolution of these claims will
not have a material impact on the Company's financial position or results of
operations.
NOTE 8--SUBSEQUENT EVENTS
On August 31, 1996, the Company and its Shareholders (the Sellers) entered
into an Asset Purchase Agreement (the Agreement) with The Fortress Group, Inc.
(the Purchaser), whereby the Seller agreed to sell to the Purchaser
substantially all of the assets of the Company in exchange for approximately
$5,000,000 in cash and the assumption of approximately $8,200,000 in
liabilities, as set forth in the Agreement.
In connection with this Agreement, the Company entered into a Shared
Services Agreement through December 31, 1997 with an affiliated corporation
owned principally by the shareholders of the Company, Landmark Organization,
Inc. (LOI). Beginning in September 1996, the Company will pay a monthly fee in
consideration of certain services, use of equipment and office space provided by
LOI to the Company.
NOTE 9--UNAUDITED PRO FORMA NET INCOME
The following unaudited pro forma income tax information (in thousands) is
presented in accordance with Statement of Financial Accounting Standards No.
109, Accounting for Income Taxes, as if the Company had been a subchapter C
corporation subject to federal income taxes for the year ended December 31, 1995
and the six months ended June 30, 1996.
<TABLE>
<CAPTION>
FOR THE FOR THE SIX
YEAR ENDED MONTHS ENDED
DECEMBER 31, JUNE 30,
1995 1995
------------ -------------
<S> <C> <C>
Earnings before pro forma adjustment, per statement of operations.................. $800 $ 1,026
Provision for income taxes......................................................... 304 389
---- -------
Pro forma net income............................................................... $496 $ 637
---- -------
---- -------
</TABLE>
F-81
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of the 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
income, shareholders' equity and of cash flows present fairly, in all material
respects, the financial position of the Combined Predecessor Companies (the
'Company') at May 20, 1996 and December 31, 1995 and 1994, and the results of
their operations and their cash flows for the period January 1, 1996 through May
20, 1996 and each of the two years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Companies' 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 The Genesee
Company as of December 31, 1994 and for the year ended December 31, 1994, the
consolidated financial statements of Solaris Development Corporation, as of
December 31, 1995 and 1994 and for the two years in the period ended December
31, 1995 and the financial statements of Sunstar Mortgage Limited Liability
Company as of December 31, 1995 and the period from March 1, 1995 (inception) to
December 31, 1995. The financial statements which we did not audit reflect total
assets of $16.4 million and $67.4 million at December 31, 1995 and 1994,
respectively, and total revenues of $42.6 million and $78.6 million and $95.8
million for the years ended December 31, 1995 and 1994, respectively. Those
statements were audited by other auditors whose reports thereon have been
furnished to us, and our opinion expressed herein, insofar as it relates to the
amounts included for The Genesee Company, Solaris Development Corporation and
Sunstar Mortgage Limited Liability Company are based solely on the reports of
the other auditors. 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 believe that our audits and the reports of the other auditors provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Minneapolis, Minnesota
February 20, 1997
F-82
<PAGE>
COMBINED PREDECESSOR COMPANIES
BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995 MAY 20, 1996
-------- -------- ------------
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents.................................................. $ 4,866 $ 2,710 $ 3,028
Related party and other receivables........................................ 967 2,106 2,797
Real estate inventories.................................................... 101,214 109,016 133,820
Property and equipment, net................................................ 1,774 2,099 1,713
Deferred transaction costs................................................. -- 2,121 4,282
Prepaid expenses and other assets.......................................... 2,582 3,614 4,298
-------- -------- --------
Total assets..................................................... $111,403 $121,666 $149,938
-------- -------- --------
-------- -------- --------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities...................... $ 9,685 $ 10,726 $ 14,645
Notes and mortgages payable................................................ 83,161 87,604 112,004
Due to related parties..................................................... 2,320 2,495 3,062
Accrued expenses........................................................... 4,393 4,588 3,585
Customer deposits.......................................................... 4,480 5,122 6,332
Commitments and contingencies (Note 11)....................................
-------- -------- --------
Total liabilities................................................ 104,039 110,535 139,628
-------- --------
Minority interests......................................................... 1,346 1,295 1,383
-------- -------- --------
Shareholders' equity:
Preferred Stock.......................................................
Common Stock.......................................................... 575 599 600
Additional paid-in Capital............................................ 1,861 2,606 3,070
Retained earnings..................................................... 3,582 6,631 5,257
-------- -------- --------
Total shareholders' equity....................................... 6,018 9,836 8,927
-------- -------- --------
Total liabilities and shareholders' equity....................... $111,403 $121,666 $149,938
-------- -------- --------
-------- -------- --------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-83
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED FOR THE PERIOD
DECEMBER 31, JANUARY 1, 1996
---------------------- THROUGH
1994 1995 MAY 20, 1996
-------- -------- ---------------
<S> <C> <C> <C>
Revenue:
Residential sales................................................ $170,377 $190,312 $64,984
Lot sales........................................................ 3,869 8,098 1,036
Other revenue.................................................... 469 619 99
-------- -------- -------
Total revenue............................................... 174,715 199,029 66,119
Cost of sales......................................................... 146,284 167,434 56,425
-------- -------- -------
Gross profit.......................................................... 28,431 31,595 9,694
Operating expenses:
Selling expenses................................................. 11,840 13,152 4,689
General and administrative expenses.............................. 11,180 11,693 3,892
-------- -------- -------
Net operating income............................................. 5,411 6,750 1,113
Other expense (income):
Interest......................................................... 136 120 63
Minority interests............................................... 907 745 89
Other, net....................................................... (460) (191) (313)
-------- -------- -------
Income before provision for income taxes.............................. 4,828 6,076 1,274
Provision for income taxes............................................ 83 21
-------- -------- -------
Net income............................................................ $ 4,745 $ 6,055 $ 1,274
-------- -------- -------
-------- -------- -------
Unaudited pro forma net income (Note 13).............................. $ 764
-------
-------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-84
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON ADDITIONAL RETAINED
STOCK PAID-IN CAPITAL EARNINGS TOTAL
------ --------------- --------- ------
<S> <C> <C> <C> <C>
Balance at December 31, 1993..................................... $575 $ 1,371 $ 2,297 $4,243
Capital contributions....................................... -- 490 -- 490
Distributions to shareholders............................... -- -- (3,074) (3,074)
Redemption of common stock.................................. -- -- (386) (386)
Net income.................................................. -- -- 4,745 4,745
------ ------- ------- ------
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
------ ------- ------- ------
------ ------- ------- ------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-85
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED FOR THE PERIOD
DECEMBER 31, JANUARY 1, 1996
----------------------- THROUGH
1994 1995 MAY 20, 1996
-------- --------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income......................................................... $ 4,745 $ 6,055 $ 1,274
Adjustments to reconcile net income to net cash (used in) provided
by operating activities
Equity in income from investment partnership.................... (4)
Depreciation and amortization................................... 613 621 277
Minority interest............................................... 907 745 89
Changes in operating assets and liabilities:
Real estate inventories....................................... (35,308) (8,155) (24,803)
Related party and other receivables........................... 101 (1,118) (690)
Prepaid expenses and other assets............................. (974) (1,299) (256)
Accounts payable and accrued construction liabilities......... 4,094 (35) 2,754
Accrued expenses.............................................. (94) 919 (578)
Customer deposits............................................. 893 513 981
-------- --------- ---------
Net cash used in operating activities...................... (25,027) (1,754) (20,952)
-------- --------- ---------
Cash flows from investing activities:
Purchase of property and equipment................................. (849) (962) (330)
Proceeds from sale of property and equipment....................... 10 26 8
-------- --------- ---------
Net cash used in investing activities...................... (839) (936) (322)
-------- --------- ---------
Cash flows from financing activities:
Borrowings under notes and mortgages payable....................... 101,789 115,740 52,839
Repayments of notes and mortgages payable.......................... (72,373) (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........................................... 2,090 2,248 1,076
Repayment of related party borrowings.............................. (1,013) (2,073) (510)
Distributions to minority interest................................. (340) (791)
Transaction costs.................................................. (1,114) (957)
Capital contributions.............................................. 490 1,123 547
Capital distributions.............................................. (2,722) (3,301) (2,730)
-------- --------- ---------
Net cash provided by financing activities.................. 27,921 534 21,592
-------- --------- ---------
Net increase (decrease) in cash and cash equivalents................. 2,055 (2,156) 318
Cash and cash equivalents, beginning of period....................... 2,811 4,866 2,710
-------- --------- ---------
Cash and cash equivalents, end of period............................. $ 4,866 $ 2,710 $ 3,028
-------- --------- ---------
-------- --------- ---------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-86
<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:
<TABLE>
<CAPTION>
COMMON PREFERRED
SHARES SHARES
PREDECESSOR COMPANY CASH ALLOCATION ALLOCATION
------------------- ---------- ---------- ----------
<S> <C> <C> <C>
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
---------- ---------- ------
---------- ---------- ------
</TABLE>
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.
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.
F-87
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
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.
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
F-88
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
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 the year ended 1994, no income tax benefit was recorded for the losses
related to the C corporations of Christopher because there was no remaining
taxable income in the three year carry back period. 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 years ended December 31, 1995 and 1994 represent the
greater of income or equity component of Texas state franchise taxes.
At December 31, 1994 and 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):
<TABLE>
<CAPTION>
YEAR ENDED PERIOD
DECEMBER 31, JANUARY 1, 1996
------------------ THROUGH
1994 1995 MAY 20, 1996
------ ------ ---------------
<S> <C> <C> <C>
Cash paid for:
Interest.................................................... $6,163 $8,612 $ 2,826
------ ------ -------
Income taxes..................................................... $ 231 $ 83 $ 6
------ ------ -------
------ ------ -------
</TABLE>
F-89
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Supplemental disclosure of non-cash activities are summarized as follows
(in thousands):
<TABLE>
<CAPTION>
YEAR ENDED PERIOD
DECEMBER 31, JANUARY 1, 1996
-------------- THROUGH
1994 1995 MAY 20, 1996
------ ---- ---------------
<S> <C> <C> <C>
Net assumption and assignment of Special Improvement District Bonds... $ 590 $623 $ (83)
Distribution of property to owners of Predecessor Companies........... 353 58
Redemption of common stock for notes payable.......................... 386
Other................................................................. 45 35
------ ---- -----
Total............................................................ $1,374 $716 $ (83)
------ ---- -----
</TABLE>
NOTE 4--REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------- MAY 20,
1994 1995 1996
-------- -------- --------
<S> <C> <C> <C>
Work-in-progress:
Sold homes.................................................... $ 38,177 $ 34,460 $ 53,355
Speculative homes............................................. 17,275 24,208 34,423
-------- -------- --------
55,452 58,668 87,778
-------- -------- --------
Land:
Finished lots................................................. 24,496 28,219 34,029
Land under development........................................ 12,447 12,819 984
Land and other costs.......................................... 729 456 1,887
-------- -------- --------
37,672 41,494 36,900
-------- -------- --------
Models............................................................. 8,090 8,854 9,142
-------- -------- --------
Total......................................................... $101,214 $109,016 $133,820
-------- -------- --------
-------- -------- --------
</TABLE>
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.
NOTE 5--PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- MAY 20,
1994 1995 1996
------ ------ -------
<S> <C> <C> <C>
Model home upgrades and furnishings........................................ $1,559 $1,997 $1,435
Equipment and furniture.................................................... 826 1,197 1,363
Vehicles................................................................... 279 266 250
Leasehold improvements..................................................... 44 44 36
Other...................................................................... 67 108
------ ------ -------
2,775 3,612 3,084
------ ------ -------
Less: Accumulated depreciation and amortization............................ (1,001) (1,513) (1,371)
------ ------ -------
$1,774 $2,099 $1,713
------ ------ -------
------ ------ -------
</TABLE>
F-90
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 6--NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MAY 20,
1994 1995 1996
------- ------- --------
<S> <C> <C> <C>
Project specific land, land development and construction loans......... $63,032 $66,629 $ 85,775
Demands for deed on sales-leasebacks................................... 2,370 230
Other loans............................................................ 1,272 1,149 3,254
Subordinated investor notes and equity participation loans............. 16,487 19,596 22,975
------- ------- --------
$83,161 $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.
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, 1994 and 1995 and at May 20, 1996 was approximately $6.1
million, $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,
1994 and 1995 and May 20, 1996 was approximately $4.3 million, $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 $6.1 million, $4.6
million and $4.5 million as of December 31, 1994 and 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.
F-91
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 6--NOTES AND MORTGAGES PAYABLE--(CONTINUED)
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.
Interest and related debt issuance costs incurred and capitalized
aggregated approximately $11.7 million, $16.1 million and $5.2 million for the
years ended December 31, 1994 and 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, 1994 and 1995 and May 20, 1996 is $2.3 million, $1.5 million and
$1.3 million, respectively.
F-92
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 8--MINORITY INTERESTS
The minority interests at December 31, 1994 and 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 $568,000, $674,000 and $315,000 were paid by Buffington for the years
ended December 31, 1994 and 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 $447,000, and
$584,000 for the years ended December 31, 1994 and 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 years ended
December 31, 1994 and 1995, approximately $356,000 and $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
$102,000 and $6,000 for the years ended December 31, 1994 and 1995,
respectively. 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. With respect to this same
partnership, Genesee has entered into several agreements to purchase land at its
estimated fair market value. For the year ended December 31, 1994, Genesee
acquired approximately $2.7 million. No land acquisitions from this partnership
were made in 1995 or 1996.
Genesee pays a fee to an entity owned by its sole shareholder which
provides negotiation services in connection with the purchase of land. For the
years ended December 31, 1994 and 1995, Genesee recognized in cost of sales
related expense of $145,000 and $5,000, respectively. No such services were
purchased during the period from January 1, 1996 through May 20, 1996.
Genesee has made several home sales to its employees for which sales
revenues and the related cost of sales have been included in the accompanying
combined statements of income. For the year ended December 31, 1994, the sales
revenue recognized was approximately $454,000, and cost of sales of $405,000.
Genesee made no home sales to employees during the year ended December 31, 1995
or the period from January 1, 1996 through May 20, 1996.
Christopher provides certain accounting services for related parties and in
return receives a management fee, which was approximately $343,000 and $39,000
for the years ended December 31, 1994 and 1995, respectively. 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 $108,000 and
$62,000 for the years ended December 31, 1994
F-93
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 9--RELATED PARTY TRANSACTIONS--(CONTINUED)
and 1995, respectively. 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 years ended December 31, 1994 and 1995 and the period from January 1,
1996 through May 20, 1996 of approximately $34,000, $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 $207,000, $156,000 and $38,000 for each of the years ended
December 31, 1994 and 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 $673,000, $825,000 and $442,000 during the years ended
December 31, 1994, 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):
<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 $196,000, $206,000 and $207,000 and accumulated
depreciation of approximately $52,000, $81,000 and $97,000 as of December 31,
1994 and 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.
F-94
<PAGE>
COMBINED PREDECESSOR COMPANIES
NOTES TO THE COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 12--SHAREHOLDERS' EQUITY
The Company has authorized 2 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.
Effective January 1, 1994, Solaris redeemed 1,000 shares of common stock
held by a shareholder and provided a note payable collateralized by the redeemed
shares in the amount of $386,000, this transaction resulted in a decrease in
retained earnings of $386,000 and no gain or loss. At December 31, 1994 the
amount of the note payable outstanding was approximately $318,000.
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.
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.
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1, 1996
THROUGH
MAY 20, 1996
---------------
<S> <C>
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
-------
-------
</TABLE>
F-95
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Shareholders of Buffington Homes, Inc.
In our opinion, the accompanying combined balance sheets and the related
combined statements of operations, shareholders' equity and of cash flows
present fairly, in all material respects, the combined financial position of
Buffington Homes, Inc. (the 'Company') at May 20, 1996, December 31, 1995 and
1994, and the combined results of their operations and cash flows for the period
January 1, 1996 through May 20, 1996 and each of the two years in the period
ended December 31, 1995 in conformity with generally accepted accounting
principles. These financial statements are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements based on our 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. 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 believe that our audits provide a reasonable basis for the opinion expressed
above.
As discussed in Note 1, Buffington Homes, Inc. was acquired by The Fortress
Group Inc. on May 20, 1996.
PRICE WATERHOUSE LLP
Austin, Texas
November 25, 1996
F-96
<PAGE>
BUFFINGTON HOMES, INC.
COMBINED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MAY 20,
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents........................................................ $ 1,741 $ 335 $ 246
Receivables...................................................................... 352 382 392
Real estate inventories.......................................................... 12,083 16,587 24,721
Property and equipment, net...................................................... 233 425 406
Prepaid and other assets......................................................... 1,355 1,547 1,899
------- ------- -------
Total assets................................................................ $15,764 $19,276 $27,664
------- ------- -------
------- ------- -------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities............................ $ 1,643 $ 1,677 $ 2,131
Notes payable.................................................................... 9,748 14,537 21,294
Other accrued expenses........................................................... 809 674 485
Customer deposits................................................................ 69 130 563
------- ------- -------
Total liabilities........................................................... 12,269 17,018 24,473
------- ------- -------
Commitments and contingencies--Note 9 Shareholders' equity:
Common stock................................................................... 22 24 25
Additional paid-in capital..................................................... 206 855 855
Retained earnings.............................................................. 3,267 1,379 2,311
------- ------- -------
Total shareholders' equity.................................................. 3,495 2,258 3,191
------- ------- -------
Total liabilities and shareholders' equity.................................. $15,764 $19,276 $27,664
------- ------- -------
------- ------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-97
<PAGE>
BUFFINGTON HOMES, INC.
COMBINED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED FOR THE PERIOD
DECEMBER 31, JANUARY 1, 1996
-------------------- THROUGH
1994 1995 MAY 20, 1996
------- ------- ---------------
<S> <C> <C> <C>
Revenue:
Sales................................................................. $63,776 $52,488 $22,332
Other revenue......................................................... 345 286 300
------- ------- -----------
Total revenue...................................................... 64,121 52,774 22,632
Cost of sales......................................................... 53,523 44,186 18,063
------- ------- -----------
Gross profit....................................................... 10,598 8,588 4,569
Operating expenses:
Selling expenses...................................................... 3,399 3,340 1,462
General and administrative expenses................................... 5,246 5,401 1,508
------- ------- -----------
Net operating income............................................... 1,953 (153) 1,599
Other expense (income):
Interest expense...................................................... 94 80 62
Interest and other income............................................. (101) (71)
------- ------- -----------
Income (loss) before provision for taxes........................... 1,960 (162) 1,537
------- ------- -----------
Provision for taxes..................................................... 83 21 --
------- ------- -----------
Net income (loss)....................................................... $ 1,877 $ (183) $ 1,537
------- ------- -----------
------- ------- -----------
Unaudited pro forma net income (Note 10)................................ $ 922
-----------
-----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-98
<PAGE>
BUFFINGTON HOMES, INC.
COMBINED STATEMENTS OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
COMMON ADDITIONAL
STOCK PAID-IN RETAINED
AMOUNT CAPITAL EARNINGS TOTAL
------ ---------- -------- ------
<S> <C> <C> <C> <C>
Balance at December 31, 1993........................................... $ 22 $106 $1,784 $1,912
Capital contributions................................................ -- 100 -- 100
Capital distributions................................................ -- -- (394) (394)
Net income........................................................... -- -- 1,877 1,877
------ -------- ------- ------
Balance at December 31, 1994........................................... 22 206 3,267 3,495
Capital contributions................................................ 2 649 -- 651
Capital distributions................................................ -- -- (1,705) (1,705)
Net loss............................................................. -- -- (183) (183)
------ -------- ------- ------
Balance at December 31, 1995........................................... 24 855 1,379 2,258
Capital contributions................................................ 1 -- -- 1
Capital distributions................................................ -- -- (605) (605)
Net income........................................................... -- -- 1,537 1,537
------ -------- ------- ------
Balance at May 20, 1996................................................ $ 25 $855 $2,311 $3,191
------ -------- ------- ------
------ -------- ------- ------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-99
<PAGE>
BUFFINGTON HOMES, INC.
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED FOR THE PERIOD
DECEMBER 31, JANUARY 1, 1996
-------------------- THROUGH
1994 1995 MAY 20, 1996
------- ------- ---------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)..................................................... $ 1,877 $ (183) $ 1,537
Adjustments to reconcile net income to net cash used by operating
activities
Depreciation and amortization...................................... 129 207 105
Increase in receivables............................................ (176) (9) (10)
Increase in real estate inventories ............................... (1,105) (4,482) (8,134)
Increase in prepaid and other assets............................... (861) (293) (352)
(Decrease) increase in accounts payable, accrued construction
liabilities and other and accrued expenses....................... (639) (101) 265
Customer deposits.................................................. (105) 61 433
------- ------- -----------
Net cash used by operating activities............................ (880) (4,800) (6,156)
------- ------- ------------
Cash flows from investing activities:
Purchase of equipment................................................. (210) (399) (86)
------- ------- ------------
Net cash used in investing activities................................. (210) (399) (86)
------- ------- ------------
Cash flows from financing activities:
Stock contribution.................................................... 100 651 1
Net increase in notes payable......................................... 1,155 4,789 6,757
Capital distribution.................................................. (41) (1,647) (605)
------- ------- ------------
Net cash provided by financing activities........................ 1,214 3,793 6,153
------- ------- ------------
Net increase (decrease) in cash......................................... 124 (1,406) (89)
Cash and cash equivalents, beginning of period.......................... 1,617 1,741 335
------- ------- ------------
Cash and cash equivalents, end of period.............................. $ 1,741 $ 335 $ 246
------- ------- ------------
------- ------- ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-100
<PAGE>
BUFFINGTON HOMES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE 1--BUSINESS AND ORGANIZATION
Buffington Homes, Inc. is primarily engaged in the construction of detached
single-family homes in the central Texas area.
The combined financial statements include the accounts of Buffington Homes,
Inc., Buffington San Antonio, Buffington Development, Buffington Central Texas
and Elements! which are wholly owned by the stockholders of Buffington Homes,
Inc. The combined entities are hereafter referred to as the Company. All
significant intercompany accounts and transactions have been eliminated in
combination.
Buffington Homes, Inc. is engaged in the construction of detached single
family homes in the Austin, Texas area. It had 1,000,000 shares of $1.00 par
value Common Stock authorized with 2,000 shares issued and outstanding for the
years ended December 31, 1994, 1995 and the period January 1 through May 20,
1996. Buffington San Antonio was formed in 1993 and is engaged in the
construction of homes in the San Antonio, Texas area. It had 1,000,000 shares of
$.01 par value Common Stock authorized with 1,000,000 shares issued and
outstanding for the years ended December 31, 1994, 1995 and the period January 1
through May 20, 1996. Elements! was formed in 1993 to provide interior design
services to Buffington Homes, Inc. and unrelated buyers. Elements! had 1,000,000
shares of $.01 par value Common Stock authorized, issued and outstanding for the
years ended December 31, 1994 and 1995 and the period January 1 through May 20,
1996. Buffington Development was incorporated in 1994 for the purpose of holding
lot inventory in Austin, Texas. Buffington Development had 1,000,000 shares of
$.01 par value Common Stock authorized with 10,000 shares issued and outstanding
at December 31, 1994 and 1995 and 11,000 shares at May 20, 1996, respectively.
In 1995, Buffington Central Texas was formed to build custom homes. Buffington
Central Texas is structured as a limited partnership and was initially
capitalized with a $2,000 contribution from the owners of Buffington Homes, Inc.
Effective May 20, 1996, the Company and its shareholder executed a
definitive agreement with the Fortress Group, Inc. (Fortress) pursuant to which
the Company merged with Fortress (the Merger). All outstanding shares of the
Company were exchanged for cash and shares of Fortress's common stock concurrent
with the consummation of the initial public offering of Fortress.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Estimates by Management
The preparation of the 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 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.
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
the Company's real estate developments. Costs incurred which are included in
inventory consist of land, direct and certain indirect construction costs,
interest and real estate taxes, certain selling incentives and direct model
construction costs and related improvements.
F-101
<PAGE>
BUFFINGTON HOMES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
At the time of revenue recognition, cost of sales is charged with the
actual construction costs incurred and any estimate to complete (specific
identification).
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 when 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.
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 is generally five years. Significant additions and
improvements are capitalized, while expenditures for repairs and maintenance are
charged to operations, as incurred.
Selling Expenses
Selling expenses includes all sales commissions paid, salaries paid to
marketing personnel, the direct and indirect costs of sales offices and
advertising expenses.
Income Taxes
Since January 1994, the Company has been a subchapter S corporation for
income tax purposes and, accordingly, any income tax liabilities are the
responsibility of the Company's shareholders. The Company's subchapter S
corporation status terminated on consummation of the Merger with Fortress
disclosed in Note 1. The tax provision for the years ended December 31, 1994 and
1995 represent the greater of income or equity component of Texas state
franchise taxes. See Note 10 for information regarding the pro forma income tax
disclosure.
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):
<TABLE>
<CAPTION>
YEAR ENDED FOR THE PERIOD
DECEMBER 31, JANUARY 1, 1996
---------------- THROUGH
1994 1995 MAY 20, 1996
---- ------ ---------------
<S> <C> <C> <C>
Cash paid for interest............................................. $937 $1,049 $ 790
---- ------ ------
Cash paid for taxes................................................ $231 $ 83 $ 6
---- ------ ------
Distributions of property to owners................................ $353 $ 58 $ --
---- ------ ------
</TABLE>
The Company secured a performance bond in the amount of $200,000 relating
to one of the Company's contracts. This amount is considered restricted cash and
is included in cash and cash equivalents at May 20, 1996.
F-102
<PAGE>
BUFFINGTON HOMES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3--REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MAY 20,
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Work in Progress:
Sold homes (under construction)...................................... $ 6,110 $ 8,569 $13,227
Speculative homes.................................................... 2,465 3,336 6,828
------- ------- -------
8,575 11,905 20,055
------- ------- -------
Land:
Finished lots........................................................ 2,231 3,041 2,892
------- ------- -------
Models................................................................. 1,277 1,641 1,774
------- ------- -------
Total.................................................................. $12,083 $16,587 $24,721
------- ------- -------
------- ------- -------
</TABLE>
Models and speculative construction include both completed homes and homes
in progress. Speculative construction represents unsold homes which were built
to accelerate closing. Capitalized interest included in real estate inventories
aggregate $157,000 at December 31, 1994, $155,000 at December 31, 1995 and
$214,000 at May 20, 1996.
NOTE 4--PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------ MAY 20,
1994 1995 1996
---- ---- -------
<S> <C> <C> <C>
Equipment and furniture....................................................... $175 $425 $ 466
Vehicles...................................................................... 112 112 119
Leasehold improvements........................................................ 44 44 36
---- ---- -------
331 581 621
Less: Accumulated depreciation and amortization............................... 98 156 215
---- ---- -------
$233 $425 $ 406
---- ---- -------
---- ---- -------
</TABLE>
Depreciation expense recognized approximated $40,000, $58,000 and $41,000
for the years ended December 31, 1994 and 1995 and for the period January 1,
1996 through May 20, 1996, respectively.
NOTE 5--OTHER ASSETS
Other assets are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------- MAY 20,
1994 1995 1996
------ ------ -------
<S> <C> <C> <C>
Model home furniture (net)................................................. $ 452 $ 432 $ 641
Lot option deposits........................................................ 729 892 1,067
Architectural plans........................................................ 138 91 83
Other...................................................................... 36 133 108
------ ------ -------
$1,355 $1,547 $1,899
------ ------ -------
------ ------ -------
</TABLE>
Deposits represent amounts paid to developers under lot option contracts.
Option contracts generally require the payment of a cash deposit for the right
to acquire lots during a specified period of time at a certain price. Under
option contracts without specific performance obligations, the Company's
liability is limited to forfeiture of the non-refundable deposits.
F-103
<PAGE>
BUFFINGTON HOMES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 5--OTHER ASSETS--(CONTINUED)
Furniture for model homes is carried at cost less accumulated depreciation
and is depreciated using the straight line method over the estimated useful life
of the assets which is generally five years. Model home furniture totaled
$626,000, $754,000 and $983,000 at December 31, 1994 and 1995 and May 20, 1996,
respectively. Accumulated depreciation totaled $174,000 and $323,000 at December
31, 1994 and 1995 and $342,000 at May 20, 1996, and depreciation expense totaled
$89,000, $149,000 and $64,000 for the years ended December 31, 1994 and 1995 and
for the period January 1, 1996 through May 20, 1996.
Architectural plans are recorded at cost and amortized evenly over twelve
months. Other assets also includes miscellaneous and prepaid expenses.
NOTE 6--NOTES PAYABLE
Notes payable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------- MAY 20,
1994 1995 1996
------ ------- -------
<S> <C> <C> <C>
Conventional lot acquisition loans...................................... $1,947 $ 2,950 $ 2,012
Revolving project specific construction loans........................... 7,801 11,587 19,282
------ ------- -------
$9,748 $14,537 $21,294
------ ------- -------
------ ------- -------
</TABLE>
Conventional lot acquisition loans are secured by land and include
conventional loans totaling $653,000 and a non-recourse lot loan of $1,359,000.
The conventional loans bear interest at both fixed and variable rates with the
fixed rate being 10% per annum and variable rates ranging from 1% to 1.5% over
the prime lending rate (9.25% to 9.75% at May 20, 1996). Fixed rate debt
included in conventional loans outstanding at May 20, 1996 totaled $260,000.
Conventional loans mature in 1996. The non-recourse lot acquisition loan bears
interest at a fixed rate of 9% and matures in 1997.
Revolving project specific construction loans are secured by the related
homes and bear interest at variable rates at 1% over the prime rate as specified
by the respective lender (9.25% at May 20, 1996). Loans generally mature as the
underlying collateral project is completed. Interest incurred for the years
ended December 31, 1994 and 1995 and the period January 1, 1996 through May 20,
1996 totaled $896,000, $1,002,000 and $704,000, respectively. Interest
capitalized to the cost of homes for the years ended December 31, 1994 and 1995
and the period January 1, 1996 through May 20, 1996 totaled $802,000, $922,000
and $642,000, respectively.
NOTE 7--RELATED PARTY TRANSACTIONS
Immediate family members of certain shareholders of the Company have an
interest in a title insurance company which is not combined into Buffington
Homes, Inc. which processes loan closings and issues title insurance as an
intermediary to customers of Buffington Homes, Inc. Buffington Homes, Inc.
normally pays closing costs and title insurance premiums to the title company on
behalf of Buffington's customers. Title insurance premiums are regulated by the
State of Texas. All fees charged to Buffington by the title company are the same
as fees charged to unrelated customers. Fees in the approximate amount of
$568,000, $674,000 and $315,000 were paid by Buffington to the title company in
1994, 1995 and the period January 1, 1996 through May 20, 1996, respectively.
The owners of Buffington Homes, Inc. have an interest in Mortgage
Acceptance Corporation (MAC), which provides mortgage loan origination services
to customers of the Company. The Company pays origination fees to MAC on behalf
of customers of Buffington Homes. Fees in the amount of $447,000, and $584,000
were paid to MAC on behalf of customers of Buffington Homes in 1994 and 1995.
Buffington Homes, Inc. discontinued its relationship with MAC at the end of
1995.
F-104
<PAGE>
BUFFINGTON HOMES, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7--RELATED PARTY TRANSACTIONS--(CONTINUED)
The Company had notes payable outstanding to certain owners and their
immediate family members in the amount of $166,000, $330,000 and $260,000 at
December 31, 1994 and 1995 and at May 20, 1996. These notes bear interest at 10%
and mature in 1996.
NOTE 8--EMPLOYEE BENEFIT PLANS
The Company has a profit sharing plan covering substantially all employees.
The Company may contribute amounts as determined by the Board of Directors, not
in excess of the lesser of the maximum deduction allowable for income tax
purposes or a specified percentage of the operating profits of the Company, as
defined in the plan. The Company accrued contributions totaling $126,000 for the
year ended December 31, 1994. No contributions were made in 1995 or the period
January 1, 1996 through May 20, 1996.
NOTE 9--COMMITMENTS AND CONTINGENCIES
The Company currently leases its office space under a five year renewable
lease. Certain equipment is also leased under non-cancelable operating leases.
Rent expense under such leases aggregated $370,000, $378,000 and $105,000 during
the years ended December 31, 1994 and 1995 and for the period from January 1,
1996 through May 20, 1996. Future minimum lease payments as of December 31, 1995
were $139,000 and $35,000 for the remainder of 1996 and 1997.
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.
NOTE 10--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.
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1, 1996
THROUGH
MAY 20, 1996
---------------
<S> <C>
Net income before pro forma adjustments, per statement of
operations....................................................... $ 1,537
Pro forma adjustment:
Provision for income taxes at estimated effective rate of 40%.... 615
-------
Pro forma net income............................................... $ 922
-------
-------
</TABLE>
F-105
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors
and Shareholder of Christopher Homes, Inc.
In our opinion, the accompanying combined balance sheets and the related
combined statements of operations, shareholder's equity (deficit) and of cash
flows present fairly, in all material respects, the financial position of
Christopher Homes, Inc. and Affiliates (the 'Company') at May 20, 1996 and
December 31, 1995 and 1994, and the results of their operations and their cash
flows for the period January 1, 1996 through May 20, 1996 and for each of the
two years in the period ended December 31, 1995 in conformity with generally
accepted accounting principles. These financial statements are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements based on our 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. 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 believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1, Christopher Homes, Inc. was acquired by The
Fortress Group Inc. on May 20, 1996.
PRICE WATERHOUSE LLP
Minneapolis, Minnesota
February 11, 1997
F-106
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
COMBINED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
MAY 20, ------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
ASSETS
Cash............................................................................. $ 98 $ 495 $ 379
Receivables...................................................................... 508 710 338
Real estate inventories.......................................................... 34,149 28,457 26,671
Property and equipment, net...................................................... 623 517 495
Prepaid and other assets......................................................... 518 706 367
------- ------- -------
Total assets................................................................ $35,896 $30,885 $28,250
------- ------- -------
------- ------- -------
LIABILITIES AND SHAREHOLDER'S EQUITY
Accounts payable and accrued construction liabilities............................ $ 4,950 $ 3,040 $ 2,885
Notes and mortgages payable...................................................... 24,998 20,665 21,369
Special improvement district bonds............................................... 1,295 1,531 2,313
Related party payable............................................................ 76 353 899
Other accrued expenses........................................................... 263 921 341
Customer deposits................................................................ 3,769 3,660 3,006
------- ------- -------
Total liabilities........................................................... 35,351 30,170 30,813
------- ------- -------
------- ------- -------
Commitments and contingencies--Note 9
Shareholder's equity (deficit)
Common stock................................................................... 550 549 549
Retained (deficit) earnings.................................................... (5) 166 (3,112)
------- ------- -------
Total shareholder's equity (deficit)........................................ 545 715 (2,563)
Total liabilities and shareholder's equity.................................. $35,896 $30,885 $28,250
------- ------- -------
------- ------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-107
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
COMBINED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD YEAR ENDED
JANUARY 1, 1996 DECEMBER 31,
THROUGH --------------------
MAY 20, 1996 1995 1994
--------------- ------- -------
<S> <C> <C> <C>
Revenue:
Residential sales..................................................... $15,582 $34,726 $13,864
Lot sales............................................................. 537 3,824 849
Other revenue......................................................... -- 62 108
----------- ------- -------
Total revenue...................................................... 16,119 38,612 14,821
Cost of sales........................................................... 13,730 31,834 12,616
----------- ------- -------
Gross profit............................................................ 2,389 6,778 2,205
Operating expenses:
Selling expenses...................................................... 850 2,008 1,512
General and administrative expenses................................... 759 1,504 1,550
----------- ------- -------
Net operating income (loss)........................................ 780 3,266 (857)
Other (expense) income, net............................................. 12 120 359
----------- ------- -------
Net income (loss)....................................................... $ 792 $ 3,386 $ (498)
----------- ------- -------
----------- ------- -------
Unaudited pro forma net income (Note 10)................................ $ 475
-----------
-----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-108
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
COMBINED STATEMENTS OF SHAREHOLDER'S
(DEFICIT) EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
RETAINED
COMMON (DEFICIT)
STOCK EARNINGS TOTAL
------ -------- -------
<S> <C> <C> <C>
Balance at January 1, 1993........................................................ $549 $(2,134) $(1,585)
Distributions to shareholder.................................................... (480) (480)
Net loss........................................................................ -- (498) (498)
------ -------- -------
Balance at December 31, 1994...................................................... 549 (3,112) (2,563)
Contributions by shareholder.................................................... 357 357
Distributions to shareholder.................................................... (465) (465)
Net income...................................................................... -- 3,386 3,386
------ -------- -------
Balance at December 31, 1995...................................................... 549 166 715
Contributions by shareholder.................................................... 1 82 83
Distributions to shareholder.................................................... (1,045) (1,045)
Net income...................................................................... -- 792 792
------ -------- -------
Balance at May 20, 1996........................................................... $550 $ (5) $ 545
------ -------- -------
------ -------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-109
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD YEAR ENDED
JANUARY 1, 1996 DECEMBER 31,
THROUGH --------------------
MAY 20, 1996 1995 1994
--------------- ------- -------
<S> <C> <C> <C>
Cash flows from operating activities
Net income (loss)..................................................... $ 792 $ 3,386 $ (498)
Adjustments to reconcile net income to net cash (used in) provided by
operating activities:
Equity in income from investment partnership....................... (4)
Depreciation and amortization...................................... 76 182 163
Loss on disposition of property and equipment...................... 6
Basis of property and equipment included in cost of sales.......... 169
Changes in operating assets and liabilities:
Real estate inventories.......................................... (5,693) (2,409) (10,805)
Receivables...................................................... 203 (373) 120
Prepaid and other assets......................................... 188 (339) (31)
Accounts payable and accrued construction liabilities............ 1,910 155 1,563
Other accrued expenses........................................... (658) 580 61
Customer deposits................................................ 109 654 705
----------- ------- -------
Net cash (used in) provided by operating activities........... (3,073) 1,836 (8,551)
----------- ------- -------
Cash flows from investing activities
Proceeds from sale of land held for investment........................ 76
Purchase of property and equipment.................................... (182) (203) (384)
Proceeds from sale of property and equipment.......................... 10
----------- ------- -------
Net cash used in investing activities......................... (182) (203) (298)
Cash flows from financing activities
Borrowings under notes and mortgages payable.......................... 15,254 37,264 20,300
Repayments of notes and mortgage payable.............................. (10,920) (37,968) (11,206)
Repayments of special improvement district bonds........................ (236) (160) (84)
Net (repayments to) advances from related parties..................... (278) (545) 557
Distributions to shareholder.......................................... (1,045) (465) (480)
Contributions to shareholder.......................................... 83 357
----------- ------- -------
Net cash provided by (used in) financing activities........... 2,858 (1,517) 9,087
----------- ------- -------
Net increase in cash and cash equivalents............................... (397) 116 238
Cash, beginning of period............................................... 495 379 141
----------- ------- -------
Cash, end of period..................................................... $ 98 $ 495 $ 379
----------- ------- -------
----------- ------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-110
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE 1--BUSINESS AND ORGANIZATION
Christopher Homes, Inc. and Affiliates (the Company) is a group of entities
owned or controlled by J. Christopher Stuhmer primarily engaged in the
construction of attached and detached single and multi-family homes in the Las
Vegas metropolitan area.
Effective May 20, 1996, the Company and its shareholder executed a
definitive agreement with the Fortress Group, Inc. (Fortress) pursuant to which
the Company merged with Fortress (the Merger). All outstanding shares of the
Company were exchanged for cash and shares of Fortress's common stock concurrent
with the consummation of the initial public offering of Fortress.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Combination
The combined financial statements include the accounts of Christopher
Homes, Inc. (CH), J. Christopher Stuhmer, Inc. (JCS), Christopher Homes Design
Center (DC), Christopher Homes--Custom Home Division, Inc. (CHD), all of which
are Nevada corporations, and Country Club Hills Limited Partnership (CCH), a
Nevada Limited Partnership. CH, JCS and CHD are wholly owned by J. Christopher
Stuhmer. CHD is the general partner of CCH. All significant intercompany
accounts and transactions have been eliminated in combination.
As of May 20, 1996, the following common stock was authorized, issued and
outstanding:
CH-- No par or stated value, 2,500 shares authorized, 1,000 shares issued
and outstanding.
JCS-- No par or stated value, 2,500 shares authorized, 100 shares issued
and outstanding.
DC--No par or stated value, 2,500 shares authorized, 500 shares issued and
outstanding.
CHD--No par or stated value, 2,500 shares authorized, 1,000 shares issued
and outstanding.
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 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.
Real Estate Inventories and Cost of Sales
Real estate inventories 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. 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.
F-111
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
At the time of revenue recognition, cost of sales is charged with the
actual construction costs incurred and any estimate to complete, plus an
allocation of the development's 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 or two 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.
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.
Property and Equipment
Property and equipment is carried at cost less accumulated depreciation and
is depreciated using the declining balance method over the estimated useful
lives of the assets which range from five to seven years. Significant additions
and improvements are capitalized while expenditures for repairs and maintenance
are charged to operations as incurred.
Income Taxes
Since 1987, CHD has been a subchapter S corporation and CCH has been a
limited partnership for income tax purposes and, accordingly, any income tax
liabilities were the responsibility of the respective company's shareholder or
partners.
DC was formed as a subchapter S corporation in 1996. CHD's subschapter S
corporation status and CCH's limited partnership status will terminate on the
consummation of the Merger as disclosed in Note 1.
Both CH and JCS are subchapter C corporation for income tax purposes and
had net operating loss carryforwards available at May 20, 1996. Both CH and
JCS's subchapter C corporation status and the availability of the net operating
loss carryfowards will terminate upon the completion of the Merger as disclosed
in Note 1.
Statement of Cash Flows
Supplemental disclosures of cash flow information are as follows (in
thousands):
<TABLE>
<CAPTION>
FOR THE PERIOD YEAR ENDED
JANUARY 1, 1996 DECEMBER 31,
THROUGH -----------------
MAY 20, 1996 1995 1994
---------------- ------ ------
<S> <C> <C> <C>
Cash paid for interest............................................ $503 $2,759 $1,916
Non-cash transactions:
Net assumptions and assignment of Special Improvement District
bonds........................................................ (83) 623 590
</TABLE>
F-112
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 3--REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
MAY 20, ------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Work-in-progress
Sold homes under construction........................................ $20,673 $14,027 $ 9,784
Speculative homes.................................................... 8,109 4,068 2,504
------- ------- -------
28,782 18,095 12,288
------- ------- -------
Land
Finished lots........................................................ 4,832 7,742 6,819
Land under development............................................... 0 916 5,975
------- ------- -------
4,832 8,658 12,794
------- ------- -------
Models................................................................. 535 1,704 1,589
------- ------- -------
Total............................................................. $34,149 $28,457 $26,671
------- ------- -------
------- ------- -------
</TABLE>
NOTE 4--INVESTMENTS IN PARTNERSHIPS
The Company was a managing partner with a 35% ownership in two partnerships
which are accounted for under the equity method. The investment balance is
included in other assets on the combined balance sheet.
The investments in partnerships were not material to the December 31, 1994
and 1995, and May 20, 1996 combined balance sheets or to the combined statements
of operations for the years ended December 31, 1994 and 1995 and the period from
January 1, 1996 through May 20, 1996.
NOTE 5--PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
MAY 20, --------------
1996 1995 1994
------- ----- -----
<S> <C> <C> <C>
Equipment and furniture...................................................... $ 330 $ 226 $ 223
Vehicles..................................................................... 74 98 117
Model home and sales office furnishings...................................... 707 551 450
Other........................................................................ 107 67
------- ----- -----
1,111 982 857
Less: Accumulated depreciation and amortization.............................. (488) (465) (362)
------- ----- -----
$ 623 $ 517 $ 495
------- ----- -----
------- ----- -----
</TABLE>
F-113
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 6--NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
MAY 20, ------------------
1996 1995 1994
------- ------- -------
<S> <C> <C> <C>
Conventional land acquisition and development loans.................... $14,196 $11,081 $12,280
Subordinated investor notes............................................ 10,573 9,181 6,091
Demands for deed on sales-leaseback.................................... 230 2,370
General revolving lines of credit...................................... 200 120 590
Other.................................................................. 29 53 38
------- ------- -------
$24,998 $20,665 $21,369
------- ------- -------
------- ------- -------
</TABLE>
Conventional land acquisition and development loans are collateralized by
property under construction, are payable in monthly interest only installments
and are due on the earlier of the close of escrow on the related collateral or
the due date. These loans bear interest at the prime rate plus 1.5% to 2% (9.75%
to 10.25% at May 20, 1996).
Subordinated investor notes are generally collateralized by deeds of trust
subordinate to the conventional land acquisition and development loans. The
notes are payable in monthly distributions equal to a 15% annualized return and
a 10% fee due at the closing of the loan.
Demands for deed on sales-leaseback represent financing arrangements on
certain finished model homes which are leased by the Company for up to two years
for marketing purposes. The demands for deed yield approximately 12% annually,
with a 3% commission paid upon resale of the model home.
General revolving lines of credit bear interest at the prime rate plus 2%
(10.25% at May 20, 1996) and are due on demand.
The Company's management believes that cost approximates fair value for
notes and mortgages payable at December 31, 1994 and 1995 and May 20, 1996.
Substantially all of the conventional land acquisition and development
loans and subordinated investor notes are personally guaranteed by the sole
shareholder of the Company and his spouse.
Interest incurred and capitalized totaled approximately $1,976,000,
$4,421,000, and $2,000,000 for the years ended December 31, 1994 and 1995 and
for the period January 1, 1996 through May 20, 1996, respectively.
At May 20, 1996, the Company has approximately $10,200,000 in unused lines
of credit available for construction loans, which is subject to collateral
requirements.
Maturities of notes and mortgages payable in future years are as follows
(in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1996..................................................................... $22,642
1997..................................................................... 2,356
-------
$24,998
-------
-------
</TABLE>
NOTE 7--SPECIAL IMPROVEMENTS
Special Improvement District (SID) bonds payable were $2,313,032,
$1,531,267 and $1,300,000 at December 31, 1994 and 1995 and May 20, 1996,
respectively.
SID bonds consist of special assessments issued by the city of Las Vegas to
fund the acquisition and construction of certain public improvements
specifically 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
F-114
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7--SPECIAL IMPROVEMENTS--(CONTINUED)
on property within the district and are payable by the property owners. Interest
rate assessments are due on April 1 and October 1 of each year until October 1,
2009. The bonds are due October 1, 2009, unless assumed by buyers of homes from
the Company. Management believes that maturities of these obligations, prior to
buyer assumptions thereof, are not material to the Company's combined financial
statements.
NOTE 8--RELATED PARTY TRANSACTIONS
Related party receivables as of December 31, 1994 and 1995 and May 20, 1996
were $105,920, $54,269 and $177,000, respectively, and are included in
receivables on the combined balance sheets.
JCS provided certain accounting services for related parties and in return
received a management fee, which was $342,534, and $39,000 for the years ended
December 31, 1994 and 1995, respectively. There were no such services provided
or fees received in the period January 1, 1996 through May 20, 1996.
Sales commissions paid by related parties to CHD amounted to $108,079 and
$62,000 for the years ended December 31, 1994 and 1995, respectively. No sales
commissions were earned or paid by related parties for the period January 1,
1996 through May 20, 1996.
Home sales to related parties were $596,080 and $581,000 for the year ended
December 31, 1995 and the period January 1, 1996 through May 20, 1996. No home
sales were made to related parties in 1994.
The Company paid rent during the years ended December 31, 1994 and 1995 and
from January 1, 1996 through May 20, 1996 of $33,858, $34,431, and $14,000,
respectively, for office and warehouse space under a month-to-month lease to a
related party.
NOTE 9--COMMITMENTS AND CONTINGENCIES
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 those legal proceedings will have a material adverse impact on the
financial condition or results of operations of the Company.
The Company rents model homes under cancelable and non-cancelable operating
leases. All non-cancelable leases expire during 1996. Minimum lease payments on
non-cancelable leases for the period January 1, 1996 through May 20, 1996 are
approximately $65,000.
Model home lease expense for the years ended December 31, 1994 and 1995 and
the period January 1, 1996 through May 20, 1996 was $61,198, $204,365 and
$175,000, respectively.
The Company has signed a letter of intent to purchase a parcel of land for
$7,695,000 in a master planned development in Las Vegas, Nevada.
F-115
<PAGE>
CHRISTOPHER HOMES, INC. AND AFFILIATES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 10--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.
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1, 1996
THROUGH
MAY 20, 1996
---------------
<S> <C>
Net income before pro forma adjustments, per statement of
operations....................................................... $ 792
Pro forma adjustment:
Provision for income taxes at estimated effective rate
of 40%........................................................ 317
------
Pro forma net income............................................... $ 475
------
------
</TABLE>
F-116
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholder
of The Genesee Company
In our opinion, the accompanying combined balance sheets and the related
combined statements of operations, shareholder's equity and of cash flows
present fairly, in all material respects, the financial position of The Genesee
Company and Related Entities at May 20, 1996 and 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 the Company's management; our responsibility 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. 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 believe that our
audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 1, The Genesse Company and Related Entities were
acquired by The Fortress Group Inc. on May 20, 1996.
PRICE WATERHOUSE LLP
Denver, Colorado
February 20, 1997
F-117
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors
The Genesee Company
Golden, Colorado
We have audited the accompanying combined balance sheet of The Genesee
Company and related entities as of December 31, 1994, and the related combined
statements of operations, shareholder's equity and cash flows for the year then
ended. These combined financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
combined financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the combined financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the combined financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall combined
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present
fairly, in all material respects, the combined financial position of The Genesee
Company and related entities as of December 31, 1994, and the results of their
operations and their cash flows for year then ended, in conformity with
generally accepted accounting principles.
HEIN & ASSOCIATES LLP
December 12, 1995
Denver, Colorado
F-118
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
COMBINED BALANCE SHEETS
(IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------ MAY 20,
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
ASSETS
Cash and cash equivalents........................................................ $ 1,364 $ 978 $ 1,455
Related party and other receivables.............................................. 155 850 1,639
Real estate inventories.......................................................... 47,676 49,673 56,232
Equipment and furniture, net of accumulated depreciation of
$200, $215 and $227, respectively.............................................. 227 241 229
Prepaid and other assets......................................................... 1,125 1,178 1,460
------- ------- -------
Total assets................................................................ $50,547 $52,920 $61,015
------- ------- -------
------- ------- -------
LIABILITIES AND SHAREHOLDER'S EQUITY
Accounts payable and accrued construction........................................ $ 2,102 $ 3,409 $ 2,958
Notes payable.................................................................... 41,175 41,393 50,184
Due to related parties........................................................... 1,422 1,003 1,382
Other accrued expenses........................................................... 930 1,462 1,542
Customer deposits................................................................ 1,013 872 1,311
------- ------- -------
Total liabilities........................................................... 46,642 48,139 57,377
------- ------- -------
------- ------- -------
Commitments and contingencies (Note 8)........................................... -- --
Shareholder's Equity:
Common stock................................................................... 3 3 3
Additional paid-in capital..................................................... 1,655 1,770 2,234
Retained earnings.............................................................. 2,247 3,008 1,401
------- ------- -------
Total shareholder's equity.................................................. 3,905 4,781 3,638
------- ------- -------
------- ------- -------
Total liabilities and shareholder's equity..................................... $50,547 $52,920 $61,015
------- ------- -------
------- ------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-119
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
COMBINED STATEMENTS OF OPERATIONS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1994 1995
---------- ----------
<S> <C> <C>
Revenue:
Residential sales.................................................... $ 59,539 $ 60,534
Lot sales............................................................ 3,020 4,274
Other revenue........................................................ -- 222
---------- -----------
62,559 65,030
Cost of sales.......................................................... (53,887) (57,620)
---------- -----------
Gross profit........................................................... 8,672 7,410
Operating expenses:
Selling expenses..................................................... 4,184 4,451
General and administrative expenses.................................. 2,620 2,098
---------- -----------
Net income (loss)...................................................... $ 1,868 $ 861
---------- -----------
---------- -----------
Unaudited pro forma net loss (Note 9)..................................
<CAPTION>
FOR THE
PERIOD
JANUARY 1,
1996
THROUGH
MAY 20, 1996
------------
<S> <C>
Revenue:
Residential sales.................................................... $ 15,323
Lot sales............................................................ 499
Other revenue........................................................ 56
-----------
15,878
Cost of sales.......................................................... 14,768
----------
Gross profit........................................................... 1,110
Operating expenses:
Selling expenses..................................................... 1,379
General and administrative expenses.................................. 900
----------
Net income (loss)...................................................... $ (1,169)
----------
----------
Unaudited pro forma net loss (Note 9).................................. $(12,637)
----------
----------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-120
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
COMBINED STATEMENTS OF SHAREHOLDER'S EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
ADDITIONAL TOTAL
COMMON PAID-IN RETAINED SHAREHOLDER'S
STOCK CAPITAL EARNINGS EQUITY
------ ---------- -------- --------------
<S> <C> <C> <C> <C>
Balance at January 1, 1994....................................... $3 $1,265 $ 1,814 $ 3,082
Stock option exercise.......................................... -- 390 -- 390
Distributions.................................................. -- -- (1,435) (1,435)
Net income..................................................... -- -- 1,868 1,868
--------- -------- ------------
Balance at December 31, 1994..................................... 3 1,655 2,247 3,905
Capital contributions.......................................... -- 115 -- 115
Distributions.................................................. -- -- (100) (100)
Net income..................................................... -- -- 861 861
--------- -------- ------------
Balance at December 31, 1995..................................... 3 1,770 3,008 4,781
Capital contributions.......................................... 464 464
Distributions.................................................. (438) (438
Net loss....................................................... -- -- (1,169) (1,169)
--------- -------- ------------
Balance at May 20, 1996.......................................... $3 $2,234 $ 1,401 $ 3,638
--------- -------- ------------
--------- -------- ------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-121
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
COMBINED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------
1994 1995
----------- -----------
<S> <C> <C>
Cash flows from operating activities
Net income (loss).................................................... $ 1,868 $ 861
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation expense.............................................. 72 78
Changes in operating assets and liabilities:
Decrease (increase) in:
Related party and other receivables.......................... 252 (695)
Real estate inventories...................................... (16,037) (1,997)
Prepaid and other assets..................................... (418) (53)
Increase (decrease) in:
Accounts payable and accrued construction.................... 301 1,307
Other accrued expenses....................................... (72) 497
Customer deposits............................................ 188 (141)
----------- ----------
Net cash used in operating activities........................ (13,846) (143)
----------- ----------
Cash flows from investing activities
Purchases of equipment and furniture................................. (53) (57)
----------- ----------
Net cash used in investing activities........................ (53) (57)
----------- ----------
Cash flows from financing activities
Borrowings under notes payable....................................... 50,226 39,846
Repayments of notes payable.......................................... (34,802) (39,628)
Related party borrowings............................................. 1,533 1,109
Repayments of related party borrowings............................... (1,013) (1,528)
Distributions to shareholder......................................... (1,435) (100)
Stock option exercis................................................. 390 115
----------- ----------
Net cash provided by (used in) financing activities.......... 14,899 (186)
----------- ----------
Increase (decrease) in cash and cash equivalents....................... 1,000 (386)
Cash and cash equivalents, beginning of period......................... 364 1,364
----------- ----------
Cash and cash equivalents, end of period............................... $ 1,364 $ 978
----------- ----------
----------- ----------
<CAPTION>
FOR THE
PERIOD
JANUARY 1,
1996
THROUGH
MAY 20, 1996
------------
<S> <C>
Cash flows from operating activities
Net income (loss).................................................... $ (1,169)
Adjustments to reconcile net income to net cash used in operating
activities:
Depreciation expense.............................................. 23
Changes in operating assets and liabilities:
Decrease (increase) in:
Related party and other receivables.......................... (789)
Real estate inventories...................................... (6,559)
Prepaid and other assets..................................... (282)
Increase (decrease) in:
Accounts payable and accrued construction.................... (451)
Other accrued expenses....................................... 80
Customer deposits............................................ 439
------------
Net cash used in operating activities........................ (8,708)
------------
Cash flows from investing activities
Purchases of equipment and furniture................................. (11)
------------
Net cash used in investing activities........................ (11)
------------
Cash flows from financing activities
Borrowings under notes payable....................................... 15,789
Repayments of notes payable.......................................... (6,998)
Related party borrowings............................................. 611
Repayments of related party borrowings............................... (232)
Distributions to shareholder......................................... (438)
Stock option exercis................................................. 464
------------
Net cash provided by (used in) financing activities.......... 9,196
------------
Increase (decrease) in cash and cash equivalents....................... 477
Cash and cash equivalents, beginning of period......................... 978
------------
Cash and cash equivalents, end of period............................... $ 1,455
------------
------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-122
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
NOTES TO COMBINED FINANCIAL STATEMENTS
NOTE 1--BUSINESS AND ORGANIZATION
The combined financial statements consist of the accounts of The Genesee
Company combined with those of The Genesee Company/Castle Pines, Ltd., The
Genesee Company of Michigan, Ltd., Genesee Venture Corporation (dba The Genesee
Company Building Group, Inc.) and, subsequent to December 31, 1994, those of
Genesee Communities I, Inc., Genesee Communities II, Inc. and Genesee
Development Company (collectively referred to as the Company). These entities
are related through common ownership and management.
The Company is engaged primarily in the construction and sale of
single-family residential property in Colorado and Arizona. The Company designs,
builds, and sells single-family homes on finished lots, which it purchases ready
for home construction or which it develops. The Company also purchases
undeveloped land to develop finished lots for sale to others.
Effective May 20, 1996, the Company and its shareholder executed a
definitive agreement with the Fortress Group, Inc. (Fortress) pursuant to which
the Company merged with Fortress (the Merger). All outstanding shares of the
Company were exchanged for cash and shares of Fortress's common stock concurrent
with the consummation of the initial public offering of Fortress.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Combination
The combined financial statements include the accounts of the entities
described in Note 1, all of which are 100% owned by the same shareholder.
Intercompany accounts and transactions have been eliminated in combination.
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
Revenues from residential 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.
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 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, plus an
allocation of the total estimated cost of land and land development, interest,
real estate taxes and any other capitalizable common costs.
F-123
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Interest charged to cost of sales is as follows (in thousands):
<TABLE>
<CAPTION>
FOR THE PERIOD
YEAR ENDED DECEMBER 31, JANUARY 1, 1996
-------------------------------------------------- THROUGH
1994 1995 MAY 20, 1996
----------------------- ----------------------- ---------------
<S> <C> <C> <C>
Interest on loans from financial institutions............. $ 1,848 $ 2,328 $ 589
Profit sharing interest under equity participation
agreements.............................................. 1,084 1,224 239
Interest on subordinated notes............................ 926 981 534
------- ------- -------
$ 3,858 $ 4,533 $ 1,362
------- ------- -------
------- ------- -------
</TABLE>
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.
Equipment and Furniture
Equipment and furniture are carried at cost less accumulated depreciation.
Depreciation is computed using the straight-line method over the estimated
useful lives of the assets which range in years from five to ten. Significant
additions and improvements are capitalized, while expenditures for repairs and
maintenance are charged to operations as incurred.
Other Assets
Other assets includes costs incurred for common area model improvements and
certain furnishings. These costs are amortized on a per unit basis as home sales
in the related development are closed.
Concentrations of Credit Risk
The Company's operations are concentrated in the construction and sale of
single-family residential property in Colorado and Arizona. Furthermore, the
Company from time to time maintains cash balances at certain financial
institutions in excess of Federally insured limits.
Income Taxes
The Company is a Subchapter S corporation for income tax purposes, and
accordingly, any income tax liabilities are the responsibility of the Company's
shareholder. The Company's Subchapter S corporation status will terminate on
consummation of the Merger as disclosed in Note 1. See Note 9 for information
regarding the unaudited pro forma net loss tax information.
F-124
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Cash and 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):
<TABLE>
<CAPTION>
FOR THE PERIOD
YEAR ENDED DECEMBER 31, JANUARY 1, 1996
-------------------------------------------------- THROUGH
1994 1995 MAY 20, 1996
----------------------- ----------------------- ---------------
<S> <C> <C> <C>
Cash paid for interest:
Related parties......................................... $ 114 $ 140 $ 47
Other................................................... 2,548 3,605 1,157
Office equipment acquired through capital leases.......... 45 35
</TABLE>
NOTE 3--REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------- MAY 20,
1994 1995 1996
------------ ------------ -------
<S> <C> <C> <C>
Work-in-progress:
Sold homes under construction........................................ $ 16,039 $ 7,507 $10,790
Speculative homes.................................................... 9,863 15,627 15,447
------------ ------------ -------
25,902 23,134 26,237
------------ ------------ -------
Land:
Finished lots........................................................ 15,446 17,436 23,687
Land under development............................................... 2,100 5,48
Land and other costs................................................. 729 -- 1,403
------------ ------------ -------
18,275 22,923 25,090
------------ ------------ -------
Models:................................................................ 3,499 3,616 4,905
------------ ------------ -------
Total............................................................. $ 47,676 $ 49,673 $56,232
------------ ------------ -------
------------ ------------ -------
</TABLE>
Speculative homes and models include completed homes and homes under
construction. Speculative construction represents homes built without an advance
sales contract in order to accelerate closing. Completed homes include the
allocation of land and development and other allocable costs. At May 20, 1996,
the real estate inventories balance includes approximately $430,000 of
capitalized general and administrative costs.
NOTE 4--NOTES PAYABLE
Notes payable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------- MAY 20,
1994 1995 1996
------------ ------------ -------
<S> <C> <C> <C>
Project specific construction loans.................................... $ 20,639 $ 16,685 $25,855
Conventional land acquisition and development loans.................... 10,140 13,746 11,331
Subordinated notes and equity participation loans...................... 10,396 10,416 12,402
Unsecured lines of credit.............................................. -- 546 596
------------ ------------ -------
$ 41,175 $ 41,393 $50,184
------------ ------------ -------
------------ ------------ -------
</TABLE>
F-125
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4--NOTES PAYABLE--(CONTINUED)
Project specific construction loans and conventional land acquisition and
development loans consist of land, land development, and construction loans
primarily from financial institutions. These loans bear interest at annual rates
ranging from 1% to 2% over prime (9.25% to 10.25% at May 20, 1996) and both
principal and interest are normally paid at the time the related real estate
properties are sold. The loan agreements include customary representations and
covenants, including limitations on the maximum principal amount that can be
outstanding at any time. All outstanding indebtedness under these facilities is
collateralized by a lien on the related real estate inventories, and all of
these loans are personally guaranteed by the Company's sole shareholder. At May
20, 1996, the Company was not in compliance with the reporting requirements of
certain loan agreements with one of their financial institutions. As a result,
this financial institution may, at its option, demand immediate payment of
amounts outstanding under the respective loan agreement. However, the financial
institution continued to advance additional funds to the Company and by December
31, 1996, the company was in compliance with these covenants.
Subordinated notes consist of notes from private investors, some of which
are unsecured and some of which are collateralized by a lien on the Company's
real estate inventories, and all of which are personally guaranteed by the
Company's sole shareholder. 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.
The Company has entered into a series of equity participation agreements
and related notes payable with one private investor. Under these agreements, the
Company had outstanding advances from this equity participant totaling
approximately $6,097,000, $4,559,000 and $4,479,000 as of December 31, 1994 and
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 these
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 payable. However, at May 20, 1996, the
Company had one equity participation note payable which requires 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, the Company has accrued
approximately $289,000 in interest costs, all of which has been capitalized,
related to this note since the development is in the start-up stage and net
profits earned as of May 20, 1996 have been less than the minimum rate of return
guaranteed the investor. Other than this note, only in the event of default in
principal payment at maturity would interest 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 instances in which interest has
been accrued on an equity participation note payable due to an event of default.
The Company periodically reviews the expected profits and cash flows of
developments with equity participation notes payable and would accrue interest
on the notes if it determines that an event of default is 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 the Company's discretion, as
follows: (i) distributions are to repay the principal balance and interest, if
applicable, of the equity participation note payable related to that
development; and (ii) once the principal balance of the equity participation
note payable for a development is repaid, net profits are distributed between
the equity participant and the Company.
F-126
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4--NOTES PAYABLE--(CONTINUED)
Maturities of notes payable at May 20, 1996 in future periods are as
follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1996..................................................................... $31,165
1997..................................................................... 16,249
1998..................................................................... 2,770
-------
$50,184
-------
-------
</TABLE>
The timing of repayments on these notes may differ from the above schedule
due to the repayment of terms of these notes, described above, some of which may
require earlier repayment.
Interest incurred and capitalized during the years ended December 31, 1994,
1995 and the period from January 1, 1996 to May 20, 1996 aggregated
approximately $4,746,000, $6,597,000, and $2,183,000 respectively.
NOTE 5--SHAREHOLDER'S EQUITY
The following is a summary of the authorized, issued and outstanding shares
of the combined entities:
<TABLE>
<CAPTION>
SHARES ISSUED
AND OUTSTANDING
DECEMBER 31,
FAIR SHARES ------------------------------ MAY 20,
VALUE AUTHORIZED 1994 1995 1996
------ ---------- ------------- ------------- -------
<S> <C> <C> <C> <C> <C>
The Genesee Company............................................ No par 100,000 2,000 90,000 90,000
The Genesee Company/Castle Pines, Ltd.......................... $ 1.00 10,000 1,000 1,000 1,000
Genesee Company of Michigan, Ltd............................... No par 10,000 1,000 1,000 1,000
Genesee Venture Corporation.................................... $ 1.00 10,000 100 100 100
Genesee Communities I, Inc..................................... $ 1.00 10,000 -- -- --
Genesee Communities II, Inc.................................... $ 1.00 10,000 -- -- --
Genesee Development Company.................................... $ 1.00 10,000 -- -- --
</TABLE>
In 1995, the Company adopted an incentive stock option plan for certain
employees. The plan allows the grant of options to purchase up to 10,000 shares
of the Company'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 in control or the occurrence of certain other events as specified in the
plan agreement. No options were granted during the period ended May 20, 1996. Of
the 10,000 options outstanding at December 31, 1995, 9,250 options were
exercised on May 20, 1996 and 750 options were forfeited.
During 1995, options to purchase 10,000 shares of the Company's common
stock were granted at an exercise price of $50.15 per share. All outstanding
options were exercised on May 20, 1996.
SFAS No. 123, 'Accounting for Stock-Based Compensation,' issued in October
1995, established financial accounting and reporting standards for stock-based
employee compensation plans. As permitted by SFAS No. 123, the Company elected
to continue to use Accounting Principles Board Opinion No. 25, Accounting for
Stock Issued to Employees and related interpretations, in accounting for its
incentive stock option plan.
If the Company had elected to recognize compensation expense based on the
fair value of the options granted as well as the vesting provisions of the
options, net income for 1995 would have been reduced by $16,800. The fair value
of the stock options on the date of grant was estimated using the Black-Scholes
option pricing model with the following assumptions: no volatility, a risk free
rate of 5.36%, an expected life of 7.5 months, and no dividend payouts.
F-127
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 6--RELATED PARTY TRANSACTIONS
The Company 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 the Company. The
Company pays a management fee consisting of a fixed monthly fee, plus an
additional fee of 0.5% of gross sales, as defined in the management agreement.
For the years ended December 31, 1994 and 1995 the Company has recorded
approximately $356,000 and $98,000 in management fees for services performed
under this agreement. The marketing and management services provided pursuant to
the agreement were terminated as of January 1, 1996.
The Company provides management services for three entities owned by the
sole shareholder of the Company. The Company is compensated by these related
entities based upon time spent performing services on their behalf. For the
years ended December 31, 1994 and 1995, the Company recognized management fee
revenues of approximately $13,000 and $25,000, respectively, for services
provided. No such services were provided during 1996.
In 1991, the Company became a general partner in a limited partnership to
purchase and develop land for resale. The Company had a 10% interest in the
partnership prior to the transfer of its interest in the partnership at book
value effective January 1, 1993, to a company from which the sole shareholder
receives compensation for management services. The Company receives a monthly
management fee from the partners for work performed on behalf of the
partnership. The Company recognized approximately $90,000 in 1994 in management
fees under this agreement. No fees were recognized in 1995 and 1996.
During 1993, the Company began receiving a two-part management fee from the
partnership for oversight of the development of a land parcel on behalf of the
partnership. The Company is entitled to a management fee equal to 4% of the cost
of developing the parcel, plus an additional fee equal to 1 1/2% of gross sales
of lots on this parcel. In 1994, 1995 and 1996, the Company recognized
approximately $12,000, $6,000 and $3,000, respectively, in management fee income
under these arrangements. The Company is also entitled to a marketing fee of 4%
of gross sales of lots on this parcel, but the Company has allowed a company,
which actually markets the lots and from which the sole shareholder receives
compensation for management services, to receive this fee directly from the
partnership with no impact on the combined financial statements of the Company.
The Company has also entered into several agreements to purchase land from
the limited partnership at estimated fair market value. During 1994, the Company
purchased approximately $2,702,000 in land from the partnership for future home
construction. No land was purchased under these agreements during 1995 or 1996.
The Company pays a fee to an entity owned by the sole shareholder of the
Company based on the number of homes closed in a particular development as
compensation for assistance in negotiations related to the purchase of the land
for the development. In 1994, 1995 and 1996, the Company paid approximately
$145,000, $5,000 and $0, respectively, in compensation to this entity which has
been recognized as a cost of sales in the combined financial statements of the
Company.
Receivables from related parties represent non-interest bearing advances
and notes to the shareholder and related entities. Such amounts are generally
due on demand or within one year.
The Company has made home sales to several employees, for which sales
revenue and the related cost of sales have been included in the accompanying
combined Statements of Operations. For the years ended December 31, 1994, 1995
and the period January 1, 1996 through May 20, 1996, the Company has recognized
revenues of approximately $454,000, $0 and $443,000, respectively, and cost of
sales of approximately $405,000, $0 and $363,000, respectively, in connection
with these sales.
NOTE 7--EMPLOYEE BENEFIT PLAN
The Company 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 eligible employees of the
F-128
<PAGE>
THE GENESEE COMPANY AND RELATED ENTITIES
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 7--EMPLOYEE BENEFIT PLAN--(CONTINUED)
Company. The Company may make annual discretionary contributions to the plan.
Discretionary contributions of $150,000 were made in December 31, 1994. No
discretionary contributions were made by the Company for the year ended December
31, 1995 and the period from January 1, 1996 through May 20, 1996.
NOTE 8--COMMITMENTS AND CONTINGENCIES
The Company leases office space at one of its locations on a month-to-month
basis from a company wholly-owned by the sole shareholder. Office rent expense
under this lease aggregated $94,000, $102,000 and $42,000 for the years ended
December 31, 1994, 1995 and the period from January 1, 1996 through May 20,
1996, respectively. The Company also leases office space at two other locations
from non-related parties; office rent expense under these leases aggregated
approximately $17,000, $20,000 and $10,000 for the years ended December 31,
1994, 1995 and the period from January 1, 1996 through May 20, 1996,
respectively. Total minimum rental commitments at May 20, 1996 are approximately
$78,000 and $7,000 for the remainder of 1996 and 1997, respectively.
The Company leases certain office equipment under agreements classified as
capital leases. Office equipment under these leases has a cost of $196,000,
$206,000 and $207,000 and accumulated depreciation of approximately $52,000,
$81,000 and $97,000 as of December 31, 1994 and 1995 and as of May 20, 1996,
respectively. The following is a schedule of future minimum lease payments (in
thousands) under capital leases at May 20, 1996:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- ------------------------
<S> <C>
1996.......................................................................... $31
1997.......................................................................... 24
1998.......................................................................... 9
---
$64
---
---
</TABLE>
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.
NOTE 9--UNAUDITED PRO FORMA NET LOSS
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.
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1, 1996
THROUGH
MAY 20, 1996
---------------
<S> <C>
Net loss before pro forma adjustments, per statement of operations..................... $(1,169)
Pro forma adjustment:
Provision for income taxes at estimated effective rate of 40%........................ 468
------------
Pro forma net loss..................................................................... $(1,637)
------------
------------
</TABLE>
F-129
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Solaris Development Corporation
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of income, shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of Solaris
Development Corporation at May 20, 1996 and the results of their operations and
their cash flows for the period January 1, 1996 through May 20, 1996 in
conformity with generally accepted accounting principles. These financial
statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audit. We conducted our audit 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
believe that our audit provides a reasonable basis for the opinion expressed
above.
As discussed in Note 1, Solaris Development Corporation was acquired by The
Fortress Group, Inc. on May 20, 1996.
PRICE WATERHOUSE LLP
Raleigh, North Carolina
December 11, 1996
F-130
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
<TABLE>
<CAPTION>
MAY 20,
1996
-------
<S> <C>
ASSETS
Housing inventory (Note 3)............................................................................. $18,717
Cash................................................................................................... 1,214
Related party accounts receivable (Note 7)............................................................. 241
Other assets, net of accumulated amortization of $14,207............................................... 207
Property and equipment, net............................................................................ 455
-------
Total assets................................................................................. $20,834
-------
-------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and other liabilities................................................................. $ 2,395
Lines of credit (Note 5)............................................................................... 1,358
Notes payable (Note 4)................................................................................. 13,457
Customer deposits...................................................................................... 688
-------
Total liabilities............................................................................ 17,898
Minority interest...................................................................................... 1,383
Shareholders' equity:
Common stock, no par value, 100,000 shares authorized, 3,000 shares issued and outstanding........ 1
Retained earnings................................................................................. 1,552
-------
Total shareholders' equity................................................................... 1,553
-------
Commitments (Note 8)
Total liabilities and shareholders' equity................................................... $20,834
-------
-------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-131
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1, 1996
THROUGH
MAY 20, 1996
---------------
<S> <C>
Revenue:
Residential homebuilding revenue............................................................... $11,747
Other revenue.................................................................................. 43
------------
Total revenue.......................................................................... 11,790
Cost and expenses:
Cost of sales.................................................................................. 9,863
General and administrative..................................................................... 725
Selling and marketing.......................................................................... 999
------------
11,587
------------
Income before minority interest........................................................ 203
Other expenses:
Minority interest in income of joint ventures.................................................. 89
------------
Net income....................................................................................... $ 114
------------
------------
Unaudited pro forma net income (Note 11)......................................................... $ 68
------------
------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-132
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
(IN THOUSANDS)
<TABLE>
<CAPTION>
TOTAL
COMMON RETAINED SHAREHOLDERS'
STOCK EARNING EQUITY
------ -------- --------------
<S> <C> <C> <C>
Balance at December 31, 1995.................................................. $1 $2,080 $2,081
Net income.................................................................. -- 114 114
Distributions to shareholders............................................... -- (642) (642)
------ -------- -------
Balance at May 20, 1996....................................................... $1 $1,552 $1,553
------ -------- -------
------ -------- -------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-133
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1, 1996
THROUGH
MAY 20, 1996
---------------
<S> <C>
Cash flows from operating activities
Net income..................................................................................... $ 114
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization............................................................... 73
Minority interest........................................................................... 89
Gain on sale of asset....................................................................... --
Changes in operating assets and liabilities:
Related party accounts receivable......................................................... (77)
Other assets.............................................................................. 404
Land under development and improved lots.................................................. 2,786
Homes under construction.................................................................. (7,204)
Accounts payable and other liabilities and customer deposits.............................. 1,031
Related party payables.................................................................... --
-------------
Net cash used in operating activities....................................................... (2,784)
Cash flows from investing activities
Purchases of property and equipment............................................................ (51)
Proceeds from sale of property and equipment................................................... 10
-------------
Net cash used in investing activities....................................................... (41)
Cash flows from financing activities
Payments on bank lines of credit............................................................... (2,225)
Proceeds from bank lines of credit............................................................. 718
Payments on notes payable...................................................................... (15,771)
Proceeds from notes payable.................................................................... 21,083
Investment in mortgage company.................................................................
Distributions to shareholders.................................................................. (642)
Distributions to minority interest............................................................. --
Return of capital to minority interest......................................................... --
-------------
Net cash provided by financing activities................................................... 3,163
-------------
Net increase in cash........................................................................... 338
Cash, beginning of period...................................................................... 876
-------------
Cash, end of period............................................................................ $ 1,214
-------------
-------------
Supplemental disclosure of cash flows information:
Cash paid during the period for interest....................................................... $ 329
-------------
-------------
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-134
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1--BUSINESS AND ORGANIZATION
Solaris Development Corporation (the Company) was formed in 1985 for the
purpose of developing land and building subdivisions featuring affordable custom
built homes in the Raleigh, Durham, Chapel Hill region of North Carolina. The
consolidated financial statements include the accounts of the Company, the
Company's interest in the Village Lakes and the Park Village joint ventures.
These entities are related through common ownership and management.
The Company and its shareholders have entered into a definitive agreement
with The Fortress Group, Inc. (Fortress) pursuant to which the Company merged
with Fortress (the Merger) on May 20, 1996. All outstanding shares of the
Company were exchanged for cash and shares of Fortress's common stock concurrent
with the consummation of the initial public offering of Fortress Group.
Subsequent to the merger, the Company purchased the remaining 34% interest in
the Park Village joint venture and repaid most outstanding notes payable and
lines of credit using proceeds received from Fortress.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The consolidated financial statements include the accounts of entities
described in Note 1. All significant intercompany accounts and transactions have
been eliminated in consolidation. As of May 20, 1996, the Company owned a 50%
interest in the Village Lakes joint venture and a 66% interest in the Park
Village joint venture. All significant intercompany balances and transactions
have been eliminated in consolidation. The Company consolidates its 50% interest
in the Village Lakes joint venture since it is the managing partner of the
venture. Solaris has full responsibility and complete discretion in the
management and control of the business of the venture and makes all decisions
regarding the management and affairs of the venture.
Minority interest as of May 20, 1996 includes the 50% interest in the
Village Lakes joint venture and the 34% interest in the Park Village joint
venture owned by various other parties.
Revenue Recognition
Residential home 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.
Other Assets
Other assets consist of earnest money deposits, land options,
organizational costs, deferred offering costs and other deposits. The
organizational costs are amortized using the straight-line method over a five
year period.
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 three to five years. Significant additions
and improvements are capitalized, while expenditures for repairs and maintenance
are changed to operations as incurred.
Income Taxes
The Company has elected S Corporation status. All federal and state income
tax liabilities are accordingly the responsibility of the shareholders rather
than the Company and are, therefore, not recorded at the Company level. The
Company's S Corporation status will terminate on consummation of the Merger
disclosed in Note 1. See Note 11 for information regarding the pro forma income
tax disclosure.
F-135
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Use of Estimates
The preparation of the 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.
Risks and Uncertainties
As of May 20, 1996, the Company had incurred and capitalized approximately
$484,000 in costs related to a planned urban development, the future development
of which is contingent upon the Company securing financing to exercise its land
purchase option and obtaining appropriate infrastructure and regulatory
approvals. These costs are recorded as 'housing inventory' in the accompanying
balance sheet. Management expects this development project to proceed as
planned. However, should financing and other contingencies not be successfully
resolved, the Company may not recover its capitalized costs.
Advertising Expense
The cost of advertising is expensed as incurred. The Company incurred
approximately $201,000 in advertising costs during the period from January 1
through May 20, 1996.
Reclassifications
Certain prior amounts in the financial statements have been reclassified to
conform with current classifications. These reclassifications did not result in
any changes in net income or shareholders' equity as previously reported.
NOTE 3--REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
<TABLE>
<CAPTION>
MAY 20, 1996
------------
<S> <C>
Work-in-progress
Sold homes........................................................................................ $ 8,664
Speculative homes................................................................................. 4,039
-----------
12,703
-----------
Land
Finished lots..................................................................................... 2,618
Land under development............................................................................ 984
Land and other costs.............................................................................. 484
-----------
4,086
Model homes......................................................................................... 1,928
-----------
Total.......................................................................................... $ 18,717
-----------
-----------
</TABLE>
Models are constructed to assist in the marketing effort of a development
and speculative construction represents non-model homes either under
construction or completed which are not subject to a sales contract.
F-136
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTES 4--NOTES PAYABLE AND CONSTRUCTION LOANS
Notes payable and construction and development loans consist of the
following (in thousands):
<TABLE>
<CAPTION>
MAY 20, 1996
------------
<S> <C>
Construction and development payable Notes payable to financial institution collateralized by a deed
of trust on real property with interest at prime plus 1% (9.25% at May 20, 1996). Interest and
principal are due on demand....................................................................... $ 2,481
Notes payable to bank, collateralized by a deed of trust on real property and personal guarantees by
the shareholders of the Company with interest at prime plus 3/4% (9% at May 20, 1996). Interest
and principal are due on demand................................................................... 2,288
Notes payable to bank, collateralized by a deed of trust on real property and personal guarantees by
the shareholders of the Company with interest at prime plus 1/2% (8.75% at May 20, 1996). Interest
and principal are due on demand.
Other notes payable................................................................................. 8,331
Notes payable to former shareholder, collateralized by a 25% equity interest in the Company with
interest at 6%, due in quarterly installments of $22,496 through January 1999..................... 227
Other notes payable................................................................................. 130
------------
$ 13,457
------------
------------
</TABLE>
Principal maturities of the above indebtedness during the remainder of 1996
and subsequent years are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
1996..................................................................... $13,188
1997..................................................................... 113
1998..................................................................... 119
1999..................................................................... 36
2000..................................................................... 1
-------
$13,457
-------
-------
</TABLE>
The Company incurred interest costs of approximately $359,099 from January
1, 1996 through May 20, 1996. Of this amount approximately $80,300 was
capitalized to land under development and improved lots and approximately
$278,800 was capitalized to homes under construction for the period January 1,
1996 through May 20, 1996, respectively.
NOTE 5--PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
<TABLE>
<CAPTION>
MAY 20,
1996
-------
<S> <C>
Automobiles................................................................................... $ 57
Computer equipment............................................................................ 12
Office equipment and furniture................................................................ 99
Model home furniture displays................................................................. 728
-------
896
-------
Less accumulated depreciation................................................................. (441)
-------
$ 455
-------
-------
</TABLE>
F-137
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 6--LINES OF CREDIT
During 1994, the Company obtained a $4 million revolving line of credit
from a bank for land development in the Park Village subdivision. This line of
credit extends through the completion of the development of the entire tract,
and bears interest at a rate of the bank's prime rate plus 3/4% (9.0% at May 20,
1996). Interest is payable monthly. Under this line of credit, the Company had
outstanding at May 20, 1996, borrowings of $450,021. The line of credit is
collateralized by first and second deeds of trust on the land, guarantees of the
Company, and limited personal guarantees of the individual owners in the joint
venture.
During 1995, the Company obtained two additional lines of credit for $2
million and $2.1 million from banks for land development in the Preston Oaks and
Lake Ridge Subdivisions. The lines of credit extend through the completion of
the development of these subdivisions. The Preston Oaks line bears interest at
prime plus 1/2% and the Lake Ridge line bears interest at prime plus 3/4% (9.0%
at May 20, 1996). At May 20, 1996, the Company had outstanding borrowings of
$400,900 and $507,144 for the Preston Oaks and Lake Ridge Subdivisions,
respectively. The lines of credit are collateralized by deeds of trust on the
land and personal guarantees by the shareholders of the Company.
NOTE 7--RELATED PARTY TRANSACTIONS
The Company conducts transactions with companies affiliated through
investments in joint ventures. The Company records these related party
transactions through its due to/due from accounts, which have been eliminated in
consolidation.
As of May 20, 1996, accounts receivable from related parties were $240,916.
Of this amount, $102,904, was due from a partner in one of the Company's joint
ventures. The remainder of the balance of approximately $138,012 is due from
Fortress for reimbursement of expenses incurred by the Company on their behalf.
These receivables represent verbal agreements between the entities and are
payable on demand.
The Company entered into an office lease agreement with an affiliated
company on November 1, 1995. Rent expense related to this agreement was
approximately $32,500 from January 1, 1996 through May 20, 1996.
NOTE 8--EMPLOYEE BENEFIT PLANS
The Company participates in a 401(k) plan under which employees can, after
one-half year of service, contribute a percentage of their gross salary up to a
maximum of $9,500 for 1996. The Company made a matching contribution of $37,900
to the Plan during the period January 1, 1996 through May 20, 1996. The Company
did not incur any plan administrative expenses during 1996, as these expenses
were offset against forfeitures.
NOTE 9--LEASES
The Company rents its facilities and certain office equipment under
operating leases. Future minimum lease payments under the leases, which have
remaining terms in excess of one year, are as follows:
<TABLE>
<CAPTION>
MAY 21 - DECEMBER 31, 1996
YEAR ENDED DECEMBER 31,
- ---------------------------
<S> <C>
1997.................................................................................. $114
1998.................................................................................. 158
1999.................................................................................. 123
2000.................................................................................. 98
----
$622
----
----
</TABLE>
Total rent expense from January 1, 1996 through May 20, 1996 was $96,000.
F-138
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 10--COMMON STOCK
Effective January 1, 1994, the Company redeemed all 1,000 shares of common
stock, held by a shareholder resulting in a decrease in retained earnings of
$386,228. In conjunction with this transaction, the Company incurred a note
payable to the former shareholder collateralized by the redeemed stock in the
amount of $386,228, of which $226,560 is outstanding as of May 20, 1996,
respectively. This transaction did not result in any gain or loss for the
Company.
On January 1, 1994, the Company entered into a contract with this same
former shareholder whereby the Company agreed to pay the individual a consulting
fee in the amount of $300,000 payable in sixty monthly installments of $5,000.
NOTE 11--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 the
period from January 1, 1996 through May 20, 1996.
<TABLE>
<CAPTION>
FOR THE PERIOD
JANUARY 1, 1996
THROUGH
MAY 20, 1996
---------------
<S> <C>
Net income before pro forma adjustment, per statement of income.................................. $ 114
Pro forma adjustment:
Provision for income taxes at estimated effective rate of 40%.................................. (46)
------
Pro forma net income............................................................................. $ 68
------
</TABLE>
F-139
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Shareholders of
Solaris Development Corporation
We have audited the accompanying consolidated balance sheets of Solaris
Development Corporation as of December 31, 1995 and 1994, and the related
consolidated statements of income, shareholders' equity, and cash flows for the
years then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Solaris Development Corporation as of December 31, 1995 and 1994, and the
consolidated results of its operations and its cash flows for the years then
ended in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
Raleigh, North Carolina
February 10, 1996
F-140
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1994 1995
----------- -----------
<S> <C> <C>
ASSETS
Housing inventories:
Homes under construction (Note 2)................................................ $10,411,366 $ 7,427,620
Land under development and improved lots......................................... 4,372,496 6,415,701
Land options for future development and related costs............................ -- 456,084
----------- -----------
14,783,862 14,299,405
Cash............................................................................... 1,380,851 873,686
Restricted cash.................................................................... 141,860 440,366
Related party accounts receivable (Note 5)......................................... 122,417 163,490
Other assets, net of accumulated amortization of $12,633 and $13,652,
respectively..................................................................... 46,347 171,528
Property and equipment:
Automobiles...................................................................... 50,204 56,590
Computer equipment............................................................... 4,711 12,388
Office equipment and furniture................................................... 63,690 93,265
Model home furniture and sales displays.......................................... 483,422 691,878
----------- -----------
602,027 854,121
Less accumulated depreciation.................................................... (234,698) (368,801)
----------- -----------
367,329 485,320
----------- -----------
Total assets............................................................. $16,842,666 $16,433,795
----------- -----------
----------- -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and other liabilities............................................. $ 3,055,595 $ 1,591,351
Line of credit (Note 4)............................................................ 1,626,199 2,863,759
Notes payable (Note 3)............................................................. 9,242,932 8,145,313
Customer deposits.................................................................. 391,671 460,224
----------- -----------
Total Liabilities........................................................ 14,316,397 13,060,647
Minority interest.................................................................. 1,346,273 1,294,632
Shareholders' equity
Common stock, no par value, 100,000 shares authorized, 3,000 shares issued and
outstanding December 31, 1994 and 1995........................................ 1,000 1,000
Retained earnings................................................................ 1,178,996 2,077,516
----------- -----------
Total shareholders' equity............................................... 1,179,996 2,078,516
Commitments (Note 8)
Total liabilities and shareholders' equity............................... $16,842,666 $16,433,795
----------- -----------
----------- -----------
</TABLE>
See accompanying notes.
F-141
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1994 1995
----------- -----------
<S> <C> <C>
Revenue:
Residential homebuilding revenue................................................. $33,197,542 $42,563,554
Interest income.................................................................. 16,133 36,891
----------- -----------
33,213,675 42,600,445
Costs and expenses:
Cost of sales.................................................................... 26,258,391 33,792,304
General and administrative....................................................... 1,763,897 2,684,718
Selling and marketing............................................................ 2,744,734 3,353,012
Interest......................................................................... 41,923 39,623
----------- -----------
30,808,945 39,869,657
----------- -----------
Income before minority interest.................................................... 2,404,730 2,730,788
Minority interest in (loss) income of subsidiaries................................. 906,672 745,457
----------- -----------
Net income......................................................................... $ 1,498,058 $ 1,985,331
----------- -----------
----------- -----------
Unaudited pro forma net income (Note 9)............................................ $ 1,191,199
-----------
-----------
</TABLE>
See accompanying notes.
F-142
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
<TABLE>
<CAPTION>
TOTAL
COMMON RETAINED SHAREHOLDERS'
STOCK EARNINGS EQUITY
------ ---------- --------------
<S> <C> <C> <C>
Balance at December 31, 1993.............................................. $1,000 $ 832,756 $ 833,756
Net income.............................................................. -- 1,498,058 1,498,058
Distributions to shareholders........................................... -- (765,590) (765,590)
Redemption of common stock (Note 8)..................................... -- (386,228) (386,228)
------ ---------- --------------
Balance at December 31, 1994.............................................. 1,000 1,178,996 1,179,996
Net income.............................................................. -- 1,985,331 1,985,331
Distributions to shareholders........................................... -- (1,086,811) (1,086,811)
------ ---------- --------------
Balance at December 31, 1995.............................................. $1,000 $2,077,516 $2,078,516
------ ---------- --------------
------ ---------- --------------
</TABLE>
See accompanying notes.
F-143
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1994 1995
------------ ------------
<S> <C> <C>
OPERATING ACTIVITIES
Net income........................................................................ $ 1,498,058 $ 1,985,331
Adjustments to reconcile net income to net cash (used in) provided by operating
activities:
Depreciation and amortization................................................... 82,298 155,819
Minority interest............................................................... 906,672 745,457
Gain on sale of asset........................................................... -- (2,483)
Changes in operating assets and liabilities:
Accounts receivable from related parties..................................... (94,879) (41,073)
Other assets................................................................. 15,811 (126,200)
Land under development and improved lots..................................... (2,685,168) (2,499,289)
Homes under construction..................................................... (4,495,241) 2,983,746
Accounts payable and other liabilities and customer deposits................. 2,942,414 (1,395,691)
Related party payables....................................................... (73,105) --
------------ ------------
Net cash (used in) provided by operating activities............................... (1,903,140) 1,805,617
INVESTING ACTIVITIES
Change in restricted cash......................................................... 165,140 (298,506)
Purchases of property and equipment............................................... (207,964) (302,297)
Proceeds from sale of property and equipment...................................... -- 25,631
------------ ------------
Net cash used in investing activities............................................. (42,824) (575,172)
FINANCING ACTIVITIES
Payments on bank line of credit................................................... (1,777,400) (2,l75,6l9)
Proceeds from bank line of credit................................................. 3,403,599 3,413,179
Payments on notes payable......................................................... (24,587,820) (31,525,538)
Proceeds from notes payable....................................................... 26,704,477 30,427,919
Distributions to shareholders..................................................... (765,590) (1,086,811)
Distributions to minority interest................................................ (339,810) (437,140)
Return of capital to minority interest............................................ -- (353,600)
------------ ------------
Net cash provided by (used in) financing activities............................... 2,637,456 (1,737,610)
------------ ------------
Increase (decrease) in cash....................................................... 691,492 (507,165)
Cash at beginning of period....................................................... 689,359 1,380,851
------------ ------------
Cash at end of period............................................................. $ 1,380,851 $ 873,686
------------ ------------
------------ ------------
Supplemental disclosure of cash flow information
Cash paid during the period for interest.......................................... $ 647,900 $ 1,058,581
------------ ------------
------------ ------------
</TABLE>
SUPPLEMENTAL DISCLOSURE OF NONCASH FINANCING ACTIVITIES
Excluded from the consolidated 1994 statement of cash flows was the effect
of a non-cash transaction in which the Company incurred $386,228 of notes
payable to a former shareholder in conjunction with the redemption of this
individual's 1,000 shares of common stock. (Note 8)
F-144
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES
Business of the Company
Solaris Development Corporation (the 'Company') was formed in 1985 for the
purpose of developing land and building subdivisions featuring affordable custom
built homes in the Raleigh, Durham, Chapel Hill region of North Carolina.
The Company and its shareholders have entered into a definitive agreement
with the Fortress Group pursuant to which the Company will merge with the
Fortress Group (the 'Merger'). All outstanding shares of the Company will be
exchanged for cash and shares of The Fortress Group's common stock concurrent
with the consummation of the initial public offering of the common stock of the
Fortress Group and subordinated debt.
Basis of Presentation
The consolidated financial statements include the accounts of the Company
and joint ventures in which it was involved during the years ended December 31,
1994 and 1995. The Company owns a 50% interest in the Village Lakes joint
venture and a 66% interest in the Park Village joint venture. All significant
intercompany balances and transactions have been eliminated in consolidation.
The Company consolidates its 50% interest in the Village Lakes joint venture
since it is the managing partner of the venture. Solaris has full responsibility
and complete discretion in the management and control of the business of the
venture, and makes all decisions regarding the management and affairs of the
venture.
Minority interest as of December 31, 1994 and 1995 includes the 50%
interest in the Village Lakes joint venture and the 34% interest in the Park
Village joint venture owned by various other parties.
Residential Home-building Revenue
The Company is primarily engaged in the construction and sale of
residential housing. Revenue is recognized at the time of the closing of a sale,
when title to and possession of the property transfer to the buyer.
Other Assets
Other assets consist of earnest money deposits, land options,
organizational costs, deferred offering costs and other deposits. The
organizational costs are amortized using the straight-line method over a five
year period.
Property and Equipment
Property and equipment are stated at cost. Depreciation is computed
primarily using accelerated methods with useful lives ranging from five to seven
years.
Restricted Cash
When a sales contract is signed, the Company receives a deposit from the
buyer which is restricted until the transaction is closed. As of December 31,
1994 and 1995, the restricted cash held in an escrow account was $141,860 and
$440,366, respectively.
Income Taxes
The Company has elected S Corporation status. All federal and state income
tax liabilities are accordingly the responsibility of the shareholders rather
than the Company and are therefore not recorded at the Company level. The
Company's S Corporation status will terminate on consummation of the Merger
disclosed above. See Note 9 for information regarding the pro forma income tax
disclosures.
F-145
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
1. BUSINESS DESCRIPTION AND SIGNIFICANT ACCOUNTING POLICIES--(CONTINUED)
Use of Estimates
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and use
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
Risks and Uncertainties
As of December 31, 1995, thc Company had incurred and capitalized
approximately $456,000 in costs related to a planned urban development, the
future development of which is contingent upon the Company securing financing to
exercise its land purchase option and obtaining appropriate infrastructure and
regulatory approvals. These costs are recorded as 'land options for future
development and related costs' in the accompanying balance sheet. Management
expects this development project to proceed as planned. However, should
financing and other contingencies not be successfully resolved, the Company
would need to write-off these capitalized costs.
Advertising Expense
The cost of advertising is expensed as incurred. The Company incurred
approximately $242,000 and $261,000 in advertising costs during 1994 and 1995,
respectively.
Reclassifications
Certain 1994 amounts in the financial statements have been reclassified to
conform with 1995 classifications. These reclassifications did not result in any
changes in net income or shareholders' equity as previously reported.
2. HOUSING INVENTORIES
Housing inventories consist principally of homes under construction, land
under development, improved lots, and land options and other costs related to
future development. Inventories are stated at the lower of cost or net
realizable value. In addition to direct land acquisition, land development and
housing construction costs, inventory costs include interest, real estate taxes,
the cost of real estate options, related legal fees, and certain administrative
costs which are capitalized in inventory during the development and construction
periods. All other costs are charged to expense as incurred. Net realizable
value estimates are based on management's present plans and intentions of
undiscounted sale prices less development and disposition costs, assuming that
disposition occurs in the normal course of business.
Homes under construction are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1994 1995
----------- ----------
<S> <C> <C>
Work in progress................................................. $ 6,243,536 $4,356,776
Models........................................................... 1,725,115 1,893,560
Speculative construction......................................... 2,442,715 1,177,284
----------- ----------
$10,411,366 $7,427,620
----------- ----------
----------- ----------
</TABLE>
Models are constructed to assist in the marketing effort of a development
and speculative construction represents non-model homes either under
construction or completed which are not subject to a sales contract.
F-146
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
3. NOTES PAYABLE AND CONSTRUCTION LOANS
Notes payable and construction and development loans consist of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1994 1995
---------- ----------
<S> <C> <C>
Construction and development loans payable:
Notes payable to financial institution collateralized by a deed
of trust on real property with interest at prime plus 1%
(Prime was 8.65% at December 31, 1995). Interest and
principal are due on demand.................................. $5,160,054 $1,513,737
Notes payable to bank, collateralized by a deed of trust on real
property and personal guarantees by the shareholders of the
Company with interest at prime plus 3/4% (Prime was 8.65% at
December 31, 1995). Interest and principal are due on
demand....................................................... 1,743,560 2,068,096
Notes payable to bank, collateralized by a deed of trust on real
property and personal guarantees by the shareholders of the
Company with interest at prime plus 1% (Prime was 8.65% at
December 31, 1995). Interest and principal are due on
demand....................................................... 1,695,350 3,910,096
Notes payable to bank, collateralized by a deed of trust on real
property and personal guarantees by the shareholders of the
Company with interest at prime plus 1/2% (Prime was 8.65% at
December 31, 1995). Interest and principal are due on
demand....................................................... -- 224,390
Other notes payable:
Notes payable to former shareholder, collateralized by a 25%
equity interest in the Company with interest at 6%, due in
quarterly installments of $22,496 through January 1999....... 317,898 245,376
Other notes payable............................................. 326,070 183,618
---------- ----------
$9,242,932 $8,145,313
---------- ----------
---------- ----------
</TABLE>
Principal maturities of the above indebtedness during the years immediately
following December 31, 1995 are as follows:
<TABLE>
<S> <C>
1996.................................................................. $7,876,500
1997.................................................................. 113,428
1998.................................................................. 118,463
1999.................................................................. 35,767
2000.................................................................. 1,155
----------
$8,145,313
----------
----------
</TABLE>
The Company incurred interest costs of approximately $647,900 in 1994 and
$1,058,581 in 1995. Of these amounts approximately $77,000 and $171,503 were
capitalized to land under development and improved lots and approximately
$529,200 and $847,455 were capitalized to homes under construction for the years
ended December 31, 1994 and 1995, respectively.
F-147
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
4. LINE OF CREDIT
During 1994, the Company obtained a $4 million revolving line of credit
from a bank for land development in the Park Village Subdivision. This line of
credit extends through the completion of the development of the entire tract,
and bears interest at a rate of the bank's prime rate plus 3/4%. Interest is
payable monthly. Under this line of credit, the Company had outstanding at
December 31, 1994 and 1995, borrowings of $1,626,199 and $1,537,964,
respectively. The line of credit is collateralized by first and second deeds of
trust on the land, guarantees of the Company, and limited personal guarantees of
the individual owners in the joint venture.
During 1995, the Company obtained two additional lines of credit for $2
million and $2.1 million from banks for land development in the Preston Oaks and
Lake Ridge Subdivisions. The lines of credit extend through the completion of
the development of these subdivisions. The Preston Oaks line bears interest at
prime plus 1/2% and the Lake Ridge line bears interest at prime plus 3/4%. Under
these lines of credit, the Company had outstanding at December 31, 1995,
borrowings of $693,700 and $632,095 for the Preston Oaks and Lake Ridge
Subdivisions, respectively. The lines of credit are collateralized by deeds of
trust on the land and personal guarantees by the shareholders of the Company.
5. RELATED PARTY TRANSACTIONS
The Company conducts transactions with companies affiliated through
investments in joint ventures. The Company records these related party
transactions through its due to/due from accounts, which have been eliminated in
consolidation.
As of December 31, 1994 and 1995, accounts receivable from related parties
were $122,417 and $163,490, respectively. Of this amount, $107,512 and $93,312
at December 31, 1994 and 1995, respectively, was due from a partner in one of
the Company's joint ventures. The remainder of the 1995 balance of approximately
$70,000 is due from an affiliated company for reimbursement of expenses incurred
by the Company on their behalf. These receivables represent verbal agreements
between the entities and are payable on demand.
The Company entered into an office lease agreement with an affiliated
company on November 1, 1995. Rent expense related to this agreement was
approximately $13,000 for the year ended December 31, 1995.
6. 401(K) PLAN
The Company participates in a 401(k) plan under which employees can, after
one half year of service, contribute a percentage of their gross salary up to a
maximum of $9,240 for 1994 and $9,500 for 1995. The Company made matching
contributions totaling $30,827 and $29,786 to the Plan during the years ended
December 31, 1994 and 1995, respectively. The Company did not incur any plan
administrative expenses during 1994 or 1995, as these expenses were offset
against forfeitures.
7. LEASES
The Company rents its facilities and certain office equipment under
operating leases. Future minimum lease payments under the leases, which have
remaining terms in excess of one year, are as follows:
<TABLE>
<S> <C>
1996.................................................................... $161,776
1997.................................................................... 133,532
1998.................................................................... 108,515
1999.................................................................... 102,507
2000.................................................................... 80,008
--------
$586,338
--------
--------
</TABLE>
F-148
<PAGE>
SOLARIS DEVELOPMENT CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. LEASES--(CONTINUED)
Total rent expense for years ended December 31, 1994 and 1995 was $96,901
and $148,444, respectively.
8. REDEMPTION OF COMMON STOCK
Effective January 1, 1994, the Company redeemed all 1,000 shares of common
stock, held by a shareholder resulting in a decrease in retained earnings of
$386,228. In conjunction with this transaction, the Company incurred a note
payable to the former shareholder collateralized by the redeemed stock in the
amount of $386,228, of which $317,898, and $245,376 is outstanding as of
December 31, 1994 and 1995, respectively. This transaction did not result in any
gain or loss for the Company.
On January 1, 1994, the Company entered into a contract with this same
former shareholder whereby the Company agreed to pay the individual a consulting
fee in the amount of $300,000 payable in sixty monthly installments of $5,000.
9. UNAUDITED PRO FORMA NET INCOME
The following unaudited pro forma income tax information is presented in
accordance with Statement of Financial Accounting Standard No. 109 (SFAS 109)
as if the Company had been a C Corporation subject to federal and state income
taxes for the year ended December 31, 1995.
Year ended
December 31,
1995
------------
Earnings before pro forma adjustments, per
statement of income......................... $1,985,331
Pro forma adjustment:
Provision for income taxes at estimated
effective rate of 40%..................... 794,132
----------
Pro forma net income.......................... $1,191,199
==========
F-149
<PAGE>
THE FORTRESS GROUP, INC.
PROXY SOLICITED BY THE BOARD OF DIRECTORS
SPECIAL MEETING OF STOCKHOLDERS
MARCH 6, 1998
James J. Martell, Jr. and J. Marshall Coleman, and each of them, are hereby
authorized to represent and vote the stock of the undersigned at the Special
Meeting of Stockholders to be held March 6, 1998, at 8:00 a.m., local time, at
the offices of The Fortress Group, Inc., 1650 Tysons Boulevard, Suite 600,
McLean, Virginia 22102 and at any adjournments thereof.
THE SHARES REPRESENTED BY THIS PROXY WILL BE VOTED IN ACCORDANCE WITH
SPECIFICATIONS MADE HEREIN. IF NO SPECIFICATIONS ARE MADE, THIS PROXY WILL BE
VOTED FOR PROPOSALS 1 AND 2 ON THE REVERSE SIDE HEREOF.
------------------------------------------------
PLEASE VOTE, DATE AND SIGN ON REVERSE AND RETURN
PROMPTLY IN THE ENCLOSED ENVELOPE.
------------------------------------------------
PLEASE SIGN EXACTLY AS YOUR NAME APPEARS ON
THIS PROXY. WHEN SIGNING AS ATTORNEY, EXECUTOR,
ADMINISTRATOR, TRUSTEE, OR GUARDIAN, PLEASE GIVE
YOUR FULL TITLE. IF SHARES ARE HELD JOINTLY,
EACH HOLDER SHOULD SIGN.
<PAGE>
<TABLE>
<CAPTION>
FOR AGAINST
<S> <C> <C>
1. Proposal to approve certain investment transactions involving the purchase by an affiliate / / / /
of Lazard Freres Real Estate Investors, LLC of up to $100,000,000 of the Company's newly
issued convertible securities and amendments to the Company's certificate of incorporation
which, among other things, would increase the Company's authorized common stock and would
require the affirmative vote of more than 81% of the Company's board of directors or
executive committee for the Company to engage in certain significant actions or
transactions.
2. Proposal to authorize an increase in the common stock subject to the Company's 1996 Stock / / / /
Incentive Plan.
3. In their discretion, the proxies are authorized to vote upon any other matter that may / / / /
properly come before the meeting.
<CAPTION>
WITHHOLD
<S> <C>
1. Proposal to approve certain investment transactions involving the purchase by an affiliate / /
of Lazard Freres Real Estate Investors, LLC of up to $100,000,000 of the Company's newly
issued convertible securities and amendments to the Company's certificate of incorporation
which, among other things, would increase the Company's authorized common stock and would
require the affirmative vote of more than 81% of the Company's board of directors or
executive committee for the Company to engage in certain significant actions or
transactions.
2. Proposal to authorize an increase in the common stock subject to the Company's 1996 Stock / /
Incentive Plan.
3. In their discretion, the proxies are authorized to vote upon any other matter that may / /
properly come before the meeting.
</TABLE>
The undersigned hereby acknowledges receipt of the notice of said Special
Meeting of Stockholders and the proxy statement relating thereto.
The undersigned hereby revokes any proxy or proxies heretofore given to vote
such stock, and hereby ratifies and confirms all that said attorneys and
proxies, or other substitutes, may do by virtue hereof. If only one attorney and
proxy shall be present and acting, then that one shall have and may exercise all
the powers of said attorneys and proxies.
The signature of shareholder should correspond exactly with the name stenciled
hereon. Joint owners should sign individually. When signing as attorney,
executor, administrator, trustee or guardian, please give your full title as
such.
- --------------------------------------------------------------------------------
SHAREHOLDER SIGN HERE DATE CO-OWNER SIGN HERE DATE
