================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998 Commission file number 0-28024
THE FORTRESS GROUP, INC.
(Exact name of registrant as specified in its charter)
-----------
Delaware 54-1774997
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
1650 Tysons Boulevard, Suite 600, McLean, Virginia 22102
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (703) 442-4545
Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days: YES X No
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statement incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. / /
Aggregate market value of the voting stock held by non-affiliates of
the registrant as of March 23, 1999 was $13,520,608.
As of March 23, 1999, 12,287,867 shares of the Registrant's Common
Stock, $.01 par value per share, were outstanding.
================================================================================
<PAGE>
Documents Incorporated By Reference
Certain information required by Items 10, 11, 12 and 13 of Form 10-K is
incorporated by reference into Part III hereof, from the registrant's proxy
statement, which will be filed with the Securities and Exchange Commission
within 120 days after the close of the fiscal year covered by this Form 10-K,
and certain documents are incorporated by reference into Part IV hereof.
2
<PAGE>
PART I
Item 1. Business
Introduction
The Fortress Group, Inc. (the "Company" or "Fortress") is a national
homebuilding company engaged in designing, building and selling single family
homes in the metropolitan areas surrounding a diversified group of cities in the
United States. The Company offers high-quality, innovative homes, targeting a
diverse range of market segments including the first-time, entry-level buyer,
move-up buyer and luxury homebuyer. The Company markets a wide range of single
family detached and attached homes ranging in size from 1,000 to 6,200 square
feet at prices ranging generally from $80,000 to $700,000.
The Company was formed in June 1995 to create a national homebuilding
company through the simultaneous acquisition of four homebuilding companies and
an initial public offering of the Company's equity and debt securities (the
"Offerings"). The acquisitions and the Offerings were completed in May 1996. The
acquired companies became wholly-owned subsidiaries of Fortress and as a group
are referred to as the Combined Predecessor Companies or the Founding Builders.
In 1996, subsequent to acquisitions and the Offerings, the Company acquired two
additional homebuilding companies; in 1997, an additional four companies were
acquired; and in 1998 an additional three companies were acquired. In March of
1999, the Company sold the assets of one builder.
The Company's homebuilding operations are currentlly conducted in the following
market areas:
STATES MARKET AREAS
------ ------------
Arizona Tucson
Colorado Denver, Fort Collins
Florida Jacksonville
Missouri St. Louis
Nevada Las Vegas
North Carolina Raleigh-Durham, Charlotte
Oregon Portland
Pennsylvania Philadelphia
South Carolina Charleston
Texas Austin, San Antonio
Virginia Loudoun County
Washington Vancouver
Wisconsin Janesville-Madison-Milwaukee
In January 1997, Fortress formed Fortress Mortgage, Inc. ("Fortress Mortgage"),
a wholly-owned subsidiary, to provide a mortgage lending source to the Company's
builder subsidiaries as an ancillary benefit. Fortress Mortgage is licensed as a
mortgage banker in Alaska, California, Colorado, Florida, Missouri, Nevada,,
North Carolina, Oregon, Pennsylvania, South Carolina, Texas, Virginia,
Washington and Wisconsin.
OPERATING STRATEGY
The Company believes it is positioned for continued success in the homebuilding
industry because of the following factors:
3
<PAGE>
ESTABLISHED MARKET POSITIONS IN ATTRACTIVE HOUSING MARKETS. 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. The Company believes
that each of its local operations has an established local market position. Each
local operation has targeted one or more specific niches within its market and
has developed products which specifically target its customers.
REDUCED THE RISK OF CYCLICALITY THROUGH GEOGRAPHIC AND PRODUCT DIVERSIFICATION.
In addition to focusing on market positioning, the Company's has created
geographic and product diversification by operating in multiple geographic
markets. As a result, the Company is less subject to the effects of local and
regional economic cycles than homebuilders that operate in a single geographic
market, developing only a select number of products.
ENHANCED PROFITABILITY THROUGH IMPROVED CAPITAL STRUCTURE AND OPERATING
SYNERGIES. The Company believes that the financial strength of its local
operations, coupled with the application of the proceeds from the Offerings and
subsequent financings, has enhanced the Company's competitive position, reduced
its overall costs associated with land acquisition and project construction, and
provided the necessary capital to employ its strategies for expansion.
Additionally, the Company's subsidiaries have generally been able to obtain
financing on more favorable terms than previously available.
Although the Company's most significant services and commodities are obtained on
a local level, the Company's overall size and strength of operations has enabled
it to begin the process of securing favorable terms from certain suppliers by
purchasing in volume. The Company has also realized 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 are beginning to benefit from
the implementation of selected practices, policies and strategies, such as
market analysis, costing procedures and quality control.
LIMITED EXPOSURE TO REAL ESTATE-RELATED RISKS. 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.
4
<PAGE>
MARKETS AND PRODUCTS
OVERVIEW
The Company's operations serve the metropolitan areas surrounding the following
cities: Raleigh-Durham and Charlotte, North Carolina; Charleston, South
Carolina; Austin and San Antonio, Texas; Las Vegas, Nevada; Denver and Fort
Collins, Colorado; Tucson, Arizona; Janesville, Madison and Milwaukee,
Wisconsin; Jacksonville, Florida; Philadelphia, Pennsylvania; Loudoun County,
Virginia (Washington, DC MSA); St. Louis, Missouri; and Portland, Oregon. The
Company believes that each of its current markets represents an attractive
homebuilding market with opportunity for growth. The Company also believes that
each of its local operations is well established in its market and has developed
a reputation for building quality homes at competitive prices. The Company
maintains the flexibility to tailor its product mix within a given market
depending upon market conditions including demographic trends, demand for a
particular type of product, margins, timing and the economic strength of the
market.
RALEIGH-DURHAM, NORTH CAROLINA
Raleigh is the state capital of North Carolina. The state government and the
three major universities located in the area provide stable employment
throughout the region. Employment growth in the region has been fueled by the
high technology industry operating in and around the area's "Research Triangle"
(Raleigh-Durham-Chapel Hill). The long-term projection in this area is for
continued modest job growth and expansion, both from net in-migration of
business as well as from home-grown high-tech and biotechnology firms conceived,
incubated, and launched in the Research Triangle, resulting in a stable housing
market.
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 $150,000 to approximately $450,000 and targets entry-level and
first- and second-time move-up buyers and retirees. Depending on the opportunity
available within each community, the Company will either develop land which it
controls under option or contract or purchase developed lots from developers or
other homebuilders. As of December 31, 1998, the Company controlled
approximately 703 optioned lots (including land anticipated to be subdivided
into lots) in the Raleigh-Durham area for new home construction. The Company's
Raleigh operation has received numerous marketing awards and has been selected
as the Sales and Marketing Council of the Raleigh-Wake County Homebuilders'
Association's "Builder of the Year" in its class, multiple times, most recently
in 1998.
CHARLOTTE, NORTH CAROLINA
During the last decade, the city of Charlotte has become a major financial
center in the nation. Wholesale trade, transportation and manufacturing have
5
<PAGE>
added significantly to form a strong economic base in the Charlotte area.
Charlotte's growth, primarily in these industries, has created a market
averaging annual employment increases of just over 20,000 new workers in the
period from 1995 to 1998. This growth has supported growth in single family
housing permits from less than 10,000 in 1995 to nearly 13,500 in 1998.
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 subsidiary focuses on delivering innovative single
family homes to entry level and first and second move-up buyers with homes
prices ranging from $110,000 to $197,000 and with square footage of 1,350 to
2,650 square feet. In 1998, the Charlotte subsidiary was voted "Best Builder
$300,000 and under" by the readers of Charlotte's Best Magazine. As of December
31, 1998, the Company controlled approximately 1,625 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 has a broad economic base with the largest
containerized cargo port on the South Atlantic and Gulf coasts, a $2.3 billion
tourism industry, an impressive medical hub, a well-established manufacturing
industry and a large military presence. This diverse base has assisted in
Charleston's apparent recovery from the closing of a shipyard and a number of
military bases. From 1995 to 1998, Charleston created an average of 6,900 jobs
per year, a growth rate of 3.1% per year. Single family housing permits in the
area have grown from 2,300 per year in 1995 to almost 3,000 in 1998. The
Charleston subsidiary targets entry level and first move-up home buyers with
homes ranging from 1,100 to 2,900 square feet. While the Company's subsidiary
builds homes from the low $100,000s to $300,000s in the Charleston market, it
focuses building in the $100,000 to $174,000 range. As of December 31, 1998, the
Company controlled approximately 303 optioned lots in the Charleston market for
new home construction and lot sales.
AUSTIN, TEXAS
Austin is the state capital of Texas. The state government and the University of
Texas provide stability to the region's employment base. Many of the trends in
employment growth in the region have been fueled by the significant growth in
the high technology industry operating in the Austin area. From 1994 through
1997, the Austin Metropolitan Statistical Area (MSA) averaged 28,200 new jobs
annually. With the exception of 1997, the Austin market has experienced
double-digit percentage increases in annual housing starts over the last five
years. This strong growth is attributed to employment growth coupled with low
mortgage interest rates.
The Company has offices located in Austin and San Antonio, Texas and conducts
operations in both of these metropolitan areas. This local operation offered
primarily single family detached homes to entry-level and first-
6
<PAGE>
time move-up homebuyers that generally range in sales price from $75,000 to
approximately $190,000 and in base square footage from 1,300 to 3,000 square
feet under the Buffington Homes name. The subsidiary's second-time move-up and
higher-end products--generally ranging in price from $140,000 to $300,000 and in
base square footage from 2,000 to 4,000 square feet--are sold under the Wilshire
Homes name. 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. In 1998, the Company's Texas operations
received several "Max Awards," given by the Texas Capital Area Builders'
Association. As of December 31, 1998, the Company controlled lots for the
construction of approximately 1,900 homes in the Austin area. During the first
quarter of 1999, the Company contracted to sell a significant amount of its lots
planned for entry-level and first-time move-up buyers in the Austin market to
another homebuilder. This move is intended to reposition the Company in the more
profitable move-up market. In conjunction with this transition, the Company has
begun marketing its homes in this market under the Wilshire Homes name
exclusively.
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--prices ranging from $90,000 to
$300,000 and square footage ranging from 1,400 to 5,000 square feet. The San
Antonio MSA owes a great deal of its strength to the services industry, which
includes a variety of jobs such as telemarketing, many of the area's technology
positions, and many of the tourism jobs. The area experienced strong net job
formations in the early to mid-1990s and appears to be reaching more moderate
levels of job growth currently. The volume of annual housing starts has
increased sharply over the last five years. The 2,117 starts recorded in the
second quarter of 1998 represented a record quarter for housing activity in the
market.
The Company's office in Austin handles the administrative functions for its San
Antonio operation. The Company believes that it is well positioned to take
advantage of the growth in the San Antonio area housing market in the near and
long term. The market repositioning discussed relative to the Austin market
relates also to this market. As of December 31, 1998, the Company controlled
approximately 486 lots in the San Antonio area for new home construction.
LAS VEGAS, NEVADA
By more than one measure, Las Vegas is the fastest growing metropolitan area in
the nation. The economic growth of the Las Vegas MSA is attributed to its
combination of climate, attractiveness to business, and the expansion of the
gaming and lodging industries. The area has exhibited growth in construction,
manufacturing and financial services, bolstering the economy. Additionally, the
Las Vegas economy benefits from the growth in retirement living due to the lower
cost of living, including lower housing costs and state taxes. From 1995 to
present, an average of just under 40,000 new jobs were created each year, an
annual growth rate of 7.0%. Single family permits jumped from 19,000 in 1995 to
approximately 21,000 in each of the last three years.
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 $200,000 to approximately
$700,000, and targets luxury second- and third-time (or higher) move-up buyers
and buyers of second homes. The attached homes range from 1,400 to 2,200 square
feet, and the detached homes range from 2,400 to 6,200 square feet. The Company
has also become active in the custom home construction market with homes that
range from $550,000 to $1,500,000 in sales price and from 5,000 to 10,000 square
feet. The Company generally controls partially developed land, which, as part of
the masterplanned community, is fully entitled, and develops the
7
<PAGE>
land into finished lots ready for home construction. In 1998, the Company's Las
Vegas subsidiary received numerous awards including the NAHB's "Best in American
Living Home of the Year" award, the "Gold Nugget Grand Award" for Home of the
Year, and Builder magazine's "Builder Choice Grand Award." At December 31, 1998,
the Company controlled a supply of 285 lots in the Las Vegas area.
DENVER, COLORADO
The economy of the Denver MSA is diversified and fueled by a wide range of
industries including financial services, telecommunications and technology
services. From 1995 to 1998, Denver created an average of just under 38,000 new
jobs annually. Employment growth in the Denver area is likely to continue
through 1999 at a more modest level as the national economy cools down and the
local telecommunications industry, which was largely responsible for Denver's
explosive growth over the last four years, has begun to mature. Single family
housing permits have grown from 10,600 in 1995 to average over 13,000 over the
past three years.
The Company's Colorado operation offers a wide range of affordably priced,
single family detached semi-custom homes that range in sales price from
approximately $170,000 to over $450,000 and targets all move-up and
"semi-custom" homebuyers. These homes range from 1,600 to 3,700 square feet. The
Company's Colorado operation has successfully established its reputation as a
"semi-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 generally develops land in the
Denver area. As of December 31, 1998, the Company controlled approximately 888
lots in the Denver area for new home construction and lot sales. 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. In addition, manufacturing and health care companies have bolstered
the economy. From 1995 through 1998, Ft. Collins exhibited a 4.5% average,
annual job growth rate. The Colorado division offers products in Fort Collins
comparable to those offered in the Denver area, selling single-family detached
homes and condominiums targeting move-up and custom-home buyers. These homes
range in sales price from approximately $160,000 to approximately $350,000 and
range in square footage from 1,600 to 3,700 square feet in the single-family
detached homes and from 1,000 to 1,700 square feet in the condominiums. This
subsidiary had one of its best years in 1997 and, in 1998, introduced a
condominium project in the area. As of December 31, 1998, the Company controlled
approximately 327 lots in the Fort Collins area for new home construction and
lot sales.
TUCSON, ARIZONA
With an annual increase in the Tucson metro population of 2.5% over the past
eight years, the housing market is more diversified than a few years ago. Single
family housing permits have remained steady in the 5,000 range for each of the
last four years. This division successfully shifted focus this year in this
market from a semi-custom builder to a production builder with homes under
$120,000 in keeping with the area's market trends. The square footage of this
new product ranges from 1,100 to 2,100 square feet. If the new program continues
to prove successful, the Company intends to expand its operations in this market
range. As of December 31, 1998, the Company controlled approximately 151 lots in
the Tucson area for new home construction and lot sales.
8
<PAGE>
JANESVILLE/MADISON/MILWAUKEE, WISCONSIN
With the acquisition of Brookstone Homes on December 31, 1996, the Company
entered the Janesville/Madison/ Milwaukee, Wisconsin area. Historically, the
cornerstone of the Milwaukee MSA has been the manufacturing industry. However,
in 1998, the services sector was the leading industry group with strong growth
in health services. While manufacturing still accounts for more than 20% of
employment, health care and other services are the higher growth industries in
the area. The manufacturing base has not historically fostered high levels of
labor force in-migration; however, housing permit levels are expected to have
slow but steady growth. While the Company's operations have historically been
more active in the western portion of this region, 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.
In keeping with the Company's plan for expansion, the Wisconsin operation
entered the Milwaukee market, where single family housing permits have been
between 3,500 and 3,800 since 1995.
The Company's subsidiary has 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 $175,000. As of December 31, 1998, the Company
controlled approximately 905 lots in the Janesville/Madison/ Milwaukee area for
new home construction and lot sales.
JACKSONVILLE, FLORIDA
The Jacksonville MSA is the dominant economy within the northeast
Florida/southeast Georgia region. In general, the Jacksonville MSA maintains a
diversified economic base that is not dependent upon 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. From
1995 through 1998, Jacksonville averaged just over 20,000 new jobs per year.
Single family housing permits for the MSA have grown from 6,400 in 1995 to
approximately 7,000 in each of the last three years.
At the end of February 1997, the Company acquired D.W. Hutson Construction
Company, now operating as Fortress Homes and Communities of Florida thereby
entering the Jacksonville, Florida market. The Jacksonville division offers
homes ranging from 1,250 to 3,000 square feet and from $80,000 to $230,000. As
of December 31, 1998, the Company controlled approximately 1,724 lots in the
Jacksonville area for new home construction.
PHILADELPHIA, PENNSYLVANIA
The Company's Philadelphia subsidiary has focused building in Delaware, Chester,
and Montgomery counties. These counties are considered to have higher population
and job growth and lower unemployment rates when compared to the Philadelphia
MSA, which includes Philadelphia County/City. The Philadelphia area boasts the
nation's second largest concentration of health care resources in the nation
with approximately 10% of the workforce employed in this industry. Research and
development companies, particularly in the areas of engineering and scientific
instruments and computers and data processing, and the "Medical Mile," with
pharmaceutical companies, biomedical research companies, and medical surgical
and dental instrument manufacturers, as well as government employment and have
formed a strong economic base for the area. During the 1985 to 1995 period, the
largest growth as a percentage of the economy was seen in the services and the
finance, insurance and real estate sectors. Additionally, Philadelphia has a
strong tourism trade. Single
9
<PAGE>
family permits in the area have ranged from 12,000 to 13,000 since 1993 while
multi-family permits virtually triples from 1996 to 1997 from 1,100 to 3,200,
but dropped back to 2,500 in 1998.
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 suburban Philadelphia subsidiary currently markets
communities in five counties in Pennsylvania and New Jersey ranking seventh
overall in the Philadelphia MSA out of 226 builders in the market. The
subsidiary is continuing to expand its operations in this market. The diverse
product line includes single-family attached (townhomes and condominiums) and
single family detached products. In Pennsylvania, their attached homes range in
size from 1,700 to 2,700 square feet with base price ranges from $160,000 to
$280,000. The subsidiary's detached homes are priced from $130,000 to $250,000.
This product line targets a large market audience including first-time buyers,
first and second move-up buyers and empty-nesters. The subsidiary is currently
building a community of ranch homes on a golf course for active adults. In 1998,
one of the Company's communities in suburban Philadelphia won the Pyramid Award
from the Chester/Delco Home Builders' Association for Community of the Year over
1,900 square feet. As of December 31, 1998, the Company controlled approximately
1,174 lots in the Philadelphia market for new home construction.
LOUDOUN COUNTY, VIRGINIA
In 1998, this subsidiary concentrated its efforts on single-family detached
homes with square footage of 1,800 to 4,500 and base prices generally ranging
from $225,000 to $350,000. As of December 31, 1998, the Company controlled on
approximately 110 lots in the Loudoun County area for new home construction. The
Company began building homes on the customers' own lots during 1998 and this
operation is expected to become a major focus of this subsidiary in 1999.
ST. LOUIS, MISSOURI
The Company entered the St. Louis market with the acquisition of the dominant
St. Charles County homebuilder in early 1998. The St. Louis area is among top
locations for corporate headquarters including TWA, Anheuser-Busch,
Ralston-Purina, Consolidated Aluminum, May Department Stores, Emerson Electric,
Peabody Coal, General American Life Insurance, Graybar Electric, Monsanto, and
Solutia. Additionally, MasterCard has recently chosen to locate its processing
center in St. Louis; this new facility, which will bring approximately 2,000
jobs to the area, is scheduled to open in 2000. St. Louis is a regional center
in the health care industry and also has a strong gaming and amusement sector.
While the St. Louis MSA is not a high-growth market, it has historically been a
very stable market outside of the recession (1991-1993) and flood (1994). From
1995 to present, the St. Louis job growth rate has averaged approximately 1.5%
per year, and single family housing permits have remained steady in the 10,000
range annually.
The Company's St. Louis subsidiary builds single family detached homes targeting
first and second move-up buyers with homes ranging from 1,355 to 3,700 square
feet with base prices ranging from $117,000 for a ranch style home up to
$176,900 for an atrium home and up to $399,500 in their high-end product line.
They also offer a custom home option. In June of 1998, the St. Louis division
hosted the St. Louis Home Builders' Association Home-A-Rama at one of the
Company's subdivisions. As of December 31, 1998, the Company controlled
approximately 1,180 lots in the St. Louis market for new home construction.
PORTLAND, OREGON
Although the Portland MSA economy has expanded since 1990, the Asian economic
situation has softened the market in 1998, and is expected to remain a factor in
1999. The area is economically diverse and not heavily dependent on one major
employment sector. The combination of technology, health care, manufacturing,
and education industries makes Portland a diversified and resilient market. The
increasing growth of high-tech companies in the Portland MSA is adding to the
economic wealth and well-being of the
10
<PAGE>
non-high-tech firms that support them. From 1995 to present, an average of
36,175 jobs have been created each year in the Portland MSA. Housing permits
have grown from just over 17,000 in 1995 to over 19,000 in 1998.
The Company entered into the Portland market through the acquisition of an
established homebuilder in 1998. This subsidiary targets entry level, first time
move-up and empty-nester markets with both condominium and single-family
detached homes. The condominiums range in square footage from 800 to 2,400
square feet and in base price from $109,900 to $164,000. The division's single
family detached homes range from 1,000 to 4,100 square feet with base prices
generally between $106,000 and $249,000. As of December 31, 1998, the Company
controlled approximately 531 lots for new home construction.
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 rare 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 total
investment risk, projected profit margins and return on capital employed; (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
11
<PAGE>
entitlements are obtained on previously unentitled land), the Company undertakes
the development activities that include site planning and engineering, as well
as constructing road, sewer, water, utilities, drainage and recreational
facilities and other amenities as necessary.
When available, the Company's homebuilding operations purchase 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 utilize rolling options
on finished land where appropriate, some 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.
Through its local operations, the Company has occasionally used partnerships or
joint ventures to purchase and develop land where such arrangements were
necessary to acquire the land or appeared to be otherwise economically
advantageous to the Company. The Company will continue to consider such
partnership, joint venture and other financing arrangements with landowners
where management perceives an opportunity to acquire land upon favorable terms,
minimize risk and exploit opportunities presented through seller financing.
The Company strives to develop a design and marketing concept for each of its
communities based on the specific geographic and target market, which includes
determination of size, style, price range of homes, layout of streets, size and
layout of individual lots and overall community design. The development and
construction of each project are managed by the Company's local operations. At
the development stage, a project manager (who may be assigned to several ongoing
projects) supervises the development of buildable lots. In addition, project
superintendents are often utilized depending on the size of the development, and
each local operation has one or more customer service and marketing
representatives assigned to its communities.
At December 31, 1998, the Company owned 2,158 finished lots and 1,808 lots held
for or under development. As of December 31, 1998, the Company also had under
contract or option, subject to the satisfaction of the Company's purchase
contingencies, 8,720 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
12
<PAGE>
employees oversee the construction of each community, including coordinating
activities of subcontractors and suppliers and insuring that all work is subject
to quality and cost controls and complies with zoning and building codes.
Subcontractors typically are retained on a subdivision-by-subdivision basis to
complete construction at a fixed price. Agreements with the Company's
subcontractors and materials suppliers are generally entered into after
competitive bidding on an individual basis.
Fortress management specifies that quality, durable materials be used in
constructing the Company's homes. The Company does not maintain a significant
inventory of construction materials. Each of the Company's local operations
maintains close contact with its respective subcontractors and suppliers, and
the Company believes that its relationship with its suppliers and subcontractors
are good. When possible, the Company negotiates price and volume discounts with
manufacturers and suppliers on behalf of subcontractors to take advantage of its
volume of production. Although the Company generally has made no long-term
purchase commitments to materials suppliers in the past and although certain key
materials and supplies are, and will continue to be, purchased at local/regional
levels, the Company negotiates contractual terms with certain of its vendors to
provide additional cost savings on a national basis. Generally, access to the
Company's principal subcontracting trades, materials and supplies continue to be
readily available in each of its markets; however, prices for these goods and
services may fluctuate due to various factors, including supply and demand
shortages which may be beyond the control of the Company or its vendors.
The Company generally provides a one-year limited warranty of workmanship and
materials with each of its homes although warranty policies may differ within
each local operation and by project. The Company's subcontractors generally
provide the Company with an indemnity and a certificate of insurance prior to
receiving payments for their work; therefore, claims relating to workmanship and
materials are usually the primary responsibility of the Company's
subcontractors. Historically, the Company's divisions have not incurred any
material costs relating to any warranty claims or defects in construction.
SALES AND MARKETING
Each of the Company's subsidiaries are directly responsible for the sales and
marketing activities relating to each of their completed and planned
communities. The Company makes extensive use of advertising and other
promotional activities, including newspaper advertisements, brochures, direct
mail and the placement of strategically located sign boards in the immediate
areas of its developments. The Company believes that each of its local
operations has an established reputation for developing high quality homes in
the markets they serve, which generates additional interest in the Company's new
projects.
The Company believes that the effective use of model homes plays an integral
part in demonstrating the competitive advantages of its home designs and
features to prospective homebuyers. The Company generally builds between one and
five 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
homebuyers.
The Company's objective is to enter into sales contracts for all of its homes in
advance of construction, thereby reducing the risk of unsold inventory upon
completion of a project. Depending on market conditions and the specific
project, the Company builds speculative homes in each of its entry-level and
move-up subdivisions and in most of its empty-nester 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
13
<PAGE>
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
contracts 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 homebuyers.
BACKLOG
The Company's homes are generally offered for sale in advance of their
construction. The majority of the Company's homes sold in 1998 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 but not yet delivered are considered the Company's "backlog." As
of December 31, 1998, the Company had backlog of $308.8 million (1,606 homes).
The Company generally 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. In certain circumstances, generally with custom homes
involving a longer period of time from execution of the contract for a home and
the closing (six months to one year), the Company does utilize the percentage of
completion method to more closely match revenue and expenses.
CUSTOMER FINANCING
In January 1997, the Company created a wholly-owned subsidiary, Fortress
Mortgage, Inc., for the purpose of providing decentralized mortgage origination
and centralized underwriting to the buyers of homes sold by the Company's
subsidiaries. Fortress Mortgage, Inc. is approved by the Federal Housing
Administration (FHA) and Veterans Administration (VA) as a qualified mortgage
lender and is licensed as a mortgage banker in Alaska, California, Colorado,
Florida, Missouri, Nevada, North Carolina, Oregon, Pennsylvania, South Carolina,
Texas, Virginia, Washington and Wisconsin. The Company facilitates the sale of
the Company's homes through the origination of first mortgage loans utilizing
programs established by FHA, VA, Government National Mortgage Association
(GNMA), Federal National Mortgage Association (FNMA) and Federal Home Loan
Mortgage Corporation (FHLMC). As a mortgage banker, this operation will complete
the processing of loan applications, perform credit checks, process applications
to underwrite loans and originate and subsequently sell the mortgage loans.
Due to the sales prices of homes, the Colorado, Arizona and Las Vegas operations
do not rely on homebuyers who seek FHA and VA mortgage financing. However, the
majority of the homes sold by the Company's Florida, Texas and Wisconsin
operations and a significant number of the homes sold by the Company's Missouri,
North Carolina, Oregon, Pennsylvania and Washington operations met the dollar
limits published in FHA and VA guidelines. FHA and VA financing generally
enables homebuyers to purchase homes with lower down payments than the down
payments required by conventional mortgage lenders, allowing a purchaser to
borrow up to 100% 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 homebuyers utilize long-term mortgage financing to purchase a
home, and lenders generally make loans only to borrowers who earn three times
the total amount of the monthly mortgage payment plus insurance and property
taxes. As a result, economic conditions, increases in unemployment and high
mortgage interest rates can eliminate a number of potential homebuyers from the
market.
14
<PAGE>
Prior to 1997, the Company did not provide customer financing to its homebuyers.
Rather, at each on-site office, sales employees provided prospective homebuyers
with information as to the qualifying criteria for mortgage financing. Either a
mortgage lender was typically made available at the sales offices to assist
prospective buyers in applying for mortgage financing or the Company acted as a
mortgage broker and received a brokerage fee once the loan was originated.
CORPORATE OPERATIONS
The Company's corporate personnel generally oversee all of the Company's local
operations. Senior managers of the Company have extensive 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) develops operational improvement initiatives and oversees the
integration and sharing of "best practices" between homebuilding subsidiaries
(v) performs accounting functions, establishes financial policies and regularly
completes financial analyses both on a consolidated and subsidiary-by-subsidiary
basis; (vi) provides for human resource development; and (vii) secures and
obtains capital resources. The corporate operations also provide for and
encourage the flow of technical information and ideas among the senior
management of its local operations.
In fulfilling the duties set forth above, the senior management developed a
Comprehensive Planning System whereby each local operation is required, among
other things, to prepare an annual plan for the upcoming fiscal year, a
three-year plan which is updated and revised each year and a project feasibility
analysis for all land acquisitions. The annual plan includes a thorough review
and analysis of the previous fiscal year, monthly detailed projections of all
revenue and expenses, financial ratio projections such as return on assets and
inventory turnover and operational changes to be instituted in the coming year.
The three-year plan insures that the local managers continue to (i) plan for
potential changes in their respective geographic and target markets; (ii)
evaluate the present and future competition; and (iii) seek opportunities to
further improve their operations. The project feasibility analysis, which is
prepared by the local managers, is reviewed and approved before any land or lot
acquisition is consummated. This pre-designed analysis requires the local
managers to provide senior management with a myriad of information and
projections such as a subdivision plan, product type, projected absorption
rates, completion time, market analysis and rate of return ratios. The senior
management ensures that the information presented in the project feasibility
analysis satisfies the Company's established minimum criteria before a capital
investment is approved.
The Company allocates the necessary capital resources for new communities
consistent with its overall strategy and utilizes anticipated return on capital
as the primary criterion 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.
Capital commitments are determined by 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 the committee 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.
15
<PAGE>
The Company's corporate office handles cash management functions for both
corporate and subsidiary funds. Subsidiaries provide 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 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) updating each buyer on the progress of their home.
ACQUISITIONS
FOUNDING BUILDERS
Simultaneous with the closing of the Offerings, Fortress acquired each of the
Founding Builders through the merger of each Founding Builder with and into a
newly formed wholly-owned subsidiary of Fortress. The Founding Builders were
Buffington Homes, Inc. and affiliated companies (Buffington), Christopher Homes,
Inc. and affiliated companies (Christopher), The Genesee Company and affiliated
companies (Genesee) and Solaris Development Corporation and affiliated companies
(Sunstar). The aggregate consideration paid by Fortress in these transactions
was as follows:
(a) An aggregate of approximately $6.0 million in cash;
(b) An aggregate of 6,233,875 shares of common stock of the Company,
representing approximately 53% of the total shares of common stock
outstanding after giving effect to the Offerings; and
(c) An aggregate of 20,000 shares of Series A 11% Cumulative
Convertible Preferred Stock of the Company.
The consideration paid for the Founding Builders was determined through arm's
length negotiations among the Company and representatives of the Founding
Builders.
The agreements governing each of the acquisitions (the Acquisition Agreements)
provide piggyback registration rights to the Founding Builders' owners which
allows them to register their shares of common stock
16
<PAGE>
under the Federal securities laws, on a pro rata basis, to the extent allowable
by the managing underwriter of such offering, in the event the Company
consummates a "follow-on" offering of the Company's common stock for cash.
Additionally, for a one-year period beginning November 1997, (i) the holders of
at least one-third of the common stock then held by the Founding Builders'
owners or (ii) all of the Founding Builders' owners of a particular Founding
Builder who hold shares of common stock, had 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. On March 26, 1998, a registration statement filed under the
Securities Act became effective (the "Resale Registration Statement"),
registering for resale up to 6,431,192 shares owned by certain of the Founding
Builders' owners and other persons.
SUBSEQUENT ACQUISITIONS
During 1996, the Company acquired certain assets and assumed related
indebtedness of Landmark Homes, Inc. (Landmark) and Brookstone Homes, Inc.
(Brookstone) on August 31, 1996 and December 31, 1996, respectively.
Effective February 28, 1997, the Company acquired the assets of D.W. Hutson
Construction Company (Hutson), a Jacksonville, Florida homebuilder. Effective
August 1, 1997, the Company acquired the stock of Don Galloway Homes, Inc. and
related interests (Galloway), a Charlotte, North Carolina and Charleston, South
Carolina builder. Effective October 1, 1997, the Company acquired The Iacobucci
Organization (Iacobucci), a homebuilder in the Philadelphia, Pennsylvania.
Effective January 1, 1998, the Company acquired WestBrook Homes (WestBrook), a
homebuilder in the Loudoun County, Virginia area of the Washington, DC MSA. The
acquisition price was not material to the Company.
Effective March 1, 1998, the Company acquired Whittaker Homes, a St. Louis,
Missouri homebuilder. The acquisition cost including cash paid and assumption of
debt was $62.1 million. The cash portion of the transaction was funded by the
sale of preferred stock to Prometheus to Prometheus Homebuilders LLC
(Prometheus).
Effective April 1, 1998, the Company acquired Quail Construction, a homebuilder
in the Portland, Oregon MSA. The acquisition price was not material to the
Company.
Cost of goods sold for the years ended December 31, 1998 and 1997 included
approximately $1,624,000 and $1,928,000 related to the allocation of purchase
price to inventory.
17
<PAGE>
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 57 Chairman of the Board and Director
George C. Yeonas 44 Chief Executive Officer and Director
Paul A. Giusti 41 Chief Operating Officer
Jeffrey W. Shirley 40 Vice President of Finance, Principal Financial Officer
and Principal Accounting Officer
</TABLE>
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.
George C. Yeonas joined the Company as Chief Operating Officer and Director in
August of 1997 and in March of 1999 was appointed Chief Executive Officer. He
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 a Divisional Partner for Trammell Crow in Tampa, Florida.
Paul A. Giusti joined the Company by means of his role as Chief Executive
Officer of Brookstone, which was acquired by the Company in December of 1996. He
retained that position, in addition to being appointed a regional vice president
of the Company in June of 1997, and was named Chief Operating Officer of the
Company in March of 1999. Mr. Giusti co-founded a Chicago area developer, Golden
Development, Inc. in 1989, which subsequently merged with Brookstone. From 1985
to 1989, Mr. Giusti held several management positions with General Electric,
Inc., including those of Manager, International Sales Support and Manager,
International Trade Development.
Jeffrey W. Shirley joined the Company as Vice President of Finance in November
of 1996. Mr. Shirley has over 15 years of experience in the homebuilding
industry. From 1984 to 1995, Mr. Shirley was with Kenneth Leventhal & Company
providing audit and consulting expertise to both local and regional
homebuilders, developers and syndicators of real estate operating properties.
Mr. Shirley was a leader in developing a homebuilding practice for the Chicago
office of Kenneth Leventhal & Company. From June of 1995 to November of 1996,
Mr. Shirley was a director of real estate services for the Chicago office of
Price Waterhouse LLP focusing on transactional services for a variety of real
estate clients.
EMPLOYEES AND SUBCONTRACTORS
As of December 31, 1998, the Company employed 1,190 (1,151 full-time and 39
part-time) persons, including corporate staff and other personnel involved in
sales, construction management and customer service. Although most of the
Company's employees are not 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.
18
<PAGE>
RISK FACTORS
COMPETITION AND MARKET FACTORS. The development and sale of residential property
is highly competitive and fragmented. The Company competes for residential sales
with national, regional and local developers and homebuilders, resales of
existing homes and, to a lesser extent, condominiums and available rental
housing. The Company's competitors include a number of large national and
regional homebuilding companies and small local homebuilding companies, some of
which may have greater financial resources, easier access to capital markets
and/or lower costs than the Company. Competition among both small and large
residential homebuilders is based on a number of interrelated factors, including
location, reputation, amenities, design, quality and price. The Company believes
it compares favorably to other homebuilders in the markets in which it operates
due primarily to (i) its experience within its specific geographic markets which
allows it to develop and offer new products to potential home buyers which
reflect, and adapt to, changing market conditions; (ii) its ability, from a
capital and resource perspective, to respond to market conditions and to exploit
opportunities to acquire land upon favorable terms; and (iii) its respective
subsidiaries' reputation for outstanding service and quality products.
The homebuilding industry is cyclical and affected by consumer confidence
levels, prevailing economic conditions in general and by job availability and
interest rate levels in particular. A variety of other factors affect the
homebuilding industry and demand for new homes, including changes in costs
associated with home ownership such as increases in property taxes and energy
costs, changes in consumer preferences, demographic trends and the availability
of and changes in mortgage financing programs. In addition, homebuilders are
subject to various risks often outside of their control, including weather
conditions and natural disasters, construction delays, cost overruns, changes in
governmental regulations, as well as availability and price fluctuations of
land, labor and raw materials.
The homebuilding industry is also subject to the potential for significant
variability and fluctuations in real estate values. Although the Company
believes the real estate assets currently reflected on the Company balance sheet
are reasonable in amount given the size of the Company's business and are
reflected at or below their fair value, no assurances can be given that
write-downs to the net realizable value of some or all of the Company's assets
will not occur if market conditions deteriorate, or that such write-downs,
should they occur, will not be material in amount.
GOVERNMENT REGULATIONS AND ENVIRONMENTAL CONTROLS. The Company is also subject
to a variety of Federal, state and local statutes, ordinances, rules and
regulations concerning protection of health and the environment. These laws may
result in delays, cause the Company to incur substantial compliance costs and
prohibit or severely restrict development in certain environmentally sensitive
regions or areas. Prior to purchasing a parcel of land, the Company's local
management evaluates such land for the presence of hazardous or toxic materials,
wastes or substances. The Company generally engages independent environmental
engineers to complete such an evaluation. The Company has not been materially
adversely affected to date by the presence or potential presence of such
materials. However, no assurance can be given that such a material adverse
affect will not occur in the future.
Whether Fortress controls entitled or unentitled land, certain building and
other permits, as well as approvals, are required to complete all residential
developments. The ability of the Company to obtain necessary approvals and
permits for its planned communities is often beyond the Company's control and
could restrict or prevent the development of otherwise desirable property. The
length of time necessary to obtain permits and approvals increases the carrying
costs of unimproved land acquired for the purpose of development and
19
<PAGE>
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 pertaining to the deductibility
of mortgage interest could affect demand for new homes.
DILUTION OF EARNINGS PER SHARE. The Company has issued $40,000,000 initial
liquidation value (40,000 shares) of Class AAA preferred stock and has also
issued Contingent Warrants which potentially provide for the issuance of between
606,061 and 33,333,333 shares of common stock to Prometheus Homebuilders LLC,
depending on the price of the common stock.
The Class AAA preferred stock is convertible at Prometheus' option into common
stock at any time into 6,666,667 shares of common stock at a conversion price of
$6.00 per share. The Contingent Warrants would become exercisable at an exercise
price of $.01 per share on September 30, 2001 and would expire on March 31,
2004. The number of shares of common stock potentially issuable pursuant to the
exercise of the Contingent Warrants is subject to adjustment depending upon the
60 day average closing price of the common stock between September 30, 2001 and
September 30, 2003. If during this entire period the closing price remains
greater than $12.00 per share, no shares would be issuable pursuant to the
Contingent Warrants. If at any time during this period the average closing price
is $12 per share or less, the number of shares of common stock for which the
Contingent Warrants may be exercisable would be adjusted, up to five times per
year. The Contingent Warrants would be exercisable for 606,061 shares if the
average closing price were no lower than $10.01 per share at any time during
this period and would increase based upon lower average closing prices,
increasing to a maximum of 33,333,333 shares if the average closing price was
$2.00 or less per share during this period. The issuance and conversion of the
Class AAA preferred stock and the issuance and exercise of the Contingent
Warrants could have the effect of materially reducing the Company's earnings per
share and diluting the economic interest of the Company's existing stockholders.
DILUTION OF VOTING POWER. Pursuant to the terms of the Class AAA preferred
stock, Prometheus has the right to elect three Preferred Stock directors out of
an up to 11-member board of directors. A proportionate number of the Preferred
Stock directors also are entitled to serve on each committee of the board of
directors, except for the executive committee. The executive committee consists
of five members of which two are Preferred Stock directors. Upon the occurrence
of an event of default under the Class AAA preferred stock (which principally
consist of defaults on dividends or other payment obligations), Prometheus would
be entitled to elect additional Preferred Stock directors sufficient to
constitute a majority of the board of directors and all committees of the board
of directors.
Prometheus, as the holder of Class AAA preferred stock, is 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. Each share of Class
AAA preferred stock entitles its holder to cast the number of votes equal to the
number of
20
<PAGE>
shares of common stock into which such share of Class AAA preferred
stock is convertible, based on the $6.00 per share conversion price. Based upon
its ownership of $40,000,000 initial liquidation value (40,000 shares) of Class
AAA preferred stock and 898,845 shares of common stock, Prometheus holds
approximately 41% of the total voting power of the Company's stock. Prometheus
may acquire additional voting power under certain circumstances, including the
conversion of Class AAA preferred stock and the exercise of the Contingent
Warrants.
CHANGE OF CONTROL. As described above, Prometheus has substantial voting power,
including the right under certain circumstances to elect a majority of the board
of directors, its executive committee and other committees. The holders of Class
AAA preferred stock also have certain consent rights, which require the approval
of the holders of at least 66 2/3% of the Class AAA preferred stock to effect
certain significant corporate actions or transactions, including a merger or
sale of substantial assets, unless the Class AAA preferred stock is redeemed as
part of the transaction. Further, under the Company's amended bylaws, and the
amended bylaws of the Company's subsidiaries, the Company may not, and may not
permit any of its subsidiaries to, engage in or agree to engage in a number of
significant actions or transactions, including adopting an annual operating
budget, taking actions not provided for in the budget, incurring new debt and
issuing securities, without the affirmative vote of over 81% of the board of
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 needs the approval of at least one of the
three Preferred Stock directors (together with 8 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 has 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 is 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.
ANTI-TAKEOVER EFFECTS. Prometheus's representation on the board of directors 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 could have
anti-takeover effects. Also, provisions of Delaware law and of the Company's
Amended and Restated Certificate of Incorporation could have the effect of
making it more difficult for a third party to acquire, or of discouraging a
third party from attempting to acquire, control of the Company. These provisions
could deter, delay or prevent 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.
SHARES ELIGIBLE FOR FUTURE SALE. The Company has outstanding approximately
12,100,000 shares of common stock, of which approximately 10,500,000 shares are
freely tradable without restriction (including shares subject to the Resale
Registration Statement) and approximately 1,600,000 shares are saleable subject
to certain volume and other restrictions of Rule 144 under the Securities Act.
In addition, at least 895,407 shares are issuable upon the conversion of the
Company's outstanding classes of preferred stock and 336,604 shares are issuable
upon exercise of currently exercisable options. Additional shares would be
issuable upon the conversion of the Class AAA preferred stock and the adjustment
and exercise of the Contingent Warrants. Sale of substantial amounts of such
shares in the public market or the prospect of such sales could materially
adversely affect the market price of the common stock.
DEPENDENCE ON MANAGEMENT. 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 that subsidiary. If any of these people become unable to
continue in
21
<PAGE>
their present roles, or if the Company is unable to attract and retain other
skilled employees, the Company's business could be adversely affected.
YEAR 2000. The risks posed by Year 2000 issues could adversely affect the
Company's business. No one knows to what extent Year 2000 issues will affect the
economy in general. If Year 2000 issues were to affect consumer confidence, the
number of persons electing to purchase new homes could be impacted. Further,
Year 2000 issues may adversely affect other entities with which we do business,
including for example, lenders, vendors and subcontractors. Finally, the
Company's information technology systems could be impaired due to Year 2000
problems.
22
<PAGE>
ITEM 2. PROPERTIES
The Company's principal executive offices are located at 1650 Tysons Boulevard,
Suite 600, McLean, Virginia 22102. The Company occupies approximately 4,800
square feet of leased office space for its corporate office in Virginia and
leases an aggregate of approximately 118,600 square feet of office space in 23
locations for its homebuilding and mortgage subsidiaries.
ITEM 3. LEGAL PROCEEDINGS
The Company is, from time to time, a party to litigation arising in the normal
course of its business. Management believes that none of the actions to which it
is a party will have a material adverse effect on the financial condition,
results of operations or cash flows of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to the Company's stockholders for consideration during
the quarter ended December 31, 1998.
23
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Price Range of Common Stock. The Company's common stock has traded on the
Nasdaq National Market since May 16, 1996. On March 23, 1999, the closing
price of the common stock was $2.00 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 periods indicated:
High Low
Fiscal Year 1997
First fiscal quarter $6.88 $5.25
Second fiscal quarter $6.63 $4.88
Third fiscal quarter $6.50 $4.50
Fourth fiscal quarter $5.25 $4.00
Fiscal year 1998
First fiscal quarter $5.50 $4.25
Second fiscal quarter $6.38 $4.50
Third fiscal quarter $7.00 $3.50
Fourth fiscal quarter $3.88 $1.25
(b) Approximate Number of Equity Security Holders. The number of record
holders of the Company's common stock as of March 23, 1998 was 78, which
does not include beneficial owners who hold the Company's stock in street
name.
(c) Dividends. In March 1997, the Company established a dividend policy
including the initiation of a cash dividend. The initial dividend policy
was to pay a dividend of one cent per year paid quarterly. Pursuant to
this policy, the Board of Directors subsequently declared a quarterly
cash dividend of one-quarter cent per share on the Company's common stock
for each of the fiscal quarters in 1997 and the first two quarters of
1998. This policy was discontinued during the third quarter of 1998.
Under the terms of its agreement with Prometheus Homebuilders LLC (Prometheus),
the Company issued 28,300 shares of Class AA preferred stock and warrants to
purchase 375,000 shares of common stock to Prometheus on March 6, 1998. See Note
9 - Shareholders' Equity in the Company's consolidated financial statements
included in Item 8 hereof.
Under a Restructuring Agreement dated December 31, 1998 between the Company and
Prometheus, the Company agreed to issue to Prometheus, effective February 4,
1999, 40,000 shares of Class AAA Redeemable Convertible Preferred Stock having
an initial liquidation value of $40,000,000 and contingent warrants in exchange
for the outstanding 40,000 shares of Class AA Convertible Preferred Stock having
a liquidation value of $40,000,000 and 375,000 warrants held by Prometheus. This
exchange was effective February 4, 1999 See Note 17 - Subsequent Events in the
Company's consolidated financial statements included in Item 8 hereof.
24
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected 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."
<TABLE>
<CAPTION>
The Fortress Group, Inc. and Combined Predecessor Companies (1)
(dollars in thousands, except per share amounts and operating data)
COMBINED PREDECESSOR COMPANIES THE FORTRESS YEAR ENDED THE FORTRESS GROUP, INC.
GROUP, INC. DEC. 31,
YEAR ENDED DEC. 31, JANUARY 1 - MAY 21 - 1996 YEAR ENDED DEC. 31,
1994 1995 MAY 20, 1996 DEC. 31, 1996 TOTAL 1997 1998
---- ---- ------------ ------------- ----- ---- ----
<S> <C> <C> <C> <C> <C> <C> <S>
Statement of Operations
Data:
Revenues $ 174,715 $ 199,029 $66,119 $ 210,354 $276,473 $447,374 $692,645
Gross Profit 28,431 31,595 9,694 32,967 42,661 67,704 104,629
Operating income 5,411 6,750 1,113 12,787 13,900 16,236 24,099
Income before provision
for income taxes 4,828 6,076 1,274 13,221 14,495 13,923 21,628
Net income(2) $ 4,745 $ 6,055 $ 1,274 $ 8,208 $ 9,482 $ 8,460 $ 12,834
========= ========= ======= ========= ======== ======== ========
Basic Earnings per share(3) $ .69 $ .68 $ .46
Diluted Earnings per share(3) $ .69 $ .63 $ .42
========= ======== ========
Cash dividends per common share $ .01 $ .005
Weighted average sharesoutstanding, basic 11,701,587 11,759,712 11,818,888
Weighted average shares outstanding, diluted 11,919,944 12,862,171 13,126,271
</TABLE>
<TABLE>
<CAPTION>
COMBINED PREDECESSOR COMPANIES THE FORTRESS GROUP, INC.
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance Sheet Data: (as of December 31)
Cash $ 4,866 $ 2,710 $ 16,212 $ 12,406 23,102
Inventory 101,214 109,016 144,106 217,342 310,706
Total assets 111,403 121,666 193,733 331,327 449,903
13.75% Senior Notes due 2003 100,000 100,000 100,000
Notes and mortgages payable 83,161 87,604 40,136 122,443 192,769
Minority interests 1,346 1,295 274 268 67
Stockholders' equity 6,018 9,836 31,986 62,897 91,193
</TABLE>
<TABLE>
<CAPTION>
COMBINED PREDECESSOR COMPANIES COMBINED (1) THE FORTRESS GROUP, INC.
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Operating Data: (for the years ended
December 31)
Units
New contracts, net of cancellations 1,015 1,100 1,410 2,706 4,366
Closings 966 998 1,402 2,762 4,016
Backlog(4) 357 459 512 1,056 1,606
Aggregate sales value of backlog
(in thousands)(4) $ 78,760 $ 97,242 $ 95,992 $198,247 $308,832
Average sales price per home closed $176,400 $190,700 $189,500 $159,300 $168,600
</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 and operational
information of the Combined Predecessor Companies has been combined on a
historical cost basis for all periods presented prior to the Acquisitions
as if these companies had always been members of the same operating group.
However, during the periods presented prior to the Acquisitions, the
Founding Builders were not under common control or management.
(2) All of the Founding Builders were S corporations through May 20, 1996 with
the exception of Buffington, which converted to an S corporation effective
January 1, 1994. As S corporations, the Founding Builders were not subject
to Federal income tax. Accordingly, the data presented should not be viewed
as comparable to or indicative of the post-combination results to be
achieved by the Company. Subsequent to the Acquisitions, the information
presented is on a consolidated basis of The Fortress Group, Inc.
(3) See calculation in Note 10- Earnings Per Share in the Company's
consolidated financial statements included in Item 8 hereof.
(4) At end of period and represents homes sold but not closed.
25
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following table sets forth for the periods indicated certain items
of the Company's consolidated results of operations including, for the periods
prior to the Offerings, the results of operations for the Combined Predecessor
Companies (dollars expressed in millions) and as a percentage of the Company's
total and, for 1998 and 1997, segment revenues:
<TABLE>
<CAPTION>
For the Year For the Year For the Period For the Period For the Year
Ended Ended May 21 - Jan. 1 - Ended
Dec. 31, 1998 Dec. 31, 1997 Dec. 31, 1996 May 20, 1996 Dec. 31, 1996
----------------------- --------------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Total revenues $692.6 100.0% $447.4 100.0%
Homebuilding revenues 687.9 99.3% 100.0% 445.3 99.5% 100.0% $210.4 100.0% $66.1 100.0% $276.5 100.0%
Gross profit without step-up(1) 106.3 15.3% 15.5% 69.6 15.6% 15.6% 33.2 15.8% N/A 42.9 15.5%
Gross profit with step-up 104.6 15.1% 15.2% 67.7 15.1% 15.2% 33.0 15.7% 9.7 14.7% 42.7 15.4%
SG&A 80.5 11.6% 11.7% 51.5 11.5% 11.6% 20.2 9.6% 8.6 13.0% 28.8 10.4%
Homebuilding pre-tax income 21.5 3.1% 3.1% 13.7 3.1% 3.1%
Mortgage revenues 4.7 0.7% 100.0% 2.1 0.4% 100.0%
Mortgage expenses 4.5 0.7% 95.7% 1.9 0.4% 90.5%
Mortgage pre-tax income 0.2 - 4.3% 0.2 - 9.5%
Pre-tax income 21.6 3.1% 13.9 3.1% 13.2 6.3% 1.3 2.0% 14.5 5.2%
</TABLE>
(1) Excluding the effect of the purchase accounting adjustments to the inventory
of the acquired companies.
ACQUISITIONS
ACQUISITION OF WESTBROOK HOMES
Effective January 1, 1998, the Company acquired WestBrook Homes ("WestBrook"), a
homebuilder in the Loudoun County, Virginia area of the Washington, DC MSA.
WestBrook concentrates its efforts on single-family detached homes for first and
second time move-up homebuyers.
ACQUISITION OF WHITTAKER HOMES, INC.
Effective March 1, 1998, the Company acquired the stock of Whittaker Homes
("Whittaker"). Whittaker, the largest homebuilder in the St. Charles County area
of the St. Louis MSA, builds single family detached homes targeting first and
second move-up buyers.
ACQUISITION OF QUAIL CONSTRUCTION, INC.
Effective April 1, 1998, the Company acquired certain assets of Quail
Construction ("Quail"). Quail provides a range of condominiums and detached
homes to entry level, first time move-up and empty-nest buyers in the Portland,
Oregon/ Vancouver, Washington area.
The Company's actual results of operations reflect the operating activity of
WestBrook, Whittaker, and Quail from the respective effective dates of their
acquisitions.
26
<PAGE>
The following table sets forth information relating to new orders, home
closings, and sales backlog by state for the years ended December 31, 1998,
1997, and 1996. (Note that 1996 unit activity reflects the combined activity of
the Company for the period May 21st through December 31st and the Combined
Predecessors for the period January 1st through May 20th.)
<TABLE>
<CAPTION>
New Orders, Net Closings Backlog at December 31,
--------------- -------- -----------------------
1998 1997 1996 1998 1997 1996 1998 1997 1996
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
State
Arizona 92 38 24 66 37 21 34 9 8
Colorado 360 377 306 361 332 267 183 183 138
Florida 850 567 N/A 702 636 N/A 299 151 N/A
Missouri 462 N/A N/A 438 N/A N/A 188 N/A N/A
Nevada 153 134 80 130 92 121 86 63 21
North Carolina 726 522 346 692 612 318 285 250 164
Oregon 61 N/A N/A 60 N/A N/A 11 N/A N/A
Pennsylvania 220 34 N/A 216 43 N/A 53 49 N/A
South Carolina 189 72 N/A 181 53 N/A 87 80 N/A
Texas 904 812 654 853 811 675 300 249 163
Virginia 53 N/A N/A 48 N/A N/A 17 N/A N/A
Washington 59 N/A N/A 71 N/A N/A 2 N/A N/A
Wisconsin 237 150 N/A 198 146 N/A 61 22 18
------ ------ ------ ------ ------ ------ ------- ------- ----
Total 4,366 2,706 1,410 4,016 2,762 1,402 1,606 1,056 512
</TABLE>
CONSOLIDATED RESULTS OF OPERATIONS
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1998 COMPARED TO THE
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997
General
As seen in the chart above, the Company achieved net new orders of 4,366 units
and 2,706 units in the years ended December 31, 1998 and 1997, a 61.3% increase.
This increase is attributable to the Company's acquisitions as well as
significant new order increases at the Company's operations in Arizona, Texas,
and Wisconsin. At December 31, 1998, the Company has a combined backlog of 1,606
units with a dollar value of $308.8 million as compared to 1,056 units with a
dollar value of $198.2 million as of December 31, 1997, which is consistent with
the strong increase in new orders as stated above.
Revenue
Homebuilding revenues for the Company totaled $687.9 million for the year ended
December 31, 1998 as compared to $445.3 million for the year ended December 31,
1997, an increase of 54.5%. The increase in revenue is consistent with the
increase in the number of homes closed during the respective years. In 1998,
4,016 homes were closed as compared to 2,762 closings in 1997. This 45.4%
increase is attributable to the Company's recent acquisitions as well as strong
increases in closings in all of the markets in which the Company operates.
Additionally, the average price of units closed rose from $159,300 in 1997 to
$168,600 in 1998. This increase reflects the effects of increased closings in
the higher-end homes available in the Las Vegas market coupled
27
<PAGE>
with the Whittaker and WestBrook acquisitions whose average price of units
closed since acquisition is approximately $171,000 and $296,000, respectively.
Lot sales and other revenue increased to $10.6 million in 1998 from $5.3 million
in 1997. Lot sales and other revenue represented 1.5% of revenue in 1998
compared to 1.2% of revenue in 1997. The increase in this area resulted
primarily from the sale of a significant number of lots from a Founding
Builder's land development project in Michigan as well as the late 1997 and
early 1998 acquisitions of builders who routinely develop their own lots and
occasionally sell lots to other homebuilders. The Michigan project is now in its
final stages with only seven remaining lots, which are expected to close early
1999. Although the Company purchases land and engages in land development
activities primarily to support its own homebuilding activities, lots and land
are occasionally sold to other developers and homebuilders. For example, in
1998, the St. Louis operation hosted the area "Home-a-Rama" in one of the
Company's subdivisions; this project entailed selling lots to several other
builders participating in the home show. The Company is currently carrying
another land parcel of significant size that was under a Founding Builder's
control at the time of the Offerings. This North Carolina subsidiary has
generally not developed long-term land projects on its own and, therefore,
actively marketed the parcel. This parcel is currently under a contingent
contract awaiting final entitlement; the Company expects this parcel to be sold
during 1999.
Gross Profit
The Company's gross profit as a percentage of homebuilding revenues, or gross
margin, remained constant from 1997 to 1998 at 15.2%. The Company experienced
increased margins at certain subsidiaries. The Company uses estimates of the
total capitalized costs in order to determine the amount of costs of sales to
record each year. As a result of increases in certain cost estimates at the Las
Vegas subsidiary in late 1998, cost of sales at this subsidiary was increased
for the fourth quarter (resulting in reduced margins). The Company expects that
increased cost of sales will continue and result in reduced margins at the Las
Vegas subsidiary in 1999 as well. The Company's generally strong margins in 1998
and 1997 were also depressed by acquisition accounting adjustments. Generally
accepted accounting principles require that, in a purchase transaction, the
acquirer write-up inventory to an estimated fair value upon acquisition. This
results in increased cost of sales as the written-up inventory is closed and,
therefore, decreased gross margins. Accordingly, gross margins of acquired
companies are lower than they otherwise would have been. At December 31, 1998,
the amount of unamortized inventory write-up is approximately $1,886,000.
Operating Expenses
Overall SG&A increased slightly as a percentage of revenue to 11.7% ($80.5
million) from 11.6% ($51.5 million) for the years ended December 31, 1998 and
1997, respectively. Selling expenses remained steady at 6.3% of homebuilding
revenues while general and administrative expenses dropped slightly to 5.0% from
5.1% in 1998 and 1997, respectively.
Amortization of goodwill increased $1.5 million to $2.4 million in 1998 from
$0.9 million in 1997. This is primarily due to the additional amortization
resulting from the Galloway and Whittaker acquisitions.
Fortress Mortgage Operations
Fortress Mortgage, Inc. ("Fortress Mortgage"), which was formed in January of
1997, continues to open new branch operations primarily in our builder markets.
At the end of the 1997, Fortress Mortgage had six operating branches and, by the
end of 1998 has opened an additional eight branches for a current total of
fourteen branches.
28
<PAGE>
Fortress Mortgage revenue grew 123.8% to $4.7 million in 1998 compared to $2.1
million in 1997. However, pre-tax income stayed constant at $.2 million. This is
largely due to the negative impact of the start-up costs incurred in conjunction
with short-term growth through the aforementioned office openings. For the year
ended December 31, 1998, Fortress Mortgage provided mortgages to 25.7% of the
Company's closings in those markets which it serves. In those markets which
Fortress Mortgage has served since 1997, the capture rate, (the percentage of
closings for which Fortress Mortgage provided mortgages), for the year has
increased to 54.3% in 1998 from 51.9% in 1997.
Net Income
Pre-tax income increased $7.7 million to $21.6 million in 1998 from $13.9
million in 1997, representing an increase of 55.4%. Net income for the year
ended December 31, 1998 increased correspondingly to $12.8 million from $8.5
million for the year ended December 31, 1997.
Diluted earnings per share for the year ended December 31, 1998 was
significantly impacted by the $5.0 million dividend paid in connection with the
restructuring of the agreement between the Company and Prometheus. Under the
terms of the revised agreement, Prometheus exchanged its Class AA preferred
stock for new Class AAA stock. Among other attributes, the Class AAA preferred
stock does not result in dilution of earnings per share similar the dilution
related to the Class AA preferred stock as detailed below.
During 1998, the Class AA was convertible at $6.00 per share. However, Class AA
preferred stock and the related warrants included future reset tables that
provided that between September 30, 2001 and September 30, 2003, the conversion
rate changed based on the then current market price of the Common Stock (See
Note 9 to the Financial Statements included herein). The dilution of earnings
per share was significantly increased during 1998 due to the lower average stock
value during the quarters ended December 31, 1998 and September 30, 1998.
Pursuant to the current relevant accounting literature, the Company was required
to report currently the potential future conversion based on the contractual
reset tables and the current market price even though the holder of the Class AA
preferred stock and warrants could not effect a conversion under these reset
tables until September 30, 2001. Excluding the effect of the $5 million
non-recurring preferred dividend and of the contingent dilution, on an adjusted
basis, basic earnings per share grew 29% to $.88 per common share for 1998 from
$.68 per common share for 1997. Based on the same adjustments, diluted earnings
per share grew 8% to $.68 for 1998 from $.63 for 1997.
Earnings before interest, taxes, depreciation and amortization (EBITDA)
increased 50.1% to $59.6 million in 1998 compared to $39.7 million in 1997.
EBITDA is provided as a supplemental measurement of the Company's operating
performance. EBITDA does not represent cash flows from operations as defined by
GAAP and should not be considered as an alternative to net income as an
indicator of the Company's operating performance or to cash flows as a measure
of liquidity. In addition, EBITDA measures presented by the Company may not be
comparable to other similarly titled measures of other companies.
RESULTS OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 1997 COMPARED TO THE
COMBINED RESULTS OF OPERATIONS OF THE COMPANY FROM MAY 21 THROUGH DECEMBER 31,
1996 AND THE COMBINED PREDECESSORS FROM JANUARY 1 THROUGH MAY 20, 1996
No comparison has been made to 1996 actual results (the period May 21 through
December 31, 1996) due to the incomparability of periods resulting from the
Company's Offerings. All 1996 references to the Company in this section indicate
the combined results of the Company and the Combined Predecessors.
29
<PAGE>
General
As seen in the chart earlier in this section, the Company achieved net new
orders of 2,706 units and 1,410 units in the years ended December 31, 1997 and
1996, an increase of 91.9%. This increase is attributable to the Company's
acquisitions and an increase in net new orders in the Company's Colorado
(increase of 71 units or 23.2%) and Nevada (increase of 54 units or 67.5%)
operations. At December 31, 1997, the Company had a combined backlog of 1,056
units with a dollar value of $198.2 million as compared to 512 units with a
dollar value of $96.0 million as of December 31, 1996, which is consistent with
the strong increase in new orders as stated above.
Revenue
Revenue for the Company was $445.3 million for the year ended December 31, 1997
as compared to $276.5 million for the year ended December 31, 1996, an increase
of 61.0%. The increase in revenue is consistent with the increase in the number
of homes closed during the respective years. In 1997, 2,762 homes were closed as
compared to 1,402 closings in 1996. This 97.0% increase is attributable to the
Company's acquisitions as well as a 28.1% increase in closings in the Company's
Denver and Fort Collins operations.
Offsetting the effect on the revenue of the increase in units closed was a
decline in the average price of units closed, to $159,300 from $189,500 for 1997
and 1996, respectively. This decrease reflects the effects of fewer closings in
the higher-end homes available in the Las Vegas market (due to a shortage of
land on which to build these homes at the beginning of the year) and the Hutson
and Brookstone acquisitions whose average price of units closed was
approximately $109,000 and $125,000 per unit, respectively. Despite the Las
Vegas slowdown in closings, the Founding Builders' unit closings were up 2.8% in
1997 compared to 1996.
Also offsetting the effect of the increase in closings was a decrease in lot
sales and other revenue to $5.3 million in 1997 from $10.8 million in 1995. Lot
sales and other revenue represented 1.2% of revenue in 1997 compared to 3.9% of
revenue in 1996. The decrease in this area was expected and will continue as it
is not the Company's policy to invest resources in land strictly for resale. One
of the Founding Builders joined Fortress with a significant land development
project in Michigan. The Company is currently carrying another land parcel of
significant size that was under a Founding Builder's control at the time of the
Offerings. This North Carolina subsidiary has generally not developed long-term
land projects on its own and is, therefore, actively marketing the parcel.
Gross Profit
The Company's gross profit as a percentage of revenue increased to 15.6% for the
year ended December 31, 1997 from 15.5% in 1996 excluding the effect of the
purchase accounting adjustments to the inventory of the acquired companies.
However, the Company's generally-improved margins in 1997 were depressed by
acquisition accounting adjustments. Generally accepted accounting principles
require that, in a purchase transaction, the acquirer write-up inventory to an
estimated fair value upon acquisition. This results in increased cost of sales
as the written-up inventory is closed and, therefore, decreased gross margins.
Accordingly, gross margins of acquired companies Landmark, Hutson, Galloway, and
Iacobucci were lower than they otherwise would have been. At December 31, 1997,
the amount of unamortized inventory write-up is approximately $219,000.
The amortization of the inventory write-up in 1997 totaled $1.9 million and in
1996 totaled $210 thousand. This amortization had the effect of decreasing the
1997 gross profit margin to an actual gross profit margin of 15.2%.
30
<PAGE>
Additionally, the Company experienced higher gross margins in its Denver and Las
Vegas markets that were offset by decreased margins in Austin and Raleigh. The
reduction of margins in the Texas and North Carolina markets reflected the
effect of increasing competitive pressure. The Company's subsidiaries responded
by implementing aggressive marketing strategies and modest price decreases to
maintain volume, which have slightly impacted the Company's margins.
Operating Expenses
In June 1997, Fortress chose not to go forward with a potential acquisition of
significant size. This resulted in the expensing of approximately $335,000 of
acquisition costs that had previously been capitalized.
Without this non-recurring item, overall SG&A increased as a percentage of
revenue to 11.5% ($51.2 million) from 10.4% ($28.7 million) for the years ended
December 31, 1997 and 1996, respectively. Selling expenses increased to 6.3%
($28.0 million) from 5.9% ($16.2 million) while general and administrative
expenses rose to 5.2% ($23.2 million) from 4.5% ($12.5 million) in 1997 and
1996, respectively. The increase in selling expenses as a percentage of revenue
was a result of the Company's successful efforts earlier during the year to
enlist outside broker services. Additionally, as previously discussed, the
Company attacked tightening markets in Austin and Raleigh with new marketing
strategies in order to counteract increasing competition.
Amortization of goodwill increased $865,125 to $947,883 in 1997 from $82,758 in
1996. Without goodwill amortization, general and administrative expenses as a
percentage of revenue would have been 5.1% in 1997. Additionally, general and
administrative expenses for 1996 are not truly comparable to those of 1997 as
they do not include any adjustment for corporate expenses which would have been
incurred if the Company had existed as a single public entity for the entire
year. In 1997, the increase in general and administrative expenses as a
percentage of revenue reflected the Company's commitment to building a corporate
structure to properly integrate and oversee its growing operations. As the
Company grew from ten markets at the end of 1996 to fourteen markets at the end
of the same period in 1997, operational and financial management increased in
order to enhance subsidiary management through strategic planning, refined
budgeting processes, and identification and implementation of operational best
practices and efficiencies and a standardized computer system.
Net Income
Pre-tax income decreased $.6 million to $13.9 million in 1997 from $14.5 million
in 1996, representing a decrease of 4.1%. Net income for the year ended December
31, 1997 ($8.5 million) decreased from net income for the year ended December
31, 1996 ($9.5 million). However, the net income for these periods was not
comparable because the 1996 net income did not include (1) a provision for
income taxes as if the Predecessor Companies were combined and subject to the
effective Federal statutory income tax rate throughout the period (including
such a provision, unaudited pro forma net income would have been $9.0 million)
or (2) any adjustment for corporate expenses which would have been incurred had
the Company existed as a single public entity for the entire 12 months.
In addition, Fortress incurred significantly higher interest expense during
1997. This was consistent with the Company's investment in "non-qualified"
assets, those assets for which interest must be immediately expensed. In 1997
and 1996, Fortress acquired several reputable homebuilders with solid
operational histories. In most cases, these acquisitions required payments in
excess of the acquired companies' book value for the goodwill that the owners'
had established, an intangible asset that has long-term value. Management
considers this a key investment in the growth of the Company; however, this
growth does come with the added cost of the goodwill.
31
<PAGE>
The Company also significantly increased its investments as a limited partner in
partnerships with land developing entities and, as previously mentioned,
invested in a company-wide standardized information system. These investments in
the future of the Company increased the overall leverage of the Company which
resulted in increased interest expense.
Earnings before interest, taxes, depreciation and amortization (EBITDA)
increased 35.0% to $39.7 million in 1997 compared to $29.4 million in 1996.
EBITDA is provided as a supplemental measurement of the Company's operating
performance. EBITDA does not represent cash flows from operations as defined by
GAAP and should not be considered as an alternative to net income as an
indicator of the Company's operating performance or to cash flows as a measure
of liquidity. In addition, EBITDA measures presented by the Company may not be
comparable to other similarly titled measures of other companies.
LIQUIDITY AND CAPITAL RESOURCES
The Company's operating activities involve several components, principally home
construction, land development and mortgage loan origination for home
purchasers. During 1998, the Company's operating activities, taken in the
aggregate, generated approximately $11.5 million of cash. This positive cash
flow from operating activities was partially offset by a $28.5 million increase
in real estate inventories and a $4.3 million increase in mortgage loans held
for resale. Additional borrowings under notes and mortgages payable secured by
this higher level of assets funded all but $9.6 million of the increase in these
two items (see the discussion of financing activities below). The increase in
inventory levels was consistent with increases in backlog.
The majority of the Company's investing activities during 1998 related to the
purchases of Whittaker and Quail as well as investments in land partnerships and
property and equipment purchases that include increases in model home
furnishings related assets.
The Company's financing activities generated $39.9 million of cash, consisting
primarily of $24.8 million from the issuance of Class AA preferred stock and
$23.2 million of net borrowings under notes and mortgages payable. The
additional borrowings were used to fund the majority of the buildup of inventory
and mortgage loans held for sale discussed above as part of cash flow from
operations. Also included in the Company's financing activities is the payment
of $7.0 million of preferred dividends, which included a $5.0 million
non-recurring preferred dividend.
The Company regularly refinances existing loan agreements, executes new loan
agreements and, in the case of acquisitions, assumes loans related to the assets
being acquired. Approximately $439.3 million of secured financing commitments
were in place at the subsidiary level at year-end. Under these credit
facilities, the Company has borrowed $192.7 million at December 31, 1998. The
total amount available under these commitments varies based on individual loan
covenants and inventory levels.
On March 6, 1998, at a special meeting of shareholders, the Company received
approval of its agreement with Prometheus. Concurrent with that approval, the
Company issued $28.3 million of Class AA preferred stock. On December 31, 1998
the Company paid a non-recurring dividend to Prometheus as part of a
restructuring of this agreement. The restructured agreement, which closed on
February 4, 1999, among other changes, (a) reduced the Company's obligation to
sell preferred stock to Prometheus from $75 million to $40 million, (b) modified
the dividend rate on the $40 million outstanding from 6% to 9% and, (c) provided
the Company with the right to redeem Prometheus' shares. The Company will
evaluate, from time to time, the appropriateness of the redemption on the
preferred stock, subject to compliance with the Senior Note Indenture, which
restricts the amount of stock redemptions or repurchases.
32
<PAGE>
The Company believes that funds available through the existing credit facilities
coupled with the cash on hand and cash generated through operations will be
adequate for the anticipated cash needs for the foreseeable future. As of
December 31, 1998 the Company had cash and cash equivalents on hand of $23.1
million.
At December 31, 1998, the Company had 4,395 lots in inventory, which represents
a nearly thirteen-month supply of land based on sales absorption rates during
1998. It is one of the Company's operating strategies to keep a relatively low
supply of finished lots and lots under development in order to manage and
minimize risk associated with land ownership. The Company utilizes land options
and investments in limited land partnerships as methods of controlling and
subsequently acquiring land. The Company plans to continue these practices and
expects to exercise, subject to market conditions, substantially all of its
option contracts. At December 31, 1998, the Company had 8,720 lots under option
representing a nearly 27-month supply of land based on the same absorption rates
as above.
SEASONALITY AND VARIABILITY OF RESULTS
The Company, and the homebuilding industry in general, experience significant
seasonality and quarterly variability in homebuilding activity levels. The
annual operating cycle generally reflects greater home new orders in the spring
and autumn months and slower new orders in the winter and summer months.
Closings are slowest during the first quarter and increase throughout the
remainder of the year. The Company believes that this seasonality is a
reflection of the impact of winter weather on construction activity and the
preference of homebuyers to close on their new home either prior to the start of
a new school year in the fall or prior to the holiday season.
OUTLOOK
The Company has experienced a significant increase in new order
activity during 1998 compared to 1997, particularly in the Florida
market. This increase has been augmented by the Company's acquisitions during
1997 and 1998, enabling it to achieve strong new orders activity in the
Charlotte, North Carolina and St. Louis, Missouri markets as well. At March 15,
1999, the Company already had 885 new orders.
As of March 15, 1999, the Company has outstanding sales contracts of
1,918 homes in backlog. These contracts represent approximately $339 million in
anticipated 1999 revenue. Management maintains a modest earnings outlook for
1999. It believes the Company is positioned to improve operations assuming
stable market conditions, interest rates, job growth and consumer confidence in
its homebuilding markets.
The Company believes the successful implementation of the Company's
key strategies should benefit future operating results in the long-run. The
Company has addressed and continues to address key business strategies through
(i) the implementation of the Fortress Mortgage business plan, (ii) the
continual focus of operational and financial management groups on the
company-wide program to reduce direct construction costs as a percentage of
revenue, and identification and implementation of processes to improve return on
assets at the subsidiary level, the sharing of "best practices" and the
implementation of an integrated computer information system, and (iii) ongoing
evaluations of certain underperforming assets and alternative strategies to
improve performance or redeploy funds which might be recovered from those
assets.
33
<PAGE>
These evaluations may culminate in transactions which do not permit
the Company to recover the asset carrying values. On March 29, 1999, the Company
sold the assets of Landmark and realized a loss of approximately $2.8 million.
As of December 31 1998, Landmark had total assets, including goodwill, of
approximately $11 million.
Please refer to Business- Risk Factors and the Statement on
Forward-Looking Information.
YEAR 2000
As many computer systems and other business equipment are embedded with chips or
processors that use only two digits to represent the year or are programmed with
software that uses such a two digit system, they may be unable to accurately
process certain data before, during or after January 1, 2000. If not addressed
and corrected, such programs and chips may cause computer systems to fail or to
miscalculate data. This issue is commonly referred to as the "Y2K" issue.
In conjunction with its ongoing process of converting all of its builder
subsidiaries to an integrated computer information system ("ICIS"), Fortress
began the project of addressing the Y2K issue during 1998. The Company's project
is directed at modifying or replacing portions of its existing computer systems
to ensure that they will function properly with respect to dates in the year
2000 and thereafter. The Company's plan encompasses both information technology
systems and non-information technology systems, such as chips embedded in its
security systems, office equipment, and facilities.
The general phases of the Company's plan include the following: (1) plan and
ensure company-wide awareness of the Y2K issue, (2) inventory all possible Y2K
risks, (3) assess inventory (including identification of non-Y2K compliant
items, prioritize inventory into mission-critical and non-mission-critical
categories, and plan for repair and replacement of non-compliant items), (4)
repair or replace non-Y2K compliant items, (5) plan and execute Y2K testing, and
(6) design and implement contingency plans for non-compliant items. Due to the
Company's structure and its ongoing computer information system rollout, the
Company is in different phases of implementation of its plan at its different
subsidiaries.
The Company has assessed the information systems of the subsidiaries as its
greatest area of business risk and, accordingly, has given this area highest
priority. At December 31, 1998, the Company has completed the first phase and is
well underway with phases two and three at all subsidiaries. The plan is to be
through phase five at all subsidiaries early in the second quarter of 1999 and
to have completed all phases throughout the Company by the end of the third
quarter of 1999.
The Company's information technology ("IT") group is currently involved with its
ICIS vendor performing Y2K testing on the ICIS. Even in its current operating
state, several applications of the system in use now are already Y2K compliant.
The most recent version, which renders the entire system Y2K compliant, is being
tested in the first quarter and will be converted in the second quarter. This
affects three of the Company's subsidiaries currently operating on the system.
As of March of 1999, three builder subsidiaries are not Y2K compliant. Of these
three, one is in the process of upgrading its current software to a Y2K
compliant version. The remaining two are planned for conversion to the ICIS in
the third quarter of 1999. The IT group has identified Y2K compliant upgrades
for these varying non-compliant systems, which are available at a cost that
would be immaterial to the Company. The main information systems at four of the
Company's builder subsidiaries are currently Y2K compliant. Due to the IT
group's current focus on bringing the Company into Y2K compliance, these
subsidiaries will not implement ICIS until 2000. Management does not consider
this delay in implementation to have a material adverse impact on the Company.
34
<PAGE>
Over the last twelve months, the Company's IT group has normalized the network
server and desktop operating systems, hardware platforms and network peripheral
devices to equipment and software that are certified as Y2K ready. Each desktop
computer in use at all builder subsidiaries has been certified to be Y2K
compliant or has been identified for replacement by the end of June of 1999.
Each server hardware component and operating system is certified to be Y2K
ready. Each component of the subsidiary builder local area networks is compliant
and the wide area network equipment and software is likewise certified.
Additional Y2K assessment and testing remains for one UNIX-based system used by
a single subsidiary and continued evaluation of little-used inventory systems
will be completed by the end of June of 1999.
While the Company is giving greatest priority to its operating systems and those
of its subsidiaries, the Company is also addressing the Y2K issues associated
with the Company's telephone and voice mail systems, fax machines, copiers and
other office systems integrated into the office facilities, and other equipment
including embedded chips or processors. Five of the Company's largest builder
subsidiaries have completed a comprehensive survey of all computer and embedded
systems and are fully Y2K compliant. The remaining builder subsidiaries are
scheduled to be assessed, repaired or replaced and tested by the end of June of
1999.
The Company is currently assessing whether third parties with which the Company
and its operating subsidiaries have a material relationship are Y2K compliant.
The Company's assessments with respect to these third party verification
projects will be substantially completed as of June 30, 1999. As part of this
assessment, the Company has examined its relationships with suppliers,
subcontractors, financial institutions and other third parties to determine the
status of their Y2K efforts as related to the Company. As a general matter, the
Company is vulnerable to significant suppliers' inability to remedy their own
Y2K issues. Furthermore, the Company relies on financial institutions,
government agencies (particularly for zoning, building permits and related
matter), utility companies, telecommunication service companies and other
service providers outside of its control. While certain third parties
significant to the Company's business have provided certain assurances regarding
their intentions to be Y2K compliant, there is no assurance that such third
parties will not suffer a Y2K business disruption. It is conceivable that such
failures could, in turn, have a material adverse effect on the Company's results
of operations, financial condition, and liquidity.
Costs
As the Company's Y2K project has been combined with the ICIS project, many areas
of the project would have been undertaken regardless of the Y2K issue.
Management estimates that the total cost of the ICIS project will be
approximately $4.0 to $4.5 million; however, it is not possible to determine the
portion of that amount which is specifically attributable only to the Y2K
compliance work. The total amount expended on the ICIS project work from
inception to December 31, 1998 was approximately $2.9 million as of December 31,
1998. The Company believes that the costs to specifically address the Y2K issue
will not have a material impact on the Company's results of operations,
financial condition, or liquidity for any year in the reasonably foreseeable
future. The plan for the successful completion of the Company's Y2K project and
the estimated total costs are based upon certain assumptions by management
regarding future events, including the continued availability of qualified
resources to implement the program and the cost of such resources.
Risks
The Company acknowledges that its failure to resolve a material Y2K issue could
result in the interruption in, or a failure of, certain normal business
activities or operations. Possible risks of Y2K failure include among other
risks, delays or errors with respect to payments, third-party delivery of
materials, and government approvals. Such failures could materially adversely
affect the Company's results of operations. Although the Company generally
considers its exposure to the Y2K issue risks from third party suppliers as
generally low,
35
<PAGE>
due to the uncertainty of the Y2K readiness of third-party suppliers, the
Company is unable to determine at this time whether the consequences of Y2K
failures will have a material impact on the Company's results of operations,
financial condition, or liquidity. In addition, the Company could be materially
adversely affected by Y2K system failures at government agencies on which the
Company is dependent for zoning, building permits, and related matters. Further,
the Company could be materially adversely affected if Y2K system failures result
in widespread economic or financial market disruption. The Company's Y2K project
is expected to significantly reduce the Company's level of uncertainty and
exposure to the Y2K issue. To date, the Company has not identified any operating
systems, either of its own or of a material third-party supplier, that present a
material risk of not being Y2K compliant or for which a suitable alternative
cannot be implemented.
Contingency Plan
The Company's Y2K contingency plan focused on whether it would be feasible to
get non-compliant builder subsidiaries converted to the Company-wide ICIS
(scheduled for conversion to the Y2K compliant version in April 1999). After
carefully assessing the current progress, the Company decided that of three
remaining non-compliant subsidiaries, two would upgrade their existing software
to a Y2K compliant version, and the third would convert to the ICIS by the end
of the third quarter of 1999. In addition, of the two subsidiaries being
upgraded on their current systems, the Company has begun the conversion process
which is slated for completion at the end of the third quarter of 1999.
While management expects that the company will not experience material adverse
consequences in connection with the Y2K issue as it relates to its internal
operating system, no assurance can be given that the system will operate as
expected in the Year 2000. See "Risks" section above.
Please refer to the Statement on Forward-Looking Information.
INTEREST RATES AND INFLATION
The Company's business performance and the homebuilding industry in general can
be negatively affected by the impact of inflation and the adverse effect
inflation has on interest rates and the overall economic climate both nationally
and in the Company's markets.
Inflation affects the Company in a number of ways including increasing the
Company's cost of construction. Costs including land acquisition and
development, materials and subcontractor labor, overhead and interest rates on
floating rate credit facilities can all be adversely affected by inflation. In
additional, inflation may reduce consumers' ability to purchase a new home,
thereby adversely affecting the Company's new order flow. During 1998 and 1997,
inflation has not significantly affected the performance of the Company.
While inflation has not been a significant factor in 1998 or 1997, rising
inflation in the future would likely have an adverse long-term impact on the
Company's business performance.
STATEMENT ON FORWARD-LOOKING INFORMATION
Certain information included within this report is forward-looking within the
meaning of the Private Litigation Reform Act of 1995, including but not limited
to, statements concerning growth, anticipated operating results, financial
position, and liquidity and financial resources. Such forward-looking
information involves important risks and uncertainties that could significantly
affect actual results and cause them to differ materially from the expectations
expressed herein. These risks and uncertainties include the competitive
environment in which the Company operates, fluctuations in interest rates,
local, regional and national economic conditions, the effect of government
regulation, the availability and costs of land, the availability of capital, the
availability and cost of labor and materials, changes in home prices, weather
conditions and other matters addressed in Business- Risk Factors.
36
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements are listed under Item 14(a)(1) and filed as part of
this report on the pages indicated and are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
37
<PAGE>
PART III
The information required by Part III is omitted from this Annual Report
on Form 10-K and is incorporated by reference from the definitive proxy
statement with respect to the 1999 Annual Meeting of Stockholders (the Proxy
Statement) which the Company will file with the Securities and Exchange
Commission (the Commission) not later than 120 days after the end of the fiscal
year covered by this Report.
Item 10. Directors and Executive Officers of the Registrant
(a) Identification of Directors. Information required by this Item will
be set forth under the caption "Proposal 1, Election of Directors -
Nominees for Election at this Annual Meeting" in the Proxy Statement,
which information is incorporated herein by reference.
(b) Identification of Executive Officers. Information required by this
Item is set forth under the caption "Executive Officers of the
Company" under Part I, Item 1 of this Report, which information is
incorporated herein by reference.
Item 11. Executive Compensation
Information required by this Item will be set forth under the captions
"Executive Compensation" and "Proposal 1, Election of Directors - Directors'
Remuneration" in the Proxy Statement, which information is incorporated herein
by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by this Item will be set forth under the caption
"Stock Ownership" in the Proxy Statement, which information is incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions
Information required by this Item will be set forth under the caption
"Certain Transactions" in the Proxy Statement, which information is incorporated
herein by reference.
38
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES AND REPORTS ON FORM 8-K.
(a) Financial Statements, Schedules and Exhibits.
1. Financial Statements
THE FORTRESS GROUP, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
THE FORTRESS GROUP, INC.
Report of PricewaterhouseCoopers LLP, Independent Accountants F-1
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-2
Consolidated Statement of Operations for the years ended December 31, 1998 and 1997 and
and the period May 21, 1996 through December 31, 1996 F-3
Consolidated Statement of Shareholders' Equity for the years ended December 31, 1998
and 1997 and the period ended December 31, 1996 F-4
Consolidated Statement of Cash Flows for the years ended December 31, 1998 and 1997
and the period May 21, 1996 through December 31, 1996 F-5
Notes to Consolidated Financial Statements F-6
COMBINED PREDECESSOR COMPANIES
Report of PricewaterhouseCoopers LLP, Independent Accountants F-26
Combined Balance Sheets as of May 20, 1996 F-27
Combined Statements of Operations for the period January 1, 1996 through May 20, 1996 F-28
Combined Statements of Shareholders' Equity for the period January 1, 1996 through May 20, 1996 F-29
Combined Statement of Cash Flows for period January 1, 1996 through May 20, 1996 F-30
Notes to Combined Financial Statements F-31
</TABLE>
39
<PAGE>
2. Financial Statement Schedules
None.
3. Exhibits
Number Description
2.1 Agreement and Plan of Reorganization dated as of March 11, 1996 by
and among the Company, Buffington Acquisition, Inc., Buffington
Holdings, Inc. and the Stockholders named therein ("Buffington Merger
Agreement"). (Exhibit 2.1 of the Registration Statement on Form S-1
(File No. 333-2332) effective May 16, 1996, is hereby incorporated by
reference.)
2.1(a) First Amended to Buffington Merger Agreement, dated May 15, 1996.
(Exhibit 2.1(a) of the Registration Statement on Form S-1 (File No.
333-2332) is hereby incorporated by reference.)
2.2 Amended and Restated Agreement and Plan of Reorganization dated as of
March 11, 1996 by and among the Company, Christopher Acquisition,
Inc., Christopher Homes, Custom Homes Division, Inc. and the
Stockholders named therein ("Christopher Merger Agreement"). (Exhibit
2.2 of the Registration Statement on Form S-1 (File No. 333-2332) is
hereby incorporated by reference.)
2.2(a) First Amendment to Christopher Merger Agreement, dated May 15, 1996.
(Exhibit 2.2(a) of the Registration Statement on Form S-1 (File No.
333-2332) is hereby incorporated by reference.)
2.3 Amended and Restated Agreement and Plan of Reorganization dated as of
March 11, 1996 by and among the Company, Genesee Acquisition, Inc.,
The Genesee Company, The Genesee Company/Castle Pines, Ltd., The
Genesee Company of Michigan, Ltd., Genesee Development Company and
the Stockholders named therein ("Genesee Merger Agreement"). (Exhibit
2.3 of the Registration Statement on Form S-1 (File No. 333-2332) is
hereby incorporated by reference.)
2.3(a) First Amendment to Genesee Merger Agreement, dated May 15, 1996.
(Exhibit 2.3(a) of the Registration Statement on Form S-1 (File No.
333-2332) is hereby incorporated by reference.)
2.4 Amended and Restated Agreement and Plan of Reorganization dated as of
March 11, 1996 by and among the Company, Sunstar Acquisition, Inc.,
Solaris Development Corporation and the Stockholders named therein
("Sunstar Merger Agreement"). (Exhibit 2.4 of the Registration
Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
reference.)
2.4(a) First Amendment to Sunstar Merger Agreement, dated May 15, 1996.
(Exhibit 2.4(a) of the Registration Statement on Form S-1 (File No.
333-2332) is hereby incorporated by reference.)
40
<PAGE>
2.5 Asset Purchase Agreement, dated August 31, 1996 by and among The
Fortress Group, Inc., Fortress Acquisition, Inc., Landmark Homes,
Inc., B. Rex Stephens, and Bobby W. Harrelson. (Exhibit 2.1 of the
Current Report on Form 8-K dated September 16, 1996 is hereby
incorporated by reference.)
2.6 Asset Purchase Agreement, dated February 28, 1997 by and among The
Fortress Group, Inc., Fortress-Florida, Inc., DW Hutson Construction,
Inc., and David Hutson. (Exhibit 10.1 of the Current Report on Form
8-K dated March 17, 1997 is hereby incorporated by reference.)
2.7 Purchase Agreement dated August 18, 1997 among The Fortress Group,
Inc.; Fortress Galloway, Inc.; Don Galloway Homes, Inc.; Don Galloway
Land, LLC; Galloway Limited Partnership; Thornblade, LLC, and the
Persons named herein. (Exhibit 1 of the Current Report on Form 8-K
dated August 27, 1997 is hereby incorporated by reference.)
2.8 Amended and Restated Purchase Agreement among the Company; Whittaker
Construction, Incorporated; RRKTG Lumber, Inc.; Lewis and Clark Title
Company and person named therein (Exhibit 2.1 of the Current Report
on Form 8-K dated March 16, 1998 is hereby incorporated by
reference.)
3.1 Amended and Restated Certificate of Incorporation of the Registrant.
(Exhibit 3.1 of the Registration Statement on Form S-1 (File No.
333-2332) is hereby incorporated by reference.)
3.2 Certificate of Amendment of Certificate of Incorporation of the
Company (Exhibit 3.1(a) of Amendment No. 3 to the Registration
Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
reference.)
3.3 Certificate of Amendment of Certificate of Incorporation of the
Company, effective March 6, 1998 (Exhibit 3.1 of the Form 8-K dated
March 16, 1998 is hereby incorporated by reference.)
3.3(a) Notice of Election to Terminate Charter Provisions (included herein)
3.4 Amended and Restated Bylaws of the Registrant. (Exhibit 3.2 of the
Registration Statement on Form S-1 (File No. 333-2332) effective May
16, 1996, is hereby incorporated by reference.)
3.5 Amendments to the Company's By-laws, effective March 6, 1998 (Exhibit
3.2 of the Form 8-K dated March 16, 1998 is hereby incorporated by
reference.)
3.6 Amendment to the Company's By-laws adopted February 4, 1999 (Exhibit
2 of the Form 8-K dated March 5, 1999 is hereby incorporated by
reference.)
4.2 Form of Indenture for Senior Notes. (Exhibit 4.2 of the Registration
Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
reference.)
4.3 Form of Certificate for Senior Notes. (Exhibit 4.3 of the
Registration Statement on Form S-1 (File No. 333-2332) is hereby
incorporated by reference.)
41
<PAGE>
The Company is a party to a number of other instruments defining the
rights of holders of long-term debt. No such instrument authorizes an
amount of securities in excess of 10% of the total assets of the
Company and its subsidiaries on a consolidated basis. On request, the
Company agrees to furnish a copy of each such instrument to the
Commission.
4.3(a) Second Supplemental Indenture dated May 27, 1997 (Exhibit 4 of the
Company's Quarterly Report on Form 10Q/A Amendment No. 1 for the
quarter ended June 30, 1997 is hereby incorporated by reference.)
4.4 Stockholders' Agreement, dated as of April 15, 1996, by and among the
Company and certain shareholders (Exhibit 10.7 to Amendment No. 1 to
the Registration Statement on Form S-1 (File No. 333-2332) is hereby
incorporated by reference.)
4.5 Amended and Restated Warrant Agreement dated as of March 6, 1998 by
and between the Company and Prometheus Homebuilders LLC (Exhibit 4.6
of the Company's Current Report on Form 8-K dated March 16, 1998 is
hereby incorporated by reference.)
4.5(a) Supplemental Warrant Agreement dated as of February 4, 1999 by and
between the Company and Prometheus Homebuilders LLC (Exhibit D of
Exhibit 1 of the Schedule 13D, Amendment No. 4 filed by Prometheus
Homebuilders LLC on January 12, 1999 is hereby incorporated by
reference.)
4.6 Amended and Restated Stockholders Agreement, dated as of March 6,
1998, by and among the Company and the Stockholders named therein
(Exhibit 4.7 of the Current Report on Form 8-K dated March 16, 1998
is hereby incorporated by reference.)
4.6(a) Second Amended and Restated Stockholders Agreement dated as of
February 4, 1999 by and between the Company and Prometheus
Homebuilders LLC (Exhibit C of Exhibit 1 of the Schedule 13D,
Amendment No. 4 filed by Prometheus Homebuilders LLC on January 12,
1999 is hereby incorporated by reference.)
4.7 Amended and Restated Registration Rights Agreement dated as of March
6, 1998 by and between the Company and Prometheus Homebuilders LLC
(Exhibit 4.8 of the Current Report on Form 8-K dated March 16, 1998
is hereby incorporated by reference.)
4.7(a) Second Amended and Restated Registration Rights Agreement dated as of
February 4, 1999 by and between the Company and Prometheus
Homebuilders LLC (Exhibit B of Exhibit 1 of the Schedule 13D,
Amendment No. 4 filed by Prometheus Homebuilders LLC on January 12,
1999 is hereby incorporated by reference.)
4.8(a) Amended Certificate of Designations, Preferences and Rights of Series
C Convertible Preferred Stock of The Fortress Group Inc. (included
herein)
4.8(b) Certificate of Designations, Preferences and Rights of Series D
Convertible Preferred Stock of The Fortress Group Inc. (Exhibit 2 of
the Current Report on Form 8-K dated August 27, 1997 is hereby
incorporated by reference.)
42
<PAGE>
4.8(c) Amended Certificate of Designations, Preferences and Rights of Series
E 6% Convertible Preferred Stock of The Fortress Group, Inc. (Exhibit
4.1 of the Quarterly Report on Form 10-Q for the Quarter ended March
31, 1997 is hereby incorporated by reference.)
4.8(d) Certificate of Designations, Preferences and Rights of Series F 6%
Convertible Preferred Stock of The Fortress Group, Inc. (Exhibit 4.2
of the Company's Quarterly Report on Form 10-Q for the Quarter ended
March 31, 1997 is hereby incorporated by reference.)
4.8(e) Certificate of Designations, Preferences and Relative, Participating,
Optional and Other Special Rights of Preferred Stock and
Qualifications, Limitations and Restrictions thereof of Class AAA
Convertible Redeemable Preferred Stock (Exhibit A of Exhibit 1 of the
Schedule 13D, Amendment No. 4 filed by Prometheus Homebuilders LLC on
January 12, 1999 is hereby incorporated by reference.)
10.1 Stock Incentive Plan. (Exhibit 10.1 of the Registration Statement on
Form S-1 (File No. 333-2332) is hereby incorporated by reference.)
10.3 Incentive Compensation Plan. (Exhibit 10.3 of the Registration
Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
reference.)
10.4(d) Employment Agreement between Christopher Homes, Custom Home Division,
Inc. and J. Christopher Stuhmer. (Exhibit 10.4(d) of the Registration
Statement on Form S-1 (File No. 333-2332) is hereby incorporated by
reference.)
10.4(e) Employment Agreement between The Genesee Company and Robert Short.
(Exhibit 10.4(e) of the Registration Statement on Form S-1 (File No.
333-2332) is hereby incorporated by reference.)
10.4(f) Employment Agreement between Solaris Development Company and Lanold
W. Caldwell. (Exhibit 10.4(f) of the Registration Statement on Form
S-1 (File No. 333-2332) is hereby incorporated by reference.)
10.4(g) Employment Agreement between Solaris Development Company and Lawrence
J. Witek. (Exhibit 10.4(g) of the Registration Statement on Form S-1
(File No. 333-2 332) is hereby incorporated by reference.)
10.4 (k) Employment agreement between The Fortress Group, Inc. and George
C. Yeonas (Exhibit 10.14 of the Company's 1997 Annual Report on Form
10K is hereby incorporated by reference.)
10.5 Directors Indemnification Agreement between The Fortress Group, Inc.
and Thomas B. Buffington, J. Marshall Coleman, Charles F. Smith, Mark
L. Fine, Steve D. Rivers, James F. McEneaney, James J. Martell, Jr.,
J. Christopher Stuhmer, Lawrence J. Witek and Robert Short. (Exhibit
10.5 of the Registration Statement on Form S-1 (File No. 333-2332) is
hereby incorporated by reference.)
43
<PAGE>
10.7 Stockholders' Agreement between Charles F. Smith, Jr., James J.
Martell, Jr., Patricia Donnelly, Michael P. Kahn and Pepi A. Kahn,
Co-Trustees of Kahn Grantor Trust of 1993, James F. McEneaney, Jr.,
James M. Pirrello, Brian McGregor, Brian Buchanan, Thomas B.
Buffington, Edward A. Kirkpartrick, James M. Giddens, J. Christopher
Stuhmer, Robert Short, Lanold W. Caldwell, and Lawrence J. Witek.
(Exhibit 10.7 of the Registration Statement on Form S-1 (File No.
333-2332) is hereby incorporated by reference.)
10.9 Consulting Agreement between The Fortress Group, Inc., and
Commonwealth Homes, Inc. (Exhibit 10.9 of the 1996 Annual Report on
Form 10-K is hereby incorporated by reference.)
10.10 Lease Agreement between Christopher Homes Custom Home Division, Inc.,
and Towne Center Limited Partnership (Exhibit 10.10 of the Company's
1996 Annual Report on Form 10-K dated March 31, 1997 is hereby
incorporated by reference.)
10.11 Lease Agreement between The Genesee Company and Genesee Holdings
Corporation (Exhibit 10.11 of the Company's 1996 Annual Report on
Form 10-K dated March 31, 1997 is hereby incorporated by reference.)
10.12 Asset Purchase Agreement, dated July 1, 1996 by and among The Genesee
Company and Genesee Custom Homes, Inc. (Exhibit 2.1 of the Quarterly
Report on Form 10-Q for the quarter ended June 30, 1996 is hereby
incorporated by reference.)
10.2 Stock Purchase Agreement dated as of August 14, 1997 by and between
the Company and Prometheus Homebuilders LLC (Exhibit 1 of the
Schedule 13D filed by Prometheus Homebuilders LLC on August 25, 1997
is hereby incorporated by reference.)
10.2(a) Amended and Restated Stock Purchase Agreement dated as of September
30, 1997 by and between the Company and Prometheus Homebuilders LLC
(Exhibit 1 of the Schedule 13D, Amendment No. 1 filed by Prometheus
Homebuilders LLC on October 15, 1997 is hereby incorporated by
reference.)
10.2(b) Second Amended and Restated Stock Purchase Agreement dated as of
February 19, 1998 by and between the Company and Prometheus
Homebuilders LLC (Exhibit 10 of the Current Report on Form 8-K dated
March 16, 1998 is hereby incorporated by reference.)
10.2(c) Restructuring Agreement by and among The Fortress Group, Inc.,
Prometheus Homebuilders LLC and the Homebuilder Stockholders listed
therein dated as of December 31, 1998 (Exhibit 1 of the Schedule 13D,
Amendment No. 4 filed by Prometheus Homebuilders LLC on January 12,
1999 is hereby incorporated by reference.)
21.1 List of Subsidiaries (included herein.)
23.1 Consent of Accountants (included herein.)
27.1 Financial Data Schedule (included herein.)
(b) Reports on Form 8-K.
None
44
<PAGE>
SIGNATURES
Pursuant to the requirements Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized March 30, 1999.
THE FORTRESS GROUP, INC.
By: /s/ George C. Yeonas
----------------------
Name: George C. Yeonas
Title: Chief Executive Officer and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons on behalf of the Registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Capacity In Which Signed Date
<S> <C> <C>
/s/ George C. Yeonas Chief Executive Officer and Director 3/30/99
- ---------------------------
George C. Yeonas
/s/ Jeffrey W. Shirley Vice President of Finance, Principal Financial 3/30/99
- --------------------------- Officer and Principal Accounting Officer
Jeffrey W. Shirley
/s/ J. Marshall Coleman Chairman of the Board and Director 3/25/99
- ---------------------------
J. Marshall Coleman
/s/ Mark L. Fine Director 3/23/99
- ---------------------------
Mark L. Fine
/s/ Murry N. Gunty Director 3/25/99
- ---------------------------
Murry N. Gunty
/s/ Linda H. Lewis
- --------------------------- Director 3/30/99
Linda H. Lewis
/s/ Klaus Kretchmann Director 3/26/99
- ---------------------------
Klaus Kretschmann
/s/ Robert Short Director 3/27/99
- ---------------------------
Robert Short
</TABLE>
45
<PAGE>
<TABLE>
<S> <C> <C>
/s/ William A. Shutzer Director 3/30/99
- ----------------------------
William A. Shutzer
/s/ Charles F. Smith Director 3/23/99
- ----------------------------
Charles F. Smith
/s/ J. Christopher Stuhmer Director 3/19/99
- ----------------------------
J. Christopher Stuhmer
</TABLE>
46
<PAGE>
Report of Independent Accountants
To the Board of Directors and
Shareholders of The Fortress Group, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity and of cash flows
present fairly, in all material respects, the financial position of The Fortress
Group, Inc. and its subsidiaries at December 3l, 1998, and 1997, and the results
of their operations and their cash flows for the two years then ended and 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.
PRICEWATERHOUSECOOPERS LLP
Washington, DC
March 11, 1999, except as to the last paragraph of Note 17, which is as of
March 29, 1999
F-1
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
ASSETS
Cash and cash equivalents.............................................. $ 23,102 $ 12,406
Accounts and notes receivable.......................................... 12,714 21,944
Due from related parties............................................... 1,378 4,416
Real estate inventories................................................ 310,706 217,342
Land held for resale................................................... 7,954 6,934
Mortgage loans......................................................... 15,397 11,128
Investments in land partnerships....................................... 9,616 6,763
Property and equipment, net............................................ 13,785 10,246
Prepaid expenses and other assets...................................... 15,980 16,678
Goodwill, net.......................................................... 39,271 23,470
-------- --------
Total assets.................................................... $449,903 $331,327
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities.................. $ 35,501 $ 23,172
Notes and mortgages payable............................................ 292,769 222,443
Due to related parties................................................. 3,405 783
Accrued expenses....................................................... 16,260 14,464
Customer deposits...................................................... 10,708 7,300
-------- -------
Total liabilities............................................... 358,643 268,162
-------- -------
Minority interest...................................................... 67 268
-------- -------
Shareholders' equity
Preferred stock, all classes and series, $.01 par value, 1 million
authorized (See Note 9)............................................ 1 1
Common stock, $.01 par value, 99 million authorized,
12,173,207 and 11,748,694 issued, respectively.............. 122 117
Additional paid-in capital......................................... 71,313 47,371
Preferred subscription receivable.................................. (333)
Retained earnings.................................................. 21,311 15,936
Treasury stock, at cost, 265,100 and 120,100 shares, respectively.. (1,221) (528)
-------- --------
Total shareholders' equity........................................ 91,193 62,897
-------- --------
Total liabilities and shareholders' equity........................ $449,903 $331,327
======== ========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-2
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share amounts)
<TABLE>
<CAPTION>
For the Year For the Year For the Period
Ended Ended May 21-
December 31, 1998 December 31, 1997 December 31, 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
TOTAL REVENUES $692,645 $447,374 $210,354
-------- -------- --------
HOMEBUILDING:
Residential Sales......................................... $677,271 $440,006 $200,721
Lot sales and other....................................... 10,636 5,305 9,633
-------- -------- --------
Homebuilding revenues........................... 687,907 445,311 210,354
Cost of sales
Construction and land costs.......................... 581,654 375,679 177,177
Amortization of purchase accounting.................. 1,624 1,928 210
adjustments
------- -------- --------
Gross profit.................................... 104,629 67,704 32,967
Selling................................................... 43,601 27,952 11,527
General and administrative................................ 34,534 22,568 8,570
Goodwill amortization..................................... 2,395 948 83
-------- --------- --------
Net operating income............................ 24,099 16,236 12,787
-------- --------- --------
Other expense (income):
Interest expense..................................... 5,547 3,396 429
Interest income...................................... (916) (336) (335)
Minority interest.................................... (35) (6) 92
Other, net........................................... (1,957) (531) (620)
-------- --------- --------
Homebuilding income before taxes.......................... 21,460 13,713 13,221
FINANCIAL SERVICES:
Operating revenues........................................ 4,738 2,063
General, administrative and other expenses................ 4,592 1,889
Interest expense.......................................... 755 298
Interest income........................................... (777) (334)
-------- ---------
Financial Services income before taxes.................... 168 210
Total income before taxes...................................... 21,628 13,923 13,221
Provision for income taxes..................................... 8,794 5,463 5,013
-------- -------- --------
Net income..................................................... $ 12,834 $ 8,460 $ 8,208
======== ======== ========
Income available to common shareholders, basic................. $ 5,436 $ 7,982 $ 8,072
======== ======== ========
Income available to common shareholders, diluted............... $ 5,464 $ 8,093 $ 8,208
======== ======== ========
NET INCOME PER SHARE DATA (See Note 10):
Basic net income per share................................ $ .46 $ .68 $ .69
======== ======== ========
Diluted net income per share.............................. $ .42 $ .63 $ .69
======== ======== ========
Basic weighted average shares outstanding................. 11,818,888 11,759,712 11,701,587
========== ========== ==========
Diluted weighted average shares outstanding............... 13,126,271 12,862,171 11,919,944
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-3
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Additional Total
Shares Amount Paid-In Subscription Retained Treasury Shareholders'
Preferred Common Preferred Common Capital Receivables Earnings Stock Equity
--------- ------ --------- ------ ------- ----------- -------- ----- ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at May 20, 1996..... 2,231 $ 22 $ (22)
Issuance of preferred stock 20
Issuance of common stock,
net of related costs..... 9,534 96 21,747 $21,843
Acquisition of Founding
Builders' equity........ 8,927 8,927
Distributions to Founding
Builders................. (6,063) (6,063)
Sale of Genesee Custom
Division................. 258 258
Redemption of preferred
stock.................... (10) (1,000) (1,000)
Preferred stock
dividends................ $ (136) (136)
Purchase of treasury
stock.................... (62) $ (429) (429)
Reissuance of treasury
stock.................... 60 (39) 417 378
Net income................ 8,208 8,208
-- ------ -- ---- ------- ----- ------- ------ -------
Balance at
December 31, 1996.......... 10 11,763 $118 $23,808 $ 8,072 $ (12) $31,986
Issuance of preferred
stock.................... 144 $1 23,828 23,829
Amortization of discount on
preferred stock 263 263
Cancellation of preferred
stock.................... (3) (315) (315)
Preferred stock
dividends............... (461) (461)
Imputed preferred
stock dividend........... 17 (17)
Issuance of common
stock.................... 69 336 336
Adjustment of stock
guarantee................ (57) (57)
Common stock dividends
declared................. (118) (118)
Purchase of treasury
stock.................... (203) 2 (1,028) (1,026)
Retirement of treasury
stock.................... (1) (511) 512
Net income................ 8,460 8,460
--- ------ -- ---- ------- ----- ------- ------ -------
Balance at
December 31, 1997.......... 151 11,629 $1 $117 $47,371 $15,936 $(528) $62,897
Issuance of preferred
stock...................... 53 27,301 $(500) 26,801
Cancellation of
preferred stock............ (1) (50) (50)
Redemption of
preferred stock............ (35) (3,534) (3,534)
Conversion of
preferred stock............ (19) 339 4 (327) (323)
Preferred stock
dividend................... (7,330) (7,330)
Imputed preferred
stock dividend............. 68 (68)
Issuance of common stock.... 85 1 459 460
Common stock dividends
declared................... (61) (61)
Vesting of non-qualified
options.................... 25 25
Purchase of treasury
stock...................... (145) (693) (693)
Subscription receivable
relief..................... 167 167
Net income.................. 12,834 12,834
--- ------ -- ---- ------- ----- ------ ------- -------
Balance at
December 31, 1998.......... 149 11,908 $ 1 $122 $71,313 $(333) $21,311 $(1,221) $91,193
=== ====== === ==== ======= ===== ======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-4
<PAGE>
THE FORTRESS GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
For the Year For the Year For the Period
Ended Ended May 21-
December 31, 1998 December 31, 1997 December 31, 1996
----------------- ----------------- -----------------
<S> <C> <C> <C>
Cash flows from operating activities
Net income............................................. $ 12,834 $ 8,460 $ 8,208
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 9,170 5,304 741
Minority interest...................................... (35) (6) 93
(Gain) loss on sale of property and equipment.......... (96) 45 19
Changes in operating assets and liabilities
Accounts receivable.................................. 9,883 (10,277) (7,586)
Due from related parties............................. 1,406 2,761 (403)
Real estate inventories.............................. (28,487) 1,116 829
Land held for resale................................. (1,020) (6,934)
Mortgage loans....................................... (4,269) (11,128)
Prepaid expenses and other assets.................... 1,370 837 (2,164)
Accounts payable and accrued construction
liabilities ........................................ 6,934 3,471 (5,205)
Accrued expenses..................................... 1,816 4,309 1,539
Customer deposits.................................... 1,992 545 (2,123)
------- -------- -------
Net cash provided by (used in) operating activities 11,498 (1,497) (6,052)
------- -------- -------
Cash flows from investing activities
Acquisition of homebuilders, net of acquired cash...... (27,616) (19,976) (3,036)
Payment of contingent consideration.................... (2,034)
Sale of Genesee Custom Homes division.................. 253
Conversion of preferred stock.......................... (324)
Redemption of preferred stock.......................... (1,500)
Purchase of property and equipment..................... (6,841) (6,933) (1,979)
Proceeds from sale of property and equipment........... 438 267 31
Investment in limited partnerships..................... (2,853) (6,763)
------- -------- -------
Net cash used in investing activities.............. (40,730) (33,405) (4,731)
------- -------- -------
Cash flows from financing activities
Borrowings under notes and mortgages payable........... 685,844 357,304 172,461
Repayment of notes and mortgages payable............... (662,651) (332,759) (152,824)
Related party borrowings............................... 118 193
Repayment of related party borrowings.................. (483) (363) (2,941)
Proceeds from issuance of common stock, net 21,843
Proceeds from issuance of Class AA Preferred
Stock, net ........................................... 24,813 9,958
Proceeds from Employee Stock Purchase Plan............. 86 14
Deferred financing costs............................... (1,882) (2,694)
Capital distributions to predecessor shareholders...... (6,063)
Distributions to minority interest..................... (1,274)
Preferred stock redemption............................. (1,000)
Preferred dividends.................................... (7,017) (110) (109)
Common dividends....................................... (89) (89)
Purchase of treasury stock............................. (693) (1,170) (429)
------- ------- -------
Net cash provided by financing activities.......... 39,928 31,096 26,970
------- ------- -------
Net increase (decrease) in cash and cash equivalents...... 10,696 (3,806) 16,187
Cash and cash equivalents, beginning of period............ 12,406 16,212 25
------- ------- -------
Cash and cash equivalents, end of period ................. $23,102 $12,406 $16,212
======= ======= =======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-5
<PAGE>
THE FORTRESS GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BUSINESS AND ORGANIZATION
The Fortress Group, Inc. ("Fortress" or the "Company") was formed in June 1995
to create a national homebuilding company for the acquisition and development of
land or improved lots and the construction of residential for-sale housing.
Four homebuilding companies were acquired by Fortress simultaneous with the
closing of its initial public offering on May 21, 1996 (the Offering) including
Buffington Homes, Inc. ("Buffington"), doing business in Austin and San Antonio,
Texas; Christopher Homes and Affiliates ("Christopher"), doing business in Las
Vegas, Nevada; The Genesee Company ("Genesee"), doing business in Denver and
Fort Collins, Colorado and Tucson, Arizona; and Solaris Development Corporation
("Sunstar"), doing business in Raleigh-Durham, North Carolina. These companies
as a group are referred to as the Predecessor Companies. Prior to the Offering,
Fortress was a nonoperating entity and principally incurred costs associated
with the consummation of the Offering.
Fortress has made additional acquisitions of Landmark Homes, Inc. ("Landmark"),
a Wilmington, North Carolina and Myrtle Beach, South Carolina homebuilder, on
August 31, 1996; Brookstone Homes, Inc. ("Brookstone"), a Janesville, Madison
and Milwaukee, Wisconsin homebuilder, on December 31, 1996; D.W. Hutson
Construction Company ("Hutson"), a Jacksonville, Florida homebuilder, on
February 28, 1997; Wilshire Homes ("Wilshire"), an Austin, Texas homebuilder,
effective April 1, 1997; Don Galloway Homes, Inc. ("Galloway"), a Charlotte,
North Carolina and Charleston, South Carolina homebuilder, effective August 1,
1997; The Iacobucci Organization ("Iacobucci"), a Philadelphia, Pennsylvania
homebuilder, effective October 1, 1997; WestBrook Homes ("WestBrook"), a Loudoun
County, Virginia homebuilder effective January 1, 1998; Whittaker Homes
("Whittaker"), a St. Louis, Missouri homebuilder, effective March 1, 1998; and
Quail Construction, Inc. ("Quail"), a Portland, Oregon homebuilder, effective
April 1, 1998.
In August 1996, the Company sold the Custom Home Division of Genesee ("Genesee
Custom") to a director. No gain or loss was recognized in conjunction with this
sale. (See Note 11 - Related Party Transactions.)
In March of 1999, the Company sold the assets of Landmark, thereby exiting the
Wilmington and Myrtle Beach markets. (See Note 17-Subsequent events.)
In January 1997, Fortress formed Fortress Mortgage, Inc. ("Fortress Mortgage"),
a wholly-owned subsidiary, to provide a mortgage lending source to the Company's
builder subsidiaries as an ancillary benefit. Fortress Mortgage is licensed as a
mortgage banker in Alaska, California, Colorado, Florida, Missouri, Nevada,
North Carolina, Oregon, Pennsylvania, South Carolina, Texas, Virginia,
Washington and Wisconsin.
Based on its internal reporting methods, the Company has determined that its two
reportable segments are homebuilding and financial services. The Company's
various homebuilding subsidiaries comprise the homebuilding segment. These
subsidiaries engage in acquiring or developing land primarily on which to build
residential for-sale housing. Fortress Mortgage is the financial services
segment. Its function is to originate mortgage loans primarily to the buyers of
homes constructed by the homebuilding segment of the Company.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of presentation
The accompanying consolidated financial statements include the accounts of
Fortress, a Delaware corporation, and its majority-owned subsidiaries. All
significant intercompany accounts and transactions have been eliminated in
consolidation.
Due to the substantial continuing interests in the Company of the former
stockholders of the Predecessor Companies, the acquisition in May 1996 of the
Predecessor Companies has been accounted for on a historical cost basis. Each
subsequent acquisition has been accounted for under the purchase method of
accounting. The purchase price of each of the acquired companies was allocated
first to record the assets and liabilities acquired at estimated fair value on
the acquisition date with any remaining balances recorded as goodwill.
F-6
<PAGE>
The consolidated statements of operations, shareholders' equity and cash flows
include the results of Fortress, inclusive of the Predecessor Companies and all
of the companies acquired since their respective dates of acquisition.
Certain prior period amounts have been reclassified to conform to the current
year presentation.
General Policies
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.
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. Significant additions and
improvements are capitalized while expenditures for repairs and maintenance are
charged to operations as incurred. 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.
Deferred financing costs
Costs associated with the issuance of the Senior Notes have been capitalized and
are being amortized using the straight-line method over the seven-year term of
the related notes.
Beneficial conversion feature
In accordance with Emerging Issues Task Force Topic D-60, Accounting for the
Issuance of Convertible Preferred Stock and Debt Securities with a Nondetachable
Conversion Feature, the Company recorded a $274,000 "discount" for the 11,700
shares of Class AA convertible preferred stock issued during 1997. (See
description of preferred stock in Note 9 - Shareholders' Equity.) As required by
Topic D-60, the Company is amortizing this discount using the effective interest
method from the date of issuance, September 30, 1997, through the date at which
the Class AA conversion features are subject to adjustment, September 30, 2001.
This amortization is recognized as an additional return to the preferred
shareholders (see Note 10 Earnings per Share) and is included in the Statement
of Shareholders' Equity for the years ended December 31, 1998 and 1997 as an
"imputed preferred stock dividend."
Use of estimates
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
New accounting pronouncements
In March 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 98-1
(SOP), "Accounting for the Costs of Software Developed or Obtained for Internal
Use". This SOP is effective for financial statements for the periods beginning
after December 15, 1998. The Company will adopt SOP 98-1 beginning in 1999.
Adoption of this standard is not expected to have a material impact on the
Company.
F-7
<PAGE>
Homebuilding Segment Policies
Revenue recognition
Residential homes and lot sales are recognized when all conditions precedent to
closing have been fulfilled and title has passed to the buyer. The Company's
homes are generally sold in advance of their construction. The Company's
standard sales contract generally requires the customer to make an earnest money
deposit which is recognized as a liability until the unit closes.
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")
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of. Costs incurred which are included in
inventory consist of land, land development, direct and certain indirect
construction costs, capitalized interest during the period of development
through the completion of construction, real estate taxes, direct model
construction costs, and related improvements.
At the time of revenue recognition, cost of sales is charged with the actual
construction costs incurred and any specifically identified estimate to
complete, plus an allocation of the total estimated cost of land and land
development, interest, real estate taxes and any other capitalizable common
costs based on the relative sales value method of accounting.
Certain components of cost of sales, particularly those pertaining to land
development, are based on management estimates of the total expected costs of an
ongoing project. These estimates are subject to change.
Warranty Costs
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.
Warranty reserves are included in "accrued expenses", and amounted to
approximately $2.0 million and $1.2 million as of December 31, 1998 and 1997,
respectively.
Investments in land partnerships
The Company records its investments in land partnerships in which it holds less
than a majority interest under the equity method of accounting.
Option deposits
The Company enters into option agreements that allow the takedown of land under
the specified terms. When a deposit is required, the Company records the deposit
amount in "other assets." When the land is taken down, the deposit becomes part
of the cost basis of the land and is reclassified as land inventory. If the
decision is made not to take down the land, the deposit is expensed. Option
deposits totaling approximately $8.1 million and $8.7 million are included in
"other assets" at December 31, 1998 and 1997, respectively.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of
assets acquired and is being amortized over periods ranging from five to twenty
years. Accumulated amortization at December 31, 1998 and amortization expense
for the year then ended were $3,425,807 and $2,395,166, respectively.
Accumulated amortization at December 31, 1997 and amortization expense for the
year then ended were $1,030,641 and $947,883, respectively. Accumulated
amortization at December 31, 1996 and amortization expense for the period May 21
through December 31, 1996 was $82,758. If facts and circumstances dictate, the
Company evaluates the recoverability of goodwill based on the estimated future
undiscounted cash flows associated with the assets. In the event that the
F-8
<PAGE>
analysis indicates that the carrying value of goodwill is impaired, it would be
written down to its estimated fair value.
Minority interest
Certain of the Company's subsidiaries are participants in real estate joint
ventures in which parties unrelated to the Company own a minority interest.
Joint venture profits are allocated to the Company and the other partners
according to their respective ownership.
Financial Services Segment Policies
Mortgage income
SFAS No. 91, Accounting for Nonrefundable Fees and Costs Associated with
Originating or Acquiring Loans and Initial Direct Costs of Leases, requires the
deferral of loan origination income and direct loan origination costs over the
estimated life of the loans. The Company defers the loan fees and costs and
recognizes them at the time of sale of the loans. A total of $103,229 and $1,813
was recorded as part of the loans held for sale balance for unamortized loan
origination fees and costs recognized under SFAS No. 91 as of December 31, 1998
and 1997, respectively.
Gains and losses from sales of mortgage loans are recognized at the time of sale
and are determined by the difference between net sale proceeds and the carrying
value of the mortgage loans sold.
Recognition of gains and losses is based on SFAS No. 125, Accounting for
Transfers and Servicing of Financial Assets and Extinguishment of Liabilities,
which was effective for transfers and servicing of financial assets and
extinguishment of liabilities occurring after December 31, 1996. SFAS No. 125 is
based upon consistent application of a financial components approach that
focuses on control. Under that approach, after a transfer of financial assets,
an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has been
surrendered, and derecognizes liabilities when extinguished.
The Company does not retain servicing on loans sold.
Mortgage loans
Mortgage loans held for sale to nonaffiliated investors are recorded in the
aggregate at the lower of cost or market. Fair value is based upon contractually
established prices at which mortgage loans will be sold or, if loans are not
committed for sale, at current market prices. Mortgage loans associated with
construction loans consist of draws that have been funded under a specific
program developed for borrowers buying upper-end homes in Nevada. No valuation
allowance was required at December 31, 1998 or 1997.
NOTE 3 - ACQUISITIONS
Effective January 1, 1998, the Company acquired certain assets and assumed
certain related indebtedness of WestBrook. Additionally, the Company acquired
the stock of Whittaker and Quail effective March 1, 1998 and April 1, 1998,
respectively. The initial purchase price for these acquisition totaled $86.7
million consisting of cash of $30.0 million, short-term notes of $0.5 million,
preferred stock with a liquidation value of $2.0 million, and assumption of
liabilities totalling $54.2 million.
The Company acquired certain assets and assumed certain related indebtedness of
Hutson and Iacobucci effective February 28, 1997 and October 1, 1997,
respectively. Additionally, the Company acquired the stock of Wilshire and
Galloway effective April 1, 1997 and August 1, 1997, respectively. The initial
purchase price for these acquisitions totaled $110.6 million including $17.7
million in cash, $5.7 million in short-term notes payable, 65,000 shares of
common stock with a stated value of $10 per share, 128,854 shares of preferred
stock (liquidation value of approximately $12.9 million), and assumed
liabilities of approximately $73.8 million. In addition, the Company loaned
approximately $3.0 million in cash to the previous owners of Galloway and
Iacobucci which is to be repaid through their respective earnouts or to be
personally repaid by the borrowers at the end of the earnout period.
F-9
<PAGE>
In each of these acquisitions, the purchase price was allocated first to record
assets and liabilities at fair value on the acquisition date; the remaining
excess purchase price was recorded as goodwill. Cost of goods sold for the years
ended December 31, 1998 and 1997 and the period May 21 through December 31, 1996
included $1,624,000, $1,928,000 and $210,000 related to the allocation of the
purchase price to inventory.
Most of the Company's acquisition agreements include earnout provisions, by
which the seller(s) may receive future consideration based upon the operational
results of the purchased business. These provisions generally extend two to four
years past the purchase date and are calculated as a set percentage of
operational results in excess of operational goal "hurdles." In each of the
acquisitions including earnout provisions, the earnout consideration has been
and will be accounted for as additional purchase price and, accordingly,
increase the goodwill related to the acquisitions and be amortized over the
corresponding remaining goodwill amortization periods. Under these provisions,
the Company is committed to earnout payments of a minimum of $1.0 million per
year in the form of Series C preferred stock through the year 2001. (See Note 9
- - Shareholders' Equity.) In addition, pursuant to these agreements, the Company
has recorded additional purchase price for earnouts in the amount of
approximately $3.8 million, $2.8 million and $0 for the years ended December 31,
1998 and 1997 and the period May 21 through December 31, 1996, respectively.
The Company's unaudited pro forma summary consolidated results of operations for
the year, as if the significant acquisitions (Hutson, Galloway and Whittaker)
had occurred at January 1, 1997 and excluding the amortization of the purchase
accounting adjustments for the step-up of inventory, are presented below.
Additionally, the issuance of 40,000 shares of Class AA convertible preferred
stock, which provided financing for the acquisitions of Galloway and Whittaker,
has been factored into the earnings per share calculations for both periods. In
preparing the unaudited pro forma information, various assumptions were made,
and the Company does not purport this information to be indicative of what would
have occurred had these transactions been made as of January 1, 1997.
Year Ended December 31,
1998 1997
---- ----
(unaudited, in thousands,
except per share amounts)
Revenue $702,040 $587,209
Net income 14,231 15,022
Net income per share .56 1.06
Net income per share - assuming dilution* .51 .71
*Assuming that the Class AA converts at its stated conversion price of $6 per
share and without the $5.0 million dividend to Prometheus relating to the
restructuring agreement, the unaudited pro forma basic earnings per share would
be $.99 and $1.06 and the unaudited pro forma diluted earnings per share would
be $.71 and $.74 for the years ended December 31, 1998 and 1997, respectively.
See Note 9- Shareholders' Equity.
NOTE 4 - SUPPLEMENTAL CASH FLOW INFORMATION
Supplemental disclosures of cash flow information are as follows (in thousands):
For the Year For the Period
Ended December 31, from May 21 -
1998 1997 December 31, 1996
---- ---- -----------------
Cash paid for the following:
Interest $32,415 $25,311 $11,214
Income taxes $10,838 $3,721 $4,958
Significant non-cash transactions
F-10
<PAGE>
In connection with acquisitions, the Company paid the following in the form
of the Company's common and preferred stock during 1998 and 1997:
(Dollars in thousands)
1998 1997
---- ----
Preferred Shares 19,881 128,854
Common Shares 0 65,000
Amount $1,988 $13,535
Also in connection with acquisitions, the following contingent
consideration amounts ("earnouts") were recorded as non-cash transactions.
1998 1997
---- ----
Applied against amounts advanced
to sellers at acquisition $1,393 $750
Recorded as due to related parties at year end $2,372
NOTE 5 - REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
December 31,
1998 1997 1996
---- ---- ----
Work-in-progress
Sold homes $112,001 $ 81,225 $ 38,547
Speculative 68,288 45,058 44,669
-------- -------- --------
Total work-in-progress 180,289 126,283 83,216
Land
Finished lots 76,824 43,585 34,671
Land under development 33,454 39,666 13,930
Unimproved land held for development 6,407 1,084 1,009
-------- -------- --------
Total land 116,685 84,335 49,610
Lumber yard inventory 2,223
Model homes 11,509 6,724 11,280
-------- -------- --------
$310,706 $217,342 $144,106
======== ======== ========
Model homes are constructed to assist in the marketing effort of a development.
Speculative homes, included above in work-in-progress, represent both completed
and under-construction, non-model homes which are not subject to a sales
contract. Both work-in-progress and model homes include the allocation of land,
land development, and other allocable costs.
NOTE 6 - INTEREST
Information regarding interest is as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
During the years ended December 31, 1998 and 1997
and the period May 21 through December 31, 1996:
Interest incurred $ 32,444 $ 24,918 $ 12,930
Interest capitalized (26,142) (21,224) (12,314)
Interest amortized to cost of sales 24,271 17,288 9,704
-------- -------- --------
F-11
<PAGE>
Total interest expensed in statement of operations $ 30,573 $ 20,982 $ 10,320
======== ======== ========
At December 31, 1998, 1997 and 1996:
Capitalized interest in ending inventory $ 23,426 $ 17,906 $ 12,159
======== ======== ========
</TABLE>
NOTE 7 - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Buildings $ 410
Model home upgrades and furnishings 9,862 $ 7,957 $ 1,845
Equipment and furniture 9,468 4,749 2,564
Vehicles 1,323 509 468
Leasehold improvements 1,602 1,524 725
------- ------- -------
22,665 14,739 5,602
Less: Accumulated depreciation and amortization (8,880) (4,493) (2,059)
------- ------- -------
$13,785 $10,246 $ 3,543
======= ======= =======
</TABLE>
NOTE 8 - NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable consist of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
13.75% Senior Notes due 2003 $100,000 $100,000 $100,000
Project specific land, land development and
construction loans 180,144 111,318 38,613
Mortgage warehouse lines of credit 14,408 15,546
Other loans 3,069 1,556 1,523
-------- -------- --------
297,621 228,420 140,136
Less: Unamortized debt issuance costs (4,852) (5,977) (4,563)
-------- -------- --------
$292,769 $222,443 $135,573
======== ======== ========
</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 Company was in compliance with all financial covenants at December 31, 1998.
In addition, the Senior Note Indenture restricts certain payments including
dividends and repurchases or redemptions of stock. As of December 31, 1998, the
Company had in excess of $10 million available for such payments. However, the
Company may make payments such as those described above from cash generated from
subsidiaries or other assets designated as "unrestricted", 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 1.25%
over prime rate and fixed rates generally from 8.0% to 12.0%. Certain of the
subsidiary credit facilities contain covenants that limit the Company's overall
ratio of debt to tangible net worth, and other covenants including minimum
tangible net worth, current ratio and interest coverage. In addition, many of
the credit facilities include similar covenants at the subsidiary level. The
Company and its subsidiaries were in compliance with all such covenants as of
December 31, 1998.
The Company's mortgage subsidiary has two lines of credit outstanding for the
purpose of originating loans. The lines of credit are secured by the mortgage
loans held for sale and are repaid upon sale of the mortgage loans. These
F-12
<PAGE>
lines bear interest at variable rates ranging from 1.5% over the Euro rate to
2.0% to 3% over the Fed Funds rate based on the type of loan and lending
requirements. At December 31, 1998, the Fed Funds rate was 4.07%, and the Euro
rate was 5.00%. The warehouse line of credit matures March 30, 1999, and is
expected to be renewed for an additional one-year period. The aggregate
commitment available at December 31, 1998 was $20,000,000. A second line is for
short-term borrowing and does not have a set expiration date.
One of the Company's subsidiaries has a line of credit for the purpose of
purchasing lumber yard inventory. The line of credit matures October 1, 1999 and
bears interest at prime minus 1/2%. At December 31, 1998, the total commitment
available is $2 million with $1.65 million outstanding. This outstanding portion
is included in "other loans" above. The remainder of "other loans" consists
primarily of debt financed corporate insurance policies which bear interest at
rates ranging from 6.8% to 7.8%.
Principal maturities of the above indebtedness at December 31, 1998 are as
follows (in thousands):
Year Ended December 31,
-----------------------
1999 $175,451
2000 12,949
2001 8,757
2002
2003 100,464
Thereafter --------
$297,621
========
NOTE 9 - SHAREHOLDERS' EQUITY
Preferred stock
The Company has authorized 1 million shares of $.01 par value preferred stock.
The following are the Company's classes and series of preferred stock, amounts
designated, and amounts outstanding at December 31, 1998 and December 31, 1997:
Class AA cumulative convertible (rate of 12% per annum decreased to 6%
on March 6, 1998), 53,333 designated, 40,000 and 11,700,
respectively, issued and outstanding ($40 million initial
liquidation preference)
Series A 11% cumulative convertible, 20,000 designated, 0 and 10,000,
respectively, issued and outstanding
Series B convertible, 40,000 designated, 0 and 8,854, respectively, issued
and outstanding
Series C convertible, 70,000 designated, 39,656 and 60,000, respectively,
issuable (See below)
Series D convertible, 67,500 designated, 45,000 and 60,000, respectively,
issued and outstanding ($4,500,000 aggregate liquidation
preference)
Series E convertible, 50,000 designated, 19,381 and 0, respectively,
issued and outstanding ($1,938,100 aggregate liquidation
preference)
Series F convertible, 5,000 designated, 5,000 and 0, respectively, issued
and outstanding ($500,000 aggregate liquidation preference)
Class AA
Effective September 30, 1997, the Company executed the first closing related to
its agreement with Prometheus Homebuilders LLC (Prometheus). In connection with
this agreement to sell Prometheus $75 million in preferred stock ($40 million in
Class AA and $35 million in Class AB), the Company designated 53,333 shares of
Class AA Convertible Preferred Stock. The Company, through its Restructuring
Agreement (see below) extinguished its obligation to sell the Class AB stock.
The Class AA preferred shares carried a cumulative 12% return per annum, until
the second closing at which time the rate was reduced to 6% per annum,
calculated on the liquidation value of $1,000 per share. The Class AA preferred
stock was convertible, in whole or in part, at the option of the holder, into
F-13
<PAGE>
Common Stock, at an initial conversion price of $6.00 per share, subject to
certain adjustments. The conversion price was subject to decrease, at the option
of the holder between September 30, 2001 and September 30, 2003, if the average
prior 60-day closing price of the Company's common stock (the Adjustment Price)
is $12.00 per share or less. The amount of adjustment was to vary based on the
average closing price of the common stock. Prometheus was to have had the right,
during this period, to elect to adjust up to five times per year the conversion
price for the Class AA preferred stock, by reference to the then prevailing
Adjustment Price as follows:
Adjustment Conversion
Price(s) Price(s)
-------- --------
$10.01 - 12.00 $5.50
5.00 - 10.00 5.25
4.01 - 4.99 3.00
2.01 - 4.00 2.00
0.00 - 2.00 1.00
Concurrent with the second closing that occurred March 6, 1998, the Company
acquired 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 was $12.00 per share or
more. In either case, the conversion price was subject to certain antidilution
adjustments. The Company did not have the right to redeem the Class AA preferred
stock. The holders of Class AA preferred stock had voting rights on an
as-converted basis equal to the holders of common stock.
Subsequent to the March 6, 1998 closing, the holders of Class AA preferred stock
were entitled elect additional directors sufficient to constitute a majority of
the Board and all committees of the Board in the event that on any date that is
60 days after the end of a fiscal quarter both (a) the average trading price of
the common stock is less than $4.375 per share (as adjusted) and (b) the
percentage change in the Company's earnings before interest expense, income
taxes and extraordinary or non-recurring items (EBIT) per share for the most
recent two fiscal quarters as measured against the same two fiscal quarters of
the prior year is less than the percentage change in the EBIT per share for a
specified comparable group of companies for the two most recent fiscal quarters
as measured against the same two fiscal quarters of the prior year. This right
was to continue until such time as neither of the conditions existed for two
consecutive fiscal quarters.
Under a Restructuring Agreement dated December 31, 1998 between the Company and
Prometheus, the Company agreed to issue to Prometheus, effective February 4,
1999, 40,000 shares of Class AAA Redeemable Convertible Preferred Stock having
an initial liquidation value of $40,000,000 in exchange for the outstanding
40,000 shares of Class AA Convertible Preferred Stock having a liquidation value
of $40,000,000 held by Prometheus. This exchange was effective February 4, 1999.
In connection with the restructuring agreement, the Company paid $ 5 million as
a non-recurring dividend on December 31, 1998. (See Note 17 - Subsequent
Events.)
Series A
As part of the acquisition of the Combined Predecessors, 20,000 shares were
issued in 1996 as Series A 11% cumulative convertible non-voting preferred
stock. The preferred stock is restricted from converting into common stock for
the first two years that the shares are issued and outstanding. The conversion
rate of the shares is the lesser of $9.00, the price of the common stock
Offering, or 75% of the lowest closing price during the thirty days immediately
preceding the date of conversion. The Company had the right to redeem all of the
preferred stock prior to conversion at a redemption price equal to the
liquidation value plus any accumulated but unpaid dividends; the 10,000 shares
outstanding at December 31, 1997 were converted during the second quarter of
1998.
Series B
In connection with the Hutson acquisition, Fortress issued 12,000 shares of
Series B convertible preferred stock with a liquidation value of $100 per share.
As a result of post-closing audit adjustments to the purchase price, 3,146 of
F-14
<PAGE>
these shares were subsequently cancelled during 1997. During 1998, these
preferred shares were converted into common stock and cash with a total value of
$100 per share.
Series C
Also in connection with the Hutson acquisition, Fortress 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.
In 1998, the acquisition agreement was amended to allow the Company to pay the
earnout in cash or Series C preferred stock. The stock has been treated as
outstanding for the purpose of calculating earnings per share; however, it will
only be legally outstanding upon issuance. The Series C preferred stock is
convertible into common stock based on $100 liquidation value per Series C
share, payable in common stock, cash, or a combination of both, at the option of
Fortress. The 1997 earnout was paid in cash during 1998. Thus, at December 31,
1998, 39,656 shares remain issuable. During the first quarter of 1999, 21,163
Series C preferred shares were issued in accordance with the Hutson acquisition
agreement.
Series D
In connection with the Galloway acquisition, Fortress issued 60,000 shares of
Series D convertible preferred stock with a liquidation value of $100 per share
($6 million aggregate liquidation preference). Each Series D share is
convertible into ten shares of common stock. Series D shares are redeemable at
the option of the holder up to 25% each year, cumulative, over a four-year
period. However, the shares can be redeemed in cash, common stock or a
combination of both equal to the $100 per share liquidation value. The
allocation between common stock and cash is at the sole option of Fortress.
During 1998, 15,000 shares were redeemed resulting in 45,000 shares outstanding
at December 31, 1998.
Series E
The Company has designated 50,000 shares as Series E 6% cumulative, convertible
preferred stock ("Series E") with a liquidation value of $100 per share. In
connection with the WestBrook and Quail acquisitions, the Company issued 19,881
shares of Series E. The purchase price was subsequently adjusted and 500 Series
E shares were returned to the Company. Each Series E share is convertible into
ten shares of common stock at any time at the option of the holder. After the
common stock has traded for $10.00 per share or more for ten consecutive
business days, the Company may require the conversion of the Series E at the
same 10-for-1 conversion rate. At the option of the holder, the Company may be
required to redeem up to 20% of the total number of shares initially issued each
year beginning with the first anniversary of the date of issuance in cash or
common stock at the Company's option. The holder's redemption right is
cumulative.
Series F
In connection with the Whittaker acquisition, the Company loaned $500,000 and
then sold 5,000 shares of Series F 6% Cumulative Convertible Preferred Stock
("Series F") with a liquidation value of $100 per share to a key member of
management at Whittaker. The loan bears interest at 6% which is offset by the 6%
dividend rate on the Series F. The Series F is convertible, based on the future
earnings of the acquired business, for a period of 60 days commencing on
February 15, 1999, 2000, and 2001 at the closing price of the Common Stock on
the Closing Date and the first and second anniversaries of the Closing Date,
respectively. The loan has been accounted for as a subscription receivable in
the equity section of the Company's balance sheet and will be reduced based on
the future earnings of the acquired business. At December 31, 1998, 5,000 shares
were outstanding.
Common stock
In May 1996, the Company completed an offering of 3,000,000 shares of common
stock (300,000 additional shares were issued in June 1996 pursuant to the
underwriter's overallotment option) for total net proceeds of approximately
$21.8 million. The proceeds were used together with proceeds from the issuance
of the Senior Notes (see Note 8 - Notes and Mortgages Payable) to retire
borrowings of the subsidiaries as well as for general corporate purposes.
F-15
<PAGE>
In November 1996, the Company's Board of Directors approved a stock repurchase
plan authorizing the purchase of up to 350,000 shares of the Company's currently
outstanding common stock. Such repurchases are effected at various prices from
time to time in the open market. During the years ended December 31, 1998 and
1997 and the period ended December 31, 1996, the Company has repurchased
145,000, 202,500 (of which 60,000 were acquired pursuant to an acquisition
agreement) and 61,700 shares, respectively, 84,100 of which were subsequently
canceled and 60,000 of which were reissued.
In March 1997, the Company established a dividend policy including the
initiation of a cash dividend of $.01 per share annually, payable quarterly, as
permitted under the Indenture. During 1997, the Board of Directors declared
quarterly dividends in accordance with this policy. During the third quarter of
1998, this policy was cancelled. There were no unpaid common stock dividends at
December 31, 1998.
Warrants
Under the agreement with Prometheus, the Company issued warrants to purchase a
minimum of 375,000 shares of common stock to Prometheus. The warrants were
exercisable between September 30, 1999 and September 30, 2004, at an exercise
price of $7.00 per share of common stock, subject to adjustment between
September 30, 2001 and September 30, 2003 based on the Adjustment Price. The
following table shows the changes in the exercise price and the number of shares
of common stock into which each warrant would have converted upon exercise of
the warrants during this period:
Additional Shares
Adjustment Price(s) Exercise Price(s) per Warrant
------------------- ----------------- -----------
$20.01 or greater $7.00 0.00
17.51 - 20.00 7.00 0.33
15.01 - 17.50 7.00 0.667
12.01 - 15.00 7.00 1.00
10.01 - 12.00 6.50 1.25
8.01 - 10.00 6.00 1.50
6.01 - 8.00 5.00 1.75
4.01 - 6.00 4.00 2.00
2.01 - 4.00 3.00 2.25
0.00 - 2.00 2.00 2.50
The exercise price and the number of shares of common stock into which each
warrant would have converted were also subject to certain antidilution
adjustments.
In connection with the issuance of the Class AAA preferred stock and the
amendment of the Supplemental Warrants in the first quarter of 1999, Prometheus
surrendered for cancellation the outstanding warrants to purchase 375,000 shares
of the Company's common stock. (See Note 17 - Subsequent Events.)
F-16
<PAGE>
NOTE 10 - EARNINGS PER SHARE
The following table reconciles the numerators (income) and the denominators
(shares) used to calculate the basic and diluted earnings per-share (in
thousands):
<TABLE>
<CAPTION>
For the Year Ended December 31, For the Period May 21-
1998 1997 December 31, 1996
---- ---- -----------------
<S> <C> <C> <C>
Net income $ 12,834 8,460 $ 8,208
Less: Preferred stock dividends (7,330) (461) (136)
Less: Imputed preferred stock dividend (68) (17)
---------- ---------- -----------
Income available to common shareholders $ 5,436 $ 7,982 $ 8,072
========== ========== ==========
Basic EPS
Income available to common
shareholders $ 5,436 $ 7,982 $ 8,072
Weighted average number of
common shares outstanding 11,818,888 11,759,712 11,701,587
---------- ---------- ----------
Basic earnings per share $ .46 $ .68 $ .69
========== ========== ==========
Diluted EPS
Income available to common
shareholders, basic $ 5,436 $ $7,982 $ 8,072
Plus preferred stock dividends 28 111 136
---------- ---------- ----------
Income available to common
shareholders, diluted $ 5,464 $ 8,093 $ 8,208
========== ========== ==========
Weighted average number of
common shares outstanding 11,818,888 11,759,712 11,701,587
Effect of dilutive securities--
Preferred stock 1,120,003 1,018,564 218,357
Options 4,183 11,753
Warrants 197,162 72,142
---------- ---------- ----------
Weighted average number of
common shares outstanding, diluted 13,140,236 12,862,171 11,919,944
========== ========== ==========
Diluted earnings per share $ .42 $ .63 $ .69
========== ========== ==========
</TABLE>
The Company's intention upon conversion or redemption (as the case may be) of
Series B, C and D preferred stock (See Note 9 - Shareholders' Equity) is to
issue common stock on the basis of the 10-for-1 conversion ratio contemplated in
the respective agreements and to pay cash for the difference between the $100
liquidation value per share and the market value of the common stock converted
at 10-for-1. Accordingly, the Company has included, in its calculation of
earnings per share, additional Common Stock to be issued under the "if
converted" method at the 10-for-1 conversion ratio.
During 1998, 40,000 shares of Class AA convertible preferred stock were
outstanding and convertible at the stated conversion price of $6 per share,
which represents 6,666,667 shares of common stock. However, for EPS purposes,
the conversion features of these shares resulted in common stock equivalents
totaling 11,184,550 shares, based on the reset of the conversion price per share
as defined in the agreement with Prometheus. Also at December 31,
F-17
<PAGE>
1998, 19,381 shares of Class E convertible preferred stock were outstanding and
convertible into 193,810 shares of common stock; for EPS purposes, the
conversion features of these shares resulted in common stock equivalents
totaling 153,693 shares. None of these shares were included in the computation
of diluted EPS as the effect of adding back the related dividends and the
weighted average common shares is antidilutive.
During the fourth quarter of 1997, 11,700 shares of Class AA convertible
preferred stock were outstanding and convertible into 1,950,000 shares of Common
Stock; for EPS purposes, the conversion features of these shares resulted in
Common Stock equivalents totaling 555,616 shares. These shares were not included
in the computation of diluted EPS as the effect of adding back the related
dividends and the weighted average common shares is antidilutive.
SFAS No. 128 requires that options are included in the earnings per share
calculation on a quarterly basis only when the average market price of the
common stock during that period exceeds the exercise price of the options. The
options included in the annual computation of earnings per share is based on the
average of the four quarters. Certain options were not included in the
computations of diluted EPS at certain quarter-ends because the options'
exercise price was greater than the average market price of the common shares.
Note 13 - Employee Benefit and Incentive Plans contains more detailed disclosure
regarding the Company's outstanding options.
NOTE 11 - RELATED PARTY TRANSACTIONS
Due from related parties
Due from related parties consists of the following (in thousands):
<TABLE>
<CAPTION>
December 31,
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Note receivable from sale of Genesee Custom $3,309
Accounts receivable from sale of Genesee Custom $ 490 977
Note receivable from director 698 487
Loans on acquisition earnouts $ 57 1,878
Employee advances and other 1,321 1,350 403
------ ------ ------
$1,378 $4,416 $5,176
====== ====== ======
</TABLE>
In connection with the sale of Genesee Custom to a director of the Company, the
Company had a note receivable bearing interest at 12% from the director for
approximately $3.3 million at December 31, 1996. The note was paid in full in
December 1997. The related accounts receivable were paid in full in January
1998.
The Company had a note receivable bearing interest at 13.75% from another
director for approximately $600,000 and $460,000, net of accrued interest, at
December 31, 1997 and 1996, respectively. The note was secured by a portion of
that director's shares in the Company and was paid in full, along with all
accrued interest, in June 1998.
In conjunction with certain acquisitions, the Company loaned amounts to certain
sellers. These loans bear interest at 6% per annum and are primarily repayable
either through the future earnout due to the borrower or by the borrower
personally. Based on actual performance, these loans are expected to be repaid
through earnout amounts due as a result of future earnings over the next two to
four years.
Due to related parties
Due to related parties at December 31, 1998 totals $3.4 million. The balance is
made up of approximately, $2.4 million representing accrued but not paid
earnouts due to the former owners of certain acquisitions, $600,000 representing
the accrued Class AA dividend payable to Prometheus, and the balance
representing individually immaterial amounts due to various related parties.
F-18
<PAGE>
Other transactions
A limited liability corporation (LLC) owned by two of the Company's directors
and one of the Company's former officers has provided consulting services
related to the Company's formation and subsequent acquisitions. Total
capitalized costs associated with this LLC during the years ended December 31,
1998 and 1997 and the period May 21 through December 31, 1996 were approximately
$350,000, $540,000 and $219,000, respectively.
During 1998 and 1997, the Company sold and leased back 2 and 22 models to
related parties, respectively. Total revenue recognized in connection with these
sales was approximately $406,500 and $5,880,000, respectively; and the total
gross profit recognized on these sales was $19,000 and $870,000, respectively.
(See Note 12 - Leases.)
Landmark purchased landscaping and lot improvement services from company
affiliated with its president. Expenses related to these services were $240,000,
$569,552 and $198,740 for the years ended December 31, 1998 and 1997 and from
acquisition through December 31, 1996, respectively. Additionally, Landmark
purchases developed land from an affiliated company in the amount of $2,146,000,
$2,771,100 and $ 1,119,600 for the years ended December 31, 1998 and 1997 and
from acquisition through December 31, 1996.
During 1998 and 1997, Hutson purchased a majority of its finished lots under
written agreements with an entity whose principal is a significant holder of the
Company's Series B and C preferred stock. In 1998 and 1997, Hutson purchased
approximately $18 million and $14 million, repectively, of such lots. The
Company had deposits of approximately $2.8 million at December 31, 1998 with
this related party for future acquisitions of finished lots with an aggregate
purchase price of approximately $25.1 million. Hutson intends to fulfill its
obligation under this agreement by acquiring these remaining lots. (See Note 16
- - Commitments and Contingencies.)
Hutson contracted cabinetry, interior finish services and other items from an
affiliated party amounting to approximately $4.8 million and $4.1 million for
the year ended December 31, 1998 and from the acquisition through December 31,
1997.
Pursuant to an option agreement executed simultaneously with the acquisition of
Iacobucci, the Company has an option to acquire from certain parties related to
Iacobucci's vice presidents approximately 385 fully improved lots over a period
of five years. In 1998 and 1997, the Company acquired 169 and 14 of these lots,
respectively, at a total cost of approximately $5.8 million and $.4 million,
respectively. The total purchase price of the remaining optioned lots will be
approximately $5.4 million. (See Note 16 - Commitments and Contingencies.)
The Company occasionally enters into lease agreements with related parties. (See
Note 12 - Leases.)
NOTE 12 - LEASES
The Company is obligated under various noncancelable operating leases for office
facilities and equipment expiring at various times through 2006. Rental expense
under these agreements amounted to approximately $5,125,000, $3,603,000 and
$757,000 for the years ended December 31, 1998 and 1997 and the period May 21
through December 31, 1996, respectively. Included in this amount is rent paid to
affiliated companies, under office, model home, and warehouse leases, totaling
$1,076,000, $1,030,000 and $290,000 for the respective periods.
As of December 31, 1998, future minimum lease payments under noncancelable
operating lease agreements are as follows (in thousands):
Year Ended
December 31,
------------
1999 $ 4,287
2000 2,918
2000 2,185
2001 1,358
2002 708
Thereafter 2,313
--------
$ 13,769
========
F-19
<PAGE>
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, 1998.
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-half year of
service with the Company may participate in the plan on the first day of the
month after becoming eligible. A participant's interest in Company contributions
are 100% vested after six years of credited service. Contributions to the plan
are entirely within the discretion of the Company's Board of Directors and are
determined annually. Company contributions to the plan were approximately
$49,000 and 0 for 1998 and 1997, respectively.
Stock purchase plan
The Board of Directors of the Company has approved a stock purchase plan under
which 500,000 shares of the Company's common stock are reserved for issuance and
sale to substantially all of the employees of the Company at 85% of market price
of the stock on specified offering dates. The number of shares issued and the
average price per share under this plan during the years ended December 31, 1998
and 1997 were 23,234 and $3.72 and 3,419 and $3.97, respectively. At December
31, 1998, a total of 473,347 shares were available for issuance. During the
first quarter of 1999, 17,030 shares were issued at a price of approximately
$1.97 under this plan.
Stock incentive plan
The Company has a stock incentive plan under which non-employee directors,
officers, key employees and consultants of the Company may be granted options to
purchase up to 1,550,000 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, 1998, no stock
appreciation rights, restricted stock or deferred stock had been granted under
this plan.
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; the option period shall not exceed ten years from
the grant date. Options granted as of December 31, 1998 vest over various
periods from immediately to over three years.
The Company accounts for its stock option plans under Accounting Principles
Board Opinion No. 25, Accounting for Stock Issued to Employees. Accordingly, as
the option price equals the market price at the date of issuance, no
compensation expense is recognized for options issued to employees. The Company
provides disclosure in accordance with SFAS No. 123, Accounting for Stock-Based
Compensation.
The fair value of each stock option grant is estimated on the date of the grant
using the Black-Scholes option-pricing model with the following weighted average
assumptions used for stock options granted in 1998: expected volatility of 50%,
risk-free interest rate of 5.0%, and an expected life of 5.82 years. The
following weighted average assumptions were used for those options granted in
1997: expected volatility of 35%, risk-free interest rate of 6.0%, and an
expected life of 7.68 years. The following weighted average assumptions were
used for those options granted in 1996: expected volatility of 30%, risk-free
interest rate of 6.44%, and an expected life of 7.93 years. In 1997 and 1996,
expected dividends were estimated at one cent per share in accordance with the
Company's dividend policy. This policy was subsequently cancelled; therefore, no
dividends were included in the 1998 fair value calculation. This change does not
have a material impact on the 1997 and 1996 calculations. The weighted-average
fair value of the stock options granted in 1998, 1997 and 1996 was approximately
$2.86 per share, $2.78 per share
F-20
<PAGE>
and $2.62 per share, respectively. Under the model, the total value of stock
options granted in 1998, 1997 and 1996 was approximately $79,000, $769,000
(including additional value for the repricing of 1996 grants) and $989,000,
respectively. Had the Company determined the compensation cost for these plans
in accordance with SFAS No. 123, the Company's resulting unaudited pro forma net
income would have been approximately $12,787,000 and the resulting unaudited pro
forma earnings per share would have been $.46 and, assuming dilution, $.41 for
the year ended December 31, 1998. The Company's resulting unaudited pro forma
net income would have been approximately $7,915,000 and the resulting unaudited
pro forma earnings per share would have been $.63 and, assuming dilution, $.59
for the year ended December 31, 1997. The resulting unaudited pro forma net
income and earnings per share for the period May 21, 1996 through December 31,
1996 would have been $8,039,000 for net income, $.68 for basic earnings per
share and $.67 for diluted earnings per share.
Option activity is summarized as follows:
<TABLE>
<CAPTION>
Shares Weighted
available Number average
for options of shares option price
----------- --------- ------------
<S> <C> <C> <C>
Balance available at May 21, 1996 575,000
Grants* (377,800) 377,800 $6.00
Exercises
Cancellations* 35,000 (35,000) 6.00
---------- -------- ----
December 31, 1996 232,200 342,800 6.00
Increase in shares available under the plan 550,000
Grants (230,895) 230,895 5.52
Exercises
Cancellations 23,624 (23,624) 5.89
---------- -------- ----
December 31, 1997 574,929 550,071 5.75
Increase in shares available under the plan 425,000
Grants (27,500) 27,500 5.37
Exercises
Cancellations 83,971 (83,971) 5.87
---------- -------- ----
December 31, 1998 1,056,400 493,600 $5.77
========== ======== =====
</TABLE>
* In May 1997, the Board re-priced the 1996 grants from the Offering price of
$9.00 to $6.00, the then-current market price of the Common Stock.
The following tables summarize information about options outstanding at December
31, 1998:
<TABLE>
<CAPTION>
Outstanding Options Exercisable Options
------------------- -------------------
Number Remaining Weighted
Range of Outstanding at Contractual Life Average
Exercise Prices December 31, 1998 (in years) Exercisable Exercise Price
--------------- ----------------- ---------- ----------- --------------
<S> <C> <C> <C> <C>
$3.50 - $4.00 2,000 9.7 2,000 $3.75
$4.01 - $5.00 24,000 1.0 24,000 $4.25
$5.01 - $5.50 119,800 5.4 117,300 $5.41
$5.51 - $6.00 310,900 5.1 280,900 $5.99
$6.01 - $6.50 36,900 7.5 18,450 $6.19
------- --- ------- -----
493,600 5.2 442,650 $5.74
======= === ======= =====
</TABLE>
F-21
<PAGE>
NOTE 14 - INCOME TAXES
The provision for income taxes consists of the following (in thousands):
Year ended Period May 21-
December 31, December 31
1998 1997 1996
---- ---- ----
Current:
Federal $7,638 $4,862 $4,840
State 1,577 935 847
------ ------ ------
9,215 5,797 5,687
Deferred:
Federal (379) (325) (619)
State (42) (9) (55)
------ ------ ------
(421) (334) (674)
Total $8,794 $5,463 $5,013
====== ====== ======
The provision for income taxes differs from the amount computed by applying the
Federal income tax statutory rate of 35%, 34.25% and 34% for the years ended
December 31, 1998 and 1997 and the period May 21 to December 31, 1996,
respectively, as follows (in thousands):
<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Income tax computed at statutory rate $7,570 $4,768 $4,495
State income taxes, net of Federal benefit 997 609 523
Other, net 227 86 (5)
------ ----- -------
Total $8,794 $5,463 $5,013
====== ====== ======
Effective Rate 40.7% 39.2% 37.9%
====== ====== ======
</TABLE>
Deferred tax assets (liabilities) arise due to the recognition of income and
expense items for tax purposes in periods which differ from those used for
financial statement purposes. At December 31, 1998 and 1997, the net
deferred tax asset was comprised of the following (in thousands):
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Deferred Tax Assets:
Warranty and other reserves $1,074 $ 692
Amortization 69 136
Capitalized inventory 163 96
Payroll accruals 243 83
Other 9 13
------ ------
Total gross deferred tax assets 1,558 1,020
Deferred Tax Liabilities:
Depreciation (78)
Prepaid expenses (10) (12)
------ ------
Total gross deferred tax liabilities (88) (12)
Net deferred tax asset $1,470 $1,008
====== ======
</TABLE>
F-22
<PAGE>
Fortress and its wholly owned subsidiaries file a consolidated federal income
tax return. The consolidated tax return of Fortress has not been selected for
audit by the Internal Revenue Service since the Company's inception.
NOTE 15 - FAIR VALUE OF FINANCIAL INSTRUMENTS
The financial instruments of the Company consist of accounts receivable, loans
held for sale, due to and from related parties, accounts payable and
construction liabilities and notes and mortgages payable. Mortgage loans held
for sale to nonaffiliated investors of $15.4 million and $11.1 million at
December 31, 1998 and 1997 are recorded in the aggregate at the lower of cost or
market. The estimated fair value of $15.4 million and $11.2 million at December
31, 1998 and 1997 is based upon contractually established prices at which
mortgage loans will be sold or, if loans are not committed for sale, at current
market prices. The fair value of the Company's Senior Notes at December 31, 1998
and 1997, which are recorded at their carrying value of $100 million, was
approximately $105 million and $121 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.
NOTE 16 - COMMITMENTS AND CONTINGENCIES
The Company believes that the homebuilding industry is subject to risks and
uncertainties including 1) cyclical markets sensitive to changes in general and
local economic conditions; 2) volatility of interest rates, which may affect
homebuilding demand and credit availability; 3) seasonal and weather-related
factors; 4) siginificant fluctuations on building material prices, finished lots
and subcontracted labor; 5) counterparty non-performance risk associated with
performance bonds; and 6) environmental regulations.
In the ordinary course of business, the Company enters into option agreements to
purchase land. As of December 31, 1998, the Company had approximately $8.1
million in deposits outstanding to acquire land with an aggregate purchase price
of approximately $229.2 million.
The Company is involved in various routine legal proceedings incidental to the
conduct of its normal business operations. The Company's management believes
that none of these legal proceedings will have a material adverse impact on the
financial condition or results of operations of the Company.
Loan Commitments
Commitments to originate loans have an off-balance sheet market risk to the
extent that the Company does not have matching commitments to sell loans
originated under such commitments. Commitments to sell loans have off-balance
sheet market risk to the extent the Company does not have the available loans to
fill those commitments, which would require the Company to purchase the loans in
the open market.
At December 31, 1998 and 1997, the Company had mandatory or best efforts
delivery commitments to cover all of the Company's loans held for sale. As of
December 31, 1998 and 1997, the Company had commitments to originate loans
(pipeline) in the amount of $93,925,540 and $37,776,357; which will sell at the
prevailing market rates at the time of closing.
Commitments related to future draws of construction loans of $4,143,761 and
$2,705,143 are outstanding as of December 31, 1998 and 1997, respectively. Of
the $1,661,766 and $2,007,386 in construction loan draws funded at December 31,
1998 and 1997, respectively, $671,207 and $819,576, respectively, of the draws
relate to loans that are committed to be sold at the completion of the home. The
remaining $990,559 and $1,187,810, respectively, of the draws relate to loans
committed for sale, have interest rates of prime plus 1.5% and are due and
payable at the completion of the home.
NOTE 17 - SUBSEQUENT EVENTS
Issuance of Preferred Stock
F-23
<PAGE>
Under a Restructuring Agreement dated December 31, 1998 between the Company and
Prometheus, the Company issued to Prometheus, effective February 4, 1999, 40,000
shares of Class AAA Redeemable Convertible Preferred Stock having an initial
liquidation value of $40,000,000 in exchange for the outstanding 40,000 shares
of Class AA Convertible Preferred Stock having a liquidation value of
$40,000,000 held by Prometheus.
The Class AAA preferred stock ranks senior to the Company's common stock as to
the payment of dividends and distributions upon the dissolution, liquidation or
winding up of the Company. Dividends are payable in cash at the annual rate of
9% cumulative and compounded quarterly, on the liquidation value of $1,000 per
share. The Company is required to declare and pay such dividends to the extent
that funds are legally available for the payment of dividends. The Class AAA
preferred stock is convertible, in whole or in part, at the option of the
holder, into the Company's common stock, at any time after issuance, at an
initial conversion price of $6.00 per share, subject to certain customary
anti-dilution adjustments. In conjunction with the issuance of the Class AAA
preferred stock, the Company also issued Supplemental Warrants. These
Supplemental Warrants include "reset" provisions substantially the same as those
previously included in the Class AA preferred stock. See the description of the
Supplemental Warrants below.
The Company will have the right to redeem the Class AAA preferred stock at any
time until December 31, 2000 for its liquidation value plus dividends that, when
combined with dividends previously paid on the Class AA preferred stock, and
subsequent dividend payments on the Class AAA preferred stock, will provide a
20% annual return from the inception of Prometheus' investment in the Company.
Any redemption of the Class AAA stock will be subject to compliance with the
Company's Senior Note Indenture, which restricts the amount of stock redemptions
or repurchases.
The Class AAA preferred stock (unlike the Class AA preferred stock) does not
include provisions permitting Prometheus to elect a majority of the Company's
board of directors (the "Board") based upon the Company's financial results and
the Company's stock price, but would entitle Prometheus to elect a majority of
the Board following certain payment defaults, including any failure to pay the
required dividends on the Class AAA preferred stock or the amounts required to
be paid in connection with the redemption of the Class AAA preferred stock.
Subject to the stock price and revenue tests described below, the Supplemental
Warrants would become exercisable on September 30, 2001 with an exercise price
of $0.01 per share of common stock and would expire on March 31, 2004. The
number of shares of common stock subject to the Supplemental Warrants is subject
to adjustment depending upon the 60 day average closing price of the common
stock between the period from September 30, 2001 and September 30, 2003. If
during such period the closing price remains greater than $12.00 per share, no
shares would be issuable pursuant to the Supplemental Warrants. If during such
period the closing price is $12 per share or less, the number of shares of
common stock issuable upon the exercise of the Supplemental Warrants could be
adjusted, up to five times per year, in accordance with the following table:
Issue Price ($) Warrants
--------------- --------
$12.01 or greater 0
10.01 - 12.00 606,061
8.01 - 10.00 1,333,333
6.01 - 8.00 3,333,333
4.01 - 6.00 6,666,667
2.01 - 4.00 13,333,333
0.00 - 2.00 33,333,333
The number of shares into which each Supplemental Warrant may be exercisable
will also be subject to certain customary anti-dilution adjustments. The
exercisability of the Supplemental Warrants would also be subject to a revenue
test, which provides that the Supplemental Warrants may not be exercised unless
the Company's consolidated revenues for the most recent 16 full fiscal quarters
exceeds $2,463,153,000. The revenue test is subject to adjustment for the sale
of any Company subsidiary. As of December 31, 1998, for purposes of the revenue
test, the Company's cumulative consolidated revenues for the most recent sixteen
quarters was $1,615,521,000.
F-24
<PAGE>
In addition, the Company is required to maintain a minimum annualized revenue
amount of $625 million for the four quarters tested, which is adjusted to $590
million for the four quarter period ended March 31, 2001 and June 30, 2001. The
minimum annualized revenue is subject to further adjustment for the sale of
Company subsidiaries.
In addition, should the Company elect to redeem all or a portion of the Class
AAA preferred stock, the Company will then be obligated under a "make-whole"
provision relating to Prometheus' common stock investment of 898,845 shares of
common stock which was purchased upon the second closing of the Class AA
preferred stock. The Company is obligated to arrange for the sale of Prometheus'
common stock at any time during the period from November 15, 2000 to February
15, 2001 and deliver cash proceeds, provided that such proceeds result in
Prometheus receiving no less than $5.50 per share. The number of shares the
Company would be obligated to sell is pro-rata based on the percentage of the
Class AAA redeemed.
In connection with the issuance of the Class AAA preferred stock and the
issuance of the Supplemental Warrants, Prometheus surrendered for cancellation
outstanding warrants to purchase 375,000 shares of the Company's common stock,
and the parties terminated the Company's obligation to issue, and Prometheus'
obligation to purchase, $35 million liquidation value of Class AB preferred
stock and warrants to purchase an additional 625,000 shares of common stock,
which would have been issued in connection with the issuance of the Class AB
preferred stock.
Disposition of Assets
As of the date of these financial statements, management of the Company is
evaluating its options related to certain under-performing assets and the
alternative uses of funds which might be recovered from those assets. These
evaluations may culminate in transactions which do not permit the Company to
recover the asset carring value. On March 29, 1999, the Company sold the assets
of Landmark and realized a loss of approximately $2.8 million. As of
December 31, 1998, Landmark had total assets, including goodwill, of
approximately $11 million.
F-25
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of the
Combined Predecessor Companies
In our opinion, the accompanying combined balance sheet and the related combined
statement of income, of 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 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.
PRICE WATERHOUSE LLP
Minneapolis, Minnesota
February 20, 1997
F-26
<PAGE>
COMBINED PREDECESSOR COMPANIES
BALANCE SHEET
May 20, 1996
(In thousands)
<TABLE>
<CAPTION>
<S> <C>
ASSETS
Cash and cash equivalents............................................................. $ 3,028
Related party and other receivables................................................... 2,797
Real estate inventories............................................................... 133,820
Property and equipment, net........................................................... 1,713
Deferred transaction costs............................................................ 4,282
Prepaid expenses and other assets..................................................... 4,298
--------
Total assets................................................................. $149,938
========
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued construction liabilities................................. $ 14,645
Notes and mortgages payable........................................................... 112,004
Due to related parties................................................................ 3,062
Accrued expenses...................................................................... 3,585
Customer deposits..................................................................... 6,332
Commitments and contingencies (Note 11)
--------
Total Liabilities............................................................ 139,628
========
Minority interests.................................................................... 1,383
--------
Shareholders' equity:
Preferred Stock
Common Stock........................................................................ 600
Additional paid-in capital.......................................................... 3,070
Retained earnings................................................................... 5,257
--------
Total shareholders' equity................................................... 8,927
--------
Total liabilities and shareholders' equity................................... $149,938
========
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-27
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENT OF OPERATIONS
FOR THE PERIOD JANUARY 1, 1996 THROUGH MAY 20, 1996
(In thousands)
<TABLE>
<CAPTION>
<S> <C>
Revenue:
Residential sales............................................................. $64,984
Lot sales..................................................................... 1,036
Other revenue................................................................. 99
-------
Total revenue............................................................ 66,119
Cost of sales...................................................................... 56,425
-------
Gross profit....................................................................... 9,694
Operating expenses:
Selling expenses.............................................................. 4,689
General and administrative expenses........................................... 3,892
-------
Net operating income.......................................................... 1,113
Other expense (income):
Interest...................................................................... 63
Minority interests............................................................ 89
Other, net.................................................................... (313)
-------
Net income......................................................................... $ 1,274
=======
Unaudited pro forma net income (Note 13)........................................... $ 764
=======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-28
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENT OF SHAREHOLDERS' EQUITY
(In thousands)
<TABLE>
<CAPTION>
Additional
Common Paid-in Retained
Stock Capital Earnings Total
----- ------- -------- -----
<S> <C> <C> <C> <C>
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-29
<PAGE>
COMBINED PREDECESSOR COMPANIES
STATEMENT OF CASH FLOWS
FOR THE PERIOD JANUARY 1, 1996 THROUGH MAY 20, 1996
(In thousands)
<TABLE>
<CAPTION>
<S> <C>
Cash flows from operating activities:
Net income................................................................... $ 1,274
Adjustments to reconcile net income to net cash
used in operating activities
Equity in income from investment partnership
Depreciation and amortization........................................... 277
Minority interest....................................................... 89
Changes in operating assets and liabilities:
Real estate inventories.............................................. (24,803)
Related party and other receivables.................................. (690)
Prepaid expenses and other assets.................................... (256)
Accounts payable and accrued construction liabilities................ 2,754
Accrued expenses..................................................... (578)
Customer deposits.................................................... 981
-------
Net cash used in operating activities.............................. (20,952)
=======
Cash flows from investing activities:
Purchase of property and equipment........................................... (330)
Proceeds from sale of property and equipment................................. 8
------
Net cash used in investing activities.............................. (322)
------
Cash flows from financing activities:
Borrowings under notes and mortgages payable................................. 52,839
Repayments of notes and mortgages payable.................................... (33,689)
Borrowings on line of credit.............................................. 7,477
Repayments on line of credit.............................................. (2,225)
Repayment of bonds........................................................ (236)
Related party borrowings..................................................... 1,076
Repayment of related party borrowings........................................ (510)
Transaction costs................................................................ (957)
Capital contributions........................................................ 547
Capital distributions........................................................ (2,730)
------
Net cash provided by financing activities.......................... 21,592
Net increase in cash and cash equivalents......................................... 318
Cash and cash equivalents, beginning of period.................................... 2,710
-------
Cash and cash equivalents, end of period.......................................... $ 3,028
=======
</TABLE>
The accompanying notes are an integral part of these financial statements.
F-30
<PAGE>
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.
F-31
<PAGE>
NOTE 3 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Estimates by management
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Revenue recognition
Residential and lot sales are recognized when all conditions precedent to
closing have been fulfilled and title has passed to the buyer. The Company
generally enters into contracts of sale for its houses in advance of their
construction. The Company's standard residential sales contract generally
requires the customer to make an earnest money deposit which is recognized as a
liability until the sale closes.
Real estate inventories and cost of sales
All real estate inventories which are held for sale are carried at cost which is
less than fair value as measured in accordance with Statement of Financial
Accounting Standards (SFAS) No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of." Fair value is
measured based on the application of discounting expected future cash flows of
each of the Company's real estate developments. Costs incurred which are
included in inventory consist of land, land development, direct and certain
indirect construction costs, interest and real estate taxes, and direct model
construction costs and related improvements.
At the time of revenue recognition, cost of sales is charged with the actual
construction costs incurred and any estimate to complete (specific
identification), plus an allocation of the total estimated cost of land and land
development, interest, real estate taxes and any other capitalizable common
costs based on the relative sales value method of accounting.
The Company generally provides a one-year limited warranty of workmanship and
materials with each of its homes. Accordingly, a warranty reserve, based on the
Company's historical experience, is provided as residential sales are closed;
this reserve is reduced by the cost of subsequent work performed.
Interest capitalization
Interest and related debt issuance costs are capitalized to qualifying real
estate inventories as incurred, in accordance with SFAS No. 34, "Capitalization
of Interest Cost," and charged to cost of sales as revenue from residential
sales is recognized. The interest and related debt issuance costs capitalized
are determined by applying a weighted average capitalization rate to the
accumulated qualified real estate expenditures. The capitalization rate is based
on the Company's outstanding borrowings associated with the acquisition,
development and construction of the qualified real estate inventory. The amount
of financing costs capitalized does not exceed those costs incurred for any year
presented in the accompanying combined financial statements.
Deferred transaction costs
Transaction costs, which consist of costs incurred in conjunction with the
Mergers and Offering, have been deferred and will be recorded as a reduction of
equity when the Offering is completed.
F-32
<PAGE>
Property and equipment
Property and equipment are carried at cost less accumulated depreciation and are
depreciated using either straight line or accelerated depreciation methods over
the estimated useful lives of the assets which range in years from five to ten.
Costs incurred for common area model improvements and certain furnishings are
amortized on a per unit basis as home sales in the related development are
closed. Significant additions and improvements are capitalized, while
expenditures for repairs and maintenance are charged to operations, as incurred.
Income taxes
Each of the Predecessor Companies was either a subchapter S corporation or
partnership for income tax purposes for all periods presented and, accordingly,
any income tax liabilities are the responsibility of the Predecessor Companies'
respective shareholders or partners. The combined financial statements of
Christopher are comprised of one subchapter S corporation, one limited
partnership and two C corporations. Each of the Predecessor Companies subchapter
S corporation or partnership status will terminate on consummation of the
Merger, as disclosed in Notes 1 and 2. See Note 13 for information regarding the
pro forma income tax disclosure.
For 1996, no income tax provision was recognized because the taxable income
generated by the combined Christopher entities was primarily incurred by the S
corporation.
At 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. The fiscal tax year ends for Christopher's C corporations are April 30
and June 30, respectively.
Historical net income per share
Historical net income per share has not been presented, as it is not deemed to
be a meaningful presentation as a result of the Mergers.
Cash and cash equivalents
For purposes of reporting cash flows, the Company considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents. Supplemental disclosures of cash flow information are as follows
(in thousands):
Period
January 1, 1996
through
May 20, 1996
------------
Cash paid for:
Interest........................... $2,826
Income taxes....................... 6
Supplemental disclosure of non-cash activities are summarized as follows (in
thousands):
Period
January 1, 1996
through
May 20, 1996
------------
Net assumption and assignment of Special
Improvement District Bonds.............. $(83)
Other..................................... --
----
Total..................................... $(83)
====
F-33
<PAGE>
NOTE 4 - REAL ESTATE INVENTORIES
Real estate inventories are summarized as follows (in thousands):
May 20,1996
-----------
Work-in-progress:
Sold homes.................. $ 53,355
Speculative homes........... 34,423
--------
87,778
--------
Land:
Finished lots............... 34,029
Land under development...... 984
Land and other costs........ 1,887
--------
36,900
--------
Models........................... 9,142
--------
Total............................ $133,820
========
Models are constructed to assist in the marketing effort of a development and
speculative construction represents non-model homes either under construction or
substantially completed which are not subject to a sales contract.
NOTE 5 - PROPERTY AND EQUIPMENT
Property and equipment is summarized as follows (in thousands):
Model home upgrades and furnishings.. $ 1,435
Equipment and furniture.............. 1,363
Vehicles............................. 250
Leasehold improvements............... 36
-------
3,084
Less: Accumulated depreciation
and amortization............... (1,371)
-------
$ 1,713
=======
F-34
<PAGE>
NOTE 6 - NOTES AND MORTGAGES PAYABLE
Notes and mortgages payable are summarized as follows (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Project specific land, land development and construction loans...................... $ 85,775
Other loans......................................................................... 3,254
Subordinated investor notes and equity participation loans.......................... 22,975
--------
$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 Solaris 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 May 20, 1996 was approximately $10.6 million.
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 May 20, 1996
was approximately $7.9 million. Generally, these loans bear interest at a fixed
annual rate of 12%, paid monthly. The unsecured notes entitle the holder to
receive an additional 6% interest per annum payable at maturity of the note.
These notes generally have maturities of six months, at which time the principal
and all unpaid interest are due.
Genesee has entered into a series of equity participation agreements and related
notes payable with one private investor. Under these agreements, Genesee has
received advances from this equity participant totaling $4.5 million as of May
20, 1996, in the form of equity participation notes payable. The proceeds from
these notes are used to acquire and develop various predetermined real estate
properties and to construct homes in certain developments.
In general, no interest is accrued on the principal balance of these notes, but
rather, the note holder is entitled to a portion of the net profits of the
development which collateralizes the note. However, at May 20, 1996, Genesee had
two equity participation notes payable which require that the private investor
receive the greater of some minimal rate of return or a portion of the net
profits of the development. At May 20, 1996, Genesee has accrued approximately
$289,000 in interest costs, all of which has been capitalized, related to these
two notes since the developments which collateralize these notes are in the
start-up stages and net profits earned as of May 20, 1996 have been less than
the minimum rate of return guaranteed the investor.
F-35
<PAGE>
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):
Year Ended
December 31,
------------
1996........................... $ 87,561
1997........................... 20,808
1998........................... 3,578
1999........................... 56
2000........................... 1
---------
$ 112,004
=========
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 $5.2 million for the period January 1, 1996 through to May 20,
1996.
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 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 May 20, 1996 is $1.3 million.
NOTE 8 - MINORITY INTERESTS
The minority interests at 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. 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.
F-36
<PAGE>
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 $315,000 were
paid by Buffington for the period from January 1, 1996 through May 20, 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. No management fees were
received in the period from January 1, 1996 through May 20, 1996. In addition,
Genesee is entitled to an additional 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.
Christopher paid rent during the period from January 1, 1996 through May 20,
1996 of approximately $14,000, 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 $38,000
for the period from January 1, 1996 through May 20, 1996.
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 $442,000 during the period January 1, 1996 through May 20, 1996.
Future minimum rental payments under fixed expiration term operating leases are
as follows (in thousands):
Year Ended
December 31
-----------
1996........................... $284
1997........................... 220
1998........................... 137
1999........................... 124
2000........................... 98
----
$863
====
Genesee leases certain office equipment classified as capital leases. These
leases have a cost of $207,000 and accumulated depreciation of approximately
$97,000 as of the period January 1, 1996 through May 20, 1996. The scheduled
future minimum lease payments are $84,000.
F-37
<PAGE>
Other commitments
On January 1, 1994 Solaris entered into a consulting contract with a former
shareholder which requires Solaris to pay a fee for services rendered in the
amount of $5,000 per month over a sixty month period.
The Company is involved in various routine legal proceedings incidental to the
conduct of its normal business operations. In the opinion of the Predecessor
Companies' management, these matters are not anticipated to have a material
adverse effect on the financial position or results of operations or cash flows
of the Company.
Christopher has signed a letter of intent to purchase a parcel of land for
approximately $7.7 million in a master planned development in Las Vegas, Nevada.
NOTE 12 - SHAREHOLDERS' EQUITY
The Company has authorized 1 million shares (par value of $.01) of which 20,000
shares have been authorized as Series A 11% Cumulative Convertible Non-Voting
Preferred Stock of which no shares were issued and outstanding as of May 20,
1996. The preferred stock is restricted from converting into common stock of
Fortress for the first two years that such shares are issued and outstanding.
The preferred stock has a liquidation preference of $100 per share ($2 million
in the aggregate) and other terms, as defined in the Certificate of Designation.
The conversion ratio of such shares is the lesser of the price of the common
stock Offering or 75% of the lowest closing price during the thirty days
immediately preceding the date of conversion.
In 1995, Genesee adopted an incentive stock option plan for certain employees.
The plan allows the grant of options to purchase up to 10,000 shares of
Genesee's common stock. The exercise price is equal to the estimated fair value
of the common stock at the date of grant. The options generally vest nine years
after the date of grant, but the vesting period is accelerated upon a change of
control or the occurrence of certain other events as specified in the plan
agreement. The options are exercisable over periods of up to 10 years. During
1995, options to purchase 10,000 shares of Genesee's common stock were granted
at an exercise price of $50.15 per share. All outstanding options were exercised
on May 20, 1996.
NOTE 13 - UNAUDITED PRO FORMA NET INCOME
The following unaudited pro forma income tax information is presented in
accordance with SFAS No. 109 Accounting for Income Taxes, as if the Company had
been a C Corporation subject to Federal and state income taxes for period from
January 1, 1996 through May 20, 1996.
For the
Period January 1, 1996
through May 20, 1996
--------------------
Net income before pro forma adjustments, per
statement of operations........................ $ 1,274
Pro forma adjustment:
Provision for income taxes at estimated
effective rate of 40%........................ 510
-------
Pro forma net income........................... . $ 764
=======
F-38
Exhibit 3.3(a)
PROMETHEUS HOMEBUILDERS LLC
c/o Lazard Freres Real Estate Investors L.L.C.
30 Rockefeller Plaza, 63rd Floor
New York, New York 10020
February 4, 1999
PERSONAL AND CONFIDENTIAL
- -------------------------
The Fortress Group, Inc.
1650 Tysons Boulevard
McLean, Virginia 22102
Attn.: Secretary
Reference is made to that certain Amended and Restated
Stockholders Agreement, dated as of March 6, 1998 (the "Agreement'), by and
among The Fortress Group, Inc. (the "Company"), Prometheus Homebuilders LLC (the
"Purchaser") and the Stockholders named therein.
The Purchaser is hereby giving notice pursuant to Section
3.2(d) of the Agreement that it elects to have Sections (A) and (B) of Article
Eleventh of the Certificate of Incorporation of the Company be of no further
force and effect as of the date hereof; provided that such election is expressly
conditioned upon the amendments to the Bylaws of the Corporation and the
subsidiaries of the Corporation in the form attached hereto as Exhibit A
becoming effective.
Very truly yours,
PROMETHEUS HOMEBUILDERS LLC
By:
-------------------------------
Name:
Title:
Exhibit 4.8(a)
AMENDED
CERTIFICATE OF DESIGNATIONS, PREFERENCES AND RIGHTS
OF
SERIES C CONVERTIBLE PREFERRED STOCK
OF
THE FORTRESS GROUP, INC.
Pursuant to Section 151 of the General Corporation Law of the
State of Delaware.
The Fortress Group, Inc., a Delaware corporation (the "Corporation"),
certifies -
(1) No shares of Series C Convertible Preferred Stock have been issued,
and
(2) That pursuant to the authority contained in its Certificate of
Incorporation and in accordance with the provisions of Section 151 of the
General Corporation Law of the State of Delaware, its Board of Directors has
adopted the following resolution amending the voting powers, designations,
preferences, and relative, participating, optional or to the rights of the
Series C Convertible Preferred Stock, $.01 par value per share:
RESOLVED, that a Series of the class of authorized Preferred Stock, $.01
par value per share, of the Corporation (the "Preferred Stock") be hereby
created, and that the designation and amount thereof and the voting powers,
preferences and relative, participating, optional and other special rights of
the shares of such series, and the qualifications, limitations and restrictions
thereof are as follows:
Section 1. Designation and Amount. The shares of such Preferred Stock
shall be designated as the "Series C Convertible Preferred Stock" (the "Series C
Preferred Stock") and the number of shares constituting such series shall be
70,000 which number may be decreased (but not increased) by the Board of
Directors without a vote of stockholders; provided, however, that such number
may not be decreased below the number of then currently outstanding shares of
Series C Preferred Stock. Certain capitalized terms used herein are defined in
Section 11 hereof.
Section 2. Dividends. If the Corporation pays any dividends or makes
any other distributions with respect to its Common Stock, the Corporation shall
pay at such time (the "Dividend Reference Date") to each holder of Series C
Preferred Stock the dividends or other distributions which such holder would
have been entitled to receive had such holder converted all of the shares of
Series C Preferred Stock held by him into Common Stock immediately prior to the
date as of which the holders of the Common Stock of record entitled to such
dividends or other distributions were determined.
<PAGE>
Section 3. Liquidation. Upon any liquidation, dissolution or winding up
of the Corporation, the holders of the Series C Preferred Stock will be entitled
to be paid, before any distribution or payment is made upon any Junior
Securities, (as hereinafter defined in Section 11), an amount in cash equal to
the aggregate Liquidation Value of all shares outstanding and the holders of the
Series C Preferred Stock will not be entitled to any further payment. If upon
any such liquidation, dissolution or winding up of the Corporation, the
Corporation's assets to be distributed among the holders of the Series C
Preferred Stock are insufficient to permit payment to such holders of the
aggregate amount which they are entitled to be paid, then the entire assets to
be distributed will be distributed ratably among such holders and the holders of
Parity Securities based upon the aggregate Liquidation Value of the Series C
Preferred Stock and the Parity Securities held by each such holder. The
Corporation will mail written notice of such liquidation, dissolution or winding
up, not less than 60 days prior to the payment date stated therein, to each
record holder of Series C Preferred Stock. Neither the consolidation or merger
of the Corporation into or with any other corporation or corporations, nor the
sale or transfer by the Corporation of all or any part of its assets, nor the
reduction of the capital stock of the Corporation, will be deemed to be a
liquidation, dissolution or winding up of the Corporation within the meaning of
this Section 3.
Section 4. Conversion.
(a) Subject to provisions for adjustment set forth herein, at
any time after the date of issuance at the option of the holder each
share of Series C Preferred Stock shall be convertible into ten (10)
fully paid and nonassessable shares of the common stock of The Fortress
Group, Inc. (the "Common Stock"); provided, however, in the event the
Average Trading Price at the time is less than $10.00 per share, each
share of Series C Preferred Stock shall receive in addition the
difference between $10.00 and the Average Trading Price (the
"Difference") in either cash or additional shares of Common Stock equal
in value at the Average Trading Price to the Difference, at the option
of the Corporation. For purposes of this instrument "Average Trading
Price" means the average trading price at which the Common Stock traded
during the ten (10) trading days prior to the date of conversion.
(b) Adjustments. The Conversion Rate shall be subject to
adjustment from time to time as follows: In case the Corporation shall
at any time or from time to time declare a dividend, or make a
distribution, on all of the outstanding shares of Common Stock in
shares of Common Stock or subdivide or reclassify all of the
outstanding shares of Common Stock into a greater number of shares or
combine or reclassify all of the outstanding shares of Common Stock
into a smaller number of shares of Common Stock, then, and in each such
case,
(i) the number of shares of Common Stock into which
each share of Series C Preferred Stock is convertible shall be
adjusted so that the holder of each share thereof shall be
entitled to receive, upon the conversion thereof, the number
of shares of Common Stock which the holder of a share of
Series C Preferred Stock would have been entitled to receive
after the happening of any of the events
2
<PAGE>
described above had such share been converted immediately
prior to the happening of such event or the record date
therefor, whichever is earlier; and
(ii) an adjustment made pursuant to this Section 4(b)
shall become effective (x) in the case of any such dividend or
distribution, immediately after the close of business on the
record date for the determination of holders of shares of
Common Stock entitled to receive such dividend or distribution
or (y) in the case of any such subdivision, reclassification
or combination, at the close of business on the day upon which
such corporate action becomes effective.
(c) Organic Change. Any capital reorganization,
reclassification, consolidation, merger or sale of all or substantially
all of the Corporation's assets to another Person which is effected in
such a way that holders of Common Stock are entitled to receive (either
directly or upon subsequent liquidation) stock, securities or assets
with respect to or in exchange for Common Stock is referred to herein
as an "Organic Change". Prior to the consummation of any Organic Change
the Corporation will make appropriate provisions (in form and substance
satisfactory to the holders of a majority of the Series C Preferred
Stock then outstanding) to insure that each of the holders of Series C
Preferred Stock will thereafter have the right to acquire and receive,
in lieu of or in addition to the shares of Common Stock immediately
theretofore acquirable and receivable upon the conversion of such
holder's Series C Preferred Stock, such shares of stock, securities or
assets as such holder would have received in connection with such
Organic Change if such holder had converted his Series C Preferred
Stock immediately prior to such Organic change. In any such case, the
Corporation will make appropriate provisions (in form and substance
satisfactory to the holders of a majority of the Series C Preferred
Stock then outstanding) to insure that the provisions of this Section 4
will thereafter be applicable to the Series C Preferred Stock. The
Corporation will not effect any such consolidation, merger or sale,
unless prior to the consummation thereof, the successor corporation (if
other than the Corporation) resulting from consolidation or merger or
the corporation purchasing such assets assumes by written instrument
(in form reasonably satisfactory to the holders of a majority of the
Series C Preferred Stock then outstanding), the obligation to deliver
to each such holder such shares of stock, securities or assets as, in
accordance with the foregoing provisions, such holder may be entitled
to acquire.
(d) DeMinimis Adjustments. If any adjustment in the number of
shares of Common Stock into which each share of Series C Preferred
Stock may be converted required pursuant to this Section 4 would result
in an increase or decrease of less than 1% in the number of shares of
Common Stock into which each share of Series C Preferred Stock is then
convertible, the amount of any such adjustment shall be carried forward
and adjustment with respect thereto shall be made at the time of and
together with any subsequent adjustment, which, together with such
amount and any other amount or amounts so carried forward, shall
aggregate at least 1% of the number of shares of Common Stock into
which each share of Series C Preferred Stock is then convertible.
3
<PAGE>
(e) Procedure for Conversion. The holder of any shares of
Series C Preferred Stock may exercise his right to convert such shares
into shares of Common Stock by surrendering for such purpose to the
Corporation, at its principal office or at such other office or agency
maintained by the Corporation for that purpose, a certificate or
certificates representing the shares of Series C Preferred Stock to be
converted accompanied by a written notice stating that such holder
elects to convert all or a specified whole number of such shares in
accordance with the provisions of this Section 5 and specifying the
name or names in which such holder wishes the certificate or
certificates for shares of Common Stock to be issued. In case such
notice shall specify a name or names other than that of such holder,
such notice shall be accompanied by payment of all transfer taxes
payable upon the issuance of shares of Common Stock (or other
securities) in such name or names. Other than such taxes, the
Corporation will pay any and all transfer and other taxes (other than
taxes based on income) that may be payable in respect of any issue or
delivery of shares of Common Stock on conversion of Series C Preferred
Stock pursuant hereto. As promptly as practicable, and in any event
within five business days after the surrender of such certificate or
certificates and the receipt of such notice relating thereto and, if
applicable, payment of all transfer taxes (or the demonstration to the
satisfaction of the Corporation that such taxes have been paid), the
Corporation shall deliver or cause to be delivered (i) certificates
representing the number of validly issued, fully paid and nonassessable
full shares of Common Stock to which the holder of shares of Series C
Preferred Stock so converted shall be entitled and (ii) if less than
the full number of shares of Series C Preferred Stock evidenced by the
surrendered certificate or certificates, of like tenor, for the number
of shares evidenced by such surrendered certificate or certificates
less the number of shares converted. Such conversion shall be deemed to
have been made at the close of business on the date of giving of such
notice and of such surrender of the certificate or certificates
representing the shares of Series C Preferred Stock to be converted so
that the rights of the holder thereof as to the shares being converted
shall cease except for the right to receive shares of Common Stock in
accordance herewith, and the person entitled to receive the shares of
Common Stock shall be treated for all purposes as having become the
record holder of such shares of Common Stock at such time.
(f) Status of Converted Shares. Any shares of Series C
Preferred Stock which are converted or otherwise acquired by the
Corporation shall be canceled, and, upon cancellation, shall become
authorized but unissued shares of Preferred Stock of the Corporation
and may be reissued as part of another series of Preferred Stock.
(g) No Fractional Shares. In connection with the conversion of
any shares of Series C Preferred Stock, no fractions of shares of
Common Stock shall be issued, but in lieu thereof the Corporation shall
pay a cash adjustment in respect of such fractional interest in an
amount equal to such fractional interest multiplied by the Current
Market Price per share of Common Stock on the day on which such shares
of Series C Preferred Stock are deemed to have been converted.
(h) Reservation of Shares of Common Stock. The Corporation
shall at all times reserve and keep available out of its authorized and
unissued Common Stock, solely for
4
<PAGE>
the purpose of effecting the conversion of the Series C Preferred
Stock, such number of shares of Common Stock as shall from time to time
be sufficient to effect the conversion of all then outstanding shares
of Series C Preferred Stock. The Corporation shall from time to time,
subject to and in accordance with the laws of Delaware, increase the
authorized amount of Common Stock if at any time the number of
authorized shares of Common Stock remaining unissued shall not be
sufficient to permit the conversion at such time of all then
outstanding shares of Series C Preferred Stock.
Section 5. Reports as to Adjustments. Whenever the number of shares of
Common Stock into which each share of Series C Preferred Stock is convertible
and the number of votes per share of Series C Preferred Stock accorded a holder
thereof is adjusted as provided in Section 4 hereof, the Corporation shall
promptly mail to the holders of record of the outstanding shares of Series C
Preferred Stock at their respective addresses as the same shall appear in the
Corporation's stock records a notice stating that the number of shares of Common
Stock into which the shares of Series C Preferred Stock are convertible and/or
the number of votes per share they are accorded has been adjusted and setting
forth the new number of shares of Common Stock (or describing the new stock,
securities, cash or other property) into which each share of Series C Preferred
Stock is convertible as a result of such adjustment, a brief statement of the
facts requiring such adjustment and the computation thereof, and when such
adjustment became effective.
Section 6. Ranking. The shares of Series C Preferred Stock shall be
superior as to the payment of distributions of whatever kind including, without
limitation distributions payable upon the dissolution, liquidation and winding
up of the Corporation, to all Junior securities. The shares of Series C
Preferred Stock shall rank pari passu, as to the payment of all such
distributions with the shares of the Corporation's Parity Securities.
Section 7. Registration of Transfer. The Corporation will keep at its
principal office a register for the registration of Series C Preferred Stock.
Upon the surrender of any certificate representing Series C Preferred Stock at
such place, the Corporation will, at the request of the record holder of such
certificate, execute and deliver (at the Corporation's expense) a new
certificate or certificates in exchange therefor representing in the aggregate
the number of shares represented by the surrendered certificate. Each such new
certificate will be registered in such name and will represent such number of
shares as is requested by the holder of the surrendered certificate and will be
substantially identical in form to the surrendered certificate, and dividends
will accrue on the Series C Preferred Stock represented by such new certificate
from the date to which dividends have been fully paid on such Series C Preferred
Stock represented by the surrendered certificate.
Section 8. Replacement. Upon receipt of the evidence reasonably
satisfactory to the Corporation (an affidavit of the registered holder will be
satisfactory) of the ownership and the loss, theft, destruction or mutilation of
any certificate evidencing shares of Series C Preferred Stock, and in the case
of any such loss, theft or destruction, upon receipt of indemnity reasonably
satisfactory to the Corporation, or, in the case of any such mutilation upon
surrender of such certificate, the Corporation will (at its expense) execute and
deliver in lieu of such certificate a new certificate of like kind representing
the number of shares represented by such lost, stolen, or
5
<PAGE>
destroyed or mutilated certificate and dated the date of such lost, stolen,
destroyed or mutilated certificate, and dividends will accrue on the Series C
Preferred Stock represented by such new certificate from the date to which
dividends have been fully paid on such lost, stolen, destroyed or mutilated
certificate.
Section 9. Amendment. No amendment, modification or waiver will be
binding or effective with respect to any provision of this Certificate of
Designations, Preferences and Rights of Series C Preferred Stock without the
prior written consent of the holders of at least majority of the then
outstanding shares of Series C Preferred Stock.
Section 10. Notice. Except as otherwise expressly provided, all notices
referred to herein will be in writing and will be delivered by registered or
certified mail, return receipt requested, postage prepaid and will be deemed to
have been given when so mailed (i) to the Corporation at its principal executive
offices and (ii) to any stockholder, at such holder's address as it appears in
the stock records of the Corporation (unless otherwise indicated by any such
holder).
Section 11. Definitions. For the purposes of the Certificate of
Designation of Series C Non-Voting Convertible Preferred Stock which embodies
this resolution:
"Junior Securities" means any of the Corporation's equity securities
other than the Parity Securities.
"Liquidation Value" means the amount of $100 per share of Series C
Preferred Stock.
"Parity Securities" means the Corporation's Series A 11% Cumulative
Convertible Stock and Series B Convertible Preferred Stock, which shall be pari
passu with the Series C Preferred Stock as to distributions made upon
dissolution, liquidation and winding up of the Corporation and any other
securities which are expressly made Parity Securities with the Corporation's
Series C Preferred Stock.
"Person" shall mean any individual partnership, joint venture, firm,
corporation, trust or unincorporated organization, or a government or agency or
political subdivision thereof or other entity, and shall include any successor
(by merger or otherwise) of such entity.
"Subsidiary" of any Person means any corporation or other entity of
which a majority of the voting power of the voting equity securities or equity
interest is owned, directly or indirectly, by such Person.
6
<PAGE>
IN WITNESS WHEREOF, the Corporation has caused this Certificate of
Designations of Series C Convertible Preferred Stock to be duly executed by its
President and attested to by its Secretary this 17th day of December, 1997.
THE FORTRESS GROUP, INC.
By: _______________________________________
James J. Martell, Jr., President
7
Exhibit 21.1
List of Subsidiaries
<TABLE>
<CAPTION>
Jurisdiction of Incorporation or
Subsidiary Organization Doing Business As
<S> <C> <C>
Brookstone Homes, Inc. Delaware Brookstone Homes
Buffington Holdings, Inc. Delaware Buffington Homes
Buffington Homes, Inc Texas
Buffington Homes, San Antonio, Inc Texas
Buffington Homes Central Texas, Ltd. Texas
Buffington Development, Inc. Texas
Elements, Inc. Texas Elements!
Christopher Homes Custom Nevada Christopher Homes
Home Division, Inc.
Fortress-Florida, Inc. Delaware D.W. Hutson Construction
d/b/a Fortress-Jax, Inc. (Fortress Homes and Communities
of Florida as of 1999)
Fortress Galloway, Inc. Delaware Don Galloway Homes
Don Galloway Homes, Inc. North Carolina
Thornblade,LLC North Carolina
Don Galloway Land, LLC North Carolina
Don Galloway Homes of North Carolina, Inc. North Carolina
Don Galloway Homes of South Carolina, Inc. South Carolina
Fortress Mortgage, Inc. Delaware Fortress Mortgage
Fortress Missouri-Construction, LLC Delaware
Whittaker Construction, Inc. Missouri Whittaker Homes
Fortress Missouri-Lumber, LLC Delaware
RRKTG Lumber, Inc. Missouri RRKTG Lumber
Fortress Missouri-Title, LLC Delaware
Lewis and Clark Title Company Missouri Lewis and Clark Title Company
Fortress Oregon, LLC Delaware
Quail Construction, Inc. Oregon Quail Construction
Camden Crossing, LLC Oregon
Quail Realty, LLC Oregon Quail Realty
Fortress Pennsylvania, LLC Delaware Iacobucci Homes
Fortress Tysons, LLC Delaware WestBrook Homes
The Genesee Company Colorado The Genesee Company
Genesee Venture Corp. Colorado
Genesee Communities I, Inc Colorado
Genesee Communities II, Inc Colorado
Genesee Communities III, Inc Colorado
Landmark Homes, Inc. North Carolina Landmark Homes
Solaris Development Corporation North Carolina Sunstar Homes
Wilshire Homes, Inc. Texas Wilshire Homes
Wilshire Homes San Antonio, Ltd. Texas
Cullen Avenue Partners, Ltd. Texas
The Park at Los Indios, Ltd. Texas
</TABLE>
Exhibit 23.1
Consent of Independent Accountants
We hereby consent to the incorporation by reference in the Prospectus
constituting part of the Registration Statement on Form S-3 (333-48147) and Form
S-8 (333-35041) of our reports as of the dates and relating to the financial
statements of the companies listed below, which appear on the following pages of
this Form 10-K.
<TABLE>
<CAPTION>
Page
Company Date of Report Ref. Document
------- -------------- ---- --------
<S> <C> <C> <C>
The Fortress Group, Inc. March 11, 1999 F-1 Annual Report on Form 10-K for the year ended
December 31, 1998
Combined Predecessor February 20, 1997 F-27 Annual Report on Form 10-K for the year ended
Companies December 31, 1998
</TABLE>
PricewaterhouseCoopers LLP
Washington, DC
March 30, 1999
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
* This schedule contains summary financial information extracted from The
Fortress Group, Inc. Consolidated Balance Sheet as of Dec. 31, 1998 and The
Fortress Group, Inc. Consolidated Statement of Operations for the year ended
Dec. 31, 1998 and is qualified in its entirety by reference to such financial
statements.
</LEGEND>
<CIK> 0001010607
<NAME> THE FORTRESS GROUP, INC.
<MULTIPLIER> 1000
<CURRENCY> U.S. Dollars
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-1-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 23,102
<SECURITIES> 0
<RECEIVABLES> 14,092
<ALLOWANCES> 0
<INVENTORY> 310,706
<CURRENT-ASSETS> 0
<PP&E> 13,785
<DEPRECIATION> 0
<TOTAL-ASSETS> 449,903
<CURRENT-LIABILITIES> 0
<BONDS> 100,000
0
1
<COMMON> 122
<OTHER-SE> 91,070
<TOTAL-LIABILITY-AND-EQUITY> 449,903
<SALES> 693,645
<TOTAL-REVENUES> 692,645
<CGS> 583,278
<TOTAL-COSTS> 663,308
<OTHER-EXPENSES> (1,951)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 5,597
<INCOME-PRETAX> 21,628
<INCOME-TAX> 8,794
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 12,834
<EPS-PRIMARY> .46
<EPS-DILUTED> .42
</TABLE>
