PROSPECTUS
124,784 WARRANTS
MONTEREY HOMES CORPORATION
To Purchase an Aggregate of 150,602 Shares of Common Stock
This Prospectus relates to the offering from time to time by certain
holders (the "Selling Security Holders") of 124,784 warrants (the "Warrants") to
purchase an aggregate of 150,602 shares (the "Warrant Shares") of common stock,
par value $.01 per share (the "Common Stock"), of Monterey Homes Corporation, a
Maryland corporation (the "Company"). The Warrants were acquired by the Selling
Security Holders in connection with the merger (the "Merger"), effective
December 31, 1996, of Monterey Homes Construction II, Inc., an Arizona
corporation ("MHC II"), and Monterey Homes Arizona II, Inc., an Arizona
corporation ("MHA II" and collectively with MHC II, the "Monterey Entities" or
"Monterey"), with and into Homeplex Mortgage Investments Corporation, a Maryland
corporation ("Homeplex"), with Homeplex surviving and changing its name to
Monterey Homes Corporation. See "The Merger." The number of Warrant Shares
obtainable upon exercise of the Warrants is subject to increase or decrease
under certain antidilution provisions. The Warrants became exercisable on the
effective date of the Merger and will continue to be exercisable at any time on
or prior to October 15, 2001 or earlier upon the dissolution, liquidation or
winding up of the Company. Each Warrant may be exercised for the purchase of
1.2069 shares of Common Stock at an exercise price of $4.0634 per Warrant. See
"The Merger - The Merger Consideration" and "Description of Capital Stock."
The Warrants may be offered by the Selling Security Holders in
transactions in the over-the-counter market at prices obtainable at the time of
sale or in privately negotiated transactions at prices determined by
negotiation. The Selling Security Holders may effect such transactions by
selling the Warrants to or through securities broker-dealers, and such
broker-dealers may receive compensation in the form of discounts, concessions or
commissions from the Selling Security Holders and/or the purchasers of the
Warrants for whom such broker-dealers may act as agent or to whom they sell as
principal, or both (which compensation as to a particular broker-dealer might be
in excess of customary commissions). Additionally, agents or dealers may acquire
Warrants or interests therein as a pledgee and may, from time to time, effect
distributions of the Warrants or interests therein in such capacity. See
"Selling Security Holders" and "Plan of Distribution." The Selling Security
Holders, the brokers and dealers through whom sales of the Warrants are made and
any agent or dealer who distributes Warrants acquired as pledgee may be deemed
"underwriters" within the meaning of the Securities Act of 1933, as amended (the
"Securities Act"), and any profits realized by them on the sale of the Warrants
may be considered to be underwriting compensation.
The Company is not selling any of the Warrants and will not receive any
of the proceeds from the sale of the Warrants being offered by the Selling
Security Holders nor from the exercise of the Warrants. William W. Cleverly and
Steven J. Hilton (the "Monterey Stockholders") will receive proceeds of $863,058
if all of the Company Warrants (defined herein to include the Warrants) are
exercised. See "Prospectus Summary" and "The Merger The Merger Consideration."
The cost of registering the Warrants is being borne by the Company.
The Company's Common Stock is traded on the NYSE under the symbol
"MTH." On May 5, 1998, the closing sale price for the Common Stock as reported
by the NYSE was $19 1/4 per share. See "Price of Common Stock and Dividend
Policy." The Warrants are not listed on any exchange or traded on any automated
quotation system. There is no market for the Warrants and no assurance can be
given that a market will develop. See "Risk Factors -- Absence of Public Trading
Market for Warrants."
SEE "RISK FACTORS" BEGINNING ON PAGE 4 FOR A DISCUSSION OF CERTAIN FACTORS THAT
SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS.
NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATION OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. NEITHER THE DELIVERY OF
THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES CREATE
ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE AFFAIRS OF THE
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COMPANY SINCE THE DATE HEREOF.
THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN
OFFER TO BUY ANY SECURITIES OFFERED HEREBY IN ANY JURISDICTION IN WHICH SUCH
OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER
OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANYONE TO WHOM IT IS UNLAWFUL TO
MAKE SUCH OFFER OR SOLICITATION.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
The date of this Prospectus is June 5, 1998.
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AVAILABLE INFORMATION
The Company has filed with the Securities and Exchange Commission (the
"Commission") Post-Effective Amendment No. 2 to the registration statement on
Form S-1 (herein, together with all amendments and exhibits thereto, referred to
as the "Registration Statement") under the Securities Act with respect to the
securities offered hereby. This Prospectus, which forms a part of the
Registration Statement, does not contain all of the information set forth in the
Registration Statement and the exhibits and schedules thereto, certain parts of
which are omitted in accordance with the rules and regulations of the
Commission. For further information with respect to the Company and securities
offered hereby, reference is made to the Registration Statement.
The Company is subject to the informational requirements of the
Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in
accordance therewith files reports, proxy statements, information statements,
and other information with the Commission. The Registration Statement and the
exhibits thereto, and the reports, proxy statements, information statements, and
other information, filed by the Company with the Commission pursuant to the
Exchange Act may be inspected and copied at the public reference facilities of
the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street N.W., Washington,
D.C. 20549 and at the Commission's regional offices at Seven World Trade Center,
13th Floor, New York, New York 10048, and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of such materials can be
obtained from the Public Reference Section of the Commission at 450 Fifth
Street, N.W., Washington, D.C. 20549, at prescribed rates, and can also be
obtained electronically through the Commission's Electronic Data Gathering,
Analysis and Retrieval system at the Commission's Web Site (http://www.sec.gov).
The Company's Common Stock is listed on the NYSE and copies of the Registration
Statement and the exhibits thereto, and of such reports, proxy statements,
information statements, and other information, can also be inspected at the
offices of the NYSE at 20 Broad Street, 17th Floor, New York, New York 10005.
FORWARD-LOOKING STATEMENTS
This Prospectus contains forward-looking statements. Additional written
or oral forward-looking statements may be made by the Company from time to time
in filings with the Commission or otherwise. The words "believe," "expect,"
"anticipate," and "project," and similar expressions identify forward-looking
statements, which speak only as of the date the statement was made. Such
forward-looking statements are within the meaning of that term in Section 27A of
the Securities Act and Section 21E of the Exchange Act. Such statements may
include, but not be limited to, projections of revenues, income or loss, home
sales, housing permits, backlog, inventory, capital expenditures, plans for
acquisitions, plans for future operations, financing needs or plans, the impact
of inflation, and plans relating to products or services of the Company, as well
as assumptions relating to the foregoing. The Company undertakes no obligation
to publicly update or revise any forward-looking statements, whether as a result
of new information, future events, or otherwise.
Forward-looking statements are inherently subject to risks and
uncertainties, some of which cannot be predicted or quantified. Potential risks
and uncertainties include such factors as the strength and competitive pricing
environment of the single-family housing market, changes in the availability and
pricing of residential mortgages, changes in the availability and pricing of
real estate in the markets in which the Company operates, demand for and
acceptance of the Company's products, the success of planned marketing and
promotional campaigns, and the ability of the Company and acquisition candidates
to successfully integrate their operations. Future events and actual results
could differ materially from those set forth in, contemplated by, or underlying
the forward-looking statements. Statements in this Prospectus, including under
the headings "Risk Factors" and "Management's Discussion and Analysis of
Financial Condition and Results of Operations" below, describe additional
factors, among others, that could contribute to or cause such differences.
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PROSPECTUS SUMMARY
The following summary is qualified in its entirety by, and should be
read in conjunction with, the more detailed information appearing elsewhere in
this Prospectus.
The Company
The Company designs, builds and sells single family homes in Arizona
and Texas. The Company builds move-up and semi-custom, luxury homes in the
Phoenix and Tucson, Arizona metropolitan areas, and entry-level and move-up
homes in the Dallas/Fort Worth, Austin and Houston, Texas metropolitan areas.
The Company has undergone significant growth in recent periods and is pursuing a
strategy of expanding the geographic scope of its operations.
The Company was originally formed as a real estate investment trust
("REIT"), investing in mortgage-related assets and, to a lesser extent, selected
real estate loans. On December 31, 1996, the Company acquired by merger (the
"Merger") the homebuilding operations of various entities operating under the
Monterey Homes name ("Monterey"). Monterey has been building homes in Arizona
for over 10 years, specializing in semi-custom, luxury homes and move-up homes.
In connection with the acquisition by the Company, the management of Monterey
assumed effective control of the Company. Following the Merger, the Company's
principal activity has been homebuilding.
As part of a strategy to diversify its operations, on July 1, 1997, the
Company combined with (the "Legacy Combination") the homebuilding operations of
several entities operating under the name Legacy Homes ("Legacy"). Legacy has
been operating in the Texas market since 1988, and designs, builds and sells
entry-level and move-up homes. In connection with the Combination, John R.
Landon, the founder and Chief Executive Officer of the Legacy Homes entities,
joined senior management and the Board of Directors of the Company, and
continues to oversee the operations of Legacy Homes.
Unaudited pro forma revenues and net earnings for 1997 would have been
$189.4 million and $17.8 million, respectively, if the Merger and the Legacy
Combination had occurred prior to 1997, with pro forma adjustments and related
income tax effects.
As a result of losses from operations by the Company during its
operation as a REIT, the Company had net operating loss carryforwards for
federal and state income tax purposes of approximately $43 million and $27
million, respectively, at December 31, 1997. Accordingly, the Company currently
pays limited income taxes.
The Company is a Maryland corporation headquartered in Scottsdale,
Arizona. The Company's principal executive offices are located at 6613 North
Scottsdale Road, Suite 200, Scottsdale, Arizona 85250, and its telephone number
is (602) 998-8700.
In connection with the Merger, the Company effected, and all share
information herein reflects, a three-for- one reverse stock split.
For additional information concerning the Company, see "Business of the
Company," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and the financial statements included herein.
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The Offering
Securities Offered .................... 124,784 Warrants which will entitle the
holders thereof to purchase, in the
aggregate, 150,602 shares of Common
Stock, subject to adjustment under
certain antidilution provisions.
Transfer Restrictions ................. Certain transfer restrictions apply to
the ownership of Common Stock of the
Company and will also apply to the
ownership of the Warrants. See "The
Merger - Amendment to the Articles of
Incorporation" and "The Merger - NOL
Carryforward" for a description of such
restrictions.
Warrants Outstanding. ................. 204,433 Warrants are outstanding (the
"Company Warrants"), of which 124,784
Warrants are subject to this Prospectus.
Common Stock Outstanding. ............. As of May 1, 1998, 5,316,692 shares of
Common Stock were outstanding.
Use of Proceeds ....................... There will be no proceeds to the Company
from the sale of the Warrants by the
Selling Security Holders or from the
exercise of the Warrants by the Selling
Security Holders. Upon the exercise of
all of the Company Warrants, the Company
will remit the exercise price of $4.0634
per Company Warrant (subject to
adjustment), or aggregate gross proceeds
of approximately $863,058 if all of the
Company Warrants are exercised, to the
Monterey Stockholders. See "Use of
Proceeds" and "The Merger."
Description of Warrants:
Expiration of Warrants. ............... October 15, 2001 or earlier upon the
dissolution, liquidation, or winding up
of the Company (the "Expiration Date").
Exercise. ............................. Each Warrant entitles the holder thereof
to purchase 1.2069 shares of Common
Stock for $4.0634 (in each case subject
to adjustment as described herein). The
Warrants may be exercised at any time on
or prior to the Expiration Date.
Adjustments ........................... The number of shares of Common Stock for
which a Warrant is exercisable and the
purchase price thereof are subject to
adjustment from time to time upon the
occurrence of certain events, including,
among other things, certain issuances of
stock, options, or other securities,
liquidating distributions, and certain
subdivisions, combinations, and
reclassifications of Common Stock. A
Warrant does not entitle the holder
thereof to receive any dividends paid on
Common Stock.
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For additional information concerning the Warrants, see "The Merger - The Merger
Consideration" and "Description of Capital Stock." For additional information
concerning the Warrant Shares, see "Description of Capital Stock."
RISK FACTORS
The Company's future operating results and financial condition are
dependent on the Company's ability to successfully design, develop, construct
and sell homes that satisfy dynamic customer demand patterns. Inherent in this
process are a number of factors that the Company must successfully manage in
order to achieve favorable future operating results and financial condition. In
addition, the price of the Company's Common Stock and the Warrants could be
affected not only by such operating and financial conditions, but also by other
factors. Potential risks and uncertainties that could affect the Company's
future operating results and financial condition and the performance of its
Common Stock and the Warrants include, without limitation, the factors discussed
below.
Absence of Public Trading Market for Warrants. The Company has not and
does not intend to apply for the listing of the Warrants on any national
securities exchange or to seek the admission thereof to trading in the NASDAQ
Stock Market, and there can be no assurance as to the liquidity or development
of any market for the Warrants.
Possible Volatility of Securities Prices. The market price of the
Company's Common Stock and Warrants could be subject to significant fluctuations
in response to certain factors, such as, among others, variations in anticipated
or actual results of operations of the Company or other companies in the
homebuilding industry, earnings estimates by analysts and changes in those
estimates, changes in conditions affecting the economy generally, and general
trends in the industry, as well as other factors unrelated to the Company's
operating results.
Restrictions on Transfer; Influence by Principal Stockholders. In order
to preserve maximum utility of certain net operating loss carryforwards, the
Company's charter, among other transfer limitations, precludes (i) any person
from transferring shares of Common Stock or rights to acquire Common Stock if
the effect thereof would be to make any person or group an owner of 4.9% or more
of the outstanding shares of Common Stock, or (ii) an increase in the ownership
position of any person or group that already owns 4.9% or more of such
outstanding shares. As a result of the foregoing factors, Messrs. Cleverly,
Hilton and Landon should have working control of the Company for the foreseeable
future. One or more of the foregoing factors could delay or prevent a future
change of control of the Company, which could depress the price of the Common
Stock. In addition, such restrictions will also apply to the Warrants. Ownership
of the Warrants will be aggregated with ownership of shares of Common Stock
otherwise held by a holder of Warrants to determine if the allowable ownership
percentage is exceeded. See "The Merger - Amendment to Articles of
Incorporation" and "The Merger - NOL Carryforward."
Homebuilding Industry Factors. The homebuilding industry is cyclical
and is significantly affected by changes in national and local economic and
other conditions, such as employment levels, availability of financing, interest
rates, consumer confidence and housing demand. Although the Company believes
that certain of its customers (particularly purchasers of luxury homes) are
somewhat less price sensitive than generally is the case for other homebuilders,
such uncertainties could adversely affect the Company's performance. In
addition, homebuilders are subject to various risks, many of which are outside
the control of the homebuilders, including delays in construction schedules,
cost overruns, changes in government regulation, increases in real estate taxes
and other local government fees, and availability and cost of land, materials,
and labor. Although the principal raw materials used in the homebuilding
industry generally are available from a variety of sources, such materials are
subject to periodic price fluctuations. There can be no assurance that the
occurrence of any of the foregoing will not have a material adverse effect on
the Company.
Customer demand for new housing also impacts the homebuilding industry.
Real estate analysts predict that in 1998 new home sales in the Phoenix
metropolitan area may slow and that sales in the Tucson metropolitan may remain
relatively flat. In the Dallas/Fort Worth, Houston and Austin metropolitan
areas, predictions are that new home sales will remain relatively flat or show a
moderate increase
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for 1998. Any slowing in new home sales in any of the principal markets in which
the Company operates could have a material adverse affect on the Company's
business and operating results.
The homebuilding industry is subject to the potential for significant
variability and fluctuations in real estate values, as evidenced by the changes
in real estate values in recent years in Arizona and Texas. Although the Company
believes that its projects are currently reflected on its balance sheet at
appropriate values, no assurance can be given that write-downs of some or all of
the Company's projects will not occur if market conditions deteriorate, or that
such write-downs will not be material in amount.
Fluctuations in Operating Results. The Company historically has
experienced, and in the future the Company expects to continue to experience,
variability in home sales and net earnings on a quarterly basis. Factors
expected to contribute to this variability include, among others (i) the timing
of home closings and land sales, (ii) the Company's ability to continue to
acquire additional land or options to acquire additional land on acceptable
terms, (iii) the condition of the real estate market and the general economy in
Arizona and Texas and in other areas into which the Company may expand its
operations, (iv) the cyclical nature of the homebuilding industry and changes in
prevailing interest rates and the availability of mortgage financing, (v) costs
or shortages of materials and labor, and (vi) delays in construction schedules
due to strikes, adverse weather conditions, acts of God or the availability of
subcontractors or governmental restrictions. As a result of such variability,
the Company's historical financial performance may not be a meaningful indicator
of the Company's future results.
Interest Rates and Mortgage Financing. The Company believes that
certain of its customers (particularly purchasers of luxury homes) have been
somewhat less sensitive to interest rates than many homebuyers. However, many
purchasers of the Company's homes finance their acquisition through third-party
lenders providing mortgage financing. In general, housing demand is adversely
affected by increases in interest rates and housing costs and the unavailability
of mortgage financing. If mortgage interest rates increase and the ability of
prospective buyers to finance home purchases is consequently adversely affected,
the Company's home sales, gross margins, and net income may be adversely
impacted and such adverse impact may be material. In any event, the Company's
homebuilding activities are dependent upon the availability and costs 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. Any limitations or restrictions on the availability of such financing
could adversely affect the Company's home sales. Furthermore, changes in federal
income tax laws may affect demand for new homes. From time to time, proposals
have been publicly discussed to limit mortgage interest deductions and to
eliminate or limit tax-free rollover treatment provided under current law where
the proceeds of the sale of a principal residence are reinvested in a new
principal residence. Enactment of such proposals may have an adverse effect on
the homebuilding industry in general, and on demand for the Company's products
in particular. No prediction can be made whether any such proposals will be
enacted and, if enacted, the particular form such laws would take.
Competition. The homebuilding industry is highly competitive and
fragmented. Homebuilders compete for desirable properties, financing, raw
materials, and skilled labor. The Company competes for residential home sales
with other developers and individual resales of existing homes. The Company's
competitors include large homebuilding companies, some of which have greater
financial resources than the Company, and smaller homebuilders, who may have
lower costs than the Company. Competition is expected to continue and become
more intense and there may be new entrants in the markets in which the Company
currently operates. Further, the Company will face a variety of competitors in
other new markets it may enter in the future.
Lack of Geographic Diversification; Limited Product Diversification.
The Company's operations are presently localized in the Phoenix and Tucson,
Arizona and Dallas/Ft. Worth, Austin and Houston, Texas metropolitan areas. In
addition, the Company currently operates in two primary market segments in
Arizona: the semi-custom, luxury market and the move-up buyer market; and in two
primary market segments in Texas: the move-up buyer market and the entry-level
home market. Failure to be more geographically or economically diversified by
product line could have an adverse impact on the Company if the homebuilding
markets in Arizona or Texas should decline. See "Risk Factors - Homebuilding
Industry Factors."
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Additional Financing; Limitations. The homebuilding industry is capital
intensive and requires significant up-front expenditures to acquire land and
begin development. Accordingly, the Company may incur substantial indebtedness
to finance its homebuilding activities. At December 31, 1997, the Company's
notes payable totaled approximately $22.9 million. The Company may be required
to seek additional capital in the form of equity or debt financing from a
variety of potential sources, including bank financing and/or securities
offerings. In addition, lenders are increasingly requiring developers to invest
significant amounts of equity in a project both in connection with origination
of new loans as well as the extension of existing loans. If the Company is not
successful in obtaining sufficient capital to fund its planned capital and other
expenditures, new projects planned or begun may be delayed or abandoned. Any
such delay or abandonment could result in a reduction in home sales and may
adversely affect the Company's operating results. There can be no assurance that
additional debt or equity financing will be available in the future or on terms
acceptable to the Company.
In addition, the amount and types of indebtedness that the Company can
incur is limited by the terms and conditions of its current indebtedness. The
Company must comply with numerous operating and financial maintenance covenants
and there can be no assurance that the Company will be able to maintain
compliance with such financial and other covenants. Failure to comply with such
covenants would result in a default and resulting cross defaults under the
Company's other indebtedness, and could result in acceleration of all such
indebtedness. Any such acceleration would have a material adverse affect on the
Company.
Government Regulations; Environmental Considerations. The Company is
subject to local, state, and federal statutes and rules regulating certain
developmental matters, as well as building and site design. In addition, the
Company is subject to various fees and charges of governmental authorities
designed to defray the cost of providing certain governmental services and
improvements. The Company may be subject to additional costs and delays or may
be precluded entirely from building projects because of "no growth" or "slow
growth" initiatives, building permit allocation ordinances, building
moratoriums, or similar government regulations that could be imposed in the
future due to health, safety, welfare, or environmental concerns. The Company
must also obtain licenses, permits, and approvals from government agencies to
engage in certain of its activities, the granting or receipt of which are beyond
the Company's control.
The Company and its competitors are subject to a variety of local,
state, and federal statutes, ordinances, rules, and regulations concerning the
protection of health and the environment. Environmental laws or permit
restrictions may result in project delays, may cause the Company to incur
substantial compliance and other costs, and may also prohibit or severely
restrict development in certain environmentally sensitive regions or areas. In
addition, environmental regulations can have an adverse impact on the
availability and price of certain raw materials such as lumber.
Recent Expansion and Future Expansion. The Company recently concluded a
significant expansion into the Texas market (see "The Legacy Combination"), and
the Company may continue to consider expansion into other areas of the country.
The magnitude, timing and nature of any future acquisitions will depend on a
number of factors, including suitable acquisition candidates, the negotiation of
acceptable terms, the Company's financial capabilities, and general economic and
business conditions. Acquisitions by the Company may result in the incurrence of
additional debt and/or amortization of expenses related to goodwill and
intangible assets that could adversely affect the Company's profitability.
Acquisitions could also result in potentially dilutive issuances of the
Company's equity securities. In addition, acquisitions involve numerous risks,
including difficulties in the assimilation of operations of the acquired
company, the diversion of management's attention from other business concerns,
risks of entering markets in which the Company has had no or only limited direct
experience and the potential loss of key employees of the acquired company.
There can be no assurance that the Company will be able to expand into new
markets on a profitable basis or that it can successfully manage its expansion
into Texas or any additional markets.
Dependence on Key Personnel. The Company's success is largely dependent
on the continuing services of certain key persons, including William W.
Cleverly, Steven J. Hilton and John R. Landon, and the ability of the Company to
attract new personnel required to continue the development of the Company. The
Company has entered into employment agreements with each of Messrs. Cleverly,
Hilton and Landon. A loss by the Company of the services of Messrs. Cleverly,
Hilton or Landon, or certain other key persons, could have a material adverse
effect on the Company.
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Dependence on Subcontractors. The Company conducts its business only as
a general contractor in connection with the design, development and construction
of its communities. Virtually all architectural and construction work is
performed by subcontractors of the Company. As a consequence, the Company is
dependent upon the continued availability and satisfactory performance by
unaffiliated third-party subcontractors in designing and building its homes.
There is no assurance that there will be sufficient availability and
satisfactory performance by unaffiliated third-party subcontractors in designing
and building its homes, and such a lack could have a material adverse affect on
the Comany.
NOL Carryforward. The ability of the Company to use the NOL
Carryforward to offset future taxable income would be substantially limited
under Section 382 of the Code if an "ownership change," within the meaning of
Section 382 of the Code, has occurred or occurs with respect to the Company
before expiration of the NOL Carryforward. The Company believes that (i) there
was not an "ownership change" of the Company prior to the effective date of the
Merger, (ii) the Merger did not cause an "ownership change," and (iii) the
Legacy Combination did not cause an "ownership change."
Pursuant to Section 384 of the Code, the Company may not be permitted
to use the NOL Carryforward to offset taxable income resulting from sales of
assets owned by the Monterey Entities at the time of the Merger (or to offset
taxable income resulting from sales of certain assets acquired in the Legacy
Combination) to the extent that the fair market value of such assets at the time
of the Merger (or at the time of the Legacy Combination) exceeded their tax
basis as of the relevant date.
There is no assurance that the Company will have sufficient earnings in
the future to fully utilize the NOL Carryforward.
USE OF PROCEEDS
There will be no proceeds to the Company from the sale of the Warrants
by the Selling Security Holders or from the exercise of the Warrants. Upon the
exercise of the Company Warrants, the Company will remit the exercise price of
$4.0634 per Company Warrant, or aggregate gross proceeds of approximately
$863,058 if all of the Company Warrants are exercised, to the Monterey
Stockholders. See "The Merger - The Merger Consideration."
THE MERGER
The Company was initially formed to operate as a REIT, investing in
mortgage related assets and selected real estate loans. The Company suffered
significant losses several years ago and determined to try to acquire a home
builder that could utilize its cash balances and other assets, as well as
maximize the Company's status as a publicly traded entity. On September 13,
1996, the Company entered into an Agreement and Plan of Reorganization (the
"Merger Agreement"), by and among Homeplex Mortgage Investments Corporation
("Homeplex") and Monterey Homes Arizona II, Inc. and Monterey Homes Construction
II, Inc. (collectively, "Monterey"), and William W. Cleverly and Steven J.
Hilton (collectively, the "Monterey Stockholders"). On December 31, 1996,
Homeplex and Monterey were merged. As a result of the Merger, the Company's
status as a REIT was terminated, the Company's name was changed to Monterey
Homes Corporation and its NYSE ticker symbol was changed to MTH. In addition, a
one-for-three reverse stock split of the Company's issued and outstanding Common
Stock was effected. The share information contained herein reflects the
one-for-three reverse stock split. Following the Merger, the principal activity
of the Company has been homebuilding.
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The Merger Consideration
Prior to the Merger, all of the outstanding common stock of Monterey
was owned by the Monterey Stockholders. As consideration for the Merger, the
Monterey Stockholders received 1,288,726 shares of Common Stock of the Company
(the "Exchange Shares"), such number being equal to (i) the book value of
Monterey on the effective date of the Merger ($2.5 million after certain
distributions) determined in accordance with generally accepted accounting
principles ("GAAP") consistent with the historical combined financial statements
of Monterey, but reflecting adjustments for certain costs and reserves agreed to
by the parties, multiplied by (ii) a factor of 3.0, and divided by (iii) the
fully diluted book value per share of Homeplex common stock on the effective
date of the Merger (after giving effect to outstanding stock options, whether
vested or not, which were dilutive to book value and after consideration of
amounts accrued for related dividend equivalent rights), determined in
accordance with GAAP consistent with the historical consolidated financial
statements of Homeplex.
Prior to the Merger, Monterey had issued and outstanding warrants to
purchase 133,334 shares of common stock of such companies (the "Monterey
Warrants") at an exercise price of $18.75 per share. The Monterey Warrants
represented approximately 16.5% of the fully diluted capitalization of Monterey
(809,259 shares). On the effective date of the Merger, the Monterey Warrants
were converted into the Company Warrants (which include the Warrants covered by
this Prospectus) based on a formula that would allow the Company Warrants to
purchase a number of shares of Common Stock of the Company determined by
multiplying 133,334 by the ratio of (i) the total number of Exchange Shares
issued in the Merger (as calculated above) divided by (ii) 809,259 (the "Warrant
Conversion Ratio"). The exercise price of the Company Warrants was adjusted by
dividing the exercise price of the Monterey Warrants immediately prior to the
Merger by the Warrant Conversion Ratio. In addition, the exercise price of the
Company Warrants was adjusted by a factor designed to compensate for certain
distributions made to the Monterey Stockholders prior to the Merger. Following
completion of audited financials for the year ended December 31, 1996, the
Company established the number of Company Warrants as 212,398. Each Warrant may
be exercised for the purchase of 1.2069 shares of Common Stock at an exercise
price of $4.0634 per Company Warrant or 250,000 shares, approximating 16.5% of
the Exchange Shares and Contingent Stock as discussed below.
Although all of the Exchange Shares were issued in the name of the
Monterey Stockholders, the Company will hold approximately 16.5%, or 212,398, of
the Exchange Shares issued in the names of the Monterey Stockholders for release
to holders of the Company Warrants upon exercise of the Company Warrants, and
the Company will remit the exercise price paid upon such exercises to the
Monterey Stockholders. Upon expiration of unexercised Company Warrants, the
Company will distribute the appropriate amount of Exchange Shares to the
Monterey Stockholders. The Monterey Stockholders are entitled to vote the
Exchange Shares issued in their names but allocated to the Company Warrants,
prior to the time the Company Warrants are exercised. Including the Exchange
Shares allocated to the Company Warrants, Mr. Cleverly owns 647,696 shares or
12.18% of the outstanding Common Stock of the Company and Mr. Hilton owns
644,363 shares or 12.12%. If all of the Company Warrants were exercised, Mr.
Cleverly would own 541,497 shares or 10.19% of the outstanding Common Stock of
the Company and Mr. Hilton would own 538,164 shares or 10.12% of the outstanding
Common Stock of the Company. These numbers exclude the Employment Options and
the Contingent Stock described below. As of the date of this prospectus, 9,612
shares of the Common Stock were issued to Warrant holders upon exercise of the
Company Warrants.
In addition to the Exchange Shares, the Company has reserved for
issuance 266,667 shares of common stock, subject to certain contingencies (the
"Contingent Stock"). Of such stock, approximately 16.5% (the "Contingent Warrant
Stock") or 43,947 shares are being reserved pending exercise of the Company
Warrants. When a Company Warrant is exercised, the holder will receive not only
the Exchange Shares into which the Company Warrant is exercisable, but also his
proportionate share of the Contingent Warrant Stock. The remaining approximately
83.5% of the original 266,667 shares of Contingent Stock are to be issued to the
Monterey Stockholders only if certain Common Stock average trading price
thresholds are reached at any time during the five years following the effective
date
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of the Merger as described below, provided that at the time of any such issuance
to a Monterey Stockholder, such Monterey Stockholder is still employed with the
Company. The average trading price thresholds and employment restrictions will
not apply to the Contingent Warrant Stock. The Contingent Stock will be issued
to the Monterey Stockholders as follows:
(i) if the closing price of the Common Stock on the NYSE (the "Stock
Price") averages $5.25 or more for twenty consecutive trading days
at any time during the five year period following the effective
date of the Merger, then 44,942 shares of the Contingent Stock
will be issued but only after the first anniversary of such
effective date;
(ii) if the Stock Price averages $7.50 or more for twenty consecutive
trading days at any time during the five year period following the
effective date of the Merger, then an additional 88,888 shares of
the Contingent Stock will be issued but only after the second
anniversary of such effective date; and
(iii) if the Stock Price averages $10.50 or more for twenty consecutive
trading days at any time during the five year period following the
effective date of the Merger, then the remaining 88,890 shares of
the Contingent Stock will be issued but only after the third
anniversary of such effective date.
As of September 5, 1997, each of the three thresholds described above
had been achieved. Therefore, in January 1998, 44,942 shares of Contingent Stock
were issued to the Monterey Stockholders; on January 1, 1999 or as soon
thereafter as is practicable, 88,888 shares will be issued to the Monterey
Stockholders; and on January 1, 2000 or as soon thereafter as is practicable,
the remaining 88,890 shares will be issued to the Monterey Stockholders, but in
each case only if the Monterey Stockholders remain employed with the Company at
such times.
Monterey Stockholder Employment Agreements and Employment Options
In connection with the Merger, the Company and the Monterey
Stockholders executed employment agreements (the "Employment Agreements"), each
with a term ending on December 31, 2001 and providing for an initial base salary
of $200,000 per year (increasing by 5% of the prior year's base salary per
year), and an annual bonus for the first two years of the lesser of 4% of the
pre-tax consolidated net income of the Company or $200,000. Thereafter, the
bonus percentage payout of consolidated net income would be determined by the
then-existing compensation committee of the board of directors of the Company,
provided that in no event will the bonus payable in any year exceed $200,000 for
each Monterey Stockholder. Under the Employment Agreements, the Monterey
Stockholders will serve as co-Chief Executive Officers and will also serve as
Chairman and President. If a Monterey Stockholder voluntarily terminates his
employment or is discharged for "Cause," the Company will have no obligation to
pay him any further salary or bonus. If a Monterey Stockholder is terminated
during the term of the Employment Agreement without "Cause" or as a result of
his death or permanent disability, the Company will be obligated to pay such
Monterey Stockholder (a) his then current annual salary through the term of the
Employment Agreement if terminated without "Cause," or for six months after
termination in the event of death or disability, plus (b) a pro rated bonus.
"Cause" is defined to mean only an act or acts of dishonesty by a Monterey
Stockholder constituting a felony and resulting or intended to result directly
or indirectly in substantial personal gain or enrichment at the expense of the
Company.
The Employment Agreements contain non-compete provisions that restrict
the Monterey Stockholders until December 31, 2001, from, except in connection
with the performance of their duties under the Employment Agreements, (i)
engaging in the homebuilding business, (ii) recruiting, hiring, or discussing
employment with any person who is, or within the past six months was, an
employee of the Company, (iii) soliciting any customer or supplier to
discontinue its relationship with the Company, or (iv) except solely as a
limited partner with no management or operating responsibilities, engaging in
the land banking or lot development business; provided, however, the foregoing
provisions do not restrict (A) the ownership of less than 5% of a
publicly-traded company, or (B) in the event the employment of such Monterey
Stockholder is terminated under the Employment Agreement, engaging in the custom
homebuilding business, engaging in the production homebuilding business outside
a 100 mile radius of any project of the Company or outside Northern
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California, or engaging in the land banking or lot development business. The
non-compete provisions will survive the termination of the Employment Agreement
unless such Monterey Stockholder is terminated by the Company without Cause.
The Employment Agreements also provide for the grant to each Monterey
Stockholder of options to purchase an aggregate of 166,667 shares of Common
Stock per Monterey Stockholder at an exercise price of $5.25 per share (the
"Employment Options"). The Employment Options expire on December 31, 2002 and
vest annually over three years in equal increments beginning on the first
anniversary of the effective date of the Merger; provided, however, the
Employment Options will vest in full and will be exercisable upon a change of
control of the Company prior to the third anniversary of the effective date of
the Merger. If a Monterey Stockholder voluntarily terminates his employment with
the Company, the Employment Options will be exercisable for a period of six
months following such termination. If a Monterey Stockholder is terminated
without Cause, the Employment Options will be immediately vested in full and
will be exercisable until December 31, 2002. If a Monterey Stockholders'
employment with the Company is terminated as a result of death or disability,
the Employment Options will be exercisable for a period of one year following
such termination. If the Company terminates a Monterey Stockholders' employment
for Cause, the Employment Options will terminate immediately.
For a description of certain amendments to the Employment Agreements,
see "The Legacy Combination - June 24, 1997 Letter Agreement."
Registration Rights
The Company has entered into a Registration Rights Agreement dated
December 31, 1996 with each of the Monterey Stockholders (the "Registration
Rights Agreements") pursuant to which it granted registration rights to the
Monterey Stockholders with respect to the Exchange Shares, the Contingent Stock,
and the Common Stock underlying the Employment Options. Pursuant to such rights,
subject to certain conditions and limitations, at any time after the first
anniversary of the effective date of the Merger, the Monterey Stockholders may
require the Company to register such shares under the Securities Act for resale
by the Monterey Stockholders. The Company has also agreed to take any action
required to be taken under applicable state securities or "blue sky" laws in
connection with such registration. The Company will pay all expenses relating to
the registration of shares pursuant to the Registration Rights Agreements. Each
Monterey Stockholder will pay any fees and expenses of counsel to the
stockholder, underwriting discounts and commissions, and transfer taxes, if any,
relating to the resale of the Monterey Stockholder's Common Stock.
Board of Directors
The board of directors of the Company currently consists of William W.
Cleverly, Steven J. Hilton, Alan Hamberlin, John R. Landon, Robert G. Sarver, C.
Timothy White and Raymond Oppel. In connection with the Merger, the Articles of
Incorporation of the Company were amended to, among other things, provide for
two classes of its directors, designated as Class I and Class II. Each Class
will consist of one-half of the directors or as close an approximation thereto
as possible. The Class I directors were elected in December of 1996 for a
two-year term. Raymond Oppel was appointed to the board of directors as a Class
I director in the fourth quarter of 1997. The Class II directors were elected in
September of 1997 for a two-year term. Messrs. Cleverly, Hilton, Hamberlin, and
Oppel are Class I directors and Messrs. Landon, Sarver and White are Class II
directors. At each subequent annual meeting of stockholders, each of the
successors to the directors of the Class whose term has expired at such annual
meeting will be elected for a term running until the second annual meeting next
succeeding his or her election and until his or her successor is duly elected
and qualified.
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Hamberlin Stock Options
Pursuant to an employment agreement entered into on December 21, 1995, in lieu
of an annual base salary in cash, Homeplex and Mr. Hamberlin entered into a
Stock Option Agreement dated December 21, 1995 (the "Hamberlin Stock Option
Agreement") pursuant to which Homeplex granted an option to Mr. Hamberlin to
purchase 250,000 shares of Homeplex common stock at $4.50 per share, which was
the fair market value per share on December 21, 1995 (the "Hamberlin Stock
Options"). The Hamberlin Stock Options are fully vested and are exercisable
until December 21, 2000. In addition, Mr. Hamberlin has also been granted other
options to purchase 105,601 shares of Common Stock of the Company.
Amendment to Articles of Incorporation
In connection with the Merger, the Articles of Incorporation of the
Company were amended to, among other things, (i) change the name of Homeplex to
"Monterey Homes Corporation," (ii) reclassify and change each share of Homeplex
common stock issued and outstanding into one-third of a share of Common Stock,
(iii) amend and make more restrictive the limitations on the transfer of Common
Stock to preserve maximum utility of the Company's net operating loss
carryforward (the "NOL Carryforward") (see "NOL Carryforward" below), and (iv)
provide for the Class I and Class II Directors (see "Board of Directors" above).
With respect to the restrictions on transfer of the Common Stock, the
Articles of Incorporation of the Company generally prohibit concentrated
ownership of the Company which might jeopardize its NOL Carryforward. The
amended transfer restrictions generally preclude for a period of up to five
years any person from transferring shares of Common Stock (or any other
subsequently issued voting or participating stock) or rights to acquire Common
Stock, if the effect of the transfer would be to (a) make any person or group an
owner of 4.9% or more of the outstanding shares of such stock (by value), (b)
increase the ownership position of any person or group that already owns 4.9% or
more of the outstanding shares of such stock (by value), or (c) cause any person
or group to be treated like the owner of 4.9% or more of the outstanding shares
of such stock (by value) for tax purposes. Direct and indirect ownership of
Common Stock and rights to acquire Common Stock are taken into consideration for
purposes of the transfer restrictions. These transfer restrictions will not
apply to (i) the exercise of any stock option issued by the Company that was
outstanding on the effective date of and immediately following the Merger, (ii)
exercise of the Hamberlin Stock Options, (iii) issuance of the Contingent
Shares, or (iv) exercise of the Employment Options. The board of directors of
the Company has the authority to waive the transfer restrictions under certain
conditions. The board of directors may also accelerate or extend the period of
time during which such transfer restrictions are in effect or modify the
applicable ownership percentage that will trigger the transfer restrictions if
there is a change in law making such action necessary or desirable. The board of
directors also has the power to make such other changes not in violation of law
as may be necessary or appropriate to preserve the Company's tax benefits. The
transfer restrictions discussed herein will apply to the transfer and exercise
of the Company Warrants. Ownerhip of Company Warrants will be aggregated with
shares of Common Stock otherwise owned by a holder to determine if the
applicable ownership percentage has been exceeded. The transfer restrictions
described herein may impede a change of control of the Company.
NOL Carryforward
At December 31, 1997, the Company had federal and state income tax net
operating loss carryforwards of approximately $43 million and $27 million,
respectively, which expire beginning in 2007 and 1998, respectively. It is
anticipated that future income taxes paid by the Company will be minimized and,
except as discussed below, will consist primarily of state income taxes (since
utilization of the Company's state net operating loss may be significantly
limited) and the federal alternative minimum tax.
The ability of the Company to use the NOL Carryforward to offset future
taxable income would be substantially limited under Section 382 of the Code if
an "ownership change," within the meaning of Section 382 of the Code has
occurred or occurs with respect to the Company before expiration of the NOL
Carryforward. The Company believes that (i) there was not an "ownership change"
of the Company prior to the effective date of the Merger, (ii) the Merger did
not cause an "ownership change", and (iii) the Legacy Combination
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<PAGE>
did not cause an "ownership change." The amendments to the Articles of
Incorporation of the Company, which became effective on the effective date of
the Merger, include restrictions on the transfer of Common Stock designed to
prevent an "ownership change" with respect to the Company after the Merger. See
"Amendment to Articles of Incorporation" above. Pursuant to Section 384 of the
Code, the Company may not be permitted to use the NOL Carryforward to offset
taxable income resulting from sales of assets owned by the Monterey Entities at
the time of the Merger (or to offset taxable income resulting from the sale of
certain assets acquired in the Legacy Combination) to the extent that the fair
market value of such assets at the time of the Merger (or at the time of the
Legacy Combination) exceeded their tax basis as of the relevant date. There is
no assurance that the Company will have sufficient earnings in the future to
fully utilize the NOL Carryforward.
Indemnification Rights
The Company and its officers, directors, and agents are entitled to
indemnification for damage, loss, liability, and expense (collectively, the
"Losses") incurred or suffered by such parties arising out of any action, suit,
claim, or demand arising out of, relating to, or based on the Monterey Entities'
or the Monterey Stockholders' breach or failure to perform in any material
respect any of their representations, warranties, covenants, or agreements under
the Merger Agreement or the transactions contemplated thereby; provided,
however, that such action, suit, claim, or demand must be first asserted prior
to the second anniversary of the effective date of the Merger. The Monterey
Stockholders are entitled to indemnification for their pro rata share of any
Loss incurred or suffered by the Monterey Stockholders arising out of any
action, suit, claim, or demand arising out of, relating to, or based on the
Company's breach or failure to perform in any material respect any of its
representations, warranties, covenants, or agreements under the Merger Agreement
or the transactions contemplated thereby; provided, however, that such action,
suit, claim or demand must be first asserted prior to the second anniversary of
the effective date of the Merger.
A committee to be comprised of the independent directors of the Company
serving after the effective date of the Merger (the "Committee") was appointed
irrevocably pursuant to the Merger Agreement to exercise the Company's
indemnification rights and was authorized to act, as the Committee may deem
appropriate, as the Company's agent in respect of receiving all notices,
documents, and certificates and making all determinations required with respect
to the indemnification provided for in the Merger Agreement.
The maximum aggregate amount of indemnification that may be required of
the Monterey Stockholders, on the one hand, and the Company, on the other,
pursuant to the Merger Agreement is $500,000 each. The Company retained from the
Merger consideration 70,176 of the Exchange Shares issued in the names of the
Monterey Stockholders, equal to $500,000 divided by the average closing price
for the last five trading days ending with the effective date of the Merger,
such shares to be utilized as security for the indemnification obligations in
favor of the Company under the Merger Agreement (the "Indemnification Fund").
The Indemnification Fund is the sole and exclusive source of reimbursement and
indemnification for the amount of any Loss or claim of the Company. The
Indemnification Fund will be adjusted each six months to maintain its $500,000
value less any amount previously applied to a loss. Cash can be deposited with
the Company at any time by the Monterey Stockholders to replace all or any
portion of the Common Stock in the Indemnification Fund. Amounts remaining in
the Indemnification Fund will be released to the Monterey Stockholders on the
second anniversary of the effective date of the Merger; provided, that if the
Monterey Stockholders are notified prior to the second anniversary of the
effective date of the Merger of a loss or claim, the amount of which is
uncertain or contingent, the Company will be entitled to retain an amount of
cash or a number of Exchange Shares that would be adequate to indemnify and hold
harmless the Company for each such loss or claim. The Monterey Stockholders will
be entitled to vote the shares of Common Stock held in the Indemnification Fund.
Holders of the Company Warrants will not bear a pro rata portion of any
reduction in Exchange Shares resulting from an indemnification claim.
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THE LEGACY COMBINATION
In an effort to further diversify the Company's homebuilding
operations, pursuant to the terms of an Agreement of Purchase and Sale of
Assets, dated May 29, 1997, by and among the Company, Legacy Homes, Ltd., Legacy
Enterprises, Inc., and John and Eleanor Landon and a related Agreement and Plan
of Merger dated June 25, 1997 (collectively with the Agreement of Purchase and
Sale of Assets, the "Combination Agreement"), among the Company, John and
Eleanor Landon, Texas Home Mortgage Corporation, and Monterey Mortgage
Acquisition Corp. (collectively, Legacy Homes, Ltd., Legacy Enterprises, Inc.
and Texas Home Mortgage Corporation shall be referred to as "Legacy"), the
Company acquired substantially all of the operations and assets of Legacy, a
Texas-based homebuilder with related mortgage brokerage operations. The
transaction closed on July 1, 1997. The Company has contributed these assets to
a wholly-owned limited partnership and related entities (collectively, the
"Texas Division").
The Legacy Combination Consideration
The consideration for the Legacy Combination consisted of $1,553,004 in
cash, 666,667 shares of Company Common Stock and deferred contingent payments
for the four years following the close of the transaction (the "Contingent
Payments"). In addition, the Company assumed substantially all of the
liabilities of Legacy including indebtedness that was incurred prior to the
closing of the transactions to fund distributions to the partners of Legacy
Homes that reduced its book value to less than $200,000.
The Contingent Payments are payable for the five consecutive earn-out
periods following the Effective Date. The first earn-out period commenced on
July 1, 1997, and ended on December 31, 1997. The remaining earn-out periods
refer to the calendar years 1998, 1999 and 2000, and the last earn-out period
refers to the period from January 1, 2001 to June 30, 2001. The Contingent
Payments will equal twenty percent (20%) of the net income of the Texas Division
before income taxes, determined in accordance with GAAP and subject to certain
adjustments, plus twelve percent (12%) of the Company's net income (without
regard to the NOL Carryforward) before income taxes, determined in accordance
with GAAP and as reported in or consistent with the Company's audited financial
statements. In no event will the total of the Contingent Payments exceed $15
million nor will a Contingent Payment exceed $5 million in any one earn-out
period. In the event a Contingent Payment would exceed $5 million in an earn-out
period, the excess of $5 million will accrue interest at the rate of ten percent
(10%) per annum and such excess plus accrued interest will be paid with the next
succeeding Contingent Payment. Any Contingent Payments due shall be subject to
the Company's rights of set-off under the Indemnification Agreement by and among
the parties.
Landon Employment Agreement and Employment Options
In connection with the Legacy Combination, the Company and John R.
Landon entered into an employment agreement (the "Landon Employment Agreement"),
with a term ending June 30, 2001 and providing for an initial base salary of
$200,000 per year (increasing by five percent (5%) of the prior year's base
salary per year), and an annual bonus for calendar years 1997 and 1998 equal to
the lesser of four percent (4%) of the pre-tax consolidated net income of the
Company or $200,000. Thereafter, the bonus percentage payout of consolidated net
income will be determined by the then-existing compensation committee of the
board of directors of the Company, provided that in no event will the bonus
payable in any year exceed $200,000. Under the Landon Employment Agreement, John
R. Landon will serve as Co-Chief Executive Officer and Chief Operating Officer
of the Company and as President and Chief Executive Officer of the Texas
Division.
If Mr. Landon voluntarily terminates his employment without "Good
Reason" or is discharged for "Cause," the Company will have no obligation to pay
him any further salary or bonus. In addition, the Company will be obligated to
pay Mr. Landon the Contingent Payments, but will have the option to make the
payments as scheduled over the term of the agreement or in one lump sum, based
on the pre-tax income of the Company and the pre-tax income of the Texas
Division for the twelve month period ending with the fiscal quarter immediately
preceding his termination, less a 25% reduction. If Mr. Landon is terminated
without "Cause" or as a result of death or disability or if he resigns for "Good
Reason", the Company will be obligated to pay Mr. Landon (i) his then current
base salary
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through the end of the stated term of employment in the event of termination by
the Company without "Cause" or resignation by Mr. Landon for "Good Reason," or
for six months after termination in the event of death or disability and (ii) a
pro rated bonus. If Mr. Landon is terminated without "Cause" or resigns for
"Good Reason," Mr. Landon will have the option to receive the Contingent
Payments as scheduled or in one lump sum based on the pre-tax income of the
Company and the Texas Division for the twelve month period ending with the
fiscal quarter immediately preceding his termination. If Mr. Landon's employment
is terminated due to death or disability, Mr. Landon or his estate may elect to
have the Contingent Payments continue as scheduled over the term of the
agreement or have the remainder paid out in one lump sum, based upon the pre-tax
income of the Company of the Texas Division for the twelve month period ending
with the fiscal quarter immediately preceding termination, less a 25% reduction.
"Cause" under the Landon Employment Agreement is defined to mean an act
or acts of dishonesty constituting a felony and resulting or intended to result
directly or indirectly in substantial personal gain or enrichment at the expense
of the Company, and willful disregard of the employee's primary duties to the
Company. "Good Reason" under the Landon Employment Agreement is defined to
include (i) assignment of duties inconsistent with the scope of the duties
associated with Mr. Landon's titles or positions or which would require Mr.
Landon to relocate his principal residence outside the Dallas/Fort Worth, Texas
metropolitan area; (ii) failure by the Company to elect Mr. Landon as a director
of the Company on or before June 30, 1998; (iii) failure by the Company to pay
any part of the Contingent Payments under the Legacy Asset Agreement; (iv)
termination of Mr. Landon for Cause and it is later determined that Cause did
not exist; or (v) failure of the Company to permit the Texas Division to utilize
its equity to obtain financing or to provide certain other monies due to the
Texas Division.
The Landon Employment Agreement contains a non-compete provision that,
until June 30, 2001, restricts John R. Landon from, except in connection with
the performance of his duties under the Landon Employment Agreement (i) engaging
in the homebuilding business and the mortgage brokerage or banking business,
(ii) recruiting, hiring or discussing employment with any person who is, or
within the past six months was, an employee of the Company, (iii) soliciting any
customer or supplier of the Company for a competing business or otherwise
attempting to induce any customer or supplier to discontinue its relationship
with the Company, or (iv) except solely as a limited partner with no management
or operating responsibilities, engaging in the land banking or lot development
business; provided, however, the foregoing provisions do not restrict (A) the
ownership of less than 5% of a publicly-traded company, or (B) in the event the
employment of Mr. Landon is terminated under his employment agreement, engaging
in the custom homebuilding business, engaging in the production homebuilding
business, or engaging in the land banking or lot development business outside a
100 mile radius, in each case, of any project of the Company. The non-compete
provisions under the Landon Employment Agreement will survive termination of the
Landon Employment Agreement unless Mr. Landon is terminated without Cause or he
resigns for "Good Reason."
The Landon Employment Agreement also provides for the grant to John R.
Landon of an option to purchase an aggregate of 166,667 shares of Company Common
Stock at an exercise price of $5.25 per share (the "Landon Employment Option").
The Landon Employment Option is exercisable as follows: 55,555 shares on July 1,
1998, 55,556 shares on July 1, 1999, 55,556 on July 1, 2000; provided, however,
that the Landon Employment Option shall become exercisable in full if there is a
change of control of the Company prior to July 1, 2000. If the Company
discharges Mr. Landon for Cause, the Landon Employment Option will terminate
immediately. If Mr. Landon voluntarily terminates his employment with the
Company or if his employment is terminated as a result of his death or
disability, then the Landon Employment Option (all 166,667 shares) will be
exercisable for a period of six months following such termination. If Mr. Landon
is terminated without Cause, the Landon Employment Option (all 166,667 shares)
will be immediately exercisable until July 1, 2001.
Registration Rights
The Company has entered into a Registration Rights Agreement, dated
July 1, 1997 (the "Landon Registration Rights Agreement") with Legacy Homes,
Ltd., Legacy Enterprises, Inc., and John and Eleanor Landon (Legacy Homes, Ltd.,
Legacy Enterprises, Inc., and John and Eleanor Landon shall be collectively
referred to as the "Holder"), pursuant to which it granted registration rights
to the Holder with respect to the shares acquired by the Holder in connection
with the Acquisition Agreement and the Landon Employment
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Option. Pursuant to such rights, subject to certain conditions and limitations,
at any time after December 31, 1997, the Holder may require the Company to
register such shares under the Securities Act for resale by the Holder. The
Company has also agreed to take any action required to be taken under applicable
state securities or "blue sky" laws in connection with such registration. The
Company will pay all expenses relating to the registration of shares pursuant to
the Landon Registration Rights Agreement. The Holder will pay any fees and
expenses of counsel of Holder, underwriting discounts and commissions, and
transfer taxes, if any, relating to the resale of the Holder's Common Stock.
Board of Directors
The Landon Employment Agreement required the Company to use its
reasonable best efforts to elect Mr. Landon as a director of the Company.
Mr.Landon was elected as a Class II director at the Annual Meeting of
Stockholders held on September 25, 1997.
June 24, 1997 Letter Agreement
In connection with the Legacy Combination, William W. Cleverly, Steven
J. Hilton, John R. Landon and Eleanor Landon entered into a letter agreement,
dated June 24, 1997 (the "Letter Agreement"), pursuant to which each of the
parties agreed that he or she will not directly or indirectly acquire or dispose
of beneficial ownership of any shares of voting securities of the Company
("Voting Securities") or rights to acquire Voting Securities which would
adversely affect the use of the Company's NOL Carryforward. See "The Merger-NOL
Carryforward." Subject to the notice provision in the immediately following
sentence, each party further agreed that for a period of five years following
the Effective Date, he or she will not purchase Voting Securities which would
cause his or her beneficial ownership of Voting Securities to exceed the
greatest number of shares beneficially owned by any other party to the Letter
Agreement. The party desiring to purchase Voting Securities agreed to provide
the other parties to the Letter Agreement at least seven days written notice of
his or her intent to purchase Voting Securities. Each other party would then be
permitted to purchase the same number of Voting Securities.
In connection with the Letter Agreement, the Employment Option
Agreements of William W. Cleverly, Steven J. Hilton and John R. Landon were
amended (the "Amended Employment Options"). The Amended Employment Options
provide for the deferment of the exercise of the option to acquire 15,000 shares
of Company Common Stock, otherwise exercisable on December 31, 1997, to January
30, 2000 for Messrs. Cleverly and Hilton, and with respect to Mr. Landon,
options to acquire 15,000 shares of Company Common Stock, otherwise exercisable
on July 1, 1998, to July 31, 2000.
Indemnification Rights
The Company and its officers, directors, and agents are entitled to
indemnification for Losses incurred or suffered by such parties arising out of
any action, suit, claim, or demand arising out of, relating to, or based on
Legacy's or its stockholders' (the "Legacy Stockholders") breach or failure to
perform in any material respect any of their representations, warranties,
covenants, or agreements under the Acquisition Agreement or the transactions
contemplated thereby; provided, however, that, in most instances, such action,
suit, claim, or demand must be first asserted prior to the second anniversary of
the closing. The Legacy Stockholders are entitled to indemnification for their
pro rata share of any Loss incurred or suffered by the Legacy Stockholders
arising out of any action, suit, claim, or demand arising out of, relating to,
or based on the Company's breach or failure to perform in any material respect
any of its representations, warranties, covenants, or agreements under the
Acquisition Agreement or the transactions contemplated thereby; provided,
however, that such action, suit, claim or demand must be first asserted prior to
the second anniversary of the effective date of the Merger.
Subject to various exceptions, the maximum aggregate amount of
indemnification that may be required of the Legacy Stockholders, on the one
hand, and the Company, on the other, pursuant to the Acquisition Agreement is
$500,000 each (unless there are breaches of representations relating to
environmental obligations, in which case the indemnity cap applicable to Legacy
may increase to $1,000,000). The Company may offset against Contingent Payment
amounts due with respect to the indemnifications of Legacy and the Legacy
Stockholders.
15
<PAGE>
SELECTED FINANCIAL AND OPERATING DATA
The following table sets forth selected historical consolidated
financial data of the Company for each of the years in the five-year period
ended December 31, 1997. The selected annual historical consolidated financial
data for 1997 and 1996 is derived from the Company's Consolidated Financial
Statements audited by KPMG Peat Marwick LLP, independent auditors. The selected
annual historical consolidated financial data for 1995, 1994 and 1993 is derived
from the Company's Consolidated Financial Statements audited by Ernst & Young
LLP, independent auditors. For additional information, see the Consolidated
Financial Statements included elsewhere in this Prospectus. Due to the Merger
and the Legacy Combination, the historical results of the Company are not
indicative of future results. Certain pro forma financial information reflecting
the Merger and the Legacy Combination is set forth in "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Pro-Forma
Results of Operations."
Historical Consolidated Financial Data
(Dollars in Thousands, Except Per Share Data)
<TABLE>
<CAPTION>
Years Ended December 31,
------------------------
1997(5) 1996 1995 1994 1993
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Income Statement Data:
Home and land sales revenue .................. $ 149,630 -- -- -- --
Cost of home and land sales .................. (124,594) -- -- -- --
---------
Gross Profit .............................. 25,036
Earnings (loss) from mortgage assets and
other income .............................. 5,435 $ 2,244 $ 3,564 $ (1,203) $ (21,814)
Interest expense ............................. 165 238 868 1,383 2,274
General, administrative and other expenses ... 15,107 1,684 1,599 1,938 1,822
--------- --------- --------- --------- ---------
Earnings (loss) before effect of income taxes,
accounting change and extraordinary loss ..... 15,199 322 1,097 (4,524) (25,910)
Income Taxes(3) .............................. (962) (26) -- -- --
Cumulative effect of accounting change(1) .... -- -- -- -- (6,078)
Extraordinary loss(2) ........................ -- (149) -- -- --
--------- --------- --------- --------- ---------
Net earnings (loss) .......................... $ 14,237 $ 147 $ 1,097 $ (4,524) $ (31,988)
========= ========= ========= ========= =========
Earnings (loss) per share before effect of
accounting change and extraordinary loss .. $ 2.68 $ 0.09 $ 0.34 $ (1.40) $ (7.98)
Cumulative effect of accounting change per
diluted share ............................. -- -- -- -- (1.89)
Extraordinary loss per share ................. -- (.05) -- -- --
--------- --------- --------- --------- ---------
Diluted earnings (loss) per share ............ $ 2.68 $ 0.04 $ 0.34 $ (1.40) $ (9.87)
========= ========= ========= ========= =========
Cash dividends per share(3) .................. N/A $ 0.06 $ 0.09 $ 0.06 $ 0.09
========= ========= ========= =========
</TABLE>
16
<PAGE>
<TABLE>
<CAPTION>
At December 31,
---------------
1997 1996(4) 1995 1994 1993
---- ------- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Real estate under development........................... $65,295 $35,991 -- -- --
Residual interests...................................... 1,422 3,909 $5,457 $7,654 $17,735
Total assets............................................ 96,633 72,821 27,816 31,150 43,882
Notes payable........................................... 22,892 30,542 7,819 11,783 19,926
Total liabilities....................................... 50,268 45,876 9,368 13,508 21,505
Stockholders' equity.................................... 46,365 26,945 18,448 17,642 22,377
</TABLE>
- ----------------
(1) Reflects the cumulative effect of adoption of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in
Debt and Equity Securities."
(2) Reflects extraordinary loss from early extinguishment of long-term
debt.
(3) For any taxable year in which the Company qualified and elected to be
treated as a REIT under the Code, the Company was not subject to
federal income tax on that portion of its taxable income that was
distributed to stockholders in or with respect to that year. Regardless
of such distributions, however, the Company may be subject to tax on
certain types of income. Due to the Merger, the Company did not qualify
as a REIT in 1996 or 1997.
(4) Reflects the Merger consummated on December 31, 1996.
(5) Includes the accounts of Legacy Homes commencing on July 1, 1997.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The Company was originally formed as a real estate investment trust
("REIT"), investing in mortgage-related assets and, to a lesser extent, selected
real estate loans. On December 31, 1996, the Company acquired by merger (the
"Merger") the homebuilding operations of various entities operating under the
Monterey Homes name ("Monterey") and essentially discontinued the Company's
mortgage-related operations. As part of a strategy to diversify its operations,
on July 1, 1997, the Company combined with the Texas-based homebuilder
operations of several entities operating under the name Legacy Homes ("Legacy").
The following sets forth a discussion and analysis of the financial
condition and results of operation for the Company for the prior three years,
reflecting primarily the Company's homebuilding operations. To facilitate an
understanding of the Company after the Merger, also included is a discussion and
analysis of the pro forma results of operations of the Company giving effect to
the Merger as if it had occurred on January 1, 1996 and the addition of Legacy
Homes subsequent to July 1, 1997.
Historical Results of Operations
Year Ended December 31, 1997 Compared to 1996
The Company had net earnings of $14,237,000 or $2.68 per share for the
twelve months ended December 31, 1997 compared to net earnings of $147,000, or
$.04 per share in 1996. The increase in the current year was caused by the
addition of the homebuilding operations during 1997. Home and land sales
revenue, cost of sales, commissions and other sales costs all increased in 1997,
reflecting the addition of homebuilding operations in 1997 along with the Legacy
Combination and the resulting expansion into the Texas markets in July 1997.
Results for the year ended December 31, 1996, include an extraordinary loss from
the early extinguishment of debt of $149,000, or $.05 per share.
17
<PAGE>
Residual interest and real estate loan interest income was higher in
the twelve months ended December 31, 1997 than in the previous year mainly due
to the sale of two of the Company's mortgage securities which resulted in gains
of approximately $3.1 million.
Selling, general and administrative expenses were $15.1 million and
$1.7 million for the years ended December 31, 1997 and 1996, respectively. The
increase was caused by homebuilding administrative costs, including amortization
of goodwill, expenses related to the Legacy Combination and other home-selling
expenses, such as commissions, which the Company did not incur in 1996.
The increase in income taxes to $962,000 for the twelve months ended
December 31, 1997 from $26,000 in the prior year resulted from a significant
increase in pre-tax earnings in 1997. The favorable effective tax rates of 6%
and 8% in 1997 and 1996, respectively, result from the Company's net operating
loss carryforward.
Year Ended December 31, 1996 Compared to 1995
The Company had net earnings of $147,000, or $.04 per share, in 1996
compared to earnings of $1,097,000, or $.34 per share, in 1995. Results for the
year ended December 31, 1996 include an extraordinary loss from the early
extinguishment of debt of $149,000, or $.05 per share.
The Company's income from mortgage assets was $2,244,000 in 1996
compared to income of $3,564,000 in 1995.
The Company's interest expense declined from $868,000 in 1995 to
$238,000 in 1996 due to a reduction in the Company's aggregate long-term debt.
Liquidity, Capital Resources, and Commitments
The Company's principal uses of working capital are land purchases, lot
development and home construction. The Company uses a combination of borrowings
and funds generated by operations to meet its working capital requirements.
The cash flow for each of the Company's communities can differ
substantially from reported earnings, depending on the status of the development
cycle. The early stages of development or expansion require significant cash
outlays for, among other things, land acquisitions, obtaining plat and other
approvals, and construction of model homes, roads, certain utilities, general
landscaping and other amenities. Because these costs are capitalized, income
reported for financial statement purposes during those early stages may
significantly exceed cash flow. After the early stages of development and
expansion when these expenditures are made, cash flow can significantly exceed
earnings reported for financial statement purposes, as cost of sales includes
charges for substantial amounts of previously expended costs.
At December 31, 1997, the Company had available short-term secured
revolving construction loan facilities totaling $70 million and a $20 million
acquisition development facility, of which approximately $14.4 and $2.4 million
were outstanding, respectively. An additional $12.5 million of unborrowed funds
supported by approved collateral were available under its credit facilities at
such date. Borrowings under the credit facilities are subject to the inventory
collateral position of the Company and a number of other conditions, including
minimum net worth, debt to equity and debt coverage tests. The Company also has
outstanding $6 million in unsecured, senior subordinated notes due October 15,
2001 (the "Notes"), which were issued in October 1994. A provision of the senior
subordinated bond indenture provides bondholders with the option, at June 30,
1998, to require the Company to buy back the bonds at 101% of face value.
18
<PAGE>
Management believes that the Company's current borrowing capacity, cash
on hand at December 31, 1997 and anticipated cash flows from operations are
sufficient to meet liquidity needs for the foreseeable future. There can be no
assurance, however, that amounts available in the future from the Company's
sources of liquidity will be sufficient to meet the Company's future capital
needs and the amount and types of indebtedness that the Company may incur may be
limited by the terms of the indenture governing its senor subordinated notes and
the credit agreements.
Comparison to Prior Year - Pro Forma Results of Operations
As a result of the Merger, the primary business of the Company shifted
to homebuilding from the making of real estate loans and holding residual
interests. Due to this change, management believes that comparison of operations
in the current year with the prior year operations is not as meaningful as a
comparison to the prior year's pro forma results. Accordingly, management has
prepared pro forma condensed combined operating results for the year ended
December 31, 1996, which reflect the impact of combining the pre-merger
companies as though the Merger had taken place on January 1, 1996. The following
current year information only reflects the addition of Legacy subsequent to July
1, 1997.
Results of Operations
For the Year Ended December 31,
-------------------------------
1997 1996
(Pro Forma)
(Dollars in thousands,
except per share data)
----------------------
Home and land sales revenue $149,630 $87,754
Cost of home and land sales 124,594 75,099
------- ------
Gross profit 25,036 12,655
Selling, general and administrative 15,106 7,777
Other income, net 5,269 1,998
----- -----
Earnings before income taxes 15,199 6,876
Income tax expense 962 756
--- ----
Net earnings $14,237 $6,120
======= ======
Diluted earnings per share $2.68 $1.31
===== =====
Key assumptions in the pro forma results of operations include:
(1) The Merger was consummated on January 1, 1996.
(2) Compensation expense was adjusted to add the new employees' cost and to
deduct the terminated employees' cost.
(3) The net operating loss was utilized to reduce the maximum amount of
taxable income possible.
19
<PAGE>
The following discussion and analysis provides information regarding
results of operations of the Company and its subsidiaries for the year ended
December 31, 1997 and pro forma operations for the year ended December 31, 1996.
All material balances and transactions between the Company and its subsidiaries
have been eliminated. Results include the operations of Legacy from July 1, 1997
to December 31, 1997. This discussion should be read in conjunction with the
consolidated financial statements contained elsewhere in this Prospectus. In the
opinion of management, the data reflects all adjustments, consisting only of
normal recurring adjustments, necessary to fairly present the Company's
financial position and results of operations for the periods presented.
Home Sales Revenue
Home sales revenue is the product of the number of units closed during the
period and the average sales price per unit. The following table presents
comparative 1997 and 1996 housing revenues:
<TABLE>
<CAPTION>
Year Ended Dollar/Unit Percentage
(Dollars in Thousands) December 31, Increase Increase
1997 1996 (Decrease) (Decrease)
---- ---- ---------- ----------
<S> <C> <C> <C> <C>
Dollars......................................... $149,385 $86,829 $62,556 72%
Units Closed.................................... 644 307 337 110%
Average Sales Price............................. $232.0 $282.8 $(50.8) (18%)
</TABLE>
The increase in revenues and number of units closed in 1997
compared to 1996 resulted mainly from the addition of the Texas operations. The
lower average sales price in 1997 is also due to sales in the Texas market,
where the Company's focus is on entry-level and moves-up homes.
Gross Profit
Gross profit equals home and land sales revenue, net of housing cost of sales,
which include developed lot costs, unit construction costs, amortization of
common community costs (such as the cost of model complex and architectural,
legal, and zoning costs), interest, sales tax, warranty, construction overhead
and closing costs. The following table presents comparative 1997 and 1996
housing gross profit:
<TABLE>
<CAPTION>
Year Ended
(Dollars in Thousands) December 31, Dollar/Unit Percentage
1997 1996 Increase Increase
---- ---- -------- --------
<S> <C> <C> <C> <C>
Dollars............................................ $25,036 $12,655 $12,381 98%
Percent of Housing Revenues........................ 16.8% 14.6% 2.2% 15%
</TABLE>
The dollar increase in gross profit in the twelve months ended December
31, 1997, is attributable to the increase in number of units closed due to the
Legacy Combination, along with increased closings in highly profitable Arizona
communities. The gross profit margin increased in 1997 due to generally higher
margins in Texas, and an increase in purchase by the customers of more
profitable custom options and upgrades with respect to Arizona closings.
Selling, General, and Administrative Expenses
Selling, general, and administrative expenses, which include
advertising, model and sales office, sales administration, commissions, and
corporate overhead costs, were approximately $15.1 million in 1997, as compared
to approximately $7.8 million for 1996, an increase of 94%. These changes were
caused mainly by higher administrative, corporate and public company costs and
the inclusion of Legacy operating costs in the second half of 1997.
20
<PAGE>
Net Orders
Net orders for any period represent the number of units ordered by
customers (net of units canceled) multiplied by the average sales price per
units ordered. The following table presents comparative 1997 and 1996 net
orders:
<TABLE>
<CAPTION>
(Dollars in Thousands) Year Ended December 31, Dollar/Unit Percentage
1997 1996 Increase Increase
---- ---- -------- --------
<S> <C> <C> <C> <C>
Dollars........................................ $157,479 $90,182 $67,297 75%
Units Ordered.................................. 693 283 410 145%
Average Sales Price............................ $227.2 $318.6 $(91.4) (29%)
</TABLE>
The Company does not include sales which are contingent on the sale of
the customer's existing home as orders until the contingency is removed.
Historically, the Company has experienced a cancellation rate of less than 16%
of gross sales. Total net orders increased in 1997 compared to 1996 due to the
expansion into Texas and the economic strength of both the Arizona and Texas
markets.
Net Sales Backlog
Backlog represents net orders of the Company which have not closed. The
following table presents comparative 1997 and 1996 net sales backlog for the
total Company, and the Arizona and Texas divisions individually:
<TABLE>
<CAPTION>
(Dollars in Thousands) December 31, Dollar/Unit Percentage
Total Company 1997 1996 (1) Increase(Decrease) Increase(Decrease)
---- -------- ------------------ ------------------
<S> <C> <C> <C> <C>
Dollars.............................. $98,963 $42,661 $56,302 132%
Units in Backlog..................... 472 120 352 293%
Average Sales Price.................. $209.7 $355.5 $(145.8) (41%)
Arizona
Dollars.............................. $56,945 $42,661 $14,284 33%
Units in Backlog..................... 168 120 48 40%
Average Sales Price.................. $339.0 $355.5 $(16.5) (5%)
Texas
Dollars.............................. $42,018 $28,570 $13,448 47%
Units in Backlog..................... 304 197 107 54%
Average Sales Price.................. $138.2 $145.0 $(6.8) (5%)
</TABLE>
(1) Prior year's Texas information is included for comparative purposes
only
Total dollar backlog increased 132% over the prior year due to a
substantial increase in units in backlog partially offset by a decrease in
average sales price. Average sales price as a whole has decreased due to the
Legacy Combination, where the focus is on entry-level and move-up homes. Units
in backlog have increased 293% over the prior year due to the increase in net
orders caused by the Texas expansion.
Arizona dollar backlog increased 33% over the prior year due to the
increased number of units in backlog offset by a decease in average sales price
due to a change in the product mix of units ordered.
21
<PAGE>
Texas dollar and unit backlog is up over the prior year due to
increased orders in 1997. The average sales price is slightly lower due to the
increase in the product mix of entry level home sales.
Seasonality
The Company has historically closed more units in the second half of
the fiscal year than in the first half, due in part to the slightly seasonal
nature of the market for its semi-custom, luxury product homes. Management
expects that this seasonal trend will continue in the future, but may change
slightly as operations expand within the move-up and entry-level segment of the
market.
BUSINESS OF THE COMPANY
History of the Company
The Company designs, builds and sells single family homes in Arizona
and Texas. The Company builds move-up and semi-custom, luxury homes in the
Phoenix and Tucson, Arizona metropolitan areas, and entry-level and move-up
homes in the Dallas/Fort Worth, Austin and Houston, Texas metropolitan areas.
The Company has undergone significant growth in recent periods and is pursuing a
strategy of expanding the geographic scope of its operations.
The Company was originally formed as a real estate investment trust
("REIT"), investing in mortgage-related assets and, to a lesser extent, selected
real estate loans. On December 31, 1996, the Company acquired through the Merger
the homebuilding operations of various entities under the Monterey Homes name,
and essentially discontinued the Company's mortgage-related operations. As part
of a strategy to diversify its operations, on July 1, 1997, the Company acquired
the homebuilding operations of several entities operating under the name Legacy
Homes ("Legacy"). Legacy has been operating in the Texas market since 1988, and
designs, builds, and sells entry-level and move-up homes.
During 1996, the Company recorded pro forma revenues of $87.8 million
and pro forma pre-tax income of $6.9 million on 307 home closings. During the
same period, Legacy closed 623 homes generating revenues of $85.1 million and
pre-tax income of $8.8 million. For the year ended December 31, 1997, the
Company generated pro forma revenues of $189.4 million, and net earnings of
$17.8 million. The historical financial results of the Company may not be
indicative of its results of operations in the future.
Industry
The homebuilding industry is highly competitive and extremely
fragmented, and is greatly affected by a number of factors, on both a national
and regional level. Among the most vital factors on a national level are
interest rates and the influence of the Federal Reserve Board on interest rates.
The homebuilding industry's sensitivity to interest rate fluctuations is
two-pronged: an increase or decrease in interest rates affects (i) the
homebuilding company directly in connection with its cost of borrowed funds for
land and project development and working capital and (ii) home buyers' ability
and desire to obtain long-term mortgages at rates favorable enough to service a
long-term mortgage obligation. The Company believes that the availability of
less expensive mortgage financing vehicles such as variable rate mortgage loans
have encouraged potential home buyers moving to high growth areas to be more
willing to purchase a new home now and refinance at a later date.
Business Strategy
The Company seeks to distinguish itself from other production
homebuilders through a business strategy focusing on the following elements:
22
<PAGE>
Superior Design and Quality. Monterey seeks to maximize customer
satisfaction by offering homes that, within their market segment, are built with
quality materials and craftsmanship, exhibit distinctive design, and are
situated in premium locations. In Arizona, its competitive edge in the selling
process focuses on the home's features, design, and available custom options. In
Texas, its competitive edge focuses on the design and quality of its entry-
level and move-up homes. The Company believes that its homes generally offer
higher quality and more distinctive designs within their defined price range or
category than those built by its competitors.
Product Breadth. The Company offers homes for a wide variety of
consumers. In Arizona, the Company addresses the luxury and move-up homebuyers'
markets. The luxury market segment is characterized by unique communities and
distinctive luxury homes. The Company's expansion into the move-up buyer segment
of the market reflects its desire to increase its share of the overall housing
market in the Phoenix and Tucson metropolitan areas. In Texas, the Company
focuses on the entry-level and move-up homebuyers markets.
Highest Level of Service. In the semi-custom, luxury market, the
Company attempts to involve the customer in every phase of the building process
through a series of conferences with the sales staff, project managers, and
construction superintendents. This procedure is designed to give the buyer the
opportunity to add custom design features and monitor development of the home,
creating a sense of participation in and control over the end product.
Conservative Land Acquisition Policy. The Company has historically
pursued, and will continue to pursue, a conservative land acquisition policy. It
generally purchases land subject to complete entitlement, including zoning and
utilities services, focusing on development sites which it expects will have
less than a three-year inventory of lots. These strategies reduce the risks
associated with investments in land. Moreover, it controls lots on a
non-recourse, rolling option basis in those circumstances in which it is
economically advantageous to do so. To date, the Company has not speculated in
raw land held for investment.
Penetration of New Markets. Depending on existing market conditions,
the Company may explore expansion opportunities in other parts of the Sunbelt
states, targeting its market niches in areas where it perceives an ability to
exploit a competitive advantage. Expansion may be effected through acquisitions
of other existing homebuilders or through internal growth.
Markets and Products
Overview. The Company's operations primarily serve the Phoenix and
Tucson, Arizona areas and the Dallas/Fort Worth, Austin and Houston areas. The
Company believes that these areas represent attractive homebuilding markets with
opportunity for long-term growth. The Company also believes that its operations
in certain markets, such as Scottsdale and Dallas/Fort Worth, are well
established and that it has developed a reputation for building quality homes
with distinctive designs within the market segments served in these communities.
Arizona Markets
In its Arizona markets, the Company's semi-custom, luxury homes are
single-story, two to five-bedroom homes, ranging in base price from
approximately $240,000 to over $500,000. The homes vary in size from
approximately 2,500 square feet to 4,500 square feet and are constructed on lots
ranging from 5,500 square feet to one acre. The Company also builds
single-family, move-up homes on subdivided lots. These are one and two-story
detached homes, with two to five bedrooms, ranging in base price from
approximately $120,000 to over $200,000. The homes range from 1,400 square feet
to 3,500 square feet and are constructed on lots ranging from 6,500 square feet
to 10,000 square feet.
During 1997, the Company closed 284 homes in Arizona with an average
sales price of $344,800. At December 31, 1997, the Company had a total of 168
home purchase contracts in backlog totaling $56.9 million, with an average price
of $339,000. In 1996, the average sales price for all homes closed in Arizona
was $282,800, and the Company had a backlog of 120 home purchase contracts
totaling
23
<PAGE>
$42.7 million at December 31. The average price of homes in the 1996 backlog was
$355,500.
Phoenix, Arizona. The Arizona Department of Economic Security estimated
that approximately 153,000 jobs will be created throughout Arizona in 1997 and
1998, resulting in gains of 4.6% and 3.3%, respectively. Nearly 80% of these new
jobs are expected to be in the Phoenix area.
From 1996 to 1997, permits for single-family residential units in the
Phoenix metropolitan area increased 7% from 29,609 to 31,715. Although
single-family housing permits in the Phoenix metropolitan area were at record
levels in 1997, real estate analysts are predicting that new home sales in this
area may be slightly lower in 1998. Any slowing in a new home sales could have
an adverse affect on the Company's operating results. The Company is actively
selling homes in seven communities in the Phoenix area.
The Company derives substantial revenues from sales of homes in the
Scottsdale area. Scottsdale is a relatively affluent city within metropolitan
Phoenix, and has developed detailed master planning and zoning regulations.
Scottsdale has typically appealed to the type of higher-income buyer which the
Company generally targets in this market, and due to the strong market in this
area, the availability of land has deceased and the cost of such land has
increased. There can be no assurance that the Company will be able to continue
to acquire property in the Scottsdale area on terms that are favorable to the
Company. The inability to acquire land on favorable terms could have a material
adverse effect on the Company's business and operating results.
Tucson, Arizona. The Company began offering homes for sale in Tucson in
April 1996, and is actively selling in three communities in that area. Tucson
also has experienced growth over the last five years. Annual building permits
issued for single-family residential units in Tucson increased moderately from
approximately 5,200 in 1996 to approximately 5,400 in 1997, a 4% increase. Real
estate analysts are predicting that new home sales in the Tucson metropolitan
area will remain relatively flat in 1998.
The following table presents information relating to the current
communities in the Arizona markets served by the Company for and as of December
31, 1997:
<TABLE>
<CAPTION>
Number of Number Homes Homes Base
Number of Homes of Homes in Sites(1) Price Range (2)
Home Sites Sold Closed Backlog Remaining (in thousands)
---------- ---- ------ ------- --------- --------------
<S> <C> <C> <C> <C> <C> <C>
Phoenix Area
Semi-custom, luxury 871 392 284 108 479 $240-$525
Move-up 571 169 146 23 402 $166-$236
--- --- --- -- --- ---------
Total 1,442 561 430 131 881
----- --- --- --- ---
Tucson Area
Semi-custom, luxury 148 63 40 23 85 $245-$385
Move-up 331 80 66 14 251 $124-$219
--- -- -- -- --- ---------
Total 479 143 106 37 336
--- --- --- -- ---
Total Arizona 1,921 704 536 168 1,217
===== === === === =====
</TABLE>
(1) "Homes Sites Remaining" is the number of homes that could be built on
both the remaining lots available for sale and land to be developed
into lots as estimated by the Company.
(2) "Base Price Range" is the current average base sales price of homes
offered for sale.
Texas Markets
The Company operates in the Texas market under the Legacy Homes name
and is value focused, as it produces homes in volume
24
<PAGE>
that are efficient to build, and offers buyers some degree of design discretion
and a number of optional features and upgrades. Typical of its Texas products
are one and two story homes, generally with attached garages, brick exteriors,
three to five bedrooms, and open kitchen/family rooms. In its Texas markets, the
Company usually purchases finished lots in newly-developing and growing areas,
though occasionally the Company will acquire undeveloped land and develop
homesites for its own use.
From July 1, 1997, the date of the Legacy Combination, the Texas
division closed a total of 360 homes with an average sales price of $143,000. At
December 31, 1997, the Texas division had a total of 304 home purchase contracts
in backlog totaling $42.0 million, with an average sales price of $138,200,
while in Texas at December 31, 1996, there were 197 home purchase contracts in
backlog totaling $28.6 million, with an average sales price of $145,000.
Dallas/Fort Worth, Texas. With approximately 72,000 new jobs created in
Dallas in 1997, this market continues to enjoy significant job growth (4.14%).
Annual closings reached their highest level since the mid-1980's, with 16,740
new homes. Fort Worth's annual job growth at 25,600 represents a 3.6% rate,
higher than the average of the last four years. Housing activity in the Fort
Worth market reflected low inventory levels, with an increase in average starts
to almost 7,000, and a drop in closings to 6,760. Dallas/Ft. Worth represents
the Company's greatest amount of activity in the Texas market. The Company is
actively selling in 16 different communities, targeted to both first time buyers
with homes starting at approximately 1,600 square feet and to move-up buyers
with homes up to 3,000 square feet. In this area, homes for first time buyers
are priced from $95,000 to $115,000 and those for the move-up market are priced
from $120,000 to $180,000.
Austin, Texas. According to the Texas Employment Commission, new jobs
created in Austin in 1997 were approximately 11,000, which is about the same as
the prior year, and is down from the 6% - 7% increases seen each year from 1992
to 1995. Annual 1997 starts of 7,270 represented a slight drop by 7.9% from
1996; a slight decrease (0.8%) in closings also occurred. Recognizing the
decrease in average sales price, the Company in 1997 re-positioned its product
to reflect the changing demand for lower priced homes by introducing a new
product line from approximately 1,400 to 2,500 square feet to take advantage of
opportunities in the $90,000 to $120,000 price range. The Company is actively
selling in five communities in the Austin area.
Houston, Texas. The Texas Workforce Commission statistics for calendar
1997 show a net gain of approximately 66,000 new jobs in Houston. This job
growth is estimated to have created approximately 36,000 new households
resulting in single family starts for 1997 at a 14 year high of 18,958. Closings
for the same period reached 16,553 homes. The Company entered the Houston market
by opening its first community late in 1997. A second community is in the
planning/pre-sell stages. The Company builds homes for affluent first-time and
move-up buyers in the desirable Northwest area, ranging form approximately 1,700
to 3,100 square feet and priced in the $110,000 to the $210,000 range. Houston's
job growth, low unemployment rate of 5% and growth in local population and
households may continue to fuel a strong demand for housing.
25
<PAGE>
The following table presents information relating to the current
communities in the Texas markets served by the Company for and as of December
31, 1997:
<TABLE>
<CAPTION>
Base
Number of Number of Number of Homes In Homes Prime Range
Home Sites Homes Sold Homes Closed Backlog Remaining(1) (in 000s)(2)
---------- ---------- ------------ ------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
Dallas/Ft. Worth Area
Move-up 1,907 1,136 942 194 771 $120 - $180
Entry-level 564 308 244 64 256 $95 - $115
--- --- --- -- --- ----------
Total 2,471 1,444 1,186 258 1,027
----- ----- ----- --- -----
Austin Area
Move-up 467 340 324 16 127 $130 - $190
Entry-level 111 20 4 16 91 $100 - $120
--- -- - -- -- -----------
Total 578 360 328 32 218
--- --- --- -- ---
Houston Area
Move-up 76 15 1 14 61 $115 - $210
-- -- - -- -- -----------
Total Texas 3,125 1,819 1,515 304 1,306
===== ===== ===== === =====
</TABLE>
(1) "Homes Sites Remaining" is the number of homes that could be built on
both the remaining lots available for sale and land to be developed
into lots as estimated by the Company.
(2) "Base Price Range" is the current average base sales price of homes
offered for sale.
Land Acquisition and Development
Most of the land acquired by the Company is purchased only after
necessary entitlements have been obtained so that the Company has certain rights
to begin development or construction as market conditions dictate. The term
"entitlements" refers to development agreements, tentative maps, or recorded
plats, depending on 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 process of obtaining such governmental approvals and permits can
substantially delay the development process. In certain situations in the
future, the Company may consider purchasing unentitled property where it
perceives an opportunity to build on such property in a manner consistent with
its business strategy.
The Company selects land for development based upon a variety of
factors, including (i) internal and external demographic and marketing studies;
(ii) suitability of the projects, which generally are developments with fewer
than 150 lots; (iii) suitability for development within a one to three year time
period from the beginning of the development process to the delivery of the last
house; (iv) financial review as to the feasibility of the proposed project,
including projected profit margins, return on capital employed, and the capital
payback period; (v) the ability to secure governmental approvals and
entitlements; (vi) results of environmental and legal due diligence; (vii)
proximity to local traffic corridors and amenities; and (viii) management's
judgment as to the real estate market, economic trends, and experience in a
particular market. The Company may consider purchasing larger properties
consisting of 200 to 500 lots or more if it deems the situation to have an
attractive profit potential and acceptable risk limitation.
26
<PAGE>
The Company acquires land through purchases and rolling option
contracts. Purchases are financed through traditional bank financing or through
working capital. The Company generally utilizes rolling option contracts that
are non-recourse and require nonrefundable deposits. In Texas, the Company
acquires land almost exclusively through such rolling option contracts.
Once the land is acquired, the Company undertakes, where required,
development activities, through contractual arrangements with subcontractors,
that include site planning and engineering, as well as constructing road, sewer,
water, utilities, drainage, and recreational facilities, and other refinements.
The Company often builds homes in master planned communities with home sites
that are along or close in proximity to a major amenity, such as a golf course.
The Company strives to develop a design and marketing concept for each
of its projects, which includes determination of size, style, and price range of
the homes, layout of streets, size and layout of individual lots, and overall
community design. The product line offered in a particular project depends upon
many factors, including the housing generally available in the area, the need of
a particular market, and the Company's cost of lots in the project.
The Company has occasionally used partnerships or joint ventures to
purchase and develop land where such arrangements were necessary to acquire the
property or appeared to be otherwise economically advantageous to Monterey. The
Company may continue to consider such arrangements where management perceives an
opportunity to acquire land upon favorable terms, minimize risk, and exploit
opportunities through seller financing.
27
<PAGE>
The following table sets forth by project the Company's land inventory
as of December 31, 1997.
<TABLE>
<CAPTION>
Land Under
----------
Land Owned Contract or Option
---------- ------------------
Lots Under Lots Under
Finished Development Finished Development
Projects Lots (estimate) Lots (estimate) Total
-------- ---- ---------- ---- ---------- -----
<S> <C> <C> <C> <C> <C>
Phoenix Area
- ------------
Semi-Custom, luxury 79 211 24 273 587
Move-up 41 -- 32 352 425
-- -- -- --- ---
Total 120 211 56 625 1,012
--- --- -- --- -----
Tucson Area
- -----------
Semi-Custom, luxury 42 -- 32 34 108
Move-up 147 -- -- 118 265
--- -- -- --- ---
Total 189 -- 32 152 373
--- -- -- --- ---
Total Arizona 309 211 88 777 1,385
--- --- -- --- -----
Dallas/Ft. Worth Area
- ---------------------
Entry Level 91 91 167 30 379
Move-up 66 190 297 353 906
-- --- --- --- ---
Total 157 281 464 383 1,285
--- --- --- --- -----
Austin Area
- -----------
Entry Level 23 -- 152 -- 175
Move-up 11 -- 37 27 75
-- -- -- -- --
Total 34 -- 189 27 250
-- -- --- -- ---
Houston Area
- ------------
Move-up -- -- 75 -- 75
-- -- -- -- --
Total Texas 191 281 728 410 1,610
--- --- --- --- -----
Total Company 500 492 816 1,187 2,995
=== === === ===== =====
</TABLE>
Construction
The Company acts as the general contractor for the construction of its
projects. Subcontractors typically are retained on a project-by-project basis in
Arizona and on a geographic area basis in Texas, to complete construction at a
fixed price. Agreements with subcontractors and materials suppliers are
generally entered into after competitive bidding on an individual basis. The
company obtains information from prospective subcontractors and suppliers with
respect to their financial condition and ability to perform their agreements
prior to commencement of the formal bidding process. From time to time, the
Company enters into longer term contracts with subcontractors and suppliers if
management believes that more favorable terms can be secured. Subcontractors are
supervised by the Company's project managers and field superintendents, who
coordinate the activities of subcontractors and suppliers, subject the work to
quality and cost controls, and assure compliance with zoning and building codes.
The Company specifies that quality, durable materials be used in
constructing its homes. The Company does not maintain significant inventories of
construction materials, except for work in process materials for homes under
construction. 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. Generally, access to the Company's principal
subcontracting trades, materials and supplies continue to be readily
28
<PAGE>
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
believes that its relations with suppliers and subcontractors are good.
The Company generally clusters the homes sold within a project, which
management believes creates efficiencies in land development and construction,
and improves customer satisfaction by reducing the number of vacant lots
surrounding a completed home. Typically, a home in Arizona is completed by the
Company within four to eight months from commencement of construction, and
within three to four months of commencement of construction in Texas, although
schedules may vary depending on the of labor, materials and supplies, product
type, location and weather. The Company strives to design homes which promote
efficient use of space and materials, and to minimize construction costs and
time.
The Company generally provides a one-year limited warranty on
workmanship and building material with each of its homes. The Company's
subcontractors generally provide an indemnity and a certificate of insurance
prior to receiving payments for their work and, therefore, claims relating to
workmanship and materials are usually the primary responsibility of the
Company's subcontractors. The Company currently reserves $600 per home built in
Arizona and 1/2 of one percent of a home's sales price in Texas for warranty
expense. To date, these reserves have been sufficient to cover warranty repair.
Marketing and Sales
The Company believes that it has an established reputation for
developing high quality homes, which helps generate interest in each new
project. In addition, the Company uses advertising and other promotional
activities, including magazine and newspaper advertisements, brochures, direct
mail, and the placement of strategically located sign boards in the immediate
areas of its developments.
The Company uses furnished model homes as a tool in demonstrating the
competitive advantages of its home designs and features to prospective home
buyers. The Company generally employs or contracts with interior designers who
are responsible for creating an attractive model home for each product line
within a project which is designed to appeal to the preferences of potential
home buyers. The Company generally builds between one and four model homes for
each active community depending upon the number of homes to be built within each
community and the product to be offered. At December 31, 1997, the Company owned
two model homes in Arizona, with 13 model units under construction. In Texas,
the Company owned 22 model homes and had three model homes under construction at
December 31, 1997. The Company's Arizona division attempts to sell its model
homes and to lease them back from purchasers who own the models for investment
purposes or who do not intend to live in the home immediately. At December 31,
1997, Monterey had sold and was leasing back 15 model homes at a total monthly
lease amount of $43,600.
In its Arizona markets, the Company tailors its product offerings,
including size, style, amenities, and price, to attract higher income home
buyers. In these markets, the Company offers a broad array of options and
distinctive designs and provides home buyers with the option of customizing many
features of their new home.
The Company's homes are generally sold by full-time, commissioned sales
employees who typically work from the sales office located in the model homes
for each project. The Company's goal is to ensure that its sales force has
extensive knowledge of the Company's operating policies and housing products. To
achieve this goal, all sales personnel are trained and attend periodic meetings
to be updated on sales techniques, competitive products in the area, the
availability of financing, construction schedules, marketing and advertising
plans, and the available product lines, pricing, options, and warranties offered
by Company. The Company also requires its sales personnel to be licensed real
estate agents where required by law. Further, the Company utilizes independent
brokers to sell its homes and generally pays a sales commission on the base
price of the home.
29
<PAGE>
From time to time, the Company offers various sales incentives, such as
landscaping and certain interior home improvements, in order to attract buyers.
The use and type of incentives depends largely on prevailing economic conditions
and competitive market conditions.
Backlog
A significant majority of the homes sold by the Company are made
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 closed are considered as "backlog." The Company does
not recognize revenue on homes covered by such contracts until the sales are
closed and the risk of ownership has been legally transferred to the buyer. The
Company generally constructs one or two homes per project in advance of
obtaining a sales contract, though such homes are not included in backlog until
they are subject to a sales contract. The Company believes it will deliver
significantly all homes in backlog at December 31, 1997 to customers during
1998.
The Company's backlog in number of units increased to 472 at December
31, 1997 from 120 at December 31, 1996. The dollar value of such backlog
increased to $99.0 million at December 31, 1997 from $42.7 million at December
31, 1996. These increases in backlog are due primarily to the addition of the
Texas operations, along with strong sales in 1997.
Customer Financing
The Company seeks to assist home buyers who require financing in
obtaining loans from unaffiliated mortgage lenders offering qualified buyers a
variety of financing options. The Company provides mortgage banking services to
its customers in its Texas markets through a related mortgage lending company,
Texas Home Mortgage Corporation. The Company may pay a portion of the closing
costs and discount mortgage points to assist home buyers with financing. Since
many home buyers utilize long-term mortgage financing to purchase a home,
adverse economic conditions, increases in unemployment, and high mortgage
interest rates my deter or reduce the number of potential home buyers.
Customer Relations and Quality Control
Management believes that strong customer relations and an adherence to
stringent quality control standards are fundamental to the Company's continued
success. The Company believes that its commitment to customer relations and
quality control have significantly contributed to its reputation as a high
quality builder.
Generally, for each development, representatives of the Company, who
may be a project manager or project superintendent, and a customer relations
representative, oversee compliance with the Company's quality control standards.
These representatives allocate responsibility for (i) overseeing home
construction; (ii) overseeing performance by subcontractors and suppliers; (iii)
reviewing the progress of each home and conducting formal inspections as
specific stages of construction are completed; and (iv) regularly updating each
buyer on the progress of his or her home.
Competition and Market Factors
The development and sale of residential property is a highly
competitive and fragmented industry. 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. Some of the homebuilders with whom Monterey competes have significantly
greater financial resources and/or lower costs than the Company. Competition
among both small and large residential homebuilders are based on a number of
interrelated factors, including location, reputation, amenities, design,
quality, and price. The Company believes that it compares favorably to other
homebuilders in the markets in which it operates due primarily to (i) its
experience within its specific geographic
30
<PAGE>
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 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, the
availability of and changes in mortgage financing programs, and the availability
and cost of land and building materials. Real estate analysts are predicting
that new home sales in the Phoenix metropolitan area may slow significantly in
1998 and that sales in the Tucson metropolitan area will remain relatively flat.
In the Dallas/Ft. Worth, Houston and Austin metropolitan areas, predictions are
that new home sales will remain relatively flat or show a moderate increase. Any
slowing in new home sales would increase competition among homebuilders in these
areas. There can be no assurance that the Company will be able to compete
successfully against other homebuilders in its current markets in a more
competitive business environment that would result from such a slowing in new
home sales or that such increased competition will not have a material adverse
affect on the Company's business and operating results.
Government Regulation and Environmental Matters
Most of the Company's land is purchased with entitlements, providing
for zoning and utility service to project sites and giving it the right to
obtain building permits and begin construction almost immediately upon
compliance with specified conditions, which generally are within the Company's
control. The length of time necessary to obtain such permits and approvals
affects the carrying costs of unimproved property acquired for the purpose of
development and construction. In addition, the continued effectiveness of
permits already granted is subject to factors such as changes in policies,
rules, and regulations, and their interpretation and application. To date, the
government approval processes discussed above have not had a material adverse
effect on the development activities of the Company. There can be no assurance,
however, that these and other restrictions will not adversely affect the Company
in the future.
Because most of the Company's land is entitled, construction
moratoriums generally would only adversely affect the Company if they arose from
health, safety, and welfare issues, such as insufficient water or sewage
facilities. Local and state governments also have broad discretion regarding the
imposition of development fees for projects in their jurisdiction. These fees
are normally established when the Company receives recorded final maps and
building permits. However, as the Company expands it may also become
increasingly subject to periodic delays or may be precluded entirely from
developing communities due to building moratoriums, "slow-growth" initiatives,
or building permit allocation ordinances which could be implemented in the
future in the states and markets in which the Company may then operate.
The Company is also subject to a variety of local, state, and federal
statutes, ordinances, rules, and regulations concerning the protection of health
and the environment. In the Scottsdale market, the Company is subject to several
environmentally sensitive land ordinances which mandate open space areas with
public easements in housing developments. The Company must also comply with
flood plain concerns in certain desert wash areas, native plant regulations, and
view restrictions. These and similar laws may result in delays, cause the
Company to incur substantial compliance and other costs, and prohibit or
severely restrict development in certain environmentally sensitive regions or
areas. To date, however, compliance with such ordinances has not materially
affected the Company's operations. No assurance can be given that such a
material adverse effect will not occur in the future.
The Company generally will condition its obligation to purchase
property on, among other things, an environmental review of the land. However,
there can be no assurance that the Company will not incur material liabilities
relating to the removal of toxic wastes or other environmental matters affecting
land currently or previously owned by the Company. To date, the Company has not
incurred any liability relating to the removal of toxic wastes or other
environmental matters and to its knowledge has not acquired any land with
environmental problems.
31
<PAGE>
Bonds and Other Obligations
The Company generally is not required, in connection with the
development of its projects, to obtain letters of credit and performance,
maintenance, and other bonds in support of its related obligations with respect
to such development. Such bonds are usually provided by subcontractors.
Mortgage Assets Acquired Prior to Merger
Prior to the Merger, the Company acquired a number of mortgage assets,
consisting of mortgage interests (commonly known as "residuals") and mortgage
instruments. As of December 31, 1997, the Company owned mortgage interests with
respect to six separate series of mortgage securities with a net amortized cost
balance of approximately $1,421,800. This cost represents the aggregate purchase
price paid for such mortgage interests less the amount of distributions on such
mortgage interests received by the Company representing a return of investment.
The Company sold its remaining residual interests for $6.6 million
during the first and second quarters of 1998 for a gain of approximately $5.2
million.
Employees and Subcontractors
At December 31, 1997, the Company employed 180 persons, including 49 in
management and administration, 42 in sales and marketing, and 89 involved in
construction operations. The employees are not unionized, and the Company
believes that its employee relations are good. The company acts solely as a
general contractor and all construction operations are conducted through project
managers and field superintendents who manage third party subcontractors. The
Company utilizes independent contractors for construction, architectural and
advertising services, and believes that its relations with subcontractors and
independent contractors are good.
Facilities
The Company leases approximately 11,000 square feet of office space for
its corporate headquarters from a limited liability company ("LLC") owned by
Messrs. Cleverly and Hilton in an approximately 14,000 square foot office
building in Scottsdale, Arizona. The Company leases the space on a five-year
lease (ending September 1, 1999), net of taxes, insurance and utilities, at an
annual rate which management believes is competitive with lease rates for
comparable space in the Scottsdale area. Rents paid to the LLC totaled $192,487
and $173,160 during fiscal years 1997 and 1996, respectively. The Company has an
option to expand its space in the building and to renew the lease for additional
terms at rates which are competitive with those in the market at such time.
Management believes that the terms of the lease are no less favorable than those
which it could obtain in an arm's length negotiated transaction. The Company
leases approximately 1,500 square feet of office space in Tucson, Arizona. The
lease term is for 37 months commencing on October 1, 1995 at an initial annual
rent of approximately $20,600, increasing during the term of the lease to an
ending rate of approximately $23,600.
The Company leases approximately 13,000 square feet of office space in
Plano, Texas from a partnership owned by John and Eleanor Landon. The annual
rent under the lease is $163,175. The lease expires May 15, 2002. Management
believes that the terms of the lease are no less favorable than those which it
could obtain in an arm's length negotiated transaction. The Company also leases
approximately 1,134 square feet of office space in Austin, Texas at an annual
rent of $20,412, with the lease expiring on March 31, 1998, and approximately
934 square feet of office space in Houston, Texas at an annual rent of $9,527,
and with an expiration date of July 1, 1998.
The Company also leases, on a triple net basis, 15 model homes at a
total monthly lease amount of $43,600. Such leases are for terms ranging from
three months to 12 months, with renewal options ranging from 30 days to over one
year, on a month-to-month basis.
32
<PAGE>
Legal Proceedings
The Company is involved in various routine legal proceedings incidental
to its business. Management believes that none of these legal proceedings,
certain of which are covered by insurance, will have a material adverse impact
on the financial condition or results of operations of the Company.
Year 2000 Compliance
Many currently installed computer systems and software products,
including several used by the Company, are coded to accept only two digit
entries in the date code field. Beginning in the year 2000, these date code
fields will need to accept four digit entries to distinguish 21st century dates
from 20th century dates. Therefore, the Company's date-critical functions
related to the Year 2000 and beyond may be adversely affected unless these
computer systems are or become Year 2000 compliant. In January 1997, the Company
developed a plan to address this problem and began converting its computer
systems to be Year 2000 compliant. The plan provides for the conversion efforts
to be completed by the end of 1999. The Company is expensing all costs
associated with these systems changes as the costs are incurred. These costs are
not expected to be material.
MANAGEMENT OF THE COMPANY
Directors and Executive Officers
The Articles of Incorporation of the Company divide the Board of
Directors into two classes serving staggered two-year terms. Class I consists of
four directors whose terms expire at the 1998 Annual Meeting of Stockholders.
Class II consists of three directors whose terms expire at the 1999 Annual
Meeting of Stockholders.
Information concerning the Company's directors and executive officers
is set forth below.
Name Age Position with the Company
- ---- --- -------------------------
William W. Cleverly 41 Managing Director, Class I
Steven J. Hilton 36 Managing Director, Class I
John R. Landon 40 Managing Director, Class II
Larry W. Seay 42 Vice President-Finance, Chief Financial
Officer, Secretary and Treasurer
Richard T. Morgan 42 Vice President
Alan D. Hamberlin(2) 49 Class I Director
Raymond Oppel(1) 41 Class I Director
Robert G. Sarver(1) 36 Class II Director
C. Timothy White(1)(2) 36 Class II Director
- ---------------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
William W. Cleverly currently serves as a Co-President and Managing
Director of the Company and served as Chairman of the Board and Co-Chief
Executive Officer from December 31, 1996 to April 1998. In 1985, Mr. Cleverly
co-founded the Monterey Entities and served as President and Director of the
Monterey Entities until the Merger on December 31, 1996. From 1983 to 1986, Mr.
33
<PAGE>
Cleverly was the President of a real estate development company which he founded
that developed and marketed multi-family projects. Mr. Cleverly received his
undergraduate degree from the University of Arizona, and is a member of the
Central Arizona Homebuilders' Association and the National Homebuilders'
Association.
Steven J. Hilton currently serves as a Co-President and Managing
Director of the Company and served as Chairman of the Board and Co-Chief
Executive Officer from December 31, 1996 to April 1998. Mr. Hilton co-founded
the Monterey Entities in 1985 and served as Treasurer, Secretary and Director of
the Monterey Entities until the Merger on December 31, 1996. From 1985 to 1986,
Mr. Hilton served as a project manager for Premier Community Homes, a
residential homebuilder. From 1984 to 1985, Mr. Hilton served as a project
manager for Mr. Cleverly's real estate development company. Mr. Hilton received
his undergraduate degree from the University of Arizona, and is a member of the
Central Arizona Homebuilders' Association, the National Homebuilders'
Association, the National Board of Realtors and the Scottsdale Board of
Realtors.
John R. Landon currently serves as Co-President and a Managing Director
of the Company, and served as the Chief Operating Officer and Co-Chief Executive
Officer of the Company from July 1, 1997 to April 1998. He was elected to the
Board of Directors in September 1997. Mr. Landon founded Legacy Homes in
December 1987 and in his capacity as its President, managed all aspects of the
Company's business, including construction operations, land acquisitions and
development, sales and marketing, and finance. Prior to establishing Legacy
Homes, Mr. Landon managed a regional land acquisition and development operation
for the Dallas/Ft. Worth division of Nash Phillips/Copus Homebuilders, a large
single-family residential homebuilder, and held positions in both sales and land
development for Trammel Crow Residential Group. Mr. Landon began his career with
the public accounting firm of Ernst & Whinney. Mr. Landon received his
undergraduate degree in Accounting from Louisiana State University and is a
member of the National Association of Homebuilders and the Dallas Home and
Apartment Builders' Association.
Larry W. Seay has served as the Vice President-Finance and Chief
Financial Officer of the Company since the Merger on December 31, 1996 and as
Secretary and Treasurer of the Company since January 1997. Mr. Seay was
appointed Vice President-Finance and Chief Financial Officer of the Monterey
Entities in April 1996 and served in that capacity until the Merger on December
31, 1996. From 1990 to 1996, Mr. Seay served as the Vice President-Treasurer of
UDC Homes, Inc., a homebuilding company based in Phoenix, Arizona. In May 1995,
while Mr. Seay served as Vice President-Treasurer, UDC Homes, Inc. filed for
bankruptcy protection under Chapter 11 of the U.S. Bankruptcy Code. UDC Homes,
Inc. emerged from reorganization proceedings in November 1995. From 1986 to
1990, Mr. Seay served as Treasurer and Chief Financial Officer of Emerald Homes,
Inc., also a Phoenix, Arizona-based homebuilding company. Prior to 1986, Mr.
Seay worked as a staff accountant and audit manager at Deloitte & Touche LLP.
Mr. Seay graduated with undergraduate degrees in finance and accounting and with
a Masters in Business Administration from Arizona State University. Mr. Seay is
a certified public accountant and a member of the American Institute of
Certified Public Accountants.
Richard T. Morgan has served as Vice President of the Company since
April 1988, and as Chief Financial Officer of Legacy Homes since January 1997.
Mr. Morgan joined Legacy Homes in November 1989 as Controller to develop and
manage the accounting department and administrative staff. From 1981 to 1989,
Mr. Morgan worked for two independent oil and gas companies serving both the
accounting and tax departments. Prior to 1981, Mr. Morgan was employed by Price
Waterhouse & Co. as a staff accountant and tax senior. Mr. Morgan received a
B.B.A. in Accounting in December 1977 from the University of Texas at Austin.
Alan D. Hamberlin has served as a director of the Company since the
Company's organization in July 1988. Mr. Hamberlin served as Chief Executive
Officer of the Company from July 1988 until the Merger on December 31, 1996, and
as Chairman of the Board of Directors from January 1990 until the Merger. He
also served as the President of the Company from its organization until
September 1995. Mr. Hamberlin served as the President and Chief Executive
Officer of the managing general partner of the Company's former Manager and has
been President of Courtland Homes, Inc., a Phoenix, Arizona single-family
residential homebuilder, since July 1983. Mr. Hamberlin has served as a director
of American Southwest Financial Corporation and American Southwest Finance Co.,
Inc. since their organization in September 1982, as a Director of American
Southwest Affiliated Companies since its organization in March 1985 and of
American Southwest Holdings, Inc. since August 1994.
34
<PAGE>
Raymond (Ray) Oppel has been in the construction, real estate, and
retail industries for over 20 years and was appointed to the Company's Board of
Directors in December 1997. In 1982, he co-founded and became Chairman and Chief
Executive Officer of the Oppel Jenkins Group, a regional homebuilder in Texas
and New Mexico with annual sales in excess of $100 million. The Oppel Jenkins
Group was sold to the public homebuilder, Kaufman & Broad, Inc. in 1995. Mr.
Oppel served as president of the Texas Panhandle Builders' Association and has
been a licensed real estate broker since 1984. Mr. Oppel is currently active as
a private investor in real estate development, banking and a new car dealership.
Robert G. Sarver has served as a director of the Company since the
Merger on December 31, 1996. Mr. Sarver has served as the Chairman and Chief
Executive Officer of GB Bancorporation, a bank holding company for Grossmont
Bank, San Diego's largest community bank, since 1995. Mr. Sarver currently
serves as a director of Zion's Bancorporation, a publicly held bank holding
company. In 1990, Mr. Sarver was a co-founder and currently serves as the
Executive Director of Southwest Value Partners and Affiliates, a real estate
investment company. In 1984, Mr. Sarver founded National Bank of Arizona, Inc.
and served as President until it was acquired by Zion's Bancorporation in 1993.
Mr. Sarver received his undergraduate degree from the University of Arizona and
is a certified public accountant.
C. Timothy White has served as a director of the Company since the
Merger on December 31, 1996. Mr. White served as a director of the Monterey
Entities from February 1995 until the Merger on December 31, 1996. Since 1989,
Mr. White has been an attorney with the law firm of Tiffany & Bosco, P.A. in
Phoenix, Arizona. During 1997 and 1996, the Company paid Tiffany & Bosco, P.A.
approximately $236,000 and $100,000, respectively, for legal services rendered.
Mr. White received his undergraduate degree from the University of Arizona and
his law degree from Arizona State University.
Committees of the Board of Directors
Compensation Committee. In 1997, the Compensation Committee of the
Board of Directors consisted of Messrs. Hamberlin and White, who are
non-employee members of the Board of Directors. The Compensation Committee
reviews all aspects of compensation of executive officers of the Company and
makes recommendations on such matters to the full Board of Directors.
Audit Committee. The Audit Committee makes recommendations to the Board
concerning the selection of independent auditors, reviews the financial
statements of the Company and considers such other matters in relation to the
external audit of the financial affairs of the Company as may be necessary or
appropriate in order to facilitate accurate and timely financial reporting.
Messrs. Sarver, White and Oppel are the members of the Audit Committee.
Other Committees. The Company does not maintain a standing nominating
committee or other committee performing similar functions.
Compensation Committee Interlocks and Insider Participation. Prior to
the Merger, the Compensation Committee of the Board of Directors consisted of
the entire Board of Directors. After the Merger, Mr. Hamberlin and Mr. White,
neither of whom are employees of the Company, were appointed to the Compensation
Committee.
Director Compensation
Non-employee directors of the Company receive an annual retainer of
$10,000 and are not additionally compensated for attendance at Board or
Committee meetings. During 1997, the Board of Directors granted options to
acquire 5,000 shares of the Company's Common Stock to each non-employee Director
as additional consideration for their services. These options vest in equal
2,500 share increments on each of the first two anniversary dates of the date of
grant and have an exercise price equal to the closing price of the Company's
Common Stock on the date of grant.
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<PAGE>
Executive Compensation
The table below sets forth information concerning the annual and
long-term compensation for services in all capacities to the Company for the
fiscal year ended December 31, 1997, of those persons who were, at December 31,
1997 (i) the Chief Executive Officers (Managing Directors) of the Company and
(ii) the other most highly compensated executive officer of the Company
(collectively, the "Named Officers"). Information with respect to compensation
for fiscal years 1996 and 1995 is not provided as none of the Named Officers
received compensation from the Company during 1996 or 1995 for their services.
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
------------
Annual Compensation Awards
------------------- ------
All Other
Name and Principal Position Year Salary Bonus Options(#) Compensation
--------------------------- ---- ------ ----- ---------- ------------
<S> <C> <C> <C> <C> <C>
William W. Cleverly, 1997 $200,000 $200,000 --- $31,905
Managing Director
Steven J. Hilton, 1997 $200,000 $200,000 --- $31,905
Managaing Director
John R. Landon, 1997 $200,000 $200,000 166,667 $11,700
Managing Director
Larry W. Seay, Vice President, 1997 $113,750 $85,000 12,500 $6,575
Chief Financial Officer,
Secretary and Treasurer
Anthony C. Dinnell, Vice
President - Phoenix Division 1997 $90,000 $149,445 10,000 $9,589
</TABLE>
36
<PAGE>
Option Grants in Last Fiscal Year
The table below sets forth information with respect to the granting of
stock options during the fiscal year ended December 31, 1997, to the Named
Officers.
<TABLE>
<CAPTION>
Individual Grants Potential Realizable Value at
----------------- Assumed Annual Rates of Stock
Price Appreciation for Option
Term(1)
-------
Percentage
of Total
Options
Granted to Exercise
Employees or Base
Options In Last Price Expiration
Name Granted Fiscal Year ($/Share) Date 0% 5% 10%
---- ------- ----------- --------- ---- -- -- ---
<S> <C> <C> <C> <C> <C> <C> <C>
William W. Cleverly -- -- -- -- -- -- --
Steven J. Hilton -- -- -- -- -- -- --
John R. Landon 166,667* -- $5.25 06/30/01 $312,501 $568,415 $863,620
Larry W. Seay 10,000 7.7% $5.62 12/31/06 -- $31,062 $76,435
2,500 1.9% $11.50 12/03/07 -- $18,081 $45,820
Anthony C. Dinnell 10,000 7.7% $5.62 12/31/06 -- $31,062 $76,435
</TABLE>
- ---------------
* Options granted were in connection with the Legacy Combination, and not
part of the Company's stock option plan.
(1) Amounts represent hypothetical gains that could be achieved for the
respective options if exercised at the end of the option terms. The
potential realizable value is calculated by assuming that the market
price of the underlying security appreciates in value from the date of
grant to the end of the option term at certain specified rates, and
that the option is exercised at the exercise price and sold on the last
day of its term at the appreciated price. These gains are based on
assumed rates of stock appreciation of 0%, 5% and 10% compounded
annually from the date the respective options were granted to their
expiration date, and are not presented to forecast future appreciation,
if any, in the price of the Common Stock.
37
<PAGE>
Aggregated Option Exercises in Last Fiscal Year and Option Value as of
December 31, 1997
The table below sets forth information with respect to the exercise of
stock options during the fiscal year ended December 31, 1997 to the Named
Officers. The Company does not have a long-term incentive plan or a defined
benefit or actuarial plan and has never issued any stock appreciation rights.
<TABLE>
<CAPTION>
Number of Unexercised Value of Unexercised In-the-
Options at Fiscal Money Options at Fiscal Year
Year End (#) End ($)(1)
------------ ----------
Shares
Acquired on Value
Name Exercise (#) Realized ($) Exercisable Unexercisable Exercisable Unexercisable
---- ------------ ------------ ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
William W. Cleverly -- -- 55,556 111,111 $381,948 $763,888
Steven J. Hilton -- -- 55,556 111,111 $381,948 $763,888
John R. Landon -- -- -- 166,667 -- $1,145,836
Larry W. Seay -- -- 2,000 10,500 $13,010 $53,603
Anthony C. Dinnell -- -- 2,000 8,000 $13,010 $52,040
</TABLE>
(1) Calculated based on the closing price of the Company's Common Stock on
December 31, 1997 of $12.125 per share less the exercise price per
share, multiplied by the number of applicable shares in the money.
Change of Control Arrangements
If prior to the third anniversary of the effective date of the stock
option agreements of Messrs. Cleverly, Hilton and Landon, there is a change of
control of the company that is required to be reported in a Form 8-K under the
Securities Exchange Act of 1934, as amended, the options granted to Messrs.
Cleverly, Hilton and Landon pursuant to their respective stock option agreements
will vest in full and be immediately exercisable.
38
<PAGE>
SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDERS
AND MANAGEMENT
The following table sets forth, as of April 1, 1998, the number and
percentage of outstanding shares of the Company's Common Stock beneficially
owned by each person known by the Company to beneficially own more than 5% of
such stock, by each director and executive officer of the Company and by all
directors and executive officers of the Company as a group.
Name and Address of Shares Beneficially Percent
Beneficial Owner(1) Owned(2) Owned(3)
------------------- -------- --------
William W. Cleverly 742,890(4) 13.8%
Steven J. Hilton 739,557(4) 13.8%
John R. Landon 666,667(5) 12.5%
Alan D. Hamberlin 368,235(6) 6.5%
Robert G. Sarver 139,800(7) 2.6%
C. Timothy White 5,500(7) *
Raymond Oppel -- *
Larry W. Seay 2,000(8) *
Richard T. Morgan 4,000 *
Anthony C. Dinnell -- *
All Directors and Executive Officers 2%
as a group (10 persons) 2,668,649 49.
- ----------------
* Represents less than 1% of the Company's outstanding Common Stock.
(1) The address for each director and officer is c/o Monterey Homes
Corporation, 6613 North Scottsdale Road, Suite 200, Scottsdale, Arizona
85250.
(2) Includes, where applicable, shares of Common Stock owned of record by
such person's minor children and spouse and by other related
individuals and entities over whose shares of Common Stock such person
has custody, voting control or the power of disposition.
(3) The percentages shown include the shares of Common Stock actually owned
as of April 1, 1998 and the shares of Common Stock which the person or
group had the right to acquire within 60 days of such date. In
calculating the percentage of ownership, all shares of Common Stock
which the identified person or group had the right to acquire within 60
days of April 1, 1998 upon the exercise of options are deemed to be
outstanding for the purpose of computing the percentage of the shares
of Common Stock owned by such person or group, but are not deemed to be
outstanding for the purpose of computing the percentage of the shares
of Common Stock owned by any other person.
(4) Includes 55,556 shares currently issuable upon exercise of outstanding
stock options.
39
<PAGE>
(5) All 666,667 shares are owned with Eleanor Landon, spouse, as
tenants-in-common.
(6) Includes 12,633 shares of Common Stock indirectly beneficially owned by
Mr. Hamberlin through a partnership and 355,602 shares of Common Stock
currently issuable to Mr. Hamberlin upon the exercise of stock options
(including dividend rights).
(7) Includes 2,500 shares currently issuable upon exercise of outstanding
stock options.
(8) Includes 2,000 shares currently issuable upon exercise of outstanding
stock options.
CERTAIN TRANSACTIONS AND RELATIONSHIPS
Since September 1994, the Company has leased approximately 11,000
square feet of office space in a Scottsdale, Arizona office building from a
limited liability company owned by Messrs. Cleverly and Hilton. The lease has a
five-year term, and the Company has an option to expand its space in the
building and renew the lease for additional terms at rates that are competitive
with those in the market at such time. Rents paid to the limited liability
company totaled $192,487, $173,160 and $164,394 during fiscal years 1997, 1996
and 1995, respectively. Monterey believes that the terms of the lease are no
less favorable than those which could be obtained in an arm's-length negotiated
transaction.
Since July 1, 1997, the Company has leased space from Home Financial
Services, a Texas partnership owned by John and Eleanor Landon, for office space
in Plano, Texas. The annual rent under the lease, which expires May 15, 2002, is
$163,175. Management believes the terms of this lease to be no less favorable
than those which it could obtain at an arm's length negotiated transaction.
During 1997 and 1996, Monterey incurred fees for legal services to
Tiffany & Bosco, P.A. of approximately $236,000 and $100,000, respectively. C.
Timothy White, a director of the Company, is a shareholder of Tiffany & Bosco,
P.A.
DESCRIPTION OF CAPITAL STOCK
The following summary of certain provisions of the Company's capital
stock describes material provisions of, but does not purport to be complete and
is subject to, and qualified in its entirety by, the Company's articles of
incorporation and by-laws and by the provisions of applicable law.
Common Stock
The Company is authorized to issue up to 50,000,000 shares of Common
Stock, $0.01 par value. As of May 5, 1998, there were 5,316,692 shares of Common
Stock outstanding, held of record by 350 holders. Holders of Common Stock are
entitled to one vote for each share held on all matters submitted to a vote of
stockholders and do not have cumulative voting rights. Accordingly, holders of a
majority of the shares of Common Stock entitled to vote in any election of
directors may elect all of the directors standing for election. Holders of
Common Stock are entitled to receive ratably such dividends, if any, as may be
declared by the board of directors out of funds legally available therefor,
subject to any preferential dividend rights of any outstanding preferred stock.
Upon the liquidation, dissolution or winding up of the Company, the holders of
Common Stock are entitled to receive ratably the net assets of the Company
available after the payment of all debts and other liabilities and subject to
the prior rights of any outstanding preferred stock. Holders of Common Stock
have no preemptive (other than as determined in the sole discretion of the board
of directors of the Company), subscription, redemption or conversion rights. The
outstanding shares of Common Stock are, and the shares subject to Warrants will
be, when issued and paid for, fully-paid and nonassessable. The rights,
preferences, and privileges of holders of Common Stock are subject to, and may
be adversely affected by, the rights of the holders of shares of any series of
preferred stock which the Company may issue in the future. The Company is not
currently authorized to issue preferred stock under its Articles of
Incorporation.
40
<PAGE>
The Company's Articles of Incorporation contain a provision allowing
action to be authorized by the affirmative vote of the holders of a majority of
the total number of shares of Common Stock outstanding and entitled to vote
thereon notwithstanding any provision of law requiring the authorization of the
action by a greater proportion than such a majority. This provision may allow
authorization of certain extraordinary transactions and amendment of the
Company's Articles of Incorporation, including an amendment changing the terms
or contract rights of any of its outstanding Common Stock by classification,
reclassification, or otherwise, by the affirmative vote of the holders of a
majority of the shares of Common Stock outstanding. But for such provision,
under Maryland law, such extraordinary transactions and amendment of the
Articles of Incorporation of the Company, with certain limited exceptions, would
require the affirmative vote of the holders of two-thirds of the outstanding
Common Stock entitled to vote thereon. The Common Stock is also subject to
significant restrictions on transfer. See "The Merger - Amendment to Articles of
Incorporation" and "The Merger - NOL Carryforward."
Warrants
The Warrants were issued in October 1994 and are governed by the
Warrant Agreement effective as of October 17, 1994 (the "Warrant Agreement")
between the Company and Norwest Bank Minnesota, N.A. (the "Warrant Agent").
Holders of Warrants are referred to the Warrant Agreement which is included as
an exhibit to the Registration Statement for a complete statement of the terms
of the Warrants. The following summary does not purport to be complete and is
qualified in its entirety by reference to all of the provisions of the Warrant
Agreement. Capitalized terms used in this "Description of the Warrants" and not
defined herein have the meanings given to them in the Warrant Agreement. The
description of the Warrants herein will also apply to the Company Warrants.
Each Warrant entitles the holder to purchase one share of the Company's
Common Stock for $4.0634 per share (the "Purchase Price"), subject to adjustment
as described herein. At the time of exercise of a Warrant, the Warrant holder
will also receive an additional .2069 shares of the Contingent Warrant Stock for
each Warrant exercised, without the payment of any additional consideration or
exercise price. See "The Merger - The Merger Consideration." The Company
Warrants currently entitle the holders thereof to acquire, in the aggregate and
including the Contingent Warrant Stock that will be acquired on exercise of the
Company Warrants, 150,602 shares of Common Stock. The Warrants became
exercisable on the effective date of the Merger and will continue to be
exercisable through October 15, 2001 except as provided in the following
sentence. In the event that notice is given in accordance with the Warrant
Agreement in connection with the liquidation, dissolution, or winding up of the
Company, the right to exercise the Warrants will expire at the close of business
on the third full business day before the date specified in such notice as the
record date for determining registered holders entitled to receive any
distribution upon such liquidation, dissolution, or winding up. The Company may
not redeem the Warrants.
On the effective date of the Merger, the Monterey Warrants were
converted into Warrants of the Company, and the Company assumed all of the
rights and obligations of the Monterey Entities under the Warrant Agreement.
The Warrants may be exercised in whole or in part by surrendering at
the office of the Warrant Agent in Minneapolis, Minnesota, the Warrant
Certificate evidencing such Warrants, together with a subscription in the form
set forth on the reverse of the Warrant Certificate, duly executed and
accompanied by payment of the Purchase Price, in U.S. dollars, by tender of
federal funds or a certified or bank cashier's check, payable to the order of
the Warrant Agent. As soon as practicable after such exercise, the Company will
cause to be issued and delivered to the holder or upon his order, in such name
or names as may be directed by him, a certificate or certificates for the number
of full shares of Common Stock to which he is entitled. If fewer than all of the
Warrants evidenced by a Warrant Certificate are exercised, the Warrant Agent
will deliver to the exercising Warrant holder a new Warrant Certificate
representing the unexercised portion of the Warrant Certificate. Fractional
shares will not be issued upon exercise of a Warrant, and in lieu thereof, the
Company will pay to the holder an amount in cash equal to such fraction
multiplied by the Current Market Price Per Share, determined in accordance with
the Warrant Agreement.
The person in whose name the certificate is to be issued will be deemed
to have become the holder of record of the stock represented thereby on the date
when the Warrant Certificate with the subscription duly executed and completed
is surrendered and
41
<PAGE>
payment of the Purchase Price is made, unless the stock transfer books of the
Company are closed on such date, in which case, such person will be deemed the
record holder of the shares at the close of business on the next succeeding date
on which the stock transfer books are opened.
No service charge will be made for registration of transfer or exchange
of any Warrant Certificate. The Company may require payment of a sum sufficient
to cover any stamp or other tax or governmental charge that may be imposed in
connection with any registration of transfer or exchange of Warrant
Certificates.
Subject to certain conditions and limitations, the number of Warrant
Shares issuable upon the exercise of the Warrants and/or the Purchase Price are
subject to adjustment in certain events including: (i) the issuance of Common
Stock (including in certain cases the issuance in a public offering of any
stock, securities, obligation, option, or other right or warrant that may be
converted into, exchanged for, or satisfied in shares of Common Stock) for
consideration per share less than the Purchase Price prior to such issue, (ii)
the declaration of a dividend on Common Stock payable in Common Stock or the
subdivision, combination, or issuance of capital stock in connection with a
reclassification of Common Stock, (iii) any distribution of the Company's assets
upon or with respect to its Common Stock as a liquidating or partial liquidating
dividend, and (iv) the issuance of stock, securities, rights, options, or
warrants to all holders of the Common Stock or in an integrated transaction
where more than 99% of such instruments or securities are acquired by persons
who, prior to the transaction, were security holders of the Company, entitling
them to subscribe for or purchase Common Stock or securities convertible into
Common Stock at a price per share less than the Current Market Price Per Share
on the record date for the issuance of such securities, instruments, or rights
or the granting of such securities, options, or warrants. The Current Market
Price Per Share of the Company's Common Stock on any date is determined in
reference to (i) the average of the daily closing prices (or if no sale is made
on any trading date, the average of the closing bid and asked prices) for the
thirty consecutive trading days commencing thirty-five trading days before such
date, if the Company's Common Stock is listed on an exchange, (ii) the average
of the last reported sale price or prices or the mean of the last reported bid
and asked prices reported by the National Association of Securities Dealers
Automated Quotations System ("NASDAQ"), or if not so quoted on NASDAQ, as quoted
on the National Quotations Bureau, Inc., for the thirty consecutive trading days
commencing thirty-five days before such date, or (iii) if neither (i) or (ii) is
applicable, the fair market value of the Common Stock as determined in good
faith by the Board of Directors of the Company.
In the event that the Company consolidates with, merges with or into,
or sells all or substantially all of its assets (for a consideration consisting
primarily of securities) to, another corporation, each Warrant thereafter shall
entitle the holder to receive upon exercise, the number of shares of common
stock or other securities or property which the holder would have received had
the Warrant been exercised immediately prior to the consolidation, merger, or
sale of assets.
In the event a bankruptcy or reorganization is commenced by or against
the Company, a bankruptcy court may hold that unexercised Warrants are executory
contracts which may be subject to rejection by the Company with approval of the
bankruptcy court. As a result, holders of the Warrants may not be entitled to
receive any consideration or may receive an amount less than they would be
entitled to if they had exercised their Warrants prior to the commencement of
any such bankruptcy or reorganization.
The holders of unexercised Warrants are not entitled, by virtue of
being holders, to exercise any rights as stockholders of the Company.
Subject to certain requirements, from time to time the Company and the
Warrant Agent, without the consent of the holders of the Warrants, may amend or
supplement the Warrant Agreement for certain purposes, including curing
ambiguities, defects, inconsistencies, or manifest errors, provided that such
amendments and supplements are not prejudicial to the rights of the Warrant
holders as indicated by the general intent of the original language.
42
<PAGE>
Maryland Law and Certain Charter Provisions
The Company is incorporated in Maryland and is subject to the
provisions of the Maryland General Corporations Law (the "MGCL"), certain of
which provisions are discussed herein.
Business Combinations. The MGCL prohibits certain "business
combinations" (including, in certain circumstances and subject to certain
exceptions, a merger, consolidation, share exchange, asset transfer, issuance of
equity securities, or reclassification of securities) between a Maryland
corporation and an Interested Stockholder or any affiliate of an Interested
Stockholder. Subject to certain qualifications, an "Interested Stockholder" is a
person (a) who beneficially owns 10% or more of the voting power of the
corporation's shares after the date on which the corporation had 100 or more
beneficial owners of its stock, or (b) is an affiliate or associate of the
corporation and was the beneficial owner of 10% or more of the voting power of
the corporation's shares, at any time within the two-year period immediately
prior to the date in question and after the date on which the corporation had
100 or more beneficial owners of its stock. Unless an exemption applies, such
business combinations are prohibited for five years after the most recent date
on which the Interested Stockholder became an Interested Stockholder. Unless an
exemption applies, any business combination that is not so prohibited must be
recommended by the board of directors and approved by the affirmative vote of at
least (a) 80% of the votes entitled to be cast by outstanding voting shares of
the corporation, and (b) 66 2/3% of the votes entitled to be cast by the holders
of voting shares of the corporation, other than voting shares held by the
Interested Stockholder, or an affiliate or associate of the Interested
Stockholder, with whom the business combination is to be effected. The MGCL
specifies a number of situations in which the business combination restrictions
described above would not apply. For example, such restrictions would not apply
to a business combination with a particular Interested Shareholder that is
approved or exempted by the board of directors of a corporation prior to the
time that the Interested Stockholder becomes an Interested Stockholder. A
Maryland corporation also may adopt an amendment to its charter electing not to
be subject to the special voting requirements of the foregoing legislation. Any
such amendment would have to be approved by the affirmative vote of the same
percentages and groups of the outstanding shares of voting stock of the
corporation as described above for approval of a business combination. No such
amendment to the charter of the Company has been effected.
Control Share Acquisitions. The MGCL provides that "control shares" of
a Maryland corporation acquired in a "control share acquisition" have no voting
rights except to the extent approved by a vote of two-thirds of the votes
entitled to be cast on the matter, excluding shares of stock owned by the
acquiror or by officers or directors who are employees of the corporation.
"Control shares" are voting shares of stock which, if aggregated with all other
shares of stock previously acquired by such a person or which that person is
entitled to vote (other than by revocable proxy), would entitle the acquiror to
exercise voting power in electing directors within one of the following ranges
of voting power: (a) 20% or more but less than 331/3%; (b) 331/3% or more but
less than a majority; or (c) a majority of all voting power. Control shares do
not include shares of stock an acquiring person is entitled to vote as a result
of having previously obtained stockholder approval. A control share acquisition
means, subject to certain exceptions, the acquisition of, ownership of, or the
power to direct the exercise of voting power with respect to, control shares.
A person who has made or proposed to make a "control share
acquisition," upon satisfaction of certain conditions (including an undertaking
to pay expenses), may compel the Board of Directors to call a special meeting of
stockholders to be held within 50 days of demand therefor to consider the voting
rights of the shares. If no request for a meeting is made, the corporation may
itself present the question at any stockholders' meeting.
If voting rights are not approved at the meeting or if the acquiring
person does not deliver an acquiring person statement as permitted by the
statute, then, subject to certain conditions and limitations, the corporation
may redeem any or all of the control shares (except those for which voting
rights have previously been approved) for fair value determined, without regard
to voting rights, as of the date of the last acquisition of control shares by
the acquiring person in a control share acquisition or if any meeting of
stockholders was held at which the rights of such shares were considered, as of
the date of such meeting. If voting rights for "control shares" are approved at
a stockholders' meeting and the acquiror becomes entitled to vote a majority of
the shares entitled to vote, all other stockholders may exercise appraisal
rights. The fair value of the stock as determined for purposes of such appraisal
rights may not be less than the highest
43
<PAGE>
price per share paid by the acquiring person in the control share acquisition,
and certain limitations and restrictions otherwise applicable to the exercise of
dissenters' rights do not apply in the context of a "control share acquisition."
The control share acquisition statute does not apply to stock acquired
in a merger, consolidation or stock exchange if the corporation is a party to
the transaction, or to acquisitions previously approved or excepted by a
provision in the charter or bylaws of the corporation. Neither the Company's
charter nor its Bylaws has provisions exempting any control share acquisitions.
Limitation of Liability and Indemnification of Directors. Under the
MGCL, a corporation's articles may, with certain exceptions, include any
provision expanding or limiting the liability of its directors and officers to
the corporation or its stockholders for money damages, but may not include any
provision that restricts or limits the liability of its directors or officers to
the corporation or its stockholders to the extent that (i) it is proved that the
person actually received an improper benefit or profit in money, property, or
services for the amount of the benefit or profit in money, property, or services
actually received; or (ii) a judgment or other final adjudication adverse to the
person is entered in a proceeding based on a finding in the proceeding that the
person's action, or failure to act, was the result of active and deliberate
dishonesty and was material to the cause of action adjudicated in the
proceeding. The Company's charter contains a provision limiting the personal
liability of officers and directors to the Company and its stockholders for
money damages to the fullest extent permitted under Maryland law.
In addition, with certain exceptions, the MGCL permits a corporation to
indemnify its present and former directors and officers, among others, against
liability incurred, unless it is established that (i) the act or omission of the
director or officer was material to the matter giving rise to the proceeding and
was committed in bad faith or was the result of active and deliberate
dishonesty, or (ii) the director or officer actually received an improper
personal benefit in money, property, or services, or (iii) in the case of any
criminal proceeding, the director or officer had reasonable cause to believe
that the act or omission was unlawful. The Company's charter provides that it
will indemnify (i) its directors to the full extent allowed under Maryland law,
(ii) its officers to the same extent it shall indemnify its directors, and (iii)
its officers who are not directors to such further extent as shall be authorized
by the board of directors and be consistent with law.
Warrant Agent, Transfer Agent and Registrar
The warrant agent is Norwest Bank Minnesota, N.A. and its address is
Norwest Center, Sixth and Marquette, Minneapolis, Minnesota 55479-0069. The
transfer agent and registrar for the Company's Common Stock is ChaseMellon
Shareholder Services, 235 Montgomery Street, San Francisco, California 94104.
PRICE OF WARRANTS AND COMMON STOCK; DIVIDEND POLICY
No Active Trading Market for the Warrants
There is no active trading market for the Warrants. The Company has not
and does not intend to apply for the listing of the Warrants on any national
exchange or to seek the admission thereof to trading in the NASDAQ Stock Market.
44
<PAGE>
Price of Common Stock
The Company's Common Stock is publicly traded on the NYSE under the
ticker symbol "MTH." The following table sets forth the high and low closing
sales prices, adjusted for stock splits, of the Common Stock, as reported by the
NYSE, for the periods indicated below.
High Low
---- ---
1998
First Quarter $19 15/16 $12 7/16
1997
Fourth Quarter 14 3/4 11 3/16
Third Quarter 14 3/4 8 1/2
Second Quarter 8 3/4 4 3/8
First Quarter 7 1/4 5 1/2
1996
Fourth Quarter 7 7/8 6 3/4
Third Quarter 8 1/4 6
Second Quarter 8 5/8 4 7/8
First Quarter 6 4 1/8
1995
Fourth Quarter 5 5/8 4 1/8
Third Quarter 6 3/8 4 1/2
Second Quarter 6 3/8 3 3/4
First Quarter 5 1/4 3
On May 5, 1998, the closing sales price of the Company's Common Stock
as reported by the NYSE was $19 1/4 per share. At that date, the number of
stockholder accounts of record of the Company's Common Stock was 350. The
Company believes that there are approximately 3,500 beneficial owners of Common
Stock.
Dividend Policy
The Company did not pay any cash dividends in 1997. Cash dividends per
share paid by the Company were $.06 in 1996, $.09 in 1995, $.06 in 1994, and
$.09 in 1993, representing distributions of taxable income arising out of the
Company's status as a REIT. The Company's loan and debt agreements contain
certain covenants that restrict the payment of dividends if the financial
condition, results of operation, and capital requirements of the Company fail to
meet certain specified levels. In addition, the Company's board of directors has
indicated that the Company will not pay any permitted cash dividends for the
foreseeable future. Instead, the Company's board intends to retain earnings to
finance the growth of the Company's business. The future payment of cash
dividends, if any, will depend upon the financial condition, results of
operations, and capital requirements of the Company, as well as other factors
deemed relevant by the board.
45
<PAGE>
SELLING SECURITY HOLDERS
Certain Selling Security Holders may sell their Warrants on a delayed
or continuous basis. The Registration Statement has been filed pursuant to Rule
415 under the Securities Act to afford holders of the Warrants the opportunity
to sell such securities in public transactions rather than pursuant to
exemptions from the registration and prospectus delivery requirements of the
Securities Act.
The following table sets forth certain information as of May 1, 1998,
with respect to the number of Warrants held by each Selling Security Holder. To
the Company's knowledge, none of the Selling Security Holders has had a material
relationship with the Company within the past three years other than as a result
of the ownership of the Warrants except as noted herein. The Selling Security
Holders may offer all or some of the Warrants that they hold pursuant to the
offering contemplated by this Prospectus at various times. Therefore, no
estimate can be given as to the amount of Warrants that will be held by the
Selling Security Holders upon completion of such offering. The Warrants may be
offered from time to time by the Selling Security Holders named below:
<TABLE>
<CAPTION>
Shares of Common Stock into Which
the Warrants are Exercisable
----------------------------
Percent of
Warrants Common
Offered Stock
Owner Prior To This Offering For Sale Number Outstanding(1)
<S> <C> <C> <C>
AC Leadbetter & Sons Inc. Profit-Sharing Plan U/A DTD 6-1-84 2,655 3,204 .06%
Bear Stearns Securities Corp. Maverick Capital LP 13,275 16,021 .30%
Boston Provident Partners LP 21,240 25,634 .48%
DDM Associates 5,310 6,409 .12%
Meslrow Alternative Strategies Fund LP 5,310 6,409 .12%
Max Palevsky 2,655 3,204 .06%
Perry Partners 53,100 64,086 1.21%
Value Partners Ltd 21,240 25,634 .48%
------ ------ ----
Total 124,784 150,602 2.83%
</TABLE>
- -------------------
(1) As of May 1, 1998, 5,316,692 shares of Common Stock of the Company were
outstanding.
Information concerning the Selling Security Holders may change from
time to time and may be set forth in supplements to this Prospectus if required.
The number of Warrant Shares underlying the Warrants is subject to adjustment in
certain events (See "Description of the Warrants" below). Accordingly, the
number of Warrants offered hereby may increase or decrease.
46
<PAGE>
PLAN OF DISTRIBUTION
The Selling Security Holders or their nominees or pledgees may sell or
distribute some or all of the Warrants from time to time through dealers,
brokers, or other agents or directly to one or more purchasers, including
pledgees in brokerage transactions, in a combination of such transactions or by
any other legally available means. Such transactions may be effected by the
Selling Security Holders at market prices prevailing at the time of sale, at
prices related to such prevailing market prices, at negotiated prices, or at
fixed prices, which may be changed. Brokers, dealers, or agents participating in
such transactions as agent may receive compensation in the form of discounts,
concessions, or commissions from the Selling Security Holders (and, if they act
as agent for the purchaser of such shares, from such purchaser). Such discounts,
concessions, or commissions as to a particular broker, dealer, or agent might be
in excess of those customary in the type of transaction involved. This
Prospectus also may be used, with the Company's consent, by donees of the
Selling Security Holders, or by other persons acquiring Warrants and who wish to
offer and sell such Warrants under circumstances requiring or making desirable
its use. To the extent required, the Company will file, during any period in
which offers or sales are being made, one or more supplements to this Prospectus
to set forth the names of donees of the Selling Security Holders and any other
material information with respect to the plan of distribution not previously
disclosed. In addition, Warrants which qualify for sale pursuant to Section 4
of, or Rules 144 or 144A under, the Securities Act may be sold under such
provisions rather than pursuant to this Prospectus.
The Selling Security Holders and any such brokers, dealers, or agents
that participate in such distribution may be deemed to be "underwriters" within
the meaning of the Securities Act, and any discounts, commissions, or
concessions received by any such underwriters, brokers, dealers, or agents might
be deemed to be underwriting discounts and commissions under the Securities Act.
Neither the Company nor the Selling Security Holders can presently estimate the
amount of such compensation. The Company knows of no existing arrangements
between any Selling Security Holder and any other Selling Security Holder,
underwriter, broker, dealer, or other agent relating to the sale or distribution
of the shares of Common Stock.
The Selling Security Holders will be subject to applicable provisions
of the Exchange Act and the rules and regulations thereunder, including without
limitation Regulation M, which provisions may limit the timing of purchases and
sales of any of the shares of Common Stock by the Selling Security Holders. All
of the foregoing may affect the marketability of the Common Stock.
The Company will pay substantially all of the expenses incident to this
offering of the Warrants by the Selling Security Holders to the public other
than commissions and discounts of brokers, dealers, or agents. Each Selling
Security Holder may indemnify any broker, dealer, or agent that participates in
transactions involving sales of the Warrants against certain liabilities,
including liabilities arising under the Securities Act. The Company has agreed
to indemnify the Selling Security Holders against certain liabilities including
certain liabilities under the Securities Act. Insofar as indemnification for
liabilities arising under the Securities Act may be permitted to directors,
officers, or persons controlling the Company, the Company has been informed that
in the opinion of the Commission such indemnification is against public policy
as expressed in the Securities Act and is therefore unenforceable.
LEGAL MATTERS
The validity of the issuance of the Warrants will be passed on for the
Company by Venable, Baetjer & Howard, LLP, 1800 Mercantile Bank & Trust
Building, 2 Hopkins Plaza, Baltimore, Maryland 21201.
EXPERTS
The consolidated financial statements of the Company as of December 31,
1997 and 1996, and for the years then ended included in this Prospectus have
been audited by KPMG Peat Marwick LLP, independent auditors, as set forth in
their report thereon appearing elsewhere herein, and are included in reliance
upon such report given upon the authority of such firm as experts in accounting
and auditing.
47
<PAGE>
The financial statements of the Company for the year ended December 31,
1995, included in this Prospectus have been audited by Ernst & Young, LLP,
independent auditors, as set forth in their report thereon appearing elsewhere
herein, and are included in reliance upon such report given upon the authority
of such firm as experts in accounting and auditing.
48
<PAGE>
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Monterey Homes Corporation
Report of Independent Auditors.........................................F-2
Report of Independent Auditors.........................................F-3
Consolidated Balance Sheets............................................F-4
Consolidated Statements of Earnings....................................F-5
Consolidated Statements of Stockholders' Equity........................F-6
Consolidated Statement of Cash Flows...................................F-7
Notes to Consolidated Financial Statements.............................F-8
F-1
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of
Monterey Homes Corporation
We have audited the accompanying consolidated balance sheets of Monterey
Homes Corporation and subsidiaries (previously known as Homeplex Mortgage
Investments Corporation and subsidiaries) as of December 31, 1997 and 1996 and
the related consolidated statements of earnings, stockholders' equity, and cash
flows the for the years then ended. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above,
present fairly in all material respects, the financial position of Monterey
Homes Corporation and subsidiaries as of December 31, 1997 and 1996, and the
results of their operations and their cash flows for the years then ended in
conformity with generally accepted accounting principles.
KPMG PEAT MARWICK LLP
Phoenix, Arizona
February 11, 1998
F-2
<PAGE>
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and Stockholders of Monterey Homes Corporation
We have audited the consolidated balance sheet of Monterey Homes
Corporation and subsidiaries (previously known as Homeplex Mortgage Investments
Corporation and subsidiaries) as of December 31, 1995 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year then ended. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Monterey
Homes Corporation and subsidiaries as of December 31, 1995 and the results of
their operations and their cash flows for the year then ended, in conformity
with generally accepted accounting principles.
ERNST & YOUNG LLP
Phoenix, Arizona
February 13, 1996
F-3
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31,
1997 1996
---- ----
<S> <C> <C>
Assets
Cash and cash equivalents $ 8,245,392 $ 15,567,918
Short-term investments -- 4,696,495
Real estate under development 65,294,654 35,991,142
Option deposits 3,070,420 546,000
Real estate loans and other receivables 985,708 2,623,502
Residual interests 1,421,754 3,909,090
Deferred tax asset 10,404,000 6,783,000
Goodwill 5,970,773 1,763,488
Property and equipment, net 706,702 266,101
Other assets 534,101 673,994
---------------- ----------------
Total Assets $ 96,633,504 $ 72,820,730
================ ================
Liabilities
Accounts payable and accrued liabilities $ 21,171,301 $ 10,569,872
Home sale deposits 6,204,773 4,763,518
Notes payable 22,892,250 30,542,276
---------------- ----------------
Total Liabilities 50,268,324 45,875,666
---------------- ----------------
Stockholders' Equity
Common stock, par value $.01 per share; 50,000,000
shares authorized; issued and outstanding - 5,255,440
shares at December 31, 1997, and 4,580,611 shares at
December 31, 1996 52,554 45,806
Additional paid-in capital 97,819,584 92,643,658
Accumulated deficit (51,096,675) (65,334,117)
Treasury stock - 53,046 shares (410,283) (410,283)
----------------- ----------------
Total Stockholders' Equity 46,365,180 26,945,064
---------------- ----------------
Total Liabilities and Stockholders' Equity $ 96,633,504 $ 72,820,730
================ ================
</TABLE>
See accompanying notes to consolidated financial statements
F-4
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
CONSOLDIATED STATEMENTS OF EARNINGS
<TABLE>
<CAPTION>
Years Ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Home sales revenue $ 149,384,548
Land sales revenue 245,000
Cost of home sales (124,368,782)
Cost of land sales (225,000)
----------------
Gross profit 25,035,766
Residual interest and real estate loan interest income 5,088,693 $ 1,610,386 $ 2,901,353
Mortgage company income, net 207,784 -- --
Selling, general and administrative expense (15,106,199) (1,683,407) (1,599,157)
Interest expense (165,173) (237,945) (868,414)
Other income, net 138,487 633,449 663,343
---------------- -------------- ---------------
Earnings before income taxes and extraordinary loss 15,199,358 322,483 1,097,125
Income taxes (961,916) (26,562) --
----------------- --------------- ---------------
Earnings before extraordinary loss 14,237,442 295,921 1,097,125
Extraordinary loss from early extinguishment of debt -- (148,433) --
---------------- --------------- ---------------
Net earnings $ 14,237,442 $ 147,488 $ 1,097,125
================ ============== ===============
Basic earnings per share $ 2.93 $ .05 $ .34
================ ============== ===============
Diluted earnings per share $ 2.68 $ .04 $ .34
================ ============== ===============
</TABLE>
See accompanying notes to consolidated financial statements
F-5
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Years Ended December 31, 1997, 1996 and 1995
Additional
Number of Common Paid-In Accumulated Treasury
Shares Stock Capital Deficit Stock Total
------ ----- ------- ------- ----- -----
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994 3,291,885 $ 32,919 $ 84,112,289 $(66,092,904) $ (410,283) $ 17,642,021
Net earnings --- --- --- 1,097,125 --- 1,097,125
Cash dividends ................ --- --- --- (291,496) --- (291,496)
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1995 3,291,885 32,919 84,112,289 (65,287,275) (410,283) 18,447,650
Net earnings ..................... --- --- --- 147,488 --- 147,488
Cash dividends ................ --- --- --- (194,330) --- (194,330)
Shares issued in connection with
Merger ....................... 1,288,726 12,887 8,531,369 --- --- 8,544,256
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1996 4,580,611 45,806 92,643,658 (65,334,117) (410,283) 26,945,064
Net earnings -- -- -- 14,237,442 -- 14,237,442
Exercise of employee stock options.... 8,162 81 118,510 -- -- 118,591
Shares issued in connection with the
Legacy Combination ............ 666,667 6,667 3,393,335 -- -- 3,400,002
Stock option and contingent stock
compensation expense............... -- -- 1,664,081 -- -- 1,664,081
------------ ------------ ------------ ------------ ------------ ------------
Balance at December 31, 1997 5,255,440 $ 52,554 97,819,584 $(51,096,675) $ (410,283) $ 46,365,180
============ ============ ============ ============= ============= ============
</TABLE>
See accompanying notes to consolidated financial statements
F-6
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Years Ended December 31,
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Cash flows from operating activities:
Net earnings ......................................... $ 14,237,442 $ 147,488 $ 1,097,125
Adjustments to reconcile net earnings to net
cash provided by operating activities:
Extraordinary loss from early extinguishment of
debt .............................................. -- 148,433 --
Depreciation and amortization ........................ 376,916 38,300 122,970
Stock option compensation expense .................... 1,664,081 -- --
Gain on sales of residual interest ................... (3,067,829) -- --
Increase in real estate under development ............ (10,575,738) -- --
Increase in option deposits .......................... (1,712,139) -- --
Decrease in other receivables and other assets ....... 2,237,295 153,350 370,454
Amortization of residual interests ................... 55,165 1,548,076 2,196,394
Increase (decrease) in accounts payable and
accrued liabilities and home sale deposits ........ 3,461,023 317,094 (272,828)
------------ ------------ ------------
Net cash provided by operating activities ......... 6,676,216 2,352,741 3,514,115
------------ ------------ ------------
Cash flows from investing activities:
Purchases of property and equipment .................. (174,257) -- --
Cash acquired in Combination/Merger .................. 1,306,998 6,495,255 --
Cash paid for acquisition, net of cash acquired ...... (1,952,857) (779,097) --
Principal payments received on real estate loans ..... 2,124,544 3,710,000 9,114,000
Real estate loans funded ............................. (428,272) (1,358,457) (3,902,000)
(Increase) decrease in short term investments ........ 4,696,495 4,272,605 (8,969,100)
Proceeds from sales of residual interest ............. 5,500,000 -- --
Decrease in funds held by Trustee .................... -- 5,637,948 1,082,549
------------ ------------ ------------
Net cash provided by (used in) investing activities 11,072,651 17,978,254 (2,674,551)
------------ ------------ ------------
Cash flows from financing activities:
Borrowings ........................................... 67,900,899 -- --
Repayment of borrowings .............................. (92,896,553) (7,818,824) (3,964,000)
Stock options exercised .............................. 118,591 -- --
Dividends paid ....................................... (194,330) (291,496) (194,330)
------------ ------------ ------------
Net cash used in financing activities ............. (25,071,393) (8,110,320) (4,158,330)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents ......... (7,322,526) 12,220,675 (3,318,766)
Cash and cash equivalents at beginning of year ............... 15,567,918 3,347,243 6,666,009
------------ ------------ ------------
Cash and cash equivalents at end of year ..................... $ 8,245,392 $ 15,567,918 $ 3,347,243
============ ============ ============
Supplemental information:
Cash paid for interest ............................... $ 3,801,764 $ 286,276 $ 804,113
Cash paid for income taxes ........................... $ 49,871 $ -- $ --
</TABLE>
See accompanying notes to consolidated financial statements
F-7
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1997, 1996 and 1995
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION
Business. Monterey Homes Corporation (the "Company") is engaged in the
development, construction, marketing and sale of new high quality, single family
homes in the semi-custom luxury, move-up and entry level markets.
The Company was originally formed as a real estate investment trust
("REIT"), investing in mortgage-related assets, and selected real estate loans.
On December 31, 1996, the Company acquired by merger (the "Merger") the
homebuilding operations of various entities operating under the Monterey Homes
name (the "Monterey Entities"), and is phasing out the Company's
mortgage-related operations. The Monterey Entities have been building homes in
Arizona for over 12 years, specializing in semi-custom, luxury homes and move-up
homes. In connection with the merger, the management of the Monterey Entities
assumed effective control of the Company.
As part of a strategy to diversify its operations, on July 1, 1997, the
Company combined with (the "Legacy Combination") the homebuilding operations of
several entities operating under the name Legacy Homes ("Legacy"). Legacy has
been operating in the Texas market since 1988, and designs, builds and sells
entry-level and move-up homes. In connection with the transaction, John R.
Landon, the founder and President of Legacy, joined senior management and became
a Co-CEO and the Chief Operating Officer of the Company and joined the Board of
Directors as a significant stockholder (See Note 9).
Basis of Presentation. The consolidated financial statements include the
accounts of Monterey Homes Corporation and its wholly-owned subsidiaries. All
significant intercompany balances and transactions have been eliminated in
consolidation. Results include the operations of Legacy from July 1, 1997.
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Cash and Cash Equivalents. Short-term investments with an initial maturity of
three months or less are considered to be cash equivalents.
Real Estate Under Development. Real estate under development is valued in
accordance with Statement of Financial Accounting Standards (FAS) No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of". Accordingly, amounts are carried at cost unless expected future
net cash flows (undiscounted and without interest) are less than cost and then
amounts are carried at estimated fair value less cost to sell. Costs capitalized
include direct construction costs for homes, development period interest and
certain common costs which benefit the entire community. Common costs are
allocated on a community by community basis to residential lots based on the
number of lots to be built in the community, which approximates the relative
sales value method.
Deposits paid related to options and contracts to purchase land are
capitalized and included in option deposits until the related land is purchased.
Upon purchase of the land, the related option deposits are transferred to real
estate under development.
Cost of sales include land acquisition and development costs, direct
construction costs of the home, development period interest and closing costs,
and an allocation of common costs.
Income Recognition. Income from home sales is recognized when the homes are
delivered and title passes to the buyer.
F-8
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Residual Interests. Interests relating to mortgage participation certificates
and residual interest certificates are accounted for as described in Note 3.
Property and Equipment. Property and equipment are recorded at cost.
Depreciation is calculated on a straight-line method over the estimated useful
lives of the assets, which range from three to five years. Accumulated
depreciation was approximately $375,700 and $156,600 at December 31, 1997 and
1996, respectively. Maintenance and repair costs are expensed as incurred.
Goodwill. The excess of purchase price over fair value of net assets acquired
(goodwill) is amortized on a straight-line basis over a 20 year period.
Accumulated amortization was approximately $162,500 at December 31, 1997. There
was no amortization of goodwill prior to the Merger at December 31, 1996. The
Company assesses the recoverability of this intangible asset by determining
whether the amortization of the goodwill balance over its remaining life can be
recovered through undiscounted future operating cash flows of the acquired
operation. The amount of goodwill impairment, if any, is measured based on
projected discounted future operating cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment of the
recoverability of goodwill will be impacted if estimated future operating cash
flows are not achieved.
Income Taxes. The Company accounts for income taxes in accordance with SFAS No.
109, "Accounting for Income Taxes". Under the asset and liability method of SFAS
No. 109, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
basis. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in future years in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in the consolidated statement of earnings as an adjustment to the
effective income tax rate in the period that includes the enactment date.
Earnings Per Share. The Company adopted SFAS No. 128, "Earnings Per Share" in
1997 and restated all prior periods in accordance with its provisions. Basic
earnings per share is computed by dividing income available to common
stockholders by the weighted-average number of common shares outstanding for the
period. Diluted earnings per share reflects the potential dilution that could
occur if securities or contracts to issue common stock were exercised or
converted into common stock or resulted in the issuance of common stock that
then shared in the earnings of the Company.
Use of Estimates. The preparation of financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions relating to the reported amounts of assets and liabilities and
the disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the period.
Actual results could differ from these estimates.
Fair Value of Financial Instruments. The carrying amounts of receivables, cash
and cash equivalents, option deposits, accounts payable and accrued liabilities
and home sale deposits approximate fair value due to the short term maturity of
these assets and liabilities. The short-term investments in 1996 are recorded at
fair value. The fair value of the Company's residual interests is discussed in
Note 3. The carrying amount of the Company's notes payable approximates fair
value because the notes are at interest rates comparable to market rates based
on the nature of the loans, their terms and remaining maturity. Considerable
judgment is required in interpreting market data to develop the estimates of
fair value. Accordingly, these fair value estimates are subjective and not
necessarily indicative of the amounts the Company would pay or receive in actual
market transactions.
F-9
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Disclosure of the fair value of financial instruments is made in
accordance with the requirements of SFAS No. 107, "Disclosure About Fair Value
of Financial Instruments."
Stock Option Plans. Prior to January 1, 1996, the Company accounted for its
stock option plan in accordance with the provisions of Accounting Principles
Board ("APB") Opinion No. 25, "Accounting for Stock Issued to Employees", and
related interpretations. As such, compensation expense would be recorded on the
date of grant only if the current market price of the underlying stock exceeded
the exercise price. On January 1, 1996, the Company adopted SFAS No. 123,
"Accounting for Stock-Based Compensation", which allows entities to continue to
apply the measurement provisions of APB Opinion No. 25 and provide pro forma net
income and pro forma earnings per share disclosures for employee stock option
grants made in 1995 and subsequent years as if the fair-value based method
defined in SFAS No. 123 had been applied. The Company has elected to continue to
apply the provisions of APB Opinion No. 25 and provide the pro forma disclosure
provisions of SFAS No. 123.
Year 2000. In January 1997, the Company developed a plan to address the Year
2000 problem and began converting its computer systems to be Year 2000
compliant. The plan provides for the conversion efforts to be completed by the
end of 1999. The Year 2000 problem is a result of computer programs being
written using two digits rather than four to define the applicable year. The
Company is expensing all costs associated with these system changes as the costs
are incurred.
Reclassifications. Certain prior period amounts have been reclassified in the
consolidated financial statements to conform with the current period
presentation.
NOTE 3 - RESIDUAL INTERESTS
The Company owns residual interests in collateralized mortgage
obligations (CMOs) and in mortgage participation certificates (MPCs)
(collectively residual interests). The residual interests are accounted for
using the prospective net level yield method, in which the interest is recorded
at cost and amortized over the life of the related CMO or MPC issuance.
Based on prevailing market interest rates and discussions with brokers
and investors who trade residual interests, Management believes that the
estimated fair value of the Company's residual interests, in the aggregate, was
approximately $6,600,000 at December 31, 1997, and $7,000,000 at December 31,
1996.
NOTE 4 - REAL ESTATE UNDER DEVELOPMENT AND CAPITALIZED INTEREST
The components of real estate under development at December 31 are as follows
(in thousands):
1997 1996
---- ----
Homes under contract, in production $ 30,523 $ 13,782
Finished lots and lots under development 28,471 18,364
Model homes and homes held for resale 6,301 3,845
--------- --------
$ 65,295 $ 35,991
========= ========
The Company capitalizes certain interest costs incurred on homes in
production and lots under development. Such capitalized interest is allocated to
inventory and included in cost of home sales when the units are delivered. The
following tables summarize interest capitalized and interest expensed (dollars
in thousands):
F-10
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Year Ended December 31,
1997 1996
---- ----
Beginning unamortized capitalized interest.... $ - $ N/A
Interest capitalized.......................... 3,679 N/A
Amortized cost of home sales.................. 1,789 N/A
--------- ---------
Ending unamortized capitalized interest....... $ 1,890 $ N/A
========= =========
Interest incurred............................. $ 3,844 $ 238
Interest capitalized.......................... 3,679 N/A
--------- ---------
Interest expense.............................. $ 165 $ 238
========= =========
Had capitalized interest maintained its character in purchase accounting
after the Merger and Legacy Combination, interest amortized by the Company (See
Note 9) through cost of home sales would have been approximately $4.2 million in
1997.
NOTE 5 - NOTES PAYABLE
<TABLE>
<CAPTION>
Notes payable consist of the following at December 31:
1997 1996
---- ----
<S> <C> <C>
$30 million bank construction line of credit, interest
payable monthly approximating prime (8.5% at December
31, 1997), plus .25% payable at the earlier of close of
escrow, maturity date of individual homes within the line
or June 19, 2000, secured by first deeds of trust on land......... $ 4,663,973 $ 7,299,159
$40 million bank construction line of credit, interest payable
monthly approximating prime, payable at the earlier of close of
escrow, maturity date of individual homes within the line or
August 1, 1998, secured by first deeds of trust on land........... 9,769,567 --
$20 million bank acquisition and development credit facility,
interest payable monthly approximating prime plus 5%,
payable at the earlier of funding of construction financing,
the maturity date of individual projects within the line or
June 19, 2000, secured by first deeds of trust on land............ 2,393,935 9,628,993
Short-term bank credit facility, paid in full, June 1997.............. -- 5,552,500
Senior subordinated unsecured notes payable, maturing October
15, 2001, annual interest of 13%, payable semi-annually,
principal payable at maturity date with a put to the
Company at June 30, 1998, at 101% of face value.................... 6,000,000 8,000,000
Other .............................................................. 64,775 61,624
------------ ------------
Total .................................................... $ 22,892,250 $ 30,542,276
============ ============
</TABLE>
F-11
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Scheduled maturities of the notes payable as of December 31, 1997 are as
follows:
Year ending
December 31,
------------
1998............ $ 16,892,250
1999............ ---
2000............ ---
2001............ 6,000,000
Thereafter...... ---
---------------
$ 22,892,250
===============
In August, 1997, $2,000,000 of the senior subordinated bonds were
repurchased by the Company. Approximately $3,000,000 of the bonds were held by
the Co-Chief Executive Officers of the Company at December 31, 1997.
NOTE 6 - EARNINGS PER SHARE
A summary of the reconciliation from basic earnings per share to diluted
earnings per share for the years ended December 31, 1997, 1996 and 1995 follows
(in thousands, except for per share amounts):
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net earnings $ 14,237 $ 147 $ 1,097
Basic EPS - Weighted average shares outstanding 4,864 3,242 3,246
--------- -------- ---------
Basic earnings per share $ 2.93 $ .05 $ .34
========= ======== =========
Basic EPS - Weighted average shares outstanding 4,864 3,242 3,246
Effect of dilutive securities
Contingent shares and warrants 114 -- --
Stock options 330 93 --
--------- -------- ---------
Dilutive EPS - Weighted average shares outstanding 5,308 3,335 3,246
--------- -------- ---------
Diluted earnings per share $ 2.68 $ .04 $ .34
========= ======== =========
Antidilutive stock options not included in diluted EPS 4 4 92
========= ======== =========
</TABLE>
Basic and diluted earnings per share for the extraordinary loss in 1996
were $.05 and $.04, respectively.
NOTE 7 - STOCK OPTIONS AND CONTINGENT STOCK
At December 31, 1997, the Company had two stock based compensation plans
which are described below. The per share weighted average fair values of stock
options granted during 1997 and 1996 were $4.58 and $1.63, respectively, on the
dates of grant using the Black Scholes pricing model with the following weighted
average assumptions for 1997 and 1996, respectively; expected dividend yield
1.2% and 1.4%, risk-free interest rate of 6.0% and 5.85%, expected volatility of
43% and 36% and an expected life
F-12
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
of five years. The Company applies APB Opinion No. 25 and related
interpretations in accounting for its plans. No compensation cost has been
recognized for its stock based compensation plan (which is a fixed stock option
plan). Had compensation cost for the Company's stock based compensation plan
been determined consistent with FASB Statement No. 123, the Company's net
earnings and earnings per share would have been reduced to the pro forma amounts
indicated below:
1997 1996
---- ----
Net earnings (loss) .............. As reported $ 14,237,442 $ 147,488
Pro forma 13,892,442 (151,345)
Diluted earnings (loss) per share. As reported $ 2.68 $.04
Pro forma $ 2.62 ($.05)
The Company's Stock Option Plans are administered by the Compensation
Committee of the Board of Directors. The plans provide for qualified stock
options which may be granted to the Company's key personnel, and non-qualified
stock options which may be granted the Company's Directors and key personnel.
The purpose of the plans are to provide a means of performance-based
compensation in order to attract and retain qualified personnel whose job
performance affects the Company.
The Homeplex Plan
The 1998 Homeplex Mortgage Investments Corporation Stock Option Plan
(the "Homeplex Plan") was in effect at the time of the Merger. No new grants
will be issued under this plan, and the options will expire on December 31,
1998.
Option holders received, at no additional cost, DER's which entitled
them to receive, upon exercise of the options, additional shares calculated
based on the dividends declared during the period from the grant date to the
exercise date. At December 31, 1997 and 1996, accounts payable and accrued
liabilities in the accompanying balance sheets include approximately $778,600
and $850,000, respectively, related to the Company's granting of DER's. This
liability will remain in the consolidated balance sheets until the options to
which the DER's relate are exercised, canceled or expire.
Under the Homeplex Plan, an exercising optionholder also has the rights
to require the Company to purchase some or all of the optionholder's shares of
the Company's common stock. That redemption right is exercisable by the
optionholder only with respect to shares (including the related dividend
equivalent rights) that the optionholder has acquired by exercise of an option
under the Plan. Furthermore, the optionholder can only exercise redemption
rights within six months from the last to expire of (i) the two year period
commencing with the grant date of an option, (ii) the one year period commencing
with the exercise date of an option, or (iii) any restriction period on the
optionholder's transfer of shares of common stock acquired through exercise of
options. The price for any shares repurchased as a result of an optionholder's
exercise of his redemption rights is the lesser of the book value of those
shares at the time of redemption or the fair market value of the shares on the
original date the options were exercised.
The Monterey Plan
At the 1997 Annual Meeting of Stockholders held on September 25, 1997, a
new stock option plan was approved by stockholders. The plan authorizes grants
of incentive stock options and non-qualified stock options to executives,
directors and consultants of the Company. A total of 225,000 shares of the
Company's common stock were reserved for issuance upon exercise of stock options
granted under the new plan, of which 150,000 were granted in 1997. The options
expire ten years after the date of grant.
F-13
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
In addition to the above referenced options, in December 1995, in
connection with the renegotiation of the prior Chief Executive Officer's
Employment Agreement, the Company replaced his annual salary of $250,000 plus
bonus with 250,000 non-qualified stock options which became fully vested upon
the Merger at December 31, 1996. The exercise price of the options is $4.50 per
share which was equal to the closing market price of the common stock on grant
date. The options will expire in December 2000.
In connection with the Merger and Legacy Combination, Mssrs. Cleverly,
Hilton and Landon each received 166,667 non-qualified stock options which vest
equally over three years. The exercise price of the options is $5.25 per share
which was negotiated at the time of the Merger. Mr. Cleverly's and Mr. Hilton's
options will expire in December, 2002 and Mr.
Landon's will expire in June, 2001.
The following summarizes stock option activity under the Stock Option
Plans:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Options outstanding at beginning of year 732,975 398,392 132,240
Employment options granted -- -- 250,000
Options granted 150,000 1,249 27,576
Merger/Legacy Combination options
granted 166,667 333,334 --
Options exercised (8,162) -- --
Options canceled -- -- (11,424)
--------------- --------------- -------------
Options outstanding at of year 1,041,480 732,975 398,392
=============== =============== =============
Options exercisable at end of year 515,090 399,941 120,634
Price range of options exercised $4.37 - $6.38
Price range of options outstanding $3.62 - $13.32 $3.62 - $13.32 $3.62 - $13.32
Total shares reserved 1,383,146 666,307 398,392
</TABLE>
On December 31, 1996, in connection with the Merger, 266,666 shares of
contingent stock were reserved to be issued equally to Mr. Cleverly and Mr.
Hilton on the first, second and third anniversaries of the Merger, provided that
stock trading prices meet certain thresholds and that the Officer is an employee
of the Company at the time of issuance. Of these shares, 43,947 shares were
reserved to be issued to warrantholders upon exercise of the warrants. Upon
expiration, if the warrants are unexercised, the reserved shares will be issued
equally to Mr. Cleverly and Mr. Hilton. As of December 31, 1997, all price
thresholds had been exceeded, and Mr. Cleverly and Mr. Hilton were each due a
total of 44,444 shares of common stock, which were issued to them subsequent to
year end.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
The Company leases office facilities, model homes and equipment under
various operating lease agreements. Approximate future minimum lease payments
for noncancellable operating leases as of December 31, 1997 are as follows:
F-14
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Year Ending
December 31,
------------
1998............. $ 825,487
1999............. 425,869
2000............. 216,000
Thereafter....... 0
----------
$1,467,356
==========
Rental expense was $1,185,372 and $21,780 for the years ended December
31, 1997 and 1996, respectively.
The Company is subject to legal proceedings and claims which arise in
the ordinary course of business. In the opinion of management, the amount of
ultimate liability with respect to these actions will not materially affect the
Company's financial statements taken as a whole.
NOTE 9 - HOMEPLEX / MONTEREY MERGER AND LEGACY HOMES COMBINATION
On December 23, 1996, the stockholders of Homeplex Mortgage Investments
Corporation, now known as Monterey Homes Corporation (the "Company"), approved
the Merger (the "Merger") of Monterey Homes Construction II, Inc. and Monterey
Homes Arizona II, Inc., both Arizona corporations (collectively, the "Monterey
Entities"), with and into the Company. The Merger was effective on December 31,
1996, and the Company's focus is now on homebuilding as its primary business.
Ongoing operations of the Company are managed by the two previous stockholders
of the Monterey Entities, who at the time of the Merger became Co-Chief
Executive Officers, with one serving as Chairman and the other as President. At
consummation of the Merger, 1,288,726 new shares of common stock, $.01 par value
per share, were issued equally to the Chairman and President.
The total consideration paid by the Company for the net assets of the
Monterey Entities was $9,323,353. This amount included 1,288,726 shares of the
Company's common stock valued at $8,544,256 and $779,097 of transaction costs.
The purchase method of accounting was used by the Company, and the purchase
price was allocated among the Monterey net assets based on their estimated fair
market value at the date of acquisition, resulting in goodwill of $1,763,488,
which will be amortized over 20 years.
On May 29, 1997, the Company signed a definitive agreement with Legacy
Homes, Ltd., Legacy Enterprises, Inc. and John and Eleanor Landon (together,
"Legacy Homes"), to acquire the homebuilding and related mortgage service
business of Legacy Homes, Ltd. and its affiliates. This transaction was
effective on July 1, 1997. Legacy Homes is a builder of entry-level and move-up
homes headquartered in the Dallas/Fort Worth metropolitan area and was founded
in 1988 by its current President, John Landon.
Consideration for the Legacy Combination consisted of approximately $1.5
million in cash, 666,667 shares of the Company's common stock valued at $3.4
million and $370,000 in transaction costs. The purchase method of accounting was
used by the Company, and the purchase price was allocated among the Company's
net assets based on their estimated fair market value at the date of the
transaction, resulting in goodwill of approximately $1.5 million, which is to be
amortized over 20 years. In addition, deferred contingent payments not to exceed
$15 million will be made by the Company through the year 2001. The 1997
contingent payment was approximately $2.8 million which was recorded as goodwill
and will be amortized over 20 years.
F-15
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Also in connection with the Legacy transaction, John Landon entered into
a four-year employment agreement with the Company and was appointed Chief
Operating Officer and Co-Chief Executive Officer of the Company and President
and Chief Executive Officer of the Company's Texas division. Mr. Landon was also
granted an option to purchase 166,667 shares of the Company's common stock and
was elected to the Company's Board of Directors.
The following unaudited pro forma information presents a summary of
consolidated results of operations of the Company as if the Merger and the
Legacy Combination had occurred at January 1, 1996, with pro forma adjustments
together with related income tax effects. The pro forma results have been
prepared for comparative purposes only and do not purport to be indicative of
the results of operations that would actually have resulted had the combination
been in effect on the date indicated (in thousands except per share data).
Years Ended December 31,
(Unaudited)
1997 1996
---- ----
Home and land revenue............. $ 189,358 $ 172,868
Net earnings...................... $ 17,764 $ 12,525
Diluted net earnings per share ... $ 3.15 $ 2.34
NOTE 10 - INCOME TAXES
The components of income tax expense are:
1997 1996
---- ----
Current:
Federal $ 221,468 $ 18,700
State 740,448 7,862
------------- ------------
$ 961,916 $ 26,562
============= ============
Deferred income tax expense was -0- in 1997, 1996 and 1995 and current
income tax expense was -0- in 1995 due to the Company's status as a REIT in
1995.
Deferred tax assets and liabilities have been recognized in the
consolidated balance sheets due to temporary differences and carryforwards as
follows:
<TABLE>
<CAPTION>
12/31/97 1997 12/31/96
-------- ---- --------
<S> <C> <C> <C>
Net operating loss carryforward.............. $ 16,270,000 $ (4,930,000) $ 21,200,000
Residual interest basis differences.......... 970,000 (1,130,000) 2,100,000
Real estate basis differences................ 590,000 190,000 400,000
Debt issuance costs.......................... 310,000 44,000 266,000
Deductible merger/acquisition costs.......... 260,000 260,000 --
AMT credit................................... 220,000 220,000 --
Other 80,000 (5,000) 85,000
---------------- --------------- -----------------
18,700,000 (5,351,000) 24,051,000
Valuation allowance.......................... (8,266,000) 8,972,000 (17,238,000)
----------------- -------------- ------------------
10,434,000 3,621,000 6,813,000
Deferred tax liabilities..................... (30,000) -- (30,000)
----------------- -------------- ------------------
Net deferred tax asset............... $ 10,404,000 $ 3,621,000 $ 6,783,000
================ ============== =================
</TABLE>
F-16
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
Management of the Company believes it is more likely than not that the
results of future operations will generate sufficient taxable income to realize
the net deferred tax asset.
Reconciliation of Effective Income Tax Expense:
Income taxes differ for the years ended December 31, 1997 and 1996 from
the amounts computed using the federal statutory income tax rate as a result of
the following:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Expected taxes at current federal statutory income tax rate $ 5,320,000 $ 60,000
State income taxes 740,448 7,862
Utilization of NOL (5,320,000) (60,000)
Alternative minimum tax 221,468 18,700
-------------- -----------
Income tax expense $ 961,916 $ 26,562
============== ===========
</TABLE>
Carryforwards.
At December 31, 1997, the Company had federal and state net operating
loss carryforwards of $43 million and $27 million, respectively. The federal and
state carryforwards expire beginning in 2007 and 1998, respectively.
NOTE 11 - SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
Unaudited quarterly consolidated financial information for the years
ended December 31, 1997 and 1996 is summarized as follows (in thousands except
per share amounts):
<TABLE>
<CAPTION>
Net Earnings Net Earnings
Revenue (Loss) (Loss) Per Share
------- ------ ----------------
<S> <C> <C> <C> <C>
1997 - Three months ended:
March 31 $ 12,573 $ 288 $ .06
June 30 24,544 1,958 .42
September 30 42,685 5,079 .87
December 31 69,828 6,912 1.17
1996 - Three months ended:
March 31 $ 635 $ 84 $ .03
June 30 (1) 636 148 .04
September 30 530 314 .09
December 31 443 (399) (.12)
</TABLE>
- ------------
(1) Net earnings in the second quarter of 1996 includes an extraordinary
charge of $148,000, or $.05 per share, to record the result of early
extinguishment of debt.
F-17
<PAGE>
MONTEREY HOMES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (Continued)
NOTE 12 - SUBSEQUENT EVENTS
Sale of Residual Interests
On February 2, 1998, the Company sold five of the six remaining
residual interests in mortgage securities for approximately $4.6 million,
resulting in pre-tax earnings of approximately $3.2 million. The Company has
also entered into an agreement to sell the final residual interest in the second
quarter of 1998 for $2.0 million, which will result in pre-tax earnings of
approximately $2.0 million.
F-18
<PAGE>
================================================================================
No dealer, salesman or any other person has been authorized to give any
information or to make any representation other than those contained in this
Prospectus, and, if given or made, such information or representation must not
be relied upon as having been authorized by the Company. Neither the delivery of
this Prospectus nor any sale made hereunder shall under any circumstances create
any implication that there has been no change in the affairs of the Company
since the date hereof. This Prospectus does not constitute an offer to sell or a
solicitation of an offer to buy any securities offered hereby in any
jurisdiction in which such offer or solicitation is not authorized or in which
the person making such offer or solicitation is not qualified to do so or to
anyone to whom it is unlawful to make such offer or solicitation.
-------------------
TABLE OF CONTENTS
Available Information.....................................1
Forward-Looking Statements................................1
Prospectus Summary........................................2
Risk Factors..............................................4
Use of Proceeds...........................................7
The Merger................................................7
The Legacy Combination...................................13
Selected Financial and Operating Data....................16
Management's Discussions and Analysis of Financial
Condition and Results of Operations....................17
Business of Company......................................22
Management of the Company................................33
Security Ownership of Principal Stockholders
and Management.........................................39
Certain Transactions and Relationships...................40
Description of Capital Stock.............................40
Price of Warrants and Common Stock; Dividend Policy......44
Selling Security Holders.................................46
Plan of Distribution.....................................47
Legal Matters............................................47
Experts ................................................47
Index to Consolidated Financial Statements..............F-1
124,784 WARRANTS
MONTEREY HOMES
CORPORATION
-------------------
PROSPECTUS
-------------------
JUNE 5, 1998
================================================================================
