<PAGE>
This Form 10-Q consists of 15 sequentially numbered pages.
FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------------------------------
QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
Commission file number 0-17189
CALIFORNIA COASTAL COMMUNITIES, INC.
------------------------------------
(Exact name of registrant as specified in its charter)
DELAWARE 02-0426634
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization.) Identification No.)
6 Executive Circle, Suite 250
IRVINE, CALIFORNIA 92614
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (949) 250-7700
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days:
Yes X No
--- ---
Indicate by check mark whether the Registrant has filed all documents
and reports required to be filed by Sections 12, 13, or 15(d) of the
Securities Exchange Act of 1934 subsequent to the distribution of securities
under a plan confirmed by a court.
Yes X No
--- ---
The number of shares of Common Stock outstanding at November 1, 1998 was
11,968,075.
<PAGE>
CALIFORNIA COASTAL COMMUNITIES, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1998
I N D E X
-----------------
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I - Financial Information:
Item 1 - Financial Statements
Balance Sheets -
December 31, 1997 and September 30, 1998..................3
Statements of Operations -
Two-Month Period Ended September 2, 1997,
One-Month Period Ended September 30, 1997,
Three Months Ended September 30, 1998,
Eight-Month Period Ended September 2, 1997
and Nine Months Ended September 30, 1998..............4
Statements of Cash Flows -
Eight-Month Period Ended September 2, 1997,
One-Month Period Ended September 30, 1997
and Nine Months Ended September 30, 1998..............5
Notes to Financial Statements.............................6
Item 2 - Management's Discussion and Analysis of Financial
Condition and Results of Operations......................11
Item 3 - Quantitative and Qualitative Disclosures About
Market Risk..............................................13
PART II - Other Information:
Item 1 - Legal Proceedings...........................................14
Item 6 - Exhibits and Reports on Form 8-K............................14
SIGNATURE........................................................................15
</TABLE>
2
<PAGE>
CALIFORNIA COASTAL COMMUNITIES, INC.
BALANCE SHEETS
--------------
(in millions)
<TABLE>
<CAPTION>
December 31, September 30,
1997 1998
------------ -------------
<S> <C> <C>
ASSETS
Cash and cash equivalents ........................ $ 7.2 $ 31.8
Real estate held for development or sale ......... 4.0 2.7
Land held for development ........................ 133.2 136.2
Reorganization value in excess of amounts
allocated to net assets ........................ 3.1 .3
Discontinued operations .......................... 19.3 --
Other assets ..................................... 6.5 7.3
------ ------
$173.3 $178.3
------ ------
------ ------
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable and accrued liabilities........ $ 3.5 $ 1.9
Other liabilities .............................. 29.7 29.9
------ ------
Total liabilities .............................. 33.2 31.8
------ ------
Stockholders' equity:
Common stock ................................... .6 .6
Capital in excess of par value ................. 140.0 141.1
Retained earnings (accumulated deficit)......... (.5) 4.8
------ ------
Total stockholders' equity ..................... 140.1 146.5
------ ------
$173.3 $178.3
------ ------
------ ------
</TABLE>
See the accompanying notes to financial statements.
3
<PAGE>
CALIFORNIA COASTAL COMMUNITIES, INC.
STATEMENTS OF OPERATIONS
------------------------
(in millions, except per share amounts)
<TABLE>
<CAPTION>
Predecessor Successor Successor Predecessor Successor
Company Company Company Company Company
------- ------- ------- -------
Two-Month One-Month Three Months Eight-Month Nine Months
Period Ended Period Ended Ended Period Ended Ended
September 2, 1997 September 30, 1997 September 30, 1998 September 2, 1997 September 30, 1998
----------------- ------------------ ------------------ ----------------- ------------------
<S> <C> <C> <C> <C> <C>
Revenues ............................. $ .5 $ 1.6 $ -- $ 33.9 $ 2.1
Costs of sales ....................... .4 1.6 -- 33.4 1.8
------ ----- ----- ------ -----
Gross operating margin ............. .1 -- -- .5 .3
General and administrative expenses .. 2.2 .2 .9 5.5 2.8
Interest expense ..................... 4.4 -- .3 17.1 1.0
Other expense (income), net .......... (.3) .1 (.2) (3.7) (.7)
------ ----- ----- ------ -----
Loss from continuing operations
before reorganization costs and
income taxes ....................... (6.2) (.3) (1.0) (18.4) (2.8)
Reorganization items:
Reorganization costs ............... 1.8 -- -- 2.8 --
Fresh-start adjustments ............ 63.8 -- -- 63.8 --
------ ----- ----- ------ -----
Loss from continuing operations
before income taxes ................ (71.8) (.3) (1.0) (85.0) (2.8)
Provision (benefit) for income
taxes .............................. .1 -- -- .3 (.3)
------ ----- ----- ------ -----
Loss from continuing operations ...... (71.9) (.3) (1.0) (85.3) (2.5)
Discontinued operations:
Income from operations,
net of income taxes of $0, $.2,
$0, $0 and $.2 ................... 6.4 .5 -- 5.4 .5
Gain on disposition, net of
income taxes of $3.3 ............. -- -- -- -- 7.2
------ ----- ----- ------ -----
Income (loss) before extraordinary
gain ............................... (65.5) .2 (1.0) (79.9) 5.3
Extraordinary gain on
extinguishment of debt, net of
income taxes of $0 .................. 89.5 -- -- 89.5 --
------ ----- ----- ------ -----
Net income (loss) .................... $ 24.0 $ .2 $(1.0) $ 9.6 $ 5.3
------ ----- ----- ------ -----
------ ----- ----- ------ -----
Earnings (loss) per common
share - basic and diluted:
Continuing operations ............ $(.02) $(.08) $(.20)
Discontinued operations .......... .04 -- .64
----- ----- -----
N/A $ .02 $(.08) N/A $ .44
------ ----- ----- ------ -----
------ ----- ----- ------ -----
Weighted average common
shares outstanding ................. N/A 11.9 12.0 N/A 12.0
------ ----- ----- ------ -----
------ ----- ----- ------ -----
</TABLE>
See the accompanying notes to financial statements.
4
<PAGE>
CALIFORNIA COASTAL COMMUNITIES, INC.
STATEMENTS OF CASH FLOWS
------------------------
(in millions)
<TABLE>
<CAPTION>
Predecessor Successor Successor
Company Company Company
------- ------- -------
Eight-Month One-Month Nine Months
Period Ended Period Ended Ended
September 2, 1997 September 30, 1997 September 30, 1998
----------------- ------------------ ------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income ................................................... $ 9.6 $ .2 $ 5.3
Adjustments to reconcile to cash provided (used) by
operating activities:
Fresh-start adjustments .................................... 63.8 -- --
Extraordinary gain on extinguishment of debt ............... (89.5) -- --
Non-cash reorganization costs .............................. 1.9 -- --
Non-cash interest expense .................................. 17.1 -- 1.0
Deferred income taxes ...................................... -- -- (.5)
Gain on sale of discontinued operation ..................... -- -- (7.2)
Gains on asset sales ....................................... (.4) -- (.3)
Proceeds from asset sales, net ............................. 33.5 1.6 2.0
Investments in real estate held for development or sale..... (2.3) (.1) (.4)
Investment in land held for development .................... (4.2) (1.8) (3.0)
Decrease (increase) in other assets ........................ 1.0 (.1) (.8)
Decrease in accounts payable, accrued and
other liabilities ........................................ (6.8) (1.0) (2.4)
----- ----- -----
Cash provided (used) by operating activities
of continuing operations ............................ 23.7 (1.2) (6.3)
----- ----- -----
Cash used by operating activities of
discontinued operations ............................. (37.6) (2.2) (28.1)
----- ----- -----
Cash flows from investing activities:
Proceeds from sale of discontinued operation ................. -- -- 33.3
----- ----- -----
Cash flows from financing activities:
Borrowings of bank debt ...................................... .9 -- --
Repayments of bank debt ...................................... (9.1) -- --
Use of restricted cash ....................................... .2 -- --
Issuance of restricted stock ................................. -- -- 1.1
----- ----- -----
Cash (used) provided by financing activities
of continuing operations ................................. (8.0) -- 1.1
----- ----- -----
Cash provided by financing activities
of discontinued operations ............................... 27.1 1.1 24.6
----- ----- -----
Net increase (decrease) in cash and cash equivalents ........... 5.2 (2.3) 24.6
Cash and cash equivalents - beginning of period ................ 2.1 7.3 7.2
----- ----- -----
Cash and cash equivalents - end of period ...................... $ 7.3 $ 5.0 $ 31.8
----- ----- -----
----- ----- -----
</TABLE>
See the accompanying notes to financial statements.
5
<PAGE>
CALIFORNIA COASTAL COMMUNITIES, INC.
NOTES TO FINANCIAL STATEMENTS
-----------------------------
NOTE 1 - BASIS OF PRESENTATION
On May 1, 1998, following completion of the sale of the commercial
development business (see Note 4), Koll Real Estate Group, Inc. changed its
name to California Coastal Communities, Inc. The corresponding change of the
Company's stock symbol from "KREG" to "CALC" was effective on May 29, 1998.
The accompanying financial statements have been prepared by California
Coastal Communities, Inc. and its consolidated subsidiaries (the "Company"),
without audit, pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and footnote disclosures normally
included in financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted pursuant to
such rules and regulations. The Company believes that the disclosures are
adequate to make the information presented not misleading when read in
conjunction with the Financial Statements and Notes thereto included in the
Company's Annual Report on Form 10-K for the year ended December 31, 1997,
and the current year's previously issued Quarterly Reports on Form 10-Q. The
financial information presented herein reflects all adjustments, including
Fresh-Start Reporting adjustments as discussed below, which are, in the
opinion of management, necessary for a fair presentation of the results for
the interim periods presented. The results for interim periods are not
necessarily indicative of the results to be expected for the full year. This
report contains forward looking statements. Readers are cautioned that any
such forward looking statements are not guarantees of future performance and
involve risks and uncertainties that actual events or results may differ
materially from those described herein as a result of various factors,
including without limitation, the factors discussed generally in this report.
NOTE 2 - RECAPITALIZATION
On September 2, 1997, the Company completed its recapitalization (the
"Recapitalization") which became effective pursuant to a prepackaged plan of
reorganization that was confirmed by the U.S. Bankruptcy Court for the
District of Delaware on August 19, 1997. The prepackaged plan was filed by
the Company, excluding all of its subsidiaries and affiliates, contemporaneously
with a voluntary petition for relief under Chapter 11 of the bankruptcy code
on July 14, 1997. The Recapitalization had previously received over 95%
approval of each class of stock and bondholders that voted through a public
solicitation process in June 1997. On September 2, 1997, the effective date
of the Recapitalization, the Company (referred to as "Successor Company" for
periods after September 2, 1997) adopted the provisions of Statement of
Position No. 90-7, "Financial Reporting by Entities in Reorganization Under
the Bankruptcy Code" ("Fresh-Start Reporting") as promulgated by the American
Institute of Certified Public Accountants in November 1990. Accordingly, all
assets and liabilities were revalued to reflect their reorganization value,
approximating their fair value at the effective date of the Recapitalization.
In addition, the accumulated deficit of the Company was eliminated and its
capital structure recast in conformity with the Recapitalization, and as
such, the Company has recorded the effects of the Recapitalization and
Fresh-Start Reporting as of the effective date.
The Recapitalization provided for a restructuring of the Company's
capital structure. The only impaired parties under the Recapitalization were
the holders of (a) the Company's 12% Senior Subordinated Pay-In-Kind
Debentures due March 15, 2002 ("Senior Debentures"), (b) the Company's 12%
Subordinated Pay-In-Kind Debentures due March 15, 2002 ("Subordinated
Debentures") (collectively, the "Debentures"), (c) liquidated, non-contingent
claims, and (d) equity securities of the Company. The prepackaged plan did
not alter the Company's obligations to its other creditors, including its
trade creditors, customers, employees, holders of contingent and unliquidated
claims, holders of guaranty claims, and parties to contracts with the Company.
The results of operations for the two-month and eight-month periods
ended September 2, 1997 and cash flows for the eight-month period ended
September 2, 1997 include operations prior to completion of the Recapitalization
(referred to as "Predecessor Company"). The results of operations and cash
flows for the one-month period ended September 30, 1997 and the nine months
ended September 30, 1998 include operations subsequent to the Company's
Recapitalization and are not comparable with prior periods for the reasons
discussed above.
6
<PAGE>
The reorganization value of the Company's common equity was determined
by the Company with the assistance of financial advisors after consideration
of several factors and by reliance on various valuation methods, including
discounted projected cash flows, and other economic and industry information
relevant to the operations of the Company. The reorganization value of the
Company was allocated to specific asset categories pursuant to Fresh-Start
Reporting. Reorganization Value in Excess of Amounts Allocated to Net Assets,
which represented the difference in the Company's estimated valuation and the
Company's net assets at fair value, of approximately $3.1 million is amortized
on a straight-line basis over 15 years. Such amount was reduced in the second
quarter of 1998 by the amount of the net income tax provision recorded for
the gain on the sale of the commercial development business pursuant to
Fresh-Start Reporting. In addition, $13.6 million of Reorganization Value in
Excess of Amounts Allocated to Net Assets was allocated to the commercial
development business, and is reflected in discontinued operations net of
related amortization, as of December 31, 1997.
Reorganization costs during the periods ended September 2, 1997
consisted primarily of legal, financial advisors and other professional fees
and expenditures directly related to the Company's Recapitalization and were
expensed as incurred.
NOTE 3 - EARNINGS PER COMMON SHARE
The Company computes earnings per share in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share". For periods
commencing September 2, 1997, earnings per share is computed using the
weighted average number of outstanding shares of the Successor Company's
Common Stock. For the three months and nine months ended September 30, 1998,
the weighted average common shares outstanding were 12.0 million. The
weighted average common shares outstanding reflect the issuance, effective
May 6, 1998, of 100,000 shares to the Company's Chief Executive Officer under
a restricted stock grant. Earnings per share, assuming dilution, is computed
using the weighted average number of common shares outstanding and the
dilutive effect of potential common shares outstanding. Per share data for
periods prior to September 2, 1997 have been omitted as these amounts do not
reflect the Successor Company's current capital structure.
NOTE 4 - DISPOSITION
On April 30, 1998 the Company completed the sale of its commercial
development business to Koll Development Company LLC ("KDC") and NorthStar
Capital Investment Corp. for (1) $33.3 million in cash, which included
approximately $3.3 million for 1998 activity, and (2) the assumption by KDC
of all liabilities related to the business. KDC is a newly formed limited
liability company, whose members include the Company's former Chairman and
Chief Executive Officer, Donald M. Koll and its former President, Richard M.
Ortwein, along with an affiliate of NorthStar Capital Investment Corp. Upon
completion of the transaction, Messrs. Koll and Ortwein resigned from their
positions with the Company and Raymond J. Pacini, the Company's Chief
Financial Officer since 1992, became the Company's new President and Chief
Executive Officer. The Company realized an after-tax gain of approximately
$7.2 million ($10.5 million pretax) from this transaction.
Discontinued operations as of December 31, 1997 was comprised of the
following (in millions):
<TABLE>
<S> <C>
Restricted cash..................................... $ .2
Real estate held for development or sale............ 87.9
Reorganization value in excess of amounts
allocated to net assets........................... 13.3
Other assets........................................ 8.5
Accounts payable and other liabilities.............. (13.1)
Bank debt........................................... (74.6)
Minority interest................................... (2.9)
------
Net assets........................................ $ 19.3
------
------
</TABLE>
Revenues related to discontinued operations were $2.4 million and
$26.9 million for the two and eight-month periods ended September 2, 1997,
respectively, $12.3 million for the one-month period ended September 30, 1997
and $28.1 million for the nine months ended September 30, 1998, through the
date of sale. The net income from discontinued operations for the two-month
and eight-month periods ended September 2, 1997 was $6.3 million and
$5.4 million, repectively, and $.5 million for the one-month period ended
September 30, 1997. Net income from discontinued operations for the nine
month period ended September 30, 1998, was $.5 million through the date of
sale.
7
<PAGE>
NOTE 5 - LAND HELD FOR DEVELOPMENT
The Company owns approximately 340 acres located in Orange County,
California adjacent to the Pacific Ocean and the Bolsa Chica lowlands (which
were sold by the Company to the State of California as described below),
surrounded by the City of Huntington Beach and approximately 35 miles south
of downtown Los Angeles. The Company's holdings include approximately 200 acres
to be developed on a mesa north of the Bolsa Chica lowlands ("Warner Mesa"),
approximately 100 acres on, or adjacent to, the Huntington mesa and
approximately 40 acres of lowlands which were acquired by the Company in
September 1997.
The planned community at Warner Mesa is expected to offer a broad mix of
home choices, including primarily single-family homes, as well as townhomes,
at a wide range of prices. A Local Coastal Program ("LCP") for development of
up to 3,300 homes (up to 2,500 on Warner Mesa and up to 900 on the Bolsa
Chica lowlands, which were subsequently sold as discussed below) was approved
by the Orange County Board of Supervisors in December 1994 and by the
California Coastal Commission (the "Coastal Commission") in January 1996.
On February 14, 1997, the Company completed the sale of its approximately
880-acre Bolsa Chica lowlands, which had previously been planned for the
development of up to 900 homes, to the California State Lands Commission for
$25 million. Under an interagency agreement among various state and federal
agencies, these agencies have agreed to restore the Bolsa Chica wetlands
habitat utilizing escrowed funds from the Ports of Los Angeles and Long Beach.
A lawsuit (the California Environmental Quality Act lawsuit, the "CEQA
Lawsuit") challenging the approvals of the Board of Supervisors was filed in
January 1995. After remanding the matter to the Board of Supervisors for
additional processing and findings, in January 1997 the court entered a
judgment in favor of the Company. Plaintiffs in the CEQA Lawsuit appealed the
trial court's decision and on June 16, 1998, the California Court of Appeal
ruled in the Company's favor by affirming the trial court's earlier decision
that the Board of Supervisor's approval of the LCP was in compliance with
CEQA. With this decision, the Court of Appeal rejected the contentions of the
plaintiffs by concluding that the final Environmental Impact Report ("EIR")
adequately considered the alternatives for treatment of archeological sites
and that the County's efforts complied with the requirements for involving
the federal government in the EIR process. In addition, the Court of Appeal
reversed the trial court's award of attorney fees and costs to the Company's
opponents because certain aspects of the trial court's decision erred on the
merits and the project opponents did not accomplish anything meaningful in
the CEQA Lawsuit.
In March 1996, a lawsuit (the "Coastal Act Lawsuit") was filed
challenging the approvals of the Coastal Commission. The judgment in the
Coastal Act Lawsuit was entered by the trial court in August 1997, and
required the Coastal Commission to reconsider the filling of a 1.7 acre pond
on the Warner Mesa ("Warner Pond") and development of any homes in the Bolsa
Chica lowlands. In October 1997, in response to the trial court's decisions,
the Coastal Commission approved modifications to the LCP which eliminated the
filling of Warner Pond and thereby reduced the maximum density from 2,500 homes
to no more than 1,235 homes on Warner Mesa. The Orange County Board of
Supervisors subsequently accepted the Coastal Commission's suggested
modifications. However, in February 1998, the trial court ruled that the
Coastal Commission should not have narrowed the scope of public comments
during the Coastal Commission's October 1997 hearing, and in March 1998 the
trial court ordered the Coastal Commission to hold a third hearing on the
LCP. In May 1998, the Company appealed the trial court's latest decision, and
there are numerous other appeals pending with respect to the Coastal Act
Lawsuit.
On October 14, 1998, the Court of Appeal completed its hearing on the
first set of appeals, which relates to the trial court's August 1997
decision. The Court of Appeal normally renders its decision within the 90 day
period following such a hearing. Opponents of the Warner Mesa project
appealed the trial court's decision on the basis that the trial court should
have reversed the Coastal Commission's January 1996 approval allowing
relocation of certain raptor habitat. The Company also appealed the trial
court's decisions which reversed the Coastal Commission's January 1996
approval (a) allowing Warner Pond to be filled and (b) allowing residential
development in lowlands. A hearing date for the Company's appeal of the trial
court's March 1998 decision on the LCP (the "Second Appeal") has not yet been
scheduled by the Court of Appeal. In the event that the Company prevails on
all of the relevant issues raised in the first set of appeals, it would not
be necessary for the Company to pursue its Second Appeal. If the Company
pursues and is successful in the Second Appeal, it would be allowed to
complete the processing of secondary permits and commence infrastructure
construction for up to 1,235 homes on Warner Mesa. If the Company does not
prevail in the first set of appeals with respect to affirmation of the trial
court's decision allowing relocation of raptor habitat, then the Coastal
Commission would be required to hold a third public hearing.
8
<PAGE>
While the Company is unable to predict exactly when these litigation
delays will end, it hopes to start infrastructure construction sometime in
1999. The Company does not believe that the litigation process will
permanently prevent it from developing the planned community at Warner Mesa;
however, there can be no assurance in that regard or that further delays will
not result.
Upon completion of the Company's Recapitalization as discussed in Note 2,
the Company applied the principles required by Fresh-Start Reporting and the
carrying value of land held for development (Warner Mesa) was adjusted to
fair value as of September 2, 1997, after consideration of the October 9,
1997 Coastal Commission action discussed above. The estimation process
involved in the determination of fair value is inherently uncertain since it
requires estimates as to future events and market conditions. Such estimation
process assumes the Company's ability to complete development and dispose of
its real estate properties in the ordinary course of business based on
management's present plans and intentions. Economic, market, environmental
and political conditions may affect management's development and marketing
plans. In addition, the implementation of such development and marketing
plans could be affected by the availability of future financing for
development and construction activities. Accordingly, the ultimate fair
values of the Company's real estate properties are dependent upon future
economic and market conditions, the availability of financing, and the
resolution of political, environmental and other related issues.
NOTE 6 - BANK DEBT
During the first quarter of 1997, the Company fully repaid the
outstanding loan balance of approximately $7.1 million under a letter of
credit and reimbursement agreement with Nomura Asset Capital Corporation. A
prepayment of $.6 million was made in January in connection with a sale of
Rancho San Pasqual lots, and the remaining balance was repaid upon the sale
of the Bolsa Chica lowlands.
Cash payments for interest on bank debt were approximately $.1 million
for the eight-month period ended September 2, 1997.
NOTE 7 - INCOME TAXES
Upon completion of the Recapitalization, the Company experienced an
"ownership change" under Section 382 of the Internal Revenue Code (the
"Code") as a result of the increase in the percentage of the Company's stock
by value held by certain persons (including creditors who exchanged debt for
stock) of more than 50 percentage points at any time during a three-year
period. Subsequent to an ownership change, the Company's annual use of its
net operating losses ("NOLs") is generally limited to the value of the
Company's equity immediately before the ownership change multiplied by the
long-term tax-exempt rate. However, Section 382(l)(5) of the Code, the
"bankruptcy exception", provides that if the ownership change occurs through
a bankruptcy, such as the Company's Recapitalization which utilized a
prepackaged plan, and if the continuing shareholders and "qualifying
creditors" before the ownership change own at least 50% of the Company's
stock after the ownership change, the general limitations of Section 382 will
not apply. "Qualifying creditors" generally must have held their debt at
least 18 months before the prepackaged plan was filed on July 14, 1997, or
the debt must have arisen in the ordinary course of the Company's business.
The Company believes that it qualifies for the "bankruptcy exception" of
Section 382(l)(5). Under this exception, the Company is required to reduce
its NOLs by (i) the amount of interest accrued on any debt exchanged for
stock in the bankruptcy proceeding during the year of the proceeding and the
three prior taxable years and (ii) an additional amount required to make the
total reduction equal to the amount of cancellation of indebtedness income
realized. Accordingly, the Company's NOLs of approximately $279 million as of
September 2, 1997 have been reduced by approximately $79 million, resulting
in remaining available NOLs of approximately $200 million as of September 2,
1997 after reflecting the tentative settlement with the IRS discussed below.
As reduced, the Company's NOL carryovers will be fully deductible against
post-reorganization income provided there is not a second ownership change as
discussed below, and subject to the general rules regarding expiration of
NOLs. The NOLs available as of September 30, 1998 are approximately $199
million after reflecting the tentative settlement with the IRS discussed
below.
If the Company were to experience another ownership change within two
years of the September 2, 1997 effective date of the Recapitalization, as the
result of a 50 percentage point change in ownership, the second ownership
change would not qualify for Section 382(l)(5) treatment and the use of all
remaining NOLs would be disallowed. Pursuant to Section 382(l)(5)(D), the
Section 382 Limitation from and after the second ownership change would be
zero, and thus would
9
<PAGE>
eliminate the availability of any remaining unused portion of the $200 million
of NOLs which existed as of September 2, 1997.
The Internal Revenue Service ("IRS") has proposed material audit
adjustments with respect to the tax returns of the Company and its
consolidated subsidiaries, including formerly affiliated entities, for the
years ended December 31, 1989, 1990 and 1991. The Company disagreed with the
positions taken by the IRS and filed protests with the IRS to contest the
proposed adjustments. The Company estimates that, if upheld, the adjustments
could result in federal tax liability, before interest, of approximately $17
million (net of amounts which may be payable by former affiliates pursuant to
tax sharing agreements). The IRS proposed adjustments, if upheld, could also
result in a disallowance of up to $132 million of available NOL
carryforwards, of which none are recognized after consideration of the
valuation allowance, as of September 30, 1998.
The Company has reached a tentative settlement agreement with the IRS
with respect to the proposed adjustments described above. As a result of
this agreement, the Company expects to pay approximately $744,000 (which
includes $280,000 of tax and $464,000 of interest through November 1998), net
of the Company's refund claim for 1992 NOL carry backs of approximately $1.6
million, in full settlement of such claims. Under this agreement
approximately $10 million of the Company's NOL carryforward will be
disallowed. The Company expects to carry back NOLs of $8.1 million from 1992
to 1991 in connection with its refund claim. There can be no assurance that
the agreement with the IRS will be completed or that the refund will be
received. The Company has reviewed the extent of potential accompanying
state tax liability adjustments and does not believe that any such
adjustments would have a material impact on the Company's financial
statements.
Cash payments for federal, state and local income taxes were approximately
$.2 million for the eight-month period ended September 2, 1997 and approximately
$.1 million for the three and nine months ended September 30, 1998.
NOTE 8 - COMMITMENTS AND CONTINGENCIES
GUARANTEES OF COMMERCIAL PROJECT DEBT
The Company guaranteed approximately $286.8 million of the commercial
development business' project loans from various banks for construction of
commercial projects. On April 30, 1998, upon completion of the sale of the
commercial development business, all of these guarantees were assumed by KDC,
which fully indemnified the Company against any and all liability with
respect to these guarantees. In addition, the Company was released from the
substantial majority of these guarantees by the various banks, although the
Company has not been released by one bank from a remaining guarantee of
approximately $22.7 million. KDC has fully indemnified the Company against
any and all liability with respect to such guarantee, and has obtained a
letter of credit in favor of the Company in the amount of $1.1 million to
secure any related obligation.
10
<PAGE>
ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The Company is a residential land development and homebuilding company
with properties located primarily in Southern California. The principal
activities of the Company and its consolidated subsidiaries include:
(i) obtaining zoning and other entitlements for land it owns and improving
the land for residential development; (ii) single-family residential
construction in Southern California; and (iii) providing residential real
estate development services to third parties. Once the residential land owned
by the Company is entitled, the Company may sell unimproved land to other
developers or homebuilders; sell improved land to homebuilders; or participate
in joint ventures with other developers, investors or homebuilders to finance
and construct infrastructure and homes. On April 30, 1998, the Company sold
its commercial development business as further described in Note 4 to the
Company's Financial Statements, and accordingly the financial statements have
been reclassified to present the commercial development business as discontinued
operations. The Company's immediate strategic goals are to (i) successfully
appeal the trial court's decisions which reversed the California Coastal
Commission's (the "Coastal Commission") approval of the Warner Mesa project,
as further discussed in Note 5 to the Company's Financial Statements;
(ii) complete the permitting for development of Warner Mesa; and (iii)
commence infrastructure construction on Warner Mesa as soon as possible;
however, the Company may also consider other strategic and joint venture
opportunities. There can be no assurance that the Company will accomplish, in
whole or in part, all or any of these strategic goals.
The substantial majority of the Company's assets is residential land
which has required significant investments before the land could be sold to
homebuilders or developed in joint ventures. Prior to the adoption of
Fresh-Start Reporting, the relatively high book value of these assets
resulted in sales approximating break-even. Pursuant to Fresh Start
Reporting, implementation of the Recapitalization through the prepackaged
plan resulted in a write-down of Warner Mesa to fair value (which will reduce
future costs of sales) and therefore, upon favorable completion of the
litigation and entitlement processes, the Company expects to begin generating
profits from the Warner Mesa project. However, with the March 1998 court
decision which ordered a third hearing before the Coastal Commission to
approve the LCP, the Company is faced with further delays in implementing its
plans for residential development on Warner Mesa. Furthermore, due to the
uncertainties associated with the litigation appeals process, the Company is
unable to predict the length of such delays at this time.
Real estate held for development or sale and land held for development
(real estate properties) are carried at fair value as of September 2, 1997,
following adoption of Fresh-Start Reporting as discussed in Note 2, as
adjusted by subsequent activity. The Company's real estate properties are
subject to a number of uncertainties which can affect the fair values of
those assets. These uncertainties include litigation or appeals of regulatory
approvals (as discussed above) and availability of adequate capital,
financing and cash flow. In addition, future values may be adversely affected
by increases in property taxes, increases in the costs of labor and materials
and other development risks, changes in general economic conditions,
including higher mortgage interest rates, and other real estate risks such as
the demand for housing generally and the supply of competitive products. Real
estate properties do not constitute liquid assets and, at any given time, it
may be difficult to sell a particular property for an appropriate price.
Recently, the strengthened economy of California has resulted in improvement
in the real estate market, and the number of potential purchasers interested
in Southern California residential properties appears to have increased,
resulting in improving prices. However, there can be no assurance regarding
the continued health of the California economy and the strength and longevity
of current conditions affecting the residential real estate market.
LIQUIDITY AND CAPITAL RESOURCES
The principal assets in the Company's portfolio are residential land
which must be held over an extended period of time in order to be developed
to a condition that, in management's opinion, will ultimately maximize the
return to the Company. Consequently, the Company requires significant capital
to finance its real estate development operations. Except for the gain on
disposition of the commercial development business in 1998, the Company
expects to report losses or insignificant income until such time as sales can
commence at Warner Mesa. Historically, sources of capital have included bank
lines of credit, specific property financings, asset sales and available
internal funds.
The Company completed the sale of its commercial development business
for $33.3 million on April 30, 1998 as further described in Note 4 to the
Company's Financial Statements, which provided substantial liquidity to fund
project development costs for Warner Mesa and general and administrative
expenses.
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FINANCIAL CONDITION
SEPTEMBER 30, 1998 COMPARED WITH DECEMBER 31, 1997
The $24.6 million increase in cash and cash equivalents primarily
reflects the $33.3 million in proceeds from the sale of the commercial
development business which was completed on April 30, 1998, along with net
proceeds from the sales of 35 lots at Rancho San Pasqual, and an industrial
building in Naples, Florida, partially offset by spending for project
development costs for Warner Mesa and general and administrative expenses, as
well as other activity presented in the Statements of Cash Flows.
The $3.0 million increase in land held for development reflects
investment in the Warner Mesa project during the first nine months of 1998.
The $2.8 million decrease in Reorganization value in excess of amounts
allocated to net assets primarily reflects a credit resulting from the income
tax provision recorded for the gain on sale of the commercial development
business, pursuant to Fresh-Start Reporting, as discussed in Note 2.
The $19.3 million decrease in discontinued operations reflects completion
of the sale of the commercial development business on April 30, 1998.
The $1.6 million decrease in accounts payable and accrued liabilities
primarily reflects the payment of accrued expenses.
RESULTS OF OPERATIONS
The nature of the Company's business is such that individual transactions
often cause significant fluctuations in operating results from year to year.
In addition, the Company's completion of the Recapitalization has significantly
deleveraged its capital structure. Furthermore, the restatement of assets and
liabilities to reflect fair value as of September 2, 1997 under Fresh-Start
Reporting will reduce future costs of sales for Warner Mesa, while increasing
interest and amortization expense related to discounted liabilities and
Reorganization value in excess of amounts allocated to net assets.
THREE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THE THREE MONTHS ENDED
SEPTEMBER 30, 1997
The absence of revenues and related costs of sales in the 1998 period as
compared to revenues of $2.1 million and related costs of sales of $2.0 million
in the 1997 period reflect the second quarter 1998 completion of phase I lot
sales at Rancho San Pasqual. As a result of litigation delays with respect to
the Warner Mesa project (see Note 5), the Company does not currently expect
to report any revenues until the third quarter of 1999, when home sales are
expected to commence at the Company's 112 home project in phase II at Rancho
San Pasqual.
General and administrative expenses in the third quarter of 1997 include
approximately $1.7 million of non-recurring costs incurred in connection with
the exchange offer for the Company's subordinated debentures.
The decrease in interest expense primarily reflects the absence in the
third quarter of 1998 of interest on the subordinated debentures after they
were cancelled on September 2, 1997, the effective date of the Recapitalization.
The $.3 million of noncash interest expense in the third quarter of 1998
reflects interest expense on (i) discounted liabilities under Fresh-Start
Reporting and (ii) capital contribution notes due to a partnership.
Other income, net of $.2 million for the three months ended September 30,
1998 primarily reflects interest income, partially offset by period costs on
the Warner Mesa project. The $.2 million in other expense, net for the three
months ended September 30, 1997 primarily reflects non-recurring professional
fees.
The benefit for income taxes for the three months ended September 30, 1997
has been offset by a corresponding valuation allowance.
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NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED WITH THE NINE MONTHS ENDED
SEPTEMBER 30, 1997
The decrease in revenues from $35.5 million in the 1997 period to
$2.1 million in the 1998 period and the decrease in the related costs of
sales from $35.0 million in the 1997 period to $1.8 million in the 1998
period reflect the 1997 sales of the Bolsa Chica lowlands to the State of
California for $25 million, lots at Rancho San Pasqual for $7.1 million and
the $3.1 million sale of a build-to-suit project in Signal Hill, California,
compared with the $1.7 million sale of the remaining 35 phase I residential
lots at Rancho San Pasqual and the $.4 million sale of an industrial building
in Naples, Florida in the first nine months of 1998. As a result of litigation
delays with respect to the Warner Mesa project (see Note 5), the Company does
not currently expect to report any revenues until the third quarter of 1999,
when home sales are expected to commence at the Company's 112 home project in
phase II at Rancho San Pasqual.
General and administrative expenses in the first nine months of 1997
include approximately $2.8 million of non-recurring costs incurred in
connection with the exchange offer for the Company's subordinated debentures.
The decrease in interest expense primarily reflects the absence in the
first nine months of 1998 of (i) interest on the subordinated debentures
after they were cancelled on September 2, 1997, the effective date of the
Recapitalization, and (ii) interest on bank debt which was repaid in February
1997. The $1.0 million of noncash interest expense in the first nine months
of 1998 reflects interest expense on (i) discounted liabilities under
Fresh-Start Reporting and (ii) capital contribution notes due to a partnership.
Other income, net of $.7 million for the nine months ended September 30,
1998 primarily reflects interest income, partially offset by amortization of
Reorganization value in excess of amounts allocated to net assets. The
$3.7 million in other income, net for the nine months ended September 30, 1997
primarily reflects nonrecurring income from (i) the sale of a minority interest
in a privately held company and (ii) gains recognized in connection with the
settlement of certain claims.
The benefit for income taxes for the nine months ended September 30, 1997
has been offset by a corresponding valuation allowance.
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
YEAR 2000 COMPLIANCE
The Year 2000 issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any computer
programs that have time-sensitive software may recognize a date using "00" as
the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including,
among other things, a temporary inability to process transactions or engage
in similar normal business activities.
The Company has completed its accounting software conversion to programs
that are Year 2000 compliant at a nominal cost. The Company is conducting
formal communications with all of its significant suppliers to determine the
extent to which those third parties' failure to remediate their own Year 2000
issue may pose problems for the Company. There can be no guarantee that the
systems of other companies on which the Company's systems rely will be timely
converted and would not have an adverse effect on the Company's systems.
The Company anticipates completing its third party inquiries regarding
Year 2000 compliance and executing any actions required, including changing
suppliers if necessary, within six months, but not later than June 30, 1999,
which is prior to any anticipated impact on its operating systems. The total
cost of the Year 2000 project will be expensed as incurred and is not expected
to have a material adverse effect on the Company's results of operations.
13
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SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Certain of the foregoing information as well as certain information set
forth in Part II of this report under the heading "Legal Proceedings" is
forward looking in nature and involves risks and uncertainties that could
significantly impact the ability of the Company to achieve its currently
anticipated goals and objectives. These risks and uncertainties include, but
are not limited to litigation or appeals of regulatory approvals (including
pending appeals of the trial court decisions in the Coastal Act Lawsuit
related to the Company's principal asset, Warner Mesa), injunctions
prohibiting implementation of approved development plans pending the outcome
of litigation, and availability of adequate capital, financing and cash flow.
In addition, future values may be adversely affected by increases in
property taxes, increases in the costs of labor and materials and other
development risks, changes in general economic conditions, including higher
mortgage interest rates, and other real estate risks such as the demand for
housing generally and the supply of competitive products. Real estate
properties do not constitute liquid assets and, at any given time, it may be
difficult to sell a particular property for an appropriate price. Other
significant risks and uncertainties are discussed in the Company's Annual
Report on Form 10-K for the year ended December 31, 1997.
PART II - OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
See Note 5 of "Notes to Financial Statements" included herein, and
"Item 1 - Business - Corporate Indemnification Matters" and "Item 3 - Legal
Proceedings" in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997.
On October 30, 1998 the Company's motion was granted in San Diego
Superior Court settling the construction defect lawsuit against Signal
Landmark, the Company's subsidiary, regarding homes in Coronado, California.
The details of the case are more fully described in "Item 3 - Legal
Proceedings" in the Company's Annual Report on Form 10-K for the year ended
December 31, 1997. The Company's insurance carriers will pay the settlement,
and additional contributions from sub-contractors are expected to reimburse
the Company's required deductible and share of attorney fees, resulting in no
cost to the Company.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27.1 Financial Data Schedule.
(b) Reports on Form 8-K:
None.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
CALIFORNIA COASTAL COMMUNITIES, INC.
Date November 12, 1998 By /s/ Sandra G. Sciutto
----------------- ---------------------------------
SANDRA G. SCIUTTO
Senior Vice President and
Chief Financial Officer
15
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