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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ______________ TO ______________
COMMISSION FILE NUMBER: 0-19891
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SCHULER HOMES, INC.
(Exact name of Registrant as Specified in its Charter)
DELAWARE 99-0293125
(State or Other Jurisdiction (I.R.S. Employer Identification
of Incorporation or Organization) No.)
828 FORT STREET MALL, 4TH FLOOR
HONOLULU, HAWAII 96813
(Address of Principal Executive Offices) (Zip Code)
(808) 521-5661
(Registrant's Telephone Number, Including Area Code)
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Securities registered pursuant to Section 12(b) of the Act:
NONE
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, Par Value $0.01 Per Share
Convertible Subordinated Debentures Due 2003
Senior Notes Due 2008
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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of the Common Stock held by non-affiliates of the
Registrant on February 26, 1999, based on the closing price of the Common Stock
as reported by the Nasdaq National Market on such date, was approximately
$73,662,592. Shares of Common Stock held by each officer and director and by
each person who owns 5% or more of the outstanding Common Stock have been
excluded from this computation in that such persons may be deemed to be
affiliates. This determination of affiliate status is not necessarily a
conclusive determination for other purposes.
As of February 26, 1999, the Registrant had outstanding 20,053,028 shares of
Common Stock.
DOCUMENTS INCORPORATED BY REFERENCE
Definitive Proxy Statement relating to the Company's 1999
Annual Meeting to be filed hereafter (incorporated into Part III hereof).
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SCHULER HOMES, INC.
INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
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PAGE
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<S> <C> <C>
PART I
Item 1. Business.......................................................... 3
Item 2. Properties........................................................ 13
Item 3. Legal Proceedings................................................. 14
Item 4. Submission of Matters to a Vote of Security Holders............... 14
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder
Matters......................................................... 15
Item 6. Selected Consolidated Financial Data.............................. 16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................... 17
Item 7A. Quantitative and Qualitative Disclosure About Market Risk......... 24
Item 8. Financial Statements and Supplementary Data....................... 25
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure............................................ 26
PART III
Item 10. Directors and Executive Officers of the Registrant................
Item 11. Executive Compensation............................................
Item 12. Security Ownership of Certain Beneficial Owners and Management....
Item 13. Certain Relationships and Related Transactions....................
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K............................................................. 27
</TABLE>
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PART I
ITEM 1. BUSINESS.
Except for historical information contained herein, the matters discussed in
this report contain forward-looking statements that involve risks and
uncertainties that could cause actual results to differ materially from those
anticipated by such forward-looking statements. Factors that might cause such a
difference include, but are not limited to, those risks discussed herein, and
other risks detailed in this Form 10-K and other documents filed by the Company
with the Securities and Exchange Commission from time to time.
GENERAL
Schuler Homes designs, constructs, markets and sells single-family
residences, townhomes and condominiums primarily to entry-level and first-time
move-up buyers. The Company operates in five geographic markets: Colorado,
Hawaii, Northern California, Oregon and Washington. The Company offers a variety
of homes generally at sizes ranging from 520 to 3,100 square feet and prices
ranging from approximately $84,000 to over $400,000, with an average sales price
of $189,000 for units closed in 1998. For the year ended December 31, 1998, the
Company reported revenues and unit closings of $282.9 million and 1,827 units,
respectively.
Schuler Homes is one of the two largest builders of single-family
residences, townhomes and condominiums in Hawaii. Since inception in March 1988
through December 31, 1998, the Company closed the sales of 5,502 homes and lots,
of which 340 home and lot sales were closed during 1998. As of December 31,
1998, the Company had land zoned and entitled for 2,824 homes in Hawaii.
Schuler Homes entered the Denver, Colorado homebuilding market in January
1997 through the purchase of Melody Homes, Inc. ("Melody"), one of the largest
builders in the Denver market, and Melody Mortgage Co. ("Melody Mortgage"), a
mortgage brokerage firm for Melody home buyers. The Company believes it is
well-positioned to benefit from the future growth in the Denver housing market
as a result of its strong land position (approximately 6,975 lots owned or
controlled as of December 31, 1998) and its local market knowledge. Since its
inception in 1953, Melody Homes has closed the sales of 16,180 homes and lots.
During 1998, Melody's deliveries of homes increased by 14.7% to 1,090 homes and
its revenues increased by 21.8% to $172.0 million. In addition, at December 31,
1998, Melody's backlog was 457 units, or $78.1 million, compared to 267 units,
or $41.3 million at December 31, 1997. In addition, the Company owns a 50%
interest in a joint venture, The Ranch-Southpointe II LLC, for the development
of 116 townhomes in Lafayette, Colorado.
The Company also established two new homebuilding operations in Northern
California and Oregon / Vancouver, Washington in late 1996. In 1998, the Company
delivered 146 new homes in these markets. The Company further expanded its
Oregon operations in October 1998 through the acquisition of certain assets
(principally options to purchase land) of Keys Homes, Inc. ("Keys"), a Portland,
Oregon homebuilder, engaged in the building of single-family, duplex and cottage
homes targeted for the entry-level market. During the twelve months ended
September 30, 1998, Keys delivered 193 homes generating revenues of
approximately $23.8 million. As of December 31, 1998, the Company's Northern
California and Oregon divisions owned or controlled 2,388 lots.
The Company entered the Puget Sound, Washington market in July 1997 by
acquiring a 49% interest in Stafford Homes ("Stafford"), a homebuilder for over
30 years in the greater Puget Sound area of Washington. During 1998, Stafford
delivered 251 homes, generating revenues of $61.3 million and as of December 31,
1998, owned or controlled 1,137 zoned lots. In January 1999, Schuler Homes
exercised its option to purchase an additional 40% ownership interest in
Stafford, increasing Schuler Homes' total ownership to 89%. The Company expects
to purchase the remaining 11% ownership interest in January 2001.
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HOMEBUILDING INDUSTRY
The homebuilding industry is cyclical and affected by changes in general and
local economic and other conditions including employment levels, demographic
considerations, availability of financing, interest rate levels, consumer
confidence and housing demand. The risks inherent to homebuilders in purchasing
and developing land increase as consumer demand for housing decreases. Because
of the long-term financial commitment involved in purchasing a home, general
economic uncertainties tend to result in more caution on the part of home
buyers, which, in turn, tends to result in fewer home purchases. In addition,
homebuilders are subject to various risks, many of them outside the control of
the homebuilder including competitive overbuilding, availability and cost of
building lots, availability and cost of materials and labor, adverse weather
conditions which can cause delays in construction schedules, cost overruns,
changes in government regulations, and increases in real estate taxes and other
local government fees and the level of interest rates. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations." In
addition, the recent downturn and continued uncertainty in Asian and other
foreign financial markets, including the devaluation of various foreign
currencies, could have an adverse impact on the Colorado, Hawaii, California,
Oregon or Washington economies and the demand for homes in those states.
The development, construction and sale of homes are subject to various risks
including, among others, the continued availability of suitable undeveloped land
at reasonable prices. The homebuilding industry is also subject to the potential
for significant variability and fluctuations in real estate values. Although the
Company believes that its projects are currently reflected on the Company's
balance sheet at or below the fair value, no assurances can be given that, in
the future, write-downs will not be material in amount.
MARKETS
The Company operates in five geographic markets: Colorado, Hawaii, Northern
California, Oregon and Washington, four of which are among the strongest housing
markets in the United States.
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YEAR
GEOGRAPHIC AREA (MARKET) MARKETS ENTERED
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Hawaii........................................... Maui 1988
Oahu 1990
Kauai 1992
Northern California.............................. Bay Area 1996
Oregon(1)........................................ Portland, Oregon 1996
Vancouver, Washington 1996
Colorado(2)...................................... Denver 1997
Fort Collins 1997
Colorado Springs 1998
Washington(3).................................... Greater Puget Sound 1997
</TABLE>
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(1) In October 1998, the Company expanded its presence in the Oregon market
through the acquisition of certain assets of Keys.
(2) Entrance into the Colorado markets was a result of the acquisition of Melody
Homes in January 1997.
(3) Entrance into the Washington market was a result of the acquisition of a 49%
interest in Stafford in July 1997. In January 1999, the Company increased
its ownership interest in Stafford Homes to 89%.
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The Company's operations are situated in Colorado, Hawaii, Northern
California, Oregon and Washington. Adverse general economic conditions in the
markets in which the Company operates could have a material adverse impact on
the operations of the Company. In 1998, approximately 61% of the Company's
revenues and a significant portion of the Company's operating income were
derived from operations in its Colorado market. In addition, at December 31,
1998, approximately 58% of the Company's total inventories were located in
Hawaii. The Company's performance could be significantly affected by changes in
the Colorado and Hawaii markets.
In 1997, the Company significantly expanded its operations, moving into the
Colorado, Northern California, Oregon and Washington markets, thus exposing the
Company to risks inherent in those markets. New markets may prove to be less
stable and may involve delays, problems and expenses, including construction
issues and risks such as expansive soils and extreme seasonal weather
conditions, not typically found by the Company in the Hawaii market, with which
it is most familiar. No assurances can be given that the Company will be able to
successfully establish operations outside of its existing markets or that such
expansion will not adversely affect its results of operations.
Since inception, the Company has experienced substantial sales growth. While
the Company has recently expanded its management and administrative personnel in
the land acquisition, construction management, financial and administrative
areas, the Company anticipates hiring additional personnel and enhancing its
management information systems to meet anticipated future growth. There can be
no assurance that such expansion or enhancement can be accomplished on a timely
and cost-effective basis without disrupting the Company's operations. Further,
there can be no assurance that such growth will continue.
The climates and geology of many of the states in which the Company operates
present special risks of natural disasters. To the extent that hurricanes,
severe storms, earthquakes, droughts, floods, wildfires or other natural
disasters or similar events occur, the homebuilding industry in general, and the
Company's business in particular, in such states may be adversely affected.
Demand in certain of the Company's markets is significantly influenced by
weather, particularly weekend weather, which is when the majority of the
Company's sales are initiated. In addition, adverse weather conditions may delay
the timing of site improvements and foundation work, among other construction
processes. The Company's results of operations could be materially adversely
affected by weather patterns which result in unseasonably cool temperatures,
rain or snow, water shortages or floods.
PROJECT AND PRODUCT DESCRIPTIONS
The Company has focused, and intends to continue to focus, its business
primarily on entry-level and first-time move-up housing in the form of
single-family residences, and, to a lesser extent, townhomes and condominiums.
The Company attempts to maximize efficiency by using standardized design plans
whenever possible and sharing design plans among markets. However, the Company
maintains the flexibility to alter its product mix within a given market
depending on market conditions and, in determining its product mix, considers
demographic trends, demand for a particular type of product, margins, timing and
the economic strength of the market. As a result of the Company's expansion into
new markets, the number and location of its active projects increased and its
home designs and product mix expanded and changed.
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The following table presents information relating to the Company's home and
lot closings and land position as of and for the year ended December 31, 1998:
<TABLE>
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YEAR ENDED DECEMBER 31,
1998 AS OF DECEMBER 31, 1998
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AVERAGE TOTAL NUMBER OF BUILDING SITES
NUMBER OF SALES SALES PROJECTS FOR NUMBER OF PROJECTS OWNED OR HOMES UNDER
MARKET CLOSED PRICE DEVELOPMENT(1) IN SALES STAGE(2) CONTROLLED(3)(4) CONSTRUCTION(5)
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<S> <C> <C> <C> <C> <C> <C>
Consolidated:
Colorado.............. 1,090 $ 158,000 22 10 6,975 256
Hawaii(7)............. 320 268,000 13 10 2,689 145
Northern California... 83 154,000 10 3 921 92
Oregon................ 63 198,000 27 9 1,467 158
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Total Consolidated.... 1,556 182,000 72 32 12,052 651
Unconsolidated Joint
Ventures:
Hawaii(8)........... 20 121,000 2 2 135 0
Washington(9)....... 251 240,000 18 9 1,137 88
Colorado(10)........ -- -- 1 1 116 8
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Total................. 1,827 189,000 93 44 13,440 747
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MARKET BACKLOG(6)
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Consolidated:
Colorado.............. 457
Hawaii(7)............. 47
Northern California... 35
Oregon................ 76
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Total Consolidated.... 615
Unconsolidated Joint
Ventures:
Hawaii(8)........... 5
Washington(9)....... 41
Colorado(10)........ 20
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Total................. 681
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</TABLE>
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(1) Reflects the total number of projects owned or under option or similar
contract and includes projects with homes in the sales stage, under
construction and projects in various stages of planning.
(2) Represents the number of active projects in which home or lot sales closed
or standard sales contracts were entered into with homebuyers.
(3) Represents the estimated number of homes/lots relating to land owned or
under option or similar contracts. The amounts are based on current
management estimates, which are subject to change. Although the Company
currently intends to consummate the purchase of the parcels under purchase
options or similar contracts, no assurances can be given that the purchase
will be completed or that the land under purchase option will be acquired.
In addition, this category includes Homes Under Construction and Backlog.
(4) For consolidated projects, includes 64 model homes and 5 completed and
unsold homes in the Colorado, Northern California and Oregon markets, and 32
model homes and 195 completed and unsold homes in the Hawaii market,
including approximately 51 homes rented and 78 homes held for sale in the
Company's high-rise condominium project in Oahu. For unconsolidated joint
ventures, includes 7 model homes and 90 completed and unsold homes and lots
in Hawaii, and 12 model homes and 30 completed and unsold homes in
Washington.
(5) Includes certain homes reflected in Backlog.
(6) Represents homes/lots subject to pending sales contracts that have not yet
closed. As such contracts are subject to certain conditions being satisfied
and may be canceled by the buyer at any time, no assurances can be given
that homes/lots subject to pending sales contracts will result in closings.
(7) Includes homes and lots sold pursuant to the Company's "zero-down" sales
program in Hawaii. Approximately $0.3 million of revenues associated with 2
zero-down closings were deferred in 1998 until the related notes receivables
are paid in full.
(8) Reflects 100% of the information with respect to the Company's two 50% owned
joint ventures in Hawaii, Iao Partners and Waiakoa Estates Subdivision Joint
Venture.
(9) Reflects 100% of the information with respect to Stafford Homes in which the
Company acquired a 49% interest in July 1997, and an additional 40% interest
in January 1999.
(10) Reflects 100% of the information with respect to the Company's 50%-owned
joint venture in Colorado, The Ranch-Southpointe II LLC, which was entered
into in July, 1998.
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LAND ACQUISITION AND DEVELOPMENT
GENERAL. The Company selects its land for development based upon a variety
of factors, including: (i) internal and external demographic and marketing
studies; (ii) financial and legal reviews as to the feasibility of the proposed
project; (iii) the ability to secure necessary financing and required government
approvals and entitlements; (iv) environmental due diligence and management's
judgment as to the real estate market economic trends; and (v) the Company's
experience in a particular market. As part of the Company's ongoing land
acquisition policy, it actively seeks to purchase land that is already zoned for
residential development.
The Company generally utilizes options or land purchase agreements to obtain
control of desired parcels of land. The Company's purchase and option agreements
are typically subject to numerous conditions, including, but not limited to, the
Company's ability to obtain any necessary governmental approvals. During the
contingency period, the Company also confirms the availability of utilities,
completes its marketing feasibility studies, verifies site and construction
costs, reviews and approves soil and environmental reports and arranges for
project financing, if necessary.
The Company also enters into partnerships or joint ventures to purchase land
and develop its communities where such arrangements are necessary to acquire the
land or appear to be otherwise economically advantageous to the Company. The
Company generally has not used partnerships or joint venture arrangements as a
method of raising capital for the development of projects, although such
arrangements may be used for purposes of expansion into other geographic areas
or other related businesses.
Although the Company's principal focus is the construction and sale of
single-family and townhome residential housing, from time to time the Company
offers residential lots for sale where it perceives an attractive market
opportunity. The Company does not anticipate that residential lot sales will
constitute a significant amount of revenues in the future.
MAINLAND U.S. The Company's home building projects in the mainland United
States have typically taken one to four years to develop, depending on the
project's size, the Company's strategy with respect to the particular project,
regulatory approvals, economic conditions, and geological conditions at the
site. Larger projects are divided into phases, with each phase generally taking
six months to one year to complete. The Company has typically acquired interests
in tracts of land that require site improvements prior to construction and are
suitable for a subdivision comprised of between 50 and 500 buildable units.
However, from time to time, the Company has acquired finished lots from land
developers, and anticipates that it will periodically acquire finished lots from
land developers in the future.
HAWAII. The Company's strategy in Hawaii is to develop projects of a
similar size and of the same general profile as in the mainland U.S. However,
certain of the Company's currently planned projects in Hawaii are anticipated to
be longer term in nature and to include a larger number of buildable units than
those in the mainland United States. These larger projects generally will have
offsite and infrastructure requirements to be fulfilled prior to the
construction of homes, which increase the amount of cash expended at the
beginning of the project. The increased length and size of such projects further
exposes the Company to risks inherent in the homebuilding industry, including
reductions in the value of land inventory. In addition, certain of the Company's
land purchase agreements in Hawaii require the Company to make additional
payments to the seller if the average sales price or the final number of all
homes exceeds an amount stated in such agreements. The Company also has
occasionally granted a profit participation interest in certain of its projects
to individuals involved in locating, structuring and assisting in the management
of the particular project.
CONSTRUCTION
The Company primarily acts as its own general contractor with its
supervisory employees coordinating all work on its projects. From time to time
the Company will hire independent general contractors on its
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projects in Hawaii, particularly for its townhome and condominium projects. The
general contractors are responsible for the general management of the
construction process, coordinating the activities of all subcontractors,
suppliers and building inspectors and following design plans generally prepared
by consulting architects and engineers who are retained by the Company and whose
designs are geared to the local market. Company employees monitor the
construction of each project, participate in all material design and building
decisions, subject the contractors' and subcontractors' work to quality and cost
controls and monitor compliance with zoning and building codes. In addition, the
Company works closely with contractors and subcontractors on engineering, site
preparation, environmental impact analysis, purchasing, architectural design,
site planning, coordinating governmental approvals, contract management and
closings. The Company will sometimes require its general contractors and/or
subcontractors to post lien-free completion and performance construction bonds.
The Company believes that its relations with its contractors are good.
The Company's homes include single-family residences, townhomes and
condominiums, which have ranged in size from approximately 520 to 3,100 square
feet. The Company typically completes the construction of a home within two to
four months from commencement of building construction. Construction time for
the Company's homes depends on the time of year, availability of labor,
materials and supplies and other factors. The Company seeks to utilize
standardized home designs and pre-fabricated components wherever feasible. This
standardization facilitates efficiencies in the on-site construction of homes
and helps permit on-site mass production and bulk purchasing of materials by the
contractors and subcontractors engaged by the Company, thus reducing costs and
expensive change orders. However, from time to time the Company develops new
designs to replace or augment existing ones as part of its continuing efforts to
assure that its homes are responsive to current consumer preferences. For new
designs, the Company has engaged a number of unaffiliated architectural firms in
addition to its in-house architect. Where it is believed to be cost-effective
and efficient, the Company has used steel building components in certain of its
projects, which represents a departure from the traditional wood-frame method of
construction.
The residential construction industry has, from time to time, experienced
serious material and labor shortages, including shortages in insulation,
drywall, certain carpentry work and cement supply. Delays in construction of
homes and higher costs due to these shortages and fluctuating lumber prices
could have an adverse effect upon the Company's operations. The Company is also
susceptible to delays caused by strikes affecting shipping and transportation of
building materials necessary for the Company's business, particularly in Hawaii
because of its remote location. In addition, many of the Company's contractors
in Hawaii are represented by labor unions or collective bargaining agreements.
No assurances can be given that the renegotiation of such agreements would not
lead to a disruption of the Company's operations and an increase in its
construction costs.
SALES AND MARKETING
The Company sells its homes primarily through commissioned employees who
typically work from a sales office located at each project, as well as through
cooperating independent brokers. In all instances, Company personnel are
available to assist prospective buyers by providing them with floor plans,
pricing information, financing options, tours of model homes and the selection
of options and upgrades. The Company generally does not permit changes in home
design, but home buyers are afforded the opportunity to select, at additional
cost, various optional amenities such as prewiring options, upgraded carpet
quality, varied interior and exterior color schemes and finishes and
occasionally expanded rooms and varied room configurations. The Company focuses
on increasing customer satisfaction through the use of its own design centers in
the majority of its markets to help customers select features and options on
their homes. Sales personnel are also trained by the Company and attend periodic
meetings to be updated on the availability of financing, construction schedules,
marketing and advertising plans, which the Company believes results in a sales
force with extensive knowledge of the Company's operating policies and housing
products. The Company also makes extensive use of advertising to market its
homes, including print, radio
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and television, in addition to other promotional activities such as direct mail,
its web sites on the Internet and the placement of strategically located sign
boards in the immediate areas of its developments.
The Company's objective is to price its homes very competitively and to
market its homes in advance of construction, in an effort to minimize levels of
unsold inventory upon completion of a project. The Company accomplishes
pre-sales by entering into pre-construction sales contracts with its customers.
The sales contracts generally provide for requisite mortgage approval within a
specified period, and the Company attempts to minimize cancellations by
requiring a cash deposit of approximately $500 to $10,000 and by training its
sales force to assess the qualifications of potential home buyers.
The Company generally does not use sales incentives in order to attract home
buyers. However, the use of sales incentives (such as landscaping and certain
interior home options and upgrades) has been used in Hawaii, and may, from time
to time, be used in certain other markets, depending largely on prevailing
economic and competitive market conditions.
The Company normally builds, decorates, furnishes and landscapes between one
to five model homes for each project and maintains on-site sales offices. At
December 31, 1998, the Company owned and maintained approximately 115 model
homes. The Company believes that model homes play a particularly important role
in the Company's marketing efforts. Consequently, the Company expends a
significant effort to create an attractive atmosphere at its model homes. The
Company also uses a cross-referral program that encourages sales personnel to
direct customers to other Company projects based on the customer's needs.
In addition, the Company maintains a customer service department which is
responsible for pre-closing and post-closing customer needs. Prior to closing, a
Company employee accompanies the buyer on a home orientation and inspection
tour. Post-closing, a Company employee follows up with the customer, to ensure
satisfaction, to answer questions and to help resolve any problems, including
responding to warranty requests.
CUSTOMER FINANCING
The Company assists its home buyers in obtaining financing from mortgage
lenders offering qualified home buyers a variety of financing options, including
a wide variety of conventional and Federal Housing Administration ("FHA")
financing programs. The Company also provides customer financing in the Colorado
market through Melody Mortgage. Melody Mortgage provides mortgage originations
only, and does not retain or service the mortgages that it originates. The
mortgages are funded by one of a number of mortgage lenders arranged by Melody
Mortgage. All of Melody Mortgage's revenues are derived from mortgages on homes
built by the Company and no third party loans are arranged for homes not built
by the Company.
In certain limited circumstances, the Company may attempt to minimize
potential risks relating to the availability of customer financing by purchasing
mortgage financing commitments that lock in the availability of funds and
interest rates at specified levels for a certain period of time. Also, the
Company has occasionally provided financing pursuant to agreements of sale and
second mortgages to purchasers of its homes and residential lots in Hawaii. The
Company had notes receivable of $2.0 million at December 31, 1998 primarily
comprised of second mortgages provided by the Company to home buyers who
purchased homes as part of the Company's "zero-down" sales incentive program in
Hawaii. To the extent the Company provides financing to its customers, it
becomes subject to the risks inherent with such practices, including possible
defaults by the purchasers. The Company believes that it has established
adequate reserves to cover these risks and the Company does not record the
related revenue and profit until the second mortgage is fully paid.
Virtually all purchasers of the Company's homes finance their purchases with
mortgage financing from lenders. In general, housing demand is adversely
affected by increases in interest rates, unavailability of mortgage financing,
increasing housing costs and unemployment. If mortgage interest rates increase
and the ability of prospective buyers to finance home purchases is adversely
affected, the Company's residential
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real estate sales, gross margins and net income and the market prices of the
Company's securities may be adversely impacted. The Company's homebuilding
activities are also dependent upon the availability and cost of mortgage
financing for buyers of homes owned by potential customers so those customers
("move-up buyers") can sell their homes and purchase a home from the Company. In
addition, the Company believes that the availability of FHA mortgage financing
is an important factor in marketing many of its homes. Any limitations or
restrictions on the availability of such financing could adversely affect the
Company's residential real estate sales. Furthermore, changes in Federal income
tax laws may affect demand for new homes. Enactment of such proposals may have
an adverse effect on the homebuilding industry in general, and demand for the
Company's products in particular. No prediction can be made whether any such
proposals will be enacted and, if enacted, the particular form such laws would
take.
WARRANTY PROGRAM
The Company generally provides limited warranties of at least one to two
years for workmanship and materials and for longer periods with respect to
structural components. Because the Company contracts its homebuilding work to
qualified contractors or subcontractors who provide the Company with an
indemnity and a lien release prior to receiving payment from the Company for
their work, claims relating to workmanship and materials are generally the
primary responsibility of the Company's contractors or subcontractors. However,
to the extent that warranty claims are not covered by the Company's contractors
or subcontractors, the Company has established a reserve to cover warranty
expenses. The Company's historical experience is that such warranty expenses
generally fall within the reserve established although no assurances can be
given that this will be the experience in the future. From time to time, where
deemed appropriate, the Company purchases structural warranty coverage from
third party insurers.
For homes closed from early 1990 until October 7, 1994, Melody's structural
warranty coverage was with the Home Owners Warranty Corporation ("HOW"). On
October 7, 1994, the Commonwealth of Virginia placed HOW under temporary
receivership, and a permanent injunction followed on October 17, 1994. Terms of
the injunction allowed policies that were effective prior to October 7, 1994, to
be honored for their full term. It is Melody's understanding that HOW is
currently paying approximately 50% of the costs associated with claims made
under the HOW policies. Concurrent with the above, Melody entered into an
agreement with Residential Warranty Corporation to provide its home buyers with
equally suitable coverage for homes closed subsequent to October 7, 1994. The
Company, based upon its due diligence in connection with the acquisition of
Melody, believes that claims under Melody's warranty programs are substantially
covered by Melody's warranty accruals or insurance. However, no assurances can
be given that the Company will not incur future claims in any of its markets in
excess of warranty accruals or insurance coverage.
ACQUISITIONS AND JOINT VENTURES
Prior to 1997, the Company operated solely in the Hawaii market, one of the
country's strongest residential housing markets in the late 1980's and early
1990's. Due to a decline in the Hawaiian economy which negatively impacted the
Hawaiian residential housing market in the mid-1990's, the Company adopted a
strategic expansion plan late in 1996 and early 1997 designed to geographically
diversify the Company's operations outside of the Hawaii market in order to
improve the Company's overall return on invested capital. The expansion plan
provided for the redeployment of capital generated by the Hawaii division to
housing markets in the Western United States that have experienced significant
population and employment growth in recent years. As a result of its
diversification efforts, the Company reported improved financial results in 1997
and 1998 with revenues of $229.6 million and $282.9 million, respectively, as
compared to $93.6 million in 1996. In addition, since 1996 the Company (i)
reduced its completed and unsold housing inventory in Hawaii by 53%, (ii)
generated approximately $32 million and $28.5 million in cash flow in Hawaii, in
1997 and 1998, respectively, and (iii) derived approximately 63% and 70% of its
revenues from sales in markets outside of Hawaii in 1997 and 1998, respectively.
10
<PAGE>
In January 1997, the Company acquired Melody, one of the largest
homebuilders in Denver, Colorado for over 40 years, and Melody Mortgage, a
mortgage brokerage firm for Melody homebuyers.
On July 31, 1997, the Company acquired a 49% interest in Stafford Homes, a
30-year-old homebuilder in the greater Seattle/Puget Sound area of Washington
State. The Company increased its interest to 89% in January 1999, and expects to
acquire the remaining 11% interest in January 2001. The Company believes that
the joint venture arrangement provided an opportunity for the Company to
strategically expand into the Seattle/Puget Sound area, an attractive housing
market, through a company with a good reputation, a strong management team and a
significant land base.
In July 1998, the Company acquired a 50% interest in a joint venture, The
Ranch-Southpointe II LLC, to build 116 townhomes in Lafayette, Colorado.
In October 1998, the Company expanded its presence in the Oregon market with
its acquisition of certain assets (principally options to purchase land) and the
employment of the former management team of Keys, a Portland, Oregon
homebuilder. Keys was engaged in the construction and sale of high quality
single-family, duplex and cottage homes targeted for the entry-level market. In
the twelve months ended September 30, 1998, Keys closed the sales of 193 homes
generating revenues of approximately $23.8 million. The Company believes that by
adding the Keys management team to its existing Oregon division, the Company
will benefit as a result of their experience and track record of profitability,
together with their strong land position of approximately 733 lots under control
at the time of acquisition.
In addition, the Company has a 50% interest in Waiakoa Estates Subdivision
Joint Venture, an unincorporated joint venture which is engaged in the
development and sale of residential lots on the island of Maui and has a 50%
interest in Iao Partners, a general partnership which is engaged in the
development and sale of an "affordable" townhome residential project on the
island of Maui.
As part of its strategy to further diversify geographically and facilitate
its expansion within its current markets and into new markets, the Company
expects to continue to evaluate potential acquisitions of homebuilding
companies, strategic investments and joint ventures.
COMPETITION
The development and sale of residential properties is highly competitive and
fragmented. The Company competes for residential sales on the basis of a number
of interrelated factors, including location, reputation, amenities, design,
quality and price, with numerous national, regional and local builders,
including some builders with greater financial resources. The Company also
competes for residential sales with individual resales of existing homes and
available rental housing. The Company believes that it compares favorably to
other builders in the markets in which it operates, due primarily to (i) its
experience within its geographic markets, (ii) its responsiveness to market
conditions, and (iii) its reputation for quality design, construction and
service. Competition is particularly intense when the Company enters or starts
operations in a new market area until its reputation becomes firmly established
in that area.
GOVERNMENT REGULATION AND ENVIRONMENTAL MATTERS
GENERAL. In developing a project, the Company must obtain the approval of
numerous governmental authorities regulating such matters as permitted land uses
and levels of density and the installation of utility services such as
electricity, water and waste disposal. Several governmental authorities have
imposed fees as a means of defraying the cost of providing certain governmental
services to developing areas. The Company has historically, for the most part,
purchased land which is fully entitled and zoned for residential development.
Because the Company historically has generally purchased land that has already
been zoned for residential development, restrictive zoning issues have not had a
material adverse effect on the Company's development activities. The Company is
also subject to local, state and federal statutes and rules regulating
environmental matters, protection and preservation of archeological finds,
zoning, building design and density requirements which limit the number of homes
that can be built within a particular
11
<PAGE>
project, and fees imposed to defray the cost of providing certain governmental
services to developing areas. These laws may result in delays, cause the Company
to incur substantial compliance costs and prohibit or severely restrict
development in certain environmentally or archaeologically sensitive regions or
areas.
The Company may be subject to additional costs, delays or may be precluded
entirely from developing its projects because of government regulations that
could be imposed in the future due to unforeseen health, safety, welfare,
archeological or environmental concerns. Environmental regulations can also have
an adverse impact on the availability and price of certain raw materials such as
lumber. Hawaii, in particular, has some of the strictest land use, environmental
and agricultural laws in the United States, and the rezoning of land for urban
development is a difficult and time-consuming process.
To varying degrees, certain permits and approvals will be required to
complete the residential developments in progress or currently being planned by
the Company. The ability of the Company to obtain necessary approvals and
permits for these projects is often beyond the Company's control and could
restrict or prevent the development of otherwise desirable property. The length
of time necessary to obtain permits and approvals increases the carrying costs
of unimproved property acquired for the purpose of development and construction
and could delay the timing of the closing of its sales. 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.
HAWAII'S AFFORDABLE HOUSING REQUIREMENTS. To promote affordable housing,
governmental agencies in Hawaii have implemented various formal and informal
policies at both the state and county level. As a condition to rezoning land for
urban development, it is the current practice of certain County governments to
negotiate agreements with residential land developers for the provision of
affordable housing. Generally, these conditions require developers of
residential projects to offer for sale to eligible buyers a portion typically
from 10% to 60%, of the total number of units in the project at affordable
prices usually determined as a price at which a purchaser earning up to 120% of
the local median income is able to satisfy specified mortgage criteria. For
purposes of determining whether a home is affordable, the Counties generally
assume a 33% income-to-loan ratio, a monthly amount for common area expenses and
taxes, a 30-year loan with an interest rate reflecting then current market
conditions and various other factors. To ensure that homes sold pursuant to a
governmentally imposed affordable housing requirement in Hawaii remain
affordable to other eligible buyers and to prevent speculation, Counties
typically impose transfer restrictions on purchasers of the Company's affordable
homes. Agreements entered into between developers and County agencies may also
provide for a shared appreciation arrangement whereby the County shares with the
owner in the appreciation of the affordable home. Based upon this affordability
criterion, specific price limitations are generally imposed on the homes that
may satisfy a developer's affordable housing requirement. Increases in mortgage
interest rates may decrease the sales price at which affordable homes may be
sold thereby potentially reducing the profitability of affordable housing
projects.
Because a portion of the Company's focus is on Hawaii's affordable housing
market, any material changes in the current policies of the Hawaii Land Use
Commission and the various county authorities with regard to affordable housing
conditions or related policies could adversely affect the Company's operations
and financial results.
EMPLOYEES
At December 31, 1998, the Company employed 269 persons, of whom 135 were
executive, project management and administrative personnel, 113 were sales and
marketing, escrow, and customer service/ warranty personnel and 21 were
construction workers, who assist with punchlist clearing and other miscellaneous
tasks. Although none of the Company's employees are covered by collective
bargaining agreements, certain of the employees of contractors which the Company
engages are represented by labor unions or are subject to collective bargaining
arrangements. The Company believes that it has good relationships with its
employees and contractors.
12
<PAGE>
The Company's success is highly dependent upon the continuing services of
its President and Chief Executive Officer, James K. Schuler. The loss of the
services of James K. Schuler would have a material adverse effect on the
Company.
At December 31, 1998, James K. Schuler owned approximately 54% of the
Company's Common Stock. Due to this ownership position, Mr. Schuler has the
ability to control the affairs and policies of the Company and has the ability
to elect a sufficient number of directors to control the Board and to approve or
disapprove any matter submitted to a vote of stockholders. Furthermore, Mr.
Schuler may have conflicts of interest with other stockholders with respect to
the affairs and policies of the Company. Mr. Schuler's ownership position,
together with the anti-takeover effects of certain provisions contained in the
Company's Certificate of Incorporation and Bylaws and the repurchase option of
the holders of the Company's Convertible Subordinated Debentures due 2003 (the
"Debentures"), may have the effect of delaying, deferring or preventing a change
in control of the Company. These factors could have a depressant effect on the
market price of the Company's Debentures, Senior Notes and Common Stock.
EXECUTIVE OFFICERS OF THE REGISTRANT
In addition to executive officers who are also directors of the Company, the
following executive officers are not directors and are elected by and serve at
the discretion of the Board of Directors:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------------- --- -------------------------------------------
<S> <C> <C>
Harvey L Goth.............................. 66 Senior Vice President of Acquisition and
Development
David L. Oyler............................. 49 Vice President/Division President-- Melody
Homes, Inc.
Douglas M. Tonokawa........................ 40 Vice President of Finance and Chief
Accounting Officer
</TABLE>
HARVEY L. GOTH. Mr. Goth has been the Company's Senior Vice President of
Acquisition and Development since May 1992. Prior to joining the Company, Mr.
Goth was President of Malama Pacific Corporation from October 1991 to May 1992
and Executive Vice President of Blackfield Hawaii Corporation from April 1983 to
May 1988. Mr. Goth was a development consultant from May 1988 to October 1991 in
Hawaii and Nevada. Malama Pacific Corporation is a real estate development
company and subsidiary of Hawaiian Electric Industries. Blackfield Hawaii
Corporation, also a real estate developer, was a subsidiary of Pacific
Enterprises.
DAVID L. OYLER. Mr. Oyler has served as the Vice President/Division
President of Melody Homes, Inc. since 1994. He joined Melody Homes, Inc. in
August, 1974 and has held the positions of Assistant Manager of Land
Development, Vice President of Land Development, Company Safety Officer and
Executive Vice President.
DOUGLAS M. TONOKAWA. Mr. Tonokawa joined the Company as Vice President of
Finance in September 1992 and has also served as Chief Accounting Officer since
1996. From 1982 to September 1992, Mr. Tonokawa was employed at Ernst & Young
LLP, a national accounting firm, where he reached the level of Senior Manager.
Mr. Tonokawa is a member of the Hawaii Society of Certified Public Accountants
and the American Institute of Certified Public Accountants.
ITEM 2. PROPERTIES.
The Company leases approximately 7,300 square feet of office space for its
corporate headquarters in Honolulu, Hawaii, pursuant to a lease expiring in
October, 2000. The Company believes that its office space for its corporate
headquarters in Hawaii is suitable and adequate for its needs for the
foreseeable future or that adequate space will be readily available. The Company
also leases approximately 4,800 square feet of space for its other offices in
Hawaii, Northern California and Vancouver, Washington under
13
<PAGE>
leases expiring in 2001. However, the Company currently anticipates that as the
Northern California and Pacific Northwest divisions expand, additional office
space will be required.
The Company owns an 11,225 square foot building in Colorado where Melody
operates and has its corporate headquarters. In addition, the Company leases
1,938 square feet under a lease expiring in 1999 for its design center in
Colorado. Melody Mortgage also leases 2,470 square feet of office space for its
mortgage operations, under a lease which expires in 1999. The Company also
leases approximately 5,100 square feet of space for its other offices in
Colorado under leases expiring between 2001 and 2002. The Company currently
anticipates that as the Colorado homebuilding operations expand, office
expansion will also be necessary.
ITEM 3. LEGAL PROCEEDINGS.
In April 1996, the Company was served with a purported class action
complaint by owners of units and the Association of Owners of Fairway Village at
Waikele alleging, among other things, material construction defects and
deficiencies, misrepresentations regarding the cost of insurance and breach of a
covenant of good faith and fair dealing. Following the Courts' denial of a class
certification request, a second action involving other homeowners at Fairway
Village advancing the same claims was initiated. The complaints do not specify
an amount of damages, but include a claim for punitive damages. Based on its
current understanding of the lawsuits, the Company believes the claims to be
largely without merit and that potential third party defendants and insurance
coverage exist to offset a material portion of any damages from the alleged
claims. The litigation continues to be vigorously defended. A court date has
been set for April 1999 for the initial suit. Trial of the first action may
proceed at that time. No trial date has been set in the second action. If these
lawsuits were decided adversely to the Company in all material respects, they
collectively could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company is also from time to time involved in routine litigation or
threatened litigation arising in the ordinary course of its business. Such
matters, if decided adversely to the Company, would not, in the opinion of
management, have a material adverse effect on the financial condition of the
Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
No matters were submitted during the fourth quarter of 1998 to a vote of
security-holders, through the solicitation of proxies or otherwise.
14
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock has been quoted on the Nasdaq National Market
under the symbol "SHLR" since March 20, 1992. The following table shows the high
and low closing sales prices for the Common Stock of the Company for the periods
indicated, as reported by the Nasdaq National Market. These prices do not
include retail markups, markdowns or commissions.
<TABLE>
<CAPTION>
HIGH LOW
--------- ---------
<S> <C> <C>
1997
Quarter ended March 31, 1997........................................... $ 6.875 $ 5.375
Quarter ended June 30, 1997............................................ 6.000 4.875
Quarter ended September 30, 1997....................................... 7.500 5.625
Quarter ended December 31, 1997........................................ 8.125 6.000
1998
Quarter ended March 31, 1998........................................... $ 9.000 $ 6.281
Quarter ended June 30, 1998............................................ 10.063 7.250
Quarter ended September 30, 1998....................................... 9.125 6.875
Quarter ended December 31, 1998........................................ 7.875 6.375
1999
Quarter ended March 31, 1999 (February 26, 1999)....................... $ 6.750 $ 8.938
</TABLE>
The closing sale price of the Company's Common Stock as reported on the
Nasdaq National Market on February 26, 1999 was $8.063 per share. As of February
26, 1999, there were 208 holders of record of the Company's Common Stock. The
Company estimates that as of February 26, 1999, there were approximately 1,000
beneficial holders of the Company's Common Stock.
DIVIDENDS
The Company anticipates that all future earnings will be retained to finance
the continuing development of its business and does not anticipate paying cash
dividends on its Common Stock in the foreseeable future. The payment of any
future dividends will be at the discretion of the Company's Board of Directors
and will depend upon, among other things, future earnings, the success of the
Company's development activities, capital requirements, the general financial
condition of the Company and general business conditions. Payment of dividends
is also restricted by the Company's credit facility.
15
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA.
The following selected consolidated financial data of the Company are
qualified by reference to and should be read in conjunction with the
consolidated financial statements, related notes thereto and other financial
data included elsewhere herein. These historical results are not necessarily
indicative of the results to be expected in the future.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------
1998 1997 1996 1995 1994
----------- ----------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Residential real estate sales(1).............. $ 282,902 $ 229,624 $ 93,645 $ 132,897 $ 217,266
Cost and expenses:
Residential real estate sales............... 225,370 184,843 76,612 101,356 159,568
Inventory impairment loss(2)................ -- -- 23,910 9,405 --
Selling and commissions..................... 19,124 17,268 7,767 7,333 7,912
General and administrative.................. 16,008 13,596 4,179 4,167 3,510
----------- ----------- ----------- ----------- -----------
Total costs and expenses.................. 260,502 215,707 112,468 122,261 170,990
Income (loss) from unconsolidated joint
ventures.................................... 2,435 (136) 157 967 3,307
----------- ----------- ----------- ----------- -----------
Operating income (loss)................... 24,835 13,781 (18,666) 11,603 49,583
Other income (expense)........................ (4,243) (4,261) (9) 462 502
----------- ----------- ----------- ----------- -----------
Income (loss) before provision for income
taxes................................... 20,592 9,520 (18,675) 12,065 50,085
Provision (credit) for income taxes........... 7,876 3,634 (7,289) 4,703 19,336
----------- ----------- ----------- ----------- -----------
Net income (loss)......................... $ 12,716 $ 5,886 $ (11,386) $ 7,362 $ 30,749
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Net income (loss) per share (basic)........... $ 0.63 $ 0.29 $ (0.55) $ 0.35 $ 1.47
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Weighted average shares outstanding (basic)... 20,102,922 20,100,267 20,583,860 20,874,177 20,867,215
Net income (loss) per share (diluted)(3)...... $ 0.63 $ 0.29 $ (0.55) $ 0.35 $ 1.37
----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- -----------
Weighted average shares outstanding
(diluted)................................... N/A N/A N/A N/A 23,501,205
</TABLE>
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash............................................................. $ 4,915 $ 3,842 $ 1,619 $ 6,147 $ 7,855
Inventories...................................................... 325,166 291,081 238,358 247,506 209,123
Total assets..................................................... 385,543 340,571 268,947 273,370 279,678
Revolving Credit Facility........................................ 17,365 91,077 44,690 36,781 27,717
9% Senior Notes due 2008......................................... 98,512 -- -- -- --
6.50% Convertible Subordinated Debentures due 2003............... 57,500 57,500 57,500 57,500 57,500
Other indebtedness............................................... 3,954 2,627 -- -- 14,583
Total debt....................................................... 177,331 151,204 102,190 94,281 99,800
Total stockholders' equity....................................... 175,555 163,355 157,465 173,851 166,489
</TABLE>
- --------------------------
(1) Revenue from a sale is recognized upon the closing of the sale and when the
down payment requirement has been met. See Notes 1 and 2 of Notes to
Consolidated Financial Statements.
(2) Represents a non-cash charge pursuant to Financial Accounting Standards
Board Statement No. 121. See Notes 1 and 3 of Notes to Consolidated
Financial Statements.
(3) Net Income (loss) per share (diluted) is computed by adding interest charged
to cost of residential real estate sold which is applicable to the
Convertible Subordinated Debentures (net of related income taxes) to net
income and dividing by the weighted average number of shares outstanding,
assuming conversion of all Convertible Subordinated Debentures. The
computation of diluted earnings per share for 1998, 1997, 1996 and 1995
excludes the impact of the Convertible Subordinated Debentures, since the
effect would be antidilutive.
16
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
Except for historical information contained herein, the matters discussed in
this report contain forward-looking statements that involve risks and
uncertainties. The Company's actual results may differ materially from the
results discussed in the forward-looking statements. Factors that might cause
such a difference include, but are not limited to, those risks discussed herein,
and other risks detailed in this Form 10-K and other documents filed by the
Company with the Securities and Exchange Commission from time to time.
OVERVIEW
Schuler Homes designs, constructs, markets and sells single-family
residences, townhomes and condominiums primarily to entry level and first-time
move-up buyers. The Company operates in five geographic markets: Hawaii,
Colorado, Northern California, Oregon and Washington.
Schuler Homes' 1998 financial results reflected higher operating margins
than in 1997, coupled with increased unit closings and sales volumes. From 1997
to 1998 revenues grew 23.2% from $229.6 million to $282.9 million, the number of
units closed increased from 1,427 to 1,827. Net income increased 116.1% from
$5.9 million in 1997 to $12.7 million in 1998.
On May 6, 1998, the Company consummated its offering of $100 million
aggregate principal amount of 9% Senior Notes due 2008. The Company received net
proceeds from the offering of approximately $97.2 million (net of discounts and
estimated offering costs of approximately $2.8 million). The Company used such
net proceeds to repay a portion of the Company's borrowings under its line of
credit.
In July 1998, SHLR of Colorado, Inc. (a wholly-owned subsidiary of the
Company) was formed to purchase a 50% ownership interest in The
Ranch-Southpointe II LLC for the development and sale of a residential townhouse
project in Lafayette, Colorado.
In January 1999, the Company exercised its option to purchase an additional
40% ownership interest in Stafford, increasing its total ownership to 89%.
In October 1998, the Company acquired certain assets (principally options to
purchase land) of Keys, a Portland, Oregon homebuilder. Keys was engaged in the
construction and sale of single-family, duplex and cottage homes targeted for
the entry-level market. During the twelve months ended September 30, 1998, Keys
closed the sales of 193 homes generating revenues of approximately $23.8
million.
RESULTS OF OPERATIONS
SELECTED FINANCIAL INFORMATION
The table below shows certain items in the Company's statements of
operations data expressed as a percentage of total residential real estate
sales.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1998 1997 1996
--------- --------- ---------
<S> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Residential real estate sales........................................ 100.0% 100.0% 100.0%
Costs and expenses:
Residential real estate sales...................................... 79.7 80.5 81.8
Inventory impairment loss.......................................... -- -- 25.5
Selling and commissions............................................ 6.8 7.5 8.3
General and administrative......................................... 5.6 5.9 4.5
--------- --------- ---------
Total costs and expenses............................................. 92.1 93.9 120.1
Income (loss) from unconsolidated joint ventures..................... 0.9 (0.1) 0.2
--------- --------- ---------
Operating income (loss)............................................ 8.8% 6.0% (19.9)%
--------- --------- ---------
--------- --------- ---------
</TABLE>
17
<PAGE>
OPERATING DATA
The operating data shown below shows certain data regarding units closed,
average sales prices of units closed, and backlog.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------
1998 1997 1996
-------------- ------------- -------------
<S> <C> <C> <C>
SELECTED OPERATING DATA:
Unit closings
Colorado....................................................... 1,090 950 --
Hawaii(1)...................................................... 320 343 460
Northern California............................................ 83 15 --
Oregon......................................................... 63 9 --
-------------- ------------- -------------
Total Consolidated........................................... 1,556 1,317 460
Unconsolidated Joint Ventures:
Hawaii(2).................................................... 20 28 52
Washington(3)................................................ 251 82 --
Colorado(4).................................................. -- -- --
-------------- ------------- -------------
Total............................................................ 1,827 1,427 512
-------------- ------------- -------------
-------------- ------------- -------------
Average sales price
Colorado....................................................... $ 158,000 $ 149,000 $ --
Hawaii(1)...................................................... 268,000 228,000 234,000
Northern California............................................ 154,000 141,000 --
Oregon......................................................... 198,000 179,000 --
Total Consolidated........................................... 182,000 169,000 234,000
Unconsolidated Joint Ventures:
Hawaii(2).................................................... 121,000 130,000 126,000
Washington(3)................................................ 240,000 223,000 --
Colorado(4).................................................. -- -- --
Total.......................................................... 189,000 172,000 225,000
Backlog at period end, units(5).................................... 681 408 78
Backlog at period end, aggregate sales value(5).................... $ 123,886,000 $ 76,125,000 $ 18,277,000
</TABLE>
- ------------------------
(1) Includes homes and lots sold pursuant to the Company's "zero-down" sales
program in Hawaii. Approximately $0.3 million, $3.4 million and $14.7
million of revenues associated with 2, 18 and 70 zero-down closings were
deferred in 1998, 1997 and 1996, respectively, until the related notes
receivables are paid in full.
(2) Reflects 100% of the information with respect to the Company's two 50% owned
joint ventures in Hawaii, Iao Partners and Waiakoa Kai Estates Subdivision
Joint Venture.
(3) Reflects 100% of the information with respect to Stafford Homes in which the
Company acquired a 49% interest in July, 1997. The number of sales closed
for the year ended December 31, 1997 would have been 160 had the Company had
an ownership interest in Stafford Homes for the entire year.
(4) Reflects 100% of the information with respect to the Company's 50%-owned
joint venture in Colorado, The Ranch-Southpointe II LLC, which was entered
into in July, 1998.
(5) Represents homes/lots subject to pending sales contracts that have not yet
closed. As such contracts are subject to certain conditions being satisfied
and may be canceled by the buyer at any time, no assurances can be given
that homes/lots subject to pending sales contracts will result in closings.
18
<PAGE>
COMPARISON OF THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
RESIDENTIAL REAL ESTATE SALES
The Company's sales of residential real estate (revenues) in 1998 were
$282.9 million, an increase of 23.2% as compared to 1997 sales of $229.6
million. The increase in revenues reflects a larger number of and higher average
sales price of unit sales closed in 1998 relative to 1997. The Company's average
sales price per unit increased in 1998 to $189,000, a 9.9% increase from an
average sales price per unit of $172,000 in 1997. The increase in the average
sales price per unit was attributable to increased sales prices in the Company's
mainland markets resulting from strong market conditions, in combination with a
different mix of homes delivered in 1998 as compared to 1997.
The Company's revenues in 1997 were $229.6 million, an increase of 145.2% as
compared to 1996 revenues of $93.6 million. The increase in revenues reflects a
larger number of unit sales closed in 1997 relative to 1996, partially offset by
lower average sales prices in 1997 than in 1996. During 1997, the Company
recognized $10.1 million of deferred revenue related to 53 of the 70 sales that
closed in 1996 pursuant to the Company's zero-down sales program, in which the
Company provided new home buyers with second mortgages of up to 20% of the
purchase price. Revenue and profit recognition on these zero-down sales was
deferred until the requirements for revenue and profit recognition were
satisfied, which occurred during the first quarter of 1997 when the second
mortgages were sold.
COSTS AND EXPENSES--RESIDENTIAL REAL ESTATE SALES
Cost of residential real estate sales represents the acquisition and
development costs of a project attributable to the homes closed. Acquisition and
development costs include primarily land acquisition costs, sitework and
construction payments to contractors, engineering and architectural costs, loan
fees, interest and other indirect costs attributable to development and project
management activities and miscellaneous construction costs.
Cost of residential real estate sales in 1998 were $225.4 million, an
increase of 21.9% as compared to cost of residential real estate sales in 1997
of $184.8 million. This increase reflects a larger number of unit sales in 1998
relative to 1997. As a percentage of revenues, cost of residential real estate
sold decreased in 1998 to 79.7% from 80.5% in 1997. This decrease reflects
higher margins realized by the Colorado division primarily due to an increase in
average sales prices and higher margins in the Company's Hawaii operation
primarily as a result of the impact in 1997 of the recognition of costs related
to the sales of second mortgages associated with zero-down sales deferred in
1996.
Cost of residential real estate sales in 1997 were $184.8 million, an
increase of 141.3% as compared to cost of residential real estate sales in 1996
of $76.6 million. This increase reflects a higher level of unit and dollar sales
closed in 1997 relative to 1996. As a percentage of revenues, cost of
residential real estate sold decreased in 1997 to 80.5% from 81.8% in 1996. This
decrease reflects higher gross margin realized by the Colorado division,
partially offset by lower gross margins realized by the Hawaii division,
including the impact of the recognition of costs related to zero-down sales
deferred in 1996 and recognized in 1997 as a result of the sale of the related
second mortgages.
COSTS AND EXPENSES--INVENTORY IMPAIRMENT LOSS
Financial Accounting Standards Board ("FASB") Statement No. 121, "Accounting
for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of," requires that inventories which are substantially completed are carried at
the lower of cost or fair value less selling cost, determined by applying a risk
adjusted discount rate to estimates of future cash flows. In addition, land held
for future development or inventories under current development are adjusted to
fair value, only if an impairment to their value is indicated.
The estimates of future cash flows require significant judgment relating to
the level of sales prices, rate of new home sales, amount of marketing costs and
price discounts needed in order to stimulate sales, rate of increase in the cost
of building materials and labor, introduction of building code modifications,
and the level of consumer confidence, among other items. While the Company did
not recognize a FASB
19
<PAGE>
121 charge in 1998 or 1997, no assurances can be given that changes in estimates
will not occur in subsequent periods.
During 1996, the Company recognized an impairment loss in its Hawaii
division of $23.9 million, ($14.6 million after-tax) primarily related to (i) an
increase in completed inventories due to the substantial completion of the
second high-rise building at the Company's Country Club Village project located
in Salt Lake on Oahu and (ii) the decline experienced by the Company in the rate
of new home sales contracts entered into, which resulted in a more conservative
outlook with respect to the estimate of future cash flows for certain other
completed projects on some of which impairment losses were recognized in 1995.
The Company's completed and unsold inventories in its wholly owned projects in
Hawaii have declined by 53% at December 31, 1998 as compared to December 31,
1996. In addition, the Company postponed the construction of the third and last
high-rise building at Country Club Village in order to reduce completed
inventories in this project in the future.
COSTS AND EXPENSES--SELLING AND COMMISSIONS
Selling and commissions expense represents the selling and marketing costs
associated with the sale of homes. Such costs include commissions, sales
incentives offered to buyers, advertising costs, model and sales office costs
and other general sales and marketing costs.
Selling and commissions expense in 1998 was $19.1 million, an increase of
10.7% as compared to selling and commissions expense in 1997 of $17.3 million.
As a percentage of revenues, selling and commissions decreased to 6.8% in 1998
from 7.5% in 1997. This decrease is a result of the selling costs and
commissions increasing at a lower rate than revenues.
Selling and commissions expense in 1997 was $17.3 million, an increase of
122.3% as compared to selling and commissions expense in 1996 of $7.8 million.
The increase in selling and commissions expense reflects a higher level of unit
and dollar sales closed in 1997 than in 1996, primarily due to the acquisition
of the Colorado division. As a percentage of revenues, selling and commissions
expense decreased to 7.5% in 1997 from 8.3% in 1996. This decrease is primarily
the result of the lower level of selling and commissions costs incurred by the
Colorado division relative to the Hawaii division, partially offset by increases
in the selling and commissions costs in Hawaii.
COSTS AND EXPENSES--GENERAL AND ADMINISTRATIVE
General and administrative expense includes salaries, office and other
administrative costs. Indirect costs attributable to specific projects are
capitalized and deducted as part of the cost of residential real estate sales.
General and administrative expenses in 1998 were $16.0 million, an increase
of 17.7% as compared to general and administrative expenses of $13.6 million in
1997. As a percentage of revenues, general and administrative expenses decreased
to 5.6% in 1998 from 5.9% in 1997. This decrease is a result of general and
administrative expenses increasing at a lower rate than revenues.
General and administrative expenses in 1997 were $13.6 million, an increase
of 225.3% as compared to general and administrative expenses in 1996 of $4.2
million. The increase in general and administrative expenses reflect the
addition of the Colorado division in 1997 and the start-up of operations in
Northern California and Washington. As a percentage of revenues, general and
administrative expenses increased to 5.9% in 1997 from 4.5% in 1996. This
increase reflects the above-mentioned increases and higher costs relative to
revenues in the Hawaii division.
INCOME FROM UNCONSOLIDATED JOINT VENTURES
Income from unconsolidated joint ventures represents the Company's 49%
interest in the operations of Stafford and its 50% interest in the operations of
two joint ventures in Hawaii. The increase in this income from 1997 to 1998 is
primarily the result of the growth in income from the Company's 49% interest in
Stafford of $1.9 million. The decrease in this income in 1997 relative to 1996
is primarily the result of the
20
<PAGE>
Company's share of a loss recognized by one of its Hawaii joint ventures in
1997, Iao Partners, of $397,000, which was driven by the Company's share of a
FASB 121 charge of $522,000. This 1997 loss was offset in part by the Company's
share of income since the date of acquisition (July 1997) of $329,000 in
Stafford.
In January 1999, the Company increased its ownership interest in Stafford
Homes to 89%. In 1999, the Company anticipates the results of operations of
Stafford to be consolidated with the Company's financial statements and not
treated as income from unconsolidated joint ventures.
OTHER INCOME (EXPENSE)
Other income (expense) represents (i) interest incurred less interest
capitalized to inventory (interest expense), (ii) amortization of financing
fees, net of amounts capitalized to inventory, and (iii) amortization of
goodwill and a covenant-not-to-compete related to the Melody acquisition; less
interest income. The increase from 1997 to 1998 is primarily the result of an
increase in the amount of interest and financing fees expensed. The increase
from 1996 to 1997 relates primarily to the acquisition of Melody in January
1997, and the associated amortization of goodwill and covenant not-to-compete.
PROVISION (CREDIT) FOR INCOME TAXES
The effective combined tax rates were approximately 38.2%, 38.2% and 39.0%
in 1998, 1997 and 1996, respectively. The lower effective income tax rate for
1998 and 1997 primarily reflects lower Colorado state income tax rate as
compared to Hawaii's state income tax rate.
BACKLOG
The Company's homes are generally offered for sale in advance of their
construction upon applicable regulatory approval and sold pursuant to standard
sales contracts. The Company's standard sales contract may be canceled by the
buyer at any time prior to closing. The Company does not recognize revenues on
homes covered by such contracts until the sales are closed. Homes covered by
such sales contracts are considered by the Company as its backlog.
The following table sets forth the Company's backlog, for both homes and
residential lots, at December 31, 1998, 1997, and 1996, which includes homes and
lots sold pursuant to the Company's zero-down sales program and 100% of the
backlog related to projects developed by the Company's joint ventures in Hawaii
and Washington.
<TABLE>
<CAPTION>
DECEMBER 31, 1998 DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------------- -------------------------- --------------------------
AGGREGATE AGGREGATE AGGREGATE
NUMBER SALES VALUE NUMBER SALES VALUE NUMBER SALES VALUE
----------- -------------- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Consolidated:
Colorado(1)............................ 457 $ 78,075,000 267 $ 41,284,000 -- $ --
Hawaii................................. 47 11,903,000 67 19,774,000 71 17,204,000
Northern California.................... 35 6,508,000 14 1,905,000 -- --
Oregon................................. 76 13,397,000 14 2,676,000 -- --
--- -------------- --- ------------- --- -------------
Total Consolidated....................... 615 109,883,000 362 65,639,000 71 17,204,000
Unconsolidated Joint Ventures:
Hawaii................................. 5 620,000 3 398,000 7 1,073,000
Washington(2).......................... 41 10,272,000 43 10,088,000 -- --
Colorado(3)............................ 20 3,111,000 -- -- -- --
--- -------------- --- ------------- --- -------------
Total.................................... 681 $ 123,886,000 408 $ 76,125,000 78 $ 18,277,000
--- -------------- --- ------------- --- -------------
--- -------------- --- ------------- --- -------------
</TABLE>
See footnotes on the following page.
21
<PAGE>
- ------------------------
(1) The Colorado market was added in 1997 as a result of the acquisition of
Melody in January 1997. Colorado backlog at December 31, 1996 approximated
219 units with an aggregate sales value of $32.2 million.
(2) The Washington market was added in 1997 as a result of the Company's
acquisition of a 49% interest in Stafford in July 1997. Washington backlog
at December 31, 1996 approximated 39 units with an aggregate sales value of
$9.3 million.
(3) Reflects the backlog of the Company's 50%-owned joint venture in Colorado,
The Ranch-Southpointe II LLC, which was entered into in July 1998.
The average sales prices of the homes and lots comprising backlog for
consolidated projects at December 31, 1998, 1997 and 1996 were $179,000,
$181,000 and $242,000, respectively. The lower average sales prices in 1998 and
1997 relative to 1996 primarily reflects an increase in the number of homes sold
in the Company's mainland U.S. divisions as a result of the strength of the
housing markets in those areas, where the average sales prices are lower than in
Hawaii, which made up 100% of the backlog in 1996.
The increase in backlog in Colorado from 1997 to 1998 reflects a higher rate
of new home sales. These improvements are related to a greater number of
projects under development and a strong overall housing market in the Denver
metropolitan area. The California and Oregon divisions backlog increased as a
result of a greater number of projects under development in 1998 as compared to
1997.
Due to the ability of buyers to cancel their sales contracts, no assurance
can be given that homes in backlog will result in actual closings.
VARIABILITY OF RESULTS; OTHER FACTORS
The Company has experienced, and expects to continue to experience,
significant variability in sales and net income. Factors that contribute to
variability of the Company's results include: the timing of home closings, a
substantial portion of which historically have occurred in the last month of
each quarter; the Company's ability to continue to acquire additional land on
favorable terms for future developments; the condition of the real estate
markets and economies in which the Company operates; the cyclical nature of the
homebuilding industry and changes in prevailing interest rates; costs of
material and labor; and delays in construction schedules caused by timing of
inspections and approval by regulatory agencies, including zoning approvals,
building permits and receipt of entitlements, the timing of completion of
necessary public infrastructure, the timing of utility hookups and adverse
weather conditions. The Company's historical financial performance is not
necessarily a meaningful indicator of future results and, in general, the
Company's financial results will vary from development to development, and from
fiscal quarter to fiscal quarter.
In addition, the Company believes that the market price of its common stock
may at times be adversely affected due to the Company's relatively small size
when compared to certain other publicly traded national homebuilding firms. The
Company further believes that the price of its common stock may be adversely
affected due to the relatively low trading volume for its shares.
YEAR 2000 COMPLIANCE
The Company has developed and is currently executing a plan designed to make
its computer systems Year 2000 compliant. The plan covers four stages including
(i) inventory, (ii) assessment, (iii) remediation, and (iv) testing. The Company
has substantially completed the inventory, assessment and remediation stages for
its systems and applications. The Company has started its testing of these
systems and applications, and expects to complete such testing by mid-1999.
The Company currently estimates that approximately $80,000 will be incurred
to address Year 2000 issues. As of December 31, 1998, approximately $50,000 has
been incurred and expensed. The Company
22
<PAGE>
anticipates that its Year 2000 costs will be funded from operations, and does
not expect to defer any other information technology projects as a result of its
Year 2000 efforts. The Company does not anticipate the Year 2000 issue will have
material adverse effects on the business operations or financial performance of
the Company. However, the failure of any internal system to achieve Year 2000
readiness could result in material disruption to the Company's operations.
The Company has also initiated discussions with parties with whom it does
business to ensure that those parties have appropriate plans to remediate Year
2000 issues where their systems impact the Company's operations. The Company is
assessing the extent to which its operations are vulnerable should these
organizations fail to properly remediate the computer systems. Although the
Company believes that alternative sources of labor and materials will be
available, there can be no assurance that the inability of the Company's key
subcontractors and suppliers to attain Year 2000 compliance will not have a
material adverse effect on the business operations and financial performance of
the Company. Even where assurances are received from third parties there remains
a risk that failure of systems and products of other companies on which the
Company relies could have a material adverse effect on the Company.
In addition, the Company is materially reliant on third parties with respect
to its ability to collect sales proceeds and pay its vendors and employees. Such
third parties include governmental agencies in various jurisdictions that record
the conveyance of property, title and escrow companies, banks and payroll
processing firms. The Company intends to create a contingency plan once
responses from such third parties to questionnaires have been received and
evaluated.
The costs of Year 2000 compliance and the foregoing statements are based
upon management's best estimates at the present time, which were derived
utilizing numerous assumptions of future events, including the continued
availability of certain resources, third party modification plans and other
factors. There can be no guarantee that these estimates will be achieved and
actual results could differ materially from those anticipated. Specific factors
that might cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, the nature and amount of programming
required to upgrade or replace each of the affected programs, the rate and
magnitude of related labor and consulting costs and the success of the Company's
external customers and suppliers in addressing the Year 2000 issue. The
Company's evaluation is on-going and it expects that new and different
information will become available to it as that evaluation continues.
Consequently, there is no guarantee that all material elements will be Year 2000
ready in time.
LIQUIDITY AND CAPITAL RESOURCES
The Company uses its liquidity and capital resources to, among other things,
(i) support its operations including its inventories of homes, home sites and
land; (ii) provide working capital; (iii) fund market expansion, including
acquisitions, investments in and advances to joint ventures, and start-up
operations; and (iv) make interest payments on outstanding debt.
CAPITAL RESOURCES
The Company anticipates continuing to acquire land for use in its future
homebuilding operations, including finished lots and partially developed land.
The Company currently intends to acquire a portion of the land inventories
required in future periods through takedowns of lots subject to option contracts
entered into in prior periods and under new option contracts. The use of option
contracts lessens the Company's land-related risk and improves liquidity.
Because of increased demand for partially developed and finished lots in certain
of the markets where the Company builds homes, the Company's ability to acquire
lots using option contracts has been reduced or has become more expensive.
In connection with the purchase of its 49% interest in Stafford 1997, the
Company entered into an agreement to make loans available to Stafford in an
aggregate principal amount of up to $10.0 million (increased from $5.0 million
as of June 1, 1998). In addition, the Company had an option to purchase the
remaining 51% interest in Stafford based on a pre-determined formula, subject to
certain contingencies. In
23
<PAGE>
January 1999, the Company increased its ownership interest in Stafford to 89%
and refinanced Stafford's existing debt. As of December 31, 1998, Stafford's
total assets were approximately $54.4 million and notes payable were
approximately $38.2 million, of which $9.5 million was outstanding to the
Company. The Company anticipates that it will acquire the remaining 11% interest
in Stafford in January 2001.
The Company anticipates that it has adequate financial resources to satisfy
its current and near-term capital requirements based on its current capital
resources and additional liquidity available under existing credit agreements.
The Company believes that it can meet its long-term capital needs (including,
among other things, meeting future debt payments and refinancing or paying off
other long-term debt as it becomes due) from operations and external financing
sources, assuming that no significant adverse changes in the Company's business,
or general economic conditions, occur as a result of the various risk factors
described elsewhere herein, in particular, increases in interest rates.
LINES OF CREDIT AND NOTES PAYABLE
On May 6, 1998, the Company consummated its offering of $100 million
aggregate principal amount of 9% Senior Notes, which are due April 15, 2008. The
Company received net proceeds from the offering of approximately $97.2 million
(net of discounts and estimated offering costs of approximately $2.8 million).
The Company used such proceeds to repay a portion of the Company's borrowings
under its line of credit. The offering costs will be amortized over the term of
the notes using the interest method. In April 1998, the Company amended certain
provisions of its Revolving Credit Facility to provide for the issuance of the
Senior Notes.
Effective September 30, 1998, the Company reduced the amount of its
Revolving Credit Facility from $97.6 million to $90 million. The Company has a
one-time option to increase the amount of the facility to $120 million. In
addition, the Company has a one-time option to reduce the amount of the facility
by $30 million on an irrevocable basis, provided the facility has been increased
to $120 million for at least six months. The Revolving Credit Facility expires
on July 1, 2001 and includes an option for the lenders to extend the term for an
additional year as of July 1 of each year. The Company can select an interest
rate based on either LIBOR (1, 2, 3 or 6-month term) or prime for each
borrowing. Based on the Company's leverage ratio, as defined, the interest rate
may vary from LIBOR plus 1.5% to 2% or prime plus 0% to 0.25%. The Revolving
Credit Facility contains covenants, including certain financial covenants and
also contains provisions which may, in certain circumstances, limit the amount
the Company may borrow. At December 31, 1998, $72.6 million of the Company's
line of credit was unused, of which $5.4 million is restricted to withdrawal for
specific project costs and letters of credit.
The Company has no material commitments or off-balance sheet financing
arrangements that would tend to affect future liquidity. The Company believes
that cash flow from operations and borrowings under its credit facilities will
provide adequate cash to fund the Company's operations at least through 1999.
However, there can be no assurance that the Company will not require additional
financing within this time frame. The Company may need to raise additional funds
in order to support more rapid expansion, respond to competitive pressures,
acquire complementary businesses or respond to unanticipated requirements. The
Company may seek to raise additional funds through private or public sales of
debt or equity securities, bank debt, or otherwise. There can be no assurance
that such additional funding, if needed, will be available on terms attractive
to the Company, or at all.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.
The Company has limited its market risk on $30 million of its Revolving
Credit Facility by entering into an interest rate swap agreement, which converts
floating rate debt to a fixed rate basis. This derivative financial instrument
is used for hedging purposes rather than speculation. The Company does not enter
into financial instruments for trading purposes.
As an example, based upon the Company's average bank borrowings of $49.2
million during 1998, if the interest rate indexes on which the Company's bank
borrowing rates are based were to increase 100
24
<PAGE>
basis points in 1999, interest incurred would increase and cash flows would
decrease in 1999 by $192,000, which amount reflects the effect on interest on
the portion of the bank borrowings in excess of the $30 million under the
interest rate swap agreement. A portion of the increased interest would be
expensed as a period cost in 1999, while the balance would be capitalized to
real estate inventories and be expensed as a component of the cost of
residential real estate sales in 1999 and future years.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
<TABLE>
<S> <C>
Report of Independent Auditors........................................................ 32
Consolidated Balance Sheets, December 31, 1998 and 1997............................... 33
Consolidated Statements of Operations for years ended December 31, 1998, 1997 and
1996................................................................................ 34
Consolidated Statements of Stockholders' Equity for years ended December 31, 1998,
1997 and 1996....................................................................... 35
Consolidated Statements of Cash Flows for years ended December 31, 1998, 1997 and
1996................................................................................ 36
Notes to Consolidated Financial Statements............................................ 37
</TABLE>
SCHEDULES
All schedules have been omitted as the required information is inapplicable
or the information is presented in the financial statements or related notes.
25
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
PART III
The Company's Proxy Statement for its 1999 Annual Meeting of Stockholders,
which, when filed pursuant to Regulation 14A under the Securities Exchange Act
of 1934, will be incorporated by reference in this Annual Report on Form 10-K
pursuant to General Instruction G(3) of Form 10-K, provides the information
required under Part III (Items 10, 11, 12 and 13), except for the information
with respect to the Company's executive officers who are not directors, which is
included in "Item 1. Business--Executive Officers of the Registrant."
26
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(A) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES.
See "Item 8. Financial Statements and Supplementary Data."
(B) REPORTS ON FORM 8-K.
None.
(C) EXHIBITS.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
2.1 Stock Purchase Agreement among the Company, Falcon Development
Corporation, Madison B. Graves, Jacob D. Bingham, Fred L. Ahlstrom and
Mark S. Doppe, dated January 8, 1997. (Incorporated by reference to the
Company's Current Report on Form 8-K dated January 8, 1997; Commission
file number 0-19891.)
3.1 Certificate of Incorporation of the Company. (Incorporated by reference to
Exhibit 3.1 of the Company's registration statement under the Securities
Act on Form S-1, Registration Statement No. 33-45485.)
3.2 Bylaws of the Company. (Incorporated by reference to Exhibit 3.2 of the
Company's registration statement under the Securities Act on Form S-1,
Registration Statement No. 33-55858.)
4.1 Indenture between the Company and Bishop Trust Company, Limited, as
Trustee, dated as of January 15, 1993. (Incorporated by reference to
Exhibit 4.1 of the Company's Current Report on Form 8-K dated January 21,
1993; Commission file number 0-19891.)
4.2 Form of Debenture (included in Exhibit 4.1).
4.3 Specimen of Common Stock certificate. (Incorporated by reference to
Exhibit 4.1 of the Company' registration statement under the Securities
Act on Form S-1, Registration No. 33-45485.)
4.4 Indenture between the Company and U.S. Trust Company of California, N.A.,
as Trustee, dated May 6, 1998. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q dated March 31, 1998; Commission file number
0-19891.)
4.5 Form of Senior Notes (included in Exhibit 4.4). (Incorporated by reference
to the Company's Quarterly Report on Form 10-Q dated March 31, 1998;
Commission file number 0-19891.)
4.6 Registration Rights Agreement dated as of April 30, 1998 between the
Company and the Initial Purchasers. (Incorporated by reference to Exhibit
4.5 of the Company's Registration Statement under Securities Act on Form
S-4, Registration No. 333-57723.)
10.1 Form of Indemnification Agreement between the Company and its directors
and certain officers. (Incorporated by reference to Exhibit 10.1 of the
Company's registration statement under the Securities Act on Form S-1,
Registration No. 33-45485.)
+10.2 1992 Stock Option Plan, as amended. (Incorporated by reference to Exhibit
10.2 of the Company's 1992 Annual Report on Form 10-K; Commission file
number 0-19891.)
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
+10.3 Form of Stock Option Agreement. (Incorporated by reference to Exhibit 28.2
of the Company's registration statement under the Securities Act on Form
S-8, Registration No. 33-53044.)
+10.4 Form of Non-Employee Director Automatic Option Grant Agreement.
(Incorporated by reference to Exhibit 28.3 of the Company's registration
statement under the Securities Act on Form S-8, Registration No.
33-53044.)
+10.5 Management Agreement dated as of January 31, 1992 between the Company and
James K. Schuler & Associates, Inc. (Incorporated by reference to Exhibit
10.8 of the Company's registration statement under the Securities Act on
Form S-1, Registration No. 33-45485.)
+10.6 Employment Agreement dated as of January 31, 1992 between the Company and
James K. Schuler. (Incorporated by reference to Exhibit 10.10 of the
Company's registration statement under the Securities Act on Form S-1,
Registration No. 33-45485.)
10.7 Joint Venture Agreement between the Company and United Realty, Inc. dated
as of August 26, 1989. (Incorporated by reference to Exhibit 10.54 of the
Company's registration statement under the Securities Act on Form S-1,
Registration No. 33-45485.)
10.8 Partnership Agreement between the Company and C. Brewer Properties, Inc.
dated as of October 15, 1992. (Incorporated by reference to Exhibit 10.75
of the Company's registration statement under the Securities Act on Form
S-1, Registration No. 33-55858.)
10.9 Purchase Agreement between the Company and Itoman Hawaii, Inc. dated
October 13, 1992. (Incorporated by reference to Exhibit 10.78 of the
Company's registration statement under the Securities Act on Form S-1,
Registration No. 33-55858.)
10.10 Agreement among the Company, Palailai Holdings, Inc. and Malama Mohala
Corp. dated November 4, 1992. (Incorporated by reference to Exhibit 10.79
of the Company's registration statement under the Securities Act on Form
S-1, Registration No. 33-55858.)
10.11 Purchase Agreement (Parcel 15) between the Company and AMFAC Property
Development Corp. dated July 14, 1992. (Incorporated by reference to
Exhibit 10.82 of the Company's registration statement under the Securities
Act on Form S-1, Registration No. 33-55858.)
10.12 Purchase Agreement (Parcel 20) between the Company and AMFAC Property
Development Corp. dated July 14, 1992. (Incorporated by reference to
Exhibit 10.83 of the Company's registration statement under the Securities
Act on Form S-1, Registration No. 33-55858.)
10.13 Lease between the Company and AALL Hawaii Holdings dated May 14, 1993
(i.e., lease of premises located at 828 Fort Street Mall, 4th Floor,
Honolulu, Hawaii). (Incorporated by reference to Exhibit 10.3 of the
Company's Quarterly Report on Form 10-Q dated June 30, 1993; Commission
file number 0-19891.)
10.14 Amendment dated April 9, 1993 to Purchase Agreement (Parcel 15) between
the Company and AMFAC Property Development Corp., a Hawaii Corporation.
(Incorporated by reference to Exhibit 10.2 of the Company's Current Report
on Form 8-K dated April 30, 1993; Commission file number 0-19891.)
10.15 Amendment dated April 9, 1993 to Purchase Agreement (Parcel 20) between
the Company and AMFAC Property Development Corp., a Hawaii Corporation.
(Incorporated by reference to Exhibit 10.4 of the Company's Current Report
on Form 8-K dated April 30, 1993; Commission file number 0-19891.)
</TABLE>
28
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
10.16 Purchase Agreement (Parcel 9) dated July 30, 1993 between the Company and
AMFAC Property Development Corp., a Hawaii Corporation. (Incorporated by
reference to Exhibit 10.1 of the Company's Quarterly Report on Form 10-Q
dated September 30, 1993; Commission file number 0-19891.)
+10.17 Schuler Homes, Inc. 401(k) Retirement Savings Plan (005) dated July 20,
1993, which amends in full the Schuler Homes, Inc. Profit Sharing Plan
(005), originally effective November 1, 1989. (Incorporated by reference
to Exhibit 10.6 of the Company's Quarterly Report on Form 10-Q dated
September 30, 1993; Commission file number 0-19891.)
+10.18 Amendment to the Schuler Homes, Inc. 401(k) Retirement Savings Plan (005)
(Sections 2.1 and 2.2) effective September 1, 1993. (Incorporated by
reference to Exhibit 10.7 of the Company's Quarterly Report on Form 10-Q
dated September 30, 1993; Commission file number 0-19891.)
10.19 Letter Agreement between the Company and Lokelani Ma'ili Kai, Ltd. and
P.H. Property Development Company, dated January 24, 1994. (Incorporated
by reference to Exhibit 10.1 of the Company's Current Report on Form 8-K
dated March 2, 1994; Commission file number 0-19891.)
10.20 Addendum to Letter Agreement dated January 24, 1994 between the Company
and Lokelani Ma'ili Kai, Ltd. and P.H. Property Development Company, dated
February 18, 1994. (Incorporated by reference to Exhibit 10.2 of the
Company's Current Report on Form 8-K dated March 2, 1994; Commission file
number 0-19891.)
10.21 Campbell Square Office Lease dated April 11, 1994 between the Company and
the Trustees Under the Will and of the Estate of James Campbell, Deceased.
(Incorporated by reference to the Company's Quarterly Report on Form
10-Q/A dated June 30, 1994; Commission file number 0-19891.)
+10.22 Amendment to the Schuler Homes, Inc. 401(k) Retirement Savings Plan (005)
(Sections 1.5(a) and 1.11, effective January 1, 1994; and Sections 2.1 and
2.2, effective September 16, 1994). (Incorporated by reference to Exhibit
10.1 of the Company's Quarterly Report on Form 10-Q dated September 30,
1994; Commission file number 0-19891.)
10.23 Agreement for Increased Density on Parcels 10, 15, 16 and 20 between the
Company and AMFAC Property Development Corp. dated December 12, 1994.
(Incorporated by reference to Exhibit 10.82 of the Company's 1994 Annual
Report on Form 10-K; Commission file number 0-19891.)
10.24 Agreement (Kapolei Knolls) between the Company and Finance Realty, Ltd.
dated September 11, 1995. (Incorporated by reference to the Company's
Quarterly Report on Form 10-Q dated September 30, 1995; Commission file
number 0-19891.)
10.25 Agreement between Waiakoa Estates Subdivision Joint Venture and Betsill
Brothers Construction, Inc. dated September 16, 1995. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q dated September
30, 1995; Commission file number 0-19891.)
10.26 Amended and Restated Purchase and Sale Agreement between the Company and
Gentry Development Company and Gentry Homes, Ltd., dated November 20,
1995. (Incorporated by reference to the Company's 1995 Annual Report on
Form 10-K; Commission file number 0-19891.)
</TABLE>
29
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
10.27 Contract for Purchase and Sale of Real Property between the Company and
Investek Properties Company, LLC, dated June 19, 1996. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q dated June 30,
1996; Commission file number 0-19891.)
10.28 Real Estate Purchase Agreement between Schuler Homes of California, Inc.
and Frank J. Andrews, Jr., dated August 20, 1996. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q dated September
30, 1996; Commission file number 0-19891.)
10.29 Option Agreement between Schuler Homes of California, Inc. and Frank J.
Andrews, Jr., dated August 20, 1996. (Incorporated by reference to the
Company's Quarterly Report on Form 10-Q dated September 30, 1996;
Commission file number 0-19891.)
10.30 Real Estate Purchase and Sale Agreement between the Company and Coop
Family Limited Partnership, dated September 20, 1996. (Incorporated by
reference to the Company's Quarterly Report on Form 10-Q dated September
30, 1996; Commission file number 0-19891.)
10.31 Supplement No. 1 to Credit Agreement between the Company, certain Banks
and First Hawaiian Bank, dated January 8, 1997. (Incorporated by reference
to the Company's Current Report on Form 8-K dated January 8, 1997;
Commission file number 0-19891.)
10.32 Security Agreement between Melody Homes, Inc. and Melody Mortgage Company,
and First Hawaiian Bank, dated January 8, 1997. (Incorporated by reference
to the Company's Current Report on Form 8-K dated January 8, 1997;
Commission file number 0-19891.)
10.33 Amended and Restated Loan Agreement between Melody Homes, Inc. and Bank
One, dated November 25, 1996. (Incorporated by reference to the Company's
Current Report on Form 8-K dated January 8, 1997; Commission file number
0-19891.)
10.34 Modification Agreement between Melody Homes, Inc. and Bank One, dated
January 8, 1997. (Incorporated by reference to the Company's Current
Report on Form 8-K dated January 8, 1997; Commission file number 0-19891.)
10.35 News release dated January 8, 1997 regarding the completion of the
acquisition of Melody Homes and Mortgage. (Incorporated by reference to
the Company's Current Report on Form 8-K dated January 8, 1997; Commission
number 0-19891.)
10.36 Second Amendment to Loan Documents between the Company, certain Banks,
First Hawaiian Bank and Bank of America NT & SA, dated April 29, 1998.
(Incorporated by reference to the Company's Quarterly Report on Form 10-Q
dated March 31, 1998; Commission file number 0-19891.)
10.37 Guaranty between the Company, certain Banks, First Hawaiian Bank and Bank
of America NT & SA, dated April 29, 1998. (Incorporated by reference to
the Company's Quarterly Report on Form 10-Q dated March 31, 1998;
Commission file number 0-19891.)
10.38 Release of Negative Pledge Agreement between the Company, certain Banks
and First Hawaiian Bank, dated April 29, 1998. (Incorporated by reference
to the Company's Quarterly Report on Form 10-Q dated March 31, 1998;
Commission file number 0-19891.)
</TABLE>
30
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DOCUMENT DESCRIPTION
- ------ --------------------------------------------------------------------------
<C> <S>
+10.39 Schuler Homes, Inc. 1998 Employee Stock Purchase Plan. (Incorporated by
reference to Exhibit 99.1 of the Company's registration statement under
the Securities Act on Form S-8, Registration No. 333-60305.)
10.40 Second Amended and Restated Credit Agreement between the Company, certain
Banks, First Hawaiian Bank and Bank of America NT & SA, dated September
30, 1998. (Incorporated by reference to the Company's Quarterly Report on
Form 10-Q dated September 30, 1998; Commission file number 0-19891.)
10.41 Guaranty by wholly-owned subsidiaries of the Company, dated September 30,
1998, relating to Second Amended and Restated Credit Agreement dated
September 30, 1998. (Incorporated by reference to the Company's Quarterly
Report on Form 10-Q dated September 30, 1998; Commission file number
0-19891.)
+10.42 Restated Schuler Homes, Inc. 401(k) Retirement Savings Plan, effective
April 1, 1998. (Incorporated by reference to the Company's 1998 Annual
Report on Form 10-K; Commission file number 0-19891.)
10.43 First Amendment to Second Amended and Restated Credit Agreement between
the Company, certain Banks, First Hawaiian Bank and Bank of America NT &
SA, dated January 21, 1999. (Incorporated by reference to the Company's
1998 Annual Report on Form 10-K; Commission file number 0-19891.)
10.44 Guaranty by wholly-owned subsidiaries of the Company to certain Banks,
First Hawaiian Bank and Bank of America NT & SA, dated January 21, 1999.
(Incorporated by reference to the Company's 1998 Annual Report on Form
10-K; Commission file number 0-19891.)
21 Subsidiaries of the Registrant. (Incorporated by reference to Note 1 of
Notes to Consolidated Financial Statements included in Item 8 of this Form
10-K.)
23.1 Consent of Independent Auditors. (Incorporated by reference to the
Company's 1998 Annual Report on Form 10-K; Commission file number
0-19891.)
27 Financial Data Schedule (Incorporated by reference to the Company's 1998
Annual Report on Form 10-K; Commission file number 0-19891.)
</TABLE>
- ------------------------
+ Management contract, compensatory plan or arrangement
(D) SEE ITEM 14(1c).
31
<PAGE>
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Schuler Homes, Inc.
We have audited the accompanying consolidated balance sheets of Schuler
Homes, Inc. as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1998. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Schuler Homes,
Inc. at December 31, 1998 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Honolulu, Hawaii
March 15, 1999
32
<PAGE>
SCHULER HOMES, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1997
------------ ------------
<S> <C> <C>
ASSETS
Cash and cash equivalents (restricted--Note 2).............. $ 4,915,000 $ 3,842,000
Receivables................................................. 1,932,000 880,000
Prepaid income taxes........................................ 381,000 1,682,000
Real estate inventories (Note 3)............................ 325,166,000 291,081,000
Investments in unconsolidated joint ventures (Note 4)....... 23,998,000 16,026,000
Deposits.................................................... 2,705,000 1,691,000
Deferred offering costs, net (Notes 9 and 10)............... 1,976,000 1,171,000
Notes receivable (Note 2)................................... 1,956,000 2,406,000
Deferred income taxes (Note 6).............................. 3,957,000 4,002,000
Intangibles, net (Note 1)................................... 13,879,000 13,742,000
Other assets................................................ 4,678,000 4,048,000
------------ ------------
Total assets................................................ $385,543,000 $340,571,000
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ $ 15,954,000 $ 12,805,000
Accrued expenses............................................ 16,703,000 13,207,000
Notes payable to bank (Note 5).............................. 17,365,000 91,077,000
Notes payable to others..................................... 3,954,000 2,627,000
Senior notes (Note 9)....................................... 98,512,000 --
Convertible subordinated debentures (Note 10)............... 57,500,000 57,500,000
------------ ------------
Total liabilities........................................... 209,988,000 177,216,000
Commitments and contingencies (Notes 5 and 11)
Stockholders' equity (Notes 1, 8 and 10):
Common stock, $.01 par value; 30,000,000 shares
authorized; 20,892,465 and 20,874,927 shares issued at
December 31, 1998 and 1997, respectively................ 209,000 209,000
Additional paid-in capital................................ 93,201,000 93,100,000
Retained earnings......................................... 87,762,000 75,046,000
Treasury stock, at cost; 869,000 and 774,000 shares at
December 31, 1998 and 1997, respectively................ (5,617,000) (5,000,000)
------------ ------------
Total stockholders' equity.................................. 175,555,000 163,355,000
------------ ------------
Total liabilities and stockholders' equity.................. $385,543,000 $340,571,000
------------ ------------
------------ ------------
</TABLE>
See accompanying notes.
33
<PAGE>
SCHULER HOMES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Residential real estate sales....................... $282,902,000 $229,624,000 $93,645,000
Costs and expenses:
Residential real estate sales..................... 225,370,000 184,843,000 76,612,000
Inventory impairment loss (Note 3)................ -- -- 23,910,000
Selling and commissions........................... 19,124,000 17,268,000 7,767,000
General and administrative (Note 7)............... 16,008,000 13,596,000 4,179,000
----------- ----------- -----------
Total costs and expenses............................ 260,502,000 215,707,000 112,468,000
Income (loss) from unconsolidated joint ventures
(Note 4).......................................... 2,435,000 (136,000) 157,000
----------- ----------- -----------
Operating income (loss)............................. 24,835,000 13,781,000 (18,666,000)
Other income (expense).............................. (4,243,000) (4,261,000) (9,000)
----------- ----------- -----------
Income (loss) before provision for income taxes..... 20,592,000 9,520,000 (18,675,000)
Provision (credit) for income taxes (Note 6)........ 7,876,000 3,634,000 (7,289,000)
----------- ----------- -----------
Net income (loss)................................... $12,716,000 $ 5,886,000 $(11,386,000)
----------- ----------- -----------
----------- ----------- -----------
Net income (loss) per share (Note 12):
Basic and diluted................................. $ 0.63 $ 0.29 $ (0.55)
----------- ----------- -----------
----------- ----------- -----------
</TABLE>
See accompanying notes.
34
<PAGE>
SCHULER HOMES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
-------------------- PAID-IN RETAINED TREASURY
SHARES AMOUNT CAPITAL EARNINGS STOCK TOTAL
--------- --------- ---------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1995.......... 20,874,177 $ 209,000 $93,096,000 $80,546,000 $ -- $173,851,000
Reacquisition of the Company's common
stock............................... (774,000) -- -- -- (5,000,000) (5,000,000)
Net loss.............................. -- -- -- (11,386,000) -- (11,386,000)
--------- --------- ---------- ----------- ---------- -----------
Balance at December 31, 1996.......... 20,100,177 209,000 93,096,000 69,160,000 (5,000,000) 157,465,000
Issuance of common stock from exercise
of stock options (Note 8)........... 750 -- 4,000 -- -- 4,000
Net income............................ -- -- -- 5,886,000 -- 5,886,000
--------- --------- ---------- ----------- ---------- -----------
Balance at December 31, 1997.......... 20,100,927 209,000 93,100,000 75,046,000 (5,000,000) $163,355,000
Issuance of common stock from exercise
of stock options (Note 8)........... 17,538 -- 101,000 -- -- 101,000
Reacquisition of the Company's common
stock............................... (95,000) -- -- -- (617,000) (617,000)
Net income............................ -- -- -- 12,716,000 -- 12,716,000
--------- --------- ---------- ----------- ---------- -----------
Balance at December 31, 1998.......... 20,023,465 $ 209,000 $93,201,000 $87,762,000 $(5,617,000) $175,555,000
--------- --------- ---------- ----------- ---------- -----------
--------- --------- ---------- ----------- ---------- -----------
</TABLE>
See accompanying notes.
35
<PAGE>
SCHULER HOMES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES:
Net income (loss).................................. $ 12,716,000 $ 5,886,000 $(11,386,000)
Adjustment to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Depreciation and amortization expense............ 3,162,000 2,883,000 814,000
(Income) loss from unconsolidated joint
ventures....................................... (2,360,000) 143,000 (72,000)
Sales financed by Company........................ -- -- (152,000)
Principal payments of notes receivable........... 207,000 2,303,000 190,000
Increase in allowance for doubtful accounts...... 96,000 -- --
Changes in assets and liabilities:
(Increase) decrease in receivables............... (1,052,000) 654,000 92,000
(Increase) decrease in prepaid income taxes...... 1,301,000 922,000 (2,047,000)
(Increase) decrease in deposits.................. (1,014,000) (1,208,000) 518,000
(Increase) decrease in real estate inventories... (34,375,000) (12,775,000) 10,358,000
(Increase) decrease in other assets.............. (711,000) (1,294,000) (262,000)
Increase (decrease) in accounts payable.......... 3,149,000 7,438,000 (420,000)
Increase (decrease) in accrued expenses.......... 2,473,000 3,696,000 (16,000)
Change in deferred income taxes.................. 45,000 3,354,000 (5,538,000)
------------ ------------ ------------
Net cash provided by (used in) operating
activities................................... (16,363,000) 12,002,000 (7,921,000)
INVESTING ACTIVITIES:
Payment for purchase of Melody Homes and Mortgage,
net of cash acquired............................. -- (29,508,000) --
Investments in unconsolidated joint ventures....... (1,000,000) (2,980,000) --
Advances to unconsolidated joint ventures.......... (8,431,000) (1,724,000) (4,082,000)
Repayments of advances to unconsolidated joint
ventures......................................... 263,000 145,000 4,248,000
Capital distributions from unconsolidated joint
venture.......................................... 3,557,000 -- 128,000
Purchase of property and equipment................. (432,000) (664,000) (39,000)
------------ ------------ ------------
Net cash provided by (used in) investing
activities..................................... (6,043,000) (34,731,000) 255,000
FINANCING ACTIVITIES:
Proceeds from bank borrowings...................... 294,064,000 223,147,000 115,723,000
Principal payments on bank borrowings.............. (367,776,000) (198,427,000) (107,814,000)
Net (increase) decrease in deferred offering
costs............................................ (805,000) 228,000 229,000
Proceeds from issuance of senior notes, net of
discount......................................... 98,408,000 -- --
Net decrease in discount on issuance of senior
notes............................................ 104,000 -- --
Proceeds from issuance of common stock from
exercise of stock options........................ 101,000 4,000 --
Reacquisition of the Company's common stock........ (617,000) -- (5,000,000)
------------ ------------ ------------
Net cash provided by (used in) financing
activities..................................... 23,479,000 24,952,000 3,138,000
------------ ------------ ------------
Increase (decrease) in cash........................ 1,073,000 2,223,000 (4,528,000)
Cash and cash equivalents (restricted) at beginning
of period........................................ 3,842,000 1,619,000 6,147,000
------------ ------------ ------------
Cash and cash equivalents (restricted) at end of
period........................................... $ 4,915,000 $ 3,842,000 $ 1,619,000
------------ ------------ ------------
------------ ------------ ------------
</TABLE>
See accompanying notes.
36
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Schuler Homes, Inc. (the Company) was incorporated in Hawaii in March 1988
and, during January 1992, was reincorporated in Delaware. The Company is engaged
in the development and sale of residential real estate in the following
geographic markets: Colorado, Hawaii, Northern California, Oregon and
Washington.
The Company has ownership interests in the following entities:
- Melody Homes, Inc., a wholly-owned subsidiary incorporated in
Delaware--This entity is engaged in the development and sale of residential real
estate in Colorado. This entity was acquired by the Company in January 1997.
- Melody Mortgage Co., a wholly-owned subsidiary incorporated in
Colorado--This entity is a mortgage brokerage firm for Melody home buyers. This
entity was acquired by the Company in January 1997.
- Schuler Homes of California, Inc., a wholly-owned subsidiary incorporated
in California--This entity is engaged in the development and sale of residential
real estate in California. This entity was formed in June, 1996.
- Schuler Homes of Washington, Inc., a wholly-owned subsidiary incorporated
in the state of Washington--This entity is engaged in the development and sale
of residential real estate in the state of Washington. This entity was formed in
August 1996.
- Schuler Homes of Oregon, Inc., a wholly-owned subsidiary incorporated in
Oregon--This entity is engaged in the development and sale of residential real
estate in Oregon. This entity was formed in October 1996. The Company further
expanded its Oregon operations in October 1998 through the acquisition of
certain assets of Keys Homes, Inc., a Portland, Oregon homebuilder.
- SHLR of Washington, Inc., a wholly-owned subsidiary incorporated in the
state of Washington-- This entity owns a 49% interest in SSHI LLC (dba Stafford
Homes), which is engaged in the development and sale of residential real estate
in the state of Washington. This entity was formed in July 1997. In January
1999, the Company exercised its option to purchase an additional 40% ownership
interest in SSHI LLC, increasing the Company's ownership to 89%.
- SHLR of Colorado, Inc., a wholly-owned subsidiary incorporated in
Colorado--This entity owns a 50% interest in The Ranch-Southpointe II LLC, which
is engaged in the development and sale of residential real estate in Colorado.
This entity was formed in July 1998.
- Schuler Realty/Maui, Inc., a wholly-owned subsidiary incorporated in
Hawaii--This entity provides sales services in connection with the Company's
projects on the island of Maui.
- Schuler Realty/Oahu, Inc., a wholly-owned subsidiary incorporated in
Hawaii--This entity provides sales services in connection with the Company's
projects on the island of Oahu.
- Lokelani Construction Corporation, a wholly-owned subsidiary incorporated
in Delaware--This entity serves as the general contractor on certain of the
Company's projects.
- Waiakoa Estates Subdivision Joint Venture (WESJV), an unincorporated
joint venture--The Company has a 50% interest in WESJV, which is engaged in the
development and sale of residential lots on the island of Maui.
- Iao Partners (Iao), a general partnership--The Company has a 50% interest
in Iao, which is engaged in the development and sale of residential projects on
the island of Maui.
37
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid debt instruments and other
short-term investments (less than 3 months) to be cash equivalents.
REAL ESTATE INVENTORIES
Real estate inventories consist of raw land, lots under development, houses
under construction and completed homes. Pursuant to FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed of," inventories which are substantially completed are carried at
the lower of cost or fair value less cost to sell. Fair value is determined by
applying a risk adjusted discount rate to estimates of future cash flows,
resulting in a lower value than under the net realizable value method previously
required. In addition, land held for future development or inventories under
current development are adjusted to fair value, only if an impairment to their
value is indicated.
The estimates of future cash flows require significant judgment relating to
level of sales prices, rate of new home sales, amount of marketing costs and
price discounts needed in order to stimulate sales, rate of increase in the cost
of building materials and labor, introduction of building code modifications,
and economic and real estate market conditions in general. Accordingly, there
exists at any date, a reasonable possibility that changes in estimates will
occur in subsequent periods.
All direct and indirect land costs, all development and construction costs,
and applicable carrying charges (primarily interest) are capitalized to real
estate projects during the development period. The capitalized costs are
assigned to individual components of projects based on specific identification,
if practicable, or allotted based on relative sales value (in accordance with
FASB Statement No. 67, "Accounting for Costs and Initial Rental Operations of
Real Estate Projects"). Selling expenses and other marketing costs are expensed
in the period incurred and are included in cost of residential real estate sold
in the accompanying consolidated statements of operations.
UNCONSOLIDATED JOINT VENTURES
Investments in unconsolidated joint ventures consist of the Company's
interest in real estate ventures, and are accounted for using the equity method.
DEPOSITS
Deposits consist of amounts paid relating to potential purchases of land.
38
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTANGIBLES
Intangibles consist of goodwill and covenants not-to-compete, which resulted
from the Company's past acquisitions. The intangibles are being amortized on a
straight-line basis over periods ranging from 15 to 20 years. Accumulated
amortization at December 31, 1998 is approximately $1,461,000.
SALES AND PROFIT RECOGNITION
A sale is generally recorded and profit recognized when closings have
occurred and a buyer has met down payment and continuing investment criteria
required by generally accepted accounting principles.
INTEREST RATE SWAP
The Company entered into an interest-rate swap agreement to modify the
interest characteristics of its outstanding debt. This agreement involves the
exchange of amounts based on a fixed interest rate for amounts based on variable
interest rates over the life of the agreement without an exchange of the
notional amount upon which the payments are based. The differential to be paid
or received as interest rates change is accrued and recognized as an adjustment
of interest incurred related to the debt (the accrual accounting method). The
fair value of the swap agreement is not recognized in the financial statements.
In the event of the termination of the interest-rate swap agreement, gains and
losses would be deferred as an adjustment to the carrying amount of the
outstanding debt and amortized as an adjustment to interest incurred related to
the debt over the remaining term of the original contract life of the terminated
swap agreement. In the event of the early extinguishment of a designated debt
obligation, any realized or unrealized gain or loss from the swap would be
recognized in income coincident with the extinguishment.
In June 1998, the Financial Accounting Standards Board issued Statement No.
133, ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES, which is
required to be adopted in years beginning after June 15, 1999. Because of the
Company's minimal use of derivatives, management does not anticipate that the
adoption of the new Statement will have a significant effect on earnings or the
financial position of the Company.
2. NOTES RECEIVABLE
Notes receivable consist primarily of notes receivable on seller financed
sales of residential units and residential lots in Hawaii. The notes provide for
terms and conditions similar to those offered by financial institutions and are
collateralized by the residential units and residential lots sold. Certain of
the notes are collateralized by second mortgages relating to home buyers who
purchased homes as part of the Company's "zero-down" sales program. Revenue and
profit recognition on such transactions are deferred until the down payment
requirement for revenue and profit recognition is met. The collection reserve
relating to the sale of certain second mortgage notes in 1997 results in a
restriction on the Company's cash in the amount of approximately $506,000.
39
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. REAL ESTATE INVENTORIES
Real estate inventories consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1998 1997
----------- -----------
<S> <C> <C>
Unimproved land held for future development...... $34,472,000 $42,955,000
Development projects in progress................. 251,821,000 205,060,000
Completed inventory (including lots held for
sale).......................................... 38,873,000 43,066,000
----------- -----------
$325,166,000 $291,081,000
----------- -----------
----------- -----------
</TABLE>
Completed inventory includes residential units which are substantially ready
for occupancy.
Pursuant to the adoption of FASB Statement No. 121, the Company recognized
an impairment loss of $23,910,000 in 1996, primarily related to a) an increase
in completed inventories due to the substantial completion of a high-rise
project and b) the decline experienced by the Company in the rate of new home
sales contracts entered into, which resulted in a more conservative outlook with
respect to the estimate of future cash flows for certain other completed
projects, on some of which, impairment losses were recognized in 1995. No losses
were recognized on land held for future development or inventories under current
development.
The Company has notes payable to land sellers with a principal balance of
$3,954,000 at December 31, 1998, which relate to land purchased for future
residential development. The notes are secured by mortgages on the purchased
land.
4. INVESTMENTS IN UNCONSOLIDATED JOINT VENTURES
Condensed combined financial information as of December 31, 1998, 1997 and
1996 and for the years then ended are as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Assets (primarily real estate inventories)...... $ 71,910,000 $ 53,298,000 $ 17,074,000
Liabilities..................................... 46,953,000 30,452,000 155,000
------------- ------------- -------------
Equity.......................................... $ 24,957,000 $ 22,846,000 $ 16,919,000
------------- ------------- -------------
------------- ------------- -------------
Revenues........................................ $ 63,933,000 $ 22,011,000 $ 6,657,000
Expenses........................................ 59,090,000 22,071,000 6,166,000
------------- ------------- -------------
Net income (loss)............................... $ 4,843,000 $ (60,000) $ 491,000
------------- ------------- -------------
------------- ------------- -------------
</TABLE>
On July 31, 1997, the Company (through a new wholly-owned subsidiary, SHLR
of Washington, Inc., incorporated in the state of Washington) acquired a 49%
interest in Stafford, with an option to purchase the remaining 51% interest,
subject to certain contingencies. In connection with this acquisition, the
Company entered into an agreement to make revolving loans to the acquiree in an
aggregate principal amount of up to $5,000,000 (increased to $10,000,000 in
1998). At December 31, 1998, outstanding loans pursuant to this agreement
totaled $9,500,000. The Company accounts for this investment as an
unconsolidated joint venture under the equity method of accounting. The increase
in amounts on the above table
40
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVESTMENTS IN UNCONSOLIDATED JOINT VENTURES (CONTINUED)
from 1996 to 1997 is due primarily to the acquisition of a 49% interest in
Stafford. In January 1999, the Company increased its interest in Stafford to 89%
and refinanced Stafford's debt with the Company's line of credit facility.
The Company's investment in WESJV includes $400,000 paid to the other
venturer under an option agreement, which gave the Company the right for a
certain period, as defined, to require the other venturer to contribute the land
to WESJV for its project. A portion of the option payment is amortized as sales
occur. In addition, the Company earns management fees from WESJV and Iao. The
option fee amortization and management fees are included in income from
unconsolidated joint ventures in the accompanying consolidated statements of
operations.
Investment in unconsolidated joint ventures includes accrued but unpaid
partnership management fees due from the Company's 50% general partner in Iao of
$612,000 and $583,000 at December 31, 1998 and 1997, respectively. The Iao
partnership agreement provides for the payment of the partnership management
fees to the Company from the cash flow of Iao.
The Company's loss from unconsolidated joint ventures in 1997 is primarily
the result of the Company's share of the loss recognized by Iao of $397,000,
offset in part by the Company's share of the income of Stafford of $329,000. As
of December 31, 1998, the Company's cumulative share of the undistributed
profits of its joint ventures is $9,117,000.
Included in the investments in unconsolidated joint ventures of the Company,
and in the liabilities of the joint ventures are advances from the Company to
its unconsolidated joint ventures of $9,611,000, $1,521,000, and $0 at December
31, 1998, 1997 and 1996, respectively.
5. NOTES PAYABLE TO BANK
In April 1998, the Company amended certain provisions of its Revolving
Credit Facility to provide for the issuance of the Senior Notes (see Note 9).
Effective September 30, 1998, the Company reduced the amount of its Revolving
Credit Facility from $97,600,000 to $90,000,000. The Company has a one-time
option to increase the amount of the facility to $120,000,000. In addition, the
Company has a one-time option to reduce the amount of the facility by
$30,000,000 on an irrevocable basis, provided the facility has been increased to
$120,000,000 for at least six months. The facility expires on July 1, 2001 and
includes an option for the lenders to extend the term for an additional year as
of July 1 of each year. The Company can select an interest rate based on either
LIBOR (1, 2, 3 or 6 month term) or prime for each borrowing. Based on the
Company's leverage ratio, as defined, the interest rate may vary from LIBOR plus
1.5% to 2% or prime plus 0% to 0.25%. The Company's ability to draw upon its
line of credit is dependent upon meeting certain financial ratios and covenants.
As of December 31, 1998, the Company met such financial ratios and covenants.
The Company has an interest rate swap to pay LIBOR (currently fixed at
5.75%) on $30,000,000, while receiving in return an interest payment at a
floating one-month LIBOR. However, if the one-month LIBOR resets at or above 7%,
the swap reverses for that payment period and no interest payments are
exchanged. The interest rate differential to be received or paid is recognized
during the period as an adjustment to interest incurred. The interest rate swap
terminates on August 1, 2003.
The Company's notes payable at December 31, 1998 consist of borrowings under
its credit facilities. At December 31, 1998, the Company's bank borrowings were
at interest rates of prime (7.75%) and
41
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. NOTES PAYABLE TO BANK (CONTINUED)
LIBOR plus 1.5% (6.69%). At December 31, 1998, $72,635,000 of the Company's line
of credit is unused, of which $5,393,000 is restricted for outstanding but
unused letters of credit.
The interest amounts in this paragraph relate to notes payable to bank and
others, senior notes and the convertible subordinated debentures. The Company
paid interest of approximately $11,818,000, $11,644,000, and $7,972,000 during
the years ended December 31, 1998, 1997 and 1996, respectively. Interest
incurred during 1998, 1997 and 1996 was approximately $13,789,000, $11,845,000,
and $7,865,000, respectively. All of such interest was capitalized to real
estate inventories except for $3,096,000, $2,985,000 and $270,000 in 1998, 1997
and 1996, respectively, which was expensed and not capitalized, as such interest
related to assets which did not meet the requirements for capitalization. The
difference between the amount of interest paid and the amount incurred is
comprised of accrued interest payable. Interest, previously capitalized to real
estate inventories, expensed as a component of cost of residential real estate
sales during 1998, 1997 and 1996 totaled $9,554,000, $6,666,000, and $3,247,000,
respectively.
The following information relates to notes payable to bank at December 31,
1998 and 1997 and interest thereon during the years then ended:
<TABLE>
<CAPTION>
AVERAGE DAILY
WEIGHTED AVERAGE MAXIMUM AMOUNT AMOUNT WEIGHTED AVERAGE
INTEREST RATE AT OUTSTANDING OUTSTANDING INTEREST RATE
END OF THE YEAR DURING THE YEAR DURING THE YEAR DURING THE YEAR*
--------------------- ----------------- --------------- ---------------------
<S> <C> <C> <C> <C>
1998..................................... 7.2% $ 112,157,000 $ 49,199,000 7.8%
-- --
-- --
----------------- ---------------
----------------- ---------------
1997..................................... 7.9% $ 113,600,000 $ 104,739,000 7.7%
-- --
-- --
----------------- ---------------
----------------- ---------------
</TABLE>
*Computed by dividing related interest charged by the average daily amount
outstanding during the year.
6. INCOME TAXES
The following summarizes the provision for income taxes:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
------------ ------------ -------------
<S> <C> <C> <C>
Currently payable:
Federal.......................................... $ 6,857,000 $ 343,000 $ (1,480,000)
State............................................ 974,000 (61,000) (271,000)
------------ ------------ -------------
7,831,000 282,000 (1,751,000)
Deferred:
Federal.......................................... 28,000 2,843,000 (4,687,000)
State............................................ 17,000 509,000 (851,000)
------------ ------------ -------------
45,000 3,352,000 (5,538,000)
------------ ------------ -------------
Provision (credit) for income taxes................ $ 7,876,000 $ 3,634,000 $ (7,289,000)
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
42
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. INCOME TAXES (CONTINUED)
The provision for income taxes on adjusted historical income differs from
the amounts computed by applying the applicable Federal statutory rates due to
the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1998 1997 1996
------------ ------------ -------------
<S> <C> <C> <C>
Provision (credit) for federal income taxes at the
statutory rate................................... $ 7,207,000 $ 3,343,000 $ (6,559,000)
Provision (credit) for state income taxes, net of
federal income tax benefits...................... 669,000 290,000 (727,000)
Other.............................................. -- 1,000 (3,000)
------------ ------------ -------------
Provision (credit) for income taxes................ $ 7,876,000 $ 3,634,000 $ (7,289,000)
------------ ------------ -------------
------------ ------------ -------------
</TABLE>
Deferred income taxes are the result of provisions of the tax laws that
either require or permit certain items of income or expense to be reported for
tax purposes in different periods than they are reported for financial reporting
purposes. The primary components of the Company's deferred income taxes relate
to capitalized interest and inventory impairment losses (Note 3). At December
31, 1998, the total deferred tax liabilities (primarily resulting from
capitalized interest) and total deferred tax assets (primarily resulting from
inventory impairment losses) are $3,574,000 and $7,531,000, respectively.
Income tax payments of $7,118,000, $455,000, and $585,000 were made during
1998, 1997 and 1996, respectively.
7. RELATED PARTY TRANSACTIONS
James K. Schuler, the Company's chief executive officer, owns a majority of
the common shares outstanding as of December 31, 1998 and 1997.
The Company and an affiliate wholly-owned by Mr. Schuler, have a management
agreement pursuant to which certain management and administrative personnel of
the Company perform certain functions for the affiliate. The affiliate
reimburses the Company on a quarterly basis for its cost of providing such
services. During 1998, 1997 and 1996, $100,000, $97,000 and $116,000 was charged
to the affiliate by the Company pursuant to this agreement.
From time to time, the Company engages the law firms in which directors of
the Company are partners. During 1998, 1997 and 1996, legal fees of
approximately $322,000, $322,000 and $60,000, respectively, to such firms were
incurred by the Company.
8. EMPLOYEE BENEFIT AND STOCK OPTION PLANS
The Company sponsors a 401(k) defined contribution retirement savings plan
that covers substantially all employees of the Company after completion of one
year of service. Company contributions to this plan, which include amounts based
on a percentage of employee contributions as well as discretionary
contributions, were $130,000, $89,000, and $116,000 for the years ended December
31, 1998, 1997 and 1996, respectively.
In January 1992, the Company adopted a stock option plan (the "Plan"). Under
the Plan, options to purchase an aggregate of not more than 1,000,000 shares of
common stock may be granted from time to
43
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. EMPLOYEE BENEFIT AND STOCK OPTION PLANS (CONTINUED)
time to employees, officers and directors of the Company. The options vest 25%
one year after being granted. Thereafter, vesting occurs pro rata each month
until 100% vesting is attained four years after the grant date. The maximum term
of the options granted is 10 years.
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
Interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation," requires use of
option valuation models that were not developed for use in valuing employee
stock options. Under APB 25, because the exercise price of the Company's
employee stock options equals the market price of the underlying stock on the
date of grant, no compensation expense is recognized.
Pro forma information regarding net income and earnings per share is
required by FASB Statement No. 123 and has been determined as if the Company had
accounted for its employee stock options under the fair value method of that
Statement. The fair value for these options was estimated at the date of grant
using a Black-Scholes option pricing model with the following weighted-average
assumptions for 1998, 1997 and 1996, respectively: risk-free interest rates of
5.6%, 6.4% and 6.0%; dividend yields of 0%, 0% and 0%; volatility factors of the
expected market price of the Company's common stock of 0.37, 0.32 and 0.33; and
a weighted-average expected life of the option of 4, 3.25 years and 4 years.
The Black-Scholes option valuation model used was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The effect of
applying FASB Statement No. 123 on pro forma net income (loss) for 1998, 1997
and 1996 are not likely to be representative of the effects for future years,
since the 1998, 1997 and 1996 pro forma net income (loss) amounts reflect
expense for only one, two and three years vesting, respectively. The Company's
pro forma information follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------ --------------
<S> <C> <C> <C>
Pro forma net income (loss)..................... $ 11,806,000 $ 5,122,000 $ (11,508,000)
Pro forma net income (loss) per share:
Basic......................................... $ 0.59 $ 0.25 $ (0.56)
Diluted....................................... 0.59 0.25 (0.56)
</TABLE>
44
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. EMPLOYEE BENEFIT AND STOCK OPTION PLANS (CONTINUED)
A summary of the Company's stock option activity, and related information
for the years ended December 31 follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------------------ ------------------------- ------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
OPTIONS PRICE OPTIONS PRICE OPTIONS PRICE
--------- ------------- ---------- ------------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding--beginning of year................. 611,085 $ 6 369,885 $ 12 325,489 $ 14
Granted........................................ 198,850 7 523,501 6 88,500 6
Exercised...................................... (17,538) 6 (750) 6 -- --
Forfeited...................................... (20,739) 7 (281,551) 13 (44,104) 12
--
--------- ---------- --- --------- ---
Outstanding-end of year........................ 771,658 $ 6 611,085 $ 6 369,885 $ 12
--
--
--------- ---------- --- --------- ---
--------- ---------- --- --------- ---
Exercisable at end of year..................... 277,446 $ 7 39,889 $ 10 202,126 $ 15
Weighted-average fair value of options granted
during the year.............................. $ 2.59 $ 1.80 $ 2.15
</TABLE>
Exercise prices for options outstanding as of December 31, 1998 ranged from
$6 to $26.
In 1997, option holders were permitted to receive new options in exchange
for certain of their existing outstanding options (covering up to an aggregate
of approximately 271,000 shares of Common Stock). Options for 256,000 shares
were exchanged in 1997 at a new exercise price of $5.625. The new options became
subject to a new vesting schedule and the existing options were canceled.
On July 31, 1998, the Company filed a Form S-8 Registration Statement with
U.S. Securities and Exchange Commission to register 500,000 shares of the
Company's common stock for issuance under the Company's Employee Stock Purchase
Plan. On February 26, 1999, approximately 24,000 shares of the Company's common
stock were issued under the Plan.
9. SENIOR NOTES
On May 6, 1998, the Company consummated its offering of $100,000,000
aggregate principal amount of 9% Senior Notes, which are due April 15, 2008. The
Company received net proceeds from the offering of approximately $97,200,000
(net of discounts and offering costs of approximately $2,800,000). The Company
used such proceeds to repay a portion of the Company's borrowings under its line
of credit. The offering costs will be amortized over the term of the notes using
the interest method. The Company offered to exchange its Senior Notes for new
notes evidencing the same debt as the Senior Notes, which were registered
pursuant to a Form S-4 Registration Statement filed with the U.S. Securities and
Exchange Commission on July 6, 1998. Pursuant to such exchange offer, all of the
Senior Notes were exchanged for new notes.
10. CONVERTIBLE SUBORDINATED DEBENTURES
On January 28, 1993, the Company issued $50,000,000 principal amount of
6 1/2% Convertible Subordinated Debentures, which are due January 15, 2003. On
February 25, 1993, the related over-allotment option for an additional
$7,500,000 was exercised in full. The Debentures are convertible at any time
prior to maturity into shares of the Company's common stock at a conversion
price of $21.83 per share, subject to adjustment under certain conditions. The
Company received net proceeds from the
45
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. CONVERTIBLE SUBORDINATED DEBENTURES (CONTINUED)
offering of approximately $55,200,000 (net of offering costs of approximately
$2,300,000). The Company used a portion of such proceeds to purchase $51,500,000
of additional land inventory for residential development, using the balance of
$3,700,000 to repay a portion of the Company's borrowings under its line of
credit. The offering costs are being amortized over the term of the debentures
using the interest method.
11. COMMITMENTS AND CONTINGENCIES
At December 31, 1998, the Company had under contract to purchase for
approximately $4,000,000, land for future residential development.
Certain of the Company's land purchase agreements require the Company to
make additional payments to the seller if the average sales price or number of
homes built on such land exceeds an amount stated in such purchase agreements.
Amounts paid pursuant to these agreements have not been significant.
One of the agreements for land purchased during early 1993 includes a
provision for the Company to pay the previous owner of the land additional
amounts if the number of units developed exceeds 580. The Company may develop up
to 832 units for sale. The Company is obligated to pay an additional $20,000 for
each residential unit in excess of 580 residences. Accordingly, the Company may
be obligated to pay the previous owner of the land an additional $5,040,000. The
additional payments are earned by the previous owners upon the issuance of a
certificate of occupancy for each excess unit. Such payments are payable at the
closing of the sale of each excess unit. The payments are secured by a
subordinated mortgage on a portion of the purchased land. As of December 31,
1998, the Company has paid $1,160,000 and accrued $700,000, for a total of
$1,860,000 related to the construction of 93 units in excess of 580.
In April 1996, the Company was served with a purported class action
complaint by owners of units and the Association of Owners of Fairway Village at
Waikele alleging, among other things, material construction defects and
deficiencies, misrepresentations regarding the cost of insurance and breach of a
covenant of good faith and fair dealing. Following the Courts' denial of a class
certification request, a second action involving other homeowners at Fairway
Village advancing the same claims was initiated. The complaints do not specify
an amount of damages, but include a claim for punitive damages. Based on its
current understanding of the lawsuits, the Company believes the claims to be
largely without merit and that potential third party defendants and insurance
coverage exist to offset a material portion of any damages from the alleged
claims. The litigation continues to be vigorously defended. A court date has
been set for April 1999 for the initial suit. Trial of the first action may
proceed at that time. No trial date has been set in the second action. If these
lawsuits were decided adversely to the Company in all material respects, they
collectively could have a material adverse effect on the Company's business,
financial condition and results of operations.
The Company is also from time to time involved in routine litigation or
threatened litigation arising in the ordinary course of its business. Such
matters, if decided adversely to the Company, would not, in the opinion of
management, have a material adverse effect on the financial condition of the
Company.
12. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share for the years ended December 31, 1998,
1997 and 1996 were computed using the weighted average number of common shares
outstanding during the period of 20,102,922, 20,100,267 and 20,583,860,
respectively.
46
<PAGE>
SCHULER HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONCLUDED)
12. NET INCOME (LOSS) PER SHARE (CONTINUED)
The computation of diluted net income(loss) per share for the years ended
December 31, 1998, 1997 and 1996 resulted in amounts greater than the basic net
income (loss) per share. Accordingly, the basic net income (loss) per share is
also presented as the diluted net income (loss) per share.
13. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amount reported in the balance sheet
for cash and cash equivalents approximates its fair value.
Notes receivable: The carrying amount of the Company's notes receivable
approximate their fair value, since the interest rate currently being offered on
new notes is similar to the interest rates on existing notes.
Accrued interest payable (included in accrued expenses) and notes payable to
bank: The carrying amounts of the Company's accrued interest payable and notes
payable to bank approximate their fair value.
Convertible subordinated debentures: The fair value of $48,300,000 for the
Company's convertible subordinated debentures is based on the quoted market
price of $84 at December 31, 1998.
Interest rate swap: The estimated fair value at December 31, 1998 is a
liability of approximately $1,138,000 and is based on a bank quote. Credit loss
from counterparty nonperformance is not anticipated.
Senior notes: The fair value of $96,500,000 for the Company's senior notes
is based on the quoted market price of $96.50 at December 31, 1998.
14. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the years ended December 31, 1998 and
1997 are presented in the following summary:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
--------------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
----------- --------- ------------ ------------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
1998
Sales...................................... $ 55,512 $ 67,433 $ 79,186 $ 80,771
Operating income (loss).................... 4,293 5,478 7,385 7,679
Pre-tax income (loss)...................... 3,257 4,640 5,767 6,928
Net income (loss).......................... 2,001 2,852 3,583 4,280
Earnings (loss) per share (diluted)........ 0.10 0.14 0.18 0.21
1997
Sales...................................... $ 49,958 $ 52,457 $ 61,057 $ 66,152
Operating income (loss).................... 2,155 2,763 3,963 4,900
Pre-tax income (loss)...................... 1,256 1,865 2,833 3,566
Net income (loss).......................... 777 1,159 1,758 2,192
Earnings (loss) per share (diluted)........ 0.04 0.06 0.09 0.11
</TABLE>
Quarterly and year-to-date computations of per share amounts are made
independently. Therefore, the sum of per share amounts for the quarters may not
agree with per share amounts for the year.
47
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
SCHULER HOMES, INC.
By: /s/ JAMES K. SCHULER
-----------------------------------------
James K. Schuler
CHAIRMAN OF THE BOARD,
PRESIDENT AND CHIEF EXECUTIVE OFFICER
Dated: March 26, 1999
</TABLE>
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
Chairman of the Board,
/s/ JAMES K. SCHULER President and Chief
- ------------------------------ Executive Officer March 26, 1999
James K. Schuler (principal executive
officer)
/s/ MICHAEL T. JONES Executive Vice President
- ------------------------------ of Operations and March 26, 1999
Michael T. Jones Director
Senior Vice President of
/s/ PAMELA S. JONES Finance, Chief Financial
- ------------------------------ Officer and Director March 26, 1999
Pamela S. Jones (principal financial
officer)
Vice President of Finance,
/s/ DOUGLAS M. TONOKAWA Chief Accounting Officer
- ------------------------------ (principal accounting March 26, 1999
Douglas M. Tonokawa officer)
/s/ MARTIN T. HART
- ------------------------------ Director March 26, 1999
Martin T. Hart
/s/ BERT T. KOBAYASHI, JR.
- ------------------------------ Director March 26, 1999
Bert T. Kobayashi, Jr.
/s/ THOMAS A. BEVILACQUA
- ------------------------------ Director March 26, 1999
Thomas A. Bevilacqua
</TABLE>
48
