Document/ExhibitDescriptionPagesSize 1: 10-K Ashton Woods Usa L.L.C. HTML 573K
2: EX-21 EX-21 List of Subsidiaries HTML 9K
3: EX-31.1 EX-31.1 Section 302 Certification of the CEO HTML 12K
4: EX-31.2 EX-31.2 Section 302 Certification of the CFO HTML 13K
5: EX-32.1 EX-32.1 Section 906 Certification of the CEO HTML 8K
6: EX-32.2 EX-32.2 Section 906 Certification of the CFO HTML 8K
(Exact Name of Registrant as Specified in Its Charter)
Nevada (State or Other Jurisdiction of
Incorporation or Organization)
75-2721881 (I.R.S. Employer Identification No.)
1080 Holcomb Bridge Rd. Bldg 200 Suite 350
Roswell, Georgia (Address of Principal Executive Offices)
30076 (Zip Code)
(Registrant’s telephone number, including area code)
(770) 998-9663
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange
on which registered
None
None
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yeso No þ
Indicate by check mark whether the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act. Yes þ No o
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 þ No o
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 the 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. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated
filer” in Rule 12b-2 of the Exchange Act.
Large accelerated filer o Accelerated filer o Non-accelerated filer þ
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
The aggregate market value of the voting and non-voting stock held by non-affiliates of the
registrant: Not Applicable. The registrant has no publicly traded equity securities.
We are one of the largest private homebuilders in the United States based on number of home
closings and revenues. We design, build and market high-quality single-family detached homes,
townhomes and stacked-flat condominiums under the Ashton Woods Homes brand name. We operate in
Atlanta, Dallas, Houston, Orlando, Phoenix, Denver and Tampa. These cities represent seven of the
20 largest new residential housing markets in the United States according to the U.S. Census
Bureau. We have been in operation for over 15 years and serve a broad customer base including
first-time buyers and first- and second-time move-up buyers. We focus on achieving the highest
standards in design, quality and customer satisfaction. We have received numerous awards, including
the 2005 and 2004 J.D. Power Award for Highest in Customer Satisfaction with New Homebuilders in
Atlanta, and we were ranked in the top 13% of all homebuilders nationally in customer satisfaction
in 2006 and 2005 by an independent nationally recognized survey company not affiliated with us.
BUSINESS STRATEGY
Provide Our Customers with Superior Value, Quality and Customer Service. Based on the awards
we have received, we believe we are recognized for building homes that offer superior design,
excellent quality and outstanding value. We believe that our rigorous focus on value, quality and
customer service provides us with an important competitive advantage which can enable us to
increase our sales and enhance our profitability. We perform comprehensive research of homebuyer
preferences and utilize the services of award-winning outside architectural firms to provide our
customers with attractive, well designed homes, consistent with the tastes and trends in each of
our markets. We offer our homebuyers the opportunity to personalize their new homes in our
state-of-the-art Ashton Woods Homes Design Centers in Atlanta, Dallas, Houston, Tampa and Orlando,
or in our fully decorated model homes in each of our communities. We instill in all our employees
the importance of high quality and superior customer service through extensive in-house training,
as well as through a compensation structure directly tied to our J.D. Power customer satisfaction
results.
Our reputation for outstanding quality, superior designs and excellent customer service is
evidenced by the numerous awards and accolades we have received over the past several years. These
awards include:
•
the 2006 Parade of Homes Grand Award (from the Tampa Bay Builders Association);
•
the 2006 Blue Ribbon for Best Overall Floor Plan (from the Tampa Bay Builders Association);
•
the 2005 Best Model Park in Houston (from the Greater Houston Builders Association);
•
the 2004 Small Volume Builder of the Year in Phoenix (from the Homebuilders
Association of Central Arizona);
•
the 2004 Best Interior Merchandising for Homes from $226,000 to $350,000 in
Phoenix (from the Homebuilders Association of Central Arizona);
•
the 2004 Best Detached Floor Plan Design for Homes from $226,000 to $350,000 in
Phoenix (from the Homebuilders Association of Central Arizona);
•
first place in 2004 for Production Detached Homes from $296,000 to $307,000 in
Orlando (from the Homebuilders Association of Metro Orlando).
The entities sponsoring these awards are trade organizations. Although we, along with other
homebuilders, are members in the organizations sponsoring these awards, we do not have an
ownership interest in and are not otherwise affiliated with the award sponsors. Additionally, we
were the only homebuilder to receive a five-star rating for home design in Atlanta from J.D.
Power, where we were also awarded Highest in Customer Satisfaction
with New Homebuilders by J.D. Power in 2005 and 2004. Our commitment to customer service has
been further recognized in a nationwide survey, where we ranked in the top 13% of homebuilders
nationally in 2006 and 2005. We intend to continue to increase sales and profitability by
continuing to provide superior values, quality and customer service.
Information regarding the J.D. Power and Associates 2005 New Home Builder Customer
Satisfaction Studysm was based on responses from 73,353 buyers of newly constructed
homes in 30 of the largest U.S. markets, who were surveyed between March and July 2005. With
respect to the 2005 survey, the Atlanta market covers Barrow, Cherokee, Clayton, Cobb, Coweta,
Dawson, Dekalb, Douglas, Fayette, Forsyth, Fulton, Gwinnett, Hall, Henry, Newton, Paulding,
Rockdale, Spalding and Walton counties. Information regarding the J.D. Power 2004 New Home Builder
Customer Satisfaction Studysm was based on responses from 64,502 buyers of newly
constructed homes, respectively, in 25 of the largest U.S. markets. With respect to the 2004
survey, the Atlanta market covers Barrow, Bartow, Carroll, Cherokee, Clayton, Cobb, Coweta, Dawson,
DeKalb, Douglas, Fayette, Forsyth, Fulton, Gwinnett, Hall, Henry, Newton, Paulding, Rockdale,
Spalding and Walton counties.
Leverage Our Product, Customer and Geographic Diversification. We offer a broad portfolio of
products including single-family detached homes, townhomes and stacked-flat condominiums, designed
for and marketed to first-time buyers and first- and second-time move-up buyers. We operate or are
initiating operations in seven geographically diverse markets. Our product, customer and geographic
diversification enables us to balance dynamic market conditions, enhance financial stability and
reduce our exposure to any specific market or homebuyer segment. Single-family detached homes,
townhomes, stacked-flat condominiums and active adult communities accounted for 80%, 13%, 6% and
1%, respectively, of our net new home orders for the fiscal year ended May 31, 2007, and 72%, 14%,
13% and 1%, respectively, of our net new home orders for the fiscal year ended May 31, 2006. We
capitalize on our broad product portfolio by targeting a diversified customer base. We estimate
that first-time buyers, and first- and second-time move-up buyers accounted for 31%, 42% and 27%,
respectively, of our net new home orders during the fiscal year ended May 31, 2007 and 37%, 41% and
22%, respectively, of our net new home orders during the fiscal year ended May 31, 2006.
We believe we are able to successfully leverage our market presence in our existing markets
and enhance our product offerings. We believe we are able to appeal to a broader group of
homebuyers and enhance our growth without a significant increase of overhead costs. This strategy
has proven successful as we build mult-family product lines, such as townhomes and stacked-flat
condominiums, in many of our markets along with an active adult line targeted to buyers over 55
years of age in Atlanta. We intend to continue to leverage our product, customer and geographic
diversification to enhance our growth prospects and profitability while maintaining a conservative
financial profile.
Pursue Disciplined Expansion in Large, High Growth Markets. We currently operate in Atlanta,
Dallas, Houston, Orlando, Phoenix, Denver and Tampa, seven of the 21 largest new residential
housing markets in the United States by single-family housing starts. Enhancing our product and
price point portfolio in each of our existing markets is central to our growth strategy. We perform
extensive research, including customer focus groups, to determine demand for additional product
offerings in each of our markets. We target the homebuyer segments with the most attractive demand
and supply characteristics, which we identify with the help of proprietary market studies analyzing
economic and demographic trends and the competitive environment. We believe our existing markets
offer attractive long-term growth opportunities. We further believe we have demonstrated our
ability to effectively compete and succeed in our markets through our expansion into townhomes,
stacked-flat condominiums and an active adult line in certain of our markets.
We will also continue to evaluate prudent expansion opportunities into select new markets. Our
strategy for growth in new markets is driven by identifying large homebuilding markets with
attractive long-term growth prospects and favorable supply and demand characteristics. We typically
hire experienced local managers to manage each new market and initially focus on providing homes
for the first- and second-time move-up buyer segments. While we consider acquisitions where
attractive opportunities are identified, we have historically pursued a strategy of developing
start-up operations to drive our expansion in select new markets.
Acquire and Develop Strong Land Positions. We maintain a rigorous focus on only acquiring land
in premier locations, which we believe provides us with superior competitive positioning and
enhanced operational
performance. We target land opportunities in each of our markets largely through the use of an
in-depth analysis of supply and demand fundamentals, combined with site-specific financial
feasibility studies, which we prepare with the help of our local operational managers. We utilize
strict financial hurdles to evaluate each land acquisition opportunity. This process enables us to
optimize our financial returns while minimizing our land and inventory risk.
Additionally, we develop a significant portion of the land we use in our homebuilding
operations. We believe that our considerable expertise in land development enables us to maintain
attractive land positions, create desirable communities and optimize our financial returns. We
intend to continue to utilize our disciplined land selection process and land development expertise
to maintain and enhance our strong land positions.
Manage Inventory Risk and Maintain Conservative Financial Profile. We operate with a
conservative approach to financial and inventory management, maintaining prudent leverage and
substantial liquidity. We have a disciplined land acquisition process with strict financial
hurdles. All land purchases must be approved by our Chief Executive Officer and our Chief Financial
Officer. We target a four-year supply of land, achieving a balance of land owned and developed for
our own use, and additional lots controlled through option contracts. As of May 31, 2007, our
supply of land controlled for use in our homebuilding operations was 3.3 years, consisting of a
2.4-year supply of owned land and a 0.9-year supply of land controlled through option contracts.
Additionally, we actively manage our housing inventory by pre-selling substantially all of our
homes prior to starting construction, limiting our inventory risk and minimizing our construction
cycles. Limitations on the number of speculative units are approved at the corporate level. As of
May 31, 2007, we had only 93 completed but unsold homes among our 44 active communities. Our
disciplined strategy enables us to maintain a conservative leverage and liquidity profile. As of
May 31, 2007, our total debt to total capitalization was 52.1%, and we had $193.5 million available
for borrowing under our senior unsecured credit facility. We intend to continue to deploy our
capital prudently and efficiently and to maintain a conservative inventory and financial profile.
Leverage Our Highly Experienced Management Team. We benefit from a strong and experienced
senior management team, with our executive officers averaging more than 15 years of experience in
the homebuilding industry. Thomas Krobot, our Chief Executive Officer, has over 35 years of
industry experience and has been with our company since 1995. Robert Salomon, our Chief Financial
Officer, has approximately 15 years of industry experience and has been with us since 1998. Mark
Thomas, our Senior Vice President, has approximately 11 years of industry experience and joined us
in 2006. In addition to our seasoned senior management team, we have an outstanding group of
division presidents who manage our individual markets. Each division president brings substantial
industry knowledge and deep market expertise, with an average of approximately 16 years of
experience in new residential construction.
HISTORY
We are headquartered in Atlanta, Georgia. We were founded in 1989 in Dallas and have
expanded into several growing housing markets primarily in the South and Southwest United States.
Since our inception, we have grown organically by forming homebuilding and land development
operations in select strategic markets with strong housing and employment growth characteristics.
Our initial homebuilding operations were established in Dallas in 1989, followed by Houston in
1990 and Atlanta in 1992. We formed land development operations in Denver in 1994 and Orlando in
1998. We focused on growing our core markets until 2001 when we entered a second expansion phase
through the formation of homebuilding operations in Orlando in 2001 and Phoenix in 2002. We most
recently entered Tampa with homebuilding operations and expanded our presence in Denver with
homebuilding operations in fiscal year 2005.
OWNERSHIP
We are owned by six families or family trusts related to the following individuals: Elly
Reisman, Norman Reisman, Bruce Freeman, Seymour Joffe, Larry Robbins and Harry Rosenbaum. The
owners control us through individual Nevada-based holding companies in which each family or
family trust owns all of the equity interests.
The same families and family trusts or related parties also control the Great Gulf Group of
Companies
(“Great Gulf Group”), which was formed in Toronto in 1983. Great Gulf Group’s operations, in
addition to
Ashton Woods, consist of one of Toronto’s largest homebuilders of single-family
attached and detached homes and high rise condominiums, a commercial, retail and industrial
properties construction and management company, and other operations focused in land and resort
development, as well as diversified financial investments.
MARKETS AND PRODUCTS
We operate in Atlanta, Dallas, Houston, Orlando, Phoenix, Denver and Tampa. We evaluate a
number of factors in determining which geographic markets to enter. We analyze economic and real
estate conditions by evaluating such statistical information as the historical and projected
population growth, the number of new jobs created and projected to be created, the number of
housing starts in previous periods, building lot availability and price, housing inventory,
competitive environment, and home sale absorption rates.
We generally seek to maintain the flexibility to alter our product mix within a given market
depending on market conditions. In determining our product mix in each market we consider
demographic trends, demand for a particular type of product, margins, timing and the economic
strength of the market. While remaining responsive to market opportunities within the industry, we
have focused, and intend to continue to focus, our business primarily on first-time and first- and
second-time move-up buyers offering single-family detached homes, townhomes and stacked-flat
condominiums, which are developments with four or fewer stories of condominium units.
While we develop single-family detached homes in all of our markets, townhomes are currently
only offered in Atlanta, Orlando, Denver and Dallas. In addition, in 2005, we began developing
stacked-flat condominiums in the Atlanta and Orlando markets, which we believe will further
diversify our product portfolio and appeal to a broader base of customers. For the fiscal year
ended May 31, 2007, our homebuilding revenue was comprised of single-family detached homes (76% of
revenues), townhomes (10% of revenues) and condominiums (14% of revenues).
Our single-family detached homes range in price from $130,000 to over $650,000, and our
townhomes range in price from $180,000 to over $400,000. Stacked-flat condominiums have prices
ranging from $200,000 to over $230,000.
As of May 31, 2007, we had 44 active communities in our existing markets, comprised of 33
single-family detached home communities, seven townhome communities, three stacked-flat condominium
communities and one active adult single-family detached home community.
HOME DESIGN AND DESIGN CENTERS
We are dedicated to providing high-quality, well-designed homes in desirable communities
meeting the demands of today’s homebuyers. The product line offered in a particular community
depends upon many factors, including the supply of existing housing and the demand for new
housing in the general area. In order to ensure we meet the demand in the marketplace, we conduct
in-depth qualitative and quantitative market research including consumer focus groups. This
research enables us to improve the linkage between the design of our homes and the community
development and meet the specific lifestyle demands of our targeted homebuyer.
Our in-house architectural team manages outside architects to ensure our home designs provide
maximum utilization of space for the wide variety of product offerings ranging from single-family
detached homes and townhomes for both first-time homebuyers and move-up homebuyers to our
stacked-flat condominiums for first-time homebuyers.
We maintain fully decorated model homes in each of our communities merchandised to provide the
homebuyers with the ability to view the completed product as part of their buying decision. In
addition, we utilize our Ashton Woods Homes Design Centers to provide homebuyers the ability to
personalize their homes. The design centers are staffed with expert in-house designers who can help
make selections from an extensive array of products, including carpets, tiles, cabinets, light
fixtures and countertops, among others. Our home design centers are organized to fully facilitate
the home buying experience for both first-time homebuyers and move-up homebuyers.
Our land strategy is to maintain a four-year land supply, based on homes closed during the
last twelve months, which may fluctuate based on improving or declining market conditions. We
believe that our attractive land positions in our markets will enable us to continue to maintain
market share in the current homebuilding environment and to increase our residential production
when the homebuilding market improves. As of May 31, 2007, we had a land supply for use in our
homebuilding operations of approximately 3.3 years, consisting of a 2.4-year supply of owned land
and a 0.9-year supply of land controlled through option contracts.
We typically purchase land only after necessary entitlements have been obtained so that
development or construction may begin as market conditions dictate. The term “entitlements’’ refers
to development agreements, tentative maps or recorded plats, depending on the jurisdiction within
which the land is located. Entitlements generally give the developer the right to obtain building
permits upon compliance with conditions that are ordinarily within the developer’s control. Even
though entitlements are usually obtained before land is purchased, we are still required to secure
a variety of other governmental approvals and permits during development. The process of obtaining
such approvals and permits can substantially delay the development process. For this reason, we may
consider, on a limited basis, purchasing unentitled property in the future when we can do so in a
manner consistent with our business strategy.
We select land for control based upon a variety of factors, including:
•
internal and external demographic and marketing studies;
•
project suitability;
•
suitability for development generally within a one to four-year time period from
the beginning of the development process to the delivery of the last home;
•
financial review as to the feasibility of the proposed project, including
projected profit margins, return on capital employed and the capital payback
period;
•
results of environmental and legal due diligence;
•
proximity to local traffic corridors and amenities; and
•
management’s judgment as to the real estate market and economic trends, and our
experience in a particular market.
In addition to the land purchased specifically for our homebuilding operations, we have in the
past pursued land development opportunities in which we acquired and developed lots for sale to
third party builders in addition to use in our own homebuilding operations. We still hold some of
this land for our use and for sale to third party builders in Denver and Orlando, among other
markets.
Our land development activities in Denver consist of the development of custom lots for sale
to third party custom builders in Parker, Colorado, which is southeast of Denver. As of May 31,2007, we had 239 lots held for development during the coming fiscal years for sale to third
parties.
We believe that we have significant land development expertise which we will continue to
leverage in developing land for our own use. However, we do not plan to engage in land development
for sale to third parties as a significant aspect of our business in the future.
We acquire land through purchases, rolling option contracts and joint ventures with other
builders or developers. We acquire approximately one-fourth to one-third of our land through
rolling option contracts, which allow us to control lots and land without incurring the risks of
land ownership or financial commitments other than relatively small non-refundable deposits. We
enter into option contracts with third parties to purchase finished lots generally as home
construction begins. These contracts are generally non-recourse and require non-refundable deposits
of 2% to 15% of the sales price. As of May 31, 2007, we had $4.4 million in non-refundable deposits
on real estate under option or contract. As of May 31, 2007, we had 6,419 lots under control for
use in our
homebuilding operations, 4,580 of which are owned by us and 1,839 or 28.6%, of which are
available to us through
rolling options. As of May 31, 2007, we had no commitments under option
contracts with specific performance obligations. Once we acquire land, we generally initiate
development through contractual agreements with local subcontractors. These activities include site
planning, engineering and home construction, as well as constructing road, sewer, water, utilities,
drainage, recreation facilities and other refinements.
The following table presents information regarding land owned and land under option by market as of
May 31, 2007:
Lots Under
Finished
Development
Raw Land
Total Lots
Lots Under
Total Lots
Market
Lots
(# of lots)
(# of lots)
Owned
Option*
Controlled
Atlanta
305
313
—
618
179
797
Dallas
560
144
—
704
578
1,282
Houston
135
604
739
848
1,587
Orlando
473
512
110
1,095
156
1,251
Phoenix
74
796
—
870
—
870
Tampa
300
201
—
501
—
501
Denver
53
—
—
53
78
131
Total
1,900
2,570
110
4,580
1,839
6,419
Percentage of total lots controlled
29.60
%
40.04
%
1.71
%
71.35
%
28.65
%
100
%
*
Includes (i) options under agreements with unrelated third parties and related parties, (ii)
options under agreements with joint ventures with unrelated third parties and related parties, and
(iii) 198 lots in Houston held by a joint venture with an unrelated third party that is managed by
us and as to which option agreements do not yet exist. All of the controlled lots held by joint
ventures described below under “Joint Ventures” are included in “Lots under option”. Additionally,
we own 239 lots of raw land and land under development in Denver that are not anticipated to be
used in our homebuilding operations.
JOINT VENTURES
Occasionally, we use partnerships or joint ventures to purchase and develop land where these
arrangements are economically advantageous. As of May 31, 2007, we controlled 518 lots for future
use by our homebuilding operations through joint ventures with unrelated third parties. We
anticipate continuing to form new partnerships or joint ventures in the future where economically
advantageous.
LETTERS OF CREDIT AND SURETY BONDS
We are frequently required, in connection with the development of our projects, to obtain
letters of credit and surety bonds in support of our related obligations with respect to such
developments. The amount of such obligations outstanding at any time varies in accordance with our
pending development activities. In the event any letters of credit or surety bonds are drawn upon,
we would be obligated to reimburse the issuer of such letters of credit or surety bond. As May 31,2007, we had outstanding $21.3 million of letters of credit and surety bonds related to our
obligations to local governments to construct roads and other improvements in various developments.
We do not believe that any such letters of credit or surety bonds will be drawn upon.
MARKETING AND SALES
We believe that we have established a reputation for developing high quality homes, which
helps generate interest in each new project. We market our products through a variety of means
ranging from fully decorated model homes at each of our communities to newspaper and magazine
advertising as well as internet exposure via our website. We focus on continually improving upon
our brand awareness and maintaining consistency across our various markets. To this end, we have
implemented a standardized sales office design and have increased national advertising to further
these initiatives.
We normally build, decorate, furnish and landscape between one and four model homes for each
project and maintain on-site sales offices. As of May 31, 2007, we maintained 129 model homes,
all of which were owned.
We believe that model homes play a particularly important role in our marketing efforts.
Consequently, we expend a significant effort in creating an attractive atmosphere at our model
homes. Interior decorations are undertaken by local third-party design specialists, and vary
within our models based upon the lifestyles of targeted homebuyers. Structural changes in design
from the model homes are generally permitted within specific guidelines, and homebuyers may
select various optional amenities through the Ashton Woods Homes Design Centers which allow our
homebuyers to personalize their new home. The design centers are staffed with expert in-house
designers that can help make selections from an extensive array of resources. Homebuyers can
choose from among hundreds of carpets, tiles, floors, cabinets, light fixtures, countertops and
more.
We generally sell our homes through commissioned employees. Our personnel are available to
assist prospective homebuyers by providing them with floor plans, price information and tours of
model homes and to assist them with the selection of options. The selection of interior features
is a principal component of our marketing and sales efforts. Sales personnel are trained by us
and attend periodic meetings to be updated on sales techniques, competitive products in the area,
the availability of financing, construction schedules and marketing and advertising plans, which
management believes result in a sales force with extensive knowledge of our operating policies
and housing products. Our policy also provides that sales personnel be licensed real estate
agents where required by law.
We sometimes use various sales incentives in order to attract homebuyers. The sales incentives
come in several forms, including sales price reductions, reductions in the prices of options or
upgrades for their homes and the payment of certain closing costs and other mortgage financing
programs. These sales incentives are included in the contract price and do not require our
continuing involvement after the home is closed and title passes to the homebuyer. The decision to
offer incentives and the type of incentives offered at any point in time are driven by market
forces, including the marketing strategies of our competitors and will vary by market depending on
the interests of target homebuyers, the features of the relevant communities and the competitive
environment.
Sales of our homes are made pursuant to home sale contracts the terms of which vary according
to market practices and to the legal requirements of the markets in which they are used. Typically,
each contract requires a deposit from the homebuyer, which may vary from one to 30 percent of the
purchase price, according to product type and market practice. In addition, the home sale contract
typically contains a financing contingency. The financing contingency provides homebuyers with the
right to cancel in the event they are unable to obtain financing at a prevailing interest rate
within a specified time period from the execution of the home sale contract.
CUSTOMER FINANCING
As part of our objective to make the home buying process more convenient and to increase the
efficiency of our building cycle, we originate mortgages for our customers through Ashton Woods
Mortgage, LLC, which is a joint venture with Wells Fargo Home Mortgage. It has a mortgage capture
rate (representing the percentage of our homes closed with mortgages originated by Ashton Woods
Mortgage, LLC) of more than 80.0% and does not retain or service the mortgages that it originates.
Ashton Woods Mortgage, LLC provides mortgage origination services only, and it originates mortgage
financing for qualified homebuyers for the ultimate purchase of our homes. Upon origination, the
mortgages are sold concurrently to Wells Fargo Home Mortgage or other third party mortgage
companies as deemed necessary by Wells Fargo Home Mortgage. We record Ashton Woods Mortgage, LLC’s
earnings using the equity method of accounting, and its earnings are a component of the line item
of “Earnings in unconsolidated entities’’ on our income statement.
TITLE SERVICES
We also offer title services to our homebuyers in Dallas and Houston through 49.0%
ownership interests in two title companies and in Florida through a 49.0% ownership interest in
a joint venture with a third party title company. The title service companies are managed by,
and all underwriting risks associated with the title are transferred to, the majority owners of
these companies. The earnings from these title companies are recorded using the equity method
of accounting, and the earnings are a component of the line item “Earnings in unconsolidated
entities’’ on our income statement.
We act as the general contractor for the construction of our projects. Subcontractors are
typically retained on a project-by-project basis to complete construction at a fixed price.
Agreements with our subcontractors and material suppliers are generally entered into after
competitive bidding. Our divisional project operators supervise the construction of each project,
coordinate the activities of subcontractors and suppliers, subject their work to quality and cost
controls and assure compliance with zoning and building codes.
We specify that quality, durable materials be used in the construction of our homes. We have
numerous suppliers of raw materials and services used in our business, and such materials and
services have been and continue to be available. From time to time we enter into regional and
national supply contracts with certain of our vendors to leverage our purchasing power and size to
control costs. However, we do not have any material long-term contractual commitments with any of
our subcontractors or suppliers. We do not maintain inventories of construction materials except
for materials being utilized for homes under construction. Material prices may fluctuate due to
various factors, including demand or supply shortages, which may be beyond the control of our
vendors. We believe that our relationships with our suppliers and subcontractors are good.
Construction time for our homes depends on the availability of labor, materials and supplies,
the type and size of the home, location and weather conditions. Our homes are designed to promote
efficient use of space and materials, and to minimize construction costs and time. In all of our
markets, construction of a home is typically completed within four to five months following
commencement of construction.
WARRANTY PROGRAM
We offer a standard one, two, ten-year warranty program. The one-year limited warranty covers
workmanship and materials and includes home inspection visits with the customer. We subcontract our
homebuilding work to subcontractors who provide us with an indemnity and a certificate of insurance
prior to receiving payments for their work and, therefore, claims relating to workmanship and
materials are generally the primary responsibility of our subcontractors. In addition, the first
year of our warranty covers defects in plumbing, electrical, heating, cooling and ventilation
systems, and construction defects. The second year of the warranty covers construction defects and
certain defects in plumbing, electrical, heating, cooling and ventilation systems of the home
(exclusive of defects in appliances, fixtures and equipment). The remaining years of protection
cover only construction defects.
We record a liability of approximately 1.0% to 1.3% of the sales price of a home to cover
warranty expenses, although this allowance is subject to adjustment in special circumstances.
Our historical experience is that warranty expenses generally fall within the amount
established for such allowance.
In addition, we maintain insurance coverage with Residential Warranty Corporation for
construction defects. We believe that our accruals and third party insurance are adequate to
cover the ultimate resolution of our potential liabilities associated with known and anticipated
warranty and construction defect related claims and litigation.
CORPORATE OPERATIONS
We perform the following functions at a centralized level:
•
evaluate and select geographic markets;
•
allocate capital resources to particular markets, including final approval of all land acquisitions;
•
regulate the flow of financial resources and maintain relationships with our lenders;
•
maintain centralized information systems; and
•
monitor the decentralized operations of our subsidiaries and divisions.
We allocate capital resources necessary for new projects in a manner consistent with our
overall operating strategy. We utilize return on assets, gross margins, net income margin and
inventory turnover as the primary criteria for our allocation of capital resources. We will vary
the capital allocation based on market conditions, results of operations and other factors. Capital
commitments are determined through consultation among selected executive and operational personnel,
who play an important role in ensuring that new projects are consistent with our strategy.
Centralized financial controls are also maintained through the standardization of accounting and
financial policies and procedures.
Structurally, we operate through separate divisions, which are located within the market in
which they operate. Each division is managed by executives with substantial experience in the
division’s market. In addition, each division is equipped with the skills to complete the functions
of land acquisition, land development, construction, marketing, sales, product service and
accounting.
COMPETITION AND MARKET FACTORS
The development and sale of residential properties is highly competitive and fragmented. We
compete with numerous small and large residential builders for sales on the basis of a number of
interrelated factors, including location, reputation, amenities, design, quality and price. We also
compete for sales with individual resales of existing homes, available rental housing and resales
of stacked-flat condominiums. We believe that we compare favorably to other builders in the markets
in which we operate, due primarily to our experience within our geographic markets and breadth of
product line, which allows us to vary our product offerings to reflect changing conditions within a
market; our responsiveness to market conditions, enabling us to capitalize on the opportunities for
advantageous land acquisitions in desirable locations; and our reputation for quality design,
construction and service. Notwithstanding our perceived advantages with respect to other builders,
some of our competitors have significantly greater financial resources or lower costs than we do.
Because some of our competitors are larger than us, they may possess certain advantages over us,
such as the ability to raise money at lower cost and the ability to negotiate significantly better
prices on supplies and with subcontractors. Certain of our smaller competitors may have an
advantage over us because they tend to have closer ties to the communities in which they build and,
based on length of operation in the market, better name recognition than us. Furthermore, many
custom homebuilders may have an advantage over us because purchasers of custom homes tend to want a
level of flexibility in the design and construction of their homes that we do not offer.
The demand for new housing is affected by consumer confidence levels and prevailing economic
conditions generally, including employment and interest rate levels. A variety of other factors
affect the housing industry and demand for new homes, including the availability of labor and
materials and increases in the costs thereof, changes in costs associated with home ownership such
as increases in property taxes and energy costs, changes in consumer preferences, demographic
trends, the amount of resale housing inventory available in the market and the availability of and
changes in mortgage financing programs.
GOVERNMENT REGULATION AND ENVIRONMENTAL MATTERS
Substantially all of our land is purchased with entitlements, giving us the right to obtain
building permits upon compliance with specified conditions, which generally are within our control.
Upon compliance with such conditions, we must obtain building permits. The length of time necessary
to obtain such permits and approvals affects the carrying costs of unimproved property acquired for
the purpose of development and construction. In addition, the continued effectiveness of permits
already granted is subject to factors such as changes in policies, rules and regulations and their
interpretation and application. Several governmental authorities have imposed impact fees as a
means of defraying the cost of providing certain governmental services to developing areas. To
date, the governmental approval processes discussed above have not had a material adverse effect on
our development activities and have not had a material effect on our capital expenditures, earnings
and competitive position, and indeed all homebuilders in a given market face the same fees and
restrictions. There can be no assurance, however, that these and other restrictions will not
adversely affect us in the future.
We may also be subject to periodic delays or may be precluded entirely from developing
communities due to building moratoriums or “slow-growth’’ or “no-growth’’ initiatives or building
permit allocation ordinances which could be implemented in the future in the states and markets in
which we operate. Substantially all of our land is entitled and, therefore, the moratoriums
generally would only adversely affect us if they arose from health, safety and welfare issues such
as insufficient water or sewage facilities. Local and state governments also have broad discretion
regarding the imposition of development fees for projects in their jurisdiction. These fees are
normally established, however, when we receive recorded final maps and building permits. We are
also subject to a variety of local, state and federal statutes, ordinances, rules and regulations
concerning the protection of health and the environment. Although in the future these laws may
result in delays, cause us to incur substantial compliance and other costs, and prohibit or
severely restrict development in certain environmentally sensitive regions or areas, these laws
have not had a material effect on our capital expenditures, earnings and competitive position to
date.
As of May 31, 2007, we employed 416 people, of whom 132 were sales and marketing personnel,
182 were executive, management and administrative personnel and 102 were involved in construction.
Although none of the our employees are covered by collective bargaining agreements, certain of the
subcontractors engaged by us are represented by labor unions or are subject to collective
bargaining arrangements. We believe that our relations with our employees and subcontractors are
good.
Item 1A. Risk Factors
Important factors currently known to management that could cause actual results to differ
materially from those in forward-looking statements include, but are not limited to, the following:
The homebuilding industry historically has been cyclical and is now experiencing the first
downturn in a number of years. Continuation of this downturn may result in continuing reduction
in our operating revenues and lower net income.
The housing industry historically has been cyclical and has been affected significantly by
adverse changes in consumer confidence levels and prevailing general and local economic conditions,
including interest rate levels. These changes in economic conditions have in the past resulted in
more caution on the part of potential purchasers of our homes and consequently resulted in a
decline in our home sales. Beginning in 2006 and continuing in 2007, the homebuilding industry has
experienced the first downturn in a number of years resulting in a significant decline in demand
for newly built homes in many of our markets. Significant drivers of these economic conditions in
this cycle have involved, among other things, a decline in demand in our markets due to changes in
consumer confidence in the real estate market, increased inventory of new and used homes for sale
and resulting increases in cancellation rates in most of our markets, pricing pressures resulting
from the imbalance between supply and demand and the recent collapse of the sub-prime lending
industry that financed a significant number of home sales over the last four years. These factors
have had an impact on our operating performance, and have caused our operating revenues to decline.
We have no basis for predicting how long demand and supply will remain out of balance in our
markets and whether, once the market stabilizes, sales volumes or pricing will return to prior
levels. While the factors discussed above may have an impact on the homebuilding industry
generally, if they continue to put pressure on the homebuilding industry they may have a more
significant impact on us compared to certain of our competitors because our operations are
concentrated in fewer geographic markets.
If the market value of our inventory drops significantly, we could be required to further write
down the carrying value of our inventory to its estimated fair value, which would negatively
impact our results of operations and financial condition.
We acquire land for expansion into new markets and for replacement of land inventory and
expansion within our current markets. The market value of land, building lots and housing
inventories can fluctuate significantly as a result of changing market conditions, and the measures
we employ to manage inventory risk may not be adequate to insulate our operations from a severe
drop in inventory values. Because of deteriorating conditions in the homebuilding industry, we
recognized asset impairment charges with respect to our inventories during fiscal years 2006 and
2007. If the market value of our inventory drops again in the future, we could be required to
further write down the carrying value of our inventory to its estimated fair value, which would
negatively impact our results of operations and financial condition.
Our home sales and operating revenues could decline due to macroeconomic and other factors
outside of our control, such as changes in consumer confidence, declines in employment levels
and terrorist attacks.
The housing industry historically has been cyclical and has been affected significantly by adverse
changes in consumer confidence levels and prevailing general and local economic conditions,
including interest rate levels. These changes in economic conditions may result in more caution on
the part of potential purchasers of our homes
and consequently result in a decline in our home sales. Significant drivers of these economic
conditions involve,
among other things, conditions of supply and demand in our markets as well as
changes in consumer confidence and income, employment levels, interest rate levels, government
regulations, terrorist attacks and domestic and international instability. These risks and
uncertainties could periodically have an adverse effect on consumer demand for and the pricing of
our homes, which could impact our operating performance, make it more difficult for us to compete
with larger home builders who have more resources to address pricing pressure and cause our
operating revenues to decline. While the factors discussed above may have an impact on the
homebuilding industry generally, they may have a more significant impact on us compared to certain
of our competitors because our operations are concentrated in fewer geographic markets and because
we may not have as significant reserves of resources to help us adjust to a decline in demand for
our homes.
Our operating results are variable, and as a result, our historical performance may not be a
meaningful indicator of future results.
We have historically experienced, and in the future expect to continue to experience,
variability in our operating results on a quarterly and an annual basis. Factors expected to
contribute to this variability include, among other things:
•
the timing of land acquisitions and zoning and other regulatory approvals;
•
the timing of home closings, land sales and level of home sales;
•
our product mix;
•
our ability to continue to acquire additional land or options thereon on acceptable terms;
•
the condition of the real estate market and the general economy;
•
delays in construction due to acts of God, adverse weather, reduced
subcontractor availability and strikes; and
•
employment levels.
For example, the timing of land acquisitions, zoning and other regulatory approvals impacts
our ability to pursue the development of new housing projects in accordance with our business plan.
If the timing of land acquisitions or zoning or regulatory approvals is delayed, we will be delayed
in our ability to develop housing projects, which would likely decrease our backlog. Furthermore,
these delays could result in a decrease in our revenues and earnings for the periods in which the
delays occur and possibly subsequent periods until the planned housing projects can be completed. A
delay in a significant number of home closings or land sales due to acts of God, adverse weather,
subcontractor availability or strikes would have a similar impact on revenues and earnings for the
period in which the delays occur. Further, revenues may increase in subsequent periods over what
would normally be expected as a result of increased home closings as the delays described above are
resolved.
Changes in employment levels could affect the number of people seeking new housing in one or
more of our markets. Consequently, if there was an adverse change in employment levels in our
markets, we may not reach our projected level of home sales, and we may have planned the
construction of more homes than necessary resulting in a slowdown in the closing of our
developments. Conversely, favorable changes in employment levels could result in unexpected
increases in our revenues and earnings.
An increase in mortgage interest rates or unavailability of mortgage financing may reduce
consumer
demand for our homes.
Virtually all purchasers of our homes finance their acquisitions through lenders providing
mortgage financing. A substantial increase in mortgage interest rates or unavailability of mortgage
financing would adversely affect the ability of prospective homebuyers to obtain the financing they
would need in order to purchase our homes, as well as adversely affect the ability of prospective
move-up homebuyers to sell their current homes. For example, if mortgage financing became less
available, demand for our homes could decline. A reduction in demand could also
have an adverse effect on the pricing of our homes because we and our competitors may reduce
prices in an effort to better compete for home buyers. A reduction in pricing could result in a
decline in revenues and in our margins.
We intend to continue to consider growth or expansion of our operations which could have a
material
adverse effect on our cash flows or profitability.
We intend to continue to consider growth or expansion of our operations in our current
markets or in other areas which will require substantial capital expenditures. The magnitude,
timing and nature of any future expansion will depend on a number of factors, including the
identification of suitable markets, our financial capabilities, the availability of qualified
personnel in the target market and general economic and business conditions. Our expansion into
new or existing markets could have a material adverse effect on our cash flows or profitability.
Historically, our strategy has been to enter new markets through the start-up of
company-developed divisions, rather than the acquisition of existing homebuilding companies.
Because we typically do not acquire existing homebuilders when entering a new market, we do not
have the advantage of the experience and goodwill of an established homebuilding company. As a
result, we incur substantial start-up costs in establishing our operations in new markets, and we
may not be successful in taking operations in new markets from the start-up phase to profitability.
If we are not successful in making operations in new markets profitable, we may not be able to
recover our investment, and our financial results could suffer.
Furthermore, in the future we may choose to enter new markets or expand operations in
existing markets through acquisitions, and these acquisitions may result in the incurrence of
additional debt. Acquisitions also involve numerous risks, including difficulties in the
assimilation of the acquired company’s operations, the incurrence of unanticipated liabilities or
expenses, the diversion of management’s attention from other business concerns, risks of entering
markets in which we have limited or no direct experience, and the potential loss of key employees
of the acquired company.
Lack of greater geographic diversification could expose our business to increased risks if
there are
economic downturns in our markets.
We have homebuilding operations in Atlanta, Dallas, Houston, Orlando, Phoenix, Tampa and
Denver. We also have land operations in Denver and Orlando. Our operations in Atlanta, Orlando
and Phoenix together provided 64.0% and 65.8% of our home building revenues for the fiscal years
ended May 31, 2007 and 2006, respectively. Failure to be more geographically diversified could
adversely impact us if the homebuilding business in our current markets, especially Atlanta,
Orlando, and Phoenix should decline.
We could experience a reduction in home sales and revenues or reduced cash flows if we are
unable to
obtain reasonably priced financing to support our homebuilding and land development
activities.
The homebuilding industry is capital intensive, and homebuilding requires significant
up-front expenditures to acquire land and begin development. Accordingly, we incur substantial
indebtedness to finance our homebuilding and land development activities. Although we believe
that internally generated funds and borrowing capacity under our senior unsecured credit
facility will be sufficient to fund our capital and other expenditures (including land
acquisition, development and construction activities), the amounts available from such sources
may not be adequate to meet our needs. If such sources are not sufficient, we would seek
additional capital in the form of debt or equity financing from a variety of potential sources,
including additional bank financing and/or securities offerings. The amount and types of
indebtedness which we may incur are limited by the terms of the agreements governing our
existing debt. In addition, the availability of borrowed funds, to be utilized for land
acquisition, development and construction, may be greatly reduced, and the lending community
may require increased amounts of equity to be invested in a project by borrowers in connection
with both new loans and the extension of existing loans. The failure to obtain sufficient
capital to fund our planned capital and other expenditures could have a material adverse effect
on our business.
Changes in the government regulations applicable to homebuilders could restrict our business
activities,
increase our operating expenses and cause our revenues to decline.
Regulatory requirements applicable to homebuilders could cause us to incur significant
liabilities and operating expenses and could restrict our business activities. We are subject to
local, state and federal statutes and rules regulating, among other things certain developmental
matters, building and site design, and matters concerning the protection of health and the
environment. Our operating expenses may be increased by governmental regulations, such as building
permit allocation ordinances, impact and other fees and taxes, which may be imposed to defray the
cost of providing certain governmental services and improvements. Other governmental regulations,
such as building moratoriums and “no growth’’ or “slow growth’’ initiatives, which may be adopted
in communities which have developed rapidly, may cause delays in our home projects or otherwise
restrict our business activities resulting in reductions in our revenues. Any delay or refusal to
grant us necessary licenses, permits or approvals from government agencies could have an adverse
effect on our operations. Because we currently operate in only seven markets, any increase in costs
or delays due to regulatory changes in one or more of our markets may have a proportionately
greater impact on us than some other homebuilding companies that operate in more markets or more
regions of the country.
We may incur additional operating expenses due to compliance requirements or fines, penalties
and
remediation costs pertaining to environmental regulations within our markets.
We are subject to a variety of local, state and federal statutes, ordinances, rules and
regulations concerning the protection of health and the environment. The particular environmental
laws which apply to any given community vary greatly according to the community site, the site’s
environmental conditions and the present and former use of the site. We expect that increasingly
stringent requirements will be imposed on homebuilders in the future. Environmental laws may result
in delays, cause us to implement time consuming and expensive compliance programs, and prohibit or
severely restrict development in certain environmentally sensitive regions or areas. Environmental
regulations can also have an adverse impact on the availability and price of certain raw materials,
such as lumber. Furthermore, our failure to comply with all applicable environmental laws and
regulations may result in the imposition of fines and penalties or remediation obligations that may
require us to pay substantial amounts of money. The occurrence of any of the foregoing could result
in an increase in our expenses and a reduction in our net income.
We are subject to warranty claims arising in the ordinary course of our business that could
adversely
affect our results of operations.
We are subject in the ordinary course of our business to home warranty claims. We provide our
homebuyers with a one year warranty covering workmanship and materials, a two year warranty
covering construction defects and certain defects in plumbing, electrical, heating, cooling and
ventilation systems and a ten year warranty covering construction defects. Warranty claims are
common in the homebuilding industry and can be costly, and the terms and limitations of the limited
warranties provided to homebuyers may not be effective against claims made by the homebuyers. We
maintain homebuilder protective policy insurance coverage with Residential Warranty Corporation for
construction defects. However, we may not be able to renew our insurance coverage or renew it at
reasonable rates. As a result, we may be liable for damages, the cost of repairs and/or the expense
of litigation surrounding possible construction defects, soil subsidence or building-related
claims. Furthermore, claims may arise out of uninsurable events or circumstances not covered by
insurance and not subject to effective indemnification agreements with our subcontractors.
Increases in the cost to insure against warranty claims may result in an increase in our
self-insured retentions and claims reserves. Further, the loss of insurance or liability for
uninsured claims could result in an increase in our expenses reducing our margins and adversely
affecting our results of operations and our ability to implement our business plan.
Our operating expenses could increase if we are required to pay higher insurance premiums or
incur
substantial litigation costs for claims involving construction and product defect liability
claims,
including claims related to mold, which could cause our net income to decline.
The costs of insuring against construction defect and product liability claims are high, and
the amount and
scope of coverage offered by insurance companies is currently limited. The scope of coverage
may continue to be limited or be further restricted and may become more costly which could require
us to divert money away from implementing our business plan in order to pay insurance premiums.
Increasingly in recent years, lawsuits (including class action lawsuits) have been filed
against builders asserting claims of personal injury and property damage caused by the presence of
mold in residential dwellings. Our insurance may not cover all of the claims, including personal
injury claims, arising from the presence of mold, or such coverage may become prohibitively
expensive. If we are not able to obtain adequate insurance against these claims, we may experience
litigation costs and losses that could reduce our net income.
Historically, builders have recovered from subcontractors and their insurance carriers a
significant portion of the construction and product defect liabilities and costs of defense that
the builders have incurred. Insurance coverage available to subcontractors for construction and
product defects is becoming increasingly expensive and the scope of coverage is restricted. If we
cannot effectively recover from our subcontractors or their carriers, we may suffer greater
losses which could decrease our net income.
A builder’s ability to recover against any available insurance policy depends upon the
continued solvency and financial strength of the insurance carrier that issued the policy. Many of
the states in which we build homes have lengthy statutes of limitations applicable to claims for
construction defects. To the extent that any carrier providing insurance coverage to us or our
subcontractors becomes insolvent or experiences financial difficulty in the future, we may be
unable to recover on those policies and our net income may decline. Our inability to recover under
those policies or to recover the losses from our subcontractors could have a more severe impact on
us than on our larger competitors that have more financial resources.
We are dependent on the services of certain key employees, and the loss of their services
could hurt our
business.
We currently operate with a management team comprised of five executive officers and a single
president overseeing each geographic market. Therefore, we rely heavily on each of these
individuals for their expertise and understanding of our business operations and strategy. Our
decision making process is generally concentrated among these individuals and is based on their
skill and depth of knowledge of us and the homebuilding industry. If we are unable to retain any of
these key employees, particularly Tom Krobot, Robert Salomon and Mark Thomas, or attract, train,
assimilate or retain other skilled personnel in the future, it could hinder the execution of our
business strategy. Further, the loss of one or more of these key employees would put additional
strain on the existing management team to fill the vacancy until a replacement can be identified.
Competition for qualified personnel in all of our operating markets is intense, and it could be
difficult for us to find experienced personnel to replace our current employees, particularly our
management team. Furthermore, a significant increase in the number of our active communities would
place additional strain on the members of our management team and would necessitate the hiring of a
significant number of additional personnel, including senior officers, who are in short supply in
our markets, particularly with respect to individuals with significant homebuilding experience.
We are dependent on the continued availability and satisfactory performance of our
subcontractors,
which, if unavailable, could have a material adverse effect on our business.
We conduct our construction operations only as a general contractor. Virtually all
construction work is performed by unaffiliated third party subcontractors. As a consequence, we
depend on the continued availability of and satisfactory performance by these subcontractors for
the construction of our homes. There may not be sufficient availability of and satisfactory
performance by these unaffiliated third party subcontractors. If there are not sufficient quality
subcontractors available to assist us in home construction, our ability to construct homes on the
schedule we have committed to with our homebuyers would be affected. This could result in an
increase in the number of homebuyers that cancel their contracts with us, resulting in less of our
backlog being closed in a year than is projected, or could result in an increase in our costs to
construct homes in a timely manner, which could result in an increase in our overall costs and thus
a decline in our margins and in our net income.
Supply risks and shortages relating to labor and materials can harm our business by delaying
construction and increasing costs.
The homebuilding industry from time to time has experienced significant difficulties with respect to:
•
shortages of qualified trades people and other labor;
•
shortages of materials; and
•
volatile increases in the cost of certain materials, including lumber, framing
and cement, which are significant components of home construction costs.
These difficulties can, and often do, cause unexpected short-term increases in construction
costs and cause construction delays. We are generally unable to pass on any unexpected increases in
construction costs to those customers who have already entered into sales contracts, as those
contracts generally fix the price of the house at the time the contract is signed, which may be up
to one year in advance of the delivery of the home. Furthermore, sustained increases in
construction costs may, over time, erode our profit margins. In the future, pricing competition may
restrict our ability to pass on any additional costs, and we may not be able to achieve sufficient
operating efficiencies and economics of scale to maintain our current profit margins.
Our financial condition and results of operations may be adversely affected by any decrease in
the value
of our land inventory, as well as by the associated carrying costs.
We must continuously acquire land for replacement and expansion of land inventory within our
existing and new markets. The risks inherent in purchasing and developing land increase as
consumer demand for housing decreases. Thus, we may have bought and developed land which we cannot
profitably sell or on which we cannot profitably build and sell homes. The market value of land,
building lots and housing inventories can fluctuate significantly as a result of changing market
conditions. It is possible that the measures we employ to manage inventory risks will not be
successful and as a result our operations may suffer.
In addition, inventory carrying costs can be significant and can result in losses in a poorly
performing project or market. In the event of significant changes in economic or market
conditions, we may have to sell homes at significantly lower margins or at a loss.
Our business and operating results could be adversely affected by adverse weather conditions
and natural
disasters.
Adverse weather conditions, such as extended periods of rain, snow or cold temperatures, and
natural disasters, such as hurricanes, tornadoes, floods and fires, can delay completion and sale
of homes, damage partially complete or other unsold homes in our inventory and/or decrease the
demand for homes or increase the cost of building homes. To the extent that natural disasters or
adverse weather events occur, our business and results may be adversely affected. To the extent
our insurance is not adequate to cover business interruption losses or repair costs resulting from
these events, our revenues and earnings may be adversely affected.
If we are unsuccessful in competing against other homebuilders, our market share could decline
or our
growth could be impaired and, as a result, our financial results could suffer.
The homebuilding industry is highly competitive. Homebuilders compete for, among other
things, desirable land, financing, raw materials, skilled labor and purchasers. We compete for
residential sales on the basis of a number of interrelated factors, including location,
reputation, amenities, design, quality and price, with numerous large and small homebuilders,
including some homebuilders with nationwide operations and greater financial resources and/or
lower costs than us. The consolidation of some homebuilding companies may create competitors that
have greater financial, marketing and sales resources than we do and thus are able to compete more
effectively against us. In addition, there may be new entrants in the markets in which we
currently conduct business. We also compete for sales with the resale market for existing homes
and with available rental housing. Increased competition could cause us to increase our selling
incentives and reduce our home prices. Increased competition
could also reduce the number of homes we deliver, reducing our revenues, or cause us to
accept reduced margins to maintain sales volumes. A reduction in our revenue or margins due to
competitive factors could affect our ability to service our debt, including the notes.
Reduced numbers of home sales may force us to absorb additional costs which could have an
adverse impact on our operating results and financial condition.
We incur many costs even before we begin to build homes in a community. These include
costs of preparing land and installing roads, sewage and other utilities, as well as taxes and
other costs related to ownership of the land on which we plan to build homes. Reducing the rate at
which we build homes extends the length of time it takes us to recover these costs, which could
have an adverse impact on our operating results and financial condition.
Increases in our cancellation rate could have a significant negative impact on our operating
results.
Our cancellation rate, which is the percentage of gross new home orders cancelled during a
reporting period, increased significantly during fiscal years 2006 and 2007, compared with
cancellation rates during fiscal years 2004 and 2005, which has negatively impacted the number of
closed homes, net home orders, and home sales revenue and net income during fiscal year 2007.
Continued high cancellation rates resulting from a number of factors, including, slower home price
appreciation, increases in the supply of homes available to be purchased, higher mortgage interest
rates, increased competition and adverse changes in economic conditions, could have a significant
negative impact on our home sales revenue and result in lower net income or higher net loss in
future reporting periods.
Item 1B. Unresolved Staff Comments
Not applicable
Item 2. Properties
We lease 6,284 square feet of office space in Atlanta, Georgia for our corporate offices.
This lease expires in 2008. In addition, we lease 90,999 square feet of space for our operating
divisions under leases expiring between 2007 and 2009. The leases have terms ranging from 12
months to 60 months, with various renewal options.
Item 3. Legal Proceedings
From time to time we are involved in various routine legal proceedings incidental to our
business. We believe that none of these matters, some of which are covered by insurance, will have
a material adverse impact upon our consolidated financial statements as a whole if decided against
us.
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Repurchases
of Equity Securities
We are a limited liability company, and all of our membership interests are owned by six
families or family trusts related to the following individuals: Elly Reisman, Norman Reisman, Bruce
Freeman, Seymour Joffe, Larry Robbins and Harry Rosenbaum. The owners control us through individual
Nevada-based holding companies in which each family or family trust owns all of the equity
interests. See Item 12 “Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters” for additional information about the ownership of our membership interests.
There is no established public trading market for our membership interests.
Although we do not pay dividends to our members, we periodically make distributions to them
for the payment of federal and state income taxes and as general distributions of our income.
During the fiscal years ended May 31, 2007 and 2006, we distributed a total of $30.4 million and
$37.3 million, respectively, to our members. In 2007 and 2006, $22.9 million and $25.1 million
respectively, were related to the payment of income taxes and $7.5 million and $12.2 million
respectively were general distributions. We are restricted in our ability to pay distributions
under various covenants of our debt agreements.
The following table sets forth selected consolidated financial information for Ashton Woods USA
L.L.C. for and as of each of the five fiscal years in the period ended May 31, 2007.
Because we are structured as a limited liability company, income tax obligations are paid by
our members and are not borne by us. Therefore, our net income is higher than it would be if
we were structured as a subchapter C corporation. However, historically we have made
distributions to our members that include amounts necessary for them to pay income taxes
attributable to them.
(2)
EBITDA (earnings before interest, taxes, depreciation and amortization) is calculated by
adding previously capitalized interest amortized to costs of sales, franchise taxes,
depreciation and amortization to net income. EBITDA is not a financial measure under generally
accepted accounting principles in the United States, or GAAP. EBITDA should not be considered
an alternative to net income determined in accordance with GAAP as an indicator of operating
performance, nor an alternative to cash flows from operating activities determined in
accordance with GAAP as a measure of liquidity. Because some analysts and companies may not
calculate EBITDA in the same manner as us, the EBITDA information in this report may not be
comparable to similar presentations by others.
EBITDA is a measure commonly used in the homebuilding industry and is presented as a useful
adjunct to net income and other measurements under GAAP because it is a meaningful measure of a
company’s performance, as interest, taxes, depreciation and amortization can vary significantly
between companies due in part to differences in structure, accounting policies, tax strategies,
levels of indebtedness, capital purchasing practices and interest rates. EBITDA also assists
management in evaluating operating performance, and we believe that it is a useful measure for
investors to compare us with our competitors.
The following is a reconciliation of EBITDA to net income, the most directly comparable GAAP
measure:
Fiscal years ended May 31
2007
2006
2005
2004
2003
($ in thousands)
Net income
$
24,683
$
86,471
$
59,454
$
42,427
$
16,497
Franchise taxes
188
595
439
361
389
Depreciation and amortization
5,925
6,192
3,870
3,915
3,574
Interest expense in cost of sales
13,047
9,037
4,790
5,822
7,460
EBITDA
$
43,843
$
102,295
$
68,553
$
52,525
$
27,920
In fiscal years 2007 and 2006, we recognized non-cash impairment charges of $18.8 million
and $4.5 million respectively. Consequently, EBITDA during each of those years was reduced by
these non-cash charges.
EBITDA does have certain limitations as a tool for measuring Company performance from period to
period, because that performance is affected by the use of cash to purchase capital assets and
to pay interest and taxes. These amounts, as well as depreciation and amortization associated
with capital assets, can fluctuate significantly over time due to fluctuations in our debt
levels used to finance our inventory, purchases of capital assets and operations, income levels
and other performance issues, which is not apparent if EBITDA is used as an evaluation tool.
Because we borrow money to finance our inventory purchases and operations, interest expense is a
necessary element of our costs and affects our ability to generate revenue. Further, because we
use capital assets, depreciation and amortization are necessary elements of our costs and also
affect our ability to generate revenue. Any performance measure that excludes interest expense,
depreciation and amortization has material limitations. To compensate for these limitations, our
management uses both EBITDA and net income, the most directly comparable GAAP measurement, to
evaluate our performance.
(3)
EBITDA margin is calculated by dividing EBITDA by total revenues.
(4)
Interest incurred for any period is the aggregate amount of interest which is capitalized
during such period.
(5)
A home is included in “homes closed” when title is transferred to the buyer. Revenues and
cost of sales for a home are recognized at the date of closing.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
OVERVIEW
We are one of the largest private homebuilders in the United States. We design, build and
market high-quality single-family detached homes, townhomes and stacked-flat condominiums under the
Ashton Woods Homes brand name. We currently operate in Atlanta, Dallas, Houston, Orlando, Phoenix,
Denver and Tampa. These cities represent seven of the 21 largest new residential housing markets in
the United States. We have been in operation for over 15 years and serve a broad customer base
including first-time buyers and first- and second-time move-up buyers. We focus on achieving the
highest standards in design, quality and customer satisfaction. We have received numerous awards,
including the 2005 and 2004 J.D. Power Award for Highest in Customer Satisfaction with New
Homebuilders in Atlanta, and are ranked in the top 13% of all homebuilders nationally in customer
satisfaction in 2006 and 2005 by a nationally recognized survey company not affiliated with us.
Our revenues are primarily generated from designing, building and marketing single-family
detached homes, townhomes, and stacked-flat condominiums in the five states and seven markets we
currently serve. We also acquire and develop land for use in our homebuilding operations and for
sale to others. From time to time, we elect to sell parcels of land or finished lots that do not
fit with our home development program. Parcels of land or finished lots may be deemed not to fit
within our home development program for a variety of reasons, including, when a specific parcel
contains a greater supply of lots than deemed appropriate for the particular development or
specific lots are designed for a housing product that is not within our business plan for that
area, such as custom built homes or homes that are not within the size specifications for the
particular development. These land sales are incidental to our business of selling and building
homes and have fluctuated significantly in the past. We anticipate continuing to sell parcels of
land and finished lots in the future when circumstances warrant; however, we do not anticipate
future sales of land being as significant a part of our revenues as they have been in the past. We
expect that the significance of land sales revenue will fluctuate from quarter to quarter.
We also conduct mortgage origination and title services for the benefit of our homebuilding
operation. These ancillary services do not provide us with significant revenues and are carried out
through separate jointly-owned entities, which are operated by our partners in these entities. The
earnings from these jointly-owned entities are recorded using the equity method of accounting, and
the earnings are a component of the line item “Earnings in unconsolidated entities” on our income
statement. We have a 49.9% interest in an entity that offers mortgage financing to all of our
buyers and in the past has offered refinancing services to others. The mortgage operation’s
revenues consist primarily of origination and premium fee income, interest income and the gain on
sale of the mortgages. We also offer title services to our homebuyers in Dallas and Houston through
49.0% ownership interests in two title companies, and in Florida through a 49.0% ownership interest
in a joint venture with a third party title company. The companies are managed by, and all
underwriting risks associated with the title are transferred to, the majority owners.
The continued downturn in the homebuilding industry has resulted in decreases in home
closings, net new home orders, revenues and net income for the fiscal year ended May 31, 2007, from
the record levels achieved during the prior fiscal year.
•
Revenues decreased to $581.0 million for fiscal year 2007, as compared to $703.0
million for fiscal year 2006. The decrease in revenues was a direct result of the
17.4% decrease in homes closed to 1,992 in fiscal year 2007, as compared to 2,413
in fiscal year 2006.
•
Net income for fiscal year 2007 decreased to $24.7 million, a decrease of 71.5%
compared to the prior fiscal year.
•
Net new home orders for fiscal year 2007 was 1,564 representing a decrease of
32.8% as compared to the prior fiscal year.
The decline in net new home orders resulted from, among other things, the continued general
reduction in the demand for new homes and the oversupply of new and used homes available for sale
in the marketplace. The recent problems in the sub-prime mortgage lending market exacerbated the
oversupply of new and used homes available for sale. Fewer potential homebuyers have
been able to qualify for a mortgage loan as
compared to a year ago resulting in a smaller pool of homebuyers and impacting the
sale of existing homes by our move-up buyers.
Throughout fiscal year 2007, we increased the sales incentives offered to homebuyers and
increased marketing efforts to stimulate net new home orders and to maintain homes in backlog. The
sales incentives offered to our homebuyers vary depending upon the particular market and include
sales price reductions, reductions in the prices of options for their homes, discounted upgrades,
the payment of certain closing costs and other mortgage financing programs. We believe that these
incentives contributed to an improvement in our cancellation rate from 34% for the first six months
of fiscal year 2007 to 29% for the final six months of fiscal year 2007. For the entire fiscal
year our average cancellation rate was 31%.
Management has been and continues to be committed to maintaining our conservative balance
sheet practices through the strict control of speculative inventory and curtailment of land
acquisition activities. We have focused our efforts on generating net new home sales through the
continued use of sales incentives and an increase in our advertising efforts. As of May 31, 2007,
we had 138 homes at various stages of completion (of which 93 homes were completed) for which we
did not have a sales contract (“spec homes”) as compared to 129 total spec homes at the end of the
prior year, of which 73 were completed. In addition, our desire to maintain a conservative balance
sheet has resulted in a land supply under our historical four-year supply target as we have
tightened our underwriting guidelines for new land acquisitions. As of May 31, 2007, our supply of
land controlled for use in our homebuilding operations was 3.3 years, consisting of a 2.4 year
supply of owned land and a 0.9 year supply of land controlled through option contracts.
Management will continue to evaluate our land supply in relation to the overall health of the
homebuilding environment and will adjust our land supply accordingly in the future.
The homebuilding market continued to deteriorate throughout fiscal year 2007 and is in a
significant downturn due in large part to the over supply of new and used homes for sale as
compared to the demand for housing by potential homebuyers. We believe the continued high level of
new and resale inventory available for sale in the market, the reduced level of consumer confidence
and higher mortgage interest rates coupled with tightened mortgage lending standards will continue
to negatively impact demand for new homes for the foreseeable future. We have made significant
adjustments in our operations including, among other things, reductions in sales and marketing and
general and administrative expenses, reduced construction costs, reduced land acquisitions and
increased sales incentives, in an effort to mitigate the effects of a prolonged decrease in the
demand for new homes, although there can be no assurances that these efforts will be successful.
Further deterioration in the homebuilding market may cause additional pressures on sales incentives
that may lead to reduced gross margins and potentially additional inventory impairments in the
future.
On January 10, 2007, we amended our senior unsecured credit facility to amend the definition
of “EBITDA” contained therein to exclude certain non-cash gains and include certain non-cash losses
or charges and to extend the maturity date to January 19, 2011, for 88.3%, or $265.0 million of the
facility. On February 21, 2007, we obtained consent from an additional lender representing 5.0% or
$15 million of the facility, to the extension of the senior unsecured credit facility to January19, 2011. In June 2007, we entered into another amendment to the revolving credit facility. The
June 2007 amendment provides for a reduction in the interest coverage ratio and for adjustments to
the leverage ratio and the interest rate in the event that our interest coverage ratio falls below
a certain level. See Note 14 to the consolidated financial statements for additional information.
RECENT ACCOUNTING PRONOUNCEMENTS
In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, (“SFAS 157”). SFAS
157 defines fair value, establishes a framework for measuring fair value under generally accepted
accounting principles and expands disclosures about fair value measurements. SFAS 157 is effective
for financial statements issued for fiscal years beginning after November 15, 2007, and interim
periods within those fiscal years. We are currently evaluating the impact of adopting SFAS 157 on
our results of operations or financial position.
RECENTLY ADOPTED ACCOUNTING POLICIES
In December 2004, the FASB issued SFAS 123 (Revised), Share-Based Payment (“SFAS 123 (R)”),
which was a revision of SFAS No. 123. “Accounting for Stock-Based Compensation” (FAS 123). FAS
123(R) supersedes APB
Opinion 25, “Accounting for Stock Issued to Employees”and amends SFAS No.
95, “Statement of Cash Flows”, and requires instead that compensation expense be recognized based
on the fair value on the date of the grant. SFAS 123(R) was effective beginning in the first
quarter of fiscal 2007. The adoption of SFAS 123(R) did not have a material impact on our
consolidated results of operations or financial position.
In September 2006, the Securities and Exchange Commission (“SEC”) Staff issued Staff
Accounting Bulletin 108, Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements (“SAB 108”). SAB 108 addresses how the effects
of prior year uncorrected financial statement misstatements should be considered in current year
financial statements. SAB 108 requires registrants to quantify misstatements using both balance
sheet and income statement approaches and to evaluate whether either approach results in
quantifying an error that is material in light of relative quantitative and qualitative factors.
SAB 108 is effective for annual financial statements covering the first fiscal year ending after
November 15, 2006. The adoption of SAB 108 did not have an effect on our consolidated financial
statements.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
General. A more comprehensive enumeration of our significant accounting policies is presented
in the notes to the accompanying financial statements as of May 31, 2007 and 2006, and for the
years ended May 31, 2007, 2006 and 2005. Each of our accounting policies has been chosen based upon
current authoritative literature that collectively comprises generally accepted accounting
principles (“GAAP”) for companies operating in the United States of America. In instances where
alternative methods of accounting are permissible under GAAP, we have chosen the method that most
appropriately reflects the nature of our business, the results of our operations and our financial
condition, and have consistently applied those methods over each of the periods presented in the
financial statements.
Some of our critical accounting policies require the use of judgment in their application or
require estimates of inherently uncertain matters. Although our accounting policies are in
compliance with GAAP, a change in the facts and circumstances of the underlying transactions could
significantly change the application of the accounting policies and the resulting financial
statement impact. Listed below are those policies that we believe are critical and require the use
of complex judgment in their application.
Basis of Presentation. Our financial statements include the accounts of Ashton Woods USA
L.L.C. and all of its wholly-owned, majority-owned and controlled subsidiaries. All significant
intercompany accounts, transactions and balances have been eliminated in consolidation. We have
also consolidated certain variable interest entities from which we are purchasing lots under option
purchase contracts, under the requirements of FASB Interpretation No. 46R issued by the FASB.
Revenue Recognition. We recognize homebuilding revenues when a home closes and title to and
possession of the property are transferred to the buyer. Substantially all of our revenues are
received in cash within a day or two of closing. We include amounts in transit from title companies
at the end of each reporting period in accounts receivable. When we execute sales contracts with
our homebuyers, or when we require advance payment from homebuyers for custom changes, upgrades or
options related to their homes, we record the cash deposits received as liabilities until the homes
are closed or the contracts are canceled. We either retain or refund to the homebuyer deposits on
canceled sales contracts, depending upon the applicable provisions of the contract.
Inventories and Cost of Sales. Finished inventories and land held for sale are stated at the
lower of accumulated cost or fair value less cost to sell. Homebuilding projects and land held for
development and construction are stated at cost unless facts and circumstances indicate that such
cost would not be recovered from the undiscounted cash flows generated by future dispositions,
after considering estimated cash flows associated with all future expenditures to develop the
assets, including interest payments that will be capitalized as part of the cost of the asset. In
this instance, such inventories are written down to estimated fair value, which is determined based
on management’s estimate of future revenues and costs that would be considered by an unrelated
buyer in determining
the fair value of the asset. Due to uncertainties in the estimation process, it is possible
that actual results could differ.
In addition to the costs of direct land acquisition, land development and home construction,
inventory costs include interest, real estate taxes and indirect overhead costs incurred during
development and home construction. We use the specific identification method for the purpose of
accumulating home construction costs. Cost of sales for homes closed includes the specific
construction costs of each home and all applicable land acquisition, land development and related
costs (both incurred and estimated to be incurred) based upon the total number of homes expected to
be closed in each project. Any changes to the estimated total development costs subsequent to the
initial home closings in a project are generally allocated on a pro-rata basis to the remaining
homes in the project.
When a home is closed, we generally have not yet paid and recorded all incurred costs
necessary to complete the home. Each month we record as a liability and a charge to cost of sales
the amount we estimate will ultimately be paid related to completed homes that have been closed as
of the end of that month.
We compare our home construction budgets to actual recorded costs to estimate the additional
costs remaining to be paid on each closed home. We monitor the accuracy of each month’s accrual by
comparing actual costs paid on closed homes in subsequent months to the amount we accrued. Although
actual costs to be paid on closed homes in the future could differ from our current estimate, our
method has historically produced consistently accurate estimates of actual costs to complete closed
homes.
Each reporting period, we review all components of inventory in accordance with SFAS No. 144,
which requires that if the sum of the undiscounted future cash flows expected to result from a
community is less than the carrying value of the community, an asset impairment must be recognized
in the consolidated financial statements as a component of cost of sales. The amount of the
impairment is calculated by subtracting the fair value of the community from the carrying value of
the community.
In order for management to assess the fair value of a community, certain assumptions must be
made which are highly subjective and susceptible to change. We evaluate, among other things, the
actual gross margins for homes closed and the gross margins for homes sold in backlog. This
evaluation also includes critical assumptions with respect to future home sales prices, cost of
sales, including levels of sales incentives and the monthly rate of sale, which are critical in
determining the fair value of a community. If events and circumstances indicate that the carrying
value of a community are not expected to be recoverable, then the community is written down to its
estimated fair value. Given the historical cyclicality of the homebuilding industry, the valuation
of homebuilding inventories are sensitive to changes in economic conditions, such as interest rates
and unemployment levels. Changes in these economic conditions could materially affect the projected
home sales price, the level of sales incentives, the costs to develop land and construct the homes
and the monthly rate of sale. Because of these potential changes in economic and market conditions
in conjunction with the assumptions and estimates required of management in valuing homebuilding
inventory, actual results could differ materially from management’s assumptions and may require
material inventory impairments to be recorded in the future.
In accordance with SFAS No. 144, valuation adjustments are recorded on finished homes and land
held for sale when events or circumstances indicate that the fair value, less costs to sell, is
less than the carrying value.
We recorded $18.8 million of impairment losses during the fiscal year ended May 31, 2007 -
$4.3 million in Atlanta, $2.1 million in Dallas, $7.1 million in Phoenix, $0.1 million in Orlando
and $5.2 million in Tampa as compared to $4.5 million of impairment losses in fiscal year 2006 -
$2.0 million for Phoenix, $1.8 million for Tampa, $0.4 million for Dallas, $0.2 million for Atlanta
and $0.1 million for Houston.
Consolidation of Variable Interest Entities. In January 2003, FASB issued FASB Interpretation
No. 46, “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51” (“FIN 46”).
On December 24, 2003, FIN 46 was replaced by FIN 46R. FIN 46R requires the consolidation of
variable interest entities in which an enterprise absorbs a majority of the entity’s expected
losses, receives a majority of the entity’s expected residual returns, or both, as a result of
ownership, contractual or other financial interests in the entity.
In the ordinary course of business, we enter into land and lot option purchase contracts in
order to procure land or lots for the construction of homes. Under such option purchase contracts,
we will fund a stated deposit in consideration for the right, but not the obligation, to purchase
land or lots at a future point in time with
predetermined terms. Under the terms of the option
purchase contracts, many of our option deposits are non-refundable. Certain non-refundable deposits
are deemed to create a variable interest in a variable interest entity under the requirements of
FIN 46R. As such, certain of our option purchase contracts result in the acquisition of a variable
interest in the entity holding the land parcel under option.
In applying the provisions of FIN 46R, we evaluate those land and lot option purchase
contracts with variable interest entities to determine whether we are the primary beneficiary based
upon analysis of the variability of the expected gains and losses of the entity. Based on this
evaluation, if we are the primary beneficiary of an entity with which we have entered into a land
or lot option purchase contract, the variable interest entity is consolidated.
Since we own no equity interest in any of the unaffiliated variable interest entities that we
must consolidate pursuant to FIN 46R, we generally have little or no control or influence over the
operations of these entities or their owners. When our requests for financial information are
denied by the land sellers, certain assumptions about the assets and liabilities of such entities
are required. In most cases, the fair value of the assets of the consolidated entities have been
estimated to be the remaining contractual purchase price of the land or lots we are purchasing. In
these cases, it is assumed that the entities have no significant debt obligations and the only
asset recorded is the land or lots we have the option to buy with a related offset to minority
interest for the assumed third party investment in the variable interest entity. Creditors, if any,
of these variable interest entities have no recourse against us.
Warranty Liabilities. We establish warranty liabilities by charging cost of sales and
crediting a warranty liability for each home closed. Unlike our two- and ten-year warranties which
we insure through a third-party insurance company, we self-insure for our obligations under our
one-year warranties. Consequently, we estimate the amounts charged to be adequate to cover expected
warranty-related costs for materials and labor required under the one-year warranty obligation
period. The one-year warranty is comprehensive for all parts and labor. Our warranty cost accruals
are based upon our historical warranty cost experience in each market in which we operate and are
adjusted as appropriate to reflect qualitative risks associated with the type of homes we build and
the geographic areas in which we build them. Actual future warranty costs could differ
significantly from our currently estimated amounts.
Insurance Claim Costs. We have, and require the majority of our subcontractors to have,
general liability and workers compensation insurance. These insurance policies protect us against a
portion of our risk of loss from claims, subject to certain deductibles and other coverage limits.
We accrue an estimated liability for costs to cover our deductible amounts under those policies and
for any estimated costs of claims and lawsuits in excess of our coverage limits or not covered by
our policies, based on an analysis of our historical claims, which includes an estimate of
construction defect claims incurred but not yet reported. Projection of losses related to these
liabilities is subject to a high degree of variability due to uncertainties such as trends in
construction defect claims relative to our markets and the types of products we build, claim
settlement patterns, insurance industry practices, and legal interpretations, among others. Because
of the high degree of judgment required in determining these estimates, actual future costs could
differ significantly from our currently estimated amounts.
RESULTS OF OPERATIONS
Overview
The following tables set forth the key operating and financial data for our operations as of
and for the fiscal years ended May 31, 2007, 2006 and 2005.
Ratio of SG&A and related party expenses to revenues
13.0
%
11.0
%
11.1
%
Ratio of net income to revenues
4.2
%
12.3
%
11.9
%
Backlog (units) at end of period
821
1,249
1,334
Sales value of backlog at end of period
$
236,234
$
379,906
$
369,949
Active communities at end of period
44
51
46
(1)
Home gross margins is defined as home sales revenues less cost of home sales, which
includes land, house construction costs, indirect costs of construction, capitalized
interest, a reserve for warranty expense, land impairments and closing costs, as a percent
of home sales revenue.
Fiscal year 2007 compared to fiscal year 2006
Revenues. Revenues decreased 17.4% or $122.0 million for fiscal year 2007 to $581.0 million
as compared to $703.0 million for fiscal year 2006. We experienced a 17.4% decrease in homes closed
to 1,992 in fiscal year 2007 from 2,413 in the prior year. Homes closed decreased in all of our
markets, except Orlando, where homes closed remained flat year over year, and Tampa, where homes
closed increased by 46 closings, in fiscal year 2007 due to the overall decline in the housing
industry. The impact of this decline was intensified by an increase in cancellations experienced
during fiscal year 2007. Despite this decline in homes closed, the average sales price per home
closed increased slightly by $9,000 per home or 3.2% to $287,000 as compared to $278,000 in fiscal
year 2006 due to the mix of homes closed during fiscal year 2007 being more heavily weighted
towards single-family detached move up
housing as compared to fiscal year 2006. This was offset
somewhat by the 3.6% and the 14.7% declines in sale
prices in Tampa and Phoenix, respectively, due to an increase in sales incentives during
fiscal year 2007 as compared to fiscal year 2006.
Our revenues from land sales decreased to $7.6 million for fiscal year 2007 as compared to
$31.3 million in the prior fiscal year, primarily as a result of identifying fewer parcels of land
or finished lots that no longer fit within our home development program. Land sales are incidental
to the business of building and selling homes.
Gross Margins. Home gross margins were 17.1% for fiscal year 2007 compared to 22.5% in the
prior fiscal year. The decrease in our home gross margins was primarily due to $18.8 million in
impairment expense related to our real estate inventory recognized in fiscal year 2007 compared to
$4.5 million in impairment expense related to our real estate inventory recognized in fiscal year
2006 and an increase in sales incentives offered in fiscal year 2007 as compared to the prior year.
Sales and Marketing Expenses. Sales and marketing expenses, which include sales commissions,
advertising, model expenses and other costs, totaled $34.8 million for fiscal year 2007 or 6.0% of
revenues, compared to $35.4 million in fiscal year 2006 or 5.0% of revenues. The dollar decrease of
$0.6 million, or 1.7%, was primarily due to a decrease in the number of homes sold and closed
during the current fiscal year and reflects the decrease in sales commissions due to the 17.4%
decrease in homes closed, offset in part by an increase in marketing costs experienced by all
divisions.
General and Administrative and Related Party Expenses. General and administrative and related
party expenses totaled $40.8 million in fiscal year 2007 or 7.0% of revenues, compared to $42.1
million in the prior year or 6.0% of revenues. The dollar decrease of $1.3 million resulted
primarily from decreased compensation costs attributable to the decrease in net earnings as all
bonuses earned by corporate and division management are partially based on our profitability.
Net Income. Net income decreased $61.8 million or 71.5% in the fiscal year ended May 31, 2007
as compared to the fiscal year ended May 31, 2006. The decrease resulted primarily from the 17.4%
decrease in homes closed, 24.0% decrease in home gross margins and the impairment expense, as well
as an increase in sales and marketing and general and administrative expenses as a percentage of
total revenues.
Net New Home Orders and Backlog. Net new home orders decreased 32.8% or by 764 orders, during
the fiscal year ended May 31, 2007 as compared to the fiscal year ended May 31, 2006. The decrease
was the result of a decrease in our active communities, the decrease in the number of homes
available for sale, the continued increase in cancellations and the continued decline in consumer
demand for new homes.
Net new home orders in Atlanta decreased in fiscal year 2007 to 321 as compared to 533 in the
prior fiscal year, representing a decrease of 212 orders, or 39.8%. The decrease was due
to the decrease in active communities from nine to eight and the
continued decline in consumer demand for new homes.
Net new home orders in Orlando decreased to 183 in fiscal year 2007 compared to 371 in fiscal
year 2006. This decrease of 188 orders, or 50.7%, reflects an increase in cancellations and a
general decline in consumer demand for new homes.
Net new home orders in Tampa increased slightly in fiscal year 2007 to 54 as compared to 46 in
the prior fiscal year, representing an increase of eight orders, or 17.4%. Although a slight
increase, the division had its first closings during the fourth quarter of fiscal year 2006.
Net new home orders in Dallas decreased to 356 in fiscal year 2007 compared to 622 in the
fiscal year ended May 31, 2006. This decrease of 266 orders, or 42.8%, reflects the continued
decline in overall market conditions.
Net new home orders in Houston decreased in fiscal year 2007 to 353 as compared to 435 in the
prior fiscal year, representing an decrease of 82 orders, or 18.9%. The decrease was primarily due
to the decrease in active communities from twelve to eight.
Net new home orders in Phoenix decreased to 275 in the fiscal year ended May 31, 2007 as
compared to 321 net new home orders in the prior year, representing 46 units, or 14.3%. This
reduction was due to a higher level of cancellations coupled with a decline in consumer demand for
new homes.
Backlog as of May 31, 2007 was 821 homes representing a sales value of $236.2 million and a
decrease in the sales value of backlog of $143.7 million or 37.8% at the end of the fiscal year as
compared to the sales value of backlog of $379.9 million at the end of fiscal year 2006. Backlog
represents the number and value of new sales orders net of any cancellations that may have occurred
during the reporting period. Historically, we have experienced a cancellation rate between 15% -
20% of the gross new orders recorded in any reporting period, which resulted in 80% – 85% of
the number of units in our backlog closing under existing sales contracts. However, during the
latter part of fiscal year 2006 and for fiscal year 2007, we experienced cancellations of gross new
home orders of approximately 30%. We attribute the increase in cancellations and the slowdown in
demand for new homes to increases in housing inventories as a result of a change in consumer
confidence and the increase in interest rates during the fiscal year. Continued deterioration of
these and other homebuilding economic factors resulted in continued and prolonged decreases in
demand for new homes. We expect, assuming no significant change in market conditions or mortgage
interest rates, approximately 70% of the number of units in our backlog will close under existing
sales contracts during fiscal year 2008.
Fiscal year 2006 compared to fiscal year 2005
Revenues. Revenues increased 40.7% or $203.4 million for fiscal year 2006 to $703.0 million
as compared to $499.6 million for fiscal year 2005. We experienced a 27.4% increase in homes closed
to 2,413 in fiscal year 2006 from 1,894 in fiscal year 2005. Homes closed increased in all of our
markets in fiscal year 2006 with the exception of Phoenix, which experienced a decrease of 32
closings due to delays created by subcontractor shortages in the market and an increase in
cancellations experienced during the fourth quarter. In addition, the average sales price per home
closed increased $34,000 per home or 13.9% to $278,000 as compared to $244,000 in fiscal year 2005
due to pricing power experienced in Orlando and Phoenix with our single-family detached product
offset somewhat by the continued product diversification into lower priced townhomes and
condominiums in Atlanta, Orlando and Dallas.
Our revenues from land sales decreased to $31.3 million for fiscal year 2006 as compared to
$37.0 million in fiscal year 2005, primarily as a result of identifying fewer parcels of land or
finished lots that no longer fit within our home development program. Land sales are incidental to
the business of building and selling homes.
Gross Margins. Home gross margins were 22.5% for fiscal year 2006 compared to 21.0% in fiscal
year 2005. The increase in our home gross margins year over year was due to the pricing power we
experienced in Orlando and Phoenix from net new home orders received during the favorable market
conditions of fiscal year 2005 and the first half of fiscal year 2006. Our diversification into
townhomes and stacked-flat condominiums in Atlanta and Orlando also favorably impacted our margins
as we experienced pricing power as a result of strong net new orders in these products.
Sales and Marketing Expenses. Sales and marketing expenses, which include sales commissions,
advertising, model expenses and other costs, totaled $35.4 million for fiscal year 2006 or 5.0% of
revenues, compared to $26.5 million in fiscal year 2005 or 5.3% of revenues. The increase of $8.9
million, or 33.6%, was primarily due to an increase in the number of homes available for sale and
closed during the current fiscal year. The increase reflects the increase in sales commissions due
to the 27.4% increase in homes closed and the increase in marketing costs experienced by the
Orlando, Phoenix and Tampa divisions as their operations continue to grow and establish brand
recognition in their respective markets.
General and Administrative and Related Party Expenses. General and administrative and related
party expenses totaled $42.1 million in fiscal year 2006 or 6.0% of revenues, compared to $28.9
million in fiscal year 2005 or 5.8% of revenues. The increase of $13.2 million resulted from the
continued significant growth in Orlando and Phoenix, the investment in the start-up divisional
operations in Tampa and Denver, the commensurate increases in our corporate staff to support these
operations and, to a lesser extent, increased compensation costs attributable to the increase in
net earnings as all bonuses earned by corporate and division management are partially based on our
profitability.
Net Income. Net income increased $27.0 million or 45.4% in the fiscal year ended May 31, 2006
as compared to the fiscal year ended May 31, 2005. The increase resulted primarily from the 27.4%
increase in homes closed and an increase in average sales price per home closed of 13.9%. Total
sales and marketing expenses increased $8.9 million due primarily to the increase in homes closed
and the related commissions attributable to those homes. General and administrative expenses also
increased $13.2 million during the fiscal year due to significant growth in our Orlando and Phoenix
operations, the establishment of two new operations in Denver and Tampa, and, to a lesser extent,
to an increase in our corporate staffing. Total sales and marketing and general and administrative
expenses decreased as a percentage of total revenues by 0.1%. Earnings from unconsolidated
entities, which represents earnings primarily from our mortgage and title joint ventures in which
we have a 49% ownership interest, increased $1.6 million or 104.0% as a result of increased home
closing volume, as compared to the prior fiscal year.
Net New Home Orders and Backlog. Net new home orders increased 4.4% or by 98 orders, during
the fiscal year ended May 31, 2006 as compared to the prior fiscal year. The increase was the
result of an increase in our active communities and the number of homes available for sale
primarily in Atlanta, Houston and Dallas offset by a decline in net new home orders in Orlando and
Phoenix. In addition, we recorded our initial net new orders in Tampa during fiscal year 2006 of 46
orders in two active communities.
Net new home orders in Atlanta increased in fiscal year 2006 to 533 as compared to 503 in the
prior fiscal year, representing an increase of 30 orders, or 6.0%. The increase reflects the
increase in active communities from eight to nine and the continued expansion in our product line
to stacked-flat condominiums and active adult single-family detached homes.
Net new home orders in Orlando decreased to 371 in fiscal year 2006 compared to 450 in the
fiscal year ended May 31, 2005. This decrease of 79 orders, or 17.6%, reflects a weakening in
market conditions experienced during primarily the third and fourth quarters of fiscal year 2006 as
we experienced an increase in cancellations and a general moderation in consumer demand for new
homes.
Net new home orders in Dallas increased to 622 in fiscal year 2006 compared to 519 in the
fiscal year ended May 31, 2005. This increase of 103 orders, or 19.8%, reflects the expansion of
our product line to include townhome communities and an improvement in overall market conditions.
Net new home orders in Houston increased in fiscal year 2006 to 435 as compared to 409 in the
prior fiscal year, representing an increase of 26 orders, or 6.4%. The increase reflects an overall
improvement in market conditions.
Net new home orders in Phoenix declined to 321 in the fiscal year ended May 31, 2006 as
compared to 349 net new home orders in the prior year, representing 28 units, or 8.0%. This
reduction was due to a combination of limits placed on the number of new home orders that we
accepted during the first half of our fiscal year due to our significant backlog and our desire to
focus our production capacity on completing the homes in our backlog and a higher level of
cancellations experienced during our fiscal fourth quarter coupled with a moderation in consumer
demand for new homes.
Backlog as of May 31, 2006 was 1,249 homes representing a sales value of $379.9 million and
an increase in the sales value of backlog of $10.0 million or 2.7% at the end of the fiscal year as
compared to the sales value of backlog of $369.9 million at the end of fiscal year 2005.
Historically, we have experienced a cancellation rate between 15%
– 20% of the gross new orders
recorded in any reporting period, which resulted in 80% – 85% of the number of units in our
backlog closing under existing sales contracts. However, during the third and fourth quarters of
fiscal year 2006, we experienced an increase in cancellations of gross new home orders to
approximately 30%. We attribute the increase in cancellations and the slowdown in demand for new
homes to increases in housing inventories as a result of speculative investors becoming net sellers
of homes rather than net buyers, a change in consumer confidence and urgency to buy homes and the
increase in interest rates during the second half of our fiscal year.
We have grouped our homebuilding activities into two reportable segments, which we refer to as
Homebuilding East and Homebuilding West. At May 31, 2007, our reportable homebuilding segments
consisted of homebuilding divisions located in the following areas:
East: Atlanta, Orlando and Tampa
West: Dallas, Houston, Phoenix and Denver
Homebuilding East: Revenues decreased to $272.8 million for the fiscal year ended May 31, 2007
from $302.7 million for the fiscal year ended May 31, 2006. The decrease in revenues was primarily
due to a lack of any land sales during fiscal year 2007 compared to $30.5 million in land sales
during fiscal year 2006 and a 10.2% decrease in the number of homes closed, which was partially
offset by an 11.4% increase in the average sales price of homes closed. Homes closed in Atlanta
decreased 25.1% due to continued weakening in the demand for new homes in the market. Homes closed
in Orlando were flat year over year, due to the significant level of backlog at the start of fiscal
year 2007. Homes closed in Tampa increased slightly because the division had its first closings
during the fourth quarter of fiscal year 2006. Since land sales are incidental to our business of
building and selling homes, we generally sell only parcels of land and finished lots that do not
fit with our home development program. The absence of land sales revenue was a result of not having
identified any parcels of land and finished lots that did not fit with our home development program
during the fiscal year ended May 31, 2007.
Gross profit decreased $33.6 million, or 39.8%, for the fiscal year ended May 31, 2007,
compared to the fiscal year ended May 31, 2006, primarily as a result of increased sales incentives
offered to homebuyers, $9.6 million of inventory valuation adjustments and a decrease in gross
profit from land sales of $16.2 million. Gross margins were 18.6% for the fiscal year ended May 31,2007, compared to 27.9% for the fiscal year ended May 31, 2006.
Homebuilding West: Revenues decreased 23% for the fiscal year ended May 31, 2007 to $308.0
million from $400.0 million in the fiscal year ended May 31, 2006. The decrease in revenues was
primarily due to the 22.9% decrease in homes closed in Dallas, the 22.6% decrease in the number of
homes closed in Houston and the 22.1% decrease in the number of homes closed in Phoenix. The
average sales price of homes delivered decreased 2.8% in the region primarily due to a 14.7%
decrease in the average sales price in Phoenix and a decrease in the number of homes closed in
higher priced communities. These decreases were offset somewhat by the slight increases in average
sales prices experienced in both Dallas and Houston as both markets delivered a greater percentage
of move-up single-family homes in fiscal year 2007 as compared to the prior fiscal year.
Gross profit decreased $30.8 million, or 37.0%, for the fiscal year ended May 31, 2007,
compared to the fiscal year ended May 31, 2006 primarily as a result of increased sales incentives
offered to homebuyers and an decrease in gross profit from land sales of $0.6 million. Gross
margins were 17.0% for the fiscal year ended May 31, 2007, compared to 20.8% for the fiscal year
ended May 31, 2006.
Fiscal year 2006 compared to fiscal year 2005
Homebuilding East: Revenues increased for the fiscal year ended May 31, 2006 to $302.7 million
from $191.9 million in the fiscal year ended May 31, 2005 primarily due to a 53.8% increase in the
number of homes closed. Homes closed in Atlanta increased 28.0% due to the continued demand for new
homes in the market. Homes closed in Orlando increased 110.5% over the prior year due primarily to
the significant backlog existing in Orlando at the beginning of the fiscal year. Homes closed in
Tampa increased because the division had its first closings during the fourth quarter of fiscal
year 2006.
Gross profit increased $30.6 million, or 56.9%, for the fiscal year ended May 31, 2006,
compared to the fiscal year ended May 31, 2005 primarily as a result of an increase in the number
of homes closed. Gross margins were flat year over year – 27.9% for the fiscal year ended May 31,2006, compared to 28.0% for the fiscal year ended May 31, 2005.
Homebuilding West: Revenues increased 30.0% for the fiscal year ended May 31, 2006 to $400.0
million from $307.7 million in the fiscal year ended May 31, 2005 primarily due to the 14.0%
increase in the number of homes closed in Dallas, the 38.6% increase in the number of homes closed
in Houston, offset by the 7.9% decrease in homes closed in Phoenix. The average sales price of
homes delivered increased 21.0% due to an increase in the number of homes closed in higher priced
communities.
Gross profit increased $18.8 million, or 29.3%, for the fiscal year ended May 31, 2006,
compared to the fiscal year ended May 31, 2005, primarily as a result of an increase in the number
of homes closed. Gross margins were flat year over year – 20.8% for the fiscal year ended May 31,2006, compared to 20.9% for the fiscal year ended May 31, 2005.
Liquidity and Capital Resources
Our principal uses of cash are land purchases, lot development and home construction. We fund
our operations with cash flows from operating activities and/or borrowings under our senior
unsecured credit facility. As we utilize our capital resources and liquidity to fund the growth of
our operations, we focus on maintaining conservative balance sheet leverage ratios. We believe that
we will be able to continue to fund our operations and our future cash needs (including debt
maturities) through a combination of cash flows from operating activities and our existing senior
unsecured credit facility.
As of May 31, 2007, our ratio of total debt to total capitalization was 52.1%, compared to
51.5% as of May 31, 2006. Total debt to total capitalization consists of notes payable divided by
total capitalization (notes payable plus members’ equity).
Operating Cash Flow. During the fiscal year ended May 31, 2007, we provided approximately
$35.3 million from our operating activities. We had net income of $24.7 million, impairment loss
of $18.8 million and a decrease in accounts receivable of $12.3 million, which was partially offset
by a decrease in accounts payable and accruals of $20.9 million.
During the fiscal year ended May 31, 2006, we used approximately $24.7 million in our
operating activities. We increased our investment in inventory by $134.0 million during fiscal
year 2006, which was partially offset by net income of $86.5 million earned during the period on
homes closed and increases in accounts payable and accruals of $21.1 million.
Investing Cash Flow. Cash used in investing activities totaled $2.9 million for the fiscal
year ended May 31, 2007 for additions to capital assets of $5.3 million offset by a
return of
investment in unconsolidated entities of $2.3 million.
For the fiscal year ended May 31, 2006, cash used in investing activities totaled $11.3
million. We increased our investment in unconsolidated entities by $2.6 million and used $8.6
million of cash for additions to capital assets.
Financing Cash Flow. During the fiscal year ended May 31, 2007, cash used by financing
activities totaled $32.5 million, which included borrowings under our senior unsecured credit
facility of $154.5 million, repayments of amounts outstanding under our senior unsecured credit
facility of $156.2 million and distributions of $30.4 million to our members for the payment of
federal and state income taxes and as general distributions of our income.
During fiscal year 2006, cash provided by financing activities totaled $36.1 million, which
included the issuance of $125.0 million of senior subordinated notes, borrowings under our senior
unsecured credit facility of $240.0 million, repayments of amounts outstanding under our senior
unsecured credit facility of $272.0 million, a reduction in related party debt of $13.7 million and
distributions of $37.3 million to our members for the payment of federal and state income taxes and
as general distributions of our income.
Senior Unsecured Credit Facility. In December 2005, we entered into an amended senior unsecured
credit facility. The senior unsecured credit facility provides for up to $300.0 million of
unsecured borrowings, subject to a borrowing base, and includes an accordion feature by which we
may request, subject to certain conditions, an increase of the senior unsecured credit facility up
to a maximum of $400.0 million. The senior unsecured credit facility provides for the issuance of
up to $50.0 million in letters of credit. At May 31, 2007, we had available borrowing capacity
under this facility of $193.5 million as determined by borrowing base limitations defined in the
agreement. Our obligations under the amended senior unsecured credit facility are guaranteed by
all of our subsidiaries and all of the holders of our membership interests.
Once during each fiscal year (i.e., June 1-May 31), we may request that the lenders extend the
maturity date by an additional year. On January 10, 2007, we amended the senior unsecured credit
facility to extend the maturity date to January 19, 2011, for 88.3%, or $265.0 million of the
facility and to amend the definition of “EBITDA” contained therein to exclude certain non-cash
gains and include certain non-cash losses or charges and. On February 21, 2007, we obtained
consent from an additional lender representing 5.0% or $15 million of the facility, to the
extension of the senior unsecured credit facility to January 19, 2011.
The senior unsecured credit facility contains a number of customary financial and operating
covenants, including covenants requiring us to maintain a minimum consolidated tangible net worth;
limiting the principal amount of our secured debt to $50 million at any given time; limiting the
net book value of our unimproved entitled land, land under development and finished lots to 150.0%
of our adjusted tangible net worth; limiting the aggregate distributions by us and our subsidiaries
in any fiscal year; restricting our ability to incur additional indebtedness; and restricting our
ability to engage in mergers and consolidations and our ability to sell all or substantially all of
our assets. The senior unsecured credit facility also contains covenants requiring us to maintain
a certain ratio of consolidated total liabilities to adjusted net worth and to maintain a certain
interest coverage ratio. In June 2007, we entered into another amendment to the senior unsecured
credit facility which provides for a permanent reduction in the interest coverage ratio to 2.0x,
from 2.50x, and includes a provision allowing such ratio to fall to no less than 1.75x for up to
three consecutive fiscal quarters in any rolling four fiscal quarter period ending on or before May31, 2009. The June 2007 amendment also provides that in the event our interest coverage ratio for
any fiscal quarter is less than 2.0x, (1) the ratio of consolidated total liabilities to adjusted
net worth decreases to 2.0x, from 2.25x, for such fiscal quarter and (2) the interest rates for
borrowings under the senior unsecured credit facility will increase to the levels set forth in the
amendment.
The borrowings under the facility bear daily interest at rates based upon the London Interbank
Offered Rate (LIBOR) plus a spread based upon our interest coverage ratio and ratio of consolidated
total liabilities to adjusted net worth. In addition to the stated interest rates, the revolving
credit facility requires us to pay certain fees. The effective interest rate of the unsecured bank
debt at May 31, 2007, was approximately 6.57%. As of and for the year ended May 31, 2007, we were
in compliance with the covenants under the senior unsecured credit facility.
Borrowings under the senior unsecured credit facility are limited by the availability of
sufficient real estate borrowing base, which is determined regularly throughout the life of the
senior unsecured credit facility. At May 31, 2007, we had $61.3 million in outstanding borrowings,
and $193.5 million in available borrowings under the senior unsecured credit facility.
9.5% Senior Subordinated Notes. In September 2005, we and Ashton Woods Finance Co., our 100% owned
finance subsidiary, co-issued $125 million aggregate principal amount of 9.5% Senior Subordinated
Notes due 2015 in a private placement pursuant to Rule 144A promulgated under the Securities Act of
1933, as amended. The net proceeds were used to repay amounts outstanding under our senior
unsecured revolving credit facility and to repay certain related party debt. In April 2006, we
completed an offer to exchange all of the notes issued in September 2005 for an equal amount of
9.5% Senior Subordinated Notes due 2015, which were registered under the Securities Act of 1933.
Interest on the notes is payable semiannually. We may redeem the notes, in whole or part, at any
time on or after October 1, 2010, at a redemption price equal to 100% of the principal amount, plus
a premium declining ratably to par, plus accrued and unpaid interest. In addition, at any time
prior to October 1, 2008, we may redeem up to 35% of the aggregate principal amount of the notes
with the proceeds of qualified equity offerings at a redemption price equal to 109.5% of the
principal amount, plus accrued and unpaid interest. The notes are unsecured and subordinated in
right of payment to all of our existing and future senior debt, including borrowings under our
senior unsecured credit facility. All of our existing subsidiaries, other than the co-issuer,
fully and unconditionally guaranteed, jointly and severally, the notes on a senior subordinated
basis. Each of the subsidiary guarantors is 100% owned by us. Future direct and indirect U.S.
subsidiaries, excluding subsidiaries that are designated unrestricted subsidiaries in accordance
with the indenture, will be required to guarantee the notes on a full and unconditional basis,
jointly and severally with the other subsidiary guarantors. The guarantees are general unsecured
obligations of the guarantors and are subordinated in right of payment to all existing and future
senior debt of the guarantors, which includes their guarantees of our senior unsecured credit
facility. We do not have any independent operations or assets apart from its investments in our
subsidiaries. As of May 31, 2007, the outstanding notes with a
face value of $125.0 million had a
fair value of approximately $118.2 million, based on quoted market prices by independent dealers.
The indenture governing the notes contains covenants that limit our ability and the ability of
our subsidiaries to, among other things, incur additional indebtedness; pay dividends or make other
distributions; make investments; sell assets; incur liens; enter into agreements restricting our
subsidiaries’ ability to pay dividends; enter into transactions with affiliates; and consolidate,
merge or sell all or substantially all of our assets. Unlike the senior unsecured credit facility,
the financial covenants in the indenture governing the notes primarily limit our ability to incur
additional debt, make distributions or engage in other actions rather than require us to maintain
certain financial ratios or levels. Consequently, the covenants in the indenture have not had a
significant impact on our operations, financial condition and results of operations. However, in
the future our ability to secure financing for our operations could be limited by these covenants,
and if we are limited in our ability to obtain financing, our operations, financial condition and
results of operations could be adversely affected. As of and for the year ended May 31, 2007, we
were in compliance with the covenants under the senior subordinated notes.
OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE AND CONTRACTUAL COMMITMENTS
Our primary contractual cash obligations for our operations are payments under our debt
agreements, lease payments under operating leases and purchase obligations with specific
performance requirements under lot option purchase agreements. These lot option purchase agreements
may require us to purchase land contingent upon the land seller meeting certain obligations. We
expect to fund our contractual obligations in the ordinary course of business through our operating
cash flows and our senior unsecured credit facility.
Our future cash requirements for contractual obligations as of May 31, 2007 are presented
below:
Payments due by period
Less than
2-3
4-5
More than
1 year
years
years
5 years
Total
(in thousands)
9.5% Senior Subordinated Notes
$
—
$
—
$
—
$
125,000
$
125,000
Senior unsecured credit facility(1)
—
—
61,339
—
61,339
Interest commitments under Senior Subordinated Notes
11,875
23,750
23,750
41,233
100,608
Secured note (2)
166
332
332
870
1,700
Operating leases
1,761
1,915
426
—
4,102
$
13,802
$
25,997
$
85,847
$
167,103
$
292,749
(1)
Excludes interest obligations under the senior unsecured credit facility as these
amounts are not currently determinable
(2)
Excludes interest obligations under the secured note as these amounts are not currently
determinable
In the ordinary course of our business, we enter into land and lot option purchase
contracts with unaffiliated entities in order to procure land or lots for the construction of
homes. Certain of such land and lot option purchase contracts contain specific performance
provisions which require us to purchase the land or lots subject to the contract upon satisfaction
of certain conditions by us and the sellers. Under option purchase contracts without specific
performance provisions, we will fund a stated deposit in consideration for the right, but not the
obligation, to purchase land or lots at a future point in time with predetermined terms.
Under option contracts without specific performance provisions, our liability is generally
limited to the forfeiture of deposits, any letters of credit posted and any other nonrefundable
amounts specified in the contracts. As of May 31, 2007, we had fulfilled our obligations under all specific performance agreements and
we expect to exercise, subject to market conditions, substantially all of our option contracts
without specific performance
provisions. Various factors, some which are beyond our control, such as market conditions, weather
conditions and the timing of the completion of development activities, can have a significant
impact on the timing of option exercises. Under the terms, and assuming no significant changes in
market conditions or other factors, we expect to exercise our land options as shown in the table
below. Amounts (in thousands) shown in the following table, include
cash deposits totaling an
aggregate of approximately $4.4 million.
Fiscal Years Ending
May 31
2008
$
31,982
2009
20,096
Thereafter
11,200
$
63,278
Under FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” as
amended by FIN 46-R issued in December 2003 (collectively referred to as “FIN 46”), if the entity
holding the land under option is a variable interest entity, our deposit represents a variable
interest in that entity. Creditors of the variable interest entities have no recourse against us.
In applying the provisions of FIN 46, we evaluated all land option agreements and determined that
we have three lot purchase contracts with certain related parties to acquire 659 finished lots at
an aggregate price of approximately $33.0 million, which have created variable interests and of
which 163 finished lots remain to be acquired for an aggregate price of $7.1 million. While we own
no equity interest in the entities, we must consolidate these entities pursuant to FIN 46R. The
consolidation of these variable interest entities added $5.9 million, $4.8 million and $0.7
million in real estate not owned, liabilities related to real estate not owned and minority
interests in real estate not owned, respectively, to our balance sheet at May 31, 2007 and added
$14.3 million, $12.2 million and $1.8 million in real estate not owned, liabilities related to
real estate not owned and minority interests in real estate not owned, respectively, to our
balance sheet at May 31, 2006.
We participate in a number of land development entities with equity investments of 50% or
less and do not have a controlling interest. These land development entities are typically entered
into with developers, other homebuilders and related parties to develop finished lots for sale to
the members of the entities and other third parties. We account for our interest in these
entities under the equity method. Our share of profits from these entities are deferred and
treated as a reduction of the cost basis of land purchased from the entity. The land development
entities with unrelated parties typically obtain secured acquisition and development financing.
In some instances, the entity partners have provided varying levels of guarantees of debt of the
unconsolidated entities. These repayment guarantees require us to repay our share of the debt of
unconsolidated entities in the event the entity defaults on its obligations under the borrowings.
We had repayment guarantees of $1.5 million and $3.6 million at May 31, 2007 and 2006,
respectively.
Forward-Looking Statements
Certain statements included in this report on Form 10-K contain forward-looking statements,
which represent our expectations or beliefs concerning future events, and no assurance can be given
that the results described in this report will be achieved. These forward-looking statements can
generally be identified by the use of statements that include words such as “estimate,’’
“project,’’ “believe,’’ “expect,’’ “anticipate,’’ “intend,’’ “plan,’’ “foresee,’’ “likely,’’
“will,’’ “goal,’’ “target’’ or other similar words or phrases. All forward-looking statements are
based upon information available to us on the date of this report.
These forward-looking statements are subject to risks, uncertainties and other factors, many
of which are outside of our control that could cause actual results to differ materially from the
results discussed in the forward-looking statements. Item 1A – “Risk Factors” contains information
about factors that could cause actual results to differ materially from the results discussed in
our forward-looking statements. Other factors, risks and uncertainties that could cause actual
results to differ materially from the results discussed in the forward-looking statements include
but are not limited to:
•
economic changes nationally or in our local markets;
•
volatility of mortgage interest rates, inflation and underwriting standards;
shortages of skilled labor or raw materials used in the production of houses;
•
increased prices for labor, land and raw materials used in the production of houses;
•
increased land development costs on projects under development;
•
the cost and availability of insurance, including the availability of
insurance for the presence of mold;
•
the impact of construction defect and home warranty claims;
•
any delays in reacting to changing consumer preferences in home design;
•
changes in consumer confidence;
•
delays in land development or home construction resulting from adverse weather conditions;
•
increases in resale inventory;
•
potential delays or increased costs in obtaining necessary permits as a result of
changes to, or complying with, laws, regulations or governmental policies, including
environmental laws, regulations and policies; or
•
terrorist acts and other acts of war.
Any forward-looking statement speaks only as of the date on which such statement is made,
and, except as required by law, we undertake no obligation to update any forward-looking
statement to reflect events or circumstances after the date on which such statement is made or to
reflect the occurrence of unanticipated events. New factors emerge from time to time and it is
not possible for management to predict all such factors.
The Company disclaims any responsibility to update any forward-looking statements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to a number of market risks in the ordinary course of business. Our primary
market risk exposure for financial instruments relates to fluctuations in interest rates. We do not
believe our exposure in this area is material to cash flows or earnings. From time to time, we have
entered into interest rate swap agreements to manage interest costs and hedge against risks
associated with fluctuating interest rates with respect to floating rate debt, however, as of May31, 2007 we have not entered into any interest rate swap agreements. We do not enter into or hold
derivatives for trading or speculative purposes. As of May 31, 2007, we had a total of $61.3
million of floating rate debt outstanding under our senior unsecured credit facility, and
borrowings under that facility generally bear interest based on an applicable margin plus LIBOR or
an alternate base rate. As of May 31, 2007, we were not a party to any interest rate swap
agreements.
Item 8. Financial Statements and Supplementary Data
The Company’s Consolidated Financial Statements appear beginning at page F-2.
Item 9. Changes In and Disagreements With Accountants on Accounting and Financial Disclosure
The Company’s Chief Executive Officer and Chief Financial Officer, with the assistance of
management, have evaluated the Company’s disclosure controls and procedures as of May 31, 2007, and
based upon that evaluation have concluded that the Company’s disclosure controls and procedures
were effective, as of May 31, 2007, to provide reasonable assurance that information the Company is
required to disclose in reports that the Company files or submits under the Securities Exchange Act
of 1934, as amended, is recorded, processed, summarized and reported as and when required.
Further, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective for purposes of ensuring that information required to be
disclosed in reports filed by us under the Securities Exchange Act of 1934, as amended, is
accumulated and communicated to management, including the Chief Executive Officer and Chief
Financial Officer, in a manner to allow timely decisions regarding the required disclosure.
It should be noted, however, that a control system, no matter how well conceived and operated,
can provide only reasonable, not absolute, assurance that the objectives of the control system are
met. Because of the limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues within the Company have been detected. Furthermore, the
design of any control system is based in part upon certain assumptions about the likelihood of
future events, and there can be no assurance that any design will succeed in achieving its stated
goals under all potential future conditions, regardless of how unlikely. Because of these inherent
limitations in a cost-effective control system, misstatements or omissions due to error or fraud
may occur and not be detected.
There has been no change in our internal control over financial reporting that occurred during
the fourth fiscal quarter of 2007 that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.
Item 9B. Other Information.
None
PART III
Item 10. Directors and Executive Officers of the Registrant
The following table presents information with respect to our executive officers and directors:
Mr. Krobot has served as our President and Chief Executive Officer since 1995 and as a member of
our Board since September 2005. Before joining the Company, Mr. Krobot worked for Ryland Homes as a
Senior Vice President responsible for seven cities, one lumber yard and over 2,000 units per year
in the Southeast Region (Georgia, North Carolina, South Carolina, Florida) and as a Regional
Manager of its Midwest Region (Columbus and Cincinnati, Ohio and Indianapolis, Indiana). Mr. Krobot
is a graduate of the University of Dayton.
Mr. Salomon has served as our Chief Financial Officer since 1998. Before joining the Company,
Mr. Salomon worked for MDC Holdings, Inc., most recently as the Senior Vice President of Finance of
its homebuilding division in California, Richmond American Homes. Mr. Salomon is a graduate of The
University of Iowa and a member of the American Institute of Certified Public Accountants.
Mr. Thomas joined the Company in March 2006 as Senior Vice President. Prior to joining the Company,
he was Area President for Pulte Homes’ Texas organization from October 2004 to February 2006. From
2002 to 2004, Mr. Thomas was the President of Pulte Homes’ Indiana division. Mr. Thomas holds a
Masters of Business Administration from Northwestern University and a Bachelors of Business
Administration from the University of Memphis.
Mr. Serbin joined the Company in 2002 as Vice President of Sales and Marketing. Prior to joining
the Company, he was Vice President of Sales and Marketing for Pulte Homes in Orlando, Florida. Mr.
Serbin is a graduate of the California State College in Hayward, California where he received a
degree in Business Administration.
Mr. Farrell joined the Company in December 2004 as the Vice President of Construction. From July
2000 to November 2004, Mr. Farrell was employed with Centex Homes as the Vice President of
Construction in Atlanta, Georgia. From 1989 to 2000, Mr. Farrell was a Construction Manager for
Pulte Homes in Atlanta, Georgia and the Washington Metro Area in Maryland.
Mr. Joffe, a member of our Board or our prior management committee since 1997, is a founder of the
Great Gulf Group and is its Chief Financial Officer. Prior to 1983, Mr. Joffe worked in real estate
and public accounting. Mr. Joffe qualified as a Chartered Accountant in South Africa and in Canada.
Mr. Freeman, a member of our Board or our prior management committee since 1997, is a founder of
the Great Gulf Group and is its Executive Vice President. Prior to 1983, Mr. Freeman was the Vice
President of Sales for Great Gulf Homes. Mr. Freeman has worked in residential real estate
marketing since 1969.
Mr. Rosenbaum, a member of our Board or our prior management committee since 1997, is a founder of
the Great Gulf Group and is its Chief Operating Officer. Prior to 1983, Mr. Rosenbaum was a partner
in a law practice. Mr. Rosenbaum graduated as a lawyer from Osgoode Hall Law School and was called
to the bar in 1976.
Audit Committee Financial Expert
The Company does not have an audit committee. Since our securities are not currently listed on
or with a national securities exchange or national securities association, we are not required to
have an independent audit committee. Further, given the small size of the Board, the Board
believes it appropriate for all members of the Board to be involved in the discussions and
decisions typically delegated to an audit committee. Our Board has determined that Mr. Joffe meets
the qualifications of an “audit committee financial expert” as defined in the rules and regulations
of the SEC, but does not meet the definition of an “independent director” under the rules
promulgated by Nasdaq or the New York Stock Exchange as a result of his affiliation with our
ownership group. However, because our securities are not listed on a national securities exchange
or national securities association, we are not required to have an audit committee financial expert
who is an “independent director.”
Although the Company has not yet adopted a code of ethics, the Company is in the process of
preparing a Code of Business Conduct and Ethics, which will meet the definition of a “code of
ethics” under Item 406 of the Securities and Exchange Commission’s Regulation S-K. Once adopted,
the Code of Business Conduct and Ethics will apply to and be binding upon all of the Company’s
employees (including the principal executive officer, principal financial officer, principal
accounting officer or controller, or persons performing similar functions).
The purpose of this compensation discussion and analysis is to provide information about each
material element of compensation awarded to, earned by, or paid to each of our named executive
officers during fiscal year 2007. Our compensation policies are designed to reward superior
performance, recognize individual initiative and achievement and encourage actions to meet our
short-term and long-term goals.
Compensation Governance and Philosophy
The entire Board of Directors undertakes the duties of the Compensation Committee with respect
to the compensation of Mr. Krobot and Mr. Salomon. Mr. Krobot, with the input from Mr. Salomon,
determines the compensation of the other executive officers. Mr. Krobot, our President and Chief
Executive Officer, is a member of our Board of Directors. As a member of the Board of Directors,
he participates in discharging the duties of the Compensation Committee, other than with respect to
his own compensation.
Our executive compensation programs have been aligned with the Board of Directors’ beliefs
that total cash compensation should be comparable to the median compensation for similar positions
in the homebuilding industry and that annual incentive opportunities should represent a
significant portion of total cash compensation for executives. The Board of Directors believes
that annual incentive compensation should provide a meaningful upside opportunity which depends on
our business and financial results and be at risk when performance or results do not meet
expectations. We communicate our general performance expectations and goals to executives, but
bonus payments are at the discretion of the Board of Directors taking into account actual
performance. It is the Board of Directors’ further belief that managing a compensation program
around these principles will place executives’ and owners’ interests together and enhance the
financial returns to our owners. The Board of Directors utilizes publicly available information
about compensation levels in the homebuilding industry in establishing the compensation levels of
our executives. Each component of compensation is described more fully below.
Base Salary
The base salaries for our executive officers provide the foundation for a fair and competitive
compensation opportunity. Base salary levels are generally targeted at or slightly below the
average of our industry. Base salary, which is a fixed element of total pay, is only one element,
and not the most significant element, of our total compensation program because of our
performance-based compensation philosophy. Base salaries are a necessary part of our compensation
program and provide executives with a fixed portion of pay that is not performance-based. Our
goal is to provide modest, yet competitive, base pay levels in comparison to other homebuilders.
Base salaries for Mr. Krobot and Mr. Salomon, in fiscal year 2007, were determined by the
Board of Directors in part after reviewing publicly available industry information. Mr. Krobot,
with input from Mr. Salomon, determined the compensation of the other executive officers based on
comparisons of industry salary practices for positions of similar responsibilities, additional
elements of the executives’ total compensation, and on individual performance.
Annual Bonus Incentives
We pay annual bonus incentives to Mr. Krobot and Mr. Salomon based on the parameters outlined
in their employment agreements.
•
Mr. Krobot’s annual bonus is equal to 4.0% of the first $10,000,000 and 3.0% of any
amount in excess of $10,000,000 of our annual net income, reflected in our annual audited
financial statements, as adjusted to exclude imputed interest on equity, bonuses paid at
the operational level and specific projects as agreed from time to time.
•
Mr. Salomon’s annual bonus is equal to 0.75% of our annual net income, reflected in our
annual audited financial statements, as adjusted to exclude initial start-up losses of any
new division during the first two
years of operation, imputed interest on equity, bonuses paid at the operational level and
specific projects as agreed from time to time.
We periodically pay bonuses to our other senior executives, which are entirely discretionary
and are based on individual performance and our performance. For fiscal year 2007, discretionary
bonuses were paid to various executives, including two named executive officers, Tad Serbin and
Ralph Farrell. We chose to pay these amounts to reward each individual’s accomplishments in light
of the results achieved by us, and as a continuing cash incentive for their performance. We hired
Mr. Thomas during fiscal year 2006, and in order to induce him to join us, we agreed to pay him a
guaranteed annual bonus of $800,000 for fiscal year 2007.
Deferred Compensation Plan
Effective June 1, 2005, we adopted the Ashton Woods USA L.L.C. Deferred Compensation Plan (the
“Plan”) for the purpose of providing deferred compensation to a select group of management and
highly compensated employees, including the named executive officers. Annually, we make
contributions, in the amounts determined by the Board of Directors, to each participant’s Plan
account. These contributions are in addition to the salary and bonuses received by the
participants. For a more detailed description of the Plan please refer to the section
“Nonqualified Deferred Compensation”.
Severance Benefits
Severance benefits are provided from time to time to executive officers as a result of
negotiations of their employment agreements. The Board of Directors does not have a standard
program applicable to all executives, but has negotiated severance or other enhanced benefits for
named executive officers upon termination of their employment or upon a change of control. Such
arrangements are negotiated from time to time in an effort to provide appropriate incentives to
executives and are negotiated based on the Board of Director’s understanding of standard market
practice among private companies in the homebuilding industry. Currently, Messrs Krobot and Salomon
are the only named executive officers with employment agreements. For a discussion of the
severance benefits available to them refer to the section “Employment Agreements”.
Compensation Committee Report
The Board of Directors has reviewed and discussed the Compensation Discussion and Analysis
with management and has recommended that it be included in this Form 10-K.
The following table sets forth certain summary information concerning the total compensation for
the fiscal year ended May 31, 2007, earned by our Chief Executive Officer, Chief Financial Officer
and our three most highly compensated executive officers, which are referred to as the named
executive officers.
Mr. Krobot’s base salary is in accordance with his employment agreement that was effective June 1, 2005.
[b]
Mr. Salomon’s base salary increased from $200,000 to $260,000, effective April 1, 2007.
[c]
Mr. Thomas’ base salary was negotiated at hire date.
[d]
Mr. Serbin’s base salary increased from $175,000 to $190,000, effective March 1, 2007.
[e]
Mr. Farrell’s base salary increased from $155,000 to $170,000, effective March 1, 2007.
[f]
Mr. Krobot’s and Mr. Salomon’s bonuses are based on the formulas in their respective employment
agreements.
[g]
Mr. Thomas’ bonus was guaranteed upon hire for fiscal year 2007.
[h]
Mr. Serbin’s and Mr. Farrell’s bonuses were discretionary.
[i]
The amounts in this column reflect the above market earnings under the Plan during fiscal year
2007.
[j]
Other annual compensation includes employer contributions for basic life insurance premium,
medical insurance, and the 401k match. Other annual compensation also includes contributions that
the Company made to the following individuals’ non-qualified deferred compensation accounts: Mr.
Krobot $50,000, Mr. Salomon $40,000; Mr. Serbin $30,000 and Mr. Farrell $30,000. Furthermore, Mr.
Krobot’s other compensation includes $400,000, which represents the vesting of a payment due to him
if he is terminated for cause or he resigns voluntarily. Refer to the section “Employment
Agreements” for a description of the payment due to Mr. Krobot in the event of his termination for
cause or voluntary resignation.
Nonqualified Deferred Compensation
The Plan is a non-qualified deferred compensation plan which is administered by a committee
appointed by the Board of Directors. Under the Plan, we may make contributions to the
participants’ accounts, and amounts in the participants’ accounts earn an annual interest rate
which is periodically determined by the Board of Directors. Currently, the annual interest rate is
9.0%.
Contributions vest ratably over a five year period. However, a participant’s account will
become fully vested if the participant remains employed with us until the participants’ death,
total disability or the participant turns 65. Furthermore, a participant’s account will become
fully vested if the participant is terminated without cause within two years of a change of
control.
Once a contribution is fully vested, a participant, who is still employed by us, may receive a
cash distribution of such vested contribution and any earnings thereon. Otherwise, a participant
will receive a cash payment of the participant’s vested contributions upon termination of the
participant’s employment with us or upon the participant’s death or disability. In the event that
the committee administering the Plan determines that a participant’s employment was terminated by
us for good cause, the participant will forfeit his or her interest in the Plan.
Consists of amounts credited to each executive officer’s account under the Ashton Woods USA
L.L.C. Nonqualified Deferred Compensation Plan for the fiscal year ended May 31, 2007. Each of
these amounts is included in the Summary Compensation Table in the “All Other Compensation” column.
[b]
Aggregate earnings equal 9% of the accumulated benefit balance as of May 31, 2007. The “Change
in Pension Value and Deferred Compensation Earnings” column in the Summary Compensation Table
reflects the portion of these earnings that are deemed to be above market.
[c]
Aggregate balance at last fiscal year end equals the amounts credited to each executive
officers account since inception of the Asthon Woods USA L.L.C. Nonqualified Compensation Plan on
June 1, 2005.
Employment Agreements
On January 30, 2006, we entered into an employment agreement with our President and Chief
Executive Officer, Tom Krobot. The agreement, which is effective as of June 1, 2005, is for a term
of approximately five years ending May 31, 2010. The employment agreement provides for an annual
base salary of $225,000 and an annual bonus in an amount equal to 4.0% of the first $10,000,000 and 3.0% of any amount in excess of
$10,000,000 of our annual net income, calculated in accordance with generally accepted accounting
principles and reflected in our annual audited financial statements, as adjusted to exclude imputed
interest on equity, bonuses paid at the operational level and specific projects as agreed from time
to time. The agreement also provides for certain incentive payments upon a sale of the Company,
irrespective of form, or the consummation by the Company of an initial public offering of equity
securities. Such payments are due upon the sale of the Company or initial public offering
irrespective of the executive’s continued employment with us. The incentive payment owed upon the
sale of the Company will be equal to an amount determined by multiplying the excess of the
aggregate purchase price paid by the buyer or buyers in such transaction over the book value of the
Company, as determined in good faith by our board of directors, at the time of such sale by 3.0%,
provided such payment is subject to a floor of $3,000,000.
Upon an initial public offering, Mr. Krobot is entitled to a payment equal to 3.0% of the
excess of the aggregate market value of the Company at such time, determined based on the excess of
valuation applied in the offering, over the then book value of the Company, as determined in good
faith by our board of directors, subject to a minimum of $3,000,000. The payment upon an initial
public offering shall be paid through the issuance of stock with an aggregate value equal to the
payment owed, if possible, otherwise, such payment shall be made in cash or some other mutually
agreed upon method.
Following the payments of amounts owed to Mr. Krobot upon a sale of initial public offering of
the Company, the agreement will terminate, and Mr. Krobot will continue as an at will employee. The
agreement also provides Mr. Krobot with certain severance payments upon termination of his
employment as follows:
Upon termination for cause, as defined in the agreement, or
voluntary resignation by Mr. Krobot, in addition to accrued salary
through the date of termination, Mr. Krobot will be entitled for
each year of employment completed between fiscal years beginning
June 1, 2005 and ending May 31, 2009, to a payment of $400,000 and
for completion of the fiscal year June 1, 2009 to May 31, 2010 to
a payment of $1,400,000.
•
Upon termination of employment upon death or disability, in
addition to base salary accrued through the date of termination,
Mr. Krobot or his estate, will be entitled to a payment in an
amount equal to the greater of (a) $3,000,000 or (b) a prorated
portion (based on the number of years of the term of the agreement
that has expired divided by five), of 3.0% of the excess of the
then-determined public market value of the Company over the book
value of the Company, in each case as determined in good faith by
the board of directors.
•
Upon termination without cause, in addition to base salary accrued
through the date of termination, Mr. Krobot will be entitled to a
payment equal to the greater of: (a) the sum of one year’s base
salary at the rate then in effect plus a bonus payable pursuant to
the annual bonus provisions of the agreement based on projections
of our net income for the following 12 months, plus an amount
equal to a bonus calculated in such manner based on a pro rata
share of net income for the then-current fiscal year; or (b) the
sum of a bonus calculated in accordance with the annual bonus
provisions of the agreement pro rated based on net income for the
then-current fiscal year plus 3.0% of the excess of the
then-determined public market value of the Company over the
then-book value of the Company, in each case as determined in good
faith by the board of directors, subject to a minimum of
$3,000,000.
•
If Mr. Krobot’s employment terminates upon expiration of the term
of the agreement, Mr. Krobot will be entitled to a payment equal
to 3.0% of the excess of then-public market value of the Company
as compared to the book value of the Company, in each case as
determined in good faith by the board of directors, subject to a
minimum payment of $3,000,000.
•
Upon the sale of the Company, if Mr. Krobot’s employment is
terminated, in addition to the incentive payment described above
and his base salary accrued through the date of termination, Mr.
Krobot will receive an amount equal to a bonus calculated in
accordance with the annual bonus provisions described above based
on a pro rated share of net income for the current fiscal year to
the date of termination.
Finally, the Agreement provides that we will provide health insurance for Mr. Krobot and his
spouse, whether or not Mr. Krobot is an employee of ours, until he reaches the age of 65, upon the
same terms then available to executive officers of the Company.
By memorandum dated April 30, 2006, our Board of Directors confirmed to Robert Salomon, our
Chief Financial Officer, his annual salary, bonus calculation and certain severance payments if Mr.
Salomon is terminated following a sale of the Company resulting in a change of control of our
equity. On August 9, 2006, we entered into an employment agreement with Mr. Salomon, which
addresses the provisions set forth in the memorandum in more detail. The agreement is for a term
of five years ending August 2011, subject to automatic renewal for additional one-year terms absent
notice of termination from either party. The initial employment agreement provided for an annual
base salary of $200,000. On March 26, 2007, the Board of Directors of the Company approved a
salary increase for Mr. Salomon. Effective April 1, 2007, Mr. Salomon’s salary increased from
$200,000 per year to $260,000 per year. The agreement also includes an annual bonus in an amount
equal to 0.75% of our annual net income, calculated in accordance with generally accepted
accounting principles and reflected in our annual audited financial statements, as adjusted to
exclude initial start-up losses of any new division during the first two years of operation,
imputed interest on equity, bonuses paid at the operational level and specific projects as agreed
from time to time.
The Agreement also provides for the following payments to Mr. Salomon upon termination of his
employment:
•
Upon termination without cause, including upon expiration of the agreement, Mr. Salomon
will be entitled to a severance payment equal to (a) one year of base salary and (b) a
prorated amount of the bonus payable for the then current year through the date of
termination.
Upon termination for any reason following the sale of the Company, irrespective of form,
Mr. Salomon will be entitled to a severance payment equal to the greater of (a) the bonus
paid pursuant to the employment agreement for the most recently completed fiscal year and
(b) $500,000.
The agreement also provides for termination with cause and upon death or disability, in which
case Mr. Salomon will receive any accrued salary to the date of termination and any other benefits
to which he is entitled under then existing benefit plans.
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE IN CONTROL
The following table provides the estimated value of the benefits that each of the named
executive officers would have received had his employment been terminated on the last business day
of fiscal year 2007 under the scenarios described below or had a change of control or initial
public offering of the Company’s equity occurred on the last business day of fiscal year 2007. The
table does not include benefits that are generally available to all salaried employees.
Payment from
Non-qualified Deferred
Compensation Plan
—
$
55,000
(3)
—
—
$
55,000
(3)
—
$
5,000
(4)
Health care continuance
—
—
—
—
—
—
—
Total
—
$
55,000
—
—
$
55,000
—
$
5,000
(1)
Lump sum payment in cash. The incentive payment is equal to the greater of $3 million or 3% of
the excess of the purchase price paid by a buyer of us over our book value. We assumed that a
buyer would pay the average of (i) a multiple our book value as of May 31, 2007 and (ii) (a) a
multiple our EBITDA for fiscal year 2007 adjusted to exclude the effect of the inventory impairment
charge taken during fiscal year 2007 less (b) our total debt as of May 31, 2007. Based on our
estimate of what a buyer would pay and our book value as of May 31, 2007, Mr. Krobot would have
received the minimum payment of $3 million. See the description of the Mr. Krobot’s employment
agreement above for an explanation of the payment due to him upon a change of control.
(2)
Lump sum payment in stock, cash or some other mutually agreed upon method. The incentive
payment is equal to the greater of $3 million or 3% of the excess of our aggregate market value,
based on the valuation applied in an IPO, over our book value. We assumed that our aggregate
market value in an IPO would be equal to the average of (i) a multiple of our book value as of May31, 2007 and (ii) (a) a multiple our EBITDA for fiscal year 2007 adjusted to exclude the effect of
the inventory impairment charge taken during fiscal year 2007 less (b) our total debt as of May 31,2007. Based on our estimate of our aggregate market value in an IPO and our book value as of May31, 2007, Mr. Krobot would have received the minimum payment of $3 million. See the description
of the Mr. Krobot’s employment agreement above for an explanation of the payment due to him upon an
IPO.
(3)
Lump sum payment in cash. Amounts in a Plan participant’s account becomes fully vested (i.e.,
accelerated vesting) upon the participant’s death or disability or upon the participant’s
termination without cause within two years of a change of control.
(4)
Lump sum payment in cash. This is vested portion of the participant’s account as of May 31,2007.
(5)
This is an estimate based on the premiums paid during fiscal 2007 to provide coverage for Mr.
Krobot and his wife.
(6)
Lump sum payment in cash. See the description of the Mr. Salomon’s employment agreement above
for an explanation of the payments due to him.
Director Compensation
The members of our Board of Directors do not receive compensation for services as our
directors.
Compensation Committee Interlocks and Insider Participation
The entire Board of Directors undertakes the duties of the Compensation Committee with respect
to the compensation of Messrs. Krobot and Salomon. Mr. Krobot, with input from Mr. Salomon,
determines the compensation of the other executive officers. Mr. Krobot, our President and Chief
Executive Officer, is a member of our Board of Directors. As a member of the Board of Directors, he
will participate in discharging the duties of the Compensation Committee.
For a discussion of transactions between us and certain affiliates of members of our Board of
Directors, see Item 13 “Certain relationships and related transactions, and director
independence.”
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth certain information as of May 31, 2007 regarding the beneficial
ownership of the membership interests in the Company. In addition, the footnotes below explain that
certain of the persons or entities listed in the table have special membership interests entitling
them to allocations of profits and cash distributions in the land development activities in Denver,
Colorado and Orlando, Florida of certain of the Company’s subsidiaries. Ashton Woods Finance co. is
a wholly-owned subsidiary of the Company.
Beneficial ownership is determined in accordance with Section 13 of the Exchange Act
and the rules promulgated thereunder. Accordingly, if an individual or entity is a member
of a “group” which has agreed to act together for the purpose of acquiring, holding, voting
or disposing of membership interests, such individual or entity is deemed to be the
beneficial owner of the membership interests held by all members of the group. Further, if
an individual or entity has or shares the power to vote or dispose of membership interests
held by another entity, beneficial ownership of the interests held by such entity may be
attributed to such other individuals or entities.
(2)
The address of this beneficial owner is 3751 Victoria Park Ave, Toronto, Ontario M1W
3Z4 Canada.
(3)
Entities and/or family trusts associated with these individuals hold interests
(including the special membership interests referred to in footnote 7 below) in the Company
through Little Shots Nevada L.L.C. For beneficial ownership purposes, the membership and
special membership interests held by Little Shots Nevada L.L.C. are attributable to each
such individual. The entities associated with each such individual have, respectively, a
33.3% ownership interest in Little Shots Nevada L.L.C. and are entitled to receive an
allocation of 33.3% of any proceeds received by Little Shots Nevada L.L.C. as a result of
its 21.0% special membership interest in the Denver, Colorado land development activities
and its 21.0% special membership interest in the Orlando, Florida land development
activities.
(4)
This entity is owned by entities and/or family trusts associated with Elly Reisman.
(5)
This entity is owned by entities and/or family trusts associated with Norman Reisman.
(6)
This entity is owned by entities and/or family trusts associated with Larry Robbins.
(7)
These and other related entities also hold special membership interests in allocations
of profits and cash distributions in the land development activities in Denver, Colorado
and Orlando, Florida of certain of the Company’s subsidiaries as follows:
As noted in footnote 3 above, entities and/or family trusts associated with Seymour Joffe,
Bruce Freeman and Harry Rosenbaum are entitled to receive a portion of the proceeds received by
Little Shots Nevada L.L.C. through allocations on such special membership interests based on their
respective percentage ownership interests in Little Shots Nevada L.L.C. as set forth in footnote 3.
Special membership interests do not entitle the holders thereof to vote or otherwise
participate in the management or operation of the Company or any of its subsidiaries.
Item 13. Certain Relationships and Related Transactions, and Director Independence
In August 2005, we entered into a Services and Software License Agreement (the “Services and
License Agreement”) with Paramount Development Corporation Limited (“Paramount”), which is an
affiliate of the Great Gulf Group. Under the Services and License Agreement, which was effective as
of June 1, 2005, Paramount licenses to us and our affiliates certain software which we use in
performing the following functions: accounting, job costing, work order, home warranty, home
design, scheduling, and purchase orders. Furthermore, pursuant to the Services and License
Agreement, Paramount provides us and our affiliates with the services of its employees to assist us
with land development matters relating to our land operations in Orlando and Denver. In return for
the software license and the land development services, we pay Paramount a fee of $600 for each
home closed. The initial term of the Services and License Agreement is two years and will
automatically renew for successive one-year terms unless either party gives notice that the
agreement will not be renewed.
Although we did not have a written agreement with Paramount covering the software license and
land development services prior to entering into the Services and License Agreement, Paramount
provided us with such software and services in return for a payment of $600 for each home closed.
During the fiscal year 2007, we paid Paramount $1.2 million for the software license and land
development services.
We, in the ordinary course of our business, from time to time enter into lot option purchase
agreements to facilitate the development of land for our use with entities that are owned directly
or indirectly by the seven families that indirectly own our membership interests or that are
otherwise affiliates of the Great Gulf Group. These entities generally obtain secured acquisition
and development financing which is supported by specific performance requirements under our lot
option purchase agreements.
As of May 31, 2007, we had three lot purchase contracts with such related parties to acquire
659 finished lots at an aggregate price of approximately $33.0 million which have created variable
interests and of which 163 finished lots remain to be purchased for an aggregate price of $7.1
million. While we do not own any equity interests in these entities, we must consolidate the
entities pursuant to FIN46R.
We believe that the transactions described above between us and the various related parties
have been and will continue to be on terms no less favorable to us than those available from
unaffiliated third-parties in transactions
negotiated at arms-length. We do not intend to enter into any transactions in the future with
or involving any of our
officers or directors or any members of their immediate family on terms
that would be less favorable to us than those that would be available from unaffiliated
third-parties in arms-length transactions.
None of the members of our Board of Directors meet the definition of an “independent director”
under the rules promulgated by Nasdaq or the New York Stock Exchange as a result of their
affiliation with our ownership group or their employment with the Company. However, because our
securities are not listed on a national securities exchange or national securities association,
none of our directors are required to qualify as an “independent director.”
Item 14. Principal Accountant Fees and Services
For the fiscal years ended May 31, 2007 and 2006, professional services were performed by KPMG
LLP.
Audit and audit-related fees aggregated $612,213 and $555,670 for the fiscal years ended May31, 2007 and 2006, respectively, and were composed of the following:
Audit Fees: The aggregate fees billed for the audit of our annual financial statements for
the fiscal years ended May 31, 2007 and 2006 and for reviews of our quarterly financial statements
were $546,000 and $375,000, respectively.
Audit-Related Fees: The aggregate fees billed for audit-related services for the fiscal
years ended May 31, 2007 and 2006 were $66,213 and $155,670, respectively. These fees relate to
assurance and related services performed by KPMG that are reasonably related to the performance of
the audit or review of our financial statements.
Tax Fees: The aggregate fees billed for tax services for the fiscal years ended May 31, 2007
and 2006 were $116,700 and $119,000, respectively. These fees relate to professional services
performed by KPMG with respect to tax compliance, tax advice and tax planning.
All Other Fees: None
The Board of Directors annually approves each year’s engagement for audit services in advance.
The Board of Directors has also established complementary procedures to require pre-approval of all
permitted non-audit services provided by the Company’s independent auditors. All non-audit services
described above were pre-approved by the Board of Directors in fiscal year 2007.
The following list of exhibits includes both exhibits submitted with this Form 10-K as filed
with the Commission and those incorporated by reference to other filings:
Amended and Restated Regulations of Ashton Woods USA L.L.C. (1)
4.1
Form of Indenture dated as of September 21, 2005 among Ashton Woods USA
L.L.C., Ashton Woods Finance Co., the guarantors named therein and the
and U.S. Bank Trust National Association, as trustee. (1)
4.2
Form of 9.5% Senior Subordinated Note due 2015. (1)
10.1
Form of Amended and Restated Credit Agreement, dated as of December 16,2005, by and among Ashton Woods USA L.L.C., the Lenders party thereto,
Wachovia Bank, National Association, as Agent for the Lenders, and
Wachovia Capital Markets, LLC, as Lead Arranger and Sole Bookrunner,
Bank of America, N.A., as Syndication Agent, and Citibank Texas, N.A.,
as Documentation Agent. (2)
10.2
Limited Partnership Agreement of Navo South Development Partners, Ltd.,
dated as of December 18, 2003, by and among G.P. Navo South, L.L.C.,
Ashton Dallas Residential, L.L.C., Horizon Homes Ltd., and Priority
Development, L.P. (1)
10.3
Agreement of Limited Partnership for CL Ashton Woods, L.P., dated as of
March 10, 2005, by and among CL Texas I, GP, LLC, CL Texas, L.P., AW
Southern Trails, Inc., and Ashton Houston Residential L.L.C. (1)
10.4
Limited Liability Company Agreement of Palm Cove Developers, LLC, dated
as of January 19, 2005, by and between Ashton Tampa Residential, LLC
and M/I Homes of Tampa, LLC. (1)
10.5
Services and Software License Agreement, dated as of June 1, 2005, by
and between Ashton Woods USA L.L.C. and Paramount Development
Corporation Limited. (1)
10.6*
Form of Ashton Woods USA, LLC Nonqualified Deferred Compensation Plan,
effective June 1, 2005 (1)
10.7*
Form of Employment Agreement, dated as of January 30, 2006, by and
between Thomas Krobot and Ashton Woods USA, L.L.C. (2)
10.8
Agreement of Limited Liability Company of Ashton Woods Mortgage, LLC (2)
10.9
Dominion Title of Dallas, L.L.C. Members’ Agreement, dated January 21,2001, by and among Stewart Title Dallas, Inc., Ashton Dallas
Residential, L.L.C. and Dominion Title of Dallas, L.L.C. (2)
10.10
Dominion Title, L.L.C. Members’ Agreement, dated June 7, 1999, by and
among Stewart Title Company, Daltor Houston Title, Inc. and Dominion
Title, L.L.C. (2)
10.11
Assignment of Membership Interest, dated as of June 1, 2002, by and
between Daltor Houston Title, Inc. and Ashton Houston Residential,
L.L.C. (2)
Form of Promissory Note to Larelnor Developments Inc. (2)
10.14*
Form of Employment Agreement, dated as of August 9, 2006, by and
between Robert Salomon and Ashton Woods USA, L.L.C.(3)
10.15
First Amendment to the First Amended and Restated Credit Agreement,
dated as of January 11, 2007, by and among Ashton Woods USA L.L.C., the
Lenders party thereto, Wachovia Bank, National Association, as Agent,
and the Guarantors party thereto. (4)
10.16
Second Amendment to the First Amended and Restated Credit Agreement,
dated as of June 15, 2007, by and among Ashton Woods USA L.L.C., the
Lenders party thereto, Wachovia Bank, National Association, as Agent,
and the Guarantors party thereto. (5)
Certification of Chief Executive Officer pursuant to Exchange Act Rules
13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. (filed herewith)
Certification of Chief Financial Officer pursuant to Exchange Act Rules
13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002. (filed herewith)
32.1
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002. (filed herewith)
32.2
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
2002. (filed herewith)
*
Represents a management contract or compensatory plan or arrangement
The exhibits, which are referenced in the above documents, are hereby incorporated by reference.
Such exhibits have been omitted for purposes of this filing but will be furnished supplementary to
the Commission upon request.
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.
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.
Report of Independent Registered Public Accounting Firm
The Members
Ashton Woods USA L.L.C.:
We have audited the accompanying consolidated balance sheets of Ashton Woods USA L.L.C. and
subsidiaries as of May 31, 2007 and 2006, and the related consolidated statements of earnings,
members’ equity, and cash flows for each of the years in the three-year period ended May 31, 2007.
These consolidated financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material misstatement. An
audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of Ashton Woods USA L.L.C., and subsidiaries as of May31, 2007 and 2006, and the results of their operations and their cash flows for each of the years
in the three-year period ended May 31, 2007, in conformity with U.S. generally accepted accounting
principles.
Note 1 — Summary of Significant Accounting Policies
Organization
Ashton Woods USA L.L.C. (the “Company’’), operating as Ashton Woods Homes, is a limited
liability company formed on February 6, 1997 for a period of duration ending no later than
February 1, 2037. The Company acquires and develops land for residential purposes and designs,
sells and builds residential homes on such land in seven markets located in Georgia, Texas,
Florida, Arizona, and Colorado. The Company also holds an investment in an unconsolidated
entity that provides mortgage origination for homebuyers through Ashton Woods Mortgage, LLC
(“Ashton Woods Mortgage’’). In addition, the Company provides title services to its buyers in
Texas and Florida through three unconsolidated entities.
Presentation
The consolidated financial statements include the accounts of the Company, and its
wholly-owned, majority-owned and controlled subsidiaries, as well as certain variable interest
entities required to be consolidated pursuant to Financial Interpretation No. 46R (“FIN 46R’’)
issued by the Financial Accounting Standards Board (FASB). All intercompany balances and
transactions have been eliminated in consolidation.
The Company’s balance sheet presentation is unclassified due to the fact that certain
assets and liabilities have both short and long-term characteristics.
Cash and Cash Equivalents
The Company considers all highly liquid investments with an initial maturity of three months
or less when purchased to be cash equivalents.
Inventory
Finished inventories and land held for sale are stated at the lower of accumulated cost or
fair value less cost to sell. Homebuilding projects and land held for development and construction
are stated at cost unless facts and circumstances indicate that such cost would not be recovered
from the undiscounted cash flows generated by future dispositions, after considering estimated cash
flows associated with all future expenditures to develop the assets, including interest payments
that will be capitalized as part of the cost of the asset. In this instance, such inventories are
written down to estimated fair value, which is determined based on management’s estimate of future
revenues and costs that would be considered by an unrelated buyer in determining the fair value of
the asset. Due to uncertainties in the estimation process, it is possible that actual results could
differ.
In addition to the costs of direct land acquisition, land development and home construction,
inventory costs include interest, real estate taxes and indirect overhead costs incurred during
development and home construction. The Company uses the specific identification method for the
purpose of accumulating home construction costs. Cost of sales for homes closed includes the
specific construction costs of each home and all applicable land acquisition, land development and
related costs (both incurred and estimated to be incurred) based upon the total number of homes
expected to be closed in each project. Any changes to the estimated total development costs
subsequent to the initial home closings in a project are generally allocated on a pro-rata basis to
the remaining homes in the project.
When a home is closed, the Company generally has not yet paid and recorded all incurred costs
necessary to complete the home. Each month the Company records as a liability and a charge to cost
of sales the amount it estimates will ultimately be paid related to completed homes that have been
closed as of the end of that month.
The Company compares home construction budgets to actual recorded costs to estimate the
additional costs remaining to be paid on each closed home. The Company monitors the accuracy of
each month’s accrual by comparing actual costs paid on closed homes in subsequent months to the
amount accrued. Although actual costs to
be paid on closed homes in the future could differ from the current estimate, this method has
historically produced consistently accurate estimates of actual costs to complete closed homes.
Each reporting period, the Company reviews all components of inventory in accordance with SFAS
No. 144, which requires that if the sum of the undiscounted future cash flows expected to result
from a community is less than the carrying value of the community, an asset impairment must be
recognized in the consolidated financial statements as a component of cost of sales. The amount of
the impairment is calculated by subtracting the fair value of the community from the carrying value
of the community.
In order for management to assess the fair value of a community, certain assumptions must be
made which are highly subjective and susceptible to change. The Company evaluates, among other
things, the actual gross margins for homes closed and the gross margins for homes sold in backlog.
This evaluation also includes critical assumptions with respect to future home sales prices, cost
of sales, including levels of sales incentives and the monthly rate of sale, which are critical in
determining the fair value of a community. If events and circumstances indicate that the carrying
value of a community are not expected to be recoverable, then the community is written down to its
estimated fair value. Given the historical cyclicality of the homebuilding industry, the valuation
of homebuilding inventories are sensitive to changes in economic conditions, such as interest rates
and unemployment levels. Changes in these economic conditions could materially affect the projected
home sales price, the level of sales incentives, the costs to develop land and construct the homes
and the monthly rate of sale. Because of these potential changes in economic and market conditions
in conjunction with the assumptions and estimates required of management in valuing homebuilding
inventory, actual results could differ materially from management’s assumptions and may require
material inventory impairments to be recorded in the future.
In accordance with SFAS No. 144, valuation adjustments are recorded on finished homes and land
held for sale when events or circumstances indicate that the fair value, less costs to sell, is
less than the carrying value.
The impairments recorded during the twelve months ended May 31, 2007 and 2006 by reportable
segment are as follows (in thousands):
2007
2006
East
$
9,581
$
2,010
West
9,251
2,506
$
18,832
$
4,516
Deposits paid related to land option purchase agreements and contracts to purchase land are
capitalized when paid and classified as other assets until the related land is acquired. The
deposits are then transferred to inventory at the time the land is acquired. Deposits are charged
to expense if the land acquisition is no longer considered probable.
Real Estate Not Owned
Consolidated real estate not owned represents the fair value of land under option purchase
agreements when consolidated pursuant to FIN 46R.
Investments in Unconsolidated Entities
The Company participates in a number of land development entities in which it has less than a
controlling interest. These land development entities are typically entered into with developers,
other homebuilders and related parties to develop finished lots for sale to the members of the
entities and other third parties. The Company accounts for its interest in these entities under
the equity method. The Company’s share of profits from these entities are deferred and treated as
a reduction of the cost basis of land purchased from the entity.
The Company’s investments in Ashton Woods Mortgage and the title services entities are also
accounted for under the equity method, as the Company does not have a controlling interest. Under the
equity method, the Company’s share of the unconsolidated entities’ earnings or loss is
recognized as earned.
Property, plant and equipment is recorded at cost. Depreciation and amortization generally is
recorded using the straight-line method over the estimated useful lives of the assets, which range
from 2 years to 5 years, and depreciable lives for leasehold improvements typically reflect the
life of the lease. Repairs and maintenance costs are expensed as incurred.
Homebuilding and lot sale revenue are recognized at the time of the closing of a sale, when
title to and possession of the property are transferred to the buyer. Sales commissions are
included in sales and marketing expenses. Virtually all homebuilding, land and lot sales
revenues are received in cash within two days of closing.
Warranty Costs
The Company provides its homebuyers with limited warranties that generally provide for ten
years of structural coverage, two years of coverage for plumbing, electrical and heating,
ventilation and air conditioning systems and one year of coverage for workmanship and materials.
Warranty liabilities are initially established on a per home basis by charging cost of sales and
establishing a warranty liability for each home delivered to cover expected costs of materials and
labor during the warranty period. The amounts accrued are based on management’s estimate of
expected warranty-related costs under all unexpired warranty obligation periods. The Company’s
warranty liability is based upon historical warranty cost experience in each market in which it
operates and is adjusted as appropriate to reflect qualitative risks associated with the types of
homes built and the geographic areas in which they are built. The following table sets forth the
Company’s warranty liability, which is included in accounts payable and accruals on the
consolidated balance sheets:
The Company expenses advertising costs as they are incurred. Advertising expense was
approximately $6.0 million, $4.4 million and $2.8 million in fiscal 2007, 2006 and 2005,
respectively.
During the fiscal year 2004 and a portion of fiscal year 2005 the Company had a controlling
interest in a limited partnership for land acquisition and development in Orlando, Florida.
Accordingly, the financial position of this partnership and results of operations were consolidated
in the Company’s consolidated financial statements and the other partner’s share of earnings of the
limited partnership was recorded as minority interest during such periods. During fiscal year 2005,
the Company acquired the minority share in this limited partnership.
Provision for Income Taxes
The Company operates as a limited liability company. Accordingly, the Company incurs no
liability for federal or state income taxes, other than franchise taxes, as these taxes are
passed through to the members.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting
principles generally accepted in the United States of America requires management to make
estimates and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. Actual results could differ from those estimates.
Reclassifications
Certain prior year balances have been reclassified to conform to the current year presentation.
Segments
The Company’s operating segments are aggregated into reportable segments in accordance with
SFAS No. 131 Disclosures About Segments of an Enterprise and Related Information (“SFAS 131”),
based primarily upon similar economic characteristics, geography and product type. The Company’s
homebuilding reportable segments are as follows:
1) East (Atlanta, Orlando and Tampa markets) and
2) West (Dallas, Houston, Phoenix and Denver markets)
See Note 13 for further discussion of the Company’s segments.
Note 2 — Inventory
Inventory consists of the following as of May 31, (in thousands):
2007
2006
Homes under construction
$
145,434
$
173,824
Finished lots
112,886
49,354
Land under development
111,500
165,867
Land held for development
9,118
4,894
$
378,938
$
393,939
The Company capitalizes interest costs to inventory during development and construction.
Capitalized interest is charged to cost of sales as the related inventory is delivered to the
buyer. The following table summarizes the
Company’s interest costs incurred,
capitalized and
charged to cost of sales during the years ended May 31, (in thousands):
2007
2006
2005
Capitalized interest, beginning of period
$
9,483
$
3,173
$
3,123
Interest incurred
19,627
15,347
4,840
Interest amortized to cost of sales
(13,047
)
(9,037
)
(4,790
)
Capitalized interest, end of period
$
16,063
$
9,483
$
3,173
Note 3 — Consolidated Land Inventory Not Owned
In the ordinary course of business, the Company enters into land option agreements in order
to procure land for the construction of homes in the future. Pursuant to these land option
agreements, the Company will provide a deposit to the seller as consideration for the right to
purchase land at different times in the future, usually at predetermined prices. Under FASB
Interpretation No. 46, “Consolidation of Variable Interest Entities,” as amended by FIN 46-R
issued in December 2003 (collectively referred to as “FIN 46”), if the entity holding the land
under option is a variable interest entity, the Company’s deposit represents a variable interest
in that entity. Creditors of the variable interest entities have no recourse against the Company.
In applying the provisions of FIN 46, the Company evaluated all land option agreements and
determined that the Company has three lot purchase contracts with certain related parties to
acquire 659 finished lots at an aggregate price of approximately $33.0 million, which have created
variable interests and of which 163 finished lots remain to be acquired for an aggregate price of
$7.1 million. In addition, the Company has provided various specific performance guarantees under
one of the option purchase contracts, which has been deemed as providing subordinated financial
support to the entity. While the Company owns no equity interest in the entities, it must
consolidate pursuant to FIN 46R. The consolidation of these variable interest entities added $5.9
million, $4.8 million and $0.7 million in real estate not owned, liabilities related to real
estate not owned and minority interests in real estate not owned, respectively, to the Company’s
balance sheet at May 31, 2007 and added $14.3 million, $12.2 million, and $1.8 million in real
estate not owned, liabilities related to real estate not owned and minority interests in real
estate not owned, respectively, to the Company’s balance sheet at May 31, 2006.
Land option agreements that did not require consolidation under FIN 46 at May 31, 2007 and
2006, had a total purchase price of $56.2 million and $35.6 million, respectively. In connection
with these agreements, the Company had deposits of $3.9 million and $2.5 million, included in
other assets at May 31, 2007 and 2006, respectively.
Note 4 — Investments in Unconsolidated Entities
The Company enters into land development joint ventures from time to time as a means of
accessing larger parcels of land and lot positions, managing its risk profile and leveraging its
capital base. At May 31, 2007 and 2006, the Company had equity investments of 50% or less and did
not have a controlling interest in these unconsolidated entities. The Company’s partners are
generally unrelated homebuilders, land developers or other real estate entities. These
unconsolidated entities follow accounting principles generally accepted in the United
States of America and the partners share in their profits and losses generally in accordance
with their ownership interests.
The Company and/or its entity partners enter into option purchase agreements under which they
can purchase finished lots held by the unconsolidated entity. Option prices are generally
negotiated prices that approximate fair value when the option contract is signed. The Company’s
share of the entity’s earnings is deferred until homes related to the lots purchased are delivered
and title passes to a homebuyer.
The land development entities with unrelated parties typically obtain secured acquisition and
development financing. As of May 31, 2007, the Company has entered into lot option purchase
agreements with three
unconsolidated
entities for the purchase of 887 lots, of which 518 remain to
be purchased with an aggregate remaining purchase price of $18.9 million. These unconsolidated
entities had borrowings outstanding totaling $8.1 million and $9.2 million at May 31, 2007 and
2006, respectively. In some instances, the entity partners have provided varying levels of
guarantees of debt of the unconsolidated entities. These repayment guarantees require the Company
to repay its share of the debt of unconsolidated entities in the event the entity defaults on its
obligations under the borrowings. The Company had repayment guarantees of $1.5 million and $3.6
million at May 31, 2007 and 2006, respectively.
Summarized condensed financial information related to unconsolidated entities that are
accounted for using the equity method at May 31, 2007 and 2006 was as follows (in thousands):
In September 2005, the Company and Ashton Woods Finance Co., the Company’s 100% owned finance
subsidiary, co-issued $125 million aggregate principal amount of 9.5% Senior Subordinated Notes
due 2015 in a private placement pursuant to Rule 144A promulgated under the Securities Act of
1933, as amended. The net proceeds were used to repay amounts outstanding under the Company’s
senior unsecured revolving credit facility and to repay certain related party debt. In April
2006, the Company completed an offer to exchange all of the notes issued in September 2005 for an
equal amount of 9.5% Senior Subordinated Notes due 2015, which were registered under the
Securities Act of 1933. Interest on the notes is payable semiannually. The Company may redeem
the notes, in whole or part, at any time on or after October 1, 2010, at a redemption price equal
to 100% of the principal amount, plus a premium declining ratably to par, plus accrued and unpaid
interest. In addition, at any time prior to October 1, 2008, the Company may redeem up to 35% of
the aggregate principal amount of the notes
with the proceeds of qualified equity offerings at a
redemption price equal to 109.5% of the principal amount, plus accrued and unpaid interest. The
notes are unsecured and subordinated in right of payment to all of the Company’s existing and
future senior debt, including borrowings under the Company’s senior unsecured credit facility.
All of the Company’s existing subsidiaries, other than the co-issuer, fully and unconditionally
guaranteed, jointly and severally, the notes on a senior subordinated basis. Each of the
subsidiary guarantors is 100% owned by the Company. Future direct and indirect U.S. subsidiaries,
excluding subsidiaries that are designated unrestricted subsidiaries in accordance with the
indenture, will be required to guarantee the notes on a full and unconditional basis, jointly and
severally with the other subsidiary guarantors. The guarantees are general unsecured obligations
of the guarantors and are subordinated in right of payment to all existing and future senior debt
of the guarantors, which includes their guarantees of the Company’s senior unsecured credit
facility. The Company does not have any independent operations or assets apart from its
investments in its subsidiaries. As of and for the year ended May 31, 2007, the Company was in
compliance with the covenants under the senior subordinated notes. As of May 31, 2007, the
outstanding notes with a face value of $125.0 million had a fair value of approximately $118.2
million, based on quoted market prices by independent dealers.
In December 2005, the Company entered into an amended senior unsecured credit facility. The senior
unsecured credit facility provides for up to $300.0 million of unsecured borrowings, subject to a
borrowing base, and includes an accordion feature by which the Company may request, subject to
certain conditions, an increase of the senior unsecured credit facility up to a maximum of $400.0
million. The senior unsecured credit facility provides for the issuance of up to $50.0 million in
letters of credit. At May 31, 2007, the Company had available borrowing capacity under this
facility of $193.5 million as determined by borrowing base limitations defined in the agreement.
The Company’s obligations under the amended senior unsecured credit facility are guaranteed by all
of its subsidiaries and all of the holders of its membership interests.
Once during each fiscal year (i.e., June 1-May 31), the Company may request that the lenders
extend the maturity date by an additional year. On January 10, 2007, the Company amended the
senior unsecured credit facility to extend the maturity date to January 19, 2011, for 88.3%, or
$265.0 million of the facility and to amend the definition of “EBITDA” contained therein to exclude
certain non-cash gains and include certain non-cash losses or charges. On February 21, 2007, the
Company obtained consent from an additional lender representing 5.0% or $15 million of the
facility, to the extension of the senior unsecured credit facility to January 19, 2011.
The senior unsecured credit facility contains a number of customary financial and operating
covenants, including covenants requiring the Company to maintain a minimum consolidated tangible
net worth; limiting the principal amount of our secured debt to $50 million at any given time;
limiting the net book value of our unimproved entitled land, land under development and finished
lots to 150.0% of its adjusted tangible net worth; limiting the aggregate distributions by the
Company and its subsidiaries in any fiscal year; restricting the Company’s ability to incur
additional indebtedness; and restricting the Company’s ability to engage in mergers and
consolidations and its ability to sell all or substantially all of its assets. The senior
unsecured credit facility also contains covenants requiring the Company to maintain a certain ratio
of consolidated total liabilities to adjusted net worth and to maintain a certain interest coverage
ratio. In June 2007, the Company entered into another amendment to the senior unsecured credit
facility which provides for a permanent reduction in the interest coverage ratio to 2.0x, from
2.50x, and includes a provision allowing such ratio to fall to no less than 1.75x for up to three
consecutive
fiscal quarters in any rolling four fiscal quarter period ending on or before May 31, 2009. The
June 2007 amendment also provides that in the event our interest coverage ratio for any fiscal
quarter is less than 2.0x, (1) the ratio of consolidated total liabilities to adjusted net worth
decreases to 2.0x, from 2.25x, for such fiscal quarter and (2) the interest rates for borrowings
under the senior unsecured credit facility will increase to the levels set forth in the amendment.
The borrowings under the facility bear daily interest at rates based upon the London Interbank
Offered Rate (LIBOR) plus a spread based upon the Company’s interest coverage ratio and ratio of
consolidated total liabilities to adjusted net worth. In addition to the stated interest rates,
the revolving credit facility requires the Company to pay certain fees. The effective interest rate
of the unsecured bank debt at May 31, 2007, was approximately 6.57%. As of and for the year ended
May 31, 2007, the Company was in compliance with the covenants under the senior unsecured credit
facility.
Borrowings under the senior unsecured credit facility are limited by the availability of
sufficient real estate borrowing base, which is determined regularly throughout the life of the
senior unsecured credit facility. At May 31, 2007, we had $61.3 million in outstanding borrowings,
and $193.5 million in available borrowings under the senior unsecured credit facility.
Note 6 — Transactions With Related Parties
A services agreement with a related party provides the Company with the license, development
and support for the Company’s computer systems and the provision of certain administrative
services. The Company pays $600 per home closing quarterly, in arrears for these services, and in
2005, the Company made payments of $1,500 per lot closed for certain services rendered by the
related party to one of the Company’s subsidiaries. During the fiscal years ended May 31, 2007,
2006 and 2005, $1.2 million, $1.5 million and $1.2 million was incurred related to these services,
respectively.
The Company had entered into option purchase agreements for the purchase of finished lots for
use in its homebuilding operations for the acquisition and development of land and lots for use in
its homebuilding operations with certain related parties. These entities were considered variable
interest entities pursuant to FIN 46R and consolidated by the Company. As of May 31, 2007, the
Company has 140 finished lots under contract to be purchased, representing $5.8 million in purchase
price.
The Company had an unsecured note with a related party in the principal amount of $13.7
million at May 31, 2005, which was repaid during the fiscal year ended May 31, 2006.
Note 7 — Employee Benefit Plans
The Company has a 401(k) plan for all Company employees who have been with the Company for a
period of three months or more. The Company matches portions of employee’s voluntary contributions
up to 4% of an employee’s compensation up to the maximum allowed under federal guidelines.
Expenses for the plan were $1.1 million, $0.9 million and $0.7 million in fiscal 2007, 2006 and
2005, respectively.
Note 8 — Financial Instruments
The fair values of the Company’s financial instruments are based on quoted market prices,
where available, or are estimated. Fair value estimates are made at a specific point in time
based on relevant market information and information about the financial instrument. These
estimates are subjective in nature, involve matters of judgment and therefore, cannot be
determined with precision. Estimated fair values are significantly affected by the assumptions
used.
The carrying amounts of cash and cash equivalents and the unsecured revolving credit
facility, as reported in the Company’s balance sheets approximate their fair values due to their
short maturity or floating interest rate terms, as applicable.
Note 9 – Employment Agreements
On January 30, 2006, the Company entered into an employment agreement with its President
and Chief Executive Officer, Tom Krobot. The agreement, which is effective as of June 1, 2005,
is for a term of approximately five years ending May 31, 2010. The employment agreement
includes base salary and annual bonus provisions that are calculated based on annual net
income. The agreement also provides for certain incentive payments upon a sale of the Company,
irrespective of form, the consummation by the Company of an initial public offering of equity
securities, upon his termination under certain circumstances or upon expiration of the
agreement. The incentive payment will be equal to the amount determined by multiplying the
excess of the aggregate fair value of the Company over the book value of the Company by 3%,
provided such payment is subject to a floor of $3.0 million. The Company has accrued
approximately $1.2 million related to this employment agreement since the effective date of
June 1, 2005. The liability under this employment agreement has been measured using the
intrinsic value method.
On August 9, 2006, the Company entered into an employment agreement with its Chief Financial
Officer, Robert Salomon. The agreement is for a term of five years ending August 9, 2011, subject
to automatic renewal for additional one-year terms absent notice of termination from either party.
The employment agreement includes base salary and an annual bonus provision that is calculated
based on annual net income. The Agreement also provides for payments to Mr. Salomon upon
termination of his employment with cause or any reason following the sale of the Company.
Note 10 — Commitments and Contingencies
The Company is involved in lawsuits and other contingencies in the ordinary course of
business. Management believes that, while the ultimate outcome of the contingencies cannot be
predicted with certainty, the ultimate liability, if any, will not have a material adverse
effect on the Company’s consolidated financial statements.
In the normal course of business, the Company provides standby letters of credit and surety
bonds issued to third parties to secure performance under various contracts. As of May 31, 2007,
2006 and 2005, the Company had letters of credit and surety bonds outstanding of $21.3 million,
$25.4 million and $11.0 million, respectively.
The Company leases office space and equipment under various operating leases. Minimum annual
lease payments under these leases at May 31, 2007 were (in thousands):
2008
$
1,761
2009
1,124
2010
791
2011
336
2012
90
$
4,102
Rent expense approximated $1.7 million, $1.8 million and $1.0 million for fiscal 2007, 2006
and 2005, respectively and is included within general and administrative expense on the
consolidated statements of earnings.
Note 11 — Cash Flow Information
Supplemental disclosures of cash flow information and non-cash activities are follows (in
thousands):
Note 12 — Quarterly Financial Information (Unaudited)
Quarter Ended
August 31
November 30
February 28
May 31
($ in thousands)
Fiscal Year 2007
Revenue
$
156,642
$
129,437
$
129,426
$
165,485
Gross profit
$
32,503
$
21,286
$
23,899
$
25,528
Net income
$
11,482
$
3,050
$
6,174
$
3,977
Quarter Ended
August 31
November 30
February 28
May 31
($ in thousands)
Fiscal Year 2006
Revenue
$
106,868
$
158,329
$
157,573
$
280,220
Gross profit
$
22,255
$
42,838
$
37,935
$
64,563
Net income
$
6,077
$
24,785
$
17,394
$
38,215
Note 13 – Information on business segments
SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information” (“SFAS
131”), defines operating segments as a component of an enterprise for which discrete financial
information is available and is reviewed regularly by the chief operating decision-maker, or
decision-making group, to evaluate performance and make operating decisions. The Company has
identified its chief operating decision-makers (“CODMs”) as three key executives—the Chief
Executive Officer, Senior Vice President and Chief Financial Officer.
The Company has identified each homebuilding market as an operating segment in accordance with
SFAS 131. Operations of the Company’s homebuilding segments primarily include the sale and
construction of single-family attached and detached homes, and to a lesser extent, condominiums, as
well as the purchase, development and sale of residential land directly and through the Company’s
unconsolidated entities. The Company’s operating segments have been aggregated into the reportable
segments noted below because they have similar: (1) economic characteristics; (2) housing products;
(3) class of homebuyer; (4) regulatory environments; and (5) methods used to construct and sell
homes. Prior to fiscal year 2007, we only had one reportable segment, therefore, we have restated
the corresponding items of segment information for earlier periods.
The Company’s homebuilding reportable segments are as follows:
(1) East (Atlanta, Orlando and Tampa markets)
(2) West (Dallas, Houston, Phoenix and Denver markets)
Each reportable segment follows the same accounting policies described in Note 1 – “Summary of
Significant Accounting Policies” to the consolidated financial statements. Operational results of
each segment are not necessarily indicative of the results that would have occurred had the segment
been an independent, stand-alone entity during the periods presented.
The following table summarizes total expenditures for additions to property and equipment for
each of the company’s reportable segments (in thousands):
Fiscal years ended May 31
2007
2006
($ in thousands)
Additions to property and equipment
Homebuilding
East
$
2,127
$
1,907
West
3,097
4,602
Total Homebuilding
5,224
6,509
Corporate
28
2,140
Consolidated
$
5,252
$
8,649
The following table sets forth information relating to home sales revenues by product for the
years ended May 31, 2007, 2006 and 2005:
Fiscal years ended May 31
2007
2006
2005
($ in thousands)
Revenue
Product:
Single family homes
$
433,160
$
512,850
$
366,448
Townhomes
57,858
110,256
94,874
Stacked flat condominums
81,148
47,381
—
Total home sales revenue
$
572,166
$
670,487
$
461,322
Note 14 – Subsequent events
On June 15, 2007, the Company amended certain terms of its unsecured revolving credit
facility. The amendment provides for a permanent reduction in the interest coverage ratio to 2.00
to 1.00, from 2.50 to 1.00, and includes a provision allowing such ratio to fall to no less than
1.75 to 1.00 for up to three consecutive fiscal quarters in any rolling four fiscal quarter period
ending on or before May 31, 2009. The amendment also provides that in the event the interest
coverage ratio for any fiscal quarter is less than 2.00 to 1.00, (1) the ratio of consolidated
total liabilities to adjusted net worth decreases to 2.00 to 1.00, from 2.25 to 1.00, for such
fiscal quarter and (2) the interest rates will increase to the levels set forth in the amendment.
F-17
Dates Referenced Herein and Documents Incorporated by Reference