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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
Or
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission file number: 1-10153
HOMEFED CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Delaware 33-0304982
(State or Other Jurisdiction of (I.R.S. Employer Identification No.)
Incorporation or Organization)
1903 Wright Place
Suite 220
Carlsbad, California 92008
(760) 918-8200
(Address, Including Zip Code, and Telephone Number, Including Area Code,
of Registrant's Principal Executive Offices)
Securities registered pursuant to Section 12(b) of the Act: None.
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statement
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K [x].
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [x] No [ ]
Based on the average bid and asked prices of the Registrant's Common Stock as
published by the OTC Bulletin Board Service as of June 30, 2003, the aggregate
market value of the Registrant's Common Stock held by non-affiliates was
approximately $111,152,000 on that date.
As of March 1, 2004, there were 8,256,679 outstanding shares of the Registrant's
Common Stock, par value $.01 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's definitive proxy statement, to be filed with the
Commission for use in connection with the 2004 Annual Meeting of Stockholders
are incorporated by reference into Part III of this Form 10-K.
PART I
Item 1. Business.
- ------ --------
THE COMPANY
Introduction
HomeFed Corporation ("HomeFed") was incorporated in Delaware
in 1988. As used herein, the term "Company" refers to HomeFed and its
subsidiaries, except as the context may otherwise require. The Company is
currently engaged, directly and through subsidiaries, in the investment in and
development of residential real estate projects in the State of California. The
Company also investigates the acquisition of new real estate projects, both
residential and commercial and within and outside the State of California,
although no assurance can be given that the Company will find new investments
providing a satisfactory return or, if found, that the Company will have access
to the capital necessary to make new real estate investments. The executive
office of the Company is located at 1903 Wright Place, Suite 220, Carlsbad,
California 92008.
The Company's current development projects consist of two
master-planned communities located in San Diego County, California: San Elijo
Hills, and a portion of the larger Otay Ranch planning area. As discussed below,
the Company acquired the owner of the San Elijo Hills project in October 2002;
the San Elijo Hills project has been included in the Company's consolidated
financial statements since the date of acquisition.
As the owner of these projects, the Company is responsible for
the completion of a wide range of activities, including design engineering,
grading raw land, constructing public infrastructure such as streets, utilities
and public facilities, and finishing individual lots for home sites or other
facilities. Prior to commencement of development of a project, the Company may
engage in incidental activities to maintain the value of the project. The
Company develops and markets its communities in phases to allow itself the
flexibility to sell finished lots to suit market conditions and to enable it to
create stable and attractive neighborhoods. Consequently, at any particular
time, the various phases of a project will be in different stages of land
development and construction. In addition, from time to time the Company will
receive expressions of interest from buyers of multiple phases of a project, or
the remaining undeveloped land of an entire project. The Company evaluates these
proposals when it receives them, but no assurance can be given that the Company
will sell all or any portion of its development projects in such a manner.
For any master-planned community, plans must be prepared that
provide for infrastructure, neighborhoods, commercial and industrial areas,
educational and other institutional or public facilities, as well as open space.
Once preliminary plans have been prepared, numerous governmental approvals,
licenses, permits and agreements, referred to as "entitlements," must be
obtained before development and construction may commence. These often involve a
number of different governmental jurisdictions and agencies, challenges through
litigation, considerable risk and expense, and substantial delays. Unless and
until the requisite entitlements are received and substantial work has been
commenced in reliance upon such entitlements, a developer generally does not
have full "vested rights" to develop a project, and as a result, allocation of
acreage between developable and non-developable land may change. In addition, as
a precondition to receipt of building-related permits, master-planned
communities such as San Elijo Hills typically are required in California to pay
impact and capacity fees, or to otherwise satisfy mitigation requirements.
Current Development Projects
San Elijo Hills
In October 2002, the Company purchased from Leucadia National
Corporation (together with its subsidiaries, "Leucadia") all of the issued and
outstanding shares of capital stock of CDS Holding Corporation ("CDS"), which
through its majority-owned subsidiaries is the owner of the San Elijo Hills
2
project. The $25,000,000 purchase price consisted of $1,000,000 in cash and
2,474,226 shares of the Company's common stock, representing approximately 30%
of the Company's outstanding shares. The San Elijo Hills project, a
master-planned community located in the City of San Marcos in San Diego County,
California, at completion is expected to be a community of approximately 3,400
homes and apartments, as well as commercial properties; the San Elijo Hills
project is expected to be completed during the course of this decade. Since
August 1998, the Company has been the development manager for this project, with
responsibility for the overall management of the project, including, among other
things, preserving existing entitlements and obtaining any additional
entitlements required for the project, arranging financing for the project,
coordinating marketing and sales activity, and acting as the construction
manager. The development management agreement provided that the Company would
participate in the net cash flow of the project through the payment of a success
fee, and that the Company receive fees for the field overhead, management and
marketing services it provides ("development management fees"), based on the
revenues of the project. No success fee had been paid prior to the Company's
acquisition of CDS. Through its majority owned subsidiaries, CDS has an
effective 68% indirect equity interest in the San Elijo Hills project, after
considering minority interests held by former owners of the project before CDS
acquired its interest. However, CDS has the right to the return of funds
advanced to the project and to receive a preferred return on its investment
before any amounts are distributed to the minority shareholders. In January
2004, a dividend of $50,000,000 was paid by the Company's subsidiary that owns
the San Elijo Hills project, of which $40,500,000 was ultimately received by the
Company and the balance was paid to the minority interests. As a result, all
amounts advanced to the project were repaid and the preferred return due at the
time the dividend was paid was fully satisfied. For more information on the
minority interests, see Note 7 of Notes to Consolidated Financial Statements.
Sales Activity. The table below summarizes sales activity at
the San Elijo Hills project subsequent to the acquisition of CDS. At closing, a
portion of the sales proceeds is deferred and not immediately recognized as
revenue in the Company's consolidated statements of operations. The Company
recognizes deferred revenue upon completion of required improvements to the
property sold, including costs related to common areas, under the percentage of
completion method of accounting. Amounts shown below as development management
fees earned are intercompany payments, which are eliminated in consolidation and
therefore not reflected in the Company's consolidated statements of operations
after the acquisition of CDS, but which are a source of liquidity for the parent
company.
Year Ended October 21, 2002 to
December 31, 2003 December 31, 2002
----------------- -----------------
(Dollars in thousands)
Number of units sold (1) 739 92
Aggregate sales proceeds from sales of residential
sites, net of closing costs (2) $133,400 $24,700
Development management fees earned $ 8,100 $ 1,400
(1) Units are comprised of single family lots and very low income apartment
units.
(2) Excludes profit participation and consent fees described elsewhere in this
Report which are received subsequent to the closing of the land sales.
Prior to the Company's acquisition of CDS, sales activity at
the San Elijo Hills project consisted of the sale of 1,584 residential and
non-residential units for aggregate sales proceeds of $182,700,000, net of
closing costs. Since the Company was not the owner of the project, it did not
reflect these sales in its consolidated statements of operations. However, the
Company did earn development management fees from these sales, which were
reflected in its consolidated statements of operations. Development management
fees earned were approximately $1,600,000 for the period from January 1, 2002 to
October 21, 2002, and $4,800,000 and $3,500,000 for the years ended December 31,
2001 and 2000, respectively.
As of December 31, 2003, the Company estimates that it will
spend approximately $15,500,000 to complete the required improvements to sold
properties, which results in a deferred revenue balance of $53,500,000. The
Company will recognize the deferred revenue in its consolidated statements of
operations as the required improvements are completed under the percentage of
completion method of accounting.
3
In January 2004, the Company closed on sales to home builders
of 94 single family lots and 45 multi-family units for aggregate cash proceeds
of $33,000,000, net of closing costs. After considering these sales, the
remaining land at the San Elijo Hills project to be developed and sold or leased
consists of the following:
Single family lots to be developed and sold 736
Multi-family units 42
Very low income apartment units 70
School sites 2
Square footage of commercial space 135,000
The Company's current plans are to construct the multi-family
units rather than sell them to another developer, after which the units will be
sold or leased. The very low income apartment units that are planned represent
an obligation to provide affordable housing in the project. The Company does not
expect to earn a profit from the development of these units, and the issuance of
building permits for lots not currently under contract may be delayed until this
obligation is satisfied, thereby affecting the timing of future lot sales.
Assuming the Company's development is not delayed, it expects to close the
sales of the remaining residential units during 2004 and 2005; however,
development activity on units sold is expected to continue into 2006 and on
common areas into 2007.
Although the Company is obligated to sell both school sites to
the school district, the school district is obligated to purchase only one site
and has an option to acquire the other. In the event the school district does
not exercise its option, underlying zoning would permit residential development
of this site. With respect to the commercial space, the Company's current plan
is to construct some of the commercial space rather than sell it to another
builder. The commercial lots are fully developed; however, with the exception of
the visitors' center, the Company has not yet constructed buildings on the
commercial lots. The Company's plan for the town center includes a supermarket,
gas station, office space and other stores, and discussions have begun with
prospective users of the commercial space. The Company expects it will begin
commercial space construction during 2004.
Although these development plans are based on the Company's
current intentions, these plans could change, including as a result of actions
of local regulatory authorities.
In order for the City of San Marcos to issue building permits
to the Company's prospective lot purchasers for lot sales not already under
contract, improvements to two off site roads need to be under construction.
During 2004, the Company entered into an amendment to the project development
agreement with the City of San Marcos/Redevelopment Agency of San Marcos (the
"City"). The amendment, among other things, increases the Company's involvement
in the development of these roads serving the San Elijo Hills project. The
amendment requires the Company to contribute $11,000,000 to fund a portion of
the cost of building these roads, including the acquisition of land, rights of
way and/or environmental permits prior to the commencement of construction. Any
costs in excess of this amount will be funded by the City. The Company believes
that this change to its development agreement increases the likelihood that the
construction of these roads will be initiated in a timely manner, such that the
issuance of building permits will not be delayed. The Company expects it will
commence construction of one of the roads during 2004 and the other in early
2005. The amendment, and the Company's obligation to fund the road construction
costs, is conditioned upon the City imposing a special tax which would be levied
against future property owners of a portion of the San Elijo Hills project. This
tax would give home builders the right to receive funds from the City to
reimburse them for the cost of public infrastructure improvements which were
made at the Company's expense; a benefit which the Company believes would enable
it to recover its road construction costs by charging home builders a price in
excess of the market price. However, there is no assurance that the tax will be
imposed or that the Company will be successful in recovering its expenses
through higher prices to home builders.
The Company must obtain additional environmental permits in
connection with the grading and development of the next phase of the project and
the construction of the off site roads referred to above. Although the Company
expects these permits to be issued in a timely manner, no assurance can be given
when the permits will ultimately be issued.
4
Since 1999, the San Elijo Hills project has carried
$50,000,000 of general liability and professional liability insurance under a
policy issued by the Kemper Insurance Companies ("Kemper"). The policy covered a
thirteen-year term from the initial date of coverage, and the entire premium for
the life of the policy was paid in 1999. This policy is specific to the San
Elijo Hills project; the Company has general and professional liability
insurance for other matters with different insurance companies.
Kemper has ceased underwriting operations and has submitted a
voluntary run-off plan to its insurance regulators. Although Kemper is not
formally in liquidation or under the supervision of insurance regulators, it is
uncertain whether they will have sufficient assets at such time, if ever, the
Company makes a claim under the policy or, if they are insolvent, whether state
insurance guaranty funds would be available to pay the claim. The Company has
investigated replacing the coverage supplied by Kemper with a new insurance
company; however, the Company has not found coverage equal to that provided by
Kemper and premium rates have increased significantly. At this time the Company
has not yet determined whether it needs to obtain replacement insurance, and if
it determines to do so, whether it will be able to acquire insurance that is
economically acceptable, if at all, or whether such insurance will cover past
occurrences at the San Elijo Hills project.
Otay Ranch
In October 1998, the Company and Leucadia formed Otay Land
Company, LLC (the "Otay Land Company") to purchase approximately 4,850
non-adjoining acres of land located within the larger 22,900 acre Otay Ranch
master-planned community south of San Diego, California. Otay Land Company
acquired this land for $19,500,000. When Otay Land Company was formed, Leucadia
contributed $10,000,000 as a preferred capital interest, and the Company
contributed all other funds as non-preferred capital. The Company is the
managing member of Otay Land Company.
In 1993, the City of Chula Vista and the County of San Diego
approved a General Development Plan for the larger planning area. Although there
is no specified time within which implementation of the General Development Plan
must be completed, it is expected that full development of the larger planning
area will take decades. This General Development Plan establishes land use
goals, objectives and policies within the larger planning area. The General
Development Plan for the larger planning area contemplates home sites, a
golf-oriented resort and residential community, commercial retail centers, a
proposed university site and a network of infrastructure, including roads and
highways, a public transportation system, park systems and schools. Any
development within the larger Otay Ranch master-planned community must be
consistent with this General Development Plan. While the General Development
Plan can be amended, subject to approval by either or both of the City of Chula
Vista and the County of San Diego, Otay Land Company has certain vested and
contractual rights, pursuant to a development agreement, that protect its
development interests in Chula Vista, covering substantially all of its
developable land. However, actual land development will require that further
entitlements and approvals be obtained.
In April 2003, Otay Land Company sold approximately 1,445
acres within the Otay Ranch master-planned community to an unrelated third party
for a sales price of $22,500,000 in cash and recognized a pre-tax gain of
approximately $17,700,000. Otay Land Company used a portion of the proceeds from
the sale to fully redeem the preferred capital interest and preferred return of
approximately $12,900,000 due to Leucadia, which was required to be paid before
any distributions could be paid to the Company.
In August 2002, Otay Land Company reached an agreement with
the City of Chula Vista and another party whereby the City agreed to acquire 439
acres of mitigation land from Otay Land Company by eminent domain proceedings.
On January 15, 2004, these proceedings were concluded and the mitigation land
was sold to the City for aggregate proceeds of approximately $5,800,000,
substantially all of which had been received as of December 31, 2003. A pre-tax
gain of approximately $4,900,000 will be recognized in 2004.
After considering the above transactions, Otay Land Company
owns approximately 2,900 acres, of which the total developable area is
approximately 700 acres, including approximately 185 acres of land designated as
"Limited Development Area and Common Use Area." The remaining approximately
5
2,200 acres are designated as various qualities of non-developable open space
mitigation land. Under the General Development Plan, 1.188 acres of open space
mitigation land from within the Otay Ranch project must be dedicated to the
government for each 1.0 acre of land that is developed, excluding land
designated Limited Development Area and Common Use Area.
Some owners of development land have adequate or excess
mitigation land, while other owners lack sufficient acreage of mitigation land
to cover their inventory of development land. Otay Land Company currently has
substantially more mitigation land than it would need to develop its property at
this project. Based upon the General Development Plan conditions, a market for
this land could develop within the larger Otay Ranch development area as
development progresses; however, such a market is partially dependent upon other
parties with developable land fully developing their land. Should other owners
choose not to develop their developable land, it is unlikely that Otay Land
Company's mitigation land can be sold to other owners within the larger Otay
Ranch planning area to meet their mitigation requirements. A sporadic market for
Otay Land Company's excess mitigation land may be developing among buyers of
such land in the San Diego County region. However, it is unclear whether the
County of San Diego would determine that Otay Ranch mitigation land is
acceptable for development unrelated to Otay Ranch.
The Company continues to evaluate how to maximize the value of
this investment while pursuing land sales and processing further entitlements on
portions of its property. Otay Land Company has also submitted a General
Development Plan Amendment to the City of Chula Vista to increase the number of
residential units that it can develop, which may or may not be granted. Even if
Otay Land Company receives its entitlements to develop its property, it is
uncertain whether it will develop or sell its developable land. As a result, the
Company is unable to predict when revenues will be derived from this project. As
indicated above, the ultimate development of projects of this type is subject to
significant governmental and environmental regulation and approval and is likely
to take many years. For additional information concerning governmental and
environmental matters, see "Government Regulation" and "Environmental
Compliance" below.
In October 2003, approximately 1,800 acres of land (consisting
almost entirely of non-developable open space mitigation land) owned by Otay
Land Company was burned by the fires that swept through Southern California.
This represents approximately 55% of the total land owned by the Otay Land
Company, and approximately 70% of the open space mitigation land. The Company
does not currently believe that the fires will have a material adverse effect on
the property's value.
Other Projects
Rampage Property
In November 2003, the Company purchased a 2,159 acre grape
vineyard located in southern Madera County, California. The purchase price for
the property was $6,000,000, excluding expenses, of which $1,700,000 was paid in
cash and the balance was financed. The Company has leased the farming rights for
approximately one-half of the property to one of the former owners for a fifteen
year period; however, the lease can be cancelled by the Company, in whole or in
part, after five years (providing two years notice are given), or can be
cancelled earlier upon the occurrence of certain other specified events. The
lease provides that annual rent payments will be based upon the revenue received
by the tenant from selling the grapes produced, but the amount is not expected
to be material.
Although the property is not currently entitled for
residential development, it is located in a growing residential area northeast
of Fresno, California. The Company purchased this land with the intention of
obtaining the necessary entitlements to develop the property as a master-planned
community; however, approvals from various government agencies will be required,
including the acquisition of a water supply that meets regulatory requirements.
The Company expects the entitlement process will take several years and no
assurance can be given that such entitlements will be obtained.
An owner of adjacent property has claimed that he has options
to purchase approximately 600 acres of the Rampage property for approximately
$4,900,000. The Company is currently evaluating the merits of this claim and how
it will proceed.
6
Competition
Real estate development is a highly competitive business.
There are numerous residential real estate developers and development projects
operating in the same geographic area in which the Company operates. Competition
among real estate developers and development projects is determined by the
location of the real estate, the market appeal of the development master plan,
and the developer's ability to build, market and deliver project segments on a
timely basis. Many of the Company's competitors may have greater financial
resources and/or access to cheaper capital than the Company. Residential
developers sell to homebuilders, who compete based on location, price, market
segmentation, product design and reputation.
Government Regulation
The residential real estate development industry is subject to
substantial environmental, building, construction, zoning and real estate
regulations that are imposed by various federal, state and local authorities. In
developing a community, the Company must obtain the approval of numerous
governmental agencies regarding such matters as permitted land uses, housing
density, the installation of utility services (such as water, sewer, gas,
electric, telephone and cable television) and the dedication of acreage for open
space, parks, schools and other community purposes. Regulations affect
homebuilding by specifying, among other things, the type and quality of building
materials that must be used, certain aspects of land use and building design and
the manner in which homebuilders may conduct their sales, operations, and
overall relationships with potential home buyers. Furthermore, changes in
prevailing local circumstances or applicable laws may require additional
approvals, or modifications of approvals previously obtained.
Timing of the initiation and completion of development
projects depends upon receipt of necessary authorizations and approvals. Because
of the provisional nature of these approvals and the concerns of various
environmental and public interest groups, the approval process can be delayed by
withdrawals or modifications of preliminary approvals and by litigation and
appeals challenging development rights. The ability of the Company to develop
projects could be delayed or prevented due to litigation challenging previously
obtained governmental approvals. The Company may also be subject to periodic
delays or may be precluded entirely from developing in certain communities due
to building moratoriums or "slow-growth" or "no-growth" initiatives that could
be implemented in the future. Such delays could adversely affect the Company's
ability to complete its projects, significantly increase the costs of doing so
or drive potential customers to purchase competitors' products.
Environmental Compliance
Environmental laws may cause the Company to incur substantial
compliance, mitigation and other costs, may restrict or prohibit development in
certain areas and may delay completion of the Company's development projects.
Delays arising from compliance with environmental laws and regulations could
adversely affect the Company's ability to complete its projects, significantly
increase the costs of doing so or cause potential customers to purchase
competitors' products.
Under various federal, state and local environmental laws, an
owner or operator of real property may become liable for the costs of the
investigation, removal and remediation of hazardous or toxic substances at that
property. These laws often impose liability without regard to whether the owner
or operator knew of, or was responsible for, the presence of the hazardous or
toxic substances. The presence of hazardous or toxic substances, or the failure
to remediate these substances when present, may adversely affect the owner's
ability to sell or rent that real property or to borrow funds using that real
property as collateral. It may impose unanticipated costs and delays on
projects. Persons who arrange for the disposal or treatment of hazardous or
toxic wastes may also be liable for the costs of the investigation, removal and
remediation of those wastes at the disposal or treatment facility, regardless of
whether that facility is owned or operated by that person. In addition to
remediation actions brought by federal, state and local agencies, the presence
of hazardous substances on a property could result in personal injury,
contribution or other claims by private parties. These claims could result in
costs or liabilities that could exceed the value of that property. We are not
aware of any notification by any private party or governmental authority of any
claim in connection with environmental conditions at any of our properties that
we believe will involve any material expenditure other than as disclosed herein.
7
The Company obtained a preliminary remediation study
concerning 34 acres of undeveloped land owned by a subsidiary of Otay Land
Company. The need for remediation results from activities conducted on the land
prior to Otay Land Company's ownership. Based upon the preliminary findings of
this study, in 2002 the Company estimated that the cost to implement the most
likely remediation alternative would be approximately $11,200,000, and accrued
that amount as an operating expense. The estimated liability is neither
discounted nor reduced for potential claims for recovery from previous owners
and users of the land who may be liable, and may increase or decrease based upon
the actual extent and nature of the remediation required, the type of remedial
process approved, the expenses of the regulatory process, inflation and other
items. The Company periodically adjusts its liability to reflect its current
best estimate; however, no assurance can be given that the actual amount of
environmental liability will not exceed the amount of reserves for this matter
or that it will not have a material adverse effect on the Company's financial
position, results of operations or cash flows.
During 2003, Otay Land Company developed an investigation
plan, which the San Diego Department of Environmental Health ("DEH") approved,
to further determine the nature and extent of contamination on the property. In
January 2004, the State Department of Toxic Substance Control ("DTSC") approved
DEH as the overseeing agency of the remediation. The Company through its
application to DTSC is now required to remediate the contamination. Otay Land
Company selected an environmental consultant to implement the investigation
plan, which is being conducted under the San Diego County Voluntary Cleanup
Program and under the oversight of the DEH. Otay Land Company expects to
complete the investigation during 2004, after which it will submit its
remediation plan to and seek approval from the DEH. However, the Company is
unable to predict when the remediation will commence and there is no current
regulatory requirement to commence remediation by a fixed date. Further, the
Company has filed a lawsuit in Federal Court in the Southern District of
California seeking compensation from the parties which it believes are
responsible for the contamination. However, the Company can give no assurances
that this lawsuit will be successful or that it will be able to recover any of
the costs incurred in investigating and/or remediating the contamination.
Employees
At December 31, 2003, the Company and its consolidated
subsidiaries had 22 full-time employees.
Relationship with Leucadia; Administrative Services Agreement
In 1995, Leucadia funded the Company's bankruptcy plan by
purchasing common stock and a secured promissory note of the Company. In 1999,
Leucadia distributed all of the HomeFed common stock that it owned to
shareholders of Leucadia. In October 2002, Leucadia again acquired an equity
interest in the Company when it received 2,474,226 shares of the Company's
common stock, representing approximately 30% of the Company's outstanding
shares, as partial consideration for its sale to the Company of CDS. For
additional information, see Note 2 of Notes to Consolidated Financial
Statements.
The Company's promissory note, which has been amended, is
secured by substantially all of the Company's assets and at December 31, 2003
had a principal amount outstanding of $26,462,000. The note is payable on
December 31, 2007 and bears interest at 6% per year through 2004, 9% in 2005,
10% in 2006 and 11% in 2007. On March 3, 2004, the Company's Board of Directors
determined to prepay the Leucadia note in full, which it expects to do before
March 31, 2004.
As a result of the distribution of HomeFed common stock to
Leucadia's shareholders in 1999, Joseph S. Steinberg, Chairman of the Board of
HomeFed, and Ian M. Cumming, a director of HomeFed, together with their
respective family members (excluding trusts for the benefit of Mr. Steinberg's
children) beneficially own, at March 1, 2004, approximately 8.7% and 9.4%,
respectively, of the Company's outstanding common stock, before consideration of
the common shares owned by Leucadia. Mr. Steinberg is also President and a
director of Leucadia and Mr. Cumming is Chairman of the Board of Leucadia. At
March 1, 2004, Mr. Steinberg and Mr. Cumming beneficially owned (together with
their respective family members but excluding trusts for the benefit of Mr.
Steinberg's children) approximately 12.9% and 13.2%, respectively, of Leucadia's
outstanding common shares. In addition to their ownership of HomeFed common
stock (directly and through family members), as a result of their beneficial
ownership of Leucadia common shares, Messrs. Cumming and Steinberg each may be
deemed to be the beneficial owner of the shares of HomeFed common stock owned by
Leucadia.
8
In 2003, the Company paid Leucadia approximately $12,900,000
in redemption of Leucadia's preferred capital interest in Otay Land Company and
in full satisfaction of the preferred return related thereto.
The Company is required to obtain infrastructure improvement
bonds primarily for the benefit of the City of San Marcos prior to the beginning
of lot construction work and warranty bonds upon completion of such improvements
in the San Elijo Hills project. These bonds provide funds primarily to the City
in the event the Company is unable or unwilling to complete certain
infrastructure improvements in the San Elijo Hills project. Leucadia has
obtained these bonds on behalf of CDS and its subsidiaries both before and after
the acquisition of CDS by the Company. CDS is responsible for paying all third
party fees related to obtaining the bonds. Should the City or others draw on the
bonds for any reason, one of CDS's subsidiaries would be obligated to reimburse
Leucadia for the amount drawn. As of December 31, 2003, the amount of
outstanding bonds was approximately $31,700,000.
Since 1995, Leucadia has been providing administrative and
accounting services to the Company. Under the current administrative services
agreement, which extends through December 31, 2004, Leucadia provides services
to the Company for a monthly fee of $10,000. Pursuant to this agreement,
Leucadia provides the services of Ms. Corinne A. Maki, the Company's Secretary,
in addition to various administrative functions. Ms. Maki is an officer of
subsidiaries of Leucadia. The cost of services provided by Leucadia during 2003
aggregated $120,000.
In March 2001, the Company entered into an unsecured
$3,000,000 line of credit agreement with Leucadia. Loans outstanding under this
line of credit bear interest at 10% per year; in 2003, the Company paid $38,000
in commitment fees and incurred no interest expense. Effective March 1, 2002,
this agreement was amended to extend the maturity to February 28, 2007, although
Leucadia had the right to terminate the line of credit on an annual basis. In
October 2002, the line of credit was increased to $10,000,000 and Leucadia's
ability to terminate the line of credit prior to maturity was removed, unless
the Company is in default. As of March 1, 2004, no amounts were outstanding
under this facility.
The Company rents office space at its corporate headquarters
and furnishings to Leucadia for a monthly rental equal to Leucadia's pro rata
share of the Company's cost for such space and furnishings. In 2003, the rent
paid by Leucadia to the Company totaled $72,000.
Investor Information
The Company is subject to the informational requirements of
the Securities Exchange Act of 1934 (the "Exchange Act"). Accordingly, the
Company files periodic reports, proxy statements and other information with the
Securities and Exchange Commission (the "SEC"). Such reports, proxy statements
and other information may be obtained by visiting the Public Reference Room of
the SEC at 450 Fifth Street, NW, Washington, D.C. 20549 or by calling the SEC at
1-800-SEC-0330. In addition, the SEC maintains an Internet site
(http://www.sec.gov) that contains reports, proxy and information statements and
other information regarding the Company and other issuers that file
electronically.
The Company does not maintain a website. The Company will
provide without charge upon request copies of its annual report on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act. Requests for such copies should be directed to: HomeFed
Corporation, 1903 Wright Place, Suite 220, Carlsbad, CA 92008 (telephone number
(760) 918-8200), Attention: Corporate Secretary.
9
Item 2. Properties.
- ------ ----------
The Company currently develops two real estate properties, the
San Elijo Hills project and the Otay Land Company project, and in 2003 acquired
the Rampage property, all of which are described under Item 1, Business. Real
estate had an aggregate book value of approximately $37,600,000 at December 31,
2003.
The Company leases 8,944 square feet for its corporate
headquarters which is located at 1903 Wright Place, Suite 220, Carlsbad,
California 92008. A portion of this space is sub-leased to Leucadia for a
monthly base rental of $6,000 in 2002, $4,000 in 2003 and $4,200 in 2004.
Item 3. Legal Proceedings.
- ------ -----------------
The Company is not a party to legal proceedings other than
ordinary, routine litigation, incidental to its business or not material to the
Company's consolidated financial position or results of operations.
Item 10. Executive Officers of the Registrant.
- ------- ------------------------------------
As of March 4, 2004, the executive officers of the Company,
their ages, the positions held by them and the periods during which they have
served in such positions are as follows:
Name Age Position with HomeFed Office Held Since
- ---- --- --------------------- -----------------
Paul J. Borden 55 President 1998
Corinne A. Maki 46 Secretary 1995
Curt R. Noland 47 Vice President 1998
Erin N. Ruhe 38 Vice President, Treasurer and Controller 2000
The officers serve at the pleasure of the Board of Directors
of HomeFed.
The recent business experience of our executive officers is
summarized as follows:
Paul J. Borden. Mr. Borden has served as a director and
President of HomeFed since May 1998. Mr. Borden had been a Vice President of
Leucadia from August 1988 through October 2000, responsible for overseeing many
of Leucadia's real estate investments.
Corinne A. Maki. Ms. Maki, a certified public accountant, has
served as Secretary of HomeFed since February 1998 and was Treasurer of HomeFed
from February 1995 to March 2004. Prior to that, Ms. Maki served as an Assistant
Secretary of HomeFed since August 1995. Ms. Maki has also been a Vice President
of Leucadia Financial Corporation, a subsidiary of Leucadia, holding the offices
of Controller, Assistant Secretary and Treasurer since October 1992. Ms. Maki
has been employed by Leucadia since December 1991.
Curt R. Noland. Mr. Noland has served as Vice President of
HomeFed since October 1998. He spent the last 24 years in the land development
industry in San Diego County as a design consultant, merchant builder and a
master developer. From November 1997 until joining HomeFed, Mr. Noland was
employed by the prior development manager of San Elijo Hills and served as
Director of Development for San Elijo Hills. Prior to November 1997, Mr. Noland
was employed for eight years by Aviara Land Associates, LP, a 1,000 acre
master-planned resort community in Carlsbad, California. He is also a licensed
civil engineer and real estate broker.
Erin N. Ruhe. Ms. Ruhe has served as Vice President of HomeFed
since April 2000, Treasurer since March 2004 and has been employed by HomeFed as
Controller since January 1999. Previously, Ms. Ruhe was Vice President since
December 1995 and Controller since November 1994 of HSD Venture, a real estate
subsidiary of Leucadia.
10
PART II
Item 5. Market for the Registrant's Common Stock, Related Stockholder Matters
and Issuer Purchases of Equity Securities.
- ------ ---------------------------------------------------------------------
On July 14, 2003, following shareholder approval, the Company
effected a reverse 1-for-250 stock split (the "reverse split") followed
immediately by a forward 25-for-1 stock split (the "forward split") of its
common stock, which had the net effect of a reverse 1-for-10 stock split (the
"reverse/forward split"). Holders of fewer than 250 shares of common stock prior
to the reverse split and holders of fractional interests in common stock
following the forward split received a cash payment for the value of their
fractional interests. The Company's transfer agent aggregated all fractional
interests and sold them at prevailing market prices. Stockholders were required
to surrender their old common stock certificates in order to receive new stock
certificates and/or cash pursuant to the reverse/forward split. Because the net
result of the reverse/forward stock split effectively was a reverse 1-for-10
stock split, the Company also proportionately reduced the number of authorized
shares of common stock to 25,000,000. All common share and per share amounts in
this Report have been restated to give retroactive effect to the reverse/forward
stock split.
Following shareholder approval at the 2003 annual meeting, the
Company amended to its certificate of incorporation to create a class of
preferred stock, of which 3,000,000 shares are authorized and none have been
issued. The Company has no current intention to issue the preferred stock.
The following table sets forth the high and low bid price of
the Company's common stock for each quarterly period within the two most recent
fiscal years. The market prices below give retroactive effect to the
reverse/forward stock split.
High Low
---- ---
Year ended December 31, 2002
First Quarter $ 9.40 $ 8.00
Second Quarter 9.70 8.30
Third Quarter 10.60 8.85
Fourth Quarter 16.50 9.00
Year ended December 31, 2003
First Quarter $ 15.30 $ 13.50
Second Quarter 29.00 13.70
Third Quarter 28.40 22.50
Fourth Quarter 30.00 24.30
Year ending December 31, 2004
First quarter (through March 1, 2004) $ 32.75 $ 29.25
The Company's common stock is traded in the over-the-counter
market. The Company's common stock is not listed on any stock exchange, and
price information for the common stock is not regularly quoted on any automated
quotation system. In connection with the reverse/forward stock split, the
trading symbol for the Company's stock was changed to "HOFD" effective July 14,
2003. The prices above are based on the high and low bid price per share, as
published by the National Association of Securities Dealers OTC Bulletin Board
Service, as adjusted to give retroactive effect to the reverse/forward stock
split. The over-the-counter quotations reflect inter-dealer prices, without
retail mark up, markdown or commission, and may not represent actual
transactions. On March 1, 2004, the closing bid price for the Company's common
stock was $32.75 per share. As of that date, there were 5,609 stockholders of
record. The Company did not declare dividends on its common stock during 2002 or
2003.
The Company does not currently meet certain requirements for
listing on a national securities exchange or inclusion on the Nasdaq Stock
Market.
11
The Company and certain of its subsidiaries have net operating
loss carryforwards ("NOLs") and other tax attributes, the amount and
availability of which are subject to certain qualifications, limitations and
uncertainties. In order to reduce the possibility that certain changes in
ownership could impose limitations on the use of the NOLs, the Company's
certificate of incorporation contains provisions which generally restrict the
ability of a person or entity from accumulating five percent or more of the
common stock and the ability of persons or entities now owning five percent or
more of the common stock from acquiring additional common stock. The
restrictions will remain in effect until the earliest of (a) December 31, 2010,
(b) the repeal of Section 382 of the Internal Revenue Code (or any comparable
successor provision) and (c) the beginning of a taxable year of the Company to
which certain tax benefits may no longer be carried forward.
The transfer agent for the Company's common stock is American
Stock Transfer & Trust Company, 59 Maiden Lane, New York, New York 10038.
12
Item 6. Selected Financial Data.
- ------ -----------------------
The following selected financial data have been summarized
from the Company's consolidated financial statements and are qualified in their
entirety by reference to, and should be read in conjunction with, such
consolidated financial statements and "Management's Discussion and Analysis of
Financial Condition and Results of Operations," contained in Item 7 of this
Report. The results of CDS are included in the Company's consolidated results of
operations from the date of acquisition (October 21, 2002), and is the primary
reason for the significant increase in 2003 revenues, expenses and profitability
as compared to earlier periods. As indicated above, all common share and per
share amounts have been restated to give retroactive effect to the
reverse/forward stock split.
Year Ended December 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------- ---------- ----------- ---------
(In thousands, except per share amounts)
SELECTED INCOME STATEMENT DATA:
Revenues (1) $148,285 $ 13,111 $ 6,523 $ 5,175 $ 2,643
Expenses (2) 50,575 22,418 6,932 7,754 9,058
Income (loss) before minority interest 85,237 (9,375) (377) (2,409) (7,002)
Net income (loss) 74,076 (11,086) (1,377) (3,409) (7,282)
Basic income (loss) per share..... $ 9.08 $ (1.80) $ (0.24) $ (0.60) $ (2.24)
Diluted income (loss) per share... $ 8.99 $ (1.80) $ (0.24) $ (0.60) $ (2.24)
At December 31,
----------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- ------------- ---------- ----------- ---------
(In thousands, except per share amounts)
Cash and cash equivalents $ 43,503 $ 33,601 $ 1,454 $ 1,631 $ 2,795
Investments 88,519 -- -- -- --
Real estate 37,612 31,108 23,890 22,979 23,707
Total assets 217,010 117,043 25,804 24,818 27,528
Note payable to Leucadia Financial Corporation 24,716 23,628 22,508 21,474 20,552
Notes payable to trust deed holders 13,580 16,704 -- -- --
Stockholders' equity (deficit) 76,330 1,650 (11,623) (10,421) (7,107)
Shares outstanding 8,155 8,155 5,680 5,680 5,655
Book value per share $ 9.36 $ 0.20 $ (2.05) $ (1.83) $ (1.25)
(1) Prior to the acquisition of CDS includes development management fee income
from San Elijo Hills of $1,600,000 for the period from January 1, 2002 to
October 21, 2002, and $4,800,000 and $3,500,000 for the years ended
December 31, 2001 and 2000, respectively. These payments will no longer be
reflected as revenues since they will be eliminated in consolidation.
(2) For the year ended December 31, 2002, includes an $11,200,000 provision for
environmental remediation, which is more fully discussed in Results of
Operations below.
Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations.
- ------ -----------------------------------------------------------
The purpose of this section is to discuss and analyze the
Company's consolidated financial condition, liquidity and capital resources and
results of operations. This analysis should be read in conjunction with the
consolidated financial statements and related notes which appear elsewhere in
this Report.
Liquidity and Capital Resources
For the years ended December 31, 2003 and 2002, net cash was
provided by operating activities, principally from the proceeds from the sale of
real estate, whereas for the year ended December 31, 2001, net cash was used for
operating activities, principally to pay interest and general and administrative
expenses. The parent company's principal sources of funds are proceeds from the
sale of real estate, its $10,000,000 line of credit with Leucadia, fee income
from the San Elijo Hills project, dividends and tax sharing payments from its
subsidiaries and borrowings from or repayment of advances by its subsidiaries.
13
As of December 31, 2003, the Company had consolidated cash and
cash equivalents and marketable securities aggregating $132,000,000. The
Company's investment portfolio and cash equivalents are comprised entirely of
highly rated investment grade securities issued by agencies of the U.S.
government. In January 2004, a dividend of $50,000,000 was paid by the Company's
subsidiary that owns the San Elijo Hills project, of which $40,500,000 was
ultimately received by HomeFed and the balance was paid to the minority
interests in the San Elijo Hills project. The dividend does not increase the
amount of consolidated liquidity reflected on the Company's consolidated balance
sheet; however, it does increase the liquidity of the parent company. When added
to the cash and cash equivalents and marketable securities already held by the
parent company as of December 31, 2003, the parent company will have
approximately $76,700,000 of liquid assets to satisfy its needs, the needs of
its subsidiaries and for future investment opportunities.
The Company expects that its cash on hand, together with the
sources described above, will be sufficient for both its short and long term
liquidity needs. The San Elijo Hills project is expected to be a continuing
source of funds to the Company during the next two years if project development
continues as planned, and if economic conditions remain favorable for the local
housing market. Until the Company is reasonably assured it will be able to sell
developed property for an adequate return, the San Elijo Hills project will not
require significant funds for development. The Company is not relying on receipt
of funds from Otay Land Company for the foreseeable future, since the timing of
sales of undeveloped property, development activity and sales of developable and
undevelopable property cannot be predicted with any certainty. However, except
for the environmental remediation matter discussed below, Otay Land Company is
not expected to require material funds in the short term, and long term needs
will not be determined until a development plan is established. The Company is
not currently committed to acquire any new real estate projects, but it does
have sufficient liquidity to take advantage of appropriate acquisition
opportunities if they are presented.
On March 3, 2004, the Board determined to prepay the
$26,462,000 borrowing from Leucadia in full. The Company expects to repay the
note in late March, using its available cash. Although the Company has no
current plans or intentions to replace this debt, the Company believes that it
will have access to financing on acceptable terms should the need arise. Since
the note is reflected in the December 31, 2003 consolidated balance sheet net of
a discount of $1,746,000, the entire discount will be reflected as an expense in
the Company's 2004 consolidated statement of operations.
The Company currently has an unsecured $10,000,000 line of
credit agreement with Leucadia, which has a maturity date of February 28, 2007.
Loans outstanding under this line of credit bear interest at 10% per year. As of
March 1, 2004, no amounts were outstanding under this facility.
During 2003, seven neighborhoods at the San Elijo Hills
project consisting of 535 single family lots and 204 very low income apartment
units were sold for an aggregate purchase price of $133,400,000, net of closing
costs. Of this amount, $1,800,000 related to non-refundable options payments
that were received in 2002. The Company deferred recognition of $39,900,000 of
revenue from these sales since it is required to complete certain improvements
under the purchase agreements.
As of December 31, 2003, the aggregate balance of deferred
revenue for all real estate sales was $53,500,000, including amounts related to
the 2003 sales. The Company estimates that it will spend approximately
$15,500,000 to complete the required improvements, including costs related to
common areas. The Company will recognize revenues previously deferred and the
related cost of sales in its statements of operations as the improvements are
completed under the percentage of completion method of accounting. The Company
currently estimates that it will substantially complete the required
improvements during 2004.
14
During 2003, the Company recorded $8,500,000 of revenues
related to profit sharing and consent payments received from home builders who
purchased lots in the San Elijo Hills project. Certain of the Company's lot
purchase agreements with home builders include provisions that entitle the
Company to a share of the profits realized by the home builders upon their sale
of the homes, and often require the Company's consent before the home builder
can resell the lots to another builder. Since the future plans and potential
profits of the Company's home builders are uncertain, the Company is unable to
predict whether additional payments will be received in the future.
In January 2004, the Company closed on sales to home builders
of 94 single family lots and 45 multi-family units for aggregate cash proceeds
of $33,000,000, net of closing costs, of which $3,100,000 of non-refundable
option payments had been received in 2003. These option payments were applied to
reduce the amount due from the purchasers at closing.
In order for the City of San Marcos to issue building permits
to the Company's prospective lot purchasers for lot sales not already under
contract, improvements to two off site roads need to be under construction.
During 2004, the Company entered into an amendment to the project development
agreement with the City of San Marcos/Redevelopment Agency of San Marcos (the
"City"). The amendment, among other things, increases the Company's involvement
in the development of these roads serving the San Elijo Hills project. The
amendment requires the Company to contribute $11,000,000 to fund a portion of
the cost of building these roads, including the acquisition of land, rights of
way and/or environmental permits prior to the commencement of construction. Any
costs in excess of this amount will be funded by the City. The Company believes
that this change to its development agreement increases the likelihood that the
construction of these roads will be initiated in a timely manner, such that the
issuance of building permits will not be delayed. The Company expects it will
commence construction of one of the roads during 2004 and the other in early
2005. The amendment, and the Company's obligation to fund the road construction
costs, is conditioned upon the City imposing a special tax which would be levied
against future property owners of a portion of the San Elijo Hills project. This
tax would give home builders the right to receive funds from the City to
reimburse them for the cost of public infrastructure improvements which were
made at the Company's expense; a benefit which the Company believes would enable
it to recover its road construction costs by charging home builders a price in
excess of the market price. However, there is no assurance that the tax will be
imposed or that the Company will be successful in recovering its expenses
through higher prices to home builders.
Since 1999, the San Elijo Hills project has carried
$50,000,000 of general liability and professional liability insurance under a
policy issued by the Kemper Insurance Companies ("Kemper"). The policy covered a
thirteen year term from the initial date of coverage, and the entire premium for
the life of the policy was paid in 1999. This policy is specific to the San
Elijo Hills project; the Company has general and professional liability
insurance for other matters with different insurance companies. To date, the
Company has not made any material claims under the policy.
Kemper has ceased underwriting operations and has submitted a
voluntary run-off plan to its insurance regulators. Although Kemper is not
formally in liquidation or under the supervision of insurance regulators, it is
uncertain whether they will have sufficient assets at such time, if ever, the
Company makes a claim under the policy or, if they are insolvent, whether state
insurance guaranty funds would be available to pay the claim. The Company has
investigated replacing the coverage supplied by Kemper with a new insurance
company; however, the Company has not found coverage equal to that provided by
Kemper and premium rates have increased significantly. At this time the Company
has not yet determined whether it needs to obtain replacement insurance, and if
it determines to do so, whether it will be able to acquire insurance that is
economically acceptable, if at all, or whether such insurance will cover past
occurrences at the San Elijo Hills project.
In April 2003, Otay Land Company sold approximately 1,445
acres within the Otay Ranch master-planned community to an unrelated third party
for a sales price of $22,500,000 in cash and recognized a pre-tax gain of
approximately $17,700,000. Otay Land Company used a portion of the proceeds from
the sale to fully redeem the preferred capital interest and preferred return of
approximately $12,900,000 due to Leucadia, which was required to be paid before
any distributions could be paid to the Company.
15
In August 2002, Otay Land Company reached an agreement with
the City of Chula Vista and another party whereby the City agreed to acquire 439
acres of mitigation land from Otay Land Company by eminent domain proceedings.
On January 15, 2004, these proceedings were concluded and the mitigation land
was sold to the City for aggregate proceeds of approximately $5,800,000,
substantially all of which had been received as of December 31, 2003. A pre-tax
gain of approximately $4,900,000 will be recognized in 2004.
In 2002, the Company entered into a joint venture with another
party to develop its remaining interest in the Paradise Valley project, located
in Fairfield, California. During 2003, the joint venture sold all of the
property at the Paradise Valley project for which the Company received net
proceeds of $2,900,000 and recognized pre-tax income of $1,500,000, net of
minority interest.
As indicated in the table below, at December 31, 2003, the
Company's contractual cash obligations totaled $47,226,000. The Company's note
payable to Leucadia is collateralized by a security interest in substantially
all of the assets of the Company, whether now owned or hereafter acquired. The
notes payable to trust deed holders are collateralized by the San Elijo Hills
project. For additional information, see Note 6 of Notes to Consolidated
Financial Statements.
Payments Due by Period (in thousands)
-------------------------------------------------------------------
Total
Amounts Less Than 1 After 5
Contractual Obligations Committed Year 1-3 Years 4-5 Years Years
- ----------------------- --------- ---- --------- --------- -----
Note payable to Leucadia $ 26,462 $ 26,462 $ -- $ -- $ --
Notes payable to trust deed holders 16,185 -- 353 537 15,295
Rampage payable 4,332 4,332 -- -- --
Operating lease, net of sublease income 247 211 36 -- --
-------- --------- ------- ------- -------
Total Contractual Cash Obligations $ 47,226 $ 31,005 $ 389 $ 537 $ 15,295
======== ========= ======= ======= ========
As discussed above, in March 2004 the Company's Board
determined to prepay the note payable to Leucadia in full in 2004. This
obligation is reflected in the consolidated balance sheet, net of debt discount,
at $24,716,000 as of December 31, 2003.
In November 2003, the Company purchased the Rampage property
for $6,000,000, excluding expenses, of which $1,700,000 was paid in cash and the
balance remains due to the seller. The Company furnished to the seller a letter
of credit (which is fully collateralized by cash) in the amount of $4,300,000 to
secure it's obligation to the seller. The Rampage property remains encumbered by
a mortgage lien of $3,800,000, which was originally granted by the seller to a
mortgage lender and which the Company is not obligated to satisfy. Although the
amount owed to the seller does not bear interest, the Company is obligated to
make interest payments due under the mortgage during 2004 while the lien remains
on the property. However, any principal payments made by the Company to the
mortgage lender will reduce the balance owed to the seller. If the lien remains
outstanding for all of 2004, the total amount of interest the Company will be
required to pay is approximately $300,000. By the end of 2004, the Company will
either fully pay the amount it owes to the seller and have the mortgage lien
released, or assume the mortgage lien or repay the mortgage, which in both
instances will be fully offset by a reduction in the amount owed to the seller.
As of December 31, 2003, the Company had NOLs of $168,600,000
available to reduce its future federal income tax liabilities and $2,200,000 of
alternative minimum tax credit carryovers. The federal NOLs are not available to
reduce federal alternative minimum taxable income, which is currently taxed at
the rate of 20%. As a result, the Company expects to pay federal income tax at a
rate of 20% during future periods. For more information, see Note 10 of Notes to
Consolidated Financial Statements.
Off-Balance Sheet Arrangements
The Company is required to obtain infrastructure improvement
bonds primarily for the benefit of the City of San Marcos prior to the beginning
of lot construction work and warranty bonds upon completion of such improvements
at the San Elijo Hills project. These bonds provide funds primarily to the City
in the event the Company is unable or unwilling to complete certain
infrastructure improvements in the San Elijo Hills project. Leucadia has
obtained these bonds on behalf of CDS and its subsidiaries both before and after
the acquisition of CDS by the Company. CDS is responsible for paying all third
party fees related to obtaining the bonds. Should the City or others draw on the
bonds for any reason, certain of the Company's subsidiaries would be obligated
to reimburse Leucadia for the amount drawn. As of December 31, 2003, the amount
of outstanding bonds was approximately $31,700,000, none of which have been
drawn upon.
16
Results of Operations
Critical Accounting Estimates
The Company's discussion and analysis of its financial
condition and results of operations are based upon its consolidated financial
statements, which have been prepared in accordance with generally accepted
accounting principles. The preparation of these financial statements requires
the Company to make estimates and assumptions that affect the reported amounts
in the financial statements and disclosures of contingent assets and
liabilities. On an on-going basis, the Company evaluates all of these estimates
and assumptions. Actual results could differ from those estimates.
Profit Recognition on Sales of Real Estate - When the Company
has an obligation to complete improvements on property subsequent to the date of
sale, it utilizes the percentage of completion method of accounting to record
revenues and cost of sales. Under percentage of completion accounting, the
Company recognizes revenues and cost of sales based upon the ratio of
development costs completed as of the date of sale to an estimate of total
development costs which will ultimately be incurred, including an estimate for
common areas. Revenues which cannot be recognized as of the date of sale are
reported as deferred revenue on the consolidated balance sheets. As of December
31, 2003, the Company's deferred revenue balance aggregated $53,500,000.
The Company believes it can reasonably estimate its future
costs and profit allocation in order to determine how much revenue should be
deferred. However, such estimates are based on numerous assumptions and require
management's judgment. For example, the estimate of future development costs
includes an assumption about the cost of construction services for which the
Company has no current contractual arrangement. If the estimate of these future
costs proves to be too low, then the Company will have recognized too much
profit as of the date of sale resulting in less profit to be reported as the
improvements are completed. However, to date the Company's estimates of future
development costs that have been used to determine the amount of revenue to be
deferred at the date of sale have subsequently been proven to be reasonably
accurate estimates.
Income Taxes - The Company records a valuation allowance to
reduce its deferred tax asset to an amount that the Company expects is more
likely than not to be realized. If the Company's estimate of the realizability
of its deferred tax asset changes in the future, an adjustment to the valuation
allowance would be recorded which would either increase or decrease income tax
expense in such period. The valuation allowance is determined after considering
all relevant facts and circumstances, but is significantly influenced by the
Company's projection of taxable income in the future. As of December 31, 2003,
the Company recorded a valuation allowance of $35,100,000, principally to
reserve for alternative minimum tax credit carryovers which the Company believes
are not currently realizable. The Company calculated the allowance based on the
assumption that it would be able to generate future taxable income of
approximately $170,000,000, which is sufficient to fully utilize the Company's
NOLs.
The calculation of the valuation allowance recognizes that the
Company's NOLs will not be available to offset alternative minimum taxable
income, which is currently taxed at a federal tax rate of 20%. When the Company
pays alternative minimum tax, it generates an alternative minimum tax credit
carryover, which can be used to reduce its future federal income tax rate once
it has used all of its NOLs. Assuming the Company realizes its projected taxable
income in the future and fully utilizes its NOLs, it will have approximately
$35,000,000 of minimum tax credit carryovers to reduce future federal income
taxes payable. However, the minimum tax credit carryovers are only able to
reduce the Company's federal income tax rate to 20% in any given year, which
means the Company would have to generate an additional $230,000,000 of taxable
income above the current projection to fully use them. As a result, the Company
has reserved for substantially all of this benefit in its valuation allowance.
The projection of future taxable income is based upon numerous
assumptions about the future, including future market conditions where the
Company's projects are located, regulatory requirements, estimates of future
real estate revenues and development costs, the ability of the Company to
realize taxable profits prior to the expiration of its NOLs, future interest
expense, operating and overhead costs and other factors. In addition, to the
extent the Company's actual taxable income in the future exceeds its estimate,
the Company will recognize additional tax benefits; conversely, if the actual
taxable income is less than the amounts projected, an addition to the valuation
allowance would be recorded that would increase tax expense in the future. The
Company evaluates the amount of its valuation allowance on a quarterly basis.
17
Provision for Environmental Remediation - The Company records
environmental liabilities when it is probable that a liability has been incurred
and the amount or range of the liability is reasonably estimable. During 2002,
the Company recorded a charge of $11,200,000 representing its estimate of the
cost to implement the most likely remediation alternative with respect to 34
acres of undeveloped land owned by a subsidiary of Otay Land Company. The
estimated liability was neither discounted nor reduced for potential claims for
recovery from previous owners and users of the land who may be liable, and may
increase or decrease based upon the actual extent and nature of the remediation
required, the type of remedial process approved, the expenses of the regulatory
process, inflation and other items. During 2003, the Company revised its
estimate and recorded additional expense of approximately $300,000, primarily
for amounts it expects it will pay to its consultants.
Otay Land Company is currently performing an investigation and
preparing the required documentation in order to obtain approval of a
remediation plan from the appropriate regulatory authority. The Company expects
that it will be able to submit its remediation plan by the end of 2004. As it
continues its investigation and develops its remediation plan, the Company may
conclude that the current estimate of its liability needs to be adjusted. A
change to the current estimate could result from, among other things, a
conclusion that a different remediation alternative is more appropriate, that
the cost to implement any remediation alternative is different than the
Company's current estimate and/or requirements imposed by regulatory authorities
that the Company did not anticipate but is nevertheless required to implement.
The Company periodically adjusts its liability to reflect its current best
estimate; however, no assurance can be given that the actual amount of
environmental liability will not exceed the amount of reserves for this matter
or that it will not have a material adverse effect on the Company's financial
position, results of operations or cash flows.
Provision for Losses on Real Estate - The Company's real
estate is carried at the lower of cost or fair value less costs to sell.
Management periodically assesses the recoverability of its real estate
investments by comparing the carrying amount with their fair value less costs to
sell. The process involved in the determination of fair value requires estimates
as to future events and market conditions. This estimation process assumes the
Company has the ability to complete development and dispose of its real estate
properties in the ordinary course of business based on management's present
plans and intentions. When management determines that the carrying value of
specific real estate investments should be reduced to properly record these
assets at fair value less costs to sell, this write-down is recorded as a charge
to current period operations. The evaluation process is based on estimates and
assumptions and the ultimate outcome may be different. The Company has not
recorded any such provisions during the three year period ended December 31,
2003.
Statement of Operations
The Company currently has two significant real estate
development projects, the San Elijo Hills project and the Otay Ranch project.
The Company acquired the San Elijo Hills project in October 2002, and this
acquisition accounts for the significant increase in 2003 revenues, cost of
sales and profitability as compared to earlier periods. The San Elijo Hills
project is a master-planned community that, when completed, will contain
approximately 2,430 single family lots, 696 multi-family units, 272 very low
income apartment units, three school sites and commercial space which will be
sold or leased. Sales from the project commenced in 2000 (prior to the Company's
acquisition), and after considering sales which closed in January 2004,
approximately 736 single family lots, 42 multi-family units, 70 very low income
apartment units (with minimal, if any profit potential), two school sites and
commercial space remain to be sold or leased. The Company currently plans to
complete its development of residential sites during 2004 and 2005, after which
the remaining activity at the San Elijo Hills will be primarily concentrated on
the commercial sites. These estimates of future property available for sale and
the timing of the sales are derived from the current plans for the project, and
could change based upon the actions of the project's home builders or regulatory
agencies.
18
While the San Elijo Hills project is a development community
with significant sales activity, sales at the Otay Ranch project have been
limited to three individual transactions for relatively large amounts of land.
Individual lot development at the Otay Ranch project has not yet begun, as the
Company continues to evaluate how to maximize the value of this investment while
pursuing land sales and processing further entitlements on portions of the
property. If and when the Company determines to commence development at the Otay
Ranch project, development activity is expected to last several years.
Similarly, the Rampage property is not expected to have sales activity for
several years. Approximately one-half of the property has been leased to another
party for a minimum of five years, and any residential development at the
property can only commence after approvals are obtained from several government
agencies.
Real Estate Sales Activity
San Elijo Hills Project:
- ------------------------
During 2003 and for the period from the acquisition of CDS
through December 31, 2002, the Company recorded revenues from sales of real
estate of approximately $121,100,000 and $5,000,000, respectively. For 2003, the
Company closed on the sale of seven neighborhoods, consisting of 535 single
family lots and 204 very low income apartment units for an aggregate purchase
price of $133,400,000, net of closing costs. For 2002, the Company closed on the
sale of one neighborhood consisting of 92 single family lots for an aggregate
purchase price of $24,700,000. As discussed above, a portion of the revenue from
these sales was deferred, and is recognized as revenues upon the completion of
the required improvements to the property, including costs related to common
areas, under the percentage of completion method of accounting. Included in
revenues are previously deferred amounts of $19,000,000 and $1,400,000 for 2003
and 2002, respectively, which were recognized upon completion of certain
required improvements.
Revenues from sales of real estate also include amounts
received pursuant to profit sharing agreements with home builders of $5,500,000
during 2003. Additionally, revenues from sales of real estate in 2003 include
approximately $3,000,000 paid by one of San Elijo's home builders for the
Company's consent to allow the home builder to re-sell his lots to another home
builder.
During 2003 and 2002, cost of sales of real estate aggregated
$29,100,000 and $2,000,000, respectively. Cost of sales is recognized in the
same proportion to the amount of revenue recognized under the percentage of
completion method of accounting.
Otay Ranch Project:
- -------------------
Sales of real estate during 2003 consist of $22,500,000 from
the sale of 1,445 acres. For 2002, sales of real estate consist of $4,300,000
from the sale of 85 acres of developable land. There were no sales relating to
this project in 2001.
During 2003 and 2002, cost of sales of real estate aggregated
$4,800,000 and $800,000, respectively. Cost of sales is based upon the
allocation of project costs to individual parcels, based upon their relative
fair values, in addition to closing costs and commissions, if any.
Paradise Valley Project:
- ------------------------
During 2003, the Company disposed of all of its remaining
interest in the Paradise Valley project and recognized pre-tax income of
$1,500,000, net of $300,000 that was allocated to the minority interest. There
were no sales relating to this project in 2002 or 2001.
19
Other Results of Operations Activity
The Company recorded co-op marketing and advertising fees of
approximately $1,300,000, $1,900,000 and $1,000,000 for the years ended December
31, 2003, 2002 and 2001, respectively. The Company records these fees when the
San Elijo Hills project builders sell homes, and are generally based upon a
fixed percentage of the homes' selling price.
Prior to the acquisition of CDS, the Company recognized
development management fee income in its consolidated statements of operations.
While development management fees have continued to be a source of liquidity to
the parent company since the acquisition of CDS, they are no longer reflected in
the consolidated statements of operations since they are intercompany payments
from a subsidiary and are eliminated in consolidation. Development management
fee income from the San Elijo Hills project was approximately $1,600,000 for the
period from January 1, 2002 to October 21, 2002 and $4,800,000 for the year
ended December 31, 2001. The decrease in 2002 primarily reflects lower field
overhead and management services fees, due to reduced sales of real estate at
the San Elijo Hills project in 2002, and the cessation of recognizing such fee
income from the date of acquisition of CDS.
Income from options on real estate properties reflects
non-refundable fees of approximately $300,000 and $700,000 in 2002 and 2001,
respectively, received to extend the closing date on the sale of the 85 acres of
developable land at the Otay Ranch project, which closed in June 2002.
As more fully discussed above, in 2002, the Company recorded a
provision of approximately $11,200,000, representing its estimated cost of
environmental remediation. During 2003, the Company revised its estimate and
recorded additional expense of approximately $300,000, primarily for amounts it
expects it will pay to its consultants.
Interest expense reflects the interest due on indebtedness to
Leucadia of approximately $1,600,000, $1,700,000 and $1,600,000 for 2003, 2002
and 2001, respectively. Interest expense also includes amortization of debt
discount related to the indebtedness to Leucadia of $1,100,000, $1,100,000 and
$1,000,000 for 2003, 2002 and 2001, respectively.
General and administrative expenses increased during 2003 as
compared to 2002 due to expenses of $1,500,000 related to CDS. In addition,
general and administrative expenses increased in 2003 as compared to 2002 due to
greater expenses related to employee compensation and legal and professional
fees. The increase in legal and professional fees principally reflects costs
associated with the Otay Ranch project, including costs incurred in connection
with the eminent domain proceedings by the City of Chula Vista discussed above,
and expenses related to the Company's reverse/forward split. In addition,
general and administrative expenses include a charge in 2003 for previously
deferred stock compensation expense of $600,000, which related to certain
performance options which were no longer subject to forfeiture, and to an
increase in the market price of the Company's common stock.
General and administrative expenses increased in 2002 as
compared to 2001 primarily due to expenses of $400,000 related to CDS, greater
legal and professional fees, increased stock compensation expense and increased
salaries. The increase in legal and professional fees principally reflects costs
associated with the Otay Ranch project and expenses related to acquisition
opportunities. The increase in stock compensation expense related to performance
options granted in 2000 reflects the appreciation of the Company's stock price
in 2002.
The increase in other income for 2003 as compared to 2002
primarily relates to greater interest income resulting from a larger amount of
invested assets, income from the reimbursement for improvement costs that were
previously expensed at the San Elijo Hills project, proceeds from an easement at
the Otay Ranch project and cash received to settle a dispute with one of the
Company's vendors. These increases were partially offset by the gain on a sale
of a foreclosed property in 2002. The decrease in other income in 2002 as
compared to 2001 primarily relates to a reimbursement in 2001 for fees and
improvements totaling approximately $700,000 related to property previously
sold, partially offset by increased interest income, the gain on a sale of a
foreclosed property and proceeds received upon the dissolution of a partnership
in excess of its recorded investment balance.
The increase in minority interest expense for 2003 as compared
to 2002 is primarily due to the minority interest related to CDS and increased
preferred capital interest related to Otay Ranch (prior to its redemption in
2003). The increase in minority expense in 2002 as compared to 2001 relates to
minority interest of CDS.
20
During the year ended December 31, 2003, as a result of an
increase in the Company's estimate of future taxable income and actual income in
2003 that exceeded its earlier estimate, the Company reduced its income tax
valuation allowance to recognize additional benefits from its NOLs and recorded
a credit to its income tax provision of $26,065,000. Income taxes paid for 2002
principally relate to state income taxes, reduced by a refund of prior year
federal alternative minimum tax payments. Income taxes for 2001 principally
relate to the payment of federal alternative minimum tax and state income tax.
In 2002, the Company did not recognize income tax benefits for its losses due to
the uncertainty of sufficient future taxable income which is required in order
to recognize such tax benefits. For more information, see Note 10 of Notes to
Consolidated Financial Statements.
Recently Issued Accounting Standards
In May 2003, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 150, "Accounting for
Certain Financial Instruments with Characteristics of both Liabilities and
Equity ("SFAS 150"), which is effective for financial instruments entered into
or modified after May 31, 2003, and otherwise is effective at the beginning of
the first interim period beginning after June 15, 2003. SFAS 150 establishes
standards for how an issuer classifies and measures certain financial
instruments with characteristics of both liabilities and equity. The
implementation of SFAS 150 did not have any impact on the Company.
In January 2003, the FASB issued FASB Interpretation No. 46
("FIN 46"), which addresses consolidation of variable interest entities, which
are entities in which equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. FIN 46 is effective immediately for variable
interest entities created after January 31, 2003, and for variable interest
entities in which an enterprise obtains an interest after that date. In October
2003, the FASB deferred to the fourth quarter of 2003 from the third quarter the
implementation date of FIN 46 with respect to variable interest entities in
which a variable interest was acquired before February 1, 2003. In December
2003, the FASB issued a revision ("FIN 46R") to FIN 46 to clarify certain
provisions and exempt certain entities from its requirements. In addition, FIN
46R deferred to the first quarter of 2004 application of its provisions to
certain entities in which a variable interest was acquired prior to February 1,
2003. The Company does not believe that the implementation of FIN 46 and FIN 46R
will have any impact on its consolidated results of operations or financial
condition.
Inflation
The Company, as well as the real estate development and
homebuilding industry in general, may be adversely affected by inflation,
primarily because of either reduced rates of savings by consumers during periods
of low inflation or higher land and construction costs during periods of high
inflation. Low inflation could adversely affect consumer demand by limiting
growth of savings for down payments, ultimately adversely affecting demand for
real estate and the Company's revenues. High inflation increases the Company's
costs of labor and materials. The Company would attempt to pass through to its
customers any increases in its costs through increased selling prices. To date,
high or low rates of inflation have not had a material adverse effect on the
Company's results of operations. However, there is no assurance that high or low
rates of inflation will not have a material adverse impact on the Company's
future results of operation.
Interest Rates
The Company's operations are interest-rate sensitive. The
Company has indirectly benefited from the prevailing low mortgage interest rate
environment, since low rates made housing more affordable for the home buyer,
thereby increasing demand for homes. The Company can not predict whether
interest rates will remain low and what impact an increase in interest rates and
mortgage rates would have on the Company's operations, although any significant
increase in these rates could have a chilling effect on the housing market,
which could adversely affect the Company's results of operations.
21
Cautionary Statement for Forward-Looking Information
Statements included in this Report may contain forward-looking
statements. Such statements may relate, but are not limited, to projections of
revenues, income or loss, plans for growth and future operations, competition
and regulation as well as assumptions relating to the foregoing. Such
forward-looking statements are made pursuant to the safe-harbor provisions of
the Private Securities Litigation Reform Act of 1995.
Forward-looking statements are inherently subject to risks and
uncertainties, many of which cannot be predicted or quantified. When used in
this Report, the words "estimates," "expects," "anticipates," "believes,"
"plans," "intends" and variations of such words and similar expressions are
intended to identify forward-looking statements that involve risks and
uncertainties. Future events and actual results could differ materially from
those set forth in, contemplated by or underlying the forward-looking
statements.
In addition to risks set forth in the Company's other public
filings with the Securities and Exchange Commission, the following important
factors could cause actual results to differ materially from any results
projected, forecasted, estimated or budgeted:
o Changes in prevailing interest rate levels, including mortgage rates. Any
significant increase in the prevailing low mortgage interest rate
environment could reduce consumer demand for housing.
o Changes in domestic laws and government regulations or requirements and in
implementation and/or enforcement of governmental rules and regulations.
The Company's plans for its development projects require numerous
governmental approvals, licenses, permits and agreements, which must be
obtained before development and construction may commence. The approval
process can be delayed by withdrawals or modifications of preliminary
approvals, by litigation and appeals challenging development rights and by
changes in prevailing local circumstances or applicable laws that may
require additional approvals.
o Changes in real estate pricing environments. Any significant decrease in
the prevailing price of real estate in the geographic areas in which the
Company owns, develops and sells real estate may adversely affect the
Company's results of operations.
o Regional or general increases in cost of living. Any significant increases
in the prevailing prices of goods and services that result in increased
costs of living, particularly in the regions in which the Company is
currently developing properties, may adversely affect consumer demand for
housing.
o Demographic and economic changes in the United States generally and
California in particular. The Company's operations are sensitive to
demographic and economic changes. Any economic downturn in the United
States in general, and California in particular, may adversely affect
consumer demand for housing by limiting the ability of people to save for
down payments and purchase homes. In addition, if the current trend of
population increases in California were not to continue, demand for real
estate in California may not be as robust as current levels indicate.
o Increases in real estate taxes and other local government fees. Any such
increases may make it more expensive to own the properties that the Company
is currently developing, which would increase the carrying costs to the
Company of owning the properties and decrease consumer demand for them.
o Significant competition from other real estate developers and homebuilders.
There are numerous residential real estate developers and development
projects operating in the same geographic area in which the Company
operates. Many of the Company's competitors may have advantages over the
Company, including greater financial resources and/or access to cheaper
capital.
o Decreased consumer spending for housing. Any decrease in consumer spending
for housing may directly affect the Company's results of operations.
22
o Delays in construction schedules and cost overruns. Any material delays
could adversely affect the Company's ability to complete its projects,
significantly increasing the costs of doing so, including interests costs,
or drive potential customers to purchase competitors' products. Cost
overruns, if material, could have a direct adverse impact on the Company's
results of operations.
o Availability and cost of land, materials and labor and increased
development costs, many of which the Company would not be able to control.
The Company's current and future development projects require the Company
to purchase significant amounts of land, materials and labor. If the costs
of these items increase, it will increase the costs to the Company of
completing its projects; if the Company is not able to recoup these
increased costs, its results of operations could be adversely affected.
o Damage to or condemnation of properties and occurrence of significant
natural disasters and fires. Damage to or condemnation of any of the
Company's properties, whether by natural disasters and fires or otherwise,
may either delay or preclude the Company's ability to develop and sell its
properties, or affect the price at which it may sell such properties.
o Imposition of limitations on the Company's ability to develop its
properties resulting from environmental laws and regulations and
developments in or new applications thereof. The residential real estate
development industry is subject to increasing environmental, building,
construction, zoning and real estate regulations that are imposed by
various federal, state and local authorities. Environmental laws may cause
the Company to incur additional costs, and adversely affect its ability to
complete its projects in a timely and profitable manner.
o The inability to insure certain risks economically. The Company cannot be
certain that it will be able to insure certain risks economically.
o The availability of adequate water resources and reliable energy source in
the areas where the Company owns real estate projects. Any shortage of
reliable water and energy resources and drop in consumer confidence in the
dependability of such resources in areas where the Company owns land may
adversely affect the values of properties owned by the Company and curtail
development projects.
o Changes in the composition of the Company's assets and liabilities through
acquisitions or divestitures. The Company may make future acquisitions or
divestitures of assets. Any change in the composition of the Company's
assets and liabilities as a result thereof could significantly affect the
financial position of the Company and the risks that it faces.
o The actual cost of environmental liabilities concerning land owned in San
Diego County, California exceeding the amount reserved for such matter. The
actual cost of remediation of undeveloped land owned by a subsidiary could
exceed the $10,800,000 reserved for such matter.
o The Company's ability to generate sufficient taxable income to fully
realize the deferred tax asset, net of the valuation allowance. The Company
and certain of its subsidiaries have NOLs and other tax attributes, but
may not be able to generate sufficient taxable income to fully realize the
deferred tax assets.
o The impact of inflation. The Company, as well as the real estate
development and homebuilding industry in general, may be adversely affected
by inflation, primarily because of either reduced rates of savings by
consumers during periods of low inflation or higher land and construction
costs during periods of high inflation.
Undue reliance should not be placed on these forward-looking
statements, which are applicable only as of the date hereof. The Company
undertakes no obligation to revise or update these forward-looking statements to
reflect events or circumstances that arise after the date of this Report or to
reflect the occurrence of unanticipated events.
23
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
- ------- ---------------------------------------------------------
The Company's market risk arises principally from interest
rate risk related to its investment portfolio and borrowing activities.
At December 31, 2003, the Company had investments of
approximately $88,500,000 in securities issued by the U.S. government and its
agencies. The Company's investment portfolio is classified as available for
sale, and is reflected in the balance sheet at fair value with unrealized gains
and losses reflected in shareholders' equity. The securities in the portfolio
are rated "AAA" and "Aaa" by Standard & Poor's and Moody's, respectively. All of
these fixed income securities mature in 2004; the estimated weighted average
remaining life of these fixed income securities was approximately 0.2 years at
December 31, 2003. These securities have a weighted average interest rate of
1.1% at December 31, 2003. The Company's fixed income securities, like all fixed
income instruments, are subject to interest rate risk and will fall in value if
market interest rates increase.
For additional information with respect to the Company's
indebtedness, see Note 6 of Notes to Consolidated Financial Statements.
Item 8. Financial Statements and Supplementary Data.
- ------ -------------------------------------------
Financial Statements and supplementary data required by this
Item 8 are set forth at the pages indicated in Item 15(a) below.
Item 9. Changes and Disagreements with Accountants on Accounting
and Financial Disclosure.
- ------ --------------------------------------------------------
Not applicable.
Item 9A. Controls and Procedures.
- ------- -----------------------
(a) The Company's management evaluated, with the participation of the
Company's principal executive and principal financial officers, the
effectiveness of the Company's disclosure controls and procedures (as defined in
Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the "Exchange Act")), as of December 31, 2003. Based on their
evaluation, the Company's principal executive and principal financial officers
concluded that the Company's disclosure controls and procedures were effective
as of December 31, 2003.
(b) There has been no change in the Company's internal control over
financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) that occurred during the Company's fiscal quarter ended December
31, 2003, that has materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
24
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ------- --------------------------------------------------
The information to be included under the captions "Proposal
for the Election of Directors" and "Information Concerning Board of Directors
and Board Committees" in HomeFed's definitive proxy statement to be filed with
the Securities and Exchange Commission pursuant to Regulation 14A of the 1934
Act in connection with the 2004 annual meeting of stockholders of HomeFed (the
"Proxy Statement") is incorporated herein by reference. In addition, reference
is made to Item 10 in Part I of this Report.
Item 11. Executive Compensation.
- ------- ----------------------
The information to be included under the caption "Executive
Compensation" in the Proxy Statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- ------- --------------------------------------------------------------
Equity Compensation Plan Information
- ------------------------------------
The following table summarizes information regarding the
Company's equity compensation plans as of December 31, 2003. All outstanding
awards relate to the Company's common stock.
Number of securities
remaining available
for future issuance
Number of Securities Weighted-average under equity
to be issued upon exercise price of compensation plans
exercise of outstanding options, outstanding options, (excluding securities
warrants and rights warrants and rights reflected in column (a))
Plan Category (a) (b) (c)
- ------------- ------------------------------- ------------------- -------------------
Equity compensation
plans approved by
security holders 120,250 $ 6.45 154,600
Equity compensation
plans not approved
by security holders -- -- --
------- ------ -------
Total 120,250 $ 6.45 154,600
======== ====== =======
The information to be included under the caption "Present
Beneficial Ownership of Common Stock" in the Proxy Statement is incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions.
- ------- ----------------------------------------------
The information to be included under the caption "Executive
Compensation - Certain Relationships and Related Transactions" in the Proxy
Statement is incorporated herein by reference.
Item 14. Principal Accounting Fees and Services.
- ------- --------------------------------------
The information to be included under the caption "Principal
Accounting Fees and Services" in the Proxy Statement is incorporated herein by
reference.
25
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
- ------- ----------------------------------------------------------------
(a)(1) Financial Statements.
Report of Independent Auditors F-1
Consolidated Balance Sheets at December 31, 2003 and 2002 F-2
Consolidated Statements of Operations for the years ended December 31, 2003, 2002 and 2001 F-3
Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years ended
December 31, 2003, 2002 and 2001 F-4
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001 F-5
Notes to Consolidated Financial Statements F-7
(a)(2) Financial Statement Schedules.
Schedules are omitted because they are not required or are not
applicable or the required information is shown in the financial
statements or notes thereto.
(a)(3) Executive Compensation Plans and Arrangements.
1999 Stock Incentive Plan (filed as Annex A to the Company's Proxy
Statement dated November 22, 1999).
2000 Stock Incentive Plan (filed as Annex B to the Company's Proxy
Statement dated June 20, 2000).
(b) Reports on Form 8-K. None.
(c) Exhibits.
3.1 Restated Certificate of Incorporation, as restated July 3, 1995 of the
Company (incorporated by reference to Exhibit 3.1 to the Company's
quarterly report on Form 10-Q for the quarter ended September 30,
1995).
3.2 By-laws of the Company as amended through December 14, 1999
(incorporated by reference to Exhibit 3.2 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 (the "1999
10-K")).
3.3 Amendment to Amended and Restated Bylaws of the Company, dated July 10,
2002 (incorporated by reference to Exhibit 3.3 to the Company's
quarterly report on Form 10-Q for the quarter ended September 30,
2002).
3.4 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2002 (incorporated by reference to Exhibit 3.4
to the Company's quarterly report on Form 10-Q for the quarter ended
September 30, 2002).
3.5 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2003.
3.6 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2003.
26
10.1 Security Agreement and Stock Pledge by and between HomeFed Corporation
and Leucadia Financial Corporation dated as of July 3, 1995.
10.2 Development Management Agreement between the Company and Provence Hills
Development Company, LLC, dated as of August 14, 1998 (incorporated by
reference to Exhibit 10.3 to the Company's current report on Form 8-K
dated August 14, 1998).
10.3 Amended and Restated Limited Liability Company Agreement of Otay Land
Company, LLC, dated as of September 20, 1999, between the Company and
Leucadia National Corporation (incorporated by reference to Exhibit
10.16 to the Company's Registration Statement on Form S-2 (No.
333-79901)).
10.4 Administrative Services Agreement, dated as of March 1, 2000, between
Leucadia Financial Corporation ("LFC"), the Company, HomeFed Resources
Corporation and HomeFed Communities, Inc. (incorporated by reference to
Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the
quarter ended June 30, 2000).
10.5 Amendment No. 1 dated as of November 1, 2000 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000 (the "2000 10-K")).
10.6 Amendment No. 2 dated as of February 28, 2001 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.22 to the Company's 2000 10-K).
10.7 Amendment No. 3 dated as of December 31, 2001 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.26 to the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2001).
10.8 Third Amendment to Option and Purchase Agreement and Escrow
Instructions, dated as of June 21, 2002, by and between Otay Land
Company, LLC and Lakes Kean Argovitz Resorts - California, LLC
(incorporated by reference to Exhibit 10.27 to the Company's quarterly
report on Form 10-Q for the quarter ended June 30, 2002).
10.9 Stock Purchase Agreement dated as of October 21, 2002, by and between
HomeFed Corporation and Leucadia National Corporation (incorporated by
reference to Exhibit 10.1 to the Company's current report on Form 8-K
dated October 22, 2002).
10.10 Registration Rights Agreement dated as of October 21, 2002, by and
between HomeFed Corporation and Leucadia National Corporation
(incorporated by reference to Exhibit 10.2 to the Company's current
report on Form 8-K dated October 22, 2002).
10.11 Second Amendment and Restated Loan Agreement dated as of October 9,
2002, by and between HomeFed Corporation and Leucadia Financial
Corporation (incorporated by reference to Exhibit 10.3 to the Company's
current report on Form 8-K dated October 22, 2002).
10.12 Second Amendment and Restated Variable Rate Secured Note dated as of
October 9, 2002 (incorporated by reference to Exhibit 10.4 to the
Company's current report on Form 8-K dated October 22, 2002).
10.13 Amended and Restated Line Letter dated as of October 9, 2002, by and
between HomeFed Corporation and Leucadia Financial Corporation
(incorporated by reference to Exhibit 10.5 to the Company's current
report on Form 8-K dated October 22, 2002).
10.14 Amended and Restated Term Note dated as of October 9, 2002
(incorporated by reference to Exhibit 10.6 to the Company's current
report on Form 8-K dated October 22, 2002).
10.15 Amendment No. 4 dated as of May 28, 2002 to the Administrative Services
Agreement dated as of March 1, 2000 (incorporated by reference to
Exhibit 10.34 to the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2002 (the "2002 10-K/A")).
27
10.16 Amendment No. 5 dated as of November 15, 2002 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.35 of the 2002 10-K/A).
10.17 Amendment dated as of October 21, 2002 to the Development Management
Agreement dated as of August 14, 1998 (incorporated by reference to
Exhibit 10.36 of the 2002 10-K/A).
10.18 Contribution Agreement between the Company and San Elijo Hills
Development Company, LLC, dated as of October 21, 2002 (incorporated by
reference to Exhibit 10.37 of the 2002 10-K/A).
10.19 Agreement and Guaranty, dated as of October 1, 2002, between Leucadia
National Corporation and CDS Holding Corporation (incorporated by
reference to Exhibit 10.38 of the 2002 10-K/A).
10.20 Obligation Agreement, dated as of October 1, 2002, between Leucadia
National Corporation and San Elijo Ranch, Inc. (incorporated by
reference to Exhibit 10.39 of the 2002 10-K/A).
10.21 Tax Allocation Agreement between the Company and its subsidiaries dated
as of November 1, 2002.
10.22 Amendment No. 1 to the First Amended and Restated Development Agreement
and Owner Participation Agreement between the City of San Marcos, the
San Marcos Redevelopment Agency and the San Elijo Hills Development
Company, LLC dated as of February 11, 2004.
10.23 Amendment No. 6 dated as of December 31, 2003 to the Administrative
Services Agreement dated as of March 1, 2000.
21 Subsidiaries of the Company.
31.1 Certification of Principal Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.*
32.2 Certification of Principal Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.*
* Furnished herewith pursuant to Item 601(b) (32) of Regulation S-K.
28
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the
Securities Exchange Act of 1934, the Registrant has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
HOMEFED CORPORATION
Date: March 10, 2004 By /s/ ERIN N. RUHE
---------------------------------
Erin N. Ruhe
Vice President, Treasurer and Controller
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.
Date: March 10, 2004 By /s/ JOSEPH S. STEINBERG
---------------------------------
Joseph S. Steinberg, Chairman
of the Board and Director
Date: March 10, 2004 By /s/ PAUL J. BORDEN
---------------------------------
Paul J. Borden, President and
Director
(Principal Executive Officer)
Date: March 10, 2004 By /s/ ERIN N. RUHE
---------------------------------
Erin N. Ruhe, Vice President,
Treasurer and Controller
(Principal Financial and Accounting
Officer)
Date: March 10, 2004 By /s/ PATRICK D. BIENVENUE
---------------------------------
Patrick D. Bienvenue, Director
Date: March 10, 2004 By /s/ TIMOTHY CONSIDINE
---------------------------------
Timothy Considine, Director
Date: March 10, 2004 By /s/ IAN M. CUMMING
--------------------------------
Ian M. Cumming, Director
Date: March 10, 2004 By /s/ MICHAEL A. LOBATZ
--------------------------------
Michael A. Lobatz, Director
29
EXHIBIT INDEX
Exhibit
Number Description
3.1 Restated Certificate of Incorporation, as restated July 3, 1995 of the
Company (incorporated by reference to Exhibit 3.1 to the Company's
quarterly report on Form 10-Q for the quarter ended September 30,
1995).
3.2 By-laws of the Company as amended through December 14, 1999
(incorporated by reference to Exhibit 3.2 to the Company's Annual
Report on Form 10-K for the year ended December 31, 1999 (the "1999
10-K")).
3.3 Amendment to Amended and Restated Bylaws of the Company, dated July 10,
2002 (incorporated by reference to Exhibit 3.3 to the Company's
quarterly report on Form 10-Q for the quarter ended September 30,
2002).
3.4 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2002 (incorporated by reference to Exhibit 3.4
to the Company's quarterly report on Form 10-Q for the quarter ended
September 30, 2002).
3.5 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2003.
3.6 Certificate of Amendment of the Certificate of Incorporation of the
Company, dated July 10, 2003.
10.1 Security Agreement and Stock Pledge by and between HomeFed Corporation
and Leucadia Financial Corporation dated as of July 3, 1995.
10.2 Development Management Agreement between the Company and Provence Hills
Development Company, LLC, dated as of August 14, 1998 (incorporated by
reference to Exhibit 10.3 to the Company's current report on Form 8-K
dated August 14, 1998).
10.3 Amended and Restated Limited Liability Company Agreement of Otay Land
Company, LLC, dated as of September 20, 1999, between the Company and
Leucadia National Corporation (incorporated by reference to Exhibit
10.16 to the Company's Registration Statement on Form S-2 (No.
333-79901)).
10.4 Administrative Services Agreement, dated as of March 1, 2000, between
Leucadia Financial Corporation ("LFC"), the Company, HomeFed Resources
Corporation and HomeFed Communities, Inc. (incorporated by reference to
Exhibit 10.1 to the Company's quarterly report on Form 10-Q for the
quarter ended June 30, 2000).
10.5 Amendment No. 1 dated as of November 1, 2000 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.21 to the Company's Annual Report on Form 10-K for the
fiscal year ended December 31, 2000 (the "2000 10-K")).
10.6 Amendment No. 2 dated as of February 28, 2001 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.22 to the Company's 2000 10-K).
10.7 Amendment No. 3 dated as of December 31, 2001 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.26 to the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2001).
10.8 Third Amendment to Option and Purchase Agreement and Escrow
Instructions, dated as of June 21, 2002, by and between Otay Land
Company, LLC and Lakes Kean Argovitz Resorts - California, LLC
(incorporated by reference to Exhibit 10.27 to the Company's quarterly
report on Form 10-Q for the quarter ended June 30, 2002).
30
10.9 Stock Purchase Agreement dated as of October 21, 2002, by and between
HomeFed Corporation and Leucadia National Corporation (incorporated by
reference to Exhibit 10.1 to the Company's current report on Form 8-K
dated October 22, 2002).
10.10 Registration Rights Agreement dated as of October 21, 2002, by and
between HomeFed Corporation and Leucadia National Corporation
(incorporated by reference to Exhibit 10.2 to the Company's current
report on Form 8-K dated October 22, 2002).
10.11 Second Amendment and Restated Loan Agreement dated as of October 9,
2002, by and between HomeFed Corporation and Leucadia Financial
Corporation (incorporated by reference to Exhibit 10.3 to the Company's
current report on Form 8-K dated October 22, 2002).
10.12 Second Amendment and Restated Variable Rate Secured Note dated as of
October 9, 2002 (incorporated by reference to Exhibit 10.4 to the
Company's current report on Form 8-K dated October 22, 2002).
10.13 Amended and Restated Line Letter dated as of October 9, 2002, by and
between HomeFed Corporation and Leucadia Financial Corporation
(incorporated by reference to Exhibit 10.5 to the Company's current
report on Form 8-K dated October 22, 2002).
10.14 Amended and Restated Term Note dated as of October 9, 2002
(incorporated by reference to Exhibit 10.6 to the Company's current
report on Form 8-K dated October 22, 2002).
10.15 Amendment No. 4 dated as of May 28, 2002 to the Administrative Services
Agreement dated as of March 1, 2000 (incorporated by reference to
Exhibit 10.34 to the Company's Annual Report on Form 10-K/A for the
fiscal year ended December 31, 2002 (the "2002 10-K/A")).
10.16 Amendment No. 5 dated as of November 15, 2002 to the Administrative
Services Agreement dated as of March 1, 2000 (incorporated by reference
to Exhibit 10.35 of the 2002 10-K/A).
10.17 Amendment dated as of October 21, 2002 to the Development Management
Agreement dated as of August 14, 1998 (incorporated by reference to
Exhibit 10.36 of the 2002 10-K/A).
10.18 Contribution Agreement between the Company and San Elijo Hills
Development Company, LLC, dated as of October 21, 2002 (incorporated by
reference to Exhibit 10.37 of the 2002 10-K/A).
10.19 Agreement and Guaranty, dated as of October 1, 2002, between Leucadia
National Corporation and CDS Holding Corporation (incorporated by
reference to Exhibit 10.38 of the 2002 10-K/A).
10.20 Obligation Agreement, dated as of October 1, 2002, between Leucadia
National Corporation and San Elijo Ranch, Inc. (incorporated by
reference to Exhibit 10.39 of the 2002 10-K/A).
10.21 Tax Allocation Agreement between the Company and its subsidiaries dated
as of November 1, 2002.
10.22 Amendment No. 1 to the First Amended and Restated Development Agreement
and Owner Participation Agreement between the City of San Marcos, the
San Marcos Redevelopment Agency and the San Elijo Hills Development
Company, LLC dated as of February 11, 2004.
10.23 Amendment No. 6 dated as of December 31, 2003 to the Administrative
Services Agreement dated as of March 1, 2000.
21 Subsidiaries of the Company.
31.1 Certification of Principal Executive Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of Principal Financial Officer pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of Principal Executive Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.*
32.2 Certification of Principal Financial Officer pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.*
* Furnished herewith pursuant to Item 601(b) (32) of Regulation S-K.
31
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and
Stockholders of HomeFed Corporation:
In our opinion, the accompanying consolidated balance sheets
and the related consolidated statements of operations, changes in stockholders'
equity (deficit) and cash flows, present fairly, in all material respects, the
financial position of HomeFed Corporation and Subsidiaries (the "Company") as of
December 31, 2003 and 2002, and the results of their operations, changes in
stockholders' equity (deficit) and their cash flows for each of the three years
in the period ended December 31, 2003, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management and evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
PricewaterhouseCoopers LLP
New York, New York
March 3, 2004
F-1
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2003 and 2002
(Dollars in thousands, except par value)
2003 2002
---- ----
ASSETS
Real estate $ 37,612 $ 31,108
Cash and cash equivalents 43,503 33,601
Restricted cash 4,609 273
Investments-available for sale (aggregate cost of $88,503) 88,519 --
Deposits and other assets 995 753
Deferred income taxes 41,772 44,742
Note receivable -- 6,566
---------- ----------
TOTAL $ 217,010 $ 117,043
========== ==========
LIABILITIES
Note payable to Leucadia Financial Corporation $ 24,716 $ 23,628
Notes payable to trust deed holders 13,580 16,704
Deferred revenue 53,491 32,621
Accounts payable and accrued liabilities 10,985 6,323
Liability for environmental remediation 10,785 10,816
Income taxes payable 503 2,875
Other liabilities 13,509 7,294
---------- ----------
Total liabilities 127,569 100,261
---------- ----------
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST 13,111 15,132
---------- ----------
STOCKHOLDERS' EQUITY
Common stock, $.01 par value; 25,000,000 shares authorized; 8,155,159 and
8,155,084 shares outstanding 82 82
Additional paid-in capital 380,545 380,364
Deferred compensation pursuant to stock incentive plans (4) (418)
Accumulated other comprehensive income 9 --
Accumulated deficit (304,302) (378,378)
---------- ----------
Total stockholders' equity 76,330 1,650
---------- ----------
TOTAL $ 217,010 $ 117,043
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
F-2
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Operations
For the years ended December 31, 2003, 2002 and 2001
(In thousands, except per share amounts)
2003 2002 2001
---- ---- ----
REVENUES
Sales of real estate $ 147,028 $ 9,259 $ --
Co-op marketing and advertising fees 1,257 1,942 1,028
Development management fee income from San Elijo Hills -- 1,610 4,775
Income from options on real estate properties -- 300 720
--------- --------- ---------
148,285 13,111 6,523
--------- --------- ---------
EXPENSES
Cost of sales 35,508 2,815 --
Provision for environmental remediation 270 11,160 --
Interest expense relating to Leucadia Financial Corporation 2,676 2,780 2,646
General and administrative expenses 12,001 5,543 4,179
Administrative services fees to Leucadia Financial Corporation 120 120 107
--------- --------- ---------
50,575 22,418 6,932
--------- --------- ---------
Income (loss) from operations 97,710 (9,307) (409)
--------- --------- ---------
Other income 1,706 311 699
--------- --------- ---------
Income (loss) before income taxes and minority interest 99,416 (8,996) 290
Income tax provision (14,179) (379) (667)
--------- --------- ---------
Income (loss) before minority interest 85,237 (9,375) (377)
Minority interest (11,161) (1,711) (1,000)
--------- --------- ---------
Net income (loss) $ 74,076 $ (11,086) $ (1,377)
========= ========= =========
Basic income (loss) per common share $ 9.08 $ (1.80) $ (0.24)
========= ========= =========
Diluted income (loss) per common share $ 8.99 $ (1.80) $ (0.24)
========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Stockholders' Equity (Deficit)
For the years ended December 31, 2003, 2002 and 2001
(Dollars in thousands, except par value)
Deferred
Common Compensation Accumulated Total
Stock Additional Pursuant to Other Stockholders
$.01 Par Paid-in Stock Comprehensive Accumulated Equity
Value Capital Incentive Plans Income Defecit (Defecit)
------- ------- --------------- ------------ ---------- ---------
Balance, January 1, 2001 $ 57 $ 355,788 $ (351) $ -- $ (365,915) $ (10,421)
---------
Comprehensive loss:
Net loss (1,377) (1,377)
---------
Amortization of restricted stock grants 63 63
Amortization related to stock options 112 112
Change in value of performance-based
stock options 100 (100) --
------ --------- ------- ---------- ---------- ---------
Balance, December 31, 2001 57 355,888 (276) -- (367,292) (11,623)
---------
Comprehensive loss:
Net loss (11,086) (11,086)
---------
Issuance of 2,474,226 shares of
common stock 25 23,975 24,000
Amortization of restricted stock grants 63 63
Amortization related to stock options 295 295
Change in value of performance-based
stock options 500 (500) --
Exercise of options to purchase common
shares 1 1
------ ------- ------- ---------- ---------- ---------
Balance, December 31, 2002 82 380,364 (418) -- (378,378) 1,650
---------
Comprehensive income:
Net change in unrealized gain
on investments, net of taxes of $7 9 9
Net income 74,076 74,076
---------
Comprehensive income 74,085
---------
Amortization of restricted stock grants 11 11
Amortization related to stock options 583 583
Change in value of performance-based
stock options 180 (180) --
Exercise of options to purchase
common shares 1 1
------ ------- ------- ---------- ---------- ---------
Balance, December 31, 2003 $ 82 $ 380,545 $ (4) $ 9 $(304,302) $ 76,330
====== ========= ======= ========== ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
---- ---- ----
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 74,076 $ (11,086) $ (1,377)
Adjustments to reconcile net income (loss) to net cash provided by
(used for) operating activities:
Minority interest 11,161 1,711 1,000
Provision for deferred income taxes 2,963 363 --
Provision for environmental remediation 270 11,160 --
Amortization of deferred compensation pursuant to stock incentive plans 594 358 175
Amortization of the debt discount on note payable to Leucadia
Financial Corporation 1,088 1,120 1,034
Other amortization related to investments (369) --
Changes in operating assets and liabilities:
Real estate (542) (6,855) (911)
Deposits and other assets (242) 169 (252)
Note receivable 6,566 (6,566) --
Notes payable to trust deed holders (1,268) (185) --
Liability for environmental remediation (301) (344) --
Recreation center liability -- -- (41)
Deferred revenue 20,870 19,792 --
Accounts payable and accrued liabilities 4,662 183 195
Income taxes payable (2,372) 286 --
Other liabilities 1,883 6,480 --
--------- --------- ---------
Net cash provided by (used for) operating activities 119,039 16,586 (177)
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments (other than short-term) (152,132) -- --
Proceeds from maturities of investments 60,600 -- --
Proceeds from sales of investments 3,398 -- --
Net cash received in acquisition of CDS -- 18,979 --
Increase in restricted cash (4,336) -- --
--------- --------- ---------
Net cash (used for) provided by investing activities (92,470) 18,979 --
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Borrowings under credit agreement with Leucadia Financial Corporation -- 2,150 900
Payments related to credit agreement with Leucadia Financial Corporation -- (2,150) (900)
Contribution from minority interest 43 -- --
Distributions to minority interest (13,469) (2,524) --
Principal payments to trust deed note holders (3,242) (895) --
Exercise of options to purchase common shares 1 1 --
--------- --------- ---------
Net cash used for financing activities (16,667) (3,418) --
--------- --------- ---------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 9,902 32,147 (177)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 33,601 1,454 1,631
--------- --------- ---------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 43,503 $ 33,601 $ 1,454
========= ========= =========
(continued)
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
HOMEFED CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows, continued
For the years ended December 31, 2003, 2002 and 2001
(In thousands)
2003 2002 2001
---- ---- ----
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $ 1,588 $ 1,660 $ 1,612
========= ========= =========
Cash paid (refunded) for income taxes $ 10,976 $ (279) $ 668
========= ========= =========
NON-CASH INVESTING ACTIVITIES:
Common stock issued for acquisition of CDS $ -- $ 24,000 $ --
========= ========= =========
NON-CASH FINANCING ACTIVITIES:
Liabilities assumed from acquisition of real estate $ 4,332 $ -- $ --
244 -- --
Contribution of real estate from minority interest --------- --------- --------
$ 4,576 $ -- $ --
========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-6
HOMEFED CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation - The accompanying consolidated financial
statements include the accounts of HomeFed Corporation (the "Company"), Otay
Land Company, LLC and its wholly-owned subsidiaries, ("Otay Land Company"),
HomeFed Communities, Inc., HomeFed Resources Corporation, CDS Holding
Corporation and its majority owned subsidiaries ("CDS") and Rampage Vineyard,
LLC. The Company is currently engaged, directly and through its subsidiaries, in
the investment in and development of residential real estate properties in the
state of California. All significant intercompany balances and transactions have
been eliminated in consolidation.
The Company's business, real estate development, is highly competitive,
and there are numerous residential real estate developers and development
projects operating in the same geographic area in which the Company operates. In
addition, the residential real estate development industry is subject to
increasing environmental, building, zoning and real estate regulations that are
imposed by various federal, state and local authorities. Timing of the
initiation and completion of development projects depends upon receipt of
necessary authorizations and approvals. Furthermore, changes in prevailing local
circumstances or applicable laws may require additional approvals, or
modifications of approvals previously obtained. Delays could adversely affect
the Company's ability to complete its projects, significantly increase the costs
of doing so or drive potential customers to purchase competitors' products.
Environmental laws may cause the Company to incur substantial compliance,
mitigation and other costs, may restrict or prohibit development in certain
areas and may delay completion of the Company's development projects. Delays
arising from compliance with environmental laws and regulations could adversely
affect the Company's ability to complete its projects, significantly increase
the costs of doing so or cause potential customers to purchase competitors'
products. The Company's business may also be adversely affected by inflation and
is interest-rate sensitive.
On July 14, 2003, following shareholder approval, the Company effected
a reverse 1-for-250 stock split (the "reverse split") followed immediately by a
forward 25-for-1 stock split (the "forward split") of its common stock, which
had the net effect of a reverse 1-for-10 stock split (the "reverse/forward
split"). Holders of fewer than 250 shares of common stock prior to the reverse
split and holders of fractional interests in common stock following the forward
split received a cash payment for the value of their fractional interests. The
Company's transfer agent aggregated all fractional interests and sold them at
prevailing market prices. Because the net result of the reverse/forward stock
split effectively was a reverse 1-for-10 stock split, the Company also
proportionately reduced the number of authorized shares of common stock to
25,000,000. The trading symbol for the Company's common stock, which continues
to trade in the over-the-counter bulletin board, was changed to "HOFD" effective
July 14, 2003. In addition, in July 2003, the Company's shareholders approved an
amendment to its certificate of incorporation to create a class of preferred
stock, of which 3,000,000 shares are authorized and none have been issued. The
financial statements and notes thereto give retroactive effect to the
reverse/forward stock split for all periods presented.
Certain amounts for prior periods have been reclassified to be
consistent with the 2003 presentation.
Critical Accounting Estimates - The preparation of financial statements
in conformity with generally accepted accounting principles requires the Company
to make estimates and assumptions that affect the reported amounts in the
financial statements and disclosures of contingent assets and liabilities. On an
on-going basis, the Company evaluates all of these estimates and assumptions.
Actual results could differ from those estimates.
Profit Recognition on Sales of Real Estate - Profit from the sale of
real estate is recognized in full at the time title is conveyed to the buyer if
the profit is determinable, collectibility of the sales price is reasonably
assured (demonstrated by meeting minimum down payment and continuing investment
requirements), and the earnings process is virtually complete, such that the
seller is not obligated to perform significant activities after the sale and has
transferred to the buyer the usual risks and rewards of ownership. If it is
determined that all the conditions for full profit recognition have not been
met, revenue and profit is deferred using the deposit, installment, cost
recovery or percentage of completion method of accounting, as appropriate
depending upon the specific terms of the transaction.
F-7
When the Company has an obligation to complete improvements on property
subsequent to the date of sale, it utilizes the percentage of completion method
of accounting to record revenues and cost of sales. Under percentage of
completion accounting, the Company recognizes revenues and cost of sales based
upon the ratio of development costs completed as of the date of sale to an
estimate of total development costs which will ultimately be incurred, including
an estimate for common areas. Unearned revenues resulting from applying the
percentage of completion accounting are reported as deferred revenue in the
liabilities section of the consolidated balance sheets.
Income Taxes - The Company records a valuation allowance to reduce its
deferred tax asset to an amount that the Company expects is more likely than not
to be realized. If the Company's estimate of the realizability of its deferred
tax asset changes in the future, an adjustment to the valuation allowance would
be recorded which would either increase or decrease income tax expense in such
period. The valuation allowance is determined after considering all relevant
facts and circumstances, but is significantly influenced by the Company's
projection of taxable income in the future. Since any projection of future
profitability is inherently unreliable, changes in the valuation allowance
should be expected.
Provision for Environmental Remediation - The Company records
environmental liabilities when it is probable that a liability has been incurred
and the amount or range of the liability is reasonably estimable. During 2002,
the Company recorded a charge of $11,200,000 representing its estimate of the
cost to implement the most likely remediation alternative with respect to 34
acres of undeveloped land owned by a subsidiary of Otay Land Company. The
estimated liability was neither discounted nor reduced for potential claims for
recovery from previous owners and users of the land who may be liable, and may
increase or decrease based upon the actual extent and nature of the remediation
required, the type of remedial process approved, the expenses of the regulatory
process, inflation and other items.
Provision for Losses on Real Estate - The Company's real estate is
carried at the lower of cost or fair value less costs to sell. Management
periodically assesses the recoverability of its real estate investments by
comparing the carrying amount with their fair value less costs to sell. The
process involved in the determination of fair value requires estimates as to
future events and market conditions. This estimation process assumes the Company
has the ability to complete development and dispose of its real estate
properties in the ordinary course of business based on management's present
plans and intentions. When management determines that the carrying value of
specific real estate investments should be reduced to properly record these
assets at fair value less costs to sell, this write-down is recorded as a charge
to current period operations. The evaluation process is based on estimates and
assumptions and the ultimate outcome may be different. The Company has not
recorded any such provisions during the three year period ended December 31,
2003.
Real Estate -Real estate, which consists of land held for development
and sale, includes all expenditures incurred in connection with the acquisition,
development and construction of the property, including interest and property
taxes. Land costs are allocated to lots based on relative fair values prior to
development and are charged to cost of sales at the time of sale.
Cash and Cash Equivalents - Cash equivalents are money market accounts
and short-term, highly liquid investments that have maturities of less than
three months at the time of acquisition.
Investments - Securities with maturities equal to or greater than three
months at the time of acquisition are classified as investments available for
sale, and are carried at fair value with unrealized gains and losses reflected
as a separate component of shareholders' equity, net of taxes.
Recognition of Fee Income - The Company receives co-op marketing and
advertising fees from the San Elijo Hills project that are paid at the time
builders sell homes, are generally based upon a fixed percentage of the homes'
selling price, and are recorded as revenue when the home is sold. Prior to its
acquisition of CDS, the Company recognized fee income for field overhead and
management services from the San Elijo Hills project in its consolidated
statements of operations when contractually earned. Subsequent to the
acquisition of CDS, such amounts are eliminated in consolidation.
Capitalization of Interest and Real Estate Taxes - Interest and real
estate taxes attributable to land and property construction are capitalized and
added to the cost of those properties while the properties are being actively
developed.
F-8
Stock-Based Compensation - Statement of Financial Accounting Standards
No. 123, "Accounting for Stock-Based Compensation", ("SFAS 123"), establishes a
fair value method for accounting for stock-based compensation plans, either
through recognition in the statements of operations or disclosure. As permitted,
the Company applies APB Opinion No. 25 and related Interpretations in accounting
for its plans. Accordingly, no compensation cost has been recognized in the
statements of operations related to employees and directors under its stock
compensation plans. Had compensation cost for the Company's fixed stock options
been recorded in the statements of operations consistent with the provisions of
SFAS 123, the Company's net income (loss) would not have been materially
different from that reported in 2003, 2002 and 2001.
Recently Issued Accounting Standards - In May 2003, the Financial
Accounting Standards Board ("FASB") issued Statement of Financial Accounting
Standards No. 150, "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity ("SFAS 150"), which is effective
for financial instruments entered into or modified after May 31, 2003, and
otherwise is effective at the beginning of the first interim period beginning
after June 15, 2003. SFAS 150 establishes standards for how an issuer classifies
and measures certain financial instruments with characteristics of both
liabilities and equity. The implementation of SFAS 150 did not have any impact
on the Company.
In January 2003, the FASB issued FASB Interpretation No. 46 ("FIN 46"),
which addresses consolidation of variable interest entities, which are entities
in which equity investors do not have the characteristics of a controlling
financial interest or do not have sufficient equity at risk for the entity to
finance its activities without additional subordinated financial support from
other parties. FIN 46 is effective immediately for variable interest entities
created after January 31, 2003, and for variable interest entities in which an
enterprise obtains an interest after that date. In October 2003, the FASB
deferred to the fourth quarter of 2003 from the third quarter the implementation
date of FIN 46 with respect to variable interest entities in which a variable
interest was acquired before February 1, 2003. In December 2003, the FASB issued
a revision ("FIN 46R") to FIN 46 to clarify certain provisions and exempt
certain entities from its requirements. In addition, FIN 46R deferred to the
first quarter of 2004 application of its provisions to certain entities in which
a variable interest was acquired prior to February 1, 2003. The Company does not
believe that the implementation of FIN 46 and FIN 46R will have any impact on
its consolidated results of operations or financial condition.
2. ACQUISITIONS
On October 21, 2002, the Company purchased from Leucadia National
Corporation ("Leucadia") all of the issued and outstanding shares of capital
stock of CDS which, through its majority-owned indirect subsidiary, San Elijo
Hills Development Company, LLC ("San Elijo"), is the owner of the San Elijo
Hills project, a master-planned community located in the City of San Marcos, in
San Diego County, California. Since August 1998, the Company has been the
development manager for the San Elijo Hills project, for which it was entitled
to participate in the net cash flow of the project through the payment of a
success fee, and receive fees for the field overhead, management and marketing
services it provides, based on the revenues of the project. No success fee had
been paid prior to the Company's acquisition of CDS.
The purchase price of $25,000,000 consisted of $1,000,000 in cash and
2,474,226 shares of the Company's common stock, which represented approximately
30% of the Company's outstanding common shares. Prior to the acquisition,
Leucadia had also committed to continue to provide to San Elijo project
improvement bonds which are required prior to the commencement of any project
development. The results of CDS have been included in the Company's consolidated
results of operations from the date of acquisition.
F-9
The balance sheet of CDS at the date of acquisition was as follows (in
thousands):
Assets:
Real estate $ 139
Cash and cash equivalents 19,979
Investments 275
Deposits and other assets 460
Deferred income taxes 45,105
--------
Total assets acquired 65,958
--------
Liabilities:
Notes payable to trust deed holders 17,560
Deferred revenue 12,829
Accounts payable and accrued liabilities 4,429
Other liabilities 3,403
--------
Total liabilities assumed 38,221
--------
Minority Interest 2,737
--------
Purchase Price $ 25,000
========
The following unaudited pro forma financial information presents
results for the years ended December 31, 2002 and 2001 as if the acquisition had
occurred at the beginning of the respective periods (in thousands, except per
share amounts):
2002 2001
---- ----
Sales of real estate $33,920 $80,721
Total revenues $36,162 $82,469
Income (loss) from operations $(2,441) $26,139
Minority interest $(2,124) $(3,337)
Net income (loss) $(3,110) $14,505
Basic earnings (loss) per common share $(.38) $1.78
Diluted earnings (loss) per common share $(.38) $1.78
The unaudited pro forma financial information is provided for
informational purposes only and is not necessarily indicative of either the
Company's operating results that would have occurred had the acquisition been
consummated at the beginning of the respective periods, or of the Company's
future operating results.
In November 2003, the Company purchased a 2,159 acre grape vineyard
located in southern Madera County, California ("Rampage"). The purchase price
for the property was $6,000,000, excluding expenses, of which $1,700,000 was
paid in cash and $4,300,000 is expected to be paid to the seller within one
year. In addition, the Company furnished to the seller a letter of credit (which
is fully collateralized by cash) in the amount of $4,300,000, which secured the
Company's obligation to the seller. The Rampage property remains encumbered by a
mortgage lien of $3,800,000, which was originally granted by the seller to a
mortgage lender and which the Company is not obligated to satisfy. Although the
amount owed to the seller does not bear interest, the Company is obligated to
make interest payments due under the mortgage during 2004 while the lien remains
on the property. However, any principal payments made by the Company to the
mortgage lender will reduce the balance owed to the seller. If the lien remains
outstanding for all of 2004, the total amount of interest the Company will be
required to pay is approximately $300,000. By the end of 2004, the Company will
either fully pay the amount it owes to the seller and have the mortgage lien
released, or assume the mortgage lien or repay the mortgage, which in both
instances will be fully offset by a reduction in the amount owed to the seller.
3. INVESTMENTS
At December 31, 2003, the Company's investments consisted of fixed
income securities issued by the U.S. government and its agencies, which were
classified as available for sale and recorded at an aggregate fair value of
$88,519,000. At December 31, 2003, these investments had an aggregate amortized
cost of $88,503,000 and the Company had recognized gross unrealized gains of
$16,000 for these securities. All of the Company's investments mature in one
year or less. The Company did not own any investments at December 31, 2002.
F-10
4. REAL ESTATE
A summary of real estate by project is as follows (in thousands):
December 31,
-------------------------
2003 2002
---- ----
Otay Ranch $21,555 $23,856
San Elijo Hills 9,664 6,023
Rampage Vineyard 6,393 --
Paradise Valley -- 1,229
------- -------
Total $37,612 $31,108
======= =======
Interest totaling $1,386,000 and $224,000, related to the San Elijo
Hills project, was incurred and capitalized in real estate during 2003 and 2002,
respectively. All of the San Elijo Hills project land is pledged as collateral
for the notes payable to trust deed holders described in Note 6, below.
During 2003, the Company disposed of all of its remaining interest in
Paradise Valley for net cash proceeds of $2,900,000, and recognized pre-tax
income of $1,500,000, net of $300,000 allocated to the minority interest.
5. NOTE RECEIVABLE
In December 2002, CDS sold 92 residential sites at the San Elijo Hills
project to a home builder for net proceeds of $23,657,000, consisting of cash of
$17,091,000 and a non-interest bearing note receivable in the amount of
$6,566,000, due upon the completion of certain improvements to the property, but
not to exceed one year. The note was paid in full during 2003.
6. INDEBTEDNESS
As of August 14, 1998, the Company and Leucadia Financial Corporation
("LFC"), a subsidiary of Leucadia, entered into an Amended and Restated Loan
Agreement pursuant to which the Company and LFC amended the original loan
agreement dated July 3, 1995 and restructured the Company's outstanding 12%
Secured Convertible Note due 2003 ("Convertible Note") held by LFC. The
restructured note dated August 14, 1998 (the "Restructured Note") has a
principal amount of $26,462,000, extended the maturity date from July 3, 2003 to
December 31, 2004, reduced the interest rate from 12% to 6% and eliminated the
convertibility feature of the Convertible Note. The Restructured Note is
collateralized by a security interest in substantially all assets of the
borrower, whether now owned or hereafter acquired. No principal payments are due
under the Restructured Note until its maturity date. On October 9, 2002, the
maturity date of this note was extended from December 31, 2004 to December 31,
2007 and the interest rate was increased to 9% for 2005, 10% for 2006 and 11%
for 2007. The effective interest rate for the year ended December 31, 2003 was
11.1%, after giving effect to the amortization of the discount on the note. In
connection with these amendments, in 2002, the Company paid LFC a $250,000 fee.
As a result of the restructuring of the Convertible Note, the
Restructured Note was recorded at fair value and the approximate $7,015,000
difference between the fair value of the Restructured Note and the carrying
value of the Convertible Note was reflected as additional paid-in capital. The
Company has been amortizing this difference as interest expense based on a
retirement date of December 31, 2005 using the interest method. Approximately
$1,100,000, $1,100,000 and $1,000,000 were amortized to interest expense during
2003, 2002 and 2001, respectively. Additional interest of approximately
$1,600,000 was expensed and paid during each of the years in the three year
period ended December 31, 2003.
On March 3, 2004, the Board determined to prepay the Restructured Note
in full. The Company expects to repay the note in late March 2004, using its
available cash. Since the note is reflected in the December 31, 2003
consolidated balance sheet net of a discount of $1,746,000, the entire discount
will be reflected as an expense in the Company's 2004 consolidated statement of
operations.
F-11
In March 2001, the Company entered into an unsecured $3,000,000 line of
credit agreement with LFC. Loans outstanding under this line of credit bear
interest at 10% per annum. Effective March 1, 2002, this agreement was amended
to extend the maturity to February 28, 2007, although LFC had the right to
terminate the line of credit on an annual basis. On October 9, 2002, the line of
credit was increased from $3,000,000 to $10,000,000 and LFC's ability to
terminate the line of credit prior to maturity was removed, unless the Company
is in default. At December 31, 2003 and 2002, no amounts were outstanding under
this facility. There was no interest expense for the line of credit during the
year ended December 31, 2003. Interest expense includes approximately $72,000
and $24,000 for the line of credit during the years ended December 31, 2002 and
2001, respectively.
Notes payable to trust deed holders consist of non-recourse promissory
notes that mature on December 31, 2010, are non-interest bearing and are
collateralized by the San Elijo Hills project land. When a portion of the San
Elijo Hills project is sold, a specified amount is required to be paid to the
note holder in order to obtain a release of their security interest in the land.
Such amount is specified in the note agreements and takes into consideration
prior note payments. In addition, depending upon the amount of payments made to
release their security interest for prior sales, the notes may require minimum
annual payments. The minimum annual payments are currently $269,000 for annual
periods subsequent to 2003. The sum of all payments made under these notes,
whether denominated as interest, principal or otherwise, cannot exceed
approximately $42,100,000. As of December 31, 2003, $25,900,000 had been paid.
The notes payable to trust deed holders were recorded at fair value at
the date of acquisition of CDS, based on the estimated future payments
discounted at 6.5%. The activity for the year ended December 31, 2003 and for
the period from October 21, 2002 through December 31, 2002 is as follows (in
thousands):
2003 2002
---- ----
Beginning balance $16,704 $17,560
Principal payments (3,242) (895)
Interest added to principal 118 39
------- -------
Ending balance $13,580 $16,704
======= =======
At the end of each reporting period, the carrying amounts of the notes
are compared to the most recent estimate of future payments. The difference is
amortized prospectively using the effective interest rate method. The effective
interest rate for the year ended December 31, 2003 and for the period from the
date of acquisition through December 31, 2002 was 9.3% and 6.5%, respectively.
Effective January 1, 2004, the effective interest rate was 12.5%. Based on the
Company's cash flow forecast, the expected payments to the trust deed holders
that will be allocated to principal are as follows (in thousands): 2004 -
$4,639; 2005 - $8,143; 2006 - $0 and 2007 - $798.
7. MINORITY INTEREST
Through its ownership of CDS, the Company owns 80% of the common stock
of CDS Devco, Inc. ("Devco"), which in turns owns 85% of the common stock of San
Elijo Ranch, Inc., ("SERI"). Pursuant to a stockholders' agreement with the
holder of the minority interest in Devco, the Company is entitled to a 15%
return on all funds advanced to Devco, compounded annually, plus the return of
its capital, prior to the payment of any amounts to the minority shareholder.
Once those amounts are paid, the minority shareholder is entitled to 20% of
future cash flows, if any, distributed to shareholders. Pursuant to a
stockholders' agreement with the holders of the minority interests in SERI,
Devco loans funds to SERI and charges a 12% annual rate. Once this loan is fully
repaid, the minority shareholders of SERI are entitled to 15% of future cash
flows, if any, distributed to shareholders. As of December 31, 2003,
approximately $13,100,000 has been accrued for the Devco and SERI minority
interests.
In January 2004, a dividend of $50,000,000 was paid by the Company's
subsidiary that owns the San Elijo Hills project, of which $40,500,000 was
ultimately received by the Company and the balance was paid to the minority
interests. As a result, all amounts advanced to the project were repaid and the
preferred return due at the time the dividend was paid was fully satisfied.
As of December 31, 2002, approximately $11,700,000 had been accrued
with respect to Leucadia's preferred capital interest and cumulative preferred
return relating to Otay Land Company, as discussed in Note 13, below. In 2003,
Otay Land Company paid approximately $12,900,000 to Leucadia to fully redeem its
preferred capital interest and preferred return.
F-12
8. STOCK INCENTIVE PLANS
Under the Company's 1999 Stock Incentive Plan (the "Plan"), the Company
may grant options, stock appreciation rights and restricted stock to
non-employee directors, certain non-employees and employees up to a maximum
grant of 30,000 shares to any individual in a given taxable year. Pursuant to
the plan, each director of the Company is automatically granted options to
purchase 1,000 shares on the date on which the annual meeting of stockholders is
held. In July 2003, following shareholder approval, the Plan was amended to,
among other things, increase to 200,000 the number of shares of common stock
that would be available under the Plan for issuance pursuant to stock options,
restricted stock or stock appreciation rights once the reverse/forward stock
split was effected. The Plan provides for the issuance of options and rights at
not less than 100% of the fair market value of the underlying stock at the date
of grant. Options generally become exercisable in five equal instalments
starting one year from the date of grant. No stock appreciation rights have been
granted. During 2000, 25,000 shares of restricted common stock were issued to
eligible participants, subject to certain forfeiture provisions. In connection
with this issuance of restricted stock, the Company recorded deferred
compensation of $188,000 representing the value of stock on the date of issuance
based upon market price. This amount was amortized over the three year vesting
period of the restricted stock. In addition, during 2000, options to purchase an
aggregate of 2,500 shares of Common Stock were granted to non-employees at an
exercise price of $7.50 per share (market price). In connection with this
issuance, the Company recorded deferred compensation of $18,000 based upon the
estimated fair value of these options at the time of grant, using the modified
Black-Scholes model. This amount is being amortized over the five year vesting
period of the options.
A summary of activity with respect to the Company's stock options for
employees and directors for 2003, 2002 and 2001 is as follows:
Common Weighted Available
Shares Average Options for Future
Subject to Exercise Exercisable Option
Option Price at Year-End Grants
------ ----- ----------- ------
Balance at January 1, 2001 16,100 $ 7.50 0 56,400
====== ======
Granted 600 $ 9.30
Exercised (25) $ 7.00
------
Balance at December 31, 2001 16,675 $ 7.50 3,225 55,800
====== ======
Granted 600 $ 9.50
Exercised (50) $ 8.15
------
Balance at December 31, 2002 17,225 $ 7.60 6,575 55,200
====== ======
Granted 600 $ 27.40
Exercised (75) $ 8.60
------
Balance at December 31, 2003 17,750 $ 8.28 10,050 199,400
====== ====== =======
The weighted-average fair value of the options granted was $17.21 per
share for 2003, $6.50 per share for 2002 and $7.30 per share for 2001 as
estimated on the date of grant using the Black-Scholes option-pricing model with
the following assumptions: (1) expected volatility of 86.1% for 2003, 95.5% for
2002 and 117.7% for 2001; (2) risk-free interest rate of 2.3% for 2003, 3.5% for
2002 and 4.8% for 2001; (3) expected lives of 4.0 years for all years; and (4)
dividend yield of 0% for all years.
The following table summarizes information about fixed stock options
outstanding at December 31, 2003.
Options Outstanding Options Exercisable
----------------------------------------------------- -------------------------
Common Weighted Weighted Common Weighted
Shares Average Average Shares Average
Range of Subject to Remaining Exercise Subject to Exercise
Exercise Prices Option Contractual Life Price Option Price
- --------------- ------ ---------------- ----- ------ -----
$7.00 - $9.50 17,150 2.2 years $ 7.61 10,050 $7.55
$27.40 600 4.5 years $27.40 -- $ --
F-13
In 2000, under the Company's 2000 Stock Incentive Plan (the "2000
Plan"), the Company granted to two key employees options to purchase an
aggregate of 100,000 shares of common stock at an exercise price of $6.10 per
share, the then current market price per share. No additional options are
available to be granted under the 2000 Plan. These options were subject to
forfeiture provisions if performance criteria were not met by April 27, 2003.
Upon the closing of a sale at Otay Land Company in April 2003, the options were
no longer subject to forfeiture. As a result, the Company expensed the remaining
deferred compensation related to the performance options of approximately
$600,000 in 2003.
9. OTHER RESULTS OF OPERATIONS
Other income for each of the three years in the period ended December
31, 2003, consists of the following (in thousands):
2003 2002 2001
---- ---- ----
Interest income $ 883 $ 96 $ 21
Proceeds from settlements 346 -- --
Easement fees 172 -- --
Reimbursement for fees and improvements
for previously sold property 198 -- 678
Gain (loss) on sale of fixed assets -- 113 (5)
Rental income from Leucadia 72 21 --
Other 35 81 5
------- ------ ------
Total $ 1,706 $ 311 $ 699
======= ====== ======
Advertising costs were $966,000, $159,000 and $41,000 for 2003, 2002
and 2001, respectively.
10. INCOME TAXES
The (provision) benefit for income taxes for each of the three years in
the period ended December 31, 2003 was as follows (in thousands):
2003 2002 2001
---- ---- ----
State income taxes - current $ (8,977) $ (471) $ (172)
Federal income taxes - current (2,239) 455 (495)
Federal income taxes - deferred (2,963) (363) --
---------- ------- -------
$ (14,179) $ (379) $ (667)
========== ======= =======
Current income taxes for all years principally relate to federal
alternative minimum tax and state income tax. The December 31, 2002 income taxes
payable balance includes approximately $2,600,000 due to Leucadia, which was
paid in 2003, related to CDS's tax sharing agreement with Leucadia for periods
prior to the Company's acquisition.
The table below reconciles the expected statutory federal income tax to
the actual income tax (provision) benefit (in thousands):
2003 2002 2001
---- ---- ----
Expected federal income tax $ (34,796) $ 3,149 $ (102)
State income taxes, net of federal income
tax benefit (5,835) (306) (112)
Federal alternative minimum tax refund
(payment) -- 455 (495)
Otay Land Company taxable income
allocated to Leucadia 429 1,024 221
(Increase) decrease in valuation allowance 26,065 (4,701) --
Other (42) -- (179)
--------- -------- -------
Actual income tax (provision) $ (14,179) $ (379) $ (667)
========= ======== =======
F-14
The Company and its wholly-owned subsidiaries have net operating loss
carryforwards ("NOLs") available for federal income tax purposes of $168,600,000
as of December 31, 2003. The NOLs were generated during 1991 to 1999 and expire
in 2006 to 2019 as follows (in thousands):
Year of Expiration Loss Carryforwards
------------------ ------------------
2004 $ --
2005 --
2006 104,570
2007 8,045
2008 9,361
Thereafter 46,586
----------
$ 168,562
==========
These NOLs are not available to reduce federal alternative minimum
taxable income, which is currently taxed at the rate of 20%. As a result, the
Company will pay federal income tax at a rate of 20% during future periods
(resulting in additional minimum tax credit carryovers), until such time as all
of its NOLs are used or expire and all minimum tax credit carryovers are used.
Alternative minimum tax credit carryovers have no expiration date.
At December 31, 2003 and 2002 the net deferred tax asset consisted of
the following (in thousands):
2003 2002
---- ----
NOL carryforwards $ 59,013 $ 84,368
Land basis 9,153 14,877
Minimum tax credit carryovers 2,239 --
Other, net 6,453 7,928
--------- ---------
76,858 107,173
Valuation allowance (35,086) (62,431)
--------- ---------
$ 41,772 $ 44,742
========= =========
The valuation allowance has been provided on the deferred tax asset due
to the uncertainty of future taxable income necessary for realization of the
deferred tax asset. The decrease in the valuation allowance primarily results
from the recognition of additional tax benefits for the expected use of all of
the NOLs. During the year ended December 31, 2003, as a result of an increase in
the Company's estimate of future taxable income and actual income in 2003 that
exceeded its earlier estimate, it reduced its income tax valuation allowance to
recognize additional benefits from its net operating loss carryforwards and
recorded a credit to its income tax provision of $26,065,000.
The calculation of the valuation allowance recognizes that the
Company's NOLs will not be available to offset alternative minimum taxable
income, which is currently taxed at a federal tax rate of 20%. When the Company
pays alternative minimum tax, it generates an alternative minimum tax credit
carryover, which can be used to reduce its future federal income tax rate once
it has used all of its NOLs. Assuming the Company realizes its projected taxable
income in the future and fully utilizes its NOLs, it will have approximately
$35,000,000 of minimum tax credit carryovers to reduce future federal income
taxes payable. However, the minimum tax credit carryovers are only able to
reduce the Company's federal income tax rate to 20% in any given year, which
means the Company would have to generate an additional $230,000,000 of taxable
income above its current estimate to fully use them. As a result, the Company
has reserved for substantially all of this benefit in its valuation allowance.
F-15
11. EARNINGS PER SHARE
Income (loss) per share of common stock was calculated by dividing net
income (loss) by the sum of the weighted average number of common shares
outstanding and, for diluted earnings (loss) per share, the incremental weighted
average number of shares issuable upon exercise of outstanding options for the
periods they were outstanding. The number of shares used to calculate basic
earnings (loss) per share amounts was 8,155,111, 6,168,891, and 5,680,790 for
2003, 2002 and 2001, respectively. The number of shares used to calculate
diluted earnings (loss) per share was 8,238,164, 6,168,891 and 5,680,790,
respectively. Options to purchase 42,135 and 35,984 weighted average shares for
2002 and 2001, respectively, were not included in the computation of diluted
loss per share as those options were antidilutive.
12. COMMITMENTS AND CONTINGENCIES
Prior to its acquisition by the Company, a subsidiary of CDS entered
into a non-cancelable operating lease for its office space, a portion of which
was sublet to the Company and a portion of which was sublet to Leucadia. This
lease will expire in February 2005, subject to an option to extend for an
additional four years. In 2002, the base rent, which escalates 4% each year, was
approximately $240,000. Effective October 21, 2002, as a result of the
acquisition of CDS, the Company has recorded sublease income from Leucadia for a
monthly amount equal to Leucadia's share of the Company's cost for such space
and furniture, and reflected such amounts in other income. Such amount
aggregated $72,000 in 2003 and $21,000 for the period from October 21, 2002 to
December 31, 2002. Rental expense (net of sublease income) was $209,000,
$227,000 and $246,000 for 2003, 2002 and 2001, respectively.
In connection with the development of San Elijo Hills, CDS has provided
a letter of credit in the amount of $273,000 which expires in 2004. The letter
of credit is collateralized by a certificate of deposit in the same amount,
which is reflected in restricted cash in the consolidated balance sheet.
As described more fully in Note 2, the Company has posted a cash
collateralized $4,300,000 letter of credit in connection with the acquisition of
the Rampage property. The letter of credit expires in 2004. The cash collateral,
which at December 31, 2003 totaled $4,300,000, is included in restricted cash in
the consolidated balance sheet.
An owner of adjacent property has claimed that he has options to
purchase approximately 600 acres of the Rampage property for approximately
$4,900,000. The Company is currently evaluating the merits of this claim and how
it will proceed.
The Company is required to obtain infrastructure improvement bonds
primarily for the benefit of the City of San Marcos (The "City") prior to the
beginning of lot construction work and warranty bonds upon completion of such
improvements in the San Elijo Hills project. These bonds provide funds primarily
to the City in the event the Company is unable or unwilling to complete certain
infrastructure improvements in the San Elijo Hills project. Leucadia has
obtained these bonds on behalf of CDS and its subsidiaries both before and after
the acquisition of CDS by the Company. CDS is responsible for paying all third
party fees related to obtaining the bonds. Should the City or others draw on the
bonds for any reason, one of CDS's subsidiaries would be obligated to reimburse
Leucadia for the amount drawn. As of December 31, 2003, the amount of
outstanding bonds was approximately $31,700,000.
Since 1999, the San Elijo Hills project has carried $50,000,000 of
general liability and professional liability insurance under a policy issued by
the Kemper Insurance Companies ("Kemper"). The policy covered a thirteen-year
term from the initial date of coverage, and the entire premium for the life of
the policy was paid in 1999. This policy is specific to the San Elijo Hills
project; the Company has general and professional liability insurance for other
matters with different insurance companies. Kemper has ceased underwriting
operations and has submitted a voluntary run-off plan to its insurance
regulators. Although Kemper is not formally in liquidation or under the
supervision of insurance regulators, it is uncertain whether they will have
sufficient assets at such time, if ever, the Company makes a claim under the
policy or, if they are insolvent, whether state insurance guaranty funds would
be available to pay the claim. The Company has investigated replacing the
coverage supplied by Kemper with a new insurance company; however, the Company
has not found coverage equal to that provided by Kemper and premium rates have
increased significantly. At this time the Company has not yet determined whether
it needs to obtain replacement insurance, and if it determines to do so, whether
it will be able to acquire insurance that is economically acceptable, if at all,
or whether such insurance will cover past occurrences at the San Elijo Hills
project.
The Company is subject to various litigation which arise in the course
of its business. Based on discussions with counsel, management is of the opinion
that such litigation is not likely to have any material adverse effect on the
consolidated financial position of the Company, its consolidated results of
operations or liquidity.
F-16
13. OTHER RELATED PARTY TRANSACTIONS
The Company has entered into the following related party transactions
with Leucadia and LFC not otherwise described in these Notes to Consolidated
Financial Statements.
(a) Development Management Agreement. In August 1998, the Company
entered into a development management agreement with an indirect subsidiary of
Leucadia that owned certain real property located in the city of San Marcos,
County of San Diego, California, to develop the San Elijo Hills project. The
development management agreement provided that the Company would act as the
development manager with responsibility for the overall management of the
project, including arranging financing for the project, coordinating marketing
and sales activity, and acting as the construction manager. The development
management agreement also provided that the Company would participate in the net
profits of the project through the payment of a success fee and fee income for
field overhead, management and marketing services based on the revenues derived
from the project. As a result of the acquisition of CDS on October 21, 2002, the
Company acquired this indirect subsidiary of Leucadia. Subsequently, the
development management agreement was amended to eliminate the success fee
provisions. While development management fees have continued to be a source of
liquidity for the parent company since the acquisition of CDS, they are no
longer reflected in the consolidated statements of operations since they are
intercompany payments from a subsidiary and are eliminated in consolidation.
(b) Otay Land Company, LLC. In October 1998, the Company and Leucadia
formed Otay Land Company to purchase approximately 4,850 acres of land, which is
part of a 22,900 acre project located south of San Diego, California, known as
Otay Ranch. Otay Land Company acquired this land for $19,500,000. When Otay Land
Company was formed, Leucadia contributed $10,000,000 as a preferred capital
interest, and the Company contributed all other funds as non-preferred capital.
The Company is the managing member of Otay Land Company. In 2003, Otay Land
Company paid approximately $12,900,000 due to Leucadia to fully redeem the
preferred capital interest and preferred return. All future proceeds from this
project will be distributable solely to the Company.
(c) Administrative Services Agreement. Pursuant to administrative
services agreements, LFC provides administrative services to the Company through
December 31, 2004, including providing the services of one of the Company's
executive officers. Administrative fees paid to LFC were $120,000 in 2003 and
2002 and $107,000 in 2001.
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The Company's material financial instruments include cash and cash
equivalents, certificate of deposits, investments available for sale, and notes
payable. In all cases, the carrying amounts of such financial instruments
approximate their fair values. In cases where quoted market prices are not
available, fair values are based on estimates using present value techniques.
F-17
15. SELECTED QUARTERLY FINANCIAL DATA (unaudited)
First Second Third Fourth
Quarter Quarter Quarter Quarter
------- ------- ------- -------
(In thousands, except per share amounts)
2003:
Sales of real estate $ 7,016 $ 78,444 $ 29,667 $ 31,901
========== ========== ========== ========
Co-op marketing and advertising fees $ 380 $ 203 $ 249 $ 425
========== ========== ========== ========
Cost of sales $ 2,340 $ 14,792 $ 8,002 $ 10,374
========== ========== ========== ========
Income from operations $ 2,565 $ 60,524 $ 18,184 $ 16,437
========== ========== ========== ========
Net income (a) $ 1,245 $ 33,743 $ 8,325 $ 30,763
========== ========== ========== ========
Basic income per share (a) $ 0.15 $ 4.14 $ 1.02 $ 3.77
========== ========== ========== ========
Diluted income per share (a) $ 0.15 $ 4.10 $ 1.01 $ 3.73
========== ========== ========== ========
2002:
Sales of real estate $ -- $ 4,285 $ -- $ 4,974
========== ========== ========== ========
Co-op marketing and advertising fees $ 470 $ 426 $ 600 $ 446
========== ========== ========== ========
Development management fee income
from San Elijo Hills $ -- $ 1,553 $ 57 $ --
========== ========== ========== ========
Income from options on real estate
properties $ 180 $ 120 $ -- $ --
========== ========== ========== ========
Cost of sales $ -- $ 809 $ -- $ 2,006
========== ========== ========== ========
Income (loss) from operations (b) $ (1,156) $ 3,750 $ (12,513) $ 612
========== ========== ========== ========
Net income (loss) (b) $ (1,296) $ 3,101 $ (12,342) $ (549)
========== ========== ========== ========
Basic income (loss) per share (c) $ (0.23) $ 0.55 $ (2.17) $ (0.07)
========== ========== ========== ========
Diluted income (loss) per share (c) $ (0.23) $ 0.54 $ (2.17) $ (0.07)
========== ========== ========== ========
(a) The fourth quarter of 2003 reflects a reduction to the income tax
provision of $26,065,000, resulting from a decrease to the valuation
allowance for deferred tax assets, in order to recognize additional tax
benefits for the expected use of NOLs.
(b) During the third quarter of 2002, the Company recorded a provision of
$11,200,000 relating to environmental remediation.
(c) In 2002, the total of quarterly per share amounts does not equal the
annual per share amount because of changes in outstanding shares during
the year.
F-18