Item 1. Business
The Company
Sundance Homes, Inc. (the "Company") is a builder of single family homes in the Chicago metropolitan area and condominiums in the Chicago urban market. Prior to September 1996, the Company primarily was a builder of affordably priced, single-family detached and attached homes in the Chicago metropolitan area.
The Chicago metropolitan area, which includes Cook County and the five surrounding counties (McHenry, Lake, DuPage, Kane and Will Counties, commonly referred to as the "collar counties"), is the third largest metropolitan area in the United States. Management believes that housing demand in these areas is strong due in large part to their proximity to concentrated job markets which have developed along major highways to the north, northwest, southwest and west of Chicago.
The Chicago urban market includes the Loop area, South Loop, West Loop, New East Side, River North, Streeterville and the Gold Coast. Extensive development is taking place in other areas near the traditional Loop boundaries. These include the areas between Roosevelt Road and Cermak Road, and Halsted Street west to the United Center, and as far as 5800 north along the Ravenswood corridor. Management believes that housing demand in this market is strong due to the high rents in the markets, job growth in the downtown area, the long commute times between the city and the suburbs and the numerous amenities available in the Chicago downtown area to prospective home buyers.
The Company is currently operating three divisions: Sundance Suburban Properties; Rembrandt Homes; and Chicago Urban Properties. The Sundance Suburban Properties Division focuses on affordably priced entry-level and first time move-up houses primarily in the collar counties surrounding Chicago. The Rembrandt Division focuses primarily on the semi-custom and custom market primarily in the north and northwest Chicago suburban counties. The Chicago Urban Properties Division focuses primarily on loft-conversion, townhouse and new construction of mid and high-rise apartment condominiums in the City of Chicago. The Company believes that the division structure allows each operating entity to provide a focused insight into the markets, competition, subcontractor pricing, and consumer tastes in which it operates. Each division operating team is responsible for the product development, sales and marketing, home construction and customer service aspects of their projects. Corporate office support is provided for broad marketing and promotional strategic decisions, accounting, finance, and information systems.
The Company currently has 23 communities in various stages of planning and development and an additional five properties under contract or option. At September 30, 1998, the Company had 384 homes subject to sales contracts. The Company currently owns or controls sufficient land and buildings for the development of approximately 1,852 housing units and is evaluating the purchase of additional land and buildings, most of which is unentitled, for the possible development of approximately 294 additional housing units.
In September 1996, the Company entered the urban real estate market with the introduction of two condominium-loft conversion projects in Chicago. In 1998, the Company continued to increase its presence in the Chicago urban market with its Chicago Urban Properties division, which completed construction on three condominium-loft conversion projects. Additionally, the Company made significant progress on completing its 24-story high rise condominium apartment project, and opened for sale two new condominium-loft conversions and our condominium apartment project in Chicago.
Also in 1998, the Company continued its expansion of its custom home division, Rembrandt Homes. The Company closed 36 custom homes in the $350,000-650,000 price range in Vernon Hills, Illinois on land that was acquired in 1997 and 1998. The Company also acquired scattered developed and undeveloped lots in high-demand areas for future expansion.
Across all of its divisions, the Company strives to deliver superior value to all market segments by providing innovative designs and diverse, high-quality products. The Company typically broadens its appeal to various market segments by offering one or more product lines within each suburban and urban project. Each product offering is architecturally designed to complement other products within the project and create a sense of community.
Business Strategy
The Company's home building strategy consists of the following key elements:
Value Pricing, Customer Satisfaction, and Commitment to Quality. The Company strives to deliver superior value across market segments by pricing its homes competitively while consistently providing innovative designs and high-quality products. The Company's commitment to overall customer satisfaction through quality construction is the cornerstone of its business strategy. The Company acts as general contractor on most of its projects and requires that its subcontractors and suppliers use high-quality, durable materials in the construction of its homes. The project manager for each project is responsible for ensuring that each home in the project meets the Company's standards for workmanship and materials.
Growth-Oriented Markets. The Company focuses its home-building in suburban communities and urban neighborhoods where land acquisition costs have remained low and demand for entry-level, move-up, custom, and urban-style homes is strong. Demographic shifts in the housing market combined with the diverse and stable economic environment in Chicago have translated into population increases in and around the downtown area. The Company will continue to evaluate extending its home-building activities to other areas as opportunities consistent with the Company's strategy arise.
Innovative Design and Effective Marketing. The Company monitors the design and feature preferences of home buyers in its markets and uses this market research to provide innovative, space-efficient and desirable architectural designs and home amenities. In each project, the Company creates and maintains a series of model homes representing the home plans offered. The Company believes that the effective use of a variety of model homes plays an integral role in marketing the competitive advantages of its home design to prospective buyers.
Property Acquisition and Development. The Company strives to minimize its overall property costs and the risks associated with the development of unentitled property by, whenever possible, using options and other financing arrangements that allow the Company to control property through the entitlement process, but defer the payment for such property until the entitlement process has been completed and the Company is prepared to commence construction. For a description of the entitlement process, see "Governmental Regulation and Environmental Controls".
The Company has substantial experience in obtaining the entitlements necessary to develop residential and urban properties. In addition, the Company will occasionally purchase entitled property to the extent that the price and terms of such purchases are believed by the Company to be advantageous.
Cost Control. The Company controls the cost of developing its projects by: (i) seeking to purchase property at a low cost per unit; (ii) using its position as a leading homebuilder in its markets to obtain favorable pricing on construction materials and labor from its subcontractors; (iii) adhering to construction schedules and monitoring the physical progress and costs of construction with the use of a computerized tracking system; and (iv) striving to achieve rapid inventory turnover by pricing its homes at competitive levels and entering into sales contracts for a majority of its homes prior to commencement of construction.
Summary of Residential Projects
Since 1983, the Company has closed sales of approximately 6,100 homes and has completed 28 projects in the Chicago metropolitan area. The table following presents information relating to the Company's completed projects in the Chicago metropolitan area as of September 30, 1998.
The following table presents information relating to the Company's current and planned projects as of September 30, 1998:
(1) The estimated number of homes to be built at completion is subject to change and there can be no assurance that the Company will build these homes. (2) Homes in backlog refers to homes subject to sales contracts that, as of September 30, 1998, had not closed and there can be no assurance that closings of such homes will occur. (3) Reflects base price, excluding any lot premiums and buyer-selected options, which vary from project to project. (4) The Company does not currently have an estimate as to when an initial closing will occur.
Property Acquisition and Development
The Company selects property for acquisition and development based upon a variety of factors, including: (i) financial and legal review as to the feasibility of the proposed project, including projected profitability; (ii) demographic and marketing studies; (iii) competition within the area of the proposed project; (iv) proximity to concentrated job markets, quality of school districts and local traffic corridors; (v) infrastructure requirements for grading, drainage, utilities and streets; and (vi) management's judgment as to the real estate market, economic trends and the Company's experience in a particular area. The development approach for the Company's suburban projects varies from its urban projects due to the nature of the acquired property.
Suburban Development. The Company seeks to minimize its overall land costs and the risks associated with developing unentitled land, whenever possible, by using options and other financing arrangements that allow the Company to control land through the entitlement process but defer the payment for such land until the entitlement process has been completed and the Company is prepared to commence construction. The Company strives to negotiate land purchase contracts that allow the Company to purchase portions of a parcel as close as possible to the commencement of construction.
After control of a parcel of unentitled land has been obtained, the Company prepares preliminary and final plans for each project, providing for infrastructure, neighborhoods, wetland preservation, educational and other public facilities, as well as open space. Once preliminary plans have been prepared, the Company must obtain numerous governmental approvals, licenses, permits and agreements, commonly referred to as "entitlements," before it can commence development and construction. In the Chicago metropolitan area, obtaining the many necessary entitlements for large residential developments is an extended process which generally takes one to two years and can involve a number of different governmental jurisdictions and agencies and considerable expense. No assurance can be given, however, that the Company will be able to obtain entitlements within originally projected time frames. Unless and until the requisite entitlements are received, a homebuilder generally does not have any rights to develop a project. For a description of the entitlement process, see "Government Regulation and Environmental Controls."
The Company has occasionally used partnerships, where such arrangements were advantageous, to acquire the land from the seller or where such arrangements appeared to be otherwise economically advantageous to the Company. The Company will continue to consider partnerships and other financing arrangements with landowners or other third parties.
In addition, the Company may purchase entitled land to the extent that the price and terms of such purchase are believed by the Company to permit development within acceptable profitability levels. Through the purchase of entitled or fully developed lots, the Company can reduce the amount of financial or market risks inherent in the development process.
Sales of land and lots have not previously had a significant impact on the Company's financial results. However, the Company will maintain the flexibility to sell land and lots to take advantage of market opportunities that may exist.
Urban Development. The Company is developing two different products in the downtown Chicago market. For the majority of the Company's urban development, the Company targets for acquisition former or current manufacturing buildings which are suitable for the conversion to residential loft-condominiums. The Company is also targeting for acquisition parcels for use in developing multi- story apartment condominiums. Typically, any building on a parcel of land of this type would be torn down prior to new construction beginning. Each of the factors outlined in the acquisition process above is performed on these sites, including assessing the Company's ability to obtain appropriate entitlements and zoning. Other factors evaluated are the Company's ability to provide adequate parking capacity and access to public transportation, commercial centers, and various City of Chicago amenities.
Prior to acquisition, the Company prepares architectural drawings, performs environmental testing and assessments, reviews zoning and entitlement requirements, and prepares feasibility studies based on projected absorption and estimated construction costs. The Company has been able to start initial construction activities soon after acquisition and typically opens for sale within six months after acquisition as the evaluation and zoning period is much shorter than for suburban developments.
Home and Community Design
The Company continuously engages in market research in an effort to ensure that its home designs, features, and selling strategies address the preferences of potential home buyers. The Company closely monitors new trends in the industry, while carefully tracking the design features chosen by buyers of its homes as well as those offered by competitors in the marketplace.
In 1998, the Company opened a state-of-the-art Design Center in Schaumburg, Illinois to provide its suburban customers with the opportunity to make design selections in a controlled, retail environment. Each customer that visits the Design center is surveyed in order to identify areas for improvement. In addition to surveying its customers during the purchasing process, the Company conducts focus groups, exit interviews at its model home sites, telephone surveys, and statistical demographic studies in an effort to produce the most desirable architectural designs and home amenities. The Company's marketing and design teams develop detailed standards and specifications for each new product line and then work closely with one of a select number of unaffiliated architectural firms to produce a product line that delivers the home designs and features preferred by the target home buyers.
Within each suburban project, the Company seeks to create a sense of community through the use of cul-de-sacs, landscaping and a variety of front elevations and architectural designs that complement each other. The Company also seeks to create continuity within each suburban project by coordinating the exterior colors and trim of neighboring homes. The product lines offered in both suburban and urban projects depend upon many factors including the housing alternatives generally available in the area, the needs of the target home buyers for such project and the Company's cost per unit in the project.
Construction
The Company typically acts as the general contractor for the development and construction of its projects, employing project managers who supervise the land development and construction within each project. Typically, the Company relies on two project superintendents to supervise construction for each product line within a project. The "rough" superintendent is responsible for each home within a product line from excavation until the drywall is in place. The "trim" superintendent is then responsible for each home within the product line until the home is delivered to the buyer. Generally, each project superintendent coordinates the activities of the subcontractors, suppliers and building inspectors and is responsible for ensuring that the homes conform to the Company's quality control standards.
The Company also typically acts as general contractor for its urban project developments. The Company employs a project construction managers who supervise one or more building conversions, and construction superintendents who supervise all phases of construction for a particular building. The length of time of the construction process for urban projects varies due to the amount of demolition, environmental or other construction requirements. Additionally, occupancy requirements typically specify completion of an entire phase prior to the initial closings, and as such will usually result in an approximate nine to eighteen month construction cycle. The Company hired an outside general contractor to build the core building for its 24-story Erie Tower project. The Company plans on using its own supervisory personnel for all individual unit trim work.
Subcontractors typically are retained on a project-by-project basis to complete construction at a fixed price per model for a varying term, usually six months to one year. The Company generally uses a competitive bidding process among competing subcontractors prior to entering into a subcontracting agreement. Construction labor has generally been available to the Company, but the home- building industry has in the past experienced occasional shortages of skilled labor in certain markets.
The Company negotiates price and volume discounts with manufacturers and suppliers on behalf of subcontractors to take advantage of its volume of production. Management believes that this strategy has given the Company an advantage in producing quality homes at the lowest possible cost.
The Company typically obtains price guarantees from manufacturers and material suppliers, but makes no long-term purchase commitments to material suppliers on behalf of subcontractors. Materials used in the construction of the Company's projects are available from a number of sources, but material prices may fluctuate due to various factors, including supply and demand imbalances. In light of such fluctuation, the Company continues to evaluate various alternative sources of materials such as using metal frames and engineered lumber (i.e., soft woods in laminated form) instead of construction lumber for certain purposes. Although there is presently an adequate supply of labor and materials for the Company's projects, it is possible that future shortages of skilled workers and/or materials may occur.
For suburban developments, the Company generally clusters the homes sold within a project, which management believes creates efficiencies in land development and construction and improves customer satisfaction by reducing the number of vacant lots surrounding a completed home. The Company typically completes the construction of a suburban home within four months from commencement of construction, although the construction schedule for a home depends in large part on the time of year, availability of labor, materials and supplies and other factors.
In the Chicago urban market, the completion time of each project typically ranges from nine months to eighteen months depending upon the size and number of condo or loft units per project.
The Company has historically provided a one year limited warranty of workmanship and materials and a two year limited warranty on the working systems for each of its homes. Beginning in 1995, the Company expanded its warranty policy to include a ten year limited warranty against certain structural defects. Historically, the Company has not incurred any significant financial costs relating to any warranty claims or defects in construction (see "Legal Proceedings").
Marketing and Sales
The Company attracts initial interest in its communities/projects through a comprehensive marketing program that employs various forms of media such as newspaper, radio, television, direct mail, and billboards. While the Company is innovative in its use of media vehicles to market its products, it believes that its reputation for building high-quality homes also assists in this process. For that purpose, the Company complements its direct marketing in both the suburban and urban markets with a buyer referral program in which buyers of the Company's homes receive referral fees for introducing new buyers to the Company.
The Company believes that the effective use of model homes plays an integral role in demonstrating the competitive advantages of its home designs and features to prospective home buyers. The Company has an exclusive relationship with an award winning interior designer who is responsible for creating and maintaining attractive model homes for each product line.
A majority of the Company's homes are sold by full-time, commissioned employees who typically work from sales offices (open seven days a week) located within each project. Additionally, the Company sells homes through independent brokers. Employees assist prospective buyers throughout the home buying process by providing them with information from a network database on the available product lines, pricing, options and upgrades, mortgage financing (including qualifying criteria), warranties and construction. The concentration of the Company's developments within the Chicago metropolitan area makes it possible for the Company to retain sales employees for a long-term, rather than on a project-by-project basis, which management believes results in reduced training costs and a more knowledgeable and motivated sales force.
The Company's objective is to enter into sales contracts for all of its homes in advance of construction, thereby greatly reducing the risk of unsold inventory. The sales contracts for its homes generally provide for mortgage approval within a specified period. The Company attempts to minimize cancellations by requiring a nonrefundable cash deposit of approximately 5% to 10% of the purchase price for buyers using conventional financing and by training its sales force to assess the qualification of potential home buyers.
Backlog
The Company's homes are generally offered for sale in advance of their construction. A majority of the Company's home sales during 1998 were sold pursuant to standard sales contracts entered into prior to commencement of construction. The Company's standard sales contract generally requires the customer to make an earnest money deposit upon signing. This deposit may range from a nominal amount for an FHA or VA financed purchase, to 5% to 10% of the purchase price for a buyer using conventional financing. Upon execution of the contract and receipt of the deposit, the home sale is included in backlog. The Company recognizes revenue on residential sales at closing, when title to the home has passed to the buyer.
The following table provides certain backlog information for the twelve month periods presented:
The Company's backlog at any particular date is subject to substantial variation and is dependent upon several factors, including the number of homes then available for sale and the length of time necessary to complete the closing of home sales subject to pending contracts. The Company anticipates that the closing of most of the sales of homes in backlog as of September 30, 1998 will occur in fiscal 1999. However, no assurances can be given that homes in backlog will result in actual closings. The aggregate sales value of backlog increased approximately $29 million from September 30, 1997 to September 30, 1998 due primarily to the Company's entrance into five new suburban projects in the southern suburbs of Chicago and its increasing presence in the Chicago urban market.
Customer Financing
Substantially all home buyers utilize long-term mortgage financing to purchase a home. Lenders generally make loans only to borrowers who earn three to four times the total amount of the mortgage payment plus insurance and property taxes. As a result, economic conditions, increases in unemployment or high mortgage interest rates can eliminate a substantial number of potential home buyers from the market. Although mortgage financing for qualified home buyers was readily available during the year ended September 30, 1998, there can be no assurance that affordable mortgage financing will remain available to the Company's customers in the future.
FHA and VA financing generally enable home buyers to purchase homes with lower down payments than the down payments required through conventional financing, allowing a purchaser to borrow from 90% to 95% of the value of the home. The Company believes that when conventional lending rates are higher, the availability of FHA and VA financing broadens the group of potential purchasers for the Company's homes.
If conventional rates increase substantially, the Company expects the percentage of buyers applying for FHA or VA approval to increase. As of September 30, 1998, the FHA financing limit for a one unit residence was $153,000.
Competition and Market Factors
The home-building industry is a highly competitive and fragmented market. The Company competes for residential sales with national, regional and local developers and homebuilders, individual resales of existing homes and condominiums, and available rental housing. The Company also competes for the acquisition of undeveloped land on which to build homes. Sales of homes and land at deeply discounted prices by competitors, lenders and similar institutions in the markets where the Company operates could have a material adverse effect on the Company. The Company is one of the leading developers of affordable homes in the Chicago metropolitan area, and believes it is competitive as a result of its price structure, development expertise, knowledge of the local real estate market and governmental permit and approval process, and its favorable reputation in the Chicago metropolitan area home-building industry.
The Chicago urban market is less fragmented than the suburban market. While there are fewer competitors active in the market, the number is quickly growing. The Company believes that it is competitive as a result of its early entry into the market, development expertise, product design, location and the size and scope of its operation.
The home-building industry is cyclical and affected by consumer confidence levels and prevailing economic conditions in general and by employment and interest rate levels in particular. A variety of other factors affect the home- building industry and demand for new homes, including changes in costs associated with home ownership such as increases in property taxes and energy costs, changes in consumer preferences, demographic trends and the availability of and changes in mortgage financing programs.
Government Regulation and Environmental Controls
Generally, the Company must obtain numerous government approvals, licenses, permits and agreements, referred to as "entitlements," before it can commence development and construction. Through options and other financing arrangements, the Company typically controls unentitled land during the entitlement process and only purchases the land after the planning and zoning process is complete. However, obtaining the many necessary entitlements for residential developments in the Chicago metropolitan area is an extended process which generally takes one to two years and can involve a number of different governmental jurisdictions and agencies and considerable expense.
No assurance can be given that the Company will be able to obtain entitlements in such time frame in the future. The Company generally does not have any rights to develop a project until after it has received all required entitlements. Several governmental authorities in the Chicago metropolitan area have imposed fees as a means of defraying the cost of providing certain governmental services to developing areas, or have required developers to donate land to the municipality or to make certain off-site land improvements.
Certain permits and approvals will be required to complete the residential developments currently being planned by the Company. The ability of the Company to obtain necessary approvals and permits for these projects is often beyond the Company's control and could restrict or prevent the development of otherwise desirable property.
The length of time necessary to obtain permits and approvals increases the carrying costs of unimproved property acquired for the purpose of development and construction.
In addition, the continued effectiveness of permits already granted is subject to factors such as changes in policies, rules and regulations and their interpretation and application.
The Company is also subject to a variety of federal, state and local statutes, ordinances, rules and regulations concerning protection of health and the environment. These laws may result in delays, cause the Company to incur substantial compliance costs and prohibit or severely restrict development in certain environmentally sensitive regions or areas. Prior to purchasing a parcel of land, the Company evaluates such land for the presence of hazardous or toxic materials, wastes or substances. To date, the Company has not experienced any material delays as a result of these laws and the Company's operations have not been materially affected by the presence or potential presence of such materials.
Bonds and Other Obligations
The Company is frequently required, in connection with the development of its projects, to obtain performance or maintenance bonds or letters of credit. The amount of such obligations outstanding at any time varies in accordance with the Company's pending development activities. In the event any such obligations are drawn upon, the Company would be obligated to reimburse the issuing surety company or bank. At September 30, 1998, there were approximately $10.6 million in performance or maintenance bonds and approximately $4.1 million in letters of credit outstanding for such purposes (see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources").
Employees
As of September 30, 1998, the Company employed 175 persons, 65 of whom were involved in project management, land development, production, contract management and contract administration, 51 of whom were sales and marketing personnel, and 59 of whom were executive, accounting, systems and administrative personnel. Although none of the Company's employees are covered by collective bargaining agreements, many of the subcontractors and suppliers which the Company engages are represented by labor unions or are subject to collective bargaining arrangements. The Company believes that its relations with its employees, subcontractors and suppliers are good.
Item 2.
Item 2. Properties
The Company currently occupies approximately 15,500 square feet of office space for its Suburban Properties Division and its corporate headquarters in Schaumburg, Illinois. The lease for this office space began on April 1, 1998 and terminates on March 31, 2003. In addition, the Company occupies approximately 3,000 square feet of office space on a month to month basis at 201 North Wells, Chicago, Illinois for its Chicago Urban Properties Division.
Item 3.
Item 3. Legal Proceedings
The Company is involved in various routine legal proceedings incidental to the conduct of its business.
In November, 1994, a lawsuit was brought against the Company and certain directors and employees of the Company by the Board of Managers of Parkside on the Green Condominium Association. The complaint seeks damages against the Company for alleged construction defects in the approximate amount of $4.8 million, together with punitive damages against the named individuals for alleged breach of fiduciary duty. The Company has assumed the defense of this lawsuit on behalf of the individual defendants. The lawsuit is in the discovery process and various inspections of the project are underway. The Company is defending the lawsuit vigorously.
Management believes that none of these legal proceedings will have a material adverse impact on the financial condition or results of operations of the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
There were no matters submitted to a vote of security holders during the Company's fiscal quarter ended September 30, 1998.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Company's Common Stock has been quoted on the NASDAQ Stock Market's National Market (the "National Market") under the symbol SUNH since July 9, 1993. The following table shows the high and low closing prices for the Common Stock for the periods indicated as reported by the National Market:
The closing price of the Company's Common Stock as reported on the National Market on December 31, 1998 was $1.5625 per share. As of December 31, 1998, there were 41 holders of record of the Company's Common Stock.
Dividends
The Company intends to retain its future earnings to finance the continuing development of its business. Accordingly, the Company does not anticipate paying any cash dividends on its Common Stock in the foreseeable future. The payment of any future dividends will be at the discretion of the Company's Board of Directors and will depend upon, among other things, future earnings, the success of the Company's development activities, capital requirements, restrictions in financing arrangements, the general financial condition of the Company and general business conditions. At present, the Company is restricted from paying any dividends as a result of the current defaults related to the Loan Agreement. (as defined hereafter, see "Management's Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources").
Item 6.
Item 6. Selected Consolidated Financial Data
The following selected consolidated financial and operating data of the Company is qualified by reference to and should be read in conjunction with the Consolidated Financial Statements and Notes thereto and other financial data included elsewhere herein. The data set forth below as of and for the years ended September 30, 1998, 1997, and 1996, the nine months ended September 30, 1995 and the year ended December 31, 1994 have been derived from the Company's audited consolidated financial statements. Consolidated balance sheets at September 30, 1998 and September 30, 1997 and the related consolidated statements of income, changes in shareholders' equity, and cash flows for each of the three years in the period ended September 30, 1998 and notes thereto appear elsewhere herein. These historical results are not necessarily indicative of the results to be expected in the future (see "Management's Discussion and Analysis of Financial Condition and Results of Operations").
(1) Sales are recognized at closing, when title to the home has passed to the buyer (see Note 1 of the Notes to Consolidated Financial Statements).
(2) The Company is the General Partner of The Sundance-Kaco Limited Partnership, with a 75% interest in said partnership. Under the terms of the partnership agreement, the limited partner is entitled to 25% of all profits of the partnership and will receive cash distributions.
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Except for historical information, matters discussed in this Form 10-K contain forward looking information and describe the Company's belief concerning future business conditions and the outlook for the Company based on currently available information. The Company has identified these "forward looking" statements by words such as "believes", "estimates", "should", "could", "expects", "anticipates", and similar expressions. Risks and uncertainties which could cause the Company's actual results or performance to differ materially from those expressed in these statements include the following: the Company's substantial leverage, ability to comply with the terms of the proposed Forbearance Agreement (as defined below), changes in general economic and market conditions, changes in interest rates and the availability of mortgage financing, changes in costs and availability of material, supplies and labor, general competitive conditions, the availability of capital, and the ability to successfully effect acquisitions. The Company assumes no obligation to update the information contained herein.
As previously announced, the Company has restated its quarterly results for the quarters ended December 31, 1997, March 31, 1998 and June 30, 1998. See Note 12 of the Notes to the Consolidated Financial Statements.
Overview
During the year ended September 30, 1998 as compared to the year ended September 30, 1997 the company's residential sales increased by $14.2 million or 13% to $122.9 million. In addition the average sales price per home closed increased by $17,500 to $188,500 from $171,000 in fiscal 1997. The Company closed 652 homes during fiscal 1998 compared to 636 in fiscal 1997.
The Company's aggregate sales value in backlog at September 30, 1998 increased by $29.2 million or 65% to $74.4 million compared to $45.2 million at September 30, 1997. In addition, the average sales price per home of the 384 homes in backlog at September 30, 1998, increased by $10,700 per home to $193,800 from $183,100 for the 247 homes in backlog at September 30, 1997.
During fiscal 1998 the Company sold its position in two separate land parcels located in the City of Chicago and 10 fully developed lots in one of its suburban projects for $6,950,000 and $1,700,000, respectively, totaling $8,650,000 in land and building sales.
Urban Development. The Company's division which develops property under the name Chicago Urban Properties experienced significant growth in fiscal 1998. Closings increased from 95 units in fiscal 1997 to 149 units in fiscal 1998. Revenues increased from $15.6 million in fiscal 1997 to $27.3 million in fiscal 1998.
The St. Paul, Michigan Avenue and Erie Center Lofts projects were substantially completed and closed out during the year. The Company's 24-story building which contains 124 condominium units and 251 parking spaces was over 80% completed by September 30, 1998 with initial deliveries scheduled for early in 1999.
The Company's three new projects in the Chicago urban market ended the fiscal year with 130 units in backlog. These projects include two new loft conversion projects located at 625 West Jackson Street and 942 West Madison Street in Chicago, Illinois, and a 130 unit new construction mid-rise condominium project at 3232 North Halsted, Chicago, Illinois.
Suburban Communities. During the year ending September 30, 1998 the Company significantly expanded its presence in the south suburbs of Chicago by purchasing approximately 400 developed lots in Orland Park and Lockport, and 166 undeveloped lots in Bolingbrook.
The Company's custom home division, Rembrandt Homes, continued to expand by completing the acquisition of 135 lots at Gregg's Landing, a golf course community in Vernon Hills, Illinois. Of the 135 acquired lots, the Company delivered 36 homes and sold 10 developed lots during the year ended September 30, 1998.
Results of Operations
The following table sets forth by each income statement line item presented as a percentage of the Company's total sales (unless otherwise indicated) and certain other information regarding the Company's operations for the periods indicated.
Year Ended September 30, 1998 Compared to the Year Ended September 30, 1997
Residential Sales. Residential sales, which are recognized upon the closing and delivery of homes, increased $14.2 million or 13%, to $122.9 million, for the year ended September 30, 1998 as compared to $108.7 for the prior year. This increase was due primarily to the increase in the number of units closed during the year and the average selling price increase of $17,500 from $171,000 for the year ended September 30, 1997 to $188,500 for the year ended September 30, 1998.
Land Sales. During the year ended September 30, 1998 the Company sold the land and the 28 story building located at 201 N. Wells in Chicago, Illinois. In February, 1997 the Company purchased the note and mortgage on this property and on April 13, 1998 obtained title through a foreclosure sale. In addition the Company sold 10 developed lots in its Turtle Bay project in Vernon Hills, Illinois and its contractual rights to purchase a land parcel located at 1300 West Diversey in Chicago, Illinois. Revenue derived from these sales totaled $8,650,000. In fiscal 1997, no revenue was derived from land sales.
Cost of Residential Sales. Cost of residential sales includes land acquisition costs, development costs, construction costs and direct overhead, job oversight supervision, customer service, warranty costs, interest and property taxes. Cost of residential sales, as a percentage of residential sales, increased by 3.8 percentage points to 92.0% for the year ended September 30, 1998 as compared to 88.2% for the year ended September 30, 1997. Cost of residential sales increased by $17.1 million to $113.0 million from $95.9 million for the year ended September 30, 1997. The primary reasons for the increase in the cost of residential sales as a percentage of residential sales were increased costs related to interest and production overheads as well as certain increases on several of the Company's close-out projects in both its Suburban and Urban Divisions.
Selling, General and Administrative Expenses. Selling expenses include advertising, sales commissions, payroll, amortization of the costs of non- permanent upgrades to convert standard homes to model homes (draperies, wall- hangings, decor items) and maintenance of model homes. Certain expenses, such as sales commissions and amortization of model home upgrades, are derived from sales prices or the number of home sales closed and thus remain relatively constant as a percentage of residential sales. Other expenses, such as advertising costs and model home maintenance, may be significantly influenced in any given period by the number of grand openings or special promotions and the number of projects operating in that period. Costs associated with upgrading standard homes to model homes are capitalized and expensed as related home sales are closed, while most other selling expenses are expensed as incurred.
Selling expenses as a percentage of total sales increased by 0.5 percentage points to 9.3% for the year ended September 30, 1998 from 8.8% for the year ended September 30, 1997. Actual selling expenses increased by $2.7 million from $9.5 million for the year ended September 30, 1997 to $12.2 million for the year ended September 30, 1998. This increase, for the year ended September 30, 1998, resulted primarily from variable costs associated with increased deliveries, as well as increased advertising expenditures resulting from the opening of several new communities.
General and administrative expenses increased by $0.6 million to $4.9 million for the year ended September 30, 1998 compared to $4.3 million for the year ended September 30, 1997. As a percentage of total sales, general and administrative expenses were 3.7% and 4.0% for the years ended September 30, 1998 and September 30, 1997, respectively.
Year Ended September 30, 1997 Compared to the Year Ended September 30, 1996
Sales. Residential sales decreased $12.2 million to $108.7 million for the year ended September 30, 1997, a decrease of 10.1% over the twelve months ended September 30, 1996. The decrease was primarily due to an overall decline in the suburban housing market of approximately 10%. The average sales price of home sales closed also decreased slightly from $172,500 in fiscal 1996 to $171,000 in fiscal 1997.
There were 686 net new sales orders for the year ended September 30, 1997 representing an increase of 10%, or 62 orders, over the fiscal 1996 total of 624. The Company attributes the increase primarily to the expansion of its market place to include the Chicago urban market.
Cost sales decreased $10.7 million to $95.9 million in fiscal 1997 primarily as a result of lower sales volume. Cost of sales as a percent of residential sales was 88.2% in fiscal 1997 as compared to 88.2% of sales revenue in fiscal 1996.
Selling, General and Administrative Expenses. Selling expenses increased by $2.1 million from $7.4 million in fiscal 1996 to $9.5 million in fiscal 1997. As a percent of residential sales, selling expenses increased from 6.1% in the year ended September 30, 1996, to 8.8% in the year ended September 30, 1997. This increase is primarily due to increased marketing activities for several projects which did not deliver closed units and homes until fiscal 1998 and additional costs incurred due to the decision by the Company to use commissioned brokers.
General and administrative expenses decreased by $639,000 in the year ended September 30, 1997 compared to the year ended September 30, 1996. These costs have decreased due to the Company's continued efforts to reduce such expenses.
Sundance - Kaco Limited Partnership
The Company is the general partner, with a 75.0% partnership interest, in the Sundance-Kaco Limited Partnership, an Illinois limited partnership. Also participating in the partnership is Kaco, Inc, the sole limited partner, which is entitled to 25.0% of all profits from the Spring Lake Farm South project. The limited partner's share of losses for 1997 was $131,000. Pursuant to the provisions of the partnership agreement, limited partner distributions of $161,000 were paid during 1997.
Year 2000 Compliance
The Year 2000 or "Y2K" issue is the result of many legacy computer programs using a two digit format, as opposed to a four digit format, to indicate the year. Many computer systems will not be able to interpret dates beyond the year 1999, which could cause a system failure or other errors, leading to disruptions in operations. In 1997, the Company developed a three phase plan to address this issue.
Phase I of the plan, which began during the fiscal year ended September 30, 1998, is the identification of all the systems, services and key operating infrastructures where the Company has exposure. Phase II is the development and implementation of the necessary steps to bring the systems, services and infrastructures into compliance. Phase II is scheduled to be completed by spring of 1999. Phase III, which is scheduled to be completed in mid to late 1999, is the testing and acceptance of each modification necessary to the systems, service and infrastructure components identified in Phase I and implemented in Phase II. The Company has identified four major areas of focus necessary to ensure successful Y2K compliance. These are: (1) its integrated suite of accounting, costing and job control applications, (2) all custom developed enhancements to the base suite, (3) all operating infrastructure components including, but not limited to various operating systems, personal computers and their associated software tools, along with other hardware and software necessary for the operation of the business and (4) third party relationships and their respective Y2K readiness.
The Company's currently installed core accounting, costing and job control applications are not Y2K compliant. However a project is currently underway to upgrade the suite to a version which is believed to be compliant. The upgrade plan will include a corresponding upgrade of the custom developed enhancements. Many of the operating infrastructure components will require modifications to achieve compliance. These modifications are currently underway and do not directly impact the upgrade of any other system. The Company is in the process of contacting all significant suppliers and other third party relationships to obtain responses indicating compliance or plans to be compliant by the year 2000.
The Company has identified the potential for 1,000 man hours of project-related work to achieve compliance. The Company has hired outside consulting resources to help facilitate the timely completion of the projects identified. Y2K specific costs incurred to date have not been significant. Estimated future costs will range from approximately $50,000-$150,000 and are scheduled to be incurred in fiscal 1999.
A formal contingency plan has not been prepared at this time due to the variety of alternatives available to the Company.
Income Taxes
The provision for income taxes for the years ended September 30, 1997 and 1996 reflects management's estimate of the Company's effective tax rate of approximately 40.0%. During the year ended September 30, 1998, the Company has recorded a charge to earnings in fiscal 1998 of approximately $2.1 million to establish a reserve against the net deferred income tax asset which resulted from the current year net operating loss.
Seasonality and Variability in Quarterly Results
The Company has experienced, and expects to continue to experience, significant seasonally and quarter to quarter variability in residential sales and net income. Generally, the receipt of sales contracts is highest during the first six months of the calendar year. Related closings typically peak in the July through September period as homes contracted for earlier in the year are delivered. Management believes that this seasonality reflects the tendency of home buyers to shop for a new home in the Spring with the goal of closing in the Fall or Winter as well as the scheduling of construction to accommodate seasonal weather conditions (see Note 12. "Quarterly Results of Operations" in the Footnotes to Consolidated Financial Statements).
Inflation
The Company, as well as the home-building industry in general, may be adversely affected during periods of high inflation, primarily because of higher land acquisition, land development and construction costs. In addition, higher mortgage interest rates may significantly affect the affordability of mortgage financing to prospective purchasers. Inflation also increases the Company's interest costs and the cost of labor and materials. The Company attempts to pass through to its buyers any increases in its costs through increased selling prices. Inflation did not have a material impact on fiscal 1998 or 1997 results.
Liquidity and Capital Resources
Net cash provided by or used for operating activities varies from period to period, due primarily to the Company's housing inventory, land acquisition and development requirements, and in lesser part to the Company's net income. Net cash used for operations in fiscal 1998 was $24.6 million, primarily due to the acquisition of new projects.
On April 30, 1998, the Company entered into a new $80 million Revolving Credit Loan Agreement (the "Loan Agreement") with LaSalle National Bank, American National Bank and Trust Company of Chicago and BankBoston, NA (collectively, "the Lenders"), which replaced the Company's previous credit loan agreement which had provided for a $60 million line of credit. The three banks participate in the $80 million facility as follows: LaSalle National Bank, $35 million; American National Bank, $25 million; and BankBoston, $20 million. The borrowings are secured by the real estate assets of the Company with certain exceptions. Borrowings under the Loan Agreement bear interest at LIBOR plus 300 basis points for borrowings up to $70 million and prime plus 0.75% for borrowings in excess of $70 million, plus certain customary fees. The Loan Agreement was originally scheduled to mature on February 1, 2000. Available borrowings under the Loan Agreement are reduced by the amount of letters of credit outstanding. The Loan Agreement includes certain customary representations and covenants, including restrictions on the Company's ability to pay dividends and maintenance of certain financial ratios. As of September 30, 1998, the Company had violated certain covenants as set forth in the Loan Agreement, including certain financial covenants, specifically those related to net worth and net income. On December 1, 1998, the Company's Lenders declared a "default" under the Loan Agreement and the outstanding balance of the loan is due and payable, subject to the satisfactory modification of the Loan Agreement. The Company and its Lenders are currently negotiating a Forbearance and Loan Modification Agreement (the "Forbearance Agreement"). The Company believes that this agreement, when finalized, will include at a minimum the following terms:
1. Existing defaults will be waived. 2. Significant limitations will be placed on the Company's ability to acquire new land. 3. The Lenders will not further fund the 130 unit condominium apartment project known as Plaza 32 in Chicago, Illinois. 4. Interest rates will be increased from prime plus 0.75% to prime plus 3.0%. 5. Certain financial penalties will be imposed if certain revised covenants are not met in the future. 6. The maximum loan amount will be systematically reduced. 7. Other various credit limiting and monitoring devices will imposed.
Following the successful execution of the Forbearance Agreement, the Company intends to replace the existing credit line at more favorable rates and terms. There can be no assurance though, that the Company will be able to enter into the Forbearance Agreement on the terms described above or replace the existing credit line on a timely basis or at all. Failure by the Company to cure the defaults, successfully negotiate the Forbearance Agreement or negotiate replacement financing on a timely basis could have a material adverse effect on the Company's operations. As of September 30, 1998, the Company had borrowed $53.7 million under the Loan Agreement and had $4.1 million outstanding letters of credit, leaving $22.2 million available for future borrowings. The Loan Agreement was originally scheduled to mature on February 1, 2000, which date may be modified in the Forbearance Agreement.
While the Company was securing its Loan Agreement, the Company entered into certain interim financing arrangements to provide funding for certain projects which were not provided for under the Company's prior credit agreement.
On March 16, 1998 the Company entered into $15 million Construction Loan Agreement with LaSalle National Bank with a maturity date of February 20, 1999, at a rate of Prime plus 1.0%. Advances under this loan totaled $4,931,562 and were used to provide construction funds for the Company's Erie Tower Project located at 375 West Erie Street, Chicago, Illinois. Concurrent with the funding of the Loan Agreement on May 12, 1998, this Construction Loan Agreement was repaid in full.
On March 17, 1998, the Company entered into an interim financing agreement with Cohen Financial Corporation in the amount of $1.6 million at a rate of prime plus 1.0% with a maturity date of October 1, 1998. This promissory note was secured by a mortgage on the property located at 3228-3244 North Halsted Street, Chicago, Illinois. Concurrent with the funding of the Loan Agreement on May 12, 1998, this note was repaid in full.
Secured Shareholder Note Payable
On May 1, 1998, Erie Center Lofts, Inc., a wholly owned subsidiary of the Company, entered into a $2.5 million Secured Subordinated Promissory Note with a maturity date of June 30, 1999, and an interest rate of 20% with Maurice Sanderman, the Company's Chairman and Principal Shareholder. The note is secured by a junior mortgage on the property commonly known as Erie Tower located at 421 West Erie Street in Chicago, Illinois. Principal payments under this note may only be paid out of net sales proceeds from the sale of units within Erie Tower and only after all advances made under the New Loan Agreement related to the Erie Tower project have been repaid.
Unsecured Shareholder Note Payable
On February 24, 1998, the Company borrowed $487,000 on an unsecured basis from Maurice Sanderman. The unsecured note was at a prime rate plus 3.0% with a maturity date of October 1, 1998. These funds were used to pay property taxes for 1996 and 1997 which became due on a building owned by the Company at 201 North Wells, Chicago, Illinois. The payment of these taxes was not provided for under the terms of the prior credit agreement. This loan was repaid on June 30, 1998 concurrently with the closing of the sale of the building.
On March 17, 1998, in order to acquire the property located at 3228-3244 North Halsted, Chicago, Illinois, the Company borrowed $890,000 on an unsecured basis from Maurice Sanderman. The unsecured note was at a rate of prime plus 3.0% with an expiration date of October 1, 1998. The purchase of this property was not provided for under the terms of the prior credit agreement. Concurrent with the funding of the Loan Agreement, on May 12, 1998, this note was repaid in full.
On May 26, 1998 the Company borrowed $1,602,241 on an unsecured basis from Maurice Sanderman. The unsecured note was at a rate of prime plus 3.0% with a maturity date of October 1, 1998. These funds were used to pay property taxes for 1990, 1991, and 1992, which became due through a court settlement on a building owned by the Company at 201 N. Wells, Chicago, Illinois. The payment of these taxes were not provided for under the terms of the Loan Agreement. This loan was repaid in full concurrent with the closing of the sale of the building on June 30, 1998.
Transaction with the Principal Shareholder
As part of the public offering and recapitialization of the Company on July 9, 1993, the Company issued promissory notes to the Company's principal shareholder, Maurice Sanderman. The notes are subordinate to the Company's bank indebtedness, bear interest at 7.5% per annum, compounded daily, and originally matured in two equal annual payments on the first and second anniversaries of the offering. On April 30, 1998 concurrent with the execution of the Loan Agreement these notes were extended to February 1, 2000. Payment of the outstanding principal balances are subject to certain restrictions under the Loan Agreement.
Item 8.
Item 8. Financial Statements and Supplementary Data
The response to this item is submitted as a separate section of this report beginning on page.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information with respect to the directors and officers of the Company is hereby incorporated herein by reference to the sections, "Election of Directors-- Nominees," "Election of Directors --Other Directors" and "Executive Officers," in the Company's Proxy Statement which is expected to be filed with the Securities and Exchange Commission (the "Commission") in definitive form no later than February 2, 1999.
Information with respect to required Section 16(a) disclosure is hereby incorporated herein by reference to the section "Executive Officers'--Compliance with Section 16(a) of The Securities Exchange Act of 1934," in the Company's Proxy Statement which is expected to be filed with the Commission in definitive form no later than February 2, 1999.
Item 11.
Item 11. Executive Compensation
Information with respect to executive compensation is hereby incorporated herein by reference to the sections, "Election of Directors" - "Compensation of Directors", and "Executive Compensation," in the Company's Proxy Statement which is expected to be filed with the Commission in definitive form no later than February 2, 1999.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information with respect to security ownership of certain beneficial owners and management is hereby incorporated herein by reference to the section "Security Ownership of Principal Shareholders and Management," in the Company's Proxy Statement which is expected to be filed with the Commission in definitive form no later than February 2, 1999.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information with respect to certain relationships and related transactions is hereby incorporated herein by reference to the section "Certain Transactions," in the Company's Proxy Statement which is expected to be filed with the Commission in definitive form no later than February 2, 1999.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(a) (1) and (2) The response to this portion of Item 14 is submitted as a separate section of this report beginning on page.
All other schedules have been omitted because they are inapplicable, not required, or the information is included elsewhere in the consolidated financial statements or notes thereto.
(3) Exhibits: The response to this Item is incorporated by reference to Item 14(c) below.
(b) No report on Form 8-K was filed by the Company during the last quarter of the period covered by this report.
(c) The exhibits listed below are filed with this report or incorporated by reference, as set forth below.
The Company will furnish to any shareholder, upon written request, any of the exhibits listed below upon payment by such shareholder of the Company's reasonable expenses in furnishing any such exhibit.
(d) The response to this Item is incorporated by reference to Item 14(a)(2).
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this amendment to be signed on its behalf by the undersigned, thereunto duly authorized, on the 11th day of January, 1999.
SUNDANCE HOMES, INC.
By: /s/ Maurice Sanderman -------------------------------------------------------------------- Maurice Sanderman, Chairman of the Board and Chief Executive Officer
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 date indicated.
SUNDANCE HOMES, INC. ITEM 8, ITEM 14(a) (1) and (2) INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Sundance Homes, Inc.
In our opinion, the consolidated financial statements listed in the index appearing on page, present fairly, in all material respects, the financial position of Sundance Homes, Inc. and its subsidiaries at September 30, 1998 and 1997, and the results of their operations and their cash flows for the each of the three years in the period ended September 30, 1998, in conformity with generally accepted accounting principles. 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 generally accepted auditing standards 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 that our audits provide a reasonable basis for the opinion expressed above.
The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 5 to the financial statements, the Company has violated certain loan covenants and accordingly is in default of its revolving credit loan agreement. The Company has been unable to renegotiate the terms of the revolving credit loan agreement or to secure alternative financing. The inability of the Company to resolve the loan default under its current loan agreement or to obtain alternative financing to meet its obligations as they become due raises substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to this matter are also described in Note 5. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
/s/ PricewaterhouseCoopers LLP Chicago, Illinois December 23, 1998
The accompanying notes are an integral part of these financial statements.
SUNDANCE HOMES, INC. CONSOLIDATED BALANCE SHEETS (in thousands, except share data)
The accompanying notes are an integral part of these financial statements.
SUNDANCE HOMES, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands, except per share data)
The accompanying notes are an integral part of these financial statements.
SUNDANCE HOMES, INC. CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (in thousands)
The accompanying notes are an integral part of these financial statements.
SUNDANCE HOMES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)
The accompanying notes are an integral part of these financial statements.
SUNDANCE HOMES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 1998
Note 1 - Summary of Significant Accounting Policies: - ----------------------------------------------------
Nature of business
Sundance Homes, Inc. is engaged in the development of land and construction of attached and detached single-family homes and urban residential buildings in the Chicago metropolitan area.
Principles of consolidation
The consolidated financial statements include the accounts of Sundance Homes, Inc., its wholly-owned subsidiaries (the "Company") and its investment in a majority-owned limited partnership. All significant intercompany accounts and transactions have been eliminated in consolidation.
Revenue recognition
Residential sales are recognized at closing when title to the home has passed to the buyer. The Company's homes are generally offered for sale in advance of their construction. To date, most of the Company's homes have been sold pursuant to standard sales contracts entered into prior to commencement of construction. The Company's standard sales contracts generally require the customer to make an earnest money deposit. This deposit may range from a nominal amount for an FHA or VA financed purchase to 5% to 10% of the purchase price for a buyer using conventional financing.
Land sales are recognized when the Company has received an adequate cash down payment and all other conditions necessary for profit recognition have been satisfied.
Real estate inventories and cost of sales
Real estate inventories are carried at cost, which is less than fair value, and include land, land development, direct and certain indirect construction costs, interest and real estate taxes.
At the time of revenue recognition, cost of sales is charged with the actual construction costs incurred and any estimate to complete, plus an allocation, based upon relative sales value, of the total estimated cost of land and land development, interest, real estate taxes and any other capitalizable common costs. The Company generally provides a one year limited warranty of workmanship and materials and a two year limited warranty on the working systems for each of its homes. Accordingly, a warranty reserve, based on the Company's historical experience, is provided as residential sales are closed. This reserve is reduced by the cost of subsequent work performed.
The accompanying notes are an integral part of these financial statements.
Interest capitalization
Interest and related debt issuance costs are capitalized to qualifying real estate inventories as incurred, in accordance with Statement of Financial Accounting Standards (SFAS) No. 34, "Capitalization of Interest Cost", and charged to cost of sales as revenue from residential sales is recognized.
Property and equipment
Property and equipment are carried at cost less accumulated depreciation and are depreciated using straight line and accelerated methods over the estimated useful lives of the assets, except for model home upgrades and furnishings which are amortized as related home sales in a development are closed. Significant additions and improvements are capitalized, while expenditures for maintenance and repairs are charged to operations as incurred. The cost and accumulated depreciation of property and equipment sold or retired are removed from the respective accounts and the resultant gains or losses, if any, are included in current operations.
Advertising costs
The Company attracts initial interest in its projects through a comprehensive advertising program using media such as newspapers, direct mail, telemarketing, billboards and, to a lesser extent, radio and television. Advertising costs, which are expensed as incurred, aggregated approximately $3.3 million, $3.6 million and $1.9 million during the years ended September 30, 1998, 1997 and 1996, respectively.
Income taxes
Deferred income taxes are determined under the asset and liability method in accordance with SFAS No. 109 "Accounting for Income Taxes". Under SFAS No. 109, deferred income taxes arise from temporary differences between the income tax basis of assets and liabilities and their reported amounts in the consolidated financial statements.
Cash and equivalents
For purposes of reporting cash flows, the Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.
Supplemental disclosures of cash flow information are as follows (in thousands):
The accompanying notes are an integral part of these financial statements.
Use of estimates
The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the year then ended. Actual results could differ from those estimates.
Reclassification of Results of Operations
Certain amounts for 1997 and 1996 were reclassified to conform to the 1998 financial presentation.
Note 2 - Change in Accounting Policy - ------------------------------------
Effective October 1, 1997 the company adopted Statement of Position (SOP) No 98- 5, Reporting on the Costs of Start-up Activities and Organization Costs. Costs of start up activities and organization costs are expensed as incurred. The cumulative effect of this change in accounting principle decreased net assets at October 1, 1997 by $2,234,000, net of related tax effect of $1,490,000.
Note 3 - Real Estate Inventories: - ---------------------------------
Real estate inventories are summarized as follows (in thousands):
Completed homes include models constructed to help market a development and include allocations of land, development and other common costs. Speculative homes represent non-model homes which are substantially complete and are not subject to a sales contract. During the year ended September 30, 1998, the Company entered into a sale leaseback agreement with a third party. Sales revenue derived from the 31 units sold subject to this agreement totaled $5.5 million. Annual lease payments due under the leaseback provisions of the agreement will be approximately $.6 million for the year ended September 30, 1999.
The accompanying notes are an integral part of these financial statements.
Capitalized interest is included in real estate inventories as follows (in thousands):
A reserve is provided as a charge against earnings when the carrying amount of any of the Company's inventories exceeds its fair value. Fair value represents the expected selling price a property will bring in the open market reduced by (a) the estimated cost to complete and improve such property to the condition expected in determining the selling price, (b) disposition costs, and (c) estimated costs to hold the property to the point of sale, including interest carrying costs and other net cash flow requirements of the project. During the year ended September 30, 1998, the Company recorded valuation reserves totaling $850,000.
Note 4 - Property and Equipment: - --------------------------------
Property and equipment are summarized as follows (in thousands):
The accompanying notes are an integral part of these financial statements.
Note 5 - Notes and Mortgages Payable: - ------------------------------------
Notes and mortgages payable are summarized as follows (in thousands):
On April 30, 1998, the Company entered into a new $80 million Revolving Credit Loan Agreement (the "Loan Agreement") with LaSalle National Bank, American National Bank and Trust Company of Chicago and BankBoston, NA (collectively, "the lenders"), which replaced the Company's previous credit loan agreement which had provided for a $60 million line of credit. The three banks participate in the $80 million facility as follows: LaSalle National Bank, $35 million; American National Bank and Trust Company of Chicago, $25 million; and BankBoston, NA, $20 million. The borrowings are secured by the real estate assets of the Company with certain exceptions. Borrowings under the Loan Agreement bear interest at LIBOR plus 300 basis points for borrowings up to $70 million and prime plus 0.75% for borrowings in excess of $70 million, plus certain customary fees. The Loan Agreement was originally scheduled to mature on February 1, 2000. Available borrowings under the Loan Agreement are reduced by the amount of letters of credit outstanding. The Loan Agreement includes certain customary representations and covenants, including restrictions on the Company's ability to pay dividends and maintenance of certain financial ratios. As of September 30, 1998, the Company had violated certain covenants as set forth in the Loan Agreement, including certain financial covenants, specifically those related to net worth and net income. On December 1, 1998, the Company's Lenders declared a "default" under the Loan Agreement and the outstanding balance of the loan is due and payable, subject to the satisfactory modification of the Loan Agreement. The Company and its Lenders are currently negotiating a Forbearance and Loan Modification Agreement (the "Forbearance Agreement").
Following the successful execution of the Forbearance Agreement, the Company intends to replace the existing credit line at more favorable rates and terms. There can be no assurance though, that the Company will be able to enter into the Forbearance Agreement on the terms described above or replace the existing credit line on a timely basis or at all. Failure by the Company to cure the defaults, successfully negotiate the Forbearance Agreement or negotiate replacement financing on a timely basis could have a material adverse effect on the Company's operations. As of September 30, 1998, the Company had borrowed $53.7 million under the Loan Agreement and had $4.1 million outstanding letters of credit, leaving $22.2 million available for future borrowings. The Loan Agreement was originally scheduled to mature on February 1, 2000, which date may be modified in the Forbearance Agreement.
While the Company was securing its Loan Agreement, the Company entered into certain interim financing arrangements to provide funding for certain projects which were not provided for under the Company's prior credit agreement.
On March 16, 1998 the Company entered into $15 million Construction Loan Agreement with LaSalle National Bank with a maturity date of February 20, 1999, at a rate of Prime plus 1.0%.
The accompanying notes are an integral part of these financial statements.
Advances under this loan totaled $4,931,562 and were used to provide construction funds for the Company's Erie Tower Project located at 375 West Erie Street, Chicago, Illinois. Concurrent with the funding of the Loan Agreement on May 12, 1998, this Construction Loan Agreement was repaid in full.
On March 17, 1998, the Company entered into an interim financing agreement with Cohen Financial Corporation in the amount of $1.6 million at a rate of prime plus 1.0% with a maturity date of October 1, 1998. This promissory note was secured by a mortgage on the property located at 3228-3244 North Halsted Street, Chicago, Illinois. Concurrent with the funding of the Loan Agreement on May 12, 1998, this note was repaid in full.
The Company entered into interim financing agreements with the Principal Shareholder as described in Note 6.
Notes payable to land sellers are non-interest bearing and are repaid through application of agreed upon amounts from the proceeds of individual home sale closings.
Scheduled maturities of notes and mortgages payable in future periods are as follows (in thousands):
Interest and related debt issuance costs incurred, all of which were capitalized, during the year ended September 30, 1998, 1997 and 1996, aggregated approximately $6.8 million, $4.5 million and $3.5 million, respectively.
Note 6 - Subordinated Notes and Notes Payable to Principal Shareholder: - -----------------------------------------------------------------------
Secured Note Payable
On May 1, 1998, Erie Center Lofts, Inc., a wholly owned subsidiary of the Company, entered into a $2.5 million Secured Subordinated Promissory Note with a maturity date of June 30, 1999, and an interest rate of 20% with Maurice Sanderman, the Company's Chairman and President. The note is secured by a junior mortgage on the property commonly known as Erie Tower located at 421 West Erie Street in Chicago, Illinois. Principal payments under this note may only be paid out of net sales proceeds from the sale of units within Erie Tower only after all advances made under the New Loan Agreement related to the Erie Tower project have been repaid.
The accompanying notes are an integral part of these financial statements.
Unsecured Notes Payable
On February 24, 1998, the Company borrowed $487,000 on an unsecured basis from Maurice Sanderman. The unsecured note was at a prime rate plus 3.0% with a maturity date of October 1, 1998. These funds were used to pay property taxes for 1996 and 1997 which became due on a building owned by the Company at 201 North Wells, Chicago, Illinois. The payment of these taxes was not provided for under the terms of the prior credit agreement. This loan was repaid on June 30, 1998 concurrently with the closing of the sale of the building.
On March 17, 1998, in order to acquire the property located at 3228-3244 North Halsted, Chicago, Illinois, the Company borrowed $890,000 on an unsecured basis from Maurice Sanderman. The unsecured note was at a rate of prime plus 3.0% with an expiration date of October 1, 1998. The purchase of this property was not provided for under the terms of the prior credit agreement. Concurrent with the funding of the Loan Agreement, on May 12, 1998, this note was repaid in full.
On May 26, 1998 the Company borrowed $1,602,241 on an unsecured basis from Maurice Sanderman. The unsecured note was at a rate of prime plus 3.0% with a maturity date of October 1, 1998. These funds were used to pay property taxes for 1990, 1991 and 1992, which became due through a court settlement on a building owned by the Company at 201 N. Wells, Chicago, Illinois. The payment of these taxes were not provided for under the terms of the Loan Agreement. This loan was repaid in full concurrent with the closing of the sale of the building on June 30, 1998.
Prior to the Company completing the public offering on July 9, 1993, the Company was recapitalized and reorganized into a parent-subsidiary structure, thereby terminating its S Corporation status. The Company declared aggregate distributions of S Corporation earnings to its Principal Shareholder in an aggregate amount such that beginning shareholders' equity as a C Corporation would be $5 million.
The accompanying notes are an integral part of these financial statements.
During the twelve months ended December 31, 1993, such distributions aggregated $9.1 million, of which $4.9 million was paid out of available cash, while the remaining $4.2 million was paid in the form of promissory notes, which are subordinate to the Company's bank indebtedness, bear interest at 7.50% which compounds daily and originally matured in two equal annual installments on the first and second anniversaries of the offering. On April 30, 1998, the maturity date of the notes was extended to February 1, 2000. Payment of the annual installments is subject to certain restrictions under the Company's Revolving Credit Loan Agreement (see Note 5 - Notes and Mortgages Payable).
Note 7 - Income Taxes: - ----------------------
The provision (benefit) for income taxes was as follows (in thousands):
Reconciliation's of the statutory Federal income tax rate of 34% to the effective income tax rate are as follows (in thousands):
The accompanying notes are an integral part of these financial statements.
The Company's net deferred tax asset is reserved through the establishment of a tax valuation allowance. The valuation allowance of $2.1 million was recorded upon consideration of the recent operating results and related uncertainty associated with realization of the tax benefit of the net operating loss carryforward, which is ultimately dependent upon the generation of future earnings of the Company.
The consolidated balance sheets included the following net deferred tax (assets) or net deferred tax liabilities:
The Company has entered into a tax indemnification agreement with the Principal Shareholder of the Company which provides for, among other things, the indemnification of the Principal Shareholder for any losses or liabilities with respect to any additional taxes (including interest, penalties and legal fees) resulting from the Company's operations during the period in which it was an S Corporation.
Note 8 - Minority Interest: - ---------------------------
During 1993, one of the Company's subsidiaries, acting as general partner with a 75% ownership interest, entered into a limited partnership with a land seller. Under the terms of this limited partnership agreement, the Company purchased the land from the seller for approximately $1.4 million, payable over the term of the agreement as home sales are closed. This partnership began closing homes in March, 1994.
The income(loss) from the limited partnership's operations is allocated to the general and limited partner based upon their relative ownership interests. Distributions with respect thereto are paid as outlined in the agreements.
The accompanying notes are an integral part of these financial statements.
A reconciliation of the minority interest balance as presented in the Consolidated Balance Sheets is as follows (in thousands):
Note 9 - Stock Incentive Plan and Directors Options Plan - --------------------------------------------------------
Stock Incentive Plan
The Board of Directors and shareholders adopted the Sundance Homes, Inc. Stock Incentive Plan (the "Stock Incentive Plan") effective as of April 7, 1993. The purpose of the Stock Incentive Plan is to enable officers and key employees of the Company to participate in the Company's future and to enable the Company to attract and retain these persons by offering them proprietary interests in the Company. The Stock Incentive Plan is administered by the Company's compensation committee and authorizes the issuance of up to 525,000 shares of common stock pursuant to the grant or exercise of stock options, stock appreciation rights, restricted or deferred stock.
Prior to the offering in July of 1993, the Company granted stock options under the Stock Incentive Plan to certain of its employees who were not previously shareholders of the Company to purchase up to 250,000 shares of common stock in the aggregate for a purchase price per share equal to the initial public offering price. Options granted to these officers will vest 25% per year on the anniversary of the grant date for four years and will expire after 10 years.
The accompanying notes are an integral part of these financial statements.
Directors Option Plan
Outside Directors are granted options by the Company's compensation committee which is authorized to issue of up to 100,000 shares of common stock. Directors are granted options to acquire 5,000 shares of Common Stock on each of: (1) the date on which a person is elected as a Director, (2) the date of the first annual meeting of shareholders held subsequent to such person's election and, (3) the date of each succeeding annual meeting of shareholders after which the person is still serving as a director (with a limit of options to acquire a total of 25,000 shares to be granted to any Outside Director). All options granted under the Director's Plan are exercisable on the one year anniversary date of the grant and, at a price per share equal to the closing price of the Common Stock as reported on the NASDAQ National Market on the date of the grant or, if the market is closed on such date, the next business day. Options will expire after ten years.
Option activity for both plans for the three years ended September 30, 1998 is as follows:
The fair value of each option grant was estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions:
The accompanying notes are an integral part of these financial statements.
The following table summarizes information about stock options at September 30, 1998:
The Company has applied Accounting Principles Board Opinion No. 25 and related interpretations in accounting for its Plan, accordingly, no compensation costs have been recognized. Had compensation costs for the Company's Plan been determined based on the fair value at the grant date for the options granted in 1998, 1997, and 1996 in accordance with the method required by Statement of Financial Accounting Standards No. 123, the Company's net income per share would have been reduced to the pro forma amounts as follows:
Note 10 - Employee Benefit Plan: - --------------------------------
The Company maintains a contributory profit sharing plan established pursuant to the provisions of Section 401(k) of the Internal Revenue Code which provides retirement benefits for eligible employees of the Company and its subsidiaries. The Company may make annual discretionary contributions to the plan. There were no discretionary contributions during the years ended September 30, 1998, 1997 and 1996.
The accompanying notes are an integral part of these financial statements.
Note 11 - Commitments and Contingencies: - ----------------------------------------
The Company is frequently required, in connection with the development of its projects, to obtain performance or other maintenance bonds or letters of credit in lieu thereof. The amount of such obligations outstanding at any time varies in connection with the Company's pending development activities. In the event any such obligations are drawn upon, the Company would be obligated to reimburse the issuing surety company or bank. At September 30, 1998, there were approximately $10.6 million in performance or maintenance bonds and approximately $4.1 million of letters of credit outstanding for such purposes. There have been no such draws during the years ended September 30, 1998 and 1997.
The Company currently leases 15,500 square feet of office space in Schaumburg, Illinois where its Suburban Properties Division is located. The Company also leases approximately 3,000 square feet of office space in Chicago, Illinois, where the Chicago Urban Properties Division is located. Certain equipment is also currently leased under non-cancelable operating leases. Rent expense under such leases aggregated $480,000, $436,000 and $380,000 during the years ended September 30, 1998, 1997 and 1996, respectively. As discussed in Note 3 to the financial statements, the Company sold certain model homes to an unrelated third party and is leasing them back from the buyer. Rent expense under the sale leaseback agreement was $153,000 during the year ended September 30, 1998.
Additionally, the Company is involved in various routine legal proceedings which the Company believes to incidental to the conduct of its business. Specifically, In November, 1994, a lawsuit was brought against the Company and certain directors and employees of the Company by the Board of Managers of Parkside on the Green Condominium Association. The complaint seeks damages against the Company for alleged construction defects in the approximate amount of $4.8 million, together with punitive damages against the named individuals for alleged breach of fiduciary duty. The Company has assumed the defense of this lawsuit on behalf of the individual defendants. The lawsuit is in the discovery process and various inspections of the project are underway. The Company is defending the lawsuit vigorously. Management believes that none of these legal proceedings will have a material adverse impact on the financial condition or results of operations of the Company.
The accompanying notes are an integral part of these financial statements.
Note 12 - Quarterly Results of Operation (unaudited): - -----------------------------------------------------
The following table reflects the results of operations for the Company during the four quarters of 1998 and 1997. Certain of the quarterly information has been restated, as described below (dollars in thousands, except unit and per share data):
(1) Reversal of parking unit closings because the transfer of legal title was incomplete.
(2) To reflect changes in construction costs that were not recognized on a timely basis.
(3) To reflect the change in accounting policy related to the early adoption of SOP 98-5, Reporting on the costs of Start-up Activities and Organization Costs, refer to Note 2.
The accompanying notes are an integral part of these financial statements.
+ Quarterly Results of Operations have been reclassified to conform to the 1998 financial presentation.
The accompanying notes are an integral part of these financial statements.