10-K 1 ten-k.txt 10-K FORM 10-K SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended June 30, 2005 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission File Number 1-6830 ORLEANS HOMEBUILDERS, INC. (formerly FPA Corporation) ------------------------------------------------------ (Exact name of registrant as specified in its charter)
One Greenwood Square, #101 3333 Street Road Delaware 59-0874323 Bensalem, PA 19020 ------------------------------- ------------------ --------------------------------------- (State or other jurisdiction of (I.R.S. Employer (Address of Principal Executive Office) incorporation or organization) Identification No.)
(215) 245-7500 --------------------------------------------------- (Registrant's telephone number, including area code) Securities registered pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class on which Registered -------------------------------------- ------------------------ Common Stock, $.10 Par Value Per Share American Stock Exchange (also formerly registered under Section 12(g) of the Act) Securities Registered Pursuant to Section 12(g) of the Act: None 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 twelve months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. YES X NO --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ____ Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES X NO --- --- The aggregate market value of the registrant's Common Stock held by non-affiliates of the registrant as of December 31, 2004 was $80,946,851. Number of shares of the registrant's outstanding Common Stock as of August 22, 2005 was 18,521,220 shares (excluding 176,911 shares held in Treasury). Documents incorporated by reference: Part III is incorporated by reference to the proxy statement for the annual meeting of Stockholders scheduled to be held in December 2005. TABLE OF CONTENTS PART I ------
PAGE ---- ITEM 1. Business 1 ITEM 2. Properties 13 ITEM 3. Legal Proceedings 14 ITEM 4. Submission of Matters to a Vote of Security Holders 14 PART II ------- ITEM 5. Market for Registrant's Common Stock and Related Stockholder Matters 14 ITEM 6. Selected Financial Data 15 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations 17 ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk 51 ITEM 8. Financial Statements and Supplementary Data 52 ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 92 ITEM 9A. Controls and Procedure 92 ITEM 9B. Other Information 93 PART III -------- ITEM 10. Directors and Executive Officers of Registrant 94 ITEM 11. Executive Compensation 94 ITEM 12. Security Ownership of Certain Beneficial Owners and Management 94 ITEM 13. Certain Relationships and Related Transactions 94 ITEM 14. Principal Accountant Fees and Services 94 PART IV ------- ITEM 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K 95
ITEM 1. BUSINESS. ------- --------- GENERAL Orleans Homebuilders, Inc. and its subsidiaries (collectively, the "Company", "OHB" or "Orleans") primarily develop, build and market high-quality single-family homes, townhouses and condominiums. The Company also operates as a land developer, primarily for its own use. The Company serves a broad customer base, including first time, move-up, luxury, empty nester and active adult homebuyers. During its fiscal year ended June 30, 2005, the Company operated in the following thirteen markets: Southeastern Pennsylvania; Central New Jersey; Southern New Jersey; Charlotte, Raleigh and Greensboro, North Carolina; Richmond and Tidewater, Virginia; Orlando, Palm Coast and Palm Bay, Florida; Orange County, New York; and Chicago, Illinois. In the Company's Charlotte, North Carolina market, it also has operations in adjacent counties in South Carolina. References to a given fiscal year in this Annual Report on Form 10-K are to the fiscal year ended June 30th of that year. For example, the phrases "fiscal 2005" and "2005 fiscal year" refer to the fiscal year ended June 30, 2005. When used in this report, "northern region" refers to the Company's Pennsylvania and New Jersey markets; "southern region" refers to the Company's North Carolina and Virginia markets; "Florida region" refers to the Company's Florida markets; and "midwestern region" refers to the Company's Illinois market. The Company has been in operation for over 85 years and is a leading homebuilder in the Pennsylvania and New Jersey markets. In October 2000, pursuant to a strategic initiative to target growth in new geographic markets, the Company entered the North Carolina and Virginia markets through the acquisition of Parker & Lancaster Corporation ("PLC"), a privately-held residential homebuilder. In July 2003, the Company entered the Orlando Florida market through its acquisition of Masterpiece Homes, Inc. ("Masterpiece Homes"), an established homebuilder located in Orange City, Florida. In July 2004, the Company entered the Chicago, Illinois market through the acquisition of Realen Homes, L.P. ("Realen Homes"), an established privately-held homebuilder with operations in Southeastern Pennsylvania and Chicago, Illinois. On December 23, 2004, pursuant to an Asset Purchase Agreement of the same date, the Company acquired certain real estate assets from Peachtree Residential Properties, LLC and Peachtree Townhome Communities, LLC which were wholly-owned subsidiaries of Peachtree Residential Properties, Inc. (collectively, "Peachtree Residential Properties") at the time of acquisition. Except as specifically indicated, information in this report includes the operations of Masterpiece Homes beginning July 29, 2003 and Realen Homes beginning July 28, 2004 as well as the revenue and expenses associated with the real estate assets acquired from Peachtree Residential Properties. See Note 2 of Notes to Consolidated Financial Statements for further details regarding the acquisitions of PLC, Masterpiece Homes, Realen Homes, and Peachtree Residential Properties. 1 During fiscal 2005, the Company delivered 2,507 homes, as compared to 1,753 homes delivered during fiscal 2004. Earned revenues from residential property activities increased by 68% during fiscal 2005 to $911,004,000 as compared to $540,745,000 in fiscal 2004. The Company's backlog at June 30, 2005 was $553,237,000, representing 1,406 homes, which was 42% greater than the backlog of $390,827,000, representing 1,119 homes, at June 30, 2004. At June 30, 2005, the Company was selling in 85 communities and owned or controlled approximately 17,100 building lots, as compared to 81 communities and approximately 12,300 owned or controlled building lots at June 30, 2004. With its backlog and lot position, the Company believes it is well positioned to continue its growth. Jeffrey P. Orleans, Chairman of the Board and Chief Executive Officer of the Company, beneficially owns (as determined in accordance with Rule 13d-3 under the Securities Exchange Act of 1934, as amended) approximately 61% of the Company's issued and outstanding shares of common stock, par value $.10 per share ("Common Stock"). The Company makes available free of charge through the Company's website (www.orleanshomes.com) its annual reports on Form 10-K, quarterly reports on Form 10-Q and 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 as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the Securities and Exchange Commission. HOMEBUILDING The Company's activities in developing residential communities include the sale of residential properties and, on a limited basis, the sale of land and developed homesites to other builders. The Company occasionally participates in joint ventures in certain of these activities. NORTHERN REGION. The Company's northern region is comprised of its Southeastern Pennsylvania, Central New Jersey, Southern New Jersey, and New York markets. The Company conducts business in the northern region under the Orleans Homebuilders brand name. In the northern region, the Company currently builds homes predominantly targeted toward move-up, luxury, empty nester and active adult homebuyers with an average regional home sales price of $468,000 in backlog as of June 30, 2005. During fiscal 2005, the Company delivered 852 homes in the northern region, generating $385 million or 42.2% of its residential revenue. During fiscal 2004, the Company delivered 669 homes in the northern region, generating $275 million, or 50.8% of its residential revenue. SOUTHERN REGION. The Company's southern region is comprised of its Richmond and Tidewater, Virginia and Charlotte, Raleigh and Greensboro, North Carolina markets. The Company entered these markets in October 2000 through its 2 acquisition of PLC and conducts business in these markets under the Parker & Orleans Homebuilders brand name. The Company in the southern region currently builds homes predominantly targeted toward the move-up homebuyer with an average regional home sales price of $424,000 in backlog as of June 30, 2005. During fiscal 2005, the Company delivered 827 homes in the southern region, generating $304 million, or 33.4% of its residential revenue. During fiscal 2004, the Company delivered 651 homes in the southern region, generating $205 million or 37.9% of its residential revenue. FLORIDA REGION. In its Florida region, the Company has operations in the Orlando and Palm Coast and Palm Bay markets. The Company entered the Florida region through its acquisition of Masterpiece Homes in July 2003. The Company conducts business in this region under the Masterpiece Homes brand name. The Company in the Florida region currently builds homes predominantly targeted toward the first-time homebuyer with an average regional home sales price of $240,000 in backlog as of June 30, 2005. During fiscal 2005, the Company delivered 456 homes in the Florida region, generating $82 million, or 9.0% of its residential revenue. During fiscal 2004, the Company delivered 433 homes in the Florida region, generating $61 million or 11.3% of its residential revenue. MIDWESTERN REGION. In its midwestern region, the Company has operations in the Chicago area. The Company entered this market through its acquisition of Realen Homes in July 2004. The Company conducts business in this region under the Realen Homes brand name. The Company in the midwestern region currently builds homes predominantly targeted toward the move-up homebuyer with an average regional home sales price of $419,000 in backlog as of June 30, 2005. For fiscal 2005, in the midwestern region the Company delivered 372 homes, generating $140 million, or 15.4% of its residential revenue. The following tables set forth certain information with respect to our residential communities and residential revenues by region and type of home. For additional financial information, including information relating to the Company's profits, see Item 7 and Item 8 in this annual report. RESIDENTIAL COMMUNITIES AS OF JUNE 30, 2005
NUMBER OF BACKLOG NUMBER OF HOMES AVERAGE SALES REGION COMMUNITIES HOME PRICE RANGE IN THOUSANDS IN BACKLOG PRICE IN BACKLOG ------ ----------- ---------------- ------------ --------------- ----------------- Northern 27 $ 256,000 - $ 914,000 $ 250,521 535 $ 468,000 Southern 46 124,000 - 725,000 158,291 373 424,000 Florida 6 145,000 - 332,000 86,202 359 240,000 Midwestern 6 180,000 - 459,000 58,223 139 419,000 --- --------- ----- Total 85 $ 553,237 1,406 === ========= =====
3 RESIDENTIAL REVENUE BY TYPE OF HOME FOR THE FISCAL YEAR ENDED JUNE 30: (IN THOUSANDS)
FISCAL YEAR ENDED JUNE 30, 2005 2004 2003 --------------------------- -------------------------- ---------------------------- RESIDENTIAL PERCENT OF RESIDENTIAL PERCENT OF RESIDENTIAL PERCENT OF REVENUE REVENUE REVENUE REVENUE REVENUE REVENUE ----------- ---------- ----------- ----------- ----------- ----------- TYPE OF HOME Single family $ 753,267 83% $ 448,818 83% $ 287, 963 75% Townhouses 145,420 16% 81,112 15% 70,764 19% Condominiums 12,317 1% 10,815 2% 23,843 6% ---------- -------- ----------- --------- ----------- --------- Total $ 911,004 100% $ 540,745 100% $ 382,570 100% ========== ======== =========== ========= =========== =========
4 The following table sets forth certain details as to residential sales activity. The information provided is for the fiscal years ended June 30, 2005, 2004 and 2003 in the case of revenues earned and new orders, and as of June 30, 2005, 2004 and 2003 in the case of backlog. The Company classifies a sales contract or potential sale as a new order for backlog purposes at the time a homebuyer executes a contract to purchase a home from the Company.
YEAR ENDED JUNE 30, ----------------------------------------------------------- (IN THOUSANDS, EXCEPT HOMES DATA) ----------------------------------------------------------- NORTHERN REGION 2005 2004 2003 NEW JERSEY AND PENNSYLVANIA (1) ----------------------------------------------------------- Residential revenue $ 384,645 $ 274,606 $ 247,035 Homes 852 669 766 Average Price $ 451 $ 410 $ 323 New Orders $ 352,347 $ 294,384 $ 286,345 Homes 727 670 761 Average Price $ 485 $ 439 $ 376 Backlog $ 250,521 $ 209,712 $ 189,934 Homes 535 463 462 Average Price $ 468 $ 453 $ 411 SOUTHERN REGION NORTH CAROLINA, SOUTH CAROLINA AND VIRGINIA (2) Residential revenue $ 304,132 $ 204,798 $ 135,535 Homes 827 651 477 Average Price $ 368 $ 315 $ 284 New Orders $ 306,280 $ 237,232 $ 175,928 Homes 788 698 587 Average Price $ 389 $ 340 $ 300 Backlog $ 158,291 $ 128,267 $ 95,833 Homes 373 337 290 Average Price $ 424 $ 381 $ 330 FLORIDA REGION (3) Residential revenue $ 82,269 $ 61,341 - Homes 456 433 - Average Price $ 180 $ 142 - New Orders 115,623 72,527 - Homes 496 454 - Average Price $ 233 $ 160 - Backlog $ 86,202 $ 52,848 - Homes 359 319 - Average Price $ 240 $ 166 - MIDWESTERN REGION (4) Residential revenue $ 139,958 - - Homes 372 - - Average Price $ 376 - - New Orders $ 100,503 - - Homes 245 - - Average Price $ 410 - - Backlog $ 58,223 - - Homes 139 - - Average Price $ 419 - -
5
COMBINED REGIONS Residential revenue $ 911,004 $ 540,745 $ 382,570 Homes 2,507 1,753 1,243 Average Price $ 363 $ 308 $ 308 New Orders $ 874,753 $ 604,143 $ 462,273 Homes 2,256 1,822 1,348 Average Price $ 388 $ 332 $ 343 Backlog $ 553,237 $ 390,827 $ 285,767 Homes 1,406 1,119 752 Average Price $ 393 $ 349 $ 380
(1) For fiscal 2005, information on residential revenue and new orders includes the acquired operations of Realen Homes' Southeastern Pennsylvania region from the date of acquisition, July 28, 2004, through June 30, 2005. (2) For fiscal 2005, information on residential revenue and new orders includes amounts acquired from Peachtree Residential Properties for the period beginning December 23, 2004, the date the Company acquired the assets, through June 30, 2005. (3) Information on residential revenue and new orders is for the period beginning July 28, 2003, the date the Company entered this region through its acquisition of Masterpiece Homes. (4) For fiscal 2005, information on residential revenue and new orders is for the period beginning July 28, 2004, the date the Company entered this region through its acquisition of Realen Homes. CONSTRUCTION The Company historically has designed its own homes with the assistance of unaffiliated architectural firms as well as supervised the development and building of its communities. When the Company constructs homes, it acts as a general contractor and employs subcontractors at specified prices for the installation of site improvements and construction of its residential homes. The Company's agreements with subcontractors provide for a fixed price for work performed or materials supplied. A large majority of the Company's single-family detached homes are constructed after contracts are signed and mortgage approval has been obtained. The Company generally begins construction of condominium and townhouse buildings after it has obtained customer commitments for at least 50% of the homes in that building. Depending on the market conditions and the specific community, the Company may also build speculative homes. Most of these speculative homes are sold while under construction. The Company monitors its speculative inventory to achieve an adequate return on investment. The Company does not manufacture any of the materials or other items used in the development of its communities, nor does it maintain substantial inventories of materials. The Company has not experienced significant delays in obtaining materials needed to date and has long-standing relationships with many of its major suppliers and contractors. None of the Company's suppliers accounted for more than 10% of its total purchases in fiscal 2005. Hurricane Katrina and the resulting gas price increases may have an adverse impact on the economy and the availability of labor and materials, which could result in higher construction costs or delays in obtaining materials. The Company does not operate in the areas affected by Hurricane Katrina. 6 PURCHASING AND BUDGETING The Company has established relationships with a number of vendors and suppliers in each of its markets. The Company believes these relationships reduce its exposure to any market shortages of labor or materials. The Company has negotiated price arrangements that it believes are favorable to it with both national and regional suppliers to purchase items such as lumber, appliances, plumbing fixtures, floor coverings and other high-quality equipment and materials. The Company has established budgets for all of its home designs and offered options. These budgets are modified and adjusted by local division management to reflect the specifications needed to meet market demands and local cost variances. SALES AND MARKETING The Company markets its homes to various homebuyer segments according to the specific needs of each market. The Company advertises extensively using newspapers, industry publications, direct mail, radio, billboards and its own brochures. The Company has developed and maintains its websites, www.orleanshomes.com, www.parkerorleans.com and www.masterpiecehomesflorida.com, to provide prospective homebuyers with information regarding its communities, available home designs and price ranges, as well as a multimedia gallery offering panoramic video tours and streaming video presentations of some of its homes. The Company typically utilizes furnished models merchandised by professional decorators, which are located in its communities to help sell its homes. The Company prefers to staff these models with its own sales professionals to assist prospective homebuyers with home selection and financing decisions. Sales professionals are compensated on a commissioned basis and are trained extensively in selling techniques, construction and home financing programs. When market conditions warrant, the Company utilizes designated real estate sales brokers who are typically paid on a commission basis. A significant portion of the Company's sales are generated in cooperation with outside brokers. Accordingly, the Company sponsors a variety of programs and events to increase awareness and provide incentives to the brokerage community to promote and sell its homes. The Company also offers a preferred buyer program, which provides its homebuyers in certain of its markets with a discount to be used toward the future purchase of one of its homes. In addition to a wide range of home designs, the Company provides its buyers with the ability to personalize their homes through an extensive home customization program. In most markets, the Company facilitates this process with the use of design centers, which provide a centralized and professionally merchandised presentation of the various options and features available in its homes. Some of the Company's most popular options include kitchen and flooring upgrades and bonus rooms. Homebuyers have the opportunity to work individually with a design consultant to assist them in making their option and upgrade 7 selections. The design consultants are paid a combination of salary and commission. The Company believes the use of design centers increases homebuyer satisfaction, streamlines the option selection process, and ultimately leads to greater profitability. Sales of the Company's homes are made pursuant to a standard home sale contract, which is modified to comply with jurisdictional requirements. Typically, each contract requires a deposit from the homebuyer, which may vary from three to ten percent of the purchase price, according to product type and market practice. In addition, the home sale contract typically contains a financing contingency. The financing contingency provides homebuyers with the right to cancel in the event they are unable to obtain financing at a prevailing interest rate within a specified time period from the execution of the home sale contract. The contract may also contain other contingencies, such as the sale of the homebuyer's existing home. The Company closely monitors all such contingencies and ensures that all contingencies are resolved prior to closing. LAND POLICY The Company acquires land in order to provide an adequate and well-located supply for its residential building operations. The Company's strategy for land acquisition and development is dictated by specific market conditions where it conducts its operations. In general, the Company seeks to minimize the overall risk associated with acquiring undeveloped land by structuring purchase agreements that allow it to control the process of obtaining environmental and other regulatory approvals, but defer the acquisition of the land until the approval process has been substantially completed. In its southern and Florida regions, the Company also acquires improved lots from land developers on a lot takedown basis. Under a typical agreement with a land developer, a minimal number of lots are purchased initially, and the remaining lot takedowns are subject to the terms of an option agreement. In evaluating possible opportunities to acquire land, the Company considers a variety of factors including feasibility of development, proximity to developed areas, population growth patterns, customer preferences, estimated cost of development and availability and cost of financing. The Company engages in many phases of development activity, including land and site planning, obtaining environmental and other regulatory approvals, and the construction of roads, sewer, water and drainage facilities, recreation facilities and other amenities. The Company believes that its experience entitling and developing lots in the highly regulated Pennsylvania and New Jersey markets for over forty years has given it expertise in all aspects of the site selection, land planning, entitlement and land development processes which can be leveraged across all markets in which the Company operates. 8 As of June 30, 2005, the Company owned building lots that would yield 7,451 homes. As of June 30, 2005, the Company also had under option land and improved lots for an aggregate purchase price of approximately $596,618,000 that would yield 9,690 homes for a total owned or controlled lot position of 17,141. Generally, the Company structures its land acquisitions so that it has the right to cancel the agreements to purchase undeveloped land and improved lots by forfeiture of its deposit under the agreement. Furthermore, the agreements are generally contingent upon obtaining all governmental approvals and satisfaction of certain requirements by the Company and the sellers. As of June 30, 2005, the Company had incurred costs associated with the acquisition and development of these parcels aggregating approximately $36,115,000, including approximately $24,664,000 of paid deposits. Contingent upon the Company obtaining all required regulatory approvals, it anticipates completing a majority of these acquisitions during the next several years. During fiscal 2005, the Company forfeited approximately $289,000 in land deposits and pre-acquisition costs related to the cancellation of contracts to purchase both improved lots and undeveloped land. The following table sets forth the Company's land positions as of June 30, 2005.
LOTS UNDER OPTION TOTAL LOTS LOTS AGREEMENT OWNED OR REGION OWNED (CONTROLLED) CONTROLLED ------ ----- ------------ ---------- Northern................................................ 3,670 4,923 8,593 Southern................................................ 1,870 2,146 4,016 Florida................................................. 850 2,015 2,865 Midwestern.............................................. 1,061 606 1,667 ---------- --------------- --------------- Total................................................ 7,451 9,690 17,141 ========== =============== ===============
CUSTOMER SERVICE AND QUALITY CONTROL The Company believes its customer service begins when the home sale contract is executed. The Company's homebuyers are provided with a detailed New Homebuyer Manual, which outlines the entire home construction and delivery process. Homebuyers are provided with up to four orientation sessions conducted at the home. These orientation sessions provide the homebuyer with the opportunity to become familiar with the construction and operation of the home as well as provide the Company with valuable feedback. Immediately prior to delivery of the home, the final orientation is conducted, from which a list of items to address is generated. After delivery of the home, the Company processes all requests for warranty service through its customer service department. In the event service is required, the Company believes that a timely response is critical. The Company typically schedules its contactors to minimize the inconvenience to the homebuyer and attempts to complete the necessary repairs within 14 days of receipt of a request for warranty service. The Company utilizes a two-step 9 customer survey process to obtain valuable feedback from its customers and to help monitor the level of customer satisfaction at the time of and after delivery of the home. WARRANTY PROGRAM AND CONSTRUCTION DEFECT CLAIMS The Company provides all of its homebuyers with a one to two year limited warranty on workmanship and materials and a ten-year limited warranty covering structural items. The extent of the warranties may vary depending on the state in which the Company operates. The Company's contracts with its subcontractors and suppliers generally require them to indemnify the Company for any claims for defective materials or workmanship arising for up to one year from the date of completion of the item, thereby reducing the Company's warranty exposure. Because of increasing insurance costs and an analysis of its claims history, in certain regions the Company now self-insures the first $2 million of each general liability claim. Until February 2004, general liability claims were fully insured, subject to applicable policy limits and exclusions. COST SHARING ARRANGEMENTS AND JOINT VENTURES From time to time, the Company has developed and owned communities through joint ventures with other parties. More recently, in the northern region, the Company has partnered with other homebuilders and developers to acquire land and/or to develop or improve common off-site facilities, such as sewer treatment plants. Most of these agreements are established as cost sharing arrangements whereby the homebuilders and developers share in the cost of acquiring the parcel or developing or improving the off-site facility. Determinations by the Company to enter into these agreements have been based upon a number of factors, including the opportunity to limit its financial exposure involved in the acquisition of larger parcels of land and the ability to pool resources with other homebuilders and developers with respect to completion of the regulatory approval process for a particular parcel. Once the approval process is complete and the land has been acquired, each company will typically take ownership of a segment of the parcel and begin its own land development and construction process. In some communities in the southern region, as an alternative to land acquisition financing, the Company has partnered with developers to construct and sell homes on the developers' lots. At the time of settlement, the developers receive a fixed amount for the cost of the lot and a portion of the profits from the sale of the home. The Company will continue to evaluate all opportunities related to cost sharing agreements and joint ventures; however, at the present time, this does not constitute a material portion of the Company's operations. As of June 30, 2005 and historically these have not been significant to the Company's operations. FINANCIAL SERVICES As a part of the Company's objective to make the home buying process more convenient and to increase the efficiency of its building cycle, the Company offers mortgage brokerage services to its customers. Through the Company's mortgage brokerage subsidiary, it assists its homebuyers in obtaining financing from unaffiliated lenders. The Company does not fund or service the mortgage 10 loans, nor does it assume any credit or interest rate risk in connection with originating the mortgages. The Company's mortgage operation derives most of its revenue from buyers of its homes, although it also offers its services to existing homeowners refinancing their mortgages, as well as to customers purchasing new homes from one of the Company's competitors. During fiscal 2005, approximately 33% of the Company's homebuyers utilized the services of its mortgage business. For fiscal 2005, the Company derived less than 1% of its total earned revenues from this business. EMPLOYEES As of June 30, 2005, the Company employed 285 executive, administrative and clerical personnel, 246 sales personnel and 318 construction supervisory personnel and laborers, for a total of 849 employees. The level of construction and sales employees varies throughout the year in relation to the level of activities at the Company's various communities. The Company considers its relations with its employees to be good. GOVERNMENT REGULATIONS The Company and its subcontractors are subject to continuing compliance requirements of various federal, state and local statutes, ordinances, rules and regulations regarding zoning, plumbing, heating, air conditioning and electrical systems, building permits and similar matters. The intensity of development in recent years in areas in which the Company is actively developing real estate has resulted in increasingly restrictive regulation and moratoriums by governments due to density, sewer and water, ecological and similar factors. Further expansion and development may require prior approval of federal, state and local authorities and may result in delay or curtailment of development activities and costly compliance programs. In January 1983, the New Jersey Supreme Court rendered a decision known as the "Mount Laurel II" decision, which has the effect of requiring certain municipalities in New Jersey to provide housing for persons of low and moderate income. In order to comply with such requirements, municipalities in New Jersey may require developers, including the Company, in connection with the development of residential communities, to contribute funds or otherwise assist in the achievement of the municipalities' fair share of low or moderate-income housing. To satisfy these requirements, these municipalities generally approve additional lots within the residential communities the Company is developing and require the Company to build low and moderate income housing on those lots. The Company's gross profit on homes built on the lots approved for low and moderate income housing is usually substantially less than the gross profit it recognizes on other homes in those communities. The Company had no residential revenue for low and moderate income housing units in fiscal 2005 and 2004, and residential 11 revenue for low and moderate income housing units totaled approximately $617,000 in fiscal 2003. In addition, the Company contributed $618,000, $398,000 and $200,000 to municipalities in fiscal 2005, fiscal 2004, and fiscal 2003, respectively, in order to satisfy low and moderate income housing requirements for municipalities in which the Company builds. Further, as of June 30, 2005, the Company had commitments with five municipalities in New Jersey for affordable housing contributions totaling approximately $4,055,000 which are payable in installments through June 2010. The affordable housing contributions are expensed through cost of sales when the house is delivered. In recent years, regulation by federal and state authorities relating to the sale and advertising of condominium interests and residential real estate has become more restrictive and extensive. In order to advertise and sell condominiums and residential real estate in many jurisdictions, including Pennsylvania and New Jersey, the Company has been required to prepare a registration statement or other disclosure document and, in some cases, to file such materials with a designated regulatory agency. Despite the Company's past ability to obtain necessary permits and authorizations for the communities the Company builds, more stringent requirements may be imposed on developers and homebuilders in the future. Although the Company cannot determine the effect of such requirements, they could result in time-consuming and expensive compliance programs and substantial expenditures for environmental controls, which could have a material adverse effect on the Company's results of operations. In addition, the continued effectiveness of permits already granted is subject to many factors beyond the Company's control, including changes in policies, rules and regulations and their interpretation and application. ENVIRONMENTAL REGULATION AND LITIGATION Development and sale of real property creates a potential for environmental liability on the part of the developer, owner, or any mortgage lender for its own acts or omissions as well as those of prior owners of the subject property or adjacent parcels. While the Company does not currently have any material environmental liabilities of which it is aware, in the future, if hazardous substances are discovered on or emanating from any of its properties, the Company, as well as any prior owners or operators, may be held liable for costs and liabilities relating to these hazardous substances. Environmental studies are generally undertaken in connection with property acquisitions by the Company and it endeavors to obtain Phase I environmental site assessments on all properties acquired. Further governmental regulation on environmental matters affecting residential development could impose substantial additional expense to the Company, which could adversely affect the results of operations or the value of properties owned, or under contract of purchase by the Company. 12 COMPETITION The homebuilding industry is highly competitive. The Company competes on the basis of its reputation, location, design, price, financing programs, quality of product and related amenities. The Company competes with regional and national homebuilders, some of which have greater sales, financial resources and geographical diversity than the Company. Numerous local homebuilders and individual resales of homes and homesites provide additional competition. ECONOMIC CONDITIONS The Company's business is affected by general economic conditions in the United States and its related regions and particularly by the level of interest rates. The Company cannot determine whether interest rates will continue to be at levels attractive to prospective home buyers or whether mortgage and construction financing will continue to be available. SEASONALITY The sale and construction of homes may be adversely affected by harsh weather conditions in some of the regions in which the Company operates, including hurricanes in our Florida region and snow and ice in our other regions. Residential revenue is typically lowest in our first fiscal quarter and highest in our fourth fiscal quarter. Hurricane Katrina and the resulting gas price increases may have an adverse impact on the economy and the availability of labor and materials, which could result in higher construction costs or delays in obtaining materials. The Company does not operate in the areas affected by Hurricane Katrina. ITEM 2. PROPERTIES. ------- ----------- The Company leases office space for its corporate headquarters at 3333 Street Road, Bensalem, Pennsylvania 19020, consisting of approximately 30,000 square feet. The Company also leases additional office space consisting of approximately 6,300 square feet in Bensalem, Pennsylvania, 8,000 square feet in Mount Laurel, New Jersey, a total of 17,000 square feet in two Virginia locations, a total of 12,000 square feet in three North Carolina locations and a total of 24,000 square feet in five locations in the Florida region for certain centralized support services related to operations in those regions. In connection with the acquisition of Realen Homes in July of 2004, the Company obtained additional leased office space of 8,800 square feet in Schaumburg, Illinois. 13 ITEM 3. LEGAL PROCEEDINGS. ------- ------------------ The Company is not currently subject to any material legal proceedings. From time to time, however, the Company is named as a defendant in legal actions arising from its normal business activities. Although the Company cannot accurately predict the amount of liability, if any, that could arise with respect to legal actions currently pending against it, in its opinion, any such liability will not have a material adverse effect on the financial position, operating results or cash flows. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. ------- ---------------------------------------------------- No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS. ------- --------------------------------------------------------------------- The principal market on which the Company's Common Stock is traded is the American Stock Exchange, Inc. (Symbol: OHB). The intra-day high and low sales prices for the Company's common stock as reported by the American Stock Exchange for the periods indicated below are as follows:
FISCAL YEAR ENDED JUNE 30, HIGH LOW -------------------------- ---- --- 2005 First Quarter $ 22.75 $ 15.40 Second Quarter 22.75 17.81 Third Quarter 21.95 18.13 Fourth Quarter 23.80 16.50 2004 First Quarter $ 12.09 $ 9.60 Second Quarter 35.00 11.95 Third Quarter 29.08 19.50 Fourth Quarter 24.10 14.77
The number of common stockholders of record of the Company as of August 16, 2005 was approximately 200. The Company began making quarterly dividend payments of $.02 a share beginning with the third quarter of fiscal 2005. Previously, the Company had not paid a cash dividend since December 1982. While the Company is currently paying a cash dividend on its common stock, there is no assurance that the Company will do so in the future. 14 In April 2005, Michael T. Vesey, President and Chief Operating Officer, exercised options to acquire 70,000 shares of the Company's Common Stock. To pay the exercise price, Mr. Vesey used Common Stock he already owned for more than one year. Mr. Vesey attested to ownership of a sufficient number of shares to pay the exercise price and 7,158 shares were withheld from the number of shares of Common Stock issued. Mr. Vesey received the number of shares subject to the options, less the 7,158 shares required to satisfy the option exercise price. The shares of Common Stock used by Mr. Vesey to pay the exercise price were valued at $18.51 each, the closing price of the Company's Common Stock on the American Stock Exchange on the date Mr. Vesey exercised his options. ITEM 6. SELECTED FINANCIAL DATA. ------- ------------------------ The following table sets forth our selected historical consolidated financial data as of and for each of the last five fiscal years ended June 30. The financial data has been derived from our Audited Consolidated Financial Statements and related notes. This data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of this annual report. 15
FISCAL YEAR ENDED JUNE 30, --------------------------------------------------------------------------------- 2005 (1) 2004(2) 2003 2002 2001(3) -------------- -------------- ---------------- ---------------- ------------- (in thousands, except homes and per share data) STATEMENT OF EARNINGS DATA: Total earned revenues: Residential properties $ 911,004 $ 540,745 $ 382,570 $ 351,060 $ 282,384 Land sales 474 787 744 80 1,786 Other income 7,752 5,726 5,171 3,516 3,052 -------------- -------------- ---------------- ---------------- ------------- Total earned revenues 919,230 547,258 388,485 354,656 287,222 Cost and expenses: Residential properties (727,006) (416,967) (294,066) (283,593) (236,129) Land sales (467) (907) (875) (102) (1,664) Other (4,971) (3,962) (3,436) (2,520) (1,290) Selling, general and administrative (95,701) (62,364) (44,821) (39,599) (30,181) Interest, net of amounts capitalized (102) (336) (232) (122) (425) -------------- -------------- ---------------- ---------------- ------------- Total costs and expenses (828,247) (484,536) (343,430) (325,936) (269,689) Income from operations before income taxes 90,983 62,722 45,055 28,720 17,533 Income taxes (35,399) (24,643) (17,758) (10,807) (6,774) -------------- -------------- ---------------- ---------------- ------------- Net income $ 55,584 $ 38,079 $ 27,297 $ 17,913 $ 10,759 Preferred dividends - (104) (210) (210) (210) -------------- -------------- ---------------- ---------------- ------------- Net income available for common shareholders $ 55,584 $ 37,975 $ 27,087 $ 17,703 10,549 ============== ============== ================ ================ ============= Earnings per share: Basic $3.09 $2.57 $2.18 $1.51 $0.91 Diluted 2.96 2.20 1.65 1.09 0.67 Weighted average common shares outstanding: Basic 17,978 14,784 12,441 11,745 11,552 Diluted 18,809 17,336 16,652 16,568 16,246 SUPPLEMENTAL OPERATING DATA: Homes delivered (homes) 2,507 1,753 1,243 1,322 1,085 Average sales price per home delivered $363 $308 $308 $266 $260 New sales contracts, net of cancellations (homes) 2,256 1,822 1,348 1,279 1,183 Backlog at end of period (homes) 1,406 1,119 752 647 623 Backlog at end of period, contract value $553,237 $390,827 $285,767 $206,064 $187,098
16
AS OF JUNE 30, ----------------------------------------------------------- 2005 2004 2003 2002 2001 ---- ---- ---- ---- ---- (in thousands) BALANCE SHEET DATA: Residential properties........... $190,855 $140,401 $109,895 $112,279 $100,950 Land and improvements............ 398,290 161,265 100,791 82,699 71,739 Inventory not owned.............. 88,252 88,995 18,443 -- -- Land deposits and costs of future developments.................... 27,408 23,356 19,978 13,116 9,258 Total assets..................... 861,540 486,602 290,709 238,499 213,500 Obligations related to inventory not owned....................... 79,585 81,992 17,643 -- -- Mortgage obligations secured by 128,773 113,058 102,605 real estate..................... 399,030 106,707 Notes payable.................... 9,400 4,018 2,531 4,974 11,669 Shareholders' equity............. 231,956 174,905 89,539 61,655 43,820
___________ (1) Includes the operations of Realen Homes for the period subsequent to the July 28, 2004 acquisition date through June 30, 2005. (2) Includes the operations of Masterpiece Homes for the period subsequent to the July 28, 2003 acquisition date through June 30, 2004. (3) Includes the operations of Parker & Orleans for the period subsequent to the October 13, 2000 acquisition date through June 30, 2001. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS ----------------------------------------------------------- The Company primarily develops, builds and markets high quality single-family homes, townhouses and condominiums. During fiscal 2005, the Company operated in the following thirteen markets: Southeastern Pennsylvania; Central and Southern New Jersey; Charlotte, Raleigh and Greensboro, North Carolina; Richmond and Tidewater, Virginia; Orlando, Palm Coast, and Palm Bay, Florida; Orange County, New York; and Chicago, Illinois. The Company has been in operations for over 85 years and is a leading homebuilder in the Pennsylvania and New Jersey markets. In each year since 1995, the Company has ranked among the top three homebuilders in the Philadelphia metropolitan area based on the number of new orders. In October 2000, pursuant to a strategic initiative to target growth in new geographic markets, the Company entered the North Carolina and Virginia markets through the acquisition of PLC. The Company's Charlotte, North Carolina market also includes operations in adjacent counties in South Carolina. In July 2003, the Company entered the Orlando, Florida market through the acquisition of Masterpiece Homes. In July 17 2004, the Company entered the Chicago, Illinois market through the acquisition of Realen Homes, an established homebuilder with its corporate headquarters in Southeastern Pennsylvania. The Southeastern Pennsylvania operations of Realen Homes was merged into the Company's northern region operations. The Chicago Illinois operations of Realen Homes is the Company's midwestern region. In December 2004, the Company also expanded its presence in North Carolina through the acquisition of assets from Peachtree Residential Properties. Information in this annual report includes the operations of Parker & Orleans only to the extent the information relates to periods after the acquisition of Parker and Lancaster Corporation on October 12, 2000, includes the operations of Masterpiece Homes only to the extent the information relates to periods after the acquisition of Masterpiece Homes on July 28, 2003 and includes the operations of Realen Homes only to the extent the information relates to periods after the acquisition of Realen Homes on July 28, 2004, as well as the revenue and expenses associated with the real estate assets acquired from Peachtree Residential Properties, unless otherwise specifically stated. RESULTS OF OPERATIONS The tables included in "Item 1 - Business" summarize the Company's revenues, new orders and backlog data for fiscal 2005 with comparable data for fiscal 2004 and 2003. The Company classifies a sales contract as a new order for backlog purposes at the time a homebuyer executes a contract to purchase a home from the Company. FISCAL YEARS ENDED JUNE 30, 2005 AND 2004 ----------------------------------------- ORDERS AND BACKLOG ------------------ New orders for fiscal 2005 increased by $270,610,000 or 44.8%, to $874,753,000 on 2,256 homes, compared to $604,143,000 on 1,822 homes for fiscal 2004. The average price per home of new orders increased by approximately 16.9% to $388,000 for the year ended June 30, 2005 compared to $332,000 for the year ended June 30, 2004. The increase in new order dollars was attributable to the Company's expansion into the midwestern region through the acquisition of Realen Homes, the Company's growth in its southern region through the acquisition of Peachtree Residential Properties communities, and increased customer demand in the regions where the Company operates. The Company believes that customer demand has increased as a result of growing population, fueled in part by immigration. In addition, historically low interest rates have made housing more affordable for lower income households thereby increasing the overall demand for housing. These factors coupled with the limited supply of entitled lots for residential housing in Pennsylvania and New Jersey due to increased government regulations have positively impacted home pricing trends. 18 The Company's backlog at June 30, 2005 increased by $162,410,000, or 41.6%, to $553,237,000 on 1,406 homes compared to the backlog at June 30, 2004 of $390,827,000 on 1,119 homes. The increase in backlog was attributable to an increase in new orders, the Company's expansion into the midwestern region through its acquisition of Realen Homes on July 28, 2004, and favorable economic conditions for the homebuilding industry in the regions where the Company operates. These favorable economic conditions have resulted in positive home pricing trends and consistent customer demand. The Company experienced a cancellation rate of 14% for the year ended June 30, 2005, compared to 15% and 11% for the year ended June 30, 2004 and June 30, 2003, respectively. Although cancellations can delay the delivery of homes, they have not had a material impact on deliveries, operations, or liquidity. Homes that are cancelled are generally resold promptly at prices at or above the original sales price. The Company anticipates that substantially all June 30, 2005 backlog will be delivered during fiscal 2006. NORTHERN REGION: New orders for the year ended June 30, 2005 increased by $57,963,000 to $352,347,000, or 19.7%, on 727 homes compared to $294,384,000 on 670 homes for the year ended June 30, 2004. The increase was primarily attributable to new orders in the communities acquired in the northern region as part of the Realen Homes acquisition. The new communities acquired in the Realen Homes acquisition accounted for $52,291,000 and 121 homes for the year ended June 30, 2005. The net decline in the number of new orders excluding the Realen Homes acquisition is attributable to the delay in the start of new communities due to increased government regulation in the northern region states in which the Company operates. The increase in new order dollars and the decrease in new home orders is also a result of the Company's efforts to intentionally slow absorption through pricing increases in several new communities to ensure production, pricing and absorption rates are properly balanced to maximize long-term profits. The average price per home of new orders increased by 10.5% to $485,000 for the year ended June 30, 2005 compared to $439,000 for the year ended June 30, 2004. The Company believes that it has been able to increase sales prices due to the strong demand for new homes resulting from the growing population, fueled in part by immigration, and historically low interest rates which have made housing more affordable. The limited supply of entitled lots for residential housing in Pennsylvania and New Jersey due to increased governmental regulation has also positively impacted home pricing trends. The Company had 27 active selling communities in the northern region as of June 30, 2005 compared to 19 active selling communities as of June 30, 2004. The increase in the number of active selling communities was primarily attributable to the acquisition of Realen Homes which resulted in the addition of 7 active selling communities in the northern region. 19 SOUTHERN REGION: New orders for the year ended June 30, 2005 increased by $69,048,000 to $306,280,000, or 29.1%, on 788 homes compared to $237,232,000 on 698 homes for the year ended June 30, 2004. The increase in new order dollars was primarily attributable to an increase in the average sales price per home for the year ended June 30, 2005 compared to the year ended June 30, 2004 and new orders of $30,281,000 on 70 homes related to the 8 communities acquired from Peachtree Residential Properties. The average price per home of new orders increased by 14.4% to $389,000 for the year ended June 30, 2005 compared to $340,000 for the year ended June 30, 2004. This increase in the average price per home of new orders is due to price increases in those communities open during the year ended June 30, 2005 when compared with the same communities and products offered for sale in the comparable prior period. The Company had 46 active selling communities in the southern region as of June 30, 2005 compared to 52 active selling communities as of June 30, 2004. The reduction in the number of communities is due to the Company's trend towards larger communities in order to control fixed selling and marketing costs. FLORIDA REGION: In spite of a series of hurricanes that struck the Florida region in September 2004, new orders for the year ended June 30, 2005 increased by $43,096,000 to $115,623,000, or 59.4%, on 496 homes compared to $72,527,000 on 454 homes for the year ended June 30, 2004. The increase in new order dollars was primarily attributable to an increase in the average sales price per home to $233,000 for the year ended June 30, 2005 compared to $160,000 the year ended June 30, 2004. While the hurricanes slowed sales activity in September 2004, they did not result in any substantial physical damage to the Company's property. The average price per home of new orders increased by 45.6% to $233,000 for the year ended June 30, 2005 compared to $160,000 for the year ended June 30, 2004. This increase in the average price per home in the Florida region is primarily due to the increased demand for new housing in this region. The Company had 6 active selling communities in the Florida region as of June 30, 2005 compared to 10 active selling communities as of June 30, 2004. Despite the reduction in the number of communities, the Company expects a continued increase in residential revenue and units sold in the Florida region as the Company owns or controls 2,865 lots at June 30, 2005 compared to 1,638 lots at June 30, 2004. 20 MIDWESTERN REGION: The Company entered the Midwestern region through the acquisition of Realen Homes on July 28, 2004. For the year ended June 30, 2005, the Midwestern region accounted for $100,503,000 of new orders on 245 homes at an average selling price per home of news orders of $410,000. As of June 30, 2005, the midwestern region had 6 active selling communities. TOTAL EARNED REVENUES --------------------- Total earned revenues for fiscal 2005 increased by $371,972,000 to $919,230,000, or 68.0%, compared to $547,258,000 for fiscal 2004. Total earned revenues principally consist of residential revenue, but also include revenues from land sales, interest income, property management fees and mortgage processing income. Revenues from the sale of homes included 2,507 homes totaling $911,004,000 during fiscal 2005, as compared to 1,753 homes totaling $540,745,000 during fiscal 2004. The average selling price per home delivered during the year ended June 30, 2005 increased by approximately 17.9% to $363,000 compared to $308,000 for the year ended June 30, 2004. NORTHERN REGION: Residential revenue earned for fiscal 2005 increased by $110,039,000 to $384,645,000, or 40.1%, on 852 homes compared to $274,606,000 on 669 home delivered for fiscal 2004. The increase was primarily attributable to homes delivered in communities acquired in the northern region as part of the Realen Homes acquisition. The new communities acquired in the Realen Homes acquisition accounted for $84,668,000 and 232 homes delivered for fiscal 2005. Excluding the acquisition of Realen Homes, residential revenue earned increased by $25,371,000 to $299,977,000 while the number of homes delivered decreased by 49 homes to 620 homes for the year ended June 30, 2005 when compared to the year ended June 30, 2004. The increase in residential revenue earned and the decrease in new home deliveries is primarily a result of the mix of new homes delivered. Specifically, single family homes, which typically have a longer building cycle than townhomes and active adult communities, comprised a larger percentage of the total homes delivered in the region during the year ended June 30, 2005 when compared to the year ended June 30, 2004. The average selling price per home delivered during the year ended June 30, 2005 increased by approximately 10.0% to $451,000 compared to $410,000 for the year ended June 30, 2004. The increase in the average selling price per home delivered is attributable to increases in the average selling price per home of new orders in fiscal 2005 resulting from sales price increases as well as the product mix of homes delivered. Specifically, single family homes, which typically have higher average sales prices than townhomes and condominiums, 21 comprised a larger percentage of the total number of homes delivered in the region during the year ended June 30, 2005 when compared to the year ended June 30, 2004. SOUTHERN REGION: Residential revenue earned for fiscal 2005 increased by $99,334,000 to $304,132,000, or 48.5%, on 827 homes compared to $204,798,000 on 651 home delivered for fiscal 2004. The increase was primarily attributable to homes delivered in communities acquired in the southern region as part of the Peachtree Residential Properties acquisition. The new communities acquired in the Peachtree Residential Properties acquisition accounted for $37,466,000 and 97 homes delivered for fiscal 2005. The average selling price per home delivered during the year ended June 30, 2005 increased by approximately 16.8% to $368,000 compared to $315,000 for the year ended June 30, 2004. The increase in the average selling price per home delivered contributed to the increase in residential revenue earned described above. The increase in the average selling price per home delivered is attributable to increases in the sales prices coupled with an increase in revenue attributable to customer selected options, such as bonus rooms and flooring upgrades, for the year ended June 30, 2005 compared to the year ended June 30, 2004. In addition, a change in the product mix of homes delivered during the year ended June 30, 2005 contributed to the increase in the average price per home delivered. Specifically, the Company delivered a larger percentage of luxury and move-up homes during the year ended June 30, 2005 than during the year ended June 30, 2004. FLORIDA REGION: In spite of a series of hurricanes that struck the Florida region in September 2004, residential revenue earned for fiscal 2005 increased by $20,928,000 to $82,269,000, or 34.1%, on 456 homes compared to $61,341,000 on 433 homes delivered for fiscal 2004. The increase was primarily attributable to a 26.8% increase in the average selling price per home to $180,000 for the year ended June 30, 2005 compared to the $142,000 for the year ended June 30, 2004. In addition, the Florida region' s results of operations were included in the Company's results of operations for the entire twelve month period ended June 30, 2005 compared to the comparable prior year period wherein the company acquired Masterpiece Homes and entered the Florida region on July 28, 2003. The Company did not experience any significant construction delays as a result of the hurricanes that struck Florida. The increase in the average selling price per home delivered is attributable to the demand for new housing and a change in the product mix towards more homes for move-up buyers. 22 MIDWESTERN REGION: The Company entered the Midwestern region through the acquisition of Realen Homes on July 28, 2004. For fiscal 2005, the Midwestern region accounted for $139,958,000 in residential revenue earned on 372 homes at an average selling price per home delivered of $376,000. OTHER INCOME ------------ Other income consists primarily of property management fees and mortgage processing income. Other income for fiscal 2005 increased $2,026,000 to $7,752,000, or 35.4% compared to $5,726,000 for fiscal 2004. The increase in other income for fiscal 2005 as compared to fiscal 2004 is primarily due to increased mortgage processing revenue as a result of the increase in residential property revenue of the Company. COSTS AND EXPENSES ------------------ Costs and expenses for fiscal 2005 increased $343,711,000 to $828,247,000, or 70.9%, compared with fiscal 2004. The cost of residential properties for fiscal 2005 increased by $310,039,000 to $727,006,000, or 74.4%, when compared with fiscal 2004. The increase in cost of residential properties was primarily attributable to the increased residential revenue in the Company's northern, southern, midwestern, and Florida regions as noted above as well as the increase in residential revenue resulting from the Company's acquisition of Realen Homes and certain assets of Peachtree Residential Properties. Interest expense included in costs and expenses for residential properties and land sold for the twelve months ended June 30, 2005 and June 30, 2004 was $13,210,000 and $7,597,000, respectively. The increase in the interest included in the costs and expenses of residential properties and land sold is attributable to increased debt levels and higher interest rates associated with the acquisition of Realen Homes and assets from Peachtree Residential Properties, land acquisitions, and the general growth of the Company. The interest incurred during the construction periods is capitalized to inventory and then expensed to the cost of residential properties in the period in which the home settles. The Company's consolidated gross profit margin for fiscal 2005 decreased by 2.7% to 20.2% compared to 22.9% for fiscal 2004. The decrease in the consolidated gross profit margin for fiscal 2005 was primarily attributable to a shift in the geographic mix of homes delivered and the impact of purchase accounting. The northern region, which has significantly higher gross profit margins than the southern, midwestern and Florida regions, comprised a smaller percentage of the consolidated residential properties revenue in fiscal 2005 than in fiscal 2004. As a result of the application of purchase accounting under SFAS No. 141 "Business Combinations", the gross profit margin is affected when the acquired Realen Homes and Peachtree Residential Properties inventory is delivered because 23 the value of the acquired inventory was increased to its fair market value at the time of acquisition which includes builder profit for work already completed. The additional costs recognized in connection with the deliveries of the acquired Realen Homes inventory as a result of the fair value write-up of the acquired inventory was approximately $3,887,000 for the twelve months ended June 30, 2005. The additional costs recognized in connection with the amortization of the intangible value of the acquired Realen Homes backlog delivered during the twelve months ended June 30, 2005 was approximately $494,000. The additional costs recognized in connection with the deliveries of the acquired Peachtree inventory as a result of the fair value write-up of the acquired inventory was approximately $987,000 for the twelve months ended June 30, 2005. It is anticipated that margins will increase in future periods in communities acquired from Realen Homes and Peachtree Residential Properties as the Company repositions products. The Company sells a variety of home types in various communities and regions, each yielding a different gross profit margin. As a result, depending on the mix of both communities and of home types delivered, the consolidated gross profit margin may fluctuate up or down on a periodic basis and period profit margins may not be representative of the consolidated gross profit margin for the year. 24 SELLING, GENERAL & ADMINISTRATIVE EXPENSES ------------------------------------------ For fiscal 2005, selling, general and administrative expenses increased by $33,337,000 to $95,701,000, or 53.5%, when compared with fiscal 2004. The increase in selling, general and administrative expenses was due in part to an increase in sales commissions and incentive compensation of approximately $15,100,000 attributable to the Company's growth in residential revenue and profit. Additionally, the Company incurred approximately $9,100,000 in fixed selling, general and administrative expenses resulting from the Company's expansion in the northern region and its expansion into the midwestern region through the acquisition of Realen Homes on July 28, 2004. In addition, salaries grew approximately $5,600,000 due to increased headcount related to the Company's growth exclusive of the Realen acquisition. Finally, selling, general and administrative expenses grew due to increased professional fees necessary to support general corporate matters, the Company's expansion into new regions, and its Sarbanes-Oxley compliance efforts. The expansion in the northern region and Midwestern region as a result of the Realen Homes acquisition added a total of 15 selling communities to the regions. The remaining increase in selling, general and administrative expenses was primarily attributable to increases in payroll, legal, consulting, advertising, and travel expenses in order to support the expansion of the Company into new regions. The selling, general and administrative expenses as a percentage of residential revenue for fiscal 2005 improved to 10.5% from 11.5% as compared to fiscal 2004. The decrease in selling, general and administrative expenses as a percentage of revenue is due to the Company's ability to capitalize on synergies in its acquisitions and spread its fixed costs over a higher revenue base. INCOME TAX EXPENSE ------------------ Income tax expense for fiscal 2005 increased by $10,756,000, or 43.6%, to $35,399,000 from $24,643,000 for fiscal 2004. The increase in income tax expense for fiscal 2005 is attributable to an increase in income from operations. Additionally, income tax expense as a percentage of income from operations before income taxes was 38.9% and 39.3% for fiscal 2005 and fiscal 2004, respectively. The slight decrease in the effective tax rate is due primarily to the Company's fiscal 2005 growth in Florida and the southern region, which have lower state tax rates than the other states in which the Company operates. NET INCOME ---------- Net income for fiscal 2005 increased by $17,505,000, or 46.0%, to $55,584,000, compared with $38,079,000 for fiscal 2004. This increase in net income is attributable to an increase in residential property revenue primarily as a 25 result of the Realen Homes and Peachtree Residential Properties acquisitions and favorable conditions in the homebuilding industry, resulting in strong customer demand and positive home pricing trends. The Company believes the primary factors resulting in favorable conditions in the homebuilding industry include: the strong demand for new homes as a result of an increase in immigration and new household formation; historically low interest rates which enhance the affordability of homes and increase the ability of the customer to spend more on options; and the limited supply of entitled lots for residential housing due to increased governmental regulation, which increases the value of lots already owned by the Company. The increase in net income for the twelve months ended June 30, 2005 was reduced by approximately $3,247,000 on an after tax basis due to the additional costs recognized in connection with the deliveries of the Realen Homes and Peachtree Residential Properties inventory, as a result of the fair market write-up of the acquired inventory and backlog. This was partially offset by the recognition of approximately $765,000 of net income that was previously deferred pending the resolution of outstanding issues associated with one of the Company's closed communities. Costs incurred in fiscal 2005 resulting from the acquisition of Masterpiece Homes included the following items: the amortized portion of the fair market value of the stock options granted to Robert Fitzsimmons, President of Masterpiece Homes; contingent payments to Mr. Fitzsimmons representing 25% of the pre-tax profits of Masterpiece Homes; and deferred payments to Mr. Fitzsimmons that are contingent upon his continued employment with the Company. The costs described above reduced the Company's consolidated net income for fiscal 2005 by $1,251,000 and are included in selling, general, and administrative expenses in the Company's Consolidated Statement of Operations. FISCAL YEARS ENDED JUNE 30, 2004 AND 2003 ----------------------------------------- ORDERS AND BACKLOG ------------------ New orders for fiscal 2004 increased by $141,870,000, or 30.7%, to $604,143,000 on 1,822 homes, compared to $462,273,000 on 1,348 homes for fiscal 2003. The increase in new order dollars was attributable to the Company's expansion into the Florida region through the acquisition of Masterpiece Homes which contributed $72,527,000 to the increase in new orders. In addition, new orders increased in the northern and southern regions by $8,039,000, or 2.8%, and $61,304,000, or 34.8%, respectively, when compared to fiscal 2003. The average price per home of new orders remains strong with increases in the northern region and southern regions of approximately 17% and 13%, respectively, compared with fiscal 2003. The increase in the average price per home of new orders on a regional basis was due to the Company's mix of product offerings and price increases in the northern and southern regions in those communities open during fiscal 2004 when compared with the same communities and products offered for 26 sale in fiscal 2003. The Company believes sales price increases are due to the strong demand for new homes as a result of the growing population, fueled in part by immigration. In addition, historically low interest rates have made housing more affordable for lower income households thereby increasing the overall demand for housing. These factors coupled with the limited supply of entitled lots for residential housing in Pennsylvania and New Jersey due to increased governmental regulations, has positively impacted home pricing trends. Overall, the number of new orders for fiscal 2004 increased to 1,822 from 1,348 homes for fiscal 2003, an increase of 474 homes, or 35.2%. In the northern region, the number of new orders for fiscal 2004 decreased to 670 homes from 761 homes in the prior fiscal year, in part, due to delays in the opening of new communities as a result of increasingly restrictive regulations and moratoriums by governments which the Company believes is due to the intensity of development in recent years. Additionally, the Company intentionally slowed absorption in several northern region new communities to ensure production, pricing and absorption rates were properly balanced. In the southern region, the number of new orders for fiscal 2004 increased to 698 homes from 587 homes for fiscal 2003 as the Company continues to expand organically in this region. Further, the Company's expansion into Florida through the acquisition of Masterpiece Homes accounted for 454 new home orders for fiscal 2004. The Company's backlog at June 30, 2004 increased by $105,060,000, or 36.8%, to $390,827,000 on 1,119 homes compared to the backlog at June 30, 2003 of $285,767,000 on 752 homes. The increase in backlog was attributable to an increase in new orders, the Company's expansion into the Florida region through its acquisition of Masterpiece Homes on July 28, 2003 and favorable economic conditions for the homebuilding industry in the regions where the Company operates. These favorable economic conditions have resulted in positive home pricing trends and consistent customer demand. TOTAL EARNED REVENUES --------------------- Total earned revenues for fiscal 2004 increased by $158,773,000 to $547,258,000, or 40.9%, compared to $388,485,000 for fiscal 2003. Total earned revenues principally consist of residential revenue, but also include revenues from land sales, interest income, property management fees and mortgage processing income. Revenues from the sale of homes included 1,753 homes totaling $540,745,000 during fiscal 2004, as compared to 1,243 homes totaling $382,570,000 during fiscal 2003. The increase in residential revenue was attributable to increases in the northern and southern region residential revenue of $27,571,000, or 11.2%, and $69,263,000, or 51.1%, respectively, when compared to fiscal 2003. In addition, the Company's expansion into the Florida region through its acquisition of Masterpiece Homes contributed $61,341,000 to the increase in residential revenue. The average price per home delivered remains strong with increases in the northern region and southern region of 27% and 11%, 27 respectively, compared with fiscal 2003. Contributing to the increase in the average price per home for the northern and southern regions was an increase in revenue attributable to customer-selected options, such as bonus rooms and flooring upgrades, for fiscal 2004 when compared to fiscal 2003. Overall, the number of homes delivered for fiscal 2004 increased by 510 homes, or 41.0%, to 1,753 homes compared to 1,243 homes for fiscal 2003. In the northern region, the number of homes delivered in fiscal 2004 decreased to 669 homes from 766 homes in fiscal 2003. The decrease in the northern region was attributable to the product mix of homes delivered. Specifically, single family homes, which typically have a longer building cycle than townhomes, comprised a larger percentage of the total homes delivered in the northern region during fiscal 2004 than townhomes when compared to the fiscal 2003. In addition, the number of homes delivered also decreased due to delays in the opening of new communities as a result of increasingly restrictive regulations and moratoriums by state or local governmental authorities. In the southern region, the number of homes delivered in fiscal 2004 increased to 651 homes from 477 homes in fiscal 2003 as the Company continues to expand in organically this region. Further, the Company's expansion into Florida through the acquisition of Masterpiece Homes accounted for an increase of 433 homes delivered in fiscal 2004. COSTS AND EXPENSES ------------------ Costs and expenses for fiscal 2004 increased by $141,106,000 to $484,536,000, or 41.1%, compared with fiscal 2003. The cost of residential properties for fiscal 2004 increased $122,901,000 to $416,967,000, or 41.8%, when compared with fiscal 2003. The increase in cost of residential properties was primarily attributable to the increased residential properties revenue in the southern and Florida regions noted above. The consolidated gross profit margin for fiscal 2004 decreased 0.2% to 22.9% compared to 23.1% for fiscal 2003. The decrease in the consolidated gross profit margin for fiscal 2004 was primarily attributable to a shift in the mix of residential properties revenue by region as a percentage of the consolidated residential properties revenue when compared to fiscal 2003. The northern region, which has significantly higher gross profit margins than the southern and Florida regions, comprised a smaller percentage of the consolidated residential properties revenue in fiscal 2004 than in fiscal 2003. While the shift in the mix of residential properties revenue by region resulted in a decrease in the consolidated gross profit margin for fiscal 2004, the gross profit margins increased in the northern and southern regions for fiscal 2004 when compared to fiscal 2003. Increased gross profit margins in the northern and southern regions were attributable to the average selling price per home increasing at a greater rate than the average cost per home. Increased costs of land, insurance and certain building materials, primarily lumber, have been outpaced by an increase in the average selling price per home and a decrease in the cost of borrowing thereby positively impacting gross profit margins. The Company sells a variety of home types in various communities and regions, each yielding a different gross profit margin. As a result, depending on the mix of 28 both communities and of home types delivered, the consolidated gross profit margin may fluctuate up or down from year to year and a comparison of annual gross profit margins from year-to-year may not be indicative of the results of operations for the year. Interest included in the costs and expenses of residential properties and land sold for fiscal 2004 and fiscal 2003 was $7,597,000 and $8,073,000, respectively. The decrease in the interest included in the costs and expenses of residential properties and land sold despite the overall increase in the cost of residential property is attributable to reduced leverage and continuing low interest rates during the construction periods for both the site improvements and the homes. The interest incurred during the construction periods is expensed to the cost of residential property in the period in which the unit settles. For fiscal 2004, selling, general and administrative expenses increased by $17,543,000 to $62,364,000, or 39.1%, when compared with fiscal 2003. The increase in selling, general and administrative expenses was due to an increase in Florida region expenses of $6,871,000 due to increased sales volume resulting from the Company's expansion into Florida through its acquisition of Masterpiece Homes on July 28, 2003, and an increase in sales commissions and selling costs in the southern region of approximately $4,960,000 as a result of the Company's continued expansion in this region. The remaining increase in selling, general and administrative expenses was primarily attributable to increases in general and administrative payroll, incentive compensation and travel expenses in the northern and southern regions. The Company has a bonus compensation plan for its executive officers and key employees calculated at a predetermined percentage of certain of its consolidated pretax earnings. In addition, certain employees not participating in the bonus compensation plan are awarded bonuses at the discretion of the Company's senior management. The selling, general and administrative expenses as a percentage of residential revenue for fiscal 2004 improved to 11.5% from 11.7% as compared to fiscal 2003. INCOME TAX EXPENSE ------------------ Income tax expense for fiscal 2004 increased by $6,885,000, or 38.8%, to $24,643,000 from $17,758,000 for fiscal 2003. The increase in income tax expense for fiscal 2004 is attributable to an increase in income from operations. Additionally, income tax expense as a percentage of income from operations before income taxes was 39.3% and 39.4% for fiscal 2004 and fiscal 2003, respectively. The slight decrease in the effective tax rate is due to the Company's fiscal 2004 entry into Florida, which has a lower state tax rate than the other states in which the Company operates. 29 NET INCOME ---------- Net income for fiscal 2004 increased by $10,782,000, or 39.5%, to $38,079,000, compared with $27,297,000 for fiscal 2003. This increase in net income is attributable to an increase in residential property revenue primarily as a result of favorable conditions in the homebuilding industry, resulting in strong customer demand and positive home pricing trends. The Company believes the primary factors resulting in favorable conditions in the homebuilding industry include: the strong demand for new homes as a result of an increase in immigration and new household formation; historically low interest rates which enhance the affordability of homes and increase the ability of the customer to spend more on options; and the limited supply of entitled lots for residential housing due to increased governmental regulation, which increases the value of lots already owned by the Company. In addition, the Company's expansion into Florida through its acquisition of Masterpiece Homes on July 28, 2003 also contributed to the increase in net income. Costs incurred in fiscal 2004 resulting from the acquisition of Masterpiece Homes included the following items: the amortized portion of the fair market value of the stock options granted to Robert Fitzsimmons; contingent payments to Robert Fitzsimmons representing 25% of the pre-tax profits of Masterpiece Homes since December 31, 2003; an inventory write-up to record the fair market value of the inventory acquired from Masterpiece Homes; and deferred payments to Robert Fitzsimmons that are contingent upon his continued employment with the Company. The costs described above, reduced the Company's consolidated net income for fiscal 2004 by $1,147,000. LIQUIDITY AND CAPITAL RESOURCES ------------------------------- On an ongoing basis, the Company requires capital to purchase and develop land, to construct units, to fund related carrying costs and overhead and to fund various advertising and marketing programs to facilitate sales. These expenditures include site preparation, roads, water and sewer lines, impact fees and earthwork, as well as the construction costs of the homes and amenities. The Company's sources of capital include funds derived from operations, sales of assets and various debt and equity financings. Most of the Company's borrowings are secured. The Company believes that funds generated from operations and financial commitments from available lenders will provide sufficient capital for the Company to meet its existing operating needs. REVOLVING CREDIT FACILITY ------------------------- At June 30, 2005, the Company had $66,100,000 of borrowing capacity under its secured revolving credit facility discussed below, of which approximately $22,500,000 was available to be drawn based upon the Company's borrowing base after repayment of $29,000,000 made within one week subsequent to year end. A 30 majority of the Company's debt is variable rate, based on 30-day LIBOR or the prime rate, and therefore, the Company is exposed to market risk in connection with interest rate changes. At June 30, 2005, the 30-day LIBOR and prime rates of interest were 3.34% and 6.25%, respectively. On December 22, 2004, Greenwood Financial, Inc., a wholly-owned subsidiary of the Company and other wholly-owned subsidiaries of the Company, as borrowers, and Orleans Homebuilders, Inc. as guarantor, entered into a Revolving Credit and Loan Agreement (the "Revolving Credit Agreement") for a $500 Million Senior Secured Revolving Credit and Letter of Credit Facility (the "Revolving Credit Facility") with various banks as lenders. Under and subject to the terms of the Revolving Credit Facility, the borrowers may borrow and re-borrow for the purpose of financing the acquisition and development of real estate, the construction of homes and improvements, for investment in joint ventures, for working capital and for such other appropriate purposes as may be approved by the lenders. Capitalized terms used below and not otherwise defined have the meanings set forth in the Revolving Credit Agreement. The Revolving Credit Facility replaces the Company's July 28, 2004 Bridge Loan Agreement with Wachovia Bank N.A. discussed below. On December 22, 2004, the Company used approximately $388,000,000 of funds available under the Revolving Credit Facility to repay substantially all of the outstanding loans of the Company and its wholly-owned subsidiaries from other banks and financial institutions and to acquire the real estate assets of Peachtree Residential Properties in Charlotte, North Carolina. At June 30, 2005, there was $394,000,000 outstanding under the Revolving Credit Facility. In addition, approximately $40,000,000 of letters of credit and other assurances of the availability of funds have been provided under the Revolving Credit facility. The Revolving Credit Facility has an initial three-year term and borrowings and advances bear interest on a per annum basis equal to LIBOR Market Index Rate plus a non-default variable spread ranging from 175 basis points to 237.5 basis points, depending upon the Company's leverage ratio. The Revolving Credit Facility may be extended for an additional one year period with the approval of the lenders and the payment of an extension fee. During the term of the Revolving Credit Facility, interest is payable monthly in arrears. At June 30, 2005, the interest rate was 5.72% which includes the 237.5 basis point spread. The total amount of loans and advances outstanding at any time under the Revolving Credit Facility may not exceed the lesser of the then-current Borrowing Base Availability or the Revolving Sublimit as defined in the Revolving Credit Facility. The Revolving Sublimit initially is $500,000,000, but under certain circumstances may be increased to up to $650,000,000. The Borrowing Base Availability is based on the lesser of the appraised value or cost of real estate owned by the Company that has been admitted to the borrowing 31 base. Various conditions must be satisfied in order for real estate to be admitted to the borrowing base, including that a mortgage in favor of lenders has been delivered to the agent for lenders and that all governmental approvals necessary to begin development of for-sale residential housing, other than building permits and certain other permits borrower in good faith believes will be issued within 120 days, have been obtained. Depending on the stage of development of the real estate, the loan to value or loan to cost advance rate ranges from 50% to 90% of the appraised value or cost of the real estate. As security for all obligations of borrowers to lenders under the Revolving Credit Facility, lenders have a first priority mortgage lien on all real estate admitted to the borrowing base. In addition, Orleans Homebuilders, Inc. has guaranteed the obligations of the borrowers to lenders pursuant to a Guaranty executed by Orleans Homebuilders, Inc. on December 22, 2004. Under the Guaranty, Orleans Homebuilders, Inc. has granted lenders a security interest in any balance or assets in any deposit or other account Orleans Homebuilders, Inc. has with any lender. In the event that the Company's leverage ratio is less than 2.00:1 as shown on its financial statements for two consecutive quarters, and provided that there exists no event of default or any fact or circumstance that, but for delivery of notice or the passage of time (or both) would constitute an event of default and that certain other conditions are met, upon request, the lenders are obligated to release their mortgage liens granted pursuant to the Revolving Credit Facility. After such a release, the requirements for real estate to be admitted to the borrowing base are decreased and a mortgage in favor of lenders will no longer be required for real estate to be admitted to the borrowing base. The Revolving Credit Facility contains customary covenants that, subject to certain exceptions, limit the ability of the Company to (among other things): Incur or assume other indebtedness, except certain permitted indebtedness; Grant or permit to exist any lien, except certain permitted liens; Enter into any merger, consolidation or acquisition of all or substantially all the assets of another entity; Sell, assign, lease or otherwise dispose of all or substantially all of its assets; or Enter into any transaction with an affiliate that is not a borrower or a guarantor under the Revolving Credit Facility, or a subsidiary of either. 32 The Revolving Credit Facility also contains various financial covenants. Among other things, the financial covenants require that: As of the last day of each fiscal quarter, the ratio of the Company's Adjusted EBITDA to Debt Service for the prior four fiscal quarters be not less than 2.25:1; The Company maintain a minimum Consolidated Adjusted Tangible Net Worth equal to an amount not less than the sum of (i) $140,000,000 plus (ii) an amount equal to fifty percent (50%) of the net income of the Company earned during each fiscal quarter that ends on or after December 22, 2004 plus (iii) all of the net proceeds of equity securities issued by the Company or any of its subsidiaries after December 22, 2004; As of the last day of each fiscal quarter that ends on or before June 30, 2006, the Company's Leverage Ratio not exceed 3.25:1; As of the last day of each fiscal quarter that ends after June 30, 2006, the Company's Leverage Ratio not exceed 3.00:1; and As of the last day of each fiscal quarter that ends on or after the date, if any, on which the collateral securing the loans under the Revolving Credit Facility is released in accordance with the terms of the Revolving Credit Agreement, the Company's Leverage Ratio shall not exceed 2.25:1. In addition, the Revolving Credit Facility contains various financial covenants with respect to the value of land in certain stages of development that may be owned by the Company, a borrower or any subsidiary of the Company and limits the number of units which are not subject to a bona-fide agreement of sale that may be in the inventory of any borrower, the Company or any subsidiary of the Company. The Revolving Credit Facility provides that, subject to any applicable notice and cure provisions, each of the following (among others) is an event of default: Failure by borrowers to pay when due any amounts owing under the Revolving Credit Facility; 33 Failure by the Company to observe or perform any promise, covenant, warranty, obligation, representation or agreement under the Revolving Credit Facility or any other loan document; Bankruptcy and other insolvency events with respect to any borrower or the Company; Dissolution or reorganization of any borrower or the Company; The entry of a judgment or judgments against borrower(s) or the Company: (i) in an aggregate amount that is at least $500,000 in excess of available insurance proceeds, if such judgment or judgments are not dismissed or bonded within 30 days; or (ii) that prevents borrowers from conveying lots and units in the ordinary course of business if such judgment or judgments are not dismissed or bonded within 30 days; or the issuance of any writs of attachment, execution or garnishment against any borrower or the Company; Any material adverse change in the financial condition of a borrower or the Company which causes the lenders, in good faith, to believe that the performance of any of the obligations under the Revolving Credit Facility is impaired or doubtful for any reason; and Specified cross defaults. Upon the occurrence and continuation of an event of default, after completion of any applicable grace or cure period, lenders may demand immediate payment in full of all indebtedness outstanding under the Revolving Credit Facility, terminate their obligations to make any loans or advances or issue any letter of credit, set off and apply any and all deposits held by any lender for the credit or account of any borrower. In addition, upon the occurrence of certain events of bankruptcy or other insolvency events with respect to any borrower or the Company, all indebtedness outstanding under the Revolving Credit Facility shall be immediately due and payable without any act or action by lenders. The Company is in compliance with the financial and other covenants of the Revolving Credit Facility. On July 28, 2004 the Company entered into an Unsecured Bridge Loan Agreement with a maximum borrowing amount of $120,000,000. Proceeds from the Unsecured Bridge Loan were used to finance the acquisition of Realen Homes, refinance certain outstanding indebtedness of Realen Homes and provide the Company with 34 short-term liquidity for land purchases and residential development and construction site improvements. The Unsecured Bridge Loan had a maturity date of November 30, 2004. On November 17, 2004, the Unsecured Bridge Loan was increased to $140,000,000 and the maturity date was extended to December 31, 2004. On December 22, 2004, the Unsecured Bridge Loan was replaced with part of the proceeds of the Revolving Credit Facility mentioned above. Interest on the Unsecured Bridge Loan was payable monthly at 30-day LIBOR plus 225 basis points on the portion of the outstanding principal balance that did not exceed $60,000,000 and 30-day LIBOR plus 250 basis points on the portion of the outstanding principal balance that exceeded $60,000,000. The average outstanding debt and interest rate under the Unsecured Bridge Loan during the Company's term was approximately $95,000,000 and 4.20%, respectively. ACQUISITIONS ------------ On December 23, 2004, pursuant to an Asset Purchase Agreement of the same date, the Company acquired, through a wholly-owned subsidiary, the real estate assets described below (the "Assets") from Peachtree Residential Properties, LLC, a North Carolina limited liability company and Peachtree Townhome Communities, LLC, a North Carolina limited liability company which at the time of acquisition were wholly-owned subsidiaries of Peachtree Residential Properties, Inc., a Georgia corporation (collectively, "Peachtree Residential Properties"). The Assets include: (a) improved and unimproved real property, (b) rights to acquire real estate under options or purchase agreements, (c) equipment, (d) rights under certain contracts for the sale of homes to be sold and leases for real property, (e) rights to certain tradenames and other intangibles, including contract backlog, (f) homes and other improvements under construction as of the closing, (g) certain plans, drawings, specifications, permits and rights under warranties and (h) governmental approvals and books and records associated with, or relating to the foregoing. The Company paid $29,300,000 in cash, to acquire the Assets and certain of the liabilities of Peachtree Residential Properties assumed by the Company, less $200,000 to be retained by the Company and applied towards the administration of certain home warranty claims on homes previously sold by Peachtree. On July 28, 2004, pursuant to a Purchase Agreement (the "Purchase Agreement") of the same date, the Company completed its acquisition of all of the issued and outstanding partnership interests in Realen Homes, a Pennsylvania limited partnership, from Realen General Partner, LLC, a Pennsylvania limited liability company, and DB Homes Venture L.P., a Pennsylvania limited partnership. The 35 Company acquired the limited partner's interest in Realen Homes and a subsidiary of the Company, RHGP LLC, acquired the general partner's interest and serves as the general partner of Realen Homes. In accordance with the Purchase Agreement, the consideration paid by the Company consisted of: (i) $53,348,000 in cash delivered at closing, (ii) a promissory note of the Company in the aggregate principal amount of $5,000,000, payable over a period of up to two years, with an interest rate of 3% per year and (iii) a warranty holdback of $1,500,000 retained by the Company to be applied toward the administration of any warranty claims made against Realen Homes in excess of certain predetermined amounts. The purchase price was determined based on Realen Homes' book value at June 30, 2004, its management personnel, its profitability, its backlog and its land position. In addition to the consideration described above, the Company incurred approximately $405,000 in professional fees in connection with the acquisition of Realen Homes. The Company evaluated the $5,000,000 3% note in accordance with Accounting Principles Board Opinion No. 21 "Interest on Receivables and Payables" ("APB 21") and determined that it was a below market rate note. In accordance with APB 21, the Company estimated, based on current market conditions that the Company would likely have been able to obtain similar fixed-rate financing from a third party at approximately 150 basis points higher than the note actually obtained. The Company imputed interest on the note at 4.5% and reduced the carrying value of the note from $5,000,000 to $4,863,000. The discount of $137,000 will be recorded as interest expense over the life of the note. The Realen Homes acquisition included, subject to specified exceptions, all assets and liabilities of Realen Homes, including land owned or under contract, homes under construction but not sold or sold but not delivered, sales offers and reservations, and model homes and furnishings. The acquired assets were used by Realen Homes in the homebuilding business in Pennsylvania and Illinois. The Company intends to continue to use the acquired assets in the homebuilding business. The Company accounted for the Realen Homes acquisition as a purchase in accordance with SFAS No. 141, "Business Combinations." The purchase price was allocated to goodwill for $13,327,000 which is defined as the fair value of assets and liabilities acquired in excess of the purchase price and to intangible assets for $500,000. The intangible assets represent the value of the backlog acquired from Realen Homes. The intangible value of the backlog will be amortized into cost of sales as the acquired backlog is delivered. The Company amortized $494,000 of the intangible value of the backlog acquired from Realen Homes in Fiscal 2005. 36 On July 28, 2003, the Company acquired all of the issued and outstanding shares of Masterpiece Homes and entered into an employment agreement with the president of Masterpiece Homes. Masterpiece Homes is an established homebuilder located in Orange City, Florida. The terms of the stock purchase agreement and employment agreement are as follows: (i) $3,900,000 in cash, at closing; and (ii) $2,130,000 payable January 1, 2005, unless prior to that date the president is terminated for cause or terminates his employment without good reason, as defined in the employment agreement; (iii) sale of 30,000 shares of the Company's common stock at $8 per share with a put option at the same price, (iv) stock options to purchase 45,000 shares of the Company's common stock at $10.64 per share vesting equally on December 31, 2004, 2005 and 2006; and (v) contingent payments representing 25% of the pre-tax profits of Masterpiece Homes for the calendar years ended December 31, 2004, 2005 and 2006. The Company also incurred approximately $297,000 in acquisition costs to complete this transaction. The aforementioned costs are considered part of the purchase price of Masterpiece Homes, except for the following items that are considered part of, and contingent upon, the employment agreement: (a) $710,000 of the $2,130,000 which was paid in January 2005; (b) stock options to purchase 45,000 shares of the Company's common stock at $10.64 per share; and (c) contingent payments representing 25% of the pre-tax profits of Masterpiece Homes for the calendar years ended December 31, 2004, 2005 and 2006. The Company accounted for these transactions in accordance with SFAS No. 141, "Business Combinations," whereby approximately $5,700,000 was considered to be part of the purchase price of the business and the remainder part of employee compensation. That portion related to employee compensation will be charged to expense over the period to which it relates. With respect to the amounts allocated to the purchase, such amounts were allocated to the fair value of assets and liabilities acquired with the excess of approximately $3,007,000 allocated to goodwill. CASH FLOW STATEMENT ------------------- Net cash used in operating activities for fiscal 2005 was $114,491,000, compared to net cash used in operating activities for fiscal 2004 of $27,945,000. The increase in net cash used in operating activities of $86,546,000 during fiscal 2005 was primarily attributable to the increased activity in residential properties completed or under construction, site work costs and the acquisition of undeveloped land and improved building lots that will yield approximately 4,704 building lots with an aggregate purchase price of approximately $227,720,000. In addition, restricted cash - due from title company of $28,785,000 contributed to the increase in net cash used in operating activities. This was partially offset by an increase in net income when compared with fiscal 2004. Net cash used in investing activities for fiscal 2005 was $58,254,000, compared to $7,757,000 for fiscal 2004. This increase was primarily related to the acquisition of Realen Homes on July 28, 2004. Net cash provided by financing activities for fiscal 2005 was $202,359,000, compared to net cash 37 provided by financing activities of $59,781,000 for fiscal 2004. The increase in net cash provided by financing activities of $142,578,000 is primarily attributable to an increase in financing to support the increase in real estate held for development as noted above. LOT POSITIONS ------------- As of June 30, 2005, the Company owned or controlled approximately 17,141 building lots. Included in the aforementioned lots, the Company had contracted to purchase, or has under option, undeveloped land and improved building lots for an aggregate purchase price of approximately $596,618,000 that are expected to yield approximately 9,690 building lots. The Company expects to utilize purchase money mortgages, secured financings and existing capital resources to finance the undeveloped land and improved building lot acquisitions described below. Contingent on the aforementioned, the Company anticipates completing a majority of these acquisitions during the next several years. UNDEVELOPED LAND ACQUISITIONS ----------------------------- In recent years, the process of acquiring desirable undeveloped land has become extremely competitive, particularly in the Company's northern region, mostly due to the lack of available parcels suitable for development. In addition, expansion of regulation in the housing industry has increased the time it takes to acquire undeveloped land with all of the necessary governmental approvals required to begin construction. Generally, the Company structures its land acquisitions so that it has the right to cancel its agreements to purchase undeveloped land by forfeiture of its deposit under the agreement. As of June 30, 2005, all of the Company's agreements to purchase undeveloped land were structured in this manner. For fiscal 2005, the Company forfeited approximately $30,000 in land deposits and expensed approximately $259,000 in pre-acquisition costs related to the cancellation of purchase agreements of which $269,000 related to contracts to purchase undeveloped land and $20,000 related to contracts to purchase improved lots. Included in the balance sheet captions "Inventory not owned - Variable Interest Entities" and "Land deposits and costs of future developments", at June 30, 2005 the Company had $29,975,000 invested in 70 parcels of undeveloped land, of which $18,840,000 is deposits, a portion of which is non-refundable. The acquisition of these parcels of undeveloped land is expected to yield approximately 8,337 building lots. 38 The Company attempts to mitigate the risks involved in acquiring undeveloped land by structuring its undeveloped land acquisitions so that the deposits required under the agreements coincide with certain benchmarks in the governmental approval process, thereby limiting the amount at risk. This process allows the Company to periodically review the approval process and make a decision on the viability of developing the acquired parcel based upon expected profitability. In some circumstances the Company may be required to make deposits solely due to the passage of time. This structure still provides the Company an opportunity to periodically review the viability of developing the parcel of land. In addition, the Company primarily structures its agreements to purchase undeveloped land contingent upon obtaining all governmental approvals necessary for construction. Under most agreements, the Company secures the responsibility for obtaining the required governmental approvals as the Company believes that it has significant expertise in this area. The Company intends to complete the acquisition of undeveloped land after all governmental approvals are in place. In certain circumstances, however, when all extensions have been exhausted, the Company must make a decision on whether to proceed with the purchase even though all governmental approvals have not yet been received. In these circumstances, the Company performs reasonable due diligence to ascertain the likelihood that the necessary governmental approvals will be granted. At June 30, 2005, the Company had preliminary approval for all of the parcels included in the balance sheet caption "Land held for development or sale and improvements." IMPROVED LOT ACQUISITIONS ------------------------- The process of acquiring improved building lots from developers is extremely competitive. The Company competes with many national homebuilders to acquire improved building lots, some of which have greater financial resources than the Company. The acquisition of improved lots is usually less risky than the acquisition of undeveloped land as the contingencies and risks involved in the land development process are borne by the developer. In addition, governmental approvals are generally in place when the improved building lots are acquired. At June 30, 2005, the Company had contracted to purchase or had under option approximately 1,353 improved building lots for an aggregate purchase price of approximately $113,732,000, including $5,824,000 of deposits. INFLATION --------- Inflation can have a significant impact on the Company's business performance and the homebuilding industry in general. Rising costs of land, materials, labor, overhead, administrative costs and interest rates on floating credit facilities can adversely affect the Company's business performance. In addition, rising costs of certain items, such as lumber, can adversely affect the expected profitability of the Company's backlog. Generally, the Company has been able to 39 recover any increases in costs through increased selling prices. However, there is no assurance the Company will be able to continue to increase selling prices to cover the effects of inflation in the future. OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND COMMITMENTS ----------------------------------------------------------------------- Certain off-balance sheet arrangements, contractual obligations and commitments are disclosed in various sections of the Consolidated Financial Statements, Notes to Consolidated Financial Statements and below. Some typical off-balance sheet arrangements commonly affecting homebuilders include: o Cost sharing arrangements and unconsolidated real estate joint ventures--capital contribution requirements; o Debt and debt service guarantees; o Surety bonds and standby letters of credit; o Executed contracts for construction and development activity; and o Variable interest entities, which are not consolidated. Each of these items are described below or in "Critical Accounting Policies" following this section. COST SHARING ARRANGEMENTS AND UNCONSOLIDATED REAL ESTATE -------------------------------------------------------- JOINT VENTURES - CAPITAL CONTRIBUTION REQUIREMENTS. The Company has developed and owned communities through joint ventures, accounted for using the equity method, with other parties in the past. However, at the present time joint venture activities do not constitute a material portion of the Company's operations. In addition, the Company has partnered with other homebuilders and developers, under cost sharing agreements, to acquire land and/or to develop or improve common off-site facilities, such as sewer treatment plants, that will benefit both parties. Most of these agreements are established as cost sharing agreements whereby the homebuilders and developers share in the cost of acquiring the parcel or improving the off-site facility. The Company currently does not have any material unfunded commitments or capital contribution requirements with respect to joint ventures or cost sharing arrangements. DEBT AND DEBT SERVICE GUARANTEES. At June 30, 2005, the Company had mortgage and other note obligations on the balance sheet totaling $408,430,000. The Company currently does not have any off-balance sheet debt service guarantees. SURETY BONDS AND STANDBY LETTERS OF CREDIT. As of June 30, 2005, the Company had $106,508,000 in surety bonds and $39,854,000 in outstanding standby letters of credit in favor of local municipalities or financial institutions to guarantee the construction of real property improvements or financial obligations. The $106,508,000 in surety bonds guarantee the construction of public improvements and infrastructure such as sewer, streets, traffic signals, grading, and 40 wildlife preservations in connection with the various communities the Company is developing. Surety bonds are commonly required by public agencies from homebuilders and other real estate developers. The surety bonds and standby letters of credit are renewable and expire upon completion of the required improvements. Standby letters of credit are a form of credit enhancement that is commonly required in real estate development to secure the construction of public improvements. In the past three fiscal years, no surety bonds or standby letters of credit have been drawn on for use to satisfy the Company's obligations to perform under the agreements with the public agencies. EXECUTED CONTRACTS FOR SITE WORK AND CONSTRUCTION ACTIVITY. The Company has entered into site work and construction contracts with various suppliers and contractors. These contracts are for construction and development activity in the numerous communities the Company has under development, and are originated in the normal course of business. The site work contracts generally require specific performance by the contractor to prepare the land for construction and are written on a community-by-community basis. For larger communities, site work contracts are awarded in phases in order to limit any long-term commitment by the Company or its contractors. Generally, site work contracts are completed in less than one year. The Company acts as a general contractor and contracts with various subcontractors at specified prices for construction of the homes it sells. Subcontractors generally work on a piece meal basis and are not awarded contracts for a specified number of homes. These commitments are typically funded by construction loans and are originated in the normal course of business. SUMMARY OF OUTSTANDING OBLIGATIONS The following table summarizes the Company's outstanding obligations as of June 30, 2005 and the effect such obligations are expected to have on its liquidity and cash flow in future periods. For mortgage and other note obligations, payments due by period are shown based on the expiration date of the loan.
PAYMENTS DUE DURING FISCAL YEAR ENDED JUNE 30, ----------------------------------------------------------------------------------------- PAYMENTS DUE TOTAL 2006 2007 2008 2009 2010 THEREAFTER -------- -------- ------ --------- ------- ------ ----------------- (IN THOUSANDS) Obligations: Mortgage and other note obligations............ $ 408,430 $ 6,153 $ 7,470 $394,086 $ 721 $ -- $ -- Operating leases........ 5,794 1,562 1,385 1,229 780 326 512 Affordable housing contributions.......... 4,055 1,157 1,879 494 430 95 -- --------- -------- ------- -------- ------ ----- ------- Total obligations....... $ 418,279 $ 8,872 $10,734 $395,809 $1,931 $ 421 $ 512 ========= ======== ======= ======== ====== ===== =======
The above table does not include certain obligations incurred in the ordinary course of business, such as trade payables. 41 The above table also does not include any amounts needed to acquire lots or land under option or cancelable purchase contracts because these arrangements are completed only at the Company's discretion, subject only to loss of option or deposit amounts and costs capitalized to date. Therefore, these option and cancelable purchase contracts do not represent binding enforceable purchase obligations. As of June 30, 2005, the Company had contracted to purchase, or had under option, undeveloped land and improved building lots for an aggregate purchase price of approximately $597 million that are expected to yield approximately 9,690 lots. CRITICAL ACCOUNTING POLICIES ---------------------------- The preparation of the Company's Consolidated Financial Statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to revenue recognition, impairment of real estate assets, capitalization of costs, environmental liability exposure, miscellaneous litigation reserves, and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of the Consolidated Financial Statements. CONSOLIDATION OF VARIABLE INTEREST ENTITIES. In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51." Variable interest entities are entities controlled by another entity through means other than voting rights. FASB Interpretation No. 46 provides guidance on determining whether and how a business enterprise should consolidate a variable interest entity. FASB Interpretation No. 46 requires significant use of judgment and estimates in determining its application. See Note 1 of Notes to Consolidated Financial Statements for additional discussion of FASB Interpretation No. 46. ESTIMATES. Impairment charges to reduce the Company's real estate inventories to net realizable value are recorded using several factors including management's plans for future operations, recent operating results and projected cash flows, which include assumptions related to expected future demand and market 42 conditions. The adequacy of the Company's impairment charges could be materially affected by changes in market conditions. Estimates for construction costs for homes closed are recorded in the period when the related home is closed. These estimates are based on detailed budgets for each home and historical experience and trends. If actual costs change, significant variances may be encountered. Reserves for the estimated cost of homes under warranty are recorded in the period in which the related home is closed and are based on historical experience and trends. Should actual warranty experience change, revisions to the estimated warranty liability would be required. Estimates for the costs to complete land development are recorded upon completion of the related land development project. Estimates for land and land development costs are allocated to development phases based on the total number of lots expected to be developed within each subdivision and are based on detailed budgets for the land development project and historical experience and trends. If actual costs or the total number of lots developed changes, significant variances may be encountered. REVENUE RECOGNITION. The Company primarily derives its total earned revenues from the sale of residential property. The Company recognizes residential revenue when title is conveyed to the homebuyer at the time of closing. The Company also sells developed and undeveloped land in bulk and under option agreements. Revenues from sales of land and other real estate are recognized when the Company has received an adequate cash down payment and all other conditions necessary for profit recognition have been satisfied. During fiscal 2005, 2004 and 2003, all sales transactions met the criteria for, and were accounted for, utilizing the full accrual method. To the extent that certain sales or portions thereof do not meet all conditions necessary for profit recognition, the Company would use other methods to recognize profit, including the percentage-of-completion, cost recovery and the deposit methods. These methods of profit recognition defer a portion or all of the profit to the extent it is dependent upon the occurrence of future events. Also, in general, specific identification and relative sales value methods are used to determine the cost of sales. Management estimates of future costs to be incurred after the completion of each sale are included in cost of sales. A change in circumstances that causes these estimates of future costs to increase or decrease significantly would affect the gain or loss recognized on future sales. IMPAIRMENT. The Company assesses the impairment of its real estate assets when events or changes in circumstances indicate that the net book value may not be recoverable. Indicators the Company considers important, which could trigger an impairment review, include the following: 43 o significant negative industry or economic trends; o a significant underperformance relative to historical or projected future operating results; o a significant change in the manner in which an asset is used; and o an accumulation of costs significantly in excess of the amount originally expected to construct an asset. Real estate is stated at the lower of cost or estimated fair value using the methodology described as follows. A write-down to estimated fair value is recorded when we determine that the net book value exceeds the estimated selling prices less cost to sell. These evaluations are made on a property-by-property basis. When the Company determines that the net book value of an asset may not be recoverable based upon the estimated undiscounted cash flow, an impairment write-down is recorded. Values from comparable property sales will also be considered. The evaluation of future cash flows and fair value of individual properties requires significant judgment and assumptions, including estimates of market value, development absorption, and remaining development costs. Significant adverse changes in circumstances affecting these judgments and assumptions in future periods could cause a significant impairment adjustment to be recorded. CAPITALIZATION OF COSTS. Costs capitalized include direct construction and development costs, including predevelopment costs, interest on indebtedness, real estate taxes, insurance, construction overhead and indirect project costs. Costs previously capitalized related to any abandoned development opportunities are written off when it is determined such costs will not provide any future benefits. Any decrease in development activity may result in a portion of capitalized costs being expensed. ENVIRONMENTAL LIABILITY EXPOSURE. Development and sale of real property creates a potential for environmental liability on the Company's part as owner and developer, for its own acts as well as the acts of prior owners of the subject property or owners or past owners of adjacent parcels. If hazardous substances are discovered on or emanating from any of its properties, the Company and prior owners may be held liable for costs and liabilities relating to those hazardous substances. The Company generally undertakes environmental studies in connection with its property acquisitions. In the event the Company incurs environmental remediation costs, including clean up costs, consulting fees for environmental studies and investigations, monitoring costs, and legal costs relating to clean up, litigation defense, and the pursuit of responsible third parties, if these costs are incurred in connection with properties the Company previously sold, then they are expensed. The Company capitalizes costs relating to land under development and undeveloped land as part of development costs. Costs incurred for properties to be sold are deferred and charged to cost of sales when the properties are sold. Should a previously undetected, substantial environmental hazard be found on the Company's properties, significant liquidity could be consumed by the resulting clean up requirements and a material expense may be recorded. Further, governmental regulation on environmental matters affecting 44 residential development could impose substantial additional expense on the Company, which could adversely affect its results of operations or the value of properties owned under contract, or purchased by the Company. For additional information regarding risks associated with environmental hazards and environmental regulation, see Note 12 of Notes to Consolidated Financial Statements. INCOME TAXES. As part of the process of preparing the consolidated financial statements, significant management judgment is required to estimate income taxes. Estimates are based on interpretation of tax laws. The Company estimates actual current tax due and assesses temporary differences resulting from differing treatment of items for tax and accounting purposes. The temporary differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheet. See Note 9 of Notes to Consolidated Financial Statements for a discussion of income taxes. Adjustments may be required by a change in assessment of deferred tax assets and liabilities, changes due to audit adjustments by Federal and State tax authorities, and changes in tax laws. To the extent adjustments are required in any given period, the adjustments would be included within the tax provision in the statement of operations and/or balance sheet. These adjustments could materially impact our financial position and results of operations and liquidity. STOCK BASED COMPENSATION. Effective July 1, 2002, the Company adopted the preferable fair value recognition provisions of SFAS No. 123, "Accounting for Stock Issued to Employees." The Company selected the prospective method of adoption as permitted by SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure." See Note 10 of Notes to Consolidated Financial Statements for additional disclosure and discussion on stock-based compensation. NEW ACCOUNTING PRONOUNCEMENTS In December 2002 the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" ("SFAS No 148") which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123. The transition provisions of this Statement are effective for fiscal years ending after December 15, 2002, and the disclosure requirements of the Statement are effective for interim periods beginning after December 15, 2002. The Company adopted SFAS No. 148 effective July 1, 2002. Only 50,000 options were unvested as of the adoption date and all grandfathered APB25 grants were fully vested as of June 30, 2003. As such, the adoption of SFAS No. 148 did not have a material impact on the financial position or results of operations of the Company. 45 In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" ("FIN 46"). The FASB issued a revised FIN 46 in December 2003 which modifies and clarifies various aspects of the original interpretations. A Variable Interest Entity ("VIE") is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE, pursuant to FIN 46, an enterprise that absorbs a majority of the expected losses of the VIE is considered the primary beneficiary and must consolidate the VIE. For VIEs created before January 31, 2003, FIN 46 was deferred to the end of the first interim or annual period ending after March 15, 2004. The Company fully adopted FIN 46 effective March 31, 2004. Based on the provisions of FIN 46, the Company has concluded that whenever it enters into an option agreement to acquire land or lots from an entity and pays a significant deposit that is not unconditionally refundable, a VIE is created under condition (ii) (b) of the previous paragraph. The Company has been deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity's expected theoretical losses if they occur. For each VIE created the Company will compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46. If the Company is deemed to be the primary beneficiary of the VIE it will consolidate the VIE on its balance sheet. The fair value of the VIEs inventory will be reported as "Inventory Not Owned - Variable Interest Entities." At June 30, 2005, the Company consolidated thirteen VIEs as a result of its option to purchase land or lots from the selling entities. The Company paid cash or issued letters of credit deposits to these thirteen VIEs totaling $6,852,000 and incurred additional pre-acquisition costs totaling $1,815,000. At June 30, 2004 the Company consolidated twenty-three VIEs as a result of its option to purchase land or lots from the selling entities. The Company paid cash or issued letters of credit deposits to these twenty-three VIEs totaling $7,683,000. The Company's deposits and any costs incurred prior to acquisition of the land or lots, represent our maximum exposure to loss. The fair value of the VIEs inventory will be reported as "Inventory Not Owned - Variable Interest Entities." The Company recorded $88,252,000 and $88,995,000 in "Inventory Not Owned - Variable Interest Entities" as of June 30, 2005 and June 30, 2004, respectively. Included in the balance at June 30, 2004 is $21,932,000 which pertains to option agreements to acquire land or lots that were executed prior to January 31, 2003 and recorded as VIEs as a result of the full adoption of FIN 46. The fair value of the property to be acquired less cash deposits and pre-acquisition costs, which totaled $79,585,000 and $81,992,000 at June 30, 46 2005 and 2004, respectively, was reported on the balance sheet as "Obligations related to inventory not owned." Creditors, if any, of these VIEs have no recourse against the Company. The Company will continue to secure land and lots using options. In addition to the deposits and other costs capitalized in connection with the VIEs above, the Company had total costs incurred to acquire land and lots at June 30, 2005 of approximately $27,448,000, including $17,812,000 of cash deposits. The total purchase price under these cancelable contracts or options is approximately $510,181,000. The maximum exposure to loss is limited to deposits, although some deposits are refundable, and costs incurred prior to the acquisition of the land or lots. In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 "Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity" ("SFAS No. 150"). This standard requires issuers to classify as liabilities the following three types of freestanding financial instruments: (1) mandatory redeemable financial instruments, (2) obligations to repurchase the issuer's equity shares by transferring assets; and (3) certain obligations to issue a variable number of shares. The Company adopted SFAS No. 150 effective July 1, 2003. The adoption of SFAS No. 150 did not have a material impact on the financial position or results of operations of the Company. In December 2003, the SEC issued Staff Accounting Bulletin No. 104 ("SAB 104"), "Revenue Recognition" which supersedes SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary purpose is to rescind the accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF 00-21. The Company adopted the provisions of this statement immediately, as required, and it did not have a significant impact on the financial position or results of operations of the Company. EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables," issued during the third quarter of 2003, provides guidance on revenue recognition for revenues derived from a single contract that contains multiple products or services. EITF 00-21 also provides additional requirements to determine when these revenues may be recorded separately for accounting purposes. The Company adopted EITF 00-21 on July 1, 2003, as required, and it did not have a significant impact on the Company's Consolidated Financial Statements. In December 2004, the FASB revised FAS 123 through the issuance of FAS No. 123-R "Share Based Payment", revised ("FAS 123-R"). FAS 123-R is effective for the Company commencing July 1, 2005. FAS 123-R, among other things, eliminates the alternative to use the intrinsic value method of accounting for stock based compensation and requires entities to recognize the cost of employee services 47 received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). The fair value based method in FAS 123-R is similar to the fair-value-based method in FAS 123 in most respects, subject to certain key differences. Because there are no remaining unvested ABP25 grants as of the adoption date and management does not believe that there will be significant change in the valuation methodologies, the Company does not anticipate that the adoption of FAS 123-R will have a material impact on the financial position or results of operations of the Company. In December 2004, the FASB issued FASB Staff Position No. FAS 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, for the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004" (FSP FAS 109-1). FSP FAS 109-1 clarifies that the deduction will be treated as a "special deduction" as described in Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." As such, the special deduction has no effect on deferred tax assets and liabilities existing at the date of enactment. The impact of the deduction will be reported in the period in which the deduction is claimed. The Company files a consolidated return on a calendar year. Accordingly, the Company began reflecting the special deduction with respect to its operations effective January 1, 2005 for the remaining six months in our fiscal year ended June 30, 2005. Its expected impact was and will be to lower the effective tax provision in the periods in which the deduction may be claimed and that this benefit will increase as the deduction is phased in under the statute (see Note 9 for discussion of deduction phase in). CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR" PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. In addition to historical information, this report contains statements relating to future events or our future results. These statements are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934, as amended (the "Exchange Act") and are subject to the Safe Harbor provisions created by the statute. Generally words such as "may", "will", "should", "could", "anticipate", "expect", "intend", "estimate", "plan", "continue", and "believe" or the negative of or other variation on these and other similar expressions identify forward-looking statements. These forward-looking statements are made only as of the date of this report. We do not undertake to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise. Forward-looking statements are based on current expectations and involve risks and uncertainties and our future results could differ significantly from those expressed or implied by our forward-looking statements. 48 Many factors, including those listed below, could cause the Company's actual consolidated results to differ materially from those expressed in any forward-looking statements made by, or on behalf of, the Company: o Future increases in interest rates or a decrease in the availability of mortgage financing could lead to fewer home sales, which could adversely affect the Company's total earned revenues and earnings. o Changes in consumer confidence due to perceived uncertainty of future employment opportunities or other factors could lead to fewer home sales by the Company. o The Company is subject to substantial risks with respect to the land and home inventories it maintains and fluctuations in market conditions may affect the Company's ability to sell its land and home inventories at expected prices, if at all, which could reduce the Company's total earned revenues and earnings. o The Company's business is subject to governmental regulations that may delay, increase the cost of, prohibit or severely restrict the Company's development and homebuilding projects and reduce its total earned revenues and growth. o States, cities and counties in which the Company operates have adopted, or may adopt, slow or no growth initiatives which would reduce the Company's ability to build and sell homes in these areas and could adversely affect the Company's total earned revenues and earnings. o The Company may not be successful in its effort to identify, complete or integrate acquisitions, which could disrupt the activities of the Company's current business and adversely affect the Company's results of operations and future growth. o The Company is dependent on the services of certain key employees and the loss of their services could harm the Company's business. o The Company may not be able to acquire suitable land at reasonable prices, which could result in cost increases the Company is unable to recover and reduce the Company's total earned revenues and earnings. o The Company's significant level of debt could adversely affect its financial condition and prevent it from fulfilling its debt service obligations. o The competitive conditions in the homebuilding industry could increase the Company's costs, reduce its total earned revenues and earnings and otherwise adversely affect its results of operations or limit its growth. o The Company may need additional financing to fund its operations or to expand its business, and if the Company is unable to obtain sufficient financing or such financing is obtained on adverse terms, the Company may not be able to operate or expand its business as planned, which could adversely affect the Company's results of operations and future growth. 49 o Shortages of labor or materials and increases in the price of materials can harm the Company's business by delaying construction, increasing costs, or both. Such shortages may result from adverse weather conditions such as hurricanes. o The Company depends on the continued availability and satisfactory performance of its subcontractors which, if unavailable, could have a material adverse effect on the Company's business by limiting its ability to build and deliver homes. o The Company is subject to construction defect, product liability and warranty claims arising in the ordinary course of business that could adversely affect its results of operations. o The Company is subject to mold litigation and mold claims arising in the ordinary course of business for which the Company has no insurance that could adversely affect the Company's results of operations. o The Company's business, total earned revenues and earnings may be adversely affected by natural disasters or adverse weather conditions. o The Company may be subject to environmental liabilities that could adversely affect its results of operations or the value of its properties. o Increases in taxes or government fees could increase the Company's costs and adverse changes in tax laws could reduce customer demand for the Company's homes, either of which could reduce the Company's total earned revenues or profitability. o There are a number of laws, regulations and accounting pronouncements, recently adopted or proposed, that could affect the Company's corporate governance or accounting practices. o Acts of war or terrorism may seriously harm the Company's business. o Jeffrey P. Orleans, Chairman and Chief Executive Officer and the Company's majority shareholder, can cause the Company to take certain actions or preclude the Company from taking actions without the approval of the other shareholders and may have interests that could conflict with the interests of other shareholders. o The Company has entered into several transactions with related parties, including entities controlled by Mr. Jeffrey P. Orleans, which may create conflicts of interest. 50 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. -------- ----------------------------------------------------------- Market risk represents the risk of loss that may impact the financial position, results of operations or cash flows of the Company, due to adverse changes in financial and commodity market prices and interest rates. The Company is exposed to market risk in the area of interest rate changes. A majority of the Company's debt is variable rate based on LIBOR and prime rate, and, therefore, affected by changes in market interest rates. Based on current operations, an increase/decrease in interest rates of 100 basis points will result in a corresponding increase/decrease in interest charges incurred by the Company of approximately $3,940,000 in a fiscal year, a portion of which will be capitalized and included in cost of sales as homes are delivered. Generally, the Company has in the past been able to increase prices to cover portions of any increase in cost of sales and interest charges incurred resulting from any increase in interest rates. As a result, the Company believes that reasonably possible near-term changes in interest rates will not result in a material negative effect on future earnings, fair values or cash flows of the Company. 51 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. ------- -------------------------------------------- ORLEANS HOMEBUILDERS, INC. AND SUBSIDIARIES INDEX TO FINANCIAL STATEMENTS
Page ---- Report of independent registered public accounting firm 53 Consolidated balance sheets at June 30, 2005 and June 30, 2004 55 Consolidated statements of operations for the years ended June 30, 2005, 2004 and 2003 56 Consolidated statements of shareholders' equity for the years ended June 30, 2005, 2004 and 2003 57 Consolidated statements of cash flows for the years ended June 30, 2005, 2004 and 2003 58 Notes to consolidated financial statements 59
All other schedules have been omitted because they are not applicable or the required information is shown in the consolidated financial statements or notes thereto. 52 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Shareholders of Orleans Homebuilders, Inc.: We have completed an integrated audit of Orleans Homebuilders Inc.'s 2005 consolidated financial statements and of its internal control over financial reporting as of June 30, 2005 and audits of its 2004 and 2003 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below. Consolidated financial statements --------------------------------- In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material respects, the financial position of Orleans Homebuilders Inc. and its subsidiaries (collectively, the "Company") at June 30, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2005 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements 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 our opinion. Internal control over financial reporting ------------------------------------------ Also, in our opinion, management's assessment, included in Management's Report on Internal Control Over Financial Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as of June 30, 2005 based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2005, based on criteria established in Internal Control - Integrated Framework issued by the COSO. The Company's management is responsible for maintaining 53 effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management's assessment and on the effectiveness of the Company's internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. /s/ PricewaterhouseCoopers LLP Philadelphia, Pennsylvania September 8, 2005 54 ORLEANS HOMEBUILDERS, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS)
JUNE 30, 2005 JUNE 30, 2004 -------------- ------------- Assets: Cash and cash equivalents............................................... $ 62,576 $ 32,962 Restricted cash--due from title company 28,785 -- Restricted cash--customer deposits...................................... 20,100 17,795 Real estate held for development and sale: Residential properties completed or under construction .............. 190,855 140,401 Land held for development or sale and improvements................... 398,290 161,265 Inventory not owned--Variable Interest Entities...................... 88,252 88,995 Property and equipment, at cost, less accumulated depreciation.......... 3,420 3,163 Deferred income taxes................................................... 2,802 2,453 Intangible assets....................................................... 6 -- Goodwill................................................................ 20,514 7,187 Receivables, deferred charges and other assets.......................... 18,532 9,025 Land deposits and costs of future developments.......................... 27,408 23,356 --------------- -------------- TOTAL ASSETS............................................ $ 861,540 $ 486,602 =============== ============== Liabilities and Shareholders' Equity Liabilities: Accounts payable..................................................... $ 47,689 $ 26,246 Accrued expenses..................................................... 65,253 46,981 Customer deposits.................................................... 27,738 22,620 Obligations related to inventory not owned........................... 79,585 81,992 Revolving Credit Facility, mortgage and other note obligations primarily secured by real estate held for development and sale.... 399,030 128,773 Notes payable and amounts due to related parties..................... -- 2,879 Other notes payable.................................................. 9,400 1,139 --------------- -------------- TOTAL LIABILITIES................................................ $ 628,695 $ 310,630 --------------- -------------- Commitments and contingencies .......................................... -- -- Redeemable common stock................................................. 889 1,067 Shareholders' Equity: Common stock, $.10 par, 23,000,000 shares authorized, 18,698,131 and 18,031,463 shares issued at June 30, 2005 and June 30, 2004, respectively.......................................................... 1,870 1,803 Capital in excess of par value--common stock ........................... 70,450 68,554 Retained earnings....................................................... 160,407 105,564 Treasury stock, at cost (176,911 and 576,330 shares held at June 30, 2005 and June 30, 2004, respectively)................................. (771) (1,016) --------------- -------------- TOTAL SHAREHOLDERS' EQUITY........................................... 231,956 174,905 --------------- -------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY........................... $ 861,540 $ 486,602 =============== ==============
See accompanying notes, which are an integral part of the consolidated financial statements 55 ORLEANS HOMEBUILDERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
FOR THE YEAR ENDED JUNE 30, ------------------------------------- 2005 2004 2003 ------ ------ ------ Earned revenues Residential properties............................... $ 911,004 $ 540,745 $ 382,570 Land sales........................................... 474 787 744 Other income......................................... 7,752 5,726 5,171 ------------ ------------- ------------ Total earned revenues............................ 919,230 547,258 388,485 ------------ ------------- ------------ Costs and expenses Residential properties.................................. 727,006 416,967 294,066 Land sales........................................... 467 907 875 Other................................................ 4,971 3,962 3,436 Selling, general and administrative.................. 95,701 62,364 44,821 Interest Incurred.......................................... 19,075 6,741 6,420 Less capitalized.................................. (18,973) (6,405) (6,188) ------------ ------------- ------------ Total costs and expenses......................... 828,247 484,536 343,430 ------------ ------------- ------------ Income from operations before income taxes.............. 90,983 62,722 45,055 Income tax expense...................................... 35,399 24,643 17,758 ------------ ------------- ------------ Net income.............................................. 55,584 38,079 27,297 Preferred dividends..................................... -- 104 210 ------------ ------------- ------------ Net income available for common shareholders............ $ 55,584 $ 37,975 $ 27,087 ============ ============= ============ Basic earnings per share............................. $ 3.09 $ 2.57 $ 2.18 ============ ============= ============ Diluted earnings per share........................... $ 2.96 $ 2.20 $ 1.65 ============ ============= ============ Common stock dividends declared per share $ 0.04 $ -- $ -- ============ ============= ============
See accompanying notes, which are an integral part of the consolidated financial statements 56 ORLEANS HOMEBUILDERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (DOLLARS IN THOUSANDS)
Capital in Excess Preferred Stock Common Stock of Par Shares Shares Value - Issued and Issued and Par Common Retained Outstanding Amount Outstanding Amount Stock Earnings ------------- -------- ------------- --------- ----------- ----------- Balance at June 30, 2002 100,000 $ 3,000 12,698,131 $ 1,270 $ 17,726 $ 40,502 Stock options, net Treasury stock purchase Shares issued upon conversion of a portion of convertible subordinated 7% note 666,666 67 933 Shares issued in connection with the acquisition of PLC Net income 27,297 Preferred dividends (210) ------------- -------- ------------- --------- ----------- ----------- Balance at June 30, 2003 100,000 3,000 13,364,797 1,337 18,659 67,589 Redeemable common stock sold 171 Preferred stock converted to common stock (100,000) (3,000) 2,000,000 200 2,800 Shares issued upon conversion of a portion of convertible subordinated 7% note 666,666 66 934 Fair market value of stock options issued 146 Issuance of common shares 2,000,000 200 45,845 Stock options, net 70 Shares issued in connection with the acquisition of PLC (107) Treasury stock sold, redeemable at $8 per share 36 Net income 38,079 Preferred dividends (104) ------------- -------- ------------- --------- ----------- ----------- Balance at June 30, 2004 - - 18,031,463 1,803 68,554 105,564 Shares issued upon conversion of a portion of convertible subordinated 7% note 666,668 67 933 Fair market value of stock options issued 278 Redeemable common stock sold 179 Stock options, net 71 Tax benefit of stock option exercises 479 Treasury stock purchase Shares issued in connection with the acquisition of PLC (132) Shares awarded under Stock Award Plan 88 Dividends paid on common stock (370) Dividends declared on common stock (371) Net income 55,584 ------------- -------- ------------- --------- ----------- ----------- Balance at June 30, 2005 - - 18,698,131 $ 1,870 $ 70,450 $160,407 ============= ======== ============= ========= =========== ===========
[RESTUBBED TABLE]
Treasury Stock Share Held Amount Total ----------- -------- ----------- Balance at June 30, 2002 812,232 $ (843) $ 61,655 Stock options, net (40,000) 37 37 Treasury stock purchase 30,000 (240) (240) Shares issued upon conversion of a portion of convertible subordinated 7% note 1,000 Shares issued in connection with the acquisition of PLC (75,000) Net income 27,297 Preferred dividends (210) ----------- -------- ----------- Balance at June 30, 2003 727,232 (1,046) 89,539 Redeemable common stock sold 171 Preferred stock converted to common stock - Shares issued upon conversion of a portion of convertible subordinated 7% note 1,000 Fair market value of stock options issued 146 Issuance of common shares 46,045 Stock options, net (45,902) (120) (50) Shares issued in connection with the acquisition of PLC (75,000) 107 - Treasury stock sold, redeemable at $8 per share (30,000) 43 79 Net income 38,079 Preferred dividends (104) ----------- -------- ----------- Balance at June 30, 2004 576,330 (1,016) 174,905 Shares issued upon conversion of a portion of convertible subordinated 7% note 1,000 Fair market value of stock options issued 278 Redeemable common stock sold 179 Stock options, net (202,842) 236 307 Tax benefit of stock option exercises 479 Treasury stock purchase 20,201 (373) (373) Shares issued in connection with the acquisition of PLC (75,000) 132 - Shares awarded under Stock Award Plan (141,778) 250 338 Dividends paid on common stock (370) Dividends declared on common stock (371) Net income 55,584 ----------- -------- ----------- Balance at June 30, 2005 176,911 $ (771) $ 231,956 =========== ======== ===========
See accompanying notes, which are an integral part of the consolidated financial statements 57 ORLEANS HOMEBUILDERS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
YEAR ENDED JUNE 30, ----------------------------------------- 2005 2004 2003 ------ ------ ------ Cash flows from operating activities: Net income $ 55,584 $ 38,079 $ 27,297 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization 1,520 673 449 Amortization of note discount 136 -- -- Deferred taxes (349) (2,220) (851) Excess tax benefit from exercise of stock options 479 -- -- Stock based compensation expense 384 146 11 Changes in operating assets and liabilities net of effects from acquisitions: Restricted cash--due from title company (28,785) -- -- Restricted cash--customer deposits 1,968 (2,730) (5,835) Real estate held for development and sale (150,647) (74,225) (15,708) Receivables, deferred charges and other assets (7,661) 1,133 19 Land deposits and costs of future developments (3,638) (7,345) (10,020) Accounts payable and other liabilities 19,966 15,383 9,320 Customer deposits (3,448) 3,161 6,764 ------------- -------------- -------------- Net cash (used in) provided by operating activities (114,491) (27,945) 11,446 ------------- -------------- -------------- Cash flows from investing activities: Purchases of property and equipment (1,175) (2,366) (1,151) Acquisitions, net of cash acquired (57,079) (5,391) (462) ------------- -------------- -------------- Net cash used in investing activities (58,254) (7,757) (1,613) ------------- -------------- -------------- Cash flows from financing activities: Borrowings from loans secured by real estate assets 647,585 364,272 252,962 Repayments of loans secured by real estate assets (448,046) (353,020) (259,313) Borrowings from unsecured credit line 135,948 -- -- Repayments of unsecured credit line (135,948) -- -- Borrowings from other note obligations 5,179 2,962 4,000 Repayment of other note obligations (2,193) (642) (5,443) Proceeds from the issuance of common stock -- 46,045 -- Sale (purchase) of treasury stock (373) 240 (240) Proceeds from stock award plan 268 -- -- Proceeds from stock options exercised 309 28 37 Common stock dividend paid (370) -- -- Preferred stock dividend paid -- (104) (210) ------------- -------------- -------------- Net cash provided by (used in) financing activities 202,359 59,781 (8,207) ------------- -------------- -------------- Net increase in cash and cash equivalents $ 29,614 $ 24,079 $ 1,626 Cash and cash equivalents at beginning of period 32,962 8,883 7,257 ------------- -------------- -------------- Cash and cash equivalents at end of period $ 62,576 $ 32,962 $ 8,883 ============= ============== ============== Supplemental disclosure of cash flow activities: Interest paid, net of amounts capitalized $ 102 $ 336 $ 232 ============= ============== ============== Income taxes paid $ 32,238 $ 23,203 $ 17,007 ============= ============== ==============
See accompanying notes, which are an integral part of the consolidated financial statements 58 ORLEANS HOMEBUILDERS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES During the fiscal year ended June 30, 2005, Orleans Homebuilders, Inc. and its subsidiaries (the "Company" or "OHB") engaged in residential real estate development in Central Florida, New Jersey, North Carolina, Pennsylvania, South Carolina, Virginia, and Illinois. A summary of the significant accounting principles and practices used in the preparation of the consolidated financial statements is as follows: PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. On July 28, 2003, the Company acquired all of the issued and outstanding shares of Masterpiece Homes, Inc. ("Masterpiece Homes"). On July 28, 2004, the Company acquired all of the issued and outstanding limited partnership interests of Realen Homes, L. P. ("Realen Homes"). Unless otherwise indicated, the term the "Company" includes the accounts of Masterpiece Homes and Realen Homes. Masterpiece is engaged in residential real estate development in central Florida while Realen Homes was engaged in residential real estate development in Philadelphia and Chicago. The Consolidated Statements of Operations and Changes in Retained Earnings and the Consolidated Statements of Cash Flows include the accounts of Masterpiece Homes from the July 28, 2003 acquisition date. The Consolidated Statements of Operations and Changes in Retained Earnings and the Consolidated Statements of Cash Flows include the accounts of Realen Homes from the July 28, 2004 acquisition. The Consolidated Balance Sheets and Consolidated Statements of Shareholders' Equity include the accounts of Realen Homes as of June 30, 2005. In addition, certain joint ventures and business arrangements are consolidated pursuant to FASB Interpretation No. 46 "Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51" ("FIN 46"). See recent accounting pronouncements section of this Note 1 and Note 4 for additional discussion of FIN 46. All material intercompany transactions and accounts have been eliminated. EARNED REVENUES FROM REAL ESTATE TRANSACTIONS The Company recognizes revenues from sales of residential properties at the time of closing. The Company also sells developed and undeveloped land in bulk and under option agreements. Revenues from sales of land and other real estate are recognized when the Company has received an adequate cash down payment and all other conditions necessary for profit recognition have been satisfied. During the three years ended June 30, 2005, 2004, and 2003, all sales transactions met the criteria for and were accounted for utilizing the full accrual method. 59 To the extent that certain sales or portions thereof do not meet all conditions necessary for profit recognition, the Company uses other methods to recognize profit, including the percentage-of-completion, cost recovery and the deposit methods. These methods of profit recognition defer a portion or all of the profit to the extent it is dependent upon the occurrence of future events. REAL ESTATE CAPITALIZATION AND COST ALLOCATION Residential properties completed or under construction are stated at cost or estimated net realizable value, whichever is lower. Costs include land and land improvements, direct construction costs and development costs, including predevelopment costs, interest on indebtedness, real estate taxes, insurance, construction overhead and indirect project costs. Selling and advertising costs are expensed as incurred. Total estimated costs of multi-unit developments are allocated to individual units based upon specific identification methods. Land and improvement costs include land, land improvements, interest on indebtedness and real estate taxes. Appropriate costs are allocated to projects on the basis of acreage, dwelling units and relative sales value. Land held for development and sale and improvements are stated at cost or estimated net realizable value, whichever is lower. Land and land improvements applicable to condominiums, townhomes and single-family homes, are transferred to construction in progress when construction commences. Interest costs included in costs and expenses of residential properties and land sold for fiscal years 2005, 2004 and 2003 were $13,210,000, $7,597,000, and $8,073,000, respectively. INTANGIBLE ASSETS Effective July 1, 2001, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" ("SFAS No. 142"), which establishes standards for financial accounting and reporting for intangible assets acquired individually or with a group of other assets and for the reporting of goodwill and other intangible assets acquired in a business acquisition subsequent to initial accounting under Statement of Financial Accounting Standards No. 141, "Business Combinations" ("SFAS No. 141"). In accordance with SFAS No. 142, upon adoption of SFAS No. 142, the Company discontinued the amortization relating to all existing indefinite lived intangible assets. Intangible assets that have finite useful lives will be amortized over their useful lives. SFAS No. 142 requires an annual assessment of goodwill and non-amortizable intangible assets to determine potential impairment of such 60 asset. The initial assessment was completed upon adoption and periodically through June 30, 2005 and it has been determined that no impairment charge was required. ADVERTISING COSTS The total amount of advertising costs charged to selling, general and administrative expense was $9,058,000, $6,110,000 and $5,731,000 for fiscal years 2005, 2004, and 2003, respectively. DEPRECIATION, AMORTIZATION AND MAINTENANCE EXPENSE Depreciation and amortization is primarily provided on the straight-line method at rates calculated to amortize the cost of the assets over their estimated useful lives. Expenditures for maintenance, repairs and minor renewals are expensed as incurred; major renewals and betterments are capitalized. At the time depreciable assets are retired or otherwise disposed of, the cost and the accumulated depreciation of the assets are eliminated from the accounts and any profit or loss is recognized. LEASES The Company's leasing arrangements as lessee include the leasing of certain office space and equipment. These leases have been classified as operating leases. Rent expense was approximately $1,575,000, $791,000 and $623,000 for the three years ended June 30, 2005, 2004 and 2003, respectively. The Company has operating lease commitments of $1,562,000, $1,385,000, $1,229,000, $780,000 $326,000 and $512,000 for fiscal years 2006, 2007, 2008, 2009, 2010 and thereafter, respectively. STOCK-BASED COMPENSATION Effective July 1, 2002, the Company adopted the preferable fair value recognition provisions of SFAS No. 123, "Accounting for Stock Issued to Employees." The Company selected the prospective method of adoption as permitted by SFAS No. 148, "Accounting for Stock-Based Compensation-Transition and Disclosure." See Note 10 for additional disclosure and discussion on stock-based compensation. See New Accounting Pronouncements for further discussion on FAS 123-R. INCOME TAXES The Company and its subsidiaries file a consolidated federal income tax return. See Note 9 for an additional discussion of income tax matters. EARNINGS PER SHARE Basic earnings per common share are computed by dividing net income by the weighted average number of common shares outstanding. Basic shares outstanding includes the pro rata portion of unconditional shares issued as part of the purchase price of the PLC acquisition. Diluted earnings per share include 61 additional common shares that would have been outstanding if the dilutive potential common shares had been issued. See Note 11 for additional disclosure on earnings per share. DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS SFAS No. 107, "Disclosures about Fair Value of Financial Instruments," requires the Company to disclose the estimated fair market value of its financial instruments. The Company believes that the carrying value of its financial instruments (primarily mortgages receivable and mortgage notes payable) approximates fair market value and that any differences are not significant. This assessment is based upon substantially all of the Company's debt obligations being based upon LIBOR or the prime rate of interest, which are variable market rates. SEGMENT REPORTING SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" establishes standards for the manner in which public enterprises report segment information about operating segments. The Company has determined that its operations primarily involve one reportable segment, home building. CONSOLIDATED STATEMENTS OF CASH FLOWS For purposes of reporting cash flows, short-term investments with original maturities of ninety days or less are considered cash equivalents. NON-CASH ACTIVITY During each of fiscal 2005 and 2004, the Company converted $1,000,000 of its Convertible Subordinated 7% Notes, issued to Jeffrey P. Orleans, Chairman and CEO of the Company, into Orleans Homebuilders, Inc. common stock at $1.50 per share. The Convertible Subordinated 7% Note was included in the Notes payable - related parties category of the balance sheet. With notice given prior to the principal payment due dates, Mr. Orleans converted each of the annual installments into shares of the Company's common stock. As of June 30, 2005, the entire balance of the Convertible Subordinated 7% Note has been converted. In April 2005, Michael T. Vesey, President and Chief Operating Officer of the Company, surrendered 7,158 shares of Company's common stock, with a fair market value of $18.51 per share, in exchange for the exercise of stock options totaling 70,000 shares of common stock. The fair market value of the stock surrendered was determined by the closing market price for the stock on the American Stock Exchange at the date of exercise. Non-cash assets acquired and liabilities assumed as a result of the Realen Homes acquisition were approximately $158,964,000 and $101,885,000, respectively. 62 Non-cash assets acquired and liabilities assumed as a result of the Masterpiece Homes acquisition were approximately $17,269,000 and $15,119,000, respectively. SUPPLEMENTAL CASH FLOW DISCLOSURE On July 28, 2004, the Company acquired Realen Homes. The following is a summary of the effects of this transaction on the Company's consolidated financial position:
July 28, 2004 --------------- (in thousands) Assets acquired: Cash $ (3,174) Restricted cash - customer deposits (4,273) Real estate held for development and sale (136,832) Property and equipment, at cost, less accumulated depreciation (166) Intangible assets, net of amortization (13,827) Receivables, deferred charges and other assets (1,788) Land deposits and costs of future development (2,078) --------------- Total assets acquired (162,138) --------------- Liabilities assumed: Accounts payable 10,771 Accrued expenses 8,529 Customer deposits 8,566 Mortgage and other note obligations primarily secured by real estate held for development and sale 70,282 Other notes payable 3,737 --------------- Total liabilities assumed 101,885 --------------- Cash paid (53,348) Note payable (5,000) Warranty holdback (1,500) Professional fees paid (405) Less cash acquired 3,174 --------------- Net cash outflow for Realen Homes acquisition $ (57,079) ===============
COMPREHENSIVE INCOME The FASB issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130") which requires the reporting of certain items reported as changes in the shareholders' equity section of the balance sheet and establishes standards for the reporting and display of comprehensive income and its components in a full set of general-purpose financial statements. SFAS No. 130 requires that all components of comprehensive income shall be reported in the financial statements in the period in which they are recognized. 63 Furthermore, a total amount for comprehensive income shall be displayed in the financial statements. The primary components of comprehensive income are net income, foreign currency translations, minimum pension liabilities, the change in value of certain investments in marketable securities classified as available-for-sale, and the mark-to-market on the effective portion of hedge instruments. Since the Company had no material such items, comprehensive income and net income are the same for fiscal 2005, 2004 and 2003. MANAGEMENT'S ESTIMATES AND ASSUMPTIONS The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. RECENT ACCOUNTING PRONOUNCEMENTS In December 2002 the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure" ("SFAS No. 148") which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123. The transition provisions of this Statement are effective for fiscal years ending after December 15, 2002, and the disclosure requirements of the Statement are effective for interim periods beginning after December 15, 2002. The Company adopted SFAS No. 148 effective July 1, 2002. The adoption of SFAS No. 148 did not have a material impact on the financial position or results of operations of the Company. Only 50,000 options were unvested as of the adoption date and all grandfathered APB25 grants were fully vested as of June 30, 2003. As such, the adoption of SFAS No. 148 did not have a material impact on the financial position or results of operations of the Company. In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" ("FIN 46"). The FASB issued a revised FIN 46 in December 2003 which modifies and clarifies various aspects of the original interpretations. A Variable Interest Entity ("VIE") is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE, pursuant to FIN 46, an enterprise that absorbs a majority of the expected losses of the VIE is considered the primary beneficiary and must consolidate the VIE. For VIEs created before January 31, 2003, FIN 46 was 64 deferred to the end of the first interim or annual period ending after March 15, 2004. The Company fully adopted FIN 46 effective March 31, 2004. Based on the provisions of FIN 46, the Company has concluded that whenever it enters into an option agreement to acquire land or lots from an entity and pays a significant deposit that is not unconditionally refundable, a VIE is created under condition (ii) (b) of the previous paragraph. The Company has been deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity's expected theoretical losses if they occur. For each VIE created the Company will compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46. If the Company is deemed to be the primary beneficiary of the VIE it will consolidate the VIE on its balance sheet. The fair value of the VIEs inventory is reported as "Inventory Not Owned - Variable Interest Entities." The Company recorded $88,252,000 and $88,995,000 in Inventory Not Owned - Variable Interest Entities as of June 30, 2005 and June 30, 2004, respectively. Included in the balance at June 30, 2004 is $21,932,000 which pertains to option agreements to acquire land or lots that were executed prior to January 31, 2003 and recorded as VIEs as a result of the full adoption of FIN 46. At June 30, 2005, the Company consolidated thirteen VIEs as a result of its option to purchase land or lots from the selling entities. The Company paid cash or issued letters of credit deposits to these thirteen VIEs totaling $6,852,000. At June 30, 2004 the Company consolidated twenty-three VIEs as a result of its option to purchase land or lots from the selling entities. The Company paid cash or issued letters of credit deposits to these twenty-three VIEs totaling $7,683,000. The Company's deposits and any costs incurred prior to acquisition of the land or lots, represent our maximum exposure to loss. The fair value of the VIEs inventory is reported as "Inventory Not Owned - Variable Interest Entities. The Company recorded $88,252,000 and $88,995,000 in Inventory Not Owned - Variable Interest Entities as of June 30, 2005 and June 30, 2004, respectively. The fair value of the property to be acquired less cash deposits and pre-acquisition costs, which totaled $79,585,000 and $81,992,000 at June 30, 2005 and 2004, respectively, was reported on the balance sheet as Obligations related to inventory not owned. Creditors, if any, of these VIEs have no recourse against the Company. The Company will continue to secure land and lots using options. In addition to the deposits and other costs capitalized in connection with the VIEs above, the Company had total costs incurred to acquire land and lots at June 30, 2005 of approximately $27,448,000, including $17,812,000 of cash deposits. The total purchase price under these cancelable contracts or options is approximately $510,181,000. The maximum exposure to loss is limited to deposits, although some deposits are refundable, and costs incurred prior to the acquisition of the land or lots. 65 In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150 "Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity" ("SFAS No. 150"). This standard requires issuers to classify as liabilities the following three types of freestanding financial instruments: (1) mandatory redeemable financial instruments, (2) obligations to repurchase the issuer's equity shares by transferring assets; and (3) certain obligations to issue a variable number of shares. The Company adopted SFAS No. 150 effective July 1, 2003. The adoption of SFAS No. 150 did not have a material impact on the financial position or results of operations of the Company. In December 2003, the SEC issued Staff Accounting Bulletin No. 104 ("SAB 104"), "Revenue Recognition" which supersedes SAB 101, "Revenue Recognition in Financial Statements." SAB 104's primary purpose is to update the accounting guidance contained in SAB 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF 00-21. The Company adopted the provisions of this statement immediately, as required, and it did not have a significant impact on the financial position or results of operations of the Company. EITF 00-21, "Accounting for Revenue Arrangements with Multiple Deliverables," issued during the third quarter of 2003, provides guidance on revenue recognition for revenues derived from a single contract that contain multiple products or services. EITF 00-21 also provides additional requirements to determine when these revenues may be recorded separately for accounting purposes. The Company adopted EITF 00-21 on July 1, 2003, as required, and it did not have a significant impact on the financial position or results of operations of the Company. In December 2004, the FASB revised FAS 123 through the issuance of FAS No. 123-R "Share Based Payment", revised ("FAS 123-R"). FAS 123-R is effective for the Company commencing July 1, 2005. FAS 123-R, among other things, eliminates the alternative to use the intrinsic value method of accounting for stock based compensation and requires entities to recognize the cost of employee services received in exchange for awards of equity instruments based on the grant-date fair value of those awards (with limited exceptions). The fair value based method in FAS 123-R is similar to the fair-value-based method in FAS 123 in most respects, subject to certain key differences. Because there are no remaining unvested ABP25 grants as of the adoption date and management does not believe that there will be significant change in the valuation methodologies, the Company does not anticipate that the adoption of FAS 123-R will have a material impact on the financial position or results of operations of the Company. In December 2004, the FASB issued FASB Staff Position No. FAS 109-1, "Application of FASB Statement No. 109, Accounting for Income Taxes, for the Tax Deduction on Qualified Production Activities Provided by the American Jobs Creation Act of 2004" (FSP FAS 109-1). FSP FAS 109-1 clarifies that the 66 deduction will be treated as a "special deduction" as described in Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes." As such, the special deduction has no effect on deferred tax assets and liabilities existing at the date of enactment. The impact of the deduction will be reported in the period in which the deduction is claimed. The Company files a consolidated return on a calendar year. Accordingly, the Company began reflecting the special deduction with respect to its operations effective January 1, 2005 for the remaining six months in our fiscal year ended June 30, 2005. Its expected impact was and will be to lower the effective tax provision in the periods in which the deduction may be claimed and that this benefit will increase as the deduction is phased in under the statute (see Note 9 for discussion of deduction phase in). NOTE 2. ACQUISITIONS PEACHTREE ACQUISITION On December 23, 2004, pursuant to an Asset Purchase Agreement of the same date, the Company acquired, through a wholly-owned subsidiary, the real estate assets described below (the "Assets") from Peachtree Residential Properties, LLC, a North Carolina limited liability company and Peachtree Townhome Communities, LLC, a North Carolina limited liability company which were at the time of acquisition wholly-owned subsidiaries of Peachtree Residential Properties, Inc., a Georgia corporation (collectively, "Peachtree Residential Properties"). The Assets include: (a) improved and unimproved real property, (b) rights to acquire real estate under options or agreements, (c) equipment, (d) rights under certain contracts for the sale of homes to be sold and leases for real property, (e) rights to certain tradenames and other intangibles, including contract backlog, (f) homes and other improvements under construction as of the closing, (g) certain plans, drawings, specifications, permits and rights under warranties and (h) governmental approvals and books and records associated with, or relating to the foregoing. The Company paid $29,300,000 in cash, to acquire the Assets and certain of liabilities of Peachtree Residential Properties assumed by the Company, less $200,000 to be retained by the Company and applied towards the administration of certain home warranty claims. REALEN HOMES ACQUISITION On July 28, 2004, pursuant to a Purchase Agreement of the same date, the Company completed its acquisition of all of the issued and outstanding partnership interests in Realen Homes, a Pennsylvania limited partnership, from Realen General Partner, LLC, a Pennsylvania limited liability company, and DB Homes Venture L.P., a Pennsylvania limited partnership. The Company acquired the 67 limited partner's interest in Realen Homes and a subsidiary of the Company, RHGP LLC, acquired the general partner's interest and serves as the general partner of Realen Homes. In accordance with the Purchase Agreement, the consideration paid by the Company consisted of: (i) $53,348,000 in cash delivered at closing, (ii) a promissory note of the Company in the aggregate principal amount of $5,000,000, payable over a period of up to two years, with an interest rate of 3% per year and (iii) a warranty holdback of $1,500,000 retained by the Company to be applied toward the administration of any warranty claims made against Realen Homes in excess of certain predetermined amounts. The purchase price was determined based on Realen Homes' book value at June 30, 2004, its management personnel, its profitability, its backlog and its land position. In addition to the consideration described above, the Company incurred approximately $405,000 in professional fees in connection with the acquisition of Realen Homes. The Company evaluated the $5,000,000 3% note in accordance with Accounting Principles Board Opinion No. 21 "Interest on Receivables and Payables" ("APB 21") and determined that it was a below market rate note. In accordance with APB 21, the Company estimated, based on current market conditions that the Company would likely have been able to obtain similar fixed-rate financing from a third party at approximately 150 basis points higher than the note actually obtained. The Company imputed interest on the note at 4.5% and reduced the carrying value of the note from $5,000,000 to $4,863,000. The discount of $137,000 will be recorded as interest expense over the life of the note. See Note 6 for additional information on the $5,000,000 note. The acquisition included, subject to specified exceptions, all assets and liabilities of Realen Homes, including land owned or under contract, homes under construction but not sold or sold but not delivered, sales offers and reservations, and model homes and furnishings. The acquired assets were used by Realen Homes in the homebuilding business in Pennsylvania and Illinois. The Company intends to continue to use the acquired assets in the homebuilding business. The Company accounted for the Realen Homes acquisition as a purchase in accordance with SFAS No. 141, "Business Combinations." The purchase price was allocated to goodwill for $13,327,000 which is defined as the fair value of assets and liabilities acquired in excess of the purchase price and to intangible assets for $500,000. The intangible assets represent the intangible value of the backlog acquired from Realen Homes. The intangible value of the backlog will be amortized into cost of sales as the acquired backlog is delivered. The Company amortized $494,000 of the intangible value of the backlog acquired from Realen Homes for the twelve months ended June 30, 2005. 68 If the Realen Homes acquisition occurred as of the beginning of the annual periods presented below the pro forma information for the Company would have been as follows:
JUNE 30, -------------------------- 2005 2004 ------ ------ (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Earned revenues $924,656 $675,219 Income from operations before income taxes 90,329 65,070 Net income 54,649 39,505 Earnings per share: Basic $3.04 $2.67 Diluted $2.91 $2.28
MASTERPIECE HOMES ACQUISITION On July 28, 2003, the Company acquired all of the issued and outstanding shares of Masterpiece Homes and entered into an employment agreement with the president of Masterpiece Homes. Masterpiece Homes is an established homebuilder located in Orange City, Florida. The terms of the stock purchase agreement and employment agreement are as follows: (i) $3,900,000 in cash, at closing; and (ii) $2,130,000 payable January 1, 2005, unless prior to that date the president is terminated for cause or terminates his employment without good reason, as defined in the employment agreement; (iii) sale of 30,000 shares of the Company's common stock at $8 per share with a put option at the same price, (iv) stock options to purchase 45,000 shares of the Company's common stock at $10.64 per share vesting equally on December 31, 2004, 2005 and 2006; and (v) contingent payments representing 25% of the pre-tax profits of Masterpiece Homes for the calendar years ended December 31, 2004, 2005 and 2006. The Company also incurred approximately $297,000 in acquisition costs to complete this transaction. The aforementioned costs are considered part of the purchase price of Masterpiece Homes, except for the following items that are considered part of, and contingent upon, the employment agreement: (a) $710,000 of the $2,130,000 which was paid in January 2005; (b) stock options to purchase 45,000 shares of the Company's common stock at $10.64 per share; and (c) contingent payments representing 25% of the pre-tax profits of Masterpiece Homes for the calendar years ended December 31, 2004, 2005 and 2006. The Company accounted for these transactions in accordance with SFAS No. 141, "Business Combinations," whereby approximately $5,700,000 was considered to be part of the purchase price of the business and the remainder part of employee compensation. That portion related to employee compensation will be charged to expense over the period to which it relates. With respect to the amounts allocated to the purchase, such amounts were allocated to the fair value of assets and liabilities acquired with the excess of approximately $3,007,000 allocated to goodwill. 69 If the Masterpiece Homes acquisition occurred as of the beginning of the annual periods presented below the pro forma information for the Company would have been as follows: FOR THE YEAR ENDED JUNE 30, 2004 2003 ---- ---- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Earned revenues $543,335 $415,837 Income from operations before income taxes 62,646 45,438 Net income 38,026 27,581 Earnings per share: Basic $2.57 $2.21 Diluted $2.20 $1.67 PARKER & LANCASTER ACQUISITION On October 13, 2000, the Company acquired all of the issued and outstanding shares of Parker & Lancaster Corporation ("PLC") and entered into employment agreements ranging from two to three years with certain of the former PLC shareholders for combined consideration of (i) approximately $5,000,000 in cash; (ii) $1,000,000 of subordinated promissory notes which bear interest at the prime rate, subject to a cap of 10% and a floor of 8% (subject to the 8% floor at June 30, 2003 and 2002) with principal payable over four years; (iii) 300,000 shares of common stock of the Company (150,000 of which are issuable under certain employment agreements) payable in equal installments on each of the four anniversaries of the closing of the acquisition; and (iv) contingent payments representing an aggregate of 50% of PLC's pre-tax profits in excess of $1,750,000 for each of the fiscal years ended June 30, 2001, 2002 and 2003, subject to an aggregate cumulative pay-out limitation of $2,500,000. Through June 30, 2003, the contingent payments earned based on PLC's share of the pre-tax profits reached the cumulative payout limitation of $2,500,000. The Company also incurred approximately $485,000 in acquisition costs to complete this transaction. The Company accounted for these transactions in accordance with Accounting Principles Board Opinion No. 16, "Business Combinations," whereby certain of these amounts were considered to be part of the purchase price of the business and the remainder part of employee compensation. With respect to the amounts allocated to the purchase, such amount was allocated to the fair value of the assets and liabilities acquired with the excess of approximately $2,480,000 allocated to goodwill. Accumulated amortization of goodwill at June 30, 2001 was approximately $167,000. In accordance with SFAS No. 142, the Company discontinued the amortization related to goodwill recorded in connection with the PLC acquisition. See also Intangible Assets in Note 1 to these Consolidated Notes. During fiscal 2003, goodwill increased by approximately $462,000 as a result of the final allocation of additional contingent payments earned by the former PLC shareholders. 70 The former shareholders of PLC have the right to cause the Company to repurchase the common stock issued pursuant to the PLC acquisition and related employment agreements approximately five years after the closing of the acquisition at a price of $3.33 per share. See Note 7 for further discussion. NOTE 3. CERTAIN TRANSACTIONS WITH RELATED PARTIES Mr. Goldman and Mr. Orleans each own a 31% equity interest in a limited partnership that has a consulting agreement with a third party real estate title insurance company (the "Title Company"). The Company purchases real estate title insurance and related closing services from the Title Company for various parcels of land acquired by the Company. The Company paid the Title Company approximately $800,000, $178,000 and $80,000 for the fiscal years 2005, 2004 and 2003, respectively. These costs are considered to approximate fair value for services provided. In addition, the Company's homebuyers may elect to utilize the Title Company for the purchase of real estate title insurance and real estate closing services but, the homebuyers are under no obligation to do so. Under the terms of the consulting agreement, which expires in July 2007, the limited partnership providing the consulting services is entitled to receive 50% of the pretax profits attributable to certain operations of the Title Company, subject to certain adjustments. In addition, the limited partnership and the principals of the limited partnership, including Mr. Goldman and Mr. Orleans, have agreed not to engage in the real estate title insurance business or the real estate closing business during the term of the consulting agreement. During fiscal 2003, Jeffrey P. Orleans, Chairman and Chief Executive Officer of the Company, purchased from the Company five low-income homes, with an aggregate sales value of approximately $317,000. These transactions satisfied, in part, the Company's low income housing requirements in Mount Laurel Township, New Jersey. The selling prices for these homes, which are determined by state statute, are the same as if the homes had been sold to unaffiliated third parties. During fiscal 2003 the Company entered into two separate ten year leases for the rental of office space with a company that is controlled by Mr. Orleans. The Company took possession of the leased premises in May 2004 at which time the lease term began. The annual rental for the leased office space is $112,000 and escalates to $128,000 after the fifth year of the lease. The Company is also responsible to pay its pro rata share of common area maintenance costs. These costs are considered to approximate fair value for services provided. The Company leases office space and obtains real estate title insurance for various parcels of land acquired by the Company from companies controlled by Mr. Russell Parker, the president of the Company's subsidiary, PLC. The annual 71 rental for the office space leased from an entity partially owned by Mr. Parker is approximately $126,000 and is considered to approximate a fair market value rental. The Company paid real estate title insurance premiums to an entity controlled by Mr. Parker, of approximately $56,000, $96,000 and $89,000 for fiscal 2005, 2004 and 2003, respectively. These costs are considered to approximate fair value for services provided. In December 2004, the Company purchased a majority interest in this real estate title insurance company. Real estate title insurance paid by the Company is capitalized as a cost of acquiring the specific parcel in accordance with the Company's real estate capitalization and cost allocation policies and is subsequently expensed as part of cost of sales upon consummation of sales to the third party homebuyers. See Note 1 to the consolidated financial statements for a discussion of these policies. See Notes 6 and 8 to the consolidated financial statements for a discussion of other related party financing transactions. NOTE 4. REAL ESTATE HELD FOR DEVELOPMENT AND SALE A summary of real estate held for development and sale is as follows: AS OF JUNE 30, 2005 2004 -------- -------- Condominiums and townhomes $ 43,528 $ 26,132 Single-family homes 147,327 114,269 Land held for development or sale and improvements 398,290 161,265 Inventory not owned 88,252 88,995 -------- -------- Total real estate held for development and sale $677,397 $390,661 ======== ======== In January 2003, the FASB issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities, an interpretation of ARB No. 51" ("FIN 46"). The FASB issued a revised FIN 46 in December 2003 which modifies and clarifies various aspects of the original interpretations. A Variable Interest Entity ("VIE") is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE, pursuant to FIN 46, an enterprise that absorbs a majority of the expected losses of the VIE is considered the primary beneficiary and must consolidate the VIE. For VIEs created before January 31, 2003, FIN 46 was deferred to the end of the first interim or annual period ending after March 15, 2004. The Company fully adopted FIN 46 effective March 31, 2004. 72 Based on the provisions of FIN 46, the Company has concluded that whenever it enters into an option agreement to acquire land or lots from an entity and pays a significant deposit that is not unconditionally refundable, a VIE is created under condition (ii) (b) of the previous paragraph. The Company has been deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity's expected theoretical losses if they occur. For each VIE created the Company will compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46. If the Company is deemed to be the primary beneficiary of the VIE it will consolidate the VIE on its balance sheet. The fair value of the VIEs inventory will be reported as "Inventory Not Owned - Variable Interest Entities At June 30, 2005, the Company consolidated thirteen VIEs as a result of its option to purchase land or lots from the selling entities. The Company paid cash or issued letters of credit deposits to these thirteen VIEs totaling $6,852,000. At June 30, 2004 the Company consolidated twenty-three VIEs as a result of its option to purchase land or lots from the selling entities. The Company paid cash or issued letters of credit deposits to these twenty-three VIEs totaling $7,683,000. The Company's deposits and any costs incurred prior to acquisition of the land or lots, represent our maximum exposure to loss. The fair value of the VIEs inventory will be reported as "Inventory Not Owned - Variable Interest Entities. The Company recorded $88,252,000 and $88,995,000 in Inventory Not Owned - Variable Interest Entities as of June 30, 2005 and June 30, 2004, respectively. The fair value of the property to be acquired less cash deposits and pre-acquisition costs, which totaled $79,585,000 and $81,992,000 at June 30, 2005 and 2004, respectively, was reported on the balance sheet as Obligations related to inventory not owned. Creditors, if any, of these VIEs have no recourse against the Company. The Company will continue to secure land and lots using options. In addition to the deposits and other costs capitalized in connection with the VIEs above, the Company had total costs incurred to acquire land and lots at June 30, 2005 of approximately $27,448,000, including $17,812,000 of cash deposits. The total purchase price under these cancelable contracts or options is approximately $510,181,000. The maximum exposure to loss is limited to deposits, although some deposits are refundable, and costs incurred prior to the acquisition of the land or lots. Sales status of residential properties completed or under construction is as follows:
Balance at June 30, ------------------------ 2005 2004 ------------------------ (in thousands) Under contract for sale ........................................... $ 128,137 $ 89,519 Unsold ............................................................ 62,718 50,882 --------- --------- Total residential properties completed or under construction....... $ 190,855 $ 140,401 ========= =========
73 NOTE 5. PROPERTY AND EQUIPMENT Property and equipment consists of the following: Balance at June 30, ------------------------- 2005 2004 ------------------------- (in thousands) Property and equipment ..................... $ 6,681 $ 5,233 Less: accumulated depreciation ............. (3,261) (2,070) ------- ------- Total property and equipment ............... $ 3,420 $ 3,163 ======= ======= Depreciation expense, included in Other Costs and Expenses on the Company's Consolidated Statements of Operations, was $1,026,000, $673,000 and $449,000 during fiscal 2005, 2004 and 2003, respectively. NOTE 6. DEBT OBLIGATIONS The following table summarizes the components of the Company's outstanding Debt Obligations, including related party amounts.
FINAL ANNUAL MATURITY EFFECTIVE OUTSTANDING BALANCE AT DATE INTEREST JUNE 30, FISCAL YEAR RATE 2004 2005 ------------------------------------------------------ (IN THOUSANDS) Revolving credit facility, mortgage and other notes payable ............................ 2008 variable $399,030 $128,773 -------- -------- Convertible Subordinated 7% Note ............ 2005 7% -- 1,000 Masterpiece Homes shareholders .............. 2005 -- -- 1,879 -------- -------- Subtotal notes payable and amounts due to related parties .......................... -- 2,879 -------- -------- Promissory note (Realen acquisition) ........ 2007 4.5% 4,926 -- Subordinated notes payable .................. 2006 4.5% 3,498 -- Property and Equipment ...................... 2006-2009 4%-8% 976 1,139 -------- -------- Subtotal other notes payable ................ $ 9,400 $ 1,139 -------- --------
The maximum balance outstanding under the Revolving Credit Facility, Unsecured Bridge Loan, construction and inventory loan agreements at any month end during fiscal 2005, 2004 and 2003 was $451,302,000, $176,768,000 and $133,018,000, respectively. The average month end balances of those obligations during fiscal 2005, 2004 and 2003 was approximately $365,509,000, $145,939,000 and $115,490,000, respectively, bearing interest at an approximate average annual rate of 4.90%, 3.71% and 4.51% respectively. 74 REVOLVING CREDIT FACILITY On December 22, 2004, Greenwood Financial, Inc., a wholly-owned subsidiary of the Company and other wholly-owned subsidiaries of the Company, as borrowers, and Orleans Homebuilders, Inc. as guarantor, entered into a Revolving Credit and Loan Agreement (the "Credit Agreement") for a $500 Million Senior Secured Revolving Credit and Letter of Credit Facility (the "Revolving Credit Facility") with various banks as lenders. The Revolving Credit Facility may be increased to $650,000,000 under certain circumstances. Under and subject to the terms of the Revolving Credit Facility, the borrowers may borrow and re-borrow for the purpose of financing the acquisition and development of real estate, the construction of homes and improvements, for investment in joint ventures, for working capital and for such other appropriate purposes as may be approved by the lenders. Capitalized terms used below and not otherwise defined have the meanings set forth in the Revolving Credit Agreement. The Revolving Credit Facility replaces the Company's July 28, 2004 Bridge Loan Agreement with Wachovia Bank, N.A. The Company used approximately $388,000,000 of funds available under the Revolving Credit Facility to repay substantially all of the loans of the Company and its wholly owned subsidiaries from other banks and financial institutions and to acquire the real estate assets of Peachtree Residential Properties in Charlotte, North Carolina. Prior to the Revolving Credit Facility, the Company had mortgage obligations with various lending institutions that were repaid at a predetermined percentage (approximately 85% on average) of the selling price of a unit when a sale is completed. The repayment percentage varied from community to community and over time within the same community. At June 30, 2005, there was $394,000,000 outstanding under the Revolving Credit Facility. In addition, approximately $40,000,000 of letters of credit and other assurances of the availability of funds have been provided under the Revolving Credit Facility. The Revolving Credit Facility has an initial three-year term and borrowings and advances bear interest on a per annum basis equal to LIBOR Market Index Rate plus a non-default variable spread ranging from 175 basis points to 237.5 basis points, depending upon the Company's leverage ratio. The Revolving Credit Facility may be extended for an additional one year period with the approval of the lenders and payment of an extension fee. During the term of the Revolving Credit Facility, interest is payable monthly in arrears. The June 30, 2005 interest rate was 5.72% which includes the 237.5 basis point spread. At June 30, 2005, the Company had approximately $66,100,000, of borrowing capacity under its secured revolving credit facility of which approximately $22,500,000 was available to be drawn based upon the Company's borrowing base after repayment of $29,000,000 made within one week subsequent to year end. Obligations under residential property and construction loans amounted to $399,030,000 and $128,773,000 at June 30, 2005 and 2004, respectively. The LIBOR and prime rate of interest at June 30, 2005 were 3.34% and 6.25%, per annum, respectively. 75 Under the Revolving Credit Facility, the total amount of loans and advances outstanding at any time may not exceed the lesser of the then-current Borrowing Base Availability or the Revolving Sublimit of $500,000,000. The Revolving Sublimit initially, under certain circumstances, may be increased to up to $650,000,000. The Borrowing Base Availability is based on the lesser of the appraised value or cost of real estate owned by the Company that has been admitted to the borrowing base. Various conditions must be satisfied in order for real estate to be admitted to the borrowing base, including that a mortgage in favor of lenders has been delivered to the agent for lenders and that all governmental approvals necessary to begin development of for-sale residential housing, other than building permits and certain other permits the Company in good faith believes will be issued within 120 days, have been obtained. Depending on the stage of development of the real estate, the loan to value or loan to cost advance rate ranges from 50% to 90% of the appraised value or cost of the real estate, whichever is less. As security for all obligations of the Company to lenders under the Revolving Credit Facility, lenders have a first priority mortgage lien on all real estate admitted to the borrowing base. In addition, Orleans Homebuilders, Inc. has guaranteed the obligations of the borrowers to lenders pursuant to a Guaranty executed by Orleans Homebuilders, Inc. on December 22, 2004. Under the Guaranty, Orleans Homebuilders, Inc. has granted lenders a security interest in any balance or assets in any deposit or other account Orleans Homebuilders, Inc. has with any lender. The Company is required to maintain certain financial ratios and customary covenants as set forth in the Revolving Credit Facility. OTHER SECURED BORROWINGS On July 28, 2004 the Company entered into an Unsecured Bridge Loan Agreement with a maximum borrowing amount of $120,000,000. Proceeds from the Unsecured Bridge Loan were used to finance the acquisition of Realen Homes, refinance certain outstanding indebtedness of Realen Homes and provide the Company with short-term liquidity for land purchases and residential development and construction site improvements. The Unsecured Bridge Loan had a maturity date of November 30, 2004. On November 17, 2004, the Unsecured Bridge Loan was increased to $140,000,000 and the maturity date was extended to December 31, 2004. On December 22, 2004, the Unsecured Bridge Loan was replaced with part of the proceeds of the Revolving Credit Facility mentioned above. Interest on the Unsecured Bridge Loan was payable monthly at 30-day LIBOR plus 225 basis points on the portion of the outstanding principal balance that did not exceed $60,000,000 and 30-day LIBOR plus 250 basis points on the portion of the 76 outstanding principal balance that exceeded $60,000,000. The average outstanding debt and interest rate under the Unsecured Bridge Loan during the Company's term was approximately $95,000,000 and 4.20%, respectively. As part of the acquisition of Realen Homes, the Company assumed a $70,000,000 secured credit facility. On December 22, 2004, the $70,000,000 secured credit facility was replaced with part of the proceeds of the Revolving Credit Facility mentioned above. Interest on the secured credit facility was payable monthly at a rate based upon the agent lender's prime rate. The Company had an option to convert all or a portion of the outstanding secured credit facility to a fixed rate facility at 30-day LIBOR plus 187.5 basis points to 250 basis points per annum in accordance with the lender's pricing formula. The average outstanding debt and interest rate under the secured credit facility during the Company's term was $70,000,000 and 4.25%, respectively. NOTES PAYABLE AND AMOUNTS DUE TO RELATED PARTIES Included in Notes Payable and Amounts Due to Related Parties at June 30, 2004 is a balance due of $1,000,000 under a Convertible Subordinated 7% Note dated August 8, 1996 issued to Jeffrey P. Orleans. This note was convertible into Orleans Homebuilders, Inc. common stock at $1.50 per share. In December 2004 and in accordance with the Company's Convertible Subordinated 7% Note issued to Jeffrey P. Orleans, Chairman and Chief Executive Officer of the Company, the final installment due of $1,000,000 was converted at $1.50 per share, into 666,668 shares of the Company's common stock. As partial consideration for the October 13, 2000 acquisition of PLC, the Company issued $1,000,000 of subordinated promissory notes to certain former PLC shareholders. The Company, via certain employment agreements entered into as a result of the acquisition, currently employs a majority of the former PLC shareholders. The promissory notes bore interest, payable quarterly, at the prime rate, subject to a cap of 10% and a floor of 8% with principal payable on the anniversary date of the note in four equal installments. The notes earned 8% interest since inception. During fiscal 2004, the Company repaid the remaining outstanding balance of $500,000 of the Subordinated Promissory Notes to the former PLC shareholders. Also included in Notes Payable and Amounts Due to Related Parties at June 30, 2004 is $1,870,000 due to the former shareholders of Masterpiece Homes related to the acquisition of Masterpiece Homes on July 28, 2003. The terms of the stock purchase agreement and the employment agreement with the president of Masterpiece Homes resulted in the Company paying $2,130,000 in January 2005 of which $1,420,000 is part of the purchase price and $710,000 is part of, and contingent upon, the employment agreement. As part of the employment agreement with the president of Masterpiece Homes, the Company expensed $260,000 and $450,000 during the fiscal years ending June 30, 2005 and 2004, respectively. At 77 June 30, 2005, there were no liabilities remaining to be paid to the former shareholders of Masterpiece Homes in connection with the acquisition of Masterpiece Homes. OTHER NOTES PAYABLE The Other Notes Payable of $9,400,000 as of June 30, 2005 is primarily comprised of a promissory note of the Company issued to the former owners of Realen Homes, in connection with the acquisition, a subordinated note payable assumed in the acquisition of Realen Homes, and payable to the former owners of Realen Homes, and a note executed in December of 2003 by the Company to finance the purchase of a 6.25% ownership interest in a corporate jet. The promissory note of the Company issued to the former owners of Realen Homes in connection with the acquisition is a $5,000,000 note with interest at 3% payable on July 28, 2006. The Company evaluated the note in accordance with APB No. 21 "Interest on Receivables and Payables" and determined that it was a below market rate note. In accordance with APB 21, the Company estimated, based on current market conditions that the Company would likely have been able to obtain similar fixed-rate financing from a third party at approximately 150 basis points higher than the note actually obtained. The Company imputed interest on the note at 4.5% and reduced the carrying value of the note from $5,000,000 to $4,863,000. The discounted balance outstanding at June 30, 2005 is $4,926,000. The subordinated note payable assumed in the acquisition of Realen Homes and payable to the former shareholders of Realen Homes is payable on a quarterly basis beginning October 1, 2004 at $162,500 per quarter with the final outstanding principle balance of $3,250,000 due October 1, 2005. The balance outstanding on the subordinated note at June 30, 2005 is $3,498,000 The note executed to finance the purchase of an interest in a corporate jet is payable monthly with an interest rate of LIBOR plus 360 basis points. The term of the note is five years with a balloon payment of $686,000 due in December 2008. The balance outstanding on the note executed to finance the purchase of an interest in a corporate jet at June 30, 2005 and 2004 is $937,000 and $1,012,000, respectively. The remaining balance included in Other Notes Payable at June 30, 2005 and 2004 is primarily comprised of market rate notes to finance the purchase of vehicles used in the operations of the Company. In June 1997, the Chester County Industrial Development Authority issued bonds in the amount of $1,855,000 and loaned the proceeds thereof to a subsidiary of the Company. The proceeds from this obligation were used to construct and operate a waste water spray irrigation facility, which is servicing the Company's Willistown Chase community in Chester County, Pennsylvania. In November 2002, the Company repaid the entire outstanding principal balance of the bonds plus accrued interest. In connection with the repayment, the Company incurred a loss of approximately $61,000 as a result of the write-off of the remaining un-amortized loan costs. Such amount is included in Interest Incurred on the Company's Consolidated Statement of Operations for the fiscal year 2003. 78 The following table summarizes the Company's outstanding debt obligations as of June 30, 2005 and the effect such obligations are expected to have on the Company's liquidity and cash flow in future periods. For mortgage and other note obligations, payments due by period are shown based on the expiration date of the loan while the Revolving Credit Facility is secured by the assets of the Company and matures on December 22, 2007.
SCHEDULE OF DEBT MATURITIES TOTAL 2006 2007 2008 2009 -------- -------- -------- -------- -------- Revolving Credit Facility, mortgage, and other note obligations ...... $399,030 $ 2,642 $ 2,388 $394,000 $ -- Other notes payable ................ 9,400 3,511 5,082 86 721 -------- -------- -------- -------- -------- $408,430 $ 6,153 $ 7,470 $394,086 $ 721 ======== ======== ======== ======== ========
NOTE 7. REDEEMABLE COMMON STOCK In connection with the Company's acquisition of PLC on October 13, 2000, the Company issued 300,000 shares of common stock of the Company to the former shareholders of PLC. At any time after July 31, 2005 and for a period from then until 30 days after the Company gives notice, the former shareholders of PLC have the right to cause the Company to repurchase the common stock issued in the acquisition still held by the shareholders at a price of $3.33 per share. As of June 30, 2005, the former shareholders of PLC have sold 105,208 of these shares of the Company's Common Stock, thereby reducing the number of shares of redeemable common stock in connection with the PLC acquisition to 194,792 shares. In connection with the Company's acquisition of Masterpiece Homes on July 28, 2003 (see Note 2), the Company sold 30,000 shares of common stock of the Company to the president of Masterpiece Homes at $8 per share. The president of Masterpiece Homes has the right to cause the Company to repurchase these shares of common stock at $8 per share by giving notice to the Company no later than the earlier of December 31, 2006 or 30 days after termination of his employment, as specified in his employment agreement. As of June 30, 2005, the President of Masterpiece Homes had not sold any of these shares. NOTE 8. PREFERRED STOCK On October 20, 1998, the Company issued 100,000 shares of Series D Preferred Stock to Jeffrey P. Orleans in exchange for an aggregate amount of $3,000,000 in Company notes formerly held by Mr. Orleans. The Series D Preferred Stock was issued from an aggregate of 500,000 shares of Preferred Stock authorized. The Series D Preferred Stock has a liquidation value of $3,000,000, or $30.00 per share, and required annual dividends of 7% of the liquidation value. The dividends were cumulative and were payable quarterly on the first day of March, June, September and December. The Series D Preferred Stock was redeemable by the Company at any time after December 31, 2003, in whole or in part, at a cash redemption price equal to the liquidation value plus all accrued and unpaid dividends on such shares to the date of redemption. 79 On December 29, 2003 and in accordance with the conversion features of the Company's Series D Preferred Stock, liquidation value of $3,000,000, held by Mr. Orleans, the Series D Preferred Stock was converted, at $1.50 per share, into 2,000,000 shares of the Company's common stock. NOTE 9. INCOME TAXES The provision (benefit) for income taxes is summarized as follows:
FOR THE YEAR ENDED JUNE 30, --------------------------- (IN THOUSANDS) 2005 2004 2003 -------- -------- -------- Current .................................................... $ 35,748 $ 26,863 $ 18,609 Deferred ................................................... (349) (2,220) (851) -------- -------- -------- Total provision (benefit) for income taxes ............... $ 35,399 $ 24,643 $ 17,758 ======== ======== ========
The differences between taxes computed at federal income tax rates and amounts provided for continuing operations are as follows:
FOR THE YEAR ENDED JUNE 30, --------------------------- 2005 2004 2003 -------- -------- -------- (IN THOUSANDS) Amount computed at statutory rate ............................. $ 31,844 $ 21,953 $ 15,319 State income taxes, net of federal tax benefit ................ 4,256 2,780 2,529 Qualified production activities income deduction .............. (320) -- -- Other, net .................................................... (381) (90) (90) -------- -------- -------- Total provision (benefit) for income taxes .................. $ 35,399 $ 24,643 $ 17,758 ======== ======== ========
The American Jobs Creation Act of 2004 provided for a special deduction for Qualified Production Activities, which will be applicable to the Company's homebuilding operations. The statue provides for a special additional deduction on qualified expenditures subject to certain limitations. The deduction phases in over a period of time with the allowable percentage of 3.0% in tax years 2005 and 2006, 6.0% in tax years ended 2007-2009 and 9.0% thereafter. Pursuant to FSP FAS 109-1, the special deduction has no effect on deferred tax assets and liabilities existing at the date of enactment. The impact of the deduction will be reported in the period in which the deduction is claimed. As discussed in Note 2, the Company files a consolidated tax return on a calendar year basis and, accordingly, began applying the special deduction effective January 1, 2005. Its expected impact was and will be to lower the effective tax provision in the periods in which the deduction may be claimed and that this benefit will increase as the deduction is phased in under the statute. 80 Deferred income taxes reflect the impact of "temporary differences" between the amount of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws in accordance with the provisions of SFAS No. 109, "Accounting for Income Taxes." The principal components of the Company's net deferred tax asset of $2,802,000 and $2,453,000, respectively at June 30, 2005 and June 30, 2004, are temporary differences arising from the deferral of deductions for accrued compensation until paid, generally the following year, and from interest and real estate taxes incurred prior to commencing active construction being capitalized for financial reporting purposes while being expensed for tax purposes and the deferral of certain common improvement costs. In addition, temporary differences arise from net realizable value adjustments recognized for financial reporting purposes, but not for tax purposes. These temporary differences reverse ratably as the communities sell out. The principal items making up the deferred income tax provisions (benefits) from continuing operations are as follows:
2005 2004 2003 ------- ------- ------- (in thousands) Deferred provision (benefit) for income taxes: Interest and real estate taxes ...................................... $ 2,307 $ (756) $ (528) Difference in tax accounting for land and property sales, net ....... (500) (814) (182) Accrued expenses .................................................... 324 187 (168) Income from joint ventures .......................................... 14 18 5 Deferred compensation ............................................... (1,193) (982) (231) Depreciation and goodwill amortization .............................. (1,294) 120 272 State taxes ......................................................... (7) 7 (19) ------- ------- ------- Total benefit for income taxes ...................................... $ (349) $(2,220) $ (851) ======= ======= =======
The components of the net deferred tax asset consisted of the following: BALANCE AT JUNE 30, 2005 2004 ------- ------- (in thousands) Gross deferred tax liabilities: Capitalized interest and real estate taxes $(3,814) $(1,507) State income taxes (1,300) (1,307) Other (1,427) (688) ------- ------- Gross deferred tax liabilities (6,541) (3,502) ------- ------- Less gross deferred tax assets: Reserve for books, not for tax 1,664 370 Partnership income 102 116 Bonus accruals 4,038 2,809 Employment contracts 11 90 Vacation accrual 132 90 Warranty and Inventory adjustments 2,816 2,316 Other 580 164 ------- ------- Total gross deferred tax assets 9,343 5,955 ------- ------- Net deferred tax assets (liabilities) $ 2,802 $ 2,453 ======= ======= 81 Temporary differences represent the cumulative taxable or deductible amounts recorded in the financial statements in different years than recognized in the tax returns. SFAS No. 109 requires the Company to record a valuation allowance when it is "more likely than not that some portion or all of the deferred tax assets will not be realized." It further states "forming a conclusion that a valuation allowance is not needed is difficult when there is negative evidence such as cumulative losses in recent years." The Company does not have a valuation allowance for deferred tax assets at June 30, 2005. The ultimate realization of certain tax assets depends on the Company's ability to generate sufficient taxable income in the future, including the effects of future anticipated arising/reversing temporary differences. NOTE 10. STOCK OPTION PLAN AND EMPLOYEE COMPENSATION STOCK BASED COMPENSATION In December 1992, the Board of Directors adopted (i) the 1992 Stock Incentive Option Plan and (ii) the Non-Employee Directors Stock Option Plan. The 1992 Plan allowed for the grant of options to purchase up to 1,210,000 shares of Common Stock of the Company. The options generally vest 25% per year beginning on the date of grant. The 1992 Plan terminated in December 2002. The termination of the 1992 Plan, however, does not affect any options granted prior to the termination. The Non-Employee Directors Stock Option Plan allows for the grant of options to purchase up to 100,000 shares of Common Stock of the Company. All Non-Employee Directors Stock Options have been issued. No options were granted under the Non-Employee Directors Stock Option Plan during the last three fiscal years. In February 1995, the Board of Directors adopted the 1995 Stock Option Plan for Non-Employee Directors (the "1995 Directors Plan"). The 1995 Directors Plan allowed for the grant of options to purchase up to 125,000 shares of Common Stock of the Company. All 1995 Directors Plan options have been issued. The options vest 25% per year beginning on the date of grant. No options were granted under the 1995 Directors Plan during the last three fiscal years. In July 2003, as part of an employment agreement with the president of Masterpiece Homes, the Company granted stock options to purchase 45,000 shares of the Company's common stock at $10.64 per share. The Company accounted for the issuance of this grant under the fair value recognition provision of SFAS No. 123. In October 2003, the Board of Directors adopted the Orleans Homebuilders, Inc. Stock Award Plan (the "Stock Award Plan"). The Stock Award Plan provides for the grant of stock awards of up to an aggregate of 400,000 shares of the Company's common stock. The Stock Award Plan allows for the payment of all or a portion of the incentive compensation awarded under the Company's bonus compensation plans to be paid by means of a transfer of shares of common stock. The plan has a ten 82 year life and is open to all employees of the Company and its subsidiaries. As of June 30, 2005, the Company has awarded 141,778 shares of the Company's common stock under the Stock Award Plan. On August 26, 2004, the board of directors of the Company adopted the Orleans Homebuilders, Inc. 2004 Omnibus Stock Incentive Plan, (the "2004 Stock Incentive Plan"), which is intended to function as an amendment, restatement and combination of all stock option and award plans of the Company other than the Orleans Homebuilders, Inc. Stock Award Plan. On August 26, 2004, the Company granted to an executive officer an option to acquire 20,000 shares of Common Stock and granted to a non-executive officer an option to acquire 7,500 shares of Common Stock. The options vest in four equal annual installments starting June 2005, and have an exercise price of $21.60 per share, the fair market value on the date of grant, and expire in 2014. The option price per share under all plans is established at the fair market value on the date of each grant. Total outstanding options under all stock option plans as of June 30, 2005 aggregated 445,000 options to purchase shares of Common Stock of the Company at prices ranging from $1.19 to $21.60 per share. All options expire between September 2005 and August 2014. The plans (other than the Stock Award Plan) were rolled into the 2004 Stock Incentive Plan. Prior to July 1, 2002, the Company accounted for its stock compensation plans under the recognition and measurement provisions of APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations. Effective in fiscal 1997 the Company adopted the provisions of SFAS No. 123, "Accounting for Stock Based Compensation" and, as permitted, the Company elected to continue to utilize the intrinsic value method and not to charge the fair value of such options as earned directly to the financial statements but to disclose the effects of such a charge. In December 2002 the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation--Transition and Disclosure" ("SFAS No. 148") which provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123. The transition provisions of this Statement are effective for fiscal years ending after December 15, 2002, and the disclosure requirements of the Statement are effective for interim periods beginning after December 15, 2002. Thus, the Company adopted the fair value recognition provisions of SFAS No. 123 prospectively to all stock awards granted, modified, or settled after July 1, 2002. Awards under the Company's plans generally have an exercise price equal to the fair market value of the underlying common stock on the date of grant, and generally vest over a four year period. On March 4, 2005, the Compensation Committee of the Company resolved to grant Michael T. Vesey, the Company's President, Chief Operating Officer and a member of the Company's Board of Directors, 125,000 restricted shares of the Company's 83 common stock pursuant to the terms of the Company's Stock Award Plan. The award was subject to Mr. Vesey's execution of a Restricted Stock Award Agreement which he has executed. The Compensation Committee also approved the payment of bonus compensation to Mr. Vesey sufficient to allow Mr. Vesey to pay the income tax liability triggered on each vesting date. The shares of restricted stock granted to Mr. Vesey will vest at a rate of ten thousand per year on the first through fifth anniversaries of the date of grant and fifteen thousand per year on the sixth through tenth anniversaries of the date of the grant, with all shares being fully vested by or on the tenth anniversary of the date of grant, assuming Mr. Vesey's continued employment with the Company. In addition, in the event of a change of control as defined in the Stock Award Plan, any shares of restricted stock not vested at that time will vest, assuming Mr. Vesey is then employed by the Company. Any shares that are not vested are subject to forfeiture in the event Mr. Vesey's employment with the Company terminates for any reason. On a monthly basis, the Company records compensation expense for the portion of the award earned along with additional compensation expense sufficient to cover the taxes Mr. Vesey will have to pay on the award. In connection with the acquisition of Masterpiece Homes on July 28, 2003 the Company granted 45,000 stock options to Bob Fitzsimmons. The fair value of the stock option grant was estimated on the date of grant using the Black-Scholes option-pricing model assuming a risk-free interest rate of 4%, an expected volatility factor of the Company's common stock of 61.72%, and an expected life of 9 years. The weighted average fair value of the option grant was $7.52. The total fair market value of the stock option grant was approximately $338,000 of which $120,000 and $146,000 was recorded as compensation expense for the fiscal years ended June 30, 2005 and 2004, respectively. Only 50,000 options were unvested as of the adoption date of SFAS No.123 and SFAS No. 148 and all grandfathered APB25 grants were fully vested as of June 30, 2003. As such, the adoption of SFAS No. 123 and SFAS No. 148 did not have a material impact on the financial position or results of operations of the Company. In addition, the Company did not grant any stock options during the fiscal year ended June 30, 2003 and, as a result, the Company's net income available for common shareholders as reported and on a pro forma basis is the same for the fiscal year ended June 30, 2003. 84 The following summarizes stock option activity for the Company's stock option plans during the three years ended June 30:
2005 2004 2003 ---- ---- ---- Weighted Weighted Weighted Average Average Average Number Exercise Number Exercise Number Exercise of Options Price of Options Price of Options Price ---------- -------- ---------- -------- ---------- -------- Outstanding, beginning of year ..... 627,500 $ 2.07 637,500 $ 1.53 677,500 $1.49 Granted ............................ 27,500 21.60 45,000 10.64 -- -- Exercised .......................... (210,000) 2.10 (55,000) 2.81 (40,000) 0. 92 Cancelled .......................... -- -- -- -- -- -- -------- -------- -------- Outstanding, end of year ........... 445,000 3.26 627,500 2.07 637,500 1.53 ======== ======== ======== Exercisable, end of year ........... 394,375 $ 1.39 582,500 $ 1.41 637,500 $1.53 ======== ======== ======== Available for grant, end of year ... 22,500 -- -- -------- -------- --------
The following table summarizes information about stock options outstanding at June 30, 2005:
WEIGHTED AVERAGE REMAINING WEIGHTED CONTRACTUAL AVERAGE WEIGHTED RANGE OF EXERCISE NUMBER LIVES EXERCISE NUMBER AVERAGE PRICES OUTSTANDING (IN YEARS) PRICE EXERCISABLE EXERCISE PRICE ------------------------------------------------------------------------------------------------------------------ $ 1.19 - $ 1.50 365,000 1.8 $ 1.37 365,000 $ 1.37 $ 1.63 - $ 2.06 22,500 .6 $ 1.70 22,500 $ 1.70 $ 10.64 30,000 8.1 $ 10.64 -- -- $ 21.60 27,500 9.2 $ 21.60 6,875 $ 21.60 -------- ------- -------- -------- $ 1.19 - $ 21.60 445,000 $ 2.07 394,375 $ 1.74
EMPLOYEE COMPENSATION The Company has a bonus compensation plan for its executive officers and key employees calculated at eight percent of its consolidated operating profits before taxes and excluding nonrecurring items, income or loss arising from extraordinary items, discontinued operations, debt repurchased at a discount, and the amount of awards under the bonus compensation plan ("Pre-Tax Profits"). Three percent of the Pre-Tax Profits are awarded as an incentive to the Chairman and one and one-half percent is awarded to the President and Chief Operating Officer. The remaining approximately three and one-half percent of the Pre-Tax Profits is awarded at the discretion of the Chairman in consultation with the President to other executive officers and key employees whose performance merits recognition under goals and policies established by the Board of Directors. The Compensation Committee of the Board of Directors approves these bonus awards. Certain regional employees not participating in the bonus compensation plan are awarded bonuses calculated at up to eight percent of operating profits before taxes at a regional level. Additionally, certain employees are awarded bonuses at the discretion of senior management. The total amount of bonus compensation charged to selling, general and administrative expense under these plans was $10,343,000, $7,308,000, and $4,364,000 for the three years ended June 30, 2005, 2004 and 2003, respectively. 85 In connection with the Masterpiece Homes acquisition on July 28, 2003, and under an employment agreement with the president of Masterpiece Homes, contingent payments representing 25% of the pretax profits of Masterpiece Homes for the calendar years ended December 31, 2004, 2005 and 2006 are payable to the president of Masterpiece Homes. Estimated contingent payments under the employment agreement of approximately $816,000 were accrued for at June 30, 2005 and approximately $1,584,000 and $833,000 was charged to selling, general and administrative expense during the fiscal years ended June 30, 2005 and 2004, respectively. In connection with the acquisition of PLC on October 13, 2000, contingent payments representing an aggregate of 50% of PLC's pretax profits in excess of $1,750,000 for each of the fiscal years ended June 30, 2001, 2002 and 2003, are payable to certain of the former PLC shareholders. The contingent payments are subject to an aggregate cumulative pay-out limitation of $2,500,000. Through June 30, 2003, the contingent payments earned based on PLC's share of the pretax profits reached the cumulative payout limitation of $2,500,000. Contingent payments of approximately $577,000 were earned and accrued for in fiscal 2003. Contingent payments charged to intangible assets and goodwill amounted to $462,000 for fiscal 2003. The remaining portion of the contingent payments was charged to selling, general and administrative expense. 401(K) PLAN Effective June 1, 2005, the Company combined its own and all of the 401(k) plans that it inherited through acquisitions, as well as its existing 401(k) plan, into a single consolidated plan, the Orleans Homebuilders, Inc. 401(k) Plan (the "OHB 401(k) Plan"). The OHB 401(k) Plan allows employees to participate in the plan after attaining age 21 and completing one year of continuous service with the Company. All employer contributions immediately vest under the OHB 401(k) Plan. At the discretion of the Board of Directors, the Company may make matching contributions on the participant's behalf of up to 50% of the participant's eligible annual contribution up to 6%. The Company made gross contributions to the combined, predecessor, and acquired plans aggregating $643,000, $570,000, and $286,000 for the three years ended June 30, 2005, 2004, and 2003, respectively. NOTE 11. EARNINGS PER SHARE COMPUTATION The weighted average number of shares used to compute basic earnings per common share and diluted earnings per common share, and a reconciliation of the numerator and denominator used in the computation for the three years ended June 30, 2005, 2004 and 2003, respectively, are shown in the following table. 86
FOR YEAR ENDED JUNE 30 2005 2004 2003 ------- ------- ------- (in thousands) Total common shares issued .................................................. 18,362 15,325 13,029 Shares not issued, but unconditionally issuable (1) ......................... 24 88 154 Less: Average treasury shares outstanding ................................... 408 629 742 ------- ------- ------- Basic EPS shares ............................................................ 17,978 14,784 12,441 Effect of assumed shares issued under treasury stock method for stock options ................................................................... 495 567 542 Effect of assumed conversion of $3,000,000 Convertible Subordinated 7% Note ................................................................... 336 996 1,669 Effect of assumed conversion of $3,000,000 Series D Preferred Stock ......... -- 989 2,000 ------- ------- ------- Diluted EPS shares .......................................................... 18,809 17,336 16,652 ======= ======= ======= Net income available for common shareholders ................................ $55,584 $37,975 $27,087 Effect of assumed conversion of $3,000,000 Convertible Subordinated 7% Note ................................................................... 22 65 109 Effect of assumed conversion of $3,000,000 Series D Preferred Stock ......... -- 104 210 ------- ------- ------- Adjusted net income for diluted EPS ........................................ $55,606 $38,144 $27,406 ======= ======= =======
(1) Represents portion of 273,000 shares unconditionally issuable in connection with the October 13, 2000 acquisition of PLC, not yet issued. The shares issuable in connection with the PLC acquisition are issuable in equal installments on each of the first four anniversaries of the date of acquisition. NOTE 12. COMMITMENTS AND CONTINGENCIES GENERAL At June 30, 2005, the Company had outstanding bank letters of credit, surety bonds and financial security agreements amounting to $146,362,000 as collateral for completion of improvements at various developments of the Company. At June 30, 2005 the Company had agreements to purchase land and approved homesites aggregating approximately 9,690 building lots with purchase prices totaling approximately $596,618,000. Generally, the Company structures its land acquisitions so that it has the right to cancel its agreements to purchase undeveloped land and improved lots by forfeiture of its deposit under the agreement. Furthermore, purchase of the properties is contingent upon obtaining all governmental approvals and satisfaction of certain requirements by the Company and the sellers. The Company expects to utilize purchase money mortgages, secured financings and existing capital resources to finance these acquisitions. Contingent on the aforementioned, the Company anticipates completing a majority of these acquisitions during the next several years. In January 1983, the New Jersey Supreme Court rendered a decision known as the "Mount Laurel II" decision, which has the effect of requiring certain municipalities in New Jersey to provide housing for persons of low and moderate income. In order to comply with such requirements, municipalities in New Jersey may require developers, including the Company, in connection with the development of residential communities, to contribute funds or otherwise assist in the achievement of the municipalities' fair share of low or moderate-income 87 housing. The Company currently has a commitment with various municipalities in New Jersey for affordable housing contributions totaling approximately $4,055,000, payable in installments through June 2010. PERSONAL INJURY In January 2003, a settlement in the amount of $9,000,000 was reached in an action brought against the Company, as defendant, arising out of an injury to a workman who was injured during the construction phase of a home at a Company project located in Newtown, Bucks County, Pennsylvania. The settlement, which was amended in June 2003, will be paid entirely by the Company's liability insurance carrier. In connection with the settlement, a lump sum payment of approximately $5,600,000 was paid to the plaintiff. In addition, payment in the amount of approximately $1,300,000 is to be placed in a structured settlement annuity which shall tender payments to the plaintiff, or the plaintiff's designated beneficiary in the event of the death of the plaintiff, in the amount of $5,000 per month through 2033, such payment increasing annually by three percent. Further, a payment of approximately $2,100,000 is to be placed, by the insurance carrier, in a structured settlement annuity which shall tender payments to the plaintiff in the amount of $120,000 per year beginning September 2003 and annually thereafter until the death of the plaintiff. CARBON MONOXIDE LITIGATION During fiscal 2003, a class action lawsuit was filed against Orleans Homebuilders, Inc. and certain of its unnamed affiliates, in Burlington County, New Jersey. The Township of Mount Laurel intervened as a party in the lawsuit. The lawsuit alleged, in part, that certain townhomes and condominiums designed and constructed by Orleans Homebuilders, Inc. and certain of its affiliates did not have sufficient combustion air in the utility rooms, thereby causing a carbon monoxide build-up in the homes. In January 2003, the Company reached a settlement of the lawsuit. The pertinent terms of the settlement are as follows: Approximately 3,600 homeowners will be given the opportunity to have their homes inspected by the Township of Mount Laurel to determine whether the utility room has adequate combustion air as required by the applicable construction code in effect at the time the home was constructed. If the inspection reveals inadequate combustion air, the Company, at its sole cost, will repair the home. In addition, those homeowners given the opportunity to have their homes inspected also will be given the opportunity to receive a carbon monoxide detector at the Company's sole cost and expense. The Township of Mount Laurel will act as administrator and the Company has agreed to pay the township for the homes inspected, up to an aggregate of $100,000. Further, approximately 1,700 homeowners will be given a one time opportunity to have their gas-fired appliances inspected and cleaned at the Company's sole cost and expense. 88 The Company has agreed to pay plaintiffs' attorneys' fees and costs of $445,000. The Company has reached a settlement with its insurer to partially cover the costs of the settlement. During fiscal 2003, the Company accrued estimated costs of approximately $500,000, net of insurance proceeds, in connection with the settlement agreement. At June 30, 2005 and 2004 the Company has approximately $110,000 and $350,000, respectively, accrued to cover the remaining costs of the aforementioned remediation. COLTS NECK LITIGATION Pursuant to an Order dated February 6, 1996 issued by the New Jersey Department of Environmental Protection ("NJDEP"), the Company submitted a Closure/Post-Closure Plan ("Plan") and Classification Exception Area ("CEA") for certain affected portions of Colts Neck Estates, a single family residential development built by the Company in Washington Township, Gloucester County, New Jersey. The affected areas include those portions of Colts Neck where solid waste allegedly was deposited. NJDEP approved the Plan and CEA on July 22, 1996 and the Company carried it out thereafter. NJDEP as a standard condition of its approval of the Plan and CEA reserves the right to amend its approval to require additional remediation measures if warranted. Neither the implementation of the Plan nor CEA is expected to have a material adverse effect on the Company's results of operations or its financial position. Approximately 145 homeowners at Colts Neck instituted three lawsuits against the Company, which were separately filed in state and Federal courts between April and November 1993. These suits were consolidated in the United States District Court for the District of New Jersey and were subject to court- sponsored mediation. In September 1993, the Company brought an action in New Jersey state court against more than 30 of its insurance companies seeking indemnification and reimbursement of costs of defense in connection with the three Colts Neck actions referred to above. As a result of the court sponsored mediation, the Company and the plaintiffs in the consolidated federal litigation entered into a settlement agreement. Under that agreement, which was approved by the Court, a $6,000,000 judgment was entered against the Company in favor of a class comprising most of the current and former homeowners. The Company, which had paid $650,000 on August 28, 1996 to the plaintiff class, has no liability for the remainder of the judgment, which is to be paid solely from the proceeds of the state court litigation against the Company's insurance carriers. Although, under the settlement agreement the Company is obligated to prosecute and fund the litigation against its insurance companies, the Company is entitled to obtain some reimbursement of those expenses. In August 2002, settlement agreements were reached with all remaining insurance company defendants to settle the Colts Neck insurance litigation. Under the 89 terms of the settlement agreement between the Company and the plaintiffs, the proceeds from the insurance settlements were paid to the plaintiffs. The Company, in turn, is relieved of all further obligations to prosecute the Colts Neck insurance litigation. The Company is not aware of any other significant environmental liabilities associated with any of its other projects. WARRANTY COSTS The Company accrues the cost for warranty and customer satisfaction into the cost of its homes as a liability at closing for each unit based on the Company's individual budget per unit. These liabilities are reviewed on a quarterly basis and generally closed to earnings within 9 to 12 months for unused amounts with any excess amounts expensed as identified as a change in estimate. Many of the items relating to workmanship are completed by the existing labor force utilized to construct the other new homes in that community and are therefore already factored into the labor and overhead cost to produce each home. Any significant material defects are generally under warranty with the Company's supplier. The Company has not historically incurred any significant litigation requiring additional specific reserves for its product offerings (e.g., mold litigation). Generally, the Company provides all of its homebuyers with a limited one year warranty as to workmanship. Under certain circumstances, this warranty may be extended to two years. In practice, the Company may extend this warranty period with the ultimate goal of satisfying the customer. In addition, the Company enrolls all of its homes in a limited warranty program with a third party provider (with the premium paid for this program included in the individual units budgets described above). This limited warranty program generally covers certain defects for periods of one to two years and major structural defects for up to ten years and actual costs incurred are paid for by the third party provider. The Company's warranty and customer satisfaction costs are charged to cost of sales at the time each home is closed and title and possession have been transferred to the homebuyer. The amount charged to additions represents warranty and customer satisfaction costs factored into the cost of each home. The amount recorded as charges incurred represents the actual warranty and customer satisfaction cost incurred for the period presented. 90 FOR THE YEAR ENDED JUNE 30, (IN THOUSANDS) ------------------------ 2005 2004 ------- ------- Balance at beginning of fiscal year ............ $ 1,570 $ 1,674 Warranty costs accrued ......................... 5,912 2,471 Realen Homes warranty reserve at acquisition ... 987 -- Actual warranty costs incurred ................. (4,462) (2,575) ------- ------- Balance at end of fiscal year .................. $ 4,007 $ 1,570 ======= ======= OTHER LITIGATION From time to time, the Company is named as a defendant in legal actions arising from its normal business activities. Although the amount of any liability that could arise with respect to currently pending actions cannot be accurately predicted, in the opinion of the Company any such liability will not have a material adverse effect on the financial position or operating results of the Company. NOTE 13. QUARTERLY FINANCIAL DATA (UNAUDITED) Unaudited summarized financial data by quarter for 2005 and 2004 are as follows (in thousands, except per share data):
THREE MONTHS ENDED ------------------ FISCAL 2005 SEPTEMBER 30 DECEMBER 31 MARCH 31 JUNE 30 ----------- ------------ ----------- -------- ------- Residential property revenues $ 138,312 $ 178,278 $ 198,120 $396,294 Gross profit 28,721 36,324 37,597 81,356 Net income available for common shareholders 8,202 8,230 10,573 28,579 Net earnings per share: Basic $ 0.47 $ 0.47 $ 0.58 $ 1.54 Diluted $ 0.44 $ 0.44 $ 0.56 $ 1.51 FISCAL 2004 ----------- Residential property revenues $98,383 $ 121,481 $ 114,563 $206,318 Gross profit 23,574 26,311 27,623 46,270 Net income available for common shareholders 7,465 7,414 7,819 15,277 Net earnings per share: Basic $ 0.58 $ 0.57 $ 0.49 $ 0.87 Diluted $ 0.45 $ 0.45 $ 0.45 $ 0.82
91 Item 9. Changes in and Disagreements with Accountants on Accounting and ------- Financial Disclosure. --------------------------------------------------------------- There are no matters required to be reported hereunder. Item 9A. Controls and Procedures. -------- ----------------------- DISCLOSURE CONTROLS AND PROCEDURES ---------------------------------- The Company's management, with the participation of the Company's Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer, President and Chief Operating Officer and the Chief Financial Officer concluded that the Company's disclosure controls and procedures, as of the end of the period covered by this report, were designed and are functioning effectively to provide reasonable assurance that the information required to be disclosed by the Company in reports filed under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING ---------------------------------------------------- There has been no change in the Company's control over financial reporting during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. MANAGEMENT'S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING ----------------------------------------------------------------- The Company's management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of the Company's financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principals. The Company's management with the participation of the Company's Chief Executive Officer, President and Chief Operating Officer and Chief Financial Officer conducted an evaluation of the effectiveness of the Company's internal control over financial reporting based on the framework in Internal Control -- Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on management's evaluation under the framework in Internal Control -- Integrated Framework, the Company's management concluded that the Company's internal control over financial reporting was effective as of June 30, 2005. 92 Management's assessment of the effectiveness of the Company's internal control over financial reporting as of June 30, 2005 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included at page 53 in this Annual Report on Form 10-K. Item 9B. Other Information. ------- ------------------ There are no matters required to be reported hereunder 93 PART III -------- Item 10. Directors and Executive Officers of the Registrant. -------- --------------------------------------------------- Incorporated herein by reference from the Company's definitive proxy statement for its Annual Meeting of Stockholders to be held in December 2005 Item 11. Executive Compensation. -------- ----------------------- Incorporated herein by reference from the Company's definitive proxy statement for its Annual Meeting of Stockholders to be held in December 2005 Item 12. Security Ownership of Certain Beneficial Owners and Management and ------- Related Stockholder Matters. ------------------------------------------------------------------- Incorporated herein by reference from the Company's definitive proxy statement for its Annual Meeting of Stockholders to be held in December 2005 Item 13. Certain Relationships and Related Transactions. -------- ----------------------------------------------- Incorporated herein by reference from the Company's definitive proxy statement for its Annual Meeting of Stockholders to be held in December 2005. Item 14. Principal Accountant Fees and Services. -------- --------------------------------------- Incorporated herein by reference from the Company's definitive proxy statement for its Annual Meeting of Stockholders to be held in December 2005. 94 PART IV Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. -------- ----------------------------------------------------------------- (a) Financial Statements and Financial Statement Schedules 1. Financial Statements --------------------- The financial statements listed in the index on the first page under Item 8 are filed as part of this Form 10-K. 2. Financial Statement Schedules ----------------------------- None. 3. Exhibits -------- Exhibit Number -------------- 2.1 Stock Purchase Agreement dated as of October 12, 2000, by and among the Company, Parker & Lancaster Corporation, and the selling stockholders party thereto (incorporated by reference to Exhibit 2 to the Company's Form 8-K filed with the Securities and Exchange Commission on October 27, 2000). 2.2 Stock Purchase Agreement among Orleans Homebuilders, Inc., Masterpiece Homes, Inc., Robert Fitzsimmons, the David R. Robinson Trust and David R. Robinson (incorporated by reference to Exhibit 2.1 to the Company's Form 10-Q for the period ended September 30, 2003). 2.3 Purchase Agreement dated as of July 28, 2004 among Orleans Homebuilders, Inc., Realen Homes, L.P., Realen General Partner, LLC, DB Homes Venture, L.P., DeLuca Enterprises, Inc. DeLuca Sub., Inc., BPG Real Estate Investors-B, L.P., Berwind Property Group, Ltd., and Berwind Property Group, Inc. (incorporated by reference to Exhibit 2 to the Company's Form 8-K filed with the Securities and Exchange Commission on August 11, 2004). 2.4 Stock Purchase Agreement among Orleans Homebuilders, Inc., Masterpiece Homes, Inc., Robert Fitzsimmons, the David R. Robinson Trust and David R. Robinson (incorporated by reference to Exhibit 2.1 to the Company's Form 10-Q for the period ended September 30, 2003). 3.1 Certificate of Incorporation of the Company, as amended, as effective December 3, 2004 (incorporated by reference to Exhibit 3.1 to the Company's Form 10-Q filed with the Securities and Exchange Commission on February 14, 2005). 3.2 By-Laws of the Company, as amended as of August 26, 2004 (incorporated by reference to Exhibit 3.1 to the Company's Form 8-K filed with the Securities and Exchange Commission on December 7, 2004). 10.1** Form of Indemnity Agreement executed by the Company with Directors of the Company (incorporated by reference to Exhibit B to the Company's Proxy Statement with respect to its 1986 Annual Meeting of Stockholders). 10.2** Employment Agreement between the Company and Jeffrey P. Orleans, dated June 26, 1987 (incorporated by reference to Exhibit 10.2 to the Form S-1). 10.3** Employment Agreement between the Company and Robert Fitzsimmons (incorporated by reference to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2003). 95 10.4 $39,040,921 Mortgage Note dated November 7, 2003 by Orleans at Lambertville, LLC in favor of Wachovia Bank, National Association (incorporated by reference to Exhibit 10.8 of the Company's Amendment No. 2 to Registration Statement on Form S-2 filed with the Securities and Exchange Commission on March 1, 2004 (S.E.C. File No. 333-111916)). 10.5 Construction Loan Agreement dated November 7, 2003 by and between Wachovia Bank, National Association and Orleans at Lambertville, LLC (incorporated by reference to Exhibit 10.9 of the Company's Amendment No. 2 to Registration Statement on Form S-2 filed with the Securities and Exchange Commission on March 1, 2004 (S.E.C. File No. 333-111916)). 10.6 Third Allonge and Modification to Master Loan Agreement and Other Loan Documents dated September 22, 2003 by and among Parker & Lancaster Corporation, Parker Lancaster & Orleans, Inc. and Bank of America, N.A. (incorporated by reference to Exhibit 10.14 of the Company's Amendment No. 2 to Registration Statement on Form S-2 filed with the Securities and Exchange Commission on March 1, 2004 (S.E.C. File No. 333-111916)). 10.7 Fourth Allonge and Modification to Master Loan Agreement and Other Loan Documents dated November 18, 2003 by and among Parker & Lancaster Corporation, Parker & Orleans Homebuilders, Inc. and Bank of America, N.A. (incorporated by reference to Exhibit 10.15 of the Company's Amendment No. 2 to Registration Statement on Form S-2 filed with the Securities and Exchange Commission on March 1, 2004 (S.E.C. File No. 333-111916)). 10.8 Loan Modification Agreement (Master Line) dated November 11, 2003 by and among Parker & Lancaster Corporation, Parker Lancaster & Orleans, Inc., the Company, and South Trust Bank. (incorporated by reference to Exhibit 10.31 of the Company's Amendment No. 2 to Registration Statement on Form S-2 filed with the Securities and Exchange Commission on March 1, 2004 (S.E.C. File No. 333-111916)). 10.9 Bridge Loan Agreement dated July 28, 2004 by and among Orleans, Inc. and Wachovia Bank incorporated by reference to Exhibit 10.32 of the Company's Form 10-K for the fiscal year ended June 30, 2004). 10.10 First Amendment to the Bridge Loan Agreement made by and among Orleans Homebuilders, Inc. and Wachovia National Bank dated November 17, 2004 (incorporated by reference to Exhibit 10.1 to the Company's Form 8-K filed with the Securities and Exchange Commission on November 19, 2004). 10.11 Revolving Credit Loan Agreement among Greenwood Financial, Inc. and certain other subsidiaries of Orleans Homebuilders, Inc., Orleans Homebuilders, Inc. and Wachovia Bank, National Association and certain other lenders, dated December 22, 2004 (incorporated by reference to Exhibit 10.1 to the Company's Form 8-K filed with the Securities and Exchange Commission on December 29, 2004). 10.12 Guaranty by Orleans Homebuilders, Inc., dated December 22, 2004 (incorporated by reference to Exhibit 10.2 to the Company's Form 8-K filed with the Securities and Exchange Commission on December 29, 2004). 10.13** Stock Award Plan (incorporated by reference to Appendix B to the Company's Proxy Statement on Schedule 14A filed with the Securities and Exchange Commission on October 27, 2003). 10.14** 2004 Omnibus Stock Incentive Plan and form of option grant (incorporated by reference to Exhibit 10.1 to the Company's Form 8-K filed with the Securities and Exchange Commission on December 6, 2004). 96 10.15** Form of Restricted Stock Award Agreement (incorporated by reference to Exhibit 10.1 to the Company's Form 8-K filed with the Securities and Exchange Commission on March 10, 2005). 21* Subsidiaries of the Registrant. 23.1* Consent of PricewaterhouseCoopers LLP. 31.1* Certification Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. 31.2 * Certification Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. 31.3 * Certification Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. 32.1* Certification Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. 32.2* Certification Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. 32.3* Certification Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. ______________ * Exhibits included with this filing. ** Management contract or compensatory plan or arrangement 97 SIGNATURES and POWER OF ATTORNEY 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. ORLEANS HOMEBUILDERS, INC. By: Jeffrey P. Orleans September 9, 2005 ------------------------- Jeffrey P. Orleans, 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 dates indicated: Jeffrey P. Orleans September 9, 2005 -------------------------------------- Jeffrey P. Orleans Chairman of the Board and Chief Executive Officer Benjamin D. Goldman September 9, 2005 -------------------------------------- Benjamin D. Goldman Vice Chairman and Director Jerome Goodman September 9, 2005 -------------------------------------- Jerome Goodman Director Robert N. Goodman September 9, 2005 -------------------------------------- Robert N. Goodman Director Andrew N. Heine September 9, 2005 -------------------------------------- Andrew N. Heine Director David Kaplan September 9, 2005 -------------------------------------- David Kaplan Director Lewis Katz September 9, 2005 -------------------------------------- Lewis Katz Director 98 Robert M. Segal September 9, 2005 -------------------------------------- Robert M. Segal Director John W. Temple September 9, 2005 -------------------------------------- John W. Temple Director Michael T. Vesey September 9, 2005 -------------------------------------- Michael T. Vesey President and Chief Operating Officer Joseph A. Santangelo September 9, 2005 -------------------------------------- Joseph A. Santangelo Chief Financial Officer, Treasurer and Secretary 99 EXHIBIT INDEX 21* Subsidiaries of the Registrant. 23.1* Consent of PricewaterhouseCoopers LLP. 31.1* Certification Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. 31.2* Certification Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. 31.3* Certification Pursuant to Section 302 of the Sarbanes - Oxley Act of 2002. 32.1* Certification Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. 32.2* Certification Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. 32.3* Certification Pursuant to Section 906 of the Sarbanes - Oxley Act of 2002. ______________ * Exhibits included with this filing. 100