-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Jty90lolkLgI1iWleZSqop6bhUGohtaWsogCuMrg4emH1Q2WwGXms2ozSljZieeO OIIoerNTAYkFihGjyekovA== 0000085974-99-000006.txt : 19990311 0000085974-99-000006.hdr.sgml : 19990311 ACCESSION NUMBER: 0000085974-99-000006 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990310 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RYLAND GROUP INC CENTRAL INDEX KEY: 0000085974 STANDARD INDUSTRIAL CLASSIFICATION: OPERATIVE BUILDERS [1531] IRS NUMBER: 520849948 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-08029 FILM NUMBER: 99561973 BUSINESS ADDRESS: STREET 1: 11000 BROKEN LAND PARKWAY CITY: COLUMBIA STATE: MD ZIP: 21044 BUSINESS PHONE: 4107157000 FORMER COMPANY: FORMER CONFORMED NAME: RYAN JAMES P CO DATE OF NAME CHANGE: 19720414 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K /X/ Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 [Fee Required] For the fiscal year ended December 31, 1998 / / Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 [No Fee Required] Commission File Number 1-8029 THE RYLAND GROUP, INC. (Exact name of registrant as specified in its charter) Maryland 52-0849948 -------- ---------- (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 11000 Broken Land Parkway Columbia, Maryland 21044 (Address of principal executive offices) Registrant's telephone number, including area code: (410) 715-7000 Securities Registered Pursuant to Section 12(b) of the Act: Title of each class Name of each exchange on which registered ------------------- ----------------------------------------- Common Stock, (Par Value $1.00) New York Stock Exchange Common Share Purchase Rights New York Stock Exchange 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 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (SS 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. / / The aggregate market value of the Common Stock of The Ryland Group, Inc., held by non-affiliates of the registrant (14,768,385 shares) as of February 24, 1999, was $384,901,034. The number of shares of common stock of The Ryland Group, Inc., outstanding on February 24, 1999, was 14,844,307. 1 DOCUMENTS INCORPORATED BY REFERENCE Name of Document Location in Report - ---------------- ------------------ Proxy Statement for 1999 Annual Meeting of Stockholders Parts I, III Annual Report to Shareholders for the year ended December 31, 1998 Parts II, IV Form 8-K filed September 12, 1989 Part IV Form 10-K for the year ended December 31, 1989 Part IV Form 8-K filed August 6, 1992 Part IV Form 10-K for the year ended December 31, 1990 Part IV Form 10-Q for the quarter ended June 30, 1992 Part IV Registration Statement on Form S-3, Registration 33-48071 Part IV Form 10-Q for the quarter ended June 30, 1994 Part IV Form 8-K filed October 24, 1996 Part IV Registration Statement on Form S-3, Registration 333-03791 Part IV Form 10-K for the year-ended December 31, 1995 Part IV Form 8-K filed July 2, 1996 Part IV Form 10-K for the year-ended December 31, 1996 Part IV Form 10-K for the year-ended December 31, 1997 Part IV 2 THE RYLAND GROUP, INC. FORM 10-K INDEX Page PART I. Number ------ Item 1. Business.....................................................4 Item 2. Properties...................................................9 Item 3. Legal Proceedings............................................9 Item 4. Submission of Matters to a Vote of Security Holders.........10 PART II. Item 5. Market for the Company's Common Stock and Related Stockholder Matters...........................................12 Item 6. Selected Financial Data.......................................12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.....................................12 Item 7A. Quantitative and Qualitative Disclosures About Market Risk....12 Item 8. Financial Statements and Supplementary Data...................12 Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure......................................12 PART III. Item 10. Directors and Executive Officers of the Registrant............13 Item 11. Executive Compensation........................................13 Item 12. Security Ownership of Certain Beneficial Owners and Management................................................13 Item 13. Certain Relationships and Related Transactions................13 PART IV. Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K...........................................14 SIGNATURES.................................................................19 INDEX OF EXHIBITS..........................................................20 3 PART I Item 1. Business. The Ryland Group, Inc. (the "Company"), is a leading national homebuilder and mortgage-related financial services firm. Established in 1967, the Company builds homes in 21 markets in 14 states and is one of the largest single- family on-site homebuilders in the United States. The Company's homebuilding segment specializes in the sale and construction of single-family attached and detached housing. The financial services segment, whose business is conducted through Ryland Mortgage Company and its subsidiaries (RMC), complements the Company's homebuilding activities by providing various mortgage-related products and services for retail customers including loan origination, title and escrow services. Homebuilding - ------------ Markets - ------- The homebuilding segment markets and builds homes that are constructed on-site in three regions which comprise 21 markets across the nation. The three regions are the North (consisting of the Mid-Atlantic and Midwest), South (consisting of the Southeast and Southwest) and West. As of December 31, 1998, the Company operated in the following metropolitan markets: Region Major Markets Served ------ -------------------- North: Mid-Atlantic: ------------ Baltimore, Washington, D.C./Northern Virginia Midwest: ------- Chicago, Cincinnati, Indianapolis, Minneapolis South: Southeast: --------- Atlanta, Charlotte, Greenville, Orlando, West Florida Southwest: --------- Austin, San Antonio, Dallas, Houston, West: West: ---- Denver, Phoenix, San Diego, Los Angeles, San Jose, Bay Area/Sacramento The Company markets detached and attached single family homes generally targeted to the entry level, first-and second-time move-up home buyer, as well as the active-adult retirement market through a diverse product line tailored to local styles and preferences in each of its geographic markets. The product line offered in a particular community is determined in conjunction with the land acquisition process, and is dependent upon a number of factors, including consumer preferences, competitive product offerings and the cost of building lots in the community. In 1998, the Company's average closing price for its homes was $185,000. During the last five years, the Company has substantially updated its product line and over the past year, the Company again introduced many new home designs across the country. The Company generally outsources architectural services to a network of architects to increase creativity and to ensure that its home designs are consistent with local market preferences. In addition, through flexible supply 4 arrangements and construction methods, the Company has significantly improved its ability to quickly bring new home designs to market and modify existing products. The Company's operations in each of its homebuilding markets may differ based on a number of market-specific factors. These factors include regional economic conditions and job growth, land availability and the local land development process, consumer tastes, competition from other builders of new homes and home resale activity. The Company considers each of these factors when entering into new markets or determining the extent of its operations and capital allocation in existing markets. During 1998, the Company completed the acquisition of The Regency Organization ("Regency"), a privately held homebuilder with operations in Pasco, Hernando and Citrus Counties, Florida, immediately north of the Company's existing Tampa Bay operations. The acquisition afforded the Company the opportunity to gain market share in a rapidly growing area of Florida and an immediate presence in the Florida retirement market. During the past year, the Company began the process of exiting three of its smaller markets, Delaware Valley, Portland, and Salt Lake, which did not meet its strategic objectives. In addition, several divisions were combined to increase operating efficiencies. Land Acquisition and Development - -------------------------------- As of December 31, 1998, the Company operated in approximately 250 communities in 21 metropolitan markets in 14 states. The Company's objective is to control a portfolio of building lots sufficient to meet anticipated homebuilding requirements for a period of two to three years. The land acquisition process is controlled through a formal corporate land approval committee to help ensure that transactions meet the Company's standards for financial performance and risk. In the ordinary course of its homebuilding business, the Company utilizes both direct acquisition and option contracts to control building lots for use in the sale and construction of homes. The Company's direct land acquisition activities include the bulk purchase of finished building lots from land developers and the purchase of undeveloped, entitled land from various third parties. The Company generally does not purchase unentitled or unzoned land. Option contract agreements are generally limited to finished building lots. Although control of lot inventory through the use of option contracts minimizes the Company's investment, such a strategy is not viable in certain markets due to the absence of third party land developers. In other markets, competitive conditions may preclude the Company from controlling quality building lots solely through the use of option contracts. In such situations, the Company may acquire undeveloped, entitled land and/or finished lots on a bulk basis. The Company utilizes selective development of entitled land in order to gain access to prime locations, increase margins and position the Company as a leader in the community through its influence over the community's character, layout and amenities. As of December 31, 1998, the Company had deposits and letters of credit outstanding of $30.6 million in connection with option and land purchase contracts having a total purchase price of $387.9 million. These options and commitments expire at various dates through 2001. Materials Costs - --------------- Substantially all materials used in the construction of homes are available from a number of sources, but may fluctuate in price due to various factors. To increase purchasing efficiencies, the Company standardizes certain building materials and products in its homes and may procure such products through national supply contracts. The Company operates a plant in Maryland that produces and ships rough lumber packages and trim materials to building sites in its Baltimore, Maryland and Washington, D.C./Northern Virginia markets. In other markets, the Company may purchase rough lumber packages from outside suppliers where this is determined to be the most cost effective procurement and construction approach. 5 Production Management and Subcontractors - ---------------------------------------- Substantially all on-site construction is performed for a fixed price by independent subcontractors selected on a competitive bid basis. The Company generally requires a minimum of three competitive bids for each phase of construction. Construction activities are supervised by the Company's production supervisors who schedule and coordinate subcontractor work, monitor quality and ensure compliance with local zoning and building codes. The Company has an integrated financial and homebuilding management information system which assists in scheduling production and controlling costs. Through this system, the Company monitors the construction status and job costs incurred for each home for each phase of construction. The system provides for detailed budgeting and allows the Company to monitor and control actual costs versus construction bids for each subcontractor. The Company has, on occasion, experienced shortages of skilled labor in certain markets. If shortages were to occur in the future, such shortages could result in longer construction times and higher costs than those experienced in the past. Marketing and Customer Service - ------------------------------ The Company generally markets it's homes to entry level, first and second-time move-up buyers as well as, active adult retirement market through targeted product offerings in each of the communities in which it operates. The Company's marketing strategy is determined during the land acquisition and feasibility stage of a community's development. The Company's homes are sold by employees and independent real estate brokers, generally by showing furnished model homes. The Company reports a new order when a customer's sales contract is approved, and records revenue from a sale at closing. The Company normally commences construction of homes when a customer has selected a lot and floor plan and has received preliminary mortgage approval. However, construction of homes may begin prior to a sale to satisfy market demand for completed homes and to facilitate construction scheduling. The Company provides each homeowner with a comprehensive one-year warranty at the time of sale and a ten-year warranty covering loss related to structural defects. The Company believes its warranty program meets or exceeds terms customarily offered in the homebuilding industry. Financial Services - ------------------ The Company repositioned its financial services segment in recent years through a strategy consisting of (1) focusing on retail mortgage loan originations and improving the efficiency of these activities by establishing regional operating centers (2) divesting of non-core assets and lines of business, (3) leveraging its affiliation with the Company's homebuilding segment to increase its capture rate for builder loans and (4) reaching mortgage customers directly at the point of sale through the use of technology. In the first quarter of 1998, the Company sold the majority of its loan servicing portfolio. Future earnings from retail operations will be negatively impacted by the sale. Operations of the financial services segment include retail loan origination, loan servicing, title, escrow, homeowners insurance and investment activities. Retail Operations Loan Origination - ---------------- In 1998, the Company's mortgage origination operations consisted of both builder loans, which are originated in connection with the sale of the Company's homes, and spot loans, which are unrelated to the financing of homes built by the Company. During 1998, RMC originated 8,412 loans totaling approximately $1.2 billion of which 70 percent were for purchases of homes built by the Company and 30 percent were for purchases of homes built by others, purchases of existing homes, or for the refinancing of existing mortgage loans. The Company has increased its focus on the Company's homebuilder loan production by deploying loan officers directly in the Company's homebuilding 6 communities and by utilizing traffic and prospect information generated by the Company's homebuilding sales and marketing staff. RMC's capture rate of the Company's homebuilding segment customers was 70 percent in 1998. The Company arranges various types of mortgage financing including conventional, Federal Housing Administration (FHA) and Veterans Administration (VA) mortgages with various fixed-and adjustable-rate features. The Company's mortgage operations are approved by Federal Home Loan Mortgage Corporation (FHLMC), Federal National Mortgage Association (FNMA) and Government National Mortgage Association (GNMA). Loan Servicing - -------------- The repositioning of the financial services segment in recent years led to the sale of the majority of its loan servicing portfolio in the first quarter of 1998. As a result, the Company primarily services loans that it originates for only a short period of time prior to the sale of servicing rights in the secondary market on a monthly or quarterly basis. As of December 31, 1998, the Company's loan servicing portfolio was $301 million. Future earnings of the financial services segment will be negatively impacted due to reductions in loan servicing income attributable to the aforementioned sale. Title and Escrow Services - ------------------------- Cornerstone Title Company, a wholly owned subsidiary, provides title services primarily to the Company's customers. As of December 31, 1998, Cornerstone had offices in Colorado, Delaware, Florida, Illinois, Maryland, New Jersey, Ohio, Texas and Virginia. The Company also operates an escrow Company in California that performs escrow and loan closing functions primarily on homes built by the Company. During 1998, Cornerstone Title Company captured 96% of the title and escrow business related to settlement of the Company's homes in those markets in which it operates. Investment Operations The Company's investment operations hold certain assets, primarily mortgage- backed securities and notes receivable, which were obtained as a result of the exercise of redemption rights on various mortgage-backed bonds previously owned by the Company's limited-purpose subsidiaries. The Company earns a net interest spread on the investment portfolio and may periodically realize gains from the sale of mortgage-backed securities from the portfolio. Real Estate and Economic Conditions - ----------------------------------- The Company is significantly affected by the cyclical nature of the homebuilding industry, which is sensitive to fluctuations in economic activity, interest rates and levels of consumer confidence, the effects of which differ among the various geographic markets in which the Company operates. Higher interest rates may affect the ability of buyers to qualify for mortgage financing and decrease demand for new homes. As a result, the Company's home sales and mortgage originations generally will be negatively impacted by rising interest rates. The Company's business is also affected by local economic conditions, such as employment rates and housing demand in the markets in which it builds homes. Inventory risk can be substantial for homebuilders. The market value of land, building lots and housing inventories can fluctuate significantly as a result of changing market and economic conditions. In addition, inventory carrying costs can be significant and can result in losses in poorly performing projects or markets. The Company must, in the ordinary course of its business, continuously seek and make acquisitions of land for expansion into new markets as well as for replacement and expansion of land inventory within its current markets. Although the Company employs various measures including 7 the land approval process, and continued review by senior management designed to manage inventory risks, there can be no assurance that such measures will be successful. Competition - ----------- The residential housing industry is highly competitive, and the Company competes in each of its markets with a large number of national, regional and local homebuilding companies. Some of these companies are larger than the Company and have greater financial resources. In addition, the increase in the availability of capital and financing in recent years has made it easier for both large and small homebuilders to expand and enter new markets and has increased competition. The Company also competes with other housing alternatives including existing homes and rental housing. Principal competitive factors in homebuilding are home price, design, quality, reputation, relationship with developers, accessibility of subcontractors, availability and location of lots and availability of customer financing. The financial services segment competes with other mortgage bankers to arrange financing for home buyers and refinancing customers. Principal competitive factors include interest rates and other features of mortgage loan products available to the consumer. Regulatory and Environmental Matters - ------------------------------------ The homebuilding segment is subject to various local, state and federal statutes, ordinances, rules and regulations concerning zoning, building design, construction and similar matters, including local regulations which impose restrictive zoning and density requirements in order to limit the number of homes that can be built within the boundaries of a particular area. The Company may also be subject to periodic delays in homebuilding projects due to building moratoria in any of the areas in which it operates. Generally, such moratoria relate to insufficient water or sewage facilities or inadequate roads or local services. The Company and its competitors are subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning the protection of health and the environment. The Company is also subject to a variety of environmental conditions that can affect its business and its homebuilding projects. The particular environmental laws which apply to any given homebuilding site vary greatly according to the site's location, the site's environmental condition and the present and former uses of the site, as well as adjoining properties. Environmental laws and conditions may result in delays, may cause the Company to incur substantial compliance and other costs, and can prohibit or severely restrict homebuilding activity in certain environmentally sensitive regions or areas. The Company's financial services segment is subject to the rules and regulations of HUD, FHA, VA, FNMA, FHLMC, and GNMA ("regulatory agencies") with respect to originating, processing, selling and servicing mortgage loans. In addition, there are other federal and state statutes and regulations affecting such activities. These rules and regulations, among other things, prohibit discrimination and establish underwriting guidelines which include provisions for inspections and appraisals, require credit reports on prospective borrowers and fix maximum loan amounts. Moreover, the Company is required to submit to the regulatory agencies audited financial statements annually, and each regulatory entity has its own financial requirements. The Company's affairs are also subject to examination by the regulatory agencies at all times to assure compliance with the applicable regulations, policies and procedures. Mortgage origination activities are subject to the Equal Credit Opportunity Act, Federal Truth-in- 8 Lending Act and Real Estate Settlement Procedures Act and the regulations promulgated thereunder which prohibit discrimination and require the disclosure of certain information to mortgagors concerning credit and settlement costs. Employees - --------- At December 31, 1998, the Company employed 2,119 people. The Company considers its employee relations to be good. No employees are represented by a collective bargaining agreement. Item 2. Properties. The Company leases office space for its corporate headquarters in Columbia, Maryland. In addition, the Company leases office space in the various markets in which it operates. The Company operates a building component plant in New Windsor, Maryland. Item 3. Legal Proceedings. Contingent liabilities may arise from the obligations incurred in the ordinary course of business, or from the usual obligations of on-site housing producers for the completion of contracts. On July 31, 1998, Ryland Mortgage Company ("RMC") entered into a Plea Agreement with the United States Attorney's Office for the Middle District of Florida to resolve all charges in connection with an indictment previously brought against RMC (the "Indictment"). The Indictment concerns actions in 1993 related to two of RMC's loan servicing contracts with the Resolution Trust Corporation ("RTC"). Under the terms of the Plea Agreement, RMC paid $3.5 million in restitution plus interest, as well as a fine of $4.2 million and admitted responsibility for two charges of impeding the function of the RTC. As a result of the Indictment, the U.S. Department of Housing and Urban Development ("HUD") previously had indicated that it was considering sanctions against RMC, including possible withdrawal of RMC's right to participate in the Federal Housing Administration ("FHA") loan program and originate FHA loans. RMC previously entered into an agreement with HUD under which it was allowed to originate loans and participate in the FHA loan program while HUD considers what administrative action, if any, it will take as a result of the resolution of the Indictment as RMC seeks to reach agreement on its ability to continue to participate in the FHA loan program with representatives of HUD. The Company also is exploring alternative arrangements in the event that RMC is not successful in these efforts. Termination of RMC's right to participate could be followed by similar exclusions from the loan programs of other RMC investors. No assurance can be given regarding the results of these ongoing discussions with HUD and its possible impact on RMC and its business. The Company is party to various other legal proceedings generally incidental to its businesses. Based on evaluation of these other matters and discussions with counsel, management believes that liabilities to the Company arising from these other matters will not have a material adverse effect on the financial condition of the Company. 9 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 year ended December 31, 1998. 10 Separate Item: Executive Officers of the Registrant Name Age Position (date elected to position) Prior Business Experience - --------------------------------------------------------------------------- R. Chad Dreier 51 Chairman of the Board of Directors (1994), President and Chief Executive Officer of the Company (1993). Michael D. Mangan 42 Executive Vice President and Chief Financial Officer of the Company (1994). Executive Vice President and Group Chief Financial Officer of GMAC Mortgage Corporation (1991-1994). John M. Garrity 52 Senior Vice President of the Company (1995), President of the South Region of Ryland Homes (1996), President of the Southeast Region of Ryland Homes (1994-1996). Division General Manager of Arvida Homes (1992-1994). Timothy J. Geckle 46 Senior Vice President, General Counsel and Secretary of the Company (1997). Vice President, Deputy General Counsel (1995-1996). Corporate Counsel (1991-1995). Edward W. Gold 41 Senior Vice President, Human Resources of the Company (1996). Vice President, Human Resources, United States Fidelity & Guaranty Company (1991-1996). Frank J. Scardina 50 Senior Vice President of the Company (1994), President of West Region of Ryland Homes (1996), President of California Region of Ryland Homes (1994-1996). Daniel G. Schreiner 41 Senior Vice President of the Company (1999), President, Ryland Mortgage Company (1998). President, Kaufman and Broad Mortgage Company (1991-1998). Kipling W. Scott 44 Senior Vice President of the Company (1995), President of the North Region of Ryland Homes (1997), President of Midwest Region of Ryland Homes (1994-1997). All officers are elected by the board of directors. There are no family relationships, arrangements or understandings pursuant to which any of the officers listed were elected. For a description of employment and severance arrangements with certain executive officers of the Company, see page 9 of the Proxy Statement for the 1999 Annual Meeting of Stockholders. 11 PART II Item 5. Market for the Company's Common Stock and Related Stockholder Matters. The information required by this item is incorporated by reference from the section entitled "Common Stock Prices and Dividends" appearing on page 45 of the Annual Report to Shareholders for the year ended December 31, 1998. Item 6. Selected Financial Data. The information required by this item is incorporated by reference from the section entitled "Selected Financial Data" appearing on page 19 of the Annual Report to Shareholders for the year ended December 31, 1998. Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The information required by this item is incorporated by reference from the section entitled "Management's Discussion and Analysis of Results of Operations and Financial Condition" appearing on pages 20 through 24 of the Annual Report to Shareholders for the year ended December 31, 1998. Item 7A. Quantitative and Qualitative Disclosures About Market Risk. The information required by this item is incorporated by reference from the section entitled "Management's Discussion and Analysis of Results of Operations and Financial Condition", Market Risk Summary, appearing on page 24 of the Annual Report to Shareholders for the year ended December 31, 1998. Item 8. Financial Statements and Supplementary Data. The information required by this item is incorporated by reference from the information appearing on pages 25 through 42 and from the section entitled "Quarterly Financial Data and Common Stock Prices and Dividends" appearing on page 45 of the Annual Report to Shareholders for the year ended December 31, 1998. Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure. During the fiscal years ended December 31, 1998 and 1997, there were no disagreements between the Company and its accountants on any matter of accounting principle or financial statement disclosure. 12 PART III Item 10. Directors and Executive Officers of the Registrant. Information as to the Company's Directors is incorporated by reference from pages 2 and 4 of the Company's Proxy Statement for its 1999 Annual Meeting of Stockholders. Information as to the Company's executive officers is shown under Part I as a separate item. Item 11. Executive Compensation. The information required by this item is incorporated by reference from pages 5 through 10 of the Company's Proxy Statement for its 1999 Annual Meeting of Stockholders. Item 12. Security Ownership of Certain Beneficial Owners and Management. The information required by this item is incorporated by reference from page 3 of the Company's Proxy Statement for its 1999 Annual Meeting of Stockholders. Item 13. Certain Relationships and Related Transactions. There are no transactions, business relationships or indebtedness required to be reported by the Company pursuant to this Item. 13 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. (a) 1. Financial Statements. The following consolidated financial statements of The Ryland Group, Inc., and Subsidiaries, included in the Annual Report to Shareholders for the year ended December 31, 1998, are incorporated by reference in Item 8: Consolidated Statements of Earnings - years ended December 31, 1998, 1997, and 1996. Consolidated Balance Sheets - December 31, 1998 and 1997. Consolidated Statements of Stockholders' Equity - years ended December 31, 1998, 1997 and 1996. Consolidated Statements of Cash Flows - years ended December 31, 1998, 1997 and 1996. Notes to Consolidated Financial Statements. (a) 2. Financial Statement Schedules. (filed herewith) Page No. Schedule II - Valuation and Qualifying Accounts.............. 18 Schedules not listed above have been omitted because they are either inapplicable or the required information has been given in the financial statements or notes thereto. 14 (a) 3. Exhibits Exhibit No. - ----------- 3.1 Charter of The Ryland Group, Inc., as amended. (Incorporated by reference from Form 10-K for the year ended December 31, 1989) 3.2 Bylaws of The Ryland Group, Inc., as amended. (Incorporated by reference from Form 10-K for the year ended December 31, 1996) 4.1 Rights Agreement dated as of October 18, 1996, between The Ryland Group, Inc., and ChaseMellon Shareholder Services, L.L.C. (Incorporated by reference from Form 8-K filed October 24, 1996) 4.2 Articles Supplementary dated as of August 31, 1989. (Incorporated by reference from Form 8-K filed September 12, 1989) 4.3 Indenture dated as of July 15, 1992, between The Ryland Group, Inc., and Security Trust Company, N.A., as Trustee. (Incorporated by reference from Form 8-K filed August 6, 1992) 4.4 Senior Subordinated Notes dated as of November 4, 1993. (Incorporated by reference from Registration Statement on Form S-3, Registration No. 33-48071) 4.5 Indenture dated as of June 28, 1996, between The Ryland Group, Inc., and Chemical Bank, as Trustee. (Incorporated by reference from Form 8-K filed July 2, 1996) 4.6 Senior Notes dated as of June 10, 1996. (Incorporated by reference from Registration Statement on Form S-3, Registration No. 333-03791) 4.7 Senior Subordinated Notes dated as of April 13, 1998. (Incorporated by reference from Registration Statement on Form S-3, Registration No. 33-50933 and 333-03791). 10.1 Lease Agreement between Seventy Corporate Center Limited Partnership and The Ryland Group, Inc., dated April 17, 1990. (Incorporated by reference from Form 10-K for the year ended December 31, 1990) 10.2 * 1992 Equity Incentive Plan of The Ryland Group, Inc. (Incorporated by reference from Form 10-Q for the quarter ended June 30, 1992) 10.3 * 1992 Non-Employee Director Equity Plan of The Ryland Group, Inc., as amended. (Incorporated by reference from Form 10-Q for the quarter ended June 30, 1994) 10.4 Restated Credit Agreement dated as of July 21, 1995, between The Ryland Group, Inc., and certain banks. (Incorporated by reference from Form 10-K for the year ended December 31, 1995) 10.5 Second Amended and Restated Credit Agreement dated as of June 24, 1997, between The Ryland Group, Inc., and certain banks. (Incorporated by reference from Form 10-K for the year ended December 31, 1997) 15 (a) 3. Exhibits, continued Exhibit No. - ---------- 10.6 Restated Loan and Security Agreement dated as of June 16, 1995, between Ryland Mortgage Company; Associates Mortgage Funding Corporation; BankOne, Texas, N.A.; and certain lenders. (Incorporated by reference from Form 10-K for the year ended December 31, 1995) 10.7 First Amendment to Restated Loan and Security Agreement dated as of June 3, 1996, between Ryland Mortgage Company, Associate Mortgage Funding Corporation, BankOne, Texas, N.A., and certain lenders. (Incorporated by reference from Form 10-K for the year ended December 31, 1996) 10.8 Second Amendment to Restated Loan and Security Agreement dated as of June 23, 1997, between Ryland Mortgage Company, Associate Mortgage Funding Corporation, BankOne, Texas, N.A., and certain lenders. (Incorporated by reference from Form 10-K for the year- ended December 31, 1997) 10.9 Third Amendment to Restated Loan and Security Agreement dated as of December 31, 1997, between Ryland Mortgage Company, Associate Mortgage Funding Corporation, BankOne, Texas, N.A., and certain lenders. (Incorporated by reference from Form 10-K for the year- ended December 31, 1997) 10.10 * Employment Agreement dated as of January 28, 1997, between R. Chad Dreier and The Ryland Group, Inc. (Incorporated by reference from Form 10-K for the year ended December 31, 1996) 10.11 * Employment Agreement dated as of September 18, 1995 between Michael D. Mangan and The Ryland Group, Inc. as amended and restated as of January 28, 1997. (Incorporated by reference from Form 10-K for the year ended December 31, 1996) 10.12 * Senior Executive Severance Agreement dated as of January 28, 1997, between the executive officers of the Company and The Ryland Group, Inc. (Incorporated by reference from Form 10-K for the year ended December 31, 1996) 10.13 * Amendment and Restatement of the Executive and Director Deferred Compensation Plan, as of March 1, 1997 between The Ryland Group, Inc. and certain of its executive employees and Directors. (Incorporated by reference from Form 10-K for the year ended December 31, 1997) 10.14* Amendment No. 1 to the Executive and Director Deferred Compensation Plan effective January 1, 1998. (Incorporated by reference from Form 10-K for the year ended December 31, 1997) 10.15* Non-Employee Directors' Stock Unit Plan between The Ryland Group, Inc. and the Board of Directors, effective January 1, 1998. (Incorporated by reference from Form 10-K for the year ended December 31, 1997) 11 Computation of Per Share Earnings. (Filed herewith) 13 Annual Report to Shareholders for the year ended December 31, 1998. (Filed herewith) 16 (a) 3. Exhibits, continued Exhibit No. - ---------- 21 Subsidiaries of the Registrant. (Filed herewith) 23 Consent of Ernst & Young LLP, Independent Auditors. (Filed herewith) 24 Power of Attorney. (Filed herewith) 27. Financial Data Schedule. (Filed herewith) * Executive Compensation Plan or Arrangement (b) There were no reports on Form 8-K filed in the fourth quarter of 1998. 17 The Ryland Group, Inc. and Subsidiaries SCHEDULE II -- VALUATION AND QUALIFYING ACCOUNTS (dollar amounts in thousands) Balance at Charged to Charged Deductions Balance at Beginning Costs and to Other and End of Description of Period Expenses Accounts Transfers Period (1) Valuation allowance: Homebuilding inventories 1998 $2,967 $4,188 $ 0 $ (922) $ 6,233 1997 3,052 580 0 (665) 2,967 1996 8,303 0 0 (5,251) 3,052 Valuation allowance: Investment in and advances to joint ventures 1998 $ 0 $1,000 $ 0 $ 0 $1,000 1997 6,500 0 0 (6,500) 0 1996 7,933 0 0 (1,433) 6,500 (1) Balances as of December 31, 1998, 1997 and 1996, represent valuation allowances for assets to be disposed of. 18 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. THE RYLAND GROUP, INC. By: /s/ R. Chad Dreier March 10, 1999 R. Chad Dreier, Chairman of the Board, President, and Chief Executive Officer (Principal 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. Principal Executive Officer: /s/ R. Chad Dreier March 10, 1999 R. Chad Dreier Chief Executive Officer Principal Financial Officer: /s/ Michael D. Mangan March 10, 1999 Michael D. Mangan Chief Financial Officer Principal Accounting Officer: /s/ David L. Fristoe March 10, 1999 David L. Fristoe Chief Accounting Officer Majority of the Board of Directors: James A. Flick, Jr.; R. Chad Dreier; Robert J. Gaw; Leonard M. Harlan; William L. Jews; William G. Kagler; Charlotte St. Martin; Leslie M. Frecon; John O. Wilson. By: /s/ Michael D. Mangan March 10, 1999 Michael D. Mangan As Attorney-in-Fact 19 Page Of Sequentially Numbered Pages -------------- INDEX OF EXHIBITS 11 Computation of Per Share Earnings 21 13 Annual Report to Shareholders for the year ended December 31, 1998 22 - 55 21 Subsidiaries of the Registrant 56 23 Consent of Ernst & Young LLP, Independent Auditors 57 24 Power of Attorney 58 27 Financial Data Schedule 59 20 EX-11 2
Exhibit 11 Computation of Per Share Earnings December 31, December 31, December 31, 1998 1997 1996 ------------- ------------- ------------- Basic: - ------- Net earnings before extraordinary item $ 43,592 $ 21,882 $ 15,839 Extraordinary item, net of tax (3,326) 0 0 --------------- -------------- ------------- Net earnings 40,266 21,882 15,839 Adjustment for dividends on convertible preferred shares (1,000) (1,630) (1,974) --------------- -------------- ------------- Net earnings applicable to common stockholders $ 39,266 $ 20,252 $ 13,865 ============== ============= ============= Weighted average common shares outstanding 14,709,404 15,227,829 15,789,184 Net earnings per share before extraordinary item $ 2.90 $ 1.33 $ 0.88 Extraordinary item (0.23) 0.00 0.00 -------------- -------------- ------------- Net earnings per share $ 2.67 $ 1.33 $ 0.88 ============== ============== ============= Diluted: - ------- Net earnings before extraordinary item $ 43,592 $ 21,882 $ 15,839 Extraordinary item, net of tax (3,326) 0 0 --------------- -------------- ------------- Net earnings 40,266 21,882 15,839 Adjustment for dividends on convertible preferred shares 0 (1,630) (1,974) -------------- -------------- ------------- Net earnings applicable to common stockholders $ 40,266 $ 20,252 $ 13,865 =============== ============== ============= Weighed average common shares outstanding 14,709,404 15,227,829 15,789,184 Common stock equivalents: Stock options 316,640 69,577 5,387 Compensation unit plan 113,894 107,661 134,240 Convertible preferred stock (1) 463,374 0 0 -------------- --------------- ----------- Total 15,603,312 15,405,067 15,928,811 =============== =============== ============= Net earnings per share before extraordinary item $ 2.79 $ 1.32 $ 0.87 Extraordinary item (0.21) 0.00 0.00 -------------- -------------- ------------- Net earnings per share $ 2.58 $ 1.32 $ 0.87 =============== =============== =============
(1) The assumed conversion of preferred shares was dilutive for the year ended December 31, 1998. For the years ending December 31, 1997 and 1996 the net earnings was adjusted for dividends on convertible preferred shares as the adjustment for incremental dividends related to the assumed conversion of convertible preferred shares would be anti-dilutive. EX-13 3 THE RYLAND GROUP, INC. & SUBSIDIARIES Selected Financial Data (dollar amounts in millions, except unit and per share data) unaudited - ----------------------------------------------------------------------------- 1998 1997 1996 1995 1994 - ----------------------------------------------------------------------------- ANNUAL RESULTS: Revenues Homebuilding $1,695 $1,557 $1,473 $1,458 $1,443 Financial services and limited- purpose subsidiaries 70 93 107 127 176 --------------------------------------- Total 1,765 1,650 1,580 1,585 1,619 Cost of sales - homebuilding (1) 1,429 1,346 1,277 1,325 1,262 Selling, general and administrative expenses 216 211 203 211 225 Interest expense 45 57 74 91 105 --------------------------------------- Earnings (loss) from continuing operations before taxes 75 36 26 (42) 27 Tax expense (benefit) 32 14 10 (17) 11 --------------------------------------- Net earnings (loss) from continuing operations before extraordinary item and cumulative effect of accounting change 43 22 16 (25) 16 Discontinued operations, net of taxes (2) 0 0 0 22 6 Extraordinary item, extinguishment of debt (3) (3) 0 0 0 0 Cumulative effect of accounting change, net of taxes (4) 0 0 0 0 2 --------------------------------------- Net earnings (loss) $ 40 $ 22 $ 16 $ (3) $ 24 --------------------------------------- YEAR-END POSITION: Assets Housing inventories $ 642 $ 555 $ 575 $ 538 $ 600 Mortgage loans held-for-sale 159 200 180 285 215 Mortgage-backed securities and notes receivable 112 153 144 113 171 Collateral for bonds payable of limited-purpose subsidiaries 92 142 214 375 459 Other assets 210 233 226 270 259 -------------------------------------- Total assets $1,215 $1,283 $1,339 $1,581 $1,704 -------------------------------------- Liabilities Long-term debt $ 308 $ 310 $ 354 $ 397 $ 409 Short-term notes payable 223 341 326 367 378 Bonds payable of limited- purpose subsidiaries 88 137 207 365 447 Other liabilities 250 190 142 151 158 -------------------------------------- Total liabilities $ 869 $ 978 $1,029 $1,280 $1,392 -------------------------------------- Stockholders'equity $ 346 $ 305 $ 310 $ 301 $ 312 -------------------------------------- PER COMMON SHARE DATA: Basic Net earnings (loss) from continuing operations before extraordinary item and cumulative effect of accounting change $ 2.90 $ 1.33 $ 0.88 $(1.78) $ 0.91 Net earnings (loss) $ 2.67 $ 1.33 $ 0.88 $(0.31) $ 1.43 Diluted Net earnings (loss) from continuing operations before extraordinary item and cumulative effect of accounting change $ 2.79 $ 1.32 $ 0.87 $(1.78) $ 0.90 Net earnings (loss) $ 2.58 $ 1.32 $ 0.87 $(0.31) $ 1.42 Dividends declared $ 0.16 $ 0.27 $ 0.60 $ 0.60 $ 0.60 Stockholders'equity $22.83 $ 20.31 $19.00 $18.69 $19.56 - ----------------------------------------------------------------------------- (1) 1995 reflects a $45 million pretax charges related to homebuilding inventories and investments in unconsolidated joint ventures. (2) The Company sold its institutional mortgage-securities administration business in the second quarter of 1995. 1995 results from discontinued operations include the second-quarter gain on the sale and the results of operations for the first half of 1995. (3) The Company reported an extraordinary after-tax charge of $3.3 million in 1998 related to a loss on the early extinguishment of debt. (4) The Company adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," in 1994. 22 MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION THE COMPANY Operations of The Ryland Group, Inc. and subsidiaries (the "Company") consist of two business segments: homebuilding and financial services. The Company's homebuilding segment constructs and sells single-family attached and detached homes in 21 markets in 14 states. The financial services segment provides mortgage-related products and services for retail customers and conducts investment activities. RESULTS OF OPERATIONS CONSOLIDATED The Company reported consolidated net earnings from operations (before extraordinary item) of $43.6 million, or $2.90 per share, for 1998, compared with consolidated net earnings of $21.9 million, or $1.33 per share, for 1997, and consolidated net earnings of $15.8 million, or $.88 per share, for 1996. The homebuilding segment reported pretax earnings of $80.1 million for 1998, compared with pretax earnings of $35.2 million for 1997 and pretax earnings of $22.6 million for 1996. Homebuilding results in 1998 increased from 1997 primarily due to higher gross profit margins combined with increased closings and lower interest expense. Homebuilding results in 1997 increased from 1996 primarily due to higher gross profit margins combined with lower interest expense. The financial services segment reported pretax earnings of $11.8 million for 1998, compared with $15.6 million for 1997 and $15.8 million for 1996. The decrease in 1998 from 1997 was primarily attributable to the significant reduction in the Company's loan-servicing operations due to portfolio sales in 1997 and the first quarter of 1998. Corporate expenses represent the costs of corporate functions, which support the business segments. Corporate expenses of $16.7 million for 1998 and $14.3 million for 1997, were up $2.4 million and $2.2 million, respectively, from the prior year levels primarily due to increases in incentive compensation attributable to the higher earnings levels in 1998 and 1997, respectively. The Company's limited-purpose subsidiaries no longer issue mortgage-backed securities and mortgage-participation securities, but they continue to hold collateral for previously issued mortgage-backed bonds in which the Company maintains a residual interest. Revenues, expenses and portfolio balances continue to decline as the mortgage collateral pledged to secure the bonds decreases due to scheduled payments, prepayments and exercises of early redemption provisions. Revenues have approximated expenses for the last three years. EXTRAORDINARY ITEM In the third quarter of 1998, the Company recognized an extraordinary loss of $3.3 million (net of taxes of $2.2 million), or $.23 per share. The loss was recorded in connection with the redemption on July 15, 1998 of $100 million of 10.5 percent senior subordinated notes due 2002. The redemption of the notes was at the stated call price of 103.9 percent of par and was funded by the April 1998 issuance of lower cost debt. Net earnings for the year 1998 after the extraordinary item were $40.3 million, or $2.67 per share, versus $1.33 per share for 1997. 23 HOMEBUILDING SEGMENT Results of operations for the homebuilding segment are summarized as follows (amounts in thousands, except average closing price): 1998 1997 1996 - ---------------------------------------------------------------- Revenues Home sales $1,664,267 $1,527,107 $1,456,634 Land sales 30,238 30,219 16,641 --------- --------- --------- Total 1,694,505 1,557,326 1,473,275 Gross profit 265,742 211,185 196,398 Selling, general and administrative expenses 168,004 152,071 146,285 Interest expense 17,681 23,964 27,517 --------- --------- --------- Homebuilding pretax earnings $ 80,057 $ 35,150 $ 22,596 --------- --------- --------- --------- --------- --------- Average closing price $ 185,000 $ 182,000 $ 174,000 Homebuilding revenues increased 9 percent in 1998, compared with 1997, due to a 7 percent increase in closings and an increase in the average closing price. The increase in closings in 1998 was due to the higher backlog at the beginning of the year and the increase in homes sold during the year. Homebuilding revenues increased 6 percent in 1997, compared with 1996, primarily due to an $8,000 increase in the average closing price and increased revenues from land sales, which more than offset the slight decline in closings. The increase in average closing price in 1997 was primarily due to increased closings in the Company's higher priced markets. Homebuilding results included pretax gains from land sales of $1.2 million in 1998, $4.8 million in 1997 and $3.7 million in 1996. Gross profit margins from home sales averaged 15.9 percent for the year 1998, a significant increase from 13.5 percent for 1997 and 13.2 percent for 1996. The improvement was primarily due to increased closings from newer communities which have better land positions and a more cost-effective product. Sales price increases in excess of increases in direct construction costs have also contributed to improved margins. Company initiatives to reduce direct construction costs have helped to limit increases in these costs. Selling, general and administrative expenses as a percent of revenues were 9.9 percent for 1998, 9.8 percent for 1997 and 9.9 percent for 1996, basically flat as a percentage of revenues. Total selling, general and administrative expenses increased in 1998 and 1997 primarily due to higher selling costs associated with increased closings and higher incentive compensation expense as a result of improved earnings. Interest expense decreased $6.3 million, or 26 percent in 1998 due to lower average homebuilding borrowings, lower effective rates paid on borrowings and an increase in the amount of interest capitalized due to an increase in land under development. The lower effective rate on borrowings was primarily due to the Company's issuance of lower cost long-term debt combined with the early redemption of higher cost debt. Interest expense decreased in 1997 due to a decrease in average homebuilding borrowings primarily attributable to a decline in average homebuilding inventories. 24 HOMEBUILDING OPERATIONAL DATA New Orders (Units) Closings (Units) % % 1998 1997 Change 1998 1997 Change ---- ---- ------- ---- ---- ------- Mid-Atlantic 1,083 1,256 (14) 1,060 1,243 (15) Midwest 1,693 1,509 12 1,610 1,372 17 Southeast 2,126 1,792 19 1,910 1,653 16 Southwest 2,079 2,027 3 1,967 1,716 15 West 2,449 2,410 2 2,447 2,393 2 ----- ----- -- ----- ----- -- Total 9,430 8,994 5 8,994 8,377 7 Outstanding Contracts Outstanding Contracts December 31, 1998 December 31, 1997 ----------------- ----------------- Dollars Dollars % in Average in Average Units Change Millions Price Units Millions Price ----- ------ -------- ----- ----- -------- ----- Mid-Atlantic 406 6 $ 87 $215,000 383 $ 81 $212,000 Midwest 689 14 126 183,000 606 106 174,000 Southeast 1,057 66 192 182,000 637 117 183,000 Southwest 757 17 120 158,000 645 95 148,000 West 543 0 128 235,000 541 110 203,000 ----- -- --- ------- ----- --- ------- Total 3,452 23 $653 $189,000 2,812 $509 $181,000 New orders increased 5 percent in 1998 compared with 1997 with increases in all regions except the Mid-Atlantic. The largest increases in new orders were in the Southeast and Midwest regions where growth occurred in both new and existing markets. In the West region, sales were relatively flat due to strong sales in California in 1997 and early 1998 which reduced the number of communities currently open for sales. The Company is opening new communities in California and expects increased sales in 1999. The decline in the Mid- Atlantic reflects the Company's reduced investment in those markets. On October 30, 1998, the Company completed the acquisition of The Regency Organization ("Regency"), a privately held homebuilder with operations in Pasco, Hernando and Citrus Counties, Florida, immediately north of the Company's existing Tampa Bay operations. Regency's operational focus has been primarily on age-restricted and active-adult retirement communities. The acquisition affords the Company the opportunity to gain market share in a rapidly growing area of Florida and an immediate presence in the Florida retirement market. The Company purchased Regency and retired Regency's indebtedness for a total cash investment of approximately $18 million. Results of Regency's operations have been included in the Company's results from the date of acquisition. The Company anticipates that this acquisition could add approximately 350-400 closings to its results for 1999 at sales prices ranging from $90-$150 thousand. As of December 31, 1998, the Company had outstanding contracts for 3,452 units, an increase of 23 percent from year-end 1997 due to the increase in new orders during the year and the acquisition of Regency. Outstanding contracts represent the Company's backlog of sold but not closed homes, which generally are built and closed, subject to cancellation, over the next two quarters. The $653 million value of outstanding contracts increased 28 percent from year-end 1997. 25 FINANCIAL SERVICES SEGMENT Revenues and expenses of the Company's financial services segment are summarized as follows (amounts in thousands): 1998 1997 1996 - ------------------------------------------------------------------------- Retail revenues: Interest and net origination fees $ 7,524 $ 7,651 $13,210 Gains on sales of mortgages and servicing rights 22,667 21,968 15,543 Loan servicing 7,675 24,464 29,684 Title/escrow 8,723 6,394 5,733 ------ ------ ------ Total retail revenues 46,589 60,477 64,170 Revenues from investment operations 13,796 16,452 15,354 ------ ------ ------ Total revenues $60,385 $76,929 $79,524 Expenses: General and administrative 32,023 43,454 44,723 Interest 16,574 17,890 18,954 ------ ------ ------ Total expenses 48,597 61,344 63,677 Pretax earnings $11,788 $15,585 $15,847 ------ ------ ------ ------ ------ ------ Pretax earnings by line of business were as follows (amounts in thousands): 1998 1997 1996 - ------------------------------------------------------------------------- Retail $ 7,915 $10,093 $ 9,539 Investments 3,873 5,492 6,308 ------ ------ ----- Total $11,788 $15,585 $15,847 ------ ------ ------ ------ ------ ------ OPERATIONAL DATA: 1998 1997 1996 - ------------------------------------------------------------------------- Retail operations: Originations Number of mortgage originations 8,412 7,248 11,161 Dollars (in millions) $1,200 $1,005 $1,466 Percent of total originations from Ryland Homes 70% 66% 47% Investment operations: Portfolio average balance (in millions) $ 139 $ 153 $ 123 Revenues and general and administrative expenses for the financial services segment decreased significantly for the year ended December 31, 1998 compared with 1997. The decreases were primarily due to the decline in loan servicing operations related to loan servicing portfolio sales in 1997 and the first quarter of 1998. Interest expense decreased 7.4 percent for the year ended December 31, 1998, compared with 1997, primarily due to a decrease in the warehouse holding period for mortgage loans before they are sold in the secondary market. Revenues for the financial services segment decreased in 1997 compared with the same period of 1996 due to fewer mortgage loan originations and lower loan servicing revenues which were partially offset by higher gains on sales of mortgages and servicing rights. Loan servicing revenues declined as a result of a lower portfolio balance and changes in the portfolio product mix. The decline in interest expense for 1997 was directly related to the reduced warehouse borrowings required to fund lower origination volume. General and administrative expenses declined in 1997 primarily due to improved 26 efficiencies in the mortgage origination process and cost savings related to the disposition of the Company's wholesale mortgage origination business in 1996. Retail operations include residential mortgage origination, loan servicing, title, escrow and homeowners insurance services for retail customers. Retail operations reported pretax earnings of $7.9 million for 1998 compared with $10.1 million for 1997 and $9.5 million for 1996. The Company sold the majority of its loan servicing portfolio in the first quarter of 1998 and realized a $6.1 million pretax gain, net of expenses and liabilities related to the sale of servicing. The decline in earnings for 1998 was primarily due to lower loan servicing income, attributable to the reduction in the portfolio, partially offset by cost reductions. Future earnings from retail operations will be negatively impacted by the sale. The 1997 results from retail operations were favorably impacted by higher gains on sales of mortgages and servicing rights and lower expenses which more than offset the effect of lower loan originations and reduced loan servicing income. Mortgage originations for 1998 increased by 16 percent from 1997 due to higher closing volume from homebuilder loan originations and higher refinancing activity. Mortgage originations decreased in 1997 by 35 percent from 1996 primarily due to the sale of the wholesale mortgage operations which was completed in May 1996 as well as lower closing volume from spot and homebuilder loan originations. Investment operations hold certain assets, primarily mortgage-backed securities which were obtained as a result of the exercise of redemption rights on various mortgage-backed bonds previously owned by the Company's limited-purpose subsidiaries. Pretax earnings from investment operations were $3.9 million for 1998 compared with $5.5 million for 1997 and $6.3 million for 1996. The decline in 1998 was due to the lower average portfolio balance which resulted in a decline in interest income, and the fact that 1997 included $.8 million of other income related to the redemption of certain securities. Pretax earnings were down $.8 million in 1997 compared with 1996. Although the average portfolio balance was higher in 1997, investment income included only $.8 million of other income related to the redemption of certain securities in 1997 compared with $1.3 million of such income in 1996. Results for 1996 also included $1.1 million in gains from the sale of mortgage-backed securities. FINANCIAL CONDITION AND LIQUIDITY The Company generally provides for the cash requirements of the homebuilding and financial services businesses from outside borrowings and internally generated funds. The Company believes that its current sources of cash are sufficient to finance its requirements. The homebuilding segment borrowings include senior notes, senior subordinated notes and an unsecured revolving credit facility. Senior and senior subordinated notes outstanding totaled $308 million as of December 31, 1998 and December 31, 1997. On April 13, 1998, the Company issued $100 million of 8.25 percent senior subordinated notes due April 1, 2008. The net proceeds from this issuance were initially used to repay outstanding amounts under the revolving credit facility and to repay short-term notes payable. On July 15, 1998, the Company borrowed funds under its revolving credit facility to retire its $100 million, 10.5 percent, senior subordinated notes due 2002 at the stated call price of 103.9 percent of par. The Company uses its unsecured revolving credit facility to finance increases in its homebuilding inventory and working capital. This facility, which matures in July 2000, provides for total borrowings of up to $300 million. There were no outstanding borrowings under this facility as of December 31, 1998 or as of December 31, 1997. The Company had letters of credit outstanding under this facility totaling $34 million at December 31, 1998 and $22 million at December 31, 1997. Housing inventories increased to $642 million as of December 31, 1998 from $555 million as of the end of 1997. The increase reflects higher sold inventory related to the significant increase in year-end backlog, additional inventory investment in certain markets and the acquisition of Regency. The increase in inventory was funded with internally generated funds and higher accounts payable. The financial services segment uses cash generated from operations and borrowing arrangements to finance its operations. A bank credit facility agreement, which matures on June 1, 2000, provides up to $260 million for mortgage warehouse funding and $30 million for working capital advances. Other borrowing arrangements as of December 31, 1998 included repurchase agreement facilities aggregating $370 million, and a $100 million revolving credit facility used to finance investment portfolio securities. At December 31, 27 1998 and December 31, 1997, the combined borrowings of the financial services segment outstanding under all agreements were $223 million and $341 million, respectively. Mortgage loans, notes receivable and mortgage-backed securities held by the limited-purpose subsidiaries are pledged as collateral for the issued bonds, the terms of which provide for the retirement of all bonds from the proceeds of the collateral. The source of cash for the bond payments is cash received from the mortgage loans, notes receivable and mortgage-backed securities. The Company has not guaranteed the debt of the financial services segment or the limited-purpose subsidiaries. During 1998, the Company repurchased approximately 353,000 shares of its outstanding common stock at a cost of approximately $7 million. As of December 31, 1998, the Company had Board authorization to repurchase up to an additional 958,400 shares of its common stock. The Company's stock repurchase program has been funded through internally generated funds. 28 MARKET RISK SUMMARY The following table provides information about the Company's significant financial instruments that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted-average interest rates by expected maturity dates. Weighted-average variable rates are based on implied forward rates as of the reporting date.
INTEREST RATE SENSITIVITY Principal Amount by Expected Maturity - ----------------------------------------------------------------------------------------------------------------------- FAIR VALUE (dollars in thousands) 1999 2000 2001 2002 2003 THEREAFTER TOTAL 12/31/98 - ----------------------------------------------------------------------------------------------------------------------- HOMEBUILDING: Liabilities Long-term debt (fixed rate) $ 8,000 $300,000 $308,000 $313,140 Average interest rate 10.5% 9.5% 9.5% FINANCIAL SERVICES: Assets Mortgage loans, held-for-sale (fixed rate) $139,786 $139,786 $141,918 Average interest rate 6.5% 6.5% Mortgage loans, held-for-sale $ 18,825 $ 18,825 $ 19,112 Average interest rate 7.2% 7.2% Mortgage-backed securities, available-for-sale $ 7,516 $ 5,441 $ 4,606 $ 3,305 $ 2,617 $10,087 $ 33,572 $ 36,414 Average interest rate 9.5% 9.6% 9.6% 9.6% 9.6% 9.7% 9.6% Mortgage-backed securities, held-to-maturity $ 1,074 $ 779 $ 662 $ 476 $ 378 $ 1,457 $ 4,826 $ 5,147 Average interest rate 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% 9.0% Notes receivable, whole loans and funds held by trustee $ 16,211 $12,455 $ 9,574 $ 7,362 $ 5,665 $19,147 $ 70,414 $ 76,224 Average interest rate 9.4% 9.4% 9.4% 9.4% 9.5% 9.5% 9.4% Liabilities Short-term notes payable (variable rate) $223,058 $223,058 $223,058 Average interest rate 5.3% 5.3% Off balance sheet financial instruments Forward delivery contracts: Notional amount $163,000 $163,000 $ (441) Average interest rate 6.5% 6.5% Commitments to originate mortgage loans: Notional amount $ 33,859 $ 33,859 $ 155 Average interest rate 6.8% 6.8% - -----------------------------------------------------------------------------------------------------------------------
29 Interest rate risk is the primary market risk facing the Company. Interest rate risk arises principally in the Company's financial services segment but also with respect to the homebuilding segment long-term debt. The Company enters into forward delivery contracts and may at times use other hedging contracts to mitigate its exposure to movements in interest rates on mortgage loan commitments and mortgage loans held-for-sale based upon the Company's marketing strategy that establishes a risk tolerance level. The major factors influencing the use of hedging contracts include general market conditions, interest rates, types of mortgages originated, and the percentage of mortgage loan commitments expected to be funded. The market risk assumed while holding the hedging contracts mitigates the market risk associated with the mortgage loan commitments and mortgage loans held-for-sale. In managing interest rate risk, the Company does not speculate on the direction of interest rates. Although the collateral for bonds payable and the bonds payable of the limited-purpose subsidiaries are subject to interest rate risk, the Company has not guaranteed nor is otherwise obligated with respect to these bond issues and therefore has no risk of loss. YEAR 2000 READINESS DISCLOSURE The Company's Year 2000 remediation efforts have focused on its key business computer applications representing those systems that the Company is dependent upon to conduct day-to-day business operations. Starting in 1997, the Company initiated a comprehensive review of its business applications to determine their Year 2000 readiness and the adequacy of these systems to meet future business requirements. Out of this effort, a number of systems were identified that were not Year 2000 compliant. In most cases these systems were already in the process of being replaced or upgraded. As of December 31, 1998, the Company believes that its key homebuilding business systems are Year 2000 compliant. No material costs have been incurred to date in achieving Year 2000 readiness for these systems. However, certain data, voice communication and financial service's systems are in the process of being replaced or upgraded. Some implementation and testing procedures were completed in 1998 and the remainder are scheduled for completion in mid-1999. The additional costs of achieving Year 2000 compliance could aggregate between $1 to $2 million. The Company is currently assessing other potential Year 2000 issues, including non-information technology systems. The Company's relationships with vendors, financial institutions and other third parties are being reviewed to determine the status of their Year 2000 compliance and the impact their potential noncompliance could have on the Company. The Company has no means of ensuring that its third party service providers will be Year 2000 ready. In the event that they are not ready on a timely basis, the Company will seek alternative sources for goods and services, where practicable. The Company is in the process of developing a Year 2000 contingency plan. Although the Company will continue to monitor the situation, it is possible that the Company or the third parties with whom it has significant relationships will not successfully complete all of their Year 2000 remediation efforts. If this were to occur, the Company could encounter disruptions to its business, but, currently believes it unlikely that such disruptions would have a material adverse effect on its results of operations. The Company could also be impacted by financial market disruption or by Year 2000 computer system failures at government agencies on which the Company is dependent for zoning, building permits and related matters. Note: Certain statements in this Annual Report may be "forward-looking statements" within the meaning of the Private Securities Litigation Act of 1995. Forward- looking statements are based on various factors and assumptions that include known and unknown risks and uncertainties, the completion and profitability of sales reported, the market for homes generally and in areas where the Company operates, the availability and cost of land, changes in economic conditions and interest rates, increases in raw material and labor costs, consumer confidence, government regulations, and general competitive factors, all or each of which may cause actual results to differ materially. 30 THE RYLAND GROUP, INC. & SUBSIDIARIES Consolidated Statement of Earnings (amounts in thousands, except share data) - ------------------------------------------------------------------------- Year ended December 31, 1998 1997 1996 - ------------------------------------------------------------------------- REVENUES: Homebuilding: Residential revenue $ 1,664,267 $ 1,527,107 $ 1,456,634 Other revenue 30,238 30,219 16,641 ---------- ----------- ---------- Total homebuilding revenue 1,694,505 1,557,326 1,473,275 Financial services 60,385 76,929 79,524 Limited-purpose subidiaries 10,598 15,551 27,387 ---------- ----------- ---------- Total revenues 1,765,488 1,649,806 1,580,186 ---------- ----------- ---------- EXPENSES: Homebuilding: Cost of sales 1,428,763 1,346,141 1,276,877 Selling, general and administrative 168,004 152,071 146,285 Interest 17,681 23,964 27,517 --------- --------- --------- Total homebuilding expenses 1,614,448 1,522,176 1,450,679 Financial services: General and administrative 32,023 43,454 44,723 Interest 16,574 17,890 18,954 --------- -------- --------- Total financial services expenses 48,597 61,344 63,677 Limited-purpose subsidiaries expenses 10,598 15,551 27,387 Corporate expenses 16,687 14,265 12,046 --------- --------- --------- Total expenses 1,690,330 1,613,336 1,553,789 --------- --------- --------- Earnings before taxes and extraordinary item 75,158 36,470 26,397 Tax expense 31,566 14,588 10,558 --------- --------- --------- NET EARNINGS BEFORE EXTRAORDINARY ITEM 43,592 21,882 15,839 Extraordinary item - loss on early extinguishment of debt (net of taxes of $2,217) (3,326) 0 0 --------- -------- -------- NET EARNINGS $ 40,266 $ 21,882 $ 15,839 - ------------------------------------------------------------------------- Preferred dividends $ 1,000 $ 1,630 $ 1,974 Net earnings applicable to common stockholders $ 39,266 $ 20,252 $ 13,865 NET EARNINGS PER COMMON SHARE: Basic: Net earnings before extraordinary item $ 2.90 $ 1.33 $ 0.88 Extraordinary item (0.23) 0 0 ---------- -------- -------- Net earnings per common share $ 2.67 $ 1.33 $ 0.88 Diluted: Net earnings before extraordinary item $ 2.79 $ 1.32 $ 0.87 Extraordinary item (0.21) 0 0 ---------- -------- -------- Net earnings per common share $ 2.58 $ 1.32 $ 0.87 Average common shares outstanding: Basic 14,709,404 15,227,829 15,789,184 Diluted 15,603,312 15,405,067 15,928,811 - ------------------------------------------------------------------------- See notes to consolidated financial statements. 31 THE RYLAND GROUP, INC. & SUBSIDIARIES Consolidated Balance Sheets (amounts in thousands) - -------------------------------------------------------------------- December 31, 1998 1997 - -------------------------------------------------------------------- ASSETS HOMEBUILDING: Cash and cash equivalents $ 48,100 $ 33,065 Housing inventories: Homes under construction 373,012 332,452 Land under development and improved lots 268,750 222,379 ------------ ----------- Total inventories 641,762 554,831 Property, plant and equipment 26,818 26,463 Purchase price in excess of net assets acquired 23,473 19,511 Other assets 38,515 37,359 ------------ ----------- 778,668 671,229 ------------ ----------- FINANCIAL SERVICES: Cash and cash equivalents 1,684 3,066 Mortgage loans held-for-sale 158,611 199,857 Mortgage-backed securities and notes receivable 111,654 153,022 Mortgage servicing rights 4,479 8,242 Other assets 10,255 46,715 ------------ ----------- 286,683 410,902 ------------ ----------- OTHER ASSETS: Collateral for bonds payable of limited-purpose subsidiaries 92,403 142,303 Net deferred taxes 31,384 35,764 Other 26,260 23,211 ------------ ----------- TOTAL ASSETS $ 1,215,398 $ 1,283,409 - --------------------------------------------------------------------- See notes to consolidated financial statements. 32 THE RYLAND GROUP, INC. & SUBSIDIARIES Consolidated Balance Sheets (amounts in thousands except share data) - -------------------------------------------------------------------- December 31, 1998 1997 - -------------------------------------------------------------------- LIABILITIES HOMEBUILDING: Accounts payable and other liabilities $ 173,370 $ 117,326 Long-term debt 308,152 310,221 ------------ ----------- 481,522 427,547 ------------ ----------- FINANCIAL SERVICES: Accounts payable and other liabilities 16,473 17,382 Short-term notes payable 223,058 340,632 ----------- ---------- 239,531 358,014 OTHER LIABILITIES: Bonds payable of limited-purpose subsidiaries 87,980 136,865 Other 60,082 55,860 ------------ ----------- TOTAL LIABILITIES 869,115 978,286 ------------ ----------- STOCKHOLDERS' EQUITY: Convertible preferred stock, $1 par value: Authorized - 1,400,000 shares Issued - 416,744 shares (502,833 for 1997) 417 503 Common stock, $1 par value: Authorized - 78,600,000 shares Issued - 14,751,753 shares (14,521,859 for 1997) 14,752 14,522 Paid-in capital 93,193 88,502 Retained earnings 236,011 199,114 Accumulated other comprehensive income 1,910 2,482 ------------ ----------- TOTAL STOCKHOLDERS' EQUITY 346,283 305,123 ------------ ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,215,398 $ 1,283,409 - --------------------------------------------------------------------- See notes to consolidated financial statements. 33
THE RYLAND GROUP, INC. & SUBSIDIARIES Consolidated Statements of Stockholders' Equity (amounts in thousands, except share data) - --------------------------------------------------------------------------------------------------------------------------------- ACCUMULATED TOTAL OTHER STOCK- PREFERRED COMMON PAID-IN RETAINED COMPREHENSIVE DUE FROM HOLDERS' STOCK STOCK CAPITAL EARNINGS INCOME RSOP TRUST EQUITY - --------------------------------------------------------------------------------------------------------------------------------- BALANCE AT JANUARY 1, 1996 $ 943 $ 15,682 $115,611 $179,937 $ 2,550 $(13,599) $301,124 Comprehensive income: Net earnings 15,839 15,839 Other comprehensive income, net of tax: Unrealized gains/(losses) on mortgage-backed securities, net of taxes of $139 208 208 Total comprehensive income 16,047 Preferred stock dividends (per share $2.21) (1,974) (1,974) Common stock dividends (per share $0.60) (9,475) (9,475) Conversion of preferred stock (81) 81 (961) (961) Reclassification of preferred paid-capital and related RSOP receivable 828 (1,759) (931) RSOP debt repayments 5,004 5,004 Employee stock plans (89,482 shares) 90 1,174 351 1,615 -------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1996 862 15,853 116,652 184,678 2,758 (10,354) 310,449 -------------------------------------------------------------------------------- Comprehensive income: Net earnings 21,882 21,882 Other comprehensive income, net of tax: Unrealized gains/(losses) on mortgage-backed securities, net of taxes of $(184) (276) (276) Total comprehensive income 21,606 Preferred stock dividends (per share $2.21) (1,630) (1,630) Common stock dividends (per share $0.27) (4,155) (4,155) Repurchase of common stock (1,689) (23,824) (25,513) Conversion of preferred stock (110) 110 (1,474) (1,474) Retirement of preferred stock and related RSOP debt (249) (9,293) (1,850) 11,392 0 Reclassification of preferred paid-in capital and related RSOP receivable 2,400 (6,037) (3,637) RSOP debt repayments 4,999 4,999 Employee stock plans (248,017 shares) 248 4,041 189 4,478 -------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1997 503 14,522 88,502 199,114 2,482 0 305,123 -------------------------------------------------------------------------------- Comprehensive income: Net earnings 40,266 40,266 Other comprehensive income,net of tax: Unrealized gains/(losses) on mortgage-backed securities, net of taxes of $(381) (572) (572) Total comprehensive income 39,694 Preferred stock dividends (per share $2.21) (1,000) (1,000) Common stock dividends (per share $0.16) (2,369) (2,369) Repurchase of common stock (353) (6,676) (7,029) Conversions and retirements of preferred stock (86) 73 (1,446) (1,459) Reclassification of preferred paid-in capital 3,242 3,242 Employee stock plans (509,580 shares) 510 9,571 10,081 -------------------------------------------------------------------------------- BALANCE AT DECEMBER 31, 1998 $ 417 $ 14,752 $ 93,193 $236,011 $ 1,910 $ 0 $346,283 -------------------------------------------------------------------------------- See notes to consolidated financial statements. 34
THE RYLAND GROUP, INC. & SUBSIDIARIES Consolidated Statement of Cash Flows (amounts in thousands) - ------------------------------------------------------------------------------ Year ended December 31, 1998 1997 1996 - ------------------------------------------------------------------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 40,266 $ 21,882 $ 15,839 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 25,586 31,396 31,373 Loss on early extinguishment of debt 5,543 0 0 Changes in assets and liabilities, net of effects from acquisition: Decrease (increase) in mortgage loans held-for-sale 41,246 (19,708) 104,852 (Increase) decrease in inventories (67,828) 19,759 (36,672) Net change in other assets, payables and other liabilities 95,272 31,657 (7,269) Other operating activities, net 354 (849) (58) ------------------------------------ Net cash provided by operating activities 140,439 84,137 108,065 ------------------------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Net additions to property, plant and equipment (22,734) (17,568) (19,500) Principal reduction of mortgage collateral 39,887 41,537 64,230 Principal reduction of mortgage- backed securities-available- for-sale 10,899 11,969 20,362 Purchase of mortgage-backed securities-available-for-sale 0 0 (8,572) Sales of mortgage-backed securities- available-for-sale 10,935 2,222 21,937 Principal reduction of mortgage- backed securities - held-to- maturity 19,942 15,064 19,818 Decrease (increase)in funds held by trustee 8,796 (6,808) 17,133 Acquisition of Regency (17,885) 0 0 Other investing activities, net 767 239 1,074 ---------------------------------- Net cash provided by investing activities 50,607 46,655 116,482 ---------------------------------- CASH FLOWS FROM FINANCING ACTIVITIES: Cash proceeds of long-term debt 98,955 2,475 103,145 Reduction of long-term debt (106,836) (46,522) (145,485) (Decrease) increase in short-term notes payable (117,574) 14,982 (41,819) Bond principal payments (50,162) (71,009) (159,665) Common and preferred stock dividends (3,399) (7,320) (11,449) Common stock repurchases (7,028) (25,513) 0 Other financing activities, net 8,651 9,538 3,442 ---------------------------------- Net cash used for financing activities (177,393) (123,369) (251,831) ---------------------------------- Net increase (decrease) in cash and cash equivalents 13,653 7,423 (27,284) Cash and cash equivalents at beginning of year 36,131 28,708 55,992 ---------------------------------- CASH AND CASH EQUIVALENTS AT END OF YEAR $ 49,784 $ 36,131 $ 28,708 ---------------------------------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest (net of capitalized interest) $ 50,866 $ 54,452 $ 69,754 Cash paid (received) for income taxes (net of refunds) $ 19,143 $ 5,887 $ (3,230) - ------------------------------------------------------------------------------ See notes to consolidated financial statements. 35 THE RYLAND GROUP, INC. & SUBSIDIARIES Notes to Consolidated Financial Statements. (amounts in thousands, except share data, in all notes unless otherwise noted) NOTE A: SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - --------------------------------------------------- Basis of Presentation The consolidated financial statements include the accounts of The Ryland Group, Inc. and its wholly owned subsidiaries (the "Company"). Intercompany transactions have been eliminated in consolidation. Certain amounts in the consolidated statements of prior years have been reclassified to conform to the 1998 presentation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. Per Share Data Basic net earnings per common share is computed by dividing net earnings, after considering preferred stock dividend requirements, by the weighted- average number of common shares outstanding. Diluted net earnings per common share additionally gives effect to dilutive common stock equivalent shares, including the assumed conversion of the preferred shares held by The Ryland Group, Inc. Retirement Savings Opportunity Plan Trust (RSOP Trust) into common stock. The effect of the RSOP Trust was dilutive for the year ended December 31, 1998. For the years ended December 31, 1997 and 1996, the conversion of preferred shares was not assumed due to an antidilutive effect. Income Taxes The Company files a consolidated federal income tax return. Certain items of income and expense are included in one period for financial reporting purposes and another for income tax purposes. Deferred income taxes are provided in recognition of these differences. Deferred tax assets and liabilities are determined based on the enacted tax rates and are subsequently adjusted for changes in these rates. A change in the deferred tax assets or liabilities results in a charge or credit to deferred tax expense. Homebuilding Revenues Homebuilding revenues are recognized when home sales are closed and title passes to the customer. Service Liabilities Service and warranty costs are estimated and accrued for at the time a home closes. Housing Inventories Housing inventories consist principally of homes under construction and land under development and improved lots. Inventories to be held and used are stated at cost, unless a subdivision is determined to be impaired, in which case the impaired inventories are written down to fair value. Writedowns of impaired inventories to fair value are recorded as adjustments to the cost basis of the respective inventory. 36 Inventories to be disposed of are stated at the lower of cost or fair value less cost to sell and are reported net of valuation reserves. Valuation reserves related to inventories to be disposed of amounted to $6.2 million at December 31, 1998, and $3.0 million at December 31, 1997. The net carrying value of the related inventories amounted to $16.2 million and $8.9 million at December 31, 1998 and 1997, respectively. Costs of inventory include direct costs of land, material acquisition, home construction and related direct overhead expenses. Real estate taxes, insurance and interest are capitalized during the land development stage. The costs of acquiring and developing land and constructing certain related amenities are allocated to the parcels to which these costs relate. The following table is a summary of capitalized interest: 1998 1997 ---- ---- Capitalized interest as of January 1, $ 23,644 $ 27,589 Interest capitalized 18,601 17,636 Interest amortized to cost of sales (20,645) (21,581) -------- -------- Capitalized interest as of December 31, $ 21,600 $ 23,644 Property, Plant and Equipment Property, plant and equipment, which includes model home furnishings, are carried at cost, less accumulated depreciation and amortization. Depreciation is provided for, principally, by the straight-line method over the estimated useful lives of the assets. Model home furnishings are amortized over the life of the community as homes are closed. Purchase Price in Excess of Net Assets Acquired Costs in excess of net assets of acquired businesses (goodwill) are being amortized on a straight-line basis over their estimated useful lives for periods of up to 30 years. On a periodic basis, the Company evaluates the businesses to which goodwill relates in order to insure that the carrying value of goodwill has not been impaired. Mortgage Loans Held-For-Sale Mortgage loans held-for-sale are reported net of discounts and are valued at the lower of cost or market determined on an aggregate basis. Any gain or loss on the sale of the loans is recognized at the time of sale. Mortgage-Backed Securities The Company classifies its mortgage-backed securities into three categories: held-to-maturity, available-for-sale and trading. Management determines the appropriate classification of these securities at the time of purchase and re- evaluates such designations as of each balance sheet date. Mortgage-backed securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Securities classified as held-to-maturity are stated at amortized cost. Securities classified as available-for-sale are measured at fair value with the unrealized gains and losses, net of tax, reflected as accumulated other comprehensive income in stockholders' equity. Securities classified as trading are measured at fair value with gains and losses, both realized and unrealized, recognized in the Consolidated Statement of Earnings. The Company may at times have securities in each category. Loan Origination Fees, Costs and Mortgage Discounts Loan origination fees, net of the related direct origination costs, and loan discount points are deferred as an adjustment to the carrying value of the related mortgage loans held-for-sale and are recognized into income upon the sale of the mortgage loans. 37 Discounts on mortgage collateral for the bonds of the limited-purpose subsidiaries primarily represent loan origination discount points and purchase price discounts. These discounts are deferred as an adjustment to the recorded book value of the related mortgage loans. They are amortized into interest income over their respective lives using the interest method, which is adjusted for the effect of prepayments. Hedging Contracts The Company enters into forward delivery contracts, options on forward delivery contracts, futures contracts and options on futures contracts, as an end-user, for the purpose of minimizing its exposure to movements in interest rates on mortgage loan commitments, mortgage loans held-for-sale and mortgage- backed securities classified as trading. These contracts primarily represent commitments or options to purchase or sell mortgages or securities generally within 90 days and at a specified price or yield. Forward delivery contracts and futures are commitments only and, as such, are not recorded on the Company's balance sheet or statement of earnings. Option premiums are deferred when paid and recognized as an adjustment to gains on sales of mortgages over the lives of the options on a straight-line basis. Changes in the fair value of contracts are deferred and included in mortgage loans held- for-sale and mortgage-backed securities classified as trading. Changes in fair value are recognized in income as an adjustment to gains on sales of mortgages when the mortgages and securities are sold. In addition, the Company entered into an interest rate swap and collar agreement to moderate the interest rate risks inherent in the financing of its investment securities classified as available-for-sale. During the term of the agreement, the net settlements are accrued and recognized as an adjustment to interest expense. The agreement is not required to be marked to market and therefore is not recorded on the Company's balance sheet. Mortgage Servicing Rights Retained mortgage servicing rights on originated loans are capitalized by allocating the total cost of the mortgage loans between the mortgage servicing rights and the loans based on their relative fair values. Mortgage servicing rights are amortized in proportion to and over the period of estimated net servicing revenue. The book value of capitalized mortgage-servicing rights at December 31, 1998 and 1997, was $4.5 million and $8.2 million, respectively, and the aggregate fair value totaled $4.5 million and $8.9 million, respectively. Comparable market values and the present value of future cash flows are used to estimate fair value. For purposes of measuring impairment, when deemed material, risk characteristics including product type, investor type and interest rates are used to stratify mortgage servicing rights. Deferred Financing Costs Financing costs incurred in connection with the issuance of bonds by the limited-purpose subsidiaries are capitalized and amortized over the respective lives of the bonds using the interest method. Stock Based Compensation The Company has elected to follow the intrinsic value method to account for compensation expense related to the award of stock options and to furnish the pro forma disclosures required under Statement of Financial Accounting Standards No. 123 (FASB 123), "Accounting for Stock-Based Compensation." Since stock option awards are granted at prices no less than the fair-market value of the shares at the date of grant, no compensation expense is recognized. New Accounting Pronouncements FASB 130 As of January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130 (FASB 130), "Reporting Comprehensive Income." FASB 130 defines comprehensive income and establishes new rules for the reporting of comprehensive income and its components; however, the adoption of this Statement had no impact on the Company's net income or stockholders' equity. FASB 130 requires unrealized gains or losses on the 38 Company's available-for-sale securities, which are included in stockholders' equity, to be reported as other comprehensive income which is added to net income to arrive at total comprehensive income. The Company has elected to report its comprehensive income in its Consolidated Statement of Stockholders' Equity. Prior year financial statements have been reclassified to conform to the FASB 130 requirements. FASB 131 In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 (FASB 131), "Disclosures about Segments for an Enterprise and Related Information." FASB 131 establishes standards for the way that public business enterprises report selected information about operating segments in financial reports issued to shareholders. The Company has adopted the provisions of FASB 131 which did not have a significant impact on the Company's definition of operating segments and related disclosures. FASB 133 In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (FASB 133), "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted in years beginning after June 15, 1999. FASB 133 requires all derivatives to be recorded on the balance sheet at fair value and establishes new accounting procedures for hedges that will effect the timing of recognition and the manner in which hedging gains and losses are recognized in the Company's financial statements. The Company has not completed its evaluation of FASB 133; however, management does not anticipate that the adoption of FASB 133 will have a material impact on the Company's earnings or financial position. The Company currently expects to adopt FASB 133 beginning on January 1, 2000. NOTE B: SEGMENT INFORMATION The Company is a leading national homebuilder and mortgage-related financial services firm. As one of the largest single-family on-site homebuilders in the United States, the Company builds homes in 21 markets in 14 states. The Company's homebuilding segment specializes in the sale and construction of single-family attached and detached housing. The financial services segment provides mortgage-related products and services for retail customers, including loan origination, loan servicing, title, escrow and homeowners insurance services, and also conducts investment activities. The Company evaluates performance and allocates resources based on a number of factors, including segment pretax earnings. The accounting policies of the segments are the same as those described in the summary of significant accounting policies in Note A. Certain corporate expenses are allocated to the homebuilding and financial services segments. In addition, amounts related to the limited-purpose subsidiaries are combined with corporate expenses and corporate assets in the following table as "Other". 39 SEGMENT INFORMATION 1998 1997 1996 - --------------------------------------------------------------------------- REVENUES: Homebuilding $1,694,505 $1,557,326 $1,473,275 Financial services 60,385 76,929 79,524 Other 10,598 15,551 27,387 --------- --------- --------- Total $1,765,488 $1,649,806 $1,580,186 --------- --------- --------- --------- --------- --------- PRETAX EARNINGS: Homebuilding $ 80,057 $ 35,150 $ 22,596 Financial services 11,788 15,585 15,847 Corporate and other (16,687) (14,265) (12,046) -------- -------- -------- Total $ 75,158 $ 36,470 $ 26,397 -------- -------- -------- -------- -------- -------- DEPRECIATION AND AMORTIZATION: Homebuilding $ 23,166 $ 23,479 $ 25,762 Financial services 895 5,901 3,296 Corporate and other 1,525 2,016 2,315 ------ ------ ------ Total $ 25,586 $ 31,396 $ 31,373 ------ ------ ------ ------ ------ ------ IDENTIFIABLE ASSETS: Homebuilding $ 778,668 $ 671,229 $ 695,284 Financial services 286,683 410,902 382,431 Corporate and other 150,047 201,278 260,809 ------- ------- ------- Total $1,215,398 $1,283,409 $1,338,524 --------- --------- --------- --------- --------- --------- 40 NOTE C: EARNINGS PER SHARE RECONCILIATION The following table sets forth the computation of basic and diluted earnings per share before extraordinary items: 1998 1997 1996 ---- ---- ---- Numerator: Net earnings before extraordinary item $43,592 $21,882 $15,839 Preferred stock dividends (1,000) (1,630) (1,974) ------ ------ ------ Numerator for basic earnings per share- earnings before extraordinary item available to common stockholders 42,592 20,252 13,865 Effect of dilutive securities- preferred stock dividends 1,000 0 0 ------ ------ ------ Numerator for diluted earnings per share - earnings before extraordinary item available to common stockholders $43,592 $20,252 $13,865 Denominator: Denominator for basic earnings per share - weighted-average shares 14,709,404 15,227,829 15,789,184 Effect of dilutive securities: Stock options 316,640 69,577 5,387 Conversion of preferred shares 463,374 0 0 Equity incentive plan 113,894 107,661 134,240 ---------- ---------- ---------- Dilutive potential common shares 893,908 177,238 139,627 Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 15,603,312 15,405,067 15,928,811 BASIC EARNINGS PER COMMON SHARE: Net earnings per share before extraordinary item $ 2.90 $ 1.33 $ 0.88 DILUTED EARNINGS PER COMMON SHARE: Net earnings per share before extraordinary item $ 2.79 $ 1.32 $ 0.87 The assumed conversion of preferred shares was dilutive for the year ended December 31, 1998. For the years ended December 31, 1997 and 1996, the conversion of preferred was not assumed due to an anti-dilutive effect. NOTE D: ASSETS OF FINANCIAL SERVICES AND THE LIMITED-PURPOSE SUBSIDIARIES Financial Services Mortgage loans held-for-sale consist of loans collateralized by first mortgages or first deeds of trust on single-family attached or detached houses. Mortgage-backed securities and notes receivable consist of GNMA certificates, FNMA mortgage pass-through certificates, FHLMC participation certificates, notes receivable secured by mortgage-backed securities, whole loans and funds held by trustee. Mortgage loans held-for-sale were reported net of mortgage discounts of $406 and $658 at December 31, 1998 and 1997, respectively. Mortgage loans held-for- sale, which are generally sold within 60 days of being 41 funded, mortgage-backed securities and notes receivable are pledged as collateral for certain short-term notes payable (see Note E). The Company sold the majority of its loan servicing portfolio in the first quarter of 1998 and realized a $6.1 million pre-tax gain, net of expenses and liabilities related to the sale of servicing. The financial services segment serviced 2,500 and 62,000 loans with principal balances totaling $301 million and $4.5 billion at December 31, 1998 and 1997, respectively, including loans subserviced for others of $1.3 billion in 1997. As a mortgage servicer, the Company may incur risk with respect to mortgages that are delinquent or in foreclosure to the extent that losses are not covered by a mortgage insurer or guarantor. The reserve for potential losses on the servicing portfolio was $377 and $1,784, at December 31, 1998 and 1997, respectively. These reserves are established based on the current economic environment and historical experience for foreclosures and delinquencies. Limited-Purpose Subsidiaries Collateral for bonds payable consists of mortgage-backed securities, notes receivable secured by mortgage-backed securities and mortgage loans, fixed- rate mortgage loans and funds held by trustee. Mortgage-backed securities consist of GNMA certificates, FNMA mortgage pass-through certificates and FHLMC participation certificates. All principal and interest on the collateral is remitted directly to a trustee and is available for payment on the bonds. The components of collateral for bonds payable at December 31 are summarized as follows: 1998 1997 ---- ---- Mortgage-backed securities $ 59,915 $ 81,089 Notes receivable 15,423 40,409 Mortgage loans 4,699 7,939 Funds held by trustee 13,681 14,426 Mortgage discounts (1,315) (1,560) ------ ------ Total $ 92,403 $142,303 Neither the Company nor its homebuilding and financial services subsidiaries have guaranteed or are otherwise obligated with respect to these bond issues. Mortgage-Backed Securities: Unrealized Gains and Losses Mortgage-backed securities are held by the financial services segment and reported in the balance sheet caption, "Mortgage-backed securities and notes receivable," and are also held by the limited-purpose subsidiaries and reported in the balance sheet caption, "Collateral for bonds payable." The following is a consolidated summary of mortgage-backed securities classified as available-for-sale and held-to-maturity as of: Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value - ---------------------------------------------------------------------------- December 31, 1998 Available-for-sale $ 40,802 $ 3,299 $ 116 $ 43,985 Held-to-maturity 56,463 4,642 0 61,105 ----------------------------------------------- Total $ 97,265 $ 7,941 $ 116 $105,090 December 31, 1997 Available-for-sale $ 50,453 $ 4,153 $ 17 $ 54,589 Held-to-maturity 76,229 5,761 0 81,990 ----------------------------------------------- Total $126,682 $ 9,914 $ 17 $136,579 =============================================== 42 NOTE E: FINANCIAL SERVICES SHORT-TERM NOTES PAYABLE Financial services had outstanding borrowings at December 31 as follows: 1998 1997 ---- ---- Mortgage warehouse and working capital facility $106,699 $ 191,352 Repurchase agreements 64,320 88,162 Revolving credit agreement 52,039 53,542 Other 0 7,576 ------- ------- Total outstanding borrowings $223,058 $340,632 ======= ======= The Company's bank facility, which matures in June 2000, provides up to $260 million for mortgage warehouse funding and $30 million for working capital advances. Warehouse advances are secured by mortgage loans held-for-sale, and working capital advances are secured by certain loan servicing rights and loan servicing advances. Borrowings outstanding under this bank facility totaling $106,699 at December 31, 1998, were collateralized by mortgage loans held-for- sale with outstanding principal balances of $121,079. Borrowings outstanding under this bank facility totaling $191,352 at December 31, 1997, were collateralized by mortgage loans held-for-sale with outstanding principal balances of $159,358, servicing rights of $10,252 and certain loan servicing advances of $21,906. The effective interest rates on these borrowings were 4.1 percent, 3.0 percent and 3.1 percent for 1998, 1997 and 1996, respectively. The agreement contains certain financial covenants, which the Company met at December 31, 1998. The repurchase agreements represent short-term borrowings that are collateralized by mortgage loans, mortgage-backed securities and investments in securities issued by the Company's limited-purpose subsidiaries with outstanding balances at December 31, 1998 and 1997, of $64,129 and $88,198, respectively, with related fair values of $66,653 and $91,806. As of December 31, 1998, $40 million of the Company's variable-rate short-term borrowings had been effectively converted by interest rate swap and collar agreements to fixed-rate borrowings. The notional amount of the swap and collar agreements will decline to $30 million in 1999. The effective interest rates on the repurchase agreements, including the effect of the interest rate swap and collar agreements, were 5.9 percent, 6.0 percent and 5.8 percent for 1998, 1997 and 1996, respectively. In May 1998, the Company renewed and extended its $100 million credit facility used to finance investment securities in the financial services segment. The agreement was extended through March 1999, bears interest at market rates and is collateralized by investment portfolio securities. Borrowings outstanding under this facility, totaling $52,039 and $53,542, were collateralized by investment portfolio securities with principal balances of $52,700 and $53,482 at December 31, 1998 and 1997, respectively. The fair values of the investment securities at December 31, 1998 and 1997 were $54,668 and $56,207, respectively. The weighted-average interest rates at the end of the period on all short-term borrowings were 5.3 percent, 4.9 percent and 4.2 percent for 1998, 1997 and 1996, respectively. The weighted-average interest rates during the period on all short-term borrowings were 5.2 percent, 4.6 percent and 4.3 percent for 1998, 1997 and 1996, respectively. NOTE F: OFF BALANCE SHEET FINANCIAL INSTRUMENTS RELATED TO MORTGAGE LOAN ORIGINATIONS The Company is a party to financial instruments in the normal course of business. The financial services segment uses financial instruments to meet the financing needs of its customers and reduce its exposure to fluctuations in interest rates. These instruments involve, to varying degrees, elements of credit and market risk not recognized in the consolidated balance sheets. The Company has no derivative financial instruments that are held for trading purposes. 43 The contract or notional amounts of these financial instruments as of December 31 are as follows: 1998 1997 - ------------------------------------------------------------------------ Commitments to originate mortgage loans $ 33,859 $ 29,765 Hedging contracts: Forward delivery contracts $163,000 $159,878 Others 4,000 0 - ------------------------------------------------------------------------ In addition, to protect against exposure to interest rate fluctuations on adjustable-rate mortgage loan commitments, at December 31, 1998 and 1997, the Company contracted with various parties to deliver $12,308 and $24,440, respectively, in adjustable and fixed-rate mortgage loans for a specified price on primarily a best-efforts basis. Commitments to originate mortgage loans represent loan commitments with customers at market rates up to 120 days before settlement. Loan commitments have no carrying value on the balance sheet. These commitments expose the Company to market risk as a result of increases in mortgage interest rates. The amount of risk is limited to the difference between the contract price and current market value, and is mitigated by fees collected from the customer and by the Company's hedging activities. Loan commitments had interest rates ranging from 6.0 percent to 10.3 percent as of December 31, 1998, and 6.5 percent to 10.3 percent as of December 31, 1997. Hedging contracts are regularly entered into by the Company for the purpose of mitigating its exposure to movements in interest rates on mortgage loan commitments and mortgage loans held-for-sale. The selection of these hedging contracts is based upon the Company's secondary marketing strategy, which establishes a risk tolerance level. The major factors influencing the use of the various hedging contracts include general market conditions, interest rate, types of mortgages originated and the percentage of mortgage loan commitments expected to be funded. The market risk assumed while holding the hedging contracts, generally mitigates the market risk associated with the mortgage loan commitments and mortgage loans held-for-sale. The Company is exposed to credit related losses in the event of non- performance by counterparties to certain hedging contracts. Credit risk is limited to those instances where the Company is in a net unrealized gain position. The Company manages this credit risk by entering into agreements with counterparties meeting the credit standards of the Company and monitoring position limits. NOTE G: FAIR VALUES OF FINANCIAL INSTRUMENTS The Company's financial instruments, both on and off the balance sheet, are held for purposes other than trading. The fair values of these financial instruments are based on quoted market prices, where available, or are estimated using present value or other valuation techniques. Estimated fair values are significantly affected by the assumptions used, including the discount rate and estimates of cash flows. In that regard, the derived fair- value estimates can not be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. The table below sets forth the carrying values and fair values of the Company's financial instruments, except for those financial instruments noted below for which the carrying values approximate fair values at the end of the year. It excludes non-financial instruments and, accordingly, the aggregate fair-value amounts presented do not represent the underlying value of the Company. 44 1998 1997 - ------------------------------------------------------------------------------ CARRYING FAIR CARRYING FAIR VALUE VALUE VALUE VALUE - ------------------------------------------------------------------------------ HOMEBUILDING: Liabilities Senior notes $108,000 $116,140 $108,000 $119,360 Senior subordinated notes 200,000 197,000 200,000 207,000 FINANCIAL SERVICES: Assets Mortgage loans held- for-sale $158,611 $161,030 $199,857 $201,583 Mortgage-backed securities, available-for-sale 36,414 36,414 50,678 50,678 Mortgage-backed securities, held-to-maturity 4,826 5,147 0 0 Notes receivable, whole loans and funds held by trustee 70,414 76,224 102,344 110,339 Off-balance sheet financial instruments Commitments to originate mortgage loans 0 155 0 386 Forward delivery contracts 0 (441) 0 (196) Other hedging contracts 0 (54) 0 0 OTHER ASSETS: Collateral for bonds payable of the limited-purpose subsidiaries $ 92,403 $ 98,341 $142,303 $152,133 OTHER LIABILITIES: Bonds payable of the limited- purpose subsidiaries $ 87,980 $ 97,344 $136,865 $151,053 The Company used the following methods and assumptions in estimating fair values: - Cash and cash equivalents, secured notes payable, loan servicing receivables, funds held by trustee and short-term notes payable: The carrying amounts reported in the balance sheet approximate fair values. - Senior notes, senior subordinated notes, mortgage loans held-for-sale, mortgage-backed securities, notes receivable and whole loans, the various hedging contracts if settled on December 31, 1998 and 1997 and mortgage loan commitments: The fair values of these financial instruments are estimated based on quoted market prices for similar financial instruments. NOTE H: LIMITED-PURPOSE SUBSIDIARIES' BONDS PAYABLE The Company's limited-purpose subsidiaries are no longer issuing mortgage- backed bonds and mortgage-participation securities. Previously, they issued mortgage-backed bonds, and the Company retained residual interests in some of these bonds. Payments are made on the bonds on a periodic basis as a result of, and in amounts relating to, corresponding payments received on the underlying mortgage collateral. 45 The following table sets forth information with respect to the limited-purpose subsidiaries' bonds payable outstanding at December 31: 1998 1997 - --------------------------------------------------------------------------- Bonds payable, net of discounts: 1998-$2,517; 1997-$3,795 $87,980 $136,865 Range of interest rates 7.25%-12.625% 7.25%-12.625% Stated maturities 2006-2019 2006-2019 - ---------------------------------------------------------------------------- NOTE I: LONG-TERM DEBT Long-term debt consists of the following: December 31, 1998 1997 - --------------------------------------------------------------------------- Senior subordinated notes $200,000 $200,000 Senior notes 108,000 108,000 Other 152 2,221 ------- ------- $308,152 $310,221 - --------------------------------------------------------------------------- The Company has an unsecured credit agreement with a group of banks, which matures in July 2000, with a total borrowing capacity of $300 million. Borrowings under this agreement bear interest at variable short-term rates. The effective interest rates for 1998, 1997 and 1996 were 6.8 percent, 7.1 percent and 7.1 percent, respectively. There were no amounts outstanding under this agreement at December 31, 1998 or 1997. The Company has $100 million of 9.625% senior subordinated notes outstanding, due June 2004, with interest payable semi-annually, which may be redeemed at the option of the Company, in whole or in part, at any time on or after December 1, 2000. In April 1998, the Company issued $100 million of 8.25% senior subordinated notes, due April 2008, with interest payable semi- annually, which may be redeemed at the option of the Company, in whole or in part, at any time on or after April 1, 2003. In July 1998 the Company redeemed $100 million of 10.5% senior subordinated notes due 2002 at the stated call price of 103.94 percent of par. As a result, the Company recognized an extraordinary loss on early extinguishment of debt in 1998 of $3.3 million (net of a $2.2 million income tax benefit). Senior subordinated notes are subordinated to all existing and future senior debt of the Company. The Company has $100 million of 10.5% senior notes due July 2006, with interest payable semi-annually, which may be redeemed at the option of the Company, in whole or in part, at any time on or after July 1, 2001. At December 31, 1998, the Company also has $8 million of senior notes bearing a fixed rate of 10.5% which mature in August 2000. Maturities of long-term debt for the next five years are as follows: 1999 - $68; 2000 - $8,000; 2001 - $84; 2002 through 2003 - $0. The bank credit agreement, senior subordinated indenture agreements and senior note agreements contain certain financial covenants. Under the loan covenants, the Company has $56.1 million of retained earnings available for dividends at December 31, 1998. At December 31, 1998, the Company is in compliance with its covenants. 46 NOTE J: INCOME TAXES The Company's expense for income taxes is summarized as follows: 1998 1997 1996 - ----------------------------------------------------------------------- Current: Federal $22,453 $14,931 $ 954 State 4,491 3,167 203 ------- ------- ------- Total current 26,944 18,098 1,157 ------- ------- ------- Deferred: Federal 3,852 (2,896) 7,756 State 770 (614) 1,645 ------- ------- ------- Total deferred 4,622 (3,510) 9,401 ------- ------- ------- Total expense $31,566 $14,588 $10,558 ------- ------- ------- - ----------------------------------------------------------------------- Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax assets and liabilities as of December 31 were as follows: 1998 1997 - -------------------------------------------------------------------- Deferred tax assets: Inventory valuation differences, operating reserves and accruals $32,598 $32,740 Other differences in inventory 2,903 7,775 Other 1,863 2,383 ------- ------- Total deferred tax assets 37,364 42,898 ------- ------- Deferred tax liabilities: Gross profit from sales reported on the installment method (2,377) (3,404) Deferred gains (1,830) (2,085) Other (1,773) (1,645) ------ ------ Total deferred tax liabilities (5,980) (7,134) ------- ------- Net deferred tax asset $31,384 $35,764 ------- ------- - --------------------------------------------------------------------- The Company has determined that no valuation allowance for the deferred tax asset is required due to tax carrybacks currently available. The Company had a current tax liability of $9,761 and $7,608 as of December 31, 1998 and 1997, respectively. The following table reconciles the statutory federal income tax rate to the Company's effective income tax rate: Years Ended December 31, 1998 1997 1996 - -------------------------------------------------------------------------- Income taxes at federal statutory rate 35.0% 35.0% 35.0% State income taxes, net of federal tax 4.5 4.5 4.5 Other, net 2.5 .5 .5 ----- ---- ---- Effective rate 42.0% 40.0% 40.0% - -------------------------------------------------------------------------- The change in the tax rate was primarily due to the fine paid in connection with the RTC matter discussed in Note M. 47 NOTE K: STOCKHOLDERS' EQUITY Preferred Stock On August 31, 1989, the Company sold 1,267,327 shares of non-transferable convertible preferred stock, par value $1.00, to the RSOP Trust for $31.5625 per share, or an aggregate purchase price of approximately $40,000. Each share of preferred stock pays an annual cumulative dividend of $2.21. During 1998, 1997 and 1996, the Company paid $1,000, $1,630 and $1,974, respectively, in dividends on the preferred stock. Each share of preferred stock is entitled to a number of votes equal to the shares into which it is convertible, and the holders of the preferred stock generally vote together with the common stockholders on all matters. Under the RSOP Trust, at the option of the trustee, the Company may be obligated to redeem the preferred stock to satisfy distribution obligations to or investment elections of participants. For purposes of these redemptions, the value of each share of preferred stock is determined monthly by an independent appraiser, with a minimum guaranteed value of $25.25 per share. The Company may issue common stock to satisfy this redemption obligation, with any excess redemption price to be paid in cash. At December 31, 1998 and 1997, the maximum cash obligation for such redemptions was shown outside of stockholders' equity as part of other liabilities. This obligation is calculated assuming that all preferred shares outstanding were submitted for redemption. Based upon the appraised value of each share of preferred stock ($39.37 and $38.69) and the market value of each share of common stock ($28.88 and $23.50) at December 31, 1998 and 1997, respectively, the redemption obligation at December 31, 1998 and 1997 was $4,376 and $7,618, respectively. During 1998 and 1997, 73,415 and 110,027 shares of preferred stock, respectively, were converted into shares of common stock, and 12,674 and 248,881 shares of preferred stock, respectively, were retired (See Note L). Common Share Purchase Rights In 1996, the Company adopted a revised shareholder rights plan under which the Company distributed one common share purchase right for each share of common stock outstanding on January 13, 1997. Each right entitles the holder to purchase one share of common stock at an exercise price of $70. The rights become exercisable 10 business days after any party acquires or announces an offer to acquire 20 percent or more of the Company's common stock. The rights expire January 13, 2007, and are redeemable at $0.01 per right at any time before 10 business days following the time that any party acquires 20 percent or more of the Company's common stock. In the event the Company enters into a merger or other business combination, or if a substantial amount of its assets are sold after the time that the rights become exercisable, the rights provide that the holder will receive, upon exercise, shares of the common stock of the surviving or acquiring company having a market value of twice the exercise price. Until the earlier of the time that the rights become exercisable, are redeemed or expire, the Company will issue one right with each new share of common stock issued. NOTE L: EMPLOYEE INCENTIVE AND STOCK PLANS Retirement Savings Opportunity Plan (RSOP) In 1989, the Company established a retirement and employee stock ownership plan that purchased shares of preferred stock from the Company. The purchase of preferred stock by the plan was financed by a loan from the Company in the amount of $40,000. The interest rate on the loan was 9.99% and through September, 1997, 48 the loan was being repaid by the plan through dividends received on the preferred stock and Company contributions. On October 1, 1997, the Company purchased 248,881 shares of preferred stock at fair market value from the plan representing preferred shares that secured the loan and had not been released for allocation to participant's accounts. The plan used the proceeds to payoff the related loan balance and the Company retired the preferred shares. The RSOP Trust incurred interest on the loan in 1997 and 1996 of $930 and $1,794, respectively. As of December 31, 1998, 416,744 shares of preferred stock are allocated to participant's accounts. As of January 1, 1998, participants receive cash and no longer receive preferred stock in connection with Company matching contributions to their accounts. All full-time employees are eligible to participate in the RSOP the first pay period of the quarter following 30 days of employment. Pursuant to Section 401(k) of the Internal Revenue Code, the plan permits deferral of a portion of a participant's income into a variety of investment options. Compensation expense reflects the Company's matching contributions of the employee 401(k) contributions. Total compensation expense related to this Plan amounted to $3,549, $4,039 and $5,230 in 1998, 1997 and 1996, respectively. Equity Incentive Plan and Other Related Plans The Company's 1992 Equity Incentive Plan permits the Company to provide equity incentives in the form of stock options, stock appreciation rights, performance shares, restricted stock and other stock-based awards to employees. Under the Company's 1992 Equity Incentive Plan, options are granted to purchase shares at prices not less than the fair-market value of the shares at the date of grant. The options are exercisable at various dates over one- to 10-year periods. Stock options granted during 1998 generally have a maximum term of 10 years and vest over three years. At the beginning of each year, 2 1/2 percent of the number of common shares outstanding at the beginning of the year are authorized for grants of options and other equity instruments. Under the Company's Non-Employee Director Equity Plan, stock options are granted to directors to purchase shares at prices not less than the fair market value of the shares at the date of grant. A maximum of 100,000 shares of common stock has been reserved for issuance under this plan.
The following is a summary of the transactions relating to all stock option plans for each year ended December 31: 1998 1997 1996 -------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Shares Price Shares Price Shares Price ------ ---------- ------ -------- ------ -------- Options outstanding beginning of year 1,932,560 $15.71 1,783,738 $16.70 1,545,700 $17.44 Granted 637,000 23.88 619,500 13.49 539,500 14.85 Exercised (540,350) 16.13 (211,110) 16.33 (4,950) 15.00 Forfeited (188,810) 18.07 (252,068) 16.47 (211,362) 16.27 Expired 0 0 (7,500) 26.00 (85,150) 19.48 --------- ----- --------- ----- --------- ----- Options outstanding end of year 1,840,400 18.02 1,932,560 15.71 1,783,738 16.70 Available for future grant 320,143 478,309 561,715 --------- ----- --------- ----- --------- ----- Total shares reserved 2,160,543 2,410,869 2,345,453 --------- ----- --------- ----- --------- ----- Options exercisable December 31 864,795 16.61 966,065 17.39 923,119 18.16 Prices related to options exercised during the year $12.88-$24.13 $13.50-$20.75 $15.00 - ------------------------------------------------------------------------------------------------------------- 49
A summary of stock options outstanding and exercisable as of December 31, 1998 follows:
Options Outstanding Options Exercisable - ------------------------------------------------------------------------------------------------------- Range of Number Weighted Average Weighted Average Number Weighted Average Exercise Prices Outstanding Remaining Life-(years) Exercise Price Exercisable Exercise Price $11.50 to $13.88 495,690 7.92 $13.28 184,535 $13.30 $14.00 to $20.75 751,360 6.08 $16.76 615,860 $16.92 $21.75 to $28.88 593,350 8.55 $23.56 64,400 $23.15
TRE RYLAND GROUP, INC. & SUBSIDIARIES Quarterly Financial Data and Common Stock Prices and Dividends (amounts in thousands, except per share data) 1998 1997 unaudited Dec. 31 Sept. 30 June 30 March 31 Dec. 31 Sept. 30 June 30 March 31 - --------------------------------------------------------------------------------------------------------------------- CONSOLIDATED RESULTS: Revenues $541,086 $462,246 $425,851 $336,305 $499,062 $421,604 $399,620 $329,520 Earnings before taxes and extraordinary item 30,335 22,295 14,711 7,817 15,891 11,235 6,451 2,893 Income tax expense 12,783 9,772 5,884 3,127 6,356 4,494 2,581 1,157 -------------------------------------------------------------------------------------- Net earnings before extraordinary item $ 17,552 12,523 8,827 4,690 9,535 6,741 3,870 1,736 Extraordinary item - loss on early extinguishment of debt (net of taxes of $2,217) 0 (3,326) 0 0 0 0 0 0 ------------------------------------------------------------------------------------- Net earnings $ 17,552 $ 9,197 $ 8,827 $ 4,690 $ 9,535 $ 6,741 $ 3,870 $ 1,736 Basic net earnings per common share $ 1.18 $ 0.61 $ 0.58 $ 0.30 $ 0.64 $ 0.42 $ 0.22 $ 0.08 Diluted net earnings per common share $ 1.12 $ 0.59 $ 0.57 $ 0.29 $ 0.62 $ 0.41 $ 0.22 $ 0.08 Weighted average common shares outstanding Basic 14,691 14,667 14,758 14,713 14,433 14,916 15,684 15,878 Diluted 15,611 15,521 15,599 15,245 15,375 15,907 15,772 16,001 - ---------------------------------------------------------------------------------------------------------------------- 54
COMMON STOCK PRICES AND DIVIDENDS The Ryland Group, Inc. lists its common shares on the New York Stock Exchange, trading under the symbol RYL. The table below presents the high and low market prices and dividend information for the Company. The number of common stockholders of record as of February 18, 1999, was 3,114. (See Note I for dividend restrictions) Dividends Dividends Declared Declared 1998 High Low Per Share 1997 High Low Per Share - ------------------------------------------------------------------------------------------------------------------------- First quarter $ 29 13/16 $ 21 1/2 $0.04 First quarter $ 14 $ 11 3/4 $0.15 Second quarter 27 11/16 19 1/2 0.04 Second quarter 14 1/8 11 3/8 0.04 Third quarter 27 5/16 19 3/4 0.04 Third quarter 18 1/2 13 3/4 0.04 Fourth quarter 29 1/8 20 7/8 0.04 Fourth quarter 24 7/8 17 5/8 0.04 - ------------------------------------------------------------------------------------------------------------------------- 55
EX-21 4 Exhibit 21 List of Subsidiaries of Registrant Ryland Mortgage Company (an Ohio Corporation) M.J. Brock & Sons, Inc. (a Delaware Corporation) LPS Holdings Corporation (a Maryland Corporation) 56 EX-23 5 Exhibit 23 Consent of Independent Auditors We consent to the incorporation by reference in this Annual Report (Form 10-K) of The Ryland Group, Inc., of our report dated January 27, 1999, included in the 1998 Annual Report to the Shareholders of The Ryland Group, Inc. Our audits also included the financial statement schedule of The Ryland Group, Inc., listed in Item 14(a). This schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also consent to the incorporation by reference in the Registration Statements (Form S-8 No. 33-32431, Form S-3 No. 33-48071, Form S-3 No. 33- 50933, Form S-8 No. 33-56905, Form S-8 No. 33-56917, Form S-3 No. 333-03791, Form S-8 No. 333-68397,) of The Ryland Group, Inc., and in the related Prospectuses of our report dated January 27, 1999, with respect to the consolidated financial statements incorporated herein by reference, and our report included in the preceding paragraph with respect to the financial statement schedule included in this Annual Report (Form 10-K) for the year ended December 31, 1998. /s/Ernst & Young LLP Baltimore, Maryland March 5, 1999 57 EX-24 6 Exhibit 24 Power of Attorney KNOW ALL MEN BY THESE PRESENTS that the undersigned directors and officers of The Ryland Group, Inc., a Maryland corporation, constitute and appoint Timothy J. Geckle and Michael D. Mangan and either of them, the true and lawful agents and attorneys-in-fact of the undersigned with full power and authority in said agents and attorneys-in-fact, and in either of them, to sign for the undersigned in their respective names as directors and officers of The Ryland Group, Inc., the Annual Report on Form 10-K of The Ryland Group, Inc., for the fiscal year ended December 31, 1998, to be filed with the Securities and Exchange Commission under the Securities Exchange Act of 1934. We hereby confirm all acts taken by such agents and attorneys-in-fact, or either of them, as herein authorized. DATED: March 1, 1999 /s/ R. Chad Dreier ------------------- R. Chad Dreier, Chairman of the Board, President, and Chief Executive Officer (Principal Executive Officer) /s/ James A. Flick, Jr. ----------------------- James A. Flick, Jr., Director /s/ Leslie M. Frecon -------------------- Leslie M. Frecon, Director /s/ Robert J. Gaw ------------------- Robert J. Gaw, Director /s/ Leonard M. Harlan --------------------- Leonard M. Harlan, Director /s/ William L. Jews -------------------- William L. Jews, Director /s/ William G. Kagler ---------------------- William G. Kagler, Director /s/ Charlotte St. Martin ------------------------ Charlotte St. Martin, Director /s/ John O. Wilson ------------------ John O. Wilson, Director 58 EX-27 7
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE RYLAND GROUP INC. FORM 10-K FOR THE PERIOD ENDED 12/31/98 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS 1000 12-MOS DEC-31-1998 DEC-31-1998 49,784 111,654 158,611 0 641,762 0 26,818 0 1,215,398 0 311,038 0 417 14,752 331,114 1,215,398 1,694,505 1,765,488 1,428,763 1,628,834 16,687 0 44,809 75,158 31,566 43,592 0 (3,326) 0 40,266 2.67 2.58
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