UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1999 or [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from _____________to_____________. Commission File Number: 1-8029 THE RYLAND GROUP, INC. (Exact name of registrant as specified in its charter) MARYLAND 52-0849948 (State of incorporation) (I.R.S. employer identification no.) 11000 Broken Land Parkway, Columbia, Maryland 21044 (410) 715-7000 (Address and telephone number of principal executive offices) 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. The number of shares of common stock of The Ryland Group, Inc., outstanding on November 3, 1999 was 14,260,273. THE RYLAND GROUP, INC. FORM 10-Q INDEX Page Number(s) ------------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets at September 30, 1999 (unaudited) and December 31, 1998 1-2 Consolidated Statements of Earnings for the Three and Nine Months Ended September 30, 1999 and 1998 (unaudited) 3 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1999 and 1998 (unaudited) 4 Notes to Consolidated Financial Statements (unaudited) 5-8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 9-14 Item 3. Quantitative and Qualitative Disclosures About Market Risk 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings 16 Item 6. Exhibits and Reports on Form 8-K 16 SIGNATURES 17 INDEX OF EXHIBITS 18 PART I. FINANCIAL INFORMATION Item 1. Financial Statements The Ryland Group, Inc. and subsidiaries CONSOLIDATED BALANCE SHEETS (amounts in thousands, except share data) September 30, December 31, 1999 1998 ------------- ------------ (unaudited) ASSETS Homebuilding: Cash and cash equivalents $ 51,502 $ 48,100 Housing inventories: Homes under construction 481,049 373,012 Land under developement and improved lots 302,335 268,750 ---------- ---------- Total inventories 783,384 641,762 Property, plant and equipment 26,123 26,818 Purchase price in excess of net assets acquired 22,151 23,473 Other assets 39,776 38,515 ---------- ---------- 922,936 778,668 ---------- ---------- Financial Services: Cash and cash equivalents 31,695 1,684 Mortgage loans held-for-sale 92,064 158,611 Mortgage-backed securities and notes receivable 99,749 111,654 Other assets 17,604 14,734 ---------- ---------- 241,112 286,683 ---------- ---------- Other Assets: Collateral for bonds payable of limited-purpose subsidiaries 59,858 92,403 Net deferred taxes 31,560 31,384 Other 30,579 26,260 ---------- ---------- Total assets $1,286,045 $1,215,398 ---------- ---------- See notes to consolidated financial statements. 1 The Ryland Group, Inc. and subsidiaries CONSOLIDATED BALANCE SHEETS (amounts in thousands, except share data) September 30, December 31, 1999 1998 ------------- ------------ (unaudited) LIABILITIES Homebuilding: Accounts payable and other liabilities $ 197,811 $ 173,370 Long-term debt 367,949 308,152 ---------- ---------- 565,760 481,522 ---------- ---------- Financial Services: Accounts payable and other liabilities 12,141 16,473 Short-term notes payable 206,310 223,058 ---------- ---------- 218,451 239,531 ---------- ---------- Other Liabilities: Bonds payable of limited-purpose subsidiaries 56,538 87,980 Other 63,210 60,082 ---------- ---------- Total liabilities 903,959 869,115 ---------- ---------- STOCKHOLDERS' EQUITY Convertible preferred stock, $1 par value: Authorized - 1,400,000 shares Issued - 364,254 shares (416,744 for 1998) 364 417 Common stock, $1 par value: Authorized - 78,600,000 shares Issued - 14,568,996 shares (14,751,753 for 1998) 14,569 14,752 Paid-in capital 86,441 93,193 Retained earnings 279,442 236,011 Accumulated other comprehensive income 1,270 1,910 ---------- ---------- Total stockholders' equity 382,086 346,283 ---------- ---------- Total liabilities and stockholders' equity $1,286,045 $1,215,398 ---------- ---------- Stockholders' equity per common share $ 25.59 $ 22.83 ---------- ---------- See notes to consolidated financial statements. 2 The Ryland Group, Inc. and subsidiaries CONSOLIDATED STATEMENTS OF EARNINGS (unaudited) (amounts in thousands, except share data) Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 ------------ ------------ ------------ ------------ Revenues: Homebuilding: Residential revenue $ 494,283 $ 440,724 $ 1,360,286 $ 1,144,612 Other revenue 1,583 6,856 16,203 24,075 ------------ ------------ ------------ ------------ Total homebuiliding revenue 495,866 447,580 1,376,489 1,168,687 Financial services 9,506 12,259 31,237 47,423 Limited-purpose subsidiaries 1,803 2,407 5,893 8,292 ------------ ------------ ------------ ------------ Total revenues 507,175 462,246 1,413,619 1,224,402 ------------ ------------ ------------ ------------ Expenses: Homebuilding: Cost of sales 411,908 375,213 1,148,112 992,021 Selling, general and administrative 45,757 42,697 135,466 116,366 Interest 2,757 4,537 8,814 14,526 ------------ ------------ ------------ ------------ Total homebuilding expenses 460,422 422,447 1,292,392 1,122,913 Financial Services: General and administrative 4,832 7,041 16,443 24,825 Interest 2,551 3,661 7,376 12,460 ------------ ------------ ------------ ------------ Total financial services expenses 7,383 10,702 23,819 37,285 Limited-purpose subsidiaries expenses 1,803 2,407 5,893 8,292 Corporate expenses 7,831 4,395 16,332 11,089 ------------ ------------ ------------ ------------ Total expenses 477,439 439,951 1,338,436 1,179,579 Earnings before taxes and extraordinary item 29,736 22,295 75,183 44,823 Tax expense 11,597 9,772 29,321 18,783 ------------ ------------ ------------ ------------ Net earnings before extraordinary item 18,139 12,523 45,862 26,040 Extraordinary item - loss on early extinguishment of debt (net of taxes of $2,217) -- (3,326) -- (3,326) ------------ ------------ ------------ ------------ Net earnings $ 18,139 $ 9,197 $ 45,862 $ 22,714 ------------ ------------ ------------ ------------ Net earnings per common share: Basic: Net earnings before extraordinary item $ 1.21 $ 0.84 $ 3.05 $ 1.72 Extraordinary item -- (0.23) -- (0.23) ------------ ------------ ------------ ------------ Net earnings per common share $ 1.21 $ 0.61 $ 3.05 $ 1.49 Diluted: Net earnings before extraordinary item $ 1.15 $ 0.81 $ 2.92 $ 1.67 Extraordinary item -- (0.22) -- (0.21) ------------ ------------ ------------ ------------ Net earnings per common share $ 1.15 $ 0.59 $ 2.92 $ 1.46 Average common shares outstanding: Basic 14,855,799 14,667,471 14,839,146 14,715,601 Diluted 15,741,410 15,521,430 15,723,099 15,609,471 See notes to consolidated financial statements. 3 The Ryland Group, Inc. and subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (amounts in thousands) Nine months ended September 30, 1999 1998 --------- --------- CASH FLOWS FROM OPERATING ACTIVITIES: Net earnings $ 45,862 $ 22,714 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization 19,763 17,770 Loss on early extinguishment of debt -- 5,543 Increase in inventories (141,622) (73,112) Net change in other assets, payables and other liabilities 18,815 75,754 Decrease in mortgage loans held-for-sale 66,547 74,133 Other operating activities, net (2,224) 98 --------- --------- Net cash provided by operating activities 7,141 122,900 --------- --------- CASH FLOWS FROM INVESTING ACTIVITIES: Net additions to property, plant and equipment (18,947) (16,492) Principal reduction of mortgage collateral 24,594 29,462 Principal (increase) reduction of mortgage-backed securities - available-for-sale (3,154) 10,301 Sales of mortgage-backed securities - available-for-sale -- 8,703 Principal reduction of mortgage-backed securities - held-to-maturity 27,113 15,098 Other investing activities, net (4,743) 9,457 --------- --------- Net cash provided by investing activities 24,863 56,529 --------- --------- CASH FLOWS FROM FINANCING ACTIVITIES: Cash proceeds of long-term debt 61,425 114,262 Reduction of long-term debt (1,628) (106,728) Decrease in short-term notes payable (16,748) (128,253) Bond principal payments (32,581) (45,153) Common and preferred stock dividends (2,449) (2,556) Common stock repurchases (8,983) (6,153) Other financing activities, net 2,373 7,217 --------- --------- Net cash provided by (used for) financing activities 1,409 (167,364) --------- --------- Net increase in cash and cash equivalents 33,413 12,065 Cash and cash equivalents at beginning of period 49,784 36,131 --------- --------- CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 83,197 $ 48,196 --------- --------- SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash paid for interest (net of capitalized interest) $ 20,131 $ 37,254 Cash paid for income taxes (net of refunds) $ 11,240 $ 9,346 See notes to consolidated financial statements. 4 The Ryland Group, Inc. and subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (amounts in thousands, except for share data, in all notes) Note 1. Consolidated Financial Statements 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. The consolidated balance sheet as of September 30, 1999, the consolidated statements of earnings for the three and nine months ended September 30, 1999 and 1998, and the consolidated statements of cash flows for the nine months ended September 30, 1999 and 1998 have been prepared by the Company, without audit. In the opinion of management, all adjustments, which include normal recurring adjustments necessary to present fairly the financial position, results of operations and cash flows at September 30, 1999, and for all periods presented, have been made. The consolidated balance sheet at December 31, 1998 is taken from the audited financial statements as of that date. Certain amounts in the consolidated statements have been reclassified to conform to the 1999 presentation. Certain information and footnote disclosures normally included in the financial statements have been condensed or omitted. These financial statements should be read in conjunction with the financial statements and related notes included in the Company's 1998 annual report to shareholders. The results of operations for the nine months ended September 30, 1999 are not necessarily indicative of the operating results for the full year. Assets presented in the financial statements are net of any valuation allowances. The following table is a summary of capitalized interest: 1999 1998 ---- ---- Capitalized interest as of January 1, $ 21,600 $ 23,644 Interest capitalized 17,870 12,972 Interest amortized to cost of sales (13,343) (15,222) -------- -------- Capitalized interest as of September 30, $ 26,127 $ 21,394 ======== ======== 5 The Ryland Group, Inc. and subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) Note 2. New Accounting Pronouncements FASB 133 In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133 (FAS 133), "Accounting for Derivative Instruments and Hedging Activities". In June 1999, the Financial Accounting Standards Board delayed for one year the effective date of FAS 133 to all years beginning after June 15, 2000. FAS 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 FAS 133; however, management does not anticipate that the adoption of FAS 133 will have a material impact on the Company's earnings or financial position. The Company currently expects to adopt FAS 133 beginning on January 1, 2001. Note 3. Segment Information Operations of 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. The financial services segment provides mortgage-related products and services for retail customers and conducts investment activities. Corporate expenses represent the costs of corporate functions, which support the business segments. Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 ---- ---- ---- ---- Earnings before taxes and extraordinary item: Homebuilding $ 35,444 $ 25,133 $ 84,097 $ 45,774 Financial services 2,123 1,557 7,418 10,138 Corporate and other (7,831) (4,395) (16,332) (11,089) -------- -------- -------- -------- Total $ 29,736 $ 22,295 $ 75,183 $ 44,823 ======== ======== ======== ======== Note 4. Earnings Per Share Reconciliation The following table sets forth the computation of basic and diluted earnings per share. The assumed conversion of preferred stock was dilutive for the three and nine months ended September 30, 1999 and 1998. 6 The Ryland Group, Inc. and subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 ---- ---- ---- ----- Numerator: Net earnings before extraordinary item $ 18,139 $ 12,523 $ 45,862 $ 26,040 Preferred stock dividends (201) (243) (637) (770) ------------ ------------ ------------ ------------ Numerator for basic earnings per share - income available to common stockholders $ 17,938 $ 12,280 $ 45,225 $ 25,270 Effect of dilutive securities: Preferred stock dividends 201 243 637 770 Numerator for diluted earnings per share - income available to common stockholders after assumed conversion $ 18,139 $ 12,523 $ 45,862 $ 26,040 Denominator: Denominator for basic earnings per share - weighted-average shares 14,855,799 14,667,471 14,839,146 14,715,601 Effect of dilutive securities: Stock options 350,970 310,813 340,679 320,880 Conversion of preferred shares 374,721 451,868 393,275 474,916 Other equity incentives 159,920 91,278 149,999 98,074 ------------ ------------ ------------ ------------ Dilutive potential common shares 885,611 853,959 883,953 893,870 Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversions 15,741,410 15,521,430 15,723,099 15,609,471 Basic earnings per share before extraodinary item $ 1.21 $ 0.84 $ 3.05 $ 1.72 Dilutive earnings per share before extraordinary item $ 1.15 $ 0.81 $ 2.92 $ 1.67 Note 5. Commitments and Contingencies Refer to Part II, Other Information, Item 1, Legal Proceedings of this document for updated information regarding the Company's commitments and contingencies. Note 6. Comprehensive Income Comprehensive income consists of net income and the increase or decrease in unrealized gains or losses on the company's available-for-sale securities and totaled $17.9 million and $9.0 million for the three months ended September 30, 1999 and 1998, respectively. For the nine months ended September 30, 1999 and 1998, comprehensive income was $45.2 million and $22.2 million, respectively. 7 The Ryland Group, Inc. and subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - continued (unaudited) Note 7. Income Taxes In the second quarter of 1999, the Company changed its effective income tax rate for the year ending December 31, 1999 to 39 percent and adjusted its income tax provision for the second quarter to achieve a 39 percent effective tax rate for the six months ended June 30, 1999. The change in the tax rate was primarily due to a reduction in the estimate of the Company's effective state income tax rate. Note 8. Financial Services Short-Term Notes Payable On May 21, 1999, the Company renewed its three year bank credit facility which provides up to $200 million for mortgage warehouse funding and will mature on May 20, 2002. Note 9. Long-Term Debt On October 20, 1999, the Company increased its unsecured revolving credit facility from $300 million to $375 million. This new facility will mature in October 2003. At September 30, 1999, the Company had $58.5 million of borrowings under the credit agreement. 8 Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS CONSOLIDATED For the third quarter of 1999, the Company reported consolidated net earnings from operations of $18.1 million, or $1.21 per share ($1.15 per share diluted). This compared with consolidated net earnings before extraordinary item of $12.5 million, or $.84 per share ($.81 per share diluted) for the third quarter 1998. The increase of $5.6 million, or $.37 per share, was driven by increased homebuilding closing volume, higher gross margins, and improved performance by the financial services segment. Consolidated net earnings for the first nine months of 1999 were $45.9 million, or $3.05 per share ($2.92 per share diluted), compared with consolidated net earnings before extraordinary item of $26.0 million, or $1.72 per share ($1.67 per share diluted), for the first nine months of 1998. The homebuilding segment reported pretax earnings of $35.4 million for the third quarter of 1999, a $10.3 million increase over the $25.1 million reported for the third quarter 1998. Homebuilding results in the third quarter increased over last year primarily due to improvement in gross profit margins, record closings, and lower interest expense. For the first nine months the homebuilding segment reported pretax earnings of $84.1 million, compared to the $45.8 million reported for the first nine months of 1998. Pretax homebuilding margins reached 7.1 percent in the third quarter of 1999 versus 5.6 percent for the third quarter of 1998. The financial services segment reported operating pretax earnings of $2.1 million for the third quarter of 1999 compared with $1.5 million for the same period in 1998. The financial services segment reported pretax earnings from operations of $7.4 million for the first nine months of 1999 compared with $4.0 million for the same period last year. The $4.0 million excludes a $6.1 million gain on the bulk sale of servicing rights. Including that gain, pretax earnings for the first nine months of 1998 were $10.1 million. Corporate expenses represent the cost of corporate functions, which support the business segments. Corporate expenses of $7.8 million for the third quarter of 1999, were up $3.4 million from the prior year levels, primarily resulting from a $2.8 million non-recurring charge relating to the relocation of the corporate offices to California. The Company's limited-purpose subsidiaries no longer issue mortgage-backed securities and mortgage-participation securities, but they continue to hold collateral for previously issued mortgage-backed bonds in which the Company maintains a residual interest. Revenues, expenses, and portfolio balances continue to decline as the mortgage collateral pledged to secure the bonds decreases due to scheduled payments, prepayments and exercises of early redemption provisions. Revenues have approximated expenses for the last three years. 9 HOMEBUILDING SEGMENT Results of operations from the homebuilding segment are summarized as follows ($ amounts in thousands, except average closing price): Three months ended Nine months ended September 30, September 30, 1999 1998 1999 1998 ---- ---- ---- ---- Revenues: Residential $ 494,283 $ 440,724 $1,360,286 $1,144,612 Other 1,583 6,856 16,203 24,075 ---------- ---------- ---------- ---------- Total 495,866 447,580 1,376,489 1,168,687 Gross profit 83,958 72,367 228,377 176,666 Selling, general and administrative expenses 45,757 42,697 135,466 116,366 Interest expense 2,757 4,537 8,814 14,526 ---------- ---------- ---------- ---------- Homebuilding pretax earnings $ 35,444 $ 25,133 $ 84,097 $ 45,774 ========== ========== ========== ========== Operational unit data: New orders (units) 2,250 2,183 8,171 7,284 Closings (units) 2,624 2,361 7,227 6,265 Outstanding contracts at September 30: Units 4,396 3,831 Dollar value $ 841,887 $ 738,252 Average closing price $ 188,000 $ 187,000 $ 188,000 $ 183,000 Homebuilding revenues increased 10.8 percent for the third quarter of 1999, compared with the same period last year, due to an 11.1 percent increase in closings (2,624 homes closed compared with 2,361 homes closed in the third quarter of 1998). For the nine months ended September 30, 1999, homebuilding revenues increased 17.8 percent, compared with the nine months ended September 30, 1998. Gross profit margins from home sales averaged 17.1 percent for the third quarter of 1999, an 80 basis point increase from the 16.3 percent for the third quarter of 1998. The improvement was primarily due to the Company's strategic initiatives and the strong market condition. Gross profit margins from home sales for the first nine months of 1999 averaged 16.7 percent versus 15.3 percent for the same period last year. New orders increased 3.1 percent from the third quarter of last year to 2,250 homes, the highest third quarter sales in the Company's history, on fewer active communities compared to third quarter of 1998. At 8,171, new orders for the first nine months of 1999 were up 12.2 percent from the first nine months of 1998. Outstanding contracts as of September 30, 1999 were 4,396 compared with 3,831 at September 30, 1998 and 3,452 at December 31, 1998. 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 value of outstanding contracts at September 30, 1999 was $841.9 million, an increase of 14.0 percent from September 30, 1998 and an increase of 28.9 percent from December 31, 1998. 10 Selling, general and administrative expenses as a percentage of revenues were 9.2 and 9.8 percent for the third quarter and first nine months of 1999, respectively, which are slightly lower than the levels in the third quarter and first nine months of 1998. Interest expense for the third quarter and first nine months of 1999 decreased by $1.8 million and $5.7 million, respectively, compared with the same periods of 1998. The decrease was due to a lower cost of funds and an increase in capitalized interest due to land development activity. FINANCIAL SERVICES Results of operations of the Company's financial services segment are summarized as follows (amounts in thousands): Three months Nine months ended September 30, ended September 30, 1999 1998 1999 1998 ---- ---- ---- ---- Retail revenues: Interest and net origination fees $ 1,546 $ 1,554 $ 4,696 $ 5,776 Net gains on sales of mortgages and servicing rights 3,115 4,438 11,701 17,343 Loan servicing 377 702 1,392 7,249 Title/escrow 2,140 2,100 6,138 6,242 ------- ------- ------- ------- Total retail revenue 7,178 8,794 23,927 36,610 Revenue from investment operations 2,328 3,465 7,310 10,813 ------- ------- ------- ------- Total revenues $ 9,506 $12,259 $31,237 $47,423 Expenses: General and administrative 4,832 7,041 16,443 24,825 Interest 2,551 3,661 7,376 12,460 ------- ------- ------- ------- Total expenses 7,383 10,702 23,819 37,285 Pretax earnings $ 2,123 $ 1,557 $ 7,418 $10,138 ======= ======= ======= ======= Pretax earnings by line of business were as follows (amounts in thousands): Three months Nine months ended September 30, ended September 30, 1999 1998 1999 1998 ---- ---- ---- ---- Retail $ 1,401 $ 534 $ 5,356 $ 7,092 Investments 722 1,023 2,062 3,046 ------- ------- ------- ------- Total $ 2,123 $ 1,557 $ 7,418 $10,138 ======= ======= ======= ======= 11 OPERATIONAL DATA: Three months Nine months ended September 30, ended September 30, 1999 1998 1999 1998 ---- ---- ---- ---- Retail operations: Originations 1,803 2,110 5,218 6,032 Percent of Ryland Homes closings 89% 75% 86% 67% Ryland Homes capture rate 67% 71% 69% 68% Investment operations: Portfolio average balance (in millions) $ 89 $ 135 $ 97 $ 143 Revenues and general and administrative expenses for the financial services segment decreased for the three and nine month period ended September 30, 1999, compared with the same period of 1998. The decreases were primarily due to the decline in the loan servicing operations related to the sale of a majority of the loan servicing portfolio in the first quarter of 1998, and overhead reduction initiatives. Interest expense decreased 30 percent and 41 percent for the three and nine months ended September 30, 1999, respectively, compared with 1998, due to a decrease in the warehouse-holding period for mortgage loans before they were sold in the secondary market and a lower investment portfolio balance. Retail operations include residential mortgage origination, loan servicing, and title, escrow and homeowners insurance services for retail customers. Retail operations reported pretax earnings of $1.4 million for the third quarter of 1999 compared with $.5 million for the same period last year. For the first nine months of 1999, retail operations reported $5.4 million versus $7.1 million for the first nine months of 1998. 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. Mortgage origination volume decreased by 14.5 and 13.5 percent for the three and nine-month period ended September 30, 1999, respectfully, compared with the same period last year primarily due to a decrease in third party origiations, partially offset by higher closing volume from homebuilder 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 $.7 million for the third quarter compared with $1.0 million in the prior year. For the first nine months of 1999, investment earnings were $2.1 million versus $3.0 million for the same period last year. The decrease was primarily due to a lower average portfolio balance, which resulted in a decline in interest and other income. 12 YEAR 2000 The Company's Year 2000 remediation efforts have focused on its key business computer applications representing those systems that the Company is dependent upon for the conduct of 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 September 1999, the Company believes that its key homebuilding and financial services business systems are Year 2000 compliant. All necesary replacements and upgrades have been completed. Some implementation and testing procedures were completed in 1998 and the remainder are scheduled for completion in 1999. The costs of achieving Year 2000 compliance incurred since 1997 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 concluding their 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 will have a material adverse effect on its financial results or 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. 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 current requirements. The homebuilding segment borrowings include senior notes, senior subordinated notes, an unsecured revolving credit facility, and nonrecourse secured notes payable. Senior and senior subordinated notes outstanding totaled $308 million as of September 30, 1999 and December 31, 1998. The Company uses its unsecured revolving credit facility to finance increases in its homebuilding inventory and working capital. On October 20, 1999, the Company increased its bank revolving credit agreement from $300 million to $375 million. This new facility will mature in October 2003. There were $58.5 million in outstanding borrowings under this facility as of September 30, 1999 and no outstanding borrowings at December 31, 1998. The Company had letters of credit outstanding under this facility totaling $35 million at September 30, 1999 and $34 million at December 31, 1998. To finance land purchases, the Company may also use seller-financed, non-recourse secured notes payable. At September 30, 1999, such notes payable outstanding amounted to $1.4 million compared with no outstanding notes payable at December 31, 1998. 13 Housing inventories increased to $783 million as of September 30, 1999, from $642 million as of December 31, 1998. The increase primarily reflects higher sold inventory related to the significant increase in backlog. The increase in inventory was funded with internally generated funds and borrowing under the revolving credit facility. The financial services segment uses cash generated from operations and borrowing arrangements to finance its operations. The financial services segment renewed its three-year bank credit facility, which provides up to $200 million for mortgage warehouse funding and will mature on May 20, 2002. Other borrowing arrangements as of September 30, 1999 included repurchase agreement facilities aggregating $370 million, and a $100 million revolving credit facility used to finance investment portfolio securities. At September 30, 1999 and December 31, 1998, the combined borrowings of the financial services segment outstanding under all agreements were $206 million and $223 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 limited-purpose subsidiaries. As of December 31, 1998, the Company had Board authorization to repurchase up to 958,400 shares of its common stock. As of November 3, 1999, pursuant to this Board authorization, the Company repurchased approximately 765,100 shares of its outstanding common stock at a cost of approximately $17.7 million. The Company's repurchase program has been funded through internally generated funds. Note: Certain statements in Management's Discussion and Analysis of Financial Condition and results of operations 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 risks and uncertainties, such as the costs of Year 2000 compliance, 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, the availability and increases in raw material and labor costs, consumer confidence, government regulation, and general competitive factors, all or each of which may cause actual results to differ materially. 14 Item 3. Quantitative and Qualitative Disclosures About Market Risk During the nine months ended September 30, 1999, the Company's decrease in third party originations has lead to a reduction in the amount of mortgage loans held-for-sale to a fair value of $66 million as of September 30, 1999 and as a result, the Company reduced the amount of outstanding forward delivery contracts by $49 million. There have been no other material changes in the Company's market risk from December 31, 1998. For information regarding the Company's market risk, refer to Form 10-K for the fiscal year ended December 31, 1998 of The Ryland Group, Inc. 15 PART II. OTHER INFORMATION Item 1. Legal Proceedings The Company is party to various 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 overall financial position of the Company. Page Number ----------- Item 6. Exhibits and Reports on Form 8-K A. Exhibits 10.5 Restated Credit Agreement dated as of October 19, 1999 19-173 Between, The Ryland Group, Inc. and Certain Banks. (filed herewith) 11 Earnings Per Share (filed herewith) 174 27 Financial Data Schedule (filed herewith) 175 B. Reports on Form 8-K. No reports on Form 8-K were filed during the third quarter of 1999. 16 SIGNATURES Pursuant to the requirements 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. Registrant November 12, 1999 By: /S/ Timothy J. Geckle ----------------- --------------------- Date Timothy J. Geckle Senior Vice President General Counsel and Secretary November 12, 1999 By: /S/ David L. Fristoe ----------------- -------------------- Date David L. Fristoe, Vice President and Corporate Controller (Principal Accounting Officer) 17 INDEX OF EXHIBITS A. Exhibits Page of Sequentially Exhibit No. numbered pages 10.5 Restated Credit Agreement dated as of October 19, 1999, 19-173 Between The Ryland Group, Inc. and Certain Banks. (filed herewith) 11 Earnings Per Share (filed herewith) 174 27 Financial Data Schedule (filed herewith 175 18