10-Q 1 l90799ae10-q.txt DOMINION HOMES, INC. FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (MARK ONE) ( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended September 30, 2001 ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Transition Period From ______ To ______ 0-23270 Commission File Number DOMINION HOMES, INC. ------------------------------------------------------- (Exact name of registrant as specified in its charter) Ohio 31-1393233 ------------------------------- ------------------ (State or other jurisdiction of (I.R.S. Employer incorporation of organization) Identification No.) 5501 Frantz Road, Dublin, Ohio ------------------------------ (Address of principal executive offices) 43017-0766 ---------- (Zip Code) (614) 761-6000 -------------- (Registrant's Telephone Number, Including Area Code) Not Applicable -------------- (Former Name, Former Address and Formal Fiscal Year, if Changed Since Last Report) 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 --- --- Number of common shares outstanding as of November 12, 2001: 6,407,907 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS DOMINION HOMES, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE INFORMATION)
September 30, December 31, 2001 2000 (Unaudited) ------------- ------------- ASSETS Cash and cash equivalents $ 3,303 $ 2,106 Notes and accounts receivable, net: Trade 301 314 Due from financial institutions for residential closings 305 712 Real estate inventories: Land and land development costs 122,036 113,186 Homes under construction 98,439 66,669 Other 4,708 4,619 --------- --------- Total real estate inventories 225,183 184,474 --------- --------- Prepaid expenses and other 4,047 4,639 Deferred income taxes 4,473 2,967 Property and equipment, at cost 12,005 10,657 Less accumulated depreciation (5,808) (4,676) --------- --------- Net property and equipment 6,197 5,981 --------- --------- Total assets $ 243,809 $ 201,193 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Accounts payable, trade $ 9,485 $ 5,808 Deposits on homes under contract 2,632 1,804 Accrued liabilities 25,495 16,889 Note payable, banks 125,163 105,701 Term debt 5,025 3,103 --------- --------- Total liabilities 167,800 133,305 --------- --------- Commitments and contingencies Shareholders' equity Common shares, without stated value, 12,000,000 shares authorized, 6,432,907 shares issued and 6,407,907 shares outstanding on September 30, 2001 and 6,407,227 shares issued and 6,382,227 shares outstanding on December 31, 2000 31,850 31,611 Deferred compensation (520) (376) Retained earnings 46,743 36,825 Accumulated other comprehensive loss (1,892) Treasury stock (172) (172) --------- --------- Total shareholders' equity 76,009 67,888 --------- --------- Total liabilities and shareholders' equity $ 243,809 $ 201,193 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 2 DOMINION HOMES, INC. CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT SHARE INFORMATION) (UNAUDITED)
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 ---------- ---------- --------- -------- Revenues $ 121,053 $ 87,547 $ 279,064 $ 226,257 Cost of real estate sold 92,712 69,575 214,925 180,983 ---------- ---------- ---------- ---------- Gross profit 28,341 17,972 64,139 45,274 Selling, general and administrative 14,940 9,917 38,479 28,637 ---------- ---------- ---------- ---------- Income from operations 13,401 8,055 25,660 16,637 Interest expense 2,970 2,620 8,266 6,354 ---------- ---------- ---------- ---------- Income before income taxes 10,431 5,435 17,394 10,283 Provision for income taxes 4,550 2,283 7,476 4,302 ---------- ---------- ---------- ---------- Net income $ 5,881 $ 3,152 $ 9,918 $ 5,981 ========== ========== ========== ========== Earnings per share Basic $ 0.93 $ 0.50 $ 1.56 $ 0.94 ========== ========== ========== ========== Diluted $ 0.89 $ 0.48 $ 1.51 $ 0.92 ========== ========== ========== ========== Weighted average shares outstanding Basic 6,349,924 6,364,105 6,352,357 6,364,527 ========== ========== ========== ========== Diluted 6,585,335 6,501,552 6,568,799 6,484,667 ========== ========== ========== ==========
The accompanying notes are an integral part of the consolidated financial statements 3 DOMINION HOMES, INC. CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY (IN THOUSANDS, EXCEPT SHARE AMOUNTS) (UNAUDITED)
Deferred Compensation Accum. Other Common Trust Retained Comprehensive Treasury Shares Liability Shares Earnings Income (Loss) Stock Total ---------------------------------------------------------------------------------------------------------------------------------- Balance, December 31, 2000 $31,611 $928 $(1,304) $36,825 $(172) $67,888 Cummulative effect of adopting accounting principle $ 94 94 ---------------------------------------------------------------------------------------- Balance, January 1, 2001 as adjusted 31,611 928 (1,304) 36,825 94 (172) 67,982 Net income 9,918 9,918 Unrealized hedging loss, net of deferred taxes (1,986) (1,986) ----------- Comprehensive income 7,932 ----------- Shares awarded and redeemed 239 (308) (69) Shares distributed from trust for deferred compensation (142) 142 -- Deferred compensation 164 164 ---------------------------------------------------------------------------------------------------------------------------------- Balance, September 30, 2001 $31,850 $642 $(1,162) $46,743 $(1,892) $(172) $76,009 ==================================================================================================================================
The accompanying notes are an integral part of the consolidated financial statements. 4 DOMINION HOMES, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
Nine Months Ended September 30, 2001 2000 ----------- ----------- Cash flows from operating activities: Net income $ 9,918 $ 5,981 Adjustments to reconcile net income to cash (used in) operating activities: Depreciation and amortization 1,647 1,461 Issuance of common shares for compensation 51 Write down of real estate inventories 376 Deferred income taxes (79) (144) Changes in assets and liabilities: Notes and accounts receivable 420 (256) Real estate inventories (36,959) (32,630) Prepaid expenses and other 373 (2,818) Accounts payable 3,677 2,293 Deposits on homes under contract 828 677 Accrued liabilities 5,424 4,961 --------- --------- Net cash used in operating activities (14,751) (20,048) --------- --------- Cash flows from investing activities: Proceeds from sale of property and equipment 38 38 Purchase of property and equipment (1,188) (1,537) --------- --------- Net cash used in investing activities (1,150) (1,499) --------- --------- Cash flows from financing activities: Proceeds from note payable, banks 260,205 218,700 Payments on note payable, banks (240,743) (197,340) Prepaid loan fees (271) (369) Payments on term debt (1,817) (1,572) Payments on capital lease obligations (207) (293) Common shares purchased or redeemed (69) (154) --------- --------- Net cash provided by financing activities 17,098 18,972 --------- --------- Net change in cash and cash equivalents 1,197 (2,575) Cash and cash equivalents, beginning of period 2,106 2,862 --------- --------- Cash and cash equivalents, end of period $ 3,303 $ 287 ========= ========= Supplemental disclosures of cash flow information: Interest paid (net of amounts capitalized) $ 2,545 $ 756 ========= ========= Income taxes paid $ 8,159 $ 5,448 ========= ========= Land acquired by seller financing $ 3,750 $ 321 ========= =========
The accompanying notes are an integral part of the consolidated financial statements. 5 DOMINION HOMES, INC. NOTES TO THE FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying unaudited financial statements for Dominion Homes, Inc. ("the Company"), have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. The December 31, 2000 balance sheet data were derived from audited financial statements but do not include all disclosures required by accounting principles generally accepted in the United States of America. These financial statements should be read in conjunction with the December 31, 2000 audited annual financial statements of the Dominion Homes, Inc. (the "Company") contained in its December 31, 2000 Form 10-K. The financial information included herein reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the results for interim periods. The results of operations for the three months and nine months ended September 30, 2001 are not necessarily indicative of the results to be expected for the full year. 2. CAPITALIZED INTEREST Interest is capitalized on land during the development period and on housing construction costs during the construction period. As a lot is transferred to homes under construction, the interest capitalized on the lot during the land development period is included as a cost of the land. Capitalized interest related to land under development and housing construction costs are included in interest expense in the period in which the home is closed. Capitalized interest related to land under development and construction in progress was $4.6 million at both September 30, 2001 and September 30, 2000. The following table summarizes the activity with respect to capitalized interest:
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 ----------- ------------ ------------- ------------- Interest incurred $2,697,000 $2,877,000 $8,182,000 $ 7,640,000 Interest capitalized (1,691,000) (1,971,000) (5,154,000) (5,156,000) ----------- ----------- ---------- ------------ Interest expensed directly 1,006,000 906,000 3,028,000 2,484,000 Previously capitalized interest charged to interest expense 1,964,000 1,714,000 5,238,000 3,870,000 ---------- ---------- ---------- ----------- Total interest expense $2,970,000 $2,620,000 $8,266,000 $ 6,354,000 ========== ========== ========== =============
6 3. NOTE PAYABLE, BANKS On May 23, 2001 the Company increased its Senior Unsecured Revolving Credit Facility ("the Facility") to $175 million from $150 million and modified certain Facility covenants. The Facility covenants were modified to eliminate a reduction in the uncommitted land to tangible net worth ratio that was scheduled to go into effect January 1, 2002 and to eliminate a restriction on the amount of investment the Company was allowed to make in Louisville, Kentucky. On October 9, 2001, the Company further modified the Facility to allow creation of a risk retention entity and to be part of qualified joint ventures on a limited basis. The original Facility was executed on May 29, 1998 and is described in the Company's Form 10-K for the year ended December 31, 2000. The Facility provides for a variable rate of interest on borrowings. In order to reduce exposure to increasing interest rates, the Company has entered into interest rate swap contracts ("Contracts") that fix the interest rate on $70 million of borrowings under the Facility. The related fair value of these Contracts at September 30, 2001 was a loss of approximately $3.3 million. The Contracts mature between May 6, 2003 and January 12, 2005 and fix the interest rates between 4.54% and 5.98%, plus a variable margin based on the Company's interest coverage ratio. The variable margin ranges from 1.75% to 2.50% and is determined quarterly. As of September 30, 2001, the Company was in compliance with the Facility covenants and had $30.5 million of borrowing capacity available under its Facility, after adjusting for borrowing base limitations. Borrowing availability under the Facility could increase, depending on the Company's utilization of the proceeds. 4. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES The Company's interest rate risk management strategy uses derivative instruments to minimize earnings fluctuations caused by interest rate volatility associated with the Company's variable rate debt. The derivative financial instruments used to meet the Company's risk management objectives are the Contracts described above under "Note Payable, Banks". The Company seeks to maintain the notional amount of the Contracts at approximately 50% of its outstanding debt. Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS No. 138, an amendment to SFAS No. 133, which established new accounting and reporting guidelines for derivative instruments and hedging activities. SFAS No. 133 and SFAS No. 138 are collectively referred to herein as "SFAS 133." In adopting SFAS 133, the Company has designated its Contracts as cash flow hedges. The after tax fair value of these Contracts at the date of adoption was $94,000. The fair value of these Contracts at the date of adoption of SFAS 133 together with changes in their fair value in subsequent periods are recognized in other comprehensive income or loss until such time as the contracts mature or are terminated. Other comprehensive income or loss is reflected as a component of shareholders' equity in the accompanying balance sheets. The fair value of the Contracts is principally impacted by fluctuations in interest rates, which declined significantly during the nine months ended September 30, 2001. This decline in interest rates led to an unrealized after tax loss on the Contracts of approximately $2.0 million. The Company recognized this $2.0 million loss and a corresponding pre-tax accrued liability of $3.3 million in its September 30, 2001 financial statements. Future fluctuations in interest rates will cause unrealized gains or losses to occur and such amounts will be adjusted through other comprehensive income or loss as long as the effectiveness of the hedge is maintained. 7 The Company formally documents relationships between hedging instruments and hedged items, as well as its risk management objectives and strategies for undertaking the hedging transactions. An assessment is made at the hedging transaction's inception and on an ongoing basis to determine whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. The Company believes the Contracts have been highly effective in achieving the risk management objectives for which they were intended since inception and will continue to be effective for the remaining term of the Contracts. Hedge effectiveness is measured at least quarterly based on the relative change in fair value between the Contracts and the hedged item over time. Any change in fair value resulting from ineffectiveness, as defined by SFAS 133, is recognized immediately in earnings. For the three and nine months ending September 30, 2001, no gain or loss has been recognized in earnings as no amount of the cash flow hedges have been determined to be ineffective. Should it be determined that a Contract is not highly effective or that it has ceased to be a highly effective hedge, the Company will discontinue hedge accounting prospectively. This will occur when (1) offsetting changes in the fair value or cash flows of the hedged items are no longer effective; (2) the derivative expires or is sold, terminated, or exercised; or (3) management determines that designation of the Contract as a hedged instrument is no longer appropriate. When hedge accounting is discontinued because a Contract qualifying as a cash flow hedge is liquidated or sold prior to maturity, the gain or loss on the Contract at the time of termination remains in accumulated other comprehensive income or loss and is recognized as an adjustment to interest expense over the original contract term. In all other situations in which hedge accounting is discontinued, the derivative will be carried at its fair value on the balance sheet, with changes in its fair value recognized in current earnings. 5. EARNINGS PER SHARE A reconciliation of the weighted average shares used in basic and diluted earnings per share is as follows:
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 --------- --------- --------- --------- Weighted average shares outstanding during the period 6,349,924 6,364,105 6,352,357 6,364,527 Assuming exercise of options 235,411 137,447 216,442 120,140 --------- --------- --------- --------- Weighted average shares outstanding adjusted for common share equivalents 6,585,335 6,501,552 6,568,799 6,484,667 ========= ========= ========= =========
8 6. LEGAL PROCEEDINGS The Company is involved in various legal proceedings, most of which arise in the ordinary course of business and some of which are covered by insurance. In the opinion of the Company's management, none of the claims relating to such proceedings will have a material adverse effect on the financial condition or results of operations of the Company. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Net income for the three months ended September 30, 2001 increased 86.6% to $5.9 million, or $.89 per diluted share, from $3.2 million, or $.48 per diluted share, during the same period a year ago. The increase in net income was largely due to a 38.3% increase in revenues and a 57.7% increase in gross profit. Revenues for third quarter 2001 increased to $121.1 million over third quarter 2000 revenues of $87.5 million, a $33.6 million increase. The increase in revenues was principally due to a larger number, and a higher average sales price, of homes that closed during third quarter 2001. During third quarter 2001, the Company closed 631 homes with an average sales price of $188,000, compared to closing 482 homes with an average sales price of $181,400 during third quarter 2000. Gross profit improved principally due to the larger number of homes that were closed, the higher average sales price of those homes, higher mortgage placement revenues, lower customer financing costs paid by the Company due to declining mortgage rates and improved control of construction costs. Selling, general and administrative expense during third quarter 2001 increased to $14.9 million, or 12.3% of sales, from $9.9 million, or 11.3% of sales, during third quarter 2000. Selling, general and administrative expense increased principally due to the selling expenses associated with selling a larger number of homes and more expensive homes and the added general and administrative expenses of the Company's new mortgage financing services subsidiary. Interest expense increased to $3.0 million, or 2.5% of sales, during third quarter 2001 from $2.6 million, or 3.0% of sales, during third quarter 2000 due to a higher average level of debt outstanding, offset by a lower average rate of interest. The Company incurred higher levels of debt principally to fund a larger backlog of more expensive homes under construction. The Company sold 484 homes, with a sales value of $89.7 million, during the three months ended September 30, 2001, compared to 353 homes, with a sales value of $67.6 million, sold during the same period the previous year. The aggregate sales value of the Company's homes in backlog at September 30, 2001 increased to $214.7 million from $174.0 million at September 30, 2000. The Company had 1,112 homes in backlog with an average selling price of $193,100 at September 30, 2001, compared to 887 homes in backlog with an average selling price of $196,200 at September 30, 2000. The average sales price of the homes in backlog at September 30, 2001 decreased due the introduction during late 2000 of a more affordable series of homes, the Independence series, which have sales prices as low as $100,000. COMPANY OUTLOOK The Company expects its fourth quarter 2001 earnings to exceed its previous year's fourth quarter earnings. However during 2001 the Company successfully reduced its overall building times, which allowed the Company to close some homes in earlier quarters than it ordinarily would have closed them. Since the Company is closing homes sooner and has a very high third quarter comparison of 631 closings, the Company does not expect, unlike in previous years, to close more homes during the fourth quarter of 2001 than in any of the previous three quarters. 9 The Company is well positioned for future periods with affordable homes and attractive mortgage offerings. However, if unemployment rates increase substantially or consumer confidence continues to erode, the Company's financial results will be unfavorably impacted and the Company will react accordingly. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION ACT OF 1995 The statements contained in this report under the captions "Company Outlook" and other provisions of this report which are not historical facts are "forward looking statements" that involve various important risks, uncertainties and other factors which could cause the Company's actual results for 2001 and beyond to differ materially from those expressed in such forward looking statements. These important factors include, without limitation, the following risks and uncertainties: real or perceived adverse economic conditions, an increase in mortgage interest rates, changes in mortgage finance programs, increases in the cost of acquiring and developing land, mortgage commitments that expire prior to homes being delivered, entry into the mortgage financing services business, the Company's ability to install public improvements or build and close homes on a timely basis due to adverse weather conditions, delays or adverse decisions in the zoning, permitting subdivision platting or inspection processes, adverse decisions or changes in requirements by environmental agencies, the effect of changing consumer tastes on the market acceptance for the Company's products, the impact of competitive products and pricing, the effect of shortages or increases in the costs of materials, subcontractors, labor and financing, the continued availability of credit on favorable terms, the commencement or outcome of litigation, the impact of changes in government regulation, and the other risks described in the Company's December 31, 2000 Form 10-K. SEASONALITY AND VARIABILITY IN QUARTERLY RESULTS The Company has experienced, and expects to continue to experience, significant seasonality and quarter-to-quarter variability in homebuilding activity levels. Typically, closings and related revenues increase in the second half of the year. The Company believes that this seasonality reflects the tendency of homebuyers to shop for a new home in the Spring with the goal of closing in the Fall or Winter. Weather conditions can also accelerate or delay the scheduling of closings. The Company attempts to mitigate these seasonal variations whenever possible. The following table sets forth certain data for each of the last eight quarters:
THREE SALES BACKLOG MONTHS REVENUES CONTRACTS (1) CLOSINGS (AT PERIOD END) ENDED (IN THOUSANDS) (IN UNITS) (IN UNITS) (IN UNITS) ======================================================================================================= Dec. 31, 1999 $ 78,941 411 446 790 Mar. 31, 2000 $ 62,218 608 359 1,039 June 30, 2000 $ 76,492 420 443 1,016 Sept. 30, 2000 $ 87,547 353 482 887 Dec. 31, 2000 $100,158 404 514 777 Mar. 31, 2001 $ 67,362 706 347 1,136 June 30, 2001 $ 90,649 589 466 1,259 Sept. 30, 2001 $121,053 484 631 1,112
----------------------------- (1) Net of cancellations 10 At September 30, 2001, the aggregate sales value of homes in backlog was $214.7 million compared to $174.0 million at September 30, 2000. The average sales value of homes in backlog at September 30, 2001 decreased to $193,100 from $196,200 at September 30, 2000 due to the more affordable Independence series of homes that the Company introduced in 2000 and began closing in 2001. The Company annually incurs a substantial amount of indirect construction costs, which are essentially fixed in nature. For purposes of financial reporting, the Company capitalizes these costs to real estate inventories on the basis of the ratio of estimated annual indirect costs to direct construction costs to be incurred. Thus, variations in construction activity cause fluctuations in interim and annual gross profits. RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain items from the statements of income expressed as percentages of total revenues:
Three Months Ended Nine Months Ended September 30, September 30, 2001 2000 2001 2000 ----------- ---------- ----------- -------- Revenues 100.0% 100.0% 100.0% 100.0% Cost of real estate sold 76.6 79.5 77.0 80.0 ----- ----- ----- ----- Gross profit 23.4 20.5 23.0 20.0 Selling, general and administrative expenses 12.3 11.3 13.8 12.7 ----- ----- ----- ----- Income from operations 11.1 9.2 9.2 7.3 Interest expense 2.5 3.0 3.0 2.8 ----- ----- ----- ----- Income before income taxes 8.6 6.2 6.2 4.5 Provision for income taxes 3.7 2.6 2.7 1.9 ----- ----- ----- ----- Net income 4.9% 3.6% 3.5% 2.6 % ===== ===== ===== =====
11 THREE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2000 REVENUES. Revenues for third quarter 2001 increased 38.3% to $121.1 million, based on 631 closings, from $87.5 million, based on 482 closings, for third quarter 2000. The increase in revenues is attributable to an increase in the number of homes closed, an increase in the average price of the homes that closed and increased revenues from the Company's mortgage financing services company. The average price of homes that closed during third quarter 2001 increased to $188,000 from $181,400 during third quarter 2000. Included in revenues were other revenues of $2.5 million, principally from the Company's mortgage financing services operations GROSS PROFIT. Gross profit for third quarter 2001 increased 57.7% to $28.3 million from $18.0 million for third quarter 2000. As a percentage of revenues, gross profit increased to 23.4% for third quarter 2001 from 20.5% for third quarter 2000. The principal reasons for the increase in third quarter 2001 gross profit were the larger number of homes closed, the higher average sale price of those homes, higher mortgage placement revenues, lower customer financing costs paid by the Company due to declining mortgage rates and improved control of construction costs. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses for third quarter 2001 increased to $14.9 million from $9.9 million for third quarter 2000. As a percentage of revenues, selling, general and administrative expenses increased to 12.3% from 11.3%. The increase in selling, general and administrative expenses is a result of higher sales commissions associated with the sale of more homes and more expensive homes, the added general and administrative expenses of the Company's new mortgage financing services subsidiary and other variable costs related to the higher closing volume. INTEREST EXPENSE. Interest expense for third quarter 2001 was $3.0 million compared to $2.6 million for third quarter 2000. As a percentage of revenues, interest expense for third quarter 2001 decreased to 2.5% from 3.0% for third quarter 2000. Interest expense was slightly higher for third quarter 2001 than third quarter 2000 because of higher borrowing levels incurred during third quarter 2001 than 2000. The higher borrowing levels during third quarter 2001 were substantially offset by a lower weighted average interest rate during the same period. The average revolving line of credit borrowings were $131.2 million and $115.0 million for third quarter 2001 and 2000, respectively. The weighted average rate of interest under the Company's revolving line of credit was 7.8% for third quarter 2001 compared to 9.4% for third quarter 2000. PROVISION FOR INCOME TAXES. Income tax expense for third quarter 2001 was $4.6 million compared to $2.3 million for third quarter 2000. The Company's estimated annual effective tax rate was 43.6% for third quarter 2001 and 42.0% for third quarter 2000. The increase resulted from certain expected costs not being deductible for tax purposes. 12 NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2000 REVENUES. Revenues for the nine months ended September 30, 2001 increased 23.3% to $279.1 million, based on 1,444 closings, from $226.3 million, based on 1,284 closings, for the nine months ended September 30, 2000. Closings for the nine months ended September 30, 2001 included eight model homes with a sales value of $1.4 million compared to nineteen model homes with a sales value of $3.2 million closed during the first nine months of 2000. The increase in revenues is attributable to an increase in the number of homes closed, an increase in the average price of homes closed and increased revenues from the Company's new mortgage financing services company. The average price of homes closed during 2001 increased to $190,100 from $175,900 during the same period in 2000. Included in revenues were other revenues of $4.5 million, principally from the Company's mortgage financing services operations. GROSS PROFIT. Gross profit for the first nine months of 2001 increased 41.7% to $64.1 million from $45.3 million for the first nine months of 2000. Gross profit as a percentage of revenues increased to 23.0% during 2001 compared to 20.0% during the same period the previous year. The principal reasons for the increase in the 2001 gross profit were the larger number of homes closed, the higher average sale price of those homes, higher mortgage placement revenues, lower customer financing costs paid by the Company due to declining mortgage rates and better control of construction costs. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses for the first nine months of 2001 increased to $38.5 million from $28.6 million for the first nine months of 2000. As a percentage of revenues, selling, general and administrative expenses for the first nine months of 2001 increased to 13.8% from 12.7% for the first nine months of 2000. The increase in selling, general and administrative expenses is a result of higher sales commissions associated with the sale of more homes and more expensive homes, the added general and administrative expenses of the Company's new mortgage financing services subsidiary and other variable costs related to the higher closing volume. INTEREST EXPENSE. Interest expense for the first nine months of 2001 increased to $8.3 million from $6.4 million for the first nine months of 2000. As a percentage of revenues, interest expense for the first nine months of 2001 increased to 3.0% from 2.8% for the first nine months of 2000. Interest expense for the first nine months of 2001 was higher than the previous year's because of higher average borrowing levels during the first nine months of 2001 compared to 2000. These higher average borrowing levels were offset by a lower weighted average rate of interest during 2001. The average revolving line of credit borrowings outstanding were $126.4 million and $109.1 million for the first nine months of 2001 and 2000, respectively. The weighted average rate of interest under the Company's revolving line of credit was 8.3% for the first nine months of 2001 compared to 9.0% for the first nine months of 2000 PROVISION FOR INCOME TAXES. Income tax expense for the first nine months of 2001 increased to $7.5 million from $4.3 million for the first nine months of 2000. The Company's estimated annual effective tax rate was 43.0% for the first nine months of 2001 and 41.8% for the first nine months of 2000. The increase resulted from certain expected costs not being deductible for tax purposes. 13 SOURCES AND USES OF CASH NINE MONTHS ENDED SEPTEMBER 30, 2001 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2000 The Company invested $14.8 million in operating activities during the first nine months 2001 compared to $20.0 million during the first nine months of 2000, a $5.2 million decrease. The Company increased its investment in real estate inventories $37.0 million during 2001 compared to $32.6 million during 2000. However, the increase in real estate inventories was substantially offset by increased net income of $9.9 million during 2001 compared to $6.0 million during 2000. Of the $37.0 million of new investments in real estate inventories during 2001, $31.8 million was invested in homes under construction, $5.1 million in land and land development costs and $89,000 in building material inventories. During the first nine months of 2000, the Company invested $19.0 million in homes under construction, $12.5 million in land and land development costs and $1.1 million in building material inventories. Net cash used to purchase property and equipment during the first nine months of 2001 was $1.2 million compared to $1.5 million during the first nine months of 2000. The Company used additional financing of $17.1 million, principally proceeds from its bank facility, during the first nine months of 2001 compared to $19.0 million during the first nine months of 2000. REAL ESTATE INVENTORIES The Company's practice is to develop most of the lots on which it builds homes. Generally, the Company attempts to maintain a land inventory that will be sufficient to meet its anticipated lot needs for the next three to five years. At September 30, 2001, the Company either owned or was under contract to purchase lots or land that could be developed into approximately 7,900 lots, including 650 lots in Louisville, Kentucky. The Company controlled through option agreements approximately 7,100 additional lots, including 400 lots in Louisville, Kentucky. The Company typically will not purchase lots until all zoning approvals have been received. Of the lots under option, approximately 50%, or 3,550 lots, have received zoning approval. Option agreements expire at varying dates through April 2009. The Company's decision to exercise any particular option or otherwise acquire additional land is based upon an assessment of a number of factors, including its existing land inventory at the time and its evaluation of the future demand for its homes. Real estate inventories at September 30, 2001 increased to $225.2 million from $184.5 million at December 31, 2000. The $40.7 million increase in real estate inventories included increases in homes under construction of $31.8 million, land and land development inventories of $8.8 million, $3.8 million of which was seller financed, and lumber and building supply inventories of $89,000. The increased investment in homes under construction reflects the larger number of homes the Company is building, the increased costs associated with building more expensive homes and the seasonal nature of building in Central Ohio and Louisville Kentucky. The higher level of land and land development inventories reflects expanded sales locations in both Central Ohio and Louisville Kentucky and greater seasonal land development activities. On September 30, 2001, the Company had 134 inventory homes in various stages of construction, which represented an aggregate investment of $12.4 million, compared to 128 inventory homes, which represented an aggregate investment of $9.9 million on September 30, 2000. Inventory homes are not reflected in sales or backlog. 14 SELLER-PROVIDED DEBT Seller-provided term debt was $3.9 million at September 30, 2001 compared to $1.5 million at September 30, 2000. The Company expects to repay $2.3 million of the term debt prior to the end of 2001 and the remaining balance during 2002. Interest rates range from 6.5% to 8.0%. LAND PURCHASE COMMITMENTS At September 30, 2001, the Company had commitments to purchase approximately 2,200 residential lots at an aggregate cost of $28.1 million, net of $2.4 million in good faith deposits. In addition, at September 30, 2001, the Company had $43.4 million of cancelable obligations to purchase residential lots and unimproved land, net of $2.9 million in good faith deposits. The majority of commitments and cancelable obligations are for post 2001 development activity, with the commitments extending through 2005 and cancelable obligations extending through 2009. The Company expects to fund its land acquisition and development obligations from internally generated cash and from the borrowing capacity under its bank credit facility. The Company may, with additional cost, delay or terminate many of its purchase obligations. In addition, many of the purchase contracts contain contingencies that delay the implementation of the contracts or prevent the contracts from being executed. CREDIT FACILITIES On May 23, 2001 the Company increased its Senior Unsecured Revolving Credit Facility ("the Facility") to $175 million from $150 million and modified certain Facility covenants. The Facility covenants were modified to eliminate a reduction in the uncommitted land to tangible net worth ratio that was scheduled to go into effect January 1, 2002 and to eliminate a restriction on the amount of investment the Company was allowed to make in Louisville, Kentucky. On October 9, 2001 the Company further modified the Facility to allow creation of a risk retention entity and to be part of qualified joint ventures on a limited basis. The original Facility was executed on May 29, 1998 and is described in the Form 10-K for the year ended December 31, 2000. The Facility provides for a variable rate of interest on borrowings. In order to reduce exposure to increasing interest rates, the Company has entered into interest rate swap contracts ("Contracts") that fix the interest rate on $70 million of borrowings under the Facility. The Contracts mature between May 6, 2003 and January 12, 2005 and fix interest rates between 4.54% and 5.98%, plus a variable margin based on the Company's interest coverage ratio. The variable margin may range from 1.75% to 2.50% and is determined quarterly. The fair value of the Contracts was a loss of $3.3 million at September 30, 2001. As of September 30, 2001, the Company was in compliance with the Facility covenants and had $30.5 million of borrowing capacity available under its Facility, after adjusting for borrowing base limitations. Borrowing availability under the Facility could increase, depending on the Company's utilization of the proceeds. 15 INFLATION AND OTHER COST INCREASES The Company is not always able to reflect all of its cost increases in the prices of its homes because competitive pressures and other factors require it in many cases to maintain or discount those prices. While the Company attempts to maintain costs with subcontractors from the date a sales contract with a customer is accepted until the date construction is completed, unanticipated additional costs may be incurred which cannot be passed on to the customer. For example, delays in construction of a home can cause the mortgage commitment to expire and can require the Company, if mortgage interest rates have increased, to pay significant amounts to the mortgage lender to extend the original mortgage interest rate. In addition, during periods of high construction activities, additional costs may be incurred to obtain subcontractor availability when certain trades are not readily available. These costs can result in lower gross profit. 16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company has entered into five interest rate swap contracts ("Contracts") with aggregate notional amounts of $70 million, as reflected in the table below. The Company enters into the contracts to minimize earnings fluctuations caused by interest rate volatility associated with the Company's variable rate debt. The Contracts allow the Company to have variable-rate borrowings and to select the level of fixed-rate debt for the Company as a whole. Under the Contracts, the Company agrees with other parties to exchange, at specified intervals, the difference between fixed rate and floating-rate amounts calculated by reference to an agreed notional amount. The level of fixed rate debt, after the effect of the Contracts has been considered, is maintained at approximately 50% of total borrowings under the revolving line of credit facility. The Company does not enter into derivative financial instrument transactions for speculative purposes. The interest rate swaps are more fully described below:
Amount Debt Start Date Maturity Date Fixed Rate ----------- ---------- ------------- ---------- $10 million May 6, 1998 May 6, 2003 5.96% $20 million Dec. 14, 2001 Jan. 12, 2004 5.98% $20 million Jan. 12, 2001 Jan. 12, 2005 5.58% $10 million Mar. 8, 2001 Mar. 8, 2004 5.16% $10 million Sept. 12, 2001 Sept. 12, 2004 4.54%
The following table presents descriptions of the financial instruments and derivative instruments that are held by the Company at September 30, 2001, and which are sensitive to changes in interest rates. For the liabilities, the table presents principal calendar year cash flows that exist by maturity date and the related average interest rate. For the interest rate derivatives, the table presents the notional amounts and expected interest rates that exist by contractual dates. The notional amount is used to calculate the contractual payments to be exchanged under the contract. The variable rates are estimated based on the three-month forward LIBOR rate plus a variable margin ranging from 1.75% to 2.50%. The fair value of the derivatives at September 30, 2001 was a loss of $3.3 million and at September 30, 2000 a gain of $258,000. All amounts are reflected in U.S. Dollars (thousands).
TOTAL SEPTEMBER 30, --------------- 2001 2002 2003 2004 2005 2001 2000 ---- ---- ---- ---- ---- ---- ---- Liabilities ----------- Variable rate $125,163 $125,163 $125,163 $125,163 $125,163 $125,163 $113,668 Average interest rate 7.73% 8.81% Interest-Rate Derivatives ------------------------- Notional amount $70,000 $70,000 $70,000 $60,000 $20,000 $70,000 $30,000 Average pay rate 5.53% 5.53% 5.53% 5.46% 5.58% 5.53% 5.87% Average receive rate 4.84% 4.84% 4.84% 4.84% 4.84% 4.84% 8.81%
17 DOMINION HOMES, INC. PART II - OTHER INFORMATION Item 1. Legal Proceedings. The Company is involved in various legal proceedings, most of which arise in the ordinary course of business and some of which are covered by insurance. In the opinion of the Company's management, none of the claims relating to such proceedings will have a material adverse effect on the financial condition or results of operations of the Company. Item 2. Change in Securities and Use of Proceeds. Not applicable. Item 3. Defaults Upon Senior Securities. Not applicable. Item 4. Submission of Matters to a Vote of Security Holders. Not applicable. Item 5. Other Information. Not Applicable. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: See attached Index to Exhibits (following the signature page). (b) Reports on Form 8-K. Not applicable. 18 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. DOMINION HOMES, INC. (Registrant) Date: November 12, 2001 By: /s/DOUGLAS G. BORROR ------------------------------------ Douglas G. Borror Duly Authorized Officer Date: November 12, 2001 By: /s/JON M. DONNELL ------------------------------------ Jon M. Donnell Duly Authorized Officer Date: November 12, 2001 By /s/PETER J. O'HANLON ----------------------------------- Peter J. O'Hanlon Principal Financial Officer 19 INDEX TO EXHIBITS
Exhibit No. Description Location ----------- ----------- -------- 2.1 Corporate Exchange and Subscription Agreement, dated January 20, Incorporated by reference to 1994, between Borror Corporation and Borror Realty Company Exhibit 2.1 to the Company's Registration Statement on Form S-1 (Registration No. 33-74298) as filed with the Commission on January 21, 1994 and as amended on March 2, 1994 (The "Form S-1"). 2.2 Form of First Amendment to Corporate Exchange and Subscription Incorporated by reference to Agreement Exhibit 2.2 to Form S-1. 3.1(a) Amended and Restated Articles of Incorporation of Dominion Homes, Incorporated by reference to Inc., as filed with the Ohio Secretary of State on March 4, 1994 Exhibit 4(a)(1) to the Company's Registration Statement on Form S-8 (Registration No. 333-26817) as filed with the Commission on May 9, 1997 (the "1997 Form S-8"). 3.1(b) Certificate of Amendment to Amended and Restated Articles of Incorporated by reference to Exhibit Incorporation of Dominion Homes, Inc., as filed with the Ohio 4(a)2 of the 1997 Form S-8. Secretary of State on May 7, 1997. 3.1(c) Amended and Restated Articles of Incorporation of Dominion Homes, Incorporated by reference to Exhibit Inc., reflecting amendments through May 7, 1997 (for purposes of 4(a)(3) of the 1997 Form S-8. Commission reporting compliance only). 3.2 Amended and Restated Code of Regulations of Dominion Homes, Inc. Incorporated by reference to Exhibit 3.2 to the Company's June 30, 2000 Form 10-Q (File No. 0-23270). 4. Specimen of Stock Certificate of Dominion Homes, Inc. Incorporated by reference to Exhibit 4 to the Company's March 31, 1997 Form 10-Q (File No. 0-23270). 10. Fourth Amendment to Credit Agreement Dated May 23, 2001 Incorporated by reference to Exhibit 10 to the Company's June 30, 2001 Form 10-Q (File No. 0-23279) 10.1 Lease dated April 30, 2001 between FGSC, LLC and Dominion Homes of Incorporated by reference to Exhibit Kentucky, Ltd. for office space in Louisville, Kentucky. 10.1 to the Company's June 30, 2001 Form 10-Q (File No. 0-23279) 10.2* Stock Option Agreement, dated May 3, 2001 between Dominion Homes, Filed herewith Inc. and Pete A. Klisares (which Agreement is substantially the same as Stock Option Agreements entered into between the Company and its other outside independent directors, Gerald Mayo and C. Ronald Tilley. 10.3 Fifth Amendment to Credit Agreement dated October 9, 2001. Filed herewith
* Indicates management contracts, compensatory plans or other arrangements. 20