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WCI Communities 10-K 2009 Documents found in this filing:
Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K
For the fiscal year ended December 31, 2008 OR
For the transition period from to Commission File Number 001-31255 WCI COMMUNITIES, INC. (Exact name of registrant as specified in its charter)
24301 Walden Center Drive Bonita Springs, Florida 34134 (Address of principal executive offices) (Zip Code) Registrant’s telephone number, including area code: (239) 947-2600 Securities registered pursuant to Section 12 (b) of the Act: NONE Securities registered pursuant to Section 12 (g) of the Act: Common Stock (par value $.01) * (Title of class) * Deregistered pursuant to a Form 15 filed on March 31, 2009 Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No þ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No þ 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 þ No ¨ Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ¨ No þ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes ¨ No þ As of June 30, 2008, the aggregate market value of the Common Stock held by non-affiliates of the Registrant was approximately $41,288,546. As of March 31 2009, there were 42,243,652 shares of Common Stock outstanding. Documents Incorporated by Reference Certain information required to be included in Part III of this Form 10-K will be provided in accordance with General Instruction G(3).
Table of ContentsTABLE OF CONTENTS
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Table of ContentsPART I
GENERAL WCI Communities, Inc. (the Company, WCI or We), a Delaware corporation that was formed in August 1998 through predecessor companies, is a fully integrated homebuilding and real estate services company with over 50 years of experience in the design, construction and operation of leisure-oriented, amenity-rich master-planned communities. We began our operations in Florida through companies that principally focused on developing amenitized communities in the state. In the late 1990’s, we changed our business model to capture greater revenues and gross margins by becoming the principal homebuilder in most of our communities. In May 2004, we initiated homebuilding operations outside of Florida with the acquisition of Spectrum Communities, a developer and homebuilder based in the Northeast U.S. In February 2005, we acquired Renaissance Housing Corporation, a homebuilder and high-rise tower developer based in the Mid-Atlantic U.S. These acquisitions, which are fully integrated with our operations, established our position in the Northeast and Mid-Atlantic U.S. luxury residential markets and broadened our capabilities to take advantage of future opportunities in the mid- and high-rise urban residential market. When this report uses the words “we,” “us,” and “our,” these words refer to WCI Communities, Inc. and its subsidiaries, unless the context otherwise requires. On August 4, 2008, WCI and 126 of its subsidiaries (excluding its Watermark real estate brokerage, our WCI Mortgage business and certain other joint ventures in which we are a partner) (the Debtors) filed voluntary petitions for reorganization relief under the provisions of Chapter 11 of Title 11 of the United States Bankruptcy Code (the Code) in the United States Bankruptcy Court for the District of Delaware in Wilmington, Case No. 08—11643 (KJC). The list of the Debtors and Tax Identification Numbers is located on the docket for Case No. 08-11643 (KJC) [Docket No. 64] and http://chapter11.epiqsystems.com/wcicommunities. We continue to operate our businesses and manage our properties as debtors and debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. As part of the “first day” relief, we obtained Bankruptcy Court approval to, among other things, continue to pay critical vendors and vendors with lien rights, meet our pre-petition payroll obligations, pay deficit funding obligations to our various community associations and clubs, maintain our cash management systems, sell homes free and clear of liens, pay our taxes, continue to provide employee benefits and maintain our insurance programs. Certain of these payment obligations are subject to monetary limits without specific approval for each transaction. The filing of the Chapter 11 petitions triggered repayment obligations under a number of our debt instruments and agreements. As a result, all of our debt obligations became immediately payable. We believe that any efforts to enforce the payment obligations are stayed as a result of the Chapter 11 filings. On September 24, 2008, pursuant to authorization from the Delaware Bankruptcy Court, the Company entered into a $150 million Debtor-In-Possession Credit Agreement (the DIP Agreement) with a syndicate of lenders, some of which were lenders under the Company’s pre-petition secured debt facilities, led by Wachovia Bank, N.A., acting as administrative agent, and Bank of America, N.A. acting as collateral agent. The Court also granted the Company final authority to continue using its on-hand cash collateral during the Chapter 11 case. The DIP Credit Agreement includes an $80 million term loan and a $70 million revolving credit facility (collectively, the DIP Loans). The $80 million term loan was a required borrowing on the closing date, approximately $50 million of which was used to repay the outstanding balance under the Company’s Third Consolidated, Amended and Restated Revolving Credit Construction Loan Agreement, dated as of September 22, 2005 (the Pre-Petition Tower Facility) with the remainder to be used for general corporate purposes. Availability of funds under the revolving credit facility is subject to a limitation on the amount of cash and cash equivalents held by the Company. The Company may also request the issuance of up to $25 million in letters of credit. As part of the order, the Company granted the prepetition agents and the lenders various forms of protection, including liens and administrative claims to protect against the diminution of the collateral value to the extent provided in the
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Table of Contentsfinal order approving the DIP Agreement. The DIP Agreement initially matures on September 24, 2009, subject to a six-month extension period. Borrowings under the DIP Agreement bear interest at the Eurodollar Rate plus 6.0% or an index base rate plus 5.0%. We conduct development and homebuilding operations in the following markets:
As of December 31, 2008, we have 54 locations where we are building or selling single- and multi-family homes or mid- and high-rise residential units. In total, we control approximately 12,000 acres of land. Our principal business lines include single- and multi-family (traditional) homebuilding, mid- and high-rise (tower) homebuilding, and real estate services. We also develop and operate amenity facilities, sell selected land parcels, and enter into real estate joint ventures, generally within our communities. See the Notes to the consolidated financial statements included in this Annual Report on Form 10-K for further information regarding our business segments for each of the three years ended December 31, 2008. BUSINESS STRATEGY During the first quarter of 2009, the Company continued its cost reduction initiatives including a significant reduction of overhead, consolidation of operating divisions, closing of sales offices and rejection of leases/ contracts through the Bankruptcy Code, and further concentrated its efforts on selling speculative inventory and non-core assets. In addition, due to the continuing deterioration of the housing industry nationally and in Florida in particular, and the challenging economic conditions and lack of visibility in the marketplace (including unpredictability in projecting pricing trends and housing recovery timeframes), the Company adopted a plan in early 2009 to currently suspend all new homebuilding construction activities except under limited circumstances, subject, however, to completion of existing homes under construction or subject to pending purchase contracts. This plan also contemplates the continuation of the sale of our speculative inventory and the ongoing maintenance of our communities, amenities operations and real estate services. As part of the Company’s overall strategy to explore alternatives to emerge from bankruptcy in an expeditious manner, the Company also engaged its financial/restructuring advisor to assist with a comprehensive marketing process for the sale or reorganization of the Company, as well as the disposition of certain assets. The Company continues to explore strategic alternatives. On March 31, 2009, the Company filed Form 15 with the Securities and Exchange Commission (the SEC) to deregister its common stock under Section 12(g) of the Securities Exchange Act of 1934, as amended (the Exchange Act), and suspended the Company’s reporting obligations under Sections 13(a) and 15(d) of the
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Table of ContentsExchange Act. Upon the filing of Form 15, the Company’s obligation to file periodic and current reports with the SEC, including Forms 10-K, 10-Q and 8-K, was immediately suspended, except for its December 31, 2008 Form 10-K. The Company was eligible to file Form 15 because it recently determined that its common stock is held of record by less than 300 persons. The Form 15 also terminates the Company’s reporting obligation with respect to its notes. The Company plans to continue posting quarterly and annual financial information on its website. HOMEBUILDING ACTIVITIES The following discussion of homebuilding, tower and marketing activities was primarily how the company operated prior to it filing voluntary petitions under Chapter 11 of the code. The discussion of these activities should be read in conjunction with the discussion under Business Strategy appearing previously in this section. Marketing and Sales We believe our proprietary marketing systems and the depth of experience of our marketing group create an increased number of selling opportunities for us and enhance our marketing presence and brand recognition. Our marketing programs reach prospective purchasers, locally, nationally and internationally through advertisements placed in demographic specific periodicals and other media. We generally advertise in newspapers, magazines and on billboards. The Internet is an important resource we use in promoting and in providing information to our customers. A visitor to our website, http://www.wcicommunities.com, can obtain detailed information regarding our communities and residences. We maintain sales centers with community scale models and lifestyle and home demonstration displays. We also maintain professionally decorated model homes staffed by our own sales personnel, which demonstrate the features of our products and the community lifestyles. Brochures, scaled architectural models, walk-in kitchen and bathroom models and other marketing materials are used to assist sales associates in explaining and demonstrating the tower residences to be built. Local realtors are integral to our marketing process and significantly impact our sales activities in many of our communities. With regard to our traditional homebuilding operations, we offer customers a wide selection of standard options and upgrades to finish their homes. In addition, some of our larger traditional homebuilding communities offer design studios staffed with professional designers where the many options and upgrades available to purchasers of our products are displayed and demonstrated to assist the buyer’s selection process. We use a wide range of sales incentives in order to attract traditional and tower residence buyers and have been using these incentives increasingly in the continuing difficult economic market conditions. These incentives are an important aspect of our sales and marketing of homes, and we rely on them more heavily in promoting communities experiencing weaker demand or to promote the sale of completed unsold homes. Without the use of these marketing incentives and discounts, our ability to sell homes would be adversely impacted. Generally, these incentives fall into one of three categories: (1) cash discounts against the purchase price; (2) golf or sports club memberships, tangible merchandise such as automobiles, provided free or at a reduced price; and (3) payment of the buyer’s loan closing costs, travel related expenses, and/or certain future expenses for a limited time period such as ad valorem taxes or property owner’s association assessments. The use of incentives depends largely on local economic and competitive market conditions. The purchaser will enter into a sales agreement and provide us with a refundable cash payment to reserve the traditional homebuilding or tower residential unit. The sales agreement typically involves a short rescission period, after which the agreement becomes binding on both parties and the deposit becomes partially or entirely non-refundable, subject to HUD regulations, if applicable. Historically, the non-refundable deposit requirements for traditional homes and for tower residences generally approximate 10% to 15% and 10% to 20%, respectively of the total purchase price. Additionally, customers are generally required to pay additional deposits when they select options or upgrade features for their traditional homes. Most of our sales contracts stipulate that when
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Table of Contentscustomers cancel their contracts with us we have the right to retain their earnest money and option deposits; however, we sometimes choose to refund such deposits. Reported new orders include the number and value of contracts net of any cancellations occurring during the reporting period. Only outstanding sales agreements that have been signed by both the home purchaser and us are reported and included in backlog. Traditional Homebuilding Backlog. At December 31, 2008 and 2007, we had a backlog of signed contracts for 60 and 317 traditional home units, respectively, with sales values aggregating $38.2 million and $191.5 million, respectively. At March 31, 2009, we had a backlog of signed contracts for 62 units with sales values aggregating $34.9 million. Tower Residences Backlog. At December 31, 2008 and 2007, we had a backlog of signed contracts with sales values aggregating $13.3 million and $20.4 million, respectively. At March 31, 2009, we had a backlog of signed contracts for 22 units with sales values aggregating $13.3 million. See Business Strategy above for a description of current suspension of new home construction activity. Traditional homes We design, sell and build traditional homes serving primary, second and retirement home buyers although, as discussed above, during the first quarter of 2009 we suspended new home construction activity pending market recovery. This suspension of new home construction activity does not impact the completion of homes under construction nor our continuing efforts to sell speculative home inventory. Our homes have ranged from approximately 1,000 square feet to over 6,000 square feet in living space. The average selling price per gross new order for the year ended December 31, 2008 was approximately $491,000. We build most of these homes within our master-planned communities, which often feature attractive amenities, including hotels, such as Ritz-Carlton, Hyatt, Regent International, and Starwood’s Luxury Collection. Many of our communities also include golf courses designed by Raymond Floyd, Peter Jacobson, Greg Norman and other notable golf course architects. We believe that this approach increases the value of our homes and communities and helps us attract affluent purchasers. Additionally, we sometimes sell selected lots directly to other builders and consumers for the design and construction of custom homes. In addition to using model homes, we also build speculative homes. These speculative homes enhance our marketing and sales efforts to prospective homebuyers as well as to independent brokers, who often represent homebuyers requiring a completed home for immediate delivery. We typically sell our speculative homes while they are under construction or immediately following completion. Our unsold completed single- and multi-family homes at December 31, 2008 were 234 units compared to 477 units at December 31, 2007. Construction. We typically act as the general contractor in the construction of our residences. Our employees provide purchasing and quality assurance for, and construction management of, the homes we build, while the material and labor components of our houses are provided by subcontractors. We typically do not maintain significant inventories of construction materials, except for work in progress materials for homes under construction. We compete with other homebuilders for qualified subcontractors, raw materials and lots in the markets where we operate. We employ construction managers to monitor homes under construction, participate in major design and building decisions, coordinate the activities of subcontractors and suppliers, review the work of subcontractors for quality and cost controls and monitor compliance with zoning and building codes. Depending upon the size and complexity of a home’s design, the weather, and the availability of labor, materials and supplies, our construction time ranges from about 4 to 12 months for our single- and multi-family homes. Tower residences We design, sell and build luxury residential towers and condominium hotels targeted to primary and affluent, leisure-oriented home purchasers. Residences available for sale in our towers have ranged in size from approximately 500 square feet to over 11,000 square feet in living space. The average selling price per gross new
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Table of Contentsorder for a tower unit in 2008 was approximately $833,000. Due to the continuing difficult market conditions, we did not commence constructing any towers in 2008 and have no towers under construction going into 2009. Design. We commence the design and planning of towers by conducting extensive research relating to the market, customer base, product requirements, pricing and absorption. Our research effort is directed by project managers specializing in the development of towers. We also contract for the services of an experienced third party general contractor during the early stages to assist in design, engineering and the estimation of construction costs. Construction. We hire experienced and bonded third party general contractors specializing in the construction of residential towers to construct these buildings. By hiring experienced general contractors to construct our towers, we mitigate many of the risks associated with construction. As the developer of the towers that we build, we manage the entire process from planning to closing of completed residences to turnover of the condominium association to residents. Historically we generally collected from each purchaser cash deposits over a period of time ranging from 10% to 20% of a residence purchase price to cover a portion of estimated construction costs. Once construction is completed, closings of sold residences occur, at which time we are paid the balance of the purchase price for the residences sold. REAL ESTATE SERVICES Realty brokerage We have a franchise agreement with Prudential Real Estates Affiliates, Inc. that gives us the exclusive right to provide residential brokerage services as Prudential Florida Realty in seven geographic areas across nine counties in Florida and commercial brokerage services in Naples, Florida. The exclusive franchise areas are in Lee, Collier, Martin, Palm Beach, Broward, Charlotte, and Dade Counties and in portions of Hillsborough and Manatee Counties. As consideration under the agreement, we pay Prudential a royalty based on gross commission revenue on a monthly basis. Additionally, through a separate subsidiary, we provide new home and certain resale brokerage services. As of December 31, 2008, our realty brokerage operations had 43 offices and approximately 1,745 sales agents. Title insurance/Other insurance We provide title insurance and closing services through WCI Title which underwrites its policies on behalf of large national title insurers and derives its revenues from commissions on title insurance premiums and closing services provided to our customers, third party residential closings and commercial closings. In addition to the foregoing, WCI Title, d/b/a Florida Homes & General Lines Insurance (FHGLI), provides quotes for homeowners and other general lines of insurance from various insurers and if such insurance is purchased by a homeowner, FHGLI is entitled to a commission from the applicable market’s general agency, which is paid from the premium paid by the purchaser. Mortgage banking Prior to June 2006, we provided residential mortgage banking services to our buyers, as well as third party purchasers through our subsidiary, Financial Resources Group, Inc., which also did business as WCI Mortgage. In June 2006, we sold our mortgage banking operations to a newly formed joint venture, WCI Mortgage LLC. In conjunction with the formation of WCI Mortgage LLC, we sold a 50.1% interest in the newly formed company to Wells Fargo Ventures, LLC. WCI Mortgage LLC began originating and funding mortgage loans for our new home and re-sale customers beginning in the third quarter of 2006.
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Table of ContentsAMENITY MEMBERSHIP AND OPERATIONS Our recreational amenities, including golf courses with clubhouses, fitness, tennis and recreational facilities, guest lodging, marinas and a variety of restaurants, are central to our mission to deliver high quality residential lifestyles. Amenities at our communities are owned by either community residents or non-residents in equity membership programs, unaffiliated third parties, or retained by us. As we plan the development of new communities, the ownership of the amenities is structured to cater to the preferences and expectations of community residents. LAND SALES We leverage our expertise and experience in master planning by strategically selling land within our communities for construction of products we do not choose to build. This enables us to create a more well-rounded community by selling land to developers who will construct residential, commercial, industrial and rental properties, which we may prefer not to develop at the time or in general. We sometimes sell selected lots to other builders and to end users for the design and construction of homes. OTHER INVESTMENTS We selectively enter into business relationships through partnerships and joint ventures with unrelated parties. These partnerships and joint ventures are utilized to acquire, develop, market and operate homebuilding, timeshare, amenities, and/or real estate services projects. As of December 31, 2008, we participated in 10 real estate joint ventures, including 6 that are consolidated in our financial statements. We may be required to make additional cash contributions to the partnerships and joint ventures pursuant to agreements. In the first quarter of 2009, we exited two joint ventures, Ocala 623 Land Development LLC and Renaissance at Woodlands LLC. See footnotes to the consolidated financial statements for further details. LAND ACQUISITION POLICY We complete market studies and other analyses before entering into a contract to acquire land. We generally purchase land or obtain an option to purchase land, which may require certain site improvements prior to construction including site planning and engineering, as well as constructing road, sewer, water, utilities, drainage and recreational facilities and other amenities. We may enter into land development joint ventures from time to time as a means of accessing land, reducing our risk profile, leveraging our capital base and enhancing our returns on capital. The majority of the land we acquire typically includes all necessary entitlements (e.g. zoning, master development plan approvals and environmental impact approvals) so that we have the right to begin development or construction. In certain circumstances, we will purchase land without all necessary entitlements where we identify an opportunity to build on the property in a manner consistent with our strategy. Although entitlements are typically obtained prior to the acquisition of land, we are usually required to obtain other governmental approvals and permits during the course of land development and construction of residences. Our land purchase agreements are typically subject to a number of conditions including, but not limited to, our ability to obtain necessary governmental approvals. If all governmental approvals are not obtained prior to a pre-determined contractual deadline, we may extend the deadline or cancel the contract and our initial deposit will be returned to us. In addition, we typically have the right to cancel any of our agreements and forfeit our deposit. In such instances, we are generally unable to recover any pre-development costs. We also enter into lot option contracts, in which we obtain the right, but generally not the obligation, to buy lots at predetermined prices on a defined schedule commensurate with anticipated home closings or planned land development. Our option contracts are generally non-recourse, which limits our financial exposure to our money
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Table of Contentsdeposited with sellers. This enables us to control lot positions with minimal capital investment, which substantially reduces the risks associated with land ownership and development. Although we purchase and develop land primarily to support our homebuilding activities, we also sell lots and land to other developers and homebuilders. During 2008 and continuing through the first quarter of 2009, due to the unfavorable condition of the residential real estate market, we did not enter into any new land and lot contracts. In addition, we re-evaluated our land and lots under contract considering the significant changes in economic and market conditions. For the year ended December 31, 2008, we recorded write-offs of approximately $16.3 million in forfeited deposits, pre-development costs and estimated future payments associated with the termination of land and lot option contracts. As of December 31, 2008, we had no remaining active land or lot option purchase contracts. OUR COMMUNITIES The following table sets forth summary information about our communities, including remaining acres, remaining entitled units and remaining number of tower sites. Our communities As of December 31, 2008
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Table of ContentsEMPLOYEES As of December 31, 2008, we had approximately 1,450 employees, of which approximately 1,070 were amenities and real estate services employees. As of March 31, 2009, we had approximately 1,250 employees, of which approximately 960 were amenities and real estate services employees. SEASONALITY We have historically experienced, and in the future expect to continue to experience, seasonal variability in revenue, profit and cash flow. Factors expected to contribute to this variability include: the timing of the introduction and start of construction of new towers; the timing of tower residence sales; the timing of closings of homes, lots and parcels; our ability to continue to acquire land and options on land on acceptable terms; the timing of regulatory approvals for development and construction; the condition of the real estate market and general economic conditions in Florida, Northeast and Mid-Atlantic United States; prevailing interest rates and the availability of financing, both for us and for the purchasers of our homes; weather conditions; and the cost and availability of materials and labor. Our historical financial performance is not necessarily a meaningful indicator of future results, and, in particular, we expect financial results to vary from project to project and from quarter to quarter. Our revenue may therefore fluctuate significantly on a quarterly basis, and we believe that quarter-to-quarter comparisons of our results should not be relied upon as an indication of future performance. COMPETITION The homebuilding industry and real estate development is highly competitive and we compete against numerous developers and others in the real estate business in and near the areas where our communities are located. We, therefore, may be competing for investment opportunities, financing, available land, raw materials and skilled labor with entities that possess greater financial, marketing and other resources. Competition generally may increase the bargaining power of property owners seeking to sell, and industry competition may be increased by future consolidation in the real estate development industry. Due to the continuing deterioration of the housing markets, we are increasingly competing with foreclosed homes and “short sale” transactions. REGULATORY AND ENVIRONMENTAL MATTERS Our operations are subject to Federal, State and local laws and regulations. In particular, development of property is subject to comprehensive Federal and State environmental legislation. This regulatory framework, in general, encompasses areas like traffic considerations, availability of municipal services, use of natural resources, impact of growth, utility services, conformity with local and regional plans, together with a number of other safety and health regulations. Permits and approvals mandated by regulation for development of any magnitude are often numerous, significantly time-consuming and onerous to obtain, and not guaranteed. Such permits, once expired, may or may not be renewed and development for which the permit is required may not be completed if such renewal is not granted. These requirements have a direct bearing on our ability to further develop communities. Our mortgage activities and the activity of title insurance agencies must also comply with various Federal and State laws, consumer credit rules and regulations and other rules and regulations unique to such activities. In particular, we have been impacted by the new Fannie Mae guidelines applicable to Florida condominiums. See “Risk Associated with Fannie Mae Requirements for Attached Condominium Projects in Florida” in Risk Factors section below. Although we believe that our operations are in full compliance in all material respects with applicable federal, state and local requirements, our operations may be materially impacted and our growth and development opportunities may be limited and more costly as a result of legislative, regulatory or municipal requirements.
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Table of ContentsOur operating costs may also be affected by the cost of complying with existing or future environmental laws, ordinances and regulations, which require a current or previous owner or operator of real property to bear the costs of removal or remediation of hazardous or toxic substances on, under or in the property. Environmental site assessments conducted at our properties have not revealed any environmental liability or compliance concerns that we believe would have a material adverse effect on our business, assets, results of operations or liquidity, nor are we aware of any material environmental liability or concerns. Although we conduct environmental site assessments with respect to our own properties, there can be no assurance that the environmental assessments that we have undertaken have revealed all potential environmental liabilities, or that an environmental condition does not otherwise exist as to any one or more of our properties that could have a material adverse effect on our business, results of operations and financial condition. AVAILABLE INFORMATION As we noted under “Business Strategy” above, the Company’s reporting obligations under Section 13 (a)and 15(d) of the Exchange Act have been suspended and the Company is not required to file any further periodic reports with the SEC after this Form 10-K for the year ended December 31, 2008. We make available free of charge on or through our Internet website (http://www.wcicommunities.com) our previously filed Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports. These filings are available to the public over the Internet at the SEC’s website at http://www.sec.gov. You may also read and copy any document we filed with the SEC at the SEC’s public reference room located at 100 F Street, NE, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for further information on the public reference room. We also have a Corporate Governance webpage. You can access our Corporate Governance webpage through our website, http://www.wcicommunities.com by clicking on the “Investors” link to the heading “Governance.”
Investors are cautioned that certain statements contained in this document, as well as some statements by the Company in periodic press releases and those in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Statements which are predictive in nature, which depend upon or refer to future events or conditions, or which include words such as “expects”, “anticipates”, “intends”, “plans”, “believes”, “estimates”, “hopes”, and similar expressions constitute forward-looking statements. In addition, any statements concerning future financial performance (including future revenues, earnings, cash flows or growth rates), ongoing business strategies or prospects, and possible future Company actions, which may be provided by management, are also forward-looking statements. Forward-looking statements are based on current expectations and beliefs concerning future events and are subject to risks and uncertainties about the Company, economic and market factors and the homebuilding industry, among other things. These statements are not guaranties of future performance. If one or more of the assumptions underlying our forward-looking statements proves incorrect, then our actual results, performance or achievements could differ materially from those expressed in, or implied by the forward-looking statements contained in this report. Therefore, we caution you not to place undue reliance on our forward-looking statements. The following cautionary discussion of risks and uncertainties relevant to our business includes factors we believe could cause our actual results to differ materially from expected and historical results. Other factors beyond those listed below, including factors unknown to us and factors known to us which we have not determined to be material, could also adversely affect us.
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Table of ContentsRisk Associated with Operating Budgets and Financial Covenants—Our cash collateral order includes operating budgets and financial covenants that limit our operating flexibility. The cash collateral order requires us to maintain certain financial budgets and covenants that, among other things, restrict our ability to take specific actions, even if we believe such actions are in our best interest. These include, among other things, restrictions on our ability to:
Subject to the provisions of the cash collateral order, we are authorized to use the cash collateral in a manner that is not materially inconsistent with the budgets. Modifications to the budgets may be made subject to approval. Risk Associated with Our Cost Structure—We may not succeed in our attempts to improve our cost structure. We may have difficulty in generating cost savings and operational improvements in the future and in adapting our cost structure adequately to adjust for significant changes in home sales, and to offset price reductions and increases in raw material or labor costs. Price reductions are often required pursuant to remain competitive with our peers and are sometimes necessary to win additional business. In addition, our cost structure may be adversely affected by changes in the laws, regulations, policies or other activities of governments, agencies and similar organizations where such actions may affect the development of residential communities, the cost thereof or applicable tax rates, or affect the cost of legal and regulatory compliance or the cost of financing. Risk Associated with Potential Future Asset Impairments and other Restructuring Charges—We may suffer future asset impairment and other restructuring charges, including write downs of goodwill or assets. From time to time in the past, we have recorded asset impairment losses related to specific residential communities. Generally, we record asset impairment losses when we determine that our estimates of the future undiscounted cash flows from an operation will not be sufficient to recover the carrying value of that asset. During 2007 and 2008, we recorded substantial long-lived asset impairment losses. In light of the shifting nature of the competitive environment in which we operate, it is possible that we will incur similar losses and charges in the future, and those losses and charges may be significant. Risk Associated with Cyclical Nature of Home Sales and Construction—The cyclical nature of home sales and construction may adversely affect our business. Our business is directly related to homes construction and sales. Home sales and construction are highly cyclical and depend on general economic conditions and other factors, including consumer spending and
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Table of Contentspreferences as well as changes in interest rate levels and consumer confidence. The current economic decline has resulted in a significant reduction in home sales which will continue to have a material adverse effect on our business, results of operations and financial condition. Risk Associated with our Reorganization—If we are unable to successfully reorganize our capital structure and operations and implement our reorganization plan through the Chapter 11 proceedings, the debtors may be required to liquidate their assets. Commencing August 4, 2008, the Company and certain of our subsidiaries filed voluntary petitions for reorganization relief under Chapter 11 of the Bankruptcy Code. At that time, risks that the Company faced related to the Chapter 11 filings included, but were not limited to, the following:
Even assuming a successful emergence from Chapter 11, there can be no assurance as to the overall long-term viability of our operational reorganization, including our ability to generate sufficient cash to support our operating needs, fulfill our objectives without incurring substantial indebtedness that will hinder our ability to compete, adapt to market changes and grow our business in the future. In addition, the uncertainty regarding the eventual outcome of our reorganization and the effect of other unknown adverse factors, could threaten our existence as a going concern. Continuing on a going-concern basis is dependent upon, among other things, implementation of the reorganization plan and the transactions contemplated thereby, maintaining the support of key vendors and customers, and retaining key personnel, along with financial, business, and other factors, many of which are beyond our control.
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Table of ContentsReliance on Key Employees and Management—We may lose or fail to attract and retain key salaried employees and management personnel. An important aspect of our competitiveness is our ability to attract and retain key salaried employees and management personnel. Our ability to do so is influenced by a variety of factors, including the compensation we award, and could be adversely affected by our recent financial performance. National and Regional Economic Conditions—A deterioration in national and regional economic conditions have adversely impacted our business. Our real estate sales, revenues, financial condition and results of operations have declined due to a continuing deterioration of regional or national economies. Our sales and revenues have been disproportionately affected by worsening economic conditions in the Florida, Midwestern, Northeastern and Mid-Atlantic United States because we generate a disproportionate amount of our sales from customers in those regions. In addition, a significant percentage of our residential units are second home purchases of which the buyers are particularly sensitive to the state of the economy. The homebuilding industry is cyclical and is significantly affected by changes in general and local economic conditions, such as employment levels; availability of financing for homebuyers; interest rates; consumer confidence; levels of new and existing homes for sale; demographic trends; and housing demand. Adverse economic changes may affect some of the markets in which we operate more than others. If adverse conditions affect any of our markets, they could have a proportionately greater impact on us than on some other homebuilding companies. An excess supply of housing, including homes held for sale by investors and speculators, and homes in foreclosure or short-sale transactions, can also lower new home prices and reduce our gross margins on new homes sales. As a result of the foregoing, potential customers may be less willing or able to buy our homes, or we may take longer or incur more costs to build them. We may not be able to recapture increased costs by raising prices in many cases because of market conditions or because we fix our prices in advance of delivery by signing home sales contracts. We may be unable to change the mix of our home offerings or the affordability of our homes to maintain our margins or satisfactorily address changing market conditions in other ways. In addition, cancellations of home sales contracts in backlog may increase as homebuyers’ sentiment changes and they fail to honor their contracts. Real estate inventory risks are substantial for our homebuilding business. Our long-term ability to build homes depends upon our acquiring land suitable for residential building at affordable prices in locations where our potential customers want to live. We must anticipate demand for new homes and opportunistically seek and make acquisitions of land for replacement and expansion of land inventory within our current markets and for new markets. In some markets, this has become more difficult and costly. The risks inherent in controlling or purchasing and developing land increase as consumer demand for housing decreases. The value of undeveloped land, building lots and housing inventories can also fluctuate significantly as a result of changing market conditions. In addition, inventory carrying costs can be significant and can result in reduced margins or losses in a poorly performing project or market. In weak economic or market conditions, we may have to sell homes or land for a lower profit margin or at a loss, and we may have to record inventory impairment charges. We cannot make any assurances that the measures we employ to manage inventory risks and costs will be successful. In light of the much weaker market conditions recently encountered, our expectations have changed and we have discontinued our purchases of land and lots. We have recently terminated land option contracts and have written off earnest money deposits and pre-acquisition costs related to these option contracts. We have also recorded inventory impairment charges related to certain projects. For the year ended December 31, 2008, we recorded real estate inventory impairment losses of approximately $601.0 million compared to $319.0 million in 2007 and $98.2 million in 2006.
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Table of ContentsFor the year ended December 31, 2008, we recorded land and lot option write-offs of approximately $16.3 million compared to approximately $22.9 million in 2007 and $41.4 million in 2006. If conditions in the homebuilding industry worsen, we may have additional impairment charges and write-offs of land and lot options. Risks Associated with Fannie Mae Requirements for Condominium Projects in Florida — The new Fannie Mae requirements may make it more difficult to sell condominium units in Florida where much of our operations are concentrated. There are currently excessive unsold inventories of condominium project units in Florida resulting from the increase in building new condominium projects and the conversion of apartments to condominium ownership that occurred during the last several years. The increase in the number of units available is one of the factors that caused home prices to reach historical lows, particularly in the condominium market. Fannie Mae assessed the performance of mortgage loans secured by condominiums located in Florida and found that the number of loans currently delinquent or in default is at an all time high. As a result, Fannie Mae modified some of the terms under which it will accept loans secured by condominium projects. These new Fannie Mae standards for condominium development in Florida went into effect January 15, 2009. Some of these new underwriting guidelines include:
These new Fannie Mae requirements may make it even more difficult to sell condominium units in Florida, where much of our operations are concentrated. Risks Associated with Our Geographic Concentration in Florida—Because of our geographic concentration in Florida, an economic downturn in Florida could reduce our sales, revenues and/or negatively affect our financial condition and results of operations. We currently develop and sell a substantial majority of our properties in Florida. Consequently, the current economic reduction in demand for new homes in Florida has reduced our sales, revenues and negatively affected our financial condition and results of operations. The timing of improvement in these market conditions and/or the extent of further declines cannot be predicted. In addition, the appeal of becoming an owner of one of our residential units may decrease if potential purchasers do not continue to view the locations of our communities as attractive primary, second home or retirement destinations. Inability to Successfully Develop Communities—If we are not able to develop our communities successfully, our revenues, financial condition and results of operations could be diminished. Before a community generates any revenues, material expenditures are required to acquire land, to obtain development approvals and to construct significant portions of project infrastructure, amenities, model homes and sales facilities. It generally takes several years for a community development to achieve cumulative positive cash flow. Our inability to develop and market our communities successfully and to generate positive cash flows from these operations in a timely manner would have a material adverse effect our financial condition and results of operations.
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Table of ContentsRisks Associated with Construction—Problems in the construction of our communities could result in substantial increases in cost and could disrupt our business which would reduce our profitability. We must contend with the risks associated with construction activities, including the inability to obtain insurance or obtaining insurance at significantly increased rates, cost overruns, shortages of lumber, steel, concrete or other materials, shortages of labor, labor disputes, unforeseen environmental or engineering problems, work stoppages and natural disasters, any of which could delay construction and result in a substantial increase in costs which would reduce our profitability. Claims may be asserted against us for construction defects, personal injury or property damage caused by the subcontractors, and these claims may give rise to liability. Where we hire general contractors, if there are unforeseen events like the bankruptcy of, or an uninsured or under-insured loss claimed against, our general contractors, we may become responsible for the losses or other obligations of the general contractors, which may materially and adversely affect our financial condition and results of operations. Should losses in excess of insured limits occur, the losses could adversely affect our financial condition and results of operations. In addition, our results of operations could be negatively impacted in the event that a general contractor experiences significant cost overruns or delays and is not able to absorb such impacts or if purchasers make claims for rescission arising out of substantial delays in completion of a building and their units. Risk of Increased Consumer Interest Rates—Because many of our customers finance their home purchases, increased interest rates could lead to fewer home sales which would reduce our revenues. Many purchasers of our homes obtain mortgage loans to finance a substantial portion of the purchase price of their homes. In general, housing demand is adversely affected by increases in interest rates, housing costs and unemployment and by decreases in the availability of mortgage financing. If mortgage interest rates increase and the ability or willingness of prospective buyers to finance home purchases is adversely affected, our sales, revenues, financial condition and results of operations may be negatively affected. Availability of Land—Because our business depends on the acquisition of new land, the unavailability of land could reduce our revenues and/or negatively affect our results of operations. Our operations and revenues are highly dependent on our ability to expand our portfolio of land parcels. We may compete for available land with entities that possess significantly greater financial, marketing and other resources. Competition generally may reduce the amount of land available as well as increase the cost of such land. An inability to effectively carry out any of our sales activities and development resulting from the unavailability of land may adversely affect our business, financial condition and results of operations. Insurance—Increased insurance risk and adverse changes in economic conditions could negatively affect our business. Insurance and surety companies are continuously re-examining their business risks, and have taken actions including increasing premiums, requiring higher self-insured retentions and deductibles, requiring additional collateral on surety bonds, reducing limits, restricting coverages, imposing exclusions, such as mold damage, sabotage and terrorism, and refusing to underwrite certain risks and classes of business. Any increased premiums, mandated exclusions, change in limits, coverages, terms and conditions or reductions in the amounts of bonding capacity available may adversely affect our ability to obtain appropriate insurance coverage’s at reasonable costs, which could have a material adverse effect on our financial condition and results of operations. A substantial increase in insurance costs could have a negative impact on contract recessions or cancellations by unit purchasers.
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Table of ContentsCommunity Relations—Poor relations with the residents of our communities could negatively impact sales, which could cause our revenues and/or results of operations to decline. As a community developer, we may be expected by community residents from time to time to resolve any real or perceived issues or disputes that may arise in connection with the operation or development of our communities. Any efforts made by us in resolving these issues or disputes could be deemed unsatisfactory by the affected residents and any subsequent action by these residents could negatively impact sales, which could cause our revenues and/or results of operations to decline. In addition, we could be required to make material expenditures related to the settlement of such issues or disputes or modify our community development plans. Variability in Our Results—We experience variability in our results of operations in each quarter and accordingly, quarter-to-quarter comparisons should not be relied upon as an indicator of our future performance. In addition, as a result of such fluctuations, the price of our securities may experience volatility. We have historically experienced, and in the future expect to continue to experience, variability in our revenues, profits and cash flows. Our historical financial performance is not necessarily a meaningful indicator of future results and we expect financial results to vary from project to project and from quarter to quarter. In particular, our revenue recognition policy for tower residences can cause significant fluctuation in our total revenue from quarter to quarter. We believe that quarter-to-quarter comparisons of our results should not be relied upon as an indicator of future performance. As a result of such fluctuations, the price of our securities may experience volatility. Risks of Seasonality—We may be negatively impacted by seasonal factors, which could limit our ability to generate revenue and cash flow. Because many of our Florida customers prefer to close on their home purchases before the winter, and due to the typical timing of tower construction commencement and completion, the fourth quarter of each year often produces a disproportionately large portion of our total year’s revenues, profits and cash flows. Historically, 30% to 40% of our total revenues are generated in the fourth quarter. Therefore, delays or significant negative economic events that occur in the fourth quarter may have a disproportionate effect on revenues, profits and cash flows for the year. Risks Associated with Natural Disasters—Our sales, revenues, financial condition and results of operations may be adversely affected by natural disasters. The Florida climate presents risks of natural disasters. To the extent that hurricanes, severe storms, floods or other natural disasters or similar events occur, our business may be adversely affected. Our Northeast and Mid-Atlantic regions may also become subject to severe winter conditions that may adversely affect our business. Although we insure for losses resulting from natural disasters, such insurance may not be adequate to cover business interruption or losses resulting therefrom, which may have a material adverse effect on our financial condition and results of operations. Risks Associated with Our Industry—Laws and regulations related to property development may subject us to additional costs and delays which could reduce our revenues and/or results of operations. We are subject to a variety of statutes, ordinances, rules and regulations governing certain developmental matters, building and site design which may impose additional costs and delays on us. In particular, we may be required to obtain the approval of numerous governmental authorities regulating such matters as permitted land uses, levels of density and the installation of utility services such as gas, electric, water and waste disposal. In addition, certain fees, some of which may be substantial, may be imposed to defray the cost of providing certain governmental services and improvements. We also may be subject to additional costs or delays or may be precluded from building a project entirely because of “no growth” or “slow growth” initiatives, building permit
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Table of Contentsallocation ordinances, building moratoriums, restrictions on the availability of utility services or similar governmental regulations that could be imposed in the future. These ordinances, moratoriums or restrictions, if imposed, could cause our costs to increase and delay our planned or existing projects, which could in turn reduce our revenues and/or results of operations. In addition, some of the land that we have acquired and some of the land that we may acquire has not yet received all of the planning approvals or entitlements necessary for planned development or future development. Failure to obtain entitlement of this land on a timely basis may adversely affect our future results. Environmental Regulation—Compliance with applicable environmental laws may substantially increase our costs of doing business which could negatively impact our financial condition and results of operations. We are subject to various environmental laws and regulations relating to the operation of our properties, which are administered by numerous federal, state and local governmental agencies. Our growth and development opportunities may be limited and more costly as a result of legislative, regulatory or municipal requirements. The inability to grow our business or pay these costs could reduce our profits. In addition, our operating costs may also be affected by our compliance with, or our being subject to, environmental laws, ordinances and regulations relating to hazardous or toxic substances of, under, or in such property. These costs could be significant and could result in decreased profits or the inability to develop our land as originally intended. Changes in Accounting Principles, Interpretations and Practices—Changes in accounting principles, interpretations and practices may affect our reported revenues, earnings and results of operations. Generally accepted accounting principles and their accompanying pronouncements, implementation guidelines, interpretations and practices for certain aspects of our business are complex and may involve subjective judgments, such as, revenue recognition, inventory valuations and income tax provisions. Changes in interpretations could significantly affect our reported revenues and operating results, and could add significant volatility to those measures without a comparable underlying change in cash flows from operations. Legal Proceedings—Our cash flows and results of operations could be adversely affected if legal claims are brought against us and are not resolved in our favor. The Company and certain of our subsidiaries are involved in various claims and litigation arising in the normal course of business. Prior to our Chapter 11 filing, we received a large number of lawsuits and rescission claims from contract purchasers who were seeking rescission and return of deposit funds. These cases were stayed as a result of the Company’s Chapter 11 filing. In the opinion of management, the outcome of these matters will not have a material adverse effect on our financial condition, results of operations or cash flows. However, it is possible that future results of operations for any particular quarterly or annual period could be materially affected by changes in our estimates and assumptions related to these proceedings, or due to the ultimate resolution of the litigation, or if additional legal actions are bought against us. Product Liability Litigation—Warranty claims that arise in the ordinary course of business may be costly, which could adversely affect our business. As a homebuilder, we have been, and continue to be, subject to construction defect, product liability and home warranty claims, including moisture intrusion and related mold claims, arising in the ordinary course of business. These claims are common to the homebuilding industry and can be costly. We and certain of our subsidiaries have been, and continue to be, named as defendants in various construction defect claims, product liability claims, complaints and other legal actions that include claims related to moisture intrusion and mold and claims related to defective drywall. See “Legal Proceedings” below. Furthermore, plaintiffs may, in certain of these legal proceedings, seek class action status with potential class
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Table of Contentssizes that vary from case to case. Class action lawsuits can be costly to defend, and if we were to lose any certified class action suit, it could result in substantial potential liability for us. We record reserves for such matters in accordance with accounting principles generally accepted in the United States. With respect to certain general liability exposures, including construction defect, moisture intrusion and related mold claims and product liability, interpretation of underlying current and future trends, assessment of claims and the related liability and reserve estimation process is highly judgmental due to the complex nature of these exposures, with each exposure exhibiting unique circumstances. Furthermore, once claims are asserted for construction defects, it is difficult to determine the extent to which the assertion of these claims will expand geographically. Although we have obtained insurance for construction defect claims, such policies may not be available or adequate to cover any liability for damages, the cost of repairs, and/or the expense of litigation surrounding current claims, and future claims may arise out of uninsurable events or circumstances not covered by insurance and not subject to effective indemnification agreements with our subcontractors. Management—Management systems and personnel may not be sufficient to effectively manage current operations. Our business strategy involves selling existing residential home inventory. Achieving our strategy is critical in order to achieve cash flow sufficient to maintain operations. Any condition that would deny, limit or delay our ability to sell residential inventory units will impact the number of employees available to manage operations. An inability to hire or retain personnel necessary to operate our facilities may adversely affect our ability to achieve our strategy. Maintaining current levels of our business will strain existing management resources and operational, financial and management information systems to the point that they may no longer be adequate to support our operations, requiring us to make significant expenditures in these areas.
Not applicable.
As of December 31, 2008, we owned approximately 149,000 square feet of office and amenity space throughout Florida. In addition, we leased approximately 68,500 square feet of office space in Bonita Springs, Florida, which serves as our corporate headquarters, and approximately 314,200 aggregate square feet of office space in other locations throughout Florida, New York, New Jersey, Connecticut and Virginia, which serve our divisional homebuilding operations and as branch office space for our related real estate services businesses.
Chapter 11 Proceedings On August 4, 2008, WCI and 126 of its subsidiaries (excluding our Watermark real estate brokerage, our WCI Mortgage business and certain other joint ventures in which we are a partner) (the Debtors) filed voluntary petitions for reorganization relief under the provisions of Chapter 11 of the Code in the United States Bankruptcy Court for the District of Delaware (“Bankruptcy Court”) in Wilmington, Case No. 08-11643 (KJC). The list of the Debtors and Tax Identification Numbers is located on the docket for Case No. 08-11643 (KJC) [Docket No. 64] and http://chapter11.epiqsystems.com/wcicommunities. Other litigation The Company and certain of its subsidiaries have been named as defendants in various claims, complaints and other legal actions arising in the normal course of business. In most cases, the lawsuits involving the Company and/or its Debtors, have been stayed as a result of the Company’s Chapter 11 filing.
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Table of ContentsThe Company has received filed claims, letters and phone calls alleging defective drywall. As a consequence of the Company’s Chapter 11 filing, the Company believes that any issues or claims that may relate to Chinese drywall constitute pre-petition claims that are subject to treatment and discharge in the Company’s Chapter 11 plan. The Company was granted permission by the Bankruptcy Court to implement an alternate dispute resolution procedure to liquidate certain pre-petition claims, including any claims relating to alleged defective drywall and to permit recovery from responsible third parties. On February, 24 2009, the Court issued an Order Approving Alternative Dispute Resolution Procedures (ADR Procedure) allowing the Company to implement the ADR Procedure and process claims, including any claims related to alleged defective drywall. The $11 million reserve established by the Company for homes with one or more air conditioning coil replacements (which may or may not be related to Chinese drywall), are pre-petition claims subject to the automatic stay and reflected in the liabilities on the balance sheet that are subject to adjustment, compromise, and modification in the Chapter 11 proceedings. On March 10, 2009, a purported class action lawsuit was filed in the U.S. District Court, Southern District of Florida (Case No. 09-CV-60371), against Knauf Plasterboard, Tianjin Co., Knauf Gips KG, Rothchilt International Ltd., and WCI Communities, Inc. on behalf of all owners who purchased homes in Florida from WCI Communities, Inc. that allegedly contain defective drywall. The plaintiffs voluntarily dismissed their claims against the Company, without prejudice, after the plaintiffs were notified on the Company’s pending Chapter 11 proceeding. In addition, on or about January 23, 2008, an action was filed in the United States District Court for the Southern District of Florida against the Company and its subsidiary, The Resort at Singer Island Properties, Inc. (RSI), on behalf of a purported class of the purchasers of hotel condominium units in The Resort at Singer Island who have entered into rental management agreements with respect to those condominium units. The aggregate purchase price of these units was approximately $138.7 million. The complaint in the action, Mastrella, et al. v. WCI Communities, Inc., et al., alleges that the Company and RSI violated Section 12(a)(1) of the Securities Act of 1933 by not registering the offering of these units with the Securities and Exchange Commission. The complaint seeks rescission of the condominium purchase agreements and rental management agreements. The Company and RSI believe they have meritorious defenses, and intend to vigorously defend the action. These cases have been stayed as a result of the Company’s Chapter 11 filing.
There were no matters submitted to a vote of security holders during the quarter ended December 31, 2008.
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Table of ContentsPART II
Our common stock traded on the New York Stock Exchange (the NYSE) under the symbol WCI until August 4, 2008, when the NYSE suspended trading of our common stock. We did not appeal the suspension. On August 5, 2008, our common stock began trading on the Pink Sheet Electronic Quotation service under the symbol WCIMQ. On August 11, 2008, the NYSE filed with the SEC Form 25, Notification of Removal of Listing and/or Registration under Section 12(b) of the Exchange Act, notifying the SEC of its intention to terminate the listing of our common stock at the opening of business on August 21, 2008. On March 31, 2009, WCI Communities, Inc. (Pink Sheets:WCIMQ) filed Form 15 with the SEC to deregister its common stock under Section 12(g) of the Exchange Act, and suspended the Company’s reporting obligations under Sections 13(a) and 15(d) of the Exchange Act. Upon the filing of Form 15, the Company’s obligation to file periodic and current reports with the SEC, including Forms 10-K, 10-Q and 8-K, was immediately suspended, except for its December 31, 2008 Form 10-K. The Company was eligible to file Form 15 because it determined immediately prior to filing of Form 15 that its common stock was held of record by less than 300 persons. The Form 15 also terminated the Company’s reporting obligation with respect to its notes. The following table sets forth the high and low price of the shares of WCI common stock for the periods indicated as reported on the NYSE and the Pink Sheet Electronic Quotation service.
We have not paid any cash dividends on our common stock to date and expect that, for the foreseeable future, we will not do so. The payment of dividends is within the discretion of our Board of Directors and any decision to pay dividends in the future will depend upon an evaluation of a number of factors, including our earnings, capital requirements, operating and financial condition and any contractual limitations then in effect. In this regard, the indentures governing our outstanding senior subordinated notes contain restrictions on the amount of dividends we may pay on our common stock. In addition, our DIP Agreement restricts the amount of dividends we may pay. As of March 31, 2009, there were approximately 192 record holders of WCI common stock. Please refer to Item 12 of this report and the notes to our consolidated financial statements for a discussion of the shares of WCI common stock that may be issued under existing equity compensation plans, all of which have been approved by shareholders, and a description of our equity incentive plans and the types of grants, in addition to options, that may be made under the plans.
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The following table sets forth our selected historical consolidated financial data for each of the five years in the period ended December 31, 2008. Balance sheet data as of December 31, 2008 and 2007 and statements of operations data for the years ended December 31, 2008, 2007 and 2006 have been derived from our audited consolidated financial statements which are included in Item 8 of this report. The following information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our audited historical consolidated financial statements, including the introductory paragraphs and related notes thereto, appearing in Items 7 and 8 of this report.
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CRITICAL ACCOUNTING POLICIES AND ESTIMATES The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements: Revenue recognition—Traditional Homebuilding. Because the construction cycle for our traditional homes is generally less than one year, we recognize homebuilding revenues when homes close and title to and possession of the property is formally transferred to the buyer. The majority of our homebuilding revenues are received in cash within one or two days subsequent to closing. We include amounts in transit from title companies at the end of each reporting period in cash and cash equivalents. Revenue recognition—Tower Homebuilding. Revenue recognition for multi-family condominiums (tower) residences under construction commences and continues to be recognized on the percentage-of-completion method where the planned construction period is greater than one year and the requirements of Statement of Financial Accounting Standards (SFAS) 66, Accounting for Sale of Real Estate, as described below, are met. Revenue is recorded as a portion of the value of non-cancelable tower unit contracts when (1) construction is beyond a preliminary stage, (2) the buyer is committed to the extent of being unable to require a full refund of its deposits except for non-delivery of the residence, (3) a substantial percentage of residences in the tower are under non-cancelable contracts, (4) collectibility of sales prices are reasonably assured and (5) aggregate sales proceeds and costs can be reasonably estimated. In accordance with paragraph 37 (e) of SFAS 66, the ability to estimate aggregate sales proceeds of a condominium project is required in order to use the percentage-of-completion method of revenue and profit recognition. If this criterion is not met, proceeds shall be accounted for on the deposit method. We believe if changes, such as a rapid decline in the market, indicate that we can no longer estimate the sales proceeds or costs of a condominium project, (e.g., additional incentives will be required, the amount of which cannot be estimated), then we should no longer apply the percentage-of-completion method and any previously recognized profit should be evaluated for realizability based on evaluation of collectibility and impairment of the project. Under the percentage-of-completion method, revenue is recognized in proportion to the percentage of total costs incurred in relation to estimated total costs. We collect deposits at a level that we believe is significant enough to ensure the collectibility of the full purchase price when the units are delivered at their completion. After entering into a sales agreement, historically our tower residence purchasers typically provide us with cash payments of approximately 10% to 20% of the total purchase price of the tower residence. Actual revenues and costs to complete building construction in the future could differ from our current estimates. If our estimates of tower revenues and development costs are significantly different from actual amounts, then our revenues, related cumulative profits and costs of sales may be revised in the period that estimates change. In November 2006, the Financial Accounting Standards Board ratified Emerging Issues Task Force Issue No. 06-8, Applicability of a Buyer’s Continuing Investment under FASB Statement No. 66 for Sales of Condominiums (EITF 06-8). EITF 06-8 provides guidance in assessing the collectibility of the sales price which is required in order to recognize
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Table of Contentsprofit under the percentage-of-completion method pursuant to SFAS 66. See Note 2 to the consolidated financial statements under Item 8 of this document for further discussion concerning the application of paragraph 37 (e) and the impact to 2007 and for further discussion of the future application of EITF 06-8. Contracts receivable. Amounts due under tower sales contracts, to the extent recognized as revenue under the percentage-of-completion method, are recorded as contracts receivable. We review the collectibility of contracts receivable on a quarterly basis and provide for estimated losses due to potential customer defaults. The majority of our tower buildings are registered with the Department of Housing and Urban Development (HUD) under the Interstate Land Sales Full Disclosure Act. The sales agreement is subject to a short rescission period, after which, the agreement becomes binding on both parties and the cash deposits become partially or entirely non-refundable, subject to HUD regulations. In those cases where we register a tower building with HUD, in the event a purchaser defaults after 15% or more of the respective purchaser’s total purchase price has been paid under the sales agreement, we are only entitled to retain the deposits in an amount equal to 15% of the total purchase price of the residence. Although after completion of a building, we may elect to deregister with HUD to allow us to retain the full deposit in the event of purchaser default. In addition, certain states in which we are constructing towers may be more restrictive on the retention of customer deposits in the event of purchaser defaults under the sales agreement, including New Jersey which has a limit of 10% plus 100% of purchase price amounts collected toward customer-selected options. Revenue recognition—Amenity Membership and Operations. Revenues from amenity operations include the sale of equity memberships and marina slips, non-equity memberships, billed membership dues and fees for services provided. Equity membership and marina slip sales are recognized at the time of closing. Equity membership sales are initially recorded using the deposit or cost recovery methods of accounting. Revenue recognition for each equity club program is reevaluated on a periodic basis based upon changes in circumstances. If no material contingencies exist, such as a developer rescission clause, and if we can demonstrate that we are likely to recover proceeds in excess of remaining carrying value, the full accrual method is then applied. Non-equity membership initiation fees represent initial payments for rights to use the amenity facilities. The non-equity membership initiation fees are deferred and amortized to amenity membership revenues over 20 years, which represents the estimated average depreciable life of the amenity facilities. Dues are billed on a quarterly or annual basis in advance and recorded as deferred revenue and then recognized as revenue ratably over the term of the membership year. Revenues for services are recorded when the service is provided. Real estate inventories and cost of sales. In accordance with SFAS 67, Accounting for Costs and Initial Rental Operations for Real Estate Projects, real estate inventories including land, common development costs, amenities to be sold or transferred in connection with the sale of individual units and estimates for costs to complete, are allocated to each parcel or lot based on the estimated relative sales value of each parcel or lot, as compared to the sales value of the total project, while site specific development costs are allocated directly to the benefited land. For amenities to be sold separately or retained by us, capitalized costs in excess of its estimated fair value as of the substantial completion date are allocated as common costs to each parcel or lot benefited based on estimated relative sales value. We use the specific identification method for the purpose of accumulating costs associated with home and tower construction. We allocate and relieve all applicable land acquisition, land development and related costs (both incurred and estimated to be incurred) to cost of sales for homes closed based upon the relative sales values of homes expected to be closed in each project. When a home is closed, we usually have not yet paid all incurred costs necessary to complete the home. Each month, we record as a liability and as a charge to cost of sales the amount we estimate to have incurred related to completed homes that have been closed. Actual costs to complete in the future could differ from our current estimated amounts. Stock—based compensation expense. Prior to January 1, 2006, we accounted for stock option awards granted in accordance with the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB 25) and related Interpretations, as permitted by SFAS No. 123, Accounting for Stock-Based Compensation, (SFAS 123). Share-based employee compensation expense
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Table of Contentsrelated to stock options was not recognized in our consolidated statements of income prior to January 1, 2006, as all stock options granted had an exercise price equal to or greater than the market value of the common stock on the date of the grant. Effective January 1, 2006, we adopted the provisions of SFAS 123R using the modified-prospective-transition method. Under this transition method, compensation expense recognized during 2006 included: (a) compensation expense for all share-based awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all share-based awards granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. In accordance with the modified-prospective-transition method, results for prior periods have not been restated. The calculation of share-based employee compensation expense involves estimates that require management’s judgments. These estimates include the fair value of each of our stock option awards, which is estimated on the date of grant using a lattice option-pricing model as discussed in the Notes to our condensed consolidated financial statements included under Item 8 of this document. The fair value of our stock option awards, which are subject to graded vesting, is expensed on a straight-line basis over the vesting period of the options. For 2005 and 2006 stock option awards expected volatility is based on historical volatility of our stock. For stock option awards prior to 2005, expected volatility was based on an average of our homebuilding peer group. The risk-free rate for periods within the contractual life of the option is based on the yield curve of a zero-coupon U.S. Treasury bond on the date of option measurement with a maturity equal to the expected term of the option granted. We use historical data to estimate stock option exercises and forfeitures within our valuation model. The expected term of stock option awards granted is derived primarily from historical exercise experience under our share-based payment plans and represents the period of time that stock option awards granted are expected to be outstanding. Warranty costs. We establish warranty reserves for traditional and tower residences at the time we recognize revenue by charging cost of sales and crediting a warranty liability. The warranty reserves are estimated by management to be adequate to cover expected warranty-related costs for materials and labor required under our warranty obligation periods. We generally provide our single- and multi-family home buyers with a one to three year limited warranty, respectively, for all materials and labor and a ten year warranty for certain structural defects. We generally provide our tower home buyers a three year warranty for the unit and common elements of the tower. Our warranty cost accruals are based upon our historical warranty cost experience in each market in which we operate and adjust the accruals as appropriate to reflect qualitative risks associated with the type of homes we build and the geographic areas in which we build them. Actual future warranty costs could differ from our currently estimated amounts. Capitalized interest and real estate taxes. We capitalize interest, up to an amount not to exceed total interest incurred, and real estate taxes on parcels, lots, homes, towers and amenity facilities (the “Projects”) while under active development. The capitalization period ends when the asset is substantially complete and ready for its intended use or sale. The amount of interest capitalized in an accounting period is determined by applying the Company’s weighted average annualized interest rate to the amount of accumulated expenditures related to the Projects under development during the period. For homebuilding projects, land sales and amenities conveyed through equity membership sales, capitalized interest and real estate taxes are apportioned on relative sales value and relieved to cost of sales, respectively, with each home closing, land sale or membership sold. For tower buildings, capitalized interest and real estate taxes are amortized to cost of sales under the percentage-of-completion method. For owned and operated assets, capitalized interest and real estate taxes are included in the base cost of the assets and depreciated. If the various underlying estimates related to interest capitalization and amortization are revised, then more or less interest and real estate taxes would be capitalized and/or allocated and relieved to cost of sales. Community development district obligations. In connection with certain real estate development activities, bond financing is utilized in many of our communities to construct on-site and off-site infrastructure improvements. Some bonds are repaid directly by us while other bonds only require us to pay non-ad valorem
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Table of Contentsassessments related to lots not yet delivered to residents. We also guarantee district shortfalls under certain bond debt service agreements. In accordance with EITF 91-10, Accounting for Special Assessments and Tax Increment Financing Entities, we annually estimate the amount of bond obligations that we may be required to fund in the future. If our estimates of the amount of bond obligations that we may be required to fund are significantly different from actual amounts funded, our real estate inventories and costs of sales may be revised on a prospective basis. Impairment of long-lived assets held for use. Inventory considered held for use is stated at the lower of cost or fair value in accordance with SFAS 144, “Accounting for the Impairment or Disposal of Long Lived Assets” (SFAS No. 144). We record valuation adjustments on land inventory and related communities under development (including tower projects), and amenities considered held and used (classified as property, plant and equipment), when the carrying amount exceeds its fair value. An impairment loss shall be recognized only if the carrying amount of the asset is not recoverable and exceeds its fair value. The carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. An impairment loss shall be measured as the amount by which the carrying amount exceeds its fair value.
Our determination of fair value requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flows. The discount rate used in determining each community’s fair value depends on the stage of development, location and other specific factors that increase or decrease the risks associated with the estimated cash flows. The
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Table of Contentsdiscount rates that we used during the periods in 2006-2007 in the determination of fair values ranged from 12% to 18%. The discount rates that we used during the year ended December 31, 2008 in the determination of fair values ranged from 20% to 22%.
Impairment of long-lived assets to be disposed of. Inventory considered held for sale is stated at the lower of cost or fair value, less costs to sell in accordance with SFAS 144. We record valuation adjustments on completed inventories of tower units and traditional homes, and investments in amenities when the cost exceeds fair value, less costs to sell. Our estimated selling costs are based on recent experience, which ranges from 5% to 7% of sales prices and includes selling commissions, sales, marketing and closing costs. Completed Inventory. When the profitability of our completed traditional homes and tower units deteriorates, the sales pace significantly declines or some other factor indicates a possible impairment in the recoverability of the assets, we further estimate the assets’ fair values. Such assets are considered held for sale and the assets’ fair values are determined primarily by discounting the estimated future cash flows related to the asset. In estimating the cash flows for completed homes and tower units, we use various estimates such as (a) expected sales pace to absorb the number of units based upon economic conditions that may have either a short-term or long-term impact on the market in which the units are located, competition within the market, historical sales rates of the units within the specific community or the estimated impact of our pricing reductions and sales incentives; and (b) expected net sales prices in the near-term based upon current pricing estimates, as well as estimated increases in future sales prices based upon historical sales prices of the units within the specific community or in similar communities owned by us or historical sales prices of similar product offerings in the market. Our determination of fair value requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with selling the assets and related estimated cash flows. The discount rates that we used during the periods in 2006-2007 in the determination of fair values ranged from 8% to 12%. The discount rates that we used during the year ended December 31, 2008 in the determination of fair values ranged from 15% to 18%. Investments in Amenities. When the underlying recreational amenity is substantially complete and available for its intended use, we consider the asset held for sale. When the profitability of our equity club membership sales deteriorates, the sales pace significantly declines or some other factor indicates a possible impairment in the recoverability of the recreational amenity assets, the assets’ fair values are determined primarily by discounting the estimated future cash flows specifically related to membership sales and asset development expenditures. In estimating the cash flows, we use various estimates such as (a) sales pace to absorb the number of memberships based upon economic conditions that may have either a short-term or long-term impact on the market in which the assets are located, competition within the market, historical sales rates of the memberships for the specific amenity or the estimated impact of our pricing reductions and sales incentives; and (b) net sales prices in the near-term based upon current pricing estimates, as well as estimated changes in future
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Table of Contentssales prices based upon historical sales prices of the memberships for the specific recreational amenity or in similar recreational amenities owned by us or historical sales prices of similar membership offerings in the market. Our determination of fair value requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with selling the memberships and related estimated cash flows. The discount rates that we used during the periods 2006-2007 in the determination of fair values ranged from 10% to 14%. The discount rates that we used during the year ended December 31, 2008 in the determination of fair values ranged from 15% to 18%. Due to uncertainties used in the estimation process, the significant volatility in demand for new housing and luxury golf and marina memberships, and the long life cycles of many of our communities, actual results could significantly differ from our estimates. Goodwill. Goodwill represents the excess of the purchase price paid over the fair value of the net assets acquired in business combinations. Evaluating goodwill for impairment involves the determination of the fair value of our reporting units in which we have recorded goodwill as well as determining the carrying value of the reporting unit. A reporting unit is a component of an operating segment for which discrete financial information is available and reviewed by management on a regular basis. Inherent in the determination of fair value of our reporting units are certain estimates and judgments, including the interpretation of current economic indicators and market valuations as well as our strategic plans with regard to our operations. We review goodwill annually (or whenever indicators of impairment exist) for impairment in accordance with SFAS No. 142, Goodwill and Other Intangible Assets, (SFAS 142). We typically use an income approach to determine the fair value of our reporting units when performing our impairment test of goodwill in accordance with SFAS 142. The income approach establishes fair value by methods which discount or capitalize earnings and/or cash flow by a discount or capitalization rate that reflects market rate of return expectations, market conditions and the risk of the relative investment. If the fair value of a reporting unit is less than the carrying value of the reporting unit, an impairment would be recorded. In determining the fair value of our reporting units under the income approach, our expected cash flows are affected by various assumptions. The most significant assumptions affecting our expected cash flows are the discount rate, projected revenue growth rate and costs of development. Litigation. The Company and certain of its subsidiaries have been named as defendants in various claims, complaints and other legal actions arising in the normal course of business. In addition, the Company has experienced a significant increase in the number of rescission claims and legal actions brought by resident contract purchasers alleging that various factors give them rescission rights under the Interstate Land Sales Act and other federal and state laws. Although the Company intends to vigorously contest these claims, there can be no assurance that the Company will prevail in each claim. However, future results of operations for any particular quarterly or annual period could be materially affected by changes in our estimates and assumptions related to these proceedings, or due to the ultimate resolution of the litigation. Deferred Income Tax. Deferred income taxes or income tax benefits are provided for temporary differences between amounts recorded for financial reporting and for income tax purposes. In accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS 109), we periodically evaluate our deferred tax assets to determine if valuation allowances are required. SFAS 109 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. See notes to the consolidated financial statements under Item 8 of this document for further discussion. Business Environment Chapter 11 Reorganization On August 4, 2008, WCI and 126 of its subsidiaries (excluding our Watermark real estate brokerage, our WCI Mortgage business and certain other joint ventures in which we are a partner) (the “Debtors”) filed voluntary petitions for reorganization relief under the provisions of Chapter 11 of the Code in the United States Bankruptcy
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Table of ContentsCourt for the District of Delaware in Wilmington, Case No. 08-11643 (KJC). The list of the Debtors and Tax Identification Numbers is located on the docket for Case No. 08-11643 (KJC) [Docket No. 64] and http://chapter11.epiqsystems.com/wcicommunities. We continue to operate our businesses and manage our properties as debtors and debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Code and orders of the Bankruptcy Court. As part of the “first day” relief, we obtained Bankruptcy Court approval to, among other things, continue to pay critical vendors and vendors with lien rights, meet our pre-petition payroll obligations, pay deficit funding obligations to our various community associations and clubs, maintain our cash management systems, sell homes free and clear of liens, pay our taxes, continue to provide employee benefits and maintain our insurance programs. Certain of these payment obligations are subject to monetary limits without specific approval for each transaction. The filing of the Chapter 11 petitions triggered repayment obligations under a number of our debt instruments and agreements. As a result, all of our debt obligations became immediately payable. We believe that any efforts to enforce the payment obligations are stayed as a result of the Chapter 11 filings. Process for Plan of Reorganization. In order to exit Chapter 11 successfully, the Debtors will need to propose, and obtain confirmation by the Bankruptcy Court of, a plan of reorganization that satisfies the requirements of the Code. A plan of reorganization would resolve, among other things, the Debtors’ pre-petition obligations, set forth the revised capital structure of the newly reorganized entity and provide for corporate governance subsequent to exit from bankruptcy. Currently we have the exclusive right to file a Chapter 11 plan or plans prior to April 30, 2009 and the exclusive right to solicit acceptance thereof until June 1, 2009. Pursuant to Section 1121 of the Code, the exclusivity periods may be expanded or reduced by the Bankruptcy Court, but in no event can the exclusivity periods to file and solicit acceptance of a plan or plans of reorganization be extended beyond 18 months and 20 months, respectively. As a result of our Chapter 11 proceedings and other matters described herein, including uncertainties related to the fact that we have not yet had time to complete and obtain confirmation of a plan or plans of reorganization, there is substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern, including our ability to meet our ongoing operational obligations, is dependent upon, among other things:
These challenges are in addition to those operational and competitive challenges that we face in connection with our business. In conjunction with our advisors, we are implementing strategies to aid our liquidity and our ability to continue as a going concern. However, such efforts may not be successful. We have taken and will continue to take aggressive actions to maximize cash receipts and minimize cash expenditures with the understanding that certain of these actions may make us less able to take advantage of future improvements in the homebuilding market. We continue to take steps to reduce our general and administrative expenses by streamlining activities and increasing efficiencies, which have led and will continue to lead to reductions in the workforce. However, much of our efforts to reduce general and administrative
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Table of Contentsexpenses are being offset by professional and consulting fees associated with our Chapter 11 proceedings. We have and will continue to analyze each community based on anticipated sales absorption rates, net cash flows and financial returns taking into consideration current market factors in the homebuilding industry. In order to generate cash and reduce our inventory to levels consistent with our business plan, we have taken and will continue to take the following actions, to the extent possible given the limitations resulting from our Chapter 11 proceedings:
BUSINESS STRATEGY During the first quarter of 2009, the Company continued its cost reduction initiatives including a significant reduction of overhead, consolidation of operating divisions, closing of sales offices and rejection of leases/ contracts through the Bankruptcy Code, and further concentrated its efforts on selling speculative inventory and non-core assets. In addition, due to the continuing deterioration of the housing industry nationally and in Florida in particular, and the challenging economic conditions and lack of visibility in the marketplace (including unpredictability in projecting pricing trends and housing recovery timeframes), the Company adopted a plan in early 2009 to currently suspend all new homebuilding construction activities except under limited circumstances, subject however, to completion of existing homes under construction or subject to pending purchase contracts. This plan also contemplates the continuation of the sale of our speculative inventory and the ongoing maintenance of our communities, amenities operations and real estate services. As part of the Company’s overall strategy to explore alternatives to emerge from bankruptcy in an expeditious manner, the Company also engaged its financial/restructuring advisor to assist with a comprehensive marketing process for the sale or reorganization of the Company, as well as the disposition of certain assets. The Company continues to explore strategic alternatives. RESULTS OF OPERATIONS Overview
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Table of ContentsReduced demand for our products and services experienced by each of our principal lines of business, lower sales prices, increased use of incentives and discounts, and asset impairment and land option abandonment charges contributed to significant decreases in revenue and gross margin for the year ended December 31, 2008. For the year ended December 31, 2008, we recorded 805 gross orders, for combined traditional and tower homebuilding with an aggregate value of $486.0 million compared to 900 gross orders with an aggregate value of $599.3 million for the same period a year ago. For the year ended December 31, 2008, we recorded real estate inventory impairment losses of approximately $601.0 million, recorded $36.6 million of property and equipment impairment losses, recorded goodwill impairment charges of approximately $1.3 million, recorded an impairment charge of approximately $4.5 million related to investments in two joint ventures, and recorded $16.3 million in lot option and land purchase abandonment charges. For the year ended December 31, 2007, we recorded real estate impairment losses of approximately $319.0 million, recorded goodwill impairment charges of approximately $59.5 million, recorded an impairment charge of approximately $10.7 million for an investment in a joint venture, and recorded $22.9 million in lot option and land purchase abandonment charges. The tax benefit as a percentage of loss from continuing operations before income taxes for the year ended December 31, 2008 was approximately 2.0%. This was almost entirely due to recording valuation allowance for our deferred tax assets during 2008. We believe the challenging market conditions are attributable to a national softening in demand for new homes as well as an oversupply of homes available for sale, particularly in our Florida market. We believe the decline in demand for our new homes is related to concerns of prospective home buyers regarding the direction of home prices, interest rates, availability of acceptable financing and their inability to sell their current homes. In addition to the traditional homebuyer, it appears that speculators and investors have significantly reduced their participation in the new home market. Many of our markets have been impacted by an overall increase in the supply of homes available for sale, as speculators and investors attempt to sell the homes they previously purchased or cancel contracts for homes under construction. High cancellation rates reported by other builders, and the increased cancellation rates we have experienced, are adding to the supply of homes in the marketplace. The weakness in the housing market has accelerated during 2008 as a result of the factors above, including increased foreclosures, lack of consumer confidence, significant disruptions in the broader financial markets and severe constraints in the credit markets. The continuing deterioration of conditions in the markets in which we operate has had, and likely will continue to have for an extended period of time, a negative impact on our liquidity. Some of the factors which have adversely affected us include, but are not limited to, declines in new home orders; increased cancellations; defaults and rescission claims; increased use of incentives and discounts; reduced margins; significant tower project delays and increased interest and insurance costs; general contractor financial instability; impairments to our assets; and credit rating downgrades. All of these factors, and others which may arise in the future, have adversely impacted and will likely continue to adversely impact our financial condition.
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Table of ContentsHomebuilding Traditional homebuilding
Year ended December 31, 2008 compared to year ended December 31, 2007 Traditional home revenues decreased 59.4% for the year ended December 31, 2008 compared to the year ended December 31, 2007 due primarily to a 46.6% decline in home deliveries and a 24.1% decrease in average selling price per home closed. We closed 423 units in our Florida market for the year ended December 31, 2008 compared to 671 units in the same period last year. The Northeast U.S. and Mid-Atlantic U.S. markets closed a combined 107 units for the year ended December 31, 2008 compared to 321 units in the same period last year. The Northeast U.S. market experienced a 67.1% decrease in home deliveries primarily as a result of one community where deliveries increased to 155 units in the twelve months ended December 31, 2007 due to construction delays in prior periods that pushed deliveries into 2007. The decreases in the average selling price per home closed for the year ended December 31, 2008 reflect the overall challenging market conditions, our focus on selling existing unsold completed homes, and the change in the mix of homes closed. Lot revenues decreased to $6.8 million from $16.4 million for the year ended December 31, 2008. From time to time, we sell certain lots for custom homes directly to prospective residents or custom homebuilders as part of our strategy to serve a broad range of customers. Lot sales are not a primary driver of the traditional homebuilding segment and therefore will fluctuate from time to time. The decreases in home gross margin for the year ended December 31, 2008 were due to lower selling prices, continued use of discounts and incentives and the recording of asset impairment losses. Sales discounts and incentives for the year ended December 31, 2008 totaled approximately $74.2 million compared to $119.5 million for the same period last year. Home gross margin for the year ended December 31, 2008 was favorably impacted by $5.1 million in forfeited deposits from contract cancellations compared to $12.3 million for the same period in 2007. We continue to focus on selling finished homebuilding product by lowering sales prices in our communities to meet the competitive market and to generate cash flow. In addition, we re-evaluated our undiscounted expected cash flows related to our communities under development. As a result we recorded $254.2 million of asset impairment and lot option abandonment losses for the year ended December 31, 2008, compared to $149.6
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Table of Contentsmillion for the year ended December 31, 2007. If conditions in the homebuilding industry worsen in the future, we may be required to evaluate additional homes and projects which may result in additional impairment charges and such charges could be significant. The following table presents traditional homebuilding impairment and lot option abandonment charges by geographic location:
Contract values of new orders decreased 35.8% for the year ended December 31, 2008 compared to the same period in 2007, primarily due to the decline in the number of new orders and the decrease in average selling price. For the year ended December 31, 2008 our Florida, Northeast U.S and Mid-Atlantic U.S markets had net new order declines of 1, 140 and 25 units, respectively, compared to the same period in 2007. The 80.0% decrease in backlog contract values reflects an 81.1% decrease in backlog units offset with a 5.5% increase in the average sales price of homes under contract to $637,000 in 2008 compared to $604,000 in 2007. The decline in backlog contract values and units can be attributed to the weak homebuilding sales experienced in most of our markets and our cancellation rate. Our cancellation rate on traditional homes for the year ended December 31, 2008 was approximately 49.4%, of contracts signed, compared to 50.0% for the same period in 2007. Based on recent cancellation experience, we do not expect to completely deliver the 60 units in backlog at December 31, 2008. We employ a wide range of sales incentives and discounts to market our homes to prospective buyers, particularly in these difficult market conditions. These incentives are an important aspect of our sales and marketing of homes, and we have relied heavily on them during this sustained downturn in the housing industry. Without the use of these marketing incentives and discounts, our ability to sell homes would be adversely impacted. Year ended December 31, 2007 compared to year ended December 31, 2006 Traditional home revenues decreased 34.9% for the year ended December 31, 2007 due primarily to the 37.1% decline in home deliveries, partially offset by a 3.7% increase in average selling price per home closed. In 2007, we closed 671 units in our Florida market compared to 1,312 in 2006. The Northeast U.S. and Mid-Atlantic U.S. markets closed 255 units and 66 units for the year compared to 152 units and 113 in 2006. The Northeast U.S. market experienced a 67.8% increase in home deliveries in 2007, primarily as a result of one community where deliveries increased to 155 units due to construction delays in prior periods that pushed
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Table of Contentsdeliveries into 2007. The increase in the average selling price per home closed for the year ended December 31, 2007 was positively impacted by a 10.1% increase contributed by the Florida market, as well as the $1.2 million average price achieved by our Mid-Atlantic U.S. market. The Florida and Northeast U.S. markets achieved average selling prices per home closed of $709,000 and $553,000 for the year ended December 31, 2007, respectively. During 2006, Florida, Northeast U.S and Mid-Atlantic U.S achieved average selling prices per home closed of $644,000, $562,000 and $1.2 million, respectively. Lot revenues decreased $21.6 million for the year. From time to time, we sell certain lots for custom homes directly to prospective residents or custom homebuilders as part of our strategy to serve a broad range of customers. Lot sales are not a primary strategy of the traditional homebuilding segment and therefore will fluctuate from time to time. The decrease in the home gross margin percentage to (7.2%) from 10.6% in 2006 was primarily due to increased utilization of sales discounts, incentives, and the recording of impairment losses on inventories, and charges related to lot option and land purchase abandonments. Impairment charges and charges related to lot option and land purchase abandonments included in cost of sales reduced gross margin by 2,150 basis points in 2007 and 1,120 basis points in 2006. Sales discounts and incentives for the year ended December 31, 2007 totaled approximately $119.5 million compared to approximately $58.3 million in 2006. Home gross margin for 2007 was favorably impacted by $12.3 million in forfeited deposits from contract cancellations compared to $5.7 million in 2006. The Florida, Northeast U.S. and Mid-Atlantic U.S. markets, achieved gross margins of (11.4%), (2.3%) and 9.5%, respectively for the year ended December 31, 2007 compared to 10%, 9.5% and 15.2% in 2006, respectively. We recorded approximately $139.0 million of asset impairment losses for the year ended December 31, 2007, compared to $93.7 in 2006. During 2007, due to the unfavorable residential real estate market, we did not enter into any new land and lot contracts. In addition, we re-evaluated our traditional homebuilding land and lots under contract considering the significant changes in economic and market conditions. For the year ended December 31, 2007, we recorded write-offs of approximately $10.7 million in forfeited deposits, pre-development costs and estimated future payments associated with the termination or probable termination of land and lot option contracts. For the year ended December 31, 2006, the write-offs totaled approximately $26.3 million. If conditions in the homebuilding industry worsen in the future, we may be required to evaluate additional projects for potential impairment which may result in additional impairment charges and such charges could be significant. Contract values of net new orders decreased 65.2%, primarily due to the decline in the number of gross new orders and the effects of cancellations and defaults. For 2007, our Florida, Mid-Atlantic and Northeast U.S. markets had gross new order declines of 269, 118 and 4 units, respectively, compared to 2006. The 71.9% decrease in backlog contract values reflects a 63.6% decrease in backlog units combined with a 23.1% decrease in the average sales price of homes under contract to $604,000 in 2007 compared to $785,000 in 2006. The decrease in average sales price of homes under contract can be attributed to sales discounts and a shift in product mix. The decline in backlog contract values and units can be attributed to the weak homebuilding sales experienced in most of our markets and an increase in our cancellation rate. Our cancellation rate on traditional homes for 2007 was approximately 49.5% of gross new contracts signed, as compared to 40.5% in 2006. Based on recent cancellation experience, we do not expect to completely deliver all of the 317 units in backlog at December 31, 2007. During 2007, we used significant incentives and discounts to sell units. We employ a wide range of sales incentives and discounts to market our homes to prospective buyers, particularly in these difficult market conditions. These incentives are an important aspect of our sales and marketing of homes, and we rely on them more heavily in promoting communities experiencing weaker demand or to promote the sale of completed unsold homes. Without the use of these marketing incentives and discounts, our ability to sell homes would be adversely impacted.
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Table of ContentsTower homebuilding
Year ended December 31, 2008 compared to year ended December 31, 2007 Tower revenues were favorably impacted by $11.1 million in forfeited deposits for the year ended December 31, 2008 compared to $21.7 million for the year ended December 31, 2007. The significant reduction of towers under construction recognizing revenue during the year ended December 31, 2008 as compared to 2007, and the reversal of revenue due to tower unit defaults contributed to the decline in revenues. One tower was under construction and recognizing revenue for the year ended December 31, 2008 compared to 11 towers for 2007. During the year ended December 31, 2008, we recorded 107 defaulted contracts that resulted in the reversal of approximately $119.3 million in revenue compared to 211 defaulted contracts and the reversal of $231.9 million in revenue in the same period of 2007. In addition, during the year ended December 31, 2008, we recorded 107 defaulted contracts, related to one of our tower projects in Florida. These defaults did not impact our tower revenue or gross margin since we had previously ceased using percentage-of-completion accounting during the fourth quarter of 2007. The twelve months ended December 31, 2008, was affected by the rescission of 24 contracts at The Watermark in connection with the previously disclosed agreement with the State of New Jersey Department of Community Affairs. The impact was a reversal of approximately $27.1 million of revenue and $4.2 million of gross margin, plus the return of approximately $5.4 million in deposits. During the year ended December 31, 2008, we recorded revenue of approximately $166.3 million in connection with the closing of 203 units from our inventory of completed and unsold tower units. For the year ended December 31, 2008, tower gross margin was impacted by $321.1 million of land option abandonment charges and asset impairment losses. In addition, for the year ended December 31, 2008, gross margin was negatively impacted by approximately $7.9 million in costs associated with the hotel operations of our tower segment. All towers under construction were completed at June 30, 2008. For the year ended December 31, 2007, tower gross margin was impacted by several changes in estimated revenues and costs, including (1) a $11.2 million increase to the contracts receivable default reserve that was required to absorb the effect of the 211 defaulted contracts and to update the balance of the reserve to reflect expected future defaults, (2) a $7.9 million increase in interest costs associated with increased tower construction cycle times, (3) a $5.9 million increase in insurance costs, (4) a $38.4 million increase in tower construction costs, incentives and sales discounts and other
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Table of Contentscosts and, (5) impairment losses of approximately $159.2 million related to certain completed tower units. The changes in estimates of tower construction costs are accounted for on a cumulative basis in the period that the change occurs. Future gross margins in towers currently under construction may be materially impacted by any additional changes in estimates. The following table presents tower homebuilding impairment and land option abandonment charges by geographic location:
For the year ended December 31, 2008, we recorded 265 gross new orders with a contract value of approximately $220.7 million offset by defaults and cancellations of 283 contracts with a contract value of approximately $324.1 million. Included in the 283 cancellations and defaults were 107 defaults, with a contract value of approximately $132.7 million, related to one of our tower projects in Florida. Year ended December 31, 2007 compared to year ended December 31, 2006 Tower revenues recognized using the percentage-of-completion method decreased $716.3 million. Tower revenues were favorably impacted in 2007 by $21.7 million in forfeited deposit income compared to $4.8 million in 2006. The decline in tower unit sales in buildings under construction, fewer towers under construction recognizing revenue, and slower construction cycles contributed to the decline in percentage-of-completion revenues. Eleven towers with a total sellout value of $1.5 billion were under construction and recognizing revenue during the year ended December 31, 2007 compared to 24 towers with a total sellout value of $2.4 billion in 2006. During 2007, we recorded 211 defaulted contracts that resulted in the reversal of approximately $231.9 million of revenue compared to 46 defaulted contracts and the reversal of approximately $46.5 million of revenue in 2006. The impact to gross margin was charged against the contracts receivable default reserve. For the year ended December 31, 2007, tower gross margin was impacted by several changes in estimated revenues and costs, including (1) a $11.2 million increase to the contracts receivable default reserve that was required to absorb the effect of the 211 defaulted contracts and to update the balance of the reserve to reflect expected future defaults, (2) a $7.9 million increase in interest costs associated with increased tower construction cycle times, (3) a $5.9 million increase in insurance costs, (4) a $26.6 million increase in tower construction costs, incentives and sales discounts and other costs, (5) a $38.4 million reserve applied to the cumulative gross margin recognized for one of our uncompleted tower projects, (6) impairment losses of approximately $159.2 million related to certain completed tower units, one uncompleted tower project and undeveloped tower land sites
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Table of Contentsand, (7) write-offs of approximately $11.7 million in forfeited deposits, pre-development costs and estimated future payments associated with the termination or probable termination of land and lot option contracts. The changes in estimates of tower construction costs are accounted for on a cumulative basis in the period that the change occurs. Future gross margins in towers currently under construction may be materially impacted by any additional changes in estimates. During the year ended December 31, 2007 one of our tower projects continued use of the percentage-of-completion. While the general real estate market, and specifically the Florida tower market, has deteriorated during the past two years, we determined that we had the ability to reasonably estimate the aggregate sales proceeds and costs of the tower project which supported the use of the percentage-of-completion method of revenue and profit recognition though September 2007. We ceased the future use of percentage-of-completion accounting as of October 1, 2007, reserved 100% of the previously recognized cumulative profit totaling $38.4 million, and reverted to the deposit method of accounting. The accounting for units at closing will be determined by the facts and circumstances at that time ranging from the cost recovery method, if the collection of sales proceeds is not reasonably assured (paragraph 35 of SFAS 66) to full accrual method if all conditions of paragraph 5 of SFAS 66 are met. We recorded approximately $159.2 million of asset impairment losses for the year ended December 31, 2007, compared to none in 2006. During 2007, due to the unfavorable residential real estate market, we did not enter into any new land and lot contracts. In addition, we re-evaluated our tower homebuilding land under contract considering the significant changes in economic and market conditions. For the year ended December 31, 2007, we recorded write-offs of approximately $11.7 million in forfeited deposits, pre-development costs and estimated future payments associated with the termination or probable termination of land and lot option contracts. For the year ended December 31, 2006, the write-offs totaled approximately $0.6 million. For the year ended December 31, 2007, we recorded 31 gross new orders with a contract value of approximately $32.3 million offset by the default of 211 contracts with a contract value of approximately $231.9 million. Similar to the traditional homebuilding division, our tower division experienced a significant decline in gross new orders, partly due to the increased supply of existing tower units for sale on the market in Florida, as well as reduced participation in the new home market by investors and speculators. The 91.1% decrease in backlog contract values was due to the completion of towers combined with no new towers under construction. We have 2 towers under construction at December 31, 2007. Real estate services
Year ended December 31, 2008 compared to year ended December 31, 2007 Real estate services revenues for the year ended December 31, 2008, including real estate brokerage and title operations, decreased 21.1%. The decrease in revenue is due to the decrease in the average sales price per transaction offset by an increase in brokerage transaction volume. During the year ended December 31, 2008, Prudential Florida WCI Reality brokerage transaction volume increased 6.2% to 6,653 closings from 6,262 closings in 2007. The average sales price per transaction decreased 24.1% to $330 from $440 in 2007. The decrease in gross margin percentage for the year ended December 31,
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Table of Contents2008, was primarily due to the decrease in revenue without a proportional decrease in fixed overhead cost associated with Prudential Florida WCI Realty partially offset by the reduced overhead contributed by the title operations. Year ended December 31, 2007 compared to year ended December 31, 2006 Real estate services revenues, including real estate brokerage and title operations, for the year ended December 31, 2007 decreased 16.1% primarily due to a decrease in the volume of transactions associated with our Prudential Florida WCI Realty brokerage operations and the sale of our mortgage banking operations in June 2006. During 2007, Prudential Florida WCI Realty brokerage transaction volume decreased 20.1% to 6,262 closings from 7,842 in 2006. The decrease in the number of transactions is primarily due to the decline in demand for homes in the Florida market. In June 2006, we sold our mortgage banking operations, formerly operated under the business name of Financial Resources Group, Inc., to a newly formed joint venture, WCI Mortgage LLC. In conjunction with the formation of WCI Mortgage LLC, we sold a 50.1% interest in the newly formed company to Wells Fargo Ventures, LLC. WCI Mortgage LLC began originating and funding mortgage loans for our new home and resale customers, beginning in the third quarter of 2006. WCI Mortgage LLC is accounted for as an unconsolidated joint venture in our financial statements. The decrease in gross margin percentage for both periods was primarily due to the decrease in revenue without a proportional decrease in fixed overhead costs associated with Prudential Florida WCI Realty combined with approximately a $1.6 million write off related to unoccupied leased facilities, partially offset by the reduced overhead and increased revenues contributed by the title operations. Other revenues and cost of sales Amenity membership and operations
Year ended December 31, 2008 compared to year ended December 31, 2007 Total amenity membership and operations revenue increased 1.0% for the year ended December 31, 2008. For the year ended December 31, 2008, we recorded $33.3 million of impairment losses related to our investments in equity club memberships compared to $20.2 million in 2007. For the year ended December 31, 2007, the company recognized $2.1 million of previously deferred revenue related to slip sales at one of our marinas in Florida. In April 2007, we sold a non-golf recreational facility for $47.5 million (excluding closing costs) and recorded a pre-tax gain of approximately $20.1 million. The gain from the sale and the operations has been reflected as discontinued operations in the statements of income. Amenity gross margins continue to be adversely affected by deficits associated with new amenity operations and slow absorption of membership sales. Year ended December 31, 2007 compared to year ended December 31, 2006 Total amenity membership and operations revenue decreased 9.2% due to reduced operating revenue from the sale of two non-golf recreational amenity assets offset by the recognition of $2.1 million of previously deferred revenue related to slip sales at one of our marinas in Florida. During 2007, we sold two non-golf recreational facilities for $55.7 million (excluding closing costs) and recorded a pre-tax gain of approximately $22.4 million. The gain from the sales and the operations has been reflected as discontinued operations. In
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Table of Contentsaddition to the impact of selling the recreational facility and golf club, the revenues for the year ended December 31, 2007 were impacted by the continued decline in luxury membership sales and increased competition in the Florida market. Gross margin was adversely impacted by recording approximately $20.2 million of asset impairment and abandonment charges for the year ended December 31, 2007, compared to $4.5 million in 2006. See “Notes to Consolidated Financial Statements” for additional explanation. Amenity gross margins continue to be adversely affected by deficits associated with new amenity operations and slow absorption of membership sales. Land Sales
Year ended December 31, 2008 compared to year ended December 31, 2007 During 2008, we sold a residential project that resulted in revenue of approximately $79.4 million with gross margin of $6.1. During 2007, we sold 7 commercial parcels located in our Florida market for $18.1 million in revenue with a gross margin of 52.4%. For the year ended December 31, 2008, we recorded $8.8 million of impairment losses on certain land parcels. Land sales are ancillary to our overall operations and are expected to continue in the future, but may significantly fluctuate. Year ended December 31, 2007 compared to year ended December 31, 2006 During 2007, we sold 7 commercial parcels located in our Florida market for $18.1 million in revenue with a gross margin of 52.4%. We sold no commercial parcels in our Northeast U.S. and Mid-Atlantic U.S. Markets. Land sales are ancillary to our overall operations and are expected to continue in the future, but will significantly fluctuate. Other Revenues and Costs of Sales Other revenues and cost of sales includes our property management operations which are an ancillary business primarily providing management services to our communities and other miscellaneous revenues and costs. Other income and expense
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Table of ContentsYear ended December 31, 2008 compared to year ended December 31, 2007 Other income for the year ended December 31, 2008 includes interest income on mortgage notes, customer deposits and other non-operating fee income and expenses, respectively. The hurricane recoveries in 2007 represent the final settlement of our Hurricane Wilma claims. Included in other expense (income) for the year ended December 31, 2008 is approximately $14.6 million of expense related to the write-off of minority interest losses related to a consolidated joint venture in which the company is funding 100% of the operations. Also included in other expense is $4.5 million for the write-off of capitalized costs related to our unsuccessful debt restructuring efforts prior to our filing petitions for reorganization relief. During the year end December 31, 2008, we recorded $36.6 million of asset impairment losses related to certain recreational amenities owned and operated by us and classified as property and equipment. During 2007, we removed the cash flow hedge designation related to an interest rate swap agreement as the result of our bank facility modifications and we are no longer applying hedge accounting. The non-cash mark-to-market resulted in a $929,000 loss for the year ended December 31, 2008. The losses are included in other expense (income). In addition, due to our filing of petitions under Chapter 11 of the Bankruptcy Code, the interest rate swap agreement was terminated by the counterparty and the fair value on the termination date became due and payable as a secured obligation to the counterparty. We incurred $27.8 million of restructuring costs for the year ended December 31, 2008 associated with our reorganization under Chapter 11. Selling, general and administrative expenses (SG&A) including real estate taxes, decreased 29.8% to $131.3 million for the year ended December 31, 2008. General and administrative costs decreased 42.6% for the respective period due to cost reductions in salaries and benefits as compared to the same period in 2007, and the non-recurring costs incurred in 2007 related to our engagement of Goldman Sachs & Co. as our financial advisor to assist us in a thorough review of the Company’s business plans, capital structure and growth prospects, with the objective of enhancing the Company’s value for all of our shareholders. Sales and marketing expenditures decreased 33.0% during the year ended December 31, 2008, primarily due to the reduction in advertising expenditures and sales office overhead reductions. Interest incurred decreased 23.0% for the year ended December 31, 2008. Interest capitalized decreased 80.1% for the year ended December 31, 2008, primarily due to the decrease in real estate inventories under development in each period. As of the filing of the petitions for reorganization, we discontinued accruing interest on pre-petition unsecured debt obligations. Contractual interest for the year ended December 31, 2008 equaled $129.1 million. Year ended December 31, 2007 compared to year ended December 31, 2006 Other income for the year ended December 31, 2007 includes interest income and other non-operating fee income and expenses. The hurricane recoveries represent settlement amounts from our Hurricane Wilma claims. During the year ended December 31, 2007, we recorded approximately $10.7 million of valuation adjustments to our investments in unconsolidated entities in accordance with Accounting Principles Board 18. The Company did not record any adjustments to its investments in unconsolidated entities related to SFAS 144 or APB 18 during 2006 or 2005. These valuation adjustments were calculated based on current market conditions and assumptions made by management, which may differ materially from actual results if market conditions change. During 2007, we removed the cash flow hedge designation related to an interest rate swap agreement as the result of our bank facility modifications and we are no longer applying hedge accounting. The non-cash mark-to-market loss recorded in 2007 was approximately $8.8 million. SG&A expenses including real estate taxes, decreased 3.2% to $187.0 million for the year ended December 31, 2007. General and administrative costs increased 6.5% primarily due to approximately $10 million in costs related to the engagement of Goldman Sachs & Co. and other outside advisors in connection with the
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Table of Contentsproxy contest, in our response to the tender offer, and the company sale process. Sales and marketing expenditures decreased 28.7%, primarily due to the reduction in advertising expenditures and sales office overhead reductions. Interest incurred increased 15.8% for the year ended December 31, 2007 primarily as a result of the average debt balance increasing to $1.9 billion for 2007 as compared to $1.7 billion in the same period last year. Interest capitalized decreased 34.6%, primarily due to the decrease in real estate inventories under development. We review goodwill annually (or whenever indicators of impairment exist) for impairment in accordance with SFAS No. 142. Our 2007 goodwill impairment charges of approximately $59.5 million were comprised of approximately $38.1 million related to specific homebuilding acquisitions made during the years 2004-2005, and approximately $21.4 million related to our homebuilding and amenities operations in Florida. Our real estate services goodwill was considered not impaired based on our estimated fair values of the reporting units exceeding the carrying value of those reporting units. As a result of our modifications and amendments to our various bank facilities that occurred during 2007, we wrote-off approximately $7.7 million of previously capitalized loan costs that were considered to have no future value. Total Taxes Deferred federal and state income tax assets primarily represent the deferred tax benefits arising from temporary differences between book and tax income which will be recognized in future years as an offset against future taxable income. In accordance with SFAS No. 109, “Accounting for Income Taxes” (SFAS 109), we evaluate our deferred tax assets quarterly to determine if valuation allowances are required. SFAS 109 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. Given the continued downturn in the homebuilding industry during the fourth quarter of 2008, resulting in additional inventory and intangible impairments, land purchase option write-offs and operating losses, we are currently in a three year cumulative loss position at December 31, 2008. According to SFAS 109, a three year cumulative loss is significant negative evidence in considering whether deferred tax assets are realizable, and also precludes relying on projections of future taxable income to support the recovery of deferred tax assets. During 2008, we continued recording valuation allowances against our deferred tax assets. The remaining deferred tax assets for which there is no valuation allowance relate to amounts that can be realized through future reversals of existing taxable temporary differences or through carryback to the 2007 year. Our approximate $195.0 million of federal net operating loss carryforwards remaining after carrybacks to 2006, expire December 31, 2028. LIQUIDITY AND CAPITAL RESOURCES The matters described herein, to the extent that they relate to future events or expectations, may be significantly affected by our Chapter 11 proceedings. Those proceedings will involve, or may result in, various restrictions on our activities, limitations on financing, the need to obtain Bankruptcy Court and Creditors’ Committee approval for various matters and uncertainty as to relationships with vendors, suppliers, customers and others whom we may conduct or seek to conduct business. Significant Liquidity Events The filing of the Chapter 11 petitions triggered repayment obligations under a number of our debt instruments and agreements. As a result, all of our debt obligations became immediately payable. We believe that any efforts to enforce the payment obligations are stayed as a result of the Chapter 11 filings.
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Table of ContentsDebtor-in-Possession Financing On September 24, 2008, pursuant to authorization from the Bankruptcy Court, the Company entered into a $150 million Debtor-In-Possession Credit Agreement (the “DIP Agreement”) with a syndicate of lenders, some of which were lenders under the Company’s pre-petition secured debt facilities, led by Wachovia Bank, National Association, acting as administrative agent, and Bank of America, N.A. acting as collateral agent. The Court also granted the Company final authority to continue using its on-hand cash collateral during the Chapter 11 case. The DIP Credit Agreement includes an $80 million term loan and a $70 million revolving credit facility (collectively, the “DIP Loans”). The $80 million term loan was a required borrowing on the closing date, approximately $50 million of which was used to repay the outstanding balance under the Company’s Third Consolidated, Amended and Restated Revolving Credit Construction Loan Agreement, dated as of September 22, 2005 (the “Pre-Petition Tower Facility”) with the remainder to be used for general corporate purposes. Availability of funds under the revolving credit facility is subject to a limitation on the amount of cash and cash equivalents held by the Company. The Company may also request the issuance of up to $25 million in letters of credit. As part of the order, the Company granted the prepetition agents and the lenders various forms of protection, including liens and administrative claims to protect against the diminution of the collateral value to the extent provided in the final order approving the DIP Agreement. The DIP Agreement initially matures on September 24, 2009, subject to a six-month extension period. Borrowings under the DIP Agreement bear interest at the Eurodollar Rate plus 6.0% or an index base rate plus 5.0%. The Company’s obligations under the DIP Agreement are guaranteed by substantially all of our subsidiaries (the “Guarantors”). The Company is required to make certain mandatory repayments under the DIP Agreement in the event it sells certain assets, including bulk unit sales, subject to certain exceptions. Certain mandatory repayments may permanently reduce the original borrowing capacity, as further defined in the DIP Agreement. The DIP Agreement and the related guarantees are secured by first priority liens on substantially all of the Company’s and the Guarantors’ assets. The DIP Agreement includes certain covenants that impose substantial restrictions on the Company’s and the Guarantors’ financial and business operations, including the ability to, among other things, incur or secure other debt, make investments, sell assets and pay dividends or repurchase stock. In addition, the Company is required to maintain an Appraised Value Ratio, as defined, of not less than 1.26 to 1.0, and to meet certain monthly cash flow variance tests. At February 28, 2009, we were in compliance with these covenants. Sources and Uses of Cash Cash and cash equivalents totaled $113.2 million as of December 31, 2008 and $188.8 million at December 31, 2007. Restricted cash totaled $12.3 million at December 31, 2008 and $20.4 million at December 31, 2007. Cash provided by operating activities For the year ended December 31, 2008, cash provided by operating activities totaled $253.9 million, which included the following significant items:
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Table of ContentsCash used in investing activities For the year ended December 31, 2008, cash used in investing activities totaled $2.6 million, which was comprised of a net $2.5 million increase in property and equipment. Cash used in financing activities For the year ended December 31, 2008, cash used in financing activities totaled $326.8 million and included the following significant items:
The Company has been experiencing a reduction in availability and in some cases cancellation of surety bond capacity and continuation of outstanding bonds. In addition to increasing cost of surety bond premiums there may be some cases where we may have to obtain a letter of credit or some other type of collateral to secure necessary surety bonds or, if unable to secure such bonds, may elect to post alternative forms of collateral with government entities or escrow agents. The following table summarizes our payments under debt, operating lease and purchase obligations as of December 31, 2008:
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Table of ContentsOFF-BALANCE SHEET ARRANGEMENTS We selectively enter into business relationships through the form of partnerships and joint ventures with unrelated parties. These partnerships and joint ventures are utilized to acquire, develop, market and operate homebuilding, amenities and real estate projects. In connection with the operation of these partnerships and joint ventures, the partners may agree to make additional cash contributions to the partnerships pursuant to the partnership agreements. We believe that future contributions, if required, will not have a significant impact on our liquidity or financial position. If we fail to make required contributions, we may lose some or all of our interest in such partnerships or joint ventures. Effective February 2009, our interests in two joint ventures were dissolved and we were released from any further obligations under the joint venture agreements. See the Notes to Consolidated Financial Statements for further discussion. In the normal course of business, we enter into contractual arrangements to acquire developed and undeveloped land parcels and lots. As of December 31, 2008, we currently have no remaining active land or lot option purchase contracts. Standby letters of credit and performance bonds, issued by third party entities, are used to guarantee our performance under various contracts, principally in connection with the development of our projects and land purchase obligations. As of December 31, 2008 we had approximately $37.1 million in letters of credit outstanding. Performance bonds do not have stated expiration dates; rather, we are released from the bonds as the contractual performance is completed. These bonds, which approximated $74.5 million as of December 31, 2008, are typically outstanding over a period of approximately one to five years. INFLATION The homebuilding industry is affected by inflation as it relates to the cost to acquire land, land improvements, homebuilding raw materials and subcontractor labor. We compete with other builders and real estate developers for raw materials and labor. On certain occasions we have experienced vendors limiting the supply of raw materials which slows the land, home and tower development process and requires us to obtain raw materials from other vendors, typically at higher prices. Unless these increased costs are recovered through higher sales prices, our gross margins would be impacted. Because the sales prices of our homes in backlog are fixed at the time a buyer enters into a contract to acquire a home, any inflation in the costs of raw materials and labor costs greater than those anticipated may result in lower gross margins. In general, if interest rates increase, construction and financing costs could increase, which would result in lower future gross margins. Increases in home mortgage interest rates may make it more difficult for our customers to qualify for home mortgage loans, potentially decreasing home sales revenue. CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION Certain information included herein and in other company reports, Securities and Exchange Commission filings, statements and presentations is forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995, including, but not limited to, statements about the company’s ability to operate its business while in Chapter 11 proceedings, anticipated operating results, financial resources, ability to acquire land, ability to sell homes and properties, ability to deliver homes from backlog, and ability to secure materials and subcontractors. Such forward-looking information involves important risks and uncertainties that could significantly affect actual results and cause them to differ materially from expectations expressed herein and in other company reports, filings, statements and presentations. These risks and uncertainties include WCI’s ability to compete as a going concern in real estate markets where we conduct business; WCI’s ability to obtain court approval with respect to motions in the Chapter 11 proceedings prosecuted by it from time to time; the ability of WCI to develop, prosecute, confirm and
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Table of Contentsconsummate one or more plans of reorganization with respect to the Chapter 11 cases; risks associated with third parties seeking and obtaining court approval to terminate or shorten the exclusivity period for WCI to propose and confirm one or more plans of reorganization, for the appointment of a Chapter 11 trustee or to convert the cases to Chapter 7 cases; WCI’s ability to obtain and maintain normal terms with vendors and service providers; WCI’s ability to maintain contracts that are critical to its operations; the potential adverse impact of the Chapter 11 cases on WCI’s liquidity or results of operations; the ability of WCI to fund and execute its business plan; the ability of WCI to attract, motivate and/or retain key executives and employees; WCI’s ability to maintain or increase historical revenues and profit margins; WCI’s ability to obtain necessary permits and approvals for the development of its lands; the availability of capital to WCI and our ability to effect growth strategies successfully; availability of labor and materials and material increases in insurance, labor and material costs; increases in interest rates and availability of mortgage financing; continued volatility in housing markets and economic conditions; the ability of prospective residential buyers to obtain mortgage financing due to tightening credit markets, appraisal problems or other factors; increases in construction and homeowner insurance and availability of insurance, the continuing negative buyer sentiment and erosion of consumer confidence; the negative impact of claims for contract rescission or increasing cancellation rates by contract purchasers; adverse legislation or regulations; impact of governmental regulations, including the Emergency Economic Stabilization Act and the American Recovery and Reinvestment Act, adverse legal proceedings; changes in generally accepted accounting principles; natural disasters; adverse weather conditions; terrorist acts and other acts of war; and changes in general economic, real estate and business conditions and other factors over which the company has little or no control. If one or more of the assumptions underlying our forward-looking statements proves incorrect, then the company’s actual results, performance or achievements could differ materially from those expressed in, or implied by the forward-looking statements contained in this report. Therefore, we caution you not to place undue reliance on our forward-looking statements. We undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. This statement is provided as permitted by the Private Securities Litigation Reform Act of 1995.
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We utilize fixed and variable rate debt. Changes in interest rates on fixed rate debt generally affect the fair market value of the instrument, but not our earnings or cash flow. Changes in interest rates on variable rate debt generally do not impact the fair market value of the instrument but does affect our earnings and cash flow. We are exposed to market risk primarily due to fluctuations in interest rates on our variable rate debt. Effective December 23, 2005, we hedged a portion of our exposure to changes in interest rates by entering into an interest swap agreement to lock in a fixed interest rate. The swap agreement effectively fixed the variable rate cash flows on our $300.0 million of variable rate senior term note and expires December 2010. On August 17, 2007, we amended the senior term note agreement, which required us to reduce the balance to $262.5 million and increased the interest rate. As a result, the underlying terms of the interest swap agreement no longer effectively matched the terms of the senior term note and we removed the designation of the swap agreement as a cash flow hedge. Subsequent changes in the fair value of the swap agreement are reflected in other income and expense in the consolidated statements of income. Due to our filing of petitions under Chapter 11 of the Code, the interest rate swap agreement was terminated by the counterparty and the fair value on the termination date became due and payable as a secured obligation to the counterparty. At December 31, 2008, the fair value of the swap agreement of ($10.6) million is reflected in liabilities subject to compromise in the consolidated balance sheet. The Chapter 11 petitions triggered repayment obligations under a number of our debt instruments and agreements. As a result, all of our pre-petition debt obligations became immediately payable and have been reflected as such in the following table. We believe any efforts to enforce the payment obligations are stayed as a result of the Chapter 11 filings. Due to the filing of Chapter 11 petitions, we are unable to obtain or estimate a reasonable fair market value of our debt obligations (dollars in millions).
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Report of Independent Registered Public Accounting Firm The Board of Directors and Shareholders of WCI Communities, Inc: We have audited the accompanying consolidated balance sheets of WCI Communities, Inc. (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances but not for the purpose of expressing an opinion on the effectiveness at the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of WCI Communities, Inc. at December 31, 2008 and 2007, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1, the Company filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy code on August 4, 2008, which raises substantial doubt about the Company’s ability to continue as a going concern. Management’s plans concerning these matters are also described in Note 1. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of this uncertainty. As discussed in Note 1 to the consolidated financial statements, the Company changed its method of accounting for income tax uncertainties as of January 1, 2007, and its method of accounting for share-based payments as of January 1, 2006. /s/ Ernst & Young LLP Miami, Florida May 7, 2009
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Consolidated Balance Sheets (In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Consolidated Statements of Operations (In thousands, except per share data)
The accompanying notes are an integral part of these consolidated financial statements.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Consolidated Statements of Changes in Shareholders’ (Deficit) Equity (In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Consolidated Statements of Cash Flows (In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Consolidated Statements of Cash Flows (Continued) (In thousands)
The accompanying notes are an integral part of these consolidated financial statements.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements December 31, 2008 (In thousands, except per share data)
On August 4, 2008, WCI Communities, Inc. (the Company, WCI or we) and 126 of its subsidiaries (excluding its Watermark real estate brokerage, our WCI Mortgage business and certain other joint ventures in which we are a partner) (the Debtors) filed voluntary petitions for reorganization relief under the provisions of Chapter 11 of Title 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the District of Delaware in Wilmington, Case No. 08—11643 (KJC). The list of the Debtors and Tax Identification Numbers is located on the docket for Case No. 08-11643 (KJC) [Docket No. 64] and http://chapter11.epiqsystems.com/wcicommunities. We continue to operate our businesses and manage our properties as debtors and debtors-in-possession under the jurisdiction of the Bankruptcy Court and in accordance with the applicable provisions of the Bankruptcy Code and orders of the Bankruptcy Court. As part of the “first day” relief, we obtained Bankruptcy Court approval to, among other things, continue to pay critical vendors and vendors with lien rights, meet our pre-petition payroll obligations, pay deficit funding obligations to our various community associations and clubs, maintain our cash management systems, sell homes free and clear of liens, pay our taxes, continue to provide employee benefits and maintain our insurance programs. Certain of these payment obligations are subject to monetary limits without specific approval for each transaction. The filing of the Chapter 11 petitions triggered repayment obligations under a number of our debt instruments and agreements. As a result, all of our debt obligations became immediately payable. We believe that any efforts to enforce the payment obligations are stayed as a result of the Chapter 11 filings. DIP Credit Agreement. On September 24, 2008, pursuant to authorization from the Delaware Bankruptcy Court, the Company entered into a $150,000 Debtor-In-Possession Credit Agreement (the DIP Agreement) with a syndicate of lenders, some of which were lenders under the Company’s pre-petition secured debt facilities, led by Wachovia Bank, National Association, acting as administrative agent, and Bank of America, N.A. acting as collateral agent. The Court also granted the Company final authority to continue using its on-hand cash collateral during the Chapter 11 case. The DIP Credit Agreement includes an $80,000 term loan and a $70,000 revolving credit facility (collectively, the DIP Loans). The $80,000 term loan was a required borrowing on the closing date, approximately $50,000 of which was used to repay the outstanding balance under the Company’s Third Consolidated, Amended and Restated Revolving Credit Construction Loan Agreement, dated as of September 22, 2005 (the Pre-Petition Tower Facility) with the remainder to be used for general corporate purposes. Availability of funds under the revolving credit facility is subject to a limitation on the amount of cash and cash equivalents held by the Company. The Company may also request the issuance of up to $25,000 in letters of credit. As part of the order, the Company granted the prepetition agents and the lenders various forms of protection, including liens and administrative claims to protect against the diminution of the collateral value to the extent provided in the final order approving the DIP Agreement. The DIP Agreement initially matures on September 24, 2009, subject to a six-month extension period. Borrowings under the DIP Agreement bear interest at the Eurodollar Rate plus 6.0% or an index base rate plus 5.0%. The Company’s obligations under the DIP Agreement are guaranteed by substantially all of our subsidiaries (the Guarantors). The Company is required to make certain mandatory repayments under the DIP Agreement in the event it sells certain assets, including bulk unit sales, subject to certain exceptions. Certain mandatory repayments may permanently reduce the original borrowing capacity, as further defined in the DIP Agreement.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
The DIP Agreement and the related guarantees are secured by first priority liens on substantially all of the Company’s and the Guarantors’ assets. The DIP Agreement includes certain covenants that impose substantial restrictions on the Company’s and the Guarantors’ financial and business operations, including the ability to, among other things, incur or secure other debt, make investments, sell assets and pay dividends or repurchase stock. In addition, the Company is required to maintain an Appraised Value Ratio, as defined, of not less than 1.26 to 1.0, and to meet certain monthly cash flow variance tests. At December 31, 2008, we were in compliance with these covenants. Notice to Creditors. Shortly after the Chapter 11 filing on August 4, 2008, the Debtors began notifying all known current or potential creditors of the Chapter 11 filing. Appointment of Creditors’ Committee. The United States Trustee for the District of Delaware has appointed an official committee of unsecured creditors (the Creditors’ Committee). The Creditors’ Committee and its legal representatives have a right to be heard on all matters that come before the Bankruptcy Court with respect to the Debtors. There can be no assurance that the Creditors’ Committee will support the Debtors’ positions or ultimate plan of reorganization, once proposed. Disagreements between the Debtors and the Creditors’ Committee could protract the Chapter 11 proceedings, negatively impact the Debtors’ ability to operate and delay the Debtors’ emergence from the Chapter 11 proceedings. Rejection of Executory Contracts. Under Section 365 and other relevant sections of the Bankruptcy Code, the Debtors may assume, assign, or reject certain executory contracts and unexpired leases, including, without limitation, leases of real property, subject to the approval of the Bankruptcy Court and certain other conditions. In general, rejection of an executory contract or unexpired lease is treated as a pre-petition breach of the executory contract or unexpired lease in question and, subject to certain exceptions, relieves the Debtors of performing their future obligations under such executory contract or unexpired lease but entitles the contract counterparty or lessor to a pre-petition general unsecured claim for damages caused by such deemed breach. Counterparties to such rejected contracts or leases can file claims against the Debtors’ estate for such damages. Generally, the assumption of an executory contract or unexpired lease requires the Debtors to cure most existing defaults under such executory contract or unexpired lease and provide adequate assurance of future performance. Accordingly, any description of an executory contract or unexpired lease elsewhere in these Notes, including where applicable, our express termination rights or a quantification of our obligations, must be read in conjunction with, and is qualified by, any overriding rejection rights we have under Section 365 of the Bankruptcy Code. We expect that liabilities subject to compromise and resolution in the Chapter 11 proceedings will arise in the future as a result of damage claims created by the Debtors’ rejection of various executory contracts and unexpired leases. Conversely, we expect that the assumption of certain executory contracts and unexpired leases may convert liabilities shown as subject to compromise to liabilities not subject to compromise. Due to the uncertain nature of many of the potential rejection claims, the magnitude of such claims is not reasonably estimable at this time. Such claims may be material. Magnitude of Potential Claims. On November 1, 2008, the Debtors filed with the Bankruptcy Court schedules and statements of financial affairs setting forth, among other things, the assets and liabilities of the Debtors, subject to the assumptions contained in certain notes filed in connection therewith. The schedules can be
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
found at the following website: http://chapter11.epiqsystems.com/WCC/claim/search.aspx. All of the schedules will be subject to further amendment or modification. Differences between amounts scheduled by the Debtors and claims by creditors will be investigated and resolved in connection with the claims resolution process. In light of the expected number of creditors, the claims resolution process may take considerable time to complete. Accordingly, the ultimate number and amount of allowed claims is not presently known, nor can the ultimate recovery with respect to allowed claims be presently ascertained. Claim Bar Date. On December 2, 2008, the Bankruptcy Court entered an order setting the last day for filing proofs of claim in the Debtors Chapter 11 cases as February 2, 2009 at 4:00 p.m. Prevailing Eastern Time (the Bar Date). As of the Bar Date we had received approximately 3,700 claims and since the Bar Date we have received approximately 200 additional claims. Information regarding the proof of claim process and appropriate forms may be found at the following web site maintained for that purpose by the Debtors’ claims and noticing agent, Epiq Systems, Inc.: http://chapter11.epiqsystems.com/wcicommunities. Costs of Reorganization. We have incurred and will continue to incur significant costs associated with the reorganization. The amount of these costs, which are being expensed as incurred, are expected to significantly affect our results of operations. Effect of Filing on Creditors and Shareowners. Under the priority scheme established by the Bankruptcy Code, unless creditors agree otherwise and subject to other applicable exceptions, pre-petition liabilities and post-petition liabilities must be satisfied in full before shareowners are entitled to receive any distribution or retain any property under a plan of reorganization. The ultimate recovery to creditors and/or shareowners, if any, will not be determined until confirmation of a plan or plans of reorganization. No assurance can be given as to what values, if any, will be ascribed in the Chapter 11 cases to each of these constituencies or what types or amounts of distributions, if any, they would receive. A plan of reorganization could result in holders of our liabilities and/or securities, including our common stock, receiving no distribution on account of their interests and cancellation of their holdings. As discussed below, if the requirements of the Bankruptcy Code are met, a plan of reorganization can be confirmed notwithstanding its rejection by the holders of our stock and notwithstanding the fact that such holders do not receive or retain any property on account of their equity interests under the plan. Because of such possibilities, the value of our liabilities and securities, including our stock is highly speculative. We urge that appropriate caution be exercised with respect to existing and future investments in any of the liabilities and/or securities of the Debtors. Process for Plan of Reorganization. In order to exit Chapter 11 successfully, the Debtors will need to propose, and obtain confirmation by the Bankruptcy Court of, a plan of reorganization that satisfies the requirements of the Bankruptcy Code. A plan of reorganization would resolve, among other things, the Debtors’ pre-petition obligations, set forth the revised capital structure of the newly reorganized entity and provide for corporate governance subsequent to exit from bankruptcy. Currently, we have the exclusive right to file a Chapter 11 plan or plans prior to April 30, 2009 and the exclusive right to solicit acceptance thereof until June 1, 2009. Pursuant to Section 1121 of the Bankruptcy Code, the exclusivity periods may be expanded or reduced by the Bankruptcy Court, but in no event can the exclusivity periods to file and solicit acceptance of a plan or plans of reorganization be extended beyond 18 months and 20 months, respectively.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
As a result of our Chapter 11 cases and other matters described herein, including uncertainties related to the fact that we have not yet had time to complete and obtain confirmation of a plan or plans of reorganization, there is substantial doubt about our ability to continue as a going concern. Our ability to continue as a going concern, including our ability to meet our ongoing operational obligations, is dependent upon, among other things:
These challenges are in addition to those operational and competitive challenges that we face in connection with our business. In conjunction with our advisors, we are implementing strategies to aid our liquidity and our ability to continue as a going concern. However, such efforts may not be successful. We have taken and will continue to take aggressive actions to maximize cash receipts and minimize cash expenditures with the understanding that certain of these actions may make us less able to take advantage of future improvements in the homebuilding market. We continue to take steps to reduce our general and administrative expenses by streamlining activities and increasing efficiencies, which have led and will continue to lead to reductions in the workforce. However, much of our efforts to reduce general and administrative expenses are being offset by professional and consulting fees associated with our Chapter 11 cases. We have and will continue to analyze each community based on anticipated sales absorption rates, net cash flows and financial returns taking into consideration current market factors in the homebuilding industry. In order to generate cash and reduce our inventory to levels consistent with our business plan, we have taken and will continue to take the following actions, to the extent possible given the limitations resulting from our Chapter 11 cases:
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
Liabilities Subject to Compromise The following table summarizes the components of liabilities subject to compromise included on our Consolidated Balance Sheet as of December 31, 2008:
Liabilities subject to compromise refers to pre-petition obligations which may be impacted by the Chapter 11 reorganization process. These amounts represent our current estimate of known or potential pre-petition obligations to be resolved in connection with our Chapter 11 proceedings. Differences between liabilities we have estimated and the claims filed, or to be filed, will be investigated and resolved in connection with the claims resolution process. We will continue to evaluate these liabilities throughout the Chapter 11 process and adjust amounts as necessary. Such adjustments may be material. In light of the expected number of creditors, the claims resolution process may take considerable time to complete. Accordingly, the ultimate number and amount of allowed claims is not presently known. Reorganization Items, net The following table summarizes the components included in reorganization items, net on our Consolidated Statements of Operations of the three and nine months ended December 31, 2008:
During the year ended December 31, 2008, cash paid for reorganization items was approximately $13,268. The foregoing discussion provides general background information regarding our Chapter 11 Cases, and is not intended to be an exhaustive description. Additional information regarding our Chapter 11 Cases, including access to court documents and other general information about the Chapter 11 Cases, is available at http//chapter11.epiqsystems.com/wcicommunities. Financial information on the website is prepared according to requirements of federal bankruptcy law and the local Bankruptcy Court. While such financial information
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
accurately reflects information required under federal bankruptcy law, such information may be unconsolidated, unaudited and prepared in a format different than that used in our consolidated financial statements prepared in accordance with generally accepted accounting principles in the United States and filed under the securities laws. Moreover, the materials filed with the Bankruptcy Court are not prepared for the purpose of providing a basis for investment decisions relating to our stock or debt or for comparison with other financial information filed with the Securities and Exchange Commission. Business Strategy During the first quarter of 2009 the Company continued its cost reduction initiatives including a significant reduction of overhead, consolidation of operating divisions, closing of sales offices and rejection of leases/ contracts through the Bankruptcy Code, and further concentrated its efforts on selling speculative inventory and non-core assets. In addition, due to the continuing deterioration of the housing industry nationally and in Florida in particular, and the challenging economic conditions and lack of visibility in the marketplace (including unpredictability in projecting pricing trends and housing recovery timeframes), the Company adopted a plan in early 2009 to currently suspend all new homebuilding construction activities except under limited circumstances, subject however, to completion of existing homes under construction or subject to pending purchase contracts. This plan also contemplates the continuation of the sale of our speculative inventory and the ongoing maintenance of our communities, amenities operations and real estate services. As part of the Company’s overall strategy to explore alternatives to emerge from bankruptcy in an expeditious manner, the Company also engaged its financial/restructuring advisor to assist with a comprehensive marketing process for the sale or reorganization of the Company, as well as the disposition of certain assets. The Company continues to explore strategic alternatives.
A summary of the significant accounting principles and practices used in the preparation of the consolidated financial statements follows. Basis of Financial Statement Presentation The consolidated financial statements include the accounts of WCI Communities, Inc., our wholly owned subsidiaries and certain joint ventures which are not variable interest entities (VIE’s) but we have the ability to exercise control. The equity method of accounting is applied in the accompanying consolidated financial statements with respect to those investments in joint ventures which are not variable interest entities and we have less than a controlling interest, have substantive participating rights, or are not the primary beneficiary as defined in FIN 46-R, Consolidation of Variable Interest Entities. All material intercompany balances and transactions are eliminated in consolidation. We prepare our financial statements in conformity with accounting principles generally accepted in the United States (GAAP). These principles require 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.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
In accordance with GAAP, we have applied the provisions of American Institute of Certified Public Accountants’ (AICPA) Statement of Position 90-7, Financial Reporting by Entities in Reorganization Under the Bankruptcy Code, in preparing the consolidated financial statements. SOP 90-7 requires that the financial statements, for periods subsequent to the Chapter 11 filing, distinguish transactions and events that are directly associated with the reorganization from the ongoing operations of the business. Accordingly, certain items of income, expense, gain or loss realized or incurred because we are in Chapter 11 are recorded in reorganization items, net on the accompanying consolidated statements of operations. Also, pre-petition obligations that may be impacted by the bankruptcy reorganization process have been classified on the consolidated balance sheet at December 31, 2008 in liabilities subject to compromise. These liabilities are reported at the amounts expected to be allowed by the Bankruptcy Court, even if they may be settled for lesser amounts. We have also prepared these consolidated financial statements on a going concern basis, which contemplates continuity of operations, realization of assets and satisfaction of liabilities in the ordinary course of business. Accordingly, our consolidated financial statements do not include any adjustments relating to the recoverability of assets and classification of liabilities that might be necessary should we be unable to continue as a going concern. As a result of sustained losses and our Chapter 11 proceedings, the realization of assets and satisfaction of liabilities, without substantial adjustments and/or changes in ownership, are subject to uncertainty. Given this uncertainty, there is substantial doubt about our ability to continue as a going concern. While operating as debtors-in-possession under Chapter 11 of the Bankruptcy Code, the Debtors may sell or otherwise dispose of or liquidate assets or settle liabilities, subject to the approval of the Bankruptcy Court or otherwise as permitted in the ordinary course of business, in amounts other than those reflected in the condensed consolidated financial statements. Further, a plan of reorganization could materially change the amounts and classifications in the historical condensed consolidated financial statements. The preparation of financial statements in accordance with GAAP 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. Those estimates and assumptions which, in the opinion of management, are both significant to the underlying amounts included in the financial statements and as to which future events or information could change those estimates include:
The accompanying consolidated financial statements do not purport to reflect or provide for the consequences of our Chapter 11 cases. In particular, the financial statements do not purport to show (1) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (2) as to stockholders’ equity accounts, the effect of any changes that may be made in our capitalization; or (3) as to operations, the effect of any changes that may be made to our business. In addition, the financial statements do not reflect the
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
amounts that may be allowed with respect to pre-petition claims and liabilities which may, as a result of the filing of proofs of claims by our creditors, result in liabilities in excess of those estimated by us in preparing the accompanying consolidated financial statements. Revenue and Profit Recognition Traditional homebuilding revenue is recognized at the time of closing under the completed contract method for single-family residences and for multi-family residences where the planned construction cycle is less than one year. The related profit is recognized when collectibility of the sales price is reasonably assured and the earnings process is substantially complete. When a sale does not meet the requirements for income recognition, profit is deferred until such requirements are met and the related sold inventory is classified as completed inventory. Revenue for tower and multi-family traditional homebuilding residences under construction is recognized on the percentage-of-completion method when the planned construction period is greater than one year. Revenue is recorded as a portion of the value of non-cancelable contracts when construction of each project is beyond a preliminary stage, the buyer is committed to the extent of being unable to require a full refund except for non-delivery of the residence, a substantial percentage of residences are under non-cancellable contracts, collectibility of the sales prices are reasonably assured and costs can be reasonably estimated. In accordance with paragraph 37 (e) of Statement of Financial Accounting Standards (SFAS) 66, Accounting for Sale of Real Estate, the ability to estimate aggregate sales proceeds of a condominium project is required in order to use the percentage-of-completion method of revenue and profit recognition. If this criterion is not met, proceeds shall be accounted for on the deposit method. We believe if changes, such as a rapid decline in the market, indicate that we can no longer estimate the sales proceeds or costs of a condominium project, (e.g., additional incentives will be required, the amount of which cannot be estimated), then we should no longer apply the percentage-of-completion method and any previously recognized profit should be evaluated for realizability based on evaluation of collectibility and impairment of the project. Revenue recognized is calculated based upon the percentage of total costs incurred in relation to estimated total costs. In accordance with the Statement of Position 81-1, Accounting for Performance of Construction-Type and Certain Production Type Contracts, changes in estimates of tower revenue and development costs are accounted for on a cumulative basis in the period that the change occurs. Our estimates of tower revenue and development costs are revised on a quarterly basis until a tower building is completed and delivered to unit owners. Subsequent to the completion of a tower, we may incur additional costs in order to finalize and close-out the project. All towers under construction were completed as of June 30, 2008. For the years ended December 31, 2008, 2007 and 2006, tower gross margin was impacted by approximately $15,400, $40,400 and $36,800, respectively, as a result of tower construction cost increases, an increase in interest costs associated with increased tower construction cycle times and changes in insurance and other costs. The impact to net (loss) income for the years ended December 31, 2008, 2007 and 2006, was $9,390, $24,590 and $22,400, respectively. The impact to diluted (loss) earnings per share for the years ended December 31, 2008, 2007 and 2006, was $.22, $.59 and $.52, respectively. The percentage-of-completion method is applied when we meet the applicable requirements under SFAS 66. Any amounts due under sales contracts, to the extent recognized as revenue are recorded as contracts receivable. Any sales after the residential building is completed are recorded as revenue on the completed contract method. One of our previous projects was a tower containing 186 units and approximately 5,000 square feet of retail space that commenced construction in the fourth quarter 2005. At that time, all conditions of paragraph 37 of SFAS 66 were met and thus we recognized profit under the percentage-of-completion method. We continued use
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
of the percentage-of-completion method through September 2007 and had recognized cumulative revenue and profit of $132,000 and $38,400, respectively. After relatively strong initial sales activity in late 2005 and early 2006 of 117 units, or 63% of total available units sold, there was limited activity in the tower. While the general real estate market, and specifically the Florida tower market, had deteriorated during the past two years, we determined that we had the ability to reasonably estimate the aggregate sales proceeds and costs of the tower project which supported the use of the percentage-of-completion method of revenue and profit recognition through September 2007. During 2007, as we approached completion of the tower project, the following factors led us to determine that we could no longer reasonably estimate aggregate sales proceeds for the project:
In accordance with paragraph 37(e) of SFAS 66, the ability to estimate aggregate sales proceeds of a condominium project is required in order to use the percentage-of-completion method of revenue and profit recognition. If this criterion is not met, proceeds shall be accounted on the deposit method. We believe if changes, such as a rapid decline in the market, indicate we are no longer able to estimate the sales proceeds or costs of a condominium project, (e.g., additional incentives will be required, the amount of which cannot be estimated), we should no longer apply the percentage-of-completion method and any previously recognized profit should be evaluated for realizability based on evaluation of collectibility and impairment of the project. As a result of our inability to estimate the ultimate amount of aggregate sales proceeds of the tower project, we ceased the future use of percentage-of-completion accounting as of October 1, 2007, reserved 100% of the previously recognized cumulative profit totaling $38,438, and reverted to the deposit method of accounting. Real estate services revenue primarily includes realty brokerage and title operations. Realty brokerage and title revenues are recognized upon closing of a sales contract. In June 2006, we sold our mortgage banking operations to a newly formed joint venture, WCI Mortgage LLC. Revenues from amenity operations include the sale of equity memberships and marina slips, non-equity memberships, billed membership dues and fees for services provided. Equity membership and marina slip sales are recognized at the time of closing. Equity membership sales and the related cost of sales are initially recorded under the deposit or cost recovery method. Revenue recognition for each equity club program is reevaluated on a periodic basis based upon changes in circumstances. If we can demonstrate that it is likely we will recover proceeds in excess of remaining carrying value and no material contingencies exist, such as a developer rescission clause, the full accrual method is then applied. Non-refundable non-equity membership initiation fees represent initial payments for rights to use the amenity facilities. The non-equity membership initiation fees are deferred and amortized to amenity membership revenues over 20 years which represents the estimated average
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depreciable life of the amenity facilities. Dues are billed on an annual basis in advance and are recorded as deferred revenue and then recognized as revenue ratably over the term of the membership year. Revenues for services are recorded when the service is provided. Revenue from land sales is recognized at the time of closing. The related profit is recognized in full when collectibility of the sales price is reasonably assured and the earnings process is substantially complete. When a sale does not meet the requirements for income recognition, profit is deferred under the deposit method and the related inventory is classified as completed inventory. The deferred income is recognized as our involvement is completed. Sales incentives such as reductions in listed sales prices of homes, tower units, golf club memberships and marina slips are classified as a reduction of revenue. Sales incentives such as free products or services are classified as cost of sales. Contracts Receivable Amounts due under tower sales contracts, to the extent recognized as revenue under the percentage-of-completion method are recorded as contracts receivable. On a quarterly basis, we prepare an analysis for each specific tower and analyze each unit with respect to information we have that leads us to believe specific units are at risk of defaulting. Based on this analysis, actual defaults experienced at each tower location, and the current market environment, we estimate the number of defaults that may occur for future unit closings. This analysis requires us to make significant estimates and assumptions that affect the reported amounts in our financial statements. These estimates are subject to revision as additional information becomes available and actual defaults could differ materially from our estimates. At December 31, 2008, all of our contracts receivable have been closed out. At December 31, 2007, our contracts receivable balance of $358,327 is net of an allowance of $11,039 for estimated losses due to potential customer defaults. For the year ended December 31, 2008, our aggregate tower unit default rate was approximately 34%, as compared to 24% for 2007. In 2006, our residential tower default rate was approximately 7% of total sold tower units. The following table presents the activity in our contracts receivable reserve account.
Real Estate Inventories and Cost of Sales Real estate inventories consist of land and land improvements, investments in amenities and tower residences and homes that are under construction or completed. Total land and common development costs are apportioned to each home, lot, amenity or parcel on the relative sales value method, while site specific
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
development costs are allocated directly to the benefited land. Investments in amenities include clubhouses, golf courses, marinas, tennis courts and various other recreation facilities that we intend to recover through equity membership and marina slip sales. We construct amenities in conjunction with the development of certain planned communities and account for related costs in accordance with SFAS 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects. Amenities are transferred to common interest realty associations (CIRAs), sold as equity membership clubs, sold separately or retained and operated. The cost of amenities conveyed to a CIRA are classified as a common cost of the community and included in real estate inventories. These costs are allocated to cost of sales on the basis of the relative sales value of the homes sold. For amenities to be sold separately or retained by us, capitalized costs in excess of its estimated fair value as of the substantial completion date are allocated as common costs to each parcel or lot benefited based on estimated relative sales value. Costs of amenities retained and operated by us are accounted for as property and equipment. Impairment of long-lived assets held for use. Inventory considered held for use is stated at the lower of cost or fair value in accordance with SFAS 144, Accounting for the Impairment or Disposal of Long Lived Assets. We record valuation adjustments on land inventory and related communities under development (including tower projects), and amenities considered held and used (classified as property, plant and equipment), when the carrying amount exceeds its fair value. An impairment loss shall be recognized only if the carrying amount of the asset is not recoverable and exceeds its fair value. The carrying amount is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. An impairment loss shall be measured as the amount by which the carrying amount exceeds its fair value.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
Our determination of fair value requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with the assets and related estimated cash flows. The discount rate used in determining each community’s fair value depends on the stage of development, location and other specific factors that increase or decrease the risks associated with the estimated cash flows. The discount rates that we used during the periods in 2006-2007 in the determination of fair values ranged from 12%-18%. The discount rates that we used during the year ended December 31, 2008 in the determination of fair values ranged from 20%-22%.
Impairment of long-lived assets to be disposed of. Inventory considered held for sale is stated at the lower of cost or fair value, less costs to sell in accordance with SFAS 144. We record valuation adjustments on completed inventories of tower units and traditional homes, and investments in amenities when the cost exceeds fair value, less costs to sell. Our estimated selling costs are based on recent experience, which ranges from 5%-7% of sales prices and includes selling commissions, sales, marketing and closing costs. Completed Inventory. When the profitability of our completed traditional homes and tower units deteriorates, the sales pace significantly declines or some other factor indicates a possible impairment in the recoverability of the assets, we further estimate the assets’ fair values. Such assets are considered held for sale and the assets’ fair values are determined primarily by discounting the estimated future cash flows related to the asset. In estimating the cash flows for completed homes and tower units, we use various estimates such as (a) expected sales pace to absorb the number of units based upon economic conditions that may have either a short-term or long-term impact on the market in which the units are located, competition within the market, historical sales rates of the units within the specific community or the estimated impact of our pricing reductions and sales incentives; and (b) expected net sales prices in the near-term based upon current pricing estimates, as
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
well as estimated increases in future sales prices based upon historical sales prices of the units within the specific community or in similar communities owned by us or historical sales prices of similar product offerings in the market. Our determination of fair value requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with selling the assets and related estimated cash flows. The discount rates that we used during the periods in 2006-2007 in the determination of fair values ranged from 8%-12%. The discount rates that we used during the year ended December 31, 2008 in the determination of fair values ranged from 15%-18%. Investments in Amenities. When the underlying recreational amenity is substantially complete and available for its intended use, we consider the asset held for sale. When the profitability of our equity club membership sales deteriorates, the sales pace significantly declines or some other factor indicates a possible impairment in the recoverability of the recreational amenity assets, the assets’ fair values are determined primarily by discounting the estimated future cash flows specifically related to membership sales and asset development expenditures. In estimating the cash flows, we use various estimates such as (a) sales pace to absorb the number of memberships based upon economic conditions that may have either a short-term or long-term impact on the market in which the assets are located, competition within the market, historical sales rates of the memberships for the specific amenity or the estimated impact of our pricing reductions and sales incentives; (b) net sales prices in the near-term based upon current pricing estimates, as well as estimated changes in future sales prices based upon historical sales prices of the memberships for the specific recreational amenity or in similar recreational amenities owned by us or historical sales prices of similar membership offerings in the market. Our determination of fair value requires discounting the estimated cash flows at a rate commensurate with the inherent risks associated with selling the memberships and related estimated cash flows. The discount rates that we used in the periods of 2006-2007 in the determination of fair values ranged from 10%-14%. The discount rates that we used during the year ended December 31, 2008 in the determination of fair values ranged from 15%-18%. In the event that market conditions or the Company’s operations deteriorate in the future, or current difficult market conditions extend beyond our expectations, including, but not limited to, a further decline in sales prices, reduced absorption of units in inventory, increased defaults or cancellations of tower unit and traditional home contracts, or increased costs of development, additional impairments may be necessary and any such charges could be significant. Capitalized Interest and Real Estate Taxes Interest and real estate taxes incurred relating to land under development and construction of homes and tower residences are capitalized to real estate inventories during the active development period. As prescribed by SFAS 34 Capitalization of Interest Cost, we include the underlying developed land costs in our calculation of capitalized interest for tower residences under construction, and include the underlying developed land costs and in-process homebuilding costs in our calculation of capitalized interest for traditional homes under construction. Capitalization ceases upon substantial completion of each home or tower. Interest incurred relating to the construction of amenities is capitalized to real estate inventories for equity membership clubs or property and equipment for clubs to be retained and operated by us. Interest and real estate taxes capitalized to real estate inventories are amortized to costs of sales as related homes, lots, amenity memberships and parcels are sold. For tower and multi-family traditional homebuilding projects where the
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
planned construction period is greater than one year, capitalized interest and real estate taxes are amortized to costs of sales under the percentage-of-completion method. Interest capitalized to property and equipment is depreciated on the straight-line method over the estimated useful lives of the related assets. The following table is a summary of interest expense, net, and real estate taxes, net:
As of the filing of the petition for reorganization, we discontinued accruing interest on pre-petition unsecured debt obligations. Contractual interest for the year ended December 31, 2008 equaled approximately $129,130. Warranty We generally provide our single- and multi-family home buyers with a one to three year limited warranty, respectively, for all material and labor and a ten year warranty for certain structural defects. We provide our tower home buyers a three year warranty for the unit and common elements of the tower. Warranty reserves have been established by charging cost of sales and crediting a warranty liability. The amounts charged are estimated by management to be adequate to cover expected warranty-related costs under all unexpired warranty obligation periods. Our warranty cost accruals are based upon historical warranty cost experience and are adjusted as appropriate to reflect qualitative risks associated with the types of towers and homes built. The following table presents the activity in our warranty liability account included in accounts payable and other liabilities.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
Cash, Cash Equivalents and Restricted Cash We consider all highly liquid instruments with an original purchased maturity of three months or less as cash equivalents. Restricted cash consists principally of escrow accounts representing customer deposits restricted as to use. Cash as of December 31, 2008 and 2007 included $4,388 and $9,602, respectively, of amounts in transit from title companies for transactions closed at or near year-end. Property and Equipment Property and equipment, including amenities retained and operated by us, are recorded at cost less accumulated depreciation and are depreciated on the straight-line method over their estimated useful lives. If an operating amenity is converted to an equity club, the related assets are reclassified from property and equipment to real estate inventories, depreciation is ceased and accounted for in accordance with SFAS 144. Upon reclassification, the sale of equity memberships and the recognition of related cost of sales are determined in the same manner as other amenities that are being sold through an equity membership program. Included in our property and equipment are recreational amenity assets that are considered held and used. With respect to these assets, if events or changes in circumstances, such as a significant decline in membership or membership pricing, significant increases in operating costs, or changes in use, indicate that the carrying value may be impaired, an impairment analysis is performed. Our analysis consists of determining whether the asset’s carrying amount will be recovered from its undiscounted estimated future operating cash flows, including estimated residual cash flows, such as the sale of the asset. These cash flows are estimated based on various assumptions that are subject to economic and market uncertainties including, among others, demand for golf and marina club memberships, competition within the market, changes in membership pricing and costs to operate each property. If the carrying amount of the asset exceeds the sum of its undiscounted future operating and residual cash flows, an impairment loss is recorded for the difference between estimated fair value of the asset and the net carrying amount. We estimate the fair value by using discounted cash flow analysis. Expenditures for maintenance and repairs are charged to expense as incurred. Costs of major renewals and improvements, which extend useful lives, are capitalized. Other Assets Other assets primarily consist of income taxes receivable, prepaid expenses, community development district amounts, acquisition deposits and debt issue costs. Debt issue costs, principally loan origination and related fees, are deferred and amortized over the life of the respective debt using the straight-line method, which approximates the effective interest method. Goodwill and Other Intangible Assets Goodwill represents the excess of our cost of business operations acquired over the fair value of identifiable assets acquired net of liabilities assumed. SFAS 142, Goodwill and Other Intangible Assets provides guidance on accounting for intangible assets and eliminates the amortization of goodwill and certain identifiable intangible assets. Under the provisions of SFAS 142, intangible assets, including goodwill, that are not subject to amortization will be tested for impairment annually. Evaluating goodwill for impairment involves the determination of the fair value and the carrying value of our reporting units in which we have recorded goodwill.
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A reporting unit is a component of an operating segment for which discrete financial information is available and reviewed by our management on a regular basis. Inherent in the determination of fair value of reporting units are certain estimates and judgments, including the interpretation of current economic indicators and market valuations as well as our strategic plans with regard to our operations. We typically use an income approach to determine the fair value of our reporting units when performing our impairment test of goodwill in accordance with SFAS 142. The income approach establishes fair value by methods which discount or capitalize earnings and/or cash flow by a discount or capitalization rate that reflects market rate of return expectations, market conditions and the risk of the relative investment. If the fair value of a reporting unit is less than the carrying value of the reporting unit, an impairment would be recorded. In determining the fair value of our reporting units under the income approach, our expected cash flows are affected by various assumptions. The most significant assumptions affecting our expected cash flows are the discount rate, projected revenue growth rate and costs of development. We review goodwill annually (or whenever indicators of impairment exist) for impairment in accordance with SFAS 142. Our 2008 goodwill impairment charges of approximately $1,343 were related to real estate service units whose operations have been merged into similar reporting units. Our 2007 goodwill impairment charges of approximately $59,534 were comprised of approximately $38,073 related to specific homebuilding acquisitions made during the years 2004-2005, and approximately $21,462 related to our homebuilding and amenities operations in Florida. Our real estate services goodwill was considered not impaired based on our estimated fair values of the reporting units exceeding the carrying value of those reporting units. The components of our goodwill are as follows:
We have identifiable intangible assets with estimated finite useful lives of 5 years. These assets were acquired through acquisitions and are being amortized on the straight-line basis over their estimated useful lives and had accumulated amortization of $1,196 and $726 at December 31, 2008 and 2007, respectively. We amortized $395, $501 and $624 for the years ended December 31, 2008, 2007 and 2006, respectively.
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The estimated aggregate amortization expense remaining is as follows:
Accounts Payable and Other Liabilities As a result of our Chapter 11 filing certain of our accounts payable and other liabilities have been classified in liabilities subject to compromise on the balance sheet as of December 31, 2008. The table below is presented before the reclassification to provide comparability to the prior year. Accounts payable and other liabilities primarily consist of the following:
Customer Deposits Customer deposits primarily represent amounts received from customers under real estate sales contracts. Derivative Instruments and Hedging Activities SFAS 133, Accounting for Derivative Instruments and Hedging Activities, requires companies to recognize derivative instruments as either assets or liabilities in the statement of financial position at fair value. The accounting for changes in the fair value (i.e., gains or losses) of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship. For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative instrument is reported as a component of other comprehensive income and reclassified into earnings in the same line item associated with the forecasted transaction in the same period or periods during which the hedged transaction affects earnings. We have an interest rate swap agreement with a counterparty that is a major financial institution. The swap agreement effectively fixed the variable rate cash flows on our senior term note for the entire 5-year term. The interest rate swap agreement expires December 2010. The swap agreement was designated as a cash flow hedge.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
For the years ended December 31, 2006 and 2005, we recognized a cumulative net unrealized gain of $803 and a loss of $1,826, respectively, on our interest rate swap which were included in other comprehensive income, net of taxes, and the related asset was included in other assets. The fair value of the interest rate swap agreement was estimated based on quoted market rates of similar financial instruments. The related gains or losses were recorded in shareholders’ equity as accumulated other comprehensive income or loss. On August 17, 2007, we amended the senior term note agreement, which required us to reduce the balance to $262,500 and increased the interest rate. As a result, the underlying terms of the interest swap agreement no longer effectively matched the terms of the senior term note and we removed the designation of the swap agreement as a cash flow hedge. Subsequent changes in the fair value of the swap agreement are reflected in other income and expense in the consolidated statements of income. Due to our filing of petitions under Chapter 11 of the Bankruptcy Code, the interest rate swap agreement was terminated by the counterparty and the fair value on the termination date became due and payable as a secured obligation to the counterparty. At December 31, 2008, the fair value of the swap agreement of ($10,575) is reflected in liabilities subject to compromise in the consolidated balance sheet. Fair Value of Financial Instruments In September 2006, the FASB issued SFAS 157, Fair Value Measurement. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 was effective for our financial assets and liabilities on January 1, 2008. The FASB delayed the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008. SFAS 157’s valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect our market assumptions. The Standard classifies these inputs into the following hierarchy: Level 1 Inputs—Quoted prices for identical instruments in active markets. Level 2 Inputs—Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable. Level 3 Inputs—Instruments with primarily unobservable value drivers. We have one derivative instrument, an interest rate swap agreement, subject to valuation under SFAS 157:
The non-cash mark-to-market resulted in a loss of $929 for the year ended December 31, 2008. Due to our filing of petitions under Chapter 11 of the Bankruptcy Code, the interest rate swap agreement was terminated by the counterparty and the fair value on the termination date became due and payable as a secured obligation to the counterparty.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
Advertising Costs Advertising costs consists primarily of television, radio, newspaper, direct mail, billboard, brochures and other media advertising programs. We expense advertising costs as incurred to selling, general and administrative costs. Tangible advertising costs such as architectural models and visual displays are capitalized to property and equipment or real estate inventories. Advertising expense was approximately $9,718, $17,964, and $31,577 for the years ended December 31, 2008, 2007 and 2006, respectively. Income Taxes We account for income taxes in accordance with SFAS 109, Accounting for Income Taxes. This approach requires recognition of income tax currently payable, as well as deferred tax assets and liabilities resulting from temporary differences by applying enacted statutory tax rates applicable to future years to differences between the financial statement carrying amounts and the tax bases of assets and liabilities. SFAS 109 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard. We assess our deferred tax assets quarterly to determine if valuation allowances are required. See Note 18 for further discussion of the valuation allowances recorded in 2008. Effective January 1, 2007, we adopted FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109. FIN 48 defines the methodology for recognizing the benefits of tax return positions as well as guidance regarding the measurement of the resulting tax benefits. FIN 48 requires an enterprise to recognize the financial statement effects of a tax position when it is more likely than not (defined as a likelihood of more than 50%), based on the technical merits, that the position will be sustained upon examination. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The evaluation of whether a tax position meets the more-likely-than-not recognition threshold requires a substantial degree of judgment by management based on the individual facts and circumstances. Actual results could differ from these estimates. Stock-Based Compensation At December 31, 2008, we have two stock incentive plans, which are described more fully in Note 17. Prior to January 1, 2006, we accounted for stock-based awards granted under the plans in accordance with the recognition and measurement provisions of APB 25 and related Interpretations, as permitted by SFAS 123 Accounting for Stock-Based Compensation. Compensation expense related to stock options was not recognized in our condensed consolidated statement of operations prior to January 1, 2006, as all stock option awards granted under the plans had an exercise price equal to the market value of the common stock on the date of the grant. Effective January 1, 2006, we adopted the provisions of SFAS 123R, Share-Based Payment, using the modified-prospective transition method. Under this transition method, compensation expense recognized subsequent to January 1, 2006 included: (a) compensation expense for all share-based awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS 123, and (b) compensation expense for all share-based awards granted subsequent to January 1, 2006, based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. In accordance with the modified-prospective transition method, results for prior periods have not been restated.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
On November 10, 2005, the FASB issued FASB Staff Position SFAS 123(R)-3, Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards. The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee stock-based compensation, and to determine the subsequent impact on the APIC pool. After evaluating SFAS 123(R)-3 we chose to elect the simplified method, and established our beginning pool balance using the short form method of SFAS 123R. No impact on net income resulted from our adoption of same. Employee Benefit Plan Company employees who meet certain requirements as to age and service are eligible to participate in our 401(k) benefit plan. For the years ended December 31, 2008, 2007 and 2006, our expenses related to the plan were $1,597, $2,356, and $3,083, respectively. Shareholders’ Equity In addition to common stock, we have 100,000 shares authorized of series common stock, $.01 par value per share, and 100,000 shares authorized of preferred stock, $.01 par value per share. No shares of series common stock or preferred stock are issued and outstanding. Treasury stock is recorded at cost. Issuance of treasury shares is accounted for on a first-in, first-out basis. In September 2006, our Board of Directors approved the repurchase of an additional 3,000 shares. During the year ended December 31, 2006, we repurchased 3,000 shares at an average price of $23.02 per share. During the years ended December 31, 2008 and 2007, we received approximately 12 and 7 shares, respectively, to satisfy employees tax liability on shares issued in conjunction with our stock-based compensation program. Earnings Per Share Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of common shares outstanding for the period. Diluted earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares outstanding including the dilutive effect of stock options and convertible notes. Options to purchase common stock, restricted stock units and performance stock grants totaling 1,384, 3,906 and 1,879 shares were excluded from the computation of diluted weighted average shares outstanding for 2008, 2007 and 2006, respectively, due to their antidilutive effect. Approximately 4,534 shares related to the contingent convertible notes were excluded from the calculation of diluted weighted average shares outstanding for the years ended 2008 and 2007 due to their antidilutive effect. Information pertaining to the calculation of earnings per share for each of the three years ended December 31 is as follows:
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
Consolidated Statement of Cash Flows—Supplemental Disclosures
Non-monetary transactions during 2008, 2007 and 2006:
New Accounting Pronouncements In December 2007, the FASB issued SFAS 141R, Business Combinations and SFAS 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51. SFAS 141R will change how business acquisitions are accounted for and will impact financial statements both on the acquisition date and in subsequent periods. SFAS 160 will change the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. SFAS 141R and SFAS 160 are effective for both public and private companies for fiscal years beginning on of after December 15, 2008. SFAS 141R will be applied prospectively. SFAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS 160 will be applied prospectively. Early adoption is prohibited for both standards. The impact on our financial statements for that period has not yet been determined. In March 2008, the FASB issued SFAS 161, Disclosures About Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133. SFAS 161 expands the disclosure requirements in SFAS 133, Accounting for Derivative Instruments and Hedging Activities, regarding an entity’s derivative instruments and hedging activities. SFAS 161 is effective for fiscal years beginning after November 1, 2008. We do not expect the adoption of SFAS 161 to have a material effect on our consolidated financial statements. In April 2008, the FASB issued FASB Staff Position 90-7-1, “An Amendment of AICPA Statement of Position 90-7,”. FSP 90-7-1, which was effective immediately and amends SOP 90-7, paragraph 38 to nullify the requirement regarding changes in accounting principles. Previously under paragraph 38 of SOP 90-7, changes in accounting principles that will be required in the financial statements of an emerging entity within the 12 months following the adoption of fresh-start accounting were required to be adopted at the time fresh-start reporting was adopted. As a result of the amendment, an entity emerging from bankruptcy that applies fresh-start reporting should follow only the accounting standards in effect at the date fresh-start reporting is adopted, which include those standards eligible for early adoption if an election is made to adopt early. In May 2008, the FASB issued FASB Staff Position APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (Including Partial Cash Settlement). FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate on the instrument’s issuance date when
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
interest cost is recognized in subsequent periods. Our 2003 4.0% contingent convertible senior subordinated notes due August 5, 2023 are within the scope of FSP APB 14-1. We will be required to record the debt portions of our 4.0% contingent convertible senior subordinated notes at their fair value on the date of issuance or subsequent amendment date and amortize the discount into interest expense over the life of the debt; however, there would be no effect on our cash interest payments. FSP APB 14-1 will be effective for financial statements issued for fiscal years beginning after December 15, 2008 and the interim periods within those fiscal years, and would be applied retrospectively to all periods presented. Early adoption is not permitted. We do not expect the adoption of FSP APB 14-1 to have a material effect on our consolidated financial statements. Concentration Risks Approximately 96% of our total revenues are generated from our Florida operations, with our Mid-Atlantic United States (Mid-Atlantic U.S.) and the Northeast United States (Northeast U.S.) markets comprising the remaining revenues. Consequently, the significant economic downturn in the Florida, Mid-Atlantic U.S. and Northeast U.S. markets has adversely affected our business, results of operations and financial condition.
Since the condensed consolidated financial statements of the Company include entities not in Chapter 11 reorganization proceedings, the following presents condensed combined financial information of the entities in Chapter 11 reorganization proceedings. The condensed combined financial information has been prepared, in all material respects, on the same basis as the condensed consolidated financial statements of the company.
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
Condensed Combined Debtors-in-Possession Balance Sheet
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
Condensed Combined Debtors-in-Possession Statement of Operations
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
Condensed Combined Debtors-in-Possession Statement of Cash Flows
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Table of ContentsWCI Communities, Inc. Debtor-in-Possession Notes to Consolidated Financial Statements—(Continued) December 31, 2008 (In thousands, except per share data)
We operate in three principal business segments: Tower Homebuilding, Traditional Homebuilding, which includes sales of lots, and Real Estate Services, which includes real estate brokerage and title operations. The reportable segments are each managed separately because they provide distinct products or services with different productions processes. Land Sales and Amenity Membership and Operations and Other have been disclosed for purposes of additional analysis. The amount of previously capitalized interest included in cost of sales of each segment, thereby reducing segment gross margin, is also presented for purposes of additional analysis. The accounting policies of the segments are the same as those described in our significant accounting policies in Note 2. Asset information by business segment is not presented, since we do not prepare such information.
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