Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The issuer’s revenues for its most recent fiscal year were $63,283,527. The aggregate market value of the voting and non-voting common equity held by non-affiliates as of March 3, 2008 was $4,294,973.1 For purposes of the foregoing calculation only, directors and executive officers and holders of 10% or more of the issuer’s common capital stock have been deemed affiliates. The number of shares outstanding of the Registrant’s common stock as of March 3, 2008 was 11,263,306.
Transitional Small Business Disclosure Format: Yes ¨ No x
| 1 |
Market value based upon sales occurring on that date. Calculation does not account for common shares issuable upon conversion of convertible preferred stock. |
Table of Contents
2007 FORM 10-KSB
TABLE OF CONTENTS
| ITEM |
PAGE | |||
| ITEM 1. |
DESCRIPTION OF BUSINESS | 1 | ||
| ITEM 2. |
DESCRIPTION OF PROPERTY | 7 | ||
| ITEM 3. |
LEGAL PROCEEDINGS | 8 | ||
| ITEM 4. |
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS | 8 | ||
| ITEM 5. |
MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS | 9 | ||
| ITEM 6. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION | 10 | ||
| ITEM 7. |
FINANCIAL STATEMENTS | 17 | ||
| ITEM 8. |
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE | 18 | ||
| ITEM 8A. |
CONTROLS AND PROCEDURES | 18 | ||
| ITEM 8B. |
OTHER INFORMATION | 18 | ||
| ITEM 9. |
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT | 19 | ||
| ITEM 10. |
EXECUTIVE COMPENSATION | 22 | ||
| ITEM 11. |
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS | 26 | ||
| ITEM 12. |
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS | 29 | ||
| ITEM 13. |
EXHIBITS | 31 | ||
| ITEM 14. |
PRINCIPAL ACCOUNTANT FEES AND SERVICES | 33 | ||
Table of Contents
PART I
Special Note Regarding Forward-Looking Statements
Information included or incorporated by reference in this Annual Report on Form 10-KSB may contain forward-looking statements. This information may involve known and unknown risks, uncertainties, and other factors which may cause our actual results, performance, or achievements to be materially different from the future results, performance, or achievements expressed or implied by any forward-looking statements. Forward-looking statements, which involve assumptions and describe our future plans, strategies, and expectations, are generally identifiable by use of the words “may,” “should,” “expect,” “anticipate,” “estimate,” “believe,” “intend,” or “project” or the negative of these words or other variations on these words or comparable terminology.
| ITEM 1. | DESCRIPTION OF BUSINESS |
Unless otherwise indicated or the context otherwise requires, all references below in this filing to “we,” “us,” the “Company,” and “Deer Valley” are to Deer Valley Corporation, a Florida corporation, together with its wholly-owned subsidiary, Deer Valley Homebuilders, Inc. (“DVH”), an Alabama corporation formed in January 2004 and the Company’s primary operating entity.
Business Development
The Company, under the name Cytation Corporation, was incorporated under the laws of Delaware on November 1, 1999. Until June 20, 2001, the Company provided an extensive range of in-school and online services directed at high school students and their parents, high school counselors, college admissions officers, and corporations which target the teen marketplace. On June 20, 2001, the Company sold all of its assets associated with these activities to TMP Worldwide Inc. for approximately $7.2 million in cash and debt assumed.
During the period commencing with the fourth quarter of 2002 and ending in December 2004, the Company engaged in the business of providing consulting and related services to private companies wishing to become reporting companies under the Securities Exchange Act of 1934. In the first quarter of 2005, the Company discontinued all business operations except finding an appropriate private entity with which it could acquire or merge.
During the first quarter of 2006, the Company entered into the Securities Purchase and Share Exchange Agreement, which, among other matters, resulted in the Company raising in excess of $7,400,000 in exchange for the issuance of its Series A Convertible Preferred Stock, Series A Common Stock Purchase Warrants, and Series B Common Stock Purchase Warrants.
Contemporaneous with the completion of the Series A Preferred Offering and Share Exchange, Deer Valley Acquisition Corp (“DVA”), a wholly owned subsidiary of the Company, acquired 100% of the issued and outstanding capital stock of DVH. On July 24, 2006 the Company held a Special Meeting of Stockholders not in lieu of an annual meeting at which time it obtained the approval of an amendment to the Company’s Certificate of Incorporation to change the name of the Company from Cytation Corporation to Deer Valley Corporation.
Business of the Issuer
Overview
The Company, through its wholly-owned subsidiary, DVH, with its business offices located at 205 Carriage Street, P.O. Box 310, Guin, Alabama 35563, is engaged in the production, sale and marketing of factory-built homes in the southeastern and south central U.S. housing market. As of the date of this filing, we manufacture all of our factory-built homes in two manufacturing facilities, one located in Guin, Alabama and one located in Sulligent, Alabama. We rely upon a team of regional sales directors and approximately 80 independent dealers to market our factory-built homes in over 100 retail locations. As of the date of this filing, we are selling our factory-built homes in 13 states through our network of independent dealers and retail centers.
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In addition, the Company has increased its involvement in the modular segment of the factory built housing industry. A modular home is a home comprised of sections, known as modules, which are built in a factory and transported to a site to be joined together on a permanent foundation and is distinct from our factory-built homes (“HUD Code homes”), which are constructed in accordance with the Federal Manufactured Home Construction and Safety Standards promulgated by the U.S. Department of Housing and Urban Development, better known as the “HUD Code.” As its initial entry into the modular segment, the Company is targeting the production of smaller units (less than 3,000 square feet) that are readily producible, in a cost efficient manner, using the Company’s existing manufacturing capabilities. The Company sells these models to large tract developers, government sponsored agencies, and independent dealers.
Beginning in the second quarter of calendar year 2007, state and federal agencies, and other government sponsored entities, began distributing Requests for Proposals (RFPs) for housing designed to test and evaluate future disaster recovery housing units for the Gulf Coast region. In June 2007, the Company’s plant in Guin, Alabama was selected by the State of Mississippi to produce 50 two-bedroom and 100 three-bedroom cottages as part of a program that is designed to test and evaluate future disaster housing units. The total combined value of this initial pilot phase contract awarded to the Company was $7,535,000. All units contracted for with the Company under this initial contract were produced and delivered before the end of the third quarter of 2007.
During the fourth quarter of 2007, the Company was awarded two separate contract extensions by the State of Mississippi for the production and delivery of an additional 250 two-bedroom cottages as part of the State of Mississippi’s pilot program to test and evaluate future disaster housing units. All of the units to be produced by the Company under the contract extension are scheduled to be delivered prior to March 31, 2008. The total anticipated proceeds from the two extensions, when combined with the original contract, brings the combined proceeds of the pilot phase contracts awarded to Deer Valley to a total of $19,510,000.
To provide increased flexibility to fulfill it government contracts, on August 10, 2007, DVH entered into a Revolving Bridge Loan and Security Agreement with Fifth Third Bank, providing for a line of credit of $5,000,000. This facility has a six-month term and has a variable interest rate at 2.50% above LIBOR. (see paragraph below titled “Liquidity and Capital Resources”).
Manufacturing Operations
We currently produce all of our factory-built homes at two manufacturing facilities in Guin and Sulligent, Alabama. Our facilities normally function on a single-shift, five-day work week basis. However, at the beginning of 2007 and continuing through the first quarter of 2007, we restricted our production to four days per week or approximately 80% of our “normal” production rate and closed our manufacturing facilities for the last week of March. These reductions reflected the industry wide softness in demand during the first quarter of 2007 for HUD Code housing units. During the fourth quarter of 2007, the Company’s average production rate was [9.5] “floors” produced per day.
The principal raw materials used in the production of HUD Code and modular homes include wood, wood products, panels, steel, sheetrock, vinyl siding, gypsum wallboard, fiberglass insulation, carpet, appliances, electrical items, windows, roofing materials, electrical supplies, roof trusses, and plumbing fixtures. We believe that the raw materials used in the production of our factory-built homes are readily available from a wide variety of suppliers and that the loss of any single supplier would not have a material adverse effect on our business. Although we rely upon Odyssey Group (sheet rock, plumbing, and other assembly items), WoodPerfect (lumber supplies), Morris Sales Company (lumber and siding, panels), General Electric (appliances), and Owens Corning (insulation) in purchasing materials to assemble our homes, we are not dependent on a single source or supplier for component purchases.
While our HUD Code and modular homes are constructed with many of the same components and building materials used in site-built homes, we utilize a cost-efficient assembly line manufacturing process which enables us to produce a quality home at a significantly lower cost per square foot than a traditional, site-built home. Our homes are built with residential features, including 1/2 inch drywall, thermally sealed double-paned windows from Capitol™, enhanced insulation, oak cabinets, cultured marble vanities, and two inch by six inch exterior wall construction standards.
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Because the cost of transporting a factory-built home is significant, substantially all of our homes are sold to dealers within a 500 mile radius of our manufacturing facility. DVH arranges, at dealers’ expense, for the transportation of finished homes to dealer locations using independent trucking companies. Customary sales terms are cash-on-delivery or guaranteed payment from a floor-plan financing source. Dealers or other independent installers are responsible for placing the home on site and connecting utilities.
Backlog of Orders and Sales Policies
Substantially all production of our factory-built homes is initiated against specific orders. As of December 29, 2007, our total backlog of orders stood at 5.6 weeks based on our average production rate of 9.5 floors per day. Excluding the cottages scheduled to be manufactured for the State of Mississippi during the first quarter of 2008, our total sales backlog was approximately 1.5 weeks at our average production rate. Dealer orders are subject to cancellation prior to commencement of production, and we do not consider our backlog to be firm orders. Because we operate in an industry where order lead times are extremely short, we do not view backlog at any point in time to be indicative of the level of our future revenues.
Sales of our HUD Code homes are made to dealers either through floor-plan financing arrangements with a financial institution or on a cash basis. When a HUD Code home is purchased, we receive payment either directly from the dealer or from a financial institution which has agreed to finance dealer purchases of our manufactured homes. As is customary in our industry, many financial institutions that finance dealer purchases require that we execute a repurchase agreement which provides that, in the event a dealer defaults on its repayment of the financing arrangement, we agree to repurchase the manufactured home from the financing institution, in accordance with a declining repurchase price schedule that is mutually agreed upon. Because we do not build significant inventories of either finished goods or raw materials and because we initiate production against a specific product order, we do not have significant inventories or a backlog of product orders.
Products
We currently offer 45 different models of HUD Code homes, with a variety of decors that are marketed under our Deer Valley brand name. We currently manufacture and sell single-section and multi-section HUD Code homes, with 90% of the HUD Code homes we produced in 2007 consisting of multi-section units (excluding the cottages for the State of Mississippi). We offer over 45 different floor plans, ranging in size from approximately 840 to 2,580 square feet. Many of our homes are customized to homebuyers’ specifications. Many features associated with site-built homes are included in factory-built homes, such as central heating, name-brand appliances, carpeting, cabinets, walk-in closets, wall coverings, and porches. Also, many of our independent dealers offer optional features including central air conditioning, carports, garages, and furniture packages. We believe that our willingness to offer factory trim-out services and customize floor plans and design features to match homebuyers’ preferences is a principal factor which differentiates us from our competitors.
Each HUD Code home typically includes three to five bedrooms, a great room which functions as a living room, family room, and dining room, a kitchen, and two or three bathrooms and features central air conditioning and heating, a water heater, a dishwasher, a refrigerator, a microwave, a cook top/range, and an oven. We offer a wide range of colors, moldings, and finishes and provide optional features including fireplaces, wood floors, and modern kitchen counter-tops. We continue to modify and improve the design of our HUD Code homes in consultation with our sales representatives and independent dealer network. We also utilize computer-aided and other design methods in an effort to continuously improve the design of our HUD Code homes and to permit our customers to customize their purchases.
In March 2007, the Company continued to expand its product offerings with a new modular home line. The company initially constructed three floor plans between 1,770 and 1,980 square feet. The homes are currently offered in five states: Alabama, Mississippi, Louisiana, Arkansas and Tennessee. These modular homes include front load porch designs to accommodate the narrow lot lines typical in coastal areas. Our modular homes will be constructed standard to a 110 mile per hour wind load and an optional 140 mile per hour wind load. The Company is seeking to expand into other states with new designs to fulfill the growing demand among builders and developers for factory-built structures. Typical features in our modular homes include “heavy built” construction very similar to Deer Valley Homebuilders, Inc.’s other offerings. The Company will perform customization in this line of modular homes, as each builder has different needs.
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Our modular homes must be constructed in accordance with the local building codes in effect at the point of delivery. These codes vary from state to state and also within states. Such variance in standards is not conducive to standardized factory construction of a quality home. Accordingly, we build our modular homes to the standards of the International Residential Code (“IRC”), which is generally more stringent than local building codes. The IRC has been adopted wholesale by several states and by selected localities in many others.
Our two and three-bedroom cottages which we have contracted to manufacture for the State of Mississippi are designed and manufactured to meet the requirements of both the HUD Code and the International Residential Code. As a result, such cottages can either remain on an integrated steel frame and axle or be joined to a permanent foundation.
Due to the nature of our business, we do not have a significant formal research and development program and we do not allocate significant funds for research and development activities.
Deer Valley has traditionally focused on designing factory-built homes with features comparable to site-built homes. In addition to offering the consumer options specified in the preceding paragraph, Deer Valley generally offers extensive customization of floor plan designs and exterior elevations to meet specific customer preferences. The following table sets forth the total factory homes built and sold, square footage, and retail price range in 2007:
Number of Homes Sold:
| Multi-section Homes | 1750 floors or 876 units | |
| Single-section Homes | 95 floors or 95 units | |
| State of Mississippi Cottages | 200 floors or 200 units | |
| Total Homes | 2045 floors or 1171 units |
| Type of Homes |
Square Feet |
Retail Price Range (excluding land) | ||
| Multi-floor Homes | 1,560 to 2,580 | $59,000 to $119,000 | ||
| Single-floor Homes | 840 to 1,140 | $39,000 to $59,000 | ||
| State of Mississippi Cottages | 728 to 840 | $47,900 to $51,400 |
Independent Dealer Network, Sales and Marketing
As of the date of this filing, we had approximately 80 participating independent dealers marketing our factory-built homes at around 100 locations. Our independent dealers are not required to exclusively sell our homes and will typically choose to offer the products of other manufacturers in addition to ours. We do not have written exclusive agreements with our independent dealers and do not have any control over the operations of, or financial interest in, any of our independent dealers. We are not dependent on any single dealer, and in 2007, our largest dealer location accounted for approximately 8% of our sales including the State of Mississippi, and 9.5% excluding the State of Mississippi. The contracts with the State of Mississippi accounted for 15.3% of our sales.
We believe that our independent dealer network enables us to avoid the substantial investment in management, capital, and overhead associated with company-owned sales centers. Although we do not rely upon exclusive dealer arrangements, we typically rely upon a single dealer within a given geographical market to distribute our products. We believe our strategy of selling our homes through independent dealers helps to ensure that our homes are competitive with those of other companies in terms of quality, consumer acceptability, product design, and price.
During the fiscal year ended December 31, 2007, we estimate that the percentage of our revenues by region was as follows:
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| Regions |
Primary States |
Percentage of Revenue by Region | ||
| Southeast | Alabama, Florida, Georgia, Kentucky, Mississippi, Tennessee and West Virginia | 54% | ||
| South Central | Louisiana, Oklahoma, Texas, Illinois, Arkansas, Missouri, Indiana and Kansas | 46% | ||
Our manufacturing facility currently serves approximately 80 dealers and our sales staff maintains and monitors our relationships with each independent retailer in an effort to maintain excellent relationships with our network of independent dealers.
Continuing Operations
Factory-Built Homes - Industry Trends
Due to the difficult financing environment for chattel financing nationwide, the industry has been trending toward more conventional mortgage financing for land and homes. Chattel financing is personal property financing secured only by the home and not by the underlying land on which the home is sited. In contrast, “land and home” financing is real property financing secured by the home and by the underlying land on which the home is placed.
Because a variety of products are described as “modular,” including educational and commercial facilities, as well as single-family homes, accurate information on modular home sales is difficult to obtain. However, it is widely accepted that HUD Code home sales are trending downward largely due to being zoned out of certain urban and coastal areas. All housing starts were down 36% in 2007 as compared to 2006, and HUD Code homes are not immune from this trend. In addition, HUD Code sales are periodically affected by financing shortages. Conversely, modular home shipments have been rising, as the availability of on-site labor decreases and the demand for affordable housing increases.
Economic pressures in the last half of 2007 have caused some dealers in the Company’s network to cease doing business. The Company typically replaces any non-operating dealers with other dealers in or around the area. However, this trend may continue in the near future presenting an ongoing risk to the Company.
Warranties, Quality Control, and Service
We endeavor to adhere to strict quality standards and continuously refine our production procedures. In addition, in accordance with the construction codes promulgated by HUD, an independent HUD-approved, third-party inspector inspects each HUD Code home for compliance during construction at our manufacturing facilities.
We provide initial home buyers with a one-year limited warranty against manufacturing defects in the home’s construction. In addition, direct warranties are often provided by the manufacturers of components and appliances.
We have experienced quality assurance personnel at each of our manufacturing facilities who provide on-site service to dealers and home buyers. We continuously work to enhance our quality assurance systems, placing high emphasis on improving the value and appeal of our homes and reducing consumer warranty claims.
Independent Dealer Financing
Substantially all of our independent dealers finance their purchases through “floor-plan” arrangements under which a financial institution provides the dealer with a loan for the purchase price of the home and maintains a security interest in the home as collateral. In connection with a floor-plan arrangement, the financial institution that provides the independent dealer financing customarily requires DVH to enter into a separate repurchase agreement with the financial institution, under which DVH is obligated, upon default by the independent dealer, to repurchase the home at the original invoice price less the cost of all damaged/missing items, plus certain administrative and shipping expenses. The repurchase agreement relates to homes located on an authorized dealer’s lot and in new, sellable condition. As a result, the potential repurchase liability may be offset by the value of the repurchased house. The risk of loss which we face under these repurchase agreements is also lessened by additional factors listed under Item 6 of this filing, at “Reserve for Repurchase Commitments.”
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As of December 31, 2007, DVH’s contingent repurchase liability under floor plan financing arrangements through independent dealers was approximately $17,202,000. While homes repurchased by DVH under floor-plan financing arrangements are usually sold to other dealers, no assurance can be given that DVH will be able to sell to other dealers homes which it may be obligated to repurchase in the future or that DVH will not suffer more losses with respect to, and as a consequence of, those arrangements than we have accrued in our financial statements.
Competition
The factory-built housing industry is highly competitive at both the manufacturing and retail levels, with competition based upon numerous factors, including total price to the dealer, customization to homeowners’ preferences, product features, quality, warranty repair service, and the terms of dealer and retail customer financing. We have many competitors, ranging from very large, experienced, and well-financed companies to small, specialized manufacturers. Numerous firms produce HUD Code homes and modular homes in the southeastern and south central United States, many of which are in direct competition with us. In addition, certain of our competitors provide retail customers with financing from captive finance subsidiaries.
HUD Code and modular homes also compete with other forms of housing, including site-built and prefabricated homes. Historically, HUD Code housing has had a price advantage over these other forms of housing. That advantage has deteriorated, however, as the credit market in the HUD Code housing industry has, at both the retail and wholesale levels, continued to tighten, while interest rates for site-built houses in recent years have been at historic lows, thus increasing the competitive pressures on HUD Code housing.
The capital requirements for entry as a producer in the factory-built housing industry are relatively small in comparison to potential revenue. However, we believe that entry into the industry may be more difficult due to the repurchase requirements imposed by the floor plan financing obtained by dealers. In addition, we believe that the qualifications for obtaining inventory financing, which are based upon the financial strength of the manufacturer and each of its dealers, have recently become more difficult to meet due to the departure of financial institutions from the market and efforts of our competitors to add dealers to their sales network.
We believe that our willingness to customize floor plans and design features to match customer preferences, offer factory-provided trim-out and installation services, and provide efficient customer service differentiate us from most of our competitors in the factory-built housing industry. By focusing our manufacturing efforts exclusively on HUD Code homes and modular homes on a cost-effective basis and by relying upon our strong network of regional independent dealers within our geographical market, we have been able to minimize our administrative and marketing expenses while providing our customers with a competitively priced product that maximizes value for the purchase price paid for the home. In addition, we maintain close relationships with each of our independent dealers and carefully monitor our service responsibilities to the customers who purchase a factory-built home from us.
Regulation
Deer Valley’s factory-built homes are subject to a number of federal, state and local laws. Construction of HUD Code homes is governed by the National Manufactured Housing Construction and Safety Standards Act of 1974 (“1974 Act”). In 1976, HUD issued regulations under the 1974 Act establishing comprehensive national construction standards. The HUD regulations cover all aspects of HUD Code home construction, including structural integrity, fire safety, wind loads, thermal protection, plumbing, and electrical work. Such regulations preempt conflicting state and local regulations. Our manufacturing facilities and the plans and specifications of our HUD Code homes have been approved by a HUD-designated inspection agency. An independent, HUD-approved, third-party inspector checks each of our HUD Code homes for compliance during at least one phase of construction. In 1994, HUD amended construction safety standards to improve the wind force resistance of HUD Code homes sold for occupancy in coastal areas prone to hurricanes. Failure to comply with the HUD regulations could expose us to a wide variety of sanctions, including closing our manufacturing plants. We believe that our HUD Code homes meet or surpass all present HUD requirements.
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HUD Code, modular, and site-built homes are all built with oriented strand board, paneling, and other products that contain formaldehyde resins. Since February 1985, HUD has regulated the allowable concentration of formaldehyde in certain products used in factory-built homes and requires manufacturers to warn purchasers concerning formaldehyde-associated risks. We currently use materials in our factory-built homes that meet HUD standards for formaldehyde emissions and that otherwise comply with HUD regulations in this regard. In addition, certain components of factory-built homes are subject to regulation by the Consumer Product Safety Commission (“CPSC”), which is empowered to ban the use of component materials believed to be hazardous to health and to require the manufacturer to repair defects in components of its homes. The CPSC, the Environmental Protection Agency, and other governmental agencies are evaluating the effects of formaldehyde. In February 1983, the Federal Trade Commission adopted regulations requiring disclosure of HUD Code home’s insulation specifications.
Our HUD Code and modular homes are also subject to local zoning and housing regulations. Utility connections are subject to state and local regulation, which must be followed by the dealer or other person installing the home. A number of states require HUD Code and modular home producers to post bonds to ensure the satisfaction of consumer warranty claims. Several states have adopted procedures governing the installation of HUD Code and modular homes. We have complied with these requirements in Alabama, Mississippi, Louisiana, Arkansas, Georgia, Florida, Tennessee, Kentucky, Indiana, Illinois, Missouri, Oklahoma, and Texas. Many of these states require that companies renew their compliance or notify the state after a change in ownership. We are taking the steps necessary to remain in compliance with these state laws.
There are no special or unusual environmental laws or regulations which require us to make material expenditures or which can be expected to materially impact the operation of our business.
Patents and Licenses
We do not rely upon any significant patent rights, licenses or franchises under the trademarks or patents of any other person or entity in conducting our business. While DVH utilizes the mark “Deer Valley” and “Deer Valley Homebuilders” as Company trademarks in marketing its factory-built homes, we do not own any trademarks or patents registered with the United States Patent and Trademark Office. However, we have applied for trademark protection for “Deer Valley Homebuilders, Inc.” with the United States Patent and Trademark Office.
Employees
We currently have approximately 453 employees, all of whom are full-time. None of our employees are represented by a labor union and we consider our relationships with our employees to be good.
| ITEM 2. | DESCRIPTION OF PROPERTY |
The Company’s executive and operating offices are located at 4218 W. Linbaugh Avenue, Tampa, FL, which were formerly located at 4902 Eisenhower Blvd., Suite 185, Tampa, FL 33634. The Company moved its offices to the new location on in early 2007. The telephone number at the Company’s executive offices is (813) 885-5998. DVH’s principal manufacturing plant and offices are located at 205 Carriage Street, Guin, Alabama 35563 (the “Guin Property”), and its telephone number is (205) 468-8400. DVH’s principal manufacturing plant and company offices consist of a manufacturing plant with 107,511 square feet, a frame shop with 10,800 square feet, material shed of 23,172 square feet and offices with 11,250 square feet of space. DVH owns the buildings and 25.5 acres underlying these facilities. DVH has executed a mortgage on the Guin Property in favor of a national bank.
In addition, DVH owns a satellite manufacturing facility with a 65,992 square foot manufacturing plant located on approximately 13 acres of land in Sulligent, Alabama (the “Sulligent Property”). The purchase price for the Sulligent Property was $725,000, subdivided as follows. DVH assumed the seller’s mortgage of approximately $610,000 and agreed to pay the remaining $115,000 to the seller in equal monthly payments of $5,000 for twenty-three months. The seller of the Sulligent Property was Steven J. Logan, the father of DVH’s President and General Manager, Joel Logan. The Sales Contract was approved by the disinterested members of DVH’s Board of Directors and the Chief Executive Officer of the Company.
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We believe that the general physical condition of our manufacturing facilities and executive offices is adequate to satisfy our current production needs. Accordingly, there are no present plans to improve or develop any of the unimproved or undeveloped portions of the Guin or Sulligent Properties.
Except for ownership of the manufacturing facilities we occupy or intend to occupy, we do not invest in real estate or real estate mortgages. It is not our policy to acquire properties for capital gain or rental income. In our opinion, we have sufficient property insurance for our property.
| ITEM 3. | LEGAL PROCEEDINGS |
Although the Company in the normal course of business is subject to claims and litigation, the Company is not a party to any material legal proceeding nor is the Company aware of any circumstance which may reasonably lead a third party to initiate legal proceeding against the Company.
As of the date of this filing, there are no material pending legal or governmental proceedings relating to our company or properties to which we are a party, and to our knowledge there are no material proceedings to which any of our directors, executive officers, or affiliates are a party adverse to us or which have a material interest adverse to us.
| ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
During the fourth quarter of the fiscal year which ended on December 31, 2007, no matter was submitted to a vote of security holders.
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PART II
| ITEM 5. | MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND SMALL BUSINESS ISSUER REPURCHASES OF SECURITIES |
Market Information
Our common stock trades on the OTC Bulletin Board under the trading symbol “DVLY.” The figures set forth below reflect the quarterly high and low bid information for shares of our common stock during the last two fiscal years, as reported by the OTC Bulletin Board. These quotations reflect inter-dealer prices without retail markup, markdown, or commission, and may not represent actual transactions. Please note that the board of directors approved a two-for-one stock dividend on November 4, 2005, payable to shareholders of record as of November 14, 2005, which doubled the numbers of shares outstanding.
| 2006 Quarter Ended |
High | Low | ||||
| December 31, 2006 |
$ | 2.35 | $ | 1.45 | ||
| September 30, 2006 |
$ | 2.90 | $ | 1.11 | ||
| June 30, 2006 |
$ | 3.90 | $ | 2.25 | ||
| March 31, 2006 |
$ | 2.97 | $ | 1.10 | ||
| 2007 Quarter Ended |
||||||
| December 31, 2007 |
$ | 1.15 | $ | .95 | ||
| September 30, 2007 |
$ | 1.24 | $ | .96 | ||
| June 30, 2007 |
$ | 1.40 | $ | 1.10 | ||
| March 31, 2007 |
$ | 2.00 | $ | 1.20 | ||
Our common stock is covered by an SEC rule imposing additional sales practice requirements on broker-dealers who sell such securities to persons other than established customers and accredited investors, which are generally institutions with assets in excess of $5,000,000, or individuals with net worth in excess of $1,000,000 or annual income exceeding $200,000, or $300,000 jointly with a spouse. For transactions covered by the rule, the broker-dealer must make a special suitability determination for the purchaser and transaction prior to the sale. Consequently, the rule may affect the ability of broker-dealers to sell our securities, and also may affect the ability of purchasers of our stock to sell their shares in the secondary market. The rule may also cause fewer broker-dealers to be willing to make a market in our common stock, and it may affect the level of news coverage we receive.
Holders Of Common Stock
On March 3, 2008, there were 398 registered holders or persons otherwise entitled to hold our common shares pursuant to a shareholders’ list provided by our transfer agent, Computershare Investor Services, N.A. The number of registered shareholders excludes any estimate by us of the number of beneficial owners of common shares held in street name.
Dividends
We have not declared or paid any cash dividends on our common stock since our inception, and our Board of Directors currently intends to retain all earnings for use in the business for the foreseeable future. Any future payment of dividends to holder of common stock will depend upon our results of operations, financial condition, cash requirements, and other factors deemed relevant by our Board of Directors.
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Securities Authorized For Issuance Under Equity Compensation Plans
EQUITY COMPENSATION PLAN INFORMATION
| Plan Category |
Number of securities to be issued upon exercise of outstanding option, warrants and rights |
Weighted-average exercise price of outstanding options, warrants and rights |
Number of securities remaining available for future issuances under equity compensation plans (excluding securities reflected in column (a)) |
|||||
| Equity compensation plans approved by security holders |
— | — | — | |||||
| Equity compensation plans not approved by security holders |
700,000 | $ | 1.115 | 1,100,000 | (1) | |||
| Total |
700,000 | $ | 1.115 | 1,100,000 | ||||
| (1) | Under the terms of the 2007 Incentive Plan, there are only 300,000 shares remaining that may be issued as incentive stock options leaving 800,000 issuable shares that would not be the subject of an option or warrant. |
On September 7, 2007, the Company’s Board of Directors ratified the Company’s 2007 Long Term Incentive Plan (the “2007 Incentive Plan”). The 2007 Incentive Plan was effective as of July 1, 2007. A maximum of 1,800,000 shares of common stock has been authorized to be issued under the 2007 Incentive Plan in connection with the grant of awards, subject to adjustment for corporate transactions, including, without limitation, any stock dividend, forward stock split, reverse stock split, merger or recapitalization. Of this amount, no more than 1,000,000 shares of common stock may be issued as incentive stock options.
Pursuant to the 2007 Incentive Plan, each of the seven members of the Board of Directors were issued an option exercisable for 50,000 shares of the Company’s common stock, at an exercise price of $1.14. Such options were approved at a meeting of the Board of Directors in March 2007 and were effective as of July 1, 2007. In addition, under the 2007 Incentive Plan, each of the seven members of the Board of Directors were issued an option exercisable for 50,000 shares of the Company’s common stock, at an exercise price of $1.09. Such options were approved at a meeting of the Board of Directors on September 7, 2007 and were effective as of September 7, 2007.
Recent Sales of Unregistered Securities
Except as reported in previous filings, we did not sell any securities in transactions which were not registered under the Securities Act in the quarter ended December 31, 2007.
| ITEM 6. | MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION |
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Cautionary Notice Regarding Forward Looking Statements
We desire to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. This filing contains a number of forward-looking statements which reflect management’s current views and expectations with respect to our business, strategies, products, future results and events, and financial performance. All statements made in this filing other than statements of historical fact, including statements addressing operating performance, events, or developments which management expects or anticipates will or may occur in the future, including statements related to distributor channels, volume growth, revenues, profitability, new products, adequacy of funds from operations, statements expressing general optimism about future operating results, and non-historical information, are forward looking statements. In particular, the words “believe,” “expect,” “intend,” “anticipate,” “estimate,” “may,” variations of such words, and similar expressions identify forward-looking statements, but are not the exclusive means of identifying such statements, and their absence does not mean that the statement is not forward-looking. These forward-looking statements are subject to certain risks and uncertainties, including those discussed below. Our actual results, performance or achievements could differ materially from historical results as well as those expressed in, anticipated, or implied by these forward-looking statements. We do not undertake any obligation to revise these forward-looking statements to reflect any future events or circumstances.
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Readers should not place undue reliance on these forward-looking statements, which are based on management’s current expectations and projections about future events, are not guarantees of future performance, are subject to risks, uncertainties and assumptions (including those described below), and apply only as of the date of this filing. Our actual results, performance or achievements could differ materially from the results expressed in, or implied by, these forward-looking statements. Factors which could cause or contribute to such differences include, but are not limited to, the risks to be discussed in our next Annual Report on form 10-KSB and in the press releases and other communications to shareholders issued by us from time to time which attempt to advise interested parties of the risks and factors which may affect our business. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Overview
The Company, through its wholly owned subsidiary DVH, manufactures and designs factory-built homes at its principal manufacturing plant located in Guin, Alabama and a separate manufacturing plant in Sulligent, Alabama that are sold to a network of independent dealers located primarily in the southeastern and south central regions of the United States. For more information on the company’s lines of business and principal products and services, please see the section of this filing entitled “Description of Business.”
In recent years, the factory-built housing industry has suffered a downturn in sales as a result of a tightening of credit standards, restricted availability of retail and wholesale financing, and excessive inventory levels. This industry decline began in 1999, approximately five years before we successfully launched and began to rapidly grow our business in January, 2004. The Company’s executives are continuing to focus on two matters to continue to combat this slowdown. First, management is addressing the well-publicized slowdown in the housing industry with a focus on sales. We have excelled in a tough industry through efficient manufacturing at our production facilities, industry leading products, experienced and capable relations oriented sales and management teams, stringent cost controls, and attention to dealer support, customer satisfaction, and service efforts.
Second, in recognition of an important trend in the housing market toward modular homes and as part of its strategic plan to continue its growth in a challenging industry, management plans will continue to increase the Company’s involvement in the modular segment of the factory-built housing industry. As its initial entry into the modular segment, the Company has targeted the production of smaller units (less than 3,000 square feet) that are readily producible, in a cost efficient manner, using the Company’s existing manufacturing capabilities. The Company intends to sell these models to large tract developers and independent dealers.
Beginning in the second quarter of calendar year 2007, state and federal agencies, and other government sponsored entities, began distributing Requests for Proposals (RFPs) for housing designed to test and evaluate future disaster recovery housing units for the Gulf Coast region. These RFPs have presented an opportunity for a near term upswing in production for Deer Valley and other companies in the industry serving the Gulf Coast.
The Company has aggressively sought to take advantage of its Alabama location and reputation in the Gulf Coast area to become a significant participant in the permanent rebuilding of the Gulf Coast region and the production of prototypes for future disaster recovery housing units. As an immediate result of its efforts, in June 2007 the Company’s plant in Guin, Alabama was selected by the State of Mississippi to produce 50 two-bedroom and 100 three-bedroom cottages as part of a program, the “Mississippi Alternative Pilot Program”, that is designed to test and evaluate future disaster housing units. The total combined value of this initial pilot phase contract awarded to the Company was $7,535,000. All units contracted for with the Company under this initial contract were produced and delivered before the end of the third quarter of 2007.
In October 2007, the Company was awarded a contract extension by the State of Mississippi for the production and delivery of an additional 150 two-bedroom cottages as part of the State of Mississippi’s pilot program to test and evaluate future disaster housing units. As with the initial contract, the Company will deliver the units to state designated staging areas located near the Gulf Coast. Total proceeds from this contract extension is $7,185,000 which, when combined with the original contract for the manufacture of 50 two-bedroom and 100 three-bedroom cottages, brought the proceeds of the State of Mississippi contracts awarded to Deer Valley to a total of $14,720,000.
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In December 2007, the scope of the Company’s contract with the State of Mississippi was further increased to provide for the production and delivery of an additional 100 two-bedroom cottages. The Company estimates that this increase in scope will generate an additional $4,790,000 in revenue, which will bring the Company’s combined revenue from the State of Mississippi contract to a total of $19,510,000. All of the units to be produced by the Company under the two contract extensions are scheduled to be delivered prior to March 31, 2008. The total amount received for the contracts with the State of Mississippi accounted for 15.3% of the Company’s total sales. The Company cannot predict whether the State of Mississippi will provide any additional extensions of the initial contract beyond those that the Company has already received.
To provide increased flexibility to fulfill it government contracts, on August 10, 2007, DVH entered into a Revolving Bridge Loan and Security Agreement with Fifth Third Bank, providing for a line of credit of $5,000,000. This facility has a six-month term and has a variable interest rate at 2.50% above LIBOR. (see paragraph below titled “Liquidity and Capital Resources”), which the Company subsequently extended to a nine month term.
Results of Operations
The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements, included herewith. This discussion should not be construed to imply that the results discussed herein will necessarily continue into the future, or that any conclusion reached herein will necessarily be indicative of actual operating results in the future. Such discussion represents only the best present assessment by our management. Information for the year ended December 31, 2006 and year ended December 31, 2007 is that of the Company on a consolidated basis with DVH reflecting the Company’s acquisition of DVH on January 18, 2006, pursuant to the terms of the Securities Purchase and Share Exchange Agreement.
Revenues. The Company had gross revenues of $63,283,527 in fiscal year 2007, as compared to $65,460,735 in fiscal year 2006. Revenue for 2007 was less than that of 2006 primarily due to reduced production schedule during the first quarter of 2007 reflecting the industry wide softness in demand for HUD Code housing units. This difference was partially offset by the Company’s fulfillment of its initial contract with the State of Mississippi for the production of 50 two-bedroom and 100 three-bedroom cottages as part of its program that is designed to test and evaluate future disaster housing units. Our cost of revenues sold as a percentage of revenue decreased to a minor degree for 2007 versus 2006. For the fiscal year 2007, our cost of revenues as a percentage of revenue decreased to 83.7%, as compared to 84.6% for the corresponding period for 2006.
Selling, General, and Administrative Expenses. Selling, general and administrative expenses consisted of payroll and related expenses for executive, accounting, and administrative personnel, professional fees, and other general corporate expenses. Selling, general, and administrative expenses for the fiscal year ending December 31, 2007 were $6,794,375, compared to $6,078,914 for the fiscal year 2006. General and administrative costs increased primarily due to increased production capacity, increased trade show participation, increased administration cost associated with the MEMA project, and increased non-cash compensation to members of the Board of Directors. During the 2007 fiscal year, the Company awarded to members of the board of directors, in the aggregate, 350,000 stock options with an exercise price of $1.14 and 350,000 stock options with an exercise price of $1.09. In connection with such awards, the Company recognized $119,903 of expense related to issuances in the Consolidated Statement of Operations for the fiscal year ending December 31, 2007.
Net Income (Loss). The net income for the year ended December 31, 2007 was $2,445,685, compared to $2,798,544 for the year ended December 31, 2006. After accounting for the stock dividend payable to preferred stockholders and the deemed dividend to preferred stockholders on beneficial conversion features, the net income to common stockholders for the fiscal year 2007 was $2,022,645, compared to a net loss of $6,456,956 for the fiscal year 2006. The significant increases in net income to common stockholders for 2007 versus 2006 are primarily attributable to the elimination of an $8.78 million non-recurring, non-cash, deemed dividend to preferred stockholders on beneficial conversion features that burdened the reported earnings attributable to common stockholders for the first three fiscal quarters of 2006. With the realization of the deemed dividend to shareholders in the third quarter of 2006, the impact of the beneficial conversion features upon the Company’s financial statements ceased.
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Liquidity and Capital Resources
Management believes that the Company currently has sufficient cash flow from operations, available bank borrowings, cash, and cash equivalents to meet its short-term working capital requirements. The Company had $4,778,334 in cash and cash equivalents as of December 31, 2007, compared to $7,431,152 in cash and cash equivalents as of December 31, 2006. This decrease was primarily due to the payment of the accrued liability resulting from payments to certain former owners of DVH relating to an earnout agreement discussed below in “Off-Balance Sheet Arrangements.” Should our costs and expenses prove to be greater than we currently anticipate, or should we change our current business plan in a manner which will increase or accelerate our anticipated costs or capital demand, such as through the acquisition of new products, our working capital could be depleted at an accelerated rate.
The net cash used in operating activities for the fiscal year ended December 31, 2007 was $401,570. The net cash provided from operating activities for fiscal year ended December 31, 2006 was $4,678,701. The reduction of cash provided by operating activities for 2007, in comparison to the Company’s prior fiscal year, is attributable primarily to a temporary increase in receivables in the third and fourth quarters related to the Company’s fulfillment of its initial contract and subsequent extensions with the State of Mississippi. During October 2007, the Company received payment from the State of Mississippi for a significant portion of the initial contract and repaid all borrowings under its Revolving Bridge Loan with Fifth Third Bank. The Company’s account receivables as of December 31, 2007 was $5,098,010, including $2,395,000 due from the State of Mississippi, as compared to $2,174,998 as of December 31, 2006. The Company anticipates receiving all remaining payments from the State of Mississippi during the first and second quarters of 2008.
The net cash used in investing activities for the fiscal year ended December 31, 2007 was $1,664,519, which primarily reflects additional purchase price paid to the previous owners under the earnout provisions. The net cash used in investing activities for the fiscal year ended December 31, 2006 was $4,582,651, which primarily relates to the Company’s acquisition of DVH and property and equipment costs related to the opening of the Sulligent plant.
The net cash used in financing activities for the fiscal year ended December 31, 2007 of $586,728 was the net result of cash payments of $2,464,550 relating to the earnout agreement and borrowing $1,916,000 on the Revolving Bridge Loan against outstanding accounts receivable with the State of Mississippi. The net cash provided from investing activities for the fiscal year ended December 31, 2006 of $7,334,881 was the result of the issuance of preferred stock of $7,698,648 and net borrowings on the line of credit of $457,033 offset by payments of accrued shareholder distributions of $817,794.
On April 11, 2007, the Company entered into a Loan and Security Agreement providing for a revolving line of credit in an amount not to exceed Two Million Five Hundred Thousand and No/100 Dollars ($2,500,000) (the “DV Loan Agreement”) evidenced by a revolving credit note and secured by accounts receivable, inventory, equipment and all other tangible and intangible personal property of the Company and DVH. The purpose of the DV Loan Agreement is to provide a standby source of working capital, letters of credit required by the terms of certain repurchase agreements and performance bonds entered into in the normal course of the Company’s business, to provide financing for potential acquisition(s) of new manufacturing facilities or subsidiaries, and to provide funding for the Company’s entry into the modular home market. The DV Loan Agreement has a one year term and has a variable interest rate at 2.60% above LIBOR. Upon issuance of a letter of credit, the Company is charged a letter of credit fee equal to 1.00% of the face amount of the letter of credit.
In addition to the above, on April 11, 2007, DVH renewed its existing Loan and Security Agreement providing for a revolving line of credit in an amount not to exceed Two Million Five Hundred Thousand and No/100 Dollars ($2,500,000.00) (the “DVH Loan agreement”) evidenced by a revolving credit note and secured by accounts receivable, inventory, equipment and all other tangible and intangible personal property of DVH and the Company. The purpose of the DVH Loan is to provide standby working capital and letters of credit required by the terms of certain repurchase agreements and performance bonds entered into in the normal course of DVH’s business. The DVH Loan Agreement has a one year term and has a variable interest rate at 2.60% above LIBOR. Upon issuance of a letter of credit, DVH is charged a letter of credit fee equal to 1.00% of the face amount of the letter of credit.
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On August 10, 2007, DVH entered into the Revolving Bridge Loan with Fifth Third Bank, providing for a line of credit in an amount not to exceed Five Million and No/100 Dollars ($5,000,000), evidenced by a revolving credit note and secured by accounts receivable, inventory, equipment and all other tangible and intangible personal property of DVH. The purpose of the new facility is to provide a standby source of working capital for fulfillment of one or more contracts with the State of Mississippi to construct housing units under the “Mississippi Alternative Pilot Program.” This facility originally had a six-month term with has a variable interest rate at 2.50% above LIBOR. In the first quarter of 2008, the term for the Company’s Revolving Bridge Loan was extended to nine months.
On May 26, 2006, DVH entered into a Loan Agreement with a national bank (the “Lender”) providing for a loan of Two Million and No/100 Dollars ($2,000,000.00) (the “Loan”) evidenced by a promissory note and secured by a first mortgage on DVH’s properties in Guin, Alabama and Sulligent, Alabama, including the structures and fixtures located thereon, as well as its interest in any lease thereof. The purpose of the loan is to pay off an existing loan from another bank secured by the Guin property and to reduce the outstanding balance on DVH’s revolving credit facility with the Lender. The net effect of the reduction in the revolving credit balance is to increase the credit available to DVH for working capital under its revolving facility. The Loan has a term from May 26, 2006 through June 1, 2011 and has a variable interest rate at 2.25% above LIBOR. There is no prepayment penalty. Future advances are available under the Loan Agreement, subject to approval by the Lender. Also on May 26, 2006, the Company guaranteed the Loan. Should DVH default, thereby triggering acceleration of the Loan, the Company would become liable for payment of the Loan.
In addition to the revolving line of credit described in the preceding paragraph, DVH, during its normal course of business, is required to issue irrevocable standby letters of credit in the favor of independent third party beneficiaries to cover obligations under repurchase agreements. The Company is contingently liable under the terms of these repurchase agreements with financial institutions providing inventory financing for retailers of our products. For more information on the repurchase agreements, including the Company’s contingent liability thereunder, please see “Reserve for Repurchase Commitments” below. As of December 31, 2007, no amounts had been drawn on the above irrevocable letters of credit by the beneficiaries.
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires us to make estimates and judgments which affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. For a description of those estimates, see Note 2, Summary of Significant Accounting Policies, contained in the explanatory notes to the Company’s financial statements for the fiscal year ended December 31, 2007, contained in this filing. On an ongoing basis, we evaluate our estimates, including those related to reserves, deferred tax assets, valuation allowances, impairment of long-lived assets, fair value of equity instruments issued to consultants for services, and estimates of costs to complete contracts. We base our estimates on historical experience and on various other assumptions which we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities which are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. However, we believe that our estimates, including those for the above-described items, are reasonable.
Critical Accounting Estimates
Management is aware that certain changes in accounting estimates employed in generating financial statements can have the effect of making the Company look more or less profitable than it actually is. Management does not believe that either the Company or its auditors have made any such changes in accounting estimates. A summary of the most critical accounting estimates employed by the Company in generating financial statements follows below.
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Warranties
We provide our retail buyers with a one-year limited warranty covering defects in material or workmanship, including plumbing and electrical systems. We record a liability for estimated future warranty costs relating to homes sold, based upon our assessment of historical experience and industry trends. In making this estimate, we evaluate historical sales amounts, warranty costs related to homes sold and timing in which any work orders are completed. The Company has accrued a warranty liability reserve of $2,130,000 on its balance sheet as of December 31, 2007 compared with a warranty liability reserve of $2,000,000 on its balance sheet as of December 31, 2006. Although we maintain reserves for such claims, there can be no assurance that warranty expense levels will remain at current levels or that the reserves that we have set aside will continue to be adequate. A large number of warranty claims which exceed our current warranty expense levels could have a material adverse affect upon our results of operations.
Volume Incentives Payable
We have relied upon volume incentive payments to our independent dealers who retail our products. These volume incentive payments are accounted for as a reduction to gross sales, and are estimated and accrued when sales of our factory-built homes are made to our independent dealers. Volume incentive reserves are recorded based upon the annualized purchases of our independent dealers who purchase a qualifying amount of home products from us. We accrue a liability to our dealers, based upon estimates derived from historical payout rates. Volume incentive costs represent a significant expense to us, and any significant changes in actual payouts could have an adverse affect on our financial performance. We had a reserve for volume incentives payable of $695,975 as of December 31, 2007, as compared to $791,928 as of December 31, 2006.
Reserve for Repurchase Commitments
Most of our independent dealers finance their purchases under a wholesale floor plan financing arrangement under which a financial institution provides the dealer with a loan for the purchase price of the home and maintains a security interest in the home as collateral. When entering into a floor plan arrangement, the financial institution routinely requires that we enter into a separate repurchase agreement with the lender, under which we are obligated, upon default by the independent dealer, to repurchase the factory-built home at our original invoice price less the cost of administrative and shipping expenses. Our potential loss under a repurchase obligation depends upon the estimated net resale value of the home, as compared to the repurchase price that we are obligated to pay. This amount generally declines on a predetermined schedule over a period that usually does not exceed 24 months.
The risk of loss that we face under these repurchase agreements is lessened by several factors, including the following:
| (i) | the sales of our products are spread over a number of independent dealers, |
| (ii) | we have had only isolated instances where we have incurred a repurchase obligation, |
| (iii) | the price we are obligated to pay under such repurchase agreements declines based upon a predetermined amount over a period which usually does not exceed 24 months, and |
| (iv) | we have been able to resell homes repurchased from lenders at current market prices, although there is no guarantee that we will continue to be able to do so. |
The maximum amount for which the Company is contingently liable under such agreements amounted to approximately $17,202,000 at December 31, 2007, as compared to $15,765,000 at December 31, 2006. As of December 31, 2007 and December 31, 2006, we had reserves of $185,000 and $77,500, respectively, established for future repurchase commitments, based upon our prior experience and evaluation of our independent dealers’ financial conditions. Because Deer Valley to date has not experienced any significant losses under these agreements, management does not expect any future losses to have a material effect on our accompanying financial statements.
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Revenue Recognition
Revenue for our products sold to independent dealers are generally recorded when all of the following conditions have been met: (i) an order for the home has been received from the dealer, (ii) an agreement with respect to payment terms has been received, and (iii) the home has been shipped and risk of loss has passed to the dealer.
Recent Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations . This accounting principle requires the fundamental requirements of acquisition accounting (purchase accounting) be applied to all business combinations in which control is obtained regardless of consideration and for an acquirer to be identified for each business combination. Additionally, this accounting principle requires acquisition-related costs and restructuring costs at the date of acquisition to be expensed rather than allocated to the assets acquired and the liabilities assumed; minority interests, including goodwill, to be recorded at fair value at the acquisition date; recognition of the fair value of assets and liabilities arising from contractual contingencies and contingent consideration (payments conditioned on the outcome of future events) at the acquisition date; recognition of bargain purchase (acquisition-date fair value exceeds consideration plus any noncontrolling interest) as a gain; and recognition of changes in deferred taxes. This accounting principle will be adopted January 2009. The accounting requirements will be adopted prospectively. Earlier adoption is prohibited. Adoption is not expected to have an impact on consolidated financial position, results of operations or cash flows.
In December 2007, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 160, Noncontrolling Interests in Consolidated Financial Statements . This accounting principle eliminates noncomparable accounting for minority interests. Specifically, minority interests are presented as a component of shareholders’ equity; consolidated net income includes amounts attributable to both the parent and minority interest and is disclosed on the face of the income statement; changes in the ownership interest are accounted for as equity transactions if ownership remains controlling; elimination of purchase accounting for acquisitions of noncontrolling interests and acquisitions of additional interests; and recognition of deconsolidated controlling interest based on fair value consistent with Statement of Financial Accounting Standards No. 141 (revised 2007), Business Combinations . This accounting principle will be adopted January 2009. The accounting requirements will be adopted prospectively, however presentation and disclosure will be adopted retrospectively for all periods presented. Earlier adoption is prohibited. Adoption is not expected to have an impact on consolidated financial position, results of operations or cash flows.
FASB Interpretation No 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”), was issued in July 2006. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” It prescribes a recognition threshold and measurement attribute for financial statement disclosure of tax positions taken, or expected to be taken, on a tax return. The Company will be required to adopt FIN 48 in the first quarter of fiscal 2008. Management is currently evaluating the requirements of FIN 48 and has not yet determined the impact on the financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin No. 108 (“SAB No. 108”), Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements. SAB No. 108 provides guidance to registrants for assessing materiality. SAB No. 108 states that registrants should use both a balance sheet approach and income statement approach when quantifying and evaluating the materiality of a misstatement. SAB No. 108 also provides guidance on correcting errors under the dual approach as well as transition guidance for correcting previously immaterial errors that are now considered material. We adopted SAB No. 108 as of January 1, 2007 without any impact on our financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurement” (“SFAS 157”), which defines fair value, establishes a framework for measuring fair value and expands disclosures about assets and liabilities measured at fair value. The Company will be required to adopt SFAS 157 in the first quarter of fiscal 2009. Management is currently evaluating the requirements of SFAS 157 and has not yet determined the impact on the financial statements.
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In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 will be effective at the beginning of fiscal year 2008. We are presently evaluating the impact of the adoption of SFAS No. 159 on our results of operations and financial position.
Off-Balance Sheet Arrangements
In connection with the Capital Stock Purchase Agreement, the Company entered into the Earnout Agreement, pursuant to which additional payments may be paid to the former owners of DVH, as an earnout, based upon the Net Income Before Taxes of DVH during the next five (5) years, up to a maximum of $6,000,000. The business purpose of executing the Earnout Agreement was to set the purchase price of DVH by an objective standard, given that the owners of DVH and the Company could not agree on an outright purchase price.
On November 19, 2007, the Company entered into an amendment to the Earnout Agreement dated January 18, 2006, with the original founders (the “Founders”), now the core operating management for the Company’s wholly owned subsidiary, Deer Valley Homebuilders, Inc. (the “Earnout Amendment”).
During the term of the Earnout Agreement, 50% of the pre-tax profit exceeding $1,000,000 per year will be accrued and become distributable to the former owners of DVH. For the years ended December 31, 2007 and 2006, Deer Valley Homebuilders, Inc. had a pre-tax profit in the amount of $4,461,916 and $4,936,287, respectively, of which $3,461,916 and $3,936,287 was respectively above the Company’s earnout threshold of $1,000,000. The Company accrued 50%, or $1,730,958 in 2007 and $1,968,144 in 2006, of the amount in excess of earnout threshold.
In exchange for the elimination of future performance based cash accruals that were expected to total an additional $2 million over the next 12 to 36 months, the Company issued to the Founders two million shares of Deer Valley’s common stock. In addition, accrued liabilities, totaling approximately $2.75 million by December 31, 2007, were paid to the Founders just prior to year end. The common stock will be held in escrow for a period of approximately three and one half years. The final number of shares released to recipients may be reduced in accordance with vesting requirements if the original earnout criteria is not met. For those shares that are ultimately released, if the open market price of the shares at the time of the release should be less than $1.00/share, the Company has agreed to either issue additional shares or pay a cash amount equal to the difference between $1.00 and the share price.
| ITEM 7. | FINANCIAL STATEMENTS |
Included herewith are the following financial statements: