NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations
The Company’s principal business activity involves acquiring raw land and developed lots for the purpose of building and selling single family and multi-family dwellings in Washington, California, Texas, and Florida. It utilizes its heavy equipment resources to develop an inventory of developed lots and provide development infrastructure construction, on a contract basis, for other home builders. Single family construction and infrastructure construction contracts vary but are typically less than one year.
On August 1, 2019, the Company changed its name from Harbor Custom Homes, Inc. to Harbor Custom Development, Inc.
The Company became an effective filer with the SEC and started trading on The Nasdaq Stock Market LLC ("Nasdaq”) on August 28, 2020.
Principles of Consolidation
The condensed consolidated financial statements include the following subsidiaries of Harbor Custom Development, Inc. as of the reporting period ending dates as follows (all entities are formed as Washington LLC's):
| | | | | | | | | | | | | | | | | | | | |
Names | | Dates of Formation | | Attributable Interest |
| | | | March 31, 2022 | | December 31, 2021 |
Saylor View Estates, LLC* | | March 30, 2014 | | N/A | | 51 | % |
Harbor Materials, LLC** | | July 5, 2018 | | N/A | | N/A |
Belfair Apartments, LLC | | December 3, 2019 | | 100 | % | | 100 | % |
Pacific Ridge CMS, LLC | | May 24, 2021 | | 100 | % | | 100 | % |
Tanglewilde, LLC | | June 25, 2021 | | 100 | % | | 100 | % |
HCDI FL CONDO LLC | | August 3, 2021 | | 100 | % | | 100 | % |
HCDI Mira, LLC | | August 30, 2021 | | 100 | % | | 100 | % |
HCDI Bridgeview LLC | | October 28, 2021 | | 100 | % | | 100 | % |
HCDI Wyndstone, LLC | | September 15, 2021 | | 100 | % | | 100 | % |
HCDI Semiahmoo, LLC | | December 17, 2021 | | 100 | % | | 100 | % |
*Saylor View Estates, LLC was voluntarily dissolved with the State of Washington as of January 20, 2022.
**Harbor Materials, LLC was voluntarily dissolved with the State of Washington as of January 29, 2021.
As of March 31, 2022 and December 31, 2021, the aggregate non-controlling interest was $0 and $(1.3) million, respectively.
Basis of Presentation
The unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These financial statements should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021. The accompanying unaudited condensed consolidated financial statements include all adjustments that are of a normal recurring nature and necessary for the fair presentation of our results for the interim periods presented. Results for interim periods are not necessarily indicative of results to be expected for the full year.
All numbers in the financial statements are rounded to the nearest $100, except for Earnings (Loss) per Share ("EPS") data, and numbers in the notes to the financial statements are rounded to the nearest million.
Reclassification
Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had no effect on the reported results of operations.
Use of Estimates
Management uses estimates and assumptions in preparing these financial statements in accordance with generally accepted accounting principles. Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could vary from the estimates that were used.
Stock-Based Compensation
The Company accounts for stock-based compensation in accordance with Financial Accounting Standards Board ("FASB") Accounting Standard Codification ("ASC") Topic 718, “Compensation – Stock Compensation” (“ASC 718”) which establishes financial accounting and reporting standards for stock-based employee and non-employee compensation. It defines a fair value-based method of accounting for an employee stock option or similar equity instrument.
The Company recognizes all forms of share-based payments, including stock option grants, warrants and restricted stock grants, at their fair value on the grant date, which is based on the estimated number of awards that are ultimately expected to vest.
Options and warrants are valued using a Black-Scholes option pricing model. Grants of share-based payment awards issued to non-employees for services rendered have been recorded at the fair value of the share-based payment. The grants are amortized on a straight-line basis over the requisite service periods, which is generally the vesting period. The Company accounts for forfeitures of stock options as they occur. When forfeitures occur, previously recognized compensation cost is reversed in the period of the forfeiture.
Stock-based compensation expenses are included in operating expenses in the condensed consolidated statement of operations.
For the three months ended March 31, 2022 and 2021 when computing fair value of share-based payments, the Company has considered the following variables:
| | | | | | | | | | | |
| March 31, 2022 | | March 31, 2021 |
Risk-free interest rate | 1.73% - 2.14% | | 0.23% |
Exercise price | $2.00 - $3.00 | | $3.75 |
Expected life of grants | 3.93 - 6.50 | | 2.75 |
Expected volatility of underlying stock | 42.39% - 48.13% | | 53.52% |
Dividends | — | | — |
The expected term is computed using the “simplified” method as permitted under the provisions of FASB ASC Topic 718-10-S99. The Company uses the simplified method to calculate the expected term of share options and similar instruments as the Company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term. The share price is the public trading price at the time of grant. Expected volatility is based on the historical stock price volatility of comparable companies’ common stock, as the stock does not have sufficient historical trading activity. Risk free interest rates were obtained from U.S. Treasury rates for the applicable periods.
Earnings (Loss) Per Share
EPS is the amount of earnings attributable to each share of common stock. For convenience, the term is used to refer to either earnings or loss per share. EPS is computed pursuant to 260-10-45 of the FASB ASC. Pursuant to ASC Paragraphs 260-10-45-10 through 260-10-45-16, basic EPS shall be computed by dividing income available to common stockholders (the numerator) by the weighted-average number of common shares outstanding (the denominator) during the period. Income available to common stockholders shall be computed by deducting both the dividends declared in the period on
preferred stock (whether or not paid) and the dividends accumulated for the period on cumulative preferred stock (whether or not earned) from income from continuing operations (if that amount appears in the income statement) and also from net income. The computation of diluted EPS is similar to the computation of basic EPS except that the numerator may have to adjust for any dividends and income or loss associated with potentially dilutive securities that are assumed to have resulted in the issuance of common shares and denominator may have to adjust to include the number of additional common shares that would have been outstanding if the dilutive potential common shares had been issued during the period to reflect the potential dilution that could occur from common shares issuable through a contingent shares issuance arrangement, stock options, warrants, RSUs, or convertible preferred stock. For purposes of determining diluted earnings per common share, the treasury stock method is used for stock options, warrants, and RSUs, and if-converted method is used for convertible preferred stock as prescribed in FASB ASC Topic 260.
The following table provides a reconciliation of the numerator and denominator used in computing basic and diluted net income (loss) attributable to common stockholders per common share for the three months ended March 31, 2022 and 2021.
| | | | | | | | | | | |
| March 31, 2022 | | March 31, 2021 |
Numerator: | | | |
Net loss attributable to common stockholders | $ | (366,700) | | | $ | (1,549,800) | |
Effect of dilutive securities: | — | | | — | |
| | | |
Diluted net loss | $ | (366,700) | | | $ | (1,549,800) | |
| | | |
Denominator: | | | |
Weighted average common shares outstanding - basic | 13,200,758 | | | 13,269,055 | |
Dilutive securities (a): | | | |
Restricted Stock Awards | — | | | — | |
Options | — | | | — | |
Warrants | — | | | — | |
Convertible Preferred Stock | — | | | — | |
| | | |
Weighted average common shares outstanding and assumed conversion – diluted | 13,200,758 | | | 13,269,055 | |
| | | |
Basic net loss per common share | $ | (0.03) | | | $ | (0.12) | |
| | | |
Diluted net loss per common share | $ | (0.03) | | | $ | (0.12) | |
| | | |
(a) - Outstanding anti-dilutive securities excluded: | | | |
Unvested restricted stock units | 127,500 | | | — | |
Stock options | 468,925 | | | 256,345 | |
Warrants to purchase common stock | 18,586,859 | | | 22,525 | |
Convertible preferred stock | 4,016,955 | | | — | |
Warrants to purchase convertible preferred stock | 12,000 | | | — | |
*Preferred stock is convertible into common shares on a 5.556 to 1 ratio.
Fair Value of Financial Instruments
For purpose of this disclosure, the fair value of a financial instrument is the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation. The carrying amount of the Company’s short-term financial instruments approximates fair value due to the relatively short period to maturity for these instruments.
Cash and Cash Equivalents
The Company considers all short-term debt securities purchased with a maturity of three months or less to be cash equivalents. There were no cash equivalents as of March 31, 2022 and December 31, 2021.
Restricted Cash
On August 10, 2021, the Company entered into a Letter of Credit (“LOC”) agreement with WaFd bank in the amount of $0.6 million. The Company signed a lease on October 5, 2021 for a new office space. The landlord of the property, University Street Properties I, LLC, is the beneficiary of the LOC. The amount of funds that cover this LOC were moved by the WaFd bank to a controlled account on August 13, 2021. (See Note 10. Letter of Credit).
Accounts Receivable
Accounts receivables are reported at the amount the Company expects to collect from outstanding balances. The Company provides for an allowance for doubtful accounts based upon a review of the outstanding accounts receivable, historical collection information and existing economic conditions. The Company determines if receivables are past due based on days outstanding, and amounts are written off when determined to be uncollectible by management. The allowance for doubtful accounts was $0 as of March 31, 2022 and December 31, 2021.
Property and Equipment and Depreciation
Property and equipment are recorded at cost. Expenditures for major additions and betterments are capitalized. Maintenance and repair charges are expensed as incurred. Depreciation is computed by the straight-line method (after considering their respective estimated residual values) over the estimated useful lives:
| | | | | |
Construction Equipment | 5-10 years |
Leasehold Improvements | The lesser of 10 years or the remaining life of the lease |
Furniture and Fixtures | 5 years |
Computers | 3 years |
Vehicles | 10 years |
Real Estate Assets
Real estate assets are recorded at cost, except when real estate assets are acquired that meet the definition of a business combination in accordance with FASB ASC Topic 805, “Business Combinations,” where acquired assets are recorded at fair value. Interest, property taxes, insurance, and other incremental costs (including salaries) directly related to a project are capitalized during the construction period of major facilities and land improvements. The capitalization period begins when activities to develop the parcel commence and ends when the asset constructed is completed. The capitalized costs are recorded as part of the asset to which they relate and are expensed when the underlying asset is sold.
The Company capitalized interest from related party borrowings of $0.3 million and $0.2 million for the three months ended March 31, 2022 and 2021, respectively. The Company capitalized interest from third-party borrowings of $0.8 million and $0.2 million for the three months ended March 31, 2022 and 2021, respectively.
A property is classified as “held for sale” when all the following criteria for a plan of sale have been met:
(1) Management, having the authority to approve the action, commits to a plan to sell the property;
(2) The property is available for immediate sale in its present condition, subject only to terms that are usual and customary;
(3) An active program to locate a buyer and other actions required to complete the plan to sell, have been initiated;
(4) The sale of the property is probable and is expected to be completed within one year of the contract date;
(5) The property is being actively marketed for sale at a price that is reasonable in relation to its current fair value; and
(6) Actions necessary to complete the plan of sale indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
When all these criteria have been met, the property is classified as “held for sale.”
In addition to the annual assessment of potential triggering events in accordance with FASB ASC Topic 360, the Company applies a fair value-based impairment test to the net book value of assets on an annual basis and on an interim basis if certain events or circumstances indicate that an impairment loss may have occurred.
As of March 31, 2022 and December 31, 2021, the Company did not identify any triggering events that would require further investigation under ASC 360.
Revenue and Cost Recognition
FASB ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”), establishes principles for reporting information about the nature, amount, timing and uncertainty of revenue and cash flows arising from the entity’s contract to provide goods or services to customers.
In accordance with ASC 606, revenue is recognized when a customer obtains control of the promised good or service. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these goods or services. The provision of ASC 606 includes a five-step process by which the Company determines revenue recognition, depicting the transfer of goods or services to customers in amounts reflecting the payment to which the Company expects to be entitled in exchange for those goods or services.
ASC 606 requires the Company to apply the following steps: (1) identify the contract with the customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when, or as, performance obligations are satisfied.
A detailed breakdown of the five-step process for the revenue recognitions as follows:
Homes, Developed Lots, and Entitled Land
1. Identify the contract with a customer.
The Company signs an agreement with a buyer to purchase the parcel of entitled land, developed lots that have completed infrastructure and completed home.
2. Identify the performance obligations in the contract.
Performance obligations of the Company include delivering entitled land, developed lots and completed homes to the customer, which are required to meet certain specifications outlined in the contract.
3. Determine the transaction price.
The transaction price is fixed and specified in the contract. Any subsequent change orders or price changes are required to be approved by both parties.
4. Allocation of the transaction price to performance obligations in the contract.
The parcel, lots, and home are a separate performance obligation for which the specific price is in the contract.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.
The Company recognizes revenue when title is transferred. The Company does not have any further performance obligations once title is transferred.
Fee Build
1. Identify the contract with a customer.
The Company signs an agreement with a customer to construct the required infrastructure so that houses can be developed on the lots.
2. Identify the performance obligations in the contract.
Performance obligations of the Company include delivering developed lots which are required to meet certain specifications that are outlined in the contract.
3. Determine the transaction price.
The transaction price is fixed and specified in the contract. Any subsequent change orders or price changes are required to be approved by both parties.
4. Allocation of the transaction price to performance obligations in the contract.
The nature of the industry involves a number of uncertainties that can affect the current state of the contract. Variable considerations are the estimates made due to a contract modification in the contractual service. Change orders, claims, extras, or back charges are common in contractual services activity as a form of variable consideration. If there is going to be a contract modification, judgment by management will need to be made to determine if the variable consideration is enforceable. The following factors are considered in determining if the variable consideration is enforceable:
1.The customer’s written approval of the scope of the change order;
2.Current contract language that indicates clear and enforceable entitlement relating to the change order;
3.Separate documentation for the change order costs that are identifiable and reasonable; and
4.The Company’s experience in negotiating change orders, especially as it relates to the specific type of contract and change order being evaluated.
Once the Company receives a contract, it generates a budget of projected costs for the contract based on the contract price. If the scope of the contract during the contractual period needs to be modified, the Company files a change order. The Company does not continue to perform services until the change modification is agreed upon with documentation by both the Company and the customer. There are few times that claims, extras, or back charges are included in the contract.
If there are multiple performance obligations to the contract, the costs must be allocated appropriately and consistently to each performance obligation. In the Company’s experience, usually only one performance obligation is stated per contract. If there are multiple services provided for one customer, the Company has a policy of splitting out the services over multiple contracts.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.
The Company uses the total costs incurred on the project relative to the total expected costs to satisfy the performance obligation. The input method involves measuring the resources consumed, labor hours expended, costs incurred, time lapsed, or machine hours used relative to the total expected inputs to the satisfaction of the performance obligation. Costs incurred prior to actual contract (i.e., design, engineering, procurement of material, etc.) should not be recognized as the Company does not have control of the good/service provided. When the estimate on a contract indicates a loss or claims against costs incurred reduce the likelihood of recoverability of such costs, the Company records the entire estimated loss in the period the loss becomes known. Project contracts typically provide for a schedule of billings or invoices to the customer based on the Company’s job to date percentage of completion of specific tasks inherent in the fulfillment of its performance obligation(s). The schedules for such billings usually do not precisely match the schedule on which costs are incurred. As a result, contract revenue recognized in the statement of operations can and usually does differ from amounts that can be billed or invoiced to the customer at any point during the contract. Amounts by which cumulative contract revenue recognized on a contract as of a given date exceed cumulative billings and unbilled receivables to the customer under the contract are reflected as a current asset in the Company’s balance sheet under the caption “Contract Asset, net” which is further disclosed in Note 17. Amounts by which cumulative billings to the customer under a contract as of a given date exceed cumulative contract revenue recognized on the contract would be reflected as a current liability in the Company’s balance sheet.
Revenues from contracts with customers are summarized by category as follows for the three months ended March 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| | | | 2022 | | 2021 |
Homes | $ | 12,274,500 | | | $ | 6,814,200 | |
Developed Lots | 9,080,000 | | | 7,000,000 | |
Entitled Land | 4,480,000 | | | — | |
Fee Build | 2,713,900 | | | — | |
Construction Materials | 32,600 | | | 60,000 | |
Total Revenue | $ | 28,581,000 | | | $ | 13,874,200 | |
Disaggregation of Revenue from Contracts with Customers
The following table disaggregates the Company’s revenue based on the type of sale or service and the timing of satisfaction of performance obligations for the three months ended March 31, 2022 and 2021:
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2022 | | 2021 |
Performance obligations satisfied at a point in time | $ | 25,867,100 | | | $ | 13,874,200 | |
Performance obligations satisfied over time | 2,713,900 | | | — | |
Total Revenue | $ | 28,581,000 | | | $ | 13,874,200 | |
Cost of Sales
Land acquisition costs are allocated to each lot based on the size of the lot in relation to the size of the total project. Development costs and capitalized interest are allocated to lots sold based on the same criteria.
Costs relating to the handling of recycled construction materials and converting items into usable construction materials for resale are charged to cost of sales as incurred.
Income Taxes
Deferred income tax assets and liabilities are determined based on the estimated future tax effects of net operating loss, credit carryforwards and temporary differences between the tax basis of assets and liabilities and their respective financial reporting amounts measured at the current enacted tax rates. Management applies the criteria established under FASB ASC Topic 740, Income Taxes to determine if any valuation allowances are needed each year.
The Company recognizes a tax benefit for an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. There are no uncertain tax positions as of March 31, 2022 and December 31, 2021.
Recent Accounting Pronouncements
On May 3, 2021, the FASB released ASU No. 2021-04, Compensation – Earning Per Share (Topic 260), Debt - Modifications and Extinguishments (subtopic 470-50), Compensation - Stock compensation (Topic 718), Contracts in Entity’s Own Equity (Subtopic 815-40) Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified Written Call Options. The FASB issued this update to clarify and reduce diversity in an issuer’s accounting for modifications or exchanges of freestanding equity-classified written call options (for example warrants) that remain equity classified after modification or exchange. The standard is effective for fiscal years beginning after December 15, 2021. The Company adopted ASU 2021-04 on January 1, 2022, however the adoption did not have an impact on the Company's Financial Statements.
Impairment of Long-Lived Assets
The Company reviews long-lived assets for impairment whenever events or circumstances indicate that the carrying value of such assets may not be fully recoverable. Impairment is present when the sum of estimated undiscounted future cash flow expected to result from use of the assets is less than carrying value. If impairment is present, the carrying value of the impaired asset is reduced to its fair value. Fair value is determined based on discounted cash flow or appraised values,
depending on the nature of the assets. As of March 31, 2022 and December 31, 2021, there were no impairment losses recognized for long-lived assets.
2. CONCENTRATIONS
Cash Concentrations
The Company maintains cash balances at various financial institutions. These balances are secured by the Federal Deposit Insurance Corporation. These balances generally exceed the federal insurance limits. Uninsured cash balances were $20.8 million and $24.5 million as of March 31, 2022 and December 31, 2021, respectively.
Revenue Concentrations
Homes
There were no concentrations in relation to the homes revenue segment for the three months ended March 31, 2022 and 2021.
Developed Lots
SAC Land Dev LLC and Suhail Ahmad, Muhammad Azhar Chaudhary and Ghulam Murtaza represented 62% and 26%, respectively of the developed lots revenue for the three months ended March 31, 2022. Lennar Northwest, Inc. represented 100% of the developed lots revenue for the three months ended March 31, 2021.
Entitled Land
Noffke Horizon View LLC represented 100% of the entitled land revenue for the three months ended March 31, 2022.
Fee Build
Lennar Northwest, Inc. represented 100% of fee build revenue for the three months ended March 31, 2022.
3. NOTES RECEIVABLE
The total principal balance of the notes receivable amounted to $12.7 million These notes arose as financing by the Company for the sale of real estate properties or financing the development of the properties prior to purchasing. These notes are secured by the underlying improved real estate properties and accrue interest at annual rates ranging from 5% to 9%. All payments of principal and interest are due in full between December 31, 2022 and December 20, 2024. The outstanding balance of the notes amounted to $12.7 million and $2.0 million at March 31, 2022 and December 31, 2021, respectively. Interest income was $0.1 million and $0 for the three months ended March 31, 2022 and 2021, respectively. The Company considers the note receivable plus accrued interest to be fully collectible and, therefore, has determined that an allowance is not necessary. The details of notes receivables are as follows:
| | | | | | | | | | | | | | |
| | March 31, 2022 | | December 31, 2021 |
Broadmoor Commons LLC | | $ | 624,300 | | | $ | 500,000 | |
Modern Homestead LLC | | 2,000,000 | | | 1,500,000 | |
Rocklin Winding Lane 22, LLC | | 4,802,500 | | | — | |
Noffke Horizon View, LLC | | 3,280,000 | | | — | |
Suhail Ahmad, Ghulam Murtaza Ansari, and Muhammad Azhar Chaudhary | | 2,040,000 | | | — | |
| | $ | 12,746,800 | | | $ | 2,000,000 | |
4. PROPERTY AND EQUIPMENT
Property and equipment stated at cost, less accumulated depreciation and amortization, consisted of the following:
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
| | | |
Machinery and Equipment | $ | 10,566,900 | | | $ | 10,577,600 | |
Vehicles | 71,800 | | | 71,800 | |
Furniture and Fixtures | 468,600 | | | 420,300 | |
Leasehold Improvements | 1,086,100 | | | 81,200 | |
Total Fixed Assets | 12,193,400 | | | 11,150,900 | |
Less Accumulated Depreciation | (2,255,000) | | | (1,951,200) | |
Fixed Assets, Net | $ | 9,938,400 | | | $ | 9,199,700 | |
Depreciation expense was $0.3 million and $0.2 million for the three months ended March 31, 2022 and 2021, respectively.
5. REAL ESTATE
Real Estate consisted of the following components:
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
| | | |
Land Held for Development | $ | 55,395,800 | | | $ | 73,524,400 | |
Construction in Progress | 58,264,500 | | | 43,362,700 | |
Held for Sale | 15,409,100 | | | 5,249,000 | |
| $ | 129,069,400 | | | $ | 122,136,100 | |
6. ACCOUNTS PAYABLE AND ACCRUED EXPENSES
Accounts payable and accrued liabilities consisted of the following:
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
| | | |
Trade Accounts Payable | $ | 8,772,500 | | | $ | 5,558,400 | |
Income Tax Payable | 3,289,500 | | 2,415,900 | |
Accrued Compensation, Bonuses, and Benefits | 649,900 | | | 1,071,700 | |
Accrued Quarry Reclamation Costs | 442,700 | | | 500,000 | |
Retainage Payable | 784,800 | | | 445,800 | |
Other Accruals | 1,977,900 | | | 671,000 | |
Total Accounts Payable and Accrued Expenses | $ | 15,917,300 | | | $ | 10,662,800 | |
7. REVOLVING LINE OF CREDIT
On March 7, 2022, the Company entered into a senior secured revolving credit facility "the credit facility" with BankUnited, N.A. for $25.0 million. The credit facility has a 2 year term, with a maturity date of March 7, 2024. The unpaid principal bears interest at a fluctuating rate of interest per annum equal to the daily simple secured overnight financing rate (SOFR) plus the applicable margin of 4.75%. The credit facility is used to fund our general working capital needs and interest is expensed as incurred. For the three months ended March 31, 2022, the Company incurred debt issuance costs of $1.1 million. Amortization of debt discount is recognized ratably over the life of the loan. The credit facility is collateralized by various assets and contains specific financial covenants. As of March 31, 2022 the company was in compliance with these covenants. Interest expense was $0.03 million and $0 for the three months ended March 31, 2022 and 2021, respectively.
As of March 31, 2022, the revolving line of credit loan balance was $12.1 million and the unamortized debt discount balance was $1.1 million.
8. EQUIPMENT LOANS
Equipment loans consists of the following:
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
| | | |
Various notes payable to banks and financial institutions with interest rates varying from 0% to 13.89%, collateralized by equipment with monthly payments ranging from $400 to $11,600 through 2025: | $ | 5,167,600 | | | $ | 5,268,500 | |
Book value of collateralized equipment: | 7,612,500 | | | 7,229,000 | |
Future equipment loan maturities at March 31, 2022 are as follows:
Year Ending December 31,
| | | | | |
2022 (nine months) | $ | 1,512,200 | |
2023 | 1,860,400 | |
2024 | 1,613,800 | |
2025 | 181,200 | |
| $ | 5,167,600 | |
Interest expense was $0.04 million and $0.04 million for the three months ended March 31, 2022 and 2021, respectively.
9. CONSTRUCTION LOANS
The Company has various construction loans with private individuals and finance companies. The loans are collateralized by specific construction projects. Most loans are generally on a 1-year term but will be refinanced if the project is not completed within one year and will be due upon the completion of the project. Interest accrues on the loans and is included with the payoff of the loan. Interest ranges from 5% to 9%. Interest expense and amortization of debt discount are capitalized when incurred and expensed as cost of goods sold when the corresponding property is sold. During the quarter ended March 31, 2022, we refinanced construction loans of $4.5 million. These modifications are accounted for as the extinguishment of existing debt and the issuance of new debt. The loan balances related to third party lenders as of March 31, 2022 and December 31, 2021, were $38.7 million and $39.4 million, respectively. The unamortized debt discounts related to these construction loans as of March 31, 2022 and December 31, 2021 were $1.6 million and $4.4 million, respectively. The book value of collateralized real estate as of March 31, 2022 and December 31, 2021 was $129.1 million and $122.1 million, respectively.
10. LETTER OF CREDIT
The Company entered into a letter of credit agreement with WaFd bank of $0.6 million on August 10, 2021. The letter of credit expires February 1, 2032. The interest rate of the letter of credit is Prime plus 1%. The letter of credit has been established for the purpose of collateralizing the Company’s new Tacoma office lease obligations with the landlord, who is the beneficiary of the letter of credit.
11. NOTE PAYABLE DIRECTORS & OFFICERS INSURANCE
The Company purchased Directors & Officers ("D&O") insurance on August 28, 2021 for $1.5 million. A down payment of $0.1 million was made and the remaining balance of $1.4 million was financed over eleven months. The interest rate on the loan is 4.42%. The loan balance as of March 31, 2022 and December 31, 2021 was $0.5 million and $0.9 million respectively.
12. COMMITMENTS AND CONTINGENCIES
From time to time the Company is subject to compliance audits by federal, state, and local authorities relating to a variety of regulations including wage and hour laws, taxes, and workers’ compensation. There are no significant or pending litigation or regulatory proceedings known at this time.
On June 15, 2020, the Company entered into a purchase and sale agreement to acquire property for the construction of 33 town homes located in East Bremerton, Washington for $2.0 million. Closing is expected to take place in Q2 2022.
On December 2, 2021, the Company entered into a purchase and sale agreement for the acquisition of 438 acres in Blaine, Washington for $13.5 million. Closing is expected to take place in Q4 2023.
On December 15, 2021, the Company entered into a purchase and sale agreement for the acquisition of 66 town homes located in Poulsbo, Washington for $2.9 million. Closing is expected to take place in Q2 2022.
On March 18, 2022, the Company entered into a purchase and sale agreement for the sale of 112 lots in Burien, Washington for $3.8 million. Closing is expected to take place in Q2 2022.
13. RELATED PARTY TRANSACTIONS
Notes Payable
The Company entered into construction loans with Sound Equity, LLC of which Robb Kenyon, a former director and minority shareholder, is a partner. These loans were originated between April 2019 and June 2021; all of the loans have a one-year maturity with interest rates ranging between 7.99% and 9.99%. For the three months ended March 31, 2022 and 2021, the Company incurred loan origination fees of $0 and $0.1 million, respectively. These fees are recorded as debt discount and amortized over the life of the loan. The amortization is capitalized to real estate. As of March 31, 2022, and December 31, 2021, there were $0.03 million and $0.2 million of remaining debt discounts, respectively. The interest is capitalized to real estate as incurred. During the three months ended March 31, 2022 and 2021 the Company incurred interest of $0.3 million and $0.2 million, respectively. As of March 31, 2022, and December 31, 2021 the outstanding loan balances were $11.0 million and $14.5 million, respectively.
Robb Kenyon resigned as a director of the Company on July 8, 2021.
Due to Related Party
The Company utilizes a quarry to process waste materials from the completion of raw land into sellable/buildable lots. The quarry is located on land owned by SGRE, LLC which is 100% owned by the Company’s Chief Executive Officer and President. The materials produced by the quarry and sold by the Company to others are subject to a 25% commission payable to SGRE, LLC. The commission expense is recorded in operating expenses. On March 31, 2022 and December 31, 2021, the commission payable was $0.01 million and $0.01 million, respectively. The commission expense for the three months ended March 31, 2022 and 2021, was $0.03 million and $0.02 million, respectively.
14. INCOME TAX
Our effective tax rate for the three months ending March 31, 2022 was 23.6%, compared to 0% for the three months ending March 31, 2021. The increase in the effective tax rate for the three months ended March 31, 2022 compared to the three months ended March 31, 2021 is driven by the release of the valuation allowance at December 31, 2021 and nondeductible incentive stock options.
15. STOCKHOLDERS’ EQUITY
Common Stock
The Company is authorized to issue 50,000,000 shares of common stock, at no par value per share. At March 31, 2022, the Company has 13,237,179 shares of common stock issued and outstanding.
Each share of common stock has one vote per share for all purposes. Common stock does not provide any preemptive, subscription or conversion rights and there are no redemption or sinking fund provisions or rights. Common stockholders are not entitled to cumulative voting for purposes of electing members to the Board of Directors.
Preferred Stock
At March 31, 2022, the Company is authorized to issue 10,000,000 shares of preferred stock, at no par value per share. As of March 31, 2022, the Company has 4,016,955 shares of Series A Cumulative Convertible Preferred Stock (“Series A Preferred Shares”) issued and outstanding. The holders of the Series A Preferred Shares are entitled to receive dividends at a rate of 8% per annum payable monthly in arrears starting June 30, 2021 and are entitled to a liquidation preference equal
to $25.00 per share plus all accrued and unpaid dividends. Beginning on June 9, 2024, the Company may, at its option, redeem the Series A Preferred Shares, in whole or in part, by paying $25.00 per share, plus any accrued and unpaid dividends to but not including the date of redemption. To the extent declared by the Board of Directors, dividends will be payable not later than 20 days after the end of each calendar month. Dividends on the Series A Preferred Shares will accumulate whether or not the Company has earnings, whether or not there are funds legally available for the payment of such dividends, and whether or not such dividends are declared by the Board of Directors.
Conversion at Option of Holder. Each of these Series A Preferred Shares, together with accrued but unpaid dividends, is convertible into 5.556 shares of common stock at any time at the option of the holder.
Dividends
Preferred Stock. The holders of the Series A Preferred Shares are entitled to receive dividends at a rate of 8% per annum payable monthly in arrears. The Company has accrued dividends of $0.7 million as of March 31, 2022 which were paid to the shareholders on April 11, 2022.
Common Stock. The declaration of any future cash dividends is at the discretion of the board of directors and depends upon the Company’s earnings, if any, capital requirements and financial position, general economic conditions, and other pertinent conditions. It is the Company’s present intention not to pay any cash dividends on the Company’s common stock in the foreseeable future, but rather to reinvest earnings, if any, in business operations.
(A) Options
The following is a summary of the Company’s option activity:
| | | | | | | | | | | |
| Options | | Weighted Average Exercise Price |
Outstanding – January 1, 2022 | 463,251 | | $ | 2.82 | |
Exercisable – January 1, 2022 | 343,724 | | $ | 2.77 | |
Granted | 30,000 | | $ | 2.03 | |
Exercised | (21,623) | | | $ | 0.40 | |
Forfeited/Cancelled | (2,703) | | | $ | 0.40 | |
Outstanding – March 31, 2022 | 468,925 | | $ | 2.76 | |
Exercisable – March 31, 2022 | 342,565 | | $ | 2.74 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Options Outstanding | | Options Exercisable |
Exercise Price | | Number Outstanding | | Weighted Average Remaining Contractual Life (in years) | | Weighted Average Exercise Price | | Number Exercisable | | Weighted Average Exercise Price |
| | | | | | | | | | |
$0.40 - $6.50 | | 468,925 | | 7.59 | | $ | 2.76 | | | 342,565 | | $ | 2.74 | |
During the three months ended March 31, 2022, the Company issued 30,000 options to employees. The options have an exercise price between $2.00 and $2.09 per share, a term of 10 years, and vest over one or three years. The options have an aggregated fair value of approximately $0.03 million that was calculated using the Black-Scholes option-pricing model based on the assumptions discussed above in Note 1 under Stock-Based Compensation.
During the three months ended March 31, 2022, the Company had 21,623 options exercised by former employees. These shares were exercised at $0.40 per share for a total of $0.01 million.
The Company recognized share-based compensation net of forfeitures related to options of $0.02 million and $0.1 million for the three months ended March 31, 2022 and 2021, respectively.
On March 31, 2022, unrecognized share-based compensation was $0.1 million.
The intrinsic value for outstanding and exercisable options as of March 31, 2022 was $0.3 million and $0.2 million.
(B) Warrants
The following is a summary of the Company’s Common Stock Warrant activity:
| | | | | | | | | | | |
| Warrants | | Weighted Average Exercise Price |
Outstanding – January 1, 2022 | 18,486,859 | | $ | 3.46 | |
Exercisable – January 1, 2022 | 18,486,859 | | $ | 3.46 | |
Granted | 100,000 | | $ | 3.00 | |
Exercised | — | | $ | — | |
Forfeited/Cancelled | — | | $ | — | |
Outstanding – March 31, 2022 | 18,586,859 | | $ | 3.46 | |
Exercisable – March 31, 2022 | 18,495,192 | | $ | 3.46 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Warrants Outstanding | | Warrants Exercisable |
Exercise Price | | Number Outstanding | | Weighted Average Remaining Contractual Life (in years) | | Weighted Average Exercise Price | | Number Exercisable | | Weighted Average Exercise Price |
| | | | | | | | | | |
$0.40 - $7.50 | | 18,586,859 | | 4.44 | | $ | 3.46 | | | 18,495,192 | | $ | 3.46 | |
During the three months ended March 31, 2022, the Company issued 100,000 warrants in connection with investor relation services being performed. The warrants have an exercise price of $3.00 per share, a term of 5 years, and vest over 3 years. The fair value of these warrants is $0.1 million as of March 31, 2022.
The intrinsic value for outstanding and exercisable warrants as of March 31, 2022 was $0.04 million and $0.04 million.
The following is a summary of the Company’s Preferred Stock Warrant activity:
| | | | | | | | | | | |
| Warrants | | Weighted Average Exercise Price |
Outstanding – January 1, 2022 | 12,000 | | $ | 24.97 | |
Exercisable – January 1, 2022 | 12,000 | | $ | 24.97 | |
Granted | — | | | $ | — | |
Exercised | — | | $ | — | |
Forfeited/Cancelled | — | | $ | — | |
Outstanding – March 31, 2022 | 12,000 | | $ | 24.97 | |
Exercisable – March 31, 2022 | 12,000 | | $ | 24.97 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Warrants Outstanding | | Warrants Exercisable |
Exercise Price | | Number Outstanding | | Weighted Average Remaining Contractual Life (in years) | | Weighted Average Exercise Price | | Number Exercisable | | Weighted Average Exercise Price |
| | | | | | | | | | |
$ | 24.97 | | | 12,000 | | 4.19 | | $ | 24.97 | | | 12,000 | | $ | 24.97 | |
The intrinsic value for outstanding and exercisable preferred warrants as of March 31, 2022 was $0.
(C) Restricted Stock Plan
The following is a summary of the Company’s restricted stock activity:
| | | | | | | | | | | |
| Restricted Stock | | Weighted Average Exercise Price |
Non Vested Balance - January 1, 2022 | 145,000 | | $ | 2.45 | |
Granted | 61,100 | | $ | 2.37 | |
Vested | 78,600 | | $ | 2.54 | |
Forfeited/Cancelled | — | | $ | — | |
Non Vested Balance - March 31, 2022 | 127,500 | | $ | 2.36 | |
The Company periodically grants restricted stock awards to the Board of Directors and certain employees pursuant to the 2020 Restricted Stock Plan (the "2020 Plan”). These typically are awarded by the Compensation Committee at one time and from time to time, to vest in four equal installments quarterly, unless otherwise determined by the Compensation Committee. The Company recognized $0.2 million and $0.04 million of share-based compensation during the three months ended March 31, 2022 and 2021, respectively. On March 31, 2022, there was $0.3 million of unrecognized compensation related to non-vested restricted stock.
16. SEGMENTS
In accordance with FASB ASC Topic 280, Segment Reporting, an operating segment is defined as a component of an enterprise for which discrete financial information is available and reviewed regularly by the chief operating decision maker ("CODM"), or decision making group, to evaluate performance and make operating decisions.
The Company identified its CODM group as its three executive officers, the Chief Executive Officer, Chief Financial Officer, and the Chief Operating Officer. In determining the reportable segments, the CODM group considers similar economics and characteristics including product types, construction processes, customer type, regulatory environments and underlying demand and supply.
The Company’s business is organized into four material reportable segments which aggregate 99% of revenue:
1) Homes
2) Developed lots
3) Entitled land
4) Fee build
The reporting segments follow the same accounting policies used in the preparation of the Company’s consolidated financial statements. The following represents selected information for the Company’s reportable segments for the three months ended March 31, 2022 and 2021. Immaterial construction materials revenues and costs are included in the homes segment.
| | | | | | | | | | | |
| Three Months Ended March 31, |
| 2022 | | 2021 |
Revenue by segment | | | |
Homes | $ | 12,274,500 | | | $ | 6,814,200 | |
Developed lots | 9,080,000 | | | 7,000,000 | |
Entitled land | 4,480,000 | | | — | |
Fee Build | 2,713,900 | | | — | |
Other | 32,600 | | | 60,000 | |
| $ | 28,581,000 | | | $ | 13,874,200 | |
| | | |
Cost of goods sold by segment | | | |
Homes | $ | 10,551,500 | | | $ | 6,060,800 | |
Developed lots | 8,063,400 | | | 6,844,300 | |
Entitled land | 712,900 | | | — | |
Fee Build | 2,564,800 | | | — | |
Other | 633,700 | | | 361,900 | |
| $ | 22,526,300 | | | $ | 13,267,000 | |
| | | |
Gross profit (loss) by segment | | | |
Homes | $ | 1,723,000 | | | $ | 753,400 | |
Developed lots | 1,016,600 | | | 155,700 | |
Entitled land | 3,767,100 | | | — | |
Fee Build | 149,100 | | | — | |
Other | (601,100) | | | (301,900) | |
| $ | 6,054,700 | | | $ | 607,200 | |
17. UNCOMPLETED CONTRACTS
Costs, estimated earnings and billings on uncompleted contracts are summarized as follows at March 31, 2022 and December 31, 2021:
| | | | | | | | | | | |
| March 31, 2022 | | December 31, 2021 |
Costs incurred on uncompleted contracts | $ | 8,556,100 | | | $ | 5,991,300 | |
Estimated earnings | 968,500 | | | 811,600 | |
Costs and estimated earnings on uncompleted contracts | 9,524,600 | | | 6,802,900 | |
Billings to date | 6,885,500 | | | 4,635,700 | |
Costs and estimated earnings in excess of billings on uncompleted contracts | 2,639,100 | | | 2,167,200 | |
Billings in excess of costs and estimated earnings on uncompleted contracts | — | | | — | |
| $ | 2,639,100 | | | $ | 2,167,200 | |
At March 31, 2022, the contract asset of $2.6 million consists of estimated earnings of $1.0 million and costs in excess of billings of $1.6 million. The uncollected billings as of March 31, 2022 were $1.1 million. At December 31, 2021 the
contract asset of $2.2 million consists of estimated earnings of $0.8 million and costs in excess of billings of $1.4 million. The uncollected billings as of December 31, 2021 were $1.0 million.
18. SUBSEQUENT EVENTS
On April 10, 2022, the board of directors of the Company declared a monthly cash dividend on the Company’s 8.0% Series A Cumulative Convertible Preferred Stock of $0.167 per share. The cash dividend is payable on May 20, 2022 to stockholders of record on April 30, 2022.
On April 22, 2022 the Company entered into a purchase and sale agreement for the purchase of 4.81 acres in Port Orchard, Washington for $2.6 million. Closing is expected to take place in Q4 2022.
On May 3, 2022 the Company entered into a purchase and sale agreement for the purchase of 261 units in Edmonds, Washington for $11.5 million. Closing is expected to take place in Q4 2022.
On May 11, 2022 the Company entered into a purchase and sale agreement for the sale of 15.44 acres in Blaine, Washington for $5.4 million. Closing is expected to take place in Q2 2022.