DREAM FINDERS HOMES, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the accompanying financial statements and related notes thereto. Unless the context otherwise requires, the terms "Dream Finders," "DFH," "the Company," "we," "us" and "our" refer toDream Finders Homes, Inc. and its subsidiaries.
Key Results
Key financial results as of and for the year ended
• Revenues increased 52.3% to
• Net new orders increased 95.7% to 4,186 net new orders from 2,139 net new
orders.
• Homes closed increased 54.0% to 3,154 homes from 2,048 homes.
• Backlog of sold homes increased 183.8% to 2,424 homes from 854 homes.
• Average sales price of homes closed decreased 1.4% to
• Gross margin as a percentage of home sales revenues increased to 14.6% from
13.3%.
• Adjusted gross margin (non-GAAP) as a percentage of home sales revenues
increased to 22.5% from 21.1%.
• Net and comprehensive income increased 88.2% to
million.
• Net and comprehensive income attributable to
increased 101.8% to
• EBITDA (non-GAAP) as a percentage of home sales revenues increased to 10.7%
from 9.5%.
• Adjusted EBITDA (non-GAAP) as a percentage of home sales revenues increased to
10.7% from 9.6%.
• Active communities at the end of 2020 increased to 126 from 85.
• Total owned and controlled lots increased 137.6% to 22,407 lots at
2020 from 9,429 lots at
For reconciliations of the non-GAAP financial measures of adjusted gross margin, EBITDA and adjusted EBITDA to the most directly comparable GAAP financial measures, please see "-Non-GAAP Financial Measures."
Company Overview
We are one of the nation's fastest growing private homebuilders by revenue and home closings since 2014. We design, build and sell homes in high-growth markets, includingJacksonville ,Orlando ,Denver , theWashington D.C. metropolitan area andAustin ,Charlotte andRaleigh . We employ an asset-light lot acquisition strategy with a focus on the design, construction and sale of single-family entry-level, first-time move-up and second-time move-up homes. To fully serve our homebuyer customers and capture ancillary business opportunities, we also offer title insurance and mortgage banking solutions. Our asset-light lot acquisition strategy enables us to generally purchase land in a "just-in-time" manner with reduced up-front capital commitments, which in turn has increased our inventory turnover rate, enhanced our strong returns on equity and contributed to our impressive growth. In addition, we believe our asset-light model reduces our balance sheet risk relative to other homebuilders that own a higher percentage of their land supply. As ofDecember 31, 2020 , 99% of our owned and controlled lots were controlled through finished lot option contracts and land bank option contracts compared to the average among the public company homebuilders of 46%. We believe that our asset-light model has been instrumental in our generation of attractive returns on equity of 47% for the year endedDecember 31, 2020 and 34% for the year endedDecember 31, 2019 , substantially exceeding the average returns on equity among the public company homebuilders of 16% and 13%, respectively, for the same periods. We intend to continue to leverage our proven asset-light strategy in furtherance of our growth and stockholder returns objectives. 50
--------------------------------------------------------------------------------
Table of Contents
COVID-19 Impact and Strategy
The ongoing coronavirus (COVID-19) outbreak, which theWorld Health Organization declared a pandemic andthe United States declared a national emergency inMarch 2020 , has resulted in widespread adverse impacts on the global economy and financial markets, and on our employees, customers, suppliers and other parties with whom we have business relations. In response to these declarations and the rapid spread of COVID-19, federal, state and local governments imposed varying degrees of restrictions on business and social activities to contain COVID-19, including business shutdowns and closures, travel restrictions, quarantines, curfews, shelter-in-place orders and "stay-at-home" orders in certain of our markets. There is considerable uncertainty regarding the extent to which COVID-19 and its variants will continue to spread, the widespread availability and efficacy of vaccines and the extent and duration of governmental and other measures implemented to try to slow the spread, such as large-scale travel bans and restrictions, border closures, quarantines, shelter-in-place orders and business and government shutdowns. State and local authorities have also implemented multi-step policies with the goal of re-opening various sectors of the economy. However, certain jurisdictions began re-opening only to return to restrictions in the face of increases in new COVID-19 cases, while other jurisdictions are continuing to re-open or have nearly completed the re-opening process despite increases in COVID-19 cases. The COVID-19 outbreak may significantly worsen inthe United States , which may cause federal, state and local governments to reconsider restrictions on business and social activities. In the event governments increase restrictions, the re-opening of the economy may be further curtailed. We have experienced some resulting disruptions to our business operations, as these restrictions have significantly impacted, and may continue to impact, many sectors of the economy, with various businesses curtailing or ceasing normal operations and subsequently attempting to resume operations. InMarch 2020 , our homebuilding business began to decline, but beginning inMay 2020 we have seen a strong resurgence in net new orders , and from May toDecember 2020 have been eight of our nine most successful months since inception, as measured by volume of net new orders. We have modified certain business and workforce practices (including those related to employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences) and implemented protocols to promote social distancing and enhance sanitary measures in our offices and facilities to conform to government restrictions and best practices encouraged by governmental and regulatory authorities. However, the quarantine of personnel or the inability to access our offices or other locations could adversely affect our operations. If a large proportion of our employees were to contract COVID-19 or be quarantined as a result of the virus, at the same time, we would rely upon our business continuity plans in an effort to continue operations, but there is no certainty that such measures will be sufficient to mitigate the adverse impact to our operations that could result from shortages of highly skilled employees. Many of our suppliers and other business counterparties have made similar modifications. The resources available to those of our employees who are working remotely may not enable them to maintain the same level of productivity and efficiency, and those and other employees may face additional demands on their time, such as increased responsibilities resulting from school closures or the illness of family members. Although we have experienced only limited absenteeism from employees who are required to be on-site to perform their jobs, absenteeism may increase in the future and may harm our productivity. Further, our increased reliance on remote access to our information systems increases our exposure to potential cybersecurity breaches. We may take further actions as government authorities require or recommend or as we determine to be in the best interests of our employees, customers, suppliers and other business counterparties. As a result of the COVID-19 pandemic, we have observed an amplification of migration from urban centers to the suburban areas in which we build our homes, and an increase in entry-level homebuyers, one of our primary customer focuses, seeking to move out of apartments and into more spacious homes, as people are generally spending more time at home with remote-working arrangements increasing in prevalence. In addition, theFederal Reserve's efforts to address the sharp economic downturn that resulted from the COVID-19 pandemic has contributed to mortgage interest rates reaching historic lows. According to the Freddie Mac's nationwide survey of mortgage rates released onJuly 16, 2020 , the average rate on a 30-year fixed mortgage has fallen below 3.0% for the first time since the mortgage-backed finance firm began publishing data in 1971. We believe such low interest rates, particularly if sustained through broader economic recovery and job creation, are likely to serve as a powerful incentive for some potential homebuyers to expedite their next home purchase in order to secure these favorable mortgage terms, therefore driving home sales. Our primary focus remains doing everything we can to ensure the safety and well-being of our employees, customers and trade partners. While COVID-19 infection rates, hospitalizations and deaths declined in certain parts of the country since the initial surge in April andMay 2020 , infection rates increased significantly in other parts of the country, including inFlorida andTexas during June andJuly 2020 , two states that account for a significant portion of our homebuilding business. Residential construction has been deemed an essential business in each of our markets throughout the COVID-19 pandemic. In addition, state and/or local governments in each of our markets have instituted social distancing measures and other restrictions, which have resulted in significant changes to the way we conduct business. In all markets where we are permitted to operate, we are operating in accordance with the guidelines issued by theCenters for Disease Control and Prevention , as well as state and local guidelines. 51
--------------------------------------------------------------------------------
Table of Contents
Despite the encouraging rebound in our net new orders sinceApril 2020 , we cannot be certain that these positive trends will continue if COVID-19 infections and related hospitalizations and deaths continue to grow in our core markets or that we will be able to convert net new orders into home closings. There is uncertainty regarding the extent and timing of the disruption to our business that may result from the COVID-19 pandemic and any related governmental actions. There is also uncertainty as to the effects of the COVID-19 pandemic and related economic relief efforts on theU.S. economy, unemployment, consumer confidence, demand for our homes and the mortgage market, including lending standards, interest rates and secondary mortgage markets. We are unable to predict the extent to which this will impact our operational and financial performance, including the impact of future developments such as the duration and spread of the COVID-19 virus, corresponding governmental actions (including as a result of the change in theU.S. presidential administration) and the impact of such on our employees, customers and trade partners. For more information, see "Risk Factors-Our business could be materially and adversely disrupted by an epidemic or pandemic (such as the current COVID-19 pandemic), or similar public threat, or fear of such an event, and the measures that federal, state and local governments and other authorities implement to address it." Initial Public Offering OnJanuary 25, 2021 , we completed the IPO of 11,040,000 shares of our Class A common stock at a price to the public of$13.00 per share, which was conducted pursuant to our Registration Statement on Form S-1 (File No. 333-251612), as amended, that was declared effective onJanuary 20, 2021 . The IPO provided us with net proceeds of$133.5 million . OnJanuary 25, 2021 , we used the net proceeds from the IPO, cash on hand and borrowings under our Credit Agreement to repay (i) all borrowings under our then-existing 34 separate secured vertical construction lines of credit facilities totaling$319.0 million and upon such repayment terminated such facilities and (ii) the BOMN Bridge Loan used to finance the H&H Acquisition, totaling$20.0 million , plus contractual interest of$0.6 million . The historical consolidated financial statements included in this Annual Report on Form 10-K are based on the consolidated financial statements of our predecessor,DFH LLC , prior to our Corporate Reorganization in connection with the IPO. As a result, the historical consolidated financial data may not give you an accurate indication of what our actual results would have been if the reorganization transactions in conjunction with the IPO had been completed at the beginning of the periods presented or of what our future results of operations are likely to be. 52
--------------------------------------------------------------------------------
Table of Contents
Results of Operations
Year Ended
The following table presents summary consolidated results of operations for the
periods presented:
Year Ended December 31
2020 2019 Amount Change % Change
Revenues $ 1,133,806,607 $ 744,292,323 $ 389,514,284 52.3 %
Cost of sales 962,927,606 641,340,496 321,587,110 50.1 %
Selling, general and administrative expense 90,791,259 58,733,781 32,057,478 54.6 %
Income from equity in earnings of unconsolidated entities (7,991,764 ) (2,208,182 ) (5,783,582 ) 261.9 % Gain on sale of assets
(117,840 ) (28,652 ) (89,188 ) 311.3 %
Other Income (1,321,741 ) (2,447,879 ) 1,126,138 -46.0 %
Other expense 4,134,792 3,783,526 351,266 9.3 %
Interest expense 870,868 221,449 649,419 293.3 %
Income tax expense - - - 0.0 %
Net and comprehensive income $ 84,513,427 $ 44,897,784 $ 39,615,643 88.2 %
Net and comprehensive income attributable to non-controlling interests
(5,419,972 ) (5,706,518 ) 286,546 -5.0 %
Net and comprehensive income attributable to
79,093,455$ 39,191,266 $ 39,902,189 101.8 % Earnings per unit Basic$ 756.86 $ 353.40 $ 403.46 114.2 % Diluted $
754.32
99,065 97,830 1,235 1.3 %
Diluted 99,647 97,830 1,817 1.9 %
Consolidated Balance Sheets Data (at period end):
Cash and cash equivalents $
35,495,595
$ 733,680,241 $ 514,919,450 $ 218,760,791 42.5 % Long-term debt, net$ 319,531,998 $ 232,013,468 $ 87,518,530 37.7 % Finance lease liabilities $
345,062
$
55,638,450
$ 20,593,001 $ 16,248,246 $ 4,344,755 26.7 % Common members' equity$ 103,852,646 $ 56,502,464 $ 47,350,182 83.8 % Non-controlling interests$ 31,939,117 $ 30,471,371 $ 1,467,746 4.8 % Other Financial and Operating Data (unaudited) Active communities at end of period(1) 126 85 41 48.2 % Home closings 3,154 2,048 1,106 54.0 % Average sales price of homes closed$ 357,633 $ 362,728 $ (5,095 ) -1.4 % Net new orders 4,186 2,139 2,047 95.7 % Cancellation rate 12.8 % 15.6 % -2.8 % -17.9 % Backlog (at period end) - homes 2,424 854 1,570 183.8 % Backlog (at period end, in thousands) - value$ 865,109 $ 334,783 $ 530,326 158.4 % Gross margin(2)$ 165,047,621 $ 98,404,707 $ 66,642,914 67.7 % Gross margin %(3) 14.6 % 13.3 % 1.3 % 10.0 % Net profit margin % 7.0 % 5.3 % 1.7 % 32.5 % Adjusted gross margin(4)$ 252,694,562 $ 156,343,533 $ 96,351,029 61.6 % Adjusted gross margin %(3) 22.5 % 21.1 % 1.4 % 6.6 % EBITDA(4)$ 120,885,189 $ 70,522,000 $ 50,363,189 71.4 % EBITDA margin %(4)(5) 10.7 % 9.5 % 1.2 % 12.2 %
(1) A community becomes active once the model is completed or the community has
its fifth sale. A community becomes inactive when it has fewer than five
units remaining to sell.
(2) Gross margin is home sales revenue less cost of sales.
(3) Calculated as a percentage of home sales revenue.
(4) Adjusted gross margin and EBITDA are a non-GAAP financial measures. For
definitions of adjusted gross margin and EBITDA and a reconciliation to our
most directly comparable financial measures calculated and presented in
accordance with GAAP, see "-Non-GAAP Financial Measures."
(5) Calculated as a percentage of revenues.
53--------------------------------------------------------------------------------
Table of Contents
Revenues. Revenues for the year endedDecember 31, 2020 were$1,133.8 million , an increase of$389.5 million , or 52.3%, from$744.3 million for the year endedDecember 31, 2019 . The increase in revenues was primarily attributable to an increase in home closings of 1,106 homes, or 54.0%, during the year endedDecember 31, 2020 as compared to the year endedDecember 31, 2019 . The increase in home closings was attributable to a 48.2% increase in active communities from 85 atDecember 31, 2019 to 126 atDecember 31, 2020 and an increase in the average monthly sales per community. The average monthly sales per community increased 38.5% from an average of 2.6 in 2019 to an average of 3.6 in 2020. In addition,H&H Homes contributed 312 home closings and$89.5 million in homebuilding revenues in 2020 after the acquisition was consummated. The average sales price of homes closed remained relatively consistent year over year as our shift to a higher proportionate share of first-time and move-up homebuyers with lower price points was offset by an increasing proportionate share of home closings from our operating segments with higher price points such as DC Metro andColorado . Cost of Sales and Gross Margin. Cost of sales for the year endedDecember 31, 2020 was$962.9 million , an increase of$321.6 million , or 50.1%, from$641.3 million for the year endedDecember 31, 2019 . The increase in the cost of sales is primarily due to the increase in home closings in 2020 as compared to 2019. Gross margin for the year endedDecember 31, 2020 was$165.0 million , an increase of$66.6 million , or 67.7%, from$98.4 million for the year endedDecember 31, 2019 . Gross margin as a percentage of home sales revenue was 14.6% for the year endedDecember 31, 2020 , an increase of 130 bps, or 10.0%, from 13.3% for the year endedDecember 31, 2019 . The increase in gross margin percentage was attributable to higher margins in certain of our operating segments, driven by increased efficiencies in build times and costs. Adjusted Gross Margin. Adjusted gross margin for the year endedDecember 31, 2020 was$252.7 million , an increase of$96.4 million , or 61.6%, from$156.3 million for the year endedDecember 31, 2019 . Adjusted gross margin as a percentage of home sales revenue for the year endedDecember 31, 2020 was 22.5%, an increase of 140 bps, or 6.6%, as compared to 21.1% for the year endedDecember 31, 2019 . The increases in adjusted gross margin and adjusted gross margin percentage was driven by increased efficiencies in build times and costs. Adjusted gross margin is a non-GAAP financial measure. For the definition of adjusted gross margin and a reconciliation to our most directly comparable financial measure calculated and presented in accordance with GAAP, see "-Non-GAAP Financial Measures." Selling, General and Administrative Expense. Selling, general and administrative expense for the year endedDecember 31, 2020 was$90.8 million , an increase of$32.1 million , or 54.6%, from$58.7 million for the year endedDecember 31, 2019 . The increase in selling, general and administrative expense was primarily due to the inclusion of expenses for the operations ofH&H Homes for the fourth quarter of 2020, an increase in payroll related costs of$17.0 million (of which$3.0 million related toH&H Homes payroll expenses) commensurate with the increasing scale and profitability of the Company as well as increased costs related to the Corporate Reorganization and IPO inJanuary 2021 . Income from Equity in Earnings of Unconsolidated Entities. Income from equity in earnings of unconsolidated entities for the year endedDecember 31, 2020 was$8.0 million , an increase of$5.8 million , or 261.9%, as compared to$2.2 million for the year endedDecember 31, 2019 . The increase in income from equity in earnings of unconsolidated entities was largely attributable to an increase in mortgage loan fundings in 2020 as compared to 2019. Other Income. Other income for the year endedDecember 31, 2020 was$1.3 million , a decrease of$1.1 million , or 46.0%, as compared to$2.4 million for the year endedDecember 31, 2019 . The decrease in other income was primarily attributable to a decrease in joint venture home closings in the year endedDecember 31, 2020 as compared to the year endedDecember 31, 2019 . Joint venture home closings were 247 and 254 for the years endedDecember 31, 2020 and 2019, respectively, with average selling prices of$319,200 and$397,300 , respectively. Other Expense. Other expense for the year endedDecember 31, 2020 was$4.1 million , an increase of$0.4 million , or 9.3%, as compared to$3.8 million for the year endedDecember 31, 2019 . Other expense consists primarily of payments made to a land developer for homes closed in certain communities in ourColorado segment. This community was no longer active as ofDecember 31, 2020 . Net and Comprehensive Income. Net and comprehensive income for the year endedDecember 31, 2020 was$84.5 million , an increase of$39.6 million , or 88.2%, from$44.9 million for the year endedDecember 31, 2019 . The increase in net and comprehensive income was primarily attributable to an increase in gross margin on homes closed of$66.6 million , or 67.7%, during the year endedDecember 31, 2020 as compared to the year endedDecember 31, 2019 . 54
--------------------------------------------------------------------------------
Table of Contents
Net and Comprehensive Income Attributable toDream Finders Holdings LLC . Net and comprehensive income attributable toDream Finders Holdings LLC for the year endedDecember 31, 2020 was$79.1 million , an increase of$39.9 million , or 101.8%, from$39.2 million for the year endedDecember 31, 2019 . The increase was primarily attributable to a significant increase in home closings and gross margin. We closed 3,154 homes for the year endedDecember 31, 2020 , an increase of 1,106 units, or 54.0%, from the 2,048 homes closed for the year endedDecember 31, 2019 . Gross margin for the year endedDecember 31, 2020 was$165.0 million , an increase of$66.6 million , or 67.7%, from$98.4 million for the year endedDecember 31, 2019 . Net and Comprehensive Income Attributable to Noncontrolling Interests. Net and comprehensive income attributable to noncontrolling interests for the year endedDecember 31, 2020 was$5.4 million , a decrease of$0.3 million , or 5.0%, as compared to$5.7 million for the year endedDecember 31, 2019 . Backlog. Backlog atDecember 31, 2020 was 2,424 homes valued at approximately$865.1 million , an increase of 1,570 homes and$530.3 million , respectively, or 183.8% and 158.4%, respectively, as compared to 854 homes valued at approximately$334.8 million atDecember 31, 2019 . The increase in backlog was primarily attributable to an increase in active communities of 41, or 48.2%, during the year endedDecember 31, 2020 . 55
--------------------------------------------------------------------------------
Table of Contents
Year Ended
The following table presents summary consolidated results of operations for the
periods presented:
Year Ended December 31
2019 2018 Amount Change % Change
Revenues $ 744,292,323 $ 522,258,473 $ 222,033,850 42.5 %
Cost of sales 641,340,496 454,402,820 186,937,676 41.1 %
Selling, general and administrative expense 58,733,781 43,545,254 15,188,527 34.9 %
Income from equity in earnings of unconsolidated entities (2,208,182 ) (1,271,303 ) (936,879 ) 73.7 % Gain on sale of assets
(28,652 ) (3,293,187 ) 3,264,535 -99.1 %
Other Income (2,447,879 ) (3,016,273 ) 568,394 -18.8 %
Other expense 3,783,526 7,947,641 (4,164,115 ) -52.4 %
Interest expense 221,449 682,152 (460,703 ) -67.5 %
Income tax expense - - - -
Net and comprehensive income $ 44,897,784 $ 23,261,369 21,636,415 93.0 %
Net and comprehensive income attributable to non-controlling interests
(5,706,518 ) (5,939,015 ) 232,497 -3.9 %
Net and comprehensive income attributable to
39,191,266$ 17,322,354 $ 21,868,912 126.2 % Earnings per unit Basic$ 353.40 $ 170.92 $ 182.48 106.8 % Diluted $
353.40
97,830 97,830 - 0.0 %
Diluted 97,830 97,830 - 0.0 %
Consolidated Balance Sheets Data (at period end):
Cash and cash equivalents $
44,007,245
$ 514,919,450 $ 375,445,611 $ 139,473,839 37.1 % Long-term debt, net$ 232,013,468 $ 175,876,335 $ 56,137,133 31.9 % Finance lease liabilities $
498,691
$
58,269,166
$ 16,248,246 $ 13,534,739 $ 2,713,507 20.0 % Common members' equity$ 56,502,464 $ 33,093,591 $ 23,408,873 70.7 % Non-controlling interests$ 30,471,371 $ 28,929,857 $ 1,541,514 5.3 % Other Financial and Operating Data (unaudited) Active communities at end of period(1) 85 53 32 60.4 % Home closings 2,048 1,408 640 45.5 % Average sales price of homes closed$ 362,728 $ 361,860 $ 868 0.2 % Net new orders 2,139 1,349 790 58.6 % Cancellation rate 15.6 % 15.8 % -0.2 % -1.3 % Backlog (at period end) - homes 854 636 218 34.3 % Backlog (at period end, in thousands) - value$ 334,783 $ 249,672 $ 85,111 34.1 % Gross margin(2)$ 98,404,707 $ 64,650,737 $ 33,753,970 52.2 % Gross margin %(3) 13.3 % 12.5 % 0.8 % 6.4 % Net profit margin 5.3 % 3.3 % 1.9 % 58.8 % Adjusted gross margin(4)$ 156,343,533 $ 103,973,948 $ 52,369,585 50.4 % Adjusted gross margin %(3) 21.1 % 20.0 % 1.1 % 5.5 % EBITDA(4)$ 70,522 $ 37,179 $ 33,343 89.7 % EBITDA margin %(4)(5) 9.5 % 7.1 % 2.4 % 33.8 %
(1) A community becomes active once the model is completed or the community has
its fifth sale. A community becomes inactive when it has fewer than five
units remaining to sell.
(2) Gross margin is home sales revenue less cost of sales.
(3) Calculated as a percentage of home sales revenue.
(4) Adjusted gross margin and EBITDA are a non-GAAP financial measures. For
definitions of adjusted gross margin and EBITDA and a reconciliation to our
most directly comparable financial measures calculated and presented in
accordance with GAAP, see "-Non-GAAP Financial Measures."
(5) Calculated as a percentage of revenues.
Revenues. Revenues for the year endedDecember 31, 2019 were$744.3 million , an increase of$222.0 million , or 42.5%, from$522.3 million for the year endedDecember 31, 2018 . The increase in revenues was primarily attributable to an increase in home closings of 640 homes, or 45.5%, during the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . The increase in home closings was primarily attributable to a 60.4% increase in active communities from 53 atDecember 31, 2018 to 85 atDecember 31, 2019 . Average sales price of homes closed remained consistent year over year as our shift to a higher proportionate share of first-time and move-up homebuyers with lower price points was offset by an increasing proportionate share of home closings from our operating segments with higher price points such as DC Metro andColorado . 56
--------------------------------------------------------------------------------
Table of Contents
Cost of Sales and Gross Margin. Cost of sales for the year endedDecember 31, 2019 was$641.3 million , an increase of$186.9 million , or 41.1%, from$454.4 million for the year endedDecember 31, 2018 . The increase in the cost of sales is primarily due to more home closings in 2019 as compared to 2018. Gross margin for the year endedDecember 31, 2019 was$98.4 million , an increase of$33.8 million , or 52.2%, from$64.7 million for the year endedDecember 31, 2018 . Gross margin as a percentage of home sales revenue was 13.3% for the year endedDecember 31, 2019 , an increase of 80 bps, or 6.4%, from 12.5% for the year endedDecember 31, 2018 . The increases in gross margin and gross margin as a percentage of home sales revenue were primarily attributable to increased margins in our newer markets, decreased cost of labor, decreased price of materials and decreased average build times during the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . Adjusted Gross Margin. Adjusted gross margin for the year endedDecember 31, 2019 was$156.3 million , an increase of$52.4 million , or 50.4%, from$104.0 million for the year endedDecember 31, 2018 . Adjusted gross margin as a percentage of home sales revenue for the year endedDecember 31, 2019 was 21.1%, an increase of 110 bps, or 5.5%, from 20.0% for the year endedDecember 31, 2018 . The increases in adjusted gross margin and adjusted gross margin as a percentage of home sales revenue were primarily attributable to a decrease in the average cost of interest expense charged to cost of sales, decreased labor and material costs as a percentage of average sales price of homes closed and lower internal and external commissions expense charged to costs of sales in the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . The increase in adjusted gross margin was also attributable to an increase in the amount of purchase accounting premium adjustments that were added back for the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . Adjusted gross margin is a non-GAAP financial measure. For the definition of adjusted gross margin and a reconciliation to our most directly comparable financial measure calculated and presented in accordance with GAAP, see "-Non-GAAP Financial Measures." Selling, General and Administrative Expense. Selling, general and administrative expense for the year endedDecember 31, 2019 was$58.7 million , an increase of$15.2 million , or 34.9%, from$43.5 million for the year endedDecember 31, 2018 . The increase in selling, general and administrative expense was primarily attributable to the inclusion of expenses attributable toVillage Park Homes , an increase in payroll as we continued to grow in scale and other expenses associated with the increase in average community count. Income from Equity in Earnings of Unconsolidated Entities. Income from equity in earnings of unconsolidated entities for the year endedDecember 31, 2019 was$2.2 million , an increase of$0.9 million , or 73.7%, as compared to$1.3 million for the year endedDecember 31, 2018 . The increase in income from equity in earnings of unconsolidated entities was attributable to an increase in mortgage loan fundings 2019 as compared to 2018. Other Income. Other income for the year endedDecember 31, 2019 was$2.4 million , a decrease of$0.6 million , or 18.8%, as compared to$3.0 million for the year endedDecember 31, 2018 . The decrease in other income was primarily attributable to a decrease in the number of joint venture home closings in the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . Other Expense. Other expense for the year endedDecember 31, 2019 was$3.8 million , a decrease of$4.2 million , or 52.4%, as compared to$7.9 million for the year endedDecember 31, 2018 . The decrease in other expense was primarily attributable to our purchase of the membership interests of a former joint venture partner in 2018 and corresponding elimination of the requirement to share profits with this joint venture partner from home closing as ofDecember 17, 2018 . Net and Comprehensive Income. Net and comprehensive income for the year endedDecember 31, 2019 was$44.9 million , an increase of$21.6 million , or 93.0%, from$23.3 million for the year endedDecember 31, 2018 . The increase in net and comprehensive income was primarily attributable to an increase in gross margin on homes closed of$33.8 million , or 52.2%, during the year endedDecember 31, 2019 as compared to the year endedDecember 31, 2018 . 57
--------------------------------------------------------------------------------
Table of Contents
Net and Comprehensive Income Attributable toDream Finders Holdings LLC . Net and comprehensive income attributable toDream Finders Holdings LLC for the year endedDecember 31, 2019 was$39.2 million , an increase of$21.9 million , or 126.2%, from$17.3 million for the year endedDecember 31, 2018 . The increase was primarily attributable a significant increase in homes closed and gross margin. We closed 2,048 homes for the year endedDecember 31, 2019 , an increase of 640 units, or 45.5%, from the 1,408 homes closed for the year endedDecember 31, 2018 . Gross margin for the year endedDecember 31, 2019 was$98.4 million , an increase of$33.8 million , or 52.2%, from$64.7 million for the year endedDecember 31, 2018 . Net and Comprehensive Income Attributable to Noncontrolling Interests. Net and comprehensive income attributable to noncontrolling interests for the year endedDecember 31, 2019 was$5.7 million , a decrease of$0.2 million , or 3.9%, as compared to$5.9 million for the year endedDecember 31, 2018 . Backlog. Backlog atDecember 31, 2019 was 854 homes valued at approximately$334.8 million , an increase of 218 homes and$85.1 million , respectively, or 34.3% and 34.1%, respectively, as compared to 636 homes valued at approximately$249.7 million atDecember 31, 2018 . The increase in backlog was primarily attributable to an increase in active communities of 32, or 60.4%, during the year endedDecember 31, 2019 .
Non-GAAP Financial Measures
Adjusted Gross Margin
Adjusted gross margin is a non-GAAP financial measure used by management as a supplemental measure in evaluating operating performance. We define adjusted gross margin as gross margin excluding the effects of capitalized interest, amortization included in the cost of sales (including adjustments resulting from the application of purchase accounting in connection with acquisitions) and commission expense. Our management believes this information is meaningful because it isolates the impact that capitalized interest, amortization (including purchase accounting adjustments) and commission expense have on gross margin. However, because adjusted gross margin information excludes capitalized interest, amortization (including purchase accounting adjustments) and commission expense, which have real economic effects and could impact our results of operations, the utility of adjusted gross margin information as a measure of our operating performance may be limited. We include commission expense in cost of sales, not selling, general and administrative expense, and therefore commission expense is taken into account in gross margin. As a result, in order to provide a meaningful comparison to the public company homebuilders that include commission expense below the gross margin line in selling, general and administrative expense, we have excluded commission expense from adjusted gross margin. In addition, other companies may not calculate adjusted gross margin information in the same manner that we do. Accordingly, adjusted gross margin information should be considered only as a supplement to gross margin information as a measure of our performance.
The following table presents a reconciliation of adjusted gross margin to the GAAP financial measure of gross margin for each of the periods indicated (unaudited and in thousands, except percentages).
Year Ended December 31
2020 2019 2018
Revenues $ 1,133,807 $ 744,292 $ 522,258
Other revenue 5,831 4,547 3,205
Home sales revenue 1,127,976 739,745 519,053
Cost of sales 962,928 641,340 454,403
Gross Margin(1) 165,048 98,405 64,650Interest expense in cost of sales 32,044 21,055 16,364 Amortization in cost of sales(3) 5,070 7,119
550
Commission expense 50,533 29,765 22,410
Adjusted gross margin $ 252,695 $ 156,344 $ 103,974
Gross margin %(2) 14.6 % 13.3 % 12.5 %
Adjusted gross margin %(2) 22.4 % 21.1 % 20.0 %
(1) Gross margin is home sales revenue less cost of sales.
(2) Calculated as a percentage of home sales revenues.
(3) Includes purchase accounting adjustment, as applicable.
EBITDA and Adjusted EBITDA
EBITDA and adjusted EBITDA are not measures of net income as determined by GAAP.
EBITDA and adjusted EBITDA are supplemental non-GAAP financial measures used by
management and external users of our consolidated financial statements, such as
industry analysts, investors, lenders and rating agencies. We define EBITDA as
net income before (i) interest income, (ii) capitalized interest expensed in
cost of sales, (iii) interest expense, (iv) income tax expense and (v)
depreciation and amortization. We define adjusted EBITDA as EBITDA before
stock-based compensation expense.
58--------------------------------------------------------------------------------
Table of Contents
Management believes EBITDA and adjusted EBITDA are useful because they allow management to more effectively evaluate our operating performance and compare our results of operations from period to period without regard to our financing methods or capital structure or other items that impact comparability of financial results from period to period. EBITDA and adjusted EBITDA should not be considered as alternatives to, or more meaningful than, net income or any other measure as determined in accordance with GAAP. Our computations of EBITDA and adjusted EBITDA may not be comparable to EBITDA or adjusted EBITDA of other companies. We present EBITDA and adjusted EBITDA because we believe they provide useful information regarding the factors and trends affecting our business.
The following table presents a reconciliation of EBITDA and adjusted EBITDA to the GAAP financial measure of net income for each of the periods indicated (unaudited and in thousands, except percentages).
Year Ended December 31
2020 2019 2018
Net income $ 79,093 $ 39,191 $ 17,322
Interest income (45 ) (99 ) (9 )
Interest expensed in cost of sales 32,044 21,055 16,364 Interest expense
871 221 682
Depreciation and amortization 8,922 10,154 2,820
EBITDA $ 120,885 $ 70,522 $ 37,179
Stock-based compensation expense 947 895 896
Adjusted EBITDA $ 121,832 $ 71,417 $ 38,075
EBITDA margin %(1) 10.7 % 9.5 % 7.1 %
Adjusted EBITDA margin %(1) 10.7 % 9.6 % 7.3 %
(1) Calculated as a percentage of revenues.
Components of Our Operating Results
Below are general definitions of the income statement line items set forth in our period over period changes in results of operations.
Revenues
Revenues include the proceeds from the closing of homes sold to our customers,
as well as fees from our wholly-owned title insurance business, DF Title.
Revenues from home sales are recorded at the time each home sale is closed,
title and possession are transferred to the buyer and there is no significant
continuing involvement with the home. For home sales on a homesite that the
customer owns, we recognize revenue based on the percentage of completion of the
home. Proceeds from home sales are generally received within a few days after
closing. Home sales are reported net of sales discounts and incentives granted
to homebuyers, which includes seller-paid closing costs. The pace of net new
orders, average home sales price, the level of incentives provided to the
customer and the amount of upgrades or options selected all impact our recorded
revenues in a given period.
Cost of Sales
Cost of sales includes the lot purchase and carrying costs associated with each
lot, construction costs of each home, capitalized interest, lot option fees,
building permits, internal and external realtor commissions and warranty costs
(both incurred and estimated to be incurred). Land, development and other
allocated costs, including interest, lot option fees and property taxes,
incurred during development and home construction are capitalized and expensed
to cost of sales when the home is closed and revenue is recognized. We adjust
the cost of lots remaining in a community on a pro rata basis, when changes to
estimated total development costs occur, including lot option fees and community
costs. Indirect costs such as maintenance of communities, signage and
supervision are expensed as incurred.
59--------------------------------------------------------------------------------
Table of Contents
Selling, General and Administrative Expense
Selling, general and administrative expense consists of corporate and marketing overhead expenses such as payroll, insurance, IT, office expenses, advertising, outside professional services and travel expenses. Selling, general and administrative expense also includes maintaining model homes and sales centers, including the rent associated with any model homes or sales centers that we have sold and leased to a third party. We recognize these costs in the period they are incurred.
Income from Equity in Earnings of Unconsolidated Entities
Income from equity in earnings of unconsolidated entities consists primarily of income earned from minority interests in our unconsolidated mortgage banking joint venture,Jet LLC , which underwrites and originates home mortgages across our geographic footprint. Our 49% minority interest inJet LLC is accounted for under the equity investment method and is not consolidated in our consolidated financial statements, as we do not control, and are not deemed the primary beneficiary of,Jet LLC's income.
Other Income
Other income consists of interest income and management fees we earn for managing certain joint ventures. In general, we earn four to six percent of the sales price of homes built by us on behalf of the joint ventures.
Other Expense
Other expense consists primarily of payments made to a land developer on homes closed in certain communities in ourColorado segment, as well as required payments to certain of our unconsolidated joint ventures and stock based compensation expense. For the year endedDecember 31, 2018 , other expense also includes profits due to former partners in unconsolidated joint ventures where we build homes in our name and were contractually required to share profits based on ownership percentages.
Net and Comprehensive Income Attributable to Noncontrolling Interests
Net and comprehensive income attributable to noncontrolling interests consists of income attributable to partners in our consolidated joint ventures. In certain of our joint ventures, we agree to split the profits from home closings with our joint venture partners. Net and comprehensive income attributable to noncontrolling interests shows our joint venture partners' share of homebuilding profits, less any community costs shared with our joint venture partners. In addition, certain of our joint ventures own lots and from time to time we may record impairment charges relating to such lots. In such cases, we would typically record an impairment charge relating to our proportionate ownership of the joint venture, and the remaining impairment would be reflected through a decrease in income attributable to noncontrolling interests.
Net and Comprehensive Income Attributable to Dream Finders
Net and comprehensive income attributable to Dream Finders is revenues less cost of sales, selling, general and administrative expense, income from equity in earnings of unconsolidated entities, gain on sale of assets, other income, other expense, interest expense and net and comprehensive income attributable to noncontrolling interests.
Returns on Equity
Returns on equity is pre-tax net and comprehensive income attributable to Dream Finders tax effected for our anticipated 25% federal and state blended tax rate less accrued preferred unit distributions divided by average total participating equity. Participating equity is all equity that participates in the earnings of the Company, including Series A preferred equity and all common equity. Following consummation of the IPO, we became subject to taxation as a corporation, and prospectively we will calculate returns on equity as net income attributable to Dream Finders less preferred distributions divided by the average beginning and ending participating equity for the fiscal year.
Net new orders is a key performance metric for the homebuilding industry and is
an indicator of future revenues and cost of sales. Depending on whether net new
orders are associated with a joint venture, they can also be an indicator of
future net and comprehensive income attributable to noncontrolling interests.
Net new orders for a period are gross sales less any customer cancellations
received during the same period. Sales are recognized when a customer signs a
contract and we approve such contract and collect any deposit from the customer
required by such contract.
60--------------------------------------------------------------------------------
Table of Contents
Cancellation Rate
We record a cancelation when a customer notifies us that he or she does not wish to purchase a home. Increasing cancellations are a negative indicator of future performance and can be an indicator of decreased revenues, cost of sales and net income. When a cancellation occurs, we generally retain the customer deposit and resell the home to a new customer. Cancellations can occur due to customer credit issues or changes to the customer's desires. The cancellation rate is the total number of new sales purchase contracts during the period divided by the total new gross sales for homes during the period.
Backlog (at period end)
Backlog (at period end) is the number of homes in backlog from the previous period plus the number of net new orders generated during the current period minus the number of homes closed during the current period. Backlog at period end includes homes currently under construction and homes that are sold where construction has not commenced.
Gross Margin
Gross margin is home sales revenue less cost of sales for the reported period.
Adjusted Gross Margin
Adjusted gross margin is gross margin less capitalized interest expensed in cost of sales, commission expense, and amortization in cost of sales (including purchase accounting adjustments).
Liquidity and Capital Resources
Overview
We believe we have a prudent strategy for company-wide cash management, including controls related to cash outflows for lot deposits, land-bank development arrangements, lot purchases and vertical construction lines of credit. We believe we are conservative, yet flexible in order to capitalize on potential opportunities to increase controlled lots in desirable locations. As ofDecember 31, 2020 , we had$35.5 million in cash and cash equivalents (excluding$49.7 million of restricted cash), a decrease of$8.5 million , or 19.3%, from$44.0 million as ofDecember 31, 2019 . We generate cash from the sale of our inventory net of loan release payments on our vertical construction lines of credit facilities, and we intend to re-deploy the net cash generated from the sale of inventory to acquire and control land and further grow our operations year over year. We believe that our sources of liquidity are sufficient to satisfy our current commitments. Our principal uses of capital are land deposits and purchases, vertical home construction, operating expenses and the payment of routine liabilities. During 2020, we also used cash to make distributions on certain of our preferred units, make tax distributions to our members. We use funds generated by operations and available borrowings to meet our short-term working capital requirements. We are focused on generating high margins in our homebuilding operations and acquiring desirable land positions while maintaining our asset-light land financing strategy that strengthens our balance sheet and maximizes returns on equity. Cash flows generated by our projects can differ materially from our results of operations, as these depend upon the stage in the life cycle of each project. The majority of our projects begin at the land acquisition stage when we enter into finished lot option contracts by placing a deposit with a land seller or developer. Our lot deposits are an asset on our balance sheets, and these cash outflows are not recognized in our results of operations. Early stages in our communities require material cash outflows relating to finished rolling option lot purchases, entitlements and permitting, construction and furnishing of model homes, roads, utilities, general landscaping and other amenities, as well as ongoing association fees and property taxes. These costs are capitalized within our real estate inventory and are not recognized in our operating income until a home sale closes. As such, we incur significant cash outflows prior to the recognition of earnings. In later stages of the life cycle of a community, cash inflows could significantly exceed our results of operations, as the cash outflows associated with land purchase and home construction and other expenses were previously incurred. We actively enter into finished lot option contracts by placing deposits with land sellers of typically 10% or less of the aggregate purchase price of the finished lots. When entering into these contracts, we also agree to purchase finished lots at pre-determined time frames and quantities that match our expected selling pace in the community. For the year endedDecember 31, 2020 , the majority of these future lot purchases were financed within our fully collateralized vertical construction lines of credit facilities. 61
--------------------------------------------------------------------------------
Table of Contents
From time to time, we also enter into land development arrangements with land sellers, land developers and land bankers. We typically provide a lot deposit of 10% or less, or 15% or less in the case of land bank option contracts, of the total investment required to develop lots that we will have the option to acquire in the future. In these transactions, we also incur lot option fees that have historically been 15% or less of the outstanding capital balance held by the land banker. The initial investment and lot option fees require our ability to allocate liquidity resources to projects that will be not materialize into cash inflows or operating income in the near term. The above cash strategies are designed to allow us to maintain adequate lot supply in our existing markets and support ongoing growth and profitability. As we continue to operate in a low interest rate environment, with consistent increase in the demand for new homes and constrained lot supply compared to population and job growth trends, we intend to continue to re-invest our earnings into our business and focus on expanding our operations. In addition, as the opportunity to purchase finished lots in desired locations becomes increasingly more limited and competitive, we are committed to allocating additional liquidity to land-bank deposits on land development projects, as this strategy mitigates the risks associated with holding undeveloped land on our balance sheet, while allowing us to control adequate lot supply in our key markets to support forecasted growth. As ofDecember 31, 2020 , our lot deposits and investments related to finished lot option contracts and land bank option contracts were$66.7 million , including$1.1 million of refundable lot deposits. For the year endedDecember 31, 2020 , we closed 3,154 homes, acquired 3,254 lots and started construction on 3,416 homes. We employ both secured debt and equity financing as part of our ongoing financing strategy, and we fully redeploy our cash flows generated from continuing operations. Our leverage is generally 60-70% of our work-in-progress inventory, as we draw cash available under our fully collateralized vertical construction lines of credit facilities based on the actual progress on our inventory. Our indebtedness as ofDecember 31, 2020 was fully collateralized by our homes under construction and, to a much smaller extent, finished lots. Immediately following the closing of our IPO, we replaced all of our secured vertical construction lines of credit facilities with our Credit Agreement, which has a borrowing base of$450.0 million and an accordion feature that allows the facility to expand to a borrowing base of up to$750.0 million . We believe that the consolidation of our indebtedness into a single credit facility will reduce our financing costs, create operating efficiencies and enhance returns. We intend to finance future land acquisitions and developments with the most advantageous source of capital available to us at the time of the transaction, which may include a combination of common equity and unsecured corporate level debt Cash Flows
Year Ended
The following table summarizes our cash flows for the periods indicated:
Year Ended
2020 2019 2018
Net cash provided by (used in) operating activities$ 95,339 $ 23,839 $ (2,510 ) Net cash provided by (used in) investing activities (13,027 ) (17,820 ) 2,630 Net cash provided by (used in) financing activities (65,830 ) 26,077 (2,421 ) Net cash provided by operating activities was$95.3 million for the year endedDecember 31, 2020 , an increase of$71.5 million , as compared to$23.8 million of net cash provided by operating activities for the year endedDecember 31, 2019 . The increase in net cash provided by operating activities was driven by higher deposits of$39.2 million received from customers and the increase in net income generated on home closings. This increase was partially offset by the increase in lot deposits of$37.9 million to secure finished lots in the future. Net cash used in investing activities was$13.0 million for the year endedDecember 31, 2020 , a decrease of$4.8 million , as compared to$17.8 million of cash used in investing activities for the year endedDecember 31, 2019 . The decrease in net cash used in investing activities was primarily attributable to the Company converting several joint ventures to land bank financing structures during 2020. The cash outflow for the land bank structures is presented in the operating section of the Consolidated Statements of Cash Flows. Net cash used in financing activities was$65.8 million for the year endedDecember 31, 2020 , a decrease of$91.9 million , as compared to$26.1 million of cash provided by financing activities for the year endedDecember 31, 2019 . The decrease in net cash used in financing activities was primarily attributable to the redemption of the Series D preferred units ofDFH LLC of$12.0 million , increased payments on construction lines due to increased home closings of 1,106 and increased distributions of$7.9 million to the members ofDFH LLC due to higher tax payments. 62
--------------------------------------------------------------------------------
Table of Contents
Credit Facilities, Letters of Credit, Surety Bonds and Financial Guarantees
As ofDecember 31, 2020 , giving effect to the H&H Acquisition, we had 34 vertical construction lines of credit facilities with cumulative maximum availability of$763.0 million and an aggregate outstanding balance of$289.9 million . As ofDecember 31, 2019 , we had 19 vertical construction lines of credit facilities with a cumulative maximum availability of$457.8 million and an aggregate outstanding balance of$217.7 million . Historically, our vertical construction lines of credit facilities were fully collateralized by finished lots and homes under construction and were personally guaranteed byPatrick Zalupski , our founder, President, Chief Executive Officer and Chairman of our Board of Directors. In connection with the IPO, we entered into our Credit Agreement with a syndicate of lenders andBank of America, N.A , as administrative agent, providing for a senior unsecured revolving credit facility which has an initial aggregate commitment of up to$450.0 million and an accordion feature that allows the facility to expand to a borrowing base of up to$750.0 million . In connection with the consummation of the IPO, we used the net proceeds from the IPO, cash on hand and borrowings under our Credit Agreement to repay all borrowings under our vertical construction lines of credit facilities and our BOMN Bridge Loan, and upon such repayment, terminated all such vertical construction lines of credit facilities.
We enter into surety bonds and letter of credit arrangements with local
municipalities, government agencies and land developers. These arrangements
relate to certain performance-related obligations and serve as security for
certain land option agreements. At
Contractual Obligations, Commitments and Contingencies
A summary of the contractual obligations for our predecessor,
Payments Due by Period for the Year Ended December 31 ,
(in thousands)
2021 2022 2023 2024 2025 Thereafter Total Long-term debt, including current portion
$ 289,879 $ 6,551 $ 3,102 $ - $ - $ -$ 299,532 Interest on long-term debt 15,352 - - - - - 15,352 Operating lease obligations 3,626 2,270 1,327 1,305 1,337 10,018 19,883 Capital lease obligations 173 153 49 - - - 375
2,753 2,835 - - - 7,887 H&H Homes acquisition contingent consideration(1) 4,601 5,270 5,878 4,830 - - 20,579 Total$ 315,930 $ 16,997 $ 13,191 $ 6,135 $ 1,337 $ 10,018 $ 363,608
(1) Such acquisition contingent consideration payments, if any, will be equal to
25% of pre-tax earnings for the fiscal years ending
2022, inclusive of 1% corporate overhead charge.
Series B Preferred Units
Following the Corporate Reorganization and upon completion of theIPO, MOF II DF Home LLC andMCC Investment Holdings LLC (both controlled byMedley Capital Corporation ) continued to hold the Series B preferred units ofDFH LLC . As such, they have certain rights and preferences with regard toDFH LLC that holders of our Class A common stock do not have. In the event that the sole manager ofDFH LLC elects, from time to time, to make distributions, the holders of the Series B preferred units are entitled to receive distributions until the holders of each outstanding Series B preferred unit have received distributions equaling the Series B Preferred Return, which accrues quarterly. Once the holders of each Series B preferred unit have received distributions equaling 8% per annum cumulative preferred return on any outstanding and unreturned capital contribution applicable to such Series B preferred units (the "Series B Preferred Return"), they are thereafter entitled to$1,000 per Series B preferred unit. Additionally, holders of the Series B preferred units are entitled to receive tax distributions sufficient to fund their federal and state income tax liabilities attributable to the taxable income on their Series B preferred units, if any. The Series B preferred units shall be deemed cancelled once they have received distributions totaling their initial capital contribution plus the Series B Preferred Return. 63
--------------------------------------------------------------------------------
Table of Contents
Holders of Series B preferred units have the right to vote on all matters submitted to a vote of the members ofDFH LLC but do not have the right to convert their Series B preferred units into shares of our common stock. Any holder of Series B preferred units desiring to transfer their Series B preferred units to a non-affiliated third party must either (i) obtain approval from the sole manager ofDFH LLC or (ii) must first offer such units toDFH LLC at the same price that the proposed third-party transferee would have paid or, in certain cases, at fair market value. At any time on or prior toSeptember 30, 2022 ,DFH LLC has the right to redeem some or all of the outstanding Series B preferred units at a price equal to the sum of (i) the difference of (A)$1,000 and (B) the amount of previous distributions having already been paid towards each such unit and (ii) unreturned capital contributions for such unit plus the Series B Preferred Return (the "Series B Redemption Price"). In the event of a liquidation or dissolution ofDFH LLC , the holders of Series B preferred units shall have preference over our membership interest inDFH LLC . Further, in the event of (i) a sale of substantially all ofDFH LLC's assets or (ii) a merger or reorganization resulting in the members ofDFH LLC immediately prior to such transaction no longer beneficially owning at least 50% of the voting power ofDFH LLC , the holders of the Series B preferred units may demand redemption of their Series B preferred units at a price equal to the Series B Redemption Price. Series C Preferred Units Following the Corporate Reorganization and upon completion of the IPO, Värde Capital continued to hold the Series C preferred units ofDFH LLC . OnJanuary 27, 2021 , we redeemed all 26,000 outstanding Series C preferred units ofDFH LLC at a redemption price of$26.0 million , plus accrued distributions and fees of$0.2 million .
Factors Affecting Our Results of Operations
We believe that our future performance will depend on many factors, including those described below and in the sections titled "Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements" included elsewhere in this Annual Report on Form 10-K.
Availability of Finished Lots
Our sourcing of finished lots is affected by changes in the general availability of finished lots in the markets in which we operate, the willingness of land sellers to sell finished lots at competitive prices, competition for available finished lots and other market conditions. If the supply of finished lots is limited because of these or other factors, we may build and sell fewer homes as a result. To the extent that we are unable to acquire finished lots at competitive prices, or at all, our revenues, margins and other results of operations could be negatively impacted.
Availability of Mortgages; Applicable Interest Rates
The majority of our homebuyers in 2020 obtained a mortgage to purchase their
home. As a result, the availability of mortgages on terms that make purchases of
our homes affordable to a broad base of consumers has a significant impact on
our business. The availability and accessibility of mortgages can depend in part
on current interest rates and down payment requirements, which are not within
our control. The majority of our customers that obtain mortgages obtain loans
that conform to the terms established by Freddie Mac and Fannie Mae. Interest
rates available to homebuyers obtaining conforming loans are driven by Freddie
Mac's and Fannie Mae's ability to package and sell loans into the secondary
market. Disruptions in this supply chain could impact our business significantly
if our homebuyers are unable to obtain mortgages on terms that are acceptable,
or at all.
64--------------------------------------------------------------------------------
Table of Contents
Costs of
Our cost of sales includes the acquisition and finance costs of home sites or lots, municipality fees, the costs associated with obtaining building permits, materials and labor to construct the home, interest rates for construction loans, internal and external realtor commissions and other miscellaneous closing costs. Home site costs range from 20-25% of the average cost of a home. Building materials range from 40-50% of the average cost to build the home, labor ranges from 30-40% of the average cost to build the home and interest, commissions and closing costs range from 4-10% of the average cost to build the home. In general, the cost of building materials fluctuates with overall trends in the underlying prices of raw materials. The cost of certain of our building materials, such as lumber and oil-based products, fluctuates with market-based pricing curves. We often obtain volume discounts and/or rebates with certain suppliers of our building materials, which in turn reduces our cost of sales. However, increases in the cost of building materials may reduce gross margin to the extent that market conditions prevent the recovery of increased costs through higher home sales prices. The price changes that most significantly influence our operations are price increases in commodities, including lumber. Significant price increases of these materials may negatively impact our cost of sales and, in turn, our net income. For example, in the last 18 months, the cost of lumber has been volatile due to theU.S. government-imposed tariffs on imports of Canadian lumber and the supply-chain disruptions caused by the closing of lumber mills in response to the COVID-19 pandemic. The recent increases in lumber commodity prices may result in the renewal of our lumber contracts at more expensive rates, which may significantly impact the cost to construct our homes and our business. If the current lumber shortage, and related pricing impacts, continue, our cost of sales and, in turn, our net income could be negatively impacted.
Changes in Price and Availability of Land
Acquiring home sites or finished lots in desirable geographic areas with prices and acquisition terms that drive profitable home delivery is an important component of our business. Our infrastructure is designed to build a certain number of homes each year and an adequate lot supply is crucial to meeting our business objectives. Lot value appreciation or depreciation varies across the markets in which we operate. Our acquisition costs associated with finished lots have increased in certain of our markets where job and population growth are outpacing lot supply. Historically, we have utilized joint ventures to finance the acquisition and development of finished lots. We consolidate the assets, liabilities and income from certain of these joint ventures under GAAP. The revenues and cost of sales associated with homes closed from these consolidated joint ventures are recognized under the "revenues" and "cost of sales" line items, respectively, on our statements of comprehensive income contained in our consolidated financial statements included elsewhere in this prospectus. The portion of income that is due and the equity that is attributable to our joint venture partners is recognized under the "net and comprehensive income attributable to noncontrolling interests" line item on our statements of comprehensive income contained in our consolidated financial statements included elsewhere in this prospectus. In the future, our primary financing strategy for controlling finished lots will be through the utilization of land bank relationships. Land bank relationships may result in a higher cost of sales, but we will not be required to share home closing gross margin with our land bank partners. This may reduce the net and comprehensive income attributable to noncontrolling interests and gross margin.
Changes in Product Mix
We sell four series of products: the Dream Series, the Designer Series, the Platinum Series and the Custom Series. See "Business-Our Products and Customers-Our Homes and Homebuyers" for additional information. Each of our series has several floor plans to meet customer demands, a range of lot sizes and varying lot coverage restrictions. Beginning in 2018 with the launch of the Dream Series, we implemented a strategy to secure lots that can meet the increasing supply and demand gap for entry-level and first-time move-up homebuyers. The average selling price point for these homebuyers varies across our markets. Our active selling communities and future projects are strategically located around major metropolitan areas with specific demographic and economic characteristics, including consistent population and job growth. Our strategy remains focused on providing an affordable and desirable product to entry-level and first-time move-up buyers.
Housing Supply and Demand
When the supply of new homes exceeds new home demand, new home prices may generally be expected to decline. Although the COVID-19 pandemic initially caused a sharp decline in our homebuilding business in March andApril 2020 , the decline was followed by a sharp increase in sales beginning inMay 2020 . As a result of the COVID-19 pandemic, we have observed an increase in demand from entry-level homebuyers, our primary customer focus, seeking to move out of apartments and into more spacious homes in anticipation of spending more time at home with remote-working arrangements increasing in prevalence. TheU.S. housing market is expected to weather the COVID-19 pandemic relatively well given supply dynamics and lack of distressed home sales. Recent job losses are more concentrated in lower income bands, impacting apartment rentals more than for sale housing. We expect housing market conditions to remain relatively healthy in 2021. 65
--------------------------------------------------------------------------------
Table of Contents
Seasonality
In all of our markets, we have historically experienced similar variability in our results of operations and capital requirements from quarter to quarter due to the seasonal nature of the homebuilding industry. We generally sell more homes in the first and second quarters and close more homes in our third and fourth quarters. As a result, our revenue may fluctuate on a quarterly basis and we may have higher capital requirements in our second, third and fourth quarters in order to maintain our inventory levels. As a result of seasonal activity, our quarterly results of operations and financial position at the end of a particular quarter, especially our first quarter, are not necessarily representative of the results we expect at year end. We expect this seasonal pattern to continue in the long term.
Non-GAAP Financial Measures
In addition to our financial results reported in accordance with GAAP, we have provided information in this prospectus relating to "adjusted gross margin," "EBITDA" and "adjusted EBITDA." For definitions of adjusted gross margin, EBITDA and adjusted EBITDA and a reconciliation to our most directly comparable financial measures calculated and presented in accordance with GAAP, see "-Non-GAAP Financial Measures."
Factors Affecting the Comparability of Our Financial Condition and Results of Operations
Our historical financial condition and results of operations for the periods presented may not be comparable, either from period to period or going forward, for the following reasons: Century Acquisition
For information regarding the Century Acquisition, see "Business-Acquisitions-Century Acquisition."
H&H Acquisition
For information regarding the H&H Acquisition, see "Business-Acquisitions-H&H Acquisition."
Corporate Reorganization
For information regarding our Corporate Reorganization, see "Business-Corporate Reorganization."
Income Taxes Prior to the IPO and the related Corporate Reorganization, we were composed of various pass-through entities that are all treated as partnerships for federal income tax purposes but are subject to certain minimal taxes and fees; however, income taxes on taxable income or losses realized by our predecessor,DFH LLC , are generally the obligation of the individual members or partners. Following the consummation of the IPO, we became be a corporation subject to corporate-level taxes, our income taxes became dependent upon our taxable income and our net income in future periods now reflects such taxes. We will recognize the financial statement impacts of GAAP and tax timing differences on a quarterly basis. See "-Results of Operations" for further clarity on the comparability differences between our current and future financial statements.
Selling, General and Administrative Expense
Our selling, general and administrative expense have increased as a result of the H&H Acquisition and the initial and on-going compliance costs associated with being a public company, including certain provisions of the Sarbanes-Oxley Act and relatedSEC regulations, and the requirements associated with our Class A common stock being approved for listing on Nasdaq. As a result of being a public company, we will need to increase our operating expenses in order to pay our employees, legal counsel and accountants to assist us in, among other things, external reporting, instituting and monitoring a more comprehensive compliance and board governance function, establishing and maintaining internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act and preparing and distributing periodic public reports in compliance with our obligations under applicable federal securities laws. We may need to hire additional employees to perform this compliance and reporting function. We also recognized the acceleration of certain of our predecessor's,DFH LLC , costs, such capitalized debt issue costs and unvested stock compensation, which vested at the date of the IPO. 66
--------------------------------------------------------------------------------
Table of Contents
Equity Incentive Plan
To incentivize individuals providing services to us or our affiliates, the Board of Directors adopted the 2021 Equity Incentive Plan in connection with the IPO. Our 2021 Equity Incentive Plan provides for the grant, from time to time, at the discretion of our Board of Directors or a committee thereof, of stock options, stock appreciation rights, restricted stock, restricted stock units, stock awards, dividend equivalents, other stock-based awards, cash awards, substitute awards and performance awards. Any individual who is our officer or employee or an officer or employee of any of our affiliates, and any other person who provides services to us or our affiliates, including our directors, is eligible to receive awards under our 2021 Equity Incentive Plan at the discretion of our Board of Directors or the compensation committee of our Board of Directors. In connection with the IPO, we issued equity awards covering 461,538 shares of Class B common stock and 298,171 shares of Class A common stock, which will vest over 3 years beginning onJanuary 21, 2022 , to certain of our officers and directors. We expect that we will recognize equity compensation expenses aggregating up to$17.6 million per year over the 3 year vesting term.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in accordance with GAAP. Our critical accounting policies are those that we believe have the most significant impact to the presentation of our financial position and results of operations and that require the most difficult, subjective or complex judgments. In many cases, the accounting treatment of a transaction is specifically dictated by GAAP without the need for the application of judgment. In certain circumstances, however, the preparation of consolidated financial statements in conformity with GAAP requires us to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements, as well as the reported amounts of revenues and expenses during the reporting period. While our significant accounting policies are more fully described in "Note 1. Nature of Business and Significant Accounting Policies" to our consolidated financial statements, we believe the following topics reflect our critical accounting policies and our more significant judgment and estimates used in the preparation of our consolidated financial statements.
Revenue Recognition
We recognize revenue in two ways. In accordance with Accounting Standards
Codification ("ASC") 2014-09, revenues from home sales with respect to homes
that we construct on homesites that we own title are recorded at the time each
home sale is closed and title and possession are transferred to the buyer. In
accordance with ASC 2014-09, revenues from home sales in which the buyer retains
title to the homesite while we build the home are recognized based on the
percentage of completion of the home construction, which is measured on a
quarterly basis.
Real Estate Inventory and Cost of Home Sales
Inventories include the cost of direct land acquisition, land development, construction, capitalized interest, real estate taxes and direct overhead costs incurred related to land acquisition and development and home construction. Indirect overhead costs are charged to selling, general and administrative expense as incurred.
Land and development costs are typically allocated to individual residential lots on a pro-rata basis based on the number of lots in the development, and the costs of residential lots are transferred to construction work in progress when home construction begins. Sold units are expensed on a specific identification basis as cost of contract revenues earned. Cost of contract revenues earned for homes closed includes the specific construction costs of each home and all applicable land acquisition, land development and related costs allocated to each residential lot. Inventories are carried at the lower of accumulated cost or net realizable value. We periodically review the performance and outlook of our inventories for indicators of potential impairment. No impairments were recognized during the years endedDecember 31, 2020 , 2019 and 2018. 67
--------------------------------------------------------------------------------
Table of Contents
Business Combinations and Valuation of Contingent Consideration
The Company accounts for business combinations using the acquisition method. Under ASC 805 a business combination occurs when an entity obtains control of a "business." The Company determines whether or not the gross assets acquired meet the definition of a business. If they meet this criteria, the Company accounts for the transaction as a stock purchase. If they do not meet this criteria the transaction is accounted for as an asset purchase. The consideration transferred in the acquisition is generally measured at fair value, as are the identifiable net assets acquired. Any goodwill that arises is tested annually for impairment. Any gain on a bargain purchase is recognized in profit or loss immediately. Transaction costs are expensed as incurred, except if related to the issue of debt or equity securities. Any contingent consideration is measured at fair value at the date of acquisition and is based on expected cash flow of the acquisition target discounted over time using an observable market discount rate. The Company generally utilizes outside valuation experts to determine the amount of contingent consideration. Contingent consideration is remeasured at fair value at each reporting date and subsequent changes in the fair value of the contingent consideration are recognized in profit or loss on the Consolidated Statement of Comprehensive Income.
Recent Accounting Pronouncements
See "Note 1. Nature of Business and Significant Accounting Policies" to our consolidated financial statements.
Inflation
Inflation inthe United States has been relatively low in recent years and did not have a material impact on our results of operations for the years endedDecember 31, 2020 , 2019 and 2018. Although the impact of inflation has been insignificant in recent years, it is still a factor in theU.S. economy, and we tend to experience inflationary pressure on wages and raw materials.
Off-Balance Sheet Arrangements
Asset-Light Lot Acquisition Strategy
We operate an asset-light and capital efficient lot acquisition strategy and generally seek to avoid engaging in land development. We primarily employ two variations of our asset-light land financing strategy, finished lot option contracts and land bank option contracts, pursuant to which we secure the right to purchase finished lots at market prices from various land sellers and land bank partners, by paying deposits based on the aggregate purchase price of the finished lots. The deposits required are typically 10% or less in the case of finished lot option contracts and 15% or less in the case of land bank option contracts. Our asset-light and capital efficient lot acquisition strategy is intended to avoid the financial commitments and risks associated with direct land ownership and land development by allowing us to control a significant number of lots for a relatively low capital cost. These option contracts generally allow us, at our option, to forfeit our right to purchase the lots controlled by these option contracts for any reason, and our sole legal obligation and economic loss as a result of such forfeitures is limited to the amount of the deposits paid pursuant to such option contracts and, in the case of land bank option contracts, any related fees paid to the land bank partner. We do not have any financial guarantees or completion obligations, and we do not guarantee lot purchases on a specific performance basis under these agreements. As ofDecember 31, 2020 , we owned and controlled 22,407 lots through finished lot option contracts and land bank option contracts. Our entire risk of loss pertaining to the aggregate purchase price of contractual commitments resulting from our non-performance under our finished lot option contracts and land bank option contracts is limited to approximately$65.6 million in deposits and investments made as ofDecember 31 , 2020-$66.7 million of lot deposits, including$1.1 million of refundable lot deposits pertaining to deals that are still in the due diligence inspection period.
Surety Bonds and Letters of Credit
We enter into letter of credit and surety bond arrangements with local municipalities, government agencies and land developers. These arrangements relate to certain performance-related obligations and serve as security for certain land option agreements. AtDecember 31, 2020 , we had outstanding letters of credit and surety bonds totaling$0.9 million and$28.0 million , respectively. We believe we will fulfill our obligations under the related arrangements and do not anticipate any material losses under these letters of credit or surety bonds. 68
--------------------------------------------------------------------------------
Table of Contents
© Edgar Online, source
