ITEM 1. BUSINESS.
Except for historical information contained herein, the matters discussed in this report contain forward-looking statements that involve risks and uncertainties that could cause results to differ materially, including the land valuation write-downs, changing market conditions, and other risks detailed in this report.
GENERAL
Inco Homes Corporation ("Inco Homes" or the "Company") is a developer and builder of affordably priced single-family detached homes. Historically, its markets have been in Southern California, primarily in San Bernardino and Riverside Counties, and to a lesser extent, in Los Angeles County. The Company's homes are primarily targeted to the first time buyer and also to the first time move-up buyer where the Company believes there is significant long-term demand. The Company strives to deliver superior value to its homebuyers by aggressively pricing its homes while providing a high quality product.
In 1994, Inco Homes entered the Phoenix, Arizona and Las Vegas, Nevada markets as part of a diversification and growth strategy. During the fourth quarter of 1994, the Company consolidated its two Southern California homebuilding divisions, the High Desert Division and the Inland Division, into one Southern California operation due to the reduced sales activity in the high desert market and to realize the benefit of certain cost savings. In December 1995 the Company sold its Phoenix and Las Vegas homebuilding divisions to an unrelated third party in order to raise needed capital and refocus on its historical core markets in Southern California.
During 1996, prices for the Company's homes ranged from $59,990 to $219,000, with an average sales price of $136,000. The Company believes that its focus on affordable housing and history of developing and delivering these types of homes since 1976 has helped it to develop a positive reputation in this market with homebuyers.
The Company's business strategy in evaluating new projects includes such factors as (i) the strength of the demand for affordable housing, (ii) the existence and type of competition, (iii) the availability of relatively low-cost land, (iv) the availability of utilities and zoning and (v) the receptiveness of local government and community to growth in the housing sector. The Company considers the demand for affordable housing by evaluating such statistical information as (i) the projected growth of the population, (ii) the number of new jobs created or projected to be created, (iii) the number of housing starts in previous periods, (iv) housing inventory and (v) sales absorption rates.
The Company places great emphasis on customer service and relations and maintaining favorable visibility in the markets in which the Company builds homes. This emphasis on customer service and relations and the Company's value-driven product have earned the Company substantial referrals and a favorable reputation among homebuyers and local governments. The Company believes that customer service and relations is an integral part of its strategy. See " -- Customer Service and Relations."
The Company was incorporated in October 1992 to succeed to the homebuilding business of its predecessors (the "Predecessor Subsidiaries") operating under the "Inco Homes" name through several limited partnerships and various corporations under the control of Ira C. Norris, the Company's founder (the "Reorganization"). Pursuant to an exchange offer made to the shareholders and partners of the Predecessor Subsidiaries which was effected in April 1993 at the time of the Company's initial public offering (the "Initial Public Offering") of its Common Stock, the Company (i) acquired the outstanding capital stock or partnership interests of the Predecessor Subsidiaries and (ii) consolidated ownership of all of the Company's projects and businesses, except those related to Inco Land Acquisition Company and Palmdale Vistas Housing Developments, L.P. ("Palmdale Vistas"), into the Company. Under the terms of the Reorganization, the consideration paid to acquire the outstanding capital stock and partnership interests of the Predecessor Subsidiaries consisted of shares of Common Stock. Inco Homes(R) and the Company's logo are registered trademarks of the Company.
THE HOMEBUILDING INDUSTRY
The homebuilding industry is cyclical and is significantly affected by changes in general and local economic conditions, such as employment levels, availability of land, availability and cost of financing land acquisition, development and construction, interest rates, consumer confidence and housing demand, as well as changes in elected officials and changes in government regulation. A variety of other factors affect the housing industry and demand for new homes, including changes in costs associated with home ownership such as increases in property taxes and energy costs, changes in consumer preferences, demographic trends and the availability of and changes in mortgage financing programs. Homebuilders are subject to various risks, including conditions of supply and demand in local markets, availability and cost of land, building materials and labor, weather conditions, delays in construction schedules, cost overruns, the entitlement process, the effect of moratoriums and environmental controls, decreased availability of homeowners insurance, and increases in real estate taxes and other local government fees. The Company's business could be adversely affected in the event the Company is not able to attract qualified subcontractors for its projects. Although the Company generally believes its relationships with its subcontractors have been good, recently relationships with certain subcontractors have weakened due to its inability to pay all of its subcontractors on a current basis. Numerous subcontractors and suppliers have filed liens, and some are pursuing further legal action, including the filing of complaints. The Company has negotiated payment arrangements, as appropriate, in an effort to settle these claims and release the liens. Certain of the Company's projects are long-term in nature and are particularly susceptible to cyclical real estate conditions and the other risks outlined above due to the significant up-front expenditures required and the length of time required to achieve profits from these projects.
During 1996, the Company's financial results were particularly affected by certain factors, including but not limited to the continued low sales activity in Southern California, higher mortgage interest rates during a portion of the year, and the 1995 sale of its Phoenix and Las Vegas divisions.
SOUTHERN CALIFORNIA HOUSING MARKETS
As a result of the 1995 sale of the Company's Phoenix and Las Vegas divisions, the Company currently conducts all of its business in the Southern California Counties of San Bernardino, Riverside and Los Angeles. The Company believes that the depressed economic and real estate conditions in California over the last several years have adversely affected its results of operations, most particularly in the high desert region of San Bernardino County. Due to the large number of defense contractors and major corporations located in California, the state's economy has been adversely affected by military spending cutbacks. The prolonged economic downturn in California has had and could continue to have a material adverse effect on the Company's business, financial condition and results of operations.
The Company continues to conduct detailed reviews of its land holdings, which include land costs, capitalized costs and related seller financing. This has resulted in various writedowns and allowances in current and prior years. Additionally, in both 1995 and 1994 the Company concluded that certain seller-financed parcels were no longer economically viable based on current financing terms. Accordingly, several measures were initiated, including requests that certain sellers substantially restructure the terms of their debt, including extending the maturity date, reducing or eliminating payment and accrual of interest and deferring principal payments. The Company also identified certain properties that should be deeded back to the sellers in full satisfaction of the remaining debt outstanding. There can be no assurance that there will be no write-off of additional costs in the future.
The areas in which the Company operates in California are subject to earthquakes and other natural disasters. Damage to the Company's projects or highway access to such projects from such earthquakes or other natural disasters, or the perception of potential homebuyers as to the possible damage to a home in these areas, could have a material adverse effect on the Company's business, financial condition and results of operations. To the Company's knowledge, the Company has never suffered any physical damage to its projects as a result of an earthquake, including the Northridge earthquake in January 1994.
SUMMARY OF RESIDENTIAL PROJECTS
Table I presents information relating to the Company's projects completed since 1987. All homes are single-family detached homes.
TABLE I - PROJECTS COMPLETED SINCE 1987
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(1) Sales price range reflects base price, excluding any lot premiums, buyer-selected options and incentives, which vary from project to project.
(2) Reflects homes closed by the Company prior to the December 1995 sale of the Phoenix and Las Vegas divisions.
Table II presents information as of December 31, 1996 relating to the Company's projects in which construction is either in progress or is in the planning process. All homes are single-family detached homes. In all cases the Company either owns the land or has a contract or option to acquire the land, and all such land is entitled.
TABLE II - CURRENT AND PLANNED PROJECTS
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(1) Victorville, Adelanto and Fontana are located in San Bernardino County. Palmdale and Lancaster are located in Los Angeles County. Lake Elsinore, La Quinta and Corona are located in Riverside County.
(2) Estimated number of homes at completion is subject to change and there can be no assurance that the Company will build these homes.
(3) Anticipated year of initial closing is based on the Company's current planning estimates and forecasts, new orders and the status of construction at these projects, and therefore is subject to change.
(4) Sales price range reflects estimated base price, excluding any lot premiums, buyer-selected options and incentives, which vary from project to project.
(5) The Company is the managing general partner of, and has a 50% interest in, Freedom-Eagle Ranch Housing Partners ("FERHP"), the limited partnership that owns this project. One of the owners of two entities that own approximately 12.2% of the Company's outstanding common stock and a warrant to acquire approximately an additional 10.9%, respectively, is a partner of FERHP. See "Item 5. Market for Registrant's Common Equity and Related Stockholder Matters" and "Item 8. Financial Statements and Supplementary data, Note 8" herein. See also "Certain Relationships and Related Transactions" in the Company's Proxy Statement for its 1997 Annual Meeting of Stockholders (the "1997 Proxy Statement"), which, when filed pursuant to Regulation 14A under the Securities Act of 1934, will be incorporated by reference in this Annual Report on Form 10-K. (6) Represents additional land owned by the Company which will be used for future projects.
(7) 45% of project net income from the sale of 151 of these homes will be paid by the Company to ALG 1996-1 ("ALG"), the holder of a Secured Participation Note. Thomas E. Gibbs, Jr., a member of the Company's Board of Directors, holds a 25% general partner's interest in ALG. See "Item 8. Financial Statements and Supplementary Data, Note 9" herein, and "Certain Relationships and Related Transactions" in the Company's 1997 Proxy Statement.
(8) This land, which is subject to seller financing aggregating $1.0 million at December 31, 1996, is anticipated to be deeded back to the sellers in satisfaction of the related debt. See " -- Southern California Housing Markets."
(9) The Company is the managing general partner of, and has a 51.295% interest in, Palmdale Vistas Housing Developments, Ltd. ("Palmdale Vistas"), the limited partnership that owns this project. Mr. Gibbs holds a 1.295% limited partner's interest in Palmdale Vistas, and also a 23% general partner's interest and a 1.376% limited partner's interest in Palmdale Vistas Housing Investments, a limited partnership which holds a 47.41% limited partner's interest in Palmdale Vistas. See "Item 8. Financial Statements and Supplementary Data, Note 9" herein, and "Certain Relationships and Related Transactions" in the Company's 1997 Proxy Statement.
(10) The Company is the managing general partner of, and has a 50% interest in, Triumph-Lancaster Housing Partners ("Triumph"), the limited partnership that owns this project. The Gibbs Family Trust, of which Mr. Gibbs is a beneficiary and a trustee, holds a 50% limited partner's interest in Triumph. See "Item 8. Financial Statements and Supplementary Data, Note 9" herein, and "Certain Relationships and Related Transactions" in the Company's 1997 Proxy Statement.
(11) This land, which is subject to seller financing aggregating $0.3 million at December 31, 1996, was deeded back to the sellers in January 1997 in satisfaction of the related debt. See " -- Southern California Housing Markets."
(12) 50% of project net income from the sale of these homes will be paid by the Company to Hunters Ridge Investment Partners ("HRIP"), the holder of a Secured Participation Note. Mr. Gibbs is the managing general partner of HRIP, with a 56.25% interest. See "Item 8. Financial Statements and Supplementary Data, Note 9" herein, and "Certain Relationships and Related Transactions" in the Company's 1997 Proxy Statement.
(13) This land, which is subject to seller financing aggregating $0.4 million at December 31, 1996, is anticipated to be deeded back to the sellers in satisfaction of the related debt. See " -- Southern California Housing Markets."
(14) The Company is the general partner of, and has a 50% interest in, Spirit Corona 77, L.P. ("Spirit 77"), the limited partnership that is developing 77 of these home sites. The Company purchased 31 developed lots from this partnership in 1996, 10 additional lots in February 1997, and expects to purchase the remaining lots. However, the Company is in default on the Purchase Agreement since the Company has not purchased all of the required minimum number of lots from Spirit 77. The Company and Spirit 77 are currently negotiating a modification to the Purchase Agreement. Additionally, the Company is in default on two notes payable to Spirit 77 related to the purchase of lots in 1996. The Company and Spirit 77 are currently negotiating extensions to the due dates of these notes.
LAND ACQUISITION AND DEVELOPMENT
The Company generally purchases land that has the necessary entitlements to enable the Company to begin development or construction as market conditions warrant. In addition, as the Company becomes familiar with local entitlement and zoning procedures, or when the location and/or price is attractive, the Company may buy unentitled land upon completion of a feasibility analysis. The term "entitlements" refers to development agreements and/or tentative maps, pursuant to which a developer has the right to obtain building permits upon compliance with conditions which are usually within the developer's control. Even if entitlements are obtained prior to the Company's purchase of the land, however, the Company is still required to obtain a variety of governmental approvals and permits during the development process. The Company strives to acquire land as economically as possible, and to negotiate land purchase contracts which allow the Company to defer payment for parcels until it is ready to begin construction.
The Company selects its land for development based upon a variety of additional factors, including: (i) internally and externally generated demographic and marketing studies; (ii) soil and other physical conditions of the site; (iii) financial and legal reviews as to the feasibility of the proposed project, including projected profitability; (iv) the ability to secure necessary financing and additional governmental approvals and entitlements; (v) environmental due diligence; (vi) competition; (vii) proximity to local traffic corridors and community facilities; (viii) infrastructure requirements for grading, drainage, utilities and streets; and (ix) management's judgment as to the real estate market, economic trends and the Company's experience in a particular market.
In some cases, the Company purchases finished lots which are ready for construction. In other instances, the Company purchases land or obtains an option to purchase land that may require certain site improvements prior to construction. The Company then undertakes the development activities that include site planning and engineering, as well as constructing roads, sewer, water, utilities and drainage facilities and other amenities. The activities are carefully managed, with the phases geared to anticipated demand.
The Company historically has conducted some residential development activities through partnerships in order to fund a portion of the Company's land acquisition, model complex development costs and initial marketing expenditures. The Company will continue to utilize such partnership arrangements when management perceives a favorable opportunity. In 1996 the Company formed three such limited partnerships, FERHP, Triumph and Spirit 77, for certain projects in which the Company is the general partner and has a 50% interest. Additionally, in 1996 the Company was the maker of Secured Participation Notes with ALG and HRIP, providing the holders with 45% and 50%, respectively, of a certain project's net income. Thomas E. Gibbs, Jr., a member of the Company's Board of Directors, holds partnership interests in each of Triumph, ALG and HRIP. Also, one of the owners of two entities which own approximately 12.2% of the Company's outstanding common stock and a warrant to acquire approximately an additional 10.9%, respectively, is a partner of FERHP. See "Item 8. Financial Statements and Supplementary Data, Notes 8 and 9" herein, and "Certain Relationships and Related Transactions" in the Company's 1997 Proxy Statement.
With respect to its landholdings, the Company maintains the flexibility to sell parcels of land adjacent to existing phases of a project to other builders in a single transaction or a series of transactions. Sales of land and lots, which are not the Company's principal business focus, are made to take advantage of market opportunities that might exist from time to time. Accordingly, these sales vary from year to year depending on market conditions. Land sales were $373,000 in 1994. The Company had no land sales in 1996 or 1995. In addition, parcels of land owned by the Company and adjacent to its residential projects may be zoned for commercial use. To date, the Company has never built on commercial land, and does not intend to build on such land, but may later sell, lease or joint venture such land with commercial property developers. In December 1996, in consideration of a $50,000 payment, the Company gave an exclusive option to a third party to purchase approximately 71 acres of commercial property located in one of the Company's high desert projects. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
CONSTRUCTION
The Company strives to develop a design and marketing concept for each of its housing subdivisions, which includes determination of size, style and price range of the homes, layout of streets, layout of individual lots and overall community design. The product line offered in a particular subdivision depends upon many factors, including the housing generally available in the area, the needs of a particular market and the Company's cost of lots in the subdivision.
The development, construction and closing of each project generally is managed at the various stages by Company employees reporting to persons responsible for the various disciplines. Projects move through a series of stages, departmentally organized, beginning with the entitlement process, if applicable, and ending with the closing and post-closing stages. The Company believes this strategy, as opposed to assigning each project to a manager who is responsible for all stages of development, is more efficient, providing for standardized procedures, quality service and considerable cost savings.
The Company utilizes what it considers to be a "manufacturer's approach" to home construction, always seeking to increase production efficiency and position itself to be among the lowest-cost producers in each of its markets. The Company (i) generally adheres to strict construction schedules and standardized plans, (ii) generally pre-sells a majority of its homes before commencing construction of a phase of a project, and (iii) generally purchases land that has necessary entitlements. See " -- Land Acquisition and Development."
The Company acts as the general contractor for the construction of its residential projects. The Company's employees supervise the construction of each project, coordinate the activities of subcontractors and suppliers, subject subcontractors' work to quality and cost controls and assure compliance with zoning and building codes, but do no actual construction. The Company specifies that high-quality, durable materials be used in the construction of its homes. The Company's subcontractors follow design plans prepared by architects who are retained by the Company and whose designs are geared to the local market. Subcontractors typically are retained on a project-by-project basis to complete construction at a fixed price. Agreements with the Company's subcontractors are generally entered into after competitive bidding.
The Company generally believes its relationships with its subcontractors has been good. However, as a result of the limited amount of available working capital, relationships with certain subcontractors have weakened due to the Company's inability to pay all of its subcontractors and their suppliers on a current basis. Numerous subcontractors and suppliers have filed liens, and some are pursuing further legal action, including the filing of complaints. The Company has negotiated payment arrangements, as appropriate, in an effort to settle these claims and release the liens. The Company does not believe that any of these claims, in the aggregate, will have a material adverse financial effect on the Company's business. However, if the Company continues to have disputes with its subcontractors and suppliers, in the future it may be difficult for the Company to attract and retain qualified subcontractors and suppliers who are willing to work with the Company and the Company's business could be adversely affected.
Generally, the Company "pre-sells" (execution of a sales contract, receipt of a deposit, and generally an indication of the buyer's ability to qualify for a mortgage) a majority of the homes to be built in a phase before construction in that phase is commenced. Construction lenders typically specify minimum pre-sale requirements. The Company attempts to minimize cancellations by requiring a refundable cash deposit of approximately $500 to $2,500 and by training its sales force to assess the qualification of potential homebuyers. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
The Company generally adheres to strict construction schedules and standardized plans. Construction time for the Company's homes depends on the availability of labor, materials and supplies, product type and location, but the Company historically has completed construction of a home within three to six months from commencement. Homes are designed to promote efficient use of space and materials and to minimize construction costs and time.
Materials used in the construction of the Company's homes are available from a number of sources, but material prices may fluctuate due to various factors, including demand or supply shortages. Construction labor and materials have generally been available to the Company, although in 1994 there was a strike by the employees of one of the Company's cabinet suppliers. While the strike was eventually settled, it had the effect of delaying approximately 50 closings from the third quarter to the fourth quarter of 1994. Although there is presently an adequate supply of labor and materials it is possible that future shortages of skilled workers and/or materials may occur. See " -- The Homebuilding Industry."
The Company generally provides a one-year limited warranty of workmanship and materials with each of its homes. In addition, California law provides a ten-year period during which consumers can seek redress for structural defects in new homes. The Company reserves against the possibility of charges relating to its one-year warranty. In 1994, certain homeowners in one of the Company's Southern California projects filed a complaint against the Company alleging construction defects. See "Item 3. Legal Proceedings."
MARKETING AND SALES
The Company develops marketing programs tailored to the specific buyers and markets in which the Company operates. The Company takes a consumer product approach to marketing its homes, conducting product research and developing buyer and visitor profiles on each project. Techniques employed by the Company include referral incentives, customer testimonials, direct mail, television, radio and print advertisements.
The Company normally builds, decorates, furnishes and landscapes model homes for each project and maintains on-site sales offices, which typically are open seven days a week. The Company believes that model homes and the selection of interior designs play a particularly important role in the Company's marketing efforts. Consequently, the Company expends a significant effort in creating an attractive atmosphere at its model homes. Interior decorations vary among the Company's models and are carefully selected based upon the lifestyles of targeted buyers.
Structural changes in design from the Company's standard plans are not generally permitted, but homebuyers may select various optional amenities. Additionally, the Company has designed a number of homes offering an options program that gives homebuyers numerous opportunities to customize the interior design without significant additional cost. For example, these options may provide for the ability to tailor a room according to a homebuyer's needs such as a third garage space, an extended family room, or an additional den, bedroom or bonus room.
In June 1994, the Company opened a design center in Southern California to provide homebuyers with a greater visual presentation of the available amenities and options, primarily in the area of flooring and window treatments. Most of the Company's homebuyers that have upgraded their flooring and window treatments have utilized the Company's design center.
The Company sells its homes primarily through its internal sales force, who typically work from the sales offices located at the model homes used in each subdivision. In January 1997, the Company contracted with an independent sales and marketing company to manage its sales force. The Company also uses independent and cooperative brokers. Company personnel are available to assist prospective buyers by providing them with floor plans, price information and tours of model homes and by assisting them with the selection of options. The Company's selection of interior features is a principal component of its marketing and sales efforts. Sales personnel are trained by the Company and attend periodic meetings to be updated on sales techniques, competitive products in the area, the variety of financing programs available, construction schedules and marketing and advertising plans, which management believes results in reduced training costs and a more motivated sales force with extensive knowledge of the Company's operating policies and housing products.
Through a customer referral program, persons referring homebuyers to the Company may receive $250 or more from the Company at the closing of a home sale.
The Company has developed a savings program to assist homebuyers in saving the money required to close the sale of their home. Under the savings program, the Company determines the monthly contribution required to be put into escrow so that the homebuyer has sufficient money in escrow to close the purchase of the home when it is completed. The Company monitors the homebuyer's contributions to escrow under the savings program.
CUSTOMER FINANCING
The Company seeks to assist its homebuyers in obtaining financing by arranging with independent mortgage lenders to offer qualified buyers a variety of financing options and to process their loans. When necessary, the Company provides prospective homebuyers free credit counseling and prequalification to determine the price of the home they are able to afford. These services had been provided through the Company's wholly-owned mortgage brokerage subsidiary, Freedom Mortgage, Inc. ("Freedom"). In the third quarter of 1995, the Company transferred the California and Las Vegas operations of Freedom to an unrelated third party and in December 1995 transferred the Phoenix operations in connection with the sale of its Phoenix division.
Substantially all homebuyers utilize long-term mortgage financing to purchase a home and lenders generally make loans only to borrowers who earn three to four times the total amount of the mortgage payment plus insurance and property taxes. Therefore, adverse economic conditions such as increases in unemployment and high mortgage interest rates can eliminate a substantial number of potential homebuyers from the market. When necessary, the Company will pay a fee to subsidize interest rates to assist homebuyers with financing. Under such programs, lower interest rates on mortgages are provided to the Company's homebuyers than would otherwise prevail under then-current market conditions. Although mortgage financing for qualified homebuyers was readily available during 1996, there can
be no assurance that mortgage financing will remain readily available to the Company's customers as a result of changing general economic conditions and any restrictions of the ability of mortgage finance markets to provide financing for the purchase of homes by homebuyers. The Company attempts to minimize its exposure to interest rate fluctuations by purchasing mortgage financing commitments that lock in the availability of funds and interest rates at specified levels for a certain period of time and by entering into hedging contracts, as it deems necessary. See "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
Most of the Company's current projects meet applicable Federal Housing Administration ("FHA") or Veteran's Administration ("VA") requirements. In 1996, 1995 and 1994, FHA or VA financing was provided to a substantial number of purchasers of the Company's homes. FHA and VA financing generally enables homebuyers to purchase homes with lower down payments than the down payments required by conventional mortgage lenders. The principal reason why certain of the Company's projects may not meet applicable FHA or VA requirements is that the base price of homes in those projects exceeds established FHA or VA maximum home prices. The Company believes that the availability of FHA and VA financing broadens the group of potential purchasers for the Company's homes. The VA financing limit is $203,000. The FHA financing limit is $152,362 in San Bernardino and Riverside Counties, and $160,950 in Los Angeles County. The FHA generally permits loans for up to 97% of the value of the home.
In general, housing demand is adversely affected by increases in interest rates. If mortgage interest rates increase significantly, affecting prospective buyers' ability to adequately finance home purchases, the Company's business, financial condition and results of operations could be materially effected. The Company's homebuilding activities are also dependent upon the availability and cost of mortgage financing for (i) potential customers who purchase a home from the Company, and (ii) buyers of homes owned by potential customers so they can sell their existing homes and purchase new homes from the Company, to the extent they are not first time buyers. In addition, the Company believes that the availability of FHA or VA mortgage financing is an important factor in marketing its homes. Any limitations or restrictions on the availability of such financing could have a material adverse effect on the Company's business, financial condition and results of operations.
CUSTOMER SERVICE AND RELATIONS
The Company believes that providing a high level of customer service is a key component of its homebuilder strategy. Salespeople are encouraged to develop a personal relationship with the homebuyers and offer encouragement and guidance throughout the homebuying process. The Company has developed video brochures for some of the Company's projects which provide information about the homebuying process, emphasizing the advantages of home ownership, and reinforcing why homebuyers should purchase one of the Company's homes. These videos are designed to motivate potential homebuyers on an emotional level, presenting an image of community and orienting potential homebuyers to local shopping, hospitals, industry, schools and recreation. The videos also familiarize homebuyers with the loan and escrow procedures, as well as the final home inspection process.
The Company provides each homebuyer with a Homebuyer's Information Booklet describing area amenities and services, such as schools, health services and emergency services. A Warranty and Information Guide identifies the appliances, fixtures and heating/cooling and other systems installed in the house, and provides information on warranties, maintenance and manufacturer information. The Company's utilization of these sales and closing programs are designed to reduce the prospective homebuyer's anxiety over relocating and to help the homebuyer settle into the new neighborhood.
Approximately thirty days after closing, every homebuyer is asked to complete a questionnaire that evaluates all aspects of the buying experience, including questions about the home itself, the salespeople, the escrow process, mortgage financing assistance, the closing process and customer service. The Company uses the responses to identify any problem areas, as well as to evaluate and improve the floor plans and amenities offered in the Company's projects.
The Company believes that its commitment to customer service has earned the Company substantial referrals and an excellent reputation among homebuyers.
COMPETITION AND MARKET FORCES
The development and sale of residential properties is highly competitive. Homebuilders, such as the Company, compete for desirable properties, financing, raw materials and skilled labor. The Company competes for residential sales on the basis of a number of interrelated factors, including location, reputation, amenities, design, quality and price, with numerous large and small homebuilders, including some homebuilders with nationwide operations and greater financial resources than the Company. The Company also competes for residential sales with individual resales of existing homes and condominiums and with available rental housing. Entrants into the markets in which the Company operates increases competition in those markets. In response to declining overall home sales, the Company has been required to provide homebuyers with price discounts and other sales incentives in order to remain competitive. This has resulted in reduced profitability or losses for the homes that the Company has sold. In addition, sales of homes and land at deeply discounted prices by competitors, lenders and similar institutions in the markets where the Company operates could have a material adverse effect on the Company's business, financial condition and results of operation. Competition for the acquisition of desirable real estate on which to build homes is also intense.
The housing industry is cyclical and affected by consumer confidence levels and prevailing economic conditions in general and by job availability and interest rate levels in particular. A variety of other factors affect the housing industry and demand for new homes, including changes in costs associated with home ownership such as increases in property taxes and energy costs, changes in consumer preferences, demographic trends and the availability of and changes in mortgage financing programs.
GOVERNMENT REGULATION AND ENVIRONMENTAL MATTERS
The Company is subject to a variety of statutes and rules regulating certain environmental and developmental matters, as well as building design and site design.
The Company generally purchases land with entitlements, giving it the right to obtain building permits upon compliance with specified conditions which are within the Company's control. Upon compliance with such conditions, the Company must seek building permits for each house. In developing a project, the Company must obtain the approval of numerous governmental authorities regulating such matters as permitted land uses and levels of density and the installation of utility services such as electricity, water and waste disposal. The length of time necessary to obtain permits and approvals increases the carrying costs of unimproved property acquired for the purpose of development and construction. Several governmental authorities in California have imposed fees as a means of defraying the cost of providing certain governmental services to developing areas. To date, the governmental approval processes discussed above have not had a material adverse effect on the Company's development activities. In addition, because the Company generally purchases land that has already been zoned for residential development, restrictive zoning issues also have not had a material adverse effect on the Company's development activities. However, there is no assurance that these and other restrictions will not adversely affect the Company in the future.
The Company may also be subject to additional costs or periodic delays or may be precluded entirely from developing communities due to building moratoriums or "slow-growth" or "no-growth" initiatives, building permit allocation ordinances or similar governmental regulations that could be implemented in the future in the areas in which it operates. Because the Company usually purchases land with entitlements, the moratoriums generally would only adversely affect the Company if they arose from unforeseen health, safety and welfare issues. Local and state governments also have broad discretion regarding the imposition of development fees for projects in their jurisdiction.
The Company is also subject to a variety of local, state and federal statutes, ordinances, rules and regulations concerning protection of the environment. The particular environmental laws which apply to any given community vary greatly according to the community site, the site's environmental conditions and the present and former uses of the site. These laws may result in delays, cause the Company to incur substantial compliance costs, and prohibit or severely restrict development in certain environmentally sensitive regions or areas. Homebuilding projects in California are especially susceptible to restrictive government regulations and environmental laws. Environmental regulations can also have an adverse impact on the availability and price of certain raw materials such as lumber.
BONDS AND OTHER OBLIGATIONS
The Company is frequently required, in connection with the development of its projects, to post performance, maintenance and other bonds. The amount of these bonds outstanding at any time varies in accordance with the Company's pending development activities. In the event any such obligations are drawn upon because of the Company's failure to build required infrastructure, the Company would be obligated to reimburse the issuing surety company or bank. The Company has never defaulted on any such bond. At December 31, 1996, there were approximately $8.9 million in outstanding bonds for such purposes.
EMPLOYEES
At December 31, 1996, the Company employed 63 persons. None of the Company's employees are covered by collective bargaining agreements. The Company believes that its relations with its employees are good. Certain of the subcontractors that the Company engages are represented by labor unions or are subject to collective bargaining arrangements. During 1994, there was a strike by the employees of one of the Company's cabinet suppliers. While the strike was eventually settled, it had the effect of delaying approximately 50 closings from the third quarter to the fourth quarter of 1994.
The Company's success is highly dependent upon the performance of its senior management and, in particular, Ira C. Norris, President of the Company, who is well recognized in California's homebuilding industry. The loss of key personnel or an inability to attract, retain and motivate key personnel could have a material adverse effect on the Company's business. Mr. Norris intends to continue to devote his full time to the affairs of the Company.
At March 31, 1997, Ira C. Norris and Ronald L. Neeley, directors of the Company, own beneficially approximately 25% and 8% of the Company's outstanding Common Stock, respectively. Due to this ownership position, Mr. Norris and Mr. Neeley may be able to control the affairs and policies of the Company and may be able to elect a sufficient number of directors to control the Company's Board of Directors and to approve or disapprove any matter submitted to a vote of stockholders. Furthermore, Mr. Norris and Mr. Neeley may have conflicts of interest with other stockholders with respect to the affairs and policies of the Company. The ownership positions of Mr. Norris and Mr. Neeley, together with the anti-takeover effect of certain provisions contained in the Company's Restated Certificate of Incorporation and Restated Bylaws, may have the effect of delaying, deferring or preventing a change in control of the Company. These factors could have an adverse effect on the market price of the Company's Common Stock.
EXECUTIVE OFFICERS OF THE REGISTRANT
The following are the names and respective ages as of December 31, 1996 of the executive officers of the Company. The Company's executive offers are elected by, and serve at, the discretion of the Board of Directors.
(1) Robert H. Daskal stepped down from his positions as Executive Vice President and Chief Financial Officer on January 15, 1997 to pursue other professional interests. He will remain a member of the Company's board of
directors and will be available to the Company on a consulting basis. Norman B. Gold was elected by the Company's Board of Directors as Vice President and Chief Financial Officer on January 15, 1997.
Ira C. Norris founded the Company in 1976, and has served as the Chairman of the Board, President and Chief Executive Officer since that time. From 1968 to 1976, Mr. Norris served as a Corporate Vice President and Division Operating Manager of Kaufman and Broad, Inc., a company engaged in the real estate and life insurance business. From 1960 to 1968, he was an independent builder/developer in Los Angeles and the San Fernando Valley suburbs.
Robert H. Daskal was Executive Vice President and Chief Financial Officer from October 1994 until his resignation in January 1997. Prior to joining the Company, Mr. Daskal was Executive Vice President-Finance and Chief Financial Officer of UDC Homes, Inc., a homebuilder in Tempe, Arizona, from 1985 to 1994.
Norman B. Gold has been affiliated with the Company since September 1994 in various capacities, most recently as Director of Finance and Accounting. Prior to joining the Company, Mr. Gold was Financial Vice President of Barclay Associates, Inc., a builder/developer in Newport Beach, California, from 1985 to 1994.
Lynn C. Parkes has been the Controller since June 1992. She served as the Director of Human Resources from early 1989 until she became Assistant Controller in December 1989, and served in that position until she was promoted to Controller. Ms. Parkes joined the Company in 1980, serving in various capacities.
ITEM 2.

ITEM 2. PROPERTIES.
At December 31, 1996, the Company had leased 8,187 square feet of office space in Southern California, for its corporate headquarters and design center operations. These two leases expire in May 1997 and September 2000, respectively. The Company believes that in general its facilities are sufficient to meet its needs for the next year.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS.
The Company is involved in routine litigation arising in the ordinary course of business. Such matters, if decided adversely to the Company, would not, in the opinion of management, have a material adverse effect on the financial condition of the Company. In addition, from time to time, the Company could be involved in litigation in connection with claims of development or construction defects, which matters, if decided adversely to the Company, could have a material adverse effect on the financial condition of the Company.
In 1994, a former employee initiated litigation against the Company for wrongful termination and other employment related claims. The parties agreed to a final settlement of cash, notes payable through April 1997, and restricted stock and the litigation was dismissed. The full amount of the settlement was accrued in 1994.
In May 1994, the owners of 11 homes sold by the Company at its 201-home Northfork project located in Murrieta, California filed a complaint against Inco Development Corporation, a wholly-owned subsidiary of the Company ("Inco Development"), in the Superior Court of California in Riverside County. In June 1994, the owners of six additional homes filed a separate complaint. These two complaints were consolidated into one action. Subsequent to the consolidation, one of the homeowners dismissed the lawsuit due to the Company's repair of the alleged defects. In August 1994, one additional homeowner filed a complaint. In October 1996, an additional eighteen homeowners filed a separate complaint. The complaint was subsequently amended to include an additional four homeowners. The Company is attempting to have this complaint consolidated with the previously consolidated complaints. The complaints each allege, among other things, negligence, nuisance, strict liability, breach of warranty, negligent infliction of emotional distress and fraud based on alleged design and construction defects and inadequate soils conditions. The plaintiffs are seeking general, special, and punitive damages in an unspecified amount, and attorney fees. The causes of action for fraud were dismissed by the court in 1994 with respect to the complaints filed in 1994, and accordingly, there are no claims for punitive damages. The Company believes that the claims made against it are without merit and intends to continue to vigorously defend itself in this action. The Company believes that this litigation will not have a material adverse effect on the Company's business. Additionally, the Company believes it has adequate insurance coverage to pay the majority of claims and the costs related to these complaints, if any. However, as
this litigation is still in process, it is not possible to predict with certainty the ultimate outcome and the impact on the Company, and therefore no assurances can be given with respect thereto.
As a result of the limited amount of available working capital, relationships with certain subcontractors have weakened due to the Company's inability to pay all of its subcontractors and their suppliers on a current basis. Numerous subcontractors and suppliers have filed liens, and some are pursuing further legal action, including the filing of complaints. The Company has negotiated payment arrangements, as appropriate, in an effort to settle these claims and release the liens. The Company does not believe that any of these claims, in the aggregate, will have a material adverse financial effect on the Company's business. However, if the Company continues to have disputes with its subcontractors and suppliers, in the future it may be difficult for the Company to attract and retain qualified subcontractors and suppliers who are willing to work with the Company and the Company's business could be adversely affected.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY-HOLDERS.
On December 16, 1996, a "Notice of Special Meeting of Stockholders To Be Held on January 15, 1997" was sent to stockholders of record as of December 11, 1996. At the special meeting, a majority of the stockholders approved an amendment to the Company's Restated Certificate of Incorporation to effect a reverse stock split of the Company's Common Stock such that every six (6) shares of Common Stock outstanding would be converted into one (1) share of Common Stock. The amendment became effective January 16, 1997.
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
PRICE RANGE OF COMMON STOCK
The Company's Common Stock was quoted on the Nasdaq National Market tier of the Nasdaq Stock Market under the symbol "INHM" from April 2, 1993 to November 10, 1996. Effective November 11, 1996, the Common Stock became listed on the Nasdaq SmallCap Market tier of the Nasdaq Stock Market under the same symbol. Subsequent to the Company's reverse stock split, on January 16, 1997 the Company's symbol was changed to "INHMD". The following table shows the high and low closing sales prices for the Common Stock of the Company for the periods indicated, as reported by the Nasdaq National Market through November 10, 1996 and reported by the Nasdaq SmallCap Market thereafter. These prices do not include retail markups, markdowns or commissions.
Prices listed above have been restated as if the reverse stock split on January 16, 1997 was in effect for all periods presented. See "Item 4. Submission of Matters to a Vote of Security-Holders".
The closing sale price of the Company's Common Stock as reported on the Nasdaq SmallCap Market on March 31, 1997 was $2.625 per share. As of March 31, 1997, there were approximately 154 holders of record of the Company's Common Stock.
DIVIDENDS
The Company has not declared or paid any cash dividends on its Common Stock since the Initial Public Offering. The Company anticipates that all earnings in the foreseeable future will be retained to finance the continuing development of its business and does not anticipate paying cash dividends on its Common Stock in the foreseeable future. The payment of any future dividends will be at the discretion of the Company's Board of Directors and will depend upon, among other things, future earnings, the success of the Company's business activities, capital requirements, the general financial condition of the Company and general business conditions.
RECENT SALES OF UNREGISTERED SECURITIES
In December 1996, the Company entered into a Common Stock Purchase Agreement with a third party to sell 200,000 shares (restated for reverse stock split) of the Company's common stock in a private transaction. The stock was issued subsequent to year end for a total purchase price of $750,000. The Company also granted the third party the right to require the Company to register the stock for public sale with the Securities and Exchange Commission. At that time, in consideration of a $50,000 payment, the third party was also given an exclusive option to purchase approximately 71 acres of commercial property located in one of the Company's high desert projects. Additionally, in December 1996, the Company issued a warrant to purchase 200,000 shares (restated for reverse stock split) of common stock in a private transaction to an entity related to this third party. The warrant was
issued as compensation for all services to be performed pursuant to a Consulting Agreement entered into in December 1996. The Consulting Agreement is for a term of two years during which the related entity, on a non-exclusive basis, shall seek out, investigate and pursue residential development projects and present them to the Company for its consideration and approval. The warrant may be exercised within eighteen months of the date of the agreement at a price of $5.25 per share (restated for reverse stock split). If at least half of the warrant shares are not exercised during this period, then half of the warrant shares will expire, with the balance exercisable over an additional eighteen month period at $9.75 per share (restated for reverse stock split). The related entity may also convert the warrant shares or any portion thereof into shares of common stock using a formula based upon the fair market value of the Company's common stock on the conversion date. These transactions were exempt pursuant to Rule 505 under Regulation D. One of the owners of this third party and the related entity is a partner in FERHP, one of the Company's consolidated partnerships, and is a general partner of the owner of land in which the Company has entered into a Development and Marketing Agreement. See "Item 8. Financial Statements and Supplementary Data, Note 8."
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA.
The following selected financial data of the Company are qualified by reference to and should be read in conjunction with the financial statements, related notes thereto and other financial data included elsewhere herein. These historical results are not necessarily indicative of the results to be expected in the future. Common stock shares and per share data have been restated to give effect to the Company's reverse stock split. See "Item 4. Submission of Matters to a Vote of Security Holders."
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(1) During the year ended December 31, 1992, settlement of compensation for services and severance arrangements reflects an estimated non-cash charge for the value of certain shares of Common Stock issued
in connection with the Reorganization. During the year ended December 31, 1993, the Company recognized income in the amount of approximately $1,043,000 which was attributable to the adjusted final settlement of the estimated charge from the previous year.
(2) The pro forma statement of operations data reflect the effects on the historical statements of operations data for the years ended December 31, 1993 and 1992 as if (i) the Reorganization had taken place on January 1, 1992, (ii) settlement of compensation for services and severance arrangements was eliminated and (iii) the amount of compensation paid to Ira C. Norris was limited to the $750,000 maximum compensation arrangements effective during 1993 and 1994. The pro forma statement of operations data also reflects provisions for federal and state income taxes assuming a 40% effective tax rate.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Except for historical information contained herein, the matters discussed in this report contain forward-looking statements that involve risks and uncertainties that could cause results to differ materially, including the land valuation write-downs, changing market conditions, and other risks detailed in this report.
OVERVIEW
The Company's results of operations for the periods presented reflect the cyclical nature of the homebuilding industry and the Company's historical focus on the Southern California housing market. The most recent peak in the industry cycle occurred in 1988 and 1989, which was followed by a downturn in 1990, coinciding with the general national recession and the depressed economic and real estate conditions in Southern California. These conditions continued in 1996 and have had an adverse impact on the Company's results of operations.
The Company's financial results have been adversely affected by the continuing weakness in the Southern California new home market. In response to declining overall home sales in this market, the Company has been required to provide homebuyers with price discounts and other sales incentives in order to remain competitive. This has resulted in reduced profitability or losses on the homes that the Company has sold.
In 1994 the Company entered the Phoenix and Las Vegas markets, and expanded its operations in Riverside County of Southern California. Additionally, in 1994 the Company implemented cost reduction measures including (i) consolidation of its High Desert Division with its Inland Division and (ii) closing or reducing the scope of several communities in the high desert region. These cost reduction efforts continued in 1995 and 1996. In 1995, the Company closed an additional underperforming project in the high desert region and reduced the current scope of development of a project in Riverside County.
During the third quarter of 1995, the Company further consolidated all of its Southern California operations and personnel in one location, closing its Inland Division operating office and relocating the division into office space at the Company's headquarters in Upland. The Company also sold its insurance services operations to an unrelated third party and transferred the California and Las Vegas operations of its mortgage brokerage subsidiary to an unrelated third party.
In December 1995 the Company sold its Phoenix and Las Vegas operations, including its Phoenix mortgage operations, to an unrelated third party. The sales price was $14.5 million, of which the purchaser assumed $12.0 million of bank indebtedness, and accounts payable and accrued liabilities. This sale was consummated as a result of the Company's continuing efforts to raise needed capital, and enabled the Company to focus its efforts and capital on its historical core business in Southern California. However, the sale initially has resulted in a reduced level of closings and revenues, and has had an adverse effect on earnings.
As a result of cost controls and the consolidation of offices, the Company reduced its total personnel from 162 at December 31, 1994 to 63 at December 31, 1996.
As a result of the impact of the sale of the Phoenix and Las Vegas operations on future earnings, the land deed backs and write-downs, and current business operations, pursuant to Statement of Financial Accounting Standards No. 109 ("SFAS No. 109") "Accounting for Income Taxes", as of December 31, 1996 the Company has recorded reductions of the deferred tax asset with a cumulative valuation allowance of $11.7 million to reflect the uncertainties created regarding the timing of the realization of the deferred tax asset. No assurances can be given that the Company will not have to record a further valuation allowance against future tax benefits.
In 1994, the Company recorded charges of approximately $2.8 million related to costs associated with a proposed debt offering, certain post-warranty work at one of its projects and other litigation costs and the settlement of an outstanding lumber purchase commitment. The Company had pursued a private debt offering that was terminated
due to unfavorable market conditions. The post-warranty work was performed in an effort to mitigate construction defect claims by homeowners at the affected project.
RESULTS OF OPERATIONS
The following discussion of results of operations and financial condition should be read in conjunction with the Selected Financial and Operating Data and the Financial Statements and Notes thereto.
The following table sets forth, for the periods indicated, selected information of the Company as of and for each of the three years ended December 31, 1996, 1995, and 1994:
The following table sets forth, for the periods indicated, the percentage of the Company's revenue represented by each line item:
Revenue from Home Sales
Revenue from home sales in 1996 was $19.6 million, a decrease of $51.7 million from revenue of $71.3 million during 1995. The total number of homes closed in 1996 was 144 at an average sales price of $136,000, compared to 595 homes closed at an average sales price of $119,900 in 1995, a decrease of 75.8% in number of homes closed and a 13.4% increase in average sales prices.
The following table sets forth, for the periods indicated, the number of homes closed by the Company's three operating divisions:
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(1) In December 1995 the Company sold its Phoenix and Las Vegas home building divisions to an unrelated third party. See "Item 1. Business -- General."
The decrease in revenue and number of homes closed during the year ended December 31, 1996 is attributable to the close-out of two successful subdivisions in Riverside County in 1995, the sale of the Phoenix and Las Vegas divisions and a decrease in demand combined with declining inventory available for sale in Southern California. The increased average sales price is attributable to a change in the mix of homes offered for sale.
Revenue from home sales in 1995 was $71.3 million, an increase of $100,000 from revenue of $71.2 million during 1994. The total number of homes closed in 1995 was 595 at an average sales price of $119,900, compared to 600 homes closed at an average sales price of $118,600 in 1994, a decrease of 0.8% in number of homes closed and a 1.1% increase in average sales prices. The Company estimates that the sale of its Phoenix and Las Vegas divisions eliminated approximately 40 to 50 potential December 1995 new home closings in these two markets.
Revenue From Land and Lot Sales
Revenue from land and lot sales, which are not the Company's principal business focus, is generated when such sales are made to take advantage of market opportunities that might exist from time to time. Accordingly, these sales vary from year to year. The $373,000 of land sales revenue in 1994 represents the sale of a 10 acre parcel in the Company's Eagle Ranch master planned community in Southern California to a local school district and the sale of a land contract in Las Vegas. The Company had no land sales in 1996 or 1995.
Cost of Homes Sold
Cost of homes sold includes land acquisition, development, construction, direct and indirect costs, job-site supervision, customer service, warranty costs, capitalized interest, property taxes and other capitalized indirect costs.
Cost of homes sold during the year ended December 31, 1996 was $18.3 million, a decrease of $43.5 million, or 70.5%, from $61.8 million during the year ended December 31, 1995. Cost of homes sold as a percentage of revenue increased to 93.2% in the year ended December 31, 1996 from 86.7% in the same period in 1995. The increase in cost of homes sold as a percentage of revenue for the year ended December 31, 1996 is the result of a number of factors including price discounts and other sales incentives due to continuing competitive pressures, the close out of certain high desert communities and certain fixed costs included in cost of homes sold.
Cost of homes sold during the year ended December 31, 1995 was $61.8 million, a decrease of $1.6 million, or 2.5%, from $63.4 million during the year ended December 31, 1994. Cost of homes sold as a percentage of revenue decreased to 86.7% in the year ended December 31, 1995 from 89.1% in the same period in 1994. The primary reasons for the decrease in cost of homes sold as a percentage of revenue were increased lumber costs in 1994, and a lower percentage of home closings in the high desert market in 1995, partially offset by a write-off of capitalized costs associated with the operation of the Company's Phoenix and Las Vegas divisions.
The Company believes that, since the prices of lumber, other building materials and related services are subject to fluctuation, its gross margins in future periods may be significantly affected by changes in prevailing prices. In late 1992 and throughout 1993, the Company encountered a significant increase in the price of lumber purchased for use in its homes. In response, the Company in the fourth quarter of 1993 entered into a lumber purchase contract for 600 homes in 1994 at specified pre-established prices. The Company purchased lumber for approximately 100 homes under the contract. In February 1995, the Company reached an agreement with the lumber company to settle its outstanding lumber purchase commitment for $800,000, $645,000 of which was paid during 1995, with the balance paid during 1996.
For a description of certain risks associated with the homebuilding industry, see "Item 1. Business -- The Homebuilding Industry."
Selling and Marketing Expenses
Selling expenses include loan discount points, internal and third party sales commissions, escrow fees, title insurance fees and other closing costs.
Selling expenses were $1.5 million and $3.3 million for the years ended December 31, 1996 and 1995, respectively, a decrease of $1.8 million or 56.3%. Selling expenses as a percentage of revenue were 7.5% and 4.7% for the years ended December 31, 1996 and 1995, respectively. The decrease in the dollar amount of selling expenses was a result of the sale of the Phoenix and Las Vegas divisions, a smaller number of active projects in Southern California and the implementation of cost reduction measures to further reduce selling expenses. The increase in selling expenses as a percentage of revenue is primarily due to financing and sales incentives granted to homebuyers as a result of higher interest rates and low sales activity, and the low level of closing revenues.
Selling expenses were $3.3 million and $3.4 million for the years ended December 31, 1995 and 1994, respectively, a decrease of $100,000, or 2.9%. The decrease is directly related to the slight decrease in the number of homes closed. Selling expenses as a percentage of revenue were 4.7% and 4.8% for the years ended December 31, 1995 and 1994, respectively.
Marketing expenses include advertising and promotion and costs associated with maintaining model homes and sales offices. Marketing expenses in any given period may be significantly influenced by the number of grand openings and the number of projects which are being actively marketed during the period. Marketing costs associated with items such as establishing the sales offices and upgrading standard homes to model homes are capitalized when incurred and are expensed as revenue is earned, while other marketing costs are expensed as incurred.
Marketing expenses were $1.6 million and $4.7 million for the years ended December 31, 1996 and 1995, respectively, representing a 66.4% decrease. As a percentage of revenue, marketing expenses were 8.0% and 6.6% for the years ended December 31, 1996 and 1995, respectively. The decrease in the dollar amount of marketing costs was a result of the sale of the Phoenix and Las Vegas divisions, a smaller number of active projects in Southern California and the continuation of cost reduction measures to further reduce marketing expenses. The increase in marketing costs as a percentage of revenues is due to the low level of closing revenues. During 1996, the Company had grand openings for three new projects and was delivering homes from nine active projects compared with four grand openings and fourteen active projects in 1995.
Marketing expenses were $4.7 million and $9.6 million for the years ended December 31, 1995 and 1994, respectively, representing a 51.0% decrease. As a percentage of revenue, marketing expenses were 6.6% and 13.4% for the years ended December 31, 1995 and 1994, respectively. The decrease in marketing costs was a result of a number of factors. During 1995, the Company had grand openings for four new projects and was delivering homes from fourteen active projects, compared with nine grand openings and seventeen active projects in 1994. Marketing expenses in 1994 included increased marketing programs and sales incentives in the high desert and the accelerated write-off of previously capitalized marketing costs of $2.2 million due to closing or reducing the scope of seven projects in the high desert. In 1995 the Company accelerated the write-off of $600,000 of previously capitalized marketing costs relating to one project in the high desert and one project in Riverside County. Additionally, in 1995 the Company implemented cost reduction measures to further reduce its marketing expenses.
General and Administrative Expenses
General and administrative expenses include payroll and related benefits, insurance, financial reporting, general office expense and other corporate and division level expenses.
General and administrative expenses were $2.1 million and $3.8 million for the years ended December 31, 1996 and 1995, respectively, a decrease of $1.7 million or 46.0%. As a percentage of total revenue, general and administrative expenses were 10.5% and 5.4% for the years ended December 31, 1996 and 1995, respectively. The decrease in the dollar amount of general and administrative expenses primarily reflects the sale of the Phoenix and Las
Vegas divisions and the Company's continuing cost reduction measures. The increase as a percentage of revenues is due to the low level of closing revenues.
General and administrative expenses were $3.8 million and $7.9 million for the years ended December 31, 1995 and 1994, respectively, a decrease of $4.1 million or 51.9%. As a percentage of total revenue, general and administrative expenses were 5.4% and 11.0% for the years ended December 31, 1995 and 1994, respectively. General and administrative expenses for 1995 decreased as a result of the consolidation of the Southern California operating divisions, the subsequent relocation of this division into office space at the Company's headquarters, the cessation of its insurance services operations and the results of other cost reduction measures. The Company also recorded approximately $2.2 million of charges in 1994 including costs associated with a proposed debt offering that was terminated due to unfavorable market conditions, charges related to post warranty work at one of its projects performed to potentially mitigate construction defect claims by homeowners and other litigation costs (See "Item 3. Legal Proceedings."), and costs associated with closing the High Desert Division in 1994.
Other Income
Other income includes the interest earned on cash balances related to certain projects, miscellaneous income and revenue from the Company's insurance services operation. Other income was $77,000 and $353,000 for the years ended December 31, 1996 and 1995, respectively a decrease of 78.2%. Other income was $353,000 and $112,000 for the years ended December 31, 1995 and 1994, respectively, an increase of 215.2%. Changes in other income from 1996 to 1995 and from 1995 to 1994 are primarily attributable to the sale of the Company's insurance services operations in the third quarter of 1995 to an unrelated third party.
Mortgage Brokerage Income (Loss) - Net
Mortgage brokerage income (loss) - net of Freedom, the Company's prior mortgage brokerage business, reflects revenue earned from loan origination, discount and servicing release fees, net of costs.
In the third quarter of 1995, the Company transferred the California and Las Vegas operations of Freedom to an unrelated third party, and recorded a write-off for unamortized start-up costs and the undepreciated portion of certain fixed assets of Freedom in the amount of $100,000, and in December 1995 the Company transferred its Phoenix operations in conjunction with the sale of its Phoenix division.
Freedom realized a net loss of $355,000 and $320,000 for the years ended December 31, 1995 and 1994, respectively. The net losses are primarily attributable to Freedom's low capture rate and its high general and administrative costs.
Provision for Write-Down of Real Estate Assets
Effective January 1, 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 ("SFAS No. 121") "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", which requires impairment losses to be recorded on long-lived assets being developed, based on fair value, when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Assets held for sale are to be carried at the lower of cost or fair value less the costs to sell.
Prior to 1996, real estate inventories are carried at the lower of historical cost or estimated net realizable value. Net realizable value is the price obtainable in the future for parcels as improved with a completed housing unit, net of disposal and holding costs (including interest), without provision for future profit and without discounting future cash receipts to present value.
The estimation process in determining the value of real estate inventories is inherently uncertain and relies to a considerable extent on current and future economic and market conditions, the availability of suitable financing
to fund holding, development and construction activities, and the repayment or refinancing of existing indebtedness. Such economic and market conditions may affect management's development and marketing plans. Accordingly, the ultimate realization of the Company's real estate inventories is dependent upon future events and conditions that may cause realizations to differ from amounts presently estimated.
In 1996, the Company determined that the undiscounted cash flows estimated to be generated by various real estate holdings were less than the assets' carrying amounts. An impairment allowance, which writes these assets down to fair value was established at December 31, 1996 totaling $785,000, of which $255,000 relates to properties in the high desert and $530,000 relates to a property in Riverside County. Additionally, in both 1995 and 1994, the Company determined that it was necessary to reflect a reduction in the estimated future cost recovery of various real estate holdings and established an allowance for net realizable value. Write-downs of real estate totaling $5.8 million were recorded as of December 31, 1995, of which $4.4 million related to properties in the high desert and $1.4 million related to properties in Riverside County. Write-downs of real estate totaling $2.6 million were recorded as of December 31, 1994, all of which related to properties in the high desert.
The Company also concluded in 1995 and 1994 that certain seller-financed parcels were no longer economically viable based on current financing terms. Accordingly, several measures were initiated, including requests that certain sellers substantially restructure the terms of their debt (including extending the maturity date, reducing or eliminating payment and accrual of interest and deferring principal payments). The Company also identified certain properties that should be deeded back to the sellers in full satisfaction of the remaining debt outstanding. In 1995 the Company commenced negotiations with six land sellers from whom the Company purchased land in the high desert. The Company owned these properties subject to seller loans that had current or approaching maturity dates. In this regard, the Company recorded a charge to operations in 1995 of $5.3 million. The balance of the related real estate inventories and indebtedness at December 31, 1995 was $3.1 million. In 1996, the Company deeded property with a book value of $2.1 million back to four of these land sellers in satisfaction of $2.1 million in indebtedness. Continuing negotiations may result either in extensions of maturity dates and/or other adjustments to the seller notes, or deedbacks of the two remaining properties with a book value of $1.0 million to the sellers in satisfaction of $1.0 million in indebtedness outstanding at December 31, 1996.
During 1995 the Company also reduced the scope of one community in Riverside County which resulted in the write-off of approximately $300,000 of previously capitalized costs associated with architectural development and marketing activities. As of December 31, 1996, the Company was still in the process of deeding back land to the seller from whom the Company purchased the property that will result in a reduction of real estate inventories of $0.4 million in satisfaction of $0.4 million of indebtedness outstanding at December 31, 1996.
In 1995, the Company established a reserve in the amount of $300,000 to cover the write-off of previously capitalized costs associated with an under performing subdivision in the high desert area. Also in 1995, the balance of the land in this subdivision was returned to the original seller pursuant to the terms of the purchase contract and the remaining debt of $240,000 was deemed satisfied.
In 1994, the Company commenced the process of deeding property back to nine other land sellers from whom the Company purchased land in the high desert. In this regard, the Company recorded a charge to operations in 1994 of $4.1 million. The balance of the related real estate inventories and indebtedness at December 31, 1994 was $3.2 million. Deed backs of real estate with a book value and related indebtedness of $1.4 million and $1.5 million occurred in 1995 and 1996, respectively. As of December 31, 1996, the Company was still in the process of deeding back land to one of these land sellers that will result in a reduction of real estate inventories of $0.3 million in satisfaction of $0.3 million of indebtedness outstanding at December 31, 1996. This land was deeded back in January 1997. During 1994 the Company also closed four communities and reduced the scope of three other communities in the high desert which resulted in the acceleration of the write-off of previously capitalized costs associated with its regional development and marketing activities of approximately $4.0 million.
There can be no assurance that there will be no additional write-downs of land inventory or write-offs of costs in the future.
Minority Partners' Share
Minority partners' share represents the interest of affiliated limited partners in partnerships consolidated in the Company's financial statements. Pursuant to the Reorganization in April 1993, all interests of minority partners were eliminated except for the interest of partners in Palmdale Vistas. In 1996, the Company formed three new limited partnerships, FERHP, Triumph and Spirit 77. FERHP and Triumph are consolidated in the Company's financial statements.
The minority partners' share of losses was $214,000, $0, and $28,000 for the years ended December 31, 1996, 1995, and 1994, respectively.
Provision (Benefit) for Income Taxes
Provision (benefit) for income taxes represents federal income taxes based on net income (loss) computed at the effective federal tax rate plus state income taxes computed at the effective tax rate, net of federal tax benefit, as adjusted for regulations affecting net operating losses.
In 1996, the Company recorded an income tax provision of $0 consisting of a deferred tax benefit of $3.9 million and a valuation allowance of $3.9 million. In 1995, the Company recorded an income tax provision of $2.3 million consisting of a deferred tax benefit of $5.5 million and a valuation allowance of $7.8 million. In 1994, the Company recorded an income tax benefit of $7.7 million, consisting of income taxes receivable of $2.1 million due to the carryback of the Company's net operating loss and a deferred tax benefit of $5.6 million. In order to fully realize the recorded net deferred tax asset of $13.9 million, the Company will need to generate future taxable income of approximately $34.8 million. The deferred tax asset is based on current applicable corporate income tax rates. Future changes in tax rates will be reflected in the valuation of the deferred tax asset in the period of change.
Statement of Financial Accounting Standards No. 109 ("SFAS No. 109"), "Accounting for Income Taxes" requires, among other things, the recognition of deferred tax assets for the estimated future tax effects attributable to net deductible temporary differences and net operating loss carryforwards. SFAS No. 109 further requires the reduction of deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The future realization of the deferred tax asset must be evaluated along with the accumulated differences caused by other tax and book basis differences. Uncertainties exist due to the reduced level of closings, revenues and earnings resulting from the sale of the Company's Phoenix and Las Vegas divisions, the need to raise capital for new land acquisitions and current business operations. Accordingly, the Company has provided a cumulative $11.7 million valuation allowance at December 31, 1996 to reserve against the deferred tax asset as a result of these uncertainties. At such time as it becomes more likely than not that portions of the additional tax asset will be realized in the future, the valuation allowance can be adjusted. The Company believes that during the time period in which the deferred tax asset can be utilized it will generate sufficient income to realize the net deferred tax asset. It is difficult to assess the ultimate timing of the realization of the deferred tax asset. No assurances can be given regarding the realization of the deferred tax asset or that the Company will not have to record a further valuation allowance against future tax benefits.
BACKLOG
The Company's homes are offered for sale in advance of their construction. Historically, the Company has entered into standard sales contracts for a majority of the homes to be built in the phase of a project before construction commences. Such sales contracts are usually subject to certain contingencies such as the buyer's ability to qualify for financing and/or the sale of an existing home. Homes covered by such sales contracts, as well as completed homes covered by such sales contracts, are considered by the Company as its backlog. The Company does not recognize revenue on homes covered by such contracts until the escrows are closed and title is transferred. The following table sets forth the Company's backlog at the dates indicated:
(1) In December 1995 the Company sold its Phoenix and Las Vegas home building divisions to an unrelated third party. See "Item 1. Business -- General."
The Company's backlog at any particular date is subject to substantial variation and is dependent upon several factors including the number of homes then available for sale, prevailing market conditions and the length of time necessary to complete the closing of home sales subject to pending contracts. The Company has generally experienced a rapid increase in backlog during periods in which it holds a grand opening for one of its projects. In 1996 the Company had three grand openings compared to four grand openings in 1995. The Company's backlog changed insignificantly in 1996 from 1995 due to a fewer number of grand openings and active projects, and declining inventory available for sale. The aggregate sales value of the units in backlog decreased by $0.5 million or 4.8%, and the average sales price of homes in backlog decreased by $14,900 or 10.6% due to a change in the mix of homes offered for sale.
During the latter part of 1995, the Company opened no new projects, compared with six in 1994. Also, the Company sold its Phoenix and Las Vegas divisions in December 1995, which contributed 121 units to its backlog at December 31, 1994. As a result, the Company's backlog decreased to 77 from 273 units at December 31, 1995 and 1994, respectively, a decrease of 196 units or 71.8%. The aggregate sales value of homes in backlog was $10.8 million and $34.1 million at December 31, 1995 and 1994, respectively, a decrease of $23.3 million or 68.3%.
No assurances can be given that homes in backlog will result in actual closings because cancellations vary from period to period. The Company believes that cancellations have been relatively high in recent periods, reflecting the weak economic conditions that have existed in the Southern California markets, increased competition, higher interest rates and the inability of certain potential homebuyers to qualify for mortgage financing.
NET ORDERS
Net orders represents the number of homes for which the Company has received signed sales contracts and purchase deposits during the period, net of cancellations.
The following table sets forth the Company's net orders by region for the dates indicated:
(1) In December 1995 the Company sold its Phoenix and Las Vegas home building divisions to an unrelated third party. See "Item 1. Business -- General."
Net new orders declined 73.3% to 149 homes from 558 homes for the years ended December 31, 1996 and 1995, respectively. The decrease in Southern California net orders was 44 homes or 22.8% in 1996. The decrease in Southern California net orders is attributable to market weakness as well as fewer subdivisions and declining inventory available for sale.
Net new orders declined 24.9% to 558 homes from 743 homes for the years ended December 31, 1995 and 1994, respectively. The Company experienced substantial decreases in net orders in both its Southern California markets partially offset by increases in net orders in Phoenix and Las Vegas during the first eleven months of 1995. The decrease in Southern California net orders was attributable to continued market weakness in the high desert region, as well as fewer subdivisions and declining inventory available for sale in both the high desert and Riverside County. The increase in Phoenix and Las Vegas was attributable to having more homes available for sale during 1995.
VARIABILITY IN QUARTERLY RESULTS
The Company has experienced, and expects to continue to experience, significant variability in its operating results. See "Item 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders of Inco Homes Corporation
In our opinion, the accompanying consolidated balance sheet and the related consolidated statements of operations, of stockholders' equity and of cash flows present fairly, in all material respects, the financial position of Inco Homes Corporation at December 31, 1996 and the results of their operations and their cash flows for the year in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for the opinion expressed above.
As discussed in Note 2 to the consolidated financial statements, the Company changed its method of accounting for real estate inventories. Effective January 1, 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of."
PRICE WATERHOUSE LLP
Costa Mesa, California March 27, 1997
INDEPENDENT AUDITORS' REPORT
To the Board of Directors and Shareholders of Inco Homes Corporation
We have audited the consolidated balance sheet of Inco Homes Corporation as of December 31, 1995 and the related consolidated statements of operations, stockholders' equity, and cash flows for the years ended December 31, 1995 and 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly in all material respects, the consolidated financial position of Inco Homes Corporation as of December 31, 1995 and the consolidated results of its operations and its consolidated cash flows for the years ended December 31, 1995 and 1994 in conformity with generally accepted accounting principles.
ERNST & YOUNG LLP
Los Angeles, California March 19, 1996, except as to Note 12, Second paragraph, which the date is March 20, 1996
INCO HOMES CORPORATION CONSOLIDATED BALANCE SHEETS
See accompanying notes to financial statements
INCO HOMES CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to financial statements
INCO HOMES CORPORATION CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
See accompanying notes to financial statements
INCO HOMES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to financial statements
INCO HOMES CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
Supplemental schedule of non-cash activities
[1] During 1996, the Company deeded back property with a book cost basis of $3.6 million to land sellers in satisfaction of $3.6 million in indebtedness - see Note 3.
[2] During 1996, the Company issued 90,878 shares of common stock (restated for reverse stock split) to creditors in exchange for relieving the Company of $539,000 of accounts payable - see Note 8.
[3] During 1996, the Company issued a warrant to purchase 41,667 shares of common stock (restated for reverse stock split) to a lender in connection with the extension of a line of credit - see Note 5. The value of this warrant was estimated at $111,000.
[4] During 1996, the Company issued a warrant to purchase 200,000 shares of common stock (restated for reverse stock split) to a third party as compensation for all services to be performed pursuant to a consulting agreement - see Note 8. The value of this warrant was estimated at $131,000.
[5] During 1995, the Company sold its Phoenix and Las Vegas divisions as follows -SEE NOTE 1:
[6] During 1995, the Company deeded back property with a book cost basis of $1.6 million to land sellers in satisfaction of $1.6 million in
See accompanying notes to financial statements
INCO HOMES CORPORATION NOTES TO FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
NOTE 1. BACKGROUND AND ORGANIZATION
Inco Homes Corporation, a Delaware corporation, ("Inco" or the "Company") is a developer and builder of affordably priced single-family detached homes. In 1994, the Company expanded into Phoenix, Arizona and Las Vegas, Nevada. In December 1995, the Company sold its Phoenix and Las Vegas divisions, including its Phoenix mortgage operations, to an unrelated third party. The sales price was $14.5 million, of which the purchaser assumed $12.0 million of bank indebtedness, and accounts payable and accrued liabilities. As a result, the Company's sole market is in Southern California and it is substantially dependent on local economic factors.
The Company was incorporated in October 1992 to consolidate the business conducted by various partnerships and corporations (the "Predecessor Entities") under the control of Ira C. Norris ("Norris" or the "Stockholder"). In April 1993, the Company effected a reorganization (the "Reorganization") of its operations, which involved an exchange offer (the "Exchange Offer") with the shareholders and partners of the Predecessor Entities and an initial public offering (the "IPO" or the "Initial Public Offering").
Pursuant to the Exchange Offer made to the shareholders and partners of the Predecessor Entities that was effected immediately prior to the consummation of the IPO, the Company (i) acquired the outstanding capital stock of the corporations under Inco Enterprises, and the outstanding partnership interests, and (ii) consolidated ownership of all of the Company's projects and businesses, except those related to Inco Land Acquisition Company which has been liquidated. The partners in Palmdale Vistas Housing Developments Ltd. ("Palmdale Vistas"), other than Norris, did not participate in the Exchange Offer and the Company continues to maintain its investment in this partnership. Norris transferred his 12.5% interest in this partnership to the Company upon consummation of the offering.
Under the terms of the Reorganization, the consideration to acquire the outstanding capital stock and partnership interests consisted of 5,850,139 shares of common stock of the Company. The total number of shares of common stock issued in the Reorganization was determined by dividing the value (the "Exchange Value") assigned to each of the corporations and partnerships by $10.00. The Exchange Values for each corporation and partnership were determined by the Company, based in part on independent appraisals, and were not the result of arm's-length negotiations.
On April 2, 1993, the Company sold 2,000,000 shares of common stock at $10.00 per share through an Initial Public Offering, raising $20.0 million less offering costs of approximately $2.9 million.
On January 16, 1997, a stockholder approved amendment to the Company's Restated Certificate of Incorporation effecting a one-for-six reverse stock split ("the reverse stock split") became effective.
NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation. The accompanying consolidated financial statements include the accounts of the Company, all wholly-owned subsidiaries, and the Company's general partnership interests in Palmdale Vistas, Freedom-Eagle Ranch Housing Partners ("FERHP") and Triumph-Lancaster Housing Partners ("Triumph"). All significant intercompany transactions have been eliminated.
The investment in non-consolidated partnership represents the Company's investment in Spirit Corona 77, L.P. ("Spirit 77") and its share of profits and losses allocated to the Company in accordance with the provisions of the Partnership Agreement, based upon the equity method of accounting.
The minority partners' investment in consolidated partnerships represents the limited partners' net equity in the real estate projects. Pursuant to the terms of the partnership agreements, losses are generally allocated 99% to the limited partners, and their net equity will be repaid to the extent the partnerships generate sufficient funds. Due to previous estimated losses of Palmdale Vistas, future losses, if any, from operations will be substantially borne by the Company.
Use of Estimates. The preparation of the Company's consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the financial statement dates and the reported amounts of revenues and expenses during the reporting periods. Due to uncertainties inherent in the estimation process, it is reasonably possible that actual results could differ from the estimates.
Basis of Presentation. The Company has incurred net operating losses which have significantly impacted its working capital levels and its ability to pay its obligations. The accompanying financial statements have been prepared assuming the Company will continue as a going concern. Management's current business plan reflects that, in addition to future profits, sales of real estate inventories provide a return of equity in the form of cash flow to the Company to help meet operating requirements. During 1997, the Company will need to extend the maturity dates of certain notes payable and to raise capital for acquisitions of land for future projects and working capital needs. Management's plans and anticipated results are dependent on future events and economic market conditions which are inherently uncertain. No assurances can be given that anticipated cash flows from operations and the Company's ability to borrow from various lenders will be sufficient to fund most of its planned expenditures. The Company currently is attempting to raise additional needed capital for both ongoing working capital and the acquisition of land for future projects in Southern California. The Company is in active discussions with certain capital sources and is optimistic that it can successfully complete a transaction in 1997. However, no agreements between the Company and these potential capital sources have been signed, and no assurances can be given whether or when the Company will enter into a definitive agreement with any source or, if entered into, what the precise terms of the agreement will be.
If the Company is not successful in obtaining sufficient capital in 1997 to fund its planned expenditures, some or all of its projects may be significantly delayed or abandoned. Any such delay or abandonment could result in cost increases and have a material adverse effect on the Company's business, financial condition and results of operations The Company is unable to predict whether it will be successful in raising such capital, nor can any assurances be given that, if successful, the capital will be raised on terms favorable to the Company. Accordingly, absent raising capital, the Company's ability to continue its current level of business operations and finance the acquisition of additional land for the delivery of future homes will be greatly impaired.
Cash and Cash Equivalents. Cash equivalents represent short-term, highly liquid investments with a maturity of three months or less when acquired. The Company maintains some of its cash in bank deposit accounts which, at times, may exceed the federally insured limits. Based on the quality of the financial institutions, the Company does not believe it is exposed to any significant concentrations of credit risk on cash and cash equivalents.
Real Estate Inventories. Costs incurred which are included in inventory consist of land, land development costs, direct and indirect costs of construction, other overhead costs, interest and
property taxes. Interest and property taxes are capitalized to real estate inventories when development activities begin, and capitalization ends when the qualifying assets are ready for their intended use.
Effective January 1, 1996, the Company adopted the provisions of Statement of Financial Accounting Standards No. 121 ("SFAS No. 121") "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", which requires impairment losses to be recorded on long-lived assets being developed, based on fair value, when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Assets held for sale are to be carried at the lower of cost or fair value less the costs to sell.
Prior to 1996, real estate inventories are carried at the lower of historical cost or estimated net realizable value. Net realizable value is the price obtainable in the future for parcels as improved with a completed housing unit, net of disposal and holding costs (including interest), without provision for future profit and without discounting future cash receipts to present value.
The estimation process in determining the value of real estate inventories is inherently uncertain and relies to a considerable extent on current and future economic and market conditions, the availability of suitable financing to fund holding, development and construction activities, and the repayment or refinancing of existing indebtedness. Such economic and market conditions may affect management's development and marketing plans. Accordingly, the ultimate realization of the Company's real estate inventories is dependent upon future events and conditions that may cause realizations to differ from amounts presently estimated.
Sales and Profit Recognition. Revenue from the sale of homes, land and lots is recognized when closings have occurred and a buyer has met down payment requirements. At the time of revenue recognition, cost of sales is charged with direct costs of construction, and an allocation of a project's total estimated costs of land, land development, indirect construction, other overhead costs, interest and property taxes.
Earnings Per Share. Primary and fully diluted weighted average number of common shares outstanding was 1,417,794, 1,341,582, and 1,330,833 for the years ended December 31, 1996, 1995, and 1994, respectively. On January 16, 1997, a stockholder approved amendment to the Company's Restated Certificate of Incorporation effecting a one-for-six reverse stock split became effective. The amount of shares has been restated to give effect to the reverse stock split. Common share equivalents include dilutive stock options and warrants using the treasury stock method. There were no dilutive options or warrants for any of the periods covered.
Fair Value of Financial Instruments. The carrying amounts reported on the balance sheet for the Company's cash equivalents and accounts payable and accrued liabilities approximate fair value due to the short-term nature of these items. The carrying amounts of the Company's notes payable secured by real estate, lines of credit, and notes to stockholder approximate fair value based on a comparison with current market rates for loans of similar risks and maturities.
NOTE 3. REAL ESTATE INVENTORIES
Real estate inventories consist of the following:
As of December 31, 1996 and 1995, the Company owned title to approximately 3,300 and 4,200 lots, respectively. As of December 31, 1996 and 1995, approximately 700 lots and 1,400 lots, respectively, were in the process of being deeded back to land sellers (see below).
In 1996, the Company determined that the undiscounted cash flows estimated to be generated by various real estate holdings were less than the assets' carrying amounts. An impairment allowance, which writes these assets down to fair value was established at December 31, 1996 totaling $785,000, of which $255,000 relates to properties in the high desert and $530,000 relates to a property in Riverside County. Additionally, in both 1995 and 1994, the Company determined that it was necessary to reflect a reduction in the estimated future cost recovery of various real estate holdings and established an allowance for net realizable value. Write-downs of real estate totaling $5.8 million were recorded as of December 31, 1995, of which $4.4 million related to properties in the high desert and $1.4 million related to properties in Riverside County. Write-downs of real estate totaling $2.6 million were recorded as of December 31, 1994, all of which related to properties in the high desert.
The Company also concluded in 1995 and 1994 that certain seller-financed parcels were no longer economically viable based on current financing terms. Accordingly, several measures were initiated, including requests that certain sellers substantially restructure the terms of their debt (including extending the maturity date, reducing or eliminating payment and accrual of interest and deferring principal payments). The Company also identified certain properties that should be deeded back to the sellers in full satisfaction of the remaining debt outstanding. In 1995 the Company commenced negotiations with six land sellers from whom the Company purchased land in the high desert. The Company owned these properties subject to seller loans that had current or approaching maturity dates. In this regard, the Company recorded a charge to operations in 1995 of $5.3 million. The balance of the related real estate inventories and indebtedness at December 31, 1995 was $3.1 million. In 1996, the Company deeded property with a book value of $2.1 million back to four of these land sellers in satisfaction of $2.1 million in indebtedness. Continuing negotiations may result either in extensions of maturity dates and/or other adjustments to the seller notes, or deedbacks of the two remaining properties with a book value of $1.0 million to the sellers in satisfaction of $1.0 million in indebtedness outstanding at December 31, 1996.
During 1995 the Company also reduced the scope of one community in Riverside County which resulted in the write-off of approximately $300,000 of previously capitalized costs associated with architectural development and marketing activities. As of December 31, 1996, the Company was still in the process of deeding back land to the seller from whom the Company purchased the property that will result in a reduction of real estate inventories of $0.4 million in satisfaction of $0.4 million of indebtedness outstanding at December 31, 1996.
In 1994, the Company commenced the process of deeding property back to nine other land sellers from whom the Company purchased land in the high desert. In this regard, the Company recorded a charge to operations in 1994 of $4.1 million. The balance of the related real estate inventories and indebtedness at December 31, 1994 was $3.2 million. Deed backs of real estate with a book value and related indebtedness of $1.4 million and $1.5 million occurred in 1995 and 1996, respectively. As of December 31, 1996, the Company was still in the process of deeding back land
to one of these land sellers that will result in a reduction of real estate inventories of $0.3 million in satisfaction of $0.3 million of indebtedness outstanding at December 31, 1996. This land was deeded back in January 1997. During 1994 the Company also closed four communities and reduced the scope of three other communities in the high desert which resulted in the acceleration of the write-off of previously capitalized costs associated with its regional development and marketing activities of approximately $4.0 million.
The Company incurred interest that was capitalized. The following table shows the components of interest:
NOTE 4. NOTES PAYABLE SECURED BY REAL ESTATE
Notes payable secured by real estate consist of the following:
Included in construction loans is a $600,000 secured participation note payable to ALG 1996-1 ("ALG") and a $900,000 secured participation note payable to Hunters Ridge Investment Partners ("HRIP") (see Note 9).
The weighted average short term borrowing rate for construction loans was 10.13% and 10.47% for the years ended December 31, 1996 and 1995, respectively.
The minimum future principal payments due on the notes payable secured by real estate at December 31, 1996 are as follows:
NOTE 5. LINES OF CREDIT
The Company has secured lines of credit with banks as follows: (i) a $3.0 million line that bears annual interest at the prime rate plus 1% that matures December 1999, and provides for quarterly principal payments of $500 for each home closed, commencing with the fourth quarter of 1995 and scheduled principal payments of $400,000, $500,000 and $600,000 in calendar years 1997, 1998 and 1999, respectively. In connection with the extension and modification of this line of credit, the Company issued a warrant to the lender to purchase 41,667 shares (restated for reverse stock split) of the Company's common stock at $6.00 per share (restated for reverse stock split) that expires June 30, 2000; and (ii) a $1.5 million line that bears interest at the prime rate plus 2.5% that matured March 1996, is now in default, and the Company is negotiating the terms of an extension (see Note 8). The net outstanding balance under these lines of credit at December 31, 1996 was $4.3 million.
NOTE 6. NOTES TO STOCKHOLDER
At December 31, 1996, the Company had received from Ira C. Norris unsecured advances net of paybacks totaling $676,000 (which includes accrued interest of $13,000). Subsequent to year end, the Company received an additional $537,000 from Mr. Norris and paid back $220,000 to him. The Company has issued several notes to Mr. Norris, bearing interest at 10.0% , all of which mature June 30, 1997.
NOTE 7. INCOME TAXES
The Company and its subsidiaries file a consolidated federal income tax return and combined state income tax returns.
The accompanying financial statements reflect provision (benefit) for federal and state income taxes as follows:
Statement of Financial Accounting Standards No. 109 ("SFAS 109") "Accounting for Income Taxes", requires, among other things, the recognition of deferred tax assets for the estimated future tax effects attributable to net deductible temporary differences and net operating loss carryforwards. SFAS No. 109 further requires the reduction of deferred tax assets by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The future realization of the deferred tax asset must be evaluated along with the accumulated differences caused by other tax and book basis differences. Uncertainties exist due to the reduced level of closings, revenues and earnings resulting from the sale of
the Company's Phoenix and Las Vegas divisions, the need to raise capital for new land acquisitions and current business operations. Accordingly, the Company has provided a cumulative $11.7 million valuation allowance at December 31, 1996 to reserve against the deferred tax asset as a result of these uncertainties. At such time as it becomes more likely than not that additional portions of the tax asset will be realized in the future, the valuation allowance can be adjusted. The Company believes that during the time period in which the deferred tax asset can be utilized it will generate sufficient income to realize the net deferred tax asset. It is difficult to assess the ultimate timing of the realization of the deferred tax asset.
The tax effects of temporary differences and net operating loss carryforwards that give rise to the deferred tax asset and deferred tax liability consist of the following at:
At December 31, 1996, the Company has net operating loss carryforwards for federal income tax purposes of $17.1 million that are available to offset future federal taxable income. Of these federal net operating losses, $3.7 million, $5.0 million and $8.4 million expire in the years 2009, 2010 and 2011, respectively.
A reconciliation of the computed statutory income tax benefit at the Federal statutory rate to the effective income tax benefit follows:
NOTE 8. COMMITMENTS, CONTINGENCIES AND OTHER MATTERS
The Company is involved in routine litigation arising in the ordinary course of business. Such matters, if decided adversely to the Company, would not, in the opinion of management, have a material adverse effect on the financial condition of the Company. In addition, from time to time, the Company could be involved in litigation in connection with claims of development or construction defects, which matters, if decided adversely to the Company, could have a material adverse effect on the financial condition of the Company.
The Company generally believes its relationships with its subcontractors has been good. However, as a result of the limited amount of available working capital, relationships with certain subcontractors have weakened due to the Company's inability to pay all of its subcontractors and their suppliers on a current basis. Numerous subcontractors and suppliers have filed liens, and some are pursuing further legal action, including the filing of complaints. The Company has negotiated payment arrangements, as appropriate, in an effort to settle these claims and release the liens.
In December 1996, a commercial bank filed notices of default relating to matured loans with principal balances totaling $2.8 million secured by one of the Company's projects. In February 1997, the Company obtained new financing that provided approximately $2.3 million to pay the loans in full pursuant to a Discounted Loan Payoff Agreement. In January 1997, this same bank filed separate notices of default relating to matured loans with principal balance totaling $3.5 million secured by an estimated 1,140 lots and 71 commercially zoned acres of the Company's Eagle Ranch project located in the high desert. There is no assurance that the Company will be successful in its negotiations with this bank. The law permits the bank to proceed with a non-judicial sale of the property as of April 9, 1997, 90 days after the notices of default were filed. Although the Company is currently in negotiations with the bank to amend the terms of the loans and remove the notices of default, there can be no assurances that the Company will be successful in its negotiations with the bank or that the bank will not commence with a non-judicial sale of the property. The final settlement could result in writedowns in 1997 in amounts ranging from minimal to approximately $6.0 million.
During 1996 the Company entered into common stock purchase agreements for 90,878 shares (restated for reverse stock split) of common stock with certain subcontractors, suppliers and other creditors, including a director and former directors of the Company. These shares were issued in exchange for relieving the Company of debt owed to the respective creditors in the aggregate amount of $539,000. In March 1996, the Company filed a Registration Statement on Form S-3 in accordance with the terms of the common stock purchase agreement that granted registration rights to these stockholders. The Registration Statement was declared effective by the Securities and Exchange Commission in April 1996. None of the proceeds from the sale of the shares by the selling stockholders under that Registration Statement will be received by the Company. The Company agreed to bear all expenses (other than underwriting discounts and commissions) in connection with the registration.
In December 1996, the Company entered into a Common Stock Purchase Agreement with a third party to sell 200,000 shares (restated for reverse stock split) of the Company's common stock in a private transaction. The stock was issued subsequent to year end for a total purchase price of $750,000. The Company also granted the third party the right to require the Company to register the stock for public sale with the Securities and Exchange Commission. At that time, in consideration of a $50,000 payment, the third party was also given an exclusive option to purchase approximately 71 acres of commercial property located in one of the Company's high desert projects. Additionally, in December 1996, the Company issued a warrant to purchase 200,000 shares (restated for reverse stock split) of common stock in a private transaction to an entity related to this third party. The warrant was issued as compensation for all services to be performed pursuant to a Consulting Agreement entered into in December 1996. The Consulting Agreement is for a term of two years during which the related entity, on a non-exclusive basis, shall seek out, investigate and pursue residential development projects and present them to the Company for its consideration and approval. The warrant may be exercised within eighteen months of the date of the agreement at a price of $5.25 per share (restated for reverse stock split). If at least half of the warrant shares are not exercised during this period, then half of the warrant shares will expire, with the balance exercisable over an additional eighteen month period at $9.75 per share (restated for reverse stock split). The related entity may also convert the warrant shares or any portion thereof into shares of common stock using a formula based upon the fair market value of the Company's common stock on the conversion date. One of the owners of this third party and the related entity is a partner in FERHP, one of the Company's consolidated partnerships and is a general partner of the owner of land in which the Company has entered into the Development and Marketing Agreement described below.
In November 1996, the Company entered into a Development and Marketing Agreement with a third party to develop, construct, and market 163 lots owned by the third party in Victorville, California. All financing and bonding will be the responsibility of the third party. The Company will receive compensation in the form of overhead draws, development fees and sales and marketing fees totaling approximately 8.0% of the gross sales price of the homes. The Company will assume the home warranty costs for which it will be paid $750 per house.
In April 1996, the Company entered into a letter of intent with an unaffiliated privately held home builder primarily doing business in Southern California relating to a potential combination of the Company and the home builder and certain of the home builders' affiliates. After conducting due diligence relating to the proposed combination, negotiations were mutually terminated. Subsequently, at the request of the unaffiliated home builder, informal discussions have resumed. No assurances can be given whether or when the Company and the home builder may enter into a definitive agreement or, if entered into, what the precise terms of the transactions will be and whether any conditions to the consummation of such a transaction will be satisfied.
In May 1994, the owners of 11 homes sold by the Company at its 201-home Northfork project located in Murrieta, California filed a complaint against Inco Development Corporation, a wholly-owned subsidiary of the Company ("Inco Development"), in the Superior Court of California in Riverside County. In June 1994, the owners of six additional homes filed a separate complaint. These two complaints were consolidated into one action. Subsequent to the consolidation, one of the homeowners dismissed the lawsuit due to the Company's repair of the alleged defects. In August 1994, one additional homeowner filed a complaint. In October 1996, an additional eighteen homeowners filed a separate complaint. This complaint was subsequently amended to include an additional four homeowners. The Company is attempting to have this complaint consolidated with the previously consolidated complaints. The complaints each allege, among other things, negligence, nuisance, strict liability, breach of warranty, negligent infliction of emotional distress and fraud based on alleged design and construction defects and inadequate soils conditions. The plaintiffs are seeking general, special, and punitive damages in an unspecified amount, and attorney fees. The causes of action for fraud were dismissed by the court in 1994 with respect to the complaints filed in 1994, and accordingly, there are no claims for punitive damages. The Company intends to continue to vigorously defend itself in this action. In 1994 the Company incurred as general and administrative expenses approximately $850,000 of post-warranty costs to potentially mitigate these items.
Commitments and contingencies also include the usual obligations incurred by real estate developers in the ordinary course of business, including the securing of financing, performance bonds, entitlement and water rights. Outstanding performance bonds at December 31, 1996 and 1995 were $8.9 and $10.7 million, respectively.
In 1993, the Company began to purchase lumber directly from suppliers pursuant to forward purchase commitments. These commitments were initiated in an effort to mitigate the continuing escalation in lumber pricing and ensure supply. The agreement in place for 1994 obligated the Company to purchase lumber to build at least 600 homes during 1994 at specified pre-established prices. The Company purchased lumber for approximately 100 homes under the contract. In February 1995 the Company reached an agreement with the lumber company to settle its lumber purchase commitment for $800,000, $645,000 of which was paid during 1995, with the balance paid during 1996. The Company accrued the full settlement as cost of homes sold in 1994.
The Company is responsible for a one-year warranty period upon the sale of single-family homes. An estimated reserve for warranty costs is included in accounts payable and accrued liabilities.
The Company is committed under various operating leases for office space and equipment. Rental expense relating to operating leases of $274,000, $520,000, and $440,000, for the years ended December 31, 1996, 1995, and 1994, respectively, is included in general and administrative expenses. The minimum future payments due on the lease contracts payable at December 31, 1996 are $299,000 for 1997, $167,000 for 1998, $111,000 for 1999, $82,000 for 2000, and $0 for 2001.
At December 31, 1996, the Company did not satisfy a certain financial covenant pursuant to a loan to Spirit 77 related to minimum net worth levels. The Company has received a waiver from the lender. Based on the anticipated results for 1997, the Company may be in violation of certain financial covenants under this loan agreement for the quarter ending March 31, 1997 and subsequent quarters. Although the Company believes these covenants could continue to be modified or waived, it is not certain that such modifications or waivers will be obtained.
The Company is currently in default on the Purchase Agreement with Spirit 77 since the Company has not purchased all of the required minimum number of lots from Spirit 77. The Company and Spirit 77 are currently negotiating a modification to the Purchase Agreement. The Company is also in default on two notes payable to Spirit 77 related to the purchase of lots in 1996. The Company and Spirit 77 are currently negotiating extensions to the due dates of these notes.
NOTE 9. RELATED PARTY TRANSACTIONS
For the years ended December 31, 1996, 1995, and 1994, the Company incurred $47,000, $46,000, and $109,000, respectively, in model home design fees and $153,000, $50,000, and $387,000, respectively, as reimbursement for the cost of the model home furnishings to Nancy Orman Interiors. Nancy Orman Interiors is owned by Nancy Norris, the wife of Ira C. Norris.
For the years ended December 31, 1996, 1995, and 1994, the Company paid $107,000, $147,000, and $154,000, respectively, for the use of office space, to Inco Plaza, Ltd. Inco Plaza, Ltd. is a limited partnership owned 80% by G&N Investments, Ltd., its sole general partner. G&N Investments, Ltd. is a limited partnership owned 70% by Nancy and Ira C. Norris, its sole general partners.
Included in other assets at December 31, 1995 is an unsecured non-interest bearing advance in the amount of $293,000, from Victor Valley Commercial Properties. Victor Valley Commercial Properties is a limited partnership owned 50% by G&N Investments, Ltd., its sole general partner. During 1996 the Company assigned this advance to Ira C. Norris in exchange for a cash payment of $293,000.
Thomas E. Gibbs, Jr., a director of the Company, holds a 1.295% limited partner's interest in Palmdale Vistas. Mr. Gibbs also holds a 23% general partner's interest and a 1.376% limited partner's interest in Palmdale Vistas Housing Investments, which holds a 47.41% limited partner's interest in Palmdale Vistas. Mr. Gibbs also holds a 25% and 56.25% general partner's interest in ALG and HRIP, respectively. Additionally, the Gibbs Family Trust, of which Mr. Gibbs is a beneficiary and trustee, is a 50% limited partner in Triumph.
One of the owners of two entities that own approximately 12.2% of the Company's outstanding common stock and a warrant to acquire approximately an additional 10.9%, respectively, holds a 5.55% limited partnership interest in FERHP.
In January 1993 the Company borrowed $1.8 million under a loan agreement with one of its limited partners and a current stockholder and director of the Company. Ten percent of the rights and obligations under this agreement were assigned to another stockholder of the Company. The loan accrued interest at an annual rate of 1.0% above the prime rate. The loan, plus interest, was paid in full in April 1993, subsequent to the IPO. In connection with this loan the Company issued to such stockholders warrants to purchase 7,920 shares (restated for reverse stock split) and 880 shares (restated for reverse stock split), respectively, of the Company's common stock at an exercise price of $60.00 per share (restated for reverse stock split). The warrants expire in April 1998. As of December 31, 1996 none of the warrants had been exercised.
NOTE 10. EMPLOYEES' PROFIT SHARING PLAN
The Company has an employee profit-sharing plan covering substantially all employees. Contributions are made annually on a discretionary basis. No contributions have been made for the years ended December 31, 1996, 1995, and 1994.
NOTE 11. STOCK OPTIONS/STOCK ISSUANCE PLAN
In November 1992, the Company's Board of Directors adopted the Stock Option/Stock Issuance Plan (the "Plan"). Under the plan, 100,000 shares (restated for reverse stock split) of common stock were authorized for issuance. The discretionary option grant program provides for the grant of options to purchase shares of the Company's common stock to key employees (including officers and directors) and consultants of the Company.
The options issued to employees are subject to certain vesting requirements. The options issued to directors may be exercised in full six months after the grant date.
The Company has adopted Statement of Financial Accounting Standards No. 123 ("SFAS No. 123") "Accounting for Stock-Based Compensation." In accordance with the provisions of SFAS No. 123, the Company applies APB Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its plan and does not recognize compensation expense for its stock-based compensation plan. If the Company had elected to recognize compensation expense based upon the fair value at the grant date for awards given in 1996 and 1995 under this plan consistent with the methodology prescribed by SFAS No. 123, the Company's net loss and net loss per share for the years ended December 31, 1996 and 1995 would not change materially from what is presented.
During 1996, 19,142 options (restated for reverse stock split) were granted at prices ranging from $3.750 to $4.875 per share (restated for reverse stock split). As of October 2, 1995 the Compensation Committee of the Board of Directors offered all employees of the Company the right to exchange 26,167 existing options (restated for reverse stock split) at prices ranging from $14.25 to $56.25 (restated for reverse stock split) with replacement options. The replacement options were set at $6.75, the current fair market value at the time (restated for reverse stock split), and reset the required holding period. All employees elected to exchange their existing options for replacement options. As of December 31, 1996, 45,741 options (restated for reverse stock split) were outstanding at prices ranging from $3.75 to $56.25 per share (restated for reverse stock split), none of which have been exercised.
NOTE 12. SUBSEQUENT EVENTS
On January 16, 1997, a stockholder approved amendment to the Company's Restated Certificate of Incorporation effecting a one-for-six reverse stock split became effective.
In December 1996, a commercial bank filed notices of default relating to matured loans with principal balances totaling $2.8 million secured by one of the Company's projects. In February 1997, the Company obtained new financing that provided approximately $2.3 million to pay the loans in full pursuant to a Discounted Loan Payoff Agreement. In January 1997, this same bank filed separate notices of default relating to matured loans with principal balance totaling $3.5 million secured by an estimated 1,140 lots and 71 commercially zoned acres of the Company's Eagle Ranch project located in the high desert. The law permits the bank to proceed with a non-judicial sale of the property as of April 9, 1997, 90 days after the notices of default were filed. Although the Company is currently in negotiations with the bank to amend the terms of the loans and remove the notices of default, there can be no assurances that the Company will be successful in its negotiations with the bank or that the bank will not commence with a non-judicial sale of the property.
In December 1996, the Company entered into a Common Stock Purchase Agreement with a third party to sell 200,000 shares (restated for reverse stock split) of the Company's common stock in a private transaction. The stock was issued subsequent to year end for a total purchase price of $750,000.
NOTE 13. QUARTERLY RESULTS (UNAUDITED)
The Company has experienced, and expects to continue to experience, significant variability in its operating results. The following table reflects the quarterly operating results of the Company for 1996 and 1995 (in thousands, except for earnings per share, number of homes sales closed, and average sales price).
Quarterly and year-to-date computations of per share amounts are made independently. Therefore, the sum of per share amounts for the quarters may not agree with per share amounts for the year.
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
PART III
The Company's Proxy Statement for its 1997 Annual Meeting of Stockholders, which, when filed pursuant to Regulation 14A under the Securities Exchange Act of 1934, will be incorporated by reference in this Annual Report on Form 10-K pursuant to General Instruction G(3) of Form 10-K and provides the information required under Part III (Items 10, 11, 12 and 13), except for the information with respect to the registrant's executive officers who are not directors, which is included in "Item 1. Business -- Executive Officers of the Registrant."
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
2. The following financial statement schedules are included in this Report:
None
Information required by other schedules has either been incorporated in the financial statements and accompanying notes, or is not applicable to the Company.
(B) REPORTS ON FORM 8-K.
The Company filed a current report on Form 8-K dated September 17, 1996 regarding a change of its independent accountant to Price Waterhouse LLP from Ernst & Young LLP. The Company filed Amendments No. 1 and No. 2 to this Form 8-K dated September 25, 1996 and October 1, 1996, respectively, to file the requisite letters received from Ernst & Young LLP. No financial statements were filed as part of these reports.
(C) EXHIBITS.
- ---------------- * Filed herewith + Management contract, compensatory plan or arrangement
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INCO HOMES CORPORATION
By /s/ Ira C. Norris -------------------------------- Ira C. Norris Chairman of the Board, President and Chief Executive Officer Dated: April 14, 1997
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INCO HOMES CORPORATION
FORM 10-K FOR FISCAL YEAR ENDED DECEMBER 31, 1996
EXHIBIT INDEX
- ---------------- * Filed herewith + Management contract, compensatory plan or arrangement