ITEM 1. BUSINESS
GENERAL
U.S. Home Corporation ("U.S. Home" or the "Company"), organized in 1954 and incorporated in the State of Delaware in 1959, is one of the largest single-family home builders in the United States based on homes delivered. The Company currently builds and sells homes in more than 215 new home communities in 31 market areas in 12 states. Since its formation, the Company has delivered more than 267,000 homes. In 1995, the Company was the fifth largest single-family on-site home builder in the United States based on homes completed and delivered and has been among the ten largest single-family on-site home builders in the United States for more than 20 years. The Company conducts substantially all of its home building business through U.S. Home, the parent company.
The Company offers a wide variety of moderately-priced homes that are designed to appeal to the affordable, move-up and retirement and active adult buyers. In each of its markets, the Company's primary strategy is to build quality homes, utilizing its Zero Defect Program, which the Company believes offers prospective home buyers a high level of new home value. The Company believes that many home purchasers compare homes on the basis of location, perceived quality and dollars of purchase price per square foot of living area. As a result, the Company attempts to purchase land and lots in popular growth corridors, maintain high quality standards and design homes to maximize living space.
In addition to building and selling single-family homes, the Company provides mortgage banking services to its customers. The Company originates, processes and sells mortgages to third-party investors. The Company does not retain or service the mortgages that it originates but, rather, sells the mortgages and related servicing rights to investors.
OPERATIONS
The Company is engaged in two related industry segments: home building and financial services. The revenues, operating profits or losses and identifiable assets attributable to the Company's industry segments are separately disclosed in the Consolidated Financial Statements.
HOME BUILDING OPERATIONS
The Company's primary industry segment is the on-site development of single-family residential communities. During 1996, the Company's product mix consisted of deliveries of approximately 28% affordable homes, 49% move-up homes and 23% retirement and active adult homes. The Company has set a goal to increase its retirement and active adult home deliveries to approximately 30% of the Company's volume. However, there can be no assurance such efforts will be successful. The Company presently has 18 retirement and active adult communities in Arizona, California, Florida, Maryland, Nevada, New Jersey and Texas.
MARKETS
U.S. Home's building operations are currently conducted in the following market areas:
The Company seeks to maintain geographic diversity and thus reduce the potential risk of economic volatility in any given market.
The Company's home building and marketing activities are conducted under the name of U.S. Home in each of its markets except in Minneapolis/St. Paul where the Company markets its homes under the name of Orrin Thompson Homes and in Florida where homes are marketed under the name of Rutenberg Homes as well as U.S. Home.
Set forth below are revenues for the Company from the sale of single-family homes by state for each of the last three fiscal years:
Set forth below are tables providing information (expressed in number of housing units) with respect to new orders taken, deliveries to purchasers and backlog of single-family homes by state for each of the last three fiscal years:
NEW ORDERS TAKEN
DELIVERIES
BACKLOG(1)
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(1) Homes under contract for sale but not delivered at end of year.
The Company anticipates that substantially all of its backlog units, net of cancellations, as of December 31, 1996 will be completed and delivered during 1997. While operations in certain market areas are affected by seasonal factors which limit on-site building and sales activities, the Company's ability to build and deliver its backlog is not considered to be seriously affected by such factors.
SALES AND MARKETING
The Company employs sales consultants for the sale of single-family homes, although sales by independent real estate brokers are also encouraged. Specific sales training programs are provided which inform sales consultants about sales techniques and methods as well as information about their local market, realtors and products. The sales programs focus on the Company's Zero Defect Program as a marketing tool because the sales force is the first contact with the customer. The Zero Defect Program is a quality assurance program with major emphasis on construction (see Construction below).
The Company advertises primarily in magazines and local newspapers. Additionally, homes are marketed by means of model homes, pictorial brochures and on-site displays. The Company's general marketing strategy seeks to generate one-third of housing sales through advertisements, one-third through customer referrals and one-third through realtor contacts.
The Company markets homes in "model home parks" featuring one or more model homes, attractively furnished and decorated and staffed by the Company's sales consultants who provide information regarding floor plans, the various elevations available, decorating options, as well as assisting with mortgage financing information. The model may include a variety of options and upgrades which the customer may request at an additional cost. Such upgrades may include items such as pools, fireplaces and decks. The Company constantly studies both aesthetic design and architectural trends, as well as quality construction and engineering trends, in order to provide customers with high quality, design and value. The Company has received numerous awards in various markets for outstanding housing design.
Selling prices are set in each area based on local market conditions and competitive factors. The Company's gross margins vary from area to area based on competitive factors in each market.
The Company's product lines include both single-family detached and attached homes. During 1996, approximately 83% of the homes delivered were single-family detached compared to 84% in 1995 and 85% in 1994. The number of units and average sales prices of single-family homes delivered in 1996, 1995 and 1994 were as follows:
The increases in the average sales prices of single-family detached and attached homes in 1996 and 1995 were primarily due to price increases.
In 1996, the national average sales prices of new single-family homes (both detached and attached) as reported on a preliminary basis by the U.S. Census Bureau was $165,800 compared with an average sales price of $166,100 for the Company.
Variations in the general product and customer mix may exist from year to year based on shifts in local market demand or product availability. The table below sets forth the mix of the Company's deliveries for the affordable, move-up and retirement and active adult home products during the last three years:
Many purchasers finance a large portion of the purchase price of a home through conventional or government insured/guaranteed mortgages from lending institutions. The Company generally assists purchasers in obtaining mortgages. Approximately 83% of the homes delivered in 1996, and 82% delivered in 1995 and 85% delivered in 1994, were purchased using mortgage financing.
The Company takes steps to qualify certain of its homes under Veterans Administration ("VA") and Federal Housing Administration ("FHA") mortgage financing programs, which provide mortgage financing sources. During 1996 and 1995, approximately 17% and during 1994 approximately 19% of the Company's homes delivered were financed under VA and FHA mortgage programs.
CONSTRUCTION
The Company's investment in direct employee labor costs, equipment and facilities is kept to a minimum because all construction of single-family homes is performed by independent subcontractors. At all stages of construction, however, on-site Company managers supervise and coordinate the activities of these subcontractors and subject their work to quality and cost control standards. The Company's Director of National Purchasing and Quality Control provides centralized management of quality standards, both with respect to the construction of homes and the purchase of certain major components used in the construction of homes. Company employees are rated and compensation incentives are affected by a measure of quality standards. The Company's commitment to quality and its use in the Company's sales efforts are best illustrated by its Zero Defect Program. Under the Zero Defect Program, the home buyer meets with the construction supervisor prior to the commencement of, and during, construction in order to ensure that the home buyer (i) is aware of all quality features of the house, including those which are not readily apparent in the finished house, (ii) agrees that the design features, including appliances, match those ordered and (iii) is satisfied with the finished product. The Company considers a completed house to have "zero defects" if, upon final inspection by the home buyer, only a few minor cosmetic items remain to be corrected.
Construction subcontractors are selected on the basis of competitive bids and written agreements govern their relationship with the Company. All bids are based on detailed specifications and complete blueprints to ensure commitment to the Company's expectation for high quality workmanship.
The Company purchases the majority of its construction material on a decentralized basis with a "just in time" delivery schedule to each individual job site. Materials are regularly purchased on a competitive bid basis to ensure both competitive pricing and high quality. In addition to local purchasing, the Company has entered into a number of national purchasing agreements in order to maximize purchasing power. Agreements with each vendor are negotiated on an annual basis by the Company's Director of National Purchasing and Quality Control.
In order to minimize the risk associated with completed but unsold inventory, the Company generally does not commence construction of a single-family detached home prior to receipt of an executed purchase contract, a deposit from the customer and preliminary mortgage approval based on the purchaser's mortgage application. For single-family attached homes, construction does not generally commence until 50% of the units in a building have been sold.
REGULATION
The Company and its subcontractors must comply with various federal, state and local zoning, building, pollution, environmental, health, advertising and consumer credit statutes, ordinances, rules and regulations, as well as regulations relating to specific building materials to be used, building design and minimum elevations of properties. All of these regulations have increased the time and cost required to market the Company's products by extending the time between the initial acquisition of land and the commencement of construction. The Company's operations, like those of other home builders, have been periodically subject to moratoriums on development activities caused by insufficient water, sewage and energy-related facilities. Moratoriums in local areas have not had a material adverse effect on the Company's overall activities because of the geographic diversification of the Company's operations.
COMPETITION
The single-family residential housing industry is highly competitive. U.S. Home competes in each of its markets, with respect to the location, design and price of its products, with numerous firms engaged in the on-site development of single-family residential housing, ranging from regional and national firms to small local companies. The Company is one of the largest on-site builders of single-family homes in the United States, ranking among the ten largest single-family on-site home builders in the United States for more than 20 years. However, because there are so many firms engaged in the single-family home building industry, the Company accounts for less than 1% of all new on-site single-family housing sales in the United States.
RAW MATERIALS AND SUBCONTRACTORS
The Company uses numerous suppliers of raw materials and services in its business and such materials and services have been and continue to be available. Where appropriate, the Company has adopted national programs for products to maximize price discounts through volume purchases. The Company also utilizes numerous independent subcontractors representing all building trades in connection with the construction of its homes.
COMMUNITY DEVELOPMENT
A significant portion of the Company's finished lot needs are currently satisfied through rolling lot options, which enable the Company to initially pay a small fraction of total lot cost and then purchase the lots on a scheduled basis. For example, during 1996, 55% of the Company's unit deliveries were from lots owned by the Company and 45% were from lots acquired by the exercise of rolling lot options.
The Company's policy is that land cannot be purchased or sold without prior approval of the Company's Asset Management Committee. Asset Management Committee approval requires submission of data relating to sales forecasts, a timing schedule (e.g., estimated dates for the commencement of land development, housing construction, model opening and sales) and a projection of income and internal rate of return. All development expenditures are reviewed by the Senior Vice President-Community Development and the respective President of Operations prior to the commencement of development. In addition, the Company's by-laws require approval by the Company's Board of Directors of any acquisition of unimproved real property or acreage by the Company which is material to the Company in any single transaction involving an expenditure in excess of $5 million and any other material capital expenditures, borrowings (subject to certain exceptions) and other commitments by the Company in excess of $5 million per transaction (excluding transactions involving housing inventory).
The Presidents of Operations and the Division Presidents are responsible for maintaining continuity of housing sales through awareness of trends in housing demand in each market area. Feasibility studies and market research studies are generally required before approval of the purchase of land. These studies examine the demographics of an area, including population trends, income trends, employment trends, housing stock and housing demand. Products are matched to customer profile, determined in part by the market studies and the experience of the local manager in each market.
Housing communities are generally built in or near major metropolitan areas and are normally located in growing markets for such areas. At December 31, 1996, the Company's land and finished lot inventories totaled $354.8 million, excluding option deposits. See Note 1 of Notes to Consolidated Financial Statements. Substantially all housing communities are zoned for their intended use and serviced by utilities. As of December 31, 1996, the Company had refundable and nonrefundable deposits totaling $28.0 million for options and contracts to purchase undeveloped land and finished lots for home building operations for a total purchase price of approximately $267.0 million. The Company has incurred pre-development costs of approximately $42.7 million relating to these properties.
The following table sets forth as of December 31, 1996, by state, the cost of certain of the Company's land inventories and the estimated number of lots controlled through direct ownership and under option which are being used or that are anticipated to be used in the Company's home building operations (dollars in thousands):
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(1) The estimates set forth above have been prepared based on numerous assumptions made at the date hereof, many of which are beyond the control of the Company. Many of these assumptions, and hence the estimates, are subject to change and there can be no assurances that such lots will be used or as to when they will be used. This table does not include commercial property and other properties which the Company has no current plans to use, with an aggregate cost of $12.3 million (including $6.5 million relating to land under contract for sale). In view of the various stages of development of the land owned by the Company as of December 31, 1996 (i.e., finished, under development and development not started), any per lot cost derived by dividing the book cost by the estimated number of units would not be meaningful.
Inventory risk is substantial for all home building companies. The market value of housing inventories, finished lots and raw land can change significantly over the life of a community, reflecting dynamic market conditions. In addition, inventory carrying costs are significant, which can result in losses when trying to exit a poorly performing community or market. The Company seeks to reduce its risks associated with housing inventories, finished lots and raw land through (i) maintaining its geographic diversity and (ii) acquiring lots and land under option where possible, thereby enabling the Company to control land and lots with a smaller capital investment.
In 1996, the Company's revenues from the sale of developed and undeveloped land amounted to $10.9 million, as compared to revenues of $16.1 million in 1995 and $16.2 million in 1994.
REORGANIZATION
The Company and certain of its affiliates commenced proceedings (the "Cases") under Chapter 11 of Title 11 of the United States Code on April 15, 1991, in order to restructure their indebtedness and other liabilities. The Company's plan of reorganization (the "Plan") was confirmed in May 1993 by the United States Bankruptcy Court for the Southern District of New York and became effective in June 1993 (the "Effective Date"). On the Effective Date, the Company also completed a public offering of $200 million principal amount of 9.75% senior notes due 2003, the net proceeds from which were utilized to pay a portion of the claims of certain unsecured creditors of the Company under the Plan and to repay outstanding amounts under the Company's debtor-in-possession financing facility.
The Plan effected a recapitalization of the Company and did not result in a reduction in the scope or other major restructuring of the Company's operations. During the pendency of the Cases, the Company continued its home building operations in the ordinary course in its housing markets and improved its market share in a majority of such markets.
FINANCIAL SERVICES OPERATIONS
The Company's second industry segment consists primarily of its mortgage banking activities. U.S. Home Mortgage Corporation ("Mortgage"), a wholly-owned subsidiary of the Company, commenced operations in 1971 and serves an important role in the Company's sale of its homes by arranging financing for customers.
Mortgage is a Federal National Mortgage Association/Government National Mortgage Association/Federal Home Loan Mortgage Corporation approved seller-servicer, headquartered in Clearwater, Florida with branch or satellite offices in the metropolitan areas of Phoenix and Tucson, Arizona; Bakersfield, Palmdale, Palm Springs and Sacramento, California; Colorado Springs, Denver, and Fort Collins, Colorado; Washington, D.C.; Clearwater, Fort Myers, Orlando, and Sarasota, Florida; Indianapolis, Indiana; Minneapolis, Minnesota; Las Vegas, Nevada; Cleveland, Ohio; and Dallas, and Houston, Texas. The Company offers a wide variety of conventional, FHA and VA financing programs through Mortgage, thereby providing prospective buyers the benefits of both conventional and government-assisted loan programs. As a mortgage banker, Mortgage originates and funds mortgage loans and sells the loans and the related servicing rights directly to investors. Loans and servicing rights are generally sold by Mortgage and funded by the investors within 30 days after home delivery. To limit its risk of interest rate fluctuations, Mortgage regularly enters into fixed price mandatory forward delivery contracts to sell mortgage-backed securities to securities dealers or fixed price forward delivery commitments to sell specific whole loans to investors on a mandatory or best efforts basis. Mortgage has a secured revolving line of credit to fund the mortgage loans on an interim basis until purchased by investors. See Note 2 of Notes to Consolidated Financial Statements.
The following table summarizes certain mortgage banking operating information (dollars in thousands):
While the Company continues to focus its attention primarily upon the expansion of Mortgage's operations within the Company's own customer base, Mortgage also offers its services to realtors, unaffiliated builders and refinance customers.
Among the factors affecting Mortgage's operations are general economic conditions, federal, state and local regulatory constraints, consumer confidence and interest rate volatility. These factors, together with the number of homes delivered by the Company, affect the volume of loan originations which in turn impact the resulting volume of mortgage loans and mortgage servicing rights available for sale.
ADDITIONAL INFORMATION
EMPLOYEES
At December 31, 1996, the Company had 1,466 employees. None of the Company's employees are represented by a union. The Company considers its relations with its employees to be good. The Company's single-family housing and community development operations are conducted primarily through independent subcontractors, thereby limiting the number of direct employees required.
ITEM 2.

ITEM 2. PROPERTIES
The Company leases its executive offices, located at 1800 West Loop South, Houston, Texas 77027, pursuant to a lease scheduled to expire on February 28, 1999. The Company does not believe that its executive offices or its other facilities, consisting of sales and administrative offices located in or near each of the Company's areas of operations and generally held under leases with terms not exceeding five years, are material to its operations.
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
The Company is involved from time to time in litigation arising from the normal course of business, none of which, in the opinion of the Company, is expected to have a material adverse effect on the financial position or results of operations of the Company.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS
None.
EXECUTIVE OFFICERS OF THE COMPANY
The Company's executive officers during 1996 and their respective ages and positions are set forth below:
No family relationship exists among any of the executive officers of the Company.
Each of the foregoing officers has been elected to serve in the office indicated until the first meeting of the Board of Directors following the next annual meeting of stockholders of U.S. Home and until his or her successor is elected and qualified.
Mr. Strudler has served as Chairman and Co-Chief Executive Officer since April 26, 1995: prior thereto, he had been Chairman and Chief Executive Officer of the Company since May 12, 1986.
Mr. Heimbinder has served as President, Co-Chief Executive Officer and Chief Operating Officer since April 26, 1995; prior thereto, he had been President and Chief Operating Officer of the Company since May 12, 1986.
Mr. Johnson has served as Senior Vice President -- Community Development since April 26, 1995; prior thereto, he had been Vice President -- Community Development since June 11, 1992, and Executive Vice President, Community Development since October 14, 1988.
Mr. Frueh has served as Vice President -- Tax and Audit since February 5, 1992; prior thereto, he had been Vice President -- Tax since December 18, 1986.
Mr. Napoli has served as Vice President -- Corporate Finance and Treasurer since February 13, 1997; prior thereto, he had been Vice President -- Finance and Chief Financial Officer since April 21, 1989.
Mr. Sadowski has served as Vice President -- Controller and Chief Accounting Officer since December 17, 1987.
Mr. Slaughter has served as Vice President -- Planning and Secretary since December 18, 1986.
Ms. Somoza has served as Vice President -- Investor Relations since December 6, 1996; prior thereto, she had been Vice President since June 11, 1992, and Director, Investor Relations since December 31, 1981. Ms. Somoza is also the administrator of the Company's profit sharing and employees' savings programs.
PART II
ITEM 5.

ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
As of February 7, 1997, there were 3,430 holders of record of the Company's common stock, $.01 par value per share. The principal market on which the common stock is traded is the New York Stock Exchange. Information concerning the high and low sales prices for the Company's common stock for each calendar quarter during 1996 and 1995 is set forth below:
No dividends were paid by the Company during 1996 or 1995. The Company's credit agreement (the most restrictive of the Company's borrowing agreements) prohibits the Company from paying dividends on its capital stock, other than stock dividends.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
U.S. HOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED SELECTED FINANCIAL DATA FOR THE FIVE YEARS ENDED DECEMBER 31, 1996 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
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(1) Primary and fully diluted income per share in 1996 includes $.04 primary income per share and $.03 fully diluted income per share, respectively, due to the net effect of an $8,233, net of tax, provision for impairment of land inventories and an $8,691 tax benefit.
(2) Primary and fully diluted income per share in 1993 were $2.29 and $2.21, respectively, excluding $3.87 primary income per share and $3.72 fully diluted income per share, respectively, due to a $45,000 decrease in the deferred tax asset valuation allowance.
(3) Income (loss) per common and common equivalent share has been computed using the weighted average number of common and common equivalent shares outstanding, assuming the Company's current capital structure had been effective as of the beginning of all periods presented. This differs from historical primary and fully diluted loss per common and common equivalent share previously reported (based on the Company's former capital structure) for the year ended December 31, 1992, of $.47. The Company believes that earnings per common share information for 1992 is of limited use and relevance in view of the significant changes in ownership of the Company's capital stock and the Company's capital structure which occurred in 1993.
(4) Includes unsecured debt of $266,635 at December 31, 1992 which was exchanged for a combination of cash and equity securities, and secured debt of $5,213 at December 31, 1992 which was either reinstated or the property securing the debt was deeded to the lenders in full satisfaction of the debt.
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
HOUSING
The following table, which excludes the provision for impairment of land inventories recorded in the fourth quarter of 1996 (see Results of Operations Other -- Impairment of Land Inventories below and Consolidated Statements of Operations), sets forth certain financial information for the Company's housing segment for the periods indicated (dollars in thousands, except average sales price):
Revenues and Gross Margin
Revenues from sales of single-family homes for 1996 increased 10% from 1995. The increase resulted from a 5% increase in the number of housing units delivered and a 5% increase in the average sales price. Revenues from sales of single-family homes for 1995 increased 11% from 1994, resulting primarily from a 6% increase in the number of housing units delivered and a 5% increase in the average sales price.
The increases in the average sales prices in 1996 and 1995 were primarily due to price increases.
The gross margin percentage for 1996 decreased from 1995 and the gross margin percentage for 1995 decreased from 1994. These decreases resulted primarily from cost increases which were not offset by increases in sales prices.
New orders taken in 1996 increased 6% from 1995. New orders taken in 1995 increased 12% from 1994. The increase in new orders in 1996 reflects the continued demand for new single-family homes which the Company believes was brought about by strong consumer confidence, opening of new home communities and stable mortgage interest rates. The increase in new orders in 1995 reflects the demand for new single-family
homes which the Company believes was brought about by the decrease in mortgage interest rates starting in the second quarter of 1995.
Selling, General and Administrative Expenses
As a percentage of housing revenues, selling, general and administrative expenses declined in 1996 as compared to both 1995 and 1994. Actual selling, general and administrative expense for 1996 increased $7.3 million compared to 1995. This increase was attributable to increases in volume-related expenses ($4.1 million) resulting from the increase in deliveries in 1996 when compared to 1995 and increases in other selling, general and administrative expenses resulting from increased activities and earnings. Similarly, selling, general and administrative expenses increased by $9.9 million in 1995 compared to 1994, due to increases in volume-related expenses ($4.7 million) resulting from increases in deliveries in 1995 when compared to 1994 and increases in other selling, general and administrative expenses resulting from increased activities and earnings.
Interest
Interest paid and accrued for 1996 increased approximately 5% compared to 1995 and increased approximately 4% in 1995 compared to 1994. The increase in 1996 was primarily due to the sale of the Company's 7.95% senior notes in February 1996, offset in part by a decrease in the average borrowings under the Company's Credit Facility (see Financial Condition and Liquidity -- Housing below), while the increase in 1995 was primarily due to an increase in the average borrowings under the Company's Credit Facility.
The Company capitalizes interest cost into housing inventories and charges the previously capitalized interest to interest expense when the related inventories are delivered. The amount of interest capitalized and previously capitalized interest expensed in any one year is a function of the amount of housing assets, land sales and the number of housing units delivered, average outstanding debt levels and average interest rates. In addition, the amount of previously capitalized interest charged to interest expense in 1995 and 1994 was affected by the amount of interest capitalized prior to 1994 because interest on a majority of the Company's debt was stayed during the period of the Company's bankruptcy proceedings. Capitalized interest amounts charged to interest expense in 1996 were greater than 1995 and 1994 primarily due to the increase in the number of housing units delivered and higher average debt levels, offset in part by an increase in the amount of housing assets qualifying for interest capitalization.
FINANCIAL SERVICES
Revenues
Revenues for the financial services segment for the periods indicated were as follows (dollars in thousands):
Mortgage provides financing primarily to purchasers of homes sold by the Company's housing operations through origination of residential mortgage loans and engages in the sale of such mortgages and related servicing rights to unaffiliated investors. Mortgage's operations are affected, among other things, by general economic conditions, consumer confidence and interest rate volatility. These factors, together with the number of homes delivered by the Company, affect the volume of loan originations which in turn impact the resulting volume of mortgages and servicing rights for sale.
The increase in Mortgage's revenues in 1996 from 1995 and in 1995 from 1994 was primarily due to an increase in mortgage loan originations and income from the sales of mortgage loans and servicing rights.
OTHER
Impairment of Land Inventories
During the fourth quarter of 1996, in conjunction with the completion of the 1997 business plan, the Company completed its annual detailed evaluation of the intended use of its land inventories to insure that the primary and planned use reflected the appropriate economic value for the Company's intended use. Even though industry forecasts project a softening in housing demand in 1997, no change in use was required for most of the Company's land inventories. However, it was determined during the evaluation that based on economic forecasts for 1997 the current best use of certain land inventories located primarily in Florida, Maryland and Texas had changed from the Company's previous intended use. The change in intended use for these land inventories include land previously held for long term development which will now be sold to other builders in the near term to accelerate its disposition, land that has been replanned for new products and land affected by changes in product pricing. Based on the change in intended use, the Company revised its cash flow estimates and determined the cash flow expected to be generated from the new intended use would be less than the cost of the land. Accordingly, the Company recorded a non-cash provision for impairment of approximately $13.0 million ($8.2 million, net of income taxes) to reduce the carrying value of the land to its current fair value, which amount has been included in "provision for impairment of land inventories" in the Consolidated Statements of Operations. Fair value was determined based on sales contracts or offers received on land being sold and by evaluations of comparable market prices. The provision for impairment reduced primary and fully diluted income per share in 1996 by $.69 per share and $.57 per share, respectively.
Corporate General and Administrative
Corporate general and administrative includes the operations of the Company's corporate office. As a percentage of total revenues, such expenses were 1.0%, 1.1% and 1.2% for 1996, 1995 and 1994, respectively. Actual corporate overhead expenses for 1996 totaled $11.7 million compared with $11.8 million and $11.3 million, respectively, for 1995 and 1994. The increase for 1995 over 1994 was primarily due to increased payroll expense.
Income Taxes
During the fourth quarter of 1996, the Internal Revenue Service (the "IRS") completed an examination of the Company's federal income tax returns for the years ended December 31, 1993 and 1992. The results of this examination allowed certain previously reserved deductions taken by the Company in its 1993 tax return. However, certain other deductions claimed by the Company in that year were disallowed by the IRS. At the conclusion of this examination, the Company reduced its deferred tax liability and recognized an income tax benefit totaling $8.7 million related to the deductions allowed by the IRS. The Company plans to appeal the IRS decision to disallow certain other deductions and these deductions remain reserved as a deferred tax liability as of December 31, 1996. The decrease in the deferred tax liability increased primary and fully diluted income per share in 1996 by $.73 per share and $.60 per share, respectively.
FINANCIAL CONDITION AND LIQUIDITY
HOUSING
The Company's most significant needs for capital resources are land and finished lot purchases, land development and housing construction. The Company's ability to generate cash adequate to meet these needs is principally achieved from the sale of homes and the margins thereon, the utilization of Company-owned lots and borrowings under its financing facilities, including the Credit Facility (see below).
Access to quality land and lot locations is an integral part of the Company's success. Typically, in order to secure the rights to quality locations and provide sufficient lead time for development, the Company must acquire land rights well in advance of when orders for housing units are expected to occur. The Company attempts to minimize its exposure to the cyclical nature of the housing market and its use of working capital by employing rolling lot options, primarily in its affordable and move-up home communities, which enable the Company to initially pay a small portion of the total lot cost and then purchase the lots on a scheduled basis. Over the last three years, approximately 45% of the units delivered have been on lots acquired under rolling lot option agreements. The increase in land inventories in 1996 from 1995 and 1995 from 1994 was primarily the result of increased activities, including an increase in the Company's retirement and active adult communities activities.
The Company has financed, and expects to continue to finance, its working capital needs from operations and borrowings, including those made under the Company's $130 million unsecured revolving credit agreement ("Credit Facility") entered into in September 1995. The Credit Facility (and previous credit facilities) have enabled the Company to meet peak operating needs. See Note 2 of Notes to Consolidated Financial Statements. In February 1996, the Company sold $75 million principal amount of its 7.95% senior notes due 2001. The net proceeds thereof were used to repay the then outstanding balance under the Credit Facility and for working capital and general corporate purposes. See Note 2 of Notes to Consolidated Financial Statements. Also, certain of the properties owned or under option by the Company may be located within community development districts ("Districts") formed by municipalities to construct and finance certain infrastructure/improvements on property in the Districts' area. The Districts utilize ad valorem and assessment revenue bonds to fund improvements and repay the bonds by annual tax assessments on District property based on the property's relative value to other District property. The Company provides no credit support for and is not liable for the debt of the Districts, except to the extent of actual assessments made by the Districts. The Company may utilize Districts to a greater extent in the future. However, there can be no assurance that it will do so.
The net cash provided or used by the operating, investing and financing activities of the housing operations for the years ended December 31, 1996, 1995 and 1994 is summarized below (dollars in thousands):
Housing operations are, at any time, affected by a number of factors, including the number of housing units under construction and housing units delivered. Housing construction and land asset activities increased in 1996 over 1995 and in 1995 over 1994. Housing operating activities for 1996 used more cash than in 1995 primarily due to an increase in these activities offset in part by increased profitability and the timing of payments related to these activities. Housing operating activities for 1995 used less cash than in 1994 primarily due to increased profitability and the timing of payments related to these activities.
Cash flow from housing financing activities in 1996 provided cash reflecting the sale of the Company's 7.95% senior notes, partially offset by the repayment of the amounts outstanding under the Credit Facility. Cash flow from housing financing activities increased in 1995 from 1994 primarily due to increased net borrowings under the Company's revolving credit facilities.
The Company believes that cash flow from operations and amounts available under the Credit Facility will be sufficient to meet its current working capital obligations and other needs. However, should the Company require capital in excess of that which is currently available, there can be no assurance that it will be available.
FINANCIAL SERVICES
Mortgage's activities represent a substantial portion of the financial services segment's activities. As loan originations by Mortgage are primarily from homes sold by the Company's home building operations, Mortgage's financial condition and liquidity are to a significant extent dependent upon the financial condition of the Company.
Financial services operating activities are affected primarily by the volume of Mortgage's loan originations and the timing of the sale of mortgage loans and related servicing rights to third party investors. Loans and servicing rights are generally sold to investors within 30 days after homes are delivered. In this regard, cash required by financial services operating activities for 1996 was higher compared to 1995 and 1995 was higher compared to 1994 primarily due to an increase in residential mortgage loan receivables.
The Company finances its financial services operations primarily from short-term debt which is repaid with internally generated funds, such as from the origination and sale of residential mortgage loans and related servicing rights. As more fully discussed in Notes 2 of Notes to Consolidated Financial Statements, the short-term debt consists of a $55 million secured revolving line of credit (the "Mortgage Credit Facility") which matures on August 31, 1997. While the Mortgage Credit Facility contains numerous covenants, including a debt to tangible net worth ratio and a minimum tangible net worth requirement, these covenants are not anticipated to significantly limit Mortgage's operations.
The Company has no obligation to provide funding to its financial services operations, nor does it guarantee any of its financial services subsidiaries' debt. The Company believes that internally generated funds and the Mortgage Credit Facility will be sufficient to provide for Mortgage's working capital needs.
OTHER
Impact of Inflation
Inflation not only affects interest rates on funds borrowed by the Company, but also affects the affordability of permanent mortgage financing available to prospective customers. Increased construction costs associated with rising interest rates, as well as increased material costs, compress gross margins in the short-term, but may be recovered in the long-term through increases in sales prices, although such increases may reduce sales volume. In recent years, inflation has not had a significant adverse effect on the Company.
Cautionary Disclosure Regarding Forward-Looking Statements
The Company desires to take advantage of the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995 and is including this disclosure in order to do so.
Certain statements in the Company's press releases, oral communications and filings with the Securities and Exchange Commission that are not historical facts are, or may be considered to be, forward-looking statements. Given the risks, uncertainties and contingencies of the Company's business, the actual results may differ materially from those expressed or implied by such forward-looking statements. Further, certain forward-looking statements are based on assumptions concerning future events which may not prove to be accurate.
Forward-looking statements by the Company regarding results of operations and, ultimately, financial condition, are subject to numerous risk and assumptions, including the following:
- General economic and business conditions, the level and direction of interest rates and the level of consumer confidence have significant impact on the willingness and ability of purchasers to enter into contracts for homes and to consummate purchases of such homes under contract (backlog), as well as on the performance of Mortgage, the Company's principal subsidiary.
- The development of many of the Company's communities, particularly its retirement and active adult communities, result from a lengthy, complex series of events involving land purchase, regulatory
compliance, capital availability, marketing and sales, any of which can materially affect the financial results for a community.
- The Company is in a highly competitive and fragmented industry, which places constant pressure on price (including the ability of the Company to respond to increases in prices from its suppliers), quality and marketing and particularly challenges the Company upon any entry into new geographic markets.
- The Company faces numerous regulatory hurdles in its development efforts, such as laws and regulations regarding zoning, environmental protection, building design and construction, density and rate of development.
- The Company's access to capital sufficient to fund its development activities is affected by the Company's financial leverage and by the willingness of the capital markets and banks to absorb equity or debt of the Company.
- The Company may encounter other contingencies, including labor shortages, work stoppages, product liability, litigation, natural risks such as floods or hurricanes and other factors over which the Company has little or no control.
ITEM 8.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
U.S. HOME CORPORATION AND SUBSIDIARIES
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To U.S. Home Corporation:
We have audited the accompanying consolidated balance sheets of U.S. Home Corporation (a Delaware corporation) and subsidiaries as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards 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. 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of U.S. Home Corporation and subsidiaries as of December 31, 1996 and 1995, and the results of their operations and cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Houston, Texas February 12, 1997
U.S. HOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1996 AND 1995 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
ASSETS
The accompanying notes are an integral part of these balance sheets.
U.S. HOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
The accompanying notes are an integral part of these statements.
U.S. HOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of these statements.
U.S. HOME CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994 (DOLLARS IN THOUSANDS)
The accompanying notes are an integral part of these statements.
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
(1) SIGNIFICANT ACCOUNTING POLICIES
GENERAL
Nature of Operations
The Company is one of the largest single-family home builders in the United States based on homes delivered. The Company currently builds and sells homes in more than 215 new home communities in 31 market areas in 12 states. The Company offers a wide variety of moderately-priced homes that are designed to appeal to the affordable, move-up and retirement and active adult buyers. In addition to building and selling single-family homes, the Company provides mortgage banking services to its customers. The Company originates, processes and sells mortgages to third-party investors. The Company does not retain or service the mortgages that it originates but, rather, sells the mortgages and related servicing rights to investors.
Principles of Consolidation and Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and all wholly-owned subsidiaries after elimination of all significant intercompany balances and transactions.
The preparation of 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 disclosure of any contingent assets and liabilities at the date of the consolidated financial statements and revenues and expenses during the reporting period. Management's estimates and assumptions are reflective of, among other things, prevailing and expected market conditions, current operating strategies and the availability of capital which are all subject to change. Changes to the aforementioned or other conditions could in turn cause changes to such estimates and assumptions and, as a result, actual results could differ from the original estimates.
The Company is engaged in two related industry segments, the on-site development of single-family residential communities and financial services. Identifiable assets and the results of operations of the Company's segments are reported in the consolidated balance sheets and consolidated statements of operations. Capital expenditures, depreciation and amortization expense for the years ended December 31, 1996, 1995 and 1994 were insignificant.
New Pronouncement
Effective January 1, 1996, the Company adopted Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"). SFAS No. 123 establishes a "fair value based method" of accounting for all stock-based employee compensation plans, such as the Company's incentive stock options, but allows for the continued application of the intrinsic value concept under existing accounting rules prescribed by Accounting Principles Board Opinion No. 25 ("APB 25"). The Company will continue to value its stock options using the guidance of APB 25 and, as required by SFAS No. 123, disclose in the notes to the consolidated financial statements (See Note 5) what net income and earnings per share would have been had the Company valued its stock options using the fair value based method.
Income Per Share
The following weighted average number of common and common equivalent shares were used to compute income per share:
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average number of common and common equivalent shares outstanding for primary income per share include the dilutive effect of the convertible redeemable preferred stock and Class B warrants and the assumed exercise of stock options. No effect was given to the shares that would be issuable on exercise of the warrants and stock options in 1994, since they would be antidilutive or immaterial. Fully diluted income per share includes the assumed conversion of the convertible subordinated debentures and the dilutive effect of the Class B warrants and stock options (based on the higher year-end stock price) in 1996 and 1995.
Cash Equivalents
The Company considers all short-term investments with an initial maturity of less than 90 days to be cash equivalents.
Financial Instruments
The Company believes that fair value approximates recorded values for such financial instruments as cash and cash equivalents, trade receivables and payables, short-term debt and option deposits because of the typically liquid, short-term nature, market rate terms and lack of specific concentration of these instruments.
The fair value of the senior notes and convertible subordinated debentures can not be determined as none of these instruments are actively traded on the open market. The Company has been informed that the 9.75% senior notes are currently trading at a nominal premium, the 7.95% senior notes are currently trading at a nominal discount and the convertible subordinated debentures are currently trading at a discount under ten percent; however the actual amount of the premium or discount can not be determined because of the limited activity.
The fair value of the Company's residential mortgage loans approximate their carrying value as such loans are packaged and sold to investors generally within 30 days after home delivery. Additionally, a significant portion of the Company's interest rate risk associated with and generated by these loans is mitigated by the use of forward delivery contracts and commitments. See Hedging Contracts below.
HOUSING
Sales and Profit Recognition
Profit is recognized from the sale of real estate at time of closing, i.e., when sufficient down payment has been made; any financing has been arranged; title, possession and other attributes of ownership have been transferred to the buyer; and the Company is not obligated to perform additional significant activities after the sale.
Inventories and Valuation
The components of single-family housing inventories are as follows:
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The cost of acquiring and developing land and constructing certain amenities are allocated to the related parcels. Housing inventories are recorded using the specific identification method. The Company measures any impairments on land under development and to be developed at the lower of cost or fair value and carries land substantially completed and ready for its intended use, land held for sale and housing inventories at the lower of cost or fair value less cost to sell. Fair value is the amount at which a property could be bought or sold in a current transaction between willing parties. Prior to 1995, the Company recorded its inventories at the lower of cost or net realizable value. Provisions to reduce land and housing inventories to the lower of cost or fair value/net realizable value in 1996 (other than the $12,965 provision for impairment of land inventories discussed below), 1995 and 1994 were not significant. Total land and housing reserves were $40,236, $36,370 and $35,417 at December 31, 1996, 1995 and 1994, respectively.
During the fourth quarter of 1996, in conjunction with the completion of the 1997 business plan, the Company completed its annual detailed evaluation of the intended use of its land inventories to insure that the primary and planned use reflected the appropriate economic value for the Company's intended use. Even though industry forecasts project a softening in housing demand in 1997, no change in use was required for most of the Company's land inventories. However, it was determined during the evaluation that based on economic forecasts for 1997 the current best use of certain land inventories located primarily in Florida, Maryland and Texas had changed from the Company's previous intended use. The change in intended use for these land inventories include land previously held for long term development which will now be sold to other builders in the near term to accelerate its disposition, land that has been planned for new products and land affected by changes in product pricing. Based on the change in intended use, the Company determined the cash flow expected to be generated from the new intended use would be less than the cost of the land. Accordingly, the Company recorded a non-cash provision for impairment of $12,965 ($8,233, net of income taxes) to reduce the carrying value of the land to its current fair value, which amount has been included in "provision for impairment of land inventories" in the accompanying consolidated statements of operations. Fair value was determined based on sales contracts or offers received on land being sold and by evaluations of comparable market prices. The provision for impairment reduced primary and fully diluted income per share by $.69 per share and $.57 per share, respectively.
During 1995, the Company acquired land assets in transactions with third parties totaling approximately $14,832, in which the Company received land suitable for single-family detached homes, and these acquisitions were treated as non-cash transactions for purposes of the consolidated statements of cash flows.
Interest Capitalization
Interest is capitalized on land, finished building lots and single-family residential housing construction costs during the development and construction period. Interest is capitalized to eligible assets using an allocation method based on the Company's actual interest costs. A summary of interest for 1996, 1995 and 1994 follows:
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FINANCIAL SERVICES
Revenue Recognition
The sale of loans and loan servicing rights is recognized when the closed loans are sold and delivered to an investor. During the years ended December 31, 1996, 1995 and 1994, revenues included net losses from the sale of loans of $976, $512 and $831, respectively, and net gains from the sale of servicing of $7,294, $5,467 and $4,212, respectively.
Interest Expense
Interest expense relating to financial services for the years ended December 31, 1996, 1995 and 1994 was $1,507, $692 and $537, respectively, and is included in "general, administrative and other expenses" in the accompanying consolidated statements of operations.
Residential Mortgage Loans
Residential mortgage loans held for sale ($38,491 at December 31, 1996) are included in the accompanying consolidated balance sheets at the lower of cost or market on an aggregate basis. The Company estimates the fair value of residential mortgage loans held at December 31, 1996 approximated recorded value based on quoted market prices for similar loans sold either on a whole loan basis or pooled and sold as collateral for mortgage-backed securities.
Hedging Contracts
The Company manages its interest rate market risk on the inventory loans held for sale and its estimated future commitments to originate and close mortgage loans at fixed prices ("Loan Quotes") through hedging techniques by regularly entering into either fixed price mandatory forward delivery contracts ("Forward Contracts") to sell mortgage-backed securities to security dealers or fixed price forward delivery commitments ("Forward Commitments") to sell specific whole loans to investors on a mandatory or best efforts basis ("Forward Contracts" and "Forward Commitments", collectively "Hedging Contracts"). The Company records the inventory of residential mortgage loans at the lower of cost or market on an aggregate basis after considering any market value changes in the inventory loans, Loan Quotes and Hedging Contracts. See Note 7.
(2) REVOLVING CREDIT FACILITIES, SENIOR AND CONVERTIBLE SUBORDINATED DEBT AND NOTES PAYABLE
Housing
Revolving credit facilities, senior and convertible subordinated debt and notes payable consist of the following:
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has an unsecured revolving credit agreement (the "Credit Facility") with a group of banks. The Credit Facility provides up to a maximum of $130,000, of which up to $20,000 may be used for letter of credit obligations, subject to a borrowing base limitation. The amount available for borrowing under the Credit Facility is based on housing inventories, land, finished lots and closing proceeds receivables less outstanding senior debt borrowings (as defined), including amounts outstanding under the Credit Facility; as the amount invested in these categories changes, the amount of available borrowings will increase or decrease. At December 31, 1996, $124,403 of the Credit Facility commitment was available for borrowing. Borrowings bear interest at a premium over the Eurodollar rate or the base rate announced by the agent bank. The Credit Facility, as amended, expires on September 29, 1999, but may be extended annually for successive one-year periods with the consent of the banks and contains numerous real estate and financial covenants, including restrictions on incurring additional debt, creation of liens and the levels of land and housing inventories maintained by the Company and a prohibition on the payment of dividends, other than stock dividends. In September 1996, the Company amended the Credit Facility to, among other things, extend the expiration date one year to September 29, 1999, and modify the borrowing base provisions to increase the availability for borrowing and in November 1996, amended the Credit Facility to increase to $20,000 the amount of convertible subordinated debentures and/or capital stock which may be repurchased.
On February 16, 1996, the Company completed the sale of $75,000 principal amount of its 7.95% senior notes due March 1, 2001. Interest is payable semi-annually. The indenture relating to the 7.95% senior notes contains certain covenants, including a minimum tangible net worth requirement, a limitation on the incurrence of additional debt and the making of certain restricted payments.
The 9.75% senior notes are due June 15, 2003. Interest is payable semi-annually. On or after June 15, 1998, the 9.75% senior notes may be redeemed at the option of the Company, in whole or in part, at prices ranging from 103.656% (during the 12-month period ending June 14, 1999) to 100% (on and after June 15, 2001) of the principal amount thereof, together with accrued and unpaid interest. The indenture relating to the 9.75% senior notes contains certain covenants, including a minimum tangible net worth requirement, a limitation on the incurrence of additional debt and the making of certain restricted payments.
The 4.875% convertible subordinated debentures are due November 1, 2005. Interest is payable semi-annually. The debentures are convertible at any time at the option of the holder into common stock at a conversion price of $35.50 per share, subject to adjustment under certain conditions. On or after November 1, 1996, the debentures may be redeemed at the option of the Company, in whole or in part, at prices ranging from 103.25% (during the 12 month period ending October 31, 1997) to 100% (on or after November 1, 2004) of the principal amount thereof, together with accrued and unpaid interest.
Housing notes and mortgage notes payable are primarily for the acquisition and development of land, with interest rates ranging from 6.0% to 10.0%. Assets pledged as collateral under these agreements totaled approximately $42,590 at December 31, 1996.
Upon a change of control of the Company, holders of both issues of senior notes and the debentures will have the right to require the Company to redeem the senior notes and debentures at a price of 101% of the principal amount of the senior notes and 100% of the principal amount of the debentures, together with accrued and unpaid interest. There can be no assurance that sufficient funds will be available to make the required repurchases if a change of control occurs. In addition, the Credit Facility prohibits the Company from repurchasing more than $20,000 of the debentures and/or capital stock prior to the termination of the Credit Facility. Moreover, the occurrence of a change of control will trigger an event of default under the Credit Facility.
The maximum amounts of borrowings from banks and other financial institutions outstanding at any time during 1996, 1995 and 1994 were $64,000, $67,000 and $34,600, respectively. The average amounts of debt outstanding from banks and other financial institutions during 1996, 1995 and 1994 were $15,800, $42,400 and
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$10,700, respectively, and the weighted average interest rates, without giving effect to commitment fees, were 8.4%, 9.7% and 9.2%, respectively. Computations of the weighted average interest rates were based upon the weighted average of outstanding loan balances during the respective years.
At December 31, 1996, housing notes and mortgages payable, senior debt and convertible subordinated debt mature as follows: $5,243 in 1997, $1,821 in 1998, $643 in 1999, $180 in 2000, $75,000 in 2001, $200,000 in 2003 and $80,000 in 2005.
Financial Services
Financial services revolving credit facility consists of an agreement with a financial institution whereby the Company's mortgage banking subsidiary, U.S. Home Mortgage Corporation ("Mortgage"), may borrow up to $55,000 under a revolving line of credit (the "Mortgage Credit Facility") secured by residential mortgage loans and mortgage notes receivables. The Mortgage Credit Facility is not guaranteed by the Company, was amended and renewed in August 1996 under substantially the same terms and conditions as the previous agreement, matures on August 31, 1997 and bears interest at a premium over the London Interbank Offered Rate.
The maximum amounts of financial services borrowings from banks and other financial institutions outstanding at any time during 1996, 1995 and 1994 were $42,400, $35,400 and $21,600, respectively. The average amounts of short-term debt outstanding from banks and other financial institutions during 1996, 1995 and 1994 were $22,300, $8,500 and $5,600, respectively, and the weighted average interest rates, without giving effect to balance deficiency fees, were 6.6%, 7.0% and 6.3%, respectively. Computations of such rates were made based upon the weighted average of outstanding loan balances during the respective years.
(3) INCOME TAXES
The Company and its subsidiaries file consolidated federal income tax returns. The components of the provision for income taxes consisted of the following:
Deferred income taxes are determined based upon the difference between the financial reporting and tax basis of assets and liabilities. At December 31, 1996, the Company has recorded a net deferred tax asset of $2,800 which is comprised of deferred tax assets of $36,200 (including $17,400 relating to housing reserves which were expensed for financial reporting purposes but deferred for federal income tax purposes) and deferred tax liabilities of $33,400 (including $14,000 relating to interest expense capitalized for financial reporting purposes but expensed for federal income tax purposes and an amount related to certain deductions taken in the Company's 1993 federal income tax return). At December 31, 1995, deferred tax assets and
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
deferred tax liability were $33,900 and $39,700, respectively, and were primarily attributable to the same items noted above.
During the fourth quarter of 1996, the Internal Revenue Service (the "IRS") completed an examination of the Company's federal income tax returns for the years ended December 31, 1993 and 1992. The results of this examination allowed certain previously reserved deductions taken by the Company in its 1993 tax return. However, certain other deductions claimed by the Company in that year were disallowed by the IRS. At the conclusion of this examination, the Company reduced its deferred tax liability and recognized an income tax benefit totaling $8,691 related to the deductions allowed by the IRS. The Company plans to appeal the IRS decision to disallow certain other deductions, and these deductions remain reserved as a deferred tax liability as of December 31, 1996. The decrease in the deferred tax liability increased primary and fully diluted income per share in 1996 by $.73 per share and $.60 per share, respectively.
The following table reconciles the statutory federal income tax rate to the effective income tax rate for:
(4) STOCKHOLDERS' EQUITY
As of December 31, 1996, the Company's capital structure consisted of the following:
Common Stock -- Authorized 50,000,000 shares, par value $.01 per share, outstanding 11,453,290 shares.
Preferred Stock -- Authorized 10,000,000 shares, par value $.10 per share, including 202,206 convertible redeemable preferred shares, 500,000 Series A junior non-cumulative preferred shares and 9,297,794 shares undesignated as to series.
(a) Convertible redeemable preferred stock -- $25 per share liquidation preference and redemption value, outstanding 117,863 shares. The shares may be redeemed at the option of the Company at any time at an amount equal to the liquidation preference/redemption value ($25 per share) plus any declared and unpaid dividends. Each share of convertible redeemable preferred stock is convertible, subject to adjustment, into one share of common stock at the option of the holder and at any time prior to its redemption by the Company. On February 12, 1997, the Board of Directors authorized the redemption of the remaining outstanding shares of the Company's convertible preferred stock for $25 per share on March 18, 1997. As of December 31, 1996, 2,697,794 shares of convertible redeemable preferred stock had been converted into an equal number of shares of
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
common stock. If the closing price of the common stock is equal to or greater than $30 per share for 20 consecutive trading days, the convertible redeemable preferred stock will automatically convert into common stock. Any shares converted are restored to the status of authorized and unissued preferred stock without designation as to series. The holders of the convertible redeemable preferred stock are entitled to one vote for each share of convertible redeemable preferred stock held by them.
The holders of the convertible redeemable preferred stock vote together as a single class with the holders of the common stock on substantially all matters requiring stockholder action.
(b) Series A junior non-cumulative preferred stock -- Authorized 500,000 shares, par value $.10 per share. The shares are authorized for issuance pursuant to certain rights that trade with the Company's common stock and convertible redeemable preferred stock. There are no shares of the Series A junior non-cumulative preferred stock outstanding; however, all of the shares have been reserved for issuance upon the exercise of the stock purchase rights as discussed in "Stockholder Rights Plan" below.
(c) Undesignated as to series -- None outstanding. Shares may be issued in one or more classes or series with preferences, limitations and relative rights as determined by the Company's Board of Directors at the time of issuance. Any shares issued will rank, as to dividends and liquidation preference, junior to the convertible redeemable preferred stock, if any shares are outstanding.
Class B Warrants -- In connection with the Plan of Reorganization, pre-Effective Date stockholders received Class B warrants to acquire an aggregate of 1,904,757 shares of common stock for $20 per share, of which 4,860 warrants had been exercised at December 31, 1996. The warrants expire in June 1998.
Stockholder Rights Plan -- On November 7, 1996, the Company adopted a rights plan and declared a dividend distribution of one preferred stock purchase right for each outstanding share of the Company's common stock and each outstanding share of the Company's convertible redeemable preferred stock held of record on December 4, 1996. Under certain circumstances, each right entitles the holder to purchase 1/100th of a share of the Company's Series A junior non-cumulative preferred stock ("Series A Preferred Stock") at a price of $80 ("Purchase Price"), subject to certain antidilution provisions. The rights are not exercisable until the earlier to occur of (i) 10 days following a public announcement that (a) a person or group has acquired, or has the right to acquire, 15% or more of the outstanding shares of the Company's common stock or (b) an institutional stockholder has acquired or has the right to acquire 20% or more of the outstanding shares of common stock, or (ii) 10 business days following the commencement of, or announcement of an intention to make, a tender offer for 15% or more of the then outstanding shares of common stock. In such event, each holder of a right (other than the acquiring person) shall have the right to receive, upon exercise, the number of shares of common stock or of 1/100th of a share of Series A Preferred Stock having a value of equal to two times the Purchase Price. In the event of any merger, consolidation or other transaction in which the Company's common stock is exchanged, each holder of a right, upon exercise, will be entitled to receive common stock of the acquiring company equal to two times the Purchase Price. Unless and until the rights become exercisable, they will be transferred with the Company's common stock and convertible redeemable preferred stock. At the option of the Company, the rights are redeemable prior to becoming exercisable at $.01 per right. Unless earlier redeemed or exchanged by the Company, the rights will expire on November 7, 2006. Until a right is exercised, the holder will have no rights as a stockholder of the Company, including the right to vote or receive dividends.
The Credit Facility and the senior note indentures contain restrictions on the (i) payment of dividends on the Company's common and preferred stock and (ii) purchase, redemption, retirement or other acquisition of
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the Company's common and preferred stock, other than upon conversion of the convertible redeemable preferred stock into common stock and upon exercise into the Company's common stock of Class B warrants and options to acquire common stock issued pursuant to stock options and stock payment plans.
(5) STOCK PLANS
Stock Option Plans
The Company has three stock option plans for key employees (the "1997 Employee Plan", which is subject to stockholder approval which will be sought at the 1997 annual meeting of stockholders, the "1996 Employee Plan" and the "1993 Employee Plan") to purchase a maximum of 1,500,000 shares (500,000 shares for each plan) of the Company's common stock. Under all three plans, the Company may grant incentive and non-qualified stock options. The Company also has a stock option plan whereby options may be granted to non-employee directors (the "Director Plan") to purchase a maximum of 100,000 shares of the Company's common stock. Options under the Director Plan are granted annually in a fixed amount.
Options granted under the Employee Plans will be exercisable at not less than the closing price of the common stock on date of grant. Options granted under the Director Plan will be exercisable at not less than the average closing price of the common stock for the ten consecutive trading days prior to the date of grant. However under the Employee Plans and the Director Plan, the grant price will not be less than 95% of the average closing price of the common stock for the 20 consecutive trading days prior to the date of grant. The options are exercisable as specified in the stock option agreements relating to the options and may not be exercised later than ten years from the date of grant and, with respect to the 1997 Employee Plan, no options may be exercised prior to stockholder approval.
As discussed in New Pronouncement in Note 1, the Company adopted SFAS No. 123 as of January 1, 1996. As permitted by SFAS No. 123, the Company has elected to continue to account for its stock option plans under the accounting rules prescribed by APB 25, under which no compensation costs are recognized as an expense. Had compensation costs for the stock options been determined using the fair value method of accounting as recommended by SFAS No. 123, net income and earnings per share for 1996 and 1995 would have been reduced to the following proforma amounts:
Because the SFAS No. 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting proforma compensation cost may not be representative of that to be expected in future years.
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the status of the stock option plans at December 31, 1996, 1995 and 1994 and changes during the years then ended is presented below:
Options outstanding at December 31, 1996 had exercise prices ranging from $15.13 to $27.75 per share and a weighted average remaining contractual life of 8.3 years. Options exercisable at December 31, 1996 had a weighted average remaining contractual life of 8.3 years.
The fair value of each option granted in 1996 and 1995 was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest of 6.6% for 1996 and 5.9% for 1995; expected lives of 7.1 years for 1996 and 6.1 years for 1995; and expected volatility of 25.0% for both years.
Stock Payment Plan
The Company's employee stock payment plan (the "Payment Plan") provides that up to 25% of a key employee's annual incentive pay (compensation other than base salary), which is charged to expense when earned, may be payable in shares of the Company's common stock as determined by the Company's Board of Directors, of which up to 50% of the shares payable will vest to the employee not later than two years after the end of the incentive compensation year and will expire in the event the employee is not employed by the Company on the vesting date. Shares to be issued under the Payment Plan will be valued at the average closing price of the common stock for a ten consecutive trading day period as defined in the Payment Plan, but in no event will the average closing price be less than 95% of the average closing price of the common stock for the 20 consecutive trading day period as defined in the Payment Plan. The Payment Plan has a five-year term and commenced on January 1, 1994. In 1996, 7,905 shares were issued to officers and key employees at prices ranging from $25.05 to $27.93 per share and in 1995, 21,731 shares were issued to officers and key employees at prices ranging from $16.74 to $17.99 per share. As of December 31, 1996, 220,364 shares were available for issuance under the Payment Plan.
Restricted Stock Plan
The Company has a restricted stock plan (the "Restricted Plan") for officers and other key employees. Under the Restricted Plan, a maximum of 250,000 shares of the Company's common stock may be granted as restricted stock. Shares granted under the Restricted Plan will be granted at the average closing price of the common stock for a ten consecutive trading day period as defined in the Restricted Plan. Participants in the
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Restricted Plan may not dispose of any of the stock granted for five years from date of grant. Restrictions lapse at the rate of 20% of the stock granted per year, commencing with the end of the fifth year. As defined in the Restricted Plan, the lapsing of the restrictions may be accelerated if certain stipulated improvements in the Company's return on assets over the base year are achieved or if a change in control occurs.
As of January 1, 1995, a total of 144,547 restricted shares of the Company's common stock were issued to officers and other key employees. The market value of the shares issued of $2,600 has been charged to stockholders' equity as Unearned Compensation on Restricted Stock and is being amortized to expense over a nine-year period.
(6) PROFIT SHARING
The Company has a qualified profit sharing plan for the benefit of its employees which may be terminated at any time at the option of the Company. The annual contributions may be made in such amount as the Board of Directors of the Company determines, limited to 15% of the total compensation (as defined in the profit sharing plan) of all participating employees. The aggregate amounts accrued for contribution to the profit sharing plan for distribution to employees were $1,051 in 1996, $991 in 1995 and $891 in 1994.
(7) COMMITMENTS AND CONTINGENCIES
Housing
The Company is significantly affected by the cyclical nature of the home building industry, which is sensitive to fluctuations in economic activity, interest rates and the level of consumer confidence. The sale of new homes and profitability from sales are heavily influenced by the level and expected direction of interest rates. Increases in interest rates tend to have a depressing effect on the market for new homes in view of increased monthly mortgage costs to potential home buyers.
As of December 31, 1996, the Company had refundable and nonrefundable deposits totaling $28,035 for options and contracts to purchase undeveloped land and finished lots having a total purchase price of approximately $267,000. The Company had incurred pre-development costs of $42,653 relating to these properties. These options expire at various dates through 2002.
The Company is involved from time to time in litigation arising from the normal course of business, none of which, in the opinion of the Company, are expected to have a material adverse effect on the financial position or results of operations of the Company.
Financial Services
At December 31, 1996, Mortgage, in connection with managing the interest rate market risk on its inventory loans held for sale of $38,833 and Loan Quotes of $18,755, had outstanding $41,370 (face amount of $42,000 and estimated fair value of $41,245) of Forward Contracts and $14,038 of Forward Commitments which expire over the next three months, when the inventory loans are expected to be sold and Loan Quotes are expected to close. At December 31, 1996, the estimated fair value of the inventory loans and Loan Quotes hedged by Forward Contracts and not covered by the Forward Commitments was $42,760.
Mortgage reduces its risk of nonperformance under the Hedging Contracts by entering into those contracts with reputable security dealers and investors and evaluating their financial condition. However, there is a risk if certain of the Loan Quotes do not close or are renegotiated in a declining interest rate market and close at lower prices. Mortgage reduces this risk by collecting commitment fees on certain of the Loan Quotes along with entering into Forward Commitments to deliver loans to investors on a best efforts basis and adjusting, from time to time, the estimate of loan closings covered by Forward Contracts.
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) UNAUDITED SUMMARIZED CONSOLIDATED QUARTERLY INFORMATION
Summarized quarterly financial information for the years ended December 31, 1996 and 1995 is as follows. See Notes 1 and 3 for discussions of 1996 fourth quarter adjustments.
(9) RECEIVABLES
The Company had housing and financial services receivables of approximately $1,973 in 1996 and $6,574 in 1995 that were due after one year. The 1996 balance due after one year included notes and mortgage notes receivable of $151 with interest rates ranging from 8.0% to 10.5%. A majority of the balance matures within five years.
U.S. HOME CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(10) ACCRUED EXPENSES
At December 31, 1996 and 1995, accrued expenses and other current liabilities consisted of the following:
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information relating to the directors of the Company is incorporated by reference from the Nominees for Directors Section, pages 2 through 5, of the Company's Proxy Statement, dated March 17, 1997, for the Annual Meeting of Stockholders to be held on April 23, 1997, to be filed with the Securities and Exchange Commission pursuant to Section 14 of the Securities Exchange Act of 1934 (the "1997 Proxy Statement").
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
The information is incorporated by reference from the Executive Compensation Section, pages 6 through 8 of the 1997 Proxy Statement (see Part I-Item 4, Executive Officers of the Company).
ITEM 12.

ITEM 12. COMMON STOCK
The information relating to the security ownership of certain beneficial owners and management is incorporated by reference from the Security Ownership of Management and Certain Beneficial Owners Section, pages 19 and 20 of the 1997 Proxy Statement.
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
None.
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. and 2. The following financial statements and financial statement schedules are filed as part of this Report:
See Index to Financial Statements -- Item 8.
(a) 3. Exhibits
(b) Report on Form 8-K
The Company filed a Current Report on Form 8-K, on November 8, 1996, as amended on November 18, 1996, describing under Item 5 "Other Events" the terms of the preferred stock purchase rights which the Company distributed to the holders of the Company's Common Stock, $.01 par value per share, on December 4, 1996 by declaration of the Board of Directors of the Company on November 7, 1996.
No other Current Report on Form 8-K was filed by the Company during October, November or December 1996.
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.
Date: February 21, 1997 U.S. HOME CORPORATION
By: /s/ ISAAC HEIMBINDER ------------------------------------ Isaac Heimbinder President, Co-Chief Executive Officer and Chief Operating Officer
By: /s/ CHESTER P. SADOWSKI ------------------------------------ Chester P. Sadowski Vice President, Controller and Chief Accounting Officer (principal accounting officer)
By: /s/ THOMAS A. NAPOLI ------------------------------------ Thomas A. Napoli Vice President-Corporate Finance and Treasurer (principal financial officer)
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.
INDEX TO EXHIBITS