Overview
Harbor Custom Development, Inc. is a real estate development company involved in all aspects of the land development cycle, including land acquisition, entitlements, development, construction of project infrastructure, home and apartment building construction, marketing, and sales of various residential projects in Western Washington’s Puget Sound region; Sacramento, California; Austin, Texas; and Punta Gorda, Florida.
As a land developer and builder of apartments, and single-family luxury homes, Harbor Custom Development’s business strategy is to acquire and develop land strategically based on an understanding of population growth patterns, entitlement restrictions, infrastructure development, and geo-economic forces. Harbor focuses on acquiring land with scenic views or convenient access to freeways and public transportation to develop and sell residential lots, new home communities, and multi-story apartment properties within a 20- to 60-minute commute of the nation’s fastest-growing metro employment corridors.
Our portfolio of land, lots, home plans, and finishing options, coupled with the low inventory of residential and multi-family housing in our principal geographic areas, provide an opportunity for us to increase revenue and overall market share. In addition to our single-family residential projects, we build and sell townhomes and apartments and have completed or substantially completed construction of several multi-family sites in Washington. (See Item 2. Properties.)
In an effort to strategically manage the expanding needs of our corporate team, we signed a lease on October 5, 2021 for a new office space in Tacoma, Washington and moved our headquarters in April 2022. This office space is designed with a hybrid workforce in mind and takes into account employment trends that arose after the COVID-19 global pandemic, specifically the increase in hybrid or remote employees.
It is customary for us to sign purchase and sale agreements that contain a due diligence period which allows us time, usually between 60 and 120 days, to evaluate the acquisition. However, in many cases, the closing will not occur until the entitlement and permitting processes are complete, which can further extend the due diligence period. At times, through our due diligence efforts, we find that a property is not suitable for purchase due to economic forces, zoning issues, or other matters. If we determine that a property is not suitable for our desired purposes, we terminate the purchase and sale agreement. After termination within the due diligence period, our earnest money is returned to us.
Our infrastructure development division constructs a diverse range of residential communities and improved lots. We own and lease heavy equipment which we utilize to build and develop residential subdivisions and multi-family communities. The equipment is primarily used for land clearing, site development, public and private road improvements, installation of wet utilities such as sewer, water, and storm sewer lines, in addition to construction of dry utility lines for power, gas, telephone, and cable service providers. A significant portion of this equipment was sold in December 2022. (See Note 4. Property and Equipment.)
We are a general contractor and construct single-family homes, townhomes, and apartments utilizing a base of employees in conjunction with third-party subcontractors.
As of December 31, 2022, we own or control 25 communities in Washington, Texas, California, and Florida, containing approximately 2,900 lots or units in various stages of development.
Results of Operations
The following table sets forth the summary statements of operations for the years ended December 31, 2022 and 2021. For information on the year ended December 31, 2020, refer to Part II, Item 7 of our 2021 Annual Report on Form 10-K/A.
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Our sales decreased by (23.4)% to $55.4 million for the year ended December 31, 2022 as compared to $72.4 million for the year ended December 31, 2021. This decrease was primarily due to decreases in sales of developed lots of $17.3 million, sales of entitled land of $12.7 million, partially offset by increases in home sales of $11.0 million, and fee build of $2.3 million. The decreases in developed lots and entitled land sales were mainly due to large prior year sales in Blaine, Belfair, and Bremerton, Washington, and Horseshoe Bay, Texas that did not recur in 2022. The 2022 home sales largely increased due to continued expansion into a new geographic location in Texas where $18.0 million of luxury homes sold at high sales prices.
Gross Profit
Our overall gross profit (loss) for the year ended December 31, 2022 decreased to $(0.5) million compared to gross profit of $21.9 million for the year ended December 31, 2021. Gross margin loss was (0.8)% for the year ended December 31, 2022 compared to gross margin of 30.3% for the year ended December 31, 2021. The $(22.4) million decrease in gross profit was primarily due to decreases in developed lots gross profit of $11.2 million, fee build gross profit of $5.3 million, entitled land gross profit of $5.1 million, and multi-family gross profit of $2.4 million, which was partially offset by an increase in home sales gross profit of $2.2 million. The (31.1)% decrease in gross margin was primarily driven by a (43.8)% decline in developed lots gross profit including $1.2 million impairment loss related to the Winding Lane property, a $4.5 million gross loss due to cost overruns with fee build projects, and a $2.4 million impairment loss incurred on the Pacific Ridge apartment project. These gross margin declines were partially offset by gross margin increases from homes and entitled land sales.
Operating Expenses
Our operating expenses increased by 45.6% to $16.2 million for the year ended December 31, 2022, as compared to $11.2 million for the year ended December 31, 2021. The increase in total operating expenses is primarily attributable to the following:
Other Expense
Other expense increased for the year ended December 31, 2022 to $4.7 million as compared to $0.2 million for the year ended December 31, 2021. The increase in other expense was primarily due to a $3.3 million loss incurred from selling a
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significant portion of machinery and equipment which was primarily used for fee build and quarry projects as these projects are nearing completion and are wrapping up. The increase was also attributable to $1.6 million of interest expense from a revolving line of credit, partly offset by $0.5 million of interest income from notes receivables.
Net Income (Loss)
Our net income (loss) decreased by 291.1% to $(16.9) million for the year ended December 31, 2022 as compared to a net income of $8.9 million for the year ended December 31, 2021. The decrease in net income was primarily attributable to a decrease in gross margins and increased operating expenses and other expenses as explained above.
Liquidity and Capital Resources
Overview
Our principal uses of capital were operating expenses, land purchases, land development, single and multi-family construction, the payment of routine liabilities, payments on construction loans and related party construction loans, financing fees for the revolving line of credit and construction loans, and repurchase of company equity securities. We used funds generated by operations and available borrowings to meet our short-term working capital requirements. We remain focused on generating positive margins in land acquisitions and development operations and home construction operations in order to maintain a strong balance sheet and keep us poised for growth.
We employ both debt and equity as part of our ongoing financing strategy to provide us with the financial flexibility to access capital on the best terms available. In that regard, we employ prudent leverage levels to finance the acquisition and development of our lots and construction of our homes, townhomes, and apartments. Our existing indebtedness is recourse to us and we anticipate that future indebtedness will likewise be recourse.
Our management considers a number of factors when evaluating our level of indebtedness and when making decisions regarding the incurrence of new indebtedness, including the purchase price of assets to be acquired with debt financing, the estimated market value of our assets, and the ability of particular assets, and our company as a whole, to generate cash flow to cover the expected debt service costs. Our governing documents do not contain a limitation on the amount of debt we may incur and our board of directors may change our target debt levels at any time without the approval of our shareholders.
We intend to finance future acquisitions and developments with the most advantageous source of capital available to us at the time of the transaction, which may include a combination of common and preferred equity, secured and unsecured corporate level debt, property level debt and mortgage financing, property level equity, and other public, private, or bank debt.
Real Estate Assets
Our real estate assets have increased to $205.5 million as of December 31, 2022 from $122.1 million as of December 31, 2021. This increase was due to an increase in development and construction activities for houses, townhomes, and apartments.
BankUnited Loan Restructuring
As previously announced on a Current Report on Form 8-K on October 28, 2022, and as updated on a Current Report on Form 8-K on January 25, 2023, we were working with BankUnited, N.A. (“BankUnited”) to restructure our Loan (defined below) after failing to meet two financial covenants of the Loan Agreement (defined below), namely the minimum interest coverage ratio and consolidated liquidity covenants.
As previously announced on a Current Report on Form 8-K filed on February 24, 2023, on or about February 23, 2023, we entered into that certain Amendment to the Loan Agreement (the “Amendment”) with BankUnited for the restructuring of its Loan Agreement dated March 7, 2020 (the “Loan Agreement”), which loan currently consists of a $24,613,051 principal balance plus any accrued interest (the “Loan”).
Pursuant to the Amendment, BankUnited agreed to:
i.waive any and all defaults to date in the Loan Agreement;
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ii.waive our future compliance requirements with the financial covenants contained in Article 7 of the Loan Agreement until the Loan is repaid in full and the Loan Agreement terminated; and iii.waive its right to accelerate the Loan and receive immediate payments.
In consideration of BankUnited’s waivers described above, we agreed that we will:
The aforementioned payments will continue to be made until the earlier of: (i) March 7, 2024 or (ii) the Loan has been repaid in full. If we fail to make any of the payments or meet any of the agreed upon conditions, such failure will constitute an event of default under the Loan Agreement. BankUnited has no further lending obligations to us.
Liabilities
Liabilities increased to $160.6 million as of December 31, 2022 from $70.0 million as of December 31, 2021. This increase is primarily attributable to the following:
Unrestricted Cash Balance
As of December 31, 2022, our unrestricted cash balance was $9.7 million compared to $25.6 million as of December 31, 2021.
Operating Activities
Net cash used in operating activities for the year ended December 31, 2022 was $93.9 million as compared to net cash used of $86.4 million for the year ended December 31, 2021. The increase in cash used is primarily attributable to a decrease in net income of $25.8 million, decrease in accounts payable and accrued expenses of $4.5 million, increase in deferred tax asset of $3.4 million, partially offset by decrease in real estate assets of $13.9 million, a decrease in contract assets of $4.3 million, loss on sale of equipment of $3.4 million, impairment loss on real estate of $3.6 million, and impairment loss on note receivable of 1.2 million.
Investing Activities
Net cash provided in investing activities for the year ended December 31, 2022 was $2.5 million as compared to net cash used of $0.7 million for the year ended December 31, 2021. During the year ended December 31, 2022, $2.6 million was used for the furniture, fixtures, and leasehold improvements of the new corporate office and purchase of equipment compared to $0.7 million used for the acquisition of new equipment for the year ended December 31, 2021. These purchases were offset by proceeds from the sale of equipment of $5.1 million during the year ended December 31, 2022.
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Financing Activities
Net cash provided by financing activities for the year ended December 31, 2022 was $75.4 million as compared to $110.9 million for the year ended December 31, 2021. This decrease was primarily caused by net proceeds from a common stock offering of $25.1 million and net proceeds from a preferred stock offering of $66.6 million in 2021 that did not recur in the 2022 comparable period, a decrease in cash received from related party construction loans, net of payments of $13.4 million, and an increase in cash used for 2022 preferred dividends of $5.7 million. This decrease was partially offset by cash provided by the revolving line of credit loan of $25.0 million in 2022, an increase in cash provided by construction loans, net of payments of $43.1 million, and a decrease in repurchase of common stock of $4.6 million.
Cash Resources
Although the expected revenue growth and control of expenses leads management to believe that it is probable that our cash resources will be sufficient to meet cash requirements through the fiscal year ending December 31, 2023, we may require additional funding to finance the growth of our current and expected future operations as well as to achieve our strategic objectives. There can be no assurance that financing will be available in amounts or terms acceptable to us, if at all. In that event, we would be required to change our growth strategy and seek funding on that basis, though there is no guarantee we will be able to do so. (See Note 1. Nature of Operations and Summary of Significant Accounting Policies.)
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, financings, or other relationships with unconsolidated entities or other persons, also known as “special purpose entities” (SPEs).
Inflation
Our operations can be adversely impacted by inflation, primarily from higher land, financing, labor, material, and construction costs. In addition, inflation can lead to higher mortgage rates which can significantly affect the affordability of mortgage financing to homebuyers. While we attempt to pass on cost increases to customers through increased prices, when weak housing market conditions exist, we may be unable to offset cost increases with higher selling prices. Please refer to “Item 1A. Risk Factors” for further details on industry and economic risks.
Critical Accounting Policies
Our consolidated financial statements and related public financial information are based on the application of accounting principles generally accepted in the United States (“GAAP”). GAAP requires the use of estimates, assumptions, judgments, and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenues, and expense amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk, and financial condition. We believe our use of estimates and underlying accounting assumptions adhere to GAAP and are consistently applied. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We continue to monitor significant estimates made during the preparation of our financial statements.
Our significant accounting policies are summarized in Note 1 of our consolidated financial statements.
Implications of Being an Emerging Growth Company
We are an “emerging growth company” as defined in the JOBS Act and we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies.” These provisions include:
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•an exemption from compliance with any new requirements adopted by the Public Company Accounting Oversight Board requiring mandatory audit partner rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer.
We have elected to adopt the reduced disclosure requirements available to emerging growth companies. As a result of this election, the information that we provide in this Annual Report may be different than the information you may receive from other public companies in which you hold equity interests.
We will cease to be an “emerging growth company” upon the earliest of: (i) the end of the fiscal year following the fifth anniversary of our initial public offering (December 31, 2025), (ii) the first fiscal year after our annual gross revenues are $1.235 billion or more, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities or (iv) as of the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeded $700 million as of the end of the second quarter of that fiscal year.
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