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EX-10.A - EXHIBIT 10.A - HOVNANIAN ENTERPRISES INCex10-a.htm
EX-31.B - EXHIBIT 31.B - HOVNANIAN ENTERPRISES INCex31-b.htm
EX-31.A - EXHIBIT 31.A - HOVNANIAN ENTERPRISES INCex31-a.htm
EX-32.A - EXHIBIT 32.A - HOVNANIAN ENTERPRISES INCex32-a.htm
EX-32.B - EXHIBIT 32.B - HOVNANIAN ENTERPRISES INCex32-b.htm

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

(Mark One)

[ X ]           Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended JANUARY 31, 2015

OR

 

[    ]           Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from _____ to _____

 

Commission file number 1-8551

 

Hovnanian Enterprises, Inc. (Exact Name of Registrant as Specified in Its Charter)

 

Delaware (State or Other Jurisdiction of Incorporation or Organization)

 

22-1851059 (I.R.S. Employer Identification No.)

 

110 West Front Street, P.O. Box 500, Red Bank, NJ  07701 (Address of Principal Executive Offices)

 

732-747-7800 (Registrant’s Telephone Number, Including Area Code)

 

N/A  (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [ X ]    No [   ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes [ X ]  No [    ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer [   ]  Accelerated Filer  [ X ]

Non-Accelerated Filer  [   ]  (Do not check if smaller reporting company)   Smaller Reporting Company [   ]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes [    ]  No [ X ]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 131,417,519 shares of Class A Common Stock and 14,983,719 shares of Class B Common Stock were outstanding as of March 9, 2015.

 

  

 

 
1

 

 

HOVNANIAN ENTERPRISES, INC.

  

  

  

FORM 10-Q

  

 

INDEX

PAGE

NUMBER

  

  

PART I.  Financial Information

  

Item l.  Financial Statements:

  

  

  

Condensed Consolidated Balance Sheets (unaudited) as of January 31, 2015 and October 31, 2014

3

  

  

Condensed Consolidated Statements of Operations (unaudited) for the three months ended January 31, 2015 and 2014

5

  

  

Condensed Consolidated Statement of Equity (unaudited) for the three months ended January 31, 2015

6

  

  

Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended January 31, 2015 and 2014

7

  

  

Notes to Condensed Consolidated Financial Statements (unaudited)

9

  

  

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

32

  

  

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

54

  

  

Item 4.  Controls and Procedures

55

  

  

PART II.  Other Information

  

Item 1.  Legal Proceedings

55

   

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

55

  

  

Item 6.  Exhibits

56

  

  

Signatures

57

 

 
2

 

   

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands)

 

   

January 31,

2015

   

October 31,

2014

 
   

(Unaudited)

    (1)  

ASSETS

           
             

Homebuilding:

           

Cash and cash equivalents

  $269,282     $255,117  

Restricted cash and cash equivalents

  12,478     13,086  

Inventories:

           

Sold and unsold homes and lots under development

  1,076,374     961,994  

Land and land options held for future development or sale

  315,504     273,463  

Consolidated inventory not owned:

           

Specific performance options

  2,724     3,479  

Other options

  87,374     105,374  

Total consolidated inventory not owned

  90,098     108,853  

Total inventories

  1,481,976     1,344,310  

Investments in and advances to unconsolidated joint ventures

  73,403     63,883  

Receivables, deposits and notes, net

  96,538     92,546  

Property, plant and equipment, net

  46,967     46,744  

Prepaid expenses and other assets

  78,915     69,358  

Total homebuilding

  2,059,559     1,885,044  
             

Financial services:

           

Cash and cash equivalents

  4,017     6,781  

Restricted cash and cash equivalents

  12,010     16,236  

Mortgage loans held for sale at fair value

  93,768     95,338  

Other assets

  1,868     1,988  

Total financial services

  111,663     120,343  

Income taxes receivable – including net deferred tax benefits

  290,213     284,543  

Total assets

  $2,461,435     $2,289,930  

 

(1)  Derived from the audited balance sheet as of October 31, 2014.

 

See notes to condensed consolidated financial statements (unaudited).

 

 
3

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands Except Share Amounts)

 

   

January 31,

2015

   

October 31,

2014

 
   

(Unaudited)

    (1)  

LIABILITIES AND EQUITY

           
             

Homebuilding:

           

Nonrecourse mortgages

  $100,638     $103,908  

Accounts payable and other liabilities

  337,060     370,876  

Customers’ deposits

  33,901     34,969  

Nonrecourse mortgages secured by operating properties

  16,350     16,619  

Liabilities from inventory not owned

  78,668     92,381  

Total homebuilding

  566,617     618,753  
             

Financial services:

           

Accounts payable and other liabilities

  17,895     22,278  

Mortgage warehouse lines of credit

  68,766     76,919  

Total financial services

  86,661     99,197  
             

Notes payable:

           

Senior secured notes, net of discount

  980,282     979,935  

Senior notes, net of discount

  840,657     590,472  

Senior amortizing notes

  14,987     17,049  

Senior exchangeable notes

  71,003     70,101  

Accrued interest

  31,212     32,222  

Total notes payable

  1,938,141     1,689,779  

Total liabilities

  2,591,419     2,407,729  
             

Stockholders’ equity deficit:

           

Preferred stock, $0.01 par value - authorized 100,000 shares; issued and outstanding 5,600 shares with a liquidation preference of $140,000 at January 31, 2015 and at October 31, 2014

  135,299     135,299  

Common stock, Class A, $0.01 par value – authorized 400,000,000 shares; issued 143,178,282 shares at January 31, 2015 and 142,836,563 shares at October 31, 2014 (including 11,760,763 shares at January 31, 2015 and October 31, 2014 held in Treasury)

  1,432     1,428  

Common stock, Class B, $0.01 par value (convertible to Class A at time of sale) – authorized 60,000,000 shares; issued 15,675,467 shares at January 31, 2015 and 15,497,543 shares at October 31, 2014 (including 691,748 shares at January 31, 2015 and October 31, 2014 held in Treasury)

  157     155  

Paid in capital – common stock

  700,128     697,943  

Accumulated deficit

  (851,640 )   (837,264

)

Treasury stock – at cost

  (115,360 )   (115,360

)

Total stockholders’ equity deficit

  (129,984 )   (117,799

)

Total liabilities and equity

  $2,461,435     $2,289,930  

 

(1) Derived from the audited balance sheet as of October 31, 2014.

 

See notes to condensed consolidated financial statements (unaudited).

 

 
4

 

  

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands Except Per Share Data)

(Unaudited)

 

   

Three Months Ended January 31,

 
   

2015

   

2014

 

Revenues:

           

Homebuilding:

           

Sale of homes

  $433,471     $355,181  

Land sales and other revenues

  1,121     773  

Total homebuilding

  434,592     355,954  

Financial services

  11,122     8,094  

Total revenues

  445,714     364,048  
             

Expenses:

           

Homebuilding:

           

Cost of sales, excluding interest

  354,812     288,887  

Cost of sales interest

  11,318     9,490  

Inventory impairment loss and land option write-offs

  2,230     664  

Total cost of sales

  368,360     299,041  

Selling, general and administrative

  47,646     43,962  

Total homebuilding expenses

  416,006     343,003  
             

Financial services

  7,317     6,672  

Corporate general and administrative

  16,908     16,392  

Other interest

  25,071     23,333  

Other operations

  1,544     1,109  

Total expenses

  466,846     390,509  

Income from unconsolidated joint ventures

  1,452     2,571  

Loss before income taxes

  (19,680 )   (23,890

)

State and federal income tax provision (benefit):

           

State

  3,132     633  

Federal

  (8,436 )   -  

Total income taxes

  (5,304 )   633  

Net loss

  $(14,376 )   $(24,523

)

             

Per share data:

           

Basic:

           

Loss per common share

  $(0.10 )   $(0.17

)

Weighted-average number of common shares outstanding

  146,929     145,982  

Assuming dilution:

           

Loss per common share

  $(0.10 )   $(0.17

)

Weighted-average number of common shares outstanding

  146,929     145,982  

 

See notes to condensed consolidated financial statements (unaudited).

 

 
5

 

   

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENT OF EQUITY

(In Thousands Except Share Amounts)

(Unaudited)

 

   

A Common Stock

   

B Common Stock

   

Preferred Stock

                         
   

Shares Issued and Outstanding

   

Amount

   

Shares Issued and Outstanding

   

Amount

   

Shares Issued and Outstanding

   

Amount

   

Paid-In

Capital

   

Accumulated Deficit

   

Treasury Stock

   

Total

 
                                                             

Balance, October 31, 2014

  131,075,800     $1,428     14,805,795     $155     5,600     $135,299     $697,943     $(837,264

)

  $(115,360

)

  $(117,799

)

                                                             

Stock options, amortization and issuances

                                      893                 893  
                                                             

Restricted stock amortization, issuances and forfeitures

  341,619     4     178,024     2                 1,292                 1,298  
                                                             

Conversion of Class B to Class A Common Stock

  100           (100 )                                       -  
                                                             

Net loss

                                            (14,376 )         (14,376 )
                                                             

Balance, January 31, 2015

  131,417,519     $1,432     14,983,719     $157     5,600     $135,299     $700,128     $(851,640 )   $(115,360 )   $(129,984 )

 

See notes to condensed consolidated financial statements (unaudited).

 

 
6

 

   

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

   

Three Months Ended

 
   

January 31,

 
   

2015

   

2014

 

Cash flows from operating activities:

           

Net loss

  $(14,376

)

  $(24,523

)

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

           

Depreciation

  849     853  

Compensation from stock options and awards

  3,500     3,530  

Amortization of bond discounts and deferred financing costs

  2,863     2,380  

Gain on sale and retirement of property and assets

  (168

)

  (5

)

Income from unconsolidated joint ventures

  (1,452

)

  (2,571

)

Distributions of earnings from unconsolidated joint ventures

  3,040     249  

Inventory impairment and land option write-offs

  2,230     664  

Deferred income tax benefit

  (5,945

)

  -  

Decrease (increase) in assets:

           

Mortgage loans held for sale at fair value

  1,570     55,576  

Restricted cash, receivables, prepaids, deposits and other assets

  (6,495

)

  10,018  

Inventories

  (139,896

)

  (131,834

)

Increase (decrease) in liabilities:

           

State income tax payable

  275     227  

Customers’ deposits

  (1,068

)

  1,874  

Accounts payable, accrued interest and other accrued liabilities

  (40,544

)

  (47,490

)

Net cash (used in) operating activities

  (195,617

)

  (131,052

)

Cash flows from investing activities:

           

Proceeds from sale of property and assets

  168     5  

Purchase of property, equipment and other fixed assets and acquisitions

  (879

)

  (95

)

Decrease (increase) in restricted cash related to mortgage company

  387     (343

)

Investments in and advances to unconsolidated joint ventures

  (11,735

)

  (116

)

Distributions of capital from unconsolidated joint ventures

  627     553  

Net cash (used in) provided by investing activities

  (11,432

)

  4  

Cash flows from financing activities:

           

Proceeds from mortgages and notes

  30,908     24,110  

Payments related to mortgages and notes

  (34,227

)

  (16,094

)

Proceeds from model sale leaseback financing programs

  -     6,043  

Payments related to model sale leaseback financing programs

  (5,802

)

  (1,175

)

Proceeds from land bank financing program

  3,131     926  

Payments related to land bank financing program

  (10,334

)

  (9,031

)

Proceeds from senior notes

  250,000     150,000  

Net payments related to mortgage warehouse lines of credit

  (8,153

)

  (57,846

)

Deferred financing cost from land bank financing program and note issuances

  (5,011

)

  (3,291

)

Principal payments and debt repurchases

  (2,062

)

  (2,913

)

Net cash provided by financing activities

  218,450     90,729  

Net increase (decrease) in cash and cash equivalents

  11,401     (40,319

)

Cash and cash equivalents balance, beginning of period

  261,898     329,204  

Cash and cash equivalents balance, end of period

  $273,299     $288,885  

 

 
7

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands - Unaudited)

(Continued)

 

 

   

Three Months Ended

 
   

January 31,

 
   

2015

   

2014

 

Supplemental disclosure of cash flow:

           

Cash paid during the period for:

           

Interest, net of capitalized interest (see Note 3 to the Condensed Consolidated Financial Statements)

  $26,489     $25,353  

Income taxes

  $366     $406  

 

 

See notes to condensed consolidated financial statements (unaudited).

 

 
8

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED

 

1.

Basis of Presentation

 

Hovnanian Enterprises, Inc. and Subsidiaries (the "Company”, “we”, “us” or “our”) has reportable segments consisting of six Homebuilding segments (Northeast, Mid-Atlantic, Midwest, Southeast, Southwest and West) and the Financial Services segment (see Note 17).

 

The accompanying unaudited Condensed Consolidated Financial Statements include our accounts and those of all wholly-owned subsidiaries after elimination of all significant intercompany balances and transactions. 

 

The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X and should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended October 31, 2014. In the opinion of management, all adjustments for interim periods presented have been made, which include normal recurring accruals and deferrals necessary for a fair presentation of our condensed consolidated financial position, results of operations and cash flows. The preparation of Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, and these differences could have a significant impact on the Condensed Consolidated Financial Statements. Results for interim periods are not necessarily indicative of the results which might be expected for a full year. The balance sheet at October 31, 2014 has been derived from the audited Consolidated Financial Statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements.

 

2.

Stock Compensation

 

For both the three months ended January 31, 2015 and 2014, the Company’s total stock-based compensation expense was $3.5 million ($2.6 million net of tax for the three months ended January 31, 2015). Included in this total stock-based compensation expense was the vesting of stock options of $0.9 million and $1.0 million for the three months ended January 31, 2015 and 2014, respectively.

 

3.

Interest

 

Interest costs incurred, expensed and capitalized were:

 

   

Three Months Ended

January 31,

 

(In thousands)

 

2015

   

2014

 
             

Interest capitalized at beginning of period

  $109,158     $105,093  

Plus interest incurred(1)

  41,472     34,819  

Less cost of sales interest expensed

  11,318     9,490  

Less other interest expensed(2)(3)

  25,071     23,333  

Interest capitalized at end of period(4)

  $114,241     $107,089  

 

(1) 

Data does not include interest incurred by our mortgage and finance subsidiaries.

(2)

Other interest expensed includes interest that does not qualify for interest capitalization because our assets that qualify for interest capitalization (inventory under development) do not exceed our debt. Also includes interest on completed homes and land in planning, which does not qualify for capitalization, and therefore is expensed.

(3)

Cash paid for interest, net of capitalized interest, is the sum of other interest expensed, as defined above, and interest paid by our mortgage and finance subsidiaries adjusted for the change in accrued interest on notes payable, which is calculated as follows:

 

 
9

 

 

   

Three Months Ended January 31,

 

(In thousands)

 

2015

   

2014

 

Other interest expensed

  $25,071     $23,333  

Interest paid by our mortgage and finance subsidiaries

  408     736  

Decrease in accrued interest

  1,010     1,284  

Cash paid for interest, net of capitalized interest

  $26,489     $25,353  

 

(4)

Capitalized interest amounts are shown gross before allocating any portion of impairments, if any, to capitalized interest.

 

4.

Reduction of Inventory to Fair Value

 

We record impairment losses on inventories related to communities under development and held for future development when events and circumstances indicate that they may be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their related carrying amounts. If the expected undiscounted cash flows are less than the carrying amount, then the community is written down to its fair value. We estimate the fair value of each impaired community by determining the present value of the estimated future cash flows at a discount rate commensurate with the risk of the respective community. In the first quarter of fiscal 2015, our discount rate used for the one impairment recorded was 19.0%. Should the estimates or expectations used in determining cash flows or fair value decrease or differ from current estimates in the future, we may need to recognize additional impairments. We did not record any impairment losses for the three months ended January 31, 2014.

 

During the three months ended January 31, 2015, we evaluated inventories of all 488 communities under development and held for future development for impairment indicators through preparation and review of detailed budgets or other market indicators of impairment. We performed detailed impairment calculations for five of those communities (i.e., those with a projected operating loss or other impairment indicators) with an aggregate carrying value of $20.2 million. Of those communities tested for impairment, three communities with an aggregate carrying value of $11.0 million had undiscounted future cash flow that only exceeded the carrying amount by less than 20%. As a result of our impairment analysis, we recorded an impairment loss for the three months ended January 31, 2015, which is included in the Condensed Consolidated Statement of Operations on the line entitled “Homebuilding: Inventory impairment loss and land option write-offs” and deducted from inventory, of $0.9 million, in one community in the Southeast with a pre-impairment value of $5.7 million. The pre-impairment value represents the carrying value, net of prior period impairments, if any, at the time of recording the impairment.

 

The Condensed Consolidated Statement of Operations line entitled “Homebuilding: Inventory impairment loss and land option write-offs” also includes write-offs of options and approval, engineering and capitalized interest costs that we record when we redesign communities and/or abandon certain engineering costs and we do not exercise options in various locations because the communities' pro forma profitability is not projected to produce adequate returns on investment commensurate with the risk. Total aggregate write-offs related to these items were $1.3 million and $0.7 million for the three months ended January 31, 2015 and 2014, respectively. Occasionally, these write-offs are offset by recovered deposits (sometimes through legal action) that had been written off in a prior period as walk-away costs. Historically, these recoveries have not been significant in comparison to the total costs written off. The number of lots walked away from during the three months ended January 31, 2015 and 2014 were 1,700 and 1,536, respectively, which lots were in all of our segments, with the majority in the Midwest and Southeast.

 

We decide to mothball (or stop development on) certain communities when we determine that the current performance does not justify further investment at the time. When we decide to mothball a community, the inventory is reclassified on our Condensed Consolidated Balance Sheets from “Sold and unsold homes and lots under development” to “Land and land options held for future development or sale.” During the first quarter of fiscal 2015, we did not mothball any new communities, or re-activate or sell any communities which were previously mothballed. As of January 31, 2015, the net book value associated with our 45 total mothballed communities was $104.2 million, which was net of impairment charges recorded in prior periods of $412.4 million.

 

From time to time we enter into option agreements that include specific performance requirements, whereby we are required to purchase a minimum number of lots. Because of our obligation to purchase these lots, for accounting purposes in accordance with Accounting Standards Codification (“ASC”) 360-20-40-38, we are required to record this inventory on our Condensed Consolidated Balance Sheets. As of January 31, 2015, we had $2.7 million of specific performance options recorded on our Condensed Consolidated Balance Sheets to “Consolidated inventory not owned – specific performance options,” with a corresponding liability of $2.7 million recorded to “Liabilities from inventory not owned.” 

 

We sell and lease back certain of our model homes with the right to participate in the potential profit when each home is sold to a third party at the end of the respective lease. As a result of our continued involvement, for accounting purposes in accordance with ASC 360-20-40-38, these sale and leaseback transactions are considered a financing rather than a sale. Therefore, for purposes of our Condensed Consolidated Balance Sheets, at January 31, 2015, inventory of $64.4 million was recorded to “Consolidated inventory not owned – other options,” with a corresponding amount of $59.1 million recorded to “Liabilities from inventory not owned” for the amount of net cash received from the transactions.

 

 
10

 

 

We have land banking arrangements, whereby we sell our land parcels to the land banker and they provide us an option to purchase back finished lots on a quarterly basis. Because of our options to repurchase these parcels, for accounting purposes, in accordance with ASC 360-20-40-38, these transactions are considered a financing rather than a sale. For purposes of our Condensed Consolidated Balance Sheets, at January 31, 2015, inventory of $23.0 million was recorded to “Consolidated inventory not owned – other options,” with a corresponding amount of $16.9 million recorded to “Liabilities from inventory not owned” for the amount of net cash received from the transactions.

 

5.

Variable Interest Entities

 

The Company enters into land and lot option purchase contracts to procure land or lots for the construction of homes. Under these contracts, the Company will fund a stated deposit in consideration for the right, but not the obligation, to purchase land or lots at a future point in time with predetermined terms. Under the terms of the option purchase contracts, many of the option deposits are not refundable at the Company's discretion. Under the requirements of ASC 810, certain option purchase contracts may result in the creation of a variable interest in the entity (“VIE”) that owns the land parcel under option.

 

In compliance with ASC 810, the Company analyzes its option purchase contracts to determine whether the corresponding land sellers are VIEs and, if so, whether the Company is the primary beneficiary. Although the Company does not have legal title to the underlying land, ASC 810 requires the Company to consolidate a VIE if the Company is determined to be the primary beneficiary. In determining whether it is the primary beneficiary, the Company considers, among other things, whether it has the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance. Such activities would include, among other things, determining or limiting the scope or purpose of the VIE, selling or transferring property owned or controlled by the VIE, or arranging financing for the VIE. The Company also considers whether it has the obligation to absorb losses of the VIE or the right to receive benefits from the VIE. As a result of its analyses, the Company determined that as of January 31, 2015 and October 31, 2014, it was not the primary beneficiary of any VIEs from which it is purchasing land under option purchase contracts.

 

We will continue to secure land and lots using options, some of which are with VIEs. Including deposits on our unconsolidated VIEs, at January 31, 2015, we had total cash and letters of credit deposits amounting to $92.2 million to purchase land and lots with a total purchase price of $1.2 billion. The maximum exposure to loss with respect to our land and lot options is limited to the deposits plus any pre-development costs invested in the property, although some deposits are refundable at our request or refundable if certain conditions are not met.

 

6.

Warranty Costs

 

General liability insurance for homebuilding companies and their suppliers and subcontractors is very difficult to obtain. The availability of general liability insurance is limited due to a decreased number of insurance companies willing to underwrite for the industry. In addition, those few insurers willing to underwrite liability insurance have significantly increased the premium costs. To date, we have been able to obtain general liability insurance but at higher premium costs with higher deductibles. Our subcontractors and suppliers have advised us that they have also had difficulty obtaining insurance that also provides us coverage. As a result, we have an owner controlled insurance program for certain of our subcontractors whereby the subcontractors pay us an insurance premium (through a reduction of amounts we would otherwise owe such subcontractors for their work on our homes) based on the risk type of the trade. We absorb the liability associated with their work on our homes as part of our overall general liability insurance at no additional cost to us because our existing general liability and construction defect insurance policy and related reserves for amounts under our deductible covers construction defects regardless of whether we or our subcontractors are responsible for the defect. For the three months ended January 31, 2015 and 2014, we received $0.6 million and $0.4 million, respectively, from subcontractors related to the owner controlled insurance program, which we accounted for as a reduction to inventory.

 

 We accrue for warranty costs that are covered under our existing general liability and construction defect policy as part of our general liability insurance deductible. This accrual is expensed as selling, general and administrative costs. For homes delivered in fiscal 2015 and 2014, our deductible under our general liability insurance is $20 million per occurrence for construction defect and warranty claims. For bodily injury claims, our deductible per occurrence in fiscal 2015 and 2014 is $0.25 million, up to a $5 million limit. Our aggregate retention in fiscal 2015 and 2014 is $21 million for construction defect, warranty and bodily injury claims. In addition, we establish a warranty accrual for lower cost related issues to cover home repairs, community amenities and land development infrastructure that are not covered under our general liability and construction defect policy. We accrue an estimate for these warranty costs as part of cost of sales at the time each home is closed and title and possession have been transferred to the homebuyer. Additions and charges in the warranty reserve and general liability reserve for the three months ended January 31, 2015 and 2014 were as follows:

 

   

Three Months Ended

January 31,

 

(In thousands)

 

2015

   

2014

 
             

Balance, beginning of period

  $178,008     $131,028  

Additions – Selling, general and administrative

  5,249     4,541  

Additions – Cost of sales

  3,181     2,046  

Charges incurred during the period

  (4,605 )   (4,538 )

Changes to pre-existing reserves

  -     -  

Balance, end of period

  $181,833     $133,077  

 

 
11

 

 

Warranty accruals are based upon historical experience. We engage a third-party actuary that uses our historical warranty and construction defect data, worker’s compensation data and other industry data to assist us in estimating our reserves for unpaid claims, claim adjustment expenses and incurred but not reported claims reserves for the risks that we are assuming under the general liability and workers compensation programs. The estimates include provisions for inflation, claims handling, and legal fees.   

 

Insurance claims paid by our insurance carriers, excluding insurance deductibles paid, were $0.2 million and $2.9 million for the three months ended January 31, 2015 and 2014, respectively, for prior year deliveries. In the first quarter of fiscal 2014, we settled a construction defect claim relating to the West segment which made up the majority of the payments.

 

7.

Commitments and Contingent Liabilities

 

We are involved in litigation arising in the ordinary course of business, none of which is expected to have a material effect on our financial position, results of operations or cash flows, and we are subject to extensive and complex regulations that affect the development and home building, sales and customer financing processes, including zoning, density, building standards and mortgage financing. These regulations often provide broad discretion to the administering governmental authorities. This can delay or increase the cost of development or homebuilding.

 

We also are subject to a variety of local, state, federal and foreign laws and regulations concerning protection of health and the environment, including those regulating the emission or discharge of materials into the environment, the management of stormwater runoff at construction sites, the handling, use, storage and disposal of hazardous substances, impacts to wetlands and other sensitive environments, and the remediation of contamination at properties that we have owned or developed or currently own or are developing (“environmental laws”). The particular environmental laws that apply to any given community vary greatly according to the community site, the site’s environmental conditions and the present and former uses of the site. These environmental laws may result in delays, may cause us to incur substantial compliance, remediation and/or other costs, and can prohibit or severely restrict development and homebuilding activity. In addition, noncompliance with these laws and regulations could result in fines and penalties, obligations to remediate, permit revocations or other sanctions; and contamination or other environmental conditions at or in the vicinity of our developments may result in claims against us for personal injury, property damage or other losses.

 

 In March 2013, we received a letter from the Environmental Protection Agency (“EPA”) requesting information about our involvement in a housing redevelopment project in Newark, New Jersey that a Company entity undertook during the 1990s. We understand that the development is in the vicinity of a former lead smelter and that recent tests on soil samples from properties within the development conducted by the EPA show elevated levels of lead. We also understand that the smelter ceased operations many years before the Company entity involved acquired the properties in the area and carried out the re-development project. We responded to the EPA’s request. In August 2013, we were notified that the EPA considers us a potentially responsible party (or “PRP”) with respect to the site, that the EPA will clean up the site, and that the EPA is proposing that we fund and/or contribute towards the cleanup of the contamination at the site. We have begun preliminary discussions with the EPA concerning a possible resolution but do not know the scope or extent of the Company’s obligations, if any, that may arise from the site and therefore cannot provide any assurance that this matter will not have a material impact on the Company. The EPA requested additional information in April 2014 and the Company has responded to its information request.

  

We anticipate that increasingly stringent requirements will be imposed on developers and homebuilders in the future. Although we cannot reliably predict the extent of any effect these requirements may have on us, they could result in time-consuming and expensive compliance programs and in substantial expenditures, which could cause delays and increase our cost of operations. In addition, our ability to obtain or renew permits or approvals and the continued effectiveness of permits already granted or approvals already obtained is dependent upon many factors, some of which are beyond our control, such as changes in policies, rules and regulations and their interpretations and application. 

 

 
12

 

 

The Company is also involved in the following litigation:

 

Hovnanian Enterprises, Inc. and K. Hovnanian Venture I, L.L.C. (collectively, the “Company Defendants”) have been named as defendants in a class action suit. The action was filed by Mike D’Andrea and Tracy D’Andrea, on behalf of themselves and all others similarly situated in the Superior Court of New Jersey, Gloucester County. The action was initially filed on May 8, 2006 alleging that the HVAC systems installed in certain of the Company’s homes are in violation of applicable New Jersey building codes and are a potential safety issue. On December 14, 2011, the Superior Court granted class certification; the potential class is 1,065 homes. The Company Defendants filed a request to take an interlocutory appeal regarding the class certification decision. The Appellate Division denied the request, and the Company Defendants filed a request for interlocutory review by the New Jersey Supreme Court, which remanded the case back to the Appellate Division for a review on the merits of the appeal on May 8, 2012. The Appellate Division, on remand, heard oral arguments on December 4, 2012, reviewing the Superior Court’s original finding of class certification. On June 18, 2013, the Appellate Division affirmed class certification. On July 3, 2013, the Company Defendants appealed the June 2013 Appellate Division’s decision to the New Jersey Supreme Court, which elected not to hear the appeal on October 22, 2013. The plaintiff class was seeking unspecified damages as well as treble damages pursuant to the NJ Consumer Fraud Act. The Company Defendants’ motion to consolidate an indemnity action they filed against various manufacturer and sub-contractor defendants to require these parties to participate directly in the class action was denied by the Superior Court; however, the Company Defendants’ separate action seeking indemnification against the various manufacturers and subcontractors implicated by the class action is ongoing. The Company Defendants, the Company Defendants’ insurance carriers and the plaintiff class agreed to the terms of a settlement on May 15, 2014 in which the plaintiff class was to receive a payment of $21 million in settlement of all claims, with the majority of the settlement being funded by the Company Defendants’ insurance carriers. The Company had previously reserved for its share of the settlement. The Superior Court approved the settlement agreement on December 23, 2014, and the judgment became final on February 20, 2015, when no appeal was taken. The settlement amount was paid in full and the class action matter is now concluded.

 

8.

Restricted Cash and Deposits

 

Cash represents cash deposited in checking accounts. Cash equivalents include certificates of deposit, Treasury bills and government money–market funds with maturities of 90 days or less when purchased. Our cash balances are held at a few financial institutions and may, at times, exceed insurable amounts. We believe we help to mitigate this risk by depositing our cash in major financial institutions. At January 31, 2015 and October 31, 2014, $15.3 million and $15.4 million, respectively, of the total cash and cash equivalents was in cash equivalents, the book value of which approximates fair value.

 

Restricted cash and cash equivalents on the Condensed Consolidated Balance Sheets totaled $24.5 million and $29.3 million as of January 31, 2015 and October 31, 2014, respectively, which includes cash collateralizing our letter of credit agreements and facilities and is discussed in Note 10. Also included in this balance are homebuilding and financial services customers’ deposits of $7.4 million and $12.0 million at January 31, 2015, respectively, and $7.5 million and $15.8 million as of October 31, 2014, respectively, which are restricted from use by us.

 

Total Homebuilding Customers’ deposits are shown as a liability on the Condensed Consolidated Balance Sheets. These liabilities are significantly more than the applicable periods’ restricted cash balances because in some states, the deposits are not restricted from use and, in other states, we are able to release the majority of these customer deposits to cash by pledging letters of credit and surety bonds.

 

9.

Mortgage Loans Held for Sale

 

Our mortgage banking subsidiary originates mortgage loans, primarily from the sale of our homes. Such mortgage loans are sold in the secondary mortgage market within a short period of time of origination. Mortgage loans held for sale consist primarily of single-family residential loans collateralized by the underlying property. We have elected the fair value option to record loans held for sale and therefore these loans are recorded at fair value with the changes in the value recognized in the Condensed Consolidated Statements of Operations in “Revenues: Financial services.” We currently use forward sales of mortgage-backed securities (“MBS”), interest rate commitments from borrowers and mandatory and/or best efforts forward commitments to sell loans to third-party purchasers to protect us from interest rate fluctuations. These short-term instruments, which do not require any payments to be made to the counterparty or purchaser in connection with the execution of the commitments, are recorded at fair value. Gains and losses on changes in the fair value are recognized in the Condensed Consolidated Statements of Operations in “Revenues: Financial services.”

 

At January 31, 2015 and October 31, 2014, $71.2 million and $78.6 million, respectively, of mortgages held for sale were pledged against our mortgage warehouse lines of credit (see Note 10). We may incur losses with respect to mortgages that were previously sold that are delinquent and which had underwriting defects, but only to the extent the losses are not covered by mortgage insurance or resale value of the home. The reserves for these estimated losses are included in the “Financial services – Accounts payable and other liabilities” balances on the Condensed Consolidated Balance Sheets. As of January 31, 2015 and 2014, we had reserves specifically for 131 and 201 identified mortgage loans, respectively, as well as reserves for an estimate for future losses on mortgages sold but not yet identified to us.

 

 
13

 

 

The activity in our loan origination reserves during the three months ended January 31, 2015 and 2014 was as follows:

 

   

Three Months Ended

 
   

January 31,

 

(In thousands)

 

2015

   

2014

 
             

Loan origination reserves, beginning of period

  $7,352     $11,036  

Provisions for losses during the period

  61     401  

Adjustments to pre-existing provisions for losses from changes in estimates

  568     (559 )

Payments/settlements

  -     (159 )

Loan origination reserves, end of period

  $7,981     $10,719  

 

10.

Mortgages and Notes Payable

 

We have nonrecourse mortgage loans for certain communities totaling $100.6 million and $103.9 million at January 31, 2015 and October 31, 2014, respectively, which are secured by the related real property, including any improvements, with an aggregate book value of approximately $253.3 million and $220.1 million, respectively. The weighted-average interest rate on these obligations was 5.0% at both January 31, 2015 and October 31, 2014, and the mortgage loan payments on each community primarily correspond to home deliveries. We also have nonrecourse mortgage loans on our corporate headquarters totaling $16.3 million and $16.6 million at January 31, 2015 and October 31, 2014, respectively. These loans had a weighted-average interest rate of 8.7% and 7.0% at January 31, 2015 and October 31, 2014, respectively. As of January 31, 2015, these loans had installment obligations with annual principal maturities in the years ending October 31 of approximately: $0.8 million in 2015, $1.2 million in 2016, $1.3 million in 2017, $1.4 million in 2018, $1.5 million in 2019 and $10.1 million after 2019.

  

 In June 2013, K. Hovnanian Enterprises, Inc. (“K. Hovnanian”), as borrower, and we and certain of our subsidiaries, as guarantors, entered into a five-year, $75.0 million unsecured revolving credit facility (the “Credit Facility”) with Citicorp USA, Inc., as administrative agent and issuing bank, and Citibank, N.A., as a lender. The Credit Facility is available for both letters of credit and general corporate purposes. The Credit Facility does not contain any financial maintenance covenants, but does contain certain restrictive covenants that track those contained in our indenture governing the 8.0% Senior Notes due 2019, which are described in Note 11. The Credit Facility also contains certain customary events of default which would permit the administrative agent at the request of the required lenders to, among other things, declare all loans then outstanding to be immediately due and payable if such default is not cured within applicable grace periods, including the failure to make timely payments of amounts payable under the Credit Facility or other material indebtedness or the acceleration of other material indebtedness, the failure to comply with agreements and covenants or for representations or warranties to be correct in all material respects when made, specified events of bankruptcy and insolvency, and the entry of a material judgment against a loan party. Outstanding borrowings under the Credit Facility accrue interest at an annual rate equal to either, as selected by K. Hovnanian, (i) the alternate base rate plus the applicable spread determined on the date of such borrowing or (ii) an adjusted London Interbank Offered Rate (“LIBOR”) rate plus the applicable spread determined as of the date two business days prior to the first day of the interest period for such borrowing. As of January 31, 2015 and October 31, 2014, there were no borrowings and $24.0 million and $26.5 million, respectively, of letters of credit outstanding under the Credit Facility. As of January 31, 2015, we believe we were in compliance with the covenants under the Credit Facility.

 

In addition to the Credit Facility, we have certain stand–alone cash collateralized letter of credit agreements and facilities under which there were a total of $4.6 million and $5.5 million letters of credit outstanding at January 31, 2015 and October 31, 2014, respectively. These agreements and facilities require us to maintain specified amounts of cash as collateral in segregated accounts to support the letters of credit issued thereunder, which will affect the amount of cash we have available for other uses. As of January 31, 2015 and October 31, 2014, the amount of cash collateral in these segregated accounts was $5.1 million and $5.6 million, respectively, which is reflected in “Restricted cash and cash equivalents” on the Condensed Consolidated Balance Sheets.

 

Our wholly owned mortgage banking subsidiary, K. Hovnanian American Mortgage, LLC (“K. Hovnanian Mortgage”), originates mortgage loans primarily from the sale of our homes. Such mortgage loans and related servicing rights are sold in the secondary mortgage market within a short period of time. In certain instances, we retain the servicing rights for a small amount of loans. Our secured Master Repurchase Agreement with JPMorgan Chase Bank, N.A. (“Chase Master Repurchase Agreement”), which was amended on January 30, 2015, is a short-term borrowing facility that provides up to $50.0 million through January 30, 2016. The loan is secured by the mortgages held for sale and is repaid when we sell the underlying mortgage loans to permanent investors. Interest is payable monthly on outstanding advances at an adjusted LIBOR rate, which was 0.17% at January 31, 2015, plus the applicable margin of 2.75%. Therefore, at January 31, 2015, the interest rate was 2.92%. As of January 31, 2015 and October 31, 2014, the aggregate principal amount of all borrowings outstanding under the Chase Master Repurchase Agreement was $46.0 million and $25.5 million, respectively.

   

 
14

 

 

K. Hovnanian Mortgage has another secured Master Repurchase Agreement with Customers Bank (“Customers Master Repurchase Agreement”), which was amended on May 27, 2014 to extend the maturity date to May 26, 2015, that is a short-term borrowing facility that provides up to $37.5 million through maturity. The loan is secured by the mortgages held for sale and is repaid when we sell the underlying mortgage loans to permanent investors. Interest is payable daily or as loans are sold to permanent investors on outstanding advances at the current LIBOR, plus the applicable margin ranging from 2.75% to 5.25% based on the takeout investor, type of loan, and the number of days on the warehouse line. There were no outstanding borrowings under the Customers Master Repurchase Agreement as of January 31, 2015, however, as of October 31, 2014, the aggregate principal amount of all borrowings outstanding under the Customers Master Repurchase Agreement was $20.4 million.

 

K. Hovnanian Mortgage has a third secured Master Repurchase Agreement with Credit Suisse First Boston Mortgage Capital LLC (“Credit Suisse Master Repurchase Agreement”), which was last amended on November 17, 2014, that is a short-term borrowing facility that provides up to $50.0 million through October 27, 2015. The facility also provides an additional $30.0 million which can be used between 10 calendar days prior to the end of a fiscal quarter through the 45th calendar day after a fiscal quarter end; provided that the amount outstanding may not exceed $50.0 million outside of this date range. The loan is secured by the mortgages held for sale and is repaid when we sell the underlying mortgage loans to permanent investors. Interest is payable monthly on outstanding advances at the Credit Suisse Cost of Funds, which was 0.46% at January 31, 2015, plus the applicable margin ranging from 2.25% to 2.75% based on the takeout investor, type of loan and the number of days outstanding. There were no outstanding borrowings under the Credit Suisse Master Repurchase Agreement as of January 31, 2015, however, as of October 31, 2014, the aggregate principal amount of all borrowings outstanding under the Credit Suisse Master Repurchase Agreement was $19.7 million.

 

In February 2014, K. Hovnanian Mortgage executed a secured Master Repurchase Agreement with Comerica Bank (“Comerica Master Repurchase Agreement”), which was amended on December 30, 2014 to extend the maturity date to December 29, 2015, that is a short-term borrowing facility that provides up to $35.0 million through maturity. The loan is secured by the mortgages held for sale and is repaid when we sell the underlying mortgage loans to permanent investors. Interest is payable monthly at LIBOR, subject to a floor of 0.25%, plus the applicable margin of 2.625%. As of January 31, 2015 and October 31, 2014, the interest rate was 2.875% and the aggregate principal amount of all borrowings outstanding under the Comerica Master Repurchase Agreement was $22.8 million and $11.3 million, respectively.

 

The Chase Master Repurchase Agreement, Customers Master Repurchase Agreement, Credit Suisse Master Repurchase Agreement and Comerica Master Repurchase Agreement (together, the “Master Repurchase Agreements”) require K. Hovnanian Mortgage to satisfy and maintain specified financial ratios and other financial condition tests. Because of the extremely short period of time mortgages are held by K. Hovnanian Mortgage before the mortgages are sold to investors (generally a period of a few weeks), the immateriality to us on a consolidated basis of the size of the Master Repurchase Agreements, the levels required by these financial covenants, our ability based on our immediately available resources to contribute sufficient capital to cure any default, were such conditions to occur, and our right to cure any conditions of default based on the terms of the agreement, we do not consider any of these covenants to be substantive or material. As of January 31, 2015, we believe we were in compliance with the covenants under the Master Repurchase Agreements.

 

11.

Senior Secured, Senior, Senior Amortizing and Senior Exchangeable Notes

 

Senior Secured, Senior, Senior Amortizing and Senior Exchangeable Notes balances as of January 31, 2015 and October 31, 2014, were as follows:

             

(In thousands)

 

January 31, 2015

   

October 31, 2014

 

Senior Secured Notes:

           

7.25% Senior Secured First Lien Notes due October 15, 2020

  $577,000     $577,000  

9.125% Senior Secured Second Lien Notes due November 15, 2020

  220,000     220,000  

2.0% Senior Secured Notes due November 1, 2021 (net of discount)

  53,131     53,129  

5.0% Senior Secured Notes due November 1, 2021 (net of discount)

  130,151     129,806  

Total Senior Secured Notes

  $980,282     $979,935  

Senior Notes:

           

11.875% Senior Notes due October 15, 2015 (net of discount)

  60,514     60,414  

6.25% Senior Notes due January 15, 2016 (net of discount)

  172,568     172,483  

7.5% Senior Notes due May 15, 2016

  86,532     86,532  

8.625% Senior Notes due January 15, 2017

  121,043     121,043  

7.0% Senior Notes due January 15, 2019

  150,000     150,000  

8.0% Senior Notes due November 1, 2019

  250,000     -  

Total Senior Notes

  $840,657     $590,472  

11.0% Senior Amortizing Notes due December 1, 2017

  $14,987     $17,049  

Senior Exchangeable Notes due December 1, 2017

  $71,003     $70,101  

 

 
15

 

 

Except for K. Hovnanian, the issuer of the notes, our home mortgage subsidiaries, joint ventures and subsidiaries holding interests in our joint ventures, certain of our title insurance subsidiaries and our foreign subsidiary, we and each of our subsidiaries are guarantors of the senior secured, senior, senior amortizing and senior exchangeable notes outstanding at January 31, 2015 (see Note 21). In addition, the 5.0% Senior Secured Notes due 2021 (the “5.0% 2021 Notes”) and the 2.0% Senior Secured Notes due 2021 (the “2.0% 2021 Notes” and together with the 5.0% 2021 Notes, the “2021 Notes”) are guaranteed by K. Hovnanian JV Holdings, L.L.C. and its subsidiaries except for certain joint ventures and joint venture holding companies (collectively, the “Secured Group”). Members of the Secured Group do not guarantee K. Hovnanian's other indebtedness.  

 

The indentures governing the notes do not contain any financial maintenance covenants, but do contain restrictive covenants that limit, among other things, the Company’s ability and that of certain of its subsidiaries, including K. Hovnanian, to incur additional indebtedness (other than certain permitted indebtedness, refinancing indebtedness and nonrecourse indebtedness), pay dividends and make distributions on common and preferred stock, repurchase subordinated indebtedness (with respect to certain of the senior secured and senior notes), make other restricted payments, make investments, sell certain assets, incur liens, consolidate, merge, sell or otherwise dispose of all or substantially all assets, and enter into certain transactions with affiliates. The indentures also contain events of default which would permit the holders of the notes to declare the notes to be immediately due and payable if not cured within applicable grace periods, including the failure to make timely payments on the notes or other material indebtedness, the failure to comply with agreements and covenants and specified events of bankruptcy and insolvency and, with respect to the indentures governing the senior secured notes, the failure of the documents granting security for the senior secured notes to be in full force and effect, and the failure of the liens on any material portion of the collateral securing the senior secured notes to be valid and perfected. As of January 31, 2015, we believe we were in compliance with the covenants of the indentures governing our outstanding notes.

 

Under the terms of the indentures, we have the right to make certain redemptions and, depending on market conditions and covenant restrictions, may do so from time to time. We also continue to evaluate our capital structure and may also continue to make debt purchases and/or exchanges for debt or equity from time to time through tender offers, open market purchases, private transactions, or otherwise, or seek to raise additional debt or equity capital, depending on market conditions and covenant restrictions.

 

If our consolidated fixed charge coverage ratio, as defined in the indentures governing our senior secured and senior notes (other than the senior exchangeable notes discussed in Note 12 below), is less than 2.0 to 1.0, we are restricted from making certain payments, including dividends, and from incurring indebtedness other than certain permitted indebtedness, refinancing indebtedness, and nonrecourse indebtedness. As a result of this restriction, we are currently restricted from paying dividends, which are not cumulative, on our 7.625% Series A Preferred Stock. We anticipate that we will continue to be restricted from paying dividends for the foreseeable future. Our inability to pay dividends is in accordance with covenant restrictions and will not result in a default under our debt instruments or otherwise affect compliance with any of the covenants contained in our debt instruments.

 

The 7.25% Senior Secured First Lien Notes due 2020 (the “First Lien Notes”) are secured by a first-priority lien and the 9.125% Senior Secured Second Lien Notes due 2020 (the “Second Lien Notes” and, together with the First Lien Notes, the “2020 Secured Notes”) are secured by a second-priority lien, in each case, subject to permitted liens and other exceptions, on substantially all the assets owned by us, K. Hovnanian and the guarantors of such notes. At January 31, 2015, the aggregate book value of the real property that constituted collateral securing the 2020 Secured Notes was approximately $738.9 million, which does not include the impact of inventory investments, home deliveries or impairments thereafter and which may differ from the value if it were appraised. In addition, cash and cash equivalents collateral that secured the 2020 Secured Notes was $233.6 million as of January 31, 2015, which included $5.1 million of restricted cash collateralizing certain letters of credit. Subsequent to such date, cash uses include general business operations and real estate and other investments.

 

 
16

 

 

The guarantees with respect to the 2021 Notes of the Secured Group are secured, subject to permitted liens and other exceptions, by a first-priority lien on substantially all of the assets of the members of the Secured Group. As of January 31, 2015, the collateral securing the guarantees included (1) $40.8 million of cash and cash equivalents (subsequent to such date, cash uses include general business operations and real estate and other investments); (2) approximately $131.1 million aggregate book value of real property of the Secured Group, which does not include the impact of inventory investments, home deliveries or impairments thereafter and which may differ from the value if it were appraised, and (3) equity interests in guarantors that are members of the Secured Group. Members of the Secured Group also own equity in joint ventures, either directly or indirectly through ownership of joint venture holding companies, with a book value of $69.2 million as of January 31, 2015; this equity is not pledged to secure, and is not collateral for, the 2021 Notes. Members of the Secured Group are “unrestricted subsidiaries” under K. Hovnanian's other senior notes and senior secured notes, and thus have not guaranteed such indebtedness. 

 

On January 10, 2014, K. Hovnanian issued $150.0 million aggregate principle amount of 7.0% Senior Notes due 2019, resulting in net proceeds of approximately $147.8 million. The notes are redeemable in whole or in part at our option at any time prior to July 15, 2016 at 100% of their principal amount plus an applicable “Make-Whole Amount.” We may also redeem some or all of the notes at 103.5% of principal commencing July 15, 2016, at 101.75% of principal commencing January 15, 2017 and 100% of principal commencing January 15, 2018. In addition, we may redeem up to 35% of the aggregate principal amount of the notes prior to July 15, 2016 with the net cash proceeds from certain equity offerings at 107.0% of principal. We used a portion of the net proceeds to fund the redemption on February 9, 2014 (effected on February 10, 2014 which was the next business day after the redemption date) of the remaining outstanding principal amount ($21.4 million) of our 6.25% Senior Notes due 2015. The redemption resulted in a loss on extinguishment of debt of $1.2 million, net of the write-off of unamortized fees, and was included in the Condensed Consolidated Statement of Operations as “Loss on extinguishment of debt” in the second quarter of fiscal 2014. The remaining net proceeds from the offering were used to pay related fees and expenses and for general corporate purposes.

 

On November 5, 2014, K. Hovnanian issued $250.0 million aggregate principal amount of 8.0% Senior Notes due 2019, resulting in net proceeds of $245.7 million. These proceeds were used for general corporate purposes. The notes will mature on November 1, 2019. The notes are redeemable in whole or in part at K. Hovnanian’s option at any time prior to August 1, 2019 at a redemption price equal to 100% of their principal amount plus an applicable “Make-Whole Amount.” At any time and from time to time on or after August 1, 2019, K. Hovnanian may also redeem some or all of the notes to a redemption price equal to 100% of their principal amount.

 

12.

Senior Exchangeable Notes

 

On October 2, 2012, the Company and K. Hovnanian issued $100,000,000 aggregate stated amount of 6.0% Exchangeable Note Units (the “Units”) (equivalent to 100,000 Units). Each $1,000 stated amount of Units initially consists of (1) a zero coupon senior exchangeable note due December 1, 2017 (a “Senior Exchangeable Note”) issued by K. Hovnanian, which bears no cash interest and has an initial principal amount of $768.51 per Senior Exchangeable Note, and that will accrete to $1,000 at maturity and (2) a senior amortizing note due December 1, 2017 (a “Senior Amortizing Note”) issued by K. Hovnanian, which has an initial principal amount of $231.49 per Senior Amortizing Note, bears interest at a rate of 11.0% per annum, and has a final installment payment date of December 1, 2017. Each Unit may be separated into its constituent Senior Exchangeable Note and Senior Amortizing Note after the initial issuance date of the Units, and the separate components may be combined to create a Unit.

 

Each Senior Exchangeable Note had an initial principal amount of $768.51 (which will accrete to $1,000 over the term of the Senior Exchangeable Note at an annual rate of 5.17% from the date of issuance, calculated on a semi-annual bond equivalent yield basis). Holders may exchange their Senior Exchangeable Notes at their option at any time prior to 5:00 p.m., New York City time, on the business day immediately preceding December 1, 2017. Each Senior Exchangeable Note will be exchangeable for shares of Class A Common Stock at an initial exchange rate of 185.5288 shares of Class A Common Stock per Senior Exchangeable Note (equivalent to an initial exchange price, based on $1,000 principal amount at maturity, of approximately $5.39 per share of Class A Common Stock). The exchange rate will be subject to adjustment in certain events. If certain corporate events occur prior to the maturity date, the Company will increase the applicable exchange rate for any holder who elects to exchange its Senior Exchangeable Notes in connection with such corporate event. In addition, holders of Senior Exchangeable Notes will also have the right to require K. Hovnanian to repurchase such holders’ Senior Exchangeable Notes upon the occurrence of certain of these corporate events. As of January 31, 2015, 18,305 Senior Exchangeable Notes have been converted into 3.4 million shares of our Class A Common Stock, all of which were converted during the first quarter of fiscal 2013.

 

 
17

 

 

On each June 1 and December 1 (each, an “installment payment date”), K. Hovnanian will pay holders of Senior Amortizing Notes equal semi-annual cash installments of $30.00 per Senior Amortizing Note (except for the June 1, 2013 installment payment, which was $39.83 per Senior Amortizing Note), which cash payment in the aggregate will be equivalent to 6.0% per year with respect to each $1,000 stated amount of Units. Each installment will constitute a payment of interest (at a rate of 11.0% per annum) and a partial repayment of principal on the Senior Amortizing Note. Following certain corporate events that occur prior to the maturity date, holders of the Senior Amortizing Notes will have the right to require K. Hovnanian to repurchase such holders’ Senior Amortizing Notes.

 

13.

Per Share Calculation

 

Basic earnings per share is computed by dividing net income (loss) (the “numerator”) by the weighted-average number of common shares outstanding, adjusted for nonvested shares of restricted stock (the “denominator”) for the period. The basic weighted–average number of shares for the three months ended January 31, 2014 included 6.1 million shares related to Purchase Contracts (issued as part of our then outstanding 7.25% Tangible Equity Units) which shares were issued upon settlement of the Purchase Contracts in February 2014. Computing diluted earnings per share is similar to computing basic earnings per share, except that the denominator is increased to include the dilutive effects of options and nonvested shares of restricted stock, as well as common shares issuable upon exchange of our Senior Exchangeable Notes issued as part of our 6.0% Exchangeable Note Units. Any options that have an exercise price greater than the average market price are considered to be anti-dilutive and are excluded from the diluted earnings per share calculation.   

 

All outstanding nonvested shares that contain nonforfeitable rights to dividends or dividend equivalents that participate in undistributed earnings with common stock are considered participating securities and are included in computing earnings per share pursuant to the two-class method. The two-class method is an earnings allocation formula that determines earnings per share for each class of common stock and participating securities according to dividends or dividend equivalents and participation rights in undistributed earnings in periods when we have net income. The Company’s restricted common stock (“nonvested shares”) are considered participating securities.

 

Incremental shares attributed to nonvested stock and outstanding options to purchase common stock of 0.3 million and 1.3 million for the three months ended January 31, 2015 and 2014, respectively, were excluded from the computation of diluted earnings per share because we had a net loss for the period, and any incremental shares would not be dilutive. Also, for both the three months ended January 31, 2015 and 2014, 15.2 million shares of common stock issuable upon the exchange of our Senior Exchangeable Notes (which were issued in fiscal 2012) were excluded from the computation of diluted earnings per share because we had net losses for the periods.

 

In addition, shares related to out-of-the money stock options that could potentially dilute basic earnings per share in the future that were not included in the computation of diluted earnings per share were 3.3 million and 2.2 million for the three months ended January 31, 2015 and 2014, respectively, because to do so would have been anti-dilutive for the periods presented.

 

14.

Preferred Stock

 

On July 12, 2005, we issued 5,600 shares of 7.625% Series A Preferred Stock, with a liquidation preference of $25,000 per share. Dividends on the Series A Preferred Stock are not cumulative and are paid at an annual rate of 7.625%. The Series A Preferred Stock is not convertible into the Company’s common stock and is redeemable in whole or in part at our option at the liquidation preference of the shares. The Series A Preferred Stock is traded as depositary shares, with each depositary share representing 1/1000th of a share of Series A Preferred Stock. The depositary shares are listed on the NASDAQ Global Market under the symbol “HOVNP.” During the three months ended January 31, 2015 and 2014, we did not pay any dividends on the Series A Preferred Stock due to covenant restrictions in our debt instruments.

 

15.

Common Stock

 

Each share of Class A Common Stock entitles its holder to one vote per share, and each share of Class B Common Stock generally entitles its holder to ten votes per share. The amount of any regular cash dividend payable on a share of Class A Common Stock will be an amount equal to 110% of the corresponding regular cash dividend payable on a share of Class B Common Stock. If a shareholder desires to sell shares of Class B Common Stock, such stock must be converted into shares of Class A Common Stock.

  

 
18

 

 

On August 4, 2008, our Board of Directors adopted a shareholder rights plan (the “Rights Plan”) designed to preserve shareholder value and the value of certain tax assets primarily associated with net operating loss (NOL) carryforwards and built-in losses under Section 382 of the Internal Revenue Code. Our ability to use NOLs and built-in losses would be limited if there was an “ownership change” under Section 382. This would occur if shareholders owning (or deemed under Section 382 to own) 5% or more of our stock increase their collective ownership of the aggregate amount of our outstanding shares by more than 50 percentage points over a defined period of time. The Rights Plan was adopted to reduce the likelihood of an “ownership change” occurring as defined by Section 382. Under the Rights Plan, one right was distributed for each share of Class A Common Stock and Class B Common Stock outstanding as of the close of business on August 15, 2008. Effective August 15, 2008, if any person or group acquires 4.9% or more of the outstanding shares of Class A Common Stock without the approval of the Board of Directors, there would be a triggering event causing significant dilution in the voting power of such person or group. However, existing stockholders who owned, at the time of the Rights Plan’s adoption, 4.9% or more of the outstanding shares of Class A Common Stock will trigger a dilutive event only if they acquire additional shares. The approval of the Board of Directors’ decision to adopt the Rights Plan may be terminated by the Board of Directors at any time, prior to the Rights being triggered. The Rights Plan will continue in effect until August 15, 2018, unless it expires earlier in accordance with its terms. The approval of the Board of Directors’ decision to adopt the Rights Plan was submitted to a stockholder vote and approved at a special meeting of stockholders held on December 5, 2008. Also at the Special Meeting on December 5, 2008, our stockholders approved an amendment to our Certificate of Incorporation to restrict certain transfers of Class A Common Stock in order to preserve the tax treatment of our NOLs and built-in losses under Section 382 of the Internal Revenue Code. Subject to certain exceptions pertaining to pre-existing 5% stockholders and Class B stockholders, the transfer restrictions in the amended Certificate of Incorporation generally restrict any direct or indirect transfer (such as transfers of our stock that result from the transfer of interests in other entities that own our stock) if the effect would be to (i) increase the direct or indirect ownership of our stock by any person (or public group) from less than 5% to 5% or more of our common stock; (ii) increase the percentage of our common stock owned directly or indirectly by a person (or public group) owning or deemed to own 5% or more of our common stock; or (iii) create a new public group. Transfers included under the transfer restrictions include sales to persons (or public groups) whose resulting percentage ownership (direct or indirect) of common stock would exceed the 5% thresholds discussed above, or to persons whose direct or indirect ownership of common stock would by attribution cause another person (or public group) to exceed such threshold.

 

On July 3, 2001, our Board of Directors authorized a stock repurchase program to purchase up to 4 million shares of Class A Common Stock. There were no shares purchased during the three months ended January 31, 2015. As of January 31, 2015, the maximum number of shares of Class A Common Stock that may yet be purchased under this program is 0.5 million.

 

16.

Income Taxes

 

The total income tax benefit of $5.3 million recognized for the three months ended January 31, 2015 was primarily due to deferred taxes partially offset by state tax expenses and state tax reserves for uncertain state tax positions. The total income tax expense of $0.6 million recognized for the three months ended January 31, 2014 was primarily due to state tax expenses and state tax reserves for uncertain state tax positions. 

 

 Deferred federal and state income tax assets primarily represent the deferred tax benefits arising from temporary differences between book and tax income which will be recognized in future years as an offset against future taxable income. If the combination of future years’ income (or loss) and the reversal of the timing differences results in a loss, such losses can be carried forward to future years. In accordance with ASC 740, we evaluate our deferred tax assets quarterly to determine if valuation allowances are required. ASC 740 requires that companies assess whether valuation allowances should be established based on the consideration of all available evidence using a “more likely than not” standard.  

 

As of October 31, 2014, and again at January 31, 2015, we concluded that it was more likely than not that a substantial amount of our deferred tax assets (“DTA”) would be utilized. This conclusion was based on a detailed evaluation of all relevant evidence, both positive and negative. The positive evidence included factors such as cumulative positive earnings over the last 33 months and the expectation of earnings going forward over the long term and evidence of a sustained recovery in the housing markets in which we operate. Such evidence is supported by significant increases in key financial indicators over the last few years, including new orders, revenues, gross margin, backlog, community count and deliveries compared with the prior years. Economic data has also been affirming the housing market recovery. Housing starts, homebuilding volume and prices are increasing and forecasted to continue to increase. Historically low mortgage rates, affordable home prices, reduced foreclosures and a favorable home ownership to rental comparison are key factors in the recovery.

 

Potentially offsetting this positive evidence, we are currently in a three year cumulative loss position as of January 31, 2015. As per ASC 740, cumulative losses are one of the most objectively verifiable forms of negative evidence. Thus, an entity that has suffered cumulative losses in recent years may find it difficult to support an assertion that a DTA could be realized if such an assertion is based on forecasts of future profitable results rather than an actual return to profitability. In other words, an entity that has cumulative losses generally should not use an estimate of future earnings to support a conclusion that realization of an existing DTA is more likely than not if such a forecast is not based on objectively verifiable information. An objectively verifiable estimate of future income in that instance would be based on operating results from the reporting entity's recent history.

 

 
19

 

 

We determined that the positive evidence noted above, including our two fiscal years of sustained operating profitability, outweighed the existing negative evidence and because of our current backlog, we expect to be in a three year cumulative income position in fiscal 2015. Given that ASC 740 suggests using recent historical operating results in the instance where a three year cumulative loss position still exists, we used our recent historical profit levels in projecting our pretax income over the future years in assessing the utilization of our existing DTAs. Therefore, we concluded that it is more likely than not that we will realize a substantial portion of our DTAs, and that a full valuation allowance is not necessary. This analysis resulted in a partial reversal equal to $285.1 million of our valuation allowance against DTAs at October 31, 2014, leaving a remaining valuation allowance of $642.0 million at October 31, 2014. Our valuation allowance for deferred taxes amounted to $642.5 million at January 31, 2015.

 

17.

Operating and Reporting Segments

 

Our operating segments are components of our business for which discrete financial information is available and reviewed regularly by the chief operating decision maker, our Chief Executive Officer, to evaluate performance and make operating decisions. Based on this criteria, each of our communities qualifies as an operating segment, and therefore, it is impractical to provide segment disclosures for this many segments. As such, we have aggregated the homebuilding operating segments into six reportable segments.

 

Our homebuilding operating segments are aggregated into reportable segments based primarily upon geographic proximity, similar regulatory environments, land acquisition characteristics and similar methods used to construct and sell homes. Our reportable segments consist of the following six homebuilding segments and a financial services segment:

 

Homebuilding:

 (1) Northeast (New Jersey and Pennsylvania)

 (2) Mid-Atlantic (Delaware, Maryland, Virginia, Washington D.C. and West Virginia)

 (3) Midwest (Illinois, Minnesota and Ohio)

 (4) Southeast (Florida, Georgia, North Carolina and South Carolina)

 (5) Southwest (Arizona and Texas)

 (6) West (California)

 

Financial Services

 

Operations of the Company’s Homebuilding segments primarily include the sale and construction of single-family attached and detached homes, attached townhomes and condominiums, urban infill and active adult homes in planned residential developments. In addition, from time to time, operations of the homebuilding segments include sales of land. Operations of the Company’s Financial Services segment include mortgage banking and title services provided to the homebuilding operations’ customers. We do not typically retain or service mortgages that we originate but rather sell the mortgages and related servicing rights to investors.

 

Corporate and unallocated primarily represents operations at our headquarters in Red Bank, New Jersey. This includes our executive offices, information services, human resources, corporate accounting, training, treasury, process redesign, internal audit, construction services, and administration of insurance, quality and safety. It also includes interest income and interest expense resulting from interest incurred that cannot be capitalized in inventory in the Homebuilding segments, as well as the gains or losses on extinguishment of debt from debt repurchases or exchanges.

 

Evaluation of segment performance is based primarily on operating earnings from continuing operations before provision for income taxes (“Income (loss) before income taxes”). Income (loss) before income taxes for the Homebuilding segments consist of revenues generated from the sales of homes and land, income (loss) from unconsolidated entities, management fees and other income, less the cost of homes and land sold, selling, general and administrative expenses, interest expense and non-controlling interest expense. Income before income taxes for the Financial Services segment consist of revenues generated from mortgage financing, title insurance and closing services, less the cost of such services and certain selling, general and administrative expenses incurred by the Financial Services segment.

 

Operational results of each segment are not necessarily indicative of the results that would have occurred had the segment been an independent stand-alone entity during the periods presented.

 

 
20

 

 

  Financial information relating to the Company’s segment operations was as follows:

 

   

Three Months Ended

 
   

January 31,

 

(In thousands)

 

2015

   

2014

 
             

Revenues:

           

Northeast

  $50,730     $53,253  

Mid-Atlantic

  81,185     60,520  

Midwest

  64,439     43,758  

Southeast

  37,894     39,141  

Southwest

  167,187     128,577  

West

  33,193     30,750  

Total homebuilding

  434,628     355,999  

Financial services

  11,122     8,094  

Corporate and unallocated

  (36 )   (45

)

Total revenues

  $445,714     $364,048  
             

(Loss) income before income taxes:

           

Northeast

  $(3,153 )   $(6,061

)

Mid-Atlantic

  5,177     1,913  

Midwest

  3,711     2,355  

Southeast

  (1,156 )   1,431  

Southwest

  11,325     10,405  

West

  (2,373 )   (359

)

Homebuilding income before income taxes

  13,531     9,684  

Financial services

  3,805     1,422  

Corporate and unallocated

  (37,016 )   (34,996

)

Loss before income taxes

  $(19,680 )   $(23,890

)

 

 

 

   

January 31,

   

October 31,

 

(In thousands)

 

2015

   

2014

 
             

Assets:

           

Northeast

  $314,941     $315,573  

Mid-Atlantic

  336,549     313,494  

Midwest

  176,218     169,967  

Southeast

  195,939     148,096  

Southwest

  427,782     410,756  

West

  199,819     143,245  

Total homebuilding

  1,651,248     1,501,131  

Financial services

  111,663     120,343  

Corporate and unallocated

  698,524     668,456  

Total assets

  $2,461,435     $2,289,930  

 

 
21

 

   

18.

Investments in Unconsolidated Homebuilding and Land Development Joint Ventures

 

We enter into homebuilding and land development joint ventures from time to time as a means of accessing lot positions, expanding our market opportunities, establishing strategic alliances, managing our risk profile, leveraging our capital base and enhancing returns on capital. Our homebuilding joint ventures are generally entered into with third-party investors to develop land and construct homes that are sold directly to third-party home buyers. Our land development joint ventures include those entered into with developers and other homebuilders as well as financial investors to develop finished lots for sale to the joint venture’s members or other third parties.

 

The tables set forth below summarize the combined financial information related to our unconsolidated homebuilding and land development joint ventures that are accounted for under the equity method.

 

(Dollars in thousands)

 

January 31, 2015

 
   

Homebuilding

   

Land Development

   

Total

 

Assets:

                 

Cash and cash equivalents

  $27,733     $253     $27,986  

Inventories

  293,675     15,934     309,609  

Other assets

  8,059     -     8,059  

Total assets

  $329,467     $16,187     $345,654  
                   

Liabilities and equity:

                 

Accounts payable and accrued liabilities

  $21,539     $1,086     $22,625  

Notes payable

  83,196     5,466     88,662  

Total liabilities

  104,735     6,552     111,287  

Equity of:

                 

Hovnanian Enterprises, Inc.

  69,200     3,013     72,213  

Others

  155,532     6,622     162,154  

Total equity

  224,732     9,635     234,367  

Total liabilities and equity

  $329,467     $16,187     $345,654  

Debt to capitalization ratio

  27

%

  36

%

  27

%

 

 

(Dollars in thousands)

 

October 31, 2014

 
   

Homebuilding

   

Land Development

   

Total

 

Assets:

                 

Cash and cash equivalents

  $22,415     $205     $22,620  

Inventories

  208,620     16,194     224,814  

Other assets

  11,986     -     11,986  

Total assets

  $243,021     $16,399     $259,420  
                   

Liabilities and equity:

                 

Accounts payable and accrued liabilities

  $27,175     $1,039     $28,214  

Notes payable

  45,506     5,650     51,156  

Total liabilities

  72,681     6,689     79,370  

Equity of:

                 

Hovnanian Enterprises, Inc.

  59,106     2,990     62,096  

Others

  111,234     6,720     117,954  

Total equity

  170,340     9,710     180,050  

Total liabilities and equity

  $243,021     $16,399     $259,420  

Debt to capitalization ratio

  21

%

  37

%

  22

%

 

As of January 31, 2015 and October 31, 2014, we had advances outstanding of approximately $1.2 million and $1.8 million, respectively, to these unconsolidated joint ventures, which were included in the “Accounts payable and accrued liabilities” balances in the tables above. On our Condensed Consolidated Balance Sheets, our “Investments in and advances to unconsolidated joint ventures” amounted to $73.4 million and $63.9 million at January 31, 2015 and October 31, 2014, respectively.

 

 
22

 

 

   

For the Three Months Ended January 31, 2015

 

(In thousands)

 

Homebuilding

   

Land Development

   

Total

 
                   

Revenues

  $28,045     $1,132     $29,177  

Cost of sales and expenses

  (26,517 )   (1,085 )   (27,602 )

Joint venture net income

  $1,528     $47     $1,575  

Our share of net income

  $1,467     $23     $1,490  

 

   

For the Three Months Ended January 31, 2014

 

(In thousands)

 

Homebuilding

   

Land Development

   

Total

 
                   

Revenues

  $51,275     $1,914     $53,189  

Cost of sales and expenses

  (46,080

)

  (1,619

)

  (47,699

)

Joint venture net income

  $5,195     $295     $5,490  

Our share of net income

  $2,548     $147     $2,695  

 

“Income from unconsolidated joint ventures” is reflected as a separate line in the accompanying Condensed Consolidated Statements of Operations and reflects our proportionate share of the income or loss of these unconsolidated homebuilding and land development joint ventures. The difference between our share of the income or loss from these unconsolidated joint ventures in the tables above compared to the Condensed Consolidated Statements of Operations for the three months ended January 31, 2015 and 2014, is due primarily to the reclassification of the intercompany portion of management fee income from certain joint ventures and the deferral of income for lots purchased by us from certain joint ventures. To compensate us for the administrative services we provide as the manager of certain joint ventures, we receive a management fee based on a percentage of the applicable joint venture’s revenues. These management fees, which totaled $1.2 million and $2.1 million, for the three months ended January 31, 2015 and 2014, respectively, are recorded in “Homebuilding: Selling, general and administrative” on the Condensed Consolidated Statement of Operations.

 

In determining whether or not we must consolidate joint ventures that we manage, we assess whether the other partners have specific rights to overcome the presumption of control by us as the manager of the joint venture. In most cases, the presumption is overcome because the joint venture agreements require that both partners agree on establishing the operations and capital decisions of the partnership, including budgets in the ordinary course of business.

 

Typically, our unconsolidated joint ventures obtain separate project specific mortgage financing. The amount of financing is generally targeted to be no more than 50% of the joint venture’s total assets. For some of our joint ventures, obtaining financing was challenging, therefore, some of our joint ventures are capitalized only with equity. Including the impact of impairments recorded by the joint ventures, the total debt to capitalization ratio of all our joint ventures is currently 27%. Any joint venture financing is on a nonrecourse basis, with guarantees from us limited only to performance and completion of development, environmental warranties and indemnification, standard indemnification for fraud, misrepresentation and other similar actions, including a voluntary bankruptcy filing. In some instances, the joint venture entity is considered a VIE under ASC 810-10 “Consolidation – Overall” due to the returns being capped to the equity holders; however, in these instances, we have determined that we are not the primary beneficiary, and therefore we do not consolidate these entities.

 

19.

Recent Accounting Pronouncements

 

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-04, “Receivables - Troubled Debt Restructurings by Creditors,” which clarifies when an in substance repossession or foreclosure of residential real estate property collateralizing a consumer mortgage loan has occurred. By doing so, this guidance helps determine when the creditor should derecognize the loan receivable and recognize the real estate property. The guidance was effective for the Company beginning November 1, 2015 and did not have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (Topic 606), (“ASU 2014-09”). ASU 2014-09 requires entities to recognize revenue that represents the transfer of promised goods or services to customers in an amount equivalent to the consideration to which the entity expects to be entitled to in exchange for those goods or services. The following steps should be applied to determine this amount: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2014-09 supersedes the revenue recognition requirements in ASU 605, “Revenue Recognition”, and most industry-specific guidance in the Accounting Standards Codification. ASU 2014-09 is effective for the Company beginning November 1, 2017. Early adoption is not permitted. We are currently evaluating the impact of adopting this guidance on our Condensed Consolidated Financial Statements.

 

 
23

 

 

In June 2014, the FASB issued ASU 2014-11, "Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures” (“ASU 2014-11”), which makes limited amendments to ASC 860, "Transfers and Servicing." ASU 2014-11 requires entities to account for repurchase-to-maturity transactions as secured borrowings, eliminates accounting guidance on linked repurchase financing transactions, and expands disclosure requirements related to certain transfers of financial assets. ASU 2014-11 is effective for the Company beginning February 1, 2015. Early adoption is not permitted. This guidance is not expected to have a material impact on the Company’s Condensed Consolidated Financial Statements.

 

In June 2014, the FASB issued ASU 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period” (“ASU 2014-12”). ASU 2014-12 requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. A reporting entity should apply existing guidance in ASC 718, “Compensation-Stock Compensation,” as it relates to awards with performance conditions that affect vesting to account for such awards. ASU 2014-12 is effective for the Company beginning November 1, 2015. Early adoption is permitted. We adopted ASU 2014-12 as of November 1, 2015, and the adoption did not have a material effect on our Condensed Consolidated Financial Statements.

 

In August 2014, the FASB issued Accounting Standards Update No. 2014-15, “Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern” (“ASU 2014-15”), which requires management to perform interim and annual assessments on whether there are conditions or events that raise substantial doubt about the entity’s ability to continue as a going concern within one year of the date the financial statements are issued and to provide related disclosures, if required. ASU 2014-15 is effective for the Company for our fiscal year ending October 31, 2017. Early adoption is permitted. We do not anticipate the adoption of ASU 2014-15 to have a material impact on the Company’s Condensed Consolidated Financial Statements. 

 

In February 2015, the FASB issued Accounting Standards Update No. 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis” (“ASU 2015-02”), which amends the consolidation requirements in ASC 810, primarily related to limited partnerships and VIEs. ASU 2015-02 is effective for the Company beginning on February 1, 2016. Early adoption is permitted. We do not anticipate the adoption of ASU 2015-02 to have a material impact on the Company’s Condensed Consolidated Financial Statements.  

 

20.

 Fair Value of Financial Instruments

 

ASC 820, “Fair Value Measurements and Disclosures,” provides a framework for measuring fair value, expands disclosures about fair-value measurements and establishes a fair-value hierarchy which prioritizes the inputs used in measuring fair value summarized as follows:

 

Level 1:                      Fair value determined based on quoted prices in active markets for identical assets.

 

Level 2:                      Fair value determined using significant other observable inputs.

 

Level 3:                      Fair value determined using significant unobservable inputs.

 

Our financial instruments measured at fair value on a recurring basis are summarized below:

 

(In thousands)

Fair Value Hierarchy

 

Fair Value at

January 31, 2015

   

Fair Value at

October 31, 2014

 
               

Mortgage loans held for sale (1)

Level 2

  $94,189     $95,643  

Interest rate lock commitments

Level 2

  281     15  

Forward contracts

Level 2

  (702 )   (320

)

      $93,768     $95,338  

 

(1)  The aggregate unpaid principal balance was $89.3 million and $91.2 million at January 31, 2015 and October 31, 2014, respectively.

 

We elected the fair value option for our loans held for sale for mortgage loans originated subsequent to October 31, 2008, in accordance with ASC 825, “Financial Instruments,” which permits us to measure financial instruments at fair value on a contract-by-contract basis. Management believes that the election of the fair value option for loans held for sale improves financial reporting by mitigating volatility in reported earnings caused by measuring the fair value of the loans and the derivative instruments used to economically hedge them without having to apply complex hedge accounting provisions. Fair value of loans held for sale is based on independent quoted market prices, where available, or the prices for other mortgage whole loans with similar characteristics.

 

 
24

 

 

The Financial Services segment had a pipeline of loan applications in process of $453.5 million at January 31, 2015. Loans in process for which interest rates were committed to the borrowers totaled approximately $54.7 million as of January 31, 2015. Substantially all of these commitments were for periods of 60 days or less. Since a portion of these commitments is expected to expire without being exercised by the borrowers, the total commitments do not necessarily represent future cash requirements.

 

The Financial Services segment uses investor commitments and forward sales of mandatory MBS to hedge its mortgage-related interest rate exposure. These instruments involve, to varying degrees, elements of credit and interest rate risk. Credit risk is managed by entering into MBS forward commitments, option contracts with investment banks, federally regulated bank affiliates and loan sales transactions with permanent investors meeting the segment’s credit standards. The segment’s risk, in the event of default by the purchaser, is the difference between the contract price and fair value of the MBS forward commitments and option contracts. At January 31, 2015, the segment had open commitments amounting to $18.0 million to sell MBS with varying settlement dates through February 19, 2015.

 

The assets accounted for using the fair value option are initially measured at fair value. Gains and losses from initial measurement and subsequent changes in fair value are recognized in the Financial Services segment’s income. The changes in fair values that are included in income are shown, by financial instrument and financial statement line item, below:

 

 

   

Three Months Ended January 31, 2015

 

(In thousands)

 

Mortgage

Loans Held

For Sale

   

Interest Rate

Lock

Commitments

   

Forward

Contracts

 
                   

Changes in fair value included in net loss all reflected in financial services revenues

  $60     $266     $(382 )

 

   

Three Months Ended January 31, 2014

 

(In thousands)

 

Mortgage

Loans Held

For Sale

   

Interest Rate

Lock

Commitments

   

Forward

Contracts

 
                   

Changes in fair value included in net loss all reflected in financial services revenues

  $(1,434

)

  $(120

)

  $87  

 

The Company’s assets measured at fair value on a nonrecurring basis are those assets for which the Company has recorded valuation adjustments and write-offs during the three months ended January 31, 2015. The company did not have any assets measured at fair value on a nonrecurring basis during the three months ended January 31, 2014. The assets measured at fair value on a nonrecurring basis are all within the Company’s Homebuilding operations and are summarized below:

 

Nonfinancial Assets

 

     

Three Months Ended

 
     

January 31, 2015

 
                     

(In thousands)

Fair Value

Hierarchy

 

Pre-

Impairment

Amount

   

Total Losses

   

Fair Value

 
                     

Sold and unsold homes and lots under development

Level 3

  $5,701     $(923 )   $4,778  

 

We record impairment losses on inventories related to communities under development and held for future development when events and circumstances indicate that they may be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their related carrying amounts. If the expected undiscounted cash flows are less than the carrying amount, then the community is written down to its fair value. We estimate the fair value of each impaired community by determining the present value of its estimated future cash flows at a discount rate commensurate with the risk of the respective community. Should the estimates or expectations used in determining cash flows or fair value decrease or differ from current estimates in the future, we may be required to recognize additional impairments. We recorded inventory impairments, which are included in the Condensed Consolidated Statements of Operations as “Inventory impairment loss and land option write-offs” and deducted from Inventory of $0.9 million for the three months ended January 31, 2015. We did not record any inventory impairments for the three months ended January 31, 2014.

 

 
25

 

 

The fair value of our cash equivalents and restricted cash approximates their carrying amount, based on Level 1 inputs.

 

The fair value of each series of the senior unsecured notes (other than the 7.0% Senior Notes due 2019, (the “2019 Notes”) the senior exchangeable notes and the senior amortizing notes) is estimated based on recent trades or quoted market prices for the same issues or based on recent trades or quoted market prices for our debt of similar security and maturity to achieve comparable yields, which are Level 2 measurements. The fair value of the senior unsecured notes (all series in the aggregate), other than the 2019 Notes, senior exchangeable notes and senior amortizing notes, was estimated at $688.8 million and $464.4 million as of January 31, 2015 and October 31, 2014, respectively.

 

The fair value of each of the 2019 Notes, the senior secured notes (all series in the aggregate), the senior amortizing notes and the senior exchangeable notes is estimated based on third party broker quotes, a Level 3 measurement. The fair value of the 2019 Notes, senior secured notes (all series in the aggregate), the senior amortizing notes and the senior exchangeable notes was estimated at $139.5 million, $974.2 million, $15.0 million and $78.5 million, respectively, as of January 31, 2015. As of October 31, 2014, the fair value of the 2019 Notes, senior secured notes (all series in the aggregate), senior amortizing notes and senior exchangeable notes was estimated at $148.2 million, $1.0 billion, $17.0 million and $79.6 million, respectively.

 

21.

Financial Information of Subsidiary Issuer and Subsidiary Guarantors

 

Hovnanian Enterprises, Inc., the parent company (the “Parent”), is the issuer of publicly traded common stock and preferred stock, which is represented by depository shares. One of its wholly owned subsidiaries, K. Hovnanian Enterprises, Inc. (the “Subsidiary Issuer”), acts as a finance entity that, as of January 31, 2015, had issued and outstanding approximately $992.0 million of senior secured notes ($980.3 million, net of discount), $841.1 million senior notes ($840.7 million, net of discount) and $15.0 million senior amortizing notes and $71.0 million senior exchangeable notes (issued as components of our 6.0% Exchangeable Note Units). The senior secured notes, senior notes, senior amortizing notes and senior exchangeable notes are fully and unconditionally guaranteed by the Parent.

 

In addition to the Parent, each of the wholly owned subsidiaries of the Parent other than the Subsidiary Issuer (collectively, “Guarantor Subsidiaries”), with the exception of our home mortgage subsidiaries, certain of our title insurance subsidiaries, joint ventures, subsidiaries holding interests in our joint ventures and our foreign subsidiary (collectively, the “Nonguarantor Subsidiaries”), have guaranteed fully and unconditionally, on a joint and several basis, the obligations of the Subsidiary Issuer to pay principal and interest under the senior secured notes (other than the 2021 Notes), senior notes, senior exchangeable notes and senior amortizing notes. The Guarantor Subsidiaries are directly or indirectly 100% owned subsidiaries of the Parent. The 2021 Notes are guaranteed by the Guarantor Subsidiaries and the members of the Secured Group (see Note 11).

 

The senior unsecured notes (except for the 2019 Notes), senior amortizing notes and senior exchangeable notes have been registered under the Securities Act of 1933, as amended. The 2019 Notes, 2020 Secured Notes and the 2021 Notes (see Note 11) are not, pursuant to the indentures under which such notes were issued, required to be registered. The Condensed Consolidating Financial Statements presented below are in respect of our registered notes only and not the 2019 Notes, 2020 Secured Notes or the 2021 Notes (however, the Guarantor Subsidiaries for the 2019 Notes and the 2020 Secured Notes are the same as those represented by the accompanying Condensed Consolidating Financial Statements). In lieu of providing separate financial statements for the Guarantor Subsidiaries of our registered notes, we have included the accompanying Condensed Consolidating Financial Statements. Therefore, separate financial statements and other disclosures concerning such Guarantor Subsidiaries are not presented.

 

The following Condensed Consolidating Financial Statements present the results of operations, financial position and cash flows of (i) the Parent, (ii) the Subsidiary Issuer, (iii) the Guarantor Subsidiaries, (iv) the Nonguarantor Subsidiaries and (v) the eliminations to arrive at the information for Hovnanian Enterprises, Inc. on a consolidated basis.

 

 
26

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATING BALANCE SHEET

JANUARY 31, 2015

(In Thousands)

   

Parent

   

Subsidiary

Issuer

   

Guarantor

Subsidiaries

   

Nonguarantor

Subsidiaries

   

Eliminations

   

Consolidated

 

ASSETS:

                                   

Homebuilding

  $-     $263,151     $1,393,722     $402,686     $-     $2,059,559  

Financial services

              6,894     104,769           111,663  

Income taxes receivable

  254,444           35,769                 290,213  

Intercompany receivable

        1,447,274                 (1,447,274

)

  -  

Investments in and amounts due from consolidated subsidiaries

              351,918           (351,918

)

  -  

Total assets

  $254,444     $1,710,425     $1,788,303     $507,455     (1,799,192

)

  $2,461,435  
                                     

LIABILITIES AND EQUITY:

                                   

Homebuilding

  $3,184     $31     $512,695     $50,707     $-     $566,617  

Financial services

              6,646     80,015           86,661  

Notes payable

        1,935,129     2,420     592           1,938,141  

Intercompany payable

  307,713           1,115,338     24,223     (1,447,274

)

  -  

Amounts due to consolidated subsidiaries

  73,531     24,711                 (98,242

)

  -  

Stockholders’ (deficit) equity

  (129,984

)

  (249,446

)

  151,204     351,918     (253,676

)

  (129,984

)

Total liabilities and equity

  $254,444     $1,710,425     $1,788,303     $507,455     (1,799,192

)

  $2,461,435  

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATING BALANCE SHEET

OCTOBER 31, 2014

(In Thousands)

   

Parent

   

Subsidiary

Issuer

   

Guarantor

Subsidiaries

   

Nonguarantor

Subsidiaries

   

Eliminations

   

Consolidated

 

ASSETS:

                                   

Homebuilding

  $-     $195,177     $1,336,716     $353,151     $ -     $1,855,044  

Financial services

              11,407     108,936           120,343  

Income taxes receivable

  244,391           40,152                 284,543  

Intercompany receivable

        1,275,453           36,161     (1,311,614

)

  -  

Investments in and amounts due from consolidated subsidiaries

              338,044           (338,044

)

  -  

Total assets

  $244,391     $1,470,630     $1,726,319     $498,248     $(1,649,658

)

  $2,289,930  
                                     

LIABILITIES AND EQUITY:

                                   

Homebuilding

  $2,842     $160     $544,088     $71,663     $-     $618,753  

Financial services

              11,210     87,987           99,197  

Notes payable

        1,685,892     3,336     551           1,689,779  

Intercompany payable

  308,700           1,002,914           (1,311,614

)

  -  

Amounts due to consolidated subsidiaries

  50,648     11,902                 (62,550

)

  -  

Stockholders’ (deficit) equity

  (117,799

)

  (227,324

)

  164,771     338,047     (275,494

)

  (117,799

)

Total liabilities and equity

  $244,391     $1,470,630     $1,726,319     $498,248     $(1,649,658

)

  $2,289,930  

 

 
27

 

  

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED JANUARY 31, 2015

(In Thousands)

   

Parent

   

Subsidiary

Issuer

   

Guarantor

Subsidiaries

   

Nonguarantor

Subsidiaries

   

Eliminations

   

Consolidated

 

Revenues:

                                   

Homebuilding

  $-     $-     $365,189     $69,403     $-     $434,592  

Financial services

              1,833     9,289           11,122  

Intercompany charges

        28,512                 (28,512

)

  -  

Total revenues

  -     28,512     367,022     78,692     (28,512

)

  445,714  
                                     

Expenses:

                                   

Homebuilding

  3,711     37,828     357,509     60,481           459,529  

Financial services

  68           1,573     5,676           7,317  

Intercompany charges

              28,382     130     (28,512

)

  -  

Total expenses

  3,779     37,828     387,464     66,287     (28,512

)

  466,846  

(Loss) income from unconsolidated joint ventures

              (14

)

  1,466           1,452  

(Loss) income before income taxes

  (3,779

)

  (9,316

)

  (20,456

)

  13,871     -     (19,680

)

State and federal income tax (benefit) provision

  (12,286

)

        6,982                 (5,304

)

Equity in (loss) income of consolidated subsidiaries

  (22,883

)

  (12,806

)

  13,871           21,818     -  

Net (loss) income

  $(14,376

)

  $(22,122

)

  $(13,567

)

  $13,871     $21,818     $(14,376

)

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS

THREE MONTHS ENDED JANUARY 31, 2014

(In Thousands)

   

Parent

   

Subsidiary

Issuer

   

Guarantor

Subsidiaries

   

Nonguarantor

Subsidiaries

   

Eliminations

   

Consolidated

 

Revenues:

                                   

Homebuilding

  $-     $(46

)

  $283,038     $72,962     $-     $355,954  

Financial services

              1,835     6,259