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Table Of Contents

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 APRIL 30, 2016

OR

 

[    ]

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

 

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. 131,802,260 shares of Class A Common Stock and 15,317,869 shares of Class B Common Stock were outstanding as of May 31, 2016.

 

 

 

HOVNANIAN ENTERPRISES, INC.  

    

FORM 10-Q  

 

INDEX

PAGE

NUMBER

  

  

PART I.  Financial Information

  

Item l.  Financial Statements:

  

  

  

Condensed Consolidated Balance Sheets (unaudited) as of April 30, 2016 and October 31, 2015

3

  

  

Condensed Consolidated Statements of Operations (unaudited) for the three and six months ended April 30, 2016 and 2015

5

  

  

Condensed Consolidated Statement of Equity (unaudited) for the six months ended April 30, 2016

6

  

  

Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended April 30, 2016 and 2015

7

  

  

Notes to Condensed Consolidated Financial Statements (unaudited)

9

  

  

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

34

  

  

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

56

  

  

Item 4.  Controls and Procedures

57

  

  

PART II.  Other Information

  

Item 1.  Legal Proceedings

57

 

 

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

57

  

  

Item 6.  Exhibits

58

  

  

Signatures

59

  

 

 

  

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands)

 

   

April 30,

2016

   

October 31,

2015

 
   

(Unaudited)

    (1)  

ASSETS

               
                 

Homebuilding:

               

Cash and cash equivalents

    $120,661       $245,398  

Restricted cash and cash equivalents

    6,259       7,299  

Inventories:

               

Sold and unsold homes and lots under development

    1,171,668       1,307,850  

Land and land options held for future development or sale

    191,627       214,503  

Consolidated inventory not owned

    312,841       122,225  

Total inventories

    1,676,136       1,644,578  

Investments in and advances to unconsolidated joint ventures

    70,061       61,209  

Receivables, deposits and notes, net

    65,055       70,349  

Property, plant and equipment, net

    45,670       45,534  

Prepaid expenses and other assets

    80,004       77,671  

Total homebuilding

    2,063,846       2,152,038  
                 

Financial services:

               

Cash and cash equivalents

    8,993       8,347  

Restricted cash and cash equivalents

    19,134       19,223  

Mortgage loans held for sale at fair value

    129,999       130,320  

Other assets

    2,586       2,091  

Total financial services

    160,712       159,981  

Income taxes receivable – including net deferred tax benefits

    294,069       290,279  

Total assets

    $2,518,627       $2,602,298  

 

(1)  Derived from the audited balance sheet as of October 31, 2015.

 

See notes to condensed consolidated financial statements (unaudited).

  

 

 

   

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands Except Share and Per Share Amounts)

 

   

April 30,

2016

   

October 31,

2015

 
   

(Unaudited)

    (1)  

LIABILITIES AND EQUITY

               
                 

Homebuilding:

               

Nonrecourse mortgages secured by inventory

    $125,076       $143,863  

Accounts payable and other liabilities

    360,946       348,516  

Customers’ deposits

    47,976       44,218  

Nonrecourse mortgages secured by operating properties

    14,924       15,511  

Liabilities from inventory not owned

    220,348       105,856  

Total homebuilding

    769,270       657,964  
                 

Financial services:

               

Accounts payable and other liabilities

    27,574       27,908  

Mortgage warehouse lines of credit

    109,132       108,875  

Total financial services

    136,706       136,783  
                 

Notes payable:

               

Revolving credit agreement

    50,000       47,000  

Senior secured notes, net of discount

    982,086       981,346  

Senior notes, net of discount

    607,575       780,319  

Senior amortizing notes

    10,516       12,811  

Senior exchangeable notes

    75,677       73,771  

Accrued interest

    39,119       40,388  

Total notes payable

    1,764,973       1,935,635  

Total liabilities

    2,670,949       2,730,382  
                 

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 April 30, 2016 and at October 31, 2015

    135,299       135,299  

Common stock, Class A, $0.01 par value – authorized 400,000,000 shares; issued 143,563,023 shares at April 30, 2016 and 143,292,881 shares at October 31, 2015 (including 11,760,763 shares at April 30, 2016 and October 31, 2015 held in treasury)

    1,436       1,433  

Common stock, Class B, $0.01 par value (convertible to Class A at time of sale) – authorized 60,000,000 shares; issued 16,009,617 shares at April 30, 2016 and 15,676,829 shares at October 31, 2015 (including 691,748 shares at April 30, 2016 and October 31, 2015 held in treasury)

    160       157  

Paid in capital – common stock

    704,141       703,751  

Accumulated deficit

    (877,998

)

    (853,364

)

Treasury stock – at cost

    (115,360

)

    (115,360

)

Total stockholders’ equity deficit

    (152,322

)

    (128,084

)

Total liabilities and equity

    $2,518,627       $2,602,298  

 

(1)  Derived from the audited balance sheet as of October 31, 2015.

 

See notes to condensed consolidated financial statements (unaudited).

 

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In Thousands Except Per Share Data)

(Unaudited)

 

   

Three Months Ended April 30,

   

Six Months Ended April 30,

 
   

2016

   

2015

   

2016

   

2015

 

Revenues:

                               

Homebuilding:

                               

Sale of homes

    $626,157       $455,172       $1,182,932       $888,643  

Land sales and other revenues

    11,563       1,320       12,167       2,441  

Total homebuilding

    637,720       456,492       1,195,099       891,084  

Financial services

    17,003       12,457       35,229       23,579  

Total revenues

    654,723       468,949       1,230,328       914,663  
                                 

Expenses:

                               

Homebuilding:

                               

Cost of sales, excluding interest

    536,050       382,139       1,000,196       736,951  

Cost of sales interest

    21,444       12,013       38,287       23,331  

Inventory impairment loss and land option write-offs

    9,669       4,311       21,350       6,541  

Total cost of sales

    567,163       398,463       1,059,833       766,823  

Selling, general and administrative

    56,371       52,614       103,875       100,260  

Total homebuilding expenses

    623,534       451,077       1,163,708       867,083  
                                 

Financial services

    9,618       7,508       17,833       14,825  

Corporate general and administrative

    12,598       16,493       28,919       33,401  

Other interest

    24,084       23,030       45,309       48,101  

Other operations

    1,147       1,788       2,531       3,332  

Total expenses

    670,981       499,896       1,258,300       966,742  

(Loss) income from unconsolidated joint ventures

    (1,346

)

    1,466       (2,826

)

    2,918  

Loss before income taxes

    (17,604

)

    (29,481

)

    (30,798

)

    (49,161

)

State and federal income tax (benefit) provision:

                               

State

    (758

)

    (414

)

    3,561       2,718  

Federal

    (8,385

)

    (9,508

)

    (9,725

)

    (17,944

)

Total income taxes

    (9,143

)

    (9,922

)

    (6,164

)

    (15,226

)

Net loss

    $(8,461

)

    $(19,559

)

    $(24,634

)

    $(33,935

)

                                 

Per share data:

                               

Basic:

                               

Loss per common share

    $(0.06

)

    $(0.13

)

    $(0.17

)

    $(0.23

)

Weighted-average number of common shares outstanding

    147,334       146,946       147,301       146,762  

Assuming dilution:

                               

Loss per common share

    $(0.06

)

    $(0.13

)

    $(0.17

)

    $(0.23

)

Weighted-average number of common shares outstanding

    147,334       146,946       147,301       146,762  

 

See notes to condensed consolidated financial statements (unaudited).

  

 

 

     

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, 2015

    131,532,118       $1,433       14,985,081       $157       5,600       $135,299       $703,751       $(853,364

)

    $(115,360

)

    $(128,084

)

                                                                                 

Stock options, amortization and issuances

                                                    (1,859

)

                    (1,859

)

                                                                                 

Restricted stock amortization, issuances and forfeitures

    270,032       3       332,898       3                       2,249                       2,255  
                                                                                 

Conversion of class B to class A common stock

    110               (110

)

                                                    -  
                                                                                 

Net loss

                                                            (24,634

)

            (24,634

)

                                                                                 

Balance, April 30, 2016

    131,802,260       $1,436       15,317,869       $160       5,600       $135,299       $704,141       $(877,998

)

    $(115,360

)

    $(152,322

)

 

See notes to condensed consolidated financial statements (unaudited).

  

 

 

    

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

   

Six Months Ended

 
   

April 30,

 
   

2016

   

2015

 

Cash flows from operating activities:

               

Net loss

    $(24,634

)

    $(33,935

)

Adjustments to reconcile net loss to net cash used in operating activities:

               

Depreciation

    1,729       1,719  

Compensation from stock options and awards

    825       6,665  

Amortization of bond discounts and deferred financing costs

    6,106       5,991  

Gain on sale and retirement of property and assets

    (100

)

    (851

)

Loss (income) from unconsolidated joint ventures

    2,826       (2,918

)

Distributions of earnings from unconsolidated joint ventures

    -       4,445  

Inventory impairment and land option write-offs

    21,350       6,541  

Deferred income tax benefit

    (4,077

)

    (15,975

)

(Increase) decrease in assets:

               

Origination of mortgage loans

    (584,879

)

    (429,708

)

Sale of mortgage loans

    585,200       418,594  

Restricted cash, receivables, prepaids, deposits and other assets

    2,461       134  

Inventories

    (52,908

)

    (200,988

)

Increase (decrease) in liabilities:

               

State income tax payable

    287       (70

)

Customers’ deposits

    3,758       6,462  

Accounts payable, accrued interest and other accrued liabilities

    10,869       (22,235

)

Net cash used in operating activities

    (31,187

)

    (256,129

)

Cash flows from investing activities:

               

Proceeds from sale of property and assets

    115       983  

Purchase of property, equipment and other fixed assets and acquisitions

    (1,651

)

    (1,172

)

(Increase) decrease in restricted cash related to mortgage company

    (204

)

    1,645  

Decrease in restricted cash related to letters of credit

    325       -  

Investments in and advances to unconsolidated joint ventures

    (16,743

)

    (15,539

)

Distributions of capital from unconsolidated joint ventures

    5,065       7,345  

Net cash used in investing activities

    (13,093

)

    (6,738

)

Cash flows from financing activities:

               

Proceeds from mortgages and notes

    112,894       76,569  

Payments related to mortgages and notes

    (132,033

)

    (61,858

)

Proceeds from model sale leaseback financing programs

    14,910       21,301  

Payments related to model sale leaseback financing programs

    (13,691

)

    (7,960

)

Proceeds from land bank financing programs

    153,423       4,144  

Payments related to land bank financing programs

    (38,950

)

    (17,147

)

Proceeds from senior notes

    -       250,000  

Payments related to senior notes and senior amortizing notes

    (175,040

)

    (2,062

)

Borrowings from revolving credit facility

    3,000       -  

Net proceeds related to mortgage warehouse lines of credit

    257       6,047  

Deferred financing costs from land bank financing programs and note issuances

    (4,581

)

    (6,493

)

Net cash (used in) provided by financing activities

    (79,811

)

    262,541  

Net decrease in cash and cash equivalents

    (124,091

)

    (326

)

Cash and cash equivalents balance, beginning of period

    253,745       261,898  

Cash and cash equivalents balance, end of period

    $129,654       $261,572  

 

 

      

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands - Unaudited)

(Continued)

 

   

Six Months Ended

 
   

April 30,

 
   

2016

   

2015

 

Supplemental disclosure of cash flow:

               

Cash paid (received) during the period for:

               

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

    $47,987       $41,061  

Income taxes

    $(2,373

)

    $819  

 

See notes to condensed consolidated financial statements (unaudited).

  

 

    

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, 2015. 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, 2015 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 the three and six months ended April 30, 2016, the Company’s total stock-based compensation was income of $(0.7) million and expense of $0.8 million ($0.7 million net of tax), respectively, and expense of $3.2 million and $6.7 million ($2.1 million and $4.6 million net of tax) for the three and six months ended April 30, 2015, respectively. Included in this total stock-based compensation was income of $(2.1) million for both the three and six months ended April 30, 2016 for previously recognized expense of certain performance based stock option grants for which the performance metrics are no longer expected to be satisfied. This income was slightly offset by the vesting of stock options of $0.1 million and $0.2 million, respectively, during the three and six months ended April 30, 2016. Included in total stock based compensation expense for the three and six months ended April 30, 2015 was the vesting of stock options of $0.5 million and $1.4 million, respectively.

 

3.

Interest

 

Interest costs incurred, expensed and capitalized were:

 

   

Three Months Ended

April 30,

   

Six Months Ended

April 30,

 

(In thousands)

 

2016

   

2015

   

2016

   

2015

 
                                 

Interest capitalized at beginning of period

    $117,113       $114,241       $123,898       $109,158  

Plus interest incurred (1)

    44,224       40,703       86,183       82,175  

Less cost of sales interest expensed

    21,444       12,013       38,287       23,331  

Less other interest expensed (2)(3)

    24,084       23,030       45,309       48,101  

Less interest contributed to unconsolidated joint venture (4)

    -       -       10,676       -  

Interest capitalized at end of period (5)

    $115,809       $119,901       $115,809       $119,901  

 

(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:

 

 

  

   

Three Months Ended

April 30,

   

Six Months Ended

April 30,

 

(In thousands)

 

2016

   

2015

   

2016

   

2015

 

Other interest expensed

    $24,084       $23,030       $45,309       $48,101  

Interest paid by our mortgage and finance subsidiaries

    851       268       1,410       676  

Decrease (increase) in accrued interest

    (9,948

)

    (8,726

)

    1,268       (7,716

)

Cash paid for interest, net of capitalized interest

    $14,987       $14,572       $47,987       $41,061  

 

(4)

Represents capitalized interest which was included as part of the assets contributed to the joint venture the Company entered into in November 2015, as discussed in Note 18. There was no impact to the Condensed Consolidated Statement of Operations as a result of this transaction.

(5)

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. For the six months ended April 30, 2016, our discount rate used for the impairments recorded ranged from 16.8% to 18.5%. For the six months ended April 30, 2015, our discount rate used for the impairments recorded ranged from 17.5% to 19.8%. 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. 

 

During the six months ended April 30, 2016 and 2015, we evaluated inventories of all 478 and 508 communities under development and held for future development, respectively, for impairment indicators through preparation and review of detailed budgets or other market indicators of impairment. We performed detailed impairment calculations during the six months ended April 30, 2016 and 2015 for 20 and 15 of those communities (i.e., those with a projected operating loss or other impairment indicators), respectively, with an aggregate carrying value of $89.0 million and $77.4 million, respectively. Of those communities tested for impairment during the six months ended April 30, 2016 and 2015, nine and seven communities with an aggregate carrying value of $43.5 million and $33.0 million, respectively, had undiscounted future cash flows that exceeded the carrying amount by less than 20%. As a result of our impairment analysis, we recorded aggregate impairment losses of $5.4 million and $15.1 million, in four and ten communities, respectively, with an aggregate pre-impairment value of $16.7 million and $45.4 million, respectively, for the three and six months ended April 30, 2016, respectively, and recorded aggregate impairment losses of $3.5 million and $4.4 million, in four and five communities, respectively, with an aggregate pre-impairment value of $11.0 million and $16.7 million, respectively, for the three and six months ended April 30, 2015, respectively, which are included in the Condensed Consolidated Statements of Operations on the line entitled “Homebuilding: Inventory impairment loss and land option write-offs” and deducted from inventory. The impairments recorded for the six months ended April 30, 2016 were mainly for land held for sale in the Midwest and Northeast. The inventory has been written down to fair value based on recent offers received for the properties. 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 Statements 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 $4.3 million and $0.8 million for the three months ended April 30, 2016 and 2015, respectively, and $6.3 million and $2.1 million for the six months ended April 30, 2016 and 2015, respectively. Such write-offs were located in each of our segments in both the first half of fiscal 2016 and 2015. 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 April 30, 2016 and 2015 were 2,263 and 455, respectively, and 3,519 and 2,155 during the six months ended April 30, 2016 and 2015, respectively.

 

 

 

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 half of fiscal 2016, we did not mothball any additional communities or sell any communities; we re-activated one previously mothballed community and contributed one previously mothballed community to a new joint venture which is beginning construction. As of April 30, 2016 and October 31, 2015, the net book value associated with our 29 and 31 total mothballed communities was $75.7 million and $103.0 million, respectively, which was net of impairment charges recorded in prior periods of $296.8 million and $334.5 million, respectively.

 

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 April 30, 2016 we had no specific performance options. As of October 31, 2015, we had $1.2 million of specific performance options recorded on our Condensed Consolidated Balance Sheet to “Consolidated inventory not owned,” with a corresponding liability of $1.2 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 April 30, 2016 and October 31, 2015, inventory of $98.2 million and $95.9 million, respectively, was recorded to “Consolidated inventory not owned,” with a corresponding amount of $89.1 million and $87.9 million, respectively, recorded to “Liabilities from inventory not owned” for the amount of net cash received from the transactions.

 

We have land banking arrangements, whereby we sell our land parcels to the land bankers 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 April 30, 2016 and October 31, 2015, inventory of $214.6 million and $25.1 million, respectively, was recorded as “Consolidated inventory not owned,” with a corresponding amount of $131.2 million and $16.8 million, respectively, 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 April 30, 2016 and October 31, 2015, 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 April 30, 2016, we had total cash deposits amounting to $67.4 million to purchase land and lots with a total purchase price of $1.3 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 six months ended April 30, 2016 and 2015, we received $2.0 million and $1.3 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 2016 and 2015, our deductible under our general liability insurance is a $20 million aggregate for construction defect and warranty claims. For bodily injury claims, our deductible per occurrence in fiscal 2016 and 2015 is $0.25 million, up to a $5 million limit. Our aggregate retention in fiscal 2016 and 2015 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 and six months ended April 30, 2016 and 2015 were as follows:

 

   

Three Months Ended

April 30,

   

Six Months Ended

April 30,

 

(In thousands)

 

2016

   

2015

   

2016

   

2015

 
                                 

Balance, beginning of period

    $133,389       $181,833       $135,053       $178,008  

Additions – Selling, general and administrative

    4,292       4,331       8,915       9,580  

Additions – Cost of sales

    4,539       5,635       7,921       8,816  

Charges incurred during the period

    (5,514 )     (30,492

)

    (15,183 )     (35,097

)

Changes to pre-existing reserves

    -       -       -       -  

Balance, end of period

    $136,706       $161,307       $136,706       $161,307  

  

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

 

Insurance claims paid by our insurance carriers, excluding insurance deductibles paid, were $0.5 million and $18.1 million for the three months ended April 30, 2016 and 2015, respectively, and $3.7 million and $18.3 million for the six months ended April 30, 2016 and 2015, respectively, for prior year deliveries. During the first half of fiscal 2016, we settled two construction defect claims relating to the Northeast segment which made up the majority of the payments. During the first half of fiscal 2015, we settled a class action suit which alleged specified issues related to the HVAC systems installed in certain of the Company’s homes, with the majority of the settlement being paid by our insurance carriers.

 

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 adverse effect on our financial position, results of operations or cash flows, and we are subject to extensive and complex laws and regulations that affect the development of land and home building, sales and customer financing processes, including zoning, density, building standards and mortgage financing. These laws and 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 began 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. 

 

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 April 30, 2016 and October 31, 2015, $8.6 million and $15.8 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 $25.4 million and $26.5 million as of April 30, 2016 and October 31, 2015, respectively, which includes cash collateralizing our letter of credit agreements and facilities as discussed in Note 10. Also included in this balance were (1) homebuilding and financial services customers’ deposits of $4.0 million and $17.1 million at April 30, 2016, respectively, and $4.7 million and $17.2 million as of October 31, 2015, respectively, which are restricted from use by us, and (2) $2.0 million of restricted cash at both April 30, 2016 and October 31, 2015, under the terms of our mortgage warehouse lines of credit.

 

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 April 30, 2016 and October 31, 2015, $116.8 million and $114.0 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 April 30, 2016 and 2015, we had reserves specifically for 132 and 131 identified mortgage loans, respectively, as well as reserves for an estimate for future losses on mortgages sold but not yet identified to us.

 

 

 

The activity in our loan origination reserves during the three and six months ended April 30, 2016 and 2015 was as follows:

 

   

Three Months Ended

April 30,

   

Six Months Ended

April 30,

 

(In thousands)

 

2016

   

2015

   

2016

   

2015

 
                                 

Loan origination reserves, beginning of period

    $8,028       $7,981       $8,025       $7,352  

Provisions for losses during the period

    117       68       158       129  

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

    161       (107

)

    123       461  

Loan origination reserves, end of period

    $8,306       $7,942       $8,306       $7,942  

 

10.

Mortgage and Notes Payable

  

We had nonrecourse mortgage loans for certain communities totaling $125.1 million and $143.9 million at April 30, 2016 and October 31, 2015, respectively, which are secured by the related real property, including any improvements, with an aggregate book value of $330.9 million and $388.1 million, respectively. The weighted-average interest rate on these obligations was 4.6% and 5.1% at April 30, 2016 and October 31, 2015, respectively, and the mortgage loan payments on each community primarily correspond to home deliveries. We also had nonrecourse mortgage loans on our corporate headquarters totaling $14.9 million and $15.5 million at April 30, 2016 and October 31, 2015, respectively. These loans had a weighted-average interest rate of 8.8% at both April 30, 2016 and October 31, 2015. As of April 30, 2016, these loans have remaining installment obligations with annual principal maturities in the years ending October 31 of: $0.6 million in 2016, $1.3 million in 2017, $1.4 million in 2018, $1.5 million in 2019, $1.7 million in 2020 and $8.4 million after 2020.

   

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 April 30, 2016 and October 31, 2015 there were $50.0 million and $47.0 million of borrowings, respectively, and $22.4 million and $25.9 million of letters of credit outstanding, respectively, under the Credit Facility. As of April 30, 2016, 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 $2.2 million and $2.6 million letters of credit outstanding at April 30, 2016 and October 31, 2015, 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 April 30, 2016 and October 31, 2015, the amount of cash collateral in these segregated accounts was $2.3 million and $2.6 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 29, 2016, is a short-term borrowing facility that provides up to $50.0 million through January 31, 2017. 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 0.44% at April 30, 2016, plus the applicable margin of 2.5% or 2.63% based upon type of loan. As of April 30, 2016 and October 31, 2015, the aggregate principal amount of all borrowings outstanding under the Chase Master Repurchase Agreement was $31.9 million and $30.5 million, respectively.

   

 

 

K. Hovnanian Mortgage has another secured Master Repurchase Agreement with Customers Bank (“Customers Master Repurchase Agreement”), which was amended on February 18, 2016 to extend the maturity date to February 17, 2017, that is a short-term borrowing facility that provides up to $25.0 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 daily or as loans are sold to permanent investors on outstanding advances at the current LIBOR rate, plus the applicable margin ranging from 2.5% to 5.25% based on the type of loan and the number of days outstanding on the warehouse line. As of April 30, 2016 and October 31, 2015, the aggregate principal amount of all borrowings outstanding under the Customers Master Repurchase Agreement was $24.1 million and $29.7 million, respectively.

  

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 amended on February 23, 2016, that is a short-term borrowing facility that provides up to $50.0 million through February 21, 2017. 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 Base Rate (as defined in the loan documents), which was 0.85% at April 30, 2016, plus an applicable margin of 2.25% to 2.5%. As of April 30, 2016 and October 31, 2015, the aggregate principal amount of all borrowings outstanding under the Credit Suisse Master Repurchase Agreement was $27.6 million and $30.1 million, respectively.

  

In February 2014, K. Hovnanian Mortgage executed a secured Master Repurchase Agreement with Comerica Bank (“Comerica Master Repurchase Agreement”), which was amended on December 28, 2015 to extend the maturity date to December 27, 2016. The Comerica Master Repurchase Agreement 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 the current LIBOR rate, subject to a floor of 0.25%, plus the applicable margin of 2.5%. As of April 30, 2016 and October 31, 2015, the aggregate principal amount of all borrowings outstanding under the Comerica Master Repurchase Agreement was $25.5 million and $18.6 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 applicable agreement, we do not consider any of these covenants to be substantive or material. As of April 30, 2016, 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 April 30, 2016 and October 31, 2015, were as follows:

 

(In thousands)

 

April 30,

2016

   

October 31,

2015

 

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)

    53,143       53,139  

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

    131,943       131,207  

Total Senior Secured Notes

    $982,086       $981,346  

Senior Notes:

               

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

    $-       $172,744  

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       250,000  

Total Senior Notes

    $607,575       $780,319  

11.0% Senior Amortizing Notes due December 1, 2017

    $10,516       $12,811  

Senior Exchangeable Notes due December 1, 2017

    $75,677       $73,771  

 

 

 

 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 April 30, 2016 (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 April 30, 2016, 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, (currently, however, our ability to incur additional permitted indebtedness is limited and we expect it to be limited for the foreseeable future) refinancing indebtedness, and nonrecourse indebtedness. As a result of this ratio 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 April 30, 2016, the aggregate book value of the real property that constituted collateral securing the 2020 Secured Notes was approximately $685.1 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 $106.4 million as of April 30, 2016, which included $2.3 million of restricted cash collateralizing certain letters of credit. Subsequent to such date, fluctuations as a result of cash uses include general business operations and real estate and other investments along with cash inflow primarily from deliveries.

 

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 April 30, 2016, the collateral securing the guarantees included (1) $16.5 million of cash and cash equivalents (subsequent to such date, fluctuations as a result of cash uses include general business operations and real estate and other investments along with cash inflow primarily from deliveries); (2) $153.9 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 $66.3 million as of April 30, 2016; 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 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 at a redemption price equal to 100% of their principal amount.

 

On January 15, 2016, $172.7 million principal amount of our 6.25% Senior Notes due 2016 matured and was paid. In the third quarter of fiscal 2016, on May 15, 2016, $86.5 million principal amount of our 7.5% Senior Notes due 2016 matured and was paid. We have $121.0 million principal amount of our 8.625% Senior Notes due on January 15, 2017. While our preference is to refinance these notes, in light of current availability of debt financing in the capital and loan markets to companies with comparable credit ratings, we may not be able to refinance these obligations or do so at an attractive rate. In this situation, we currently believe we will have sufficient liquidity from our operations and our planned reduction of our geographic operating footprint (as described below) to enable us to pay these notes at maturity. However, depending on market conditions, we may also need to reduce or delay investments or consider other liquidity-enhancing measures such as new land banking arrangements, an increase in joint venture activity and/or project specific financings and model sale leasebacks.

 

As a result of our evaluation of our geographic operating footprint as it relates to our strategic objectives, we decided to exit the Minneapolis, MN and Raleigh, NC markets, and in the third quarter of fiscal 2016, we completed the sale of our land portfolios in those markets. We have also decided to wind down our operations in the San Francisco Bay area in Northern California and in Tampa, FL by building and delivering homes to sell through our existing land position.

 

Any other liquidity-enhancing transaction will depend on identifying counterparties, negotiation of documentation and applicable closing conditions and any required approvals. Due to covenant restrictions in our debt instruments, we are currently limited in the amount of debt we can incur that does not qualify as refinancing indebtedness (a limitation that we expect to continue for the foreseeable future), even if market conditions would otherwise be favorable, which could also impact our ability to grow our business. 

 

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 April 30, 2016, 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.

 

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. 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 for the six months ended April 30, 2015 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. There were no incremental shares attributed to nonvested stock and outstanding options to purchase common stock for the three and six months ended April 30, 2016 and the three months ended April 30, 2015. Also, for both the three and six months ended April 30, 2016 and 2015, 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 6.4 million for both the three and six months ended April 30, 2016, and 3.3 million for the three and six months ended April 30, 2015 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 and six months ended April 30, 2016 and 2015, 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.

 

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 and six months ended April 30, 2016. As of April 30, 2016, 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 $9.1 million and $6.2 million for the three and six months ended April 30, 2016, respectively, was primarily due to deferred taxes, partially offset by state tax expenses and state tax reserves for uncertain tax positions. The six months ended April 30, 2016 was also impacted by permanent differences between book income and taxable income as a result of the issuance of shares under a deferred compensation plan that were expensed during vesting at significantly higher value than the value at the time of issuance. The total income tax benefit of $9.9 million and $15.2 million recognized for the three and six months ended April 30, 2015, respectively, was primarily due to deferred taxes, partially offset by state tax expenses and state tax reserves for uncertain 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, 2015, and again at April 30, 2016, 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 positive earnings for two of the last three fiscal years 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, backlog, and community count 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 is the fact that we had a loss before income taxes for the fiscal year ended October 31, 2015 as well as for the six months ended April 30, 2016. However, we are not in a three year cumulative loss position as of April 30, 2016. As per ASC 740, cumulative losses are one of the most objectively verifiable forms of negative evidence; we no longer have this negative evidence and we expect to be profitable going forward over the long term. Our recent three years cumulative performance and our expectations for the coming years based on our current backlog, community count and recent sales contracts provide evidence that reaffirms our conclusion that a full valuation allowance was not necessary and that the current valuation allowance for deferred taxes of $635.4 million as of April 30, 2016 is appropriate.

 

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 lifestyle 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 any 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 and 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 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.

 

 

  

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

  

   

Three Months Ended April 30,

   

Six Months Ended April 30,

 

(In thousands)

 

2016

   

2015

   

2016

   

2015

 
                                 

Revenues:

                               

Northeast

    $54,046       $39,274       $126,550       $90,004  

Mid-Atlantic

    89,987       76,777       183,807       157,962  

Midwest

    84,631       73,256       176,551       137,695  

Southeast

    51,298       49,275       90,550       87,169  

Southwest

    276,735       190,427       481,060       357,614  

West

    81,095       27,522       136,673       60,715  

Total homebuilding

    637,792       456,531       1,195,191       891,159  

Financial services

    17,003       12,457       35,229       23,579  

Corporate and unallocated

    (72 )     (39

)

    (92 )     (75

)

Total revenues

    $654,723       $468,949       $1,230,328       $914,663  
                                 

(Loss) income before income taxes:

                               

Northeast

    $(6,684 )     $(3,812

)

    $(3,950 )     $(6,965

)

Mid-Atlantic

    1,072       (178

)

    3,694       4,999  

Midwest

    (23 )     1,210       (5,582 )     4,921  

Southeast

    (7,255 )     (1,202

)

    (9,089 )     (2,358

)

Southwest

    18,491       14,022       34,860       25,347  

West

    (4,318 )     (8,963

)

    (10,286 )     (11,336

)

Homebuilding income before income taxes

    1,283       1,077       9,647       14,608  

Financial services

    7,385       4,949       17,396       8,754  

Corporate and unallocated

    (26,272 )     (35,507

)

    (57,841 )     (72,523

)

Loss before income taxes

    $(17,604 )     $(29,481

)

    $(30,798 )     $(49,161

)

 

 

(In thousands)

 

April 30, 2016

   

October 31, 2015

 
                 

Assets:

               

Northeast

    $287,781       $321,983  

Mid-Atlantic

    355,629       342,159  

Midwest

    169,786       197,899  

Southeast

    281,694       223,206  

Southwest

    454,939       465,740  

West

    298,220       259,943  

Total homebuilding

    1,848,049       1,810,930  

Financial services

    160,712       159,981  

Corporate and unallocated(1)

    509,866       631,387  

Total assets

    $2,518,627       $2,602,298  

  

(1) Includes $294.1 million and $290.3 million of income taxes receivable, including deferred tax assets, as of April 30, 2016 and October 31, 2015, respectively.

 

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.

 

 

 

In November 2015, the Company entered into a new joint venture to which the company contributed a land parcel that had been mothballed by the company, but on which construction by the joint venture has now begun. Upon formation of the joint venture, the Company received $25.7 million of cash proceeds for the contributed land.

 

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)

 

April 30, 2016

 
   

Homebuilding

   

Land

Development

   

Total

 

Assets:

                       

Cash and cash equivalents

    $29,757       $1,642       $31,399  

Inventories

    400,785       11,692       412,477  

Other assets

    19,536       -       19,536  

Total assets

    $450,078       $13,334       $463,412  
                         

Liabilities and equity:

                       

Accounts payable and accrued liabilities

    $39,591       $992       $40,583  

Notes payable

    116,852       3,319       120,171  

Total liabilities

    156,443       4,311       160,754  

Equity of:

                       

Hovnanian Enterprises, Inc.

    66,300       3,271       69,571  

Others

    227,335       5,752       233,087  

Total equity

    293,635       9,023       302,658  

Total liabilities and equity

    $450,078       $13,334       $463,412  

Debt to capitalization ratio

    28

%

    27

%

    28

%

 

(Dollars in thousands)

 

October 31, 2015

 
   

Homebuilding

   

Land

Development

   

Total

 

Assets:

                       

Cash and cash equivalents

    $27,856       $1,755       $29,611  

Inventories

    314,814       11,767       326,581  

Other assets

    11,225       -       11,225  

Total assets

    $353,895       $13,522       $367,417  
                         

Liabilities and equity:

                       

Accounts payable and accrued liabilities

    $29,994       $669       $30,663  

Notes payable

    112,554       3,774       116,328  

Total liabilities

    142,548       4,443       146,991  

Equity of:

                       

Hovnanian Enterprises, Inc.

    57,336       3,122       60,458  

Others

    154,011       5,957       159,968  

Total equity

    211,347       9,079       220,426  

Total liabilities and equity

    $353,895       $13,522       $367,417  

Debt to capitalization ratio

    35

%

    29

%

    35

%

 

As of April 30, 2016 and October 31, 2015, we had advances outstanding of $0.5 million and $0.8 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 $70.1 million and $61.2 million at April 30, 2016 and October 31, 2015, respectively.

 

 

    

   

For the Three Months Ended April 30, 2016

 

(In thousands)

 

Homebuilding

   

Land Development

   

Total

 
                         

Revenues

    $25,760       $521       $26,281  

Cost of sales and expenses

    (31,480 )     (96 )     (31,576 )

Joint venture net (loss) income

    $(5,720 )     $425       $(5,295 )

Our share of net (loss) income

    $(1,353 )     $213       $(1,140 )

 

   

For the Three Months Ended April 30, 2015

 

(In thousands)

 

Homebuilding

   

Land Development

   

Total

 
                         

Revenues

    $27,648       $1,483       $29,131  

Cost of sales and expenses

    (29,258

)

    (1,722

)

    (30,980

)

Joint venture net loss

    $(1,610

)

    $(239

)

    $(1,849

)

Our share of net income (loss)

    $1,465       $(119

)

    $1,346  

  

 

   

For the Six Months Ended April 30, 2016

 

(In thousands)

 

Homebuilding

   

Land Development

   

Total

 
                         

Revenues

    $46,026       $1,617       $47,643  

Cost of sales and expenses

    (55,659 )     (1,319 )     (56,978 )

Joint venture net (loss) income

    $(9,633 )     $298       $(9,335 )

Our share of net (loss) income

    $(2,849 )     $149