10-Q 1 hov20220131_10q.htm FORM 10-Q hov20220131_10q.htm
0000357294 HOVNANIAN ENTERPRISES INC false --10-31 Q1 2022 0.01 0.01 100,000 100,000 5,600 5,600 5,600 5,600 140,000 140,000 0.01 0.01 16,000,000 16,000,000 6,084,670 6,066,164 0.01 0.01 2,400,000 2,400,000 704,273 686,876 470,430 470,430 27,669 27,669 476.56 0 1 0 420 6 6 4.3 57.5 0.25 0.25 5 5 0.1 0.1 3 5 10.0 10.0 November 15, 2025 November 15, 2025 158,502 7.75 7.75 February 15, 2026 February 15, 2026 10.5 10.5 February 15, 2026 February 15, 2026 11.25 11.25 February 15, 2026 February 15, 2026 8.0 8.0 November 1, 2027 November 1, 2027 0 0 13.5 13.5 February 1, 2026 February 1, 2026 5.0 5.0 February 1, 2040 February 1, 2040 February 1, 2027 February 1, 2027 January 31, 2028 January 31, 2028 81,498 0 0 2.7 0.001 0 1 10 1 1 0 6 0 0 20 50 50 0 0 10.0 November 15, 2025 7.75 February 15, 2026 10.5 February 15, 2026 11.25 February 15, 2026 13.5 February 1, 2026 5.0 February 1, 2040 February 1, 2027 January 31, 2028 10.0 November 15, 2025 7.75 February 15, 2026 10.5 February 15, 2026 11.25 February 15, 2026 13.5 February 1, 2026 5.0 February 1, 2040 February 1, 2027 January 31, 2028 0 Data does not include interest incurred by our mortgage and finance subsidiaries. Corporate and unallocated for the three months ended January 31, 2022 included corporate general and administrative costs of $29.4 million, interest expense of $11.5 million (a component of Other interest on our Condensed Consolidated Statements of Operations), and $0.5 million of other income and expenses primarily related to interest income and stock compensation. Corporate and unallocated for the three months ended January 31, 2021 included corporate general and administrative costs of $23.5 million, interest expense of $16.2 million (a component of Other interest on our Condensed Consolidated Statements of Operations), and $(0.2) million of other income and expenses primarily related to interest income and stock compensation. Deferred tax assets for the Financial services segment are included in the Deferred tax assets, net line on the Condensed Consolidated Balance Sheets. Capitalized interest amounts are shown gross before allocating any portion of impairments, if any, to capitalized interest. At January 31, 2022, provides for up to $125.0 million in aggregate amount of senior secured first lien revolving loans. Availability thereunder will terminate on December 28, 2022. 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 January 31, (In thousands) 2022 2021 Other interest expensed $ 13,393 $ 23,975 Interest paid by our mortgage and finance subsidiaries 468 425 Increase in accrued interest (19,115 ) (14,478 ) Cash paid for interest, net of capitalized interest $ (5,254 ) $ 9,922 $26.0 million of 8.0% Senior Notes due 2027 (the "8.0% 2027 Notes") are owned by a wholly-owned consolidated subsidiary of HEI. Therefore, in accordance with GAAP, such notes are not reflected on the Condensed Consolidated Balance Sheets of HEI. 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, which amounted to $11.5 million and $16.2 million for the three months ended January 31, 2022 and 2021, respectively. Other interest also includes interest on completed homes, land in planning and fully developed lots without homes under construction, which does not qualify for capitalization and therefore is expensed. This component of other interest was $1.9 million and $7.8 million for the three months ended January 31, 2022 and 2021, respectively. 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Table of Contents

 

UNITED STATES

 

SECURITIES AND EXCHANGE COMMISSION

 

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

 

(Mark One)

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

 

For the quarterly period ended January 31, 2022

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.)

 

90 Matawan Road, 5th Floor, Matawan, NJ 07747 (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)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

Trading symbol(s)

Name of each exchange on which registered

Class A Common Stock, $0.01 par value per share

HOV

New York Stock Exchange

Preferred Stock Purchase Rights(1)

N/A

New York Stock Exchange

Depositary Shares each representing

1/1,000th of a share of 7.625% Series A

Preferred Stock

HOVNP

The Nasdaq Stock Market LLC

 

(1) Each share of Common Stock includes an associated Preferred Stock Purchase Right. Each Preferred Stock Purchase Right initially represents the right, if such Preferred Stock Purchase Right becomes exercisable, to purchase from the Company one ten-thousandth of a share of its Series B Junior Preferred Stock for each share of Common Stock. The Preferred Stock Purchase Rights currently cannot trade separately from the underlying Common Stock.

 

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 ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).  Yes ☒  No ☐

 

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

 

Large Accelerated Filer ☐

Accelerated Filer ☒ 

Nonaccelerated Filer ☐  

Smaller Reporting Company 

Emerging Growth Company

          

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

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

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 5,616,444 shares of Class A Common Stock and 676,560 shares of Class B Common Stock were outstanding as of March 1, 2022.

 

 

 

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, 2022 and October 31, 2021

3

  

  

Condensed Consolidated Statements of Operations (unaudited) for the three months ended January 31, 2022 and 2021

4

  

  

Condensed Consolidated Statements of Changes in Equity (Deficit) (unaudited) for the three months ended January 31, 2022 and 2021

5

  

  

Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended January 31, 2022 and 2021

7

  

  

Notes to Condensed Consolidated Financial Statements (unaudited)

8

  

  

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

31

  

  

Item 3.  Quantitative and Qualitative Disclosures About Market Risk

53

  

  

Item 4.  Controls and Procedures

53

  

  

PART II.  Other Information

  

Item 1.  Legal Proceedings

54

   

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

54

   

Item 6.  Exhibits

55

  

  

Signatures

57

 

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In Thousands)

 

  

January 31,

  

October 31,

 
  

2022

  

2021

 
   (Unaudited)     

ASSETS

        

Homebuilding:

        

Cash and cash equivalents

 $137,898  $245,970 

Restricted cash and cash equivalents

  14,260   16,089 

Inventories:

        

Sold and unsold homes and lots under development

  1,112,928   1,019,541 

Land and land options held for future development or sale

  175,615   135,992 

Consolidated inventory not owned

  124,845   98,727 

Total inventories

  1,413,388   1,254,260 

Investments in and advances to unconsolidated joint ventures

  67,467   60,897 

Receivables, deposits and notes, net

  34,798   39,934 

Property, plant and equipment, net

  20,017   18,736 

Prepaid expenses and other assets

  62,069   56,186 

Total homebuilding

  1,749,897   1,692,072 
         

Financial services

  143,057   202,758 
         

Deferred tax assets, net

  416,213   425,678 

Total assets

 $2,309,167  $2,320,508 
         

LIABILITIES AND EQUITY

        

Homebuilding:

        

Nonrecourse mortgages secured by inventory, net of debt issuance costs

 $196,386  $125,089 

Accounts payable and other liabilities

  335,669   426,381 

Customers’ deposits

  83,219   68,295 

Liabilities from inventory not owned, net of debt issuance costs

  75,344   62,762 

Senior notes and credit facilities (net of discounts, premiums and debt issuance costs)

  1,247,221   1,248,373 

Accrued Interest

  47,269   28,154 

Total homebuilding

  1,985,108   1,959,054 
         

Financial services

  122,199   182,219 

Income taxes payable

  4,973   3,851 

Total liabilities

  2,112,280   2,145,124 
         

Equity:

        

Hovnanian Enterprises, Inc. stockholders' equity:

        

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, 2022 and October 31, 2021

  135,299   135,299 

Common stock, Class A, $0.01 par value - authorized 16,000,000 shares; issued 6,084,670 shares at January 31, 2022 and 6,066,164 shares at October 31, 2021

  61   61 

Common stock, Class B, $0.01 par value (convertible to Class A at time of sale) - authorized 2,400,000 shares; issued 704,273 shares at January 31, 2022 and 686,876 shares at October 31, 2021

  7   7 

Paid in capital - common stock

  721,570   722,118 

Accumulated deficit

  (545,089)  (567,228)

Treasury stock - at cost – 470,430 shares of Class A common stock and 27,669 shares of Class B common stock at January 31, 2022 and October 31, 2021

  (115,360)  (115,360)

Total Hovnanian Enterprises, Inc. stockholders’ equity

  196,488   174,897 

Noncontrolling interest in consolidated joint ventures

  399   487 

Total equity

  196,887   175,384 

Total liabilities and equity

 $2,309,167  $2,320,508 

 

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 January 31,

 
  

2022

  

2021

 

Revenues:

        

Homebuilding:

        

Sale of homes

 $551,366  $551,365 

Land sales and other revenues

  638   3,802 

Total homebuilding

  552,004   555,167 

Financial services

  13,309   19,497 

Total revenues

  565,313   574,664 
         

Expenses:

        

Homebuilding:

        

Cost of sales, excluding interest

  427,917   439,638 

Cost of sales interest

  13,745   17,165 

Inventory impairment loss and land option write-offs

  99   1,877 

Total cost of sales

  441,761   458,680 

Selling, general and administrative

  42,746   40,225 

Total homebuilding expenses

  484,507   498,905 
         

Financial services

  10,400   10,354 

Corporate general and administrative

  29,435   23,483 

Other interest

  13,393   23,975 

Other operations

  368   278 

Total expenses

  538,103   556,995 

Income from unconsolidated joint ventures

  8,191   1,916 

Income before income taxes

  35,401   19,585 

State and federal income tax provision (benefit):

        

State

  2,543   626 

Federal

  8,050   - 

Total income taxes

  10,593   626 

Net income

  24,808   18,959 

Less: preferred stock dividends

  2,669   - 

Net income available to common stockholders

 $22,139  $18,959 
         

Per share data:

        

Basic:

        

Net income per common share

 $3.12  $2.79 

Weighted-average number of common shares outstanding

  6,389   6,225 

Assuming dilution:

        

Net income per common share

 $3.07  $2.75 

Weighted-average number of common shares outstanding

  6,501   6,303 

 

See notes to condensed consolidated financial statements (unaudited).

 

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

Three MONTH PERIOD ENDED January 31, 2022

(In Thousands Except Share Amounts)

(Unaudited)

 

  

A Common Stock

  

B Common Stock

  

Preferred Stock

                     
  

Shares

      

Shares

      

Shares

                         
  

Issued and

      

Issued and

      

Issued and

      

Paid-In

  

Accumulated

  

Treasury

  

Noncontrolling

     
  

Outstanding

  

Amount

  

Outstanding

  

Amount

  

Outstanding

  

Amount

  

Capital

  

Deficit

  

Stock

  

Interest

  

Total

 
                                             

Balance, October 31, 2021

  5,595,734  $61   659,207  $7   5,600  $135,299  $722,118  $(567,228) $(115,360) $487  $175,384 
                                             

Stock options, amortization and issuances

  804                       4               4 
                                             

Preferred dividend declared ($476.56 per share)

                              (2,669)          (2,669)
                                             

Restricted stock amortization, issuances and forfeitures

  17,654       17,445               (552)              (552)
                                             

Conversion of Class B to Class A common stock

  48       (48)                              - 
                                             

Changes in noncontrolling interest in consolidated joint ventures

                                      (88)  (88)
                                             

Net income

                              24,808           24,808 
                                             

Balance, January 31, 2022

  5,614,240  $61   676,604  $7   5,600  $135,299  $721,570  $(545,089) $(115,360) $399  $196,887 

 

See notes to condensed consolidated financial statements (unaudited).

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (DEFICIT)

Three MONTH PERIOD ENDED January 31, 2021

(In Thousands Except Share Amounts)

(Unaudited)

 

  

A Common Stock

  

B Common Stock

  

Preferred Stock

                     
  

Shares

      

Shares

      

Shares

                         
  

Issued and

      

Issued and

      

Issued and

      

Paid-In

  

Accumulated

  

Treasury

  

Noncontrolling

     
  

Outstanding

  

Amount

  

Outstanding

  

Amount

  

Outstanding

  

Amount

  

Capital

  

Deficit

  

Stock

  

Interest

  

Total

 
                                             

Balance, October 31, 2020

  5,519,880  $60   622,217  $7   5,600  $135,299  $718,110  $(1,175,045) $(115,360) $835  $(436,094)
                                             

Stock options, amortization and issuances

                          54               54 
                                             

Restricted stock amortization, issuances and forfeitures

  7,207       2,370               668               668 
                                             

Conversion of Class B to Class A common stock

  45       (45)                              - 
                                             

Changes in noncontrolling interest in consolidated joint ventures

                                      78   78 
                                             

Net income

                              18,959           18,959 
                                             

Balance, January 31, 2021

  5,527,132  $60   624,542  $7   5,600  $135,299  $718,832  $(1,156,086) $(115,360) $913  $(416,335)

  

See notes to condensed consolidated financial statements (unaudited). 

 

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In Thousands)

(Unaudited)

 

  

Three Months Ended

 
  

January 31,

 
  

2022

  

2021

 

Cash flows from operating activities:

        

Net income

 $24,808  $18,959 

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

        

Depreciation

  1,175   1,338 

Compensation from stock options and awards

  1,635   902 

Amortization of bond discounts, premiums and deferred financing costs

  (280)  209 

Gain on sale and retirement of property and assets

  (5)  (14)

Income from unconsolidated joint ventures

  (8,191)  (1,916)

Distributions of earnings from unconsolidated joint venture

  2,100   2,841 

Noncontrolling interest in consolidated joint ventures

  62   78 

Inventory impairment and land option write-offs

  99   1,877 

(Increase) decrease in assets:

        

Origination of mortgage loans

  (272,877)  (334,272)

Sale of mortgage loans

  342,090   312,794 

Receivables, prepaids, deposits and other assets

  (2,139)  (9,531)

Inventories

  (159,227)  (87,251)

Deferred tax assets

  9,465   - 

Increase (decrease) in liabilities:

        

State income tax payable

  1,122   557 

Customers’ deposits

  14,924   8,975 

Accounts payable, accrued interest and other accrued liabilities

  (70,490)  (9,605)

Net cash used in operating activities

  (115,729)  (94,059)

Cash flows from investing activities:

        

Proceeds from sale of property and assets

  5   16 

Purchase of property, equipment, and other fixed assets and acquisitions

  (2,453)  (964)

Investment in and advances to unconsolidated joint ventures

  (1,033)  (3,214)

Distributions of capital from unconsolidated joint ventures

  554   12,035 

Net cash (used in) provided by investing activities

  (2,927)  7,873 

Cash flows from financing activities:

        

Proceeds from mortgages and notes

  136,021   64,257 

Payments related to mortgages and notes

  (63,892)  (72,235)

Proceeds from model sale leaseback financing programs

  8,737   1,360 

Payments related to model sale leaseback financing programs

  (3,553)  (3,583)

Proceeds from land bank financing programs

  21,425   15,025 

Payments related to land bank financing programs

  (13,642)  (24,726)

Payments for partner distributions to consolidated joint venture

  (150)  - 

Net (payments) proceeds related to mortgage warehouse lines of credit

  (63,311)  23,925 

Preferred dividends paid

  (2,669)  - 

Deferred financing costs from land banking financing programs and note issuances

  (1,848)  (590)

Net cash provided by financing activities

  17,118   3,433 

Net decrease in cash and cash equivalents, and restricted cash and cash equivalents

  (101,538)  (82,753)

Cash and cash equivalents, and restricted cash and cash equivalents balance, beginning of period

  311,396   309,460 

Cash and cash equivalents, and restricted cash and cash equivalents balance, end of period

 $209,858  $226,707 
         

Supplemental disclosures of cash flows:

        

Cash paid during the period for:

        

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

 $(5,254) $9,922 

Income taxes

 $7  $69 
         

Reconciliation of Cash, cash equivalents and restricted cash

        

Homebuilding: Cash and cash equivalents

 $137,898  $172,098 

Homebuilding: Restricted cash and cash equivalents

  14,260   12,628 

Financial Services: Cash and cash equivalents, included in Financial services assets

  6,846   4,531 

Financial Services: Restricted cash and cash equivalents, included in Financial services assets

  50,854   37,450 

Total cash, cash equivalents and restricted cash shown in the statement of cash flows

 $209,858  $226,707 

 

 

HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED

 

 

 

1.

Basis of Presentation

 

Hovnanian Enterprises, Inc. (“HEI”) conducts all of its homebuilding and financial services operations through its subsidiaries (references herein to the “Company,” “we,” “us” or “our” refer to HEI and its consolidated subsidiaries and should be understood to reflect the consolidated business of HEI’s subsidiaries). HEI 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 HEI's accounts and those of all of its consolidated subsidiaries after elimination of all of its significant intercompany balances and transactions. Noncontrolling interest represents the proportionate equity interest in a consolidated joint venture that is not 100% owned by the Company. One of HEI's subsidiaries owns a 99% controlling interest in the consolidated joint venture, and therefore HEI is required to consolidate the joint venture within its Condensed Consolidated Financial Statements. The 1% that the Company does not own is accounted for as noncontrolling interest. Another one of HEI's subsidiaries owns an 80% controlling interest in a consolidated joint venture, and therefore HEI is required to consolidate the joint venture within its Condensed Consolidated Financial Statements. The 20% that the Company does not own is accounted for as noncontrolling interest. 

 

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 accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. These Condensed Consolidated Financial Statements 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, 2021. 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.  

 

 

2.

Stock Compensation

 

For the three months ended January 31, 2022 and 2021, the Company’s total stock-based compensation expense was $1.6 million ($1.1 million net of tax) and $0.9 million ($0.8 million net of tax), respectively. Included in total stock-based compensation expense was the vesting of stock options of $45 thousand and $0.1 million for the three months ended January 31, 2022 and 2021, respectively.

 

8

 

 

3.

Interest

 

Interest costs incurred, expensed and capitalized were:

 

   

Three Months Ended

 
   

January 31,

 

(In thousands)

 

2022

   

2021

 

Interest capitalized at beginning of period

  $ 58,159     $ 65,010  

Plus interest incurred(1)

    32,783       41,457  

Less cost of sales interest expensed

    13,745       17,165  

Less other interest expensed(2)(3)

    13,393       23,975  

Interest capitalized at end of period(4)

  $ 63,804     $ 65,327  

 

(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, which amounted to $11.5 million and $16.2 million for the three months ended January 31, 2022 and 2021, respectively. Other interest also includes interest on completed homes, land in planning and fully developed lots without homes under construction, which does not qualify for capitalization and therefore is expensed. This component of other interest was $1.9 million and $7.8 million for the three months ended January 31, 2022 and 2021, respectively.

(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

 
  

January 31,

 

(In thousands)

 

2022

  

2021

 

Other interest expensed

 $13,393  $23,975 

Interest paid by our mortgage and finance subsidiaries

  468   425 

Increase in accrued interest

  (19,115)  (14,478)

Cash paid for interest, net of capitalized interest

 $(5,254) $9,922 

 

(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. 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 three months ended January 31, 2022 and 2021, we evaluated inventories of all 382 and 360 communities under development and held for future development or sale, respectively, for impairment indicators through preparation and review of detailed budgets or other market indicators of impairment. As a result of such analysis, we did not identify any impairment indicators and therefore were not required to perform undiscounted future cash flow analyses during the three months ended January 31, 2022 for any of the 382 communities. We performed undiscounted future cash flow analyses during the three months ended January 31, 2021 for one of the 360 communities with an aggregate carrying value of $2.3 million, which had projected operating losses or other impairment indicators. As a result of our undiscounted future cash flow analyses, we performed discounted cash flow analyses and recorded an impairment loss of $0.8 million in the community for the three months ended January 31, 2021. In the first quarter of fiscal 2021, the discount rate used for the impairment recorded was 19.3%. In the first quarter of fiscal 2022, we did not record any impairment losses. Impairment losses are 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.

  

9

 

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 $0.1 million and $1.1 million for the three months ended January 31, 2022 and 2021, 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 both the three months ended  January 31, 2022 and 2021 were 420. The walk-aways were located in the Northeast, Southeast, Southwest and West segments in the first quarter of fiscal 2022 and in the Southwest and West segments in the first quarter of fiscal 2021.

 

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 2022, we did not mothball any additional communities, and we did not sell or re-activate any previously mothballed communities. As of both January 31, 2022 and October 31, 2021, the net book value associated with our six total mothballed communities was $4.3 million, which was net of impairment charges recorded in prior periods of $57.5 million.

 

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 606-10-55-68, 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, 2022 and October 31, 2021, inventory of $36.2 million and $32.5 million, respectively, was recorded to “Consolidated inventory not owned,” with a corresponding amount of $36.5 million and $31.5 million (net of debt issuance costs), 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 predetermined schedule. Because of our options to repurchase these parcels, for accounting purposes, in accordance with ASC 606-10-55-70, these transactions are considered a financing rather than a sale. For purposes of our Condensed Consolidated Balance Sheets, at January 31, 2022 and October 31, 2021, inventory of $88.6 million and $66.2 million, respectively, was recorded to “Consolidated inventory not owned,” with a corresponding amount of $38.8 million and $31.3 million (net of debt issuance costs), 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 January 31, 2022 and October 31, 2021, 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, 2022, we had total cash deposits amounting to $123.9 million to purchase land and lots with a total purchase price of $1.5 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.

 

10

 

 

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, 2022 and 2021, we received $1.2 million and $1.5 million, respectively, from subcontractors related to the owner-controlled insurance program, which we accounted for as reductions 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 to be delivered in fiscal 2022 and previously delivered in 2021, our deductible under our general liability insurance is or was a $25 million and $20 million, respectively, aggregate for construction defect and warranty claims. For bodily injury claims, our deductible per occurrence in fiscal 2022 and 2021 is or was $0.25 million, up to a $5 million limit. Our aggregate retention for construction defect, warranty and bodily injury claims is or was $25 million for fiscal 2022 and $20 million for fiscal 2021. 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, 2022 and 2021 were as follows:

 

  

Three Months Ended

 
  

January 31,

 

(In thousands)

 

2022

  

2021

 
         

Balance, beginning of period

 $94,916  $86,417 

Additions – Selling, general and administrative

  2,216   2,048 

Additions – Cost of sales

  1,424   1,898 

Charges incurred during the period

  (4,154)  (1,976)

Changes to pre-existing reserves

  (1,049)  474 

Balance, end of period

 $93,353  $88,861 

 

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 less than $0.1 million for both the three months ended January 31, 2022 and 2021 for prior year deliveries.

 

11

 

 

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. The significant majority of our litigation matters are related to construction defect claims. Our estimated losses from construction defect litigation matters, if any, are included in our construction defect reserves.

 

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 storm water 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 a site may vary greatly according to the community site, for example, due to the community, the environmental conditions at or near the site, 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.

 

We anticipate that increasingly stringent requirements will continue to be imposed on developers and homebuilders in the future. In addition, some of these laws and regulations that significantly affect how certain properties may be developed are contentious, attract intense political attention, and may be subject to significant changes over time.  For example, regulations governing wetlands permitting under the federal Clean Water Act have been the subject of extensive rulemakings for many years, resulting in several major joint rulemakings by the EPA and the U.S. Army Corps of Engineers that have expanded and contracted the scope of wetlands subject to regulation; and such rulemakings have been the subject of many legal challenges, some of which remain pending. It is unclear how these and related developments, including at the state or local level, ultimately may affect the scope of regulated wetlands where we operate. Although we cannot reliably predict the extent of any effect these developments regarding wetlands, or any other requirements that may take effect 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.

 

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 tests on soil samples from properties within the development conducted by the EPA showed 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 again in March 2017 and the Company responded to the information requests. On May 2, 2018 the EPA sent a letter to the Company entity demanding reimbursement for 100% of the EPA’s costs to clean-up the site in the amount of $2.7 million. The Company responded to the EPA’s demand letter on June 15, 2018 setting forth the Company’s defenses and expressing its willingness to enter into settlement negotiations. Two other PRPs identified by the EPA are now also in negotiations with the EPA and in preliminary negotiations with the Company regarding the site. In the course of negotiations, the EPA informed the Company that the New Jersey Department of Environmental Protection ("NJDEP") has also incurred costs remediating part of the site. The EPA has since requested that the three PRPs present a joint settlement offer to the EPA. The Company and the other two PRPs are parties to a series of agreements tolling the statute of limitations on the EPA's claims for reimbursement, most recently extending the date until April 20, 2022. We believe that we have adequate reserves for this matter.

 

   

12

 

In 2015, the condominium association of the Four Seasons at Great Notch condominium community (the “Great Notch Plaintiff”) filed a lawsuit in the Superior Court of New Jersey, Law Division, Passaic County (the “Court”) alleging various construction defects, design defects, and geotechnical issues relating to the community. The operative complaint (“Complaint”) asserts claims against Hovnanian Enterprises, Inc. and several of its affiliates, including K. Hovnanian at Great Notch, LLC, K. Hovnanian Construction Management, Inc., and K. Hovnanian Companies, LLC. The Complaint also asserts claims against various other design professionals and contractors. The Great Notch Plaintiff has also filed a motion, which remains pending, to permit it to pursue a claim to pierce the corporate veil of K. Hovnanian at Great Notch, LLC to hold its alleged parent entities liable for any damages awarded against it. To date, the Hovnanian-affiliated defendants have reached a partial settlement with the Great Notch Plaintiff as to a portion of the Great Notch Plaintiff’s claims against them for an amount immaterial to the Company. On its remaining claims against the Hovnanian-affiliated defendants, the Great Notch Plaintiff has asserted damages of approximately $119.5 million, which amount is potentially subject to treble damages pursuant to the Great Notch Plaintiff’s claim under the New Jersey Consumer Fraud Act. The trial is currently scheduled for June 6, 2022. Mediation was held in September 2020, and a further mediation session is scheduled in March 2022. The Hovnanian-affiliated defendants intend to defend these claims vigorously.

 

In December 2020, the NJDEP and the Administrator of the New Jersey Spill Compensation Fund (the “Spill Fund”) filed a lawsuit in the Superior Court of New Jersey, Law Division, Union County against Hovnanian Enterprises, Inc. in addition to other unrelated parties, in connection with contamination at Hickory Manor, a residential condominium development. Alleged predecessors of certain defendants had used the Hickory Manor property for decades for manufacturing purposes. In 1998, NJDEP confirmed that groundwater at this site was impacted from an off-site source. The site was later remediated, resulting in the NJDEP issuing an unconditional site-wide No Further Action determination letter and Covenant Not to Sue in 1999. Subsequently, one of our affiliates was involved in redeveloping the property as a residential community. The complaint asserts claims under the New Jersey Spill Act and other state law claims and alleges that the NJDEP and the Spill Fund have incurred over $5.3 million since 2009 to investigate vapor intrusion at the development and to install vapor mitigation systems. Among other things, the complaint seeks recovery of the costs incurred, an order that defendants perform additional required remediation and disgorgement of profits on our affiliate’s sales of the units in the development. Discovery has commenced. Hovnanian Enterprises, Inc. intends to defend these claims vigorously.   

 

 

8.

Cash and Cash Equivalents, Restricted Cash and Cash Equivalents and Customer's 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, 2022 and October 31, 2021, $13.4 million and $15.7 million, respectively, of the total cash and cash equivalents was in cash equivalents and restricted cash equivalents, the book value of which approximates fair value.

 

Homebuilding - Restricted cash and cash equivalents on the Condensed Consolidated Balance Sheets totaled $14.3 million and $16.1 million as of January 31, 2022 and October 31, 2021, respectively, which primarily consists of cash collateralizing our letter of credit agreements and facilities as discussed in Note 12.

 

Financial services restricted cash and cash equivalents, which are included in Financial services assets on the Condensed Consolidated Balance Sheets, totaled $50.9 million and $43.5 million as of January 31, 2022 and October 31, 2021, respectively. Included in these balances were (1) financial services customers’ deposits of $46.8 million at January 31, 2022 and $40.7 million as of  October 31, 2021, which are subject to restrictions on our use, and (2) $4.1 million at January 31, 2022 and $2.8 million as of October 31, 2021 of restricted cash 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.

Leases

 

We lease certain office space for use in our operations. We assess each of these contracts to determine whether the arrangement contains a lease as defined by ASC 842 “Leases” ("ASC 842"). In order to meet the definition of a lease under ASC 842, the contractual arrangement must convey to us the right to control the use of an identifiable asset for a period of time in exchange for consideration. We recognize lease expense for these leases on a straight-line basis over the lease term and combine lease and non-lease components for all leases. Our office lease terms are generally from three to five years and generally contain renewal options. In accordance with ASC 842, our lease terms include those renewals only to the extent that they are reasonably certain to be exercised. The exercise of these lease renewal options is generally at our discretion. In accordance with ASC 842, the lease liability is equal to the present value of the remaining lease payments while the right of use (“ROU”) asset is based on the lease liability, subject to adjustment, such as for lease incentives. Our leases do not provide a readily determinable implicit interest rate and therefore, we must estimate our incremental borrowing rate. In determining the incremental borrowing rate, we consider the lease period and our collateralized borrowing rates.

 

13

 

Our lease population at January 31, 2022 is comprised of operating leases where we are the lessee, and these leases are primarily real estate for office space for our corporate office, division offices and design centers. As allowed by ASC 842, we adopted an accounting policy election to not record leases with lease terms of twelve months or less on our Condensed Consolidated Balance Sheets.

 

Lease cost included in our Condensed Consolidated Statements of Operations in Selling, general and administrative expenses and payments on our lease liabilities are presented in the table below. Our short-term lease costs and sublease income are de minimis.

 

   

Three Months Ended

 

(In thousands)

 

January 31, 2022

   

January 31, 2021

 

Operating lease cost

  $ 2,588     $ 2,616  

Cash payments on lease liabilities

  $ 2,440     $ 2,298  

 

ROU assets are classified within Prepaids and other assets on our Condensed Consolidated Balance Sheets, while lease liabilities are classified within Accounts payable and other liabilities on our Condensed Consolidated Balance Sheets. During the three months ended January 31, 2022, the Company recorded an additional $6.6 million to both its ROU assets and lease liabilities as a result of new leases that commenced during the period. The following table contains additional information about our leases:

 

(In thousands)

 

At January 31, 2022

   

At October 31, 2021

 

ROU assets

  $ 19,922     $ 17,844  

Lease liabilities

  $ 21,004     $ 18,952  

Weighted-average remaining lease term (in years)

    3.6       3.1  

Weighted-average discount rate (incremental borrowing rate)

    9.4 %     9.4 %

 

Maturities of our operating lease liabilities as of January 31, 2022 are as follows:

 

Year ending October 31,

 

(in thousands)

 

2022 (excluding the three months ended January 31, 2022)

  $ 6,668  

2023

    7,126  

2024

    4,479  

2025

    3,750  

2026

    2,758  

Thereafter

    1,396  

Total payments

    26,177  

Less: imputed interest

    (5,173 )

Present value of lease liabilities

  $ 21,004  

 

 

10.

Mortgage Loans Held for Sale

 

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 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, 2022 and October 31, 2021, $69.3 million and $136.5 million, respectively, of mortgages held for sale were pledged against our mortgage warehouse lines of credit (see Note 11). 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” balances on the Condensed Consolidated Balance Sheets. As of January 31, 2022 and 2021, we had reserves specifically for 14 and 15 identified mortgage loans, respectively, as well as reserves for an estimate for future losses on mortgages sold but not yet identified to us.

 

 

14

 

The activity in our loan origination reserves during the three months ended January 31, 2022 and 2021 was as follows:

 

   

Three Months Ended

 
   

January 31,

 

(In thousands)

 

2022

   

2021

 
                 

Loan origination reserves, beginning of period

  $ 1,632     $ 1,458  

Provisions for losses during the period

    41       50  

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

    -       -  

Loan origination reserves, end of period

  $ 1,673     $ 1,508  

 

 

11.

Mortgages

 

Nonrecourse. We have nonrecourse mortgage loans for certain communities totaling $196.4 million and $125.1 million (net of debt issuance costs) at January 31, 2022 and October 31, 2021, respectively, which are secured by the related real property, including any improvements, with an aggregate book value of $563.9 million and $448.5 million, respectively. The weighted-average interest rate on these obligations was 4.8% and 4.4% at January 31, 2022 and October 31, 2021, respectively, and the mortgage loan payments on each community primarily correspond to home deliveries.

 

Mortgage Loans. 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. K. Hovnanian Mortgage finances the origination of mortgage loans through various master repurchase agreements, which are recorded in "Financial services" liabilities on the Condensed Consolidated Balance Sheets.

 

Our secured Master Repurchase Agreement with JPMorgan Chase Bank, N.A. (“Chase Master Repurchase Agreement”), which was amended on January 31, 2022 to extend the maturity date to January 31, 2023, is a short-term borrowing facility that provides up to $50.0 million through its maturity on June 30, 2022. 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 SOFR rate, which was 0.98% at January 31, 2022, plus the applicable margin of 2.375% to 2.5%. As of January 31, 2022 and October 31, 2021, the aggregate principal amount of all borrowings outstanding under the Chase Master Repurchase Agreement was $29.7 million and $45.7 million, respectively.

 

K. Hovnanian Mortgage has another secured Master Repurchase Agreement with Customers Bank (“Customers Master Repurchase Agreement”), which is a short-term borrowing facility that provides up to $50.0 million through its maturity on March 9, 2022, which we expect to be renewed for a one year term. 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 2.125% to 4.75% based on the type of loan and the number of days outstanding on the warehouse line. As of January 31, 2022 and October 31, 2021, the aggregate principal amount of all borrowings outstanding under the Customers Master Repurchase Agreement was $29.6 million and $40.5 million, respectively.

 

K. Hovnanian Mortgage also has a secured Master Repurchase Agreement with Comerica Bank (“Comerica Master Repurchase Agreement”), which was amended on January 11, 2022 to extend the maturity date to January 9, 2023 and which is a short-term borrowing facility through its maturity. The Comerica Master Repurchase Agreement provides up to $60.0 million on the 15th day of the last month of the Company's fiscal quarters, and reverts back to up to $50.0 million 30 days thereafter. 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 daily adjusting BSBY rate, subject to a floor of 0.50%, plus the applicable margin of 1.875% or 3.25% based upon the type of loan. As of January 31, 2022 and October 31, 2021, the aggregate principal amount of all borrowings outstanding under the Comerica Master Repurchase Agreement was $12.3 million and $48.7 million, respectively.

 

The Chase Master Repurchase Agreement, Customers 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 January 31, 2022, we believe we were in compliance with the covenants under the Master Repurchase Agreements.

 

15

 

 

12.

Senior Notes and Credit Facilities

 

Senior notes and credit facilities balances as of January 31, 2022 and October 31, 2021, were as follows:

 

  

January 31,

  

October 31,

 

(In thousands)

 

2022

  

2021

 

Senior Secured Notes:

        

10.0% Senior Secured 1.75 Lien Notes due November 15, 2025

 $158,502  $158,502 

7.75% Senior Secured 1.125 Lien Notes due February 15, 2026

  350,000   350,000 

10.5% Senior Secured 1.25 Lien Notes due February 15, 2026

  282,322   282,322 

11.25% Senior Secured 1.5 Lien Notes due February 15, 2026

  162,269   162,269 

Total Senior Secured Notes

 $953,093  $953,093 

Senior Notes:

        

8.0% Senior Notes due November 1, 2027 (1)

 $-  $- 

13.5% Senior Notes due February 1, 2026

  90,590   90,590 

5.0% Senior Notes due February 1, 2040

  90,120   90,120 

Total Senior Notes

 $180,710  $180,710 

Senior Unsecured Term Loan Credit Facility due February 1, 2027

 $39,551  $39,551 

Senior Secured 1.75 Lien Term Loan Credit Facility due January 31, 2028

 $81,498  $81,498 

Senior Secured Revolving Credit Facility (2)

 $-  $- 

Subtotal notes payable

 $1,254,852  $1,254,852 

Net (discounts) premiums

 $8,672  $10,769 

Net debt issuance costs

 $(16,303) $(17,248)

Total notes payable, net of discounts, premiums and debt issuance costs

 $1,247,221  $1,248,373 

 

(1) $26.0 million of 8.0% Senior Notes due 2027 (the "8.0% 2027 Notes") are owned by a wholly-owned consolidated subsidiary of HEI. Therefore, in accordance with GAAP, such notes are not reflected on the Condensed Consolidated Balance Sheets of HEI.

 

(2) At January 31, 2022, provides for up to $125.0 million in aggregate amount of senior secured first lien revolving loans. Availability thereunder will terminate on December 28, 2022.

 

General

 

Except for K. Hovnanian, the issuer of the notes and borrower under the Credit Facilities (as defined below), our home mortgage subsidiaries, certain of our title insurance subsidiaries, joint ventures and subsidiaries holding interests in our joint ventures, we and each of our subsidiaries are guarantors of the Credit Facilities, the senior secured notes and senior notes outstanding (except for the 8.0% 2027 Notes which are not guaranteed by K. Hovnanian at Sunrise Trail III, LLC, a wholly-owned subsidiary of the Company) at January 31, 2022 (collectively, the “Notes Guarantors”).

 

The credit agreements governing the Credit Facilities and the indentures governing the senior secured and senior notes (together, the “Debt Instruments”) outstanding at January 31, 2022 do not contain any financial maintenance covenants, but do contain restrictive covenants that limit, among other things, the ability of HEI and certain of its subsidiaries, including K. Hovnanian, to incur additional indebtedness (other than non-recourse indebtedness, certain permitted indebtedness and refinancing indebtedness), pay dividends and make distributions on common and preferred stock, repay/repurchase certain indebtedness prior to its respective stated maturity, repurchase (including through exchanges) common and preferred stock, make other restricted payments (including investments), sell certain assets (including in certain land banking transactions), incur liens, consolidate, merge, sell or otherwise dispose of all or substantially all of their assets and enter into certain transactions with affiliates. The Debt Instruments also contain customary events of default which would permit the lenders or holders thereof to exercise remedies with respect to the collateral (as applicable), declare the loans made under the Unsecured Term Loan Facility (defined below) (the “Unsecured Term Loans”), loans made under the Secured Term Loan Facility (defined below) (the “Secured Term Loans”) and loans made under the Secured Credit Agreement (as defined below) (the “Secured Revolving Loans”) or notes to be immediately due and payable if not cured within applicable grace periods, including the failure to make timely payments on the Unsecured Term Loans, Secured Term Loans, Secured Revolving Loans or notes or other material indebtedness, cross default to other material indebtedness, the failure to comply with agreements and covenants and specified events of bankruptcy and insolvency, with respect to the Unsecured Term Loans, Secured Term Loans and Secured Revolving Loans, material inaccuracy of representations and warranties and with respect to the Unsecured Term Loans, Secured Term Loans and Secured Revolving Loans, a change of control, and, with respect to the Secured Term Loans, Secured Revolving Loans and senior secured notes, the failure of the documents granting security for the obligations under the secured Debt Instruments to be in full force and effect, and the failure of the liens on any material portion of the collateral securing the obligations under the secured Debt Instruments to be valid and perfected. As of January 31, 2022, we believe we were in compliance with the covenants of the Debt Instruments.

 

16

 

If our consolidated fixed charge coverage ratio is less than 2.0 to 1.0, as defined in the applicable Debt Instrument, we are restricted from making certain payments, including dividends (in each such case, our secured debt leverage ratio must also be less than 4.0 to 1.0), and from incurring indebtedness other than certain permitted indebtedness, refinancing indebtedness and nonrecourse indebtedness. As of October 31, 2021, as a result of our improved operating results, our fixed coverage ratio was above 2.0 to 1.0 and our secured debt leverage ratio was below 4.0 to 1.0, therefore we were no longer restricted from paying dividends. As such, on December 3, 2021 our Board of Directors authorized a dividend payment of $2.7 million to preferred shareholders of record on January 1, 2022, which was paid in the first quarter of fiscal 2022.

 

Under the terms of our Debt Instruments, we have the right to make certain redemptions and prepayments and, depending on market conditions, our strategic priorities and covenant restrictions, may do so from time to time. We also continue to actively analyze and evaluate our capital structure and explore transactions to simplify our capital structure and to strengthen our balance sheet, including those that reduce leverage, interest rates and/or extend maturities, and will seek to do so with the right opportunity. We may also continue to make debt purchases and/or exchanges for debt or equity from time to time through tender offers, exchange offers, redemptions, open market purchases, private transactions, or otherwise, or seek to raise additional debt or equity capital, depending on market conditions and covenant restrictions.

 

Fiscal 2022

 

There were no transactions in respect of our Debt Instruments in the first quarter of fiscal 2022.

 

Fiscal 2021

 

                  There were no transactions in respect of our Debt Instruments in the first quarter of fiscal 2021.

 

17

 

Secured Obligations

 

On October 31, 2019, K. Hovnanian, HEI, the Notes Guarantors, Wilmington Trust, National Association, as administrative agent, and affiliates of certain investment managers (the “Investors”), as lenders, entered into a credit agreement (the “Secured Credit Agreement” and, together with the Unsecured Term Loan Facility (defined below) and the Secured Term Loan Facility, the “Credit Facilities”) providing for up to $125.0 million in aggregate amount of Secured Revolving Loans to be used for general corporate purposes, upon the terms and subject to the conditions set forth therein. Secured Revolving Loans are to be borrowed by K. Hovnanian and guaranteed by the Notes Guarantors. Availability under the Secured Credit Agreement will terminate on December 28, 2022. The Secured Revolving Loans bear interest at a rate per annum equal to 7.75%, and interest is payable in arrears, on the last business day of each fiscal quarter.

 

The 7.75% Senior Secured 1.125 Lien Notes due 2026 (the "1.125 Lien Notes") have a maturity of February 15, 2026 and bear interest at a rate of 7.75% per annum payable semi-annually on February 15 and August 15 of each year, to holders of record at the close of business on February 1 and August 1, as the case may be, immediately preceding such interest payment dates. In addition, up to 35% of the original aggregate principal amount of the 1.125 Lien Notes may be redeemed with the net cash proceeds from certain equity offerings at 107.75% of principal at any time prior to February 15, 2022. K. Hovnanian may also redeem some or all of the 1.125 Lien Notes at 103.875% of principal commencing February 15, 2022, at 101.937% of principal commencing February 15, 2023 and at 100.0% of principal commencing February 15, 2024.

 

The 10.5% Senior Secured 1.25 Lien Notes due 2026 (the "1.25 Lien Notes") have a maturity of February 15, 2026 and bear interest at a rate of 10.5% per annum payable semi-annually on February 15 and August 15 of each year to holders of record at the close of business on February 1 and August 1, as the case may be, immediately preceding such interest payment dates. In addition, up to 35% of the original aggregate principal amount of the 1.25 Lien Notes may be redeemed with the net cash proceeds from certain equity offerings at 110.5% of principal at any time prior to February 15, 2022. K. Hovnanian may also redeem some or all of the 1.25 Lien Notes at 105.25% of principal commencing February 15, 2022, at 102.625% of principal commencing February 15, 2023 and at 100.0% of principal commencing February 15, 2024.

 

The 11.25% Senior Secured 1.5 Lien Notes due 2026 (the "1.5 Lien Notes") have a maturity of February 15, 2026 and bear interest at a rate of 11.25% per annum payable semi-annually on February 15 and August 15 of each year to holders of record at the close of business on February 1 and August 1, as the case may be, immediately preceding such interest payment dates. The 1.5 Lien Notes are redeemable in whole or in part at our option at any time prior to February 15, 2026 at 100.0% of their principal amount.

 

The 10.0% 1.75 Lien Notes due 2025 (the “1.75 Lien Notes”) have a maturity of November 15, 2025 and bear interest at a rate of 10.0% per annum payable semi-annually on May 15 and November 15 of each year to holders of record at the close of business on May 1 or November 1, as the case may be, immediately preceding each such interest payment date. At any time and from time to time prior to November 15, 2022, K. Hovnanian may redeem some or all of the 1.75 Lien Notes at a redemption price equal to 105.00% of their principal amount, at any time and from time to time after November 15, 2022 and prior to November 15, 2023, K. Hovnanian may redeem some or all of the 1.75 Lien Notes at a redemption price equal to 102.50% of their principal amount and at any time and from time to time after November 15, 2023, K. Hovnanian may redeem some or all of the 1.75 Lien Notes at a redemption price equal to 100.0% of their principal amount.

 

On December 10, 2019, K. Hovnanian entered into a Senior Secured 1.75 Lien Term Loan Credit Facility due January 31, 2028 (the “Secured Term Loan Facility”). The secured term loans under the Secured Term Loan Facility (the “Secured Term Loans”) bear interest at a rate equal to 10.0% per annum and will mature on January 31, 2028, with interest payable in arrears on the last business day of each fiscal quarter. At any time and from time to time prior to November 15, 2022, K. Hovnanian may voluntarily prepay some or all of the Secured Term Loans at a prepayment price equal to 105.00% of their principal amount, at any time and from time to time after November 15, 2022 and prior to November 15, 2023, K. Hovnanian may voluntarily prepay some or all of the Secured Term Loans at a prepayment price equal to 102.50% of their principal amount and at any time and from time to time after November 15, 2023, K. Hovnanian may voluntarily prepay some or all of the Secured Term Loans at a prepayment price equal to 100.0% of their principal amount.

 

18

 

Each series of secured notes and the guarantees thereof, the Secured Term Loans and the guarantees thereof and the Secured Credit Agreement and the guarantees thereof are secured by the same assets. Among the secured debt, the liens securing the Secured Credit Agreement are senior to the liens securing all of K. Hovnanian’s other secured notes and the Secured Term Loan. The liens securing the 1.125 Lien Notes are senior to the liens securing the 1.25 Lien Notes, 1.5 Lien Notes, the 1.75 Lien Notes, the Secured Term Loans and any other future secured obligations that are junior in priority with respect to the assets securing the 1.125 Lien Notes, the liens securing the 1.25 Lien Notes are senior to the liens securing the 1.5 Lien Notes, the 1.75 Lien Notes, the Secured Term Loans and any other future secured obligations that are junior in priority with respect to the assets securing the 1.25 Lien Notes, the liens securing the 1.5 Lien Notes are senior to the liens securing the 1.75 Lien Notes, the Secured Term Loans and any other future secured obligations that are junior in priority with respect to the assets securing the 1.5 Lien Notes, the liens securing the 1.75 Lien Notes and the Secured Term Loans (which are secured on a pari passu basis with each other) are senior to any other future secured obligations that are junior in priority with respect to the assets securing the 1.75 Lien Notes and the Secured Term Loans, in each case, with respect to the assets securing such debt.

 

As of January 31, 2022, the collateral securing the Secured Credit Agreement, the Secured Term Loan Facility and the secured notes included (1) $140.7 million of cash and cash equivalents, which included $8.1 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); (2) $414.3 million aggregate book value of real property, 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 joint venture holding companies with an aggregate book value of $102.7 million.

 

Unsecured Obligations

 

The 13.5% Senior Notes due 2026 (the “13.5% 2026 Notes”) bear interest at 13.5% per annum and mature on February 1, 2026. Interest on the 13.5% 2026 Notes is payable semi-annually on February 1 and August 1 of each year to holders of record at the close of business on January 15 or July 15, as the case may be, immediately preceding each such interest payment date. The 13.5% 2026 Notes are redeemable in whole or in part at K. Hovnanian’s option at any time prior to February 1, 2025 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 February 1, 2025, K. Hovnanian may also redeem some or all of the 13.5% 2026 Notes at a redemption price equal to 100.0% of their principal amount.

 

The 5.0% Senior Notes due 2040 (the “5.0% 2040 Notes”) bear interest at 5.0% per annum and mature on February 1, 2040. Interest on the 5.0% 2040 Notes is payable semi-annually on February 1 and August 1 of each year to holders of record at the close of business on January 15 or July 15, as the case may be, immediately preceding each such interest payment date. At any time and from time to time, K. Hovnanian may redeem some or all of the 2040 Notes at a redemption price equal to 100.0% of their principal amount. 

 

The Unsecured Term Loans bear interest at a rate equal to 5.0% per annum and interest is payable in arrears, on the last business day of each fiscal quarter. The Unsecured Term Loans will mature on February 1, 2027.

 

Other

 

We have certain stand-alone cash collateralized letter of credit agreements and facilities under which there was a total of $7.9 million and $9.3 million letters of credit outstanding at January 31, 2022 and October 31, 2021, 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. At January 31, 2022 and October 31, 2021, the amount of cash collateral in these segregated accounts was $8.1 million and $9.9 million, respectively, which is reflected in “Restricted cash and cash equivalents” on the Condensed Consolidated Balance Sheets.

 

 

13.

Per Share Calculation

 

Basic earnings per share is computed by dividing net income (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. 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.   

  

19

 

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.

 

Basic and diluted earnings per share for the periods presented below were calculated as follows:

 

   

Three Months Ended

 
   

January 31,

 

(In thousands, except per share data)

 

2022

   

2021

 
                 

Numerator:

               

Numerator for basic and diluted earnings per share

  $ 19,950     $ 17,360  

Denominator:

               

Denominator for basic earnings per share – weighted average shares outstanding

    6,389       6,225  

Effect of dilutive securities:

               

Share based payments

    112       78  

Denominator for diluted earnings per share – weighted average shares outstanding

    6,501       6,303  

Basic earnings per share

  $ 3.12     $ 2.79  

Diluted earnings per share

  $ 3.07     $ 2.75  

 

 

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 less than 0.1 million and 0.2 million for the three months ended January 31, 2022 and 2021, 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 payable 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 Stock Market LLC under the symbol “HOVNP.” During the three months ended January 31, 2022 we paid a dividend in the amount of $2.7 million on the Series A Preferred Stock.  During the three months ended January 31, 2021, 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 at a one to one conversion rate.

  

20

 

On August 4, 2008, our Board of Directors adopted a shareholder rights plan (the “Rights Plan”), which was amended on January 11, 2018 and January 18, 2021, 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 initial adoption on August 4, 2008, 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 14, 2024, unless it expires earlier in accordance with its terms. The approval of the Board of Directors’ decision to initially adopt the Rights Plan and the amendments thereto were approved by shareholders. Our stockholders also 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 our Restated 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” (as defined in the applicable United States Treasury regulations). 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 0.2 million shares of Class A Common Stock. There were no shares purchased during the three months ended January 31, 2022. As of January 31, 2022, the maximum number of shares of Class A Common Stock that may yet be purchased under this program is 22 thousand.

 

 

16.

Income Taxes

 

The total income tax expense for the three months ended January 31, 2022 was $10.6 million. The expense was primarily due to federal and state tax expense recorded as a result of our pretax income. The federal tax expense is not paid in cash as it is offset by the use of our existing NOL carryforwards. For the three months ended January 31, 2021, our deferred tax assets were still fully reserved, therefore we had no federal tax expense and only recorded state tax expense of $0.6 million primarily related to state tax expense from income generated in states where we do not have NOL carryforwards to offset that income.

 

Our federal net operating losses of $1.2 billion expire between 2029 and 2038, and $17.1 million have an indefinite carryforward period. Of our $2.4 billion of state NOLs, $229.8 million expire between 2022 through 2026; $1.5 billion expire between 2027 through 2031; $397.2 million expire between 2032 through 2036; $169.8 million expire between 2037 through 2041; and $53.9 million have an indefinite carryforward period.

 

The Company recognizes deferred income taxes for deferred tax benefits arising from NOL carryforwards and temporary differences between book and tax income which will be recognized in future years as an offset against future taxable income. A valuation allowance is provided to offset deferred tax assets if, based upon the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. Future realization of deferred tax assets depends on the existence of sufficient taxable income of the appropriate character. Sources of taxable income include future reversals of existing taxable temporary differences, expected future taxable income, taxable income in prior carryback years if permitted under the tax law, and tax planning strategies. Management has determined that it is more likely than not that sufficient taxable income will be generated in the future to realize its deferred tax assets except for a portion related to state deferred tax assets. The Company’s deferred tax assets as of January 31, 2022 were $416.2 million.

 

As of October 31, 2020, we had a valuation allowance of $396.5 million of federal deferred tax assets related to NOLs, as well as other matters, all of which was reversed during the year ended October 31, 2021. We also had a valuation allowance of $181.0 million of deferred tax assets related to state NOLs as of October 31, 2020, of which $78.1 million was reversed in the second quarter of fiscal 2021 and $101.6 million remained at October 31, 2021.

 

As of January 31, 2022, we considered all available positive and negative evidence to determine whether, based on the weight of that evidence, our valuation allowance for our deferred state income tax assets ("DTAs") was appropriate in accordance with ASC 740. Overall the positive evidence, both objective and subjective, outweighed the negative evidence. Based on this analysis, we determined that the current valuation allowance for deferred taxes of $101.6 million as of January 31, 2022, which partially reserves for our state DTAs, is appropriate.

 

21

 

The significant positive improvement in our operations in the last 27 months, coupled with our contract backlog of $1.9 billion as of January 31, 2022 provided positive evidence to support the conclusion that a full valuation allowance is not necessary for all of our DTAs. As such, we used our go forward projections to estimate our usage of our existing federal and state DTAs. From that review, we concluded that a valuation allowance for our federal DTAs was not needed. However, with respect to our state DTAs, we concluded that a valuation allowance of $101.6 million was still necessary related to states that have shorter carryforward periods or from states where we have significantly reduced or eliminated our operations and thus are not able to project that we will fully utilize those DTAs.

 

 

17.

Operating and Reporting Segments

 

HEI’s operating segments are components of the Company’s 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 the Company's communities qualifies as an operating segment, and therefore, it is impractical to provide segment disclosures for this many segments. As such, HEI has aggregated the homebuilding operating segments into six reportable segments.

 

HEI’s 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. HEI’s reportable segments consist of the following six homebuilding segments and a financial services segment noted below.

 

Homebuilding:

 

 

(1)

Northeast (New Jersey and Pennsylvania)

 

(2)

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

 

(3)

Midwest (Illinois and Ohio)

 

(4)

Southeast (Florida, Georgia and South Carolina)

 

(5)

Southwest (Arizona and Texas)

 

(6)

West (California)

  

22

 

Financial Services

 

Operations of the 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 Financial Services segment include mortgage banking and title services provided to the homebuilding operations’ customers. Our financial services subsidiaries 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 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 or benefit for income taxes (“Income before income taxes”). Income before income taxes for the Homebuilding segments consist of revenues generated from the sales of homes and land, income 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.

 

 

23

 

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

 

  

Three Months Ended

 
  

January 31,

 

(In thousands)

 

2022

  

2021

 
         

Revenues:

        

Northeast

 $20,359  $32,044 

Mid-Atlantic

  99,614   92,945 

Midwest