Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis should be read together with the sections entitled “Risk Factors,” “Selected Financial Data,” and the financial statements and the accompanying notes included elsewhere in this Form 10-K. We have omitted discussion of 2018 results where it would be redundant to include discussion previously included in Item 7 of our 2019 Annual Report on Form 10-K filed with the SEC on November 13, 2019.
In addition, the statements in this discussion and analysis regarding industry outlook, our expectations regarding the performance of our business, anticipated financial results, liquidity and the other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in “Forward-Looking Statements” and in “Risk Factors” above. Our actual results may differ materially from those contained in or implied by any forward-looking statements.
Executive Overview and Outlook
Market Conditions
The demand for new and existing homes is dependent on a variety of demographic and economic factors, including job and wage growth, household formation, consumer confidence, mortgage financing, and overall housing affordability. At the start of our fiscal 2020, factors including rising levels of household formation, a constrained supply of new and used homes, wage growth, strong employment conditions and mortgage rates that continue to be low by historical standards were contributing to improving conditions for new home sales.
Beginning in mid-March of fiscal 2020, we experienced extraordinary volatility in business conditions. On March 11, 2020, the World Health Organization declared the novel strain of coronavirus (COVID-19) a global pandemic and, on March 13, 2020, the United States declared a national emergency concerning the outbreak. In response to the initial onset of the pandemic in the U.S., state and local governmental authorities and institutions implemented containment and mitigation measures, including various “shelter in place” or “stay at home” orders, which created broad and severe economic impacts. However, all the states and local government authorities in the markets in which we operate deemed housing an essential service, which enabled us to continue building and delivering homes to our customers.
In response to the pandemic, we placed our highest priority on helping to protect the health and safety of our employees, customers, and trade partners. We took unprecedented actions in mid-March to temporarily close our sales centers, model homes and design studios to the general public. Our sales teams shifted to an appointment-only home sales process and leveraged virtual sales tools to connect with our customers online. We followed recommended social distancing and other health and safety protocols when meeting in person with a customer and shifted our corporate and division office functions to work remotely. We implemented construction site health and safety guidelines in an effort to ensure both our employees and our trade partners were adhering to safety, hygiene, and social distancing requirements. During the latter part of May, with restrictions easing in many of our markets, we began to take steps to effectively and safely resume nearly all of our operations, while also expanding construction and warranty service activities to the extent permitted by local authorities and our safety protocols.
While the economic recovery following initial containment and mitigation measures is still ongoing, economic conditions in our markets have improved. We believe this is the result of low interest rates and short supply of homes, together with what may be a desire by many people to move out of crowded urban areas into new homes in the suburbs. The strength in our markets may also be partially attributable to pent up demand from the earlier part of the COVID-19 pandemic when more restrictive "stay-at-home" orders were in place. Due to the return of demand towards the end of May, homebuilding gross margin (excluding impairments, abandonments and amortized interest) was 21.2% and 21.7% for the fiscal third quarter and fourth quarter, respectively, up 180 basis points and 180 basis points compared to prior year quarters, respectively.
Despite growth in many of our key operational metrics as housing market conditions improved, the magnitude and duration of the COVID-19 pandemic remains unknown. If economic conditions deteriorate, we expect to experience material declines in our net new orders, closings, revenues, cash flow and/or profitability in fiscal 2021, compared to the corresponding prior-year periods, and compared to our expectations. In addition, if conditions in the overall housing market or in a specific market worsen in the future beyond our current expectations, if future changes in our business strategy significantly affect any key assumptions used in our projections of future cash flows, or if there are material changes in any of the other items we consider in assessing recoverability, we may recognize charges in future periods for inventory impairments related to our current inventory assets. Any such charges could be material to our consolidated financial statements. For further discussion of the potential impacts on our business from the COVID-19 pandemic, see Part I, Item 1A – Risk Factors above.
28
Overview of Results for Our Fiscal 2020
Fiscal 2020 represented continued progress towards the execution of our balanced growth strategy. Specifically, we have successfully improved our balance sheet by reducing our debt balance, and our strong improvements in net new orders, sales pace, homes in backlog and homebuilding gross margin has positioned us well for fiscal 2021 growth.
Profitability
For the fiscal year ended September 30, 2020, we recorded net income from continuing operations of $53.3 million, an increase of $132.7 million from the prior fiscal year’s net loss from continuing operations of $79.4 million. There were certain items that impacted the comparability of our net income (loss) from continuing operations between periods:
•We recorded $2.9 million in inventory impairment and abandonment charges in fiscal 2020, as compared to $148.6 million charges recorded in the prior year.
•We recognized $1.3 million in restructuring and severance charges in fiscal 2020 compared to no such charges in fiscal 2019.
•We recognized $24.9 million in loss on extinguishment of debt in fiscal 2019 compared to no such charges in fiscal 2020.
•Income tax expense from continuing operations was $18.0 million for fiscal 2020 and income tax benefit was $37.2 million for fiscal 2019. The income tax expense in fiscal 2020 primarily resulted from income from operations and our permanent book/tax differences, partially offset by the generation of additional federal tax credits. The income tax benefit in fiscal 2019 primarily resulted from the loss from operations and the generation of additional federal tax credits. Refer to Note 13 of the notes to the consolidated financial statements for additional discussion of these matters.
Balanced Growth Strategy
At the start of our fiscal year, we executed against our long-term balanced growth strategy, which we define as the expansion of earnings at a faster rate than our revenue growth, supported by a less-leveraged and return-driven capital structure. Due to the impacts of the initial onset of the COVID-19 pandemic, we shifted focus to maximizing cash flow, including temporarily reducing or deferring land acquisition and development and general and administrative spending. During the third quarter of fiscal 2020 as conditions in our markets improved, we gradually restarted land acquisition and development spending, while remaining focused on maintaining a strong liquidity position. Currently, we continue to execute against our long-term balanced growth strategy. This strategy provides us with flexibility to increase return on capital, reduce leverage, or increase investment in land and other operating assets in response to changing market conditions. The following is a summary of our performance against certain key operating and financial metrics during the current period:
•Sales per community per month was 3.2 and 2.8 for the fiscal years ended September 30, 2020 and 2019, respectively. Our strong emphasis on sales absorptions allowed us to expand the unit and dollar value of our backlog. The increase in sales pace in fiscal 2020 primarily resulted from low interest rates and short supply of homes. Due to the high demand experienced during the fourth fiscal quarter in the homebuilding industry, our sales absorption rate for the quarter ending September 30, 2020 increased to 4.4 compared to 2.9 in the prior year quarter. Over time, we expect sales pace will normalize at the competitive range of 2.8 to 3.2 going forward.
•Our ASP for homes closed during the fiscal year ended September 30, 2020 was $385.5 thousand, up 2.1% compared to the prior year. The year-over-year increase in ASP on closings was primarily a function of geographic mix and product shift, though we also benefited from pricing power in most markets. In addition, we ended fiscal 2020 with an ASP of $396.7 thousand for our units in backlog, indicating that ASP growth may continue in the near term.
•During the year ended September 30, 2020, our net new orders increased to 6,293, up 12.9% from the prior year, while our average active community count of 163 was down 1.7% from the prior year. Our net new orders for the quarter ending September 30, 2020 increased to 2,009 compared to 1,458 in the prior year quarter, up 37.8%. We ended the year with an active community count of 145 in part due to strong sales pace experienced in the fourth fiscal quarter. We will work to rebuild community counts by investing in new communities. We continue to evaluate strategic opportunities to purchase land within our geographic footprint, balancing our desire to reduce leverage with land acquisition strategies that maximize the efficiency of capital employed.
29
•Homebuilding gross margin excluding impairments and abandonments and interest for the fiscal year ended September 30, 2020 was 21.0%, up from 19.7% in the prior year. With our strong sales paces and strong backlog, we believe opportunities remain for continued gross margin expansion through maximizing revenue while reducing costs by simplifying our product offerings, although cost pressures from lumber and other direct materials costs may temper gross margin expansion in the future.
•SG&A for the fiscal year ended September 30, 2020 was 11.9% of total revenue compared with 11.6% a year earlier. We have taken steps to limit overhead expenditures, partly through reducing our workforce which resulted in restructuring and severance charges of $1.3 million for the year ended September 30, 2020. We remain focused on improving overhead cost management in relation to our revenue growth.
•Capital efficiency, debt reduction, and share repurchases.We continue to employ a number of strategies to improve capital efficiency, including the use of option contracts, acquisition of shorter duration land parcels, and activation of previously land held for future development communities. In addition, as part of our share repurchase program, we repurchased a total of $3.3 million of our common stock during fiscal 2020 through open market transactions and 10b-1 plans. During fiscal 2020, we also made the first $50.0 million principal payment on our Senior Unsecured Term Loan (see Note 8 of the notes to our consolidated financial statements in this Form 10-K for discussion of debt activities). We expect to continue to reduce outstanding debt during fiscal 2021 with a goal of having less than $1.0 billion of outstanding debt over time.
Seasonal and Quarterly Variability: Our homebuilding operating cycle historically has reflected escalating new order activity in the second and third fiscal quarters and increased closings in the third and fourth fiscal quarters. However, these seasonal patterns may be impacted or reduced by a variety of factors, including periods of economic downturn, which result in decreased revenues and closings. While the first half of fiscal 2020 largely followed our typical seasonal pattern, the impacts of the COVID-19 pandemic resulted in a shift from our typical seasonal trend such that higher levels of new home orders were observed in the fourth fiscal quarter instead of the third fiscal quarter, which we expect will lead to increased closings in the first half of fiscal 2021 as compared to fiscal 2020. The following tables present new order and closings data for the periods presented:
New Orders (Net of Cancellations)
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Total
Closings
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr Total
30
RESULTS OF CONTINUING OPERATIONS
The following table summarizes certain key income statement metrics for the periods presented:
Fiscal Year Ended September 30,
Revenues:
Gross profit (loss):
Gross margin:
Land sales and other (b) (4.6) % (381.2) % (10.9) %
G&A as a percentage of total revenue 8.0 % 7.7 % 8.0 %
Operating income (loss) as a percentage of total revenue 3.7 % (4.3) % 3.9 %
Equity in income of unconsolidated entities $ 347 $ 404 $ 34
Loss on extinguishment of debt, net $ — $ (24,920) $ (27,839)
(a) Homebuilding gross margin for fiscal 2019 was impacted by $110.0 million of impairments primarily related to impairments recorded in the second quarter for certain projects in progress in California.
(b) Calculated as land sales and other gross loss divided by land sales and other revenue. Land sales and other gross margin is shown as a significant negative percentage for fiscal 2019 due to the $38.6 million of impairments recorded in the second quarter related to land held for sale assets in California.
(c) Calculated as tax expense (benefit) for the period divided by income (loss) from continuing operations. Due to a variety of factors, including the impact of discrete tax items on our effective tax rate, our income tax expense (benefit) is not always directly correlated to the amount of pre-tax income (loss) for the associated periods.
31
Homebuilding Operations Data
The following table summarizes net new orders and cancellation rates by reportable segment for the periods presented:
New Orders, net Cancellation Rates
Net new orders for the year ended September 30, 2020 increased to 6,293, up 12.9% from the year ended September 30, 2019. The increase in net new orders was primarily driven by an increase in sales per active community per month to 3.2 for fiscal 2020 compared to 2.8 for fiscal 2019 with increases in all three segments due to higher demand for new homes. Due to the high demand experienced during the fourth fiscal quarter in the homebuilding industry, our net new orders for the quarter ending September 30, 2020 increased to 2,009, up 37.8%, compared to 1,458 from the prior year quarter, and our sales per active community per month for the quarter ending September 30, 2020 increased to 4.4, up 52.6%, compared to 2.9 in the prior year quarter. Net new orders increased in the West and the East but decreased slightly in the Southeast segment primarily due to a decrease in average active communities, partially offset by a slight increase in sales per active community per month.
The table below summarizes backlog units by reportable segment as well as the aggregate dollar value and ASP of homes in backlog as of September 30, 2020, 2019, and 2018:
As of September 30,
Backlog Units:
Backlog reflects the number of homes for which the Company has entered into a sales contract with a customer but has not yet delivered the home. Homes in backlog are generally delivered within three to six months following commencement of construction. The aggregate dollar value of homes in backlog as of September 30, 2020 increased 49.6% compared to the prior year due to a 46.9% increase in units in backlog and a 1.9% increase in the ASP of homes in backlog. The increase in backlog units was primarily due to the aforementioned increase in net new orders for the year ended September 30, 2020 compared to prior year. Potential negative impacts of the COVID-19 pandemic could cause us to experience higher cancellation rates compared to prior periods related to homes within our backlog as of September 30, 2020.
32
Homebuilding Revenue, Average Selling Price, and Closings
The tables below summarize homebuilding revenue, the ASP of our homes closed, and closings by reportable segment for the periods presented:
Homebuilding Revenue Average Selling Price
Closings
Our overall increase in homebuilding revenue for fiscal 2020 as compared to fiscal 2019 is primarily the result of increase in ASP. The increase in ASP for fiscal 2020 was impacted by a change in the mix of closings between geographies, products, and communities within each individual market as compared with the prior fiscal year. It was also positively impacted by improved market conditions in certain geographies in the latter half of our fiscal year. On average, we anticipate that our ASP will continue to increase slightly during the first two quarters of fiscal 2021, as indicated by our ASP for homes in backlog as of September 30, 2020.
For fiscal 2020, year-over-year increase in closings in our West segment was primarily attributable to our Southern California market which had more units in beginning backlog for fiscal 2020 compared to fiscal 2019. Closings in the East were slightly down year-over-year primarily driven by lower closings due to lower average active communities during fiscal 2020 compared to the prior year. Southeast segment closings were down year-over-year as a result of fewer units in beginning backlog for fiscal 2020 compared to fiscal 2019.
33
Homebuilding Gross Profit and Gross Margin
The following tables present our homebuilding (HB) gross profit and gross margin by reportable segment and in total. In addition, such amounts are presented excluding inventory impairments and abandonments and interest amortized to cost of sales (COS). Homebuilding gross profit is defined as homebuilding revenue less home cost of sales (which includes land and land development costs, home construction costs, capitalized interest, indirect costs of construction, estimated warranty costs, closing costs, and inventory impairment and abandonment charges).
$ in thousands Fiscal Year Ended September 30, 2020
$ in thousands Fiscal Year Ended September 30, 2019
$ in thousands Fiscal Year Ended September 30, 2018
(a) w/o - without
34
Our overall homebuilding gross profit increased to $348.1 million for the fiscal year ended September 30, 2020, from $206.0 million in the prior year. As shown in the tables above, the comparability of our gross profit and gross margin was impacted by impairment and abandonment charges which decreased by $108.4 million and interest amortized to homebuilding cost of sales which increased by $1.0 million year-over-year (refer to Note 5 and Note 6 of the notes to our consolidated financial statements in this Form 10-K for additional details). When excluding the impact of impairments and abandonments and interest amortized to homebuilding cost of sales, year-over-year homebuilding gross profit increased by $34.7 million, primarily driven by growth in homebuilding revenue of $39.7 million and an increase in gross margin by 130 basis points to 21.0%.
The year-over-year change in gross margin is due to a variety of factors, including: (1) mix of closings between geographies/markets, individual communities within each market, and product type; (2) our pricing strategies, including margin impact on homes closed during the current fiscal year; (3) increased focus on managing our house costs and improving cycle times; and (4) lower warranty costs in the current period. In fiscal 2020, we focused on a continuing objective to simplify our product offerings, which includes streamlining our plan and structural options and design studio offerings to improve efficiency and reduce costs. We expect these efforts to positively contribute to our gross margin in the future.
Measures of homebuilding gross profit and gross margin after excluding inventory impairments and abandonments, interest amortized to cost of sales, and other non-recurring items are not GAAP financial measures. These measures should not be considered alternatives to homebuilding gross profit and gross margin determined in accordance with GAAP as an indicator of operating performance.
In particular, the magnitude and volatility of non-cash inventory impairment and abandonment charges for the Company and other homebuilders have been significant historically and, as such, have made financial analysis of our industry more difficult. Homebuilding metrics excluding these charges, as well as interest amortized to cost of sales and other similar presentations by analysts and other companies, are frequently used to assist investors in understanding and comparing the operating characteristics of homebuilding activities by eliminating many of the differences in companies' respective level of impairments and levels of debt. Management believes these non-GAAP measures enable holders of our securities to better understand the cash implications of our operating performance and our ability to service our debt obligations as they currently exist and as additional indebtedness is incurred in the future. These measures are also useful internally, helping management to compare operating results and to measure cash available for discretionary spending.
In a given period, our reported gross profit is generated from both communities previously impaired and communities not previously impaired. In addition, as indicated above, certain gross profit amounts arise from recoveries of prior period costs, including warranty items that are not directly tied to communities generating revenue in the period. Home closings from communities previously impaired would, in most instances, generate very low or negative gross margins prior to the impact of the previously recognized impairment. Gross margin for each home closing is higher for a particular community after an impairment because the carrying value of the underlying land was previously reduced to the present value of future cash flows as a result of the impairment, leading to lower cost of sales at the home closing. This improvement in gross margin resulting from one or more prior impairments is frequently referred to in the aggregate as the “impairment turn” or “flow-back” of impairments within the reporting period. The amount of this impairment turn may exceed the gross margin for an individual impaired asset if the gross margin for that asset prior to the impairment would have been negative. The extent to which this impairment turn is greater than the reported gross margin for the individual asset is related to the specific historical cost basis of that individual asset.
The asset valuations that result from our impairment calculations are based on discounted cash flow analyses and are not derived by simply applying prospective gross margins to individual communities. As such, impaired communities may have gross margins that are somewhat higher or lower than the gross margins for unimpaired communities. The mix of home closings in any particular quarter varies to such an extent that comparisons between previously impaired and never impaired communities would not be a reliable way to ascertain profitability trends or to assess the accuracy of previous valuation estimates. In addition, since any amount of impairment turn is tied to individual lots in specific communities, it will vary considerably from period to period. As a result of these factors, we review the impairment turn impact on gross margin on a trailing 12-month basis rather than a quarterly basis as a way of considering whether our impairment calculations are resulting in gross margins for impaired communities that are comparable to our unimpaired communities. For fiscal 2020, our homebuilding gross margin was 16.4% and excluding interest and inventory impairments and abandonments, it was 21.0%. For the same period, homebuilding gross margin was as follows in those communities that have previously been impaired, which represented 9.8% of total closings during fiscal 2020:
35
Homebuilding Gross Margin from previously impaired communities:
Pre-impairment turn gross margin 0.4 %
Impact of interest amortized to COS related to these communities 4.5 %
Pre-impairment turn gross margin, excluding interest amortization 4.9 %
Impact of impairment turns 17.5 %
Gross margin (post impairment turns), excluding interest amortization 22.4 %
For a further discussion of our impairment policies and communities impaired during the current and prior two fiscal years, refer to Notes 2 and 5 of the notes to consolidated financial statements in this Form 10-K.
Land Sales and Other Revenue and Gross Profit (Loss)
Land sales revenue relate to land and lots sold that do not fit within our homebuilding programs and strategic plans. We also have other revenue related to title examinations provided for our homebuyers in certain markets. The following tables summarize our land sales and other revenue and related gross profit (loss) by reportable segment for the periods presented:
$ in thousands Land Sales and Other Revenue
$ in thousands Land Sales and Other Gross Profit (Loss)
(a) Corporate and unallocated includes capitalized interest and capitalized indirect costs expensed to land cost of sale related to land sold, as well as capitalized interest and capitalized indirect costs impaired in order to reflect land held for sale assets at net realizable value.
For the fiscal year ended September 30, 2020, we recognized impairment charges in our West, Southeast, and Corporate and unallocated segments. Please see Note 5 of the notes to consolidated financial statements in this Form 10-K for additional details.
To further support our efforts to reduce leverage, we continued to focus on closing a number of land sales for land positions that did not fit within our strategic plans. Future land and lot sales will depend on a variety of factors, including local market conditions, individual community performance, and changing strategic plans.
36
Operating Income (Loss)
The table below summarizes operating income (loss) by reportable segment for the periods presented:
Fiscal Year Ended September 30,
(a) Corporate and unallocated operating loss includes amortization of capitalized interest and capitalized indirect costs, expenses related to numerous shared services functions that benefit all segments but are not allocated to the operating segments, and certain other amounts that are not allocated to our operating segments.
(b) Operating income (loss) is impacted by impairment and abandonment charges incurred during the periods presented (see Note 5 of the notes to our consolidated financial statements in this Form 10-K).
Our operating income increased by $169.0 million to $79.1 million for the fiscal year ended September 30, 2020, compared to a loss of $89.9 million for fiscal 2019. Excluding the impact of impairment and abandonment charges and interest amortized to cost of sales which impacts year-over-year comparability, the increase in operating income was primarily driven by the previously discussed increase in gross profit, partially offset by higher SG&A costs compared to the prior year. SG&A as a percentage of total revenue increased year-over-year by 30 basis points.
Below operating income, we had two noteworthy fluctuations between fiscal 2020 and fiscal 2019 as follows: (1) we experienced an increase in other expense, net, primarily attributable to a year-over-year increase in interest costs not qualified for capitalization; and (2) we recorded a loss of $24.9 million on the extinguishment of debt in fiscal 2019 due to the management of our debt portfolio compared to no such expense in fiscal 2020. See the notes to our consolidated financial statements in this Form 10-K for additional discussion of these matters.
Fiscal year ended September 30, 2020 as compared to 2019
West Segment: Homebuilding revenue increased by 16.5% for the fiscal year ended September 30, 2020 compared to the prior fiscal year due to a 12.1% increase in closings as well as a 3.9% increase in ASP. Compared to the prior fiscal year, homebuilding gross profit increased by $139.1 million primarily due to an increase in homebuilding revenue and $92.9 million of previously discussed impairment charges recognized during the second quarter of fiscal 2019. Excluding impairments, homebuilding gross margin increased to 22.0% from 21.0% in the prior year driven primarily by lower sales incentives and pricing increases. The $167.3 million year-over-year increase in operating income was the result of the aforementioned impairment charges, partially offset by higher SG&A expenses in the segment.
East Segment: Homebuilding revenue decreased by 6.0% for the fiscal year ended September 30, 2020 compared to the prior fiscal year due to a 4.3% decrease in closings as well as a 1.7% decrease in ASP. Compared to the prior fiscal year, homebuilding gross profit increased by $2.4 million due to higher homebuilding gross margin. Excluding impairments, homebuilding gross margin increased to 20.7% from 19.0% in the prior year driven primarily by lower sales incentives and pricing increases. The $4.7 million year-over year increase in operating income was a result of the aforementioned increase in gross profit as well as lower SG&A expenses in the segment.
Southeast Segment: Homebuilding revenue decreased by 17.5% for the fiscal year ended September 30, 2020 compared to the prior fiscal year due to a decrease in closings of 19.9%, partially offset by a 2.9% increase in ASP. Compared to the prior fiscal year, homebuilding gross profit decreased by $7.7 million due to the decrease in homebuilding revenue partially offset by an increase in homebuilding gross margin. Excluding impairments, homebuilding gross margin increased to 19.2% from 17.3% in the prior year driven primarily by lower sales incentives and pricing increases. The $0.6 million year-over-year increase in operating income was a result of lower SG&A expenses, partially offset by lower gross profit in the segment.
37
Corporate and Unallocated: Our corporate and unallocated results include amortization of capitalized interest and capitalized indirect costs, expenses for various shared services functions that benefit all segments but are not allocated, including information technology, treasury, corporate finance, legal, branding and national marketing, and certain other amounts that are not allocated to our operating segments. For the fiscal year ended September 30, 2020, corporate and unallocated net costs increased by $3.6 million over the prior fiscal year. The increase was primarily due to an increase in G&A costs, andan increase in the proportion of interest and indirect costs expensed to cost of sales year-over-year, partially offset by prior year write-off of capitalized interest and indirect costs related to the impairment of assets in the West and Southeast segments.
Income taxes
Our income tax assets and liabilities and related effective tax rate are affected by various factors, the most significant of which is the valuation allowance recorded against a portion of our deferred tax assets. Due to the effect of our valuation allowance adjustments beginning in fiscal 2008, a comparison of our annual effective tax rates must consider the changes in our valuation allowance. As such, our effective tax rates have not been meaningful metrics, as our income tax expense/benefit was not directly correlated to the amount of pretax income or loss for the associated periods. Beginning in fiscal 2016, the Company began using an annualized effective tax rate in interim periods to determine its income tax expense/benefit, which we believe more closely correlates with our periodic pretax income or loss. The annualized effective tax rate will continue to be impacted by discrete tax items.
The income tax expense recorded during the fiscal year ended September 30, 2020 primarily resulted from income generated in the current year and permanent book/tax differences, partially offset by the generation of additional federal tax credits.
The income tax benefit recorded during our fiscal year ended September 30, 2019 primarily resulted from loss generated in the fiscal year and the generation of additional federal tax credits.
The income tax expense recorded during our fiscal year ended September 30, 2018 primarily resulted from income generated in the fiscal year and the remeasurement of deferred tax asset at the newly enacted 21.0% federal tax rate, partially offset by the generation of federal tax credits and an additional release of our valuation allowance. The valuation allowance on all of our federal tax net operating losses and credits as well as portions of our state net operating losses was reduced due to our determination that it is more likely than not that these assets will be realized.
Refer to Note 13 of the notes to the consolidated financial statements in this Form 10-K for a further discussion of our income taxes and valuation allowance.
Liquidity and Capital Resources
Our sources of liquidity include, but are not limited to, cash from operations, proceeds from Senior Notes, our Secured Revolving Credit Facility (the Facility) and other bank borrowings, the issuance of equity and equity-linked securities, and other external sources of funds. Our short-term and long-term liquidity depends primarily upon our level of net income, working capital management (cash, accounts receivable, accounts payable and other liabilities) and available credit facilities.
Cash, cash equivalents, and restricted cash changed as follows for the periods presented:
Operating Activities
Net cash provided by operating activities was $289.1 million for the fiscal year ended September 30, 2020. The primary drivers of operating cash flows are typically cash earnings and changes in inventory levels, including land acquisition and land development spending. Net cash provided by operating activities during the period was driven primarily by income before income taxes of $69.9 million, which included $28.2 million of non-cash charges, a net decrease in non-inventory working
38
capital of $36.1 million, and a decrease in inventory of $154.9 million as a result of from home sales partially offset by land acquisition, land development, and house construction spending to support continued growth.
Net cash provided by operating activities was $113.6 million during the fiscal year ended September 30, 2019. Net cash provided by operating activities during the period was driven primarily by loss before income taxes of $116.8 million, which included $198.5 million of non-cash charges, a net increase in non-inventory working capital of $11.0 million, and a decrease in inventory of $42.9 million as a result of from home sales offset by land acquisition, land development, and house construction spending to support continued growth.
Investing Activities
Net cash used in investing activities for the fiscal year ended September 30, 2020 and September 30, 2019, was $10.2 million and $25.1 million, respectively, primarily driven in both periods by capital expenditures for model homes.
Financing Activities
Net cash used in financing activities was $59.2 million for the fiscal year ended September 30, 2020 driven by installment payment of the Senior Unsecured Term Loan (Term Loan), common stock repurchases under our share repurchase program, tax payments for stock-based compensation awards vesting, cash settlement of performance-based restricted stock, the repayment of other secured notes payable, and payment of debt issuance costs.
Net cash used in financing activities during the fiscal year ended September 30, 2019 was $119.0 million, primarily due to the repayment of certain debt issuances (including our 2022, 2023, 2025 and 2027 Senior Notes and other secured notes payable), the payment of cash for debt issuance costs, common stock repurchases under our share repurchase program, partially offset by proceeds received from the issuance of Senior Notes due 2029 as well as the Term Loan.
Financial Position
As of September 30, 2020, our liquidity position consisted of $327.7 million in cash and cash equivalents and $250.0 million of remaining capacity under the Facility.
The unprecedented public health and governmental efforts to contain the COVID-19 pandemic have created significant uncertainty as to general economic and housing market conditions for 2020 and beyond. As of the date of this report, we believe we have adequate capital resources and sufficient access to external financing sources to satisfy our current and reasonably anticipated requirements for funds to conduct our operations and meet other needs in the ordinary course of our business.
During this time, we may also engage in capital markets, bank loan, project debt or other financial transactions, including the repurchase of debt or potential new issuances of debt or equity securities to support our business needs. The amounts involved in these transactions, if any, may be material. In addition, as necessary or desirable, we may adjust or amend the terms of and/or expand the capacity of the Facility (including as described below), or enter into additional letter of credit facilities, or other similar facility arrangements, in each case with the same or other financial institutions, or allow any such facilities to mature or expire. However, with the uncertainty surrounding the COVID-19 pandemic, our ability to engage in such transactions may be constrained by volatile or tight economic, capital, credit and financial market conditions, as well as lender interest and capacity and our liquidity, leverage and net worth. Accordingly, we can provide no assurance as to the successful completion of, or the operational limitations arising from, any one or series of such transactions. For further discussion of the potential impacts from the COVID-19 pandemic on our capital resources and liquidity, see Part I, Item 1A – Risk Factors.
Debt
We generally fulfill our short-term cash requirements with cash generated from our operations and available borrowings. Additionally, our Secured Revolving Credit Facility provides working capital and letter of credit capacity of $250.0 million. As of September 30, 2020, no borrowings and no letters of credit were outstanding under the facility, resulting in $250.0 million remaining capacity.
We have also entered into a number of stand-alone, cash-secured letter of credit agreements with banks. These combined facilities provide for letter of credit needs collateralized by either cash or assets of the Company. We currently have $12.7 million of outstanding letters of credit under these facilities, secured with cash collateral that is maintained in restricted accounts totaling $12.9 million.
39
To provide greater letter of credit capacity, the Company has also entered into a reimbursement agreement, which provides for the issuance of performance letters of credit, and an unsecured credit agreement that provides for the issuance of up to $50.0 million of standby letters of credit to backstop the Company's obligations under the reimbursement agreement (collectively, the "Bilateral Facility"). On June 17, 2020, the Company executed an Amendment No. 1 to the Bilateral Facility that extends the termination date of the agreement from June 10, 2021 to June 10, 2022. As of September 30, 2020, the total stated amount of performance letters of credit issued under the reimbursement agreement was $36.1 million (and the stated amount of the backstop standby letter of credit issued under the credit agreement was $40.0 million).
In the future, we may from time to time seek to continue to retire or purchase our outstanding debt through cash repurchases or in exchange for other debt securities, in open market purchases, privately-negotiated transactions, or otherwise. We may also seek to expand our business through acquisition, which may be funded through cash, additional debt, or equity. In addition, any material variance from our projected operating results could require us to obtain additional equity or debt financing. There can be no assurance that we will be able to complete any of these transactions in the future on favorable terms or at all. See Note 8 of the notes to the consolidated financial statements in this Form 10-K for more information related to our borrowings.
Supplemental Guarantor Information
As discussed in Note 8 of the notes to the consolidated financial statements in this Form 10-K, the Company's obligations to pay principal and interest under certain debt agreements are guaranteed on a joint and several basis by substantially all of the Company's subsidiaries. Some of the immaterial subsidiaries do not guarantee the Senior Notes. The guarantees are full and unconditional.
In March 2020, the SEC released Rule Release No. 33-10762, Financial Disclosures About Guarantors and Issuers of Guaranteed Securities and Affiliates Whose Securities Collateralize a Registrant’s Securities ("Rule 33-10762”). Rule 33-10762 simplifies the disclosure requirements related to certain registered securities under SEC Regulation S-X, Rules 3-10 and 3-16, permitting registrants to provide certain alternative financial disclosures and non-financial disclosures in lieu of separate consolidating financial statements for subsidiary issuers and guarantors of registered debt securities (which we previously included within the notes to our consolidated financial statements included in our Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q) if certain conditions are met. The amendments in Rule 33-10762 are generally effective for filings on or after January 4, 2021, with early application permitted. We early adopted the new disclosure requirements permitted under Rule 33-10762 effective for the interim period ending June 30, 2020.
The following summarized financial information is presented for Beazer Homes USA, Inc. and the guarantor subsidiaries on a combined basis after elimination of intercompany transactions between entities in the combined group and amounts related to investments in any subsidiary that is a non-guarantor.
in thousands As of September 30, 2020 As of September 30,2019
Due from non-guarantor subsidiary $ 417 $ —
Due to non-guarantor subsidiary $ — $ 1,680
Year Ended Year Ended
Income (loss) from continuing operations $ 53,909 $ (79,507)
40
Credit Ratings
Our credit ratings are periodically reviewed by rating agencies. In July 2020, Moody's reaffirmed the Company's issuer corporate family rating of B3 and stable outlook for the Company. In October 2020, S&P revised the Company’s outlook to positive and reaffirmed the Company’s corporate credit rating of B-. These ratings and our current credit condition affect, among other things, our ability to access new capital. Negative changes to these ratings may result in more stringent covenants and higher interest rates under the terms of any new debt. Our credit ratings could be lowered, or rating agencies could issue adverse commentaries in the future, which could have a material adverse effect on our business, financial condition, results of operations, and liquidity. In particular, a weakening of our financial condition, including any further increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, could result in a credit rating downgrade or change in outlook, or could otherwise increase our cost of borrowing.
Stock Repurchases and Dividends Paid
During the first quarter of fiscal 2019, the Company's Board of Directors approved a share repurchase program that authorizes the Company to repurchase up to $50.0 million of its outstanding common stock. As part of this program, the Company has repurchased common stock during fiscal 2019 through open market transactions, 10b5-1 plans, and accelerated share repurchase (ASR) agreements. All shares have been retired upon repurchase during fiscal 2019. The aggregate reduction to stockholders’ equity related to share repurchases during the fiscal year ended September 30, 2019 was $34.6 million.
During fiscal 2020, the Company repurchased approximately 362,000 shares of its common stock for $3.3 million at an average price per share of $9.20 through open market transactions and 10b5-1 plans. All shares have been retired upon repurchase. As of September 30, 2020, the remaining availability of the share repurchase program was $12.0 million.
The indentures under which our Senior Notes were issued contain certain restrictive covenants, including limitations on the payment of dividends. There were no dividends paid during our fiscal years ended September 30, 2020, 2019, or 2018.
Off-Balance Sheet Arrangements
Lot Option Contracts
We historically have attempted to control a portion of our land supply through options. As of September 30, 2020, we controlled 17,830 lots, which includes 399 lots of land held for future development and 529 lots of land held for sale. Of the total active 16,902 lots, we owned 11,024, or 65.2%, of these lots and the remaining 5,878 of these lots, or 34.8%, were under option contracts with land developers and land bankers, which generally require the payment of cash or the posting of a letter of credit for the right to acquire lots during a specified period of time at a certain price. As a result of the flexibility that these options provide us, upon a change in market conditions (such as those created as a result of the impacts of the COVID-19 pandemic), we may renegotiate the terms of the options prior to exercise or terminate the agreement. Under option contracts, purchase of the properties is contingent upon satisfaction of certain requirements by us and the sellers, and our liability is generally limited to forfeiture of the non-refundable deposits and other non-refundable amounts incurred, which totaled approximately $75.9 million as of September 30, 2020. The total remaining purchase price, net of cash deposits, committed under all options was $395.1 million as of September 30, 2020. Based on market conditions and our liquidity, we may further expand our use of option agreements to supplement our owned inventory supply.
We expect to exercise, subject to market conditions and seller satisfaction of contract terms, most of our option contracts. Various factors, some of which are beyond our control, such as market conditions, weather conditions, and the timing of the completion of development activities, will have a significant impact on the timing of option exercises or whether lot options will be exercised at all.
We have historically funded the exercise of lot options with operating cash flows, which we expect to continue to be adequate to fund anticipated future option exercises. Therefore, we do not anticipate that the exercise of our lot options will have a material adverse effect on our liquidity.
Investments in Unconsolidated Entities
Occasionally, we use legal entities in which we have less than a controlling interest. We enter into the majority of these arrangements with land developers, other homebuilders, and financial partners to acquire attractive land positions, to manage our risk profile, and to leverage our capital base. The underlying land positions are developed into finished lots for sale to the unconsolidated entity’s members or other third parties. We account for our interest in unconsolidated entities under the equity method.
41
Historically, we and our partners have provided varying levels of guarantees of debt or other obligations for our unconsolidated entities. As of September 30, 2020, we had no repayment guarantees outstanding related to the debt of our unconsolidated entities. See Note 4 of the notes to the consolidated financial statements in this Form 10-K for additional information.
Letters of Credit and Surety Bonds
In connection with the development of our communities, we are frequently required to provide performance, maintenance, and other bonds and letters of credit in support of our related obligations with respect to such developments. The amount of such obligations outstanding at any time varies in accordance with our pending development activities. In the event any such bonds or letters of credit are drawn upon, we would be obligated to reimburse the issuer of such bonds or letters of credit. We had outstanding letters of credit and surety bonds of $48.8 million and $248.2 million, respectively, as of September 30, 2020, primarily related to our obligations to local governments to construct roads and other improvements in various developments.
Contractual Commitments
The following table summarizes our aggregate contractual commitments as of September 30, 2020:
Payments Due by Period
in thousands Total Less than 1 Year 1-3 Years 3-5 Years More than 5 Years
Uncertain tax positions (c) — — — — —
(a) For a listing of our borrowings, refer to Note 8 of the notes to the consolidated financial statements in this Form 10-K.
(b) Interest on variable rate obligations is based on rates effective as of September 30, 2020.
(c) Based on its current inventory of uncertain tax positions and tax carryforward attributes, the Company does not expect a cash settlement of unrecognized tax benefits related to uncertain tax positions in future years. See Note 13 of the notes to the consolidated financial statements in this Form 10-K for additional information regarding the Company's unrecognized tax benefits related to uncertain tax positions as of September 30, 2020.
We had outstanding letters of credit and surety bonds of $48.8 million and $248.2 million, respectively, as of September 30, 2020, primarily related to our obligations to local governments to construct roads and other improvements in various developments.
Derivative Instruments and Hedging Activities
We are exposed to fluctuations in interest rates. From time to time, we may enter into derivative agreements to manage interest costs and hedge against risks associated with fluctuating interest rates. However, as of September 30, 2020, we were not a party to any such derivative agreements. We do not enter into or hold derivatives for trading or speculative purposes.
Critical Accounting Policies and Estimates
Our critical accounting policies require the use of judgment in their application and in certain cases require estimates of inherently uncertain matters. Although our accounting policies are in compliance with accounting principles generally accepted in the United States of America (GAAP), a change in the facts and circumstances of the underlying transactions could significantly change the application of the accounting policies and the resulting financial statement impact. It is also possible that other professionals applying reasonable judgment to the same set of facts and circumstances could reach a different conclusion. Listed below are those policies that we believe are critical and require the use of complex judgment in their application.
42
Inventory Valuation - Projects in Progress
Our homebuilding inventories that are accounted for as held for development (projects in progress) include land and home construction assets grouped together as communities. Homebuilding inventories held for development are stated at cost (including home construction costs, direct overhead costs, capitalized indirect costs, capitalized interest, real estate taxes and allocated lot costs) unless facts and circumstances indicate that the carrying value of the assets may not be recoverable. We assess these assets no less than quarterly for recoverability. Generally, upon the commencement of land development activities, it may take three to five years (depending on, among other things, the size of the community and its sales pace) to fully develop, sell, construct, and close all of the homes in a typical community. Recoverability of assets is measured by comparing the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If the expected undiscounted cash flows generated are expected to be less than its carrying amount, an impairment charge is recorded to write down the carrying amount of such asset to its estimated fair value based on discounted cash flows.
When conducting our community level review for the recoverability of our homebuilding inventory related to projects in progress, we consider both qualitative and quantitative factors to establish a quarterly “watch list” of communities. Each community is evaluated qualitatively and quantitatively to determine if there are factors driving the low profitability levels. Communities with more than ten homes remaining to close with potential indicators of impairment resulting from this initial evaluation are subjected to substantial additional financial and operational reviews that consider the competitive environment and other factors contributing to profit margins below our specified thresholds. Our assumptions about future home sales prices and absorption rates require significant judgment because the residential homebuilding industry is cyclical and is highly sensitive to changes in economic conditions. For certain communities, it may be prudent to reduce sales prices or further increase sales incentives in response to a variety of factors, including competitive market conditions in those specific submarkets for the product and locations of these communities. For communities where the current competitive and market dynamics indicate that assets may not be recoverable, a formal impairment analysis is performed. The formal impairment analysis consists of both qualitative competitive market analyses and a quantitative analysis reflecting market and asset specific information.
Our qualitative competitive market analyses include site visits to new home communities of our competitors and written community-level competitive assessments. A competitive assessment consists of a comparison of our specific community with its competitor communities, considering square footage of homes offered, amenities offered within the homes and the communities, location, transportation availability and school districts, among other relevant attributes. In addition, we review the pace of monthly home sales of our competitor communities in relation to our specific community. We also review other factors, such as the target buyer and the macro-economic characteristics that impact the performance of our asset, including unemployment and the availability of mortgage financing, among other things. Based on this qualitative competitive market analysis, adjustments to our sales prices may be required in order to make our communities competitive. We incorporate these adjusted prices in our quantitative analysis for the specific community.
The quantitative analyses compare the projected future undiscounted cash flows for each such community with its current carrying value. This undiscounted cash flow analysis requires important assumptions regarding the location and mix of house plans to be sold, current and future home sale prices and incentives for each plan, current and future construction costs for each plan, and the pace of monthly sales to occur today and into the future.
There is uncertainty associated with preparing the undiscounted cash flow analyses because future market conditions will almost certainly be different, either better or worse, than current conditions. The single most important input to the cash flow analysis is current and future home sales prices for a specific community. The risk of over or under-stating any of the important cash flow variables, including home prices, is greater with longer-lived communities and within markets that have historically experienced greater home price volatility. In an effort to address these risks, we consider some home price and construction cost appreciation in future years for certain communities that are expected to be selling for more than three years and/or if the market has typically exhibited high levels of price volatility. Absent these assumptions on cost and sales price appreciation, we believe the long-term cash flow analysis would be unrealistic and would serve to artificially improve expected future profitability. Finally, we also ensure that the monthly sales absorptions, including historical seasonal differences of our communities and those of our competitors, used in our undiscounted cash flow analyses are realistic, consider our development schedules, and relate to those achieved by our competitors for the specific communities.
43
If the aggregate undiscounted cash flows from our quantitative analyses are in excess of the carrying value, the asset is considered to be recoverable and is not impaired. If the aggregate undiscounted cash flows are less than the carrying or book value, we perform a discounted cash flow analysis to determine the fair value of the community. The fair value of the community is estimated using the present value of the estimated future cash flows using discount rates commensurate with the risk associated with the underlying community assets. The discount rate used may be different for each community. The factors considered when determining an appropriate discount rate for a community include, among others: (1) community specific factors such as the number of lots in the community, the status of land development in the community, and the competitive factors influencing the sales performance of the community and (2) overall market factors such as employment levels, consumer confidence, and the existing supply of new and used homes for sale. If the determined fair value is less than the carrying value of the specific asset, the asset is considered not recoverable and is written down to its fair value. The carrying value of assets in communities that were previously impaired and continue to be classified as projects in progress is not increased for future estimates of increases in fair value in future reporting periods. However, market deterioration that exceeds our initial estimates may lead us to incur impairment charges on previously impaired homebuilding assets, in addition to homebuilding assets not currently impaired but for which indicators of impairment may arise if markets deteriorate.
Inventory Valuation - Land Held for Future Development
For those communities that have been idled (land held for future development), all applicable carrying costs, such as interest and real estate taxes, are expensed as incurred, and the inventory is stated at cost unless facts and circumstances indicate that the carrying value of the assets may not be recoverable, such as the future enactment of a development plan or the occurrence of outside events. We evaluate the potential plans for each community in land held for future development if changes in facts and circumstances occur that would give rise to a more detailed analysis for a change in the status of a community.
Inventory Valuation - Land Held for Sale
We record assets held for sale at the lower of the asset's carrying value or fair value less costs to sell. The following criteria are used to determine if land is held for sale:
•management has the authority and commits to a plan to sell the land;
•the land is available for immediate sale in its present condition, subject only to terms that are usual and customary for sales of land assets;
•there is an active program to locate a buyer and the plan to sell the property has been initiated;
•the sale of the land is probable within one year;
•the property is being actively marketed at a reasonable sales price relative to its current fair value; and
•it is unlikely that the plan to sell will be withdrawn or that significant changes to the plan will be made.
Additionally, in certain circumstances, such as a change in strategy, management will re-evaluate the best use of an asset that is currently being accounted for as held for development. In such instances, management will review, among other things, the current and projected competitive circumstances of the community, including the level of supply of new and used inventory, the level of sales absorptions by us and our competition, the level of sales incentives required and the number of owned lots remaining in the community. If, based on this review, we believe that the best use of the asset is the sale of all or a portion of the asset in its current condition, then all or portions of the community are accounted for as held for sale if the foregoing criteria have been met as of the end of the applicable reporting period.
In determining the fair value of the assets less cost to sell, we consider factors including current sales prices for comparable assets in the area, recent market analysis studies, appraisals, any recent legitimate offers and listing prices of similar properties. If the estimated fair value less cost to sell of an asset is less than its current carrying value, the asset is written down to its estimated fair value less cost to sell.
Due to uncertainties in the estimation process, it is reasonably possible that actual results could differ from the estimates used in our historical analyses. Our assumptions about land sales prices require significant judgment because the market is highly sensitive to changes in economic conditions. We calculate the estimated fair values of land held for sale based on current market conditions and assumptions made by management, which may differ materially from actual results and may result in additional impairments if market conditions deteriorate.
44
Revenue Recognition
We recognize revenue upon the transfer of promised goods to our customers in an amount that reflects the consideration to which we expect to be entitled by applying the following five-step process specified in ASC 606.
•Identify the contract(s) with a customer
•Identify the performance obligations
•Determine the transaction price
•Allocate the transaction price
•Recognize revenue when the performance obligations are met
Homebuilding revenue
Homebuilding revenue is reported net of any discounts and incentives and is generally recognized when title to and possession of the home are transferred to the buyer at the closing date. The performance obligation to deliver the home is generally satisfied in less than one year from the original contract date. Home sale contract assets consist of cash from home closings held in escrow for our benefit, typically for less than five days, and are considered accounts receivable.
Land sales and other revenue
Land sales revenue relates to land and lots sold that do not fit within our homebuilding programs and strategic plans. Land sales typically require cash consideration on the closing date, which is generally when performance obligations are satisfied. We also provide title examinations for our homebuyers in certain markets. Revenues associated with our title operations are recognized as closing services are rendered and title insurance policies are issued, both of which generally occur as each home is closed.
Warranty Reserves
We currently provide a limited warranty ranging from one to two years covering workmanship and materials per our defined quality standards. In addition, we provide a limited warranty for up to ten years covering only certain defined structural element failures.
Our homebuilding work is performed by subcontractors who typically must agree to indemnify us with regard to their work and provide certificates of insurance demonstrating that they have met our insurance requirements and have named us as an additional insured under their policies. Therefore, many claims relating to workmanship and materials that result in warranty spending are the primary responsibility of these subcontractors. In addition, we maintain insurance coverage related to our construction efforts that can result in recoveries of warranty and construction defect costs above certain specified limits.
Warranty reserves are included in other liabilities on our consolidated balance sheets. We record reserves covering our anticipated warranty expense for each home closed. Management reviews the adequacy of warranty reserves each reporting period based on historical experience and management's estimate of the costs to remediate any claims and adjusts these provisions accordingly. Our review includes a quarterly analysis of the historical data and trends in warranty expense by division. An analysis by division allows us to consider market specific factors such as our warranty experience, the number of home closings, the prices of homes, product mix, and other data in estimating our warranty reserves. In addition, our analysis also factors in the existence of any non-recurring or community-specific warranty matters that might not be contemplated in our historical data and trends. The cost of material non-recurring or community-specific warranty matters is often separately estimated based on management's judgment of the ultimate cost of repair for that specific issue. As a result of our analyses, we adjust our estimated warranty liabilities on a quarterly basis. Based on historical results, we believe that our existing estimation process is accurate and do not anticipate the process to materially change in the future. Our estimation process for such accruals is discussed in Note 9 of notes to the consolidated financial statements in this Form 10-K. While we believe that our current warranty reserves are adequate, there can be no assurances that historical data and trends will accurately predict our actual warranty costs or that future developments might not lead to a significant change in the reserve.
45
Income Taxes - Valuation Allowance and Ownership Change
Judgment is required in estimating valuation allowances for deferred tax assets. Deferred tax assets are reduced by a valuation allowance if an assessment of their components indicates that it is more likely than not that all or some portion of these assets will not be realized. The realization of a deferred tax asset ultimately depends on the existence of sufficient taxable income in either the carryback or carryforward periods under tax law. We assess the need for valuation allowances for deferred tax assets based on more-likely-than-not realization threshold criteria. In our assessment, appropriate consideration is given to all positive and negative evidence related to the realization of the deferred tax assets. This assessment considers, among other matters, (1) the nature, frequency and severity of any current and cumulative losses; (2) forecasts of future profitability; (3) the duration of statutory carryforward periods; (4) our experience with operating loss and tax credit carryforwards not expiring unused; (5) the Section 382 limitation on our ability to carryforward pre-ownership change net operating losses; (6) recognized built-in losses or deductions; and (7) tax planning alternatives.
Our assessment of the need for the valuation of deferred tax assets includes assessing the likely future tax consequences of events that have been recognized in our financial statements or tax returns. We base our estimate of deferred tax assets and liabilities on current tax laws and rates and, in certain cases, business plans and other expectations about future outcomes. Changes in existing tax laws or rates could affect actual tax results and future business results may affect the amount of deferred tax liabilities or the valuation of deferred tax assets over time. Our accounting for deferred tax consequences represents our best estimate of future events. Although it is possible there will be changes that are not anticipated in our current estimates, we believe it is unlikely such changes would have a material period-to-period impact on our financial condition or results of operations.
During fiscal 2008, we determined that it was not more likely than not that substantially all of our deferred tax assets would be realized and, therefore, we established a valuation allowance on substantially all of our deferred tax assets. Each period, we evaluate the continued need for the valuation allowance based on extensive quantitative and qualitative factors, a process that requires significant estimates to be made. As of September 30, 2015, we determined that it was appropriate to release a substantial portion of our valuation allowance, generating a non-cash tax benefit. Based on the available evidence and operating trends, as of September 30, 2018 we determined that it was appropriate to release an additional portion of our valuation allowance, which also generated a non-cash tax benefit. As of September 30, 2020, our conclusions on whether we are more likely than not to realize all of our federal tax attributes and certain portions of our state tax attributes remain consistent with our fiscal 2018 determinations. For fiscal 2020, a number of additional positive and negative factors were considered as part of our analysis. The negative factors for fiscal 2020 included the general economic uncertainties due to the COVID-19 pandemic. The positive factors included our current income from continuing operations, a recovery in housing demand throughout the year that resulted in backlog levels significantly higher than prior year, and interest savings from our multi-year debt reduction strategy. These analyses, while rooted in actual Company performance, are highly subjective and rely on certain estimates, including forecasts, which could be very different from actual results.
We experienced an “ownership change” as defined in Section 382 of the Internal Revenue Code (Section 382) as of January 12, 2010. Section 382 contains rules that limit the ability of a company that undergoes an “ownership change” to utilize its net operating loss carryforward and certain built-in losses or deductions recognized during the five-year period after the ownership change. Therefore, our ability to utilize our pre-ownership change net operating loss carryforwards and certain recognized built-in losses or deductions is substantially limited by Section 382. There can be no assurance that another ownership change, as defined in the tax law, will not occur. If another “ownership change” occurs, a new annual limitation on the utilization of net operating losses would be determined as of that date. This limitation, should one be required in the future, is subject to assumptions and estimates that could differ from actual results.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
We are exposed to a number of market risks in the ordinary course of business. Our primary market risk exposure relates to fluctuations in interest rates. We do not believe that our exposure in this area is material to our cash flows or results of operations. As of September 30, 2020, our Junior Subordinated Notes were our only variable-rate debt outstanding, totaling approximately $68.1 million. A one percent increase in the interest rate for these notes would result in an increase of our interest expense by approximately $1.0 million over the next twelve-month period. The estimated fair value of our fixed rate debt as of September 30, 2020 was $1.10 billion, compared to a carrying value of $1.06 billion. The effect of a hypothetical one-percentage point decrease in our estimated discount rates would increase the estimated fair value of the fixed rate debt instruments from $1.10 billion to $1.16 billion as of September 30, 2020.
46
Item 8. Financial Statements and Supplementary Data
BEAZER HOMES USA, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
Investments in unconsolidated entities 4,003 3,962
Operating lease right-of-use assets 13,103 —
LIABILITIES AND STOCKHOLDERS’ EQUITY
Operating lease liabilities 15,333 —
Stockholders’ equity:
See accompanying notes to consolidated financial statements.
47
BEAZER HOMES USA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
Fiscal Year Ended September 30,
Equity in income of unconsolidated entities 347 404 34
Loss on extinguishment of debt, net — (24,920) (27,839)
Loss from discontinued operations, net of tax (1,090) (99) (329)
Weighted-average number of shares:
Basic income (loss) per share:
Continuing operations $ 1.80 $ (2.59) $ (1.40)
Diluted income (loss) per share:
Continuing operations $ 1.78 $ (2.59) $ (1.40)
See accompanying notes to consolidated financial statements.
48
BEAZER HOMES USA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Common Stock Paid-in Capital Accumulated Deficit
in thousands Shares Amount Total
Net loss and comprehensive loss — — — (45,375) (45,375)
Stock-based compensation expense — — 10,258 — 10,258
Exercises of stock options 8 — 64 64
Shares issued under employee stock plans, net 443 — — — —
Forfeiture of restricted stock (216) — — — —
Common stock redeemed for tax liability (229) — (3,378) — (3,378)
Other activity — 18 — 18
Net loss and comprehensive loss — — — (79,520) (79,520)
Stock-based compensation expense — — 10,526 — 10,526
Exercises of stock options 32 — 314 — 314
Shares issued under employee stock plans, net 917 — — — —
Forfeiture of restricted stock (68) — — — —
Common stock redeemed for tax liability (185) — (1,969) — (1,969)
Net income and comprehensive income — — — 52,226 52,226
Stock-based compensation expense — — 10,036 — 10,036
Exercises of stock options 52 — 226 — 226
Shares issued under employee stock plans, net 588 — — — —
Forfeiture and other settlements of restricted stock (26) — (2,058) — (2,058)
Common stock redeemed for tax liability (173) — (2,686) — (2,686)
See accompanying notes to consolidated financial statements.
49
BEAZER HOMES USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Fiscal Year Ended September 30,
Cash flows from operating activities:
Gain on sale of fixed assets (335) (232) (351)
Change in allowance for doubtful accounts 54 (74) 48
Equity in income of unconsolidated entities (347) (403) (127)
Cash distributions of income from unconsolidated entities 306 408 331
Loss on extinguishment of debt, net — 24,920 27,839
Changes in operating assets and liabilities:
Decrease in income tax receivable 315 — 88
Decrease (increase) in other assets 3 323 (1,300)
Cash flows from investing activities:
Proceeds from sale of fixed assets 478 251 370
Acquisition, net of cash acquired — (4,088) (57,253)
Investments in unconsolidated entities — — (421)
Return of capital from unconsolidated entities — 68 176
Cash flows from financing activities:
Tax payments for stock-based compensation awards (2,686) (1,969) (3,378)
Stock option exercises and other financing activities (1,832) 314 64
See accompanying notes to consolidated financial statements.
50
BEAZER HOMES USA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) Description of Business
Beazer Homes USA, Inc. (“we,” “us,” “our,” “Beazer,” “Beazer Homes” and the “Company”) is a geographically diversified homebuilder with active operations in 13 states within three geographic regions in the United States: the West, East and Southeast.
Our homes are designed to appeal to homeowners at different price points across various demographic segments, and are generally offered for sale in advance of their construction. Our objective is to provide our customers with homes that incorporate exceptional value and quality, while seeking to maximize our return on invested capital over the course of a housing cycle.
(2) Basis of Presentation and Summary of Significant Accounting Policies
Basis of Presentation and Consolidation
The accompanying consolidated financial statements of the Company have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), and present the consolidated financial position, income, stockholders' equity, and cash flows of Beazer Homes USA, Inc. and its consolidated subsidiaries. Intercompany transactions and balances have been eliminated in consolidation. Our net income (loss) is equivalent to our comprehensive income (loss), so we have not presented a separate statement of comprehensive income (loss).
In the past, we have discontinued homebuilding operations in various markets. Results from certain of these exited markets are reported as discontinued operations in the accompanying consolidated statements of operations for all periods presented (see Note 19 for a further discussion of our discontinued operations).
Our fiscal year 2020 began on October 1, 2019 and ended on September 30, 2020. Our fiscal year 2019 began on October 1, 2018 and ended on September 30, 2019. Our fiscal year 2018 began on October 1, 2017 and ended on September 30, 2018.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make informed estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Accordingly, actual results could differ from these estimates.
Business Combinations
The Company accounts for acquisitions in accordance with ASC 805, Business Combinations, by allocating the purchase price of the business to assets acquired and liabilities assumed based upon management's estimates of fair values as of the acquisition date. Any excess purchase price over the estimated fair value of net assets acquired is recorded as goodwill, which is assigned to applicable reporting units based on expected revenues. The fair value estimation process includes analyses based on income and market approaches. Significant judgment is often required in estimating the fair value of assets acquired, particularly inventory and intangible assets. These estimates and assumptions are based on historical experience, information obtained from the management of the acquired companies, and the Company’s judgment about the significant assumptions that market participants would use when determining fair value. The estimates and assumptions are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, adjustments to the assets acquired and liabilities assumed, with the corresponding offset to goodwill, are recorded in the reporting period in which the adjustment amounts are determined. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded in our results of operations in the reporting period such adjustments are made.
On July 13, 2018, the Company acquired substantially all of the assets, operations, and certain assumed liabilities of Venture Homes, a leading private homebuilder in the Atlanta market, for a purchase price of $61.3 million, net of cash acquired. The acquired assets and liabilities were recorded at their estimated fair values and resulted in inventory of $55.2 million and goodwill of $11.4 million, and other assets of $0.4 million as well as accounts payable of $5.5 million and other liabilities of $0.2 million.
51
Cash and Cash Equivalents and Restricted Cash
We consider highly liquid investments with maturities of three months or less when acquired to be cash equivalents. As of September 30, 2020, the majority of our cash and cash equivalents were on demand deposits with major banks. These assets were valued at par and had no withdrawal restrictions. Restricted cash includes cash restricted by state law or a contractual requirement, including cash collateral for our outstanding cash-secured letters of credit (refer to Note 8).
Accounts Receivable and Allowance
Accounts receivable include escrow deposits to be received from title companies associated with closed homes, receivables from municipalities related to the development of utilities or other infrastructure, land banker reimbursements to be received related to land development costs, rebates to be received from our suppliers and other miscellaneous receivables. Generally, we receive cash from title companies within a few days of the home being closed. We regularly review our receivable balances for collectability and record an allowance against any receivable for which collectability is deemed to be uncertain.
Owned Inventory
Owned inventory consists of residential real estate developments. Inventory includes land acquisition costs, land development costs, home construction costs, capitalized interest, real estate taxes, direct overhead costs and capitalized indirect costs incurred during land development and home construction, and common costs that benefit the entire community, less impairments, if any. Land acquisition, land development and other common costs (both incurred and estimated to be incurred) are allocated to individual lots on a pro-rata basis, and the cost of individual lots is transferred to homes under construction when home construction begins. Home construction costs are accumulated on a per-home basis. Cost of home closings includes the specific construction costs of the home and the allocated lot costs. Any changes to the estimated total development costs of a community or phase are allocated to the remaining homes to be closed in the community or phase. Refer to Note 5 for a further discussion and detail of our inventory balance.
Inventory Valuation - Projects in Progress
Our homebuilding inventories that are accounted for as held for development (projects in progress) include land and home construction assets grouped together as communities. Homebuilding inventories held for development are stated at cost (including home construction costs, direct overhead costs, capitalized indirect costs, capitalized interest, real estate taxes and allocated lot costs) unless facts and circumstances indicate that the carrying value of the assets may not be recoverable. We assess these assets no less than quarterly for recoverability. Generally, upon the commencement of land development activities, it may take three to five years (depending on, among other things, the size of the community and its sales pace) to fully develop, sell, construct and close all the homes in a typical community. Recoverability of assets is measured by comparing the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If the expected undiscounted cash flows generated are less than its carrying amount, an impairment charge is recorded to write down the carrying amount of such asset to its estimated fair value based on discounted cash flows.
When conducting our community level review for the recoverability of our homebuilding inventory related to projects in progress, we consider both qualitative and quantitative factors to establish a quarterly “watch list” of communities. Each community is evaluated qualitatively and quantitatively to determine if there are factors driving the low profitability levels. Communities with more than ten homes remaining to close with potential indicators of impairment resulting from this initial evaluation are subjected to substantial additional financial and operational analyses and review that consider the competitive environment and other factors contributing to profit margins below our specified thresholds. Our assumptions about future home sales prices and absorption rates require significant judgment because the residential homebuilding industry is cyclical and is highly sensitive to changes in economic conditions. For certain communities, it may be prudent to reduce sales prices or further increase sales incentives in response to a variety of factors, including competitive market conditions in those specific submarkets for the product and locations of these communities. For communities where the current competitive and market dynamics indicate that assets may not be recoverable, a formal impairment analysis is performed. The formal impairment analysis consists of both qualitative competitive market analyses and a quantitative analysis reflecting market and asset specific information.
52
Our qualitative competitive market analyses include site visits to new home communities of our competitors and written community-level competitive assessments. A competitive assessment consists of a comparison of our specific community with its competitor communities, considering square footage of homes offered, amenities offered within the homes and the communities, location, transportation availability and school districts, among other relevant attributes. In addition, we review the pace of monthly home sales of our competitor communities in relation to our specific community. We also review other factors, such as the target buyer and the macro-economic characteristics that impact the performance of our asset, including unemployment and the availability of mortgage financing, among other things. Based on this qualitative competitive market analysis, adjustments to our sales prices may be required in order to make our communities competitive. We incorporate these adjusted prices in our quantitative analysis for the specific community.
The quantitative analyses compare the projected future undiscounted cash flows for each such community with its current carrying value. This undiscounted cash flow analysis requires important assumptions regarding the location and mix of house plans to be sold, current and future home sale prices and incentives for each plan, current and future construction costs for each plan and the pace of monthly sales to occur today and into the future.
There is uncertainty associated with preparing the undiscounted cash flow analyses because future market conditions will almost certainly be different, either better or worse, than current conditions. The single most important input to the cash flow analysis is current and future home sales prices for a specific community. The risk of over or under-stating any of the important cash flow variables, including home prices, is greater with longer-lived communities and within markets that have historically experienced greater home price volatility. To address these risks, we consider some home price and construction cost appreciation in future years for certain communities that are expected to be selling for more than three years and/or if the market has typically exhibited high levels of price volatility. Absent these assumptions on cost and sales price appreciation, we believe the long-term cash flow analysis would be unrealistic and would serve to artificially improve expected future profitability. Finally, we also ensure that the monthly sales absorptions, including historical seasonal differences of our communities and those of our competitors, used in our undiscounted cash flow analyses are realistic, considering our development schedules and comparing to those achieved by our competitors for the comparable communities.
If the aggregate undiscounted cash flows from our quantitative analyses are in excess of the carrying value, the asset is considered to be recoverable and is not impaired. If the aggregate undiscounted cash flows are less than the carrying value, we perform a discounted cash flow analysis to determine the fair value of the community. The fair value of the community is estimated based on the present value of the estimated future cash flows using discount rates commensurate with the risk associated with the underlying community assets. The discount rate used may be different for each community. The factors considered when determining an appropriate discount rate for a community include, among others: (1) community specific factors such as the number of lots in the community, the status of land development in the community and the competitive factors influencing the sales performance of the community and (2) overall market factors such as employment levels, consumer confidence and the existing supply of new and used homes for sale. If the determined fair value is less than the carrying value of the specific asset, the asset is considered not recoverable and is written down to its fair value. The carrying value of assets in communities that were previously impaired and continue to be classified as projects in progress is not increased for future estimates of increases in fair value in future reporting periods. However, market deterioration that exceeds our initial estimates may lead us to incur impairment charges on previously impaired homebuilding assets, in addition to homebuilding assets not currently impaired but for which indicators of impairment may arise if markets deteriorate.
Inventory Valuation - Land Held for Future Development
For those communities that have been idled (land held for future development), all applicable carrying costs, such as interest and real estate taxes, are expensed as incurred, and the inventory is stated at cost unless facts and circumstances indicate that the carrying value of the assets may not be recoverable, such as the future enactment of a development plan or the occurrence of outside events. We evaluate the potential plans for each community in land held for future development if changes in facts and circumstances occur that would give rise to a more detailed analysis for a change in the status of a community.
Inventory Valuation - Land Held for Sale
We record assets held for sale at the lower of the asset's carrying value or fair value less costs to sell. The following criteria are used to determine if land is held for sale:
•management has the authority and commits to a plan to sell the land;
•the land is available for immediate sale in its present condition, subject only to terms that are usual and customary for sales of land assets;
•there is an active program to locate a buyer and the plan to sell the property has been initiated;
53
•the sale of the land is probable within one year;
•the property is being actively marketed at a reasonable sale price relative to its current fair value; and
•it is unlikely that the plan to sell will be withdrawn or that significant changes to the plan will be made.
Additionally, in certain circumstances, such as a change in strategy, management will re-evaluate the best use of an asset that is currently being accounted for as held for development. In such instances, management will review, among other things, the current and projected competitive circumstances of the community, including the level of supply of new and used inventory, the level of sales absorptions by us and our competition, the level of sales incentives required and the number of owned lots remaining in the community. If, based on this review, we believe that the best use of the asset is the sale of all or a portion of the asset in its current condition, then all or portions of the community are accounted for as held for sale if the foregoing criteria have been met as of the end of the applicable reporting period.
In determining the fair value of the assets less cost to sell, we consider factors including current sales prices for comparable assets in the area, recent market analysis studies, appraisals, any recent legitimate offers and listing prices of similar properties. If the estimated fair value less cost to sell of an asset is less than its current carrying value, the asset is written down to its estimated fair value less cost to sell.
Due to uncertainties in the estimation process, it is reasonably possible that actual results could differ from the estimates used in our historical analyses. Our assumptions about land sales prices require significant judgment because the market is highly sensitive to changes in economic conditions. We calculate the estimated fair values of land held for sale based on current market conditions and assumptions made by management, which may differ materially from actual results and may result in additional impairments if market conditions deteriorate.
Lot Option Agreements and Variable Interest Entities (VIE)
In addition to purchasing land directly, we utilize lot option agreements that enable us to defer acquiring portions of properties owned by third parties and unconsolidated entities until we have determined whether to exercise our lot option. The majority of our lot option contracts require a non-refundable cash deposit or irrevocable letter of credit based on a percentage of the purchase price of the land for the right to acquire lots during a specified period at a specified price. Purchase of the properties under these agreements is contingent upon satisfaction of certain requirements by us and the sellers. Under lot option contracts, our liability is generally limited to forfeiture of the non-refundable deposits, letters of credit and other non-refundable amounts incurred. If the Company cancels a lot option agreement, it would result in a write-off of the related deposits and pre-acquisition costs, but would not expose the Company to the overall risks or losses of the applicable entity we are purchasing from.
In accordance with ASC Topic 810, Consolidation (ASC 810), if the entity holding the land under option is a variable VIE, the Company's deposit represents a variable interest in that entity. ASC 810 requires a company consolidate a VIE if the company is determined to be the primary beneficiary. To determine whether we are the primary beneficiary of the VIE, we first evaluate whether we have the ability to control the activities of the VIE that most significantly impact its economic performance. Such activities include, but are not limited to, (1) the ability to determine the budget and scope of land development work, if any; (2) the ability to control financing decisions for the VIE; (3) the ability to acquire additional land into the VIE or dispose of land in the VIE not under contract with Beazer; and (4) the ability to change or amend the existing option contract with the VIE. If we are not determined to control such activities, we are not considered the primary beneficiary of the VIE and thus do not consolidate the VIE. If we do have the ability to control such activities, we will continue our analysis by determining if we are expected to absorb a potentially significant amount of the VIE's losses or, if no party absorbs the majority of such losses, if we will benefit from potentially a significant amount of the VIE's expected gains.
If we are the primary beneficiary of the VIE, we will consolidate the VIE even though creditors of the VIE have no recourse against the Company. For those we consolidate, we record the remaining contractual purchase price under the applicable lot option agreement, net of option deposits already paid, to consolidated inventory not owned with an offsetting increase to obligations related to consolidated inventory not owned on our consolidated balance sheets. Also, to reflect the total purchase price of this inventory on a consolidated basis, we present the related option deposits as consolidated inventory not owned. No VIEs required consolidation as of September 2020 and 2019 because we have determined that we were not the primary beneficiary of any VIEs.
54
Investments in Unconsolidated Entities
We participate in a number of joint ventures and other investments in which we have less than a controlling interest. We enter into the majority of these investments with land developers, other homebuilders and financial partners to acquire attractive land positions, to manage our risk profile and to leverage our capital base. The land positions are developed into finished lots for sale to the unconsolidated entity’s members or other third parties. We recognize our share of equity in income (loss) and profits (losses) from the sale of lots to other buyers. Our share of profits from lots we purchase from the unconsolidated entities is deferred and treated as a reduction of the cost of the land purchased from the unconsolidated entity. Such profits are subsequently recognized at the time the home closes and title passes to the homebuyer. We evaluate our investments in unconsolidated entities for impairment during each reporting period. A series of operating losses of an investee or other factors may indicate that a decrease in the value of our investment in the unconsolidated entity has occurred that is other-than-temporary. The amount of impairment recognized is the excess of the investment’s carrying value over its estimated fair value. Our unconsolidated entities typically obtain secured acquisition, development and construction financing. We account for our interest in unconsolidated entities under the equity method. For additional discussion of these entities, refer to Note 4.
Property and Equipment, Net
Our property and equipment is recorded at cost, net of accumulated depreciation. Depreciation is computed on a straight-line basis based on estimated useful lives as follows:
Asset Class Useful Lives
Buildings 25 - 30 years
Information systems Lesser of estimated useful life of the asset or 5 years
Furniture, fixtures and computer and office equipment 3 - 7 years
Goodwill
Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets from the businesses that we acquire. The Company's entire goodwill balance, recorded in our Southeast reportable segment, is related to the Venture Homes acquisition that occurred during fiscal 2018. The Company evaluates goodwill for impairment at the reporting unit level annually during the fourth quarter or more often if indicators of impairment exist.
The Company has the option to perform a qualitative or quantitative assessment to determine whether the fair value of a reporting unit exceeds its carrying value. Qualitative factors may include, but are not limited to economic conditions, industry and market considerations, cost factors, overall financial performance of the reporting unit and other entity and reporting unit specific events. If after assessing these qualitative factors, the Company determines it is more likely than not that the fair value of the reporting unit is less than the carrying value, then a quantitative assessment is performed.
The fair value of the reporting unit is estimated using a combination of the income approach, utilizing the discounted cash flow method, and the market approach, utilizing readily available market valuation multiples. If the estimated fair value of the reporting unit is less than its carrying value, an impairment will be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. Determining the fair value of a reporting unit under the quantitative goodwill impairment assessment requires the Company to make estimates and assumptions regarding future operating results, cash flows (including timing), discount rates, expected growth rates, capital expenditures and cost of capital, similar to those a market participant would use to assess fair value. We also make certain assumptions about future economic conditions and other data. Many of the factors used in assessing fair value are outside the control of management, and these assumptions and estimates may change in future periods.
During the fourth quarter of 2020, the Company performed its annual goodwill impairment analysis and concluded our goodwill was not impaired.
Other Assets
Our other assets principally include prepaid expenses and assets related to our deferred compensation plan (refer to Note 15 for a discussion of our deferred compensation plan).
55
Other Liabilities
Our other liabilities principally include accrued compensations and benefits, accrued interest on our outstanding borrowings, customer deposits, accrued warranty expense, litigation accruals, income tax liabilities and other accruals related to our operations. Refer to Note 12 for a detail of our other liabilities.
Income Taxes
Our provision for income taxes is comprised of taxes that are currently payable and deferred taxes that relate to temporary differences between financial reporting carrying values and tax bases of assets and liabilities. Deferred tax assets and liabilities result from deductible or taxable amounts in future years when such assets and liabilities are recovered or settled, and are measured using the enacted tax rates and laws that are expected to be in effect when the assets and liabilities are recovered or settled. We include any estimated interest and penalties on tax related matters in income taxes payable. We recognize the effect of income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. We record interest and penalties related to unrecognized tax benefits in income tax expense within our consolidated statements of operations. Changes in recognition of measurement are recorded in the period in which the change in judgment occurs. For a discussion of our evaluation of and accounting for valuation allowances, refer to Note 13.
Our income tax receivable includes the refundable portion of our alternative minimum tax credit. The alternative minimum tax credit became a refundable credit when the alternative minimum tax was eliminated with the enactment of the Tax Cuts and Jobs Act on December 22, 2017. The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020. The CARES Act provides companies with the ability to make a refund claim for their entire alternative minimum tax credits as early as their 2018 tax return. As a result, we reduced our deferred tax asset by the remaining $4.6 million of alternative minimum tax credits and increased our tax receivable for the refund we expect to receive with the filing of our fiscal 2019 tax return.
Revenue Recognition
We recognize revenue upon the transfer of promised goods to our customers in an amount that reflects the consideration to which we expect to be entitled by applying the following five-step process specified in ASC 606.
•Identify the contract(s) with a customer
•Identify the performance obligations
•Determine the transaction price
•Allocate the transaction price
•Recognize revenue when the performance obligations are met
The following table presents our total revenue disaggregated by revenue stream:
Fiscal Year Ended
September 30,
(a) Please see Note 18 for total revenue disaggregated by reportable segment.
56
Homebuilding revenue
Homebuilding revenue is reported net of any discounts and incentives and is generally recognized when title to and possession of the home are transferred to the buyer at the closing date. The performance obligation to deliver the home is generally satisfied in less than one year from the original contract date. Home sale contract assets consist of cash from home closings held
by title companies in escrow for our benefit, typically for less than five days, and are considered accounts receivable. Contract liabilities include customer deposits related to sold but undelivered homes and totaled $18.9 million and $11.5 million as of September 30, 2020 and September 30, 2019, respectively. Of the customer liabilities outstanding as of September 30, 2019, $10.5 million was recognized in revenue during the year ended September 30, 2020, upon closing of the related homes, and $1.0 million was refunded to or forfeited by the buyer.
Land sales and other revenue
Land sales revenue relates to land and lots sold that do not fit within our homebuilding programs and strategic plans. Land sales typically require cash consideration on the closing date, which is generally when performance obligations are satisfied. We also provide title examinations for our homebuyers in certain markets. Revenues associated with our title operations are recognized as closing services are rendered and title insurance policies are issued, both of which generally occur as each home is closed.
Home Construction Expenses
Home construction expenses includes the specific construction costs of the home and the allocated lot costs (land acquisition, land development and other common costs are allocated to individual lots on a pro-rata basis based on the number of lots remaining to close). All home closing costs are charged to home construction expenses in the period when the revenues from home closing are recognized.
Sales discounts and incentives include cash discounts, discounts on home building options, option upgrades and seller-paid financing or closing costs. Cash discounts are accounted for as a reduction in the sale price of the home, thereby decreasing the amount of revenue we recognize on that closing. All sales incentives other than cash discounts are recognized as a cost of selling the home and are included in home construction expenses.
Estimated future warranty costs are charged to home construction expense in the period when the revenues from home closings are recognized. Such estimated warranty costs generally range from 0.3% to 1.3% of total revenue recognized for each home closed. Additional warranty costs are charged to home construction expenses as necessary based on management's estimate of the costs to remediate existing claims. See Note 9 for a more detailed discussion of warranty costs and related reserves.
Advertising Costs
Advertising costs related to continuing operations of $15.9 million, $17.9 million, and $17.6 million for our fiscal years 2020, 2019 and 2018, respectively, were expensed as incurred and were included in general and administrative (G&A) expenses in the consolidated statements of operations.
Fair Value Measurements
Certain of our assets are required to be recorded at fair value on a recurring basis, for example, the fair value of our deferred compensation plan assets are based on market-corroborated inputs (level 2). Certain of our assets are required to be recorded at fair value on a non-recurring basis when events and circumstances indicate that the carrying value may not be recovered (level 3). For example, we review our long-lived assets, including inventory, for recoverability when factors indicate an impairment may exist, but no less than quarterly. Fair value is based on estimated cash flows discounted for market risks associated with the long-lived assets. The fair value of certain of our financial instruments approximates their carrying amounts due to the short maturity of these assets and liabilities or the variable interest rates on such obligations. The fair value of our publicly-held debt is generally estimated based on quoted bid prices for these instruments (level 2). Certain of our other financial instruments are estimated by discounting scheduled cash flows through maturity or using market rates currently being offered on loans with similar terms and credit quality. The fair value of our investments in unconsolidated entities is determined primarily using a discounted cash flow model to value the underlying net assets of the respective entities. See Note 10 for additional discussion of our fair value measurements.
57
Stock-Based Compensation
We use the Black-Scholes option-pricing model to value our stock option grants. Other stock-based awards with only performance conditions granted to employees are valued based on the market price of the common stock on the date of the grant. Stock-based awards with market conditions granted to employees are valued using the Monte Carlo valuation method. On the date of grant, we estimate forfeitures in calculating the expense related to stock-based compensation. In addition, we reflect the benefits of tax deductions in excess of recognized compensation cost as an operating cash outflow. Compensation cost arising from all stock-based compensation awards is recognized as expense using the straight-line method over the vesting period and is included in G&A in our consolidated statements of operations. See Note 16 for additional discussion of our stock-based compensation.
Recent Accounting Pronouncements
Leases. On October 1, 2019, we adopted Accounting Standards Update (ASU) No. 2016-02, Leases (ASU 2016-02) and related amendments, collectively codified in ASC 842, Leases (ASC 842). ASC 842 requires lessees to record most leases on their balance sheets by recognizing a right-of-use asset, representing the right to use the identified asset during the lease term, and a corresponding lease liability, representing the present value of the lease payments over the lease term. Lessor accounting will be largely similar to that under the previous accounting rules. ASC 842 also requires significantly enhanced disclosures around an entity's leases and the related accounting. As part of our adoption of ASC 842, we applied a modified retrospective approach, whereby prior year financial statements were not recast. As a result, our consolidated financial statements as of and for the year ending September 30, 2019 were not restated and continues to be reported under the previous lease standard (ASC 840) and is therefore not comparative. We also elected the package of transition practical expedients, which allowed us to not reassess (1) whether any expired or existing contracts are or contain leases, (2) the lease classification for any expired or existing leases, and (3) the initial direct costs for any existing leases. In addition, we elected the practical expedient that allows lessees to account for lease and non-lease components together as a single component for all leases. Upon adoption of ASC 842, we recorded net operating lease right-of-use (ROU) assets of $13.9 million and operating lease liabilities of $16.0 million. Existing prepaid rent and accrued rent were recorded as an offset to the gross operating lease ROU assets. The adoption of ASC 842 did not have any impact on our retained earnings. See Note 11 for additional discussion of our operating leases.
Fair Value Measurements. In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework (ASU 2018-13). The updated guidance improves the disclosure requirements for fair value measurements. The updated guidance is effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years. Early adoption is permitted for any removed or modified disclosures. We do not expect the adoption of ASU 2018-13 to have a material impact on our consolidated financial statements or related disclosures.
Reference Rate Reform. In March 2020, the FASB issued ASU 2020-04, Facilitation of the Effects of Reference Rate Reform on Financial Reporting (ASU 2020-04). ASU 2020-04 provides companies with optional guidance to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. This guidance is effective beginning on March 12, 2020, and can be adopted no later than December 31, 2022, with early adoption permitted. The Company is currently evaluating the effect that the new guidance will have on its consolidated financial statements and related disclosures.
58
(3) Supplemental Cash Flow Information
The following table presents supplemental disclosure of non-cash and cash activity as well as a reconciliation of total cash balances between the condensed consolidated balance sheets and condensed consolidated statements of cash flows for the periods presented:
Fiscal Year Ended September 30,
Supplemental disclosure of non-cash activity:
Beginning operating lease right-of-use asset (ASC 842 adoption) $ 13,895 $ — $ —
Beginning operating lease liability (ASC 842 adoption) 16,028 — —
Supplemental disclosure of cash activity:
Reconciliation of cash, cash equivalents and restricted cash:
59
(4) Investments in Unconsolidated Entities
Unconsolidated Entities
As of September 30, 2020, the Company participated in certain joint ventures and had investments in unconsolidated entities in which it had less than a controlling interest. The following table presents the Company's investment in these unconsolidated entities as well as the total equity and outstanding borrowings of these unconsolidated entities as of September 30, 2020 and September 30, 2019:
Investment in unconsolidated entities $ 4,003 $ 3,962
Total equity of unconsolidated entities 7,079 9,969
Total outstanding borrowings of unconsolidated entities 8,807 12,658
Equity in income from unconsolidated entity activities included in income from continuing operations is as follows for the periods presented:
Fiscal Year Ended September 30,
Income from unconsolidated entity activity $ 347 $ 404 $ 375
Impairment of unconsolidated entity investment — — (341)
Equity in income of unconsolidated entities $ 347 $ 404 $ 34
No impairments for unconsolidated entities were recorded during the fiscal years ended September 30, 2020 and September 30, 2019. For the fiscal year ended September 30, 2018, we recorded a $0.3 million impairment charge in the consolidated statements of operations related to an investment in an unconsolidated entity.
Guarantees
Historically, the Company's joint ventures typically obtained secured acquisition, development, and construction financing. In addition, the Company and its joint venture partners provided varying levels of guarantees of debt and other debt-related obligations for these unconsolidated entities. However, as of September 30, 2020 and September 30, 2019, the Company had no outstanding guarantees or other debt-related obligations related to our investments in unconsolidated entities.
The Company and its joint venture partners generally provide unsecured environmental indemnities to land development joint venture project lenders. These indemnities obligate the Company to reimburse the project lenders for claims related to environmental matters for which they are held responsible. During our fiscal years ended September 30, 2020 and 2019, the Company was not required to make any payments related to environmental indemnities.
In assessing the need to record a liability for these guarantees, the Company considers its historical experience in being required to perform under the guarantees, the fair value of the collateral underlying these guarantees, and the financial condition of the applicable unconsolidated entities. In addition, the fair value of the collateral of unconsolidated entities is monitored to ensure that the related borrowings do not exceed the specified percentage of the value of the property securing the borrowings. As of September 30, 2020, no liability was recorded for the contingent aspects of any guarantees that were determined to be reasonably possible but not probable.
60
(5) Inventory
The components of our owned inventory as of September 30, 2020 and September 30, 2019 are as follows:
Homes under construction include homes substantially finished and ready for delivery and homes in various stages of construction, including the cost of the underlying lot. We had 133 (with a cost of $42.2 million) and 238 (with a cost of $82.2 million) substantially completed homes that were not subject to a sales contract (spec homes) as of September 30, 2020 and 2019, respectively.
Development projects in progress consist principally of land acquisition, land development and other common costs. These land related costs are allocated to individual lots on a pro-rata basis, and the lot costs are transferred to homes under construction when home construction begins for the respective lots. Certain of the fully developed lots in this category are reserved by a customer deposit or sales contract.
Land held for future development consists of communities for which construction and development activities are expected to occur in the future or have been idled and are stated at cost unless facts and circumstances indicate that the carrying value of the assets may not be recoverable. All applicable interest and real estate taxes on land held for future development are expensed as incurred.
Land held for sale includes land and lots that do not fit within our homebuilding programs and strategic plans in certain markets, and land is classified as held for sale once certain criteria are met (refer to Note 2). These assets are recorded at the lower of the carrying value or fair value less costs to sell.
The amount of interest we are able to capitalize depends on our qualified inventory balance, which considers the status of our inventory holdings. Our qualified inventory balance includes the majority of our homes under construction and development projects in progress but excludes land held for future development and land held for sale (see Note 6 for additional information on capitalized interest).
61
Total owned inventory by reportable segment is presented in the table below as of September 30, 2020 and September 30, 2019:
(a) Projects in progress include homes under construction, development projects in progress, capitalized interest, and model home categories from the preceding table.
(b) Projects in progress amount includes capitalized interest and indirect costs that are maintained within our Corporate and unallocated segment.
62
Inventory Impairments and Abandonments
The following table presents, by reportable segment, our total impairment and abandonment charges for the periods presented:
Fiscal Year Ended September 30,
Projects in Progress:
Corporate and unallocated (a) — 16,260 212
Total impairments on projects in progress $ — $ 110,030 $ 1,005
Land Held for Sale:
Abandonments:
West $ 923 $ — $ —
East 82 — —
Southeast 641 — —
Total abandonments $ 1,646 $ — $ —
Discontinued Operations:
Land Held for Sale $ — $ — $ 450
Total discontinued operations $ — $ — $ 450
(a)Amount represents capitalized interest and indirect costs that were impaired. Capitalized interest and indirect costs are maintained within our Corporate and unallocated segment.
Projects in Progress Impairments
When conducting our community level review for the recoverability of inventory related to projects in progress, we consider both qualitative and quantitative factors to establish a quarterly “watch list” of communities. Each community is evaluated qualitatively and quantitatively to determine if there are factors driving the low profitability levels. Communities with more than ten homes remaining to close with potential indicators of impairment resulting from this initial evaluation are subjected to additional financial and operational reviews that consider the competitive environment and other factors contributing to gross margins below our specified threshold. Our assumptions about future home sales prices and absorption rates require significant judgment because the residential homebuilding industry is cyclical and is highly sensitive to changes in economic conditions. For certain communities, it may be prudent to reduce sales prices or further increase sales incentives in response to a variety of factors, including competitive market conditions in those specific submarkets for the product and locations of these communities. For communities where the current competitive and market dynamics indicate that assets may not be recoverable, a formal impairment analysis is performed. The formal impairment analysis consists of both qualitative competitive market analyses and quantitative analyses reflecting market and asset specific information. The quantitative analyses compare the projected future undiscounted cash flows for each such community with its current carrying value. If the aggregate undiscounted cash flows from our quantitative analyses are in excess of the carrying value, the asset is considered to be recoverable and is not impaired. If the aggregate undiscounted cash flows are less than the carrying value, we perform a discounted cash flow analysis to determine the fair value of the community.
During the year ended September 30, 2020, we performed our quarterly inventory impairment assessment taking into consideration the qualitative and quantitative factors discussed above, and determined that no community required a formal impairment analysis (projected cash flow analysis). No project in progress impairment charges were recognized during fiscal 2020.
63
During the year ended September 30, 2019, we performed discounted cash flow analysis on ten communities, nine in the West segment and one in the Southeast segment, and recognized a total of $110.0 million impairment charges related to our projects in progress. Refer to below for further discussion.
During the year ended September 30, 2018, we performed discounted cash flow analysis on one community in the Southeast segment, and recognized an impairment charge of $1.0 million principally due to a reduction in price taken that is other than temporary based on the competitive and market dynamics.
The table below presents, by reportable segment, details of the impairment charges taken on projects in progress for the periods presented (no discounted cash flow analysis was performed during fiscal 2020):
$ in thousands Results of Discounted Cash Flow Analyses Prepared
Corporate and unallocated (a) — — 212 —
(a) Amount represents the capitalized interest and indirect cost that were impaired. Capitalized interest and indirect costs are maintained within our Corporate and unallocated segment.
During the second quarter of fiscal 2019, we recognized impairment charges of $147.6 million related to fifteen communities in our California submarkets, all of which were previously land held for future development assets. As of the beginning of the quarter, nine of these communities were included in projects in progress due to their activation for development in prior periods, while the remaining six communities were classified as land held for future development (refer to below section titled "Land Held for Sale Impairments" for further discussion). We performed discounted cash flow analyses for the nine communities in projects in progress and recognized $109.0 million impairment charges, principally due to a reduction in price that is other than temporary based on competitive and market dynamics.
Valuation assumptions for communities tested for impairment are specific to each community. For projects in progress impaired during the periods presented, we determined the fair value of each community by discounting its estimated future cash flows at a rate commensurate with the risks inherent in the project. The discount rate used depends on the development stage and expected duration of the project, local market conditions, and other specific factors. The estimated future cash flows for each community were determined based on the expected pace of closings and average sales price of the community less expected costs for land acquisition and land development, direct construction, overhead, and interest. We determined the fair value of land held for sale assets impaired during the periods presented based on sales contracts, letters of intent, and recent comparable land sale transactions, as applicable. The assumptions used in the determination of fair value of both projects in progress and land held for sale communities are based on factors known to us at the time such estimates are made and our expectations of future operations and market conditions. Should the estimates or expectations used in determining estimated fair
64
values deteriorate in the future, we may be required to recognize additional impairment charges and write-offs related to these assets, and such amounts could be material.
The table below presents the ranges or values of significant quantitative unobservable inputs we used in determining the fair value of the communities impaired during the periods presented:
Fiscal Year Ended September 30,
Average selling price (in thousands) $350 - $615 $356
Closings per community per month 1 - 4 1 - 6
Land Held for Sale Impairments
Impairments on land held for sale generally represent write downs of these properties to net realizable value based on sales contracts, letters of intent, current market conditions and recent comparable land sale transactions, as applicable. Absent an executed sales contract, our assumptions related to land sales prices require significant judgment because the real estate market is highly sensitive to changes in economic conditions, and our estimates of sale prices could differ significantly from actual results.
During the year ended September 30, 2020, we recognized $1.3 million land held for sales impairment charges related to two held for sale communities in our West and Southeast segments.
During the second quarter of fiscal 2019, concurrent with the California projects in progress impairment analyses described above, we performed a strategic review of our remaining land held for future development assets in California and determined to sell these parcels. As a consequence of change in strategy with respect to the future use of these assets, we recognized land held for sale impairments totaling $38.6 million for six communities in our West segment.
During the year ended September 30, 2018, we recognized $5.5 million land held for sales impairment charges related to two held for sale communities in the East and Southeast segments. In addition, we recognized $0.5 million land held for sales impairment charges related to one held for sale community in our discontinued operations.
Abandonments
From time-to-time, we may determine to abandon lots or not exercise certain option contracts that are not projected to produce adequate results, or no longer fit with our long-term strategic plan. In determining whether to abandon lots or lot option contracts, our evaluation is primarily based upon the expected cash flows from the property. Additionally, in certain limited instances, we are forced to abandon lots due to seller non-performance, or permitting or other regulatory issues that do not allow us to build on those lots. If we intend to abandon or walk away from a property, we record an abandonment charge to earnings for the deposit amount and any related capitalized costs in the period such decision is made. During the year ended September 30, 2020, we recognized $1.6 million abandonment charges related to six under contract land acquisition deals that we decided to terminate. There were no abandonment charges recognized during our fiscal 2019 and 2018.
Lot Option Agreements
As previously discussed, we also have access to land inventory through lot option contracts, which generally enable us to defer acquiring portions of properties owned by third parties and unconsolidated entities until we have determined whether to exercise our lot option. The majority of our lot option contracts require a non-refundable cash deposit or irrevocable letter of credit based on a percentage of the purchase price of the land for the right to acquire lots during a specified period of time at a specified price. Under lot option contracts, purchase of the properties is contingent upon satisfaction of certain requirements by us and the sellers. Our liability under option contracts is generally limited to forfeiture of the non-refundable deposits, letters of credit, and other non-refundable amounts incurred. We expect to exercise, subject to market conditions and seller satisfaction of contract terms, most of our remaining option contracts. Various factors, some of which are beyond our control, such as market conditions, weather conditions, and the timing of the completion of development activities, will have a significant impact on the timing of option exercises or whether lot options will be exercised at all.
65
The following table provides a summary of our interests in lot option agreements as of September 30, 2020 and September 30, 2019:
(6) Interest
Interest capitalized during the fiscal years ended September 30, 2020, 2019 and 2018 was limited by the balance of inventory eligible for capitalization. The following table presents certain information regarding interest for the periods presented:
Fiscal Year Ended September 30,
(a) The amount of interest capitalized depends on the qualified inventory balance, which considers the status of the Company's inventory holdings. The qualified inventory balance includes the majority of homes under construction and development projects in progress but excludes land held for future development and land held for sale.
(b) Capitalized interest amortized to home construction and land sales expenses varies based on the number of homes closed during the period and land sales, if any, as well as other factors.
(7) Property and Equipment
The following table presents our property and equipment as of September 30, 2020 and September 30, 2019:
Model furnishings and sales office improvements $ 17,604 $ 21,114
Furniture, fixtures and office equipment 10,287 10,068
66
(8) Borrowings
The Company's debt, net of unamortized debt issuance costs consisted of the following as of September 30, 2020 and September 30, 2019:
in thousands Maturity Date September 30, 2020 September 30, 2019
Secured Revolving Credit Facility February 2022 (a) — —
Other Secured Notes Payable Various Dates — 1,154
(a)On October 8, 2020, the Company executed a Ninth Amendment to the Facility. The Ninth Amendment extended the termination date of the Facility from February 15, 2022 to February 15, 2023. For further discussion of the Ninth Amendment, refer to Note 21.
As of September 30, 2020, the future maturities of our borrowings were as follows:
Fiscal Year Ended September 30,
in thousands
Secured Revolving Credit Facility
The Secured Revolving Credit Facility (the Facility) provides working capital and letter of credit capacity of $250.0 million. The Facility is currently with four lenders.
The Facility allows us to issue letters of credit against the undrawn capacity. Subject to our option to cash collateralize our obligations under the Facility upon certain conditions, our obligations under the Facility are secured by liens on substantially all of our personal property and a significant portion of our owned real property. We also pledged approximately $1.1 billion of inventory assets to the Facility to collateralize potential future borrowings or letters of credit (in addition to the letters of credit already issued under the Facility). As of September 30, 2020 and September 30, 2019, no borrowings and no letters of credit were outstanding under the Facility, resulting in a remaining capacity of $250.0 million. The Facility requires compliance with certain covenants, including negative covenants and financial covenants. As of September 30, 2020, the Company believes it was in compliance with all such covenants.
Senior Unsecured Term Loan
On September 9, 2019, the Company entered into a term loan agreement, which provides for a Senior Unsecured Term Loan (the Term Loan). The principal balance as of September 30, 2020 is $100.0 million. The Term Loan will (1) mature in September 2022, with remaining $50.0 million annual repayment installments due in September 2021 and September 2022; (2) bears interest at a fixed rate of 4.875%; and (3) includes an option to prepay, subject to certain conditions and the payment of certain premiums. The Term Loan contains covenants generally consistent with the covenants contained in the Facility. As of September 30, 2020, the Company believes it was in compliance with all such covenants.
67
Letter of Credit Facilities
The Company has entered into stand-alone, cash-secured letter of credit agreements with banks to maintain pre-existing letters of credit and to provide for the issuance of new letters of credit (in addition to the letters of credit issued under the Facility). As of September 30, 2020 and September 30, 2019, the Company had letters of credit outstanding under these additional facilities of $12.7 million and $14.1 million, respectively, all of which were secured by cash collateral in restricted accounts. The Company may enter into additional arrangements to provide additional letter of credit capacity.
In May 2018, the Company entered into a reimbursement agreement, which provides for the issuance of performance letters of credit, and an unsecured credit agreement that provides for the issuance of up to $50.0 million of standby letters of credit to backstop the Company's obligations under the reimbursement agreement (collectively, the "Bilateral Facility"). On June 17, 2020, the Company executed an Amendment No. 1 to the Bilateral Facility that extends the termination date of the agreement from June 10, 2021 to June 10, 2022. As of September 30, 2020, the total stated amount of performance letters of credit issued under the reimbursement agreement was $36.1 million (and the stated amount of the backstop standby letter of credit issued under the credit agreement was $40.0 million). The Company may enter into additional arrangements to provide greater letter of credit capacity.
Senior Notes
The Company's Senior Notes are unsecured obligations ranking pari passu with all other existing and future senior indebtedness. Substantially all of the Company's significant subsidiaries are full and unconditional guarantors of the Senior Notes and are jointly and severally liable for obligations under the Senior Notes and the Facility. Each guarantor subsidiary is a 100% owned subsidiary of Beazer Homes.
All unsecured Senior Notes rank equally in right of payment with all existing and future senior unsecured obligations, senior to all of the Company's existing and future subordinated indebtedness and effectively subordinated to the Company's existing and future secured indebtedness, including indebtedness under the Facility, if outstanding, to the extent of the value of the assets securing such indebtedness. The unsecured Senior Notes and related guarantees are structurally subordinated to all indebtedness and other liabilities of all of the Company's subsidiaries that do not guarantee these notes, but are fully and unconditionally guaranteed jointly and severally on a senior basis by the Company's wholly-owned subsidiaries party to each applicable indenture.
The Company's Senior Notes are issued under indentures that contain certain restrictive covenants which, among other things, restrict our ability to pay dividends, repurchase our common stock, incur certain types of additional indebtedness, and make certain investments. Compliance with the Senior Note covenants does not significantly impact the Company's operations. The Company believes it was in compliance with the covenants contained in the indentures of all of its Senior Notes as of September 30, 2020.
We recognized $24.9 million in loss on extinguishment of debt in fiscal 2019 compared to no such charges in fiscal 2020.
68
For additional redemption features, refer to the table below that summarizes the redemption terms of our Senior Notes:
Senior Note Description Issuance Date Maturity Date Redemption Terms
69
Junior Subordinated Notes
The Company's unsecured junior subordinated notes (Junior Subordinated Notes) mature on July 30, 2036. The Junior Subordinated Notes are redeemable at par and paid interest at a fixed rate of 7.987% for the first 10 years ending July 30, 2016. The securities now have a floating interest rate as defined in the Junior Subordinated Notes Indenture, which was a weighted-average of 4.25% as of September 30, 2020. The obligations relating to these notes are subordinated to the Facility and the Senior Notes. In January 2010, the Company modified the terms of $75.0 million of these notes and recorded them at their then estimated fair value. Over the remaining life of the Junior Subordinated Notes, we will increase their carrying value until this carrying value equals the face value of the notes. As of September 30, 2020, the unamortized accretion was $32.6 million and will be amortized over the remaining life of the notes. As of September 30, 2020, the Company believes it was in compliance with all covenants under the Junior Subordinated Notes.
(9) Contingencies
Beazer Homes and certain of its subsidiaries have been and continue to be named as defendants in various construction defect claims, complaints, and other legal actions. The Company is subject to the possibility of loss contingencies related to these defects as well as others arising from its business. In determining loss contingencies, we consider the likelihood of loss and our ability to reasonably estimate the amount of such loss. An estimated loss is recorded when it is considered probable that a liability has been incurred and the amount of loss can be reasonably estimated.
Warranty Reserves
We currently provide a limited warranty ranging from one to two years covering workmanship and materials per our defined quality standards. In addition, we provide a limited warranty for up to ten years covering only certain defined structural element failures.
Our homebuilding work is performed by subcontractors who typically must agree to indemnify us with regard to their work and provide certificates of insurance demonstrating that they have met our insurance requirements and have named us as an additional insured under their policies. Therefore, many claims relating to workmanship and materials that result in warranty spending are the primary responsibility of these subcontractors. In addition, we maintain insurance coverage related to our construction efforts that can result in recoveries of warranty and construction defect costs above certain specified limits.
Warranty reserves are included in other liabilities within the consolidated balance sheets, and the provision for warranty accruals is included in home construction expenses in the consolidated statements of operations. Reserves covering anticipated warranty expenses are recorded for each home closed. Management assesses the adequacy of warranty reserves each reporting period based on historical experience and the expected costs to remediate potential claims. Our review includes a quarterly analysis of the historical data and trends in warranty expense by division. Such analysis considers market specific factors such as warranty experience, the number of home closings, the prices of homes, product mix, and other data in estimating warranty reserves. In addition, the analysis also contemplates the existence of any non-recurring or community-specific warranty-related matters that might not be included in historical data and trends. While estimated warranty liabilities are adjusted each reporting period based on the results of our quarterly analyses, we may not accurately predict actual warranty costs, which could lead to significant changes in the reserve.
Changes in warranty reserves are as follows for the periods presented:
Fiscal Year Ended September 30,
(a) Accruals for warranties issued are a function of the number of home closings in the period, the selling prices of the homes closed and the rates of accrual per home estimated as a percentage of the selling price of the home.
70
Insurance Recoveries
The Company has insurance policies that provide for the reimbursement of certain warranty costs incurred above specified thresholds for each period covered. Amounts recorded for anticipated insurance recoveries are reflected within the consolidated statements of operations as a reduction of home construction expenses. Amounts not yet received from our insurer are recorded on a gross basis, without any reduction for the associated warranty expense, within accounts receivable on our consolidated balance sheets.
Litigation
In the normal course of business, we are subject to various lawsuits. We cannot predict or determine the timing or final outcome of these lawsuits or the effect that any adverse findings or determinations in pending lawsuits may have on us. In addition, an estimate of possible loss or range of loss, if any, cannot presently be made with respect to certain of these pending matters. An unfavorable determination in any of the pending lawsuits could result in the payment by us of substantial monetary damages that may not be fully covered by insurance. Further, the legal costs associated with the lawsuits and the amount of time required to be spent by management and our Board of Directors on these matters, even if we are ultimately successful, could have a material adverse effect on our financial condition, results of operations, or cash flows.
Claims Related to Inventory Impairment Charges. During the quarter ended March 31, 2019, we recognized inventory impairment charges related to 15 communities in California, all of which were previously land held for future development assets. Related to these inventory impairment charges, on June 5, 2019, a putative class action lawsuit was filed against Beazer Homes USA, Inc. and certain of our officers in the U.S. District Court for the Southern District of New York. The proposed class consisted of all persons and entities that acquired our securities between August 1, 2014 and May 2, 2019. On October 18, 2019, the plaintiffs filed a notice of voluntary dismissal of this case, and the Court subsequently entered an order dismissing the case.
Beginning June 25, 2019, several shareholder derivative lawsuits relating to the same inventory impairment charges discussed above were filed against Beazer Homes USA, Inc., certain of our officers and members of our Board of Directors in the U.S. District Court for the Northern District of Georgia. The plaintiffs in these cases allege breaches of fiduciary duty, unjust enrichment and violations of the federal securities laws. These federal actions have been consolidated into a single derivative action. Additionally, a substantially similar derivative action has been filed in the Superior Court of Fulton County, Georgia. The plaintiffs in each of these actions seek, among other things, monetary damages, disgorgement of profits and attorneys’ and experts’ fees, but do not specify any specific amounts. On October 25, 2020, the Court granted a motion to dismiss the consolidated federal action but provided the plaintiffs an opportunity to attempt to amend their complaint. We continue to believe the allegations are without merit and intend to continue to vigorously defend against the claims. However, because the outcome of these legal proceedings cannot be predicted with certainty, we have determined that the amount of any possible losses or range of possible losses in connection with these matters is not reasonably estimable.
Other Matters
We and certain of our subsidiaries have been named as defendants in various claims, complaints, and other legal actions, most relating to construction defects, moisture intrusion, and product liability. Certain of the liabilities resulting from these actions are covered in whole or in part by insurance. In our opinion, based on our current assessment, the ultimate resolution of these matters will not have a material adverse effect on our financial condition, results of operations, or cash flows.
We have an accrual of $5.0 million and $3.4 million in other liabilities on our consolidated balance sheets related to litigation and other matters, excluding warranty, as of September 30, 2020 and 2019, respectively.
We had outstanding letters of credit and surety bonds of $48.8 million and $248.2 million, respectively, as of September 30, 2020, related principally to our obligations to local governments to construct roads and other improvements in various developments.
(10) Fair Value Measurements
As of the dates presented, we had assets on our consolidated balance sheets that were required to be measured at fair value on a recurring or non-recurring basis. We use a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value as follows:
•Level 1 – Quoted prices in active markets for identical assets or liabilities;
•Level 2 – Inputs other than quoted prices included in Level 1 that are observable either directly or indirectly through corroboration with market data; and
71
•Level 3 – Unobservable inputs that reflect our own estimates about the assumptions market participants would use in pricing the asset or liability.
Certain of our assets are required to be recorded at fair value on a recurring basis. The fair value of our deferred compensation plan assets is based on market-corroborated inputs (Level 2).
Certain of our assets are required to be recorded at fair value on a non-recurring basis when events and circumstances indicate that the carrying value of these assets may not be recovered. We review our long-lived assets, including inventory, for recoverability when factors indicate an impairment may exist, but no less than quarterly. Fair value on assets deemed to be impaired is determined based upon the type of asset being evaluated. Fair value of our owned inventory assets, when required to be calculated, is further discussed within Notes 2 and 5. The fair value of our investments in unconsolidated entities is determined primarily using a discounted cash flow model to value the underlying net assets of the respective entities. Due to the substantial use of unobservable inputs in valuing the assets on a non-recurring basis, they are classified within Level 3.
During the fiscal year ended September 30, 2020, we recognized no impairments on projects in process and $1.3 million on land held for sale. During the fiscal year ended September 30, 2019, we recognized impairments of $110.0 million on projects in process and $38.6 million on land held for sale. During the fiscal year ended September 30, 2018, we recognized impairments of $1.0 million on projects in process and $5.9 million on land held for sale.
Determining within which hierarchical level an asset or liability falls requires significant judgment. We evaluate our hierarchy disclosures each quarter.
The following table presents the period-end balances of assets measured at fair value on a recurring basis and the impairment-date fair value of certain assets measured at fair value on a non-recurring basis for each hierarchy level. These balances represent only those assets whose carrying values were adjusted to fair value during the periods presented:
in thousands Level 1 Level 2 Level 3 Total
Deferred compensation plan assets (a) $ — $ 2,339 $ — $ 2,339
Land held for sale (b) — — 6,240 (c) 6,240
Deferred compensation plan assets (a) $ — $ 1,970 $ — $ 1,970
Development projects in progress (b) — — 84,982 (c) 84,982
Land held for sale (b) — — 5,207 (c) 5,207
Deferred compensation plan assets (a) $ — $ 1,578 $ — $ 1,578
Development projects in progress (b) — — 1,312 (c) 1,312
Land held for sale (b) — — 1,724 (c) 1,724
Unconsolidated entity investments — — 80 80
(a) Measured at fair value on a recurring basis.
(b) Measured at fair value on a non-recurring basis, including the capitalized interest and indirect costs related to the asset.
(c) Amount represents the impairment-date fair value of the development projects in progress and land held for sale assets that were impaired during the period indicated.
The fair value of cash and cash equivalents, restricted cash, accounts receivable, trade accounts payable, other liabilities, amounts due under the Facility (if outstanding), and other secured notes payable approximate their carrying amounts due to the short maturity of these assets and liabilities. When outstanding, obligations related to consolidated inventory not owned approximate fair value.
72
The following table presents the carrying value and estimated fair value of certain other financial liabilities as of September 30, 2020 and September 30, 2019:
in thousands CarryingAmount (a) Fair Value CarryingAmount (a) Fair Value
(a)Carrying amounts are net of debt issuance costs or accretion.
(b)The estimated fair value for our publicly-held Senior Notes and the Term Loan have been determined using quoted market rates (Level 2).
(c) Since there is no trading market for our Junior Subordinated Notes, the fair value of these notes is estimated by discounting scheduled cash flows through maturity (Level 3). The discount rate is estimated using market rates currently being offered on loans with similar terms and credit quality. Judgment is required in interpreting market data to develop these estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts that we could realize in a current market exchange.
(11) Operating Leases
The Company leases certain office space and equipment under operating leases for use in our operations. We recognize operating lease expense on a straight-line basis over the lease term. Certain of our lease agreements include one or more options to renew. The exercise of lease renewal options is generally at our discretion. Variable lease expense primarily relates to maintenance and other monthly expense that do not depend on an index or rate.
We determine if an arrangement is a lease at contract inception. Lease and non-lease components are accounted for as a single component for all leases. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of the future lease payments over the expected lease term, which includes optional renewal periods if we determine it is reasonably certain that the option will be exercised. As our leases do not provide an implicit rate, the discount rate used in the present value calculation represents our incremental borrowing rate determined using information available at the commencement date.