Form 10-K Shea Homes Limited Partnership

10-K - Annual report [Section 13 and 15(d), not S-K Item 405]

Published: 2015-03-06 21:46:19
Submitted: 2015-03-09
Period Ending In: 2014-12-31
d828229d10k.htm FORM 10-K


ENT> 10-K 1 d828229d10k.htm FORM 10-K

Form 10-K

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2014

OR

 

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 333-177328

 

 

SHEA HOMES LIMITED PARTNERSHIP

(Exact name of registrant as specified in its charter)

 

 

 

California   95-4240219

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

655 Brea Canyon Road, Walnut, California, 91789

(Address of principal executive offices)

(909) 594-9500

(Registrant’s telephone number, including area code)

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

None

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

None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  

¨
    No  
x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  

x
    No  
¨

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

¨
    No  
x

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  

x
    No  
¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  

x

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

 

Large accelerated filer  
¨
   Accelerated filer  
¨
Non-accelerated filer  
x
 (Do not check if a smaller reporting company)
   Smaller reporting company  
¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  

¨
    No  
x

None of the voting or non-voting common equity of the registrant is held by a non-affiliate of the registrant. There is no publicly traded market for any class of common equity of the registrant.

Documents incorporated by reference:

None

 

 

 


Table of Contents

EXPLANATORY NOTE

The registrant is a voluntary filer and is not subject to the filing requirements of the Securities Exchange Act of 1934 (the “Exchange Act”). Although not subject to these filing requirements, the registrant has filed all Exchange Act reports for the preceding 12 months.


Table of Contents

SHEA HOMES LIMITED PARTNERSHIP

INDEX

 

         Page No.  
    PART I       
Item 1.   Business      2   
Item 1A.   Risk Factors      9   
Item 1B.   Unresolved Staff Comments      23   
Item 2.   Properties      23   
Item 3.   Legal Proceedings      23   
Item 4.   Mine Safety Disclosures      24   
  PART II   
Item 5.   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      25   
Item 6.   Selected Financial Data      25   
Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      25   
Item 7A.   Quantitative and Qualitative Disclosures About Market Risk      46   
Item 8.   Financial Statements and Supplementary Data      48   
Item 9.   Changes in and Disagreements With Accountants on Accounting and Financial Disclosure      84   
Item 9A.   Controls and Procedures      84   
Item 9B.   Other Information      84   
  PART III   
Item 10.   Directors, Executive Officers and Corporate Governance      85   
Item 11.   Executive Compensation      86   
Item 12.   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      91   
Item 13.   Certain Relationships and Related Transactions, and Director Independence      93   
Item 14.   Principal Accounting Fees and Services      99   
  PART IV   
Item 15.   Exhibits and Financial Statement Schedules      100   


Table of Contents

FORWARD-LOOKING STATEMENTS

This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In addition, other statements we may make from time to time, such as press releases, oral statements made by Company officials and other reports we file with the Securities and Exchange Commission, may also contain such forward-looking statements. These forward looking statements and information relating to us are based on beliefs of management as well as assumptions made by, and information currently available to, us. When used in this document, words such as “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan” and “project” and similar expressions, as they relate to us are intended to identify forward-looking statements. These statements reflect our current views with respect to future events, are not guarantees of future performance and involve risks and uncertainties difficult to predict. Further, certain forward-looking statements are based upon assumptions of future events that may not prove to be accurate.

See “Item 1A: Risk Factors” of this Form 10-K for a description of risk factors that could significantly affect our financial results. In addition, the following factors could cause actual results to differ materially from results that may be expressed or implied by such forward-looking statements. These factors include, among other things:

 

    changes in employment levels;

 

    changes in availability of financing for homebuyers;

 

    changes in interest rates;

 

    changes in consumer confidence;

 

    changes in levels of new and existing homes for sale;

 

    changes in demographic trends;

 

    changes in housing demand;

 

    changes in home prices;

 

    elimination or reduction of tax benefits associated with owning a home;

 

    litigation risks associated with home warranty and construction defect and other claims; and

 

    various other factors, both referenced and not referenced in this Form 10-K.

Many of these factors are macroeconomic in nature and are, therefore, beyond our control. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results, performance or achievements may vary materially from those described in this Form 10-K as anticipated, believed, estimated, expected, intended, planned or projected. Except as required by law, we neither intend nor assume any obligation to revise or update these forward-looking statements, which speak only as of their dates.

 

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SHEA HOMES LIMITED PARTNERSHIP

PART I

ITEM 1. BUSINESS

Overview

Shea Homes Limited Partnership, a California limited partnership (“SHLP”, the “Company”, “us”, “our”, or “we”), is one of the nation’s largest privately owned homebuilders based on total number of home deliveries and total revenues according to data compiled for Builder Magazine’s 2013 “Builder 100” list. We design, build and market single-family detached and/or attached homes in various geographic markets in California, Arizona, Colorado, Washington, Nevada, Florida, Virginia, North Carolina and Texas. We serve a broad customer base including entry, move-up, luxury and active lifestyle buyers. We have been recognized by industry professionals and our homebuyers for quality, customer service and craftsmanship, as evidenced by our receipt of some of the homebuilding industry’s most prominent awards, including being named as “Builder of the Year” in 2007 by Professional Builder magazine and one of “America’s Best Builders” in 2005 by the National Association of Homebuilders and Builder magazine. In 2011 and 2012, Shea Homes was honored as one of the 50 top consumer brands in the country to be named a “Customer Service Champion” by J.D. Power Associates.

SHLP was formed January 4, 1989, pursuant to an agreement of partnership, as most recently amended August 6, 2013, by and between J.F. Shea, G.P., a Delaware general partnership, as general partner, and our limited partners who are comprised of entities and trusts, including J.F. Shea Co., Inc. (“JFSCI”), under the common control of Shea family members (collectively, the “Partners”). J.F. Shea, G.P., is 96% owned by JFSCI. SHLP is one of a group of companies owned by the Shea family (collectively, the “Shea Family Owned Companies”). Since 1881 in Portland, Oregon, beginning with only a plumbing contractor business, the Shea family has expanded to start and currently owns and operates various businesses, including homebuilding, heavy construction, venture capital, home mortgage, insurance and commercial property. The Shea Family Owned Companies have grown but remained privately held by the Shea family. The Shea family began building homes in 1968 through JFSCI and, in 1989, moved homebuilding under the Shea Homes brand to the newly formed SHLP, an entity still under the broader umbrella of JFSCI.

Since our founding more than 45 years ago, Shea Homes has delivered almost 94,000 homes, including deliveries from unconsolidated joint ventures, and has expanded significantly to become one of the most well-regarded homebuilders in the markets in which we compete:

 

    1968: Residential homebuilding division was formed, operating in southern California;

 

    1970: Residential homebuilding division delivered first homes in northern California;

 

    1985: Opened San Diego division;

 

    1989: Acquired Knoell Homes and opened Arizona division;

 

    1996: Opened Denver division and acquired a portfolio of assets in California from Chevron Land;

 

    1997: Purchased Mission Viejo Company and its land holdings in California and Colorado from Philip Morris;

 

    1998: Purchased UDC Homes, Inc. and launched the Shea Homes Active Lifestyle Communities (“SHALC”) division and the Trilogy Brand;

 

    2001: SHALC division began operations in Washington;

 

    2006: Acquired homebuilding land, commercial land and income properties that comprised the Denver Tech Center;

 

    2007: SHALC division began operations in Florida;

 

    2009: Launched the SPACES Brand;

 

    2010: SHALC division began operations in Nevada;

 

    2013: Opened Houston division; launched Shea3D™ product line; and SHALC division began operations in Virginia; and

 

    2014: SHALC division began operations in North Carolina.

 

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Markets and Products

For the year ended December 31, 2014, we operated an average of 64 consolidated active selling communities in California, Arizona, Colorado, Washington, Nevada and Florida, and were in the process of commencing operations in Texas, North Carolina and Virginia. When determining markets to enter, we evaluate various factors, including local economic and real estate conditions, historical and projected population and job growth trends, number of housing starts, land availability and price, housing inventory, climate, customer profile, regional raw material costs, competitive environment and home sales rates.

Within each homebuilding community, we offer a product mix depending on market conditions, studies and opportunities. In determining our product mix in each community, we consider demographic trends, demand for a particular type of product, margins, timing and economic strength of the market. While remaining responsive to market opportunities, we have focused, and intend to continue to focus, our core homebuilding business primarily on entry-level and move-up/luxury buyers, offering single-family detached and/or attached homes. For the year ended December 31, 2014, our product mix based upon deliveries was: 43% entry-level, 39% move-up/luxury and 18% active lifestyle. While 43% of our 2014 deliveries were designed for entry-level buyers, the average selling price of our entry-level homes was $437,000 for the year ended December 31, 2014. Many of our entry-level homes contain a high number of amenities, particularly in California, and are located close to employment centers, which results in the relatively higher price compared to traditional entry-level homes.

We operate under four brands that reflect our value proposition: homes designed to meet the needs of our customers, with standard energy-efficient features, built in an environmentally-responsible manner.

 

    Shea Homes, our flagship brand, generally attracts entry-level and move-up/luxury buyers. Each of our segments, except the East, builds and markets homes under the Shea Homes brand.

 

    Trilogy communities are master-planned communities designed and built to meet the needs and active lifestyles of homebuyers 55 and older. These communities combine quality homes with diverse resort-like amenities in our Southern California, Northern California, Mountain West, South West and East segments.

 

    SPACES generally attracts 25-40 year-old buyers with contemporary, practical homes that have flexible floor plans and stylish, energy-efficient features at an affordable price point. We have opened SPACES communities in our Southern California, Northern California, Mountain West and South West segments.

 

    Shea 3D, introduced in 2014, allows buyers to choose the placement of their kitchen, dining, entertainment, outdoor and other living areas to design a home that matches how the buyer lives. We have opened Shea 3D communities in our Northern California, San Diego, Mountain West, South West and East segments.

We manage each homebuilding community as an operating segment and have aggregated these communities into reportable segments based generally on geography as follows:

 

    Southern California, comprised of communities in Los Angeles, Ventura and Orange Counties, and the Inland Empire;

 

    San Diego, comprised of communities in San Diego County, California;

 

    Northern California, comprised of communities in northern and central California, and the central coast of California;

 

    Mountain West, comprised of communities in Colorado and Washington;

 

    South West, comprised of communities in Arizona, Nevada and Texas; and

 

    East, comprised of communities in Florida, North Carolina and Virginia.

In 2013, we entered the Houston, Texas housing market and acquired our first parcel of land in Winchester, Virginia for a SHALC project. In 2014, we acquired our first parcel of land in North Carolina for a SHALC project that is operated in an unconsolidated joint venture.

We conduct our homebuilding business through projects that we wholly-own, operate in joint ventures with third parties and generally have a 50% or less economic interest, and manage projects where we have no ownership interest. Most of our joint ventures and managed projects are Trilogy master-planned communities. For the Trilogy communities we manage, part of our compensation reflects the use and licensing of our Trilogy brand.

 

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The following table presents certain operating information for our reportable segments for the years ended December 31, 2014, 2013 and 2012:

 

     December 31,  
     2014     2013     2012  

Southern California:

      

Homes delivered

     481        271        249   

Percentage of total homes delivered

     24     14     16

Average selling price

   $ 812,121      $ 757,376      $ 523,498   

Total homebuilding revenues (in millions) (a)

   $ 393.5      $ 207.6      $ 134.0   

San Diego:

      

Homes delivered

     252        256        194   

Percentage of total homes delivered

     13     14     12

Average selling price

   $ 568,095      $ 490,172      $ 440,897   

Total homebuilding revenues (in millions) (a)

   $ 143.2      $ 125.5      $ 86.0   

Northern California:

      

Homes delivered

     385        456        323   

Percentage of total homes delivered

     19     24     21

Average selling price

   $ 668,179      $ 510,300      $ 487,003   

Total homebuilding revenues (in millions) (a)

   $ 259.3      $ 242.4      $ 166.1   

Mountain West:

      

Homes delivered

     356        372        284   

Percentage of total homes delivered

     18     20     18

Average selling price

   $ 458,379      $ 444,156      $ 446,352   

Total homebuilding revenues (in millions) (a)

   $ 175.7      $ 186.9      $ 147.8   

South West:

      

Homes delivered

     511        510        492   

Percentage of total homes delivered

     26     27     31

Average selling price

   $ 324,456      $ 311,951      $ 280,283   

Total homebuilding revenues (in millions) (a)

   $ 168.3      $ 160.7      $ 138.2   

East:

      

Homes delivered

     0        25        31   

Percentage of total homes delivered

     0     1     2

Average selling price

   $ 0      $ 262,160      $ 230,645   

Total homebuilding revenues (in millions) (a)

   $ 0      $ 6.6      $ 7.1   

Total:

      

Homes delivered

     1,985        1,890        1,573   

Average selling price

   $ 564,241      $ 473,177      $ 410,045   

Total homebuilding revenues (in millions) (a)

   $ 1,140.0      $ 929.7      $ 679.2   

 

(a) Total homebuilding revenues are primarily comprised of revenues from home deliveries and land sales.

For additional segment information, see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 18 to our consolidated financial statements.

Strategy

Provide Customers with Value via Design, Quality and Service

An integral component of our business strategy is to design and deliver quality homes focused on specific product types in “core” housing markets, combined with a customer experience that is consistently among the leaders in the homebuilding industry. We have historically been at or near the top of individual customer service rankings for each of our homebuilding markets. In 2011 and 2012, we were also honored as one of 50 top consumer brands in the country to be named a “Customer Service Champion” by J.D. Power Associates. We are one of only two homebuilders to ever receive this award and the only homebuilder to have received this award in multiple years. We view a positive customer service experience and adherence to stringent quality control standards as fundamental to our business model and continued success. We believe our quality assurance programs help improve production efficiency, reduce warranty costs and increase customer satisfaction and referrals. Our commitment to product quality includes a comprehensive checkpoint evaluation at key points in the construction process, continuous improvement based on direct feedback and sharing of best practices with our TradePartners®.

 

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Maintain Disciplined Operating Strategy

We currently employ a lean “hybrid” organizational structure to reduce costs, maintain consistency and increase operational flexibility:

 

    local-level, decentralized decision making to provide flexibility with regard to: personnel hiring, land identification and sourcing, land development and homebuilding processes;

 

    regionalized purchasing for home construction and building materials to promote increased buying power, take advantage of regional market differences and facilitate nationwide cost sharing; and

 

    centralized functions to provide cost-efficient operation of customer call center, customer service, architecture (construction documents) and other back office operations including accounting, information technology and payroll.

We focus on lowering costs and construction cycle times through benchmarking and the sharing of best practices among divisions. By concentrating on these objectives, we believe we can manage our business through changing economic climates.

We seek to allocate the capital necessary for new projects in a manner consistent with our overall operating strategy and based on market conditions. We utilize return on assets, peak cash investment, gross margin and net income margin as the primary criteria prior to deploying our capital resources. Capital commitments are determined via a formal land committee among selected executive and operational personnel who play an important role in ensuring that new projects reflect our strategy.

Continue Balanced Land Policies

We plan to capitalize on our existing land supply, which we believe is largely sufficient to support our homebuilding operations for the next two years in most of our divisions and limits our need to acquire land to execute our business plan. We also maintain a supply of lots that we strategically and opportunistically sell to other builders, capitalizing on demand for lot inventory. We generally only purchase entitled land but will provide the expertise to entitle land held by a seller and contracted to us under an option agreement. This provides a potentially lower cost way of controlling land inventory for the future. To reduce the risks associated with our investments in land, we utilize deal structures including long-term purchase options, rolling lot takedowns and purchase contracts that sometimes provide for payment to land sellers upon delivery of homes built on land purchased. We plan to continue land acquisitions, with a continued focus on core “A” markets closest to major employment centers and an emphasis on acquiring smaller land parcels with quicker turns. We focus on minimizing unsold, under-construction housing inventory.

Preserve and Build on Positions in Existing Markets

We will pursue growth to the extent that we believe it is consistent with our disciplined operating strategy, balanced land policies and overall commitment to quality. Our growth strategy focuses primarily on investing and acquiring land in core locations in our existing geographic markets. We believe our current geographic markets represent regions of the country that present above average growth potential based on long-term employment, demographic and economic trends. We have operated in most of these markets for many years and our teams have extensive local knowledge and critical business relationships that are essential in competing for land, subcontractors and customers. While we are focused primarily on growth in our existing markets, we will also opportunistically consider entry into new geographic markets that meet the same criteria as our existing markets and which we can reasonably support through our capital base.

Marketing and Sales

We believe we have an established and valuable brand, with a reputation for high quality construction, innovative design and strong customer service. We believe our reputation helps generate interest in each new project we undertake. Customers often comment on the quality of our homes and their positive buying experience. These attributes enhance our brand position and increase referrals.

We use a variety of marketing platforms, including website, internet and mobile applications, customer information centers, advertisements, newspapers, magazines and brochures, direct mail, billboards and fully decorated model units. We focus on being at the forefront of technological based marketing, including how we communicate information to the marketplace. We have had success working through Facebook, Twitter, blogs and an application for Apple Inc.’s iPhone and iPod Touch devices. We also maintain a state-of-the-art website that allows potential customers to insert their existing furniture into our floor plans, and benefit from an exclusive arrangement with our website design firm.

 

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Model homes are an important part of our marketing efforts where we focus on creating an attractive atmosphere at each community. We use local third party design specialists for interior decorations and furniture, which vary within models based upon characteristics of homebuyers. At December 31, 2014, we owned 206 model homes. We also have home design service centers offering a range of customization options to satisfy individual customer tastes.

To sell homes, we employ commissioned sales agents who are licensed real estate agents where required by law. We also use independent brokers who are typically paid a market-based commission based on the price of the home.

Customer purchase deposit requirements vary among markets based on state laws as well as customs and practices and are sometimes dictated by the financing program used by the consumer, as well as market conditions. Total base purchase price deposits range from $500 to $40,000 (excluding options). Subject to applicable law and depending on a particular market, additional purchase deposits are required for options and upgrades and range from 10% to 100% of the option price (as opposed to the overall purchase price), with a higher deposit sometimes required for custom options or certain options above an amount designated for the community. Generally, higher deposit percentages are required for large option orders. Our sales contracts may include, among other contingencies, a financing contingency which permits customers to cancel and receive a refund of their deposits if they cannot obtain mortgage financing at prevailing or specified interest rates within a specified period. Our contracts may include other contingencies, such as the sale of an existing home. Our cancellation rate as a percentage of home sales orders averaged approximately 21% from 1997-2006 before the downturn in the homebuilding industry. Though this rate increased to a high of 31% in 2008, it returned to 20% in 2009. For the year ended December 31, 2014, our cancellation rate was 16%.

To reduce the risk of unsold inventory, we formalized our approval process of home construction starts. Generally, customers must have approved financing, no contingencies tied to the sale of an existing home, and an appropriate deposit before construction of a home begins. Depending on market conditions in each community, we may begin construction on a limited number of homes when no signed sales contracts exist to provide inventory to buyers who want a finished home for a quicker move in. In addition, we may use various sales incentives, such as payment of certain homebuyer costs as part of our sales process. Use of incentives and inventory construction is dependent on local economic and competitive market conditions.

Land Acquisition and Development

We have a disciplined and structured land acquisition process. Each acquisition must be approved by our land committee, which is comprised of members of senior management and directors of J.F. Shea Construction Management, Inc., our ultimate general partner. The committee reviews potential new projects, and option and deposit funds are placed at risk only if approved by the committee. As part of this process, the committee reviews underwriting and due diligence information provided by our division management and land acquisition personnel and typically includes market, environmental and site-planning studies, project and market risk assessments, and financial analysis. We expect to acquire more land inventory in each market to meet expected demand.

For our homebuilding operations, we typically purchase land only after substantially all of the necessary governmental development approvals or entitlements have been obtained so that development or construction may begin as and when market conditions dictate. The term “entitlements”, as used herein, refers to the right, for the duration of the term of the entitlements, to develop a specific number of residential lots without the need for further public hearings or discretionary local government approvals. Entitlements generally give developers the right to obtain building permits upon compliance with certain conditions that are ordinarily within the developer’s control. Although entitlements are usually obtained before we acquire land, we are still required to secure other governmental approvals and obtain permits prior to and during development and construction. The process of obtaining such approvals and permits can be costly, time consuming and difficult to obtain, and substantially delay the originally planned development cycle.

We acquire land through purchase and option contracts. Deposits are generally refundable until the necessary entitlements and zoning, including plan approval and in some cases engineering plan approval, are obtained, at which time deposits become non-refundable. Actual land acquisitions are generally financed from cash on our balance sheet, cash flow from operations or, if necessary, our $125.0 million secured revolving credit facility. Option contracts allow us to control lots and land without incurring risks of land ownership or financial commitments other than, in some circumstances, a non-refundable deposit. We also enter into option contracts with land owners and developers and, in certain circumstances, other third parties, including affiliates, to purchase finished lots over time and before home construction begins. These option contracts may require a certain number of purchases per quarter. We typically have the right to decline to exercise future purchases and to cancel our future rights to lots, typically forfeiting only the deposits held by the sellers at that time.

When we acquire undeveloped land, we generally begin development through contractual agreements with consultants and our TradePartners® (see below). These activities include site planning and engineering and constructing roads, sewer, water, utility and drainage systems and, in certain instances, recreational amenities. For additional information regarding our land position, see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations—Selected Homebuilding Operational Data—Land and Homes in Inventory.”

 

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Backlog

Sales order backlog represents homes under contract to be built, but not delivered with the transfer of title. Revenue is recognized on homes under sales contracts when the home delivers. Homes deliver when all conditions of escrow are met, including delivery of the home or other real estate asset to the customer, title passage, appropriate consideration is received or collection of associated receivables, if any, is reasonably assured and when we have no other continuing involvement in the assets. At December 31, 2014, we had a backlog of 918 units with a sales value of $551.7 million that is anticipated to be realized as deliveries, which are subject to cancellation, primarily throughout 2015.

Seasonality

Historically, the homebuilding industry experiences seasonal fluctuations. We typically experience the highest home sales order activity in spring and summer, although this activity is also highly dependent on the number of active selling communities, timing of new community openings and other market factors. Since it typically takes three to seven months to construct a new home, we deliver more homes in the second half of the year as spring and summer home sales orders convert to home deliveries. Because of this seasonality, home starts, construction costs and related cash outflows have historically been highest from April to October, and the majority of cash receipts from home deliveries occur during the second half of the year.

Consumer Financial Services

We make available certain financial services to our homebuyers through:

 

    Shea Insurance Services, Inc., a wholly-owned subsidiary that provides insurance brokerage services; and

 

    Shea Mortgage, Inc. (“Shea Mortgage”), an affiliate, that provides mortgage services.

Construction

As the general contractor for most communities, we employ subcontractors that meet our requirements for becoming TradePartners®. These requirements include quality and workplace safety standards and participation in various training programs. We typically hire TradePartners® on a community-by-community basis at a fixed price. Occasionally, we enter into longer term contracts or national account agreements (exclusive or non-exclusive) with suppliers or manufacturers if we can obtain more favorable terms or receive rebates based upon product usage and volumes. Our construction managers and field superintendents coordinate and schedule the activities of TradePartners® and suppliers and subject their work to quality and cost controls.

We do not maintain significant inventories of construction materials, except for work-in-process materials for homes under construction. When possible, we negotiate price and volume discounts with manufacturers and suppliers to take advantage of production volume and regional purchasing capabilities, including parties such as Delta, for plumbing fixtures, and GE, for appliances. Prices for these goods and services may fluctuate due to various factors, including supply shortages that may be beyond the control of our suppliers.

Quality Control and Warranty Programs

We view a positive customer service experience and adherence to stringent quality control standards as fundamental to our business model and continued success. We believe our quality assurance programs help improve production efficiency, reduce warranty costs and increase customer satisfaction and referrals. Our commitment to product quality includes a comprehensive checkpoint evaluation at key points in the construction process, continuous improvement based on direct feedback from our TradePartners®, and our participation in TradePartners® councils to discuss industry practices, solve problems and distribute information in an effort to build better homes.

We offer our customers a comprehensive one or two-year fit and finish warranty for our homes and typically provide more limited ongoing customer service support for up to ten years in some markets as required by state law. Specific length, terms and conditions of these warranties vary depending on the market in which a home is sold. Additionally, post-delivery, we proactively provide one, five and eleven-month customer care home visits. On-site customer care personnel coordinate with TradePartners® to service the homes.

We record a reserve of approximately 1.0% to 2.0% of the home sales price to cover warranty and customer service expenses, although this allowance is subject to adjustment in special circumstances. Our historical experience has been warranty and customer service expenses generally fall within this allowance. We believe our reserves are adequate to cover the ultimate resolution of potential liabilities associated with known and anticipated warranty and customer service related claims.

 

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Insurance Coverage

We obtain workers compensation insurance, commercial general liability insurance, and insurance for completed operations losses and damages with respect to our homebuilding operations from affiliate and unrelated third party insurance providers. Policies covering these items are written at various coverage levels but include a self-insured retention or deductible ranging from $0.5 million to $15.0 million, depending on the layer. We typically procure general liability, workers compensation and completed operations insurance from affiliated entities to insure these retentions or deductibles, plus excess layers above the third party limits. See “Item 13: Certain Relationships and Affiliate Transactions, and Director Independence —Transactions with Unconsolidated Joint Ventures and Other Shea Family Owned Companies — Supplemental Insurance Coverage and PIC Transaction.”

We require TradePartners® to be insured for work on our communities for workers compensation, commercial general liability and completed operations losses and damages, and many of our TradePartners® carry this insurance through our “rolling wrap-up” insurance program, where our risks and the risks of participating TradePartners® on our projects are insured through a set of master policies.

Competition and Market Factors

Development and sale of residential properties is highly competitive and fragmented. We compete for sales with many large and small homebuilders, including homebuilders with national operations, based on various interrelated factors, including location, reputation, amenities, design, quality and price. We also compete for sales with existing home sales and rental housing.

Demand for new housing is affected by, among other factors, consumer confidence and prevailing economic conditions, including employment levels and job growth or contraction, interest rates, and state and federal home ownership legislative policies. Other factors affect the housing industry and demand for new homes, including availability of labor and materials and increases in the costs thereof, changes in costs of home ownership, such as property taxes and energy costs, changes in consumer preferences, demographic trends and availability of and changes in mortgage financing programs.

Government Regulation and Environmental Matters

The homebuilding industry is subject to extensive and complex regulations. We and our TradePartners® must comply with various federal, state and local laws and regulations, including zoning, density and development requirements and building, environmental, advertising and real estate sales rules and regulations. These requirements affect the development process, materials and designs of our properties. Moreover, we are dependent on state and local authorities to issue permits and other approvals to complete our projects. The time to obtain these permits and other approvals impacts our carrying costs. The effectiveness of granted permits is subject to changes in policies, rules and regulations and their interpretation and application.

Some state and local governments in our markets have approved, and others may approve, slow-growth or no-growth initiatives that have and could continue to adversely impact land availability and building opportunities. Additionally, approval of these initiatives could adversely affect our ability to build and sell homes in the affected markets or could require satisfaction of additional administrative and regulatory requirements, which could delay or extend construction and increase costs.

Our homebuilding operations are also subject to various local, state and federal statutes, ordinances, rules and regulations concerning land use and protection of health, safety and the environment. The particular impact and requirements of environmental laws for each project vary greatly according to location, environmental condition and present and former uses of the site and adjoining properties. Complying with such laws may result in delays, cause us to incur substantial compliance and other costs or prohibit or severely restrict development in certain environmentally sensitive regions or areas. To date, such compliance has not had a material adverse effect on our operations, although in the future it may have such an effect.

We typically conduct environmental due diligence reviews prior to acquisition of land. Prior to development, we perform an appropriate level of site planning for each community, which may include design and implementation of storm water management plans, wetlands delineation and mitigation plans, perennial stream flow determinations, erosion and sediment control plans and archeological, cultural and endangered species surveys. We may be required to obtain permits or other approvals for our operations, particularly in environmentally sensitive areas, such as wetlands. Infrastructure projects impacting public health and the environment, such as construction of drain fields or connection to public sewer lines, and drilling of wells or connection to municipal water supplies, may be subject to inspection and approval by local authorities. We also could incur cleanup costs and obligations with respect to environmental conditions at our communities, including, under some environmental laws, conditions resulting from operations of prior owners or operators, or at properties where we, or others, have disposed of wastes. Although no assurances can be given, we are not aware of obligations or liabilities arising from environmental conditions in any of our existing communities that are likely to be material or adversely impact us.

 

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Employees

At December 31, 2014, we employed 668 people, including 330 management, office and administrative staff, 125 sales personnel and 213 construction personnel. No employees are covered by collective bargaining agreements. Employees of certain TradePartners® are represented by labor unions or are subject to collective bargaining arrangements. We believe relations with our employees and TradePartners® are satisfactory.

Business Segment Financial Data

For business segment financial data, please see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations”, as well as Note 18 to our consolidated financial statements.

Availability of Reports

This annual report on Form 10-K and each of our subsequent quarterly reports on Form 10-Q and current reports on Form 8-K, including any amendments, are available free of charge on our website, www.sheahomes.com, as soon as reasonably practicable after such material is electronically filed with, or furnished to, the Securities and Exchange Commission (“SEC”). The information contained on our website is not incorporated by reference into this report and should not be considered part of this report. In addition, the SEC website contains reports and other information about us at sec.report.

ITEM 1A. RISK FACTORS

The discussion of our business and operations included in this annual report on Form 10-K should be read together with the risk factors set forth below. They describe various risks and uncertainties to which we are or may become subject. These risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flows, strategies or prospects in a material and adverse manner. As used below, the term “notes” and “Secured Notes” refers to the outstanding 8.625% Senior Secured Notes, due 2019, issued by Shea Homes Limited Partnership and Shea Homes Funding Corp. and guaranteed by certain of our subsidiaries.

Market and Economic Risks

The homebuilding industry, which is very cyclical and affected by a variety of factors, was in a significant and prolonged economic downturn, and, while the industry has attained a moderate level of stabilization and recovery, any return to a sustained and more normal economic and housing market environment is uncertain. A return to weak housing and general economic conditions or deterioration in industry conditions or in broader economic conditions could have additional material adverse effects on our business, financial condition and results of operations.

The homebuilding industry is cyclical and is significantly affected by industry and local, regional and national economic conditions, including changes in:

 

    employment and wage levels;

 

    availability of financing for homebuyers;

 

    interest rates;

 

    consumer confidence;

 

    levels of new and existing homes for sale;

 

    demographic trends;

 

    housing demand; and

 

    government policies.

These changes may occur on a national scale or may acutely affect some of the local regions or markets where we operate more than others. When adverse conditions affect any of our larger markets, they could have a proportionately greater impact on us than on other homebuilding companies that have a smaller presence in such markets. Our operations in previously strong markets, particularly California and Arizona, have adversely affected our results of operations disproportionately compared to our other markets in the latest downturn.

 

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An oversupply of alternatives to new homes, including foreclosed homes, homes held for sale by investors and speculators, other existing homes and rental properties, can also adversely impact our ability to sell new homes, depress new home prices and reduce our margins on the sales of new homes. High levels of foreclosures not only contribute to additional inventory available for sale, but also reduce appraised values for new homes, potentially resulting in lower sales prices.

As a result of the foregoing matters, potential customers may be less willing or able to buy our homes.

The recent downturn in the homebuilding industry was one of the most severe housing downturns in U.S. history. This downturn was marked by the significant decline in demand for new homes, significant oversupply of homes on the market and significant reductions in the availability of financing for homebuyers. As a result, we experienced material reductions in our home sales and homebuilding revenues, and incurred material inventory impairments and losses from our joint venture interests and other write-offs. It is not clear at this time if these trends have permanently reversed or when we may return to meaningful, sustained profitability.

In 2014, the housing market continued to improve from the most recent housing downturn. This recovery, which began in 2012, was primarily attributable to improved demand for homes, low inventories of homes available for sale and generally healthy and improving economic and demographic factors. Recent housing demand has been supported by population and household formation growth, as well as affordability largely attributable to low mortgage loan interest rates and increased consumer confidence. However, the performance of individual housing markets varied during the year, with home sales volume and selling price appreciation differing across markets due to, among other things, different levels of employment growth, unemployment rates and consumer confidence, and varying levels of new and existing home inventories available for sale.

We expect such unevenness in housing market conditions will continue in 2015 and beyond, whether or not this housing recovery progresses and prevailing conditions in various housing markets and submarkets will fluctuate. These fluctuations may be significant and unfavorable in 2015 and future periods, and may include a softening or sustained deterioration of home sales activity and/or selling prices, which could be more pronounced in the markets where we operate. Additionally, while some of the negative factors contributing to the housing downturn appear to have subsided, several remain and others could return and, collectively, could intensify to inhibit future improvement in housing market conditions in 2015 and beyond. A housing or economic relapse or recession would have a material adverse effect on our business, financial condition and results of operations.

Our ability to respond to any downturn is limited. Numerous home mortgage foreclosures during the recent downturn increased supply and drove down prices, making the purchase of a foreclosed home an attractive alternative to purchasing a new home. Homebuilders responded to declining sales and increased cancellation rates with significant concessions, including incentives, further adding to the price declines. With the decline in the value of homes and the inability of many homeowners to make their mortgage payments, the credit markets were significantly disrupted, putting strains on many households and businesses. These conditions could return if there is a weakening economy and housing market.

We cannot predict the duration or ultimate magnitude of any economic downturn or the extent of a recovery. Nor can we provide assurance that our response to a homebuilding downturn or the government’s attempts to address the troubles in the overall economy would be successful.

The reduction in availability of mortgage financing over the recent downturn has adversely affected our business, and it is likely that access to mortgage financing going forward will be more restrictive than in previous housing cycles.

Although there has been some improvement and a general increase in housing prices over the past three years, the mortgage lending and mortgage finance industries experienced significant instability during the recent housing downturn, beginning with increased defaults on subprime loans and other nonconforming loans followed by a surge in defaults in the broader mortgage loan market. This in turn resulted in a decline in the market value of many mortgage loans and related securities. Lenders, regulators and others questioned the adequacy of lending standards and other credit requirements for many loan products and programs offered in recent years. Credit requirements have tightened, and investor demand for mortgage loans and mortgage-backed securities has declined. The deterioration in credit quality has caused most lenders to stop offering subprime mortgages and other loan products that are not eligible for sale to Fannie Mae or Freddie Mac or loans that do not meet Federal Housing Administration (“FHA”) and Veterans Administration (“VA”) requirements. Fewer loan products, changes in conforming loan limits, tighter loan qualifications, higher down payments and a reduced willingness of lenders to provide loans make it more difficult for buyers to finance the purchase of homes. These factors have served to reduce the pool of qualified homebuyers and made it more difficult to sell to entry-level and move-up buyers who historically made up a substantial part of our customers. These reductions in demand have adversely affected our business, financial condition and results of operations over the past several years, and the duration and severity of their effects are uncertain.

 

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Liquidity provided by Fannie Mae and Freddie Mac to the mortgage industry has been very important to the housing market. These entities have required substantial injections of capital from the federal government and may require additional government support in the future. At times, the federal government has discussed changing the nature of its relationship with Fannie Mae and Freddie Mac, and possibly eliminating these entities. If Fannie Mae and Freddie Mac were dissolved or if the federal government stopped providing liquidity support to the mortgage market, there would be a reduction in available financing from these institutions. Any such reduction would likely have an adverse effect on interest rates, mortgage availability and new home sales.

The FHA insures mortgage loans that generally have lower down payments and, as a result, it continues to provide important support for financing home purchases. Recently, more restrictive guidelines were placed on FHA insured loans, such as increased minimum down payments and increased insurance premiums. Further restrictions on FHA insured loans could be adopted, including, but not limited to, limitations on seller-paid closing costs and concessions. These or any other restrictions may further negatively affect availability or affordability of FHA financing, which could adversely affect our ability to sell homes.

Some customers still utilize 100% financing through programs offered by the VA and United States Department of Agriculture. There can be no assurance these or other programs will continue to be available or will be as attractive to customers as programs currently offered, which could adversely affect our home sales.

Elimination or reduction of the tax benefits associated with owning a home could prevent potential customers from buying our homes and adversely affect our business or financial results.

Significant expenses of owning a home, including mortgage interest and real estate taxes, generally are deductible expenses for an individual’s federal and, in some cases, state income taxes, subject to certain limitations. If the federal government or a state government changes its income tax laws to eliminate or substantially modify these income tax deductions, the after-tax cost of owning a new home would increase for many potential customers. The resulting loss or reduction of homeowners’ tax deductions, if such tax law changes were enacted without offsetting provisions, would adversely affect demand for new homes.

Because most customers require mortgage financing, increases in interest rates could lower demand for our products, limit our marketing effectiveness and limit our ability to realize our backlog.

Most customers finance their home purchases through lenders providing mortgage financing. Increases in interest rates could lower demand for new homes because the mortgage costs to potential homebuyers would increase. Even if potential new homebuyers do not need financing, changes in interest rates could make it difficult to sell their existing homes to potential buyers who need financing. This could prevent or limit our ability to attract new customers and fully realize our backlog in delivering homes because our sales contracts generally include a financing contingency which permits buyers to cancel their sales contracts if mortgage financing is unobtainable within a specified time. This contingency period is typically 30 to 60 days following the date of execution of the sales contract. Exposure to such financing contingencies renders us vulnerable to changes in prevailing interest rates.

Cancellations of home sales orders in backlog may increase as homebuyers choose to not honor their contracts.

For the years ended December 31, 2014, 2013 and 2012, our cancellation rate as a percentage of home sales orders was 16%, 15% and 15%, respectively. We experienced elevated rates of sales order cancellations from 2006 through 2008. We believe the elevated cancellation rates during this period were largely a result of reduced homebuyer confidence, due principally to continued price declines, growth in foreclosures, continued high unemployment and the fact that homebuyer deposits are generally a small percentage of the purchase price. A more restrictive mortgage lending environment since 2008 and the inability of some buyers to sell their existing homes has also impacted cancellations. Many of these factors are beyond our control, and it is uncertain whether they will cause cancellation rates to rise in the future.

Home prices and demand in California, Arizona, Colorado, Washington, Nevada, Texas, Florida, North Carolina and Virginia have a large impact on our results of operations because we conduct our homebuilding business in these states.

Our operations are concentrated in regions that were among some of the most severely affected by the recent economic downturn. We conduct our homebuilding business in California, Arizona, Colorado, Washington, Nevada, Texas, Florida, North Carolina and Virginia. Home prices and sales in these states have declined significantly since 2006 and, while improving, these states, particularly California, have experienced some economic challenges in recent years, including elevated levels of unemployment and precarious budget situations in state and local governments. These conditions may materially adversely affect the market for our homes in those areas. Declines in home prices and sales in these states also adversely affect our financial condition and results of operations.

 

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Inflation could adversely affect our business, financial condition and results of operations.

Inflation can adversely affect us by increasing costs of land, materials and labor. We are currently experiencing a significant increase in the cost of labor and materials to construct our homes. In addition, with rising home prices, land prices have increased. We may be unable to offset these increases with higher sales prices. In addition, inflation is often accompanied by higher interest rates, which have a negative impact on housing demand. In such an environment, we may be unable to raise home prices sufficiently to keep up with the rate of cost inflation and, accordingly, our margins could decrease. Moreover, with inflation, the purchasing power of our cash resources can decline. Efforts by the government to stimulate the economy may not be successful, but have increased the risk of significant inflation and its resulting adverse effect on our business, financial condition and results of operations.

Homebuilding is very competitive, and competitive conditions could adversely affect our business, financial condition and results of operations.

The homebuilding industry is highly competitive. Homebuilders compete not only for homebuyers, but also for desirable land, financing, raw materials and skilled labor. We compete with other local, regional and national homebuilders, often within larger subdivisions designed, planned and developed by such homebuilders and developers. We also compete with existing home sales, foreclosures and rental properties. In addition, some competitors may have greater financial, marketing and sales resources with the ability to compete more effectively. New competitors may also enter our markets. These competitive conditions in the homebuilding industry can result in:

 

    fewer sales;

 

    lower selling prices;

 

    increased selling incentives;

 

    lower profit margins;

 

    impairments in the value of inventory and other assets;

 

    difficulty in acquiring suitable land, raw materials and skilled labor at acceptable prices or terms; or

 

    delays in home construction.

These competitive conditions affect our business, financial condition and results of operations.

Operational Risks

Supply shortages and risks of demand for building materials and skilled labor could increase costs and delay deliveries.

The homebuilding industry has periodically experienced significant difficulties that can affect the cost or timing of construction, and adversely impact our revenues and operating margins, including:

 

    difficulty in acquiring land suitable for residential building at affordable prices in locations where our potential customers want to live;

 

    shortages of qualified labor;

 

    reliance on local subcontractors, manufacturers and distributors who may be inadequately capitalized;

 

    shortages of materials; and

 

    increases in the cost of materials, particularly lumber, drywall, cement, steel, plumbing and electrical components, which are significant components of home construction costs.

Competitive bidding helps control labor and building material costs. With the improvement of the real estate market, a trend of increasing costs for material and labor has emerged in our markets. An increase in costs without an increase in selling prices of our homes could adversely affect our financial condition and results of operations.

In most of our markets, we need to replenish our lot inventory for construction. If the housing market recovers, the price of improved or finished lots for construction in these markets could increase and adversely affect our financial condition and results of operations.

 

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Homebuilding is subject to home warranty and construction defect claims and other litigation risks in the ordinary course of business that can be significant. Our operating expenses could increase if we are required to pay higher insurance premiums or incur substantial warranty and litigation costs with respect to such claims and risks.

As a homebuilder, we are subject to home warranty and construction defect claims and other claims arising in the ordinary course of business. As a consequence, we maintain liability insurance in the form of a “rolling wrap-up” insurance program which insures both us and, in some markets, our TradePartners®. We also record customer service and warranty reserves for the homes we sell based on our historical experience in our markets and our judgment of the qualitative risks associated with the types of homes built. Because of the uncertainties inherent in these matters, we cannot provide assurance that, in the future, our insurance coverage and reserves will be adequate to address all warranty and construction defect claims.

Costs of insuring against construction defect liability claims are high, and the amount and scope of coverage offered by insurance companies at acceptable rates is limited. The scope of coverage may continue to be limited, become further restricted, more costly, disputed or a combination of the above.

Aggressive marketing/solicitation efforts from plaintiff construction defect lawyers, anti-builder legislation and case law, and decreases in home values as a result of general economic conditions can result in an increase in construction defect claims. Our insurance may not cover all of the claims arising from such issues, or such coverage may become prohibitively expensive. Notwithstanding, our annual policy limits presently are $50.0 million per occurrence and $50.0 million in the aggregate, a portion of which is insured through affiliate insurance companies, who may reinsure our policy limits from time to time. If we are unable to obtain adequate insurance against these claims, we may experience litigation costs and losses that could adversely affect our financial condition and results of operations. Even if we are successful in defending such claims, we may incur significant costs.

Historically, builders have recovered a significant portion of the construction defect liabilities and defense costs from their subcontractors and insurance carriers. We try to minimize our liability exposure by providing a master insurance policy and requiring TradePartners® to enroll in a “rolling wrap-up” insurance policy. If we cannot effectively recover from our carriers, we may suffer greater losses because we may not have rights to pursue TradePartners® included in the “rolling wrap-up” insurance policy, which could adversely affect our financial condition and results of operations.

Furthermore, a builder’s ability to recover against an insurance policy depends upon the continued solvency and financial strength of the insurance carrier issuing the policy, as well as the insurance carrier’s willingness to honor the policy. The states where we build homes typically limit property damage claims resulting from construction defects to those arising within a ten-year period from close of escrow. To the extent any carrier providing insurance coverage to us or our TradePartners® becomes insolvent or experiences financial difficulty, or disputes coverage, we may be unable to recover on those policies, which could adversely affect our financial condition and results of operations.

Our success depends on the availability of suitable undeveloped land and improved lots at acceptable prices, and having sufficient liquidity to acquire such properties.

Our success in developing land and building and selling homes depends in part upon the continued availability of suitable undeveloped land and improved lots at acceptable prices. Availability of undeveloped land and improved lots for purchase at favorable prices depends on many factors beyond our control, including risk of competitive over-bidding and restrictive governmental regulation. Should suitable land become less available, the number of homes we may be able to build and sell would be reduced, which would reduce revenue and profits. In addition, our ability to purchase land depends upon us having sufficient liquidity. We may be disadvantaged in competing for land due to our debt obligations, limited cash resources, inability to incur further debt and, as a result, more limited access to capital compared to publicly traded competitors.

Poor relations with the residents of our communities could adversely impact sales, which could cause revenues or results of operations to decline.

Residents of communities we develop rely on us to resolve issues or disputes that may arise in connection with development or operation of their communities. Efforts to resolve these issues or disputes could be deemed unsatisfactory to the affected residents and subsequent actions by these residents could adversely affect our reputation or sales. In addition, we could be required to incur costs to settle these issues or disputes or to modify our community development plans, which could adversely affect our financial condition and results of operations.

 

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If we are unable to develop our communities successfully or within expected timeframes, results of operations could be adversely affected.

Before a community generates revenues, time and capital are required to acquire land, obtain development approvals and construct project infrastructure, amenities, model homes and sales facilities. Our inability to successfully develop and market our communities and to generate cash flow from these operations in a timely manner could have a material adverse effect on our business, financial condition and results of operations. In addition, certain project-related costs such as sales and marketing expenses, model maintenance, utilities, taxes and overhead expenses, are time-based costs and could be significantly higher if the project duration is extended.

Risks associated with our land and lot inventory could adversely affect our business, financial condition and results of operations.

The risks inherent in controlling or purchasing, holding and developing land for new home construction are substantial and increase as consumer demand for housing decreases. The value of undeveloped land, building lots and housing inventories can fluctuate significantly from changing market conditions. If the fair market value of the land, lots and inventories we hold decreases, we may be required to reduce their carrying value and take significant impairment charges. We may have acquired options on or bought and developed land at a cost we will not be able to recover fully or on which we cannot build and sell homes profitably. In addition, our deposits for land controlled under option or similar contracts may be put at risk. In certain circumstances, a grant of entitlements or development agreement with respect to particular land may include restrictions on the transfer of such entitlements to a buyer, which may increase our exposure to decreases in the price of such entitled land by restricting our ability to sell it for its full entitled value. In addition, inventory carrying costs can be significant and result in reduced margins or losses in a poorly performing community or market. In a weak market, we have recorded significant inventory impairment charges and sold homes and land for lower margins or at a loss, and such conditions may return and persist for extended periods of time.

Historically, our goals for the ownership and control of land were based on management’s expectations for future volume growth. In light of weak market conditions that persisted from 2006 through early 2012, we significantly reduced purchases of undeveloped land and land development spending, and made substantial land sales to reduce inventory to better align with the then reduced rate of production. We also terminated certain land option contracts and wrote off earnest money deposits and pre-acquisition costs related to these option contracts. While housing market conditions have improved, future market conditions are uncertain and we cannot provide assurance we will be successful in managing future inventory risks or avoiding future impairment charges. We could be limited in the amount of land we can dispose of and, therefore, our cash inflows attributable to land sales may decline.

Also, use of option contracts is dependent on the willingness of land sellers, availability of capital, housing market conditions and geographic preferences. Options may be more difficult to obtain from land sellers in stronger housing markets and are more prevalent in certain geographic regions.

At a consolidated homebuilding project in Colorado, we have a contractual obligation to purchase and receive water system connection rights which, at December 31, 2014, was $27.4 million, which is less than their estimated market value. These water system connection rights are held, then transferred to homebuyers upon delivery of their home, transferred upon the sale of land to the respective buyer, sold or leased, but generally only within the local jurisdiction. The risks inherent in purchasing, controlling or holding these water system connection rights are substantial and increase as consumer demand for housing decreases. The value of these water system connection rights and their marketability can also fluctuate from changing market conditions. If the fair market value of these water system connection rights decreases, we may be required to reduce their carrying value, which could adversely affect our financial condition and results of operations.

Certain of our homebuilding projects utilize community facility district, metro-district and other local government bond financing programs to fund acquisition or construction of infrastructure improvements. Interest and principal on these bonds are typically paid from taxes and assessments levied on landowners, including land we own, and/or homeowners following the delivery of new homes in the community. Occasionally, we also enter into credit support arrangements requiring us to pay interest and principal on these bonds if taxes and assessments levied on landowners and/or homeowners are insufficient to cover such obligations. Furthermore, reimbursement of these payments to us is dependent on the district or local government’s ability to generate tax and assessment revenues from the new homes.

We also pay certain fees and costs associated with the construction of infrastructure improvements in homebuilding projects that utilize these district bond financing programs. These fees and costs are typically reimbursable to us from, and therefore dependent on, bond proceeds or taxes and assessments levied on landowners and/or homeowners.

Until bond proceeds or tax and assessment revenues are sufficient to cover our obligations and/or reimburse us, our responsibility to make interest and principal payments on these bonds or pay fees and costs associated with the construction of infrastructure improvements could be prolonged and significant. In addition, if bond proceeds or tax and assessment revenues are not sufficient to cover our obligations and/or reimburse us, the amounts might not be recoverable, which could adversely affect our financial condition and results of operations.

 

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Our consolidated financial statements could be adversely affected if we are unable to obtain performance bonds.

In the course of developing our communities, we are often required to provide to various municipalities and other government agencies performance bonds and/or letters of credit to secure the completion of certain improvements in our communities such as roads, sewers, water systems and other utilities, and to support similar development activities by certain of our unconsolidated joint ventures. Our ability to obtain such bonds or letters of credit and the cost to do so depend on our credit rating, overall market capitalization, available capital, past operational and financial performance, management expertise and other factors, including surety and housing market conditions and the underwriting practices and resources of performance bond issuers. If we are unable to obtain performance bonds and/or letters of credit when required or the cost of operational restrictions or conditions imposed by issuers to obtain them increases significantly, we may not be able to develop, or we may be significantly delayed in developing, a community or communities and/or we may incur significant additional expenses and, as a result, our consolidated financial statements, cash flows and/or liquidity could be materially and adversely affected.

We continue to consider growth or expansion of our operations, which could have a material adverse effect on our financial condition and results of operations.

If the housing market continues to remain healthy, we will consider opportunities for growth, primarily within our existing markets, but also in new markets. Historically, our strategy has been to enter new markets using our existing brands, rather than the acquisition of existing homebuilding companies. Because we typically do not acquire existing homebuilders when entering a new market, we do not have the advantage of the experience and goodwill of an established homebuilding company. As a result, we incur substantial start-up costs in establishing our operations in new markets, and we may not be successful in taking operations in new markets from the start-up phase to profitability. If we are not successful in making operations in new markets profitable, we may not be able to recover our investment, which could adversely affect our financial condition and results of operations.

In addition, growth of our business, either through increased land purchases or development of larger projects, may have a material adverse effect on our financial condition and results of operations. Any expansion of our business into new markets could divert the attention of senior management from our existing business and could fail due to our relative lack of experience in those markets. In addition, while we do not currently intend to acquire any homebuilding operations from third parties, opportunities may arise in the future, and any acquisition could be difficult to integrate with our operations and could require us to assume unanticipated liabilities or expenses.

Our business is seasonal in nature and quarterly operating results can fluctuate.

Our quarterly operating results generally fluctuate by season. We typically experience the highest home sales orders in spring and summer, although this activity is also highly dependent on the number of active selling communities, timing of community openings and other market factors. Since it typically takes three to seven months to construct a new home, we deliver more homes in the second half of the year as spring and summer home sales orders convert to home deliveries. Because of this seasonality, construction costs and related cash outflows are historically highest from April to October, and the majority of cash receipts from home deliveries occur during the second half of the year. If, due to construction delays or other causes, we cannot deliver our expected number of homes in the second half of the year, our financial condition and full year results of operations may be adversely affected.

We may be adversely affected by weather conditions and natural disasters.

Weather conditions and natural disasters, such as hurricanes, tornadoes, earthquakes, snow storms, landslides, wildfires, volcanic activity, droughts and floods can harm our homebuilding business and delay home deliveries, increase the cost or availability of materials or labor, or damage homes under construction. In addition, the climates and geology of many of the states where we operate present increased risks of adverse weather or natural disasters. In particular, a large portion of our homebuilding operations are concentrated in California, which is subject to increased risk of earthquakes. Any such event or any business interruption caused therefrom could have a material adverse effect on our business, financial condition and results of operations.

Utility and resource shortages or rate fluctuations could have an adverse effect on operations.

Our communities at times have experienced utility and resource shortages, including significant changes to water availability and increases in utility and resource costs. Shortages of natural resources, particularly water, may make it more difficult to obtain regulatory approval of new developments. We may incur additional costs and be unable to complete construction as scheduled if these shortages and utility rate increases continue. Furthermore, these shortages and utility rate increases may adversely affect the regional economies where we operate, which may reduce demand for our homes.

 

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In addition, costs of petroleum products, which are used to deliver materials and transport employees, fluctuate and may increase due to geopolitical events or accidents. This could also result in higher costs for products utilizing petrochemicals, which could adversely affect our financial condition and results of operations.

We are dependent on the services of our senior management team and certain of our key employees, and loss of their services could hurt our business.

We believe our senior management’s experience in the homebuilding industry and tenure with us are competitive strengths, and our success depends upon our ability to retain these executives. In addition, we believe our ability to attract, train, assimilate and retain new skilled personnel is important to our success. If we are unable to retain senior management and certain key employees, particularly lead personnel in our markets, as well as our senior corporate officers, or attract, train, assimilate or retain other skilled personnel, it could hinder the execution of our business strategy. Competition for qualified personnel in our markets is intense, and it could be difficult to find experienced personnel to replace our employees, many of whom have significant homebuilding experience. Furthermore, a significant increase in our active communities would necessitate hiring a significant number of field construction and sales personnel, who may be in short supply in our markets.

Information technology failures and data security breaches could harm our business.

We use information technology and other computer resources to carry out important operational and marketing activities, as well as maintain our business records. Many of these resources are provided to us and/or maintained on our behalf by third party service providers pursuant to agreements that specify certain security and service level standards. Although we and our service providers employ what we believe are adequate security, disaster recovery and other preventative and corrective measures, our ability to conduct our business may be impaired if these resources are compromised, degraded, damaged or fail, whether due to a virus or other harmful circumstance, intentional penetration or disruption of our information technology resources by a third party, natural disaster, hardware or software corruption or failure or error (including a failure of security controls incorporated into or applied to such hardware or software), telecommunications system failure, service provider error or failure, intentional or unintentional personnel actions (including the failure to follow our security protocols), or lost connectivity to our networked resources. A significant and extended disruption in the functioning of these resources could impact our ability to conduct business and damage our reputation, which could cause us to lose customers, sales and revenue, result in the unintended public disclosure or the misappropriation of proprietary, personal and confidential information (including information about our homebuyers and business partners), and require us to incur significant expense to address and resolve these kinds of issues. The release of confidential information may also lead to litigation or other proceedings against us by affected individuals, business partners and/or by regulators, and the outcome of such proceedings, which could include penalties or fines, could have a material and adverse effect on our consolidated financial statements. In addition, the costs of maintaining adequate protection against such threats, depending on their evolution, pervasiveness, frequency and/or government-mandated standards or obligations regarding protective efforts, could be material to our consolidated financial statements.

Acts of war or terrorism may seriously harm our business

Acts of war or terrorism or any outbreak or escalation of hostilities throughout the world may cause disruption to the economy, our company, our employees and our customers, which could undermine consumer confidence and result in a decrease in new sales contracts and cancellations of existing contracts, which, in turn, could impact our revenue, costs and expenses and financial condition.

Failure to maintain effective internal control over financial reporting could materially adversely affect our business, results of operations and financial condition.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (“Sar Ox”), we are required to provide a report by management on internal control over financial reporting, including management’s assessment of the effectiveness of such control. Changes to our business will necessitate ongoing changes to our internal control systems and processes. Internal control over financial reporting may not prevent or detect misstatements because of its inherent limitations, including possibility of human error, circumvention or overriding of controls or fraud. Therefore, even effective internal controls can provide only reasonable assurance with respect to the preparation and fair presentation of financial statements. If we fail to maintain adequate internal controls, including any required new or improved controls, we may be unable to provide financial information in a timely and reliable manner and might be subject to sanctions or investigation by regulatory authorities such as the SEC or the Public Company Accounting Oversight Board. Any such action could adversely affect our financial results or investors’ confidence in us and could adversely impact the price of our notes. Furthermore, we are not an “accelerated filer” or “large accelerated filer” as defined in Rule 12b-2 of the Exchange Act, and as a result are not currently required to comply with the auditor attestation requirements of Section 404 of Sar Ox.

 

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Regulatory Risks

Government regulations could increase the cost and limit the availability of our development and homebuilding projects and adversely affect our business, financial condition and results of operations.

We are subject to extensive and complex regulations that affect land development and home construction, including zoning, density restrictions, building design and building standards. These regulations often provide broad discretion to the administering governmental authorities as to the conditions we must meet prior to being approved, if approved at all. We are subject to determinations by these authorities as to the adequacy of water and sewage facilities, roads and other local services. New housing developments may also be subject to various assessments for schools, parks, streets and other public improvements. In addition, in many markets, government authorities have implemented no growth or growth control initiatives and preservation of land, often as a result of local grass-roots lobbying efforts. Furthermore, restrictions on immigration can create a shortage of skilled labor. Any of these regulatory issues can limit or delay home construction and increase operating costs.

We are also subject to various local, state and federal laws and regulations concerning the protection of health, safety and the environment, including endangered species. These matters may result in delays, may cause us to incur substantial compliance, remediation, mitigation and other costs or subject us to fines, penalties and related litigation. These laws and regulations can also prohibit or severely restrict development and homebuilding activity in environmentally sensitive areas.

We may incur additional operating expenses or delays due to compliance requirements or fines, penalties and remediation costs pertaining to environmental regulations within our markets.

We are subject to local, state and federal statutes, ordinances, rules and regulations concerning land use and the protection of health and the environment, including those governing discharge of pollutants to water and air, handling of hazardous materials and cleanup of contaminated sites. The particular impact and requirements of environmental laws that apply to any given community vary greatly according to the community site, the site’s environmental conditions and the present and former use of the site. We expect that increasingly stringent requirements will be imposed on homebuilders. Environmental laws may result in delays, cause us to implement time consuming and expensive compliance programs and prohibit or severely restrict development in certain environmentally sensitive regions or areas. Environmental regulations can also have an adverse impact on the availability and price of certain raw materials, such as lumber. Furthermore, we could incur substantial costs, including cleanup costs, fines, penalties and other sanctions and damages from third party claims for property damage or personal injury, as a result of our failure to comply with, or liabilities under, applicable environmental laws and regulations. In addition, we are subject to third party challenges under environmental laws and regulations to the permits and other approvals required for our projects and operations.

Changes in governmental regulation of our financial services operations could adversely affect our business, financial condition and results of operations.

We assist customers with finding homeowners’ insurance through Shea Insurance Services, Inc., a wholly owned subsidiary of Shea Homes, Inc. (“SHI”). Through Shea Mortgage, an affiliate within the Shea Family Owned Companies but not a subsidiary of SHLP or consolidated in its financial statements, we are also able to offer mortgage origination options for our customers, helping us to ensure they secure financing for their home purchases. Our homebuilding operations sometimes offer financial incentives to our homebuyers to use Shea Mortgage in accordance with applicable laws. In addition to the financial benefits accruing to Shea Mortgage from these mortgage originations, the homebuilding operations are able to better manage the inventory of homes under construction and the closing process, as well as prequalify our homebuyers as a result of this affiliate arrangement. The homebuyers are not required to use Shea Mortgage as the homebuyer’s lender. Each homebuyer may select any lending institution of his or her choice for the purpose of securing mortgage financing and is not in any way limited to obtaining financing from Shea Mortgage.

These financial services operations are subject to federal, state and local laws and regulations. There have been numerous proposed and adopted changes in these regulations as a result of the housing downturn. For example, the Dodd-Frank Wall Street Reform and Consumer Protection Act (H.R.4173) was signed into law, which has and will continue to have, a significant impact on the regulation of the financial services industry, including new standards related to regulatory oversight of systemically important financial companies, derivatives transactions, asset-backed securitization, mortgage underwriting and consumer financial protection. Among other things, this legislation provides for a number of new requirements relating to residential mortgage lending practices, many of which are to be developed further by implementing rules. These include, among others, minimum standards for mortgages and lender practices in making mortgages, the definitions and parameters of a Qualified Mortgage and a Qualified Residential Mortgage, future risk retention, limitations on certain fees, retention of credit risk, prohibition of certain tying arrangements and remedies for borrowers in foreclosure proceedings. The effect of such provisions on our financial services business will depend on the rules that are ultimately enacted. In addition, we cannot predict what similar changes to, or new enactments of, statutes and regulations pertinent to our financial services operations will occur. Any such changes or new enactments could have a material adverse effect on our financial condition and results of operations.

 

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Financing Risks

Our ability to generate sufficient cash or access other limited sources of liquidity to operate our business and service our debt depends on many factors, some of which are beyond our control.

Our ability to make payments on our notes and to fund land acquisition, development and construction costs depends on our ability to generate sufficient cash flow, which is subject to general economic, financial, competitive, legislative and regulatory factors and other factors beyond our control. We cannot assure we will generate sufficient cash flow from operations to pay principal and interest on our notes or fund operations. As a result, we may need to refinance all or a portion of our debt, including our notes, on or before the maturity thereof, or incur additional debt. We cannot assure we will be able to do so on favorable terms, if at all. If we are unable to timely refinance our debt, we may need to dispose of certain assets, minimize capital expenditures or take other steps that could be detrimental to our business and could reduce the value of the collateral. There is no assurance these alternatives will be available, if at all, on satisfactory terms or on terms that will not require us to breach the terms and conditions of our existing or future debt agreements. Any inability to generate sufficient cash flow, refinance debt or incur additional debt on favorable terms could have a material adverse effect on our financial condition and results of operations, and could compromise our ability to service our debt, including our notes.

In addition, we use letters of credit and surety bonds to secure our performance under various construction and land development agreements, escrow agreements, financial guarantees and other arrangements. Should our future performance or economic conditions make such letters of credit and surety bonds costly or difficult to obtain or lead to our being required to collateralize such instruments to a greater extent than previously, our business, financial condition and results of operations could be adversely affected.

We have a significant number of contingent liabilities, including obligations relating to local government bond financing programs, and if any are satisfied by us, it could have a material adverse effect on our financial condition and results of operations.

At a consolidated homebuilding project in Colorado, we have a contractual obligation to purchase and receive water system connection rights which, at December 31, 2014, was $27.4 million, which is less than their estimated market value. These water system connection rights are held, then transferred to homebuyers upon delivery of their home, transferred upon the sale of land to the respective buyer, sold or leased, but generally within the local jurisdiction. The risks inherent in purchasing, controlling or holding these water system connection rights are substantial and increase as consumer demand for housing decreases. The value of these water system connection rights and their marketability can also fluctuate from changing market conditions. If the fair market value of these water system connection rights decreases, we may be required to reduce their carrying value, which could adversely affect our financial condition and results of operations.

Certain of our homebuilding projects utilize community facility district, metro-district and other local government bond financing programs to fund acquisition or construction of infrastructure improvements. Interest and principal on these bonds are typically paid from taxes and assessments levied on landowners, including land we own, and/or homeowners following the delivery of new homes in the community. Occasionally, we also enter into credit support arrangements requiring us to pay interest and principal on these bonds if taxes and assessments levied on landowners and/or homeowners are insufficient to cover such obligations. Furthermore, reimbursement of these payments to us is dependent on the district or local government’s ability to generate sufficient tax and assessment revenues from the new homes. At December 31, 2014 and December 31, 2013, in connection with credit support arrangements, there was $10.9 million and $8.6 million, respectively, reimbursable to us from certain agencies in Colorado and, accordingly, were recorded in inventory as a recoverable project cost.

We also pay certain fees and costs associated with the construction of infrastructure improvements in homebuilding projects that utilize these district bond financing programs. These fees and costs are typically reimbursable to us from, and therefore dependent on, bond proceeds or taxes and assessments levied on landowners and/or homeowners. At December 31, 2014 and December 31, 2013, in connection with certain funding arrangements, there was $14.0 million and $13.1 million, respectively, reimbursable to us from certain agencies, including $12.8 million and $11.9 million, respectively, from metro-districts in Colorado and, accordingly, were recorded in inventory as a recoverable project cost.

Until bond proceeds or tax and assessment revenues are sufficient to cover our obligations and/or reimburse us, our responsibility to make interest and principal payments on these bonds or pay fees and costs associated with the construction of infrastructure improvements could be prolonged and significant. In addition, if bond proceeds or tax and assessment revenues are not sufficient to cover our obligations and/or reimburse us, these amounts might not be recoverable, which could adversely affect our financial condition and results of operations.

 

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In 2009, we filed a petition with the United States Tax Court (the “Tax Court”) regarding our tax filing position on the completed contract method of accounting (“CCM”) for homebuilding operations. Although we received a favorable ruling on February 12, 2014, which permits us to continue use of the CCM for tax purposes (the “Tax Court Decision”), on July 15, 2014, the Tax Court Decision was appealed by the U.S. Internal Revenue Service (the “IRS”) in the U.S. Court of Appeals for the Ninth Circuit (the “Court of Appeals”). If the Tax Court Decision is overturned in whole or in part, we could be obligated to pay the IRS, applicable state taxing authorities and/or make distributions to the Partners for their respective amounts owed, which could adversely affect our financial condition and results of operations (see Note 13 to our consolidated financial statements).

We have other contingent liabilities typical to the homebuilding industry. For further discussion, see Note 16 to our consolidated financial statements.

The indenture governing our notes and our revolving credit facility do, and agreements governing our future indebtedness may, contain covenants that could adversely affect our ability to operate our business, as well as significantly affect our financial condition, and therefore could adversely affect our results of operations.

The indenture governing our notes and revolving credit facility contain covenants that prohibit or restrict certain activities, such as:

 

    pay dividends or distributions, repurchase equity or prepay subordinated debt;

 

    incur additional debt or issue certain equity interests;

 

    incur liens on assets;

 

    merge or consolidate with another company or sell all or substantially all of our assets;

 

    enter into transactions with affiliates;

 

    make certain investments;

 

    create certain restrictions on the ability of restricted subsidiaries to transfer assets;

 

    guarantee certain debt; and

 

    enter into sale and lease-back transactions.

These covenants, among other things, limit our ability to grant certain liens to support indebtedness, to invest in joint venture transactions and merge or sell assets in connection with our business. This in turn could adversely affect our ability to finance our operations or capital needs or engage in, expand or pursue our business activities and prevent us from engaging in certain transactions that might otherwise be considered beneficial. In particular, restrictions on our ability to enter into joint venture transactions may limit our ability to undertake new large scale master-planned development opportunities, including developments of our homes under the Trilogy brand, and may thereby adversely affect our growth and results of operations. In addition, these covenants may restrict our ability to meet capital commitments under our joint venture agreements, including obligations to remargin joint venture loans, which may result in our ownership interests in the corresponding joint ventures being reduced or eliminated.

The agreements we enter into governing our future indebtedness may impose similar or other restrictions. The restrictions contained in the indenture governing our notes and in any agreements governing future indebtedness may limit our financial flexibility, prohibit or limit any contemplated strategic initiatives, limit our ability to grow and increase our revenues or restrict our ability to respond to competitive changes.

We conduct certain operations through unconsolidated joint ventures with independent and affiliated parties in which we do not have a controlling interest. These investments involve risks and are highly illiquid.

We conduct certain operations through a number of unconsolidated homebuilding and land development joint ventures with independent and affiliated parties in which we do not have a controlling interest. At December 31, 2014, we had net capital investment and loan advances of $42.5 million in these unconsolidated joint ventures and guaranteed, on a joint and several basis, $55.7 million of outstanding liabilities for projects under development by these unconsolidated joint ventures. In addition, we may issue letters of credit under our revolving credit facility as credit support for liabilities of our unconsolidated joint ventures.

 

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Our investments in the unconsolidated joint ventures involve risks and are highly illiquid, and their success depends in part on our joint venture partners’ performance, which can be impacted by their financial strength and other factors. There are a limited number of sources willing to provide acquisition, development and construction financing to land development and homebuilding joint ventures and, as market conditions become more challenging, it may be difficult or impossible to obtain financing for our unconsolidated joint ventures on commercially reasonable terms. Due to tighter credit markets, financing for newly created unconsolidated joint ventures has been difficult to obtain. In addition, since we lack a controlling interest in our unconsolidated joint ventures, we are usually unable to require these unconsolidated joint ventures to sell assets or return invested capital, make additional capital contributions, or take other actions without the vote of at least one other venture partner. Therefore, absent partner agreement, we may be unable to liquidate our unconsolidated joint ventures investments to generate cash.

Our substantial debt could adversely affect our financial condition and results of operations.

We have substantial debt. At December 31, 2014, the total principal amount of our debt was $761.4 million. In addition, we have contingent liabilities which could affect our business.

Our debt and contingent liabilities could have important consequences for the holders of our notes, including:

 

    making it more difficult for us to satisfy obligations with respect to our notes;

 

    increasing vulnerability to adverse economic or industry conditions;

 

    limiting our ability to obtain additional financing to fund capital expenditures and acquisitions, particularly when the availability of financing in the capital markets is limited;

 

    requiring a substantial portion of cash flows from operations for the payment of interest on our debt and reducing our ability to use cash flows to fund working capital, capital expenditures, acquisitions and general corporate requirements;

 

    limiting flexibility in planning for, or reacting to, changes in our business and the industry where we operate; and

 

    placing us at a competitive disadvantage to less leveraged competitors.

We may incur additional indebtedness, which indebtedness might rank equal to our notes or the guarantees thereof.

Despite our indebtedness, we and our subsidiaries may be able to incur significant additional indebtedness, including secured indebtedness, in the future, including under our revolving credit facility, which is secured on a pari-passu basis with our notes but will have the benefit of payment priority upon enforcement against the collateral. Although the indenture governing our notes contains restrictions on our and our subsidiaries’ ability to incur additional indebtedness, these restrictions are subject to qualifications and exceptions, and, under certain circumstances, the indebtedness incurred in compliance with such restrictions could be substantial and certain of this indebtedness may be secured by the same collateral securing our notes, and the respective guarantees thereof. If new indebtedness is added to our and our subsidiaries’ debt levels, the related risks that we and the note guarantors face would be increased, and we may not be able to meet all our debt obligations, including repayment of our notes, in whole or in part. If we incur any additional debt that is secured on an equal and ratable basis with our notes or the guarantees thereof, the holders of that debt will be entitled to share ratably with the holders of our notes in any proceeds distributed in connection with any enforcement against the collateral or an insolvency, liquidation, reorganization, dissolution or other winding-up of the applicable note issuer or guarantor. This may have the effect of reducing the amount of proceeds paid to holders of our notes.

We could be adversely affected by negative changes in our credit ratings.

Our ability to access capital on favorable terms is a key factor in our ability to service our debt and fund our operations. Downgrades to our credit ratings and negative changes to the outlook for such credit ratings have in the past required and, may in the future require, significant management time and effort to address. Such changes in the past have made it difficult and costly for us to access debt capital and engage in other ordinary course financing transactions relating to our new developments. Any future adverse action by any of the principal credit agencies may exacerbate these difficulties.

Credit ratings assigned to our notes may not reflect all risks of an investment in our notes.

Credit ratings assigned to our notes reflect the rating agencies’ assessments of our ability to make payments on our notes when due. Consequently, real or anticipated changes in these credit ratings, or to the outlook for such credit ratings, will generally affect the market value of our notes. These credit ratings, however, may not reflect the potential impact of risks related to structure, market or other factors related to the value of our notes.

 

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Other Risks

We have a significant number of affiliates with whom we have entered into many transactions. Our relationship with these entities could adversely affect us.

We are part of the Shea Family Owned Companies, which are operated in four major groups: homebuilding, heavy construction, venture capital, and commercial property development and management. Though our business forms the core of the homebuilding group, we have historically entered into many transactions with other Shea Family Owned Companies which are not part of the homebuilding group. These transactions range from management and administrative-related matters to joint ventures, transfers of assets and financial guarantees and other credit support arrangements. We are currently party to many such affiliate transactions. In the future, we will continue to be party to many of the affiliate transactions currently in existence, and it is likely we will enter into new affiliate transactions.

The homebuilding group of the Shea Family Owned Companies, which is operated largely through us, has been operated as an independent business without credit support from the other Shea Family Owned Companies since 2011. If we are unable to continue to operate without such credit support, it could materially adversely affect our business, financial condition and results of operations. In addition, though we do not expect to receive new credit support from other Shea Family Owned Companies, we will still depend on our affiliates to provide us with certain management and administrative services. If these affiliates become unable to provide us with such services, we could incur significant additional costs to obtain them through other means due to lost efficiencies.

Until August 2011, one of our affiliates, JFSCI, provided us with centralized cash management services. As part of this function, we engaged in affiliate transactions and monetary transfers to settle amounts owed. The resultant accounts receivables and payables from these transfers were paid monthly. In August 2011, we ceased our participation in the centralized cash management service and began to perform the function independently.

Although the indenture governing our notes contains a covenant limiting transactions with affiliates, this covenant has a number of significant exceptions and, in any case, does not prohibit transactions with affiliates but only requires they be on arm’s length terms. In particular, with respect to transactions involving the transfer of real property to an affiliate, we are required to obtain three third party independent estimates of the value of such real property when the transaction involves consideration exceeding $10.0 million. With respect to all other affiliate transactions, we are required to obtain an independent third party fairness opinion in connection with transactions involving consideration exceeding $5.0 million.

Finally, though the current intention with respect to the Shea Family Owned Companies is to create four independent businesses that do not provide credit support to each other, it is possible the homebuilding group would be adversely affected by future financial and other difficulties arising with respect to the heavy construction, venture capital or commercial property group. For example, if any of the Shea Family Owned Companies not a part of the homebuilding group requires financial support, it is likely the attention and financial resources of the Shea family members could be diverted from us and toward the business in need of additional support. Moreover, if any of the Shea Family Owned Companies becomes subject to a bankruptcy, liquidation or similar proceeding, such proceeding could have a substantial effect on our business. It is possible that, among other consequences:

 

    any existing affiliate transaction could be terminated, resulting in our inability to access needed services;

 

    prior affiliate transactions could be examined and set aside, resulting in our liability to the bankruptcy or liquidation estate; and

 

    such Shea Family Owned Company could be sold to an unrelated buyer, resulting in a loss of any synergies from which we benefit as a member of the Shea Family Owned Companies.

The families and family trusts that own our equity interests may have interests different from yours.

Entities directly or indirectly owned by the Shea family beneficially own substantially all of the equity interests in SHLP. As a result, members of the Shea family have the ability to control SHLP and, except as otherwise provided by law or our organizational documents, to approve or disapprove matters that may be submitted to a vote of SHLP’s Partners. Each director of J.F. Shea Construction Management, Inc., our ultimate general partner, is a member of the Shea family or an employee of other Shea Family Owned Companies. We have been advised that Shea family members do not currently plan to appoint any nonaffiliated or independent directors.

 

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Our ownership group and their affiliates operate businesses using the Shea Homes brand that derive revenue from homebuilding and land development, including Shea Homes North Carolina, which are not owned by SHLP. We do not receive any brand licensing or sales revenue from these affiliated businesses, although in certain circumstances we provide them with management and administrative services. Certain of these affiliated entities have also engaged, and will continue to engage, in transactions with us. Shea Mortgage derives revenue from loan fees paid by our customers. Shea Properties LLC (“SPLLC”) develops commercial properties that are sometimes built on land purchased from us, and we develop properties on land that is sometimes purchased from SPLLC. In the future, we may enter into other agreements with affiliates of SPLLC. Shea family members comprising our ownership group are not restricted from engaging in homebuilding or land development activities through independent entities.

The interests of our limited partners and owners of J.F. Shea Construction Management, Inc. could conflict with interests of our note holders. For example, if we encounter financial difficulties or are unable to pay our debts as they mature, the interests of our equity holders might conflict with the interests of our note holders. In addition, our owners may have interests in pursuing acquisitions, divestitures, financings or other transactions that, in their judgment, could enhance their investments, even though such transactions might involve risks to our note holders. Furthermore, our owners currently own, and may in the future own, businesses which may operate under the Shea Homes brand and directly compete with our business. In addition, although the indenture governing our notes contains a covenant limiting transactions with affiliates, this covenant has a number of significant exceptions and, in any case, does not prohibit transactions with affiliates but only requires they be on arm’s length terms. No owner has any obligation to provide us with any additional debt or equity financing.

The IRS can challenge our income and expense recognition methodologies. If we are unsuccessful in supporting or defending our positions, we could become subject to a substantial tax liability from previous years.

In the normal course of business, we are audited by federal, state and local authorities regarding income tax matters. Significant judgment is required to determine our provision for income taxes and our liabilities for federal, state, local and other taxes. Any changes as a result of IRS and state audits could have a material adverse effect on our income tax provision or benefit, or other tax reserves, in the reporting period in which such determination is made and, consequently, on our results of operations, financial position and/or cash flows for such period.

Since 2002, SHLP and SHI used the CCM to determine when to recognize taxable income or loss with respect to the majority of their respective homebuilding operations. Federal law allows homebuilders like SHLP and SHI to defer taxable income/loss recognition from their homebuilding operations until the tax year in which the contracts are substantially complete, rather than annually based on the percentage of completion method. The IRS objected to SHLP’s and SHI’s use of the CCM and assessed a tax deficiency against them, contending they did not accurately and appropriately apply the relevant U.S. Treasury Regulations in calculating their respective homebuilding projects’ income/loss pursuant to the CCM for years 2004 through 2008, and years 2003 through 2008, respectively. SHLP and SHI believe their use of the CCM complies with the relevant regulations and filed a petition in 2009 with the Tax Court to contest the notice of deficiency and to challenge the IRS position. On February 12, 2014, the Tax Court ruled in our favor, issuing the Tax Court Decision on April 21, 2014. Pursuant to the ruling, we are permitted to continue to report income and loss from the delivery of homes using the CCM. As a result, no additional tax, interest or penalties are currently due and owing by the Partners or us. The IRS has appealed the Tax Court Decision to the Court of Appeals. We and the IRS have each filed briefs and the IRS is entitled to file a reply brief, which is due to be filed no later than March 2015. The Court of Appeals will schedule oral argument after briefing is completed; we cannot predict when it will schedule the argument or issue its decision.

If the Tax Court Decision is overturned in whole or in part, SHLP and SHI would be required to recognize income for prior years that would otherwise be deferred until future years. With respect to SHI, this earlier recognition of income could result in a tax liability of up to $74 million (federal and state income taxes inclusive of interest). With respect to SHLP, the earlier recognition of income could result in the Partners incurring an additional tax liability of up to $134 million (federal and state income taxes inclusive of interest) for the years at issue, and SHLP would be required to make a distribution to the Partners to pay a portion of such tax liability. The indenture governing the notes restricts SHLP’s ability to make distributions to the Partners pursuant to an agreement which requires SHLP to distribute cash payments to the Partners for taxes incurred by such Partners (or their direct or indirect holders) for their ownership interest in SHLP (the “Tax Distribution Agreement”) in excess of an amount specified by the indenture (such maximum amount of collective distributions referred to as the “Maximum CCM Payment”), unless SHLP receives a cash equity contribution from JFSCI for such excess or unless we use some of our capacity under the indenture governing the notes to make restricted payments. The initial Maximum CCM Payment is $70.0 million, which amount will be reduced by payments made by SHI in connection with any resolution of our dispute with the IRS regarding our use of the CCM and payments made by SHLP on certain guarantee obligations permitted in the indenture. Such potential additional taxes imposed on SHI and tax distributions by SHLP may have a material adverse effect on the financial condition and results of operations of SHI and SHLP, respectively, which could compromise our ability to service our debt, including our notes.

 

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Under our Tax Distribution Agreement, we are required to make distributions to our equity holders from time to time based on their ownership in SHLP, which is a limited partnership and, under certain circumstances, those distributions may occur even if SHLP does not have taxable income.

Under our Tax Distribution Agreement, SHLP is required to make cash distributions to the Partners (or their direct or indirect holders) for taxable income allocated to them in connection with their ownership interests in SHLP. In addition, SHLP will be required under the Tax Distribution Agreement to provide tax distributions to the Partners (or their direct or indirect holders) for any additional taxable income allocated to them as a result of any audit, tax proceeding or tax contest arising from or in connection with any tax position taken by SHLP (or any entity treated as a “pass-through” entity under U.S. federal income tax principles in which SHLP has an ownership interest). If any audit, proceeding or contest in connection with years prior to 2011 (including those related to the CCM) ultimately results in an increase in taxable income allocated to the Partners, or any disallowance of losses or deductions previously allocated to the Partners, then we would be required to make additional tax distributions to them, even if the audit, proceeding or contest resulted in a reduction of a tax loss previously allocated for such period and no taxable income had been previously allocated to them for such period or would be so allocated after such reduction. Any distribution under the Tax Distribution Agreement could have a material adverse effect on our business, financial condition and results of operations, which could compromise our ability to service our debt, including our notes.

Decreases in the market value of our investments in marketable securities could have an adverse impact on our results of operations.

We have investments in marketable securities, money market funds and other short-term investments, of which the market value is subject to changes. Furthermore, during periods of financial stress, values of money market and short-term securities funds have come under pressure. Decreases in the market value in these investments could adversely affect our financial condition and results of operations.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

We lease 144,118 square feet of office space in various locations from affiliates and unrelated parties. All rents were at market rates at the time of lease execution. At December 31, 2014, we have satellite offices in Corona, California; Livermore, California; San Diego, California; Scottsdale, Arizona; Highlands Ranch, Colorado; and Houston, Texas. Subsequent to December 31, 2014, we entered into a new lease agreement and will move our operations from Corona, California to Irvine, California. The total square footage leased from affiliates is 82,188 and comprises offices in Livermore, San Diego and Highlands Ranch. Our corporate office is in Walnut, California, approximately 35 miles east of Los Angeles, California. JFSCI leases this office from an affiliate and SHLP bears 61.0% of its total cost. For information about land owned or controlled by us for use in our homebuilding activities, see “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations—Selected Homebuilding Operational Data—Land and Homes in Inventory.”

ITEM 3. LEGAL PROCEEDINGS

Lawsuits, claims and proceedings have been and will likely be instituted or asserted against us in the normal course of business, including actions brought on behalf of various classes of claimants. We are also subject to local, state and federal laws and regulations related to land development activities, house construction standards, sales practices, employment practices and environmental protection. As a result, we are subject to periodic examinations or inquiry by agencies that administer these laws and regulations.

In 2009, we filed a petition with the Tax Court regarding our tax filing position on the CCM for homebuilding operations. Although the Tax Court Decision permits us to continue use of the CCM for tax purposes, on July 15, 2014, the Tax Court Decision was appealed by the IRS to the Court of Appeals. If the Tax Court Decision is overturned in whole or in part, we could be obligated to pay the IRS, applicable state taxing authorities and/or make distributions to the Partners for their respective amounts owed, which could adversely affect our financial condition and results of operations (see Note 13 to our consolidated financial statements).

 

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On or around October 10, 2014, SHI was named as a defendant in an action entitled Aamodt v. Shea Homes, Inc., Case No. 14-cv-01566, filed in the U.S. District Court for the Western District of Washington. The plaintiffs in the matter purported to bring a claim seeking an undisclosed monetary recovery for alleged construction defects under Washington’s Consumer Protection Act originally involving approximately 589 homes, but subsequently amended their complaint to include approximately 964 homes and we have reached a tentative settlement of the case. While most of the settlement amount should be covered by insurance, one of our insurance carriers has denied coverage for the settlement and related matters. We are disputing this insurance carrier’s position (see Note 16 to our consolidated financial statements).

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

We are a privately held company, with no public or private trading market for our common equity. Ownership interests in SHLP are held in three classes: Class B, Class C and Class D. At December 31, 2014, there is one holder of our Class B limited partnership interests, eight holders of our Class C limited partnership interests and six holders of our Class D limited partnership interests. See “Item 12: Security Ownership of Certain Beneficial Owners and Management” for information regarding the beneficial ownership of SHLP.

No dividends were paid to our equity holders in 2014 or 2013. Our $125.0 million secured revolving credit facility (the “Revolver”) and the indenture governing our 8.625% senior secured notes (the “Secured Notes”) contain covenants that limit, among other things, our ability to pay dividends and distributions on our equity. See “Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations – Liquidity and Capital Resources – Notes Payable” for information about limitations on our ability to pay dividends.

ITEM 6. SELECTED FINANCIAL DATA

The following should be read in conjunction with our consolidated financial statements and related notes included elsewhere in this Form 10-K.

 

     Years Ended December 31,  
     2014      2013      2012      2011     2010  
     (In thousands)  

Consolidated Statements of Operations:

             

Revenues

   $ 1,140,606       $ 930,610       $ 680,147       $ 587,770      $ 639,566   

Net income (loss)

   $ 133,399       $ 125,939       $ 29,184       $ (107,242   $ (55,215

Consolidated Balance Sheet Information (at end of year):

             

Cash and cash equivalents, restricted cash and investments

   $ 247,143       $ 216,833       $ 304,865       $ 314,512      $ 190,391   

Inventory

   $ 1,173,585       $ 1,013,272       $ 837,653       $ 783,810      $ 800,029   

Total assets

   $ 1,666,710       $ 1,505,333       $ 1,373,537       $ 1,328,116      $ 1,414,886   

Total debt

   $ 761,404       $ 751,708       $ 758,209       $ 752,056      $ 730,005   

Total equity

   $ 554,858       $ 445,457       $ 319,247       $ 328,003      $ 432,113   

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the section “Selected Financial Data” and our consolidated financial statements and related notes included elsewhere in this Form 10-K.

RESULTS OF OPERATIONS

The tabular homebuilding operating data presented throughout this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes data for SHLP and its wholly owned subsidiaries and consolidated joint ventures. Data for our unconsolidated joint ventures is presented separately where indicated. Our ownership interest in unconsolidated joint ventures varies, but is generally less than or equal to 50%.

Overview

In 2014, we experienced a continuation of improved housing conditions that emerged in 2012. Generally, demand for new homes remained healthy during the year in our Southern California, San Diego, Northern California and Mountain West segments, while we saw demand improve in our South West segment during the fourth quarter, specifically, from our Phoenix communities, which were sluggish for the first three quarters of 2014.

For the year ended December 31, 2014, compared to the year ended December 31, 2013, net new home sales orders increased 12%, which was primarily attributable to a 2% higher sales rate per community and an increase in the average number of active selling communities from 58 in 2013 to 64 in 2014. For the year ended December 31, 2014, compared to the year ended December 31, 2013, homebuilding revenues increased 23%, which was primarily attributable to a 5% increase in homes delivered and a 19% increase in the average selling price (“ASP”) of homes delivered. The higher year over year deliveries were primarily attributable to a 12% increase in new home sales. Gross margin, as a percentage of revenues, decreased from 23.8% in 2013 to 22.4% in 2014, primarily

 

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attributable to $9.0 million in impairment charges and a $16.9 million legal charge related to a legal matter in Washington (see “Business – Legal Proceedings”, “Gross Margin” and Note 16 to our consolidated financial statements). We ended 2014 with a backlog of 918 homes with a sales value of $551.7 million, up 8% and 18%, respectively, from December 31, 2013.We had $237.3 million in cash, cash equivalents and restricted cash at December 31, 2014 and expect to continue investing in new land opportunities in desirable locations to supplement our existing land positions.

 

     Years Ended December 31,  
     2014     2013     2012     %
Change
2013-2014
    %
Change
2012-2013
 
     (Dollars in thousands)  

Revenues

   $ 1,140,606      $ 930,610      $ 680,147        23     37

Cost of sales

     (885,018     (709,412     (538,434     25        32   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross margin

  255,588      221,198      141,713      16      56   

Selling expenses

  (63,429   (54,338   (45,788   17      19   

General and administrative expenses

  (54,921   (50,080   (43,747   10      14   

Equity in income (loss) from unconsolidated joint ventures

  9,142      (1,104   378      —       —     

Gain (loss) on reinsurance transaction

  7,177      2,011      (12,013   257      —     

Interest expense

  (595   (5,071   (19,862   (88   (74

Other income (expense), net

  (1,350   (778   9,119      74     —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

  151,612      111,838      29,800      36      275   

Income tax benefit (expense)

  (18,213   14,101      (616   —        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  133,399      125,939      29,184      6      332   

Less: Net loss (income) attributable to non-controlling interests

  37      8      (146   363      —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to SHLP

$ 133,436    $ 125,947    $ 29,038      6   334
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

In 2014, net income attributable to SHLP was $133.4 million compared to $125.9 million in 2013. This increase was primarily attributable to a $34.4 million improvement in our gross margin (from higher revenues, partially offset by a lower gross margin percentage), a $4.5 million decrease in interest expense (due to higher capitalized interest from higher qualified inventory), a $5.2 million improvement in our reinsurance transaction results, and a $10.2 million increase in equity income from unconsolidated joint ventures. These improvements were partially offset by a $32.3 million increase in income tax expense (due to a $15.6 million tax benefit in 2013 related to the reversal of our deferred tax asset valuation allowance), a $9.1 million increase in selling expenses (from higher home deliveries and revenues) and a $4.8 million increase in general and administrative expenses (from higher compensation and other volume related expenses).

In 2013, net income attributable to SHLP was $125.9 million compared to $29.0 million in 2012. This increase was primarily attributable to a $79.5 million improvement in gross margins (from higher revenues), a $14.8 million decrease in interest expense (due to higher capitalized interest from higher qualified inventory), a $14.0 million improvement in our reinsurance transaction results, and a $15.6 million reversal of the deferred tax valuation allowance. These improvements were partially offset by a $9.9 million decrease in other income (expense) (from decreased income on the sale of marketable securities), a $8.6 million increase in selling expenses (from higher home deliveries and revenues) and a $6.3 million increase in general and administrative expenses (from higher volume related and compensation expenses).

Revenues

Revenues are derived primarily from home and land deliveries. House and land revenues are recorded at delivery. Management fees from homebuilding joint ventures and managed projects are in other homebuilding revenues. Revenues from corporate, insurance brokerage services and our captive insurance company, Partners Insurance Company (“PIC”), are in other revenues.

 

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     Years Ended December 31,  
     2014      2013      2012      %
Change
2013-2014
    %
Change
2012-2013
 
     (Dollars in thousands)  

Revenues:

             

House revenues

   $ 1,120,019       $ 894,305       $ 645,000         25     39

Land revenues

     14,028         31,462         32,583         (55     (3

Other homebuilding revenues

     5,978         3,930         1,579         52        149   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total homebuilding revenues

  1,140,025      929,697      679,162      23      37   

Other revenues

  581      913      985      (36   (7
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total revenues

$ 1,140,606    $ 930,610    $ 680,147      23   37
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

In 2014, total revenues were $1,140.6 million compared to $930.6 million in 2013. This 23% increase was primarily attributable to a 5% increase in homes delivered and a 19% increase in the ASP of homes delivered.

In 2013, total revenues were $930.6 million compared to $680.1 million in 2012. This 37% increase was primarily attributable to a 20% increase in homes delivered and a 15% increase in the ASP of homes delivered.

For the years ended December 31, 2014, 2013 and 2012, homebuilding revenues by segment were as follows:

 

     Years Ended December 31,  
     2014      2013      2012     %
Change
2013-2014
    %
Change
2012-2013
 
     (Dollars in thousands)  

Southern California:

            

House revenues

   $ 390,630       $ 205,249       $ 130,351        90     57

Land revenues

     2,330         2,175         3,617        7        (40

Other homebuilding revenues

     520         226         22        130        927   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total homebuilding revenues

$ 393,480    $ 207,650    $ 133,990      89   55
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

San Diego:

House revenues

$ 143,160    $ 125,484    $ 85,534      14   47

Land revenues

  68      0      13      100      (100

Other homebuilding revenues

  6      10      424      (40   (98
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total homebuilding revenues

$ 143,234    $ 125,494    $ 85,971      14   46
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Northern California:

House revenues

$ 257,249    $ 232,697    $ 157,302      11   48

Land revenues

  0      8,300      7,923      (100   5   

Other homebuilding revenues

  2,115      1,359      881      56      54   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total homebuilding revenues

$ 259,364    $ 242,356    $ 166,106      7   46
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Mountain West:

House revenues

$ 163,183    $ 165,226    $ 126,764      (1 )%    30

Land revenues

  11,630      20,862      21,030      (44   (1

Other homebuilding revenues

  852      811      (10   5      —     
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total homebuilding revenues

$ 175,665    $ 186,899    $ 147,784      (6 )%    26
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

South West:

House revenues

$ 165,797    $ 159,095    $ 137,899      4   15

Land revenues

  0      125      0      (100   100   

Other homebuilding revenues

  2,485      1,524      262      63      482   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total homebuilding revenues

$ 168,282    $ 160,744    $ 138,161      5   16
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

East:

House revenues

$ 0    $ 6,554    $ 7,150      (100 )%    (8 )% 

Land revenues

  0      0      0      —        —     

Other homebuilding revenues

  0      0      0      —        —     
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total homebuilding revenues

$ 0    $ 6,554    $ 7,150      (100 )%    (8 )% 
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

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In 2014, total homebuilding revenues were $1,140.0 million compared to $929.7 million in 2013. This 23% increase was primarily attributable to a 5% increase in homes delivered and a 19% increase in the ASP of homes delivered. The increase in home deliveries was primarily attributable to the 77% increase in deliveries from our Southern California segment. The higher deliveries from our Southern California segment were driven by a 67% increase in new home sales orders and a 30% higher beginning backlog in 2014 versus 2013. The increase in the ASP was attributable to all three of our California segments, including a higher percentage of deliveries from our Southern California segment in 2014 versus 2013, which had an ASP of $812,121 in 2014 and is 44% higher than our Company average of $564,241.

In 2013, total homebuilding revenues were $929.7 million compared to $679.2 million in 2012. This 37% increase was primarily attributable to a 20% increase in homes delivered and a 15% increase in the ASP of homes delivered. The increase in home deliveries was primarily attributable to a 98% increase in backlog at the beginning of 2013 versus 2012.

For the years ended December 31, 2014, 2013 and 2012, homes delivered and the ASP of homes delivered by segment were as follows:

 

     Years Ended December 31,  
     2014      2013      2012      %
Change
2013-2014
    %
Change
2012-2013
 

Homes delivered:

             

Southern California

     481         271         249         77     9

San Diego

     252         256         194         (2     32   

Northern California

     385         456         323         (16     41   

Mountain West

     356         372         284         (4     31   

South West

     511         510         492         0        4   

East

     0         25         31         (100     (19
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consolidated

  1,985      1,890      1,573      5   20
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Southern California

  107      47      48      128   (2 )% 

Northern California

  60      31      18      94      72   

Mountain West

  73      55      43      33      28   

East

  96      69      40      39      73   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total unconsolidated joint ventures

  336      202      149      66   36
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total homes delivered

  2,321      2,092      1,722      11   21
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 
     Years Ended December 31,  
     2014      2013      2012      %
Change
2013-2014
    %
Change
2012-2013
 

ASP of homes delivered:

             

Southern California

   $ 812,121       $ 757,376       $ 523,498         7     45

San Diego

     568,095         490,172         440,897         16        11   

Northern California

     668,179         510,300         487,003         31        5   

Mountain West

     458,379         444,156         446,352         3        0   

South West

     324,456         311,951         280,283         4        11   

East

     0         262,160         230,645         (100     14   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consolidated

$ 564,241    $ 473,177    $ 410,045      19   15   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Southern California

$ 417,090    $ 293,304    $ 268,147      42   9

Northern California

  523,959      510,099      533,757      3      (4

Mountain West

  390,211      367,715      351,584      6      5   

East

  289,960      258,426      196,140      12      32   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total unconsolidated joint ventures

$ 394,012    $ 334,921    $ 304,980      18   10
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total ASP of homes delivered

$ 539,598    $ 459,827    $ 400,954      17   15
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Homebuilding deliveries during the year were a function of beginning backlog and new home sales orders. Deliveries in our Southern California segment increased 77% in 2014 versus 2013 as a result of a 30% higher beginning backlog and a 67% increase in new home sales orders. Deliveries in our San Diego segment decreased 2% as a result of a 7% lower beginning backlog, partially offset by a 2% increase in new home sales orders. Deliveries in our Northern California segment decreased 16% as a result of a 40%

 

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lower beginning backlog, partially offset by a 5% increase in new home sales orders. Deliveries in our Mountain West segment decreased 4% as a result of a 2% lower beginning backlog and longer construction cycle times, partially offset by a 16% increase in new home sales orders. Deliveries in our South West segment were similar as a result of a 12% higher beginning backlog, partially offset by a 17% decrease in new home sales orders.

The ASP of homes delivered is a function of product, geographic mix and general changes in new home prices. In 2014, each segment experienced some level of price increases, except for our Southwest segment. In addition to the impact of price increases, our San Diego and Northern California segments delivered a larger mix of higher priced homes in 2014 versus 2013.

Deliveries in our Southern California segment increased 9% in 2013 versus 2012 as a result of a 108% higher beginning backlog, partially offset by a 2% decrease in new home sales orders. Deliveries in our San Diego segment increased 32% as a result of a 174% higher beginning backlog, partially offset by a 5% decrease in new home sales orders. Deliveries in our Northern California segment increased 41% as a result of a 130% higher beginning backlog, partially offset by a 22% decrease in new home sales orders. Deliveries were up 31% in our Mountain West segment as a result of a 123% higher beginning backlog, partially offset by an 8% decrease in new home sales orders. Deliveries in our South West segment increased 4% as a result of a 39% higher beginning backlog, partially offset by a 3% decrease in new home sales orders.

Gross Margin

Gross margin is revenues less cost of sales and is comprised of gross margins from our homebuilding and corporate segments.

Gross margins for the years ended December 31, 2014, 2013 and 2012 were as follows:

 

     Years Ended December 31,  
     2014      Gross
Margin %
    2013      Gross
Margin %
    2012      Gross
Margin %
 
     (Dollars in thousands)  

Gross margin

   $  255,588         22.4   $ 221,198         23.8   $ 141,713         20.8
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

In 2014, gross margin was $255.6 million compared to $221.2 million in 2013. This 16% increase was primarily attributable to a 23% increase in revenues, resulting from a 5% increase in new home deliveries and a 19% increase in the ASP, partially offset by increased construction and labor costs, $9.0 million of impairment charges and $16.9 million of charges incurred by SHI in connection with Aamodt v. Shea Homes, Inc., Case No. 14-cv-01566 and related matters, of which $13.3 million was accrued at December 31, 2014 (see Note 16 to our consolidated financial statements).

In 2013, gross margin was $221.2 million compared to $141.7 million in 2012. This 56% increase was primarily attributable to a 37% increase in revenues, resulting from a 20% increase in new home deliveries and a 15% increase in the ASP, partially offset by increased construction and labor costs.

Housing impairments, which are in cost of sales and reduce gross margins, are generally attributable to lower home prices in response to lower housing demand, which can result from weak economic and housing conditions, including elevated levels of foreclosures, higher unemployment, lower consumer confidence and tighter lending standards. Since the fourth quarter of 2009, the housing market experienced some stabilization and, as a result, impairments significantly diminished. However, in the fourth quarter 2014, we experienced lower housing demand in two communities in our South West segment, resulting in impairment charges.

 

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Impairment by segment and type for the years ended December 31, 2014, 2013 and 2012 were as follows:

 

     Years Ended December 31,  
     2014      2013      2012      %
Change
2013-2014
    %
Change
2012-2013
 
     (Dollars in thousands)  

Impairment by segment:

             

Southern California

   $ 284       $ 0       $ 0         100     —     

San Diego

     0         0         0         —          —     

Northern California

     0         0         0         —          —     

Mountain West

     0         0         0         —          —     

South West

     8,751         0         0         100        —     

East

     0         0         0         —          —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total impairment

$ 9,035    $ 0    $ 0      100   —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Impairment by type:

Inventory

$ 9,035    $ 0    $ 0      100   —     

Joint venture

  0      0      0      —        —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total impairment

$ 9,035    $ 0    $ 0      100   —     
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Selling, General and Administrative Expense

Selling, general and administrative expenses for the years ended December 31, 2014, 2013 and 2012 were as follows:

 

     Years Ended December 31,  
     2014     2013     2012     %
Change
2013-2014
    %
Change
2012-2013
 
     (Dollars in thousands)  

Total homebuilding revenues

   $ 1,140,025      $ 929,697      $ 679,162        23     37

Selling expense

   $ 63,429      $ 54,338      $ 45,788        17     19
  

 

 

   

 

 

   

 

 

     

% of total homebuilding revenues

  5.6   5.8   6.7
  

 

 

   

 

 

   

 

 

     

General and administrative expense

$ 54,921    $ 50,080    $ 43,747      10   14
  

 

 

   

 

 

   

 

 

     

% of total homebuilding revenues

  4.8   5.4   6.4
  

 

 

   

 

 

   

 

 

     

Total selling, general and administrative expense

$ 118,350    $ 104,418    $ 89,535      13   17
  

 

 

   

 

 

   

 

 

     

% of total homebuilding revenues

  10.4   11.2   13.2
  

 

 

   

 

 

   

 

 

     

Selling Expense

In 2014, selling expense was $63.4 million compared to $54.3 million in 2013. This increase was primarily attributable to higher volume related costs, such as sales commission, closing costs and model costs, as well as advertising. Selling expense, as a percentage of revenues, decreased as certain fixed selling expenses were spread over a higher revenue base.

In 2013, selling expense was $54.3 million compared to $45.8 million in 2012, but decreased as a percentage of revenues as a result of a higher revenue base. The $8.5 million increase was primarily due to higher volume related costs, such as sales commissions, closing costs and model costs, as well as advertising.

General and Administrative Expense

In 2014, general and administrative expenses were $54.9 million compared to $50.1 million in 2013. This increase was primarily attributable to higher compensation expense.

In 2013, general and administrative expenses were $50.1 million compared to $43.7 million in 2012. This increase was primarily attributable to higher compensation expense, partially offset by decreased legal expenses. In 2012, we incurred $3.6 million in legal expenses related to the Tax Court CCM case.

Equity in Income (Loss) from Unconsolidated Joint Ventures

Equity in income (loss) from unconsolidated joint ventures represents our share of income (loss) from unconsolidated joint ventures accounted for under the equity method. These joint ventures are generally engaged in homebuilding and land development.

 

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In 2014, equity in income (loss) from unconsolidated joint ventures was $9.1 million compared to $(1.1) million in 2013. This increase in income was primarily attributable to income from two joint ventures in our Southern California segment that completed their operations in 2014.

In 2013, equity in income (loss) from unconsolidated joint ventures was $(1.1) million compared to $.4 million in 2012. There were no significant earnings or losses from our unconsolidated joint ventures.

Gain (Loss) on Reinsurance Transaction

Completed operations claims for policy years August 1, 2001 to July 31, 2007, and workers’ compensation and general liability risks for policy years August 1, 2001 to July 31, 2005, were previously insured through PIC. In December 2009, PIC entered into a series of transactions (the “PIC Transaction”) in which these policies were either novated to JFSCI or reinsured with third-party insurance carriers. As a result of the PIC Transaction, a $34.8 million gain was deferred and to be recorded as income when related claims are paid. In addition, the deferred gain can be adjusted up or down based on changes in actuarial estimates. Any changes to the deferred gain are recorded as income or expense in the current period.

In 2014, we recognized $7.2 million of income, primarily attributable to the claims paid on these policies. In 2013, we recognized $2.0 million of income as a result of claims paid on these policies, partially offset by adverse actuarial estimates, which increased the deferred gain.

Interest Expense

Interest expense is interest incurred and not capitalized. For all of 2014 and the latter half of 2013, substantially all interest incurred was capitalized to inventory as qualified inventory exceeded debt. During the first part of 2013 and all of 2012, some interest incurred was expensed since debt exceeded the qualified inventory amount. Assets qualify for interest capitalization during their development and other qualifying activities, such as construction; however, if qualified assets are less than the total debt, a portion of interest is expensed.

In 2014, interest expense was $0.6 million compared to $5.1 million in 2013. This decrease was primarily attributable to higher qualified assets in 2014 versus 2013, relative to our debt balance. In 2014, interest expense represents fees for the unused portion of our $125.0 million secured revolving credit facility (the “Revolver”) and is not capitalized.

In 2013, interest expense was $5.1 million compared to $19.9 million in 2012. This decrease was primarily attributable to higher qualified assets relative to our debt balance.

Other Income (Expense), Net

Other income (expense), net is comprised of interest income, gains (losses) on sales of investments, pre-acquisition cost and deposit write-offs, property tax expense and other income (expense). Interest income is primarily from affiliate notes receivable, investments and interest bearing cash accounts.

For the years ended December 31, 2014, 2013 and 2012, other income (expense), net was as follows:

 

     Years Ended December 31,  
     2014     2013     2012     %
Change
2013-2014
    %
Change
2012-2013
 
     (Dollars in thousands)  

Other income (expense), net:

          

Interest income

   $ 1,547      $ 2,204      $ 4,315        (30 )%      (49 )% 

Gain on sale of investments

     0        15        8,806        (100     (100

Pre-acquisition cost and deposit write-offs

     (1,303     (1,436     (2,039     (9     (30

Property tax expense

     (2,377     (2,766     (3,192     (14     (13

Other income

     783        1,205        1,229        (35     (2
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other income (expense), net

$ (1,350 $ (778 $ 9,119      74   (109 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

In 2014, other income (expense), net was $(1.4) million compared to $(0.8) million in 2013. This increase in expense was primarily attributable to decreased interest income.

In 2013, other income (expense), net was $(0.8) million compared to $9.1 million in 2012. This decrease in income was primarily attributable to an $8.8 million gain on the sale of marketable securities in 2012 and a $2.1 million decrease in interest income.

 

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Income Tax Benefit (Expense)

SHLP is treated as a partnership for income tax purposes and is subject to certain minimal state taxes and fees; however, taxes on income are generally the obligation of SHLP’s general and limited partners and their owners. SHI is a C corporation and its federal and state income taxes are included in the consolidated financial statements.

At December 31, 2014 and 2013, net deferred tax assets of SHI before reserves were $20.4 million and $16.8 million, respectively, primarily from available loss carryforwards, inventory and investment impairments, and housing and land inventory basis differences. At December 31, 2014, SHI had net operating loss (“NOL”) carryforwards of approximately $14.2 million, net, which expire by 2018 and are subject to annual limitations of $4.6 million.

When assessing the realizability of deferred tax assets, we consider whether it is more-likely-than-not that our deferred tax assets will not be realized. The realization of deferred tax assets is dependent upon generating sufficient taxable income in the future. We record a valuation allowance when we determine it is more-likely-than-not a portion of the deferred tax assets will not be realized.

Because of the continued annual pretax losses of SHI through the year ended December 31, 2009, we determined it was more-likely-than-not, at December 31, 2009, the net deferred tax asset of $51.9 million would not be realized. Accordingly, for the year ended December 31, 2009, the deferred tax asset valuation allowance increased $32.7 million to fully reserve the net deferred tax asset. At December 2011 and 2010, our assessment of deferred tax assets was consistent with 2009 and the net deferred tax asset of $38.2 million and $48.8 million, respectively, remained fully reserved. For the year ended December 31, 2012, SHI generated income before income taxes for the first time since 2007, a result of the beginning of the housing recovery. However, since we only returned to profitability in 2012 and the housing recovery being in its early stages, the $32.7 million net deferred tax assets at December 31, 2012 remained fully reserved.

At December 31, 2013, after experiencing continued profit improvement from operations, we determined it was more-likely-than-not that most of the net deferred tax assets would be realized, which, during the fourth quarter of 2013, resulted in a $15.6 million reversal of the valuation allowance on our deferred tax assets. We based this conclusion on positive evidence related to the actual pre-tax profits achieved during the year and higher levels of forecasted profitability in the future. We expected these increased profits to result in a greater realization of our NOL carryforwards before they expire than previously estimated, and the realization of deferred tax assets associated with impairments and basis differences of our inventory. At December 31, 2014 and 2013, the remaining valuation allowance of $0.3 million and $0.5 million, respectively, relates to capital losses that expire in 2016 and 2017, and impairment of debt securities that mature in 2021 and 2022, as it is unknown if these deferred tax assets will be realized.

Accounting for deferred taxes is based upon estimates of future results. Differences between the anticipated and actual outcome of these future results could result in changes in our estimates of our deferred tax assets and related valuation allowances, and could also materially impact our consolidated financial condition and results of operations. Also, changes in existing federal and state tax laws and tax rates could affect future tax results and the valuation of our deferred tax assets.

In 2014, income tax benefit (expense) was $(18.2) million compared to $14.1 million in 2013. The income tax benefit in 2013 was primarily attributable to the $15.6 million reversal of the valuation allowance.

In 2013, income tax benefit (expense) was $14.1 million compared to $(0.6) million in 2012. The income tax benefit in 2013 was primarily attributable to the $15.6 million reversal of the valuation allowance, partially offset by increased taxable income compared to 2012.

In 2014, we filed Form 3115 with the IRS to change our income tax accounting method of how we record certain expenses on our income tax returns beginning in 2014. As we believe it is more likely-than-not the change will be approved by the IRS, we reflected this income tax accounting method in our 2014 income tax expense. If we are unsuccessful in our application to change our income tax accounting method, we could incur an income tax liability for prior years ranging up to $13.5 million, and the Partners could have a reduction in their income tax liability ranging up to $13.5 million.

Net (Income) Loss Attributable to Non-Controlling Interests

Joint ventures are consolidated when we have a controlling interest or, absent a controlling interest, when we can substantially influence its business. Net (income) loss attributable to non-controlling interests represents the share of (income) loss attributable to the parties having a non-controlling interest. The net (income) loss attributable to non-controlling interests in 2014, 2013 and 2012 was not material.

 

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SELECTED HOMEBUILDING OPERATIONAL DATA

Homes Sales Orders and Active Selling Communities

Home sales orders are contracts executed with homebuyers to purchase homes and are stated net of cancellations. Except where market conditions or other factors justify increasing available unsold home inventory, construction of a home typically begins when a sales contract for that home is executed and other conditions are satisfied, such as financing approval. Therefore, recognition of a home sales order usually represents the beginning of the home’s construction cycle. Homebuilding construction expenditures and, ultimately, homebuilding revenues and cash flow, are therefore dependent on the timing and magnitude of home sales orders.

An active selling community represents a new home community that advertises, markets and typically sells homes through a sales office located at a model complex in the community. Sales offices in communities near the end of their sales cycle are not designated as an active selling community. An active selling community is a designation similar to a store or sales outlet and is used to measure home sales order results on a per active selling community basis. Presentation of home sales orders per active selling community is a means of assessing sales growth or reductions across communities through a common analytical measurement. The average number of active selling communities for a particular period represents the aggregate number of active selling communities in operation at the end of each month in such period divided by the number of months in such period.

For the years ended December 31, 2014, 2013 and 2012 home sales orders, net of cancellations, were as follows:

 

     Years Ended December 31,  
     2014      2013      2012      %
Change
2013-2014
    %
Change
2012-2013
 

Home sales orders, net:

             

Southern California

     514         308         313         67     (2 )% 

San Diego

     254         249         262         2        (5

Northern California

     376         359         459         5        (22

Mountain West

     424         367         401         16        (8

South West

     447         536         552         (17     (3

East

     39         9         36         333        (75
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consolidated

  2,054      1,828      2,023      12   (10 )% 
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Southern California

  111      46      66      141   (30 )% 

Northern California

  52      44      21      18      110   

Mountain West

  91      67      40      36      68   

South West

  14      0      0      100      0   

East

  120      83      72      45      15   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total unconsolidated joint ventures

  388      240      199      62   21
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total home sales orders, net

  2,442      2,068      2,222      18   (7 )% 
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

For the years ended December 31, 2014, 2013 and 2012, cancellation rates were as follows:

 

     Years Ended December 31,  
     2014     2013     2012  

Cancellation rates:

      

Southern California

     12     11     12

San Diego

     22        22        26   

Northern California

     14        14        10   

Mountain West

     16        16        14   

South West

     18        15        15   

East

     13        18        20   
  

 

 

   

 

 

   

 

 

 

Total consolidated

  16   15   15
  

 

 

   

 

 

   

 

 

 

Southern California

  18   10   11

Northern California

  17      30      5   

Mountain West

  17      20      20   

South West

  0      0      0   

East

  30      32      18   
  

 

 

   

 

 

   

 

 

 

Total unconsolidated joint ventures

  21   25   15
  

 

 

   

 

 

   

 

 

 

Total cancellation rates

  17   17   15
  

 

 

   

 

 

   

 

 

 

 

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For the years ended December 31, 2014, 2013 and 2012, average active selling communities were as follows:

 

     Years Ended December 31,  
     2014      2013      2012      %
Change
2013-2014
    %
Change
2012-2013
 

Average number of active selling communities:

             

Southern California

     11         6         8         83     (25 )% 

San Diego

     9         7         9         29        (22

Northern California

     13         13         14         0        (7

Mountain West

     12         15         14         (20     7   

South West

     18         16         17         13        (6

East

     1         1         3         0        (67
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consolidated

  64      58      65      10   (11 )% 
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Southern California

  4      4      3      0   33

Northern California

  4      2      1      100      100   

Mountain West

  5      5      5      0      0   

East

  3      2      2      50      (0
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total unconsolidated joint ventures

  16      13      11      23   18
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total average number of active selling communities

  80      71      76      13   (7 )% 
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

In 2014, consolidated home sales orders per active selling community were 32.1, or 2.7 per month, compared to 31.5, or 2.6 per month in 2013, a 2% increase. Overall, our Southern California, San Diego, Northern California and Mountain West segments continued to experience healthy demand for new homes, while for most of the year our South West segment experienced sluggish demand for new homes, resulting in a 26% decrease in its sales rate per community.

In 2013, consolidated home sales orders per consolidated active selling community were 31.5, or 2.6 per month, compared to 31.1, or 2.6 per month, in 2012. Demand was stronger in the first half of 2013 compared to the second half of 2013 when mortgage rates peaked.

Sales Order Backlog

Sales order backlog represents homes sold and under contract to be built, but not delivered. Backlog sales value is the revenue estimated to be realized at delivery. A home is sold when a sales contract is signed by the seller and buyer, and upon receipt of a prerequisite deposit. A home is delivered when all conditions of escrow are met, including delivery of the home to the customer, title passage, appropriate consideration is received or collection of associated receivables, if any, is reasonably assured, and when we have no other continuing involvement in the home. A sold home is classified “in backlog” during the time between its sale and delivery. During that time, construction costs are generally incurred to complete the home except where market conditions or other factors justify increasing available unsold home inventory. Backlog is therefore an important performance measurement in analysis of cash outflows and inflows. However, because sales order contracts are cancelled by the buyer at times, not all homes in backlog will result in deliveries.

 

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At December 31, 2014, 2013 and 2012, sales order backlog was as follows:

 

     Homes      Sales Value      ASP  
     December 31,      December 31,      December 31,  
     2014      2013      2012      2014      2013      2012      2014      2013      2012  
                          (In thousands)      (In thousands)  

Backlog:

                          

Southern California

     193         160         123       $ 166,087       $ 139,059       $ 87,675       $ 861       $ 869       $ 713   

San Diego

     102         100         107         71,164         50,223         47,580         698         502         445   

Northern California

     135         144         241         100,946         94,605         107,497         748         657         446   

Mountain West

     275         207         212         140,995         100,186         98,733         513         484         466   

South West

     174         238         212         56,293         82,565         67,519         324         347         318   

East

     39         0         16         16,242         0         4,192         416         0         262   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total consolidated

  918      849      911    $ 551,727    $ 466,638    $ 413,196    $ 601    $ 550    $ 454   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Southern California

  30      26      27    $ 14,257    $ 9,383    $ 7,427    $ 475    $ 361    $ 275   

Northern California

  15      23      10      8,865      12,562      5,535      591      546      554   

Mountain West

  41      23      11      17,935      9,413      4,267      437      409      388   

South West

  14      0      0      6,983      0      0      499      0      0   

East

  74      50      36      22,221      14,447      8,495      300      289      236   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total unconsolidated joint ventures

  174      122      84    $ 70,261    $ 45,805    $ 25,724    $ 404    $ 375    $ 306   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total backlog

  1,092      971      995    $ 621,988    $ 512,443    $ 438,920    $ 570    $ 528    $ 441   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Land and Homes in Inventory

Inventory is comprised of housing projects under development, land under development, land held for future development, land held for sale, deposits and pre-acquisition costs. As land is acquired and developed, and homes are constructed, the underlying costs are capitalized to inventory. As homes and land transactions deliver, these costs are relieved from inventory and charged to cost of sales.

As land is acquired and developed, each parcel is assigned a lot count. For parcels of land, an estimated number of lots are added to inventory once entitlement occurs. Occasionally, when the intended use of a parcel changes, lot counts are adjusted. As homes and land are sold, lot counts are reduced. Lots are categorized as (i) owned, (ii) controlled (which includes a contractual right to purchase) or (iii) owned or controlled through unconsolidated joint ventures. The status of each lot is identified by land held for development, land under development, land held for sale, lots available for construction, homes under construction, completed homes and models. Homes under construction and completed homes are also classified as sold or unsold.

 

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Table of Contents

At December 31, 2014, 2013 and 2012, total lots owned or controlled were as follows:

 

     December 31,  
     2014      2013      2012      %
Change
2013-2014
    %
Change
2012-2013
 

Lots owned or controlled by segment:

             

Southern California

     1,628         1,890         1,989         (14 )%      (5 )% 

San Diego

     838         640         764         31        (16

Northern California

     4,033         3,731         3,182         8        17   

Mountain West

     9,519         9,841         10,074         (3     (2

South West

     2,261         2,063         1,876         10        10   

East

     1,273         765         25         66        2,960   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consolidated

  19,552      18,930      17,910      3      6   

Unconsolidated joint ventures

  4,935      4,455      3,874      11      15   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total lots owned or controlled

  24,487      23,385      21,784      5   7
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Lots owned or controlled by ownership type:

Lots owned for homebuilding

  7,033      6,277      6,448      12   (3 )% 

Lots owned and held for sale

  3,176      3,313      3,382      (4   (2

Lots optioned or subject to contract for homebuilding

  6,309      6,306      5,046      0      25   

Lots optioned or subject to contract that will be held for sale

  3,034      3,034      3,034      0      0   

Unconsolidated joint venture lots

  4,935      4,455      3,874      11      15   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total lots owned or controlled

  24,487      23,385      21,784      5   7
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

At December 31, 2014, 2013 and 2012, total homes under construction and completed homes were as follows:

 

     December 31,  
     2014      2013      2012      %
Change
2013-2014
    %
Change
2012-2013
 

Homes under construction:

             

Sold

     623         611         630         2     (3 )% 

Unsold

     187         149         133         26        12   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consolidated

  810      760      763      7      0   

Unconsolidated joint ventures

  126      119      64      6      86   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total homes under construction

  936      879      827      6   6
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Completed homes: (a)

Sold (b)

  56      49      41      14   20

Unsold

  41      34      22      21      55   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total consolidated

  97      83      63      17      32   

Unconsolidated joint ventures

  15      8      9      88      (11
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total completed homes

  112      91      72      23   26
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

(a) Excludes model homes.
(b) Sold but not delivered.

 

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Table of Contents

LIQUIDITY AND CAPITAL RESOURCES

Operating and other short-term cash liquidity needs have been primarily funded from cash on our balance sheet and our homebuilding operations primarily through home deliveries and land sales, net of the underlying expenditures to fund these operations. In addition, we have, and will continue to utilize, land option contracts, public and private note offerings, land seller notes, joint venture structures (which typically obtain project level financing to reduce the amount of partner capital invested), assessment district bond financing, letters of credit and surety bonds, tax refunds and proceeds from affiliate notes receivable as sources of liquidity. In addition, as an additional source of liquidity, we obtained the Revolver in February 2014. At December 31, 2014, cash and cash equivalents were $236.9 million, restricted cash was $0.4 million and total debt was $761.4 million, compared to cash and cash equivalents of $206.2 million, restricted cash of $1.2 million and total debt of $751.7 million at December 31, 2013. Restricted cash includes customer deposits temporarily restricted in accordance with regulatory requirements and cash used in lieu of bonds.

In February 2014, we replaced our $75.0 million letter of credit facility with the Revolver, which bears interest, at our option, either at (i) a daily Eurocurrency base rate as defined in the credit agreement governing the Revolver (the “Credit Agreement”), plus a margin of 2.75%, or (ii) a Eurocurrency rate as defined in the Credit Agreement, plus a margin of 2.75%, and matures March 1, 2016. Borrowing availability is determined by a borrowing base formula and we are subject to financial covenants, including minimum net worth, and leverage and interest coverage ratios. If we do not maintain compliance with these financial covenants, the Revolver converts to an 18-month amortizing term loan. At December 31, 2014, we were in compliance with these covenants and no amounts were outstanding.

We believe the Revolver, combined with the other available sources, such as existing cash, cash equivalents and cash from operations, are sufficient to provide for cash requirements in the next twelve months. In evaluating this sufficiency, we considered the expected cash flow to be generated by homebuilding operations, our current cash position and other sources of liquidity available to us, compared to anticipated cash requirements for interest payments on our $750.0 million senior secured notes (the “Secured Notes”) and Revolver, land purchase commitments and land development expenditures, joint venture funding requirements and other cash operating expenses. We also continually monitor current and expected operational requirements to evaluate and determine the use and amount of our cash needs which includes, but is not limited to, the following disciplines:

 

    Strategic land acquisitions that meet our investment and marketing standards, including, in most cases, the quick turn of assets;

 

    Strict control and limitation of unsold home inventory and avoidance of excessive and untimely uses of cash;

 

    Pre-qualification of homebuyers, timely commencement of home construction thereon and mitigation of cancellations and creation of unsold inventory;

 

    Reduced construction cycle times, prompt deliveries of homes and improved cash flow thereon; and

 

    Maintenance of sufficient cash or other sources of liquidity that, depending on market conditions, will be available to acquire land and increase our active selling communities.

Availability of additional capital, whether from private capital sources (including banks) or the public capital markets, fluctuates as market conditions change. There may be times when the private capital markets and the public debt markets lack sufficient liquidity or when our securities cannot be sold at attractive prices, in which case we would be unable to access capital from these sources. Weakening of our financial condition, including a material increase in our leverage or decrease in our profitability or cash flows, could adversely affect our ability to obtain necessary funds, result in a credit rating downgrade or change in outlook, or otherwise increase our cost of borrowing.

Since 2002, SHLP and SHI used the CCM to determine when to recognize taxable income or loss with respect to the majority of their respective homebuilding operations. Federal law allows homebuilders like SHLP and SHI to defer taxable income/loss recognition from their homebuilding operations until the tax year in which the contracts are substantially complete, rather than annually based on the percentage of completion method. The IRS objected to SHLP’s and SHI’s use of the CCM and assessed a tax deficiency against them, contending they did not accurately and appropriately apply the relevant U.S. Treasury Regulations in calculating their respective homebuilding projects’ income/loss pursuant to the CCM for years 2004 through 2008, and years 2003 through 2008, respectively. SHLP and SHI believe their use of the CCM complies with the relevant regulations and filed a petition in 2009 with the Tax Court to contest the notice of deficiency and to challenge the IRS position. On February 12, 2014, the Tax Court ruled in our favor, issuing the Tax Court Decision on April 21, 2014. Pursuant to the ruling, we are permitted to continue to report income and loss from the delivery of homes using the CCM. As a result, no additional tax, interest or penalties are currently due and owing by the Partners or us. The IRS has appealed the Tax Court Decision to the Court of Appeals. We and the IRS have each filed briefs and the IRS is entitled to file a reply brief, which is due to be filed no later than March 2015. The Court of Appeals will schedule oral argument after briefing is completed; we cannot predict when it will schedule the argument or issue its decision.

 

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If the Tax Court Decision is overturned in whole or in part, SHI could be obligated to pay the IRS and applicable state taxing authorities up to $74 million and, under the Tax Distribution Agreement, SHLP could be obligated to make a distribution to the Partners up to $134 million to fund their related payments to the IRS and applicable state taxing authorities.

Notwithstanding, the indenture governing the Secured Notes (the “Indenture”) restricts SHLP’s ability to make distributions to the Partners pursuant to the Tax Distribution Agreement in excess of the Maximum CCM Payment, unless SHLP receives a cash equity contribution from JFSCI for such excess or unless we use some of our capacity under the Indenture to make restricted payments. The initial Maximum CCM Payment is $70.0 million, which amount will be reduced by payments made by SHI in connection with any resolution of our dispute with the IRS regarding our use of the CCM and payments made by SHLP on certain guarantee obligations permitted in the Indenture. Payments of CCM-related tax liabilities by SHLP pursuant to the Tax Distribution Agreement or by SHI will not impact our Consolidated Fixed Charge Coverage Ratio (as defined below) or our ability to incur additional indebtedness under the terms of the Indenture.

If necessary, SHLP and SHI expect to pay any CCM-related tax liability from existing cash, cash from operations, our Revolver and, to the extent SHLP is required by the Tax Distribution Agreement to pay amounts in excess of the Maximum CCM Payment, from cash equity contributions by JFSCI. However, cash from homebuilding operations may be insufficient to cover such payments. See “Item 1A: Risk Factors—The IRS can challenge our income and expense recognition methodologies. If we are unsuccessful in defending our positions, we could become subject to a substantial tax liability from previous years” and “Item 1A: Risk Factors—Under our Tax Distribution Agreement, we are required to make distributions to our equity holders from time to time based on their ownership in SHLP, which is a limited partnership and, under certain circumstances, those distributions may occur even if SHLP does not have taxable income.”

We are unable to extend our evaluation of the sufficiency of our liquidity beyond twelve months, and we cannot offer assurance that our future homebuilding operations will generate sufficient cash flow to enable us to grow our business, service our indebtedness, make payments toward land purchase commitments, or fund our joint ventures. For more information, see “Item 1A: Risk Factors—Our ability to generate sufficient cash or access other limited sources of liquidity to operate our business and service our debt depends on many factors, some of which are beyond our control” and “Item 1A: Risk Factors—We have a significant number of contingent liabilities, and if any are satisfied by us, could have a material adverse effect on our liquidity and results of operations.”

The following tables present cash provided by (used in) operating, investing and financing activities:

 

     Years Ended December 31,  
     2014     2013     2012  
     (In thousands)  

Cash provided by (used in):

      

Operating activities

   $ 2,454      $ (47,867   $ (6,655

Investing activities

     34,976        (14,804     16,888   

Financing activities

     (6,733     (10,880     1,157   
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash

$ 30,697    $ (73,551 $ 11,390   
  

 

 

   

 

 

   

 

 

 

Cash from Operating Activities

In 2014, cash provided by (used in) operating activities was $2.5 million compared to $(47.9) million in 2013. This improvement was primarily attributable to increased cash receipts from deliveries of homes, partially offset by increased land acquisitions, land development costs, construction costs and selling, general administrative costs. Total land acquisition and development costs for 2014 were $(453.3) million compared to $(329.5) million in 2013. This increase was attributable to the continued favorable housing market conditions and our desire to add to our land positions in anticipation of continued demand for new homes.

In 2013, cash provided by (used in) operating activities was $(47.9) million compared to $(6.7) million in 2012. This decrease was primarily attributable to increased land acquisitions, land development costs, construction costs and selling, general administrative costs, partially offset by increased cash receipts from deliveries of homes and land. Total land acquisition and development costs for 2013 were $(329.5) million compared to $(215.9) million in 2012. This increase was attributable to the improved housing market conditions that continued in 2013 and our desire to add to our land positions in anticipation of continued demand for new homes.

 

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Cash from Investing Activities

In 2014, cash provided by (used in) investing activities was $35.0 million compared to $(14.8) million in 2013.This improvement was primarily attributable to $25.2 million of collections on promissory notes with affiliates, principally the payoff of the note receivable from JFSCI, and $9.6 million of net distributions from unconsolidated joint ventures in 2014. In 2013, there were $(22.1) million of net contributions to unconsolidated joint ventures, of which $(12.3) million related to two unconsolidated joint ventures formed in 2013, which was partially offset by $4.1 million of collections on promissory notes with affiliates and $3.2 million of proceeds from the maturity and sales of available-for-sale investments.

In 2013, cash provided by (used in) investing activities was $(14.8) million compared to $16.9 million in 2012.This decrease was primarily attributable to $(22.1) million of net contributions to unconsolidated joint ventures in 2013, of which $(12.3) million related to two unconsolidated joint ventures formed in 2013, compared to $(11.5) million of net contributions in 2012. In addition, we received $3.2 million of proceeds from the maturity and sales of available-for-sale investments in 2013 compared to $26.5 million in 2012.

Cash from Financing Activities

In 2014, cash used in financing activities was $(6.7) million compared to $(10.9) million in 2013. This reduction in cash used was primarily attributable to a $7.6 million decrease in principal payments on notes payable, partially offset by a $4.4 million cash payment for the acquisition of land from an affiliate under common control.

In 2013, cash provided by (used in) financing activities was $(10.9) million compared to $1.2 million in 2012. This decrease was primarily attributable to higher principal payments to financial institutions and others.

Notes Payable

At December 31, 2014, 2013 and 2012, notes payable were as follows:

 

     December 31,  
     2014      2013      2012  
     (In thousands)  

Notes payable:

        

Secured Notes

   $ 750,000       $ 750,000       $ 750,000   

Revolver

     0         0         0   

Other secured promissory notes

     11,404         1,708         8,209   
  

 

 

    

 

 

    

 

 

 

Total notes payable

$ 761,404    $ 751,708    $ 758,209   
  

 

 

    

 

 

    

 

 

 

Secured Notes

Our Secured Notes were issued on May 10, 2011 at $750.0 million, bear interest at 8.625% paid semi-annually on May 15 and November 15, and do not require principal payments until maturity on May 15, 2019. The Secured Notes are redeemable, in whole or in part, at our option beginning May 15, 2015 at a price of 104.313 per bond, reducing to 102.156 on May 15, 2016 and are redeemable at par beginning May 15, 2017. The Secured Notes may be redeemed prior to May 15, 2015 subject to a make-whole premium. At December 31, 2014 and 2013, accrued interest was $8.1 million and $8.1 million, respectively.

The Indenture contains covenants that limit, among other things, our ability to incur additional indebtedness (including the issuance of certain preferred stock), pay dividends and distributions on our equity interests, repurchase our equity interests, retire unsecured or subordinated notes more than one year prior to their maturity, make investments in subsidiaries and joint ventures that are not restricted subsidiaries that guarantee the Secured Notes, sell certain assets, incur liens, merge with or into other companies, expand into unrelated businesses, and enter into certain transactions with our affiliates. At December 31, 2014 and 2013, we were in compliance with these covenants.

The Indenture provides we and our restricted subsidiaries may not incur or guarantee payment of any indebtedness (other than certain specified types of permitted indebtedness) unless, immediately after giving effect to such incurrence or guarantee and application of the proceeds therefrom, the Consolidated Fixed Charge Coverage Ratio (as defined in the Indenture) would be at least 2.0 to 1.0. “Consolidated Fixed Charge Coverage Ratio” is defined in the Indenture as the ratio of (i) our Consolidated Cash Flow Available for Fixed Charges (as defined in the Indenture) for such prior four full fiscal quarters, to (ii) our aggregate Consolidated Interest Expense (as defined in the Indenture) for such prior four full fiscal quarters, in each case giving pro forma effect to certain transactions as specified in the Indenture. At December 31, 2014, our Consolidated Fixed Charge Coverage Ratio, determined as specified in the Indenture, was 3.38.

 

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Our ability to make joint venture and other restricted payments and investments is governed by the Indenture. We are permitted to make restricted payments under (i) a $70.0 million revolving basket available solely for joint venture investments; (ii) a $10 million general basket that can be used for joint venture investments and advances; and (iii) a broader restricted payment basket available if our Consolidated Fixed Charge Coverage Ratio (as defined in the Indenture) is at least 2.0 to 1.0. The aggregate amount of restricted payments made under this broader restricted payment basket cannot exceed 50% of our cumulative Consolidated Net Income (as defined in the Indenture) generated from and including October 1, 2013, plus 100% of the aggregate net cash proceeds of, and the fair market value of, any property or other asset received by us as a capital contribution after May 10, 2011 or upon the issuance of indebtedness or certain securities by us after May 10, 2011, plus, to the extent not included in Consolidated Net Income, certain amounts received in connection with dispositions, distributions or repayments of restricted investments, plus the value of any unrestricted subsidiary which is redesignated as a restricted subsidiary after May 10, 2011 under the Indenture. We have joint ventures which have used, and are expected to use, capacity under these restricted payment baskets. In 2013, we entered into an unconsolidated joint venture in Southern California and committed to contribute up to $45.0 million. At December 31, 2013, we made aggregate contributions of $15.1 million to this joint venture. At December 31, 2014, all contributions had been returned to us, however, additional contributions are expected to be made in 2015. We also anticipate making additional contributions to other joint ventures.

Revolver

In February 2014, we replaced our $75.0 million secured letter of credit facility with the Revolver, which bears interest, at our option, either at (i) a daily Eurocurrency base rate as defined in the Credit Agreement, plus a margin of 2.75%, or (ii) a Eurocurrency rate as defined in the Credit Agreement, plus a margin of 2.75%, and matures March 1, 2016. Borrowing availability is determined by a borrowing base formula and we are subject to financial covenants, including minimum net worth and leverage and interest coverage ratios. If we do not maintain compliance with these financial covenants, the Revolver converts to an 18-month amortizing term loan. At December 31, 2014, we were in compliance with these covenants and no amounts were outstanding.

At December 31, 2014, covenant compliance for the Revolver was as follows:

 

     Actual at
December 31,
2014
     Covenant
Requirements at
December 31,
2014
 
     (Dollars in thousands)  

Covenant Requirements:

     

Minimum Consolidated Tangible Net Worth (a)

   $ 579,189         $371,996   

Minimum Liquidity

   $ 229,416        
³
$    5,000
  

Ratio of Land Assets to Tangible Net Worth

     1.23        
£
2.0
  

Interest Coverage Ratio

     3.53        
³
1.5
  

Adjusted Leverage Ratio (b)

     0.93        
£
2.5
  

Permitted Maximum Senior Leverage Ratio

     0        
£
0.75
  

Actual Borrowings/Permitted Borrowings (c)

   $ 0         $125,000   

 

(a) Consolidated Tangible Net Worth (“TNW”) cannot be less than the sum of: (a) 75% of consolidated TNW at December 31, 2013, plus (b) 50% of the cumulative Net Cash Proceeds, as defined in the Revolver, of any Equity Issuances received by borrower after February 20, 2014, plus (c) 50% of the cumulative Consolidated Net Income, as defined in the Revolver, minus income taxes at an effective rate of 50%.
(b) Not to be greater than 2.5 prior to and including December 31, 2014, and 2.0 after December 31, 2014.
(c) Borrowing capacity under the provision of the borrowing base, as defined in the Credit Agreement.

 

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CONTRACTUAL OBLIGATIONS, COMMERCIAL COMMITMENTS AND OFF-BALANCE SHEET ARRANGEMENTS

Contractual Obligations

Primary contractual obligations are payments under notes payable, operating leases and purchase obligations. Purchase obligations primarily represent land purchase and option contracts, and purchase obligations for water system connection rights.

At December 31, 2014, future estimated payments under existing contractual obligations, including estimated future cash payments, are as follows:

 

     Payments due by period  
     Total      Less than
1 Year
     2 – 3
Years
     4 – 5
Years
     After 5
Years
 
     (In thousands)  

Contractual obligations:

              

Long-term debt principal payments

   $ 761,404       $ 1,904       $ 9,500       $ 750,000       $ 0   

Long-term debt interest payments

     291,537         65,068         129,438         97,031         0   

Operating leases

     9,671         2,293         2,718         2,217         2,443   

Purchase obligations (1)

     423,243         213,534         114,647         56,570         38,492   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

$ 1,485,855    $ 282,799    $ 256,303    $ 905,818    $ 40,935   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Comprised of $395.9 million of land purchase and option contracts, and $27.4 million of water system connection rights purchase obligations.

We expect to fund contractual obligations in the ordinary course of business with existing cash resources, cash flows generated from operations, our Revolver, and issuance of new debt as market conditions permit.

Land Purchase and Option Contracts

In the ordinary course of business, we enter into land purchase and option contracts to procure land for construction of homes. These contracts typically require a cash deposit and the purchase is often contingent on satisfaction of certain requirements by land sellers, including securing property and development entitlements. We utilize option contracts to acquire large tracts of land in smaller parcels to better manage financial and market risk of holding land and to reduce use of funds. Option contracts generally require a non-refundable deposit after a diligence period for the right to acquire lots over a specified period of time at a predetermined price. However, in certain circumstances, the purchase price may not, in whole or in part, be determinable and payable until the homes or lots are delivered. In such instances, an estimated purchase price for the unknown portion is not included in the total remaining purchase price. At December 31, 2014, we had owned or controlled 7,067 lots in Colorado for which the purchase price is determined when the underlying lots deliver with a homebuyer or other purchaser. In addition, at December 31, 2014, we have an option to purchase 262 lots in Northern California where the purchase price is based on future price and profit appreciation of the homes delivered (see “Item 13 – Certain Relationships and Affiliate Transactions, and Director Independence”). At our discretion, we generally have rights to terminate our obligations under purchase and option contracts by forfeiting our cash deposit or repaying amounts drawn under our letters of credit with no further financial responsibility to the land seller. However, purchase contracts can contain additional development obligations that must be completed even if a contract is terminated.

Use of option contracts is dependent on the willingness of land sellers, availability of capital, housing market conditions and geographic preferences. Options may be more difficult to obtain from land sellers in stronger housing markets and are more prevalent in certain geographic regions.

At December 31, 2014, we had $24.8 million in option contract deposits on land with a total remaining purchase price, excluding land subject to option contracts that do not specify a purchase price, of $395.9 million, compared to $21.0 million and $422.3 million, respectively, at December 31, 2013.

Water System Connection Rights

At a homebuilding project in Colorado, we have a contractual obligation to purchase and receive water system connection rights which, at December 31, 2014, was $27.4 million, which is less than their estimated market value. These water system connection rights are held, then transferred to homebuyers upon delivery of their home, transferred upon sale of land to the respective buyer, sold or leased, but generally only within the local jurisdiction.

 

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Land Development and Homebuilding Joint Ventures

We enter into land development and homebuilding joint ventures for the following purposes:

 

    leveraging our capital base;

 

    managing and reducing financial and market risks of holding land;

 

    establishing strategic alliances;

 

    accessing lot positions; and

 

    expanding market share.

These joint ventures typically obtain secured acquisition, development and construction financing, each designed to reduce use of corporate funds.

In December 2012, an unconsolidated joint venture, RRWS, LLC (“RRWS”), was formed and is owned 50% by us and 50% by a third-party real estate developer (“the RRWS Partner”). Through two wholly-owned subsidiaries, RRWS owns land in two master planned communities in the central coast of California. One subsidiary develops lots and constructs and sells single family attached and detached homes. This subsidiary is also under contract to acquire residential lots from an entity controlled by the RRWS Partner. The other subsidiary owns commercial and residential land in which the residential land is intended to be sold to us for construction and sales of active lifestyle targeted homes.

Several acquisition, development and construction loans were entered into by RRWS, each with two-year terms and options to extend for one year, subject to certain conditions. Each loan is cross collateralized and cross-defaulted with the other loan. We and RRWS Partner each executed limited completion, interest and carry guarantees and environmental indemnities on a joint and several basis. In addition, we and RRWS Partner executed loan-to-value maintenance agreements for each loan on a joint and several basis. We have a maximum aggregate liability under the remargin arrangements of the lesser of 50% of the outstanding balances in total for these joint venture loans or $35.0 million. Our and RRWS Partner’s obligations under the remargin arrangements are limited during the first two years of the loans. In addition to remargin arrangements, the RRWS Partner and several of its principals executed repayment guarantees with no limit on their liability. At December 31, 2014 and 2013, outstanding bank notes payable were $43.0 million and $47.7 million, respectively, of which we have a maximum remargin obligation of $21.5 million and $23.8 million, respectively. We also have an agreement from RRWS Partner, under which we could potentially recover a portion of payments we made. However, we cannot provide assurance we could collect under this agreement. No liabilities were recorded for these guarantees at December 31, 2014 and 2013 as the fair value of the secured real estate assets exceeded the threshold at which a remargin payment is required.

In November 2012, an unconsolidated joint venture, Polo Estates Ventures, LLC (“Polo”), was formed and is owned 50% by us and 50% by a third-party investor (“Polo Partner”). Polo entered into acquisition, development and construction loans in July 2013 with two-year terms and options to extend for one year, subject to certain conditions. Each loan is cross collateralized and cross defaulted with the other loan. We and Polo Partner each executed loan-to-value maintenance arrangements for each loan on a joint and several basis. At December 31, 2014 and 2013, outstanding bank notes payable were $12.7 million and $4.8 million, respectively, and total maximum borrowings permitted on these loans were $21.6 million and $21.6 million, respectively. We also have reimbursement rights where we could potentially recover a portion of payments we made. However, we cannot provide assurance we could collect such payments. No liabilities were recorded for these guarantees at December 31, 2014 and 2013 as the fair value of the secured real estate assets exceeded the threshold at which a remargin payment is required.

In May 2013, we entered into an unconsolidated joint venture, RMV PA2 Development, LLC (“RMV”), to develop and sell land located in Southern California to the joint venture members and other parties. We have a preferred interest which earns a stated 10% preferred rate, with potential to earn additional earnings based on the cash flows of RMV up to a maximum of a 15% internal rate of return. We committed to contribute up to $45.0 million. At December 31, 2013, we made aggregate contributions of $15.1 million to RMV, which were returned to us by December 31, 2014. In 2015, we anticipate making additional contributions at amounts below the $45.0 million commitment, and expect such contributions will be returned by the end of 2015.

In December 2011, Vistancia, LLC, a consolidated joint venture, sold its remaining interest in an unconsolidated joint venture (the “Vistancia Sale”). As a result of the Vistancia Sale, no other assets of Vistancia, LLC economically benefit the former non-controlling member and we recorded an obligation for the remaining $3.3 million distribution payable to this member, which is paid $0.1 million quarterly. In May 2012, for a nominal amount, SHLP purchased this member’s entire 16.7% interest; however, the distribution payable remained. At December 31, 2014 and 2013, the distribution payable was $2.2 million and $2.5 million, respectively.

 

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At December 31, 2014 and 2013, total unconsolidated joint ventures’ notes payable consisted of the following:

 

     December 31,  
     2014      2013  
     (In thousands)  

Bank and seller notes payable:

     

Guaranteed (subject to remargin obligations)

   $ 55,675       $ 52,515   

Non-Guaranteed

     34,824         10,073   
  

 

 

    

 

 

 

Total bank and seller notes payable (a)

  90,499      62,588   
  

 

 

    

 

 

 

Partner notes payable (b):

Unsecured

  68,543      16,001   
  

 

 

    

 

 

 

Total unconsolidated joint venture notes payable

$ 159,042    $ 78,589   
  

 

 

    

 

 

 

Other unconsolidated joint venture notes payable (c)

$ 83,847    $ 55,441   
  

 

 

    

 

 

 

 

(a) All bank and seller notes were secured by real property.
(b) No guarantees were provided on partner notes payables. In January 2014, a $3.2 million partner note from one joint venture was paid in full.
(c) Through indirect effective ownership in two joint ventures of 12.3% and 0.0003%, respectively, that had bank notes payable secured by real property in which we have not provided a guaranty.

At December 31, 2014 and 2013, remargin obligations and guarantees provided on debt of our unconsolidated joint ventures were on a joint and/or several basis and include, but are not limited to, project completion, interest and carry, and loan-to-value maintenance guarantees.

We may be required to use our funds for obligations of these joint ventures, such as:

 

    loans (including to replace expiring loans, to satisfy loan remargin and land development and construction completion obligations or to satisfy environmental indemnity obligations);

 

    development and construction costs;

 

    indemnity obligations to surety providers;

 

    land purchase obligations; and

 

    dissolutions (including satisfaction of joint venture indebtedness through repayment or the assumption of such indebtedness, payments to partners in connection with the dissolution, or payment of the remaining costs to complete, including warranty and legal obligations).

Guarantees, Surety Obligations and Other Contingencies

At December 31, 2014 and 2013, maximum unrecorded loan remargin or other guarantees, surety obligations and certain other contingencies were as follows:

 

     December 31,  
     2014      2013  
     (In thousands)  

Tax Court CCM case (capped at $70.0 million)

   $ 70,000       $ 70,000   

Remargin obligations for unconsolidated joint venture loans

     34,199         28,684   

Costs to complete on surety bonds for Company projects

     66,836         77,276   

Costs to complete on surety bonds for joint venture projects

     22,694         22,845   

Costs to complete on surety bonds for affiliate projects

     2,152         1,614   
  

 

 

    

 

 

 

Total unrecorded contingent liabilities and commitments

$ 195,881    $ 200,419   
  

 

 

    

 

 

 

On May 10, 2011, we entered into a $75.0 million letter of credit facility. At December 31, 2013, there were no letters of credit outstanding under this facility. In February 2014, this credit facility was replaced by the Revolver, which includes a $62.5 million sublimit for letters of credit. At December 31, 2014, there were no outstanding letters of credit under the Revolver.

 

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We provide surety bonds that guarantee completion of certain infrastructure serving our homebuilding projects. At December 31, 2014, there were $66.8 million of costs to complete in connection with $146.5 million of surety bonds issued. At December 31, 2013, there were $77.3 million of costs to complete in connection with $169.7 million of surety bonds issued.

We also provide indemnification for bonds issued by certain unconsolidated joint ventures and other affiliate projects in which we have no ownership interest. At December 31, 2014, there were $22.7 million of costs to complete in connection with $63.2 million of surety bonds issued for unconsolidated joint venture projects, and $2.2 million of costs to complete in connection with $3.5 million of surety bonds issued for affiliate projects. At December 31, 2013, there were $22.8 million of costs to complete in connection with $63.7 million of surety bonds issued for unconsolidated joint venture projects, and $1.6 million of costs to complete in connection with $4.9 million of surety bonds issued for affiliate projects.

Certain of our homebuilding projects utilize community facility district, metro-district and other local government bond financing programs to fund acquisition or construction of infrastructure improvements. Interest and principal on these bonds are typically paid from taxes and assessments levied on landowners, including land we own, and/or homeowners following the delivery of new homes in the community. Occasionally, we also enter into credit support arrangements requiring us to pay interest and principal on these bonds if taxes and assessments levied on landowners and/or homeowners are insufficient to cover such obligations. Furthermore, reimbursement of these payments to us is dependent on the district or local government’s ability to generate sufficient tax and assessment revenues from the new homes. At December 31, 2014 and 2013, in connection with credit support arrangements, there was $10.9 million and $8.6 million, respectively, reimbursable to us from certain agencies in Colorado and, accordingly, recorded in inventory as a recoverable project cost.

We also pay certain fees and costs associated with the construction of infrastructure improvements in homebuilding projects that utilize these district bond financing programs. These fees and costs are typically reimbursable to us from, and therefore dependent on, bond proceeds or taxes and assessments levied on landowners and/or homeowners. At December 31, 2014 and 2013, in connection with certain funding arrangements, there was $14.0 million and $13.1 million, respectively, reimbursable to us from certain agencies, including $12.8 million and $11.9 million, respectively, from metro-districts in Colorado and, accordingly, were recorded in inventory as a recoverable project cost.

Until bond proceeds or tax and assessment revenues are sufficient to cover our obligations and/or reimburse us, our responsibility to make interest and principal payments on these bonds or pay fees and costs associated with the construction of infrastructure improvements could be prolonged and significant. In addition, if bond proceeds or tax and assessment revenues are not sufficient to cover our obligations and/or reimburse us, these amounts might not be recoverable.

As a condition of the Vistancia Sale, and the purchase of the non-controlling member’s remaining interest in Vistancia, LLC, we remain a 10% guarantor on certain community facility district bond obligations to which the we must meet a minimum calculated tangible net worth; otherwise, we are required to fund collateral to the bond issuer. At December 31, 2014 and 2013, we exceeded the minimum tangible net worth requirement.

CRITICAL ACCOUNTING POLICIES

Preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires us to make estimates and judgments that affect reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and judgments, including those that impact our most critical accounting policies. We base our estimates and judgments on historical experience and various other assumptions believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. We believe accounting policies related to the following accounts or activities are those most critical to the portrayal of our consolidated financial condition and results of operations and require the most significant judgments and estimates.

Inventory

We capitalize preacquisition, land, development and other allocated costs, including interest, during development and home construction. Applicable costs incurred after development or construction is substantially complete are charged to selling, general and administrative, and other expenses as appropriate. Preacquisition costs, including non-refundable land deposits, are expensed to other income (expense), net when we determine continuation of the respective project is not probable.

Land, development and other indirect costs are typically allocated to inventory using a methodology that approximates the relative-sales-value method. Home construction costs are recorded using the specific identification method. Cost of sales for homes delivered includes the specific construction costs of each home and all applicable land acquisition, land development and related costs (both incurred and estimated to be incurred) based upon the total number of homes expected to be delivered in each community. Changes to estimated total development costs subsequent to initial home deliveries in a community are generally allocated on a relative-sales-value method to remaining homes in the community.

 

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Inventory is stated at cost, unless the carrying amount for inventory (other than land held for sale) is determined to be unrecoverable, in which case inventory is adjusted to fair value. For land held for sale, inventory is stated at the lower of cost or fair value less cost to sell. Quarterly, we review our real estate assets at each community for indicators of impairment. Real estate assets include projects actively selling, under development, held for future development or held for sale. Indicators of impairment include, but are not limited to, significant decreases in local housing market values and prices of comparable homes, significant decreases in gross margins and sales absorption rates, costs in excess of budget, and actual or projected cash flow losses.

If there are indications of impairment, we analyze the budgets and cash flows of our real estate assets and compare the estimated remaining undiscounted future cash flows of the community to the asset’s carrying value. If the undiscounted cash flows exceed the asset’s carrying value, no impairment adjustment is required. If the undiscounted cash flows are less than the asset’s carrying value, the asset is deemed impaired and adjusted to fair value. For land held for sale, if the fair value less costs to sell exceeds the asset’s carrying value, no impairment adjustment is required. These impairment evaluations require use of estimates and assumptions regarding future conditions, including timing and amounts of development costs and sales prices of real estate assets, to determine if estimated future undiscounted cash flows will be sufficient to recover the asset’s carrying value.

When estimating undiscounted cash flows of a community, various assumptions are made, including: (i) the number of homes available and expected prices and incentives offered by us or other builders, and future price adjustments based on market and economic trends; (ii) expected sales pace and cancellation rates based on local housing market conditions, competition and historical trends; (iii) costs to date and expected to be incurred, including, but not limited to, land and land development, home construction, interest, indirect construction and overhead, and selling and marketing costs; (iv) alternative product offerings that could impact sales pace, sales price and/or building costs; and (v) alternative uses for the property.

Many assumptions are interdependent and a change in one may require a corresponding change to other assumptions. For example, increasing or decreasing sales rates have a direct impact on the estimated price of a home, the level of time sensitive costs (such as indirect construction, overhead and interest), and selling and marketing costs (such as model maintenance and advertising). Depending on the underlying objective of the community, assumptions could have a significant impact on the projected cash flows. For example, if our objective is to preserve operating margins, our cash flows will be different than if the objective is to increase sales. These objectives may vary significantly by community.

If assets are considered impaired, the impairment charge is the amount the asset’s carrying value exceeds its fair value. Fair value is determined based on estimated future cash flows discounted for inherent risks associated with real estate assets or other valuation techniques. These discounted cash flows are impacted by expected risk based on estimated land development, construction and delivery timelines; market risk of price erosion; uncertainty of development or construction cost increases; and other risks specific to the asset or market conditions where the asset is located when the assessment is made. These factors are specific to each community and may vary among communities. The discount rate used in determining each asset’s fair value depends on the community’s projected life and development stage. We generally use discount rates ranging from 10% to 25%, subject to perceived risks associated with the community’s cash flow streams relative to its inventory.

Completed Operations Claim Costs

We maintain, and require our subcontractors to maintain, general liability insurance which includes coverage for completed operations losses and damages. Most subcontractors carry this insurance through our “rolling wrap-up” insurance program, where our risks and risks of participating subcontractors are insured through a common set of master policies.

Completed operations claims reserves primarily represent claims for property damage to completed homes and projects outside of our one- to two-year fit and finish warranty period. Specific length, terms and conditions of completed operations warranties vary depending on the market where homes deliver and can range up to ten years from the delivery of a home.

We record expenses and liabilities for estimated costs of potential completed operations claims based upon aggregated loss experience, which includes an estimate of completed operations claims incurred but not reported and is actuarially estimated using individual case-based valuations and statistical analysis. These estimates make up our entire reserve and are subject to a high degree of variability due to uncertainties such as trends in completed operations claims related to our markets and products built, changes in claims reporting and settlement patterns, third party recoveries, insurance industry practices, insurance regulations and legal precedent. Because state regulations vary, completed operations claims are reported and resolved over an extended period, sometimes exceeding ten years. As a result, actual costs may differ significantly from estimates.

 

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The actuarial analyses that determine these incurred but not reported claims consider various factors, including frequency and severity of losses, which are based on historical claims experience supplemented by industry data. The actuarial analyses of these claims and reserves also consider historical third party recovery rates and claims management expenses. Due to inherent uncertainties related to each of these factors, changes based on updated relevant information could result in actual costs differing significantly from estimates.

In accordance with our completed operations insurance policies, completed operations claims costs are recoverable from our subcontractors or insurance carriers. For policy years from August 1, 2001 through the present, completed operations claims are insured or reinsured by third-party and affiliate insurance carriers.

Revenues

In accordance with Accounting Standards Codification (“ASC”) 360, revenues from housing and other real estate sales are recognized when the respective units deliver. Housing and other real estate sales deliver when all conditions of escrow are met, including delivery of the home or other real estate asset to the customer, title passage, appropriate consideration is received or collection of associated receivables, if any, is reasonably assured and when we have no other continuing involvement in the asset. Sales incentives are a reduction of revenues when the respective unit delivers.

Income Taxes

SHLP is treated as a partnership for income tax purposes. As a limited partnership, SHLP is subject to certain minimal state taxes and fees; however, taxes on income realized by SHLP are generally the obligation of the Partners and their owners.

SHI and PIC are C corporations. Federal and state income taxes are provided for these entities in accordance with ASC 740. The provision for, or benefit from, income taxes is calculated using the asset and liability method, whereby deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect the year in which differences are expected to reverse.

Deferred tax assets are evaluated to determine whether a valuation allowance should be established based on our determination if it is more likely than not some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends primarily on generation of future taxable income during periods in which those temporary differences become deductible. Assessment of a valuation allowance includes giving appropriate consideration to all positive and negative evidence related to realization of the deferred tax asset. This assessment considers, among other things, the nature, frequency and severity of current and cumulative losses in recent years, forecasts of future profitability, duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards before they expire, and tax planning alternatives. Judgment is required in determining future tax consequences of events that have been recognized in the consolidated financial statements and/or tax returns. Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated financial position or results of operations.

We follow certain accounting guidance on how uncertain tax positions should be accounted for and disclosed in the consolidated financial statements. The guidance requires assessment of tax positions taken or expected to be taken in the tax returns and to determine whether the tax positions are “more-likely-than-not” of being sustained upon examination by the applicable tax authority. Tax positions deemed to meet the more-likely-than-not criteria would be recorded as a tax benefit or expense in the current year. We are required to assess open tax years, as defined by the statute of limitations, for all major jurisdictions, including federal and certain states. Open tax years are those that are open for examination by taxing authorities. We have examinations in progress but believe no uncertain tax positions exist that do not meet the more-likely-than-not criteria.

RECENT ACCOUNTING PRONOUNCEMENTS

See Note 2 in our accompanying consolidated financial statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to market risk primarily from interest rate fluctuations. Historically, we have incurred fixed-rate and variable-rate debt. For fixed-rate debt, changes in interest rates generally affect the fair market value of the debt instrument, but not earnings or cash flow. Conversely, for variable-rate debt, changes in interest rates generally do not affect the fair market value of the debt but do affect earnings and cash flow. We did not utilize swaps, forward or option contracts on interest rates or commodities, or other types of derivative financial instruments at or during the year ended December 31, 2014. We have not entered into and currently do not hold derivatives for trading or speculative purposes. As we do not have an obligation to prepay fixed-rate debt prior to maturity, and we do not currently have a significant amount of variable-rate debt, interest rate risk and changes in fair market value should not have a significant impact on such debt until we refinance.

 

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In February 2014, we replaced our $75.0 million secured letter of credit facility with the $125.0 million Revolver, which bears interest, at the Company’s option, either at (i) a daily eurocurrency base rate as defined in the Credit Agreement, plus a margin of 2.75%, or (ii) a eurocurrency rate as defined in the Credit Agreement, plus a margin of 2.75%, and matures March 1, 2016. Borrowing availability is determined by a borrowing base formula and we are subject to financial covenants, including minimum net worth and leverage and interest coverage ratios. If we do not maintain compliance with these financial covenants, the Revolver converts to an 18-month amortizing term loan. At December 31, 2014, we were in compliance with these covenants and no amounts were outstanding.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Report of Independent Registered Public Accounting Firm

The Board of Directors, Shareholders and Partners

Shea Homes Limited Partnership

We have audited the accompanying consolidated balance sheets of Shea Homes Limited Partnership (the Company), a California limited partnership, as of December 31, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in equity, and cash flows for each of the three years in the period ended December 31, 2014. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Company’s internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Shea Homes Limited Partnership at December 31, 2014 and 2013, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2014 in conformity with U. S. generally accepted accounting principles.

/s/ Ernst & Young LLP                    

Los Angeles, California

March 6, 2015

 

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Shea Homes Limited Partnership

(A California Limited Partnership)

Consolidated Balance Sheets

(In thousands)

 

     December 31,  
     2014      2013  

Assets

     

Cash and cash equivalents

   $ 236,902       $ 206,205   

Restricted cash

     426         1,189   

Accounts and other receivables, net

     147,508         147,499   

Receivables from affiliates, net

     6,403         31,313   

Inventory

     1,173,585         1,013,272   

Investments in and advances to unconsolidated joint ventures

     42,764         48,785   

Other assets, net

     59,122         57,070   
  

 

 

    

 

 

 

Total assets

$ 1,666,710    $ 1,505,333   
  

 

 

    

 

 

 

Liabilities and equity

Liabilities:

Notes payable

$ 761,404    $ 751,708   

Payables to affiliates

  4,797      21   

Accounts payable

  67,321      62,346   

Other liabilities

  278,330      245,801   
  

 

 

    

 

 

 

Total liabilities

  1,111,852      1,059,876   

Equity:

SHLP equity:

Owners’ equity

  549,373      440,268   

Accumulated other comprehensive income

  5,106      4,788   
  

 

 

    

 

 

 

Total SHLP equity

  554,479      445,056   

Non-controlling interests

  379      401   
  

 

 

    

 

 

 

Total equity

  554,858      445,457   
  

 

 

    

 

 

 

Total liabilities and equity

$ 1,666,710    $ 1,505,333   
  

 

 

    

 

 

 

See accompanying notes

 

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Shea Homes Limited Partnership

(A California Limited Partnership)

Consolidated Statements of Income

(In thousands)

 

     Years Ended December 31,  
     2014     2013     2012  

Revenues

   $ 1,140,606      $ 930,610      $ 680,147   

Cost of sales

     (885,018     (709,412     (538,434
  

 

 

   

 

 

   

 

 

 

Gross margin

  255,588      221,198      141,713   

Selling expenses

  (63,429   (54,338   (45,788

General and administrative expenses

  (54,921   (50,080   (43,747

Equity in income (loss) from unconsolidated joint ventures

  9,142      (1,104   378   

Gain (loss) on reinsurance transaction

  7,177      2,011      (12,013

Interest expense

  (595   (5,071   (19,862

Other income (expense), net

  (1,350   (778   9,119   
  

 

 

   

 

 

   

 

 

 

Income before income taxes

  151,612      111,838      29,800   

Income tax benefit (expense)

  (18,213   14,101      (616
  

 

 

   

 

 

   

 

 

 

Net income

  133,399      125,939      29,184   

Less: Net loss (income) attributable to non-controlling interests

  37      8      (146
  

 

 

   

 

 

   

 

 

 

Net income attributable to SHLP

$ 133,436    $ 125,947    $ 29,038   
  

 

 

   

 

 

   

 

 

 

See accompanying notes

 

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Shea Homes Limited Partnership

(A California Limited Partnership)

Consolidated Statements of Comprehensive Income

(In thousands)

 

     Years Ended December 31,  
     2014     2013     2012  

Net income

   $ 133,399      $ 125,939      $ 29,184   

Other comprehensive income, before tax

      

Unrealized investment holding gains during the year

     565        552        1,569   

Less: Reclassification adjustments for investment gains included in net income

     0        (39     (3,976
  

 

 

   

 

 

   

 

 

 

Comprehensive income, before tax

  133,964      126,452      26,777   

Income tax benefit (expense)

  (247   (242   532   
  

 

 

   

 

 

   

 

 

 

Comprehensive income, net of tax

  133,717      126,210      27,309   

Less: Comprehensive (income) loss attributable to non-controlling interests

  37      8      (146
  

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to SHLP

$ 133,754    $ 126,218    $ 27,163   
  

 

 

   

 

 

   

 

 

 

See accompanying notes

 

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Shea Homes Limited Partnership

(A California Limited Partnership)

Consolidated Statements of Changes in Equity

(In thousands)

 

     Shea Homes Limited Partnership     Non-
controlling
Interests
    Total
Equity
 
     Limited Partner     General
Partner
    Total
Owners’
Equity
    Accumulated
Other
Comprehensive
Income (Loss)
    Total
SHLP
Equity
     
     Common     Preferred
Series B
     Preferred
Series D
    Common            

Balance, December 31, 2011

   $ 1      $ 173,555       $ 120,955      $ 0      $ 294,511      $ 6,392      $ 300,903      $ 27,100      $ 328,003   

Comprehensive income :

                   

Net income

     0        0         29,038        0        29,038        0        29,038        146        29,184   

Change in unrealized gains on investments, net

     0        0         0        0        0        (1,875     (1,875     0        (1,875
               

 

 

   

 

 

   

 

 

 

Total comprehensive income

  27,163      146      27,309   

Redemption of Company’s interest in consolidated joint venture (see Note 12)

  0      0      (11,580   0      (11,580   0      (11,580   (28,239   (39,819

Contributions from owners and non-controlling interests (a)

  1,862      0      0      490      2,352      0      2,352      1,746      4,098   

Distributions to non-controlling interests

  0      0      0      0      0      0      0      (344   (344
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2012

  1,863      173,555      138,413      490      314,321      4,517      318,838      409      319,247   

Comprehensive income (loss):

Net income (loss)

  34,133      43,379      39,453      8,982      125,947      0      125,947      (8   125,939   

Change in unrealized gains on investments, net

  0      0      0      0      0      271      271      0      271   
               

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

  126,218      (8   126,210   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2013

  35,996      216,934      177,866      9,472      440,268      4,788      445,056      401      445,457   

Comprehensive income (loss):

Net income (loss)

  100,340      1,934      4,757      26,405      133,436      0      133,436      (37   133,399   

Change in unrealized gains on investments, net

  0      0      0      0      0      318      318      0      318   
               

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

  133,754      (37   133,717   

Contributions from owners and non-controlling interests (a)

  748      0      0      197      945      0      945      15      960   

Distributions to owners (b)

  (20,010   0      0      (5,266   (25,276   0      (25,276   0      (25,276
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, December 31, 2014

$ 117,074    $ 218,868    $ 182,623    $ 30,808    $ 549,373    $ 5,106    $ 554,479    $ 379    $ 554,858   
  

 

 

   

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(a) For the years ended December 31, 2014 and 2012, the Company sold property to affiliates under common control and, in accordance with U.S. generally accepted accounting principles (“GAAP”), $0.9 million and $2.4 million, respectively, of consideration received in excess of the net book value was recorded as a contribution from owners.
(b) In 2014, the Company acquired property from an affiliate under common control for $4.4 million of cash, assumption of a $1.3 million net liability, and estimated future revenue participation payments of $19.6 million. The $25.3 million of consideration was recorded as a distribution to owners.

See accompanying notes

 

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Shea Homes Limited Partnership

(A California Limited Partnership)

Consolidated Statements of Cash Flows

(In thousands)

 

     Years Ended December 31,  
     2014     2013     2012  

Operating activities

      

Net income

   $ 133,399      $ 125,939      $ 29,184   

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

      

Equity in (income) loss from unconsolidated joint ventures

     (9,142     1,104        (378

(Gain) loss on reinsurance transaction

     (7,177     (2,011     12,013   

Net gain on sale of available-for-sale investments

     0        (15     (8,806

Reversal of deferred tax asset valuation allowance

     0        (15,630     0   

Depreciation and amortization expense

     12,630        10,608        8,638   

Inventory impairment

     9,035        0        0   

Net interest capitalized on investments in unconsolidated joint ventures

     (2,912     (2,278     (849

Distributions of earnings from unconsolidated joint ventures

     18,790        7,100        1,400   

Changes in operating assets and liabilities:

      

Restricted cash

     763        11,842        687   

Receivables and other assets

     (2,607     (13,161     (18,134

Inventory

     (178,700     (185,596     (68,733

Payables and other liabilities

     28,375        14,231        38,323   
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) operating activities

  2,454      (47,867   (6,655

Investing activities

Proceeds from sale of available-for-sale investments

  184      3,165      26,547   

Collections on promissory notes from affiliates

  25,183      4,104      1,881   

Investments in and advances to unconsolidated joint ventures

  (29,158   (26,145   (11,967

Distributions of capital from unconsolidated joint ventures

  38,767      4,072      427   
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) investing activities

  34,976      (14,804   16,888   

Financing activities

Principal payments to financial institutions and others

  (3,308   (10,880   (2,429

Contributions from non-controlling interests

  15      0      1,746   

Distributions to non-controlling interests

  0      0      (344

Contributions from owners

  945      0      2,352   

Distributions to owners

  (4,385   0      0   

Other financing activities

  0      0      (168
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

  (6,733   (10,880   1,157   
  

 

 

   

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

  30,697      (73,551   11,390   

Cash and cash equivalents at beginning of year

  206,205      279,756      268,366   
  

 

 

   

 

 

   

 

 

 

Cash and cash equivalents at end of year

$ 236,902    $ 206,205    $ 279,756   
  

 

 

   

 

 

   

 

 

 

See accompanying notes

 

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Shea Homes Limited Partnership

(A California Limited Partnership)

Notes to Consolidated Financial Statements

December 31, 2014

1. Organization

Shea Homes Limited Partnership, a California limited partnership (“SHLP”), was formed January 4, 1989, pursuant to an agreement of partnership (the “Agreement”), as most recently amended August 6, 2013, by and between J.F. Shea, G.P., a Delaware general partnership, as general partner, and our limited partners who are comprised of entities and trusts, including J.F. Shea Co., Inc. (“JFSCI”), that are under common control of Shea family members (collectively, the “Partners”). J.F. Shea, G.P. is 96% owned by JFSCI.

Nature of Operations

Our principal business purpose is homebuilding, which includes acquiring and developing land and constructing and selling new residential homes thereon. To a lesser degree, we develop and sell land to other homebuilders. Our principal markets are California, Arizona, Colorado, Washington, Nevada, Florida, Virginia, North Carolina and Texas.

We own a captive insurance company, Partners Insurance Company, Inc. (“PIC”), which provided warranty, general liability, workers’ compensation and completed operations insurance for related companies and third-party subcontractors. Effective for the policy years commencing in 2007, PIC ceased issuing policies for these coverages (see Note 11).

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying consolidated financial statements include SHLP and its wholly-owned subsidiaries, including Shea Homes, Inc. (“SHI”) and its wholly-owned subsidiaries. The Company consolidates all joint ventures in which it has a controlling interest or other ventures in which it is the primary beneficiary of a variable interest entity (“VIE”). Material intercompany accounts and transactions are eliminated.

Unless the context otherwise requires, the terms “we”, “us”, “our” and “the Company” refer to SHLP, its subsidiaries and its consolidated joint ventures.

Use of Estimates

Preparation of the consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect amounts reported in the consolidated financial statements and accompanying notes. Estimates primarily relate to valuation of certain real estate and reserves for self-insured risks. Actual results could differ significantly from those estimates.

Reclassifications

Certain reclassifications were made in the 2013 consolidated financial statements to conform to classifications in 2014. At December 31, 2013, in the consolidated balance sheet, advances to unconsolidated joint ventures of $1.0 million were reclassified from receivables from affiliates to investments in and advances to unconsolidated joint ventures. In addition, for the year ended December 31, 2013 and 2012, in the consolidated statements of cash flows, advances of $0.8 million were reclassified from promissory notes from affiliates to investments in and advances to unconsolidated joint ventures, and collections of $0.1 million were reclassified from promissory notes from affiliates to distributions of capital from unconsolidated joint ventures, respectively.

Cash and Cash Equivalents

All highly liquid investments (original maturities of 90 days or less) are considered to be cash equivalents.

Concentration of Credit Risk

Financial instruments representing concentrations of credit risk are primarily cash, cash equivalents, investments and insurance receivables.

 

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Cash in banks exceeded the federally insured limits; cash equivalents comprised primarily of money market securities and securities backed by the U.S. government; and insurance receivables were with highly rated insurers and/or collateralized. We have incurred no losses on deposits of cash and cash equivalents and believe our depository institutions are financially sound and present minimal credit risk.

Inventory

We capitalize preacquisition, land, development and other allocated costs, including interest, during development and home construction. Applicable costs incurred after development or construction is substantially complete are charged to selling, general and administrative, and other expenses as appropriate. Preacquisition costs, including non-refundable land deposits, are expensed to other income (expense), net when we determine continuation of the respective project is not probable.

Land, development and other indirect costs are typically allocated to inventory using a methodology that approximates the relative-sales-value method. Home construction costs are recorded using the specific identification method. Cost of sales for homes delivered includes the specific construction costs of each home and all applicable land acquisition, land development and related costs (both incurred and estimated to be incurred) based upon the total number of homes expected to be delivered in each community. Changes to estimated total development costs subsequent to initial home deliveries in a community are generally allocated on a relative-sales-value method to remaining homes in the community.

Inventory is stated at cost, unless the carrying amount (other than land held for sale) is determined to be unrecoverable, in which case inventory is adjusted to fair value. For land held for sale, inventory is stated at the lower of cost or fair value less cost to sell. Quarterly, we review our real estate assets at each community for indicators of impairment. Real estate assets include projects actively selling, under development, held for future development or held for sale. Indicators of impairment include, but are not limited to, significant decreases in local housing market values and prices of comparable homes, significant decreases in gross margins and sales absorption rates, costs in excess of budget, and actual or projected cash flow losses.

If there are indications of impairment, we analyze the budgets and cash flows of our real estate assets and compare the estimated remaining undiscounted future cash flows of the community to the asset’s carrying value. If the undiscounted cash flows exceed the asset’s carrying value, no impairment adjustment is required. If the undiscounted cash flows are less than the asset’s carrying value, the asset is deemed impaired and adjusted to fair value. For land held for sale, if the fair value less costs to sell exceeds the asset’s carrying value, no impairment adjustment is required. These impairment evaluations require use of estimates and assumptions regarding future conditions, including timing and amounts of development costs and sales prices of real estate assets, to determine if estimated future undiscounted cash flows will be sufficient to recover the asset’s carrying value.

When estimating undiscounted cash flows of a community, various assumptions are made, including: (i) the number of homes available and expected prices and incentives offered by us or other builders, and future price adjustments based on market and economic trends; (ii) expected sales pace and cancellation rates based on local housing market conditions, competition and historical trends; (iii) costs to date and expected to be incurred, including, but not limited to, land and land development, home construction, interest, indirect construction and overhead, and selling and marketing costs; (iv) alternative product offerings that could impact sales pace, sales price and/or building costs; and (v) alternative uses for the property.

Many assumptions are interdependent and a change in one may require a corresponding change to other assumptions. For example, increasing or decreasing sales rates have a direct impact on the estimated price of a home, the level of time sensitive costs (such as indirect construction, overhead and interest), and selling and marketing costs (such as model maintenance and advertising). Depending on the underlying objective of the community, assumptions could have a significant impact on the projected cash flows. For example, if our objective is to preserve operating margins, our cash flows will be different than if the objective is to increase sales. These objectives may vary significantly by community.

If assets are considered impaired, the impairment charge is the amount the asset’s carrying value exceeds its fair value. Fair value is determined based on estimated future cash flows discounted for inherent risks associated with real estate assets or other valuation techniques. These discounted cash flows are impacted by expected risk based on estimated land development, construction and delivery timelines; market risk of price erosion; uncertainty of development or construction cost increases; and other risks specific to the asset or market conditions where the asset is located when the assessment is made. These factors are specific to each community and may vary among communities. The discount rate used in determining each asset’s fair value depends on the community’s projected life and development stage. We generally use discount rates ranging from 10% to 25%, subject to perceived risks associated with the community’s cash flow streams relative to its inventory.

 

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Completed Operations Claim Costs

We maintain, and require our subcontractors to maintain, general liability insurance which includes coverage for completed operations losses and damages. Most subcontractors carry this insurance through our “rolling wrap-up” insurance program, where our risks and risks of participating subcontractors are insured through a common set of master policies.

Completed operations claims reserves primarily represent claims for property damage to completed homes and projects outside of our one- to two-year fit and finish warranty period. Specific length, terms and conditions of completed operations claims vary depending on the market where homes deliver and can range up to ten years from the delivery of a home.

We record expenses and liabilities for estimated costs of potential completed operations claims based upon aggregated loss experience, which includes an estimate of completed operations claims incurred but not reported and is actuarially estimated using individual case-based valuations and statistical analysis. These estimates make up our entire reserve and are subject to a high degree of variability due to uncertainties such as trends in completed operations claims related to our markets and products built, claims reporting and settlement patterns, third party recoveries, insurance industry practices, insurance regulations and legal precedent. Because state regulations vary, completed operations claims are reported and resolved over an extended period, sometimes exceeding ten years. As a result, actual costs may differ significantly from estimates.

The actuarial analyses that determine these incurred but not reported claims consider various factors, including frequency and severity of losses, which are based on historical claims experience supplemented by industry data. The actuarial analyses of these claims and reserves also consider historical third party recovery rates and claims management expenses. Due to inherent uncertainties related to each of these factors, changes based on updated relevant information could result in actual costs differing significantly from estimates.

In accordance with our completed operations insurance policies, completed operations claims costs are recoverable from our subcontractors or insurance carriers. For policy years from August 1, 2001 through the present, completed operations claims are insured or reinsured by third-party and affiliate insurance carriers.

Revenues

In accordance with Accounting Standards Codification (“ASC”) 360, revenues from housing and other real estate sales are recognized when the respective units deliver. Housing and other real estate sales deliver when all conditions of escrow are met, including delivery of the home or other real estate asset to the customer, title passage, appropriate consideration is received or collection of associated receivables, if any, is reasonably assured and when we have no other continuing involvement in the asset. Sales incentives are a reduction of revenues when the respective unit delivers.

Income Taxes

SHLP is treated as a partnership for income tax purposes. As a limited partnership, SHLP is subject to certain minimal state taxes and fees; however, taxes on income realized by SHLP are generally the obligation of the Partners and their owners.

SHI and PIC are C corporations. Federal and state income taxes are provided for these entities in accordance with ASC 740. The provision for, or benefit from, income taxes is calculated using the asset and liability method, whereby deferred tax assets and liabilities are recorded based on the difference between the financial statement and tax basis of assets and liabilities using enacted tax rates in effect the year in which differences are expected to reverse.

Deferred tax assets are evaluated to determine whether a valuation allowance should be established based on our determination if it is more likely than not some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets depends primarily on generation of future taxable income during periods in which those temporary differences become deductible. Assessment of a valuation allowance includes giving appropriate consideration to all positive and negative evidence related to realization of the deferred tax asset. This assessment considers, among other things, the nature, frequency and severity of current and cumulative losses in recent years, forecasts of future profitability, duration of statutory carryforward periods, our experience with operating loss and tax credit carryforwards before they expire, and tax planning alternatives. Judgment is required in determining future tax consequences of events that have been recognized in the consolidated financial statements and/or tax returns. Differences between anticipated and actual outcomes of these future tax consequences could have a material impact on our consolidated financial position or results of operations.

 

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We follow certain accounting guidance on how uncertain tax positions should be accounted for and disclosed in the consolidated financial statements. The guidance requires assessment of tax positions taken or expected to be taken in the tax returns and to determine whether the tax positions are “more-likely-than-not” of being sustained upon examination by the applicable tax authority. Tax positions deemed to meet the more-likely-than-not criteria would be recorded as a tax benefit or expense in the current year. We are required to assess open tax years, as defined by the statute of limitations, for all major jurisdictions, including federal and certain states. Open tax years are those that are open for examination by taxing authorities. We have examinations in progress but believe no uncertain tax positions exist that do not meet the more-likely-than-not criteria (see Note 13).

Advertising Costs

We expense advertising costs as incurred. For the years ended December 31, 2014, 2013 and 2012, we incurred and expensed advertising costs of $12.1 million, $7.4 million and $6.6 million, respectively.

New Accounting Pronouncements

In April 2014, the FASB issued Accounting Standard Update (“ASU”) 2014-08, Presentation of Financial Statements and Property, Plant, and Equipment: Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity (“ASU 2014-08”), which is intended to change the criteria for reporting discontinued operations and enhance disclosures. Under this new guidance, only disposals representing a strategic shift in operations having a major effect on the entity’s operations and financial results should be presented as discontinued operations. If the disposal does qualify as a discontinued operation, the entity will be required to provide expanded disclosures, as well as disclosure of the pretax income attributable to the disposal of a significant part of an entity that does not qualify as a discontinued operation. ASU 2014-08 will be effective beginning January 1, 2015 and subsequent interim periods. The adoption of ASU 2014-08 is not expected to have a material effect on our consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which provides a single comprehensive model in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. ASU No. 2014-09 requires an entity to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This update creates a five-step model requiring entities to exercise judgment when considering the terms of the contract(s) including (i) identifying the contract(s) with the customer, (ii) identifying the separate performance obligations in the contract, (iii) determining the transaction price, (iv) allocating the transaction price to the separate performance obligations, and (v) recognizing revenue when each performance obligation is satisfied. ASU 2014-09 will be effective beginning January 1, 2017 and subsequent interim periods. We have the option to apply the provisions of ASU 2014-09 either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of applying this ASU recognized at the date of initial application. Early adoption is not permitted. We are evaluating the impact the adoption of ASU 2014-09 will have on our consolidated financial statements.

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties About an Entity’s Ability to Continue as a Going Concern, (“ASU 2014-15”). ASU 2014-15 requires us to perform interim and annual assessments on whether there are conditions or events that raise substantial doubt about our ability to continue as a going concern within one year of the date the financial statements are issued and to provide related disclosures, if required. ASU 2014-15 will be effective beginning January 1, 2016 and subsequent interim periods. The adoption of ASU 2014-15 is not expected to have a material effect on our consolidated financial statements.

3. Restricted Cash

At December 31, 2014, restricted cash included customer deposits temporarily restricted in accordance with regulatory requirements and cash used in lieu of bonds. At December 31, 2014 and December 31, 2013, restricted cash was $0.4 million and $1.2 million, respectively.

 

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4. Fair Value Disclosures

ASC 820, Fair Value Measurement, defines fair value as the price that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants at measurement date and requires assets and liabilities carried at fair value to be classified and disclosed in the following three categories:

 

    Level 1 — Quoted prices for identical instruments in active markets

 

    Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are inactive; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets at measurement date

 

    Level 3 — Valuations derived from techniques where one or more significant inputs or significant value drivers are unobservable in active markets at measurement date

At December 31, 2014, the non-financial instruments measured at fair value on a non-recurring basis were Level 3 inventories with a $23.9 million net book value and a $14.9 million fair value, resulting in an impairment charge of $9.0 million recorded in cost of sales.

Fair values for inventories using Level 3 inputs were primarily based on estimated future cash flows discounted for inherent risk associated with each asset. These discounted cash flows were impacted by expected risk based on estimated land development, construction and delivery timelines; market risk of price erosion; uncertainty of development or construction cost increases; and other risks specific to the asset or market conditions where the asset was located when assessment was made. These factors were specific to each community and may vary among communities. The discount rate used in determining each asset’s fair value depended on the community’s projected life and development stage. We generally use discount rates from 10% to 25%, subject to perceived risks associated with the community’s cash flow streams relative to its inventory.

At December 31, 2014 and 2013, as required by ASC 825, net book value and estimated fair value of notes payable were as follows:

 

     December 31, 2014      December 31, 2013  
     Net Book
Value
     Estimated
Fair Value
     Net Book
Value
     Estimated
Fair Value
 
     (In thousands)  

$750,000 8.625% senior secured notes due May 2019

   $ 750,000       $ 787,500       $ 750,000       $ 830,625   

Secured promissory notes

   $ 11,404       $ 11,404       $ 1,708       $ 1,708   

The $750.0 million 8.625% senior secured notes due May 2019 (the “Secured Notes”) are level 2 financial instruments in which fair value was based on quoted market prices in an inactive market at the end of the year.

Other financial instruments consist primarily of cash and cash equivalents, restricted cash, accounts and other receivables, accounts payable and other liabilities and secured promissory notes. Book values of these financial instruments approximate fair value due to their relatively short-term nature. In addition, included in other assets are available-for-sale marketable securities, which are recorded at fair value.

5. Accounts and Other Receivables, Net

At December 31, 2014 and 2013, accounts and other receivables, net were as follows:

 

     December 31,  
     2014     2013  
     (In thousands)  

Insurance receivables

   $ 136,155      $ 138,610   

Escrow receivables

     3,965        586   

Notes receivables

     4,091        3,155   

Development receivables

     1,317        3,093   

Other receivables

     3,941        4,031   

Reserve

     (1,961     (1,976
  

 

 

   

 

 

 

Total accounts and other receivables, net

$ 147,508    $ 147,499   
  

 

 

   

 

 

 

 

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Insurance receivables are from insurance carriers for reimbursable claims pertaining to resultant damage from construction defects on delivered homes (see Note 11). Delivered homes for policy years August 1, 2001 to present are insured or reinsured by third-party and affiliate insurance carriers. At December 31, 2014 and 2013, insurance receivables from affiliate insurance carriers were $61.4 million and $44.0 million, respectively.

We reserve for uncollectible receivables that are specifically identified.

6. Inventory

At December 31, 2014 and 2013, inventory was as follows:

 

     December 31,  
     2014      2013  
     (In thousands)  

Model homes

   $ 86,340       $ 87,728   

Completed homes for sale

     32,350         20,285   

Homes under construction

     310,318         257,662   

Lots available for construction

     402,001         342,622   

Land under development

     107,120         122,257   

Land held for future development

     126,925         70,618   

Land held for sale

     78,845         79,102   

Land deposits and preacquisition costs

     29,686         32,998   
  

 

 

    

 

 

 

Total inventory

$ 1,173,585    $ 1,013,272   
  

 

 

    

 

 

 

Model homes, completed homes for sale and homes under construction include all costs associated with home construction, including land, development, indirects, permits and vertical construction. Lots available for construction include costs incurred prior to home construction such as land, development, indirects and permits. Land under development includes costs incurred during site development such as land, development, indirects and permits. Land under development transfers to lots available for construction once site development is complete and is ready for vertical construction. Land is classified as held for future development if significant development has not occurred. Land held for sale represents residential and commercial land designated for sale, including water system connection rights that will be transferred to homebuyers upon delivery of their home, transferred upon sale of land to the respective buyer, sold or leased, but generally only within the local jurisdiction. At December 31, 2014 and 2013, land held for sale included water system connection rights of $12.6 million and $11.4 million, respectively.

Impairment

Inventory, including the captions above, are stated at cost, unless the carrying amount is determined to be unrecoverable, in which case inventories are adjusted to fair value or fair value less costs to sell (see Note 2).

For the years ended December 31, 2014, 2013 and 2012, inventory impairment charges were as follows:

 

     Years Ended December 31,  
     2014      2013      2012  
     (Dollars in thousands)  

Inventory impairment charge

   $ 9,035       $ 0       $ 0   
  

 

 

    

 

 

    

 

 

 

Remaining carrying value of inventory impaired at end of year

$ 14,888    $ 0    $ 0   
  

 

 

    

 

 

    

 

 

 

Projects impaired

  3      0      0   
  

 

 

    

 

 

    

 

 

 

Projects evaluated for impairment (a)

  145      126      132   
  

 

 

    

 

 

    

 

 

 

 

(a) Large land parcels not subdivided into communities are counted as one project. Once parcels are subdivided, the project count will increase accordingly.

 

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Write-off of Deposits and Preacquisition Costs

Land deposits and preacquisition costs for potential acquisitions and land option contracts are included in inventory. When a potential acquisition or land option contract is abandoned, related deposits and preacquisition costs are written off to other income (expense), net. For the years ended December 31, 2014, 2013 and 2012, write-offs of deposits and preacquisition costs were $1.3 million, $1.4 million and $2.0 million, respectively.

Interest Capitalization

Interest is capitalized to inventory during development and other qualifying activities and is charged to cost of sales as related units deliver. Interest is capitalized to investments in unconsolidated joint ventures during the period the joint venture has activities in progress to commence its planned principal operations, and is charged to equity in income (loss) from unconsolidated joint ventures over the useful life of the joint venture’s assets.

For the years ended December 31, 2014, 2013 and 2012, interest incurred, capitalized and expensed was as follows:

 

     Years Ended December 31,  
     2014     2013     2012  
     (In thousands)  

Interest incurred

   $ 68,204      $ 67,048      $ 66,857   
  

 

 

   

 

 

   

 

 

 

Interest expensed (a)

$ 595    $ 5,071    $ 19,862   
  

 

 

   

 

 

   

 

 

 

Interest capitalized as a cost of inventory

$ 64,697    $ 59,699    $ 46,146   
  

 

 

   

 

 

   

 

 

 

Interest previously capitalized as a cost of inventory, included in cost of sales

$ (68,780 $ (60,448 $ (54,733
  

 

 

   

 

 

   

 

 

 

Interest capitalized in ending inventory (b)

$ 98,017    $ 102,100    $ 102,849   
  

 

 

   

 

 

   

 

 

 

Interest capitalized as a cost of investments in unconsolidated joint ventures

$ 2,912    $ 2,278    $ 849   
  

 

 

   

 

 

   

 

 

 

Interest previously capitalized as a cost of investments in joint ventures, included in equity in income (loss) from unconsolidated joint ventures

$ (2,444 $ (1,189 $ (849
  

 

 

   

 

 

   

 

 

 

Interest capitalized in ending investments in unconsolidated joint ventures

$ 1,557    $ 1,089    $ 0   
  

 

 

   

 

 

   

 

 

 

 

(a) For the eight months ended August 31, 2013 and for the year ended December 31, 2012, assets qualifying for interest capitalization were less than debt; therefore, non-qualifying interest was expensed. For the period from September 2013 to December 2014, qualifying assets exceeded debt; therefore, no interest on the Secured Notes (see Note 10) was expensed. 2014 interest expense represents fees charged on the unused Revolver (see Note 10) that is not considered a cost of borrowing and is not capitalized.
(b) Inventory impairment charges were recorded against total inventory of the respective community. Capitalized interest reflects the gross amount of capitalized interest as impairment charges recognized were generally not allocated to specific components of inventory.

Model Homes Costs

Certain costs of model homes are capitalized to inventory and amortized as selling expense when the related units in the respective communities deliver. For the years ended December 31, 2014, 2013 and 2012, amortized model homes costs were $12.0 million, $10.3 million and $8.2 million, respectively.

7. Investments in and Advances to Unconsolidated Joint Ventures

Unconsolidated joint ventures, which we do not control but have significant influence through ownership interests generally up to 50%, are accounted for using the equity method of accounting. These joint ventures are generally involved in real property development. Earnings and losses are allocated in accordance with terms of joint venture agreements.

Losses and distributions from joint ventures in excess of the carrying amount of our investment (“Deficit Distributions”) are included in other liabilities. We record Deficit Distributions since we are liable for this deficit to the respective joint ventures. Deficit Distributions are offset by future earnings of, or future contributions to, the joint ventures. At December 31, 2014 and 2013, Deficit Distributions were $0.3 million and $0.4 million, respectively.

 

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At December 31, 2014 and 2013, investments in and advances to unconsolidated joint ventures were as follows:

 

     December 31,  
     2014      2013  
     (In thousands)  

Equity investments

   $ 34,037       $ 47,748   

Loan advances

     8,727         1,037   
  

 

 

    

 

 

 

Total investments in and advances to unconsolidated joint ventures

$ 42,764    $ 48,785   
  

 

 

    

 

 

 

At December 31, 2014 and 2013, and for the years ended December 31, 2014, 2013 and 2012, condensed financial information for our unconsolidated joint ventures was as follows:

Condensed Balance Sheet Information

 

     December 31,  
     2014      2013  
     (In thousands)  

Assets

     

Real estate inventory

   $ 253,422       $ 267,460   

Other assets

     83,674         130,840   
  

 

 

    

 

 

 

Total assets

$ 337,096    $ 398,300   
  

 

 

    

 

 

 

Liabilities and equity

Notes payable

$ 159,042    $ 78,589   

Other liabilities

  58,376      99,395   
  

 

 

    

 

 

 

Total liabilities

  217,418      177,984   

Equity:

The Company (a)

  33,731      47,397   

Others

  85,947      172,919   
  

 

 

    

 

 

 

Total equity

  119,678      220,316   
  

 

 

    

 

 

 

Total liabilities and equity

$ 337,096    $ 398,300   
  

 

 

    

 

 

 

Condensed Income Statement Information

 

     Years Ended December 31,  
     2014     2013     2012  
     (In thousands)  

Revenues

   $ 288,623      $ 90,743      $ 46,586   

Expenses

     (223,899     (85,594     (48,079
  

 

 

   

 

 

   

 

 

 

Net income (loss)

  64,724      5,149      (1,493
  

 

 

   

 

 

   

 

 

 

The Company’s share of net income (loss)

$ 9,142    $ (1,104 $ 378   
  

 

 

   

 

 

   

 

 

 

 

(a) At December 31, 2014 and 2013, includes Deficit Distributions of $0.3 million and $0.4 million, respectively.

 

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At December 31, 2014 and 2013, total unconsolidated joint ventures’ notes payable consisted of the following:

 

     December 31,  
     2014      2013  
     (In thousands)  

Bank and seller notes payable:

     

Guaranteed (subject to remargin obligations)

   $ 55,675       $ 52,515   

Non-Guaranteed

     34,824         10,073   
  

 

 

    

 

 

 

Total bank and seller notes payable (a)

  90,499      62,588   
  

 

 

    

 

 

 

Partner notes payable (b) :

Unsecured

  68,543      16,001   
  

 

 

    

 

 

 

Total unconsolidated joint venture notes payable

$ 159,042    $ 78,589   
  

 

 

    

 

 

 

Other unconsolidated joint venture notes payable (c)

$ 83,847    $ 55,441   
  

 

 

    

 

 

 

 

(a) All bank and seller notes were secured by real property.
(b) No guarantees were provided on partner notes payables. In January 2014, a $3.2 million partner note from one joint venture was paid in full.
(c) Through indirect effective ownership in two joint ventures of 12.3% and 0.0003%, respectively, that had bank notes payable secured by real property in which we have not provided a guaranty.

At December 31, 2014 and 2013, remargin obligations and guarantees provided on debt of our unconsolidated joint ventures were on a joint and/or several basis and include, but are not limited to, project completion, interest and carry, and loan-to-value maintenance guarantees.

For a joint venture, RRWS, LLC (“RRWS”), we have a remargin obligation that is limited to the lesser of 50% of the outstanding balance in total for these joint venture loans or $35.0 million, which outstanding loan balances at December 31, 2014 and 2013 were $43.0 million and $47.7 million, respectively. Consequently, our maximum remargin obligation at December 31, 2014 and 2013 was $21.5 million and $23.8 million, respectively. We also have an agreement where we could potentially recover a portion of payments we made. However, we cannot provide assurance we could collect under this agreement.

For a second joint venture, Polo Estates Ventures, LLC (“Polo”), we have a joint and several remargin guarantee on loan obligations which, in total at December 31, 2014 and 2013 were $12.7 million and $4.8 million, respectively. At December 31, 2014 and 2013, the total maximum borrowings permitted on these loans were $21.6 million and $21.6 million, respectively. We also have reimbursement rights where we could potentially recover a portion of payments we made. However, we cannot provide assurance we could collect such payments.

No liabilities were recorded for these guarantees at December 31, 2014 and 2013 as the fair value of the secured real estate assets exceeded the threshold at which a remargin payment is required.

At December 31, 2014 and 2013, loan advances to unconsolidated joint ventures, including accrued interest, were $8.7 million and $1.0 million, respectively. These notes receivable bear interest ranging from 7.5% to 12% and mature through 2021. Further, a loan advance bearing 8% interest can earn additional interest to achieve a 17.5% internal rate of return, subject to available cash flows of the joint venture, and can be repaid prior to 2020. Quarterly, we evaluate collectability of these loan advances, which includes consideration of prior payment history, operating performance and future payment requirements under the applicable note. Based on these criteria, we do not anticipate collection risks on these loan advances.

 

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Our ability to make joint venture and other restricted payments and investments is governed by the Indenture governing the Secured Notes (the “Indenture”, see Note 10). We are permitted to make restricted payments under (i) a $70.0 million revolving basket available solely for joint venture investments and advances; (ii) a $10 million general basket that can be used for joint venture investments and advances; and (iii) a broader restricted payment basket available if our Consolidated Fixed Charge Coverage Ratio (as defined in the Indenture) is at least 2.0 to 1.0. The aggregate amount of restricted payments made under this broader restricted payment basket cannot exceed 50% of our cumulative Consolidated Net Income (as defined in the Indenture) generated from and including October 1, 2013, plus the aggregate net cash proceeds of, and the fair market value of, any property or other asset received by the Company as a capital contribution or upon the issuance of indebtedness or certain securities by the Company from and including October 1, 2013, plus, to the extent not included in Consolidated Net Income, certain amounts received in connection with dispositions, distributions or repayments of restricted investments, plus the value of any unrestricted subsidiary which is redesignated as a restricted subsidiary under the Indenture. We have joint ventures which have used, and are expected to use, capacity under these restricted payment baskets. In 2013, we entered into a joint venture in Southern California and committed to contribute up to $45.0 million. At December 31, 2013, we made aggregate contributions of $15.1 million to this joint venture, which were returned to us by December 31, 2014.

8. Variable Interest Entities

ASC 810 requires a VIE to be consolidated in the financial statements of a company if it is the primary beneficiary of the VIE. Accordingly, the primary beneficiary has the power to direct activities of the VIE that most significantly impact the VIE’s economic performance, and the obligation to absorb its losses or the right to receive its benefits. At December 31, 2014 and 2013, all VIEs were evaluated to determine the primary beneficiary.

Joint Ventures

We enter into joint ventures for homebuilding and land development activities. Investments in these joint ventures may create a variable interest in a VIE, depending on contractual terms of the venture. We analyze our joint ventures in accordance with ASC 810 to determine whether they are VIEs and, if so, whether we are the primary beneficiary. At December 31, 2014 and 2013, these joint ventures were not consolidated in our consolidated financial statements since they were not VIEs, or if they were VIEs, we were not the primary beneficiary.

At December 31, 2014 and 2013, we had a variable interest in an unconsolidated joint venture determined to be a VIE. The joint venture, RRWS, was formed in December 2012 and is owned 50% by us and 50% by a third-party real estate developer (the “RRWS Partner”). Several acquisition, development and construction loans were entered into by RRWS, each with two-year terms and options to extend for one year, subject to certain conditions. Each loan is cross collateralized and cross defaulted with the other loan. We and RRWS Partner each executed limited completion, interest and carry guarantees and environmental indemnities on a joint and several basis. In addition, we and RRWS Partner executed loan-to-value maintenance agreements for each loan on a joint and several basis. We have a maximum aggregate liability under the remargin arrangements of the lesser of 50% of the outstanding balances in total for these joint venture loans or $35.0 million. Our and RRWS Partner’s obligations under the remargin arrangements are limited during the first two years of the loans. In addition to remargin arrangements, the RRWS Partner and several of its principals executed repayment guarantees with no limit on their liability. At December 31, 2014 and 2013, outstanding bank notes payable were $43.0 million and $47.7 million, respectively, of which we have a maximum remargin obligation of $21.5 million and $23.8 million, respectively. We also have an agreement from the RRWS Partner, under which we could potentially recover a portion of payments we made. However, we cannot provide assurance we could collect under this agreement.

At December 31, 2014 and 2013, we had a variable interest in a second unconsolidated joint venture determined to be a VIE. The joint venture, Polo, was formed in November 2012 and is owned 50% by us and 50% by a third-party investor (“Polo Partner”). Polo entered into acquisition, development and construction loans in July 2013 with two-year terms and options to extend for one year, subject to certain conditions. Each loan is cross collateralized and cross defaulted with the other loan. We and Polo Partner each executed loan-to-value maintenance arrangements for each loan on a joint and several basis. At December 31, 2014 and 2013, outstanding bank notes payable were $12.7 million and $4.8 million, respectively, and total maximum borrowings permitted on these loans were $21.6 million and $21.6 million, respectively. We also have reimbursement rights where we could potentially recover a portion of payments we made. However, we cannot provide assurance we could collect such payments.

At December 31, 2014 and December 31, 2013, we had a variable interest in a third unconsolidated joint venture determined to be a VIE. The joint venture, Vistancia West Holdings LP (“Vistancia West”), was formed in August 2013 and is owned 10% by us and 90% by a third-party investor (“Vistancia West Partner”). A wholly-owned subsidiary of Vistancia West entered into a $27.5 million revolving credit facility in September 2014 with a three-year term, renewable annually subject to certain conditions. The revolving credit facility is secured by the underlying property and is non-recourse to us and the Vistancia West Partner. At December 31, 2014, outstanding bank notes payable were $3.8 million.

 

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In accordance with ASC 810, we determined we were not the primary beneficiaries of RRWS, Polo and Vistancia West because we did not have the power to direct activities that most significantly impact the economic performance of these entities, such as determining or limiting the scope or purpose of the respective entity, selling or transferring property owned or controlled by the respective entity, and arranging financing for the respective entity.

Land Option Contracts

We enter into land option contracts to procure land for home construction. Use of land option and similar contracts allows us to reduce market risks associated with direct land ownership and development, reduces capital and financial commitments, including interest and other carrying costs, and minimizes land inventory. Under these contracts, we pay a specified deposit for the right to purchase land, usually at a predetermined price. Under the requirements of ASC 810, certain contracts may create a variable interest with the land seller.

In accordance with ASC 810, we analyzed our land option and similar contracts to determine if respective land sellers are VIEs and, if so, if we are the primary beneficiary. Although we do not have legal title to the optioned land, ASC 810 requires us to consolidate a VIE if we are the primary beneficiary. At December 31, 2014 and 2013, we determined we were not the primary beneficiary of such VIEs because we did not have the power to direct activities of the VIE that most significantly impact the VIE’s economic performance, such as selling, transferring or developing land owned by the VIE.

At December 31, 2014, we had $4.2 million of refundable and non-refundable cash deposits associated with land option contracts with unconsolidated VIEs, having a $60.6 million remaining purchase price. We also had $21.2 million of refundable and non-refundable cash deposits associated with land option contracts that were not with VIEs, having a $450.6 million remaining purchase price.

Our loss exposure on land option contracts consists of non-refundable deposits, which were $24.8 million and $6.9 million at December 31, 2014 and 2013, respectively, and capitalized preacquisition costs of $4.4 million and $12.0 million, respectively, which were in inventory in the consolidated balance sheets.

9. Other Assets, Net

At December 31, 2014 and 2013, other assets were as follows:

 

     December 31,  
     2014      2013  
     (In thousands)  

Income tax receivable

   $ 1,384       $ 2,199   

Deferred tax asset (see Note 13)

     20,159         16,337   

Investments

     9,815         9,439   

Property and equipment, net

     4,140         4,103   

Capitalized loan origination fees

     9,730         11,089   

Deposits in lieu of bonds and letters of credit

     8,653         10,294   

Prepaid insurance

     2,589         2,460   

Other

     2,652         1,149   
  

 

 

    

 

 

 

Total other assets, net

$ 59,122    $ 57,070   
  

 

 

    

 

 

 

Investments

Investments consist of available-for-sale securities, primarily private debt obligations, and are measured at fair value, which is based on quoted market prices or cash flow models. Accordingly, unrealized gains and temporary losses on investments, net of tax, are reported as accumulated other comprehensive income (loss). Realized gains and losses are determined using the specific identification method.

For the year ended December 31, 2013, there were $0.1 million of realized gains on available-for-sale securities. For the year ended December 31, 2014, there were no realized gains or losses.

 

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Capitalized Loan Origination Fees

In accordance with ASC 470, loan origination fees are capitalized and amortized as interest over the term of the related debt.

Deposits in Lieu of Bonds and Letters of Credit

We make cash deposits in lieu of bonds or letters of credit with various agencies for some of our homebuilding projects. These deposits may be returned as the collateral requirements decrease or they are replaced with new bonds or letters of credit.

10. Notes Payable

At December 31, 2014 and 2013, notes payable were as follows:

 

     December 31,  
     2014      2013  
     (In thousands)  

$750.0 million 8.625% senior secured notes, due May 2019

   $ 750,000       $ 750,000   

$125.0 million secured revolving credit facility (the “Revolver”), interest currently at the applicable Eurocurrency rate plus 2.75%, matures March 1, 2016

     0         0   

Promissory notes, interest ranging from 1% to 4%, maturing through 2016, secured by deeds of trust on inventory

     11,404         1,708   
  

 

 

    

 

 

 

Total notes payable

$ 761,404    $ 751,708   
  

 

 

    

 

 

 

Our Secured Notes were issued on May 10, 2011 at $750.0 million, bear interest at 8.625% paid semi-annually on May 15 and November 15, and do not require principal payments until maturity on May 15, 2019. The Secured Notes are redeemable, in whole or in part, at the Company’s option beginning on May 15, 2015 at a price of 104.313 per bond, reducing to 102.156 on May 15, 2016 and are redeemable at par beginning on May 15, 2017. The Secured Notes may be redeemed prior to May 15, 2015 subject to a make-whole premium. At December 31, 2014 and 2013, accrued interest was $8.1 million and $8.1 million, respectively.

The Indenture contains covenants that limit, among other things, our ability to incur additional indebtedness (including the issuance of certain preferred stock), pay dividends and distributions on our equity interests, repurchase our equity interests, retire unsecured or subordinated notes more than one year prior to their maturity, make investments in subsidiaries and joint ventures that are not restricted subsidiaries that guarantee the Secured Notes, sell certain assets, incur liens, merge with or into other companies, expand into unrelated businesses, and enter in certain transactions with our affiliates. At December 31, 2014 and 2013, we were in compliance with these covenants.

In February 2014, we replaced our $75.0 million letter of credit facility with the Revolver, which bears interest, at the Company’s option, either at (i) a daily eurocurrency base rate as defined in the credit agreement governing the Revolver (the “Credit Agreement”), plus a margin of 2.75%, or (ii) a eurocurrency rate as defined in the Credit Agreement, plus a margin of 2.75%, and matures March 1, 2016. Borrowing availability is determined by a borrowing base formula and we are subject to financial covenants, including minimum net worth and leverage and interest coverage ratios. If we do not maintain compliance with these financial covenants, the Revolver converts to an 18-month amortizing term loan. At December 31, 2014, we were in compliance with these covenants and no amounts were outstanding.

 

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11. Other Liabilities

At December 31, 2014 and 2013, other liabilities were as follows:

 

     December 31,  
     2014      2013  
     (In thousands)  

Completed operations reserves

   $ 136,155       $ 138,610   

Warranty reserves

     22,698         20,648   

Accrued profit and revenue participation arrangements (see Note 12)

     23,815         678   

Deferred revenue/gain

     22,769         29,358   

Provisions for delivered homes/communities

     9,116         10,591   

Deposits (primarily homebuyer)

     17,869         14,281   

Legal reserves

     15,705         4,576   

Accrued interest

     8,127         8,086   

Accrued compensation and benefits

     12,534         9,389   

Distributions payable

     2,169         2,531   

Deficit Distributions (see Note 7)

     307         351   

Other

     7,066         6,702   
  

 

 

    

 

 

 

Total other liabilities

$ 278,330    $ 245,801   
  

 

 

    

 

 

 

Completed Operations Reserves

Reserves for completed operations primarily represent claims for property damage to completed homes and projects outside of our one-to-two year fit and finish warranty period. Specific length, terms and conditions of completed operations claims vary depending on the market in which homes deliver and can range up to ten years from the delivery of a home. Expenses and liabilities are recorded for potential completed operations claims based upon aggregated loss experience, which includes an estimate of completed operations claims incurred but not reported, and is actuarially estimated using individual case-based valuations and statistical analysis. For policy years from August 1, 2001 through the present, completed operations claims are insured or reinsured by third-party and affiliate insurance carriers.

For the years ended December 31, 2014, 2013 and 2012, changes in completed operations reserves were as follows:

 

     Years Ended December 31,  
     2014     2013     2012  
     (In thousands)  

Insured completed operations

      

Balance, beginning of the year

   $ 138,610      $ 131,519      $ 109,390   

Reserves provided

     15,133        19,002        40,087   

Claims paid

     (17,588     (11,911     (17,958
  

 

 

   

 

 

   

 

 

 

Total completed operations reserves

$ 136,155    $ 138,610    $ 131,519   
  

 

 

   

 

 

   

 

 

 

Reserves provided for completed operations are generally fully offset by changes in insurance receivables (see Note 5); however, premiums paid for completed operations insurance policies are included in cost of sales. For actual completed operations claims and estimates of completed operations claims incurred but not reported, we estimate and record corresponding insurance receivables under applicable policies when recovery is probable. At December 31, 2014 and 2013, insurance receivables were $136.2 million and $138.6 million, respectively.

Expenses, liabilities and receivables related to these claims are subject to a high degree of variability due to uncertainties such as trends in completed operations claims related to our markets and products built, claims reporting and settlement patterns, insurance industry practices, insurance regulations and legal precedent. Although considerable variability is inherent in such estimates, we believe reserves for completed operations claims are adequate.

 

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Warranty Reserve

We offer a limited one or two year fit and finish warranty for our homes. Specific terms and conditions of these warranties vary in the markets in which homes deliver. We estimate warranty costs to be incurred and record a liability and a charge to cost of sales when home revenue is recognized. We also include in our warranty reserve the uncovered losses related to completed operations coverage, which approximates 12.5% of the total property damage estimate. Factors affecting warranty liability include number of homes delivered, historical and anticipated warranty claims, and cost per claim history and trends. We regularly assess the adequacy of our warranty liabilities and adjust amounts as necessary.

For the years ended December 31, 2014, 2013 and 2012, changes in warranty liability were as follows:

 

     Years Ended December 31,  
     2014     2013     2012  
     (In thousands)  

Balance, beginning of the year

   $ 20,648      $ 17,749      $ 17,358   

Provision for warranties

     14,363        11,188        8,958   

Warranty costs paid

     (12,313     (8,289     (8,567
  

 

 

   

 

 

   

 

 

 

Balance, end of the year

$ 22,698    $ 20,648    $ 17,749   
  

 

 

   

 

 

   

 

 

 

Deferred Revenue/Gain

Deferred revenue/gain represents deferred revenues or gains on transactions in which an insufficient down payment was received or a future performance, passage of time or event is required. At December 31, 2014 and 2013, deferred revenue/gain primarily represents the PIC Transaction described below.

Completed operations claims were insured through PIC for policy years August 1, 2001 to July 31, 2007. In December 2009, PIC entered into a series of novation and reinsurance transactions (the “PIC Transaction”).

First, PIC entered into a novation agreement with JFSCI to novate its deductible reimbursement obligations related to its workers’ compensation and general liability risks at September 30, 2009 for policy years August 1, 2001 to July 31, 2007, and its completed operations risks from August 1, 2005 to July 31, 2007. Concurrently, JFSCI entered into insurance arrangements with third party insurance carriers to insure these policies. As a result of this novation, a $19.2 million gain was deferred and will be recognized as income when related claims are paid. In addition, the deferred gain may change based on changes in actuarial estimates. Changes to the deferred gain are recognized as current period income or expense. At December 31, 2014 and 2013, the unamortized deferred gain was $14.9 million and $18.9 million, respectively. For the years ended December 31, 2014, 2013 and 2012, we recognized $4.1 million, $1.4 million and $(4.7) million, respectively, of this deferral as income (expense), which was included in gain (loss) on reinsurance transaction, and includes both the impact of income recognized from claims paid and as income or expense from increases or decreases to the deferred gain from changes in actuarial estimates.

Second, PIC entered into reinsurance agreements with unrelated reinsurers that reinsured 100% of its expected completed operations risks from August 1, 2001 to July 31, 2005. As a result of the reinsurance, a $15.6 million gain was deferred and will be recognized as income when the related claims are paid. In addition, the deferred gain may change based on changes in actuarial estimates. Changes to the deferred gain are recognized as current period income or expense. At December 31, 2014 and 2013, the unamortized deferred gain was $4.7 million and $7.8 million, respectively. For the years ended December 31, 2014, 2013, and 2012, we recognized $3.1 million, $0.6 million and $(7.3) million, respectively, of this deferral as income (expense), which was included in gain (loss) on reinsurance transaction, and includes both the impact of income recognized from claims paid as well as income or expense from increases or decreases to the deferred gain from changes in actuarial adjustments.

As a result of the PIC Transaction, if the estimated ultimate loss to be paid under these policies exceeds the policy limits under the novation and reinsurance transactions, the shortfall is expected to be funded by JFSCI for the policies novated to JFSCI and by PIC for the policies it reinsured.

 

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Distributions Payable

In December 2011, our consolidated joint venture, Vistancia, LLC, sold its remaining interest in an unconsolidated joint venture (the “Vistancia Sale”). As a result of the Vistancia Sale, no other assets of Vistancia, LLC economically benefit the former non-controlling member of Vistancia, LLC and we recorded the remaining $3.3 million distribution payable to this member, which is paid $0.1 million quarterly. At December 31, 2014 and 2013, the distribution payable was $2.2 million and $2.5 million, respectively.

12. Affiliate Transactions

Affiliate Receivables and Payables

At December 31, 2014 and 2013, receivables from affiliates, net were as follows:

 

     December 31,  
     2014     2013  
     (In thousands)  

Note receivable from JFSCI

   $ 0      $ 21,588   

Notes receivable from affiliates

     15,303        18,822   

Reserves for notes receivable from affiliates

     (12,917     (12,842

Receivables from affiliates

     4,017        3,745   
  

 

 

   

 

 

 

Total receivables from affiliates, net

$ 6,403    $ 31,313   
  

 

 

   

 

 

 

In May 2011, concurrent with issuance of the Secured Notes, the previous unsecured receivable from JFSCI was partially paid down and the balance converted to a $38.9 million unsecured term note receivable, bearing 4% interest, payable in equal quarterly installments and maturing May 15, 2019. During 2013, JFSCI elected to make prepayments, including accrued interest, of $3.8 million and in 2014, paid the balance in full.

At December 31, 2014 and 2013, notes receivable from affiliates, including accrued interest, were $2.4 million and $6.0 million, respectively, net of related reserves of $12.9 million and $12.8 million, respectively. These notes are unsecured and mature from August 2016 through March 2019. At December 31, 2014, these notes bore interest ranging from Prime less 0.75% (2.5%) to 4.20%, and at December 31, 2013, from Prime less .75% (2.5%) to 4.25%. Quarterly, we evaluate collectability of these notes which includes consideration of prior payment history, operating performance and future payment requirements under the applicable notes. Based on these criteria, two notes receivable were deemed uncollectible in 2009 and fully reserved. We do not anticipate collection risks on the other notes receivable.

The Company, entities under common control and certain unconsolidated joint ventures also engage in transactions on behalf of the other, such as payment of invoices and payroll. Amounts resulting from these transactions are recorded in receivables from affiliates or payables to affiliates, are non-interest bearing, due on demand and generally paid monthly. At December 31, 2014 and 2013, these receivables were $4.0 million and $3.7 million, respectively, and these payables were $4.8 million and $0.1 million, respectively.

Real Property and Joint Venture Transactions

Redemption or Purchase of Interest in Joint Venture

In March 2012, our entire 58% interest in Shea Colorado, LLC (“SCLLC”), a consolidated joint venture with Shea Properties II, LLC, an affiliate and the non-controlling member, was redeemed by SCLLC. In valuing our 58% interest in SCLLC, and to ensure receipt of net assets of equal value to our ownership interest, we used third-party real estate appraisals. The estimated fair value of the assets received by us was $30.8 million. However, as the non-controlling member is an affiliate under common control, the assets and liabilities received by us were recorded at net book value and the difference in our investment in SCLLC and the net book value of the assets and liabilities received was recorded as a reduction to our equity.

As consideration for the redemption, SCLLC distributed assets and liabilities to us having a net book value of $24.0 million, including $2.2 million of cash, a $3.0 million secured note receivable, $20.0 million of inventory and $1.2 million of other liabilities. As a result of this redemption, effective March 31, 2012, SCLLC is no longer included in these consolidated financial statements. This transaction resulted in a net reduction of $41.8 million in assets and $2.0 million in liabilities, and a $39.8 million reduction in total equity, of which $11.6 million was attributable to our equity and $28.2 million was attributable to non-controlling interests.

 

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Other Real Property and Joint Venture Transactions

In January 2014, we entered into a purchase and sale agreement with an affiliate and acquired undeveloped land in Northern California. Consideration included $4.4 million of cash, assumption of a $1.3 million net liability, and future revenue participation payments (the “RAPA”), which is calculated at 11% of gross revenues from home deliveries, payable quarterly and limited to $19.6 million. The RAPA liability, based on a third-party real estate appraisal, is estimated to be $19.6 million, which is included in other liabilities (see Note 11). As the transaction is with an affiliate under common control, the $25.3 million of consideration to be paid in excess of book value was recorded as an equity distribution.

In February 2014, we entered into a purchase and sale agreement to sell land in Southern California to an affiliate under common control for $1.0 million cash and assumption of certain construction obligations. The $0.9 million of net sales proceeds received in excess of the net book value of the land sold was recorded as an equity contribution.

In June 2014, we entered into a purchase and sale agreement (“PSA”) to purchase land in Northern California from an unconsolidated joint venture in which we have a 33% ownership interest. We paid $2.7 million for 70 lots and acquired an option to purchase 262 lots in seven phases through 2019 for an estimated $18.5 million. The PSA also includes additional consideration based on future price and profit appreciation for each phase, payable after the last home delivery for that respective phase. In conjunction with the purchase of the 70 lots, we deferred $0.9 million of profit representing our proportionate share of the corresponding land sale profit from the joint venture and recorded it as a reduction of inventory.

In October 2012, we sold land in Colorado to an affiliate for $4.6 million. As the affiliate is under common control, the $2.4 million of net sales proceeds received in excess of the net book value of the land sold was recorded as an equity contribution.

At December 31, 2014 and 2013, we were the managing member for 13 and 10, respectively, unconsolidated joint ventures and received management fees from these joint ventures as reimbursement for direct and overhead costs incurred on behalf of the joint ventures. Fees representing cost reimbursement are recorded as an offset to general and administrative expense; fees in excess of costs are recorded as revenues. For the years ended December 31, 2014, 2013 and 2012, $11.4 million, $8.0 million and $4.3 million, respectively, of management fees were offset against general and administrative expenses; and $1.1 million, $0.5 million and $0.2 million, respectively, of management fees were included in revenues.

Other Affiliate Transactions

JFSCI provides corporate services, including management, legal, tax, information technology, risk management, facilities, accounting, treasury and human resources. For the years ended December 31, 2014, 2013 and 2012, general and administrative expenses included $23.3 million, $20.3 million and $18.1 million, respectively, for these corporate services.

We obtain workers compensation insurance, commercial general liability insurance and insurance for completed operations losses and damages with respect to our homebuilding operations from affiliate and unrelated third-party insurance providers. Some of these policies are purchased by affiliate entities and we pay premiums to these affiliates for the coverage provided by these third party and affiliate insurance providers. Policies covering these risks from unrelated third party insurance providers are written at various coverage levels but include a large self-insured retention or deductible. We have retention liability insurance from affiliated entities to insure these large retentions or deductibles. For the years ended December 31, 2014, 2013 and 2012, amounts paid to affiliates for this retention insurance coverage were $21.3 million, $14.1 million and $13.1 million, respectively.

 

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13. Income Taxes

Income Tax Benefit (Expense)

For the years ended December 31, 2014, 2013 and 2012, major components of the income tax benefit (expense), primarily for SHI, were as follows:

 

     Years Ended December 31,  
     2014     2013     2012  
     (In thousands)  

Current:

      

Federal

   $ (19,361   $ 0      $ 0   

State

     (3,673     (1,766     (78
  

 

 

   

 

 

   

 

 

 

Total current

  (23,034   (1,766   (78

Deferred:

Federal

  4,577      13,385      (532

State

  244      2,482      (6
  

 

 

   

 

 

   

 

 

 

Total deferred

  4,821      15,867      (538
  

 

 

   

 

 

   

 

 

 

Total income tax benefit (expense)

$ (18,213 $ 14,101    $ (616
  

 

 

   

 

 

   

 

 

 

Reconciliation of Expected Income Tax Benefit (Expense)

For the years ended December 31, 2014, 2013 and 2012, the effective tax rate differed from the 35% federal statutory rate due to the following:

 

     Years Ended December 31,  
     2014     2013     2012  
     (Dollars in thousands)  

Income before income taxes

   $ 151,612      $ 111,838      $ 29,800   
  

 

 

   

 

 

   

 

 

 

Income tax expense computed at statutory rate

$ (53,064 $ (39,143 $ (10,430

Increase (decrease) resulting from:

Non-taxable entities income (a)

  35,893      25,275      7,134   

State taxes, net of federal income tax benefit

  (2,603   (1,901   (1,045

Small insurance company election (831b)

  1,057      198      (2,583

Section 199 deduction

  1,313      875      0   

Change in valuation allowance for deferred tax assets

  247      32,223      5,461   

Other, net

  (1,056   (3,426   847   
  

 

 

   

 

 

   

 

 

 

Total income tax benefit (expense)

$ (18,213 $ 14,101    $ (616
  

 

 

   

 

 

   

 

 

 

Effective tax rate

  12.0   (12.6 )%    2.1
  

 

 

   

 

 

   

 

 

 

 

(a) Non-taxable entities represent income or loss related to SHLP, non-controlling interests and consolidated limited partnerships and limited liability companies in which the taxable income or loss is reflected on the respective partners’ tax return.

 

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Deferred Income Taxes

At December 31, 2014 and 2013, the tax effects of temporary differences that give rise to significant portions of deferred taxes for SHI were as follows:

 

     December 31,  
     2014     2013  
     (In thousands)  

Deferred tax assets:

    

Housing and land inventory basis differences

   $ 14,214      $ 8,746   

Available loss carryforwards

     4,961        7,696   

Impairment of inventory and investments

     482        782   

Other

     1,399        1,166   
  

 

 

   

 

 

 

Total deferred tax assets

  21,056      18,390   

Deferred tax liabilities

Income recognition

  (635   (1,544
  

 

 

   

 

 

 

Total deferred tax liabilities

  (635   (1,544
  

 

 

   

 

 

 

Subtotal

  20,421      16,846   

Valuation allowance

  (262   (509
  

 

 

   

 

 

 

Net deferred tax assets

$ 20,159    $ 16,337   
  

 

 

   

 

 

 

Due to a change in ownership of Shea Homes Southwest, Inc., formerly known as Foundation Administration Services Corp., a wholly-owned subsidiary, in 2001, NOL carryforwards utilized in a given year to offset future taxable income are subject to an annual limitation of approximately $4.6 million pursuant to Section 382 of the U.S. Internal Revenue Code of 1986, as amended. As a result of this annual limitation, available N