Contingencies

Beazer Homes and certain of its subsidiaries have been and continue to be named as defendants in various construction defect claims, complaints and other legal actions. The Company is subject to the possibility of loss contingencies arising from its business. In determining loss contingencies, we consider the likelihood of loss as well as the ability to reasonably estimate the amount of such loss or liability. An estimated loss is recorded when it is considered probable that a liability has been incurred and the amount of loss can be reasonably estimated.

Warranty Reserves. We currently provide a limited warranty (ranging from one to two years) covering workmanship and materials per our defined standards of performance. In addition, we provide a limited warranty for up to ten years covering only certain defined structural element failures.

Our homebuilding work is performed by subcontractors that typically must agree to indemnify us with regard to their work and provide us with certificates of insurance demonstrating that they have met our insurance requirements and that we are named as an additional insured under their policies. Therefore, many claims relating to workmanship and materials that result in warranty spending are the primary responsibility of these subcontractors. In addition, we maintain insurance coverage related to our construction efforts that can result in recoveries of warranty and construction defect costs above certain specified limits.

Our warranty reserves are included in other liabilities on our consolidated balance sheets, and the provision for warranty accruals is included in home construction expenses in our consolidated statements of income. We record reserves covering anticipated warranty expense for each home we close. Management reviews the adequacy of warranty reserves each reporting period based on historical experience and management’s estimate of the costs to remediate the claims and adjusts these provisions accordingly. Our review includes a quarterly analysis of the historical data and trends in warranty expense by division. An analysis by division allows us to consider market specific factors such as our warranty experience, the number of home closings, the prices of homes, product mix and other data in estimating our warranty reserves. In addition, our analysis also contemplates the existence of any non-recurring or community-specific warranty-related matters that might not be included in our historical data and trends. While we adjust our estimated warranty liabilities each reporting period to the extent required as a result of our quarterly analyses, historical data and trends may not accurately predict actual warranty costs, which could lead to a significant change in the reserve.

Changes in our warranty reserves are as follows for the periods presented:



	Fiscal Year Ended September 30,
(In thousands)	2016			2015			2014
Balance at beginning of period	$	27,681		$	16,084		$	11,663
Accruals for warranties issued ^(a)	13,835			10,356			6,087
Changes in liability related to warranties existing in prior periods ^(b)	53,109			30,482			9,836
Payments made ^(b)	(55,494		)	(29,241		)	(11,502		)
Balance at end of period	$	39,131		$	27,681		$	16,084

^(a) Accruals for warranties issued are a function of the number of home closings in the period, the selling prices of the homes closed and the rates of accrual per home estimated as a percentage of the selling price of the home. The continued increase in the amount of accrual compared to the respective prior year periods is mainly due to an increase in the number of closings and the sales prices of homes closed, as well as increases in certain divisions' accrual rates.

^(b) Changes in liability related to warranties existing and payments made in all periods, particularly fiscal 2016 and fiscal 2015, are elevated due to charges and subsequent payments related to water intrusion issues in certain of our communities located in Florida (refer to separate discussion below).

Florida and New Jersey Water Intrusion Issues

In the latter portion of our fiscal 2014, we began to experience an increase in calls from homeowners reporting stucco and water intrusion issues in certain of our communities in Florida and one community in New Jersey. These issues continued to be reported to us in Florida throughout our fiscal 2015 and fiscal 2016. In New Jersey, while the calls were initially isolated to one community, we received calls from a second community with similar issues during the current fiscal year. Through September 30, 2016, we have cumulatively recorded $80.4 million in charges related to these issues, of which $78.6 million related to communities in Florida and $1.8 million related to the two communities in New Jersey. Refer to discussion below for further detail.

Florida. The water intrusion issues in Florida (the Florida stucco issues) relate to stucco installation in multiple communities that first became known during our fiscal 2014. Other builders were also dealing with similar stucco issues, some of which received local media coverage. Throughout fiscal 2015, with many homeowners seeing an increased level of warranty-related activities occurring in their communities, the number of stucco and water-related warranty calls in Florida increased significantly. This led us to expand the scope of our inspections, including to homes and communities from which no warranty calls had been received. This enhanced review resulted in us determining that more homes and communities in Florida were likely to be adversely affected, leading to higher repair costs. Based on all of these activities and our resulting analysis, we recorded additional warranty expense of $26.3 million during the year ended September 30, 2015 related to the Florida stucco issues, in addition to the $4.3 million recorded during our fiscal 2014. As of September 30, 2015, the accrual to cover outstanding payments and potential repair costs for the impacted homes was $14.5 million, after considering the repair costs already paid.

During our fiscal 2016, we received additional homeowner calls beyond those anticipated based on our procedures and previous call history and increased our cost estimates, causing us to record additional warranty expense related to the Florida stucco issues of $48.0 million. Our cost estimates to repair homes discovered in more recent periods are considerably higher than initial estimates, as these homes require more extensive repairs. As of September 30, 2016, 690 homes have been identified as likely to require repairs (an increase of 158 homes to those that were anticipated to require repairs as of the end of our fiscal 2015), of which 437 homes have been repaired. We made payments related to the Florida stucco issues of $39.9 million during the current fiscal year, including payments on fully repaired homes, as well as payments on homes for which remediation is not yet complete, bringing the remaining accrual to $22.6 million as of September 30, 2016, which is included in our overall warranty liability detailed above. As of September 30, 2016, additional homes in the impacted communities remain within the period specified by the applicable statute of repose but are not yet deemed likely to require repairs and have not been reserved for. The cost to repair these additional homes would be approximately $4.7 million if the current cost estimates were applied to these additional homes.

Our assessment of the Florida stucco issues is ongoing. As a result, we anticipate that the ultimate magnitude of our liability may change as additional information is obtained. Certain visual and other inspections of the homes that could be subject to defect often do not reveal the severity or extent of the defects, which can only be discovered once we receive a homeowner call and begin repairs. The current fiscal year charges were more than offset by additional insurance recoveries from our insurers, while $13.6 million and $4.3 million in expense related to the Florida stucco issues was not offset by expected insurance recoveries in fiscal 2015 and 2014, respectively, as we had not yet surpassed the thresholds specified in our insurance policies. For a discussion of the amounts we have already recovered or anticipate recovering from our insurer, refer to “Insurance Recoveries” section below.

In addition, we believe that we will also recover a portion of such repair costs from sources other than our own insurer, including the subcontractors involved with the construction of these homes and their insurers; however, no amounts related to subcontractor recoveries have been recorded in our consolidated financial statements as of September 30, 2016. Any amounts recovered from our subcontractors related to homes closed during policy years for which we have surpassed the thresholds in our insurance policies would be remitted to our third-party insurers, while recoveries in other policy years would be retained by us.

New Jersey. Initially, the water intrusion issues in New Jersey related to flashing and stone installation on homes in one specific community, for which we recorded $0.6 million in charges during our fiscal 2014. During our fiscal 2016, we began to receive homeowner calls related to one additional community citing similar issues, causing us to inspect the homes within the community and record an additional reserve of $1.2 million during the current fiscal year, which is also included in our overall warranty liability as of September 30, 2016. Similar to the Florida stucco issues discussed above, the costs recorded during the current year period were fully offset by additional insurance recoveries from our third-party insurance, which is described below, while costs incurred related to this issue in our fiscal 2014 were not offset.

Insurance Recoveries

The Company has insurance policies that provide for the reimbursement of certain warranty costs incurred by us above a specified threshold for each period covered. We have surpassed these thresholds for certain policy years, particularly those that cover most of the homes impacted by the water intrusion issues discussed above. As such, we expect a substantial majority of additional costs incurred after the first quarter of our fiscal 2015 for warranty work on homes within these policy years to be reimbursed by our insurers. For one policy year, our accruals have exceeded the insurance claim limit for one division under our first layer of coverage; however, we expect to claim and recover such amounts under our excess insurance coverage.

Warranty expense beyond the thresholds set in our insurance policies was recorded related to homes impacted by the Florida stucco issues and the water intrusion issues in New Jersey, as well as other various warranty issues, resulting in our recognition of $59.3 million and $18.9 million in insurance recoveries during our fiscal 2016 and 2015, respectively, that we have received or deem probable of receiving. Amounts recorded for anticipated insurance recoveries are reflected within our consolidated statements of income as a reduction of our home construction expenses, and associated amounts not yet received from our insurer were recorded on a gross basis (i.e. not net of any associated warranty expense) as a receivable within accounts receivable on our consolidated balance sheets.

As of September 30, 2016, we have cumulatively recorded $78.2 million in insurance recoveries related to insurance policy years for which we have surpassed our deductible. We have received multiple payments under these policies from our insurance provider during fiscal 2015 and 2016, reducing our insurance recovery receivable related to insurance policy years for which we have surpassed our deductible to $30.7 million as of September 30, 2016. The total recovery amount recorded during the current fiscal year of $59.3 million fully offsets the incremental expense recorded related to the water intrusion issues in New Jersey, and was $3.6 million greater than the underlying expense related to the Florida stucco issues, as we began to recover more costs than initially anticipated. The remaining insurance recovery amount for the year ended September 30, 2016 beyond the water intrusion issues in New Jersey and the Florida stucco issues related to expenditures for warranty issues that are individually immaterial but are also in excess of our insurance thresholds. The total recovery amount recorded during our fiscal 2015 of $18.9 million offset $12.7 million of the underlying expense related to the Florida stucco issues (leaving a net expense of $13.6 million related to these matters), while the remainder related to expenditures for warranty issues that were individually immaterial but were also in excess of our insurance thresholds.

Amounts still to be recovered under our insurance policies will vary based on whether expected additional warranty costs are actually incurred for periods for which our threshold has already been met. As a result, we anticipate the balance of our established receivable for insurance recoveries to fluctuate for potential future reimbursements, as well as the amounts ultimately owed to us from our insurer.

Additionally, we entered into agreements with our third-party insurer during the current fiscal year to resolve certain issues related to the extent of our insurance coverage for multiple policy years. These agreements resulted in our recognition of $15.5 million in further insurance recoveries (in addition to those discussed above), which was recorded within our consolidated statement of income as a reduction of our home construction expenses. As of September 30, 2016, we collected the entire settlement.

Litigation

From time-to-time, we have received claims from institutions that have acquired mortgages originated by our subsidiary, Beazer Mortgage Corporation (BMC), demanding damages or indemnity arising from BMC's activities or that we repurchase such mortgages. BMC stopped originating mortgages in 2008. We have been able to resolve these claims for amounts that are not material to our consolidated financial statements. We currently have one outstanding claim for an immaterial amount. We cannot rule out the potential for additional mortgage loan repurchase or indemnity claims in the future from other investors. At this time, we do not believe that the exposure related to any such claims would be material to our consolidated financial condition, results of operations or cash flows. As of September 30, 2016, no liability has been recorded for any such additional claims, as such exposure is not both probable and reasonably estimable.

A purported class action lawsuit was filed on July 7, 2016 against the Company in Maricopa County Arizona Superior Court on behalf of all homeowners in Arizona that purchased homes from the Company that included a certain roof underlayment. The complaint alleges various construction defects, but principally claims that the roof underlayment used in these homes is susceptible to leaks and was not installed in accordance with best practices. The monetary damages the plaintiffs seek have not been quantified. The Company believes these allegations are without merit and that class action treatment is inappropriate. We have removed this case to federal court. The Company intends to vigorously defend itself against these claims, and believes at this time that any potential exposure is neither probable nor able to be estimated. To that end, we filed motions to dismiss the class action allegations on various grounds. After the filing of the motions to dismiss, the plaintiffs agreed to withdraw the class action allegations without prejudice and filed an amended complaint removing the class action portion of the allegations.

In the normal course of business, we are subject to various lawsuits. We cannot predict or determine the timing or final outcome of these lawsuits or the effect that any adverse findings or determinations in pending lawsuits may have on us. In addition, an estimate of possible loss or range of loss, if any, cannot presently be made with respect to certain of these pending matters. An unfavorable determination in any of the pending lawsuits could result in the payment by us of substantial monetary damages, which may not be fully covered by insurance. Further, the legal costs associated with the lawsuits and the amount of time required to be spent by management and the Board of Directors on these matters, even if we are ultimately successful, could have a material adverse effect on our financial condition, results of operations or cash flows.

Other Matters

On July 1, 2009, we entered into a Deferred Prosecution Agreement and associated Bill of Information (the DPA) with the United States Attorney for the Western District of North Carolina and a separate but related agreement with the United States Department of Housing and Urban Development (HUD) and the Civil Division of the United States Department of Justice (the HUD Agreement). We have satisfied our obligations under the DPA and in July 2014 the United States District Court for the Western Division of North Carolina dismissed the Bill of Information. However, under these agreements, we were obligated to make payments equal to 4% of “adjusted EBITDA,” as defined in the agreements, until the earlier of (a) September 30, 2016 or (b) the date that a cumulative $48.0 million had been paid pursuant to the DPA and the HUD Agreement. Accordingly, after making the fiscal year 2016 payments described below, our obligations under the HUD Agreement will expire. As of September 30, 2016, we have paid a cumulative $28.1 million related to the DPA and the HUD Agreement. Additionally, we have a liability of $6.9 million recorded on our consolidated balance sheet as of September 30, 2016 related to the DPA and the HUD Agreement. Our expense related to these agreements was $4.9 million, $5.3 million, and $5.4 million for our fiscal 2016, 2015 and 2014, respectively, and was recorded in G&A in our consolidated statements of income.

We and certain of our subsidiaries have been named as defendants in various claims, complaints and other legal actions, most relating to construction defects, moisture intrusion and product liability. Certain of the liabilities resulting from these actions are covered in whole or part by insurance. In our opinion, based on our current assessment, the ultimate resolution of these matters will not have a material adverse effect on our financial condition, results of operations or cash flows.

We have an accrual of $10.2 million and $12.6 million in other liabilities on our consolidated balance sheets related to litigation and other matters, excluding warranty, as of September 30, 2016 and 2015, respectively.

We had outstanding letters of credit and performance bonds of approximately $50.3 million and $207.6 million, respectively, as of September 30, 2016, related principally to our obligations to local governments to construct roads and other improvements in various developments. We had an immaterial amount of outstanding letters of credit relating to our land option contracts as of September 30, 2016.