10-Q 1 f10q73104.txt FORM 10-Q QUARTER ENDED 7/31/04 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [ X ] Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For quarterly period ended JULY 31, 2004 or [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 Commission file number 1-8551 Hovnanian Enterprises, Inc. (Exact Name of Registrant as Specified in Its Charter) Delaware 22-1851059 (State or Other Jurisdiction of (I.R.S. Employer Incorporation or Organization) Identification No.) l0 Highway 35, P.O. Box 500, Red Bank, NJ 07701 (Address of Principal Executive Offices) (Zip Code) 732-747-7800 (Registrant's Telephone Number, Including Area Code) Same (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check mark whether the registrant: (l) has filed all reports required to be filed by Section l3 or l5(d) of the Securities Exchange Act of l934 during the preceding l2 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ X ] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. 46,390,719 Class A Common Shares and 14,685,529 Class B Common Shares were outstanding as of September 7, 2004. HOVNANIAN ENTERPRISES, INC. FORM 10-Q INDEX PAGE NUMBER PART I. Financial Information Item l. Financial Statements: Condensed Consolidated Balance Sheets as of July 31, 2004 (unaudited) and October 31, 2003 3 Condensed Consolidated Statements of Income for the three and nine months ended July 31, 2004 and 2003 (unaudited) 5 Condensed Consolidated Statement of Stockholders' Equity for the nine months ended July 31, 2004 (unaudited) 6 Condensed Consolidated Statements of Cash Flows for the nine months ended July 31, 2004 and 2003 (unaudited) 7 Notes to Condensed Consolidated Financial Statements (unaudited) 8 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 20 Item 3. Quantitative and Qualitative Disclosures About Market Risk 36 Item 4. Controls and Procedures 37 PART II. Other Information Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 38 Item 6. Exhibits 39 Signatures 40 HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands)
July 31, October 31, ASSETS 2004 2003 ----------- ----------- (unaudited) Homebuilding: Cash and cash equivalents..................... $ 6,667 $ 121,913 ----------- ----------- Inventories - At the lower of cost or fair value: Sold and unsold homes and lots under development............................... 1,785,771 1,184,907 ----------- ----------- Land and land options held for future development or sale....................... 357,092 270,502 ----------- ----------- Consolidated Inventory Not Owned: Specific performance options.............. 23,076 56,082 Variable interest entities................ 198,634 100,327 Other options............................. 32,811 48,226 ----------- ----------- Total Consolidated Inventory Not Owned... 254,521 204,635 ----------- ----------- Total Inventories......................... 2,397,384 1,660,044 ----------- ----------- Receivables, deposits, and notes ............. 49,614 42,506 ----------- ----------- Property, plant, and equipment - net.......... 37,647 26,263 ----------- ----------- Prepaid expenses and other assets............. 146,174 106,525 ----------- ----------- Goodwill and indefinite life intangibles...... 32,658 82,658 ----------- ----------- Definite life intangibles..................... 122,062 56,978 ----------- ----------- Total Homebuilding........................ 2,792,206 2,096,887 ----------- ----------- Financial Services: Cash and cash equivalents..................... 12,317 6,308 Mortgage loans held for sale.................. 150,782 224,052 Other assets.................................. 3,047 3,945 ----------- ----------- Total Financial Services.................. 166,146 234,305 ----------- ----------- Income Taxes Receivable - Including deferred tax benefits.................................. 21,903 1,179 ----------- ----------- Total Assets.................................... $2,980,255 $2,332,371 =========== =========== See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (In Thousands)
July 31, October 31, LIABILITIES AND STOCKHOLDERS' EQUITY 2004 2003 ----------- ----------- (unaudited) Homebuilding: Nonrecourse land mortgages....................... $ 23,066 $ 43,795 Accounts payable and other liabilities........... 290,686 230,696 Customers' deposits.............................. 92,383 58,376 Liabilities from inventory not owned............. 49,824 94,780 ----------- ----------- Total Homebuilding........................... 455,959 427,647 ----------- ----------- Financial Services: Accounts payable and other liabilities........... 5,583 5,917 Mortgage warehouse line of credit................ 144,853 166,711 ----------- ----------- Total Financial Services..................... 150,436 172,628 ----------- ----------- Notes Payable: Revolving and term credit agreements............. 215,000 115,000 Senior notes..................................... 602,589 387,166 Senior subordinated notes........................ 300,000 300,000 Accrued interest................................. 14,546 15,675 ----------- ----------- Total Notes Payable.......................... 1,132,135 817,841 ----------- ----------- Total Liabilities............................ 1,738,530 1,418,116 ----------- ----------- Minority interest from inventory not owned......... 179,255 90,252 ----------- ----------- Minority interest from consolidated joint ventures. 8,731 4,291 ----------- ----------- Stockholders' Equity: Preferred Stock,$.01 par value-authorized 100,000 shares; none issued............................. Common Stock,Class A,$.01 par value-authorized 200,000,000 shares; issued 56,768,461 shares at July 31, 2004 and 56,036,116 shares at October 31, 2003 (including 10,395,656 shares at July 31, 2004 and 10,780,436 shares at October 31, 2003 held in Treasury).................................... 567 560 Common Stock,Class B,$.01 par value (convertible to Class A at time of sale) authorized 30,000,000 shares; issued 15,379,780 shares at July 31, 2004 and 15,537,016 shares at October 31, 2003 (including 691,748 shares at July 31, 2004 and October 31, 2003 held in Treasury).............. 154 155 Paid in Capital................................... 184,260 163,355 Retained Earnings................................. 920,103 705,182 Deferred Compensation............................. (1,295) Treasury Stock - at cost.......................... (50,050) (49,540) ----------- ----------- Total Stockholders' Equity.................... 1,053,739 819,712 ----------- ----------- Total Liabilities and Stockholders' Equity..........$2,980,255 $2,332,371 =========== =========== See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (In Thousands Except Per Share Data) (Unaudited)
Three Months Ended Nine Months Ended July 31, July 31, ------------------- ----------------------- 2004 2003 2004 2003 --------- --------- ----------- ---------- Revenues: Homebuilding: Sale of homes......................$1,044,610 $830,734 $2,702,826 $2,104,788 Land sales and other revenues...... 5,395 4,441 12,959 16,445 --------- --------- ----------- ---------- Total Homebuilding............... 1,050,005 835,175 2,715,785 2,121,233 Financial Services................... 13,683 13,642 41,926 35,036 --------- --------- ----------- ---------- Total Revenues................... 1,063,688 848,817 2,757,711 2,156,269 --------- --------- ----------- ---------- Expenses: Homebuilding: Cost of sales...................... 778,216 621,897 2,016,257 1,582,294 Selling, general and administrative 82,905 66,136 235,210 180,035 Inventory impairment loss.......... 1,438 149 2,230 1,633 --------- --------- ----------- ---------- Total Homebuilding............... 862,559 688,182 2,253,697 1,763,962 Financial Services................... 8,637 7,635 25,334 19,629 Corporate General and Administrative. 13,011 16,978 42,229 45,026 Interest............................. 17,725 17,204 53,764 44,308 Expenses Related To Extinguishment Of Debt............................ 8,663 1,619 9,597 1,619 Other Operations..................... 3,361 4,232 9,107 10,888 Intangible Amortization.............. 9,716 3,159 19,115 5,465 --------- --------- ----------- ---------- Total Expenses................... 923,672 739,009 2,412,843 1,890,897 --------- --------- ----------- ---------- Income Before Income Taxes............. 140,016 109,808 344,868 265,372 --------- --------- ----------- ---------- State and Federal Income Taxes: State................................ 7,761 5,439 20,417 11,874 Federal.............................. 45,517 35,567 109,530 87,367 --------- --------- ----------- ---------- Total Taxes........................ 53,278 41,006 129,947 99,241 --------- --------- ----------- ---------- Net Income............................. $ 86,738 $ 68,802 $ 214,921 $ 166,131 ========= ========= =========== ========== Per Share Data: Basic: Income per common share.............. $ 1.40 $ 1.12 $ 3.47 $ 2.68 Weighted average number of common shares outstanding................. 62,001 61,260 61,887 62,088 Assuming dilution: Income per common share.............. $ 1.33 $ 1.06 $ 3.30 $ 2.53 Weighted average number of common shares outstanding................ 65,115 65,086 65,158 65,612 See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Dollars In Thousands)
A Common Stock B Common Stock ------------------- ------------------- Shares Shares Issued and Issued and Paid-In Retained Deferred Treasury Outstanding Amount Outstanding Amount Capital Earnings Comp. Stock Total ----------- ------ ----------- ------ ------- -------- -------- --------- ---------- Balance, October 31, 2003. 45,255,680 $560 14,845,268 $155 $163,355 $705,182 $ $(49,540) $ 819,712 Acquisitions.............. 489,236 17,487 2,512 19,999 Sale of common stock under employee stock option plan.................... 309,166 3 1,620 1,623 Stock bonus plan.......... 211,291 2 54,652 1 503 506 Conversion of Class B to Class A Common Stock.... 211,888 2 (211,888) (2) Deferred compensation..... 1,295 (1,295) - Treasury stock purchase... (104,456) (3,022) (3,022) Net Income................ 214,921 214,921 ----------- ------ ----------- ------ ------- -------- -------- --------- ---------- Balance, July 31, 2004 (unaudited)............... 46,372,805 $567 14,688,032 $154 $184,260 $920,103 $ (1,295) $(50,050) $1,053,739 =========== ====== =========== ====== ======= ======== ======== ========= ========== See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands - unaudited)
Nine Months Ended July 31, ------------------------ 2004 2003 ----------- ----------- Cash Flows From Operating Activities: Net Income.......................................... $ 214,921 $ 166,131 Adjustments to reconcile net income to net cash (used in) operating activities: Depreciation.................................... 4,606 4,946 Intangible amortization......................... 19,115 5,465 Loss (gain) on sale and retirement of property and assets.................................... (238) 44 Expenses related to extinguishment of debt...... 9,597 1,619 Deferred income taxes........................... (14,426) (6,123) Impairment losses............................... 2,230 1,633 Decrease (increase) in assets: Mortgage notes receivable..................... 73,548 (59,049) Receivables, prepaids and other assets........ (27,232) (14,444) Inventories................................... (658,351) (338,374) (Decrease) increase in liabilities: State and Federal income taxes................ (5,817) 403 Tax effect from exercise of stock options..... (481) (6,774) Customers' deposits........................... 29,215 21,352 Interest and other accrued liabilities........ 12,602 15,108 Post development completion costs............. (2,929) 1,952 Accounts payable.............................. 32,575 (11,373) ----------- ----------- Net cash (used in) operating activities..... (311,065) (217,484) ----------- ----------- Cash Flows From Investing Activities: Net proceeds from sale of property and assets....... 721 482 Purchase of property, equipment and other fixed assets and acquisitions of homebuilding companies......................................... (56,634) (141,796) Net returns of capital from unconsolidated affiliates........................................ (23,818) 1,150 ----------- ----------- Net cash (used in) investing activities..... (79,731) (140,164) ----------- ----------- Cash Flows From Financing Activities: Proceeds from mortgages and notes................... 2,674,035 1,090,427 Proceeds from senior debt........................... 365,000 Proceeds from senior subordinated debt.............. 150,000 Principal payments on mortgages and notes........... (2,599,739) (1,022,006) Principal payments on senior debt................... (156,844) (11,369) Purchase of treasury stock.......................... (3,022) (7,261) Proceeds from sale of stock and employee stock plan. 2,129 7,506 ----------- ----------- Net cash provided by financing activities.... 281,559 207,297 ----------- ----------- Net (Decrease) In Cash........... ....................... (109,237) (150,351) Cash and Cash Equivalents Balance, Beginning Of Period........................................... 128,221 269,990 ----------- ----------- Cash and Cash Equivalents Balance, End Of Period...... $ 18,984 $ 119,639 =========== =========== Supplemental Disclosures of Cash Flow Cash paid during the year for: Interest......................................... $ 68,247 $ 41,198 =========== =========== Income taxes..................................... $ 150,016 $ 104,962 =========== =========== Supplemental disclosures of noncash operating activities: Consolidated Inventory Not Owned: Specific performance options..................... $ 21,798 $ 64,743 Variable interest entities....................... 181,265 81,537 Other options.................................... 26,010 50,486 ----------- ----------- Total Inventory Not Owned.......................... $ 229,073 $ 196,766 =========== =========== See notes to condensed consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED 1. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to form 10-Q and Article 10 of Regulation S-X. In the opinion of management, all adjustments for interim periods presented have been made, which include only normal recurring accruals and deferrals necessary for a fair presentation of our consolidated financial position, results of operations, and changes in cash flows. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and these differences could have a significant impact on the financial statements. Results for the interim periods are not necessarily indicative of the results which might be expected for a full year. The balance sheet at October 31, 2003 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In March 2004, our Board of Directors authorized a 2-for-1 stock split in the form of a 100% stock dividend of Class A and Class B Common Stock payable to stockholders of record on March 19, 2004. The additional shares were distributed on March 26, 2004. All share and per share amounts (except par value) have been retroactively adjusted to reflect the stock split. There was no net effect on total stockholders' equity as a result of the stock split. Certain prior year amounts have been reclassified to conform to the current year presentation. 2. Stock-Based Compensation Plans - SFAS No. 123 "Accounting for Stock-Based Compensation" ("SFAS 123") establishes a fair value-based method of accounting for stock-based compensation plans, including stock options and non-vested stock. Registrants may elect to continue accounting for stock-based compensation plans under APB Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25"), but are required to provide pro forma net income and earnings per share information "as if" the new fair value approach had been adopted. We intend to continue accounting for our stock-based compensation plans under APB 25. Under APB 25, no compensation expense is recognized when the exercise price of our employee stock options equals the market price of the underlying stock on the date of grant. However, for non-vested stock, compensation expense equal to the market price of the stock on the grant date is recognized ratably over the vesting period. In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" ("SFAS 148"). SFAS 148 amends SFAS 123 to provide alternative methods of transition for an entity that voluntarily adopts the fair value recognition method of recording stock-based compensation expense. SFAS 148 also amends the disclosure provisions of SFAS 123 and APB Opinion No. 28, "Interim Financial Reporting" to require disclosure in the summary of significant accounting policies of the effects of an entity's accounting policy with respect to stock-based compensation on reported net income and earnings per share in annual and interim financial statements. For purposes of pro forma disclosures, the estimated fair value of the options using Black Scholes is amortized to expense over the options' vesting period. Our pro forma information follows (dollars in thousands except for earnings per share information): Three Months Ended Nine Months Ended ------------------ ------------------- July July July July 31, 2004 31, 2003 31, 2004 31, 2003 --------- --------- --------- -------- Net income to common shareholders; as reported.....................$ 86,738 $ 68,802 $ 214,921 $166,131 Deduct: total stock-based employee compensation expense determined using Black Scholes fair value based method for all awards.... 1,244 539 3,175 1,515 Pro forma net income..............$ 85,494 $ 68,263 $ 211,746 $164,616 ========= ========= ========= ======== Pro forma basic earnings per share$ 1.38 $ 1.11 $ 3.42 $ 2.65 ========= ========= ========= ======== Basic earnings per share as reported...................... $ 1.40 $ 1.12 $ 3.47 $ 2.68 ========= ========= ========= ======== Pro forma diluted earnings per share....................... $ 1.31 $ 1.05 $ 3.25 $ 2.51 ========= ========= ========= ======== Diluted earnings per share as Reported...................... $ 1.33 $ 1.06 $ 3.30 $ 2.53 ========= ========= ========= ======== Pro forma information regarding net income and earnings per share is calculated as if we had accounted for our stock-based compensation under the fair value method of SFAS 123. The fair value for options is established at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for July 31, 2004 and 2003: risk-free interest rate of 4.2% and 4.3%, respectively; dividend yield of zero; volatility factor of the expected market price of our common stock of 0.43 for both periods; and a weighted-average expected life of the option of 5.2 and 5.1 years, respectively. The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our employee stock options have characteristics significantly different from traded options, and changes in the subjective input assumptions can materially affect the fair value estimate, management believes the existing models do not necessarily provide a reliable measure of the fair value of its employee stock options. 3. Interest costs incurred, expensed and capitalized were: Three Months Ended Nine Months Ended July 31, July 31, ------------------ ----------------- 2004 2003 2004 2003 -------- ------- ------- -------- (Dollars in Thousands) Interest Capitalized at Beginning of Period........$ 32,585 $25,480 $24,833 $22,159 Plus Interest Incurred(1)(2). 21,426 17,807 65,217 48,232 Less Interest Expensed(2).... 17,725 17,204 53,764 44,308 -------- ------- ------- -------- Interest Capitalized at End of Period (2)......... $ 36,286 $26,083 $36,286 $26,083 ======== ======= ======= ======== (1) Data does not include interest incurred by our mortgage and finance subsidiaries. (2) Includes interest on borrowings for construction, land and land development costs which are charged to interest expense when homes are delivered or when land is not under active development. 4. Accumulated depreciation at July 31, 2004 and October 31, 2003 amounted to $30.8 million and $27.5 million, respectively, for our homebuilding and senior rental residential assets. 5. In accordance with Financial Accounting Standards No. 144 ("SFAS 144") "Accounting for the Impairment of or Disposal of Long Lived Assets", we record impairment losses on inventories related to communities under development when events and circumstances indicate that they may be impaired and the undiscounted cash flows estimated to be generated by those assets are less than their carrying amounts. In addition, from time to time, we will write off certain residential land options including approval, engineering and capitalized interest costs for land management decided not to purchase. We wrote off such costs in the amount of $1.4 million and $0.1 million during the three months ended July 31, 2004 and 2003, respectively, and $2.2 million and $1.6 million during the nine months ended July 31, 2004 and 2003, respectively. Residential inventory impairment losses and option write-offs are reported in the Condensed Consolidated Statements of Income as "Homebuilding-Inventory Impairment Loss." 6. We provide a warranty accrual for repair costs over $1,000 to homes, community amenities, and land development infrastructure. We accrue for warranty costs as part of cost of sales at the time each home is closed and title and possession have been transferred to the homebuyer. In addition, we accrue warranty costs under our $150,000 per occurrence general liability insurance deductible as part of selling, general and administrative costs. Warranty accruals are based upon historical experience. Additions and charges incurred in the warranty accrual and general liability accrual for the three and nine months ended July 31, 2004 and 2003 are as follows: Three Months Ended Nine Months Ended July 31, July 31, ------------------ ------------------ 2004 2003 2004 2003 -------- -------- -------- -------- (Dollars in Thousands) Balance, beginning of period..... $47,186 $28,890 $39,532 $22,392 Company acquisitions............. 2,170 Additions........................ 10,869 5,142 27,476 15,372 Charges incurred................. (4,697) (1,912) (13,650) (7,814) -------- -------- -------- -------- Balance, end of period.......... $53,358 $32,120 $53,358 $32,120 ======== ======== ======== ======== 7. We are involved in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on our financial position or results of operations. 8. As of July 31, 2004 and October 31, 2003, respectively, we are obligated under various performance letters of credit amounting to $162.6 million and $130.3 million. 9. Our amended and restated unsecured Revolving Credit Agreement ("Agreement") with a group of banks provides a revolving credit line of $900 million through July 2008. The facility contains an accordion feature under which the aggregate commitment can be increased to $1.0 billion subject to the availability of additional commitments. Interest is payable monthly at various rates of either the prime rate or a spread over LIBOR ranging from 1.10% to 2.00% per annum, depending on our consolidated Leverage Ratio, as defined in the Agreement. In addition, we pay a fee ranging from 0.20% to 0.40% per annum, depending on our consolidated Leverage Ratio and the weighted average unused portion of the revolving credit line. Each of our significant subsidiaries, except for our financial services subsidiaries and joint ventures, is a guarantor under the Agreement. As of July 31, 2004 and October 31, 2003, the outstanding balances under the Agreement were $215.0 million and zero, respectively. Our amended secured mortgage loan warehouse agreement with a group of banks, which is a short-term borrowing, provides up to $250 million through July 2005. Interest is payable monthly at the Eurodollar Rate plus 1.25%. The loan is repaid when the underlying mortgage loans are sold to permanent investors by us. As of July 31, 2004 and October 31, 2003 borrowings under the agreement were $144.9 million and $166.7 million, respectively. 10. On November 3, 2003, we issued $215 million 6 1/2% Senior Notes due 2014. The net proceeds of the issuance were used for general corporate purposes. On March 18, 2004, we issued $150 million 6 3/8% Senior Notes due 2014. The net proceeds of the issuance were used to redeem all of our $150 million outstanding 9 1/8% Senior Notes due 2009, which occurred on May 3, 2004 and for general corporate purposes. Also on March 18, 2004, we paid off our $115 million Term Loan with available cash. The redemption of the Senior Notes and the payoff of the Term Loan resulted in expenses due to the early extinguishment of debt of $8.7 million and $0.9 million, respectively, before taxes, which have been reported as "Expenses Related to Extinguishment of Debt" on our Condensed Consolidated Statement of Income. At July 31, 2004, our long term debt consisted of: $140.3 million 10 1/2% Senior Notes due 2007, $100 million 8% Senior Notes due 2012, $215 million 6 1/2% Senior Notes due 2014,and $150 million 6 3/8% Senior Notes due 2014, (Senior Notes aggregate $602.6 million, net of discount); $150 million 8 7/8% Senior Subordinated Notes due 2012, and $150 million 7 3/4% Senior Subordinated Notes due 2013. Under the terms of the indentures governing our debt securities, we have the right to make redemptions and depending on market conditions, may do so from time to time. 11. Per Share Calculations - Basic earnings per common share is computed using the weighted average number of shares outstanding. Diluted earnings per common share is computed using the weighted average number of shares outstanding adjusted for the incremental shares attributed to non- vested stock and outstanding options to purchase common stock, of approximately 3.1 million and 3.8 million for the three months ended July 31, 2004 and 2003, respectively, and approximately 3.3 million and 3.5 million for the nine months ended July 31, 2004 and 2003, respectively. 12. Variable Interest Entities - In January 2003, the Financial Accounting Standards Board ("FASB") issued Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). A Variable Interest Entity ("VIE") is created when (i) the equity investment at risk is not sufficient to permit the entity from financing its activities without additional subordinated financial support from other parties or (ii) equity holders either (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE, pursuant to FIN 46, an enterprise that absorbs a majority of the expected losses of the VIE is considered the primary beneficiary and must consolidate the VIE. FIN 46 was effective immediately for VIE's created after January 31, 2003. Pursuant to FASB revision to FIN 46, ("FIN 46R"), issued in December 2003, our company was not required to apply the provisions of FIN 46 to an interest held in a variable interest entity or potential variable interest entity until our quarter ended April 30, 2004 for VIE's created before February 1, 2003. In accordance with FIN 46R, we have fully implemented FIN 46 as of April 30, 2004. Based on the provisions of FIN 46, we have concluded that whenever we option land or lots from an entity and pay a non-refundable deposit, a VIE is created under condition (ii) (b) and (c) of the previous paragraph. We are deemed to have provided subordinated financial support, which refers to variable interests that will absorb some or all of an entity's expected theoretical losses if they occur. For each VIE created with a significant nonrefundable option fee, we compute expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46. If we are deemed to be the primary beneficiary of the VIE we consolidate it on our balance sheet. The fair value of the VIE's inventory is reported as "Consolidated Inventory Not Owned - Variable Interest Entities". Management believes FIN 46 was not clearly thought out for application in the homebuilding industry for land and lot options. Under FIN 46, we can have an option and put down a small deposit as a percentage of the purchase price and still have to consolidate the entity. Our exposure to loss as a result of our involvement with the VIE is only the deposit, not it's total assets consolidated on the balance sheet. In certain cases we will have to place inventory on our balance sheet the VIE has optioned to other developers. In addition, if the VIE has creditors, it's debt will be placed on our balance sheet even though the creditors have no recourse against our Company. Based on these observations we believe consolidating VIE's based on land and lot option deposits does not reflect the economic realities or risks of owning and developing land. At July 31, 2004 all VIE's we were required to consolidate were a result of our options to purchase land or lots from the selling entities. We paid cash or issued letters of credit deposits to these thirty-one VIE's totaling $25.8 million. Our option deposits represent our maximum exposure to loss. The fair value of the property owned by the VIE's was $198.6 million. Because we could not get the remainder of the selling entities to provide us with any financial information, the fair value of the optioned property less our cash deposits and liabilities from inventory not owned, which totaled $179.3 million, was reported on the balance sheet as "Minority interest from inventory not owned". Creditors of these VIE's have no recourse against our Company. We will continue to secure land and lots using options. Not all our deposits are with VIE's. Including the deposits with the thirty-one VIE's above, at July 31, 2004, we have total cash and letters of credit deposits amounting to approximately $218.1 million to purchase land lots with a total purchase price of $3.1 billion. The maximum exposure to loss is limited to the deposits although some deposits are refundable at our request or refundable if certain conditions are not met. In addition to the land and lot options noted above, during the third quarter of 2004 we entered into two separate joint venture agreements, the form of which resulted in those entities being considered variable interest entities. However, in both cases, based on the expected losses and residual returns, we are not the primary beneficiary of the VIE, and therefore do not consolidate these entities. Our investment at risk in these two entities at July 31, 2004 totaled $8.5 million, and is included in prepaid expenses and other assets on the Condensed Consolidated Balance Sheet. 13. Recent Accounting Pronouncements - In March 2004, the Securities and Exchange Commission staff issued Staff Accounting Bulletin 105 ("SAB 105"). Existing accounting guidance requires an entity to record on its balance sheet the fair value of any issued and outstanding mortgage loan commitments. SAB 105 requires that the fair value measurement include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any future cash flows related to (i) expected fees to be received when the loan commitment becomes a loan, (ii) gains from selling the loan, or (iii) the servicing value created from the loan. The guidance in SAB 105 must be applied to mortgage loan commitments that are accounted for as derivatives and are entered into after March 31, 2004. The adoption of the guidance in SAB 105 did not have a material adverse effect on our financial position or results of operations. 14. On November 6, 2003 we acquired a Florida homebuilder for cash and 489,236 shares of our Class A Common Stock. This acquisition was accounted for as a purchase, with the results of operations of this entity included in our condensed consolidated financial statements as of the date of acquisition. In connection with the acquisition, we have definite life intangible assets equal to the excess purchase price over the fair value of the net assets estimated to be $33 million. It is our policy to obtain appraisals of acquisition intangibles. We are awaiting the appraisal from this acquisition. Until the appraisal is received, we estimated the intangible value for amortization calculations. We expect to have our final appraisal by our year ended October 31, 2004. We expect to amortize the definite life intangibles over their estimated lives. 15. Intangible Assets - The intangible assets recorded on our balance sheet are goodwill, tradenames, architectural designs, distribution processes, and contractual agreements, with both definite and indefinite lives resulting from acquisitions. We no longer amortize goodwill or indefinite life intangibles, but instead assess them periodically for impairment. We are amortizing the definite life intangibles over their expected useful life, ranging from three to seven years. In May 2004, we made a decision to change our fiscal 2002 California acquisition brand name to K. Hovnanian Homes. As a result, we reclassified $50 million from goodwill and indefinite life intangibles to definite life intangibles on our July 31, 2004 Condensed Consolidated Balance Sheet. 16. Hovnanian Enterprises, Inc., the parent company (the "Parent"), is the issuer of publicly traded common stock. One of its wholly owned subsidiaries, K. Hovnanian Enterprises, Inc. (the "Subsidiary Issuer"), acts as a finance entity that as of July 31, 2004 had issued and outstanding approximately $300 million Senior Subordinated Notes, $602.6 million face value Senior Notes, and $215 million drawn on a Revolving Credit Agreement. The Senior Subordinated Notes, Senior Notes and the Revolving Credit Agreement are fully and unconditionally guaranteed by the Parent. In addition to the Parent, each of the wholly owned subsidiaries of the Parent other than the Subsidiary Issuer (collectively, the "Guarantor Subsidiaries"), with the exception of various subsidiaries formerly engaged in the issuance of collateralized mortgage obligations, a mortgage lending subsidiary, a subsidiary engaged in homebuilding activity in Poland, our Title Insurance subsidiaries, and joint ventures (collectively; the "Non- guarantor Subsidiaries"), have guaranteed fully and unconditionally, on a joint and several basis, the obligation to pay principal and interest under the Senior Notes, Senior Subordinated Notes, and the Revolving Credit Agreement. In lieu of providing separate audited financial statements for the Guarantor Subsidiaries we have included the accompanying condensed consolidating financial statements. Management does not believe that separate financial statements of the Guarantor Subsidiaries are material to investors. Therefore, separate financial statements and other disclosures concerning the Guarantor Subsidiaries are not presented. The following condensed consolidating financial information presents the results of operations, financial position, and cash flows of (i) the Parent, (ii) the Subsidiary Issuer, (iii) the Guarantor Subsidiaries, (iv) the Non-guarantor Subsidiaries, and (v) the eliminations to arrive at the information for Hovnanian Enterprises, Inc. on a consolidated basis. HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING BALANCE SHEET JULY 31, 2004 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- ---------- ---------- ------------ ---------- ---------- ASSETS Homebuilding.....................$ 70 $ 29,085 $2,701,232 $ 61,819 $ $2,792,206 Financial Services................. (29) 166,175 166,146 Income Taxes (Payable) Receivable. 13,304 33 8,626 (60) 21,903 Investments in and amounts due to and from consolidated subsidiaries....................1,040,365 1,160,904 (1,377,404) (27,962) (795,903) ---------- ---------- ---------- ------------ ---------- ---------- Total Assets.....................$1,053,739 $1,190,022 $1,332,425 $ 199,972 $ (795,903)$2,980,255 ========== ========== ========== ============ ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Homebuilding......................$ $ 129 $ 454,344 $ 1,486 $ $ 455,959 Financial Services................. 150,436 150,436 Notes Payable...................... 1,131,332 (3,464) 4,267 1,132,135 Income Taxes Payable (Receivable). Minority Interest.................. 179,255 8,731 187,986 Stockholders' Equity..............1,053,739 58,561 702,290 35,052 (795,903) 1,053,739 ---------- ---------- ---------- ------------ ---------- ---------- Total Liabilities and Stockholders' Equity.........................$1,053,739 $1,190,022 $1,332,425 $ 199,972 $ (795,903)$2,980,255 ========== ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS CONDENSED CONSOLIDATING BALANCE SHEET OCTOBER 31, 2003 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- ---------- ---------- ------------ ---------- ---------- Assets Homebuilding.......................$ (279) $ 151,050 $1,910,484 $ 35,632 $ $2,096,887 Financial Services................. (252) 234,557 234,305 Income Taxes (Payable)Receivable... 18,713 (1,241) (15,656) (637) 1,179 Investments in and amounts due to and from consolidated subsidiaries..................... 801,278 690,971 (851,398) (56,837) (584,014) -------- ---------- ---------- ------------ ---------- ---------- Total Assets.......................$819,712 $ 840,780 $1,043,178 $ 212,715 $ (584,014)$2,332,371 ======== ========== ========== ============ ========== ========== Liabilities Homebuilding.......................$ $ $ 425,847 $ 1,800 $ $ 427,647 Financial Services................. (35) 172,663 172,628 Notes Payable...................... 816,960 (2,984) 3,865 817,841 Income Taxes Payable (Receivables). Minority Interest.................. 90,252 4,291 94,543 Stockholders' Equity............... 819,712 23,820 530,098 30,096 (584,014) 819,712 -------- ---------- ---------- ------------ ---------- ---------- Total Liabilities and Stockholders' Equity...........................$819,712 $ 840,780 $1,043,178 $ 212,715 $ (584,014)$2,332,371 ======== ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED JULY 31, 2004 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding....................$ $ 21 $1,045,028 $ 4,956 $ $1,050,005 Financial Services............... 1,499 12,184 13,683 Intercompany Charges............. 25,315 31,898 (57,213) Equity In Pretax Income of Consolidated Subsidiaries......140,016 (140,016) ------- ---------- ---------- ------------ ---------- ---------- Total Revenues................ 140,016 25,336 1,078,425 17,140 (197,229) 1,063,688 ------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... 8,431 938,265 3,925 (35,586) 915,035 Financial Services............... 788 8,422 (573) 8,637 ------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. 8,431 939,053 12,347 (36,159) 923,672 ------- ---------- ---------- ------------ ---------- ---------- Income (Loss) Before Income Taxes. 140,016 16,905 139,372 4,793 (161,070) 140,016 State and Federal Income Taxes..... 53,278 7,112 53,133 403 (60,648) 53,278 ------- ---------- ---------- ------------ ---------- ---------- Net Income (Loss).................$ 86,738 $ 9,793 $ 86,239 $ 4,390 $ (100,422)$ 86,738 ======= ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS THREE MONTHS ENDED JULY 31, 2003 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding.....................$ $ (45) $ 835,191 $ 4 $ 25 $ 835,175 Financial Services............... 2,033 11,609 13,642 Intercompany Charges............. (61,982) 51,085 10,897 Equity In Pretax Income of Consolidated Subsidiaries......109,808 (109,808) ------- ---------- ---------- ------------ ---------- ---------- Total Revenues................$109,808 $ (62,027)$ 888,309 $ 11,613 $ (98,886)$ 848,817 ------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... (84,286) 820,362 142 (4,844) 731,374 Financial Services............... 772 7,254 (391) 7,635 ------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. (84,286) 821,134 7,396 (5,235) 739,009 ------- ---------- ---------- ------------ ---------- ---------- Income (Loss) Before Income Taxes..109,808 22,259 67,175 4,217 (93,651) 109,808 State and Federal Income Taxes..... 41,006 8,420 25,121 1,812 (35,353) 41,006 ------- ---------- ---------- ------------ ---------- ---------- Net Income (Loss)..................$68,802 $ 13,839 $ 42,054 $ 2,405 $ (58,298)$ 68,802 ======= ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS NINE MONTHS ENDED JULY 31, 2004 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding....................$ $ 207 $2,694,491 $ 21,170 $ (83)$2,715,785 Financial Services............... 3,615 38,311 41,926 Intercompany Charges............. 60,123 95,338 (155,461) Equity In Pretax Income of Consolidated Subsidiaries......344,868 (344,868) ------- ---------- ---------- ------------ ---------- ---------- Total Revenues................ 344,868 60,330 2,793,444 59,481 (500,412) 2,757,711 ------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... 8,859 2,469,764 16,898 (108,012) 2,387,509 Financial Services............... 1,853 25,953 (2,472) 25,334 ------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. 8,859 2,471,617 42,851 (110,484) 2,412,843 ------- ---------- ---------- ------------ ---------- ---------- Income (Loss) Before Income Taxes..344,868 51,471 321,827 16,630 (389,928) 344,868 State and Federal Income Taxes.....129,947 17,971 122,666 5,081 (145,718) 129,947 ------- ---------- ---------- ------------ ---------- ---------- Net Income (Loss).................$214,921 $ 33,500 $ 199,161 $ 11,549 $ (244,210)$ 214,921 ======== ========== ========== ============ =========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS NINE MONTHS ENDED JULY 31, 2003 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding.....................$ $ 593 $2,120,611 $ 14 $ 15 $2,121,233 Financial Services................ 5,496 29,540 35,036 Intercompany Charges............. 23,389 62,544 (85,933) Equity In Pretax Income of Consolidated Subsidiaries...... 265,372 (265,372) -------- ---------- ---------- ------------ ---------- ---------- Total Revenues................ $265,372 $ 23,982 $2,188,651 $ 29,554 $ (351,290)$2,156,269 -------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... 1,723 1,961,389 361 (92,205) 1,871,268 Financial Services............... 1,907 18,971 (1,249) 19,629 -------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. 1,723 1,963,296 19,332 (93,454) 1,890,897 -------- ---------- ---------- ------------ ---------- ---------- Income (Loss) Before Income Taxes.. 265,372 22,259 225,355 10,222 (257,836) 265,372 State and Federal Income Taxes..... 99,241 7,791 84,552 4,261 (96,604) 99,241 -------- ---------- ---------- ------------ ---------- ---------- Net Income (Loss)..................$166,131 $ 14,468 $ 140,803 $ 5,961 $ (161,232)$ 166,131 ======== ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS NINE MONTHS ENDED JULY 31, 2004 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- --------- ---------- ------------ ---------- ---------- Cash Flows From Operating Activities: Net Income........................$ 214,921 $ 33,500 $ 199,161 $ 11,549 $ (244,210)$ 214,921 Adjustments to reconcile net income to net cash provided by (used in) operating activities... 45,581 (7,558) (855,724) 47,505 244,210 (525,986) -------- --------- ---------- ------------ ---------- ---------- Net Cash Provided By (Used In) Operating Activities........... 260,502 25,942 (656,563) 59,054 (311,065) Net Cash (Used In) Investing Activities............... (20,909) (58,547) (275) (79,731) Net Cash Provided By (Used In) Financing Activities............... (506) 315,000 (10,903) (22,032) 281,559 Intercompany Investing and Financing Activities - Net...................(239,087) (469,933) 737,895 (28,875) -------- --------- ---------- ------------ ---------- ---------- Net Increase (Decrease) In Cash...... (128,991) 11,882 7,872 (109,237) Balance, Beginning of Period......... 15 135,846 (14,372) 6,732 128,221 -------- --------- ---------- ------------ ---------- ---------- Cash and Cash Equivalents Balance, End of Period.....................$ 15 $ 6,855 $ (2,490)$ 14,604 $ $ 18,984 ======== ========= ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS NINE MONTHS ENDED JULY 31, 2003 (Dollars in Thousands)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- --------- ---------- ------------ ---------- ---------- Cash Flows From Operating Activities: Net Income.........................$166,131 $ 14,468 $ 140,803 $ 5,961 $ (161,232)$ 166,131 Adjustments to reconcile net income to net cash (Used In) Provided By operating activities.......... (2,534) 12,717 (510,053) (44,977) 161,232 (383,615) -------- --------- ---------- ------------ ---------- ---------- Net Cash (Used In) Provided By Operating Activities........... 163,597 27,185 (369,250) (39,016) (217,484) Net Cash (Used In) Investing Activities............... (7,588) (132,321) (255) (140,164) Net Cash (Used In) Provided By Financing Activities............... (7,261) 138,631 24,990 50,937 207,297 Intercompany Investing and Financing Activities - Net...................(148,743) (309,555) 468,463 (10,165) -------- --------- ---------- ------------ ---------- ---------- Net Increase (Decrease) In Cash and Cash Equivalents................... 5 (143,739) (8,118) 1,501 (150,351) Balance, Beginning of Period......... 10 218,844 43,689 7,447 269,990 -------- --------- ---------- ------------ ---------- ---------- Cash and Cash Equivalents Balance, End of Period......................$ 15 $ 75,105 $ 35,571 $ 8,948 $ $ 119,639 ======== ========= ========== ============ ========== ==========
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS CRITICAL ACCOUNTING POLICIES Management believes that the following critical accounting policies affect its more significant judgments and estimates used in the preparation of its consolidated financial statements: Business Combinations - When we make an acquisition of another company, we use the purchase method of accounting in accordance with the Statement of Financial Accounting Standards (SFAS) No. 141 "Business Combinations". Under SFAS No. 141 (for acquisitions subsequent to June 30, 2001) and APB 16 (for acquisitions prior to June 30, 2001) we record as our cost the estimated fair value of the acquired assets less liabilities assumed. Any difference between the cost of an acquired company and the sum of the fair values of tangible and intangible assets less liabilities is recorded as goodwill. The reported income of an acquired company includes the operations of the acquired company from the date of acquisition. Income Recognition from Home and Land Sales - Income from home and land sales is recorded when title is conveyed to the buyer, adequate cash payment has been received and there is no continued involvement. Income Recognition from Mortgage Loans - Profits and losses relating to the sale of mortgage loans are recognized when legal control passes to the buyer and the sales price is collected. Inventories - Inventories and long-lived assets held for sale are recorded at the lower of cost or fair value less selling costs. Fair value is defined as the amount at which an asset could be bought or sold in a current transaction between willing parties, that is, other than in a forced or liquidation sale. Construction costs are accumulated during the period of construction and charged to cost of sales under specific identification methods. Land, land development, and common facility costs are allocated based on buildable acres to product types within each community, then charged to cost of sales equally based upon the number of homes to be constructed in each product type. For inventories of communities under development, a loss is recorded when events and circumstances indicate impairment and the undiscounted future cash flows generated are less than the related carrying amounts. The impairment loss is based on discounted future cash flows generated from expected revenue, less cost to complete including interest, and selling costs. Insurance Deductible Reserves - Our deductible is $150,000 per occurrence for worker's compensation and general liability insurance. Reserves have been established based upon actuarial analysis of estimated losses incurred during 2004 and 2003. Interest - Costs related to properties under development are capitalized during the land development and home construction period and expensed along with the associated cost of sales as the related inventories are sold. Costs related to properties not under development are charged to interest expense. Land Options - Costs are capitalized when incurred and either included as part of the purchase price when the land is acquired or charged to operations when we determine we will not exercise the option. In accordance with Financial Accounting Standards Board ("FASB") Interpretation No. 46 ("FIN 46") "Consolidation of Variable Interest Entities", an interpretation of Accounting Research Bulletin No. 51, SFAS No. 49 "Accounting for Product Financing Arrangements" ("SFAS 49"), SFAS No. 98 "Accounting for Leases" ("SFAS 98"), and Emerging Issues Task Force ("EITF") No. 97-10 "The Effects of Lessee Involvement in Asset Construction" ("EITF 97-10"), we record on the Consolidated Balance Sheet specific performance options, options with variable interest entities, and other options under Consolidated inventory not owned with the offset to Liabilities from inventory not owned, Minority interest from inventory not owned and Minority interest from consolidated joint ventures. Intangible Assets - The intangible assets recorded on our balance sheet are goodwill, tradenames, architectural designs, distribution processes, and contractual agreements with both definite and indefinite lives resulting from company acquisitions. We no longer amortize goodwill or indefinite life intangibles, but instead assess them periodically for impairment. We are amortizing the definite life intangibles over their expected useful life, ranging from three to seven years. In May 2004, we made a decision to change our fiscal 2002 California acquisition brand name to K. Hovnanian Homes. As a result, we reclassified $50 million from goodwill and indefinite life intangibles to definite life intangibles on our July 31, 2004 Condensed Consolidated Balance Sheet. Post Development Completion Costs - In those instances where a development is substantially completed and sold and we have additional construction work to be incurred, an estimated liability is provided to cover the cost of such work. In addition, our warranty accrual includes estimated costs for construction work that is unforeseen, but estimable based on past history, at the time of closing. Both of these liabilities are recorded in accounts payable and other liabilities in the Condensed Consolidated Balance Sheets. CAPITAL RESOURCES AND LIQUIDITY Our operations consist primarily of residential housing development and sales in our Northeast Region (New Jersey, southern New York state, Pennsylvania, and Ohio), our Southeast Region (Washington D. C., Maryland, Virginia, West Virginia, North Carolina, South Carolina, and Florida), our Southwest Region (Texas and Arizona), and our West Region (California). In addition, we provide financial services to our homebuilding customers. Our cash uses during the nine months ended July 31, 2004 were for operating expenses, increases in housing inventories, construction, income taxes, interest, the payoff of our Term Loan, the redemption of Senior Notes due 2009, and the acquisition of a Florida homebuilder. We provided for our cash requirements from housing and land sales, the revolving credit facility, the issuance of $365 million of Senior Notes, financial service revenues, and other revenues. We believe that these sources of cash are sufficient to finance our working capital requirements and other needs. On July 3, 2001, our Board of Directors authorized a stock repurchase program to purchase up to 4 million shares of Class A Common Stock. As of July 31, 2004, 1.9 million shares of Class A Common Stock have been purchased under this program. In addition in 2003, we retired at no cost 1.6 million shares that were held by sellers of two previous acquisition. On March 5, 2004 our Board of Directors authorized a 2-for-1 stock split in the form of a 100% stock dividend. All share information reflects this stock dividend. Our homebuilding bank borrowings are made pursuant to an amended and restated unsecured revolving credit agreement (the "Agreement") that provides a revolving credit line and letter of credit line of $900 million through July 2008. The facility contains an accordion feature under which the aggregate commitment can be increased to $1.0 billion subject to the availability of additional commitments. Interest is payable monthly at various rates of either the prime rate or a spread over LIBOR ranging from 1.10% to 2.00% per annum, depending on our consolidated Leverage Ratio, as defined in the Agreement. In addition, we pay a fee ranging from 0.20% to 0.40% per annum, depending on our consolidated Leverage Ratio and the weighted average unused portion of the revolving credit line. At July 31, 2004, there was $215 million drawn under this Agreement and we had approximately $6.7 million of homebuilding cash. At July 31, 2004 we had issued $162.6 million of letters of credit which reduces cash available under the Agreement. We believe that we will be able either to extend the Agreement beyond July 2008 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. We currently are in compliance and intend to maintain compliance with the covenants under the Agreement. Each of our significant subsidiaries, except for our financial services subsidiaries and joint ventures, is a guarantor under the Agreement. At July 31, 2004 we had $605.3 million of outstanding senior debt ($602.6 million, net of discount), comprised of $140.3 million 10 1/2% Senior Notes due 2007, $100 million 8% Senior Notes due 2012, $215 million 6 1/2% Senior Notes due 2014, and $150 million 6 3/8% Senior Notes due 2014. At July 31, 2004, we had outstanding $300 million of senior subordinated debt comprised of $150 million 8 7/8% Senior Subordinated Notes due 2012, and $150 million 7 3/4% Senior Subordinated Notes due 2013. Each of our wholly owned subsidiaries, except for K. Hovnanian Enterprises, Inc., the issuer of the senior and senior subordinated notes, and various subsidiaries formerly engaged in the issuance of collateralized mortgage obligations, a mortgage lending subsidiary, a subsidiary engaged in homebuilding activity in Poland, our Title Insurance subsidiaries, and joint ventures, is a guarantor of the Senior Notes and Senior Subordinated Notes. On May 3, 2004 we redeemed our 9 1/8% Senior Notes due 2009, and we recorded $8.7 million of expenses associated with the extinguishment of this debt. On March 18, 2004, we paid off our $115 million Term Loan, and we recorded $0.9 million of expenses associated with the extinguishment of the debt. In both cases, these expenses have been reported as "Expenses Related to Extinguishment of Debt" on the Condensed Consolidated Statements of Income. Our mortgage banking subsidiary's warehouse agreement was amended on August 3, 2004. Pursuant to the agreement, we may borrow up to $250 million. The agreement expires in July 2005 and interest is payable monthly at the Eurodollar Rate plus 1.25%. We believe that we will be able either to extend this agreement beyond July 2005 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. As of July 31, 2004, the aggregate principal amount of all borrowings under this agreement was $144.9 million. Total inventory increased $687.5 million during the nine months ended July 31, 2004. This increase excluded the change in consolidated inventory not owned of $49.9 million consisting of specific performance options, options with variable interest entities, and other options that were added to our balance sheet in accordance with SFAS 49, SFAS 98, and EITF 97-10, and Variable Interest Entities in accordance with FIN 46. See "Notes to Condensed Consolidated Financial Statements" - Note 12 for additional information on FIN 46. Excluding the impact from our Florida acquisition in November 2003 of $42.7 million, total inventory in our Northeast Region increased $118.6 million, the Southeast Region increased $83.6 million, the Southwest Region increased $58.5 million, and our West Region increased $384.1 million. The increase in inventory was primarily the result of future planned organic growth in our existing markets. Substantially all homes under construction or completed and included in inventory at July 31, 2004 are expected to be closed during the next twelve months. Most inventory completed or under development is financed through our line of credit, and senior and senior subordinated indebtedness. We usually option property for development prior to acquisition. By optioning property, we are only subject to the loss of the cost of the option and predevelopment costs if we choose not to exercise the option. As a result, our commitment for major land acquisitions is reduced. The following table summarizes the number of buildable homes included in our total residential real estate. The July 31, 2004 and October 31, 2003 numbers exclude real estate owned and options in locations where we have ceased development. Active Proposed Grand Active Communities Developable Total Communities Homes Homes Homes ----------- --------- ------------ --------- July 31, 2004: Northeast Region.. 33 8,004 17,739 25,743 Southeast Region.. 112 11,968 18,291 30,259 Southwest Region.. 89 9,975 5,606 15,581 West Region....... 51 7,676 12,638 20,314 ----------- --------- ------------ --------- 285 37,623 54,274 91,897 =========== ========= ============ ========= Owned.......... 21,336 5,510 26,846 Optioned....... 16,287 48,764 65,051 --------- ------------ --------- Total........ 37,623 54,274 91,897 ========= ============ ========= Active Proposed Grand Active Communities Developable Total Communities Homes Homes Homes ----------- --------- ------------ ---------- October 31, 2003: Northeast Region.. 32 8,536 15,744 24,280 Southeast Region.. 107 10,163 12,345 22,508 Southwest Region.. 81 7,127 6,813 13,940 West Region....... 37 7,359 6,211 13,570 ----------- ----------- ---------- ----------- 257 33,185 41,113 74,298 =========== =========== ========== =========== Owned.......... 16,111 5,359 21,470 Optioned....... 17,074 35,754 52,828 ----------- ---------- ----------- Total........ 33,185 41,113 74,298 =========== ========== =========== Homes in active communities under contract at July 31, 2004 and October 31, 2003 were 7,235 and 5,020, respectively. Such amounts do not include our build on your own lot contracts or contracts from our unconsolidated joint ventures. The following table summarizes our started or completed unsold homes and models: July 31, October 31, 2004 2003 ----------------------- ----------------------- Unsold Unsold Homes Models Total Homes Models Total ------ ------ ----- ------ ------ ----- Northeast Region.... 103 54 157 130 44 174 Southeast Region.... 166 40 206 207 32 239 Southwest Region.... 738 86 824 557 94 651 West Region......... 315 140 455 185 105 290 ------ ------ ----- ------ ------ ----- Total 1,322 320 1,642 1,079 275 1,354 ====== ====== ===== ====== ====== ===== Receivables, deposits, and notes increased $7.1 million to $49.6 million at July 31, 2004. The increase was primarily due to the timing of cash received from homes that closed on July 31, 2004. Receivables from home sales amounted to $12.4 million and $4.1 million at July 31, 2004 and October 31, 2003, respectively. Prepaid expenses and other assets are as follows: July 31, October 31, Dollar 2004 2003 Change ---------- ----------- --------- Prepaid insurance.................... $ 2,931 $ - $ 2,931 Prepaid project costs................ 46,530 34,171 12,359 Investment in joint ventures......... 47,050 23,232 23,818 Senior residential rental properties. 8,912 9,118 (206) Other prepaids....................... 17,969 16,209 1,760 Other assets......................... 22,782 23,795 (1,013) ----------- ----------- --------- $ 146,174 $ 106,525 $ 39,649 =========== =========== ========= Prepaid insurance increased due to a payment of a full year of insurance costs during the first quarter of every year. These costs are amortized monthly on a straight line basis. Prepaid project costs increased due to increased communities. Prepaid project costs consist of community specific expenditures that are used over the life of the community. Such prepaids are expensed as homes are delivered. Investments in Joint Ventures increased as we entered into three new land development joint ventures and one new homebuilding joint venture during the nine months ended July 31, 2004, with a total investment of $27.9 million at July 31, 2004. As of July 31, 2004 we have investments in three homebuilding joint ventures and seven land and land development joint ventures. Other than completion guarantees, no other guarantees associated with unconsolidated joint ventures have been given. Also included in prepaid expenses and other assets are debt issuance fees, non-qualified associate benefit plan assets, and miscellaneous prepaids and assets. At July 31, 2004, we had $32.7 million of goodwill. This amount resulted from company acquisitions prior to fiscal 2003. In May 2004, we made a decision to change our fiscal 2002 California acquisition brand name to K. Hovnanian Homes. This resulted in a reclassification of $50 million from goodwill and indefinite life intangibles to definite life intangibles on our July 31, 2004 Condensed Consolidated Balance Sheet. Definite life intangibles increased $65.1 million to $122.1 million at July 31, 2004. This increase was the result of our November 6, 2003 Florida acquisition net of amortization expense as well as the reclassification of $50 million related to the California acquisition brand name as noted above. To the extent the acquisition price was greater than the book value of tangible assets which were stepped up to fair values, purchase price premiums were classified as intangibles. Professionals are hired to appraise all acquired intangibles. Such appraisals resulted in all fiscal 2003 acquisition premiums to be categorized as definite life intangibles. The intangibles from our fiscal 2004 acquisition are estimated, as we await the final appraisal. See the "Critical Accounting Policies" section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" for additional explanation of intangibles. For tax purposes all our intangibles, except those resulting from an acquisition classified as a tax free exchange, are being amortized over 15 years. Income taxes receivable increased $20.7 million to $21.9 million at July 31, 2004. This increase was primarily the result of the payment of $28.4 million of federal and state taxes accrued at October 31, 2003 and netted against deferred taxes receivable offset by unpaid income tax accruals recorded for the nine months ended July 31, 2004. Deferred federal and state income tax assets primarily represent the deferred tax benefits arising from temporary differences between book and tax income which will be recognized in future years as offset against future taxable income. Accounts payable and other liabilities are as follows: July 31, October 31, Dollar 2004 2003 Change --------- ----------- -------- Accounts payable.......................$102,717 $ 68,935 $ 33,782 Reserves............................... 60,232 46,699 13,533 Accrued expenses....................... 28,188 27,064 1,124 Accrued compensation................... 59,007 72,495 (13,488) Property secured by a mortgage......... 16,671 - 16,671 Other liabilities...................... 23,871 15,503 8,368 --------- ----------- -------- $290,686 $ 230,696 $ 59,990 ========= =========== ======== The increase in accounts payable and other liabilities was primarily due to the consolidation of a property in our Northeast Region that was secured by a mortgage which was replaced by a letter of credit, increases in accounts payable due to our November 2003 Florida acquisition as well as the opening of new communities in our existing markets, increases in reserves for our General Liability and Workman's Compensation policies and an increase in other liabilities due to an advance related to a structured option. These increases were offset by a decrease in accrued compensation due to the payout of our fiscal year 2003 bonuses during the first nine months of 2004. The remainder of other liabilities include payroll withholdings, deferred income, and a nonrecourse mortgage associated with our Corporate Office. Financial Services - Mortgage loans held for sale consist of residential mortgages receivable of which $150.8 million and $223.9 million at July 31, 2004 and October 31, 2003, respectively, are being temporarily warehoused and awaiting sale in the secondary mortgage market. The balance of mortgage loans held for sale are being held as an investment. We may incur risk with respect to mortgages that are delinquent, but only to the extent the losses are not covered by mortgage insurance or resale value of the house. Historically, we have incurred minimal credit losses. RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTHS ENDED JULY 31, 2004 COMPARED TO THE THREE AND NINE MONTHS ENDED JULY 31, 2003 Total Revenues: Compared to the same prior period, revenues increased as follows: Three Months Ended ------------------------------------------ July 31, July 31, Dollar Percentage 2004 2003 Change Change ------------------------------------------ (Dollars In Thousands) Homebuilding: Sale of homes........ $1,044,610 $ 830,734 $213,876 25.7% Land sales and other revenues........... 5,395 4,441 954 21.5% Financial Services..... 13,683 13,642 41 0.3% ---------- ---------- -------- -------- Total Revenues... $1,063,688 $ 848,817 $214,871 25.3% ========== ========== ======== ======== Nine Months Ended ------------------------------------------ July 31, July 31, Dollar Percentage 2004 2003 Change Change ------------------------------------------ (Dollars In Thousands) Homebuilding: Sale of homes........ $2,702,826 $2,104,788 $598,038 28.4% Land sales and other revenues........... 12,959 16,445 (3,486) (21.2%) Financial Services..... 41,926 35,036 6,890 19.7% ----------- ---------- -------- -------- Total Revenues... $2,757,711 $2,156,269 $601,442 27.9% =========== ========== ======== ======== Homebuilding: Compared to the same prior period, housing revenues increased $213.9 million or 25.7% during the three months ended July 31, 2004 and increased $598.0 million or 28.4% during the nine months ended July 31, 2004. Housing revenues are recorded when title is conveyed to the buyer, adequate cash payment has been received, and there is no continued involvement. Information on homes delivered by market area is set forth below: Three Months Ended Nine Months Ended July 31, July 31, --------------------- ---------------------- 2004 2003 2004 2003 ---------- ---------- ---------- ---------- (Dollars in Thousands) Northeast Region: (1) Dollars............ $ 261,470 $ 210,039 $ 661,998 $ 494,957 Homes.............. 792 647 2,101 1,540 Southeast Region: (1) Dollars............ $ 272,395 $ 165,583 $ 716,942 $ 479,865 Homes.............. 1,004 689 2,778 1,933 Southwest Region: (1) Dollars............ $ 181,491 $ 129,907 $ 463,869 $ 309,336 Homes.............. 1,045 640 2,653 1,519 West Region: Dollars............ $ 329,254 $ 325,205 $ 860,017 $ 819,369 Homes.............. 897 1,090 2,460 2,846 Other: Dollars............ $ -- $ -- $ -- $ 1,261 Homes.............. -- -- -- 9 Consolidated Total: Dollars............ $ 1,044,610 $ 830,734 $2,702,826 $2,104,788 Homes.............. 3,738 3,066 9,992 7,847 Unconsolidated Joint Ventures: Dollars............ $ 11,611 $ 1,901 $ 22,921 $ 6,074 Homes.............. 27 9 56 30 Totals: Housing Revenues... $ 1,056,221 $ 832,635 $2,725,747 $2,110,862 Homes Delivered.... 3,765 3,075 10,048 7,877 (1) The three and nine month periods include deliveries from our Texas, Ohio, Arizona, and Florida acquisitions which closed in January 2003, April 2003, August 2003, and November 2003, respectively. An important indicator of our future results are recently signed contracts and home contract backlog for future deliveries. Our sales contracts and homes in contract backlog using base sales prices by market area are set forth below: Sales Contracts for the Nine Months Ended Contract Backlog July 31, as of July 31, ------------------------- ------------------------ 2004 2003 2004 2003 ----------- ----------- ----------- ----------- (Dollars in Thousands) Northeast Region: (1) Dollars............ $ 778,303 $ 582,015 $ 768,066 $ 613,884 Homes.............. 2,405 1,896 2,522 2,266 Southeast Region: (1) Dollars............ $ 886,696 $ 637,177 $ 772,073 $ 497,907 Homes.............. 3,132 2,400 2,558 1,707 Southwest Region: (1) Dollars............ $ 503,157 $ 338,197 206,540 $ 127,636 Homes.............. 2,871 1,722 1,207 642 West Region: Dollars............ $1,339,917 $ 882,976 $ 777,598 $ 359,821 Homes.............. 3,600 2,994 1,933 1,103 Other: Dollars............ $ -- $ 313 $ -- $ -- Homes.............. -- 2 -- -- Consolidated Total: Dollars............ $3,508,073 $2,440,678 $2,524,277 $1,599,248 Homes.............. 12,008 9,014 8,220 5,718 Unconsolidated Joint Ventures: Dollars............ $ 179,174 $ 6,409 $ 172,130 $ 4,975 Homes.............. 301 30 281 23 Totals: Dollars............ $3,687,247 $2,447,087 $2,696,407 $1,604,223 Homes............... 12,309 9,044 8,501 5,741 (1) Included in sales contracts and contract backlog are sales contracts and backlog from our Texas, Ohio, Arizona, and Florida acquisitions which closed in January 2003, April 2003, August 2003, and November 2003, respectively. During August 2004, we signed an additional 1,290 net contracts amounting to $417.4 million in consolidated communities and 44 net contracts amounting to $24.5 million in unconsolidated joint ventures compared to 1,085 net contracts amounting to $280.9 million in consolidated communities and 5 net contracts amounting to $1.1 million in unconsolidated joint ventures in the same month last year. Cost of sales includes expenses for housing and land and lot sales. A breakout of such expenses for housing sales and housing gross margin is set forth below: Three Months Ended Nine Months Ended July 31, July 31, ------------------- ---------------------- 2004 2003 2004 2003 --------- -------- ----------- ---------- (Dollars in Thousands) Sale of Homes................$1,044,610 $830,734 $2,702,826 $2,104,788 Cost of Sales................ 778,121 618,650 2,014,799 1,572,306 --------- -------- ---------- ---------- Housing Gross Margin......... $ 266,489 $212,084 $ 688,027 $ 532,482 ========= ======== ========== ========== Gross Margin Percentage...... 25.5% 25.5% 25.5% 25.3% Cost of Sales expenses as a percentage of home sales revenues are presented below: Three Months Ended Nine Months Ended July 31, July 31, ------------------- -------- -------- 2004 2003 2004 2003 -------- -------- -------- -------- Sale of Homes................ 100.0% 100.0% 100.0% 100.0% -------- -------- -------- -------- Cost of Sales: Housing, land & development costs.... 66.7% 67.1% 66.6% 67.2% Commissions............ 2.2% 2.0% 2.2% 2.1% Financing concessions.. 1.0% 0.9% 1.0% 0.9% Overheads.............. 4.6% 4.5% 4.7% 4.5% -------- -------- -------- -------- Total Cost of Sales.......... 74.5% 74.5% 74.5% 74.7% -------- -------- -------- -------- Gross Margin................. 25.5% 25.5% 25.5% 25.3% ======== ======== ======== ======== We sell a variety of home types in various local communities, each yielding a different gross margin. As a result, depending on the geographic mix of deliveries and the mix of both communities and of home types delivered, consolidated quarterly gross margin will fluctuate up or down and may not be representative of the consolidated gross margin for the year. Excluding our Florida and Arizona acquisitions, our gross margins increased to 26.1% for both the three and nine months ended July 31, 2004, when compared to the same periods last year. These increases are primarily due to increases in sales prices and the effects from some of the process improvements that we have been implementing in our existing operations. The lower margin from our Florida acquisition is primarily due to the step up of inventory to reflect fair value at the time of purchase. Although we achieve targeted returns from our Arizona acquisition through higher inventory turnover our margins are lower than our average consolidated margins. Another factor that has begun to hinder our gross margins is the increase in material costs such as lumber and concrete. Despite the effect of our acquisitions and price increases of materials, we have been able to maintain our gross margin percentage. Based on our backlog of homes expected to close during our fiscal 2004 fourth quarter, there is the potential for upside in our homebuilding gross margin for the full fiscal year ended October 31, 2004. Homebuilding selling, general, and administrative expenses as a percentage of homebuilding revenues, remained relatively flat comparing the three and nine months ended July 31, 2004 to the same periods in the prior year. Homebuilding selling, general, and administrative expenses as a percentage of homebuilding revenues was 7.9% for both the three months ended July 31, 2004 and 2003, and 8.7% and 8.5% for the nine months ended July 31, 2004 and 2003, respectively. Such expenses increased $16.8 million and $55.2 million during the three and nine months ended July 31, 2004, respectively, compared to the same period last year. The dollar increase was primarily due to our acquisitions and increased selling, general and administrative costs associated with the increase in the number of active selling communities in all of our regions. Land Sales and Other Revenues: Land sales and other revenues consist primarily of land and lot sales. A breakout of land and lot sales is set forth below: Three Months Ended Nine Months Ended July 31, July 31, ------------------ ------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Land and Lot Sales................ $ 230 $ 3,314 $ 1,815 $13,064 Cost of Sales..................... 95 3,247 1,458 9,988 -------- -------- -------- -------- Land and Lot Sales Gross Margin... 135 67 357 3,076 Interest Expense.................. - 153 21 508 -------- -------- -------- -------- Land and Lot Sales Profit (Loss) Before Tax...................... $ 135 $ (86) $ 336 $ 2,568 ======== ======== ======== ======== Land and lot sales are incidental to our residential housing operations and are expected to continue in the future but may significantly fluctuate up or down. Financial Services Financial services consist primarily of originating mortgages from our homebuyers and selling such mortgages in the secondary market, and title insurance activities. For the three and nine months ended July 31, 2004, financial services provided a $5.0 million and $16.6 million profit before income taxes, respectively, compared to a profit of $6.0 million and $15.4 million, respectively, for the same periods in 2003. The decrease in pretax profit for the three months ended July 31,2004 as well as the decrease in pretax margin percentage in both the three and nine months ended July 31, 2004 is primarily due to reduced spreads resulting from the steady rise in homebuyers choosing to use Adjustable Rate Mortgage (ARM) products which historically are less profitable to originate and lower gross spreads due to increased competition for purchase mortgages as the market for refinancing mortgages has significantly declined. Corporate General and Administrative Corporate general and administrative expenses represents the operations at our headquarters in Red Bank, New Jersey. Such expenses include our executive offices, information services, human resources, corporate accounting, training, treasury, process redesign, internal audit, construction services, and administration of insurance, quality, and safety. As a percentage of total revenues, such expenses decreased to 1.2% for the three months ended July 31, 2004 from 2.0% for the prior year's three months and decreased to 1.5% for the nine months ended July 31, 2004 from 2.1% for the prior year's nine months. Corporate general and administrative expenses decreased $4.0 million and $2.8 million during the three and nine months ended July 31, 2004, respectively, compared to the same periods last year. Decreases in corporate general and administrative expenses are primarily attributed to reduced bonus expenses as the percentage of expected 2004 full year profit earned in the nine months ended July 31, 2004 is less than the percentage of 2003 full year profit earned in the nine months ended July 31,2003. Bonuses are accrued during the year based on profit earned to date. In addition, in 2004, we had reduced depreciation expense as certain assets are now fully depreciated and reduced consulting services as certain non-recurring projects were completed last year. These reductions were partially offset by additional salary expense due to increased headcount as our company continues to grow. Interest Interest expense includes housing and land and lot interest. Interest expense is broken down as follows: Three Months Ended Nine Months Ended July 31, July 31, ------------------ ------------------- 2004 2003 2004 2003 -------- -------- -------- -------- Sale of Homes.............. $ 17,725 $ 17,051 $ 53,743 $ 43,800 Land and Lot Sales......... - 153 21 508 -------- -------- -------- -------- Total...................... $ 17,725 $ 17,204 $ 53,764 $ 44,308 ======== ======== ======== ======== Housing interest as a percentage of sale of homes revenues decreased 0.4% for the three months ended July 31, 2004 to 1.7% from 2.1% for the same period last year and decreased 0.1% for the nine months ended July 31, 2004 to 2.0% from 2.1% for the same period last year. Housing interest as a percentage of sale of homes decreased due to our average debt as a percentage of average inventory decreasing, as well as due to a reduction in our borrowing costs from redeeming our $150 million 9 1/8% Senior Notes and replacing that debt by drawing on the lower rate revolving credit facility. Other Operations Other operations consist primarily of miscellaneous residential housing operations expenses, senior rental residential property operations, amortization of senior and senior subordinated note issuance expenses, earnout payments from homebuilding company acquisitions, amortization of the consultant agreements and the right of first refusal agreement from our California acquisition in fiscal 2002, minority interest relating to joint ventures, and corporate owned life insurance. Intangible Amortization We are amortizing our definite life intangibles over their expected useful life, ranging from three to seven years. Intangible amortization increased $6.6 million and $13.7 million for the three and nine months ended July 31,2004, respectively, when compared to the same period last year. This increase was the result of our November 2003 Florida acquisition and a full nine months of amortization expense from our Texas and Ohio acquisitions that closed in January 2003 and April 2003, respectively, as well as the amortization expense associated with the California acquisition brand name, which is being phased out as discussed above under "Capital Resources and Liquidity." Recent Accounting Pronouncements In December 2003, the Financial Accounting Standards Board ("FASB") issued Revised Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46R"). FIN 46R requires the primary beneficiary of a variable interest entity to consolidate that entity. The primary beneficiary of a variable interest entity is the party that absorbs a majority of the variable interest entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual, or other financial interests in the entity. Expected losses are the expected negative variability in the fair value of an entity's net assets exclusive of its variable interests, and expected residual returns are the expected positive variability in the fair value of an entity's net assets, exclusive of variable interests. We have fully implemented FIN 46 as of April 30, 2004. In March 2004, the Securities and Exchange Commission staff issued Staff Accounting Bulletin 105 ("SAB 105"). Existing accounting guidance requires an entity to record on its balance sheet the fair value of any issued and outstanding mortgage loan commitments. SAB 105 requires that the fair value measurement include only differences between the guaranteed interest rate in the loan commitment and a market interest rate, excluding any future cash flows related to (i) expected fees to be received when the loan commitment becomes a loan, (ii) gains from selling the loan, or (iii) the servicing value created from the loan. The guidance in SAB 105 must be applied to mortgage loan commitments that are accounted for as derivatives and are entered into after March 31, 2004. The adoption of the guidance in SAB 105 did not have a material adverse effect on our financial position or results of operations. Total Taxes Total taxes as a percentage of income before taxes increased 0.3% for the nine months ended July 31, 2004 to 37.7% from 37.4% for the same period last year. The increase is due to additional state tax reserves recorded in the nine months ended July 31, 2004. Deferred federal and state income tax assets primarily represent the deferred tax benefits arising from temporary differences between book and tax income which will be recognized in future years as an offset against future taxable income. If for some reason the combination of future years income (or loss) combined with the reversal of the timing differences results in a loss, such losses can be carried back to prior years to recover the deferred tax assets. As a result, management is confident such deferred tax assets are recoverable regardless of future income. Inflation Inflation has a long-term effect on us because increasing costs of land, materials, and labor result in increasing sale prices of our homes. In general, these price increases have been commensurate with the general rate of inflation in our housing markets and have not had a significant adverse effect on the sale of our homes. A significant risk faced by the housing industry generally is that rising house costs, including land and interest costs, will substantially outpace increases in the income of potential purchasers. In recent years, in the price ranges in which our homes sell, we have not found this risk to be a significant problem. Inflation has a lesser short-term effect on us because we generally negotiate fixed price contracts with many, but not all, of our subcontractors and material suppliers for the construction of our homes. These prices usually are applicable for a specified number of residential buildings or for a time period of between three to twelve months. Construction costs for residential buildings represent approximately 56% of our homebuilding cost of sales. Mergers and Acquisitions On November 6, 2003, we acquired a Florida homebuilder for cash and 489,236 shares of our Class A Common Stock (shares reflect stock dividend). On November 1, 2002 and December 31, 2002 we acquired two Texas homebuilding companies. On April 9, 2003, we acquired a build-on-your-own lot homebuilder in Ohio and on August 8, 2003 we acquired a homebuilder in Arizona. All fiscal 2003 acquisitions were paid for in cash. Safe Harbor Statement All statements in this Form 10-Q that are not historical facts should be considered as "Forward-Looking Statements" within the meaning of the Private Securities Litigation Act of 1995. Such statements involve known and unknown risks, uncertainties and other factors that may cause actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements. Although we believe that our plans, intentions and expectations reflected in, or suggested by such forward-looking statements are reasonable, we can give no assurance that such plans, intentions, or expectations will be achieved. Such risks, uncertainties and other factors include, but are not limited to: . Changes in general and local economic and business conditions; . Weather conditions; . Changes in market conditions; . Changes in home prices and sales activity in the California, New Jersey, Texas, North Carolina, Virginia, and Maryland markets; . Government regulation, including regulations concerning development of land, the homebuilding process, and the environment; . Fluctuations in interest rates and the availability of mortgage financing; . Shortages in, and price fluctuations of, raw materials and labor; . The availability and cost of suitable land and improved lots; . Levels of competition; . Availability of financing to the Company; . Utility shortages and outages or rate fluctuations; and . Geopolitical risks, terrorist acts and other acts of war. Certain risks, uncertainties, and other factors are described in detail in Item 1 and 2 "Business and Properties" in our Form 10-K for the year ended October 31, 2003. Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. The primary market risk facing us is interest rate risk of our long-term debt. In connection with our mortgage operations, mortgage loans held for sale and the associated mortgage warehouse line of credit are subject to interest rate risk; however, such obligations reprice frequently and are short-term in duration. In addition, we hedge the interest rate risk on mortgage loans by obtaining forward commitments from private investors. Accordingly, the risk from mortgage loans is not material. We do not hedge interest rate risk other than on mortgage loans using financial instruments. We are also subject to foreign currency risk but this risk is not material. The following table sets forth as of July 31, 2004, our long term debt obligations, principal cash flows by scheduled maturity, weighted average interest rates and estimated fair market value ("FMV").
As of July 31, 2004 -------------------------------------------------- Expected Maturity Date FMV @ 2004 2005 2006 2007 2008 2009 Thereafter Total 7/31/04 ------- ------- ------ ------- -------- -------- ---------- -------- -------- (Dollars in Thousands) Long Term Debt(1): Fixed Rate.... $ 23,141 $ 81 $ 88 $140,346 $ 104 $ 112 $ 765,115 $928,987 $951,478 Average interest rate 5.97% 8.38% 8.38% 10.50% 8.38% 8.38% 7.38% 7.82% Variable Rate. $215,000 $215,000 $215,000 Average Interest rate (2)
(1) Does not include bonds collateralized by mortgages receivable. (2) Various rates of either the prime rate or a spread over LIBOR ranging from 1.1% to 2.0% per annum, depending on our consolidated Leverage Ratio, as defined in our revolving credit agreement. In addition, we have reassessed the market risk for our variable rate debt, which is based upon the prime rate or a spread over LIBOR, and we believe that a one percent increase in the prime rate or LIBOR rate would have an approximate $0.5 million increase in interest expense for the three and nine months ended July 31, 2004, assuming $215 million of variable rate debt outstanding from May 1,2004 to July 31, 2004. Item 4. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures that are designed to ensure that information required to be disclosed in the Company's reports under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to the Company's management, including its chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. The Company's management, with the participation of the Company's chief executive officer and chief financial officer, has evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of July 31, 2004. Based upon that evaluation and subject to the foregoing, the Company's chief executive officer and chief financial officer concluded that the design and operation of the Company's disclosure controls and procedures are effective to accomplish their objectives. In addition, there was no change in the Company's internal control over financial reporting that occurred during the quarter ended July 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. PART II. Other Information Item 2. Unregistered Sales of Equity Securities and Use of Proceeds This table provides information with respect to purchases of shares of our Class A common stock made by or on behalf of Hovnanian Enterprises during the fiscal third quarter of 2004. Issuer Purchases of Equity Securities (1)
Total Number Of Shares Maximum Number of Purchased as Shares That May Part of Publicly Yet Be Purchased Total Number of Average Price Announced Plans Under The Plans Period Shares Purchased Paid Per Share or Programs or Programs ---------------- ---------------- -------------- ---------------- ----------------- May 1, 2004 Through May 31, 2004 4,510 35.24 4,510 2,187,614 ------------------------------------------------------------------------------------- June 1, 2004 Through June 30, 2004 - - - 2,187,614 ------------------------------------------------------------------------------------- July 1, 2004 Through July 31, 2004 97,844 29.94 97,844 2,089,770 ------------------------------------------------------------------------------------- Total 102,354 30.17 102,354 ================ ============== ================
(1) In July 2001, our Board of Directors authorized a stock repurchase program to purchase up to 4 million shares of Class A Common Stock. On March 5, 2004, our Board of Directors authorized a 2-for-1 stock split in the form of a 100% stock dividend. All share information reflects our dividend. No shares of our Class B common stock were purchased by or on behalf of Hovnanian Enterprises during the fiscal third quarter of 2004. Item 6. Exhibits Exhibit 3(a) Certificate of Incorporation of the Registrant. (1) Exhibit 3(b) Certificate of Amendment of Certificate of Incorporation of the Registrant. (2) Exhibit 3(c) Certificate of Amendment of Certificate of Incorporation of the Registrant. (3) Exhibit 3(d) Restated Bylaws of the Registrant. (4) Exhibit 10(a) Third Amendment to First Restated Revolving Credit Agreement dated as of August 3, 2004, among, K. Hovnanian Mortgage, Inc., and K. Hovnanian American Mortgage, LLC., Guaranty Bank, Bank of America NA, J P Morgan Chase Bank, Comerica Bank, National City Bank of Kentucky, U S Bank N A, Colonial Bank NA, and Washington Mutual Bank FA (Warehouse Agreement) Exhibit 10(b) Fourth Amended and Restated Credit Agreement dated as of June 18, 2004, among, K. Hovnanian Enterprises,Inc., Hovnanian Enterprises, Inc., PNC Bank NA, Bank of America NA, Wachovia Bank NA, Bank One NA, Key Bank, National Association, and The Royal Bank of Scotland. Exhibit 31(a) Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer. Exhibit 31(b) Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer Exhibit 32(a) Section 1350 Certification of Chief Executive Officer. Exhibit 32(b) Section 1350 Certification of Chief Financial Officer. (1) Incorporated by reference to Exhibits to Registration Statement (No. 2-85198) on Form S-1 of the Registrant. (2) Incorporated by reference to Exhibit4.2 to Registration Statement (No. 333-106761) on Form S-3 of the Registrant. (3) Incorporated by reference to Exhibits to Quarterly Report on Form 10-Q of the Registrant for the quarter ended January 31, 2004. (4) Incorporated by reference to Exhibit 3.2 to Registration Statement (No. 1-08551) on Form 8-A of the Registrant. SIGNATURES Pursuant to the requirements of the Securities Exchange Act of l934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. HOVNANIAN ENTERPRISES, INC. (Registrant) DATE: September 13, 2004 /S/J. LARRY SORSBY J. Larry Sorsby, Executive Vice President and Chief Financial Officer DATE: September 13, 2004 /S/PAUL W. BUCHANAN Paul W. Buchanan, Senior Vice President Corporate Controller