10-Q 1 f10q703.txt FORM 10-Q QUARTER ENDED 7/31/03 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10Q (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, 2003 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, N. J. 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. 22,596,588 Class A Common Shares and 7,426,051 Class B Common Shares were outstanding as of September 5, 2003 HOVNANIAN ENTERPRISES, INC. FORM 10Q INDEX PAGE NUMBER PART I. Financial Information Item l. Consolidated Financial Statements: Consolidated Balance Sheets at July 31, 2003 (unaudited) and October 31, 2002 4 Consolidated Statements of Income for the three and nine months ended July 31, 2003 and 2002 (unaudited) 6 Consolidated Statements of Stockholders' Equity for the nine months ended July 31, 2003 (unaudited) 7 Consolidated Statements of Cash Flows for the nine months ended July 31, 2003 and 2002 (unaudited) 8 Notes to Consolidated Financial Statements (unaudited) 9 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 6. Exhibits and Reports on Form 8-K. 37 (a) Exhibit 3(a) Certificate of Incorporation of the Registrant. (1) Exhibit 3(b) Certificate of Amendment of Certificate of Incorporation of the Registrant. Exhibit 3(c) Restated Bylaws of the Registrant. (3) Exhibit 10(a) Third Amended and Restated Credit Agreement dated June 19, 2003. (2) Exhibit 10(b) First Amendment to First Restated K. Hovnanian Mortgage, Inc. Revolving Credit Agreement dated July 31, 2003. 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) Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes- Oxley Act of 2002. Exhibit 32(b) Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of The Sarbanes- Oxley Act of 2002. (1) Incorporated by reference to Exhibits to Registration Statement (No. 2-85198) on Form S-1 of the Registrant. (2) Incorporated by reference to Exhibits to Annual Report on Form 10-K for the year ended February 28, 1994 of the Registrant. (3) Incorporated by reference to Exhibits to Registration Statement (No. 333-106761) on Form S-3 of the Registrant. (b) Reports on Form 8-K No reports on Form 8-K have been filed during the quarter for which this report is filed. The following report on Form 8-K has been furnished during the quarter for which this report is filed: On May 23, 2003, the Company furnished a report on Form 8-K, Item 9 (pursuant to Item 12 in accordance with SEC Release 33-8216; 34-47583; IC-25983; March 27, 2003), relating to the Company's press release dated May 28, 2003 relating to its preliminary financial results for the second quarter ended April 30, 2003. Signatures 39 HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands)
July 31, October 31, ASSETS 2003 2002 ----------- ----------- (unaudited) Homebuilding: Cash and cash equivalents..................... $ 110,820 $ 262,675 ----------- ----------- Inventories - At the lower of cost or fair value: Sold and unsold homes and lots under development............................... 1,090,908 803,829 ----------- ----------- Land and land options held for future development or sale....................... 280,706 171,081 ----------- ----------- Consolidated Inventory Not Owned: Specific performance options.............. 72,436 67,183 Variable interest entities................ 93,252 Other options............................. 54,377 39,489 ----------- ----------- Total Consolidated Inventory Not Owned.. 220,065 106,672 ----------- ----------- Total Inventories..................... 1,591,679 1,081,582 ----------- ----------- Receivables, deposits, and notes ............. 45,742 26,276 ----------- ----------- Property, plant, and equipment - net.......... 27,110 19,242 ----------- ----------- Senior residential rental properties - net.... 9,215 9,504 ----------- ----------- Prepaid expenses and other assets............. 93,695 86,582 ----------- ----------- Goodwill and indefinite life intangibles...... 82,283 82,275 ----------- ----------- Definite life intangibles..................... 59,244 ----------- ----------- Total Homebuilding.................... 2,019,788 1,568,136 ----------- ----------- Financial Services: Cash and cash equivalents..................... 8,819 7,315 Mortgage loans held for sale.................. 152,211 91,451 Other assets.................................. 3,119 11,226 ----------- ----------- Total Financial Services.............. 164,149 109,992 ----------- ----------- Income Taxes Receivable - Including deferred tax benefits...................................... 11,717 ----------- ----------- Total Assets.................................... $2,195,654 $1,678,128 =========== =========== See notes to consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In Thousands Except Per Share Data)
July 31, October 31, LIABILITIES AND STOCKHOLDERS' EQUITY 2003 2002 ----------- ----------- (unaudited) Homebuilding: Nonrecourse land mortgages..................... $ 29,173 $ 11,593 Accounts payable and other liabilities......... 211,054 198,290 Customers' deposits............................ 61,263 40,422 Nonrecourse mortgages secured by operating properties................................... 3,177 3,274 Liabilities from inventory not owned........... 116,597 97,983 ----------- ----------- Total Homebuilding......................... 421,264 351,562 ----------- ----------- Financial Services: Accounts payable and other liabilities......... 6,641 4,857 Mortgage warehouse line of credit.............. 137,039 85,498 ----------- ----------- Total Financial Services................... 143,680 90,355 ----------- ----------- Notes Payable: Term loan...................................... 115,000 115,000 Senior notes................................... 387,029 396,390 Senior subordinated notes...................... 300,000 150,000 Accrued interest............................... 17,738 9,555 ----------- ----------- Total Notes Payable........................ 819,767 670,945 ----------- ----------- Income Taxes Payable - Net of deferred tax benefits. 777 ----------- ----------- Total Liabilities.......................... 1,384,711 1,113,639 ----------- ----------- Minority interest from inventory not owned....... 80,137 ----------- ----------- Minority interest from consolidated joint ventures.. 1,860 1,940 ----------- ----------- Stockholders' Equity: Preferred Stock,$.01 par value-authorized 100,000 shares; none issued.......................... Common Stock,Class A,$.01 par value-authorized 87,000,000 shares; issued 27,875,001 shares at July 31, 2003 and 27,452,481 shares at October 31, 2002 (including 5,342,599 shares at July 31, 2003 and 4,343,240 shares at October 31, 2002 held in Treasury)................................. 279 275 Common Stock,Class B,$.01 par value (convertible to Class A at time of sale) authorized 13,000,000 shares; issued 7,772,342 shares at July 31, 2003 and 7,788,061 shares at October 31, 2002 (including 345,874 shares at July 31, 2003 and October 31, 2002 held in Treasury)........... 78 78 Paid in Capital................................ 160,479 152,977 Retained Earnings.............................. 613,933 447,802 Deferred Compensation.......................... (21) Treasury Stock - at cost....................... (45,823) (38,562) ----------- ----------- Total Stockholders' Equity................. 728,946 562,549 ----------- ----------- Total Liabilities and Stockholders' Equity....... $2,195,654 $1,678,128 =========== =========== See notes to consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In Thousands Except Per Share Data) (Unaudited)
Three Months Ended Nine Months Ended July 31, July 31, -------------------- ---------------------- 2003 2002 2003 2002 --------- --------- ---------- ---------- Revenues: Homebuilding: Sale of homes......................$ 830,734 $ 681,329 $2,104,788 $1,656,813 Land sales and other revenues...... 4,441 12,651 16,445 34,564 --------- --------- ---------- ---------- Total Homebuilding............... 835,175 693,980 2,121,233 1,691,377 Financial Services................... 13,642 10,656 35,036 28,319 --------- --------- ---------- ---------- Total Revenues................... 848,817 704,636 2,156,269 1,719,696 --------- --------- ---------- ---------- Expenses: Homebuilding: Cost of sales...................... 621,897 539,676 1,582,294 1,327,685 Selling, general and administrative 66,136 52,882 180,035 138,177 Inventory impairment loss.......... 149 426 1,633 2,755 --------- --------- ---------- ---------- Total Homebuilding............... 688,182 592,984 1,763,962 1,468,617 Financial Services................... 7,635 5,694 19,629 16,156 Corporate General and Administrative. 16,978 12,195 45,026 33,700 Interest............................. 17,204 15,849 44,308 42,353 Other Operations..................... 9,010 3,953 17,972 13,539 Restructuring Charges/Asset Writeoff. 12,000 12,000 --------- --------- ---------- ---------- Total Expenses................... 739,009 642,675 1,890,897 1,586,365 --------- --------- ---------- ---------- Income Before Income Taxes............. 109,808 61,961 265,372 133,331 --------- --------- ---------- ---------- State and Federal Income Taxes: State................................ 5,439 1,679 11,874 5,086 Federal.............................. 35,567 21,095 87,367 44,987 --------- --------- ---------- ---------- Total Taxes........................ 41,006 22,774 99,241 50,073 --------- --------- ---------- ---------- Net Income.............................$ 68,802 $ 39,187 $ 166,131 $ 83,258 ========= ========= ========== ========== Per Share Data: Basic: Income per common share..............$ 2.25 $ 1.27 $ 5.35 $ 2.76 ========= ========= ========== ========== Weighted average number of common shares outstanding................. 30,630 30,877 31,044 30,188 Assuming dilution: Income per common share..............$ 2.11 $ 1.20 $ 5.06 $ 2.61 ========= ========= ========== ========== Weighted average number of common shares outstanding................ 32,543 32,730 32,806 31,922 See notes to consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS 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, 2002 23,109,241 $275 7,442,187 $78 $152,977 $447,802 $ (21) $(38,562) $ 562,549 Shares returned in connnection with prior year acquisition........ (749,359) Sale of common stock under Employee stock option plan.................... 318,660 3 7,421 7,424 Stock bonus plan.......... 88,141 1 81 82 Conversion of Class B to Class A Common Stock.... 15,719 (15,719) Deferred compensation..... 21 21 Treasury stock purchases.. (250,000) (7,261) (7,261) Net Income................ 166,131 166,131 ----------- ------ ----------- ------ ------- -------- -------- -------- --------- Balance, July 31, 2003.... 22,532,402 $279 7,426,468 $78 $160,479 $613,933 $ -- $(45,823) $ 728,946 (Unaudited) =========== ====== =========== ====== ======= ======== ======== ======== ========= See notes to consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In Thousands - Unaudited)
Nine Months Ended July 31, --------------------- 2003 2002 ---------- ---------- Cash Flows From Operating Activities: Net Income.......................................... $ 166,131 $ 83,258 Adjustments to reconcile net income to net cash (used in) provided by operating activities: Depreciation.................................... 4,946 5,003 Amortization of definite life intangibles....... 5,465 - Loss on sale and retirement of property and assets.................................... 44 11,858 Deferred income taxes........................... (6,123) (5,742) Impairment losses............................... 1,633 2,755 Decrease (increase) in assets: Mortgage notes receivable..................... (59,049) 43,162 Receivables, prepaids and other assets........ (14,444) 9,512 Inventories................................... (338,374) (80,489) Increase (decrease) in liabilities: State and Federal income taxes................ 403 5,208 Tax effect from exercise of stock options..... (6,774) (1,074) Customers' deposits........................... 21,352 4,102 Interest and other accrued liabilities........ 14,719 17,960 Post development completion costs............. 1,952 (901) Accounts payable.............................. (11,373) 7,769 ---------- ---------- Net cash (used in) provided by operating activities................................ (219,492) 102,381 ---------- ---------- Cash Flows From Investing Activities: Net Proceeds from sale of property and assets....... 482 611 Purchase of property,equipment and other fixed assets and acquisitions of homebuilding companies. (141,796) (142,860) Distribution from (investment in and advance to) unconsolidated affiliates......................... 1,150 (8,679) ---------- ---------- Net cash (used in) investing activities..... (140,164) (150,928) ---------- ---------- Cash Flows From Financing Activities: Proceeds from mortgages and notes...................1,090,816 1,587,017 Proceeds from senior debt........................... 99,152 Proceeds from senior subordinated debt.............. 150,000 150,000 Principal payments on mortgages and notes..........(1,022,006)(1,603,320) Principal payments on senior debt................... (9,750) (99,747) Purchase of treasury stock.......................... (7,261) (1,089) Proceeds from sale of stock and employee stock plan. 7,506 4,022 ---------- ---------- Net cash provided by financing activities... 209,305 136,035 ---------- ---------- Net (Decrease) Increase In Cash and Cash Equivalents.. (150,351) 87,488 Cash and Cash Equivalents Balance, Beginning Of Period................................. 269,990 16,149 ---------- ---------- Cash and Cash Equivalents Balance, End Of Period.....$ 119,639 $ 103,637 ========== ========== Supplemental Disclosures of Cash Flow Cash paid during the period for: Interest..........................................$ 41,198 $ 39,450 ========== ========== Income taxes......................................$ 104,962 $ 52,777 ========== ========== Supplemental disclosures of noncash operating activities: Consolidated Inventory Not Owned: Specific performance options......................$ 64,743 $ 24,710 Variable interest entities........................ 81,537 Other options..................................... 50,486 ---------- ---------- Total Inventory Not Owned...........................$ 196,766 $ 24,710 ========== ========== See notes to consolidated financial statements (unaudited).
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO 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 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, 2002 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. 2. Stock Option Plan - We adopted Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25") and related Interpretations in Accounting for our employee stock options. Under APB No. 25, no compensation expense is recognized because the exercise price of our Company's employee stock options equals the market price of the underlying stock on the date of the grant. Pro forma information regarding net income and earnings per share is to be calculated as if we had accounted for our stock options under the fair value method of Financial Accounting Standards (SFAS) No. 123 "Accounting for Stock-Based Compensation". The fair value for those options is established at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for 2003 and 2002 respectively: risk-free interest rate of 4.3% and 4.3%, respectively; dividend yield of zero; volatility factor of the expected market price of our common stock of 0.43 and 0.43, respectively; and a weighted-average expected life of the option of 5.1 and 5.5 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 those of our 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. For purposes of pro forma disclosures, the estimated fair value of the options 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, 2003 31, 2002 31, 2003 31, 2002 --------- -------- -------- -------- Net income to common shareholders; as reported.........................$ 68,802 $ 39,187 $166,131 $ 83,258 Deduct: total stock-based employee compensation expense determined under fair value based method for all awards, net of minority interest 539 140 1,515 420 Pro forma net income..................$ 68,263 $ 39,047 $164,616 $ 82,838 ========= ======== ======== ======== Pro forma basic earnings per share....$ 2.23 $ 1.26 $ 5.30 $ 2.74 ========= ======== ======== ======== Basic earnings per share as reported..$ 2.25 $ 1.27 $ 5.35 $ 2.76 ========= ======== ======== ======== Pro forma diluted earnings per share..$ 2.10 $ 1.19 $ 5.02 $ 2.60 ========= ======== ======== ======== Diluted earnings per share as Reported............................$ 2.11 $ 1.20 $ 5.06 $ 2.61 ========= ======== ======== ======== 3. Interest costs incurred, expensed and capitalized were: Three Months Ended Nine Months Ended July 31, July 31, ------------------- ------------------- 2003 2002 2003 2002 -------- -------- -------- -------- (Dollars in Thousands) Interest Capitalized at Beginning of Period.........$ 25,480 $ 24,876 $ 22,159 $ 25,124 Plus Interest Incurred(1)(2).. 17,807 15,746 48,232 42,002 Less Interest Expensed(2)..... 17,204 15,849 44,308 42,353 -------- -------- -------- -------- Interest Capitalized at End of Period (2).......... $ 26,083 $ 24,773 $ 26,083 $ 24,773 ======== ======== ======== ======== (1) Data does not include interest incurred by our mortgage and finance subsidiaries. (2) Represents interest on borrowings for construction, land and development costs which are charged to interest expense when homes are delivered or when land is not under active development. 4. Homebuilding accumulated depreciation at July 31, 2003 and October 31, 2002 amounted to $22.0 million and $18.5 milion, respectively. Senior residential rental property accumulated depreciation at July 31, 2003 and October 31, 2002 amounted to $3.4 million and $3.1 million, respectively. 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 amounting to $1.6 million during the nine months ended July 31, 2003. During the nine months ended July 31, 2002 we wrote off such costs in the amount of $1.6 million in Poland, $0.8 million due to the exit of our Mid-South operations, and $0.4 million in other geographical areas. Residential inventory impairment losses and option write-offs are reported in the Consolidated Statements of Income as "Homebuilding- Inventory Impairment Loss." 6. We are involved in litigation arising in the ordinary course of business, none of which is expected to have a material adverse effect on us. 7. As of July 31, 2003 and October 31, 2002, respectively, we are obligated under various performance letters of credit amounting to $132.9 million and $100.0 million. 8. We have an unsecured Revolving Credit Agreement (the "Agreement") with a group of banks which was amended and restated on June 19, 2003. Pursuant to the agreement, our credit line increased to $590.0 million. The Agreement bears an expiration date of July 2006 and interest is payable monthly and at various rates of either the prime rate plus 0.275% or LIBOR plus 1.75%. In addition, we pay a fee equal to 0.350% per annum on the weighted average unused portion of the line. As of July 31, 2003 and October 31, 2002, there were no borrowings under the Agreement. Our mortgage warehouse line of credit was amended and restated on July 31, 2003. Pursuant to the agreement, our credit line matures in July 2004 and we have the option to borrow up to $200.0 million. Interest is payable monthly at the Federal Funds Rate plus 1.375%. As of July 31, 2003 and October 31, 2002 borrowings were $137.0 million and $85.5 million, respectively. 9. On May 9, 2003, we issued $150 million 7 3/4% Senior Subordinated Notes due 2013. The net proceeds of the note offering were used to repay the current outstanding indebtedness under the Agreement and the remainder for general corporate purposes. During the third quarter ended July 31, 2003 we paid down $9.8 million of our $150 million 10 1/2% Senior Notes due 2007. At July 31, 2003, our long-term debt consisted of: $140.3 million 10 1/2% Senior Notes due 2007, $150 million 9 1/8% Senior Notes due 2009, $100 million 8% Senior Notes due 2012 (aggregating $387 million, net of discount), $150 million 8 7/8% Senior Subordinated Notes due 2012, $150 million 7 3/4% Senior Subordinated Notes due 2013 and a $165 million Term Loan due 2007 which bears interest at either the prime rate plus 1.25% or LIBOR plus 2.5%. As of July 31, 2003 borrowings under the Term Loan were $115 million. 10. Per Share Calculations - Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share" requires the presentation of basic earnings per share and diluted earnings per share. Basic earnings per share is computed using the weighted average number of shares outstanding. Diluted earnings per common share is computed using the basic weighted average number of shares outstanding adjusted for the incremental shares attributed to outstanding options to purchase common stock. 11. Recent Accounting Pronouncements - In April 2002, the Financial Accounting Standards Board issued (SFAS) No. 145, "Reported Gains and Losses from Extinguishment of Debt", which rescinded SFAS No. 4, No. 44, and No. 64 and amended SFAS No. 13. The new standard addresses the income statement classification of gains or losses from the extinguishment of debt and criteria for classification as extraordinary items. We adopted SFAS No. 145 on November 1, 2002. We reclassified a $0.9 million extraordinary loss from extinguishment of debt to other operations and a $0.3 million reduction to State and Federal Income Taxes on our Consolidated Statements of Income to conform to the new presentation. In June 2002, the Financial Accounting Standards Board issued (SFAS) No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including certain costs incurred in a restructuring)". SFAS No. 146 requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred as opposed to when the entity commits to an exit plan as prescribed under EITF No. 94-3. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. We adopted SFAS No. 146 on January 1, 2003. The initial adoption of SFAS 146 did not have a material effect on the financial position or results of operations of our Company. However, SFAS No. 146 could impact the amount or timing of liabilities to be recognized in the event that we engage in exit or disposal activities in the future. In November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of the initial recognition and initial measurement provisions of FIN 45 did not have a material effect on our financial position or results of operations. Our disclosure of guarantees is included in Note 14 to the consolidated financial statements - unaudited. In December 2002, the Financial Accounting Standards Board issued (SFAS) No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", which amends (SFAS) No. 123. The new standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the affect of the method used on reported results. We have not elected to change to the fair value based method of accounting for stock-based employee compensation. We adopted the disclosure provisions of SFAS No. 148 in our second fiscal quarter ending April 30, 2003. Our disclosure of accounting for stock-based compensation is included in Note 2 to the consolidated financial statements - unaudited. In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities" an interpretation of ARB No. 51 ("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 is effective immediately for VIE's created after January 31, 2003. For VIE's created before January 31, 2003, FIN 46 must be applied at the beginning of the first interim or annual reporting period beginning after June 15, 2003. 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 have been 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 we will 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 will consolidate it on our balance sheet. The fair value of the VIE's inventory will be 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, 2003 we consolidated nine VIE's created from February 1, 2003 to July 31, 2003 as a result of our option to purchase land or lots from the selling entities. We paid cash or issued letters of credit deposits to these nine VIE's totaling $11.7 million. Our option deposits represent our maximum exposure to loss. The fair value of the property owned by the VIE's was $93.2 million of which $6.2 million was not optioned to our Company. We were able to ascertain that one VIE had third party debt amounting to $1.4 million. Since 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 $80.1 million, was reported on the balance sheet as Minority Interest. Creditors, if any, of these VIE's have no recourse against our Company. We will continue to secure land and lots using options. Including the deposits with the nine VIE's above, at July 31, 2003 we have total cash and letters of credit deposits amounting to approximately $180.2 million to purchase land and lots with a total purchase price of $2.4 billion. Not all our deposits are with VIE's. 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. We are in the process of evaluating all option purchase agreements in effect as of January 31, 2003. Options with VIE's where we are the primary beneficiary will be consolidated by our fiscal year end October 31, 2003. 12. On November 1, 2002 and December 31, 2002 we acquired two Houston homebuilding companies, for an approximate aggregate purchase price of $100 million. On April 9, 2003 we acquired a build-on-your-own- lot homebuilder based in Canton, Ohio. On August 8, 2003, we acquired a homebuilder in Phoenix, Arizona. All of these acquisitions were accounted for as a purchase, with the results of operations of these entities included in our consolidated financial statements as of the date of acquisition. The purchase price was allocated based on estimated fair value at the date of acquisition. As a result, estimated definite life intangible assets of $63.5 million were recorded on the consolidated balance sheet. We expect to amortize the definite life intangibles over their estimated lives. 13. Intangible Assets - As reported on the balance sheet we have goodwill and indefinite life intangibles amounting to $82.3 million and definite life intangibles amounting to $59.2 million. Our intangible assets consist of goodwill, tradenames, architectural designs, and contractual agreements. In accordance with the Financial Accounting Standards No. 142 ("SFAS No. 142") "Goodwill and Other Intangible Assets"; 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. The amortization expense of $3.2 million and $5.5 million is reported in other operations on our Consolidated Statement of Income for the three and nine months ended July 31, 2003, respectively. No amortization expense was recorded during the three and nine months ended July 31, 2002, respectively. 14. 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, 2003 had issued and outstanding approximately $300 million senior subordinated notes, $390 million face value senior notes, a term loan with an outstanding balance of $115 million, and a revolving credit agreement with no outstanding balance. The senior subordinated notes, senior notes, the revolving credit agreement, and term loan 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 subsidiaries, and joint ventures (collectively the "Non-Guarantor Subsidiaries"), have guaranteed fully and unconditionally, on a joint and several basis, the obligation of the Subsidiary Issuer to pay principal and interest under the senior notes, senior subordinated notes, the term loan and the Agreement. In lieu of providing separate audited financial statements for the Guarantor Subsidiaries we have included the accompanying consolidating condensed 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 consolidating condensed financial information present the results of operations, financial position, and cash flows of (i) the Parent, (ii) the Subsidiary Issuer, (iii) the Guarantor Subsidiaries of the Parent, (iv) the Non-Guarantor Subsidiaries, and (v) the eliminations to arrive at the information for the Parent on a consolidated basis. HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONSOLIDATING CONDENSED BALANCE SHEET JULY 31, 2003 (Thousands of Dollars)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- ---------- ---------- ------------ ---------- ---------- ASSETS Homebuilding......................$ 26 $ 92,122 $1,904,126 $ 23,514 $ $2,019,788 Financial Services................ 109 164,040 164,149 Income Taxes (Payable) Receivable. (12,316) (1,240) 26,068 (795) 11,717 Investments in and amounts due to and from consolidated subsidiaries.................... 741,236 741,658 (1,009,648) (24,151) (449,095) -------- ---------- ---------- ------------ ---------- ---------- Total Assets......................$728,946 $ 832,540 $ 920,655 $ 162,608 $(449,095) $2,195,654 ======== ========== ========== ============ ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Homebuilding......................$ $ $ 421,200 $ 64 $ $ 421,264 Financial Services................ 143,680 143,680 Notes Payable..................... 819,055 712 819,767 Income Taxes Payable(Receivables) Minority Interest................. 80,137 1,860 81,997 Stockholders' Equity.............. 728,946 13,485 418,606 17,004 (449,095) 728,946 -------- ---------- ---------- ------------ ---------- ---------- Total Liabilities and Stockholders' Equity..........................$728,946 $ 832,540 $ 920,655 $ 162,608 $(449,095) $2,195,654 ======== ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING CONDENSED BALANCE SHEET OCTOBER 31, 2002 (Thousands of Dollars)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- ---------- ---------- ------------ ---------- ---------- Assets Homebuilding.......................$ 1,501 $ 261,107 $1,269,514 $ 36,014 $ $1,568,136 Financial Services................. 111 109,881 109,992 Income Taxes (Payable) Receivable.. Investments in and amounts due to and from consolidated subsidiaries..................... 584,103 432,130 (630,186) (32,376) (353,671) -------- ---------- ---------- ------------ ---------- ---------- Total Assets.......................$585,604 $ 693,237 $ 639,439 $ 113,519 $ (353,671)$1,678,128 ======== ========== ========== ============ ========== ========== Liabilities Homebuilding.......................$ $ 35,736 $ 312,231 $ 3,595 $ $ 351,562 Financial Services................. 90,355 90,355 Notes Payable...................... 661,390 2,345 7,210 670,945 Income Taxes Payable (Receivable).. 23,055 (3,147) (18,184) (947) 777 Minority Interest.................. 1,940 1,940 Stockholders' Equity............... 562,549 (742) 343,047 11,366 (353,671) 562,549 -------- ---------- ---------- ------------ ---------- ---------- Total Liabilities and Stockholders' Equity...........................$585,604 $ 693,237 $ 639,439 $ 113,519 $ (353,671)$1,678,128 ======== ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS THREE MONTHS ENDED JULY 31, 2003 (Thousands of Dollars)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding.....................$ $ (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 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 ....................... $ 68,802 $ 13,839$ 42,054 $ 2,405 $ (58,298)$ 68,802 ======== ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS THREE MONTHS ENDED JULY 31, 2002 (Thousands of Dollars)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding.....................$ $ 295 $ 693,357 $ 7,807 $ (7,479) $ 693,980 Financial Services............... 2,270 8,386 10,656 Intercompany Charges............. 54,869 (10,326) (44,543) Equity In Pretax Income of Consolidated Subsidiaries...... 61,961 (61,961) ------- ---------- ---------- ------------ ---------- ---------- Total Revenues................ $61,961 $ 55,164 $ 685,301 $ 16,193 $(113,983) $ 704,636 ------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... 55,164 644,464 322 (62,969) 636,981 Financial Services............... 683 5,266 (255) 5,694 ------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. 55,164 645,147 5,588 (63,224) 642,675 ------- ---------- ---------- ------------ ---------- ---------- Income Before Income Taxes......... 61,961 40,154 10,605 (50,759) 61,961 State and Federal Income Taxes..... 22,774 (26) 14,971 3,908 (18,853) 22,774 ------- ---------- ---------- ------------ ---------- ---------- Net Income ....................... $39,187 $ 26 $ 25,183 $ 6,697 $ (31,906) $ 39,187 ======= ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS NINE MONTHS ENDED JULY 31, 2003 (Thousands of Dollars)
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 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.........................$166,131 $ 14,468 $ 140,803 $ 5,961 $ (161,232)$ 166,131 ======== ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONSOLIDATING CONDENSED STATEMENT OF OPERATIONS NINE MONTHS ENDED JULY 31, 2002 (Thousands of Dollars)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated ------- ---------- ---------- ------------ ---------- ---------- Revenues: Homebuilding....................$ $ 565 $1,689,257 $ 20,475 $ (18,920) $1,691,377 Financial Services............... 4,956 23,363 28,319 Intercompany Charges............. 119,275 (3,663) (115,612) Equity In Pretax Income of Consolidated Subsidiaries......133,331 (133,331) ------- ---------- ---------- ------------ ---------- ---------- Total Revenues................$133,331 $119,840 $1,690,550 $ 43,838 $(267,863) $1,719,696 ------- ---------- ---------- ------------ ---------- ---------- Expenses: Homebuilding..................... 119,840 1,588,505 1,981 (140,117) 1,570,209 Financial Services............... 1,768 15,437 (1,049) 16,156 ------- ---------- ---------- ------------ ---------- ---------- Total Expenses................. 119,840 1,590,273 17,418 (141,166) 1,586,365 ------- ---------- ---------- ------------ ---------- ---------- Income Before Income Taxes.........133,331 100,277 26,420 (126,697) 133,331 State and Federal Income Taxes..... 50,073 (180) 37,982 10,058 (47,860) 50,073 ------- ---------- ---------- ------------ ---------- ---------- Net Income.........................$83,258 $ 180 $ 62,295 $ 16,362 $ (78,837) $ 83,258 ======= ========== ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS NINE MONTHS ENDED JULY 31, 2003 (Thousands of Dollars)
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) 10,709 (510,053) (44,977) 161,232 (385,623) -------- --------- ---------- ------------ ---------- ---------- Net Cash (Used In) Provided By Operating Activities........... 163,597 25,177 (369,250) (39,016) (219,492) Net Cash (Used In) Provided By Investing Activities............... (7,588) (132,321) (255) (140,164) Net Cash (Used In) Provided By Financing Activities............... (7,261) 140,639 24,990 50,937 209,305 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) Cash and Cash Equivalents 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 ======== ========= ========== ============ ========== ==========
HOVNANIAN ENTERPRISES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED CONSOLIDATING CONDENSED STATEMENT OF CASH FLOWS NINE MONTHS ENDED JULY 31, 2002 (Thousands of Dollars)
Guarantor Non- Subsidiary Subsid- Guarantor Elimin- Consol- Parent Issuer iaries Subsidiaries ations idated -------- --------- ---------- ------------ ---------- ---------- Cash Flows From Operating Activities: Net Income.........................$ 83,258 $ (402) $ 63,190 $ 16,362 $ (79,150) $ 83,258 Adjustments to reconcile net income to net cash (Used In) Provided By operating activities.......... 99,463 11,817 (182,793) 11,486 79,150 19,123 -------- --------- ---------- ------------ ---------- ---------- Net Cash (Used In) Provided By Operating Activities........... 182,721 11,415 (119,603) 27,848 102,381 Net Cash (Used In) Provided By Investing Activities............... (46,087) (1,929) (103,096) 184 (150,928) Net Cash (Used In) Provided By Financing Activities............... (1,089) 264,726 (85,867) (41,735) 136,035 Intercompany Investing and Financing Activities - Net...................(135,545) (188,403) 310,301 13,647 -------- --------- ---------- ------------ ---------- ---------- Net Increase (Decrease) In Cash and Cash Equivalents................... 85,809 1,735 (56) 87,488 Cash and Cash Equivalents Balance, Beginning of Period................ 10 (5,840) 15,616 6,363 16,149 -------- --------- ---------- ------------ ---------- ---------- Cash and Cash Equivalents Balance, End of Period......................$ 10 $ 79,969 $ 17,351 $ 6,307 $ $ 103,637 ======== ========= ========== ============ ========== ==========
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 assets less liabilities is recorded as goodwill, indefinite or definite life intangibles. 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 are 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 - 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, cost to complete including interest, and selling costs. 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 in the Statement of Financial Accounting Standards (SFAS) No. 144 "Accounting for the Impairment of or Disposal of Long- Lived Assets" 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 amortized equally based upon the number of homes to be constructed in the community. Insurance Deductible Reserves - Our deductible is $150,000 per occurrence for our worker's compensation and general liability insurance. Reserves have been established based upon actuarial analysis of estimated future losses. 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 FIN 46, SFAS 49, SFAS 98, and EITF 97-10 we record 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 and Minority interest from inventory not owned on our Consolidated Balance Sheets. Intangible Assets - The intangible assets recorded on our balance sheet consist of goodwill, tradenames, architectural designs and contractual agreements with both definite and indefinite lives resulting from company acquisitions. In accordance with the Financial Accounting Standards No. 142 ("SFAS No. 142") " Goodwill and Other Intangible Assets", 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. 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 and is recorded in Accounts Payable and other liabilities in the Consolidated Balance Sheets. CAPITAL RESOURCES AND LIQUIDITY Our cash uses during the nine months ended July 31, 2003 were for operating expenses, increases in housing inventories, construction, income taxes, interest, the repurchase of common stock, and the acquisition of three homebuilders. We provided for our cash requirements from housing and land sales, the revolving credit facility, the issuance of $150 million Senior Subordinated 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 December 31, 2000, our stock repurchase program to purchase up to 4 million shares of Class A Common Stock expired. As of December 31, 2000, 3,391,047 shares had been purchased under this program. On July 3, 2001, our Board of Directors authorized a revision to our stock repurchase program to purchase up to 2 million shares of Class A Common Stock. As of July 31, 2003, 856,319 shares have been purchased under this program of which 250,000 were repurchased during the nine months ended July 31, 2003. Our homebuilding bank borrowings are made pursuant to an amended and restated revolving credit agreement (the "Agreement") that provides a revolving credit line and letter of credit line of $590 million through July 2006. Interest is payable monthly and at various rates of either the prime rate plus 0.275% or Libor plus 1.75%. In addition, we pay a fee equal to 0.350% per annum on the weighted average unused portion of the line. We believe that we will be able either to extend the Agreement beyond July 2006 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 is a guarantor under the revolving credit agreement. As of July 31, 2003, there were no borrowings under the Agreement. At July 31, 2003 we had $390.3 million of outstanding senior debt ($387 million, net of discount), comprised of $140.3 million 10 1/2% Senior Notes due 2007, $150 million 9 1/8% Senior Notes due 2009, and $100 million 8% Senior Notes due 2012. At July 31, 2003, we had $300 million outstanding 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 significant subsidiaries except for our financial services subsidiaries is a guarantor under the Senior Notes and Senior Subordinated Notes. On January 22, 2002 we issued a $165 million five-year Term Loan. The term loan matures in January 2007, and bears interest at either the prime rate plus 1.25% or Libor plus 2.5%. Each of our significant subsidiaries except for our financial services subsidiaries is a guarantor under the Term Loan. At July 31, 2003, borrowings under the Term Loan were $115 million. Our mortgage banking subsidiary's warehousing agreement was amended and restated on July 31, 2003. Pursuant to the agreement, we may borrow up to $200 million. The agreement bears an expiration date of July 2004 and interest is payable monthly at the Federal Funds Rate plus 1.375%. We believe that we will be able either to extend this agreement beyond July 2004 or negotiate a replacement facility, but there can be no assurance of such extension or replacement facility. As of July 31, 2003, the aggregate principal amount of all such borrowings was $137 million. Total inventory increased $396.7 million during the nine months ended July 31, 2003. This increase excluded the change in Consolidated Inventory Not Owned of $113.4 million consisting of specific performance options 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. The $396.7 million increase in inventory was due to increases in inventory levels in all of our housing markets as well as our acquisitions. Excluding the impact from acquisitions of $90.3 million, our Northeast Region increased $117.9 million and California increased $111.9 million, with the balance spread out in our other markets. The increase in our existing markets was primarily the result of seasonality factors and planned future organic growth. Substantially all homes under construction or completed and included in inventory at July 31, 2003 are expected to be closed during the next twelve months. Most inventory completed or under development is financed through our line of credit, term loan, 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 an option fee 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 housing lots included in our total residential real estate. The July 31, 2003 numbers excluded lots owned and options in locations that we have ceased development. Active Proposed Active Selling Developable Grand Total Communities Lots Lots Lots ----------- ------- ----------- ----------- July 31, 2003: Northeast Region.. 30 7,091 14,960 22,051 North Carolina.... 71 6,489 799 7,288 Metro D.C......... 36 4,393 10,685 15,078 California........ 37 5,025 10,981 16,006 Texas............. 71 5,587 3,613 9,200 ----------- ------- ---------- ----------- 245 28,585 41,038 69,623 =========== ======= ========== =========== Owned.......... 12,841 4,302 17,143 Optioned....... 15,744 36,736 52,480 ------ ---------- ----------- Total........ 28,585 41,038 69,623 ======= ========= =========== Active Proposed Active Selling Developable Grand Total Communities Lots Lots Lots ----------- ------- ----------- ----------- October 31, 2002: Northeast Region.. 28 5,699 15,700 21,399 North Carolina.... 64 5,186 2,283 7,469 Metro D.C......... 27 3,182 7,394 10,576 California........ 42 5,974 4,457 10,431 Texas............. 35 2,566 1,518 4,084 Other............. -- 29 -- 29 ----------- ------- ---------- ----------- 196 22,636 31,352 53,988 =========== ======= ========== =========== Owned.......... 11,088 2,274 13,362 Optioned....... 11,548 29,078 40,626 ------- ---------- ----------- Total........ 22,636 31,352 53,988 ======= ========== =========== Active selling lots under contract at July 31, 2003 and October 31, 2002 were 5,033 and 3,831, respectively. Such amounts do not include our build on your own lot contracts. The following table summarizes our started or completed unsold homes and models: July 31, October 31, 2003 2002 ----------------------- ----------------------- Unsold Unsold Homes Models Total Homes Models Total ------ ------ ----- ------ ------ ----- Northeast Region.... 90 56 146 73 46 119 North Carolina...... 148 19 167 191 32 223 Metro D.C........... 32 20 52 34 31 65 California.......... 153 91 244 193 65 258 Texas............... 577 72 649 261 31 292 Other............... - - - 2 -- 2 ------ ------ ----- ------ ------ ----- Total 1,000 258 1,258 754 205 959 ====== ====== ===== ====== ====== ===== Financial Services - Mortgage loans held for sale consist of residential mortgages receivable of which $152.1 million and $91.3 million at July 31, 2003 and October 31, 2002, respectively, are being temporarily warehoused and awaiting sale in the secondary mortgage market. The balance of such mortgages is being held as an investment by us. 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, 2003 COMPARED TO THE THREE AND NINE MONTHS ENDED JULY 31, 2002 Our operations consist primarily of residential housing development and sales in our Northeast Region (New Jersey, southern New York State, eastern Pennsylvania, and Ohio), North Carolina, Metro D. C. (northern Virginia, eastern West Virginia, and Maryland), California, and Texas. In addition, we provide financial services to our homebuilding customers. Total Revenues: Compared to the same prior period, revenues increased as follows: Three Months Ended ------------------------------------------ July 31, July 31, Dollar Percentage 2003 2002 Change Change ------------------------------------------ (Dollars In Thousands) Homebuilding: Sale of homes........ $ 830,734 $ 681,329 $149,405 21.9% Land sales and other revenues........... 4,441 12,651 (8,210) (64.9%) Financial Services... 13,642 10,656 2,986 28.0% ---------- ---------- -------- -------- Total Revenues... $ 848,817 $ 704,636 $144,181 20.5% ========== ========== ======== ======== Nine Months Ended ------------------------------------------ July 31, July 31, Dollar Percentage 2003 2002 Change Change ------------------------------------------ (Dollars In Thousands) Homebuilding: Sale of homes........ $2,104,788 $1,656,813 $447,975 27.0% Land sales and other revenues........... 16,445 34,564 (18,119) (52.4%) Financial Services... 35,036 28,319 6,717 23.7% ---------- --------- -------- -------- Total Revenues... $2,156,269 $1,719,696 $436,573 25.4% ========== ========= ======== ======== Homebuilding: Revenues from the sale of homes increased $149.4 million or 21.9% during the three months ended July 31, 2003, and increased $448 million or 27% during the nine months ended July 31, 2003 compared to the same periods last year. Revenues from the sale of homes are recorded at the time each home is delivered and title and possession have been transferred to the buyer. Information on homes delivered by market area is set forth below: Three Months Ended Nine Months Ended July 31, July 31, ------------------- --------------------- 2003 2002 2003 2002 --------- -------- ----------- --------- (Dollars in Thousands) Northeast Region(1): Housing Revenues..... $210,039 $177,153 $ 494,957 $ 455,171 Homes Delivered...... 647 570 1,540 1,469 North Carolina: Housing Revenues..... $ 65,399 $ 72,437 $ 173,938 $ 193,902 Homes Delivered...... 365 393 965 1,044 Metro D. C.: Housing Revenues..... $100,184 $110,030 $ 305,927 $ 258,755 Homes Delivered...... 324 386 968 944 California(2): Housing Revenues..... $325,205 $242,631 $ 819,369 $ 535,961 Homes Delivered...... 1,090 926 2,846 2,094 Texas(1): Housing Revenues..... $129,907 $ 65,432 $ 309,336 $ 172,778 Homes Delivered...... 640 286 1,519 746 Other: Housing Revenues..... $ -- $ 13,646 $ 1,261 $ 40,246 Homes Delivered...... -- 86 9 258 Totals: Housing Revenues..... $830,734 $681,329 $2,104,788 $1,656,813 Homes Delivered...... 3,066 2,647 7,847 6,555 (1) July 31, 2003 includes deliveries from our Houston, Texas and Ohio acquisitions beginning on November 1, 2002, January 1, 2003, and April 1, 2003, respectively. (2) July 31, 2002 includes deliveries from our California acquisition beginning on January 10, 2002. The increase in housing revenues was partially due to the acquisition of two homebuilders in Houston, Texas and an Ohio homebuilder for the three and nine months ended July 31, 2003 and a full nine months of deliveries from our acquisition in California for the nine months ended July 31, 2003. In addition, these increases were the result of organic growth in Metro D. C. and California (excluding our California acquisition) and increased average sales prices in most of our markets. Important indicators of our future results are recently signed contracts and home contract backlog for future deliveries. Our sales contracts and homes in contract (using base sales prices) by market area is set forth below: Sales Contracts for the Nine Months Ended Contract Backlog July 31, as of July 31, ------------------------- --------------------- 2003 2002 2003 2002 ----------- --------- --------- --------- (Dollars in Thousands) Northeast Region(2)(4): Dollars.............$ 582,015 $ 423,227 $ 613,884 $ 442,037 Homes............... 1,896 1,478 2,266 1,578 North Carolina: Dollars.............$ 214,700 $ 198,848 $ 128,997 $ 108,502 Homes............... 1,171 1,074 672 564 Metro D.C.(4): Dollars.............$ 422,477 $ 341,919 $ 368,910 $ 292,044 Homes............... 1,229 1,085 1,035 920 California(3): Dollars.............$ 882,976 $ 634,009 $ 359,821 $ 286,876 Homes............... 2,994 2,394 1,103 1,007 Texas(1)(4): Dollars.............$ 338,197 $ 171,409 $ 127,636 $ 69,556 Homes............... 1,722 778 642 295 Other: Dollars.............$ 313 $ 26,861 $ -- $ 6,456 Homes............... 2 172 -- 39 Totals: Dollars.............$2,440,678 $1,796,273 1,599,248 $1,205,471 Homes............... 9,014 6,981 5,718 4,403 (1) July 31, 2003 includes sales contracts signed from our Houston, Texas and Ohio acquisitions beginning November 1, 2002 and January 1, 2003, respectively. (2) July 31, 2003 includes sales contracts signed from our Ohio acquisition beginning April 1, 2003. (3) July 31, 2002 includes sales contracts signed from our California acquisition beginning January 10, 2002. (4) We acquired contract backlog during the nine months ended July 31, 2003 and 2002 of 694 homes valued at $93.8 million and 535 homes valued at $117 million, respectively. During August 2003, we signed an additional 1,085 contracts compared to 782 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, ------------------- --------------------- 2003 2002 2003 2002 -------- -------- ---------- --------- (Dollars in Thousands) Sale of Homes................ $830,734 $681,329 $2,104,788 $1,656,813 Cost of Sales................ 618,650 530,154 1,572,306 1,303,637 -------- -------- ---------- --------- Housing Gross Margin......... $212,084 $151,175 $ 532,482 $ 353,176 ======== ======== ========== ========== Gross Margin Percentage...... 25.5% 22.2% 25.3% 21.3% Cost of Sales expenses as a percentage of home sales revenues are presented below: Three Months Ended Nine Months Ended July 31, July 31, ------------------- ------------------- 2003 2002 2003 2002 -------- -------- -------- -------- Sale of Homes................ 100.0% 100.0% 100.0% 100.0% -------- -------- -------- -------- Cost of Sales: Housing, land & development costs.... 67.1% 70.7% 67.2% 71.0% Commissions............ 2.0% 2.2% 2.1% 2.2% Financing concessions.. 0.9% 0.9% 0.9% 1.0% Overheads.............. 4.5% 4.0% 4.5% 4.5% -------- -------- -------- -------- Total Cost of Sales.......... 74.5% 77.8% 74.7% 78.7% -------- -------- -------- -------- Gross Margin................. 25.5% 22.2% 25.3% 21.3% ======== ======== ======== ======== We sell a variety of home types in various local communities, each yielding a different gross margin. As a result, depending on 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. We achieved higher gross margins during the three and nine months ended July 31, 2003 compared to the same period last year. The consolidated gross margin increased 3.3% and 4.0% for the three and nine months ended July 31, 2003, respectively. These increased margins are the result of higher sales prices and lower costs resulting from our improvement initiatives. Selling, general, and administrative expenses as a percentage of total homebuilding revenues increased to 7.9% for the three months ended July 31, 2003 from 7.6% for the prior year's three months, and increased to 8.5% for the nine months ended July 31, 2003 from 8.2% for the prior year's nine months. Such expenses increased during the three and nine months ended July 31, 2003 by $13.3 million and $41.9 million, repsectively, compared to the same periods last year. The percentage increase for the three and nine months ended July 31, 2003 was due to the modification of our sales associate compensation plan, an increase in administrataive costs associated with opening additional communities, and higher bonus incentives due to higher returns. The dollar increase in selling, general and administrative is primarily due to our 2003 acquisitions as well as a full nine months of expenses from our 2002 California acquisition. 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, ------------------ ------------------- 2003 2002 2003 2002 -------- -------- -------- -------- Land and Lot Sales.............. $ 3,314 $ 10,587 $ 13,064 $29,127 Cost of Sales................... 3,247 9,522 9,988 24,048 -------- -------- -------- -------- Land and Lot Sales Gross Margin.. 67 1,065 3,076 5,079 Interest Expense................ 153 112 508 760 -------- -------- -------- -------- Land and Lot Sales Profit (Loss) Before Tax.................... $ (86) $ 953 $ 2,568 $ 4,319 ======== ======== ======== ======== 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, selling such mortgages in the secondary market, and title insurance activities. For the three and nine months ended July 31, 2003 financial services provided a $6.0 million and $15.4 million profit before income taxes compared to a profit of $5.0 million and $12.2 million for the same period in 2002. These increases are primarily due to reduced costs, increased mortgage loan amounts, and the addition of a mortgage joint venture from our California acquisition for a full nine months. Corporate General and Administrative Corporate general and administrative expenses include 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 increased to 2.0% for the three months ended July 31, 2003 from 1.7% for the prior year's three months and increased to 2.1% for the nine months ended July 31, 2003 from 2.0% for the prior year's nine months. Corporate general and administrative expenses increased $4.8 million and $11.3 million during the three and nine months ended July 31, 2003, respectively, compared to the same periods last year. Increases in corporate general and administrative dollar expenses are primarily attributed to higher employee incentives due to a higher return on equity. 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, ------------------ ------------------ 2003 2002 2003 2002 -------- -------- -------- -------- Sale of Homes.............. $ 17,051 $ 15,737 $43,800 $41,593 Land and Lot Sales......... 153 112 508 760 -------- -------- -------- -------- Total...................... $ 17,204 $ 15,849 $44,308 $42,353 ======== ======== ======== ======== Housing interest as a percentage of sale of homes revenues decreased to 2.1% for the three and nine months ended July 31, 2003, respectively, compared to 2.3% and 2.5% for the three and nine months ended July 31, 2002, respectively. These percentage decreases are primarily attributed to a decrease in debt leverage of our Company due to the growth in equity from earnings, and lower interest rates. Other Operations Other operations consist primarily of miscellaneous residential housing operations expenses, senior residential property operations, amortization of senior and senior subordinated note issuance expenses, earnout payments from homebuilding company acquisitions, amortization of consultant's agreement and the right of first refusal agreement from our California acquisition, amortization of definite life intangibles from our acquisitions, minority interest relating to joint ventures, and corporate-owned life insurance loan interest. Recent Accounting Pronouncements In April 2002, the Financial Accounting Standards Board issued (SFAS) No. 145, "Reporting Gains and Losses from Extinguishment of Debt", which rescinded SFAS No. 4, No. 44, and No. 64 and amended SFAS No. 13. The new standard addresses the income statement classification of gains or losses from the extinguishment of debt and criteria for classification as extraordinary items. We adopted SFAS No. 145 on November 1, 2002. We reclassified $0.9 million extraordinary loss from extinguishment of debt to other operations and ($0.3) million to state and Federal Income Taxes on our Consolidated Statements of Income to conform to the new presentation. In June 2002, the Financial Accounting Standards Board issued (SFAS) No. 146, "Accounting for Costs Associated with Exit or Disposal Activities". SFAS No. 146 addresses financial accounting and reporting for costs associated with exit or disposal activities and nullifies Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including certain costs incurred in a restructuring)". SFAS No. 146 requires recognition of a liability for a cost associated with an exit or disposal activity when the liability is incurred as opposed to when the entity commits to an exit plan as prescribed under EITF No. 94-3. SFAS No. 146 is effective for exit or disposal activities initiated after December 31, 2002. We adopted SFAS No. 146 January 1, 2003. The initial adoption of SFAS No. 146 did not have an effect on the financial position or results of operations of our Company. However, SFAS No. 146 could impact the amount or timing of liabilities to be recognized in the event that we engage in exit or disposal activities in the future. In November 2002, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the existing disclosure requirements for most guarantees, including loan guarantees such as standby letters of credit. It also clarifies that at the time a company issues a guarantee, the company must recognize an initial liability for the fair value, or market value, of the obligations it assumes under the guarantee and must disclose that information in its interim and annual financial statements. The provisions related to recognizing a liability at inception of the guarantee for the fair value of the guarantor's obligations does not apply to product warranties. The initial recognition and initial measurement provisions apply on a prospective basis to guarantees issued or modified after December 31, 2002. The adoption of the initial recognition and initial measurement provisions of FIN 45 did not have a material effect on our financial position or results of operations. Our disclosure of guarantees is included in Note 14 to the consolidated financial statements - unaudited. In December 2002, the Financial Accounting Standards Board issued (SFAS) No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure", which amends (SFAS) No. 123. The new standard provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. It also requires prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the affect of the method used on reported results. We have not elected to change to the fair value based method of accounting for stock-based employee compensation. We adopted the disclosure provisions of SFAS No. 148 in our second fiscal quarter ending April 30, 2003. Our disclosure of accounting for stock-based compensation is included in Note 2 to the consolidated financial statements - unaudited. In January 2003, the Financial Accounting Standards Board issued FASB Interpretation No. 46 "Consolidation of Variable Interest Entities" an interpretation of ARB No. 51 ("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 is effective immediately for VIE's created after January 31, 2003. For VIE's created before January 31, 2003, FIN 46 must be applied at the beginning of the first interim or annual reporting period beginning after June 15, 2003. 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 have been 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 we will 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 will consolidate it on our balance sheet. The fair value of the VIE's inventory will be 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, 2003, we consolidated nine VIE's created from February 1, 2003 to July 31, 2003 as a result of our option to purchase land or lots from the selling entities. We paid cash or issued letters of credit deposits to these three VIE's totaling $11.7 million. Our option deposits represent our maximum exposure to loss. The fair value of the property owned by the VIE's was $93.2 million of which $6.2 million was not optioned to our Company. We were able to ascertain that one VIE had third party debt amounting to $1.4 million. Since 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 $80.1 million, was reported on the balance sheet as Minority interest. Creditors of these VIE's have no recourse against our company. We will continue to secure land and lots using options. Including the deposits with the nine VIE's above, at July 31, 2003 we have total cash and letters of credit deposits amounting to approximately $180.2 million to purchase land and lots with a total purchase price of $2.4 billion. Not all our deposits are with VIE's. 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. We are in the process of evaluating all option purchase agreements in effect as of January 31, 2003. Options with VIE's where we are the primary beneficiary will be consolidated by our fiscal year end October 31, 2003. Total Taxes Total taxes as a percentage of income before taxes amounted to approximately 37.3% and 36.8% for the three months ended July 31, 2003 and 2002, respectively, and 37.4% and 37.6% for the nine months ended July 31, 2003 and 2002, respectively. 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 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 four to twelve months. Construction costs for residential buildings represent approximately 57% of our homebuilding cost of sales. Mergers and Acquisitions On January 10, 2002, we acquired a California homebuilder for a total purchase price of $196.5 million, of which $151.6 million was paid in cash and 2,208,738 shares of our Class A Common Stock were issued. At the date of acquisition we also paid off approximately $88.0 million of their third party debt. During the second quarter ended April 30, 2003 we exercised the right to retire at no cost 750,000 Class A Common Stock shares that were held by the selling principal under the terms of the acquisition. On November 1, 2002 and December 31, 2002 we acquired two Houston homebuilding companies for an approximate aggregate purchase price of $100.0 million. 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 Phoenix, Arizona. 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 . Geopolitical risks, terrorist acts and other acts of war These 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, 2002. Quantitative and Qualitative Disclosures About Market Risk. The primary market risk facing us is interest rate risk on 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, 2003, 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, 2003 ------------------------------------------------------------- Expected Maturity Rate ---------------------- FMV @ 2003 2004 2005 2006 2007 2008 Thereafter Total 7/31/03 ------- ------- ------ ------ -------- -------- ---------- -------- -------- (Dollars in Thousands) Long Term Debt(1): Fixed Rate...... $ 29,241 $ 75 $ 81 $ 88 $140,346 $ 104 $ 550,200 $720,135 $755,935 Average interest rate.......... 6.75% 8.38% 8.38% 8.38% 10.50% 8.38% 8.48% 8.80% -- Variable rate... -- -- -- -- $115,000 -- -- $115,000 $115,000 Average interest rate.......... -- -- -- -- (2) -- -- -- -- (1) Does not include bonds collateralized by mortgages receivable. (2) LIBOR plus 2.5%
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, 2003. 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 provided reasonable assurance that the 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, 2003 that has materially affected, or is reasonably likely to materially affect, the company's internal control over financial reporting. PART II. Other Information Item 6. Exhibits and Reports on Form 8-K. (a) Exhibit 3(a) Certificate of Incorporation of the Registrant. (1) Exhibit 3(b) Certificate of Amendment of Certificate of Incorporation of the Registrant. Exhibit 3(c) Restated Bylaws of the Registrant. (3) Exhibit 10(a) Third Amended and Restated Credit Agreement dated June 19, 2003. (2) Exhibit 10(b) First Amendment to First Restated K. Hovnanian Mortgage, Inc. Revolving Credit Agreement dated July 31, 2003. 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) Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002. Exhibit 32(b) Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes- Oxley Act of 2002. (1) Incorporated by reference to Exhibits to Registration Statement (No. 2-85198) on Form S-1 of the Registrant. (2) Incorporated by reference to Exhibits to Annual Report on Form 10-K for the year ended February 28, 1994 of the Registrant. (3) Incorporated by reference to Exhibits to Registration Statement (No. 333-106761) on Form S-3 of the Registrant. (b) Reports on Form 8-K No reports on Form 8-K have been filed during the quarter for which this report is filed. The following report on Form 8-K has been furnished during the quarter for which this report is filed: On May 23, 2003, the Company furnished a report on Form 8-K, Item 9 (pursuant to Item 12 in accordance with SEC Release 33-8216; 34-47583; IC-25983; March 27, 2003), relating to the Company's press release dated May 28, 2003 relating to its preliminary financial results for the second quarter ended April 30, 2003. 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 12, 2003 /S/J. LARRY SORSBY J. Larry Sorsby, Executive Vice President and Chief Financial Officer DATE: September 12, 2003 /S/PAUL W. BUCHANAN Paul W. Buchanan, Senior Vice President Corporate Controller Exhibit 31(a) CERTIFICATIONS I, Ara K. Hovnanian, President & Chief Executive Officer of Hovnanian Enterprises, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Hovnanian Enterprises, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the cast of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: September 12, 2003 /S/ARA K. HOVNNAIAN Ara K. Hovnanian President and Chief Executive Officer Exhibit 31(b) CERTIFICATIONS I, J. Larry Sorsby, Executive Vice President & Chief Financial Officer of Hovnanian Enterprises, Inc., certify that: 1. I have reviewed this quarterly report on Form 10-Q of Hovnanian Enterprises, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (c) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: September 12, 2003 /S/J. LARRY SORSBY J. Larry Sorsby Executive Vice President and Chief Financial Officer Exhibit 32(a) CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Hovnanian Enterprises, Inc. (the "Company") on Form 10-Q for the period ended July 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Ara K. Hovnanian, President and Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: September 12, 2003 /S/ARA K. HOVNANIAN Ara K. Hovnanian President and Chief Executive Officer Exhibit 32(b) CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Hovnanian Enterprises, Inc. (the "Company") on Form 10-Q for the period ended July 31, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, J. Larry Sorsby, Executive Vice President and Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: 1. The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: September 12, 2003 /S/J. LARRY SORSBY J. Larry Sorsby Executive Vice President and Chief Financial Officer